Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

Focus Media Holding Limited (NASDAQ:FMCN)

Q4 2007 Earnings Call

March 18, 2008 9:00 pm ET

Executives

Jie Chen - Investor Relations

Daniel M. Wu - Chief Financial Officer

Dr. Tan Zhi - Chief Executive Officer

Jason N. Jiang - Executive Chairman of the Board

Analysts

Jason Brueschke - Citigroup

James Mitchell - Goldman Sachs

Analyst for Aaron Kessler - Piper Jaffray

Richard Ji - Morgan Stanley

Jason Helfstein - Oppenheimer

Eddie Leung - Merrill Lynch

Operator

Good day, ladies and gentlemen, and welcome to the fourth quarter 2007 Focus Media earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Ms. Jie Chen, Investor Relations Manager. Please proceed, Madam.

Jie Chen

Thank you. Welcome to Focus Media's fourth quarter full year 2007 earnings conference call. Today, our management will discuss the company’s financial results for the fourth quarter and full year of 2007 and business outlook for the first quarter and full year of 2008.

With me here are Jason Jiang, Executive Chairman of the Board; Tan Zhi, Chief Executive Officer; and Daniel Wu, Chief Financial Officer. After Daniel updates you on our fourth quarter operational and financial performance, we will open the call for questions.

This call is also broadcast through the Internet and available through our investor relations website, ir.focusmedia.cn.

Before we begin, I would like to remind you that during the course of this call, we will make forward-looking statements that are subject to risks and uncertainties. The statements include but are not limited to statements regarding Focus Media's business objectives and plans, the expectations of development of our networks and our outlook for the first quarter and full year 2008, for example.

You can also identify forward-looking statements by terms such as "will," "expects," "anticipates," "future," "intends," "plans," "believes," "estimates" and similar statements. The accuracy of these statements may be affected by a number of risks and uncertainties that could cause our actual results to differ materially from those projected or anticipated.

These risks and uncertainties include but are not limited to our limited operating history for our current operations and the short history of the new digital media sector, which may make it difficult for you to evaluate the viability and prospects of our business, the integration of acquired businesses, competition from present and future competitors in China’s growing advertising market, and other risks outlined in our filings with the SEC, including our registration statement on Form F-1.

We do not undertake any obligation to update this forward-looking information except as required under applicable law.

Now, I will turn the call over to our CFO, Daniel Wu, for a summary of the fourth quarter and full year 2007 financial results.

Daniel M. Wu

Thank you, Jie. I am pleased to report to you another record quarterly results in the fourth quarter of 2007. Our total revenue excluding sales tax reached $184.6 million, increasing 171.4% from the same period last year and 21.9% from the previous quarter. Our fourth quarter revenues include $111 million from digital out-of-home advertising business, which include our commercial location network, residential network, in-store network, movie theater advertising, and outdoor LED network; $16 million from Focus Media wireless business; and $57.2 million from our Internet advertising business.

First, let me review in detail the results of our digital out-of-home advertising business. Total advertising revenue from our digital out-of-home advertising reached $111 million in the fourth quarter, up 75.3% as compared to $63.3 million in the same period in 2006, 17.2% sequentially.

Within our digital out-of-home advertising business, revenue from commercial location network in the fourth quarter was $73.4 million. Revenue from our in-store network was $6.5 million. The in-store network was lower year over year 17.4% and down 8.6% sequentially due to relatively more competitive environment in our in-store network business in the fourth quarter, mainly from competition with CGEN.

On January 2, 2008, we closed the acquisition of CGEN and this transaction strengthened our market leadership. The results in the fourth quarter for our in-store network does not include results of CGEN.

The revenue from our poster frame network in the fourth quarter was $31.2 million, up 126.4% year over year. The commercial location network, in-store network, and poster frame network contributed 66.1%, 5.8%, 28.1% of total digital out-of-home advertising revenue in the fourth quarter respectively.

During the fourth quarter of 2007, Focus Media wireless generated revenue of $16 million, up 355.8% from $3.5 million in the fourth quarter of 2006. Advertising service revenue from our Internet advertising business was $57.2 million in the fourth quarter of 2007, up 34.5% from $42.5 million in the third quarter of 2007. Digital marketing service accounted for 90% of the total Internet advertising revenue. Rich media, pay-for-performance, and technology solutions accounted for the remaining 10%.

Gross profit for the fourth quarter of 2007 was $87.4 million, representing an increase of 92.1% compared to $45.5 million for the same period a year ago. In the fourth quarter 2007, gross margin for the company was 47.4% compared to 50.9% in the third quarter of 2007, mainly due to larger revenue contribution from our relatively lower margin gross margin Internet advertising business and higher intangible amortization expenses resulting from historical acquisitions in our poster frame, mobile and Internet advertising businesses.

Excluding non-cash share-based compensation expense of $0.1 million and acquisition-related intangible asset amortization expense of $10.8 million in the cost of revenues, gross margin on a non-GAAP basis was 53.3% in the fourth quarter of 2007. This compares to 52.6% in the third quarter of 2007, sequentially increasing.

In the fourth quarter of 2007, excluding non-cash share-based compensation expense and acquisition-related intangible amortization expense, digital out-of-home network gross margin on a non-GAAP basis increased to 65.9% from comparably 64.2% in the third quarter of 2007, even though our in-store network gross margin decreased significantly due to intense price competition from CGEN discussed before.

Mobile handset advertising gross margin on a non-GAAP basis was 50.1% compared to 57.3% in the third quarter due to upfront investment in new WAP-based business initiatives.

Internet advertising gross margin on a non-GAAP basis was 30.1% compared to 25.2% in the third quarter, increased significantly as we continue to gain scale and improve our business model going forward.

Fourth quarter operating expenses totaled $43.3 million, including $6 million in acquired intangible amortization expense resulting from historical acquisitions and non-cash share-based compensation expense of $7.2 million.

Our operating margin in the fourth quarter of 2007 was 23.9%. Excluding non-cash share-based compensation expense and acquired intangible amortization expense, non-GAAP operating margin was 37% in the fourth quarter of 2007. This compares to 36.4% in the previous quarter.

Total intangible amortization expenses in the fourth quarter of 2007 resulting from historical acquisitions were $16.9 million. Non-cash stock-based compensation expenses were $7.3 million in the fourth quarter of 2007, or approximately 4% of total revenue.

GAAP Net income for the fourth quarter of 2007 was $43.8 million, or $0.34 on a fully diluted per share basis -- per ADS basis, up 45.6% or $30.1 million for the same period a year ago.

Non-GAAP net income, excluding non-cash share-based compensation expense and the amortization of intangible assets relating to historical acquisitions in Q4 of 2007 was $68 million, or $0.52 per fully diluted ADS.

For the full year 2007, Focus Media reported total revenues of $506.6 million, an increase of 139.1% compared to $211.9 million in 2006. Operating profit in 2007 was $143.9 million, a 79% increase from $80.4 million in 2006.

Full year net income in 2007 was $144.4 million, up 73.6% compared with $83.2 million in 2006. Net income on a non-GAAP basis in 2007 excluding non-cash share-based compensation expense and amortization of intangible assets relating to acquisitions was $190.6 million as compared to $97.3 million in 2006.

As of December 31, 2007, the company had cash and cash equivalents, including U.S. and RMB dollars, of $450.4 million.

Now I would like to provide Focus Media's business outlook for the first quarter and full year of 2008. Please note that the following outlook statements are based on our current expectations. These statements are forward-looking and the actual results may differ materially.

Based on organic growth based on the current business we have, the company estimates its total revenue for full year 2008 to range from $900 million to $930 million, of which digital out-of-home is expected to contributed approximately 63%, Internet advertising is expected to contribute 31%, and mobile handset advertising will account for 6%.

Net income of full year 2008 excluding share-based compensation expense and amortization of intangible assets relating to acquisitions is expected to be between $280 million to $300 million. This takes into consideration a 15% effective income tax rate after certain government tax incentives and rebates. This translates to approximately $2.06 to $2.21 per fully diluted ADS based on an average 136 million total ADS equivalent shares outstanding for the full year.

In accordance with SFAS-123, the company estimates total share-based compensation expense in 2008 will be approximately $35 million based on stock options that have been granted as of February 28, 2008. The company expects approximately $50 million in acquisition related intangible asset amortization in 2008. This is already including estimates for CGEN acquisition. Of course, this is subject to the finalization of the purchase price allocation analysis by a third party for recent acquisitions.

The company estimates its total revenue for the first quarter of 2008 will range from $160 million to $165 million. First quarter 2008 net income on a non-GAAP basis excluding share-based compensation expense and amortization of intangible assets relating to acquisitions is expected to be between $44 million and $45 million, or $0.33 to $0.34 per fully diluted ADS based on $133 million average total ADS equivalent shares outstanding.

The company expects its capital expenditure for 2008 to be approximately $50 million, mainly for the digital frame 2.0 upgrade and expansion in both of our residential and commercial location networks and digital LED investment in our outdoor LED business.

Thank you very much. Now we’ll open the call for questions. Joining me are the Chief Executive Officer of the company, Dr. Tan Zhi, and Executive Chairman, Jason Jiang. Thank you. Operator, we’ll open the call.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Jason Brueschke from Citigroup. Please proceed, sir.

Jason Brueschke - Citigroup

Thank you. Good morning, Daniel, Dr. Tan and Jason. Congratulations not only on a great quarter but congratulations specifically to you, Dr. Tan, on your promotion. I have two major lines of questions, if you will. First of all, could you maybe review for us what you think will be the major growth drivers for each of the three divisions in 2008?

And secondly, you’re now one of the very largest media companies in China and you’ve done a series of acquisitions, for example, in the interactive agency sector. Could you discuss qualitatively for us the basis for your visibility into your 2008 guidance?

And you mentioned in the press release that you expect that 2009 advertising demand in China post the Olympics will be strong. Could you maybe give us some color that you may have had from some of your discussions with big advertisers as to what their preliminary plans may be, or how much they are likely to spend in the post Olympic environment? Thanks.

Daniel M. Wu

Let me respond first, and then Dr. Tan, especially Jason will talk about the visibility issue in 2009 and I will translate.

First of all, if you look at our digital out-of-home business, this is mainly driven by our continued expansion of the network and continued growth of advertising spending in the tier two, outside of the tier one cities. And you see our network expansion in 2008 will be relatively speaking very rapid because we have budgeted roughly approximately $15 million for CapEx spending for our digital frame 2.0 upgrade in both residential and commercial networks, as well as our LED digital outdoor billboard expansion.

So the growth in that business is pretty straightforward. It’s from both price increase, network expansion, network upgrade and continue getting more and more advertisers.

For the mobile part of the business, the mobile advertising business in China, the entire market is very small so it’s less than 1% of the total advertising market. We expect as mobile devices become more and more -- transform from a telecommunication device to a media access device, people use that for e-mails, for instant message access, for accessing certain Internet content. As those business, as that usage of mobile devices continues to grow, we believe there are a lot more different business opportunities for the mobile wireless advertising business and we can leverage the new technology to improve the effectiveness of advertising on that particular media, new technology including Bluetooth technology and other things.

So we actually see there are a lot of interesting opportunities that exist in this new media, emerging media area.

For Internet, I think we have discussed with you several times is we have already built one of the very scale, very strong market position, interactive agency business. We will continue to focus on promoting pay-for-performance and other forms of new Internet advertising media to help the industry, this particular industry to move away from a time-based advertising sales towards a performance based advertising measurement. We believe that will maximize the potential of Internet advertising and highlight the benefit of this particular, you know, the technology we have developed and we are using today.

So there are a lot of different things for us and we are very hopeful 2008 will be a very good year. I think I will ask Jason to talk about your second question. Just give me one second.

Jason N. Jiang (Translation)

Let me translate for Mr. Jiang. This is Daniel Wu here. It’s a little bit long. Stay with me. First of all, Jason spent a lot of time with various advertising clients of Focus Media. From his point of view, in 2008 there may be a jump in advertising spending in Q3 and there will be some overspending in Q3 and that may affect some of the Q4 spending. But 2008 will be a very strong year but it’s hard to exactly see until we get to that particular timeframe.

In 2009 and 2010, excluding any special affects, special market budget for 2008 Olympics, his understanding is that overall industry, he expects the advertising spending to increase by 15% year over year relative to 2008. So the three businesses Focus Media today has already built, for the Internet mobile advertising we believe actually during the Olympic period, the benefit of advertising in this media will be highlighted and we expect both Internet advertising and mobile handset advertising will grow very strongly in 2009 as these forms of media get recognized by the advertisers and it will enter a very strong growth period after the 2008 Olympics.

For the digital out-of-home business, which today contributes more than 60% of Focus Media's business, in 2008 and 2009 we will actually enter a robust growth period because that reflects the benefit of those acquisitions and market consolidation we have done during the last few years and it reflects the technology we are deploying with our networks. And we believe the digital out-of-home business going forward in the next few years will enter a very strong growth phase to capture the benefit of this particular media.

From Jason’s point of view, he basically believes, based on his many years of experience in the advertising industry, as well as his knowledge of the business, he is very optimistic about the future prospect of Focus Media and he believe there potentially will be up to 50% growth potential for Focus Media in 2009 as well.

Jason Brueschke - Citigroup

Fantastic, Daniel and Jason. That’s very helpful and again, congratulations on the quarter and the outlook.

Operator

From Goldman Sachs, your next question comes from James Mitchell. Please proceed, sir.

James Mitchell - Goldman Sachs

Thank you for taking two questions. The first question, if you can talk through the investing cash flow line items a little bit. I’m particularly interested in the loan receivable item of $30 million and whether that means you’re in kind of the factoring business, and also whether the acquisition outflows are related to CGEN or to other stuff.

And then the second question, it obviously doesn’t affect cash flow evaluation but your amortization jumped quite sharply from the third quarter to the fourth quarter and it looks like you are guiding for your amortization to remain high in ’08, so just as a housekeeping item, if you can talk through that. Thank you.

Daniel M. Wu

First of all, the $30 million is actually a bridge loan we actually gave to CGEN prior to the acquisition. It’s after we signed the acquisition agreement but prior to the closing of the acquisition on January 2, 2008. The reason why is they have certain financing we required them to terminate, to end prior to we closing this particular transaction so Focus Media would not take over any potential liabilities from this particular acquisition. So we actually give them a working capital or loan, bridge loan prior to this acquisition. So this actually will disappear once we consolidated CGEN and that loan will be returned to Focus Media on an installment basis.

The second thing is relating to the acquisition intangible amortization expense, if you look at -- those are -- if you understand any acquisition we make, we have engaged a third party to do a purchase price allocation and the allocation, one of the components will be intangible assets. Intangible assets, that includes customer base, the employment contracts, brand or license, location contract, et cetera.

As those assets, intangible assets need to be amortized over one to five years, depending on the nature of those assets, so this is a U.S. GAAP requirement. It’s a non-cash charge. We expect the total intangible asset in 2008 to be approximately $50 million, taking into consideration of the company’s estimate for CGEN’s intangible asset amortization.

On the company’s balance sheet, there is approximately about $155 million of intangible assets today -- not today, as of December 31st of 2007. So that particular $155 million of intangible assets would be amortized within the next few years. It depends on the life of those intangible assets based on U.S. GAAP.

Of course, just keep in mind the $155 million is not including CGEN because the CGEN acquisition was closed in 2008, so the balance sheet only reflects December 31, 2007 balance. So we believe actually -- it’s a non-cash charge. It doesn’t affect the cash flow of the business but it will affect the GAAP earnings of the company in 2008 by approximately $50 million. Of course, this does not -- if there is any potential future acquisitions which at this time we do not expect, that number will also change.

James Mitchell - Goldman Sachs

Thank you. Just as a follow-on, it looked like the amortization by quarter was about $3 million in the second quarter of the year and $3 million in the third quarter, and then it increased in the fourth quarter. Was that because there was a catch-up or in anticipation of --

Daniel M. Wu

Yeah, it’s -- under the GAAP requirements, when the company makes an acquisition, we actually won’t be able to engage a third party to do an evaluation right away, so the company has approximately a 12-month period to finalize this acquisition with a third party valuation party. Those reports actually are delivered to companies before we close the book in 2007. However, the previous quarters, there are certain estimates of those intangible assets amortization by the company based on historical performance matrix and historical report provided by those third party valuation teams.

In the fourth quarter, when we received those numbers, given the SEC today has a much more stronger [buy] for higher percentage of intangible assets, so the final report actually has a larger intangible asset amount than we have booked relatively speaking in Q2 and Q3. So according to U.S. GAAP, we have to book the entire intangible asset amortization in 2007 in Q4 less the amount we have booked in Q2 and Q3. So this is more similar to a good will impairment test, which the company only requires to do it once a year. So it’s a full year amount, if you take --

James Mitchell - Goldman Sachs

But the third party -- the third party asked you to allot more of it to intangible assets and less of it to good will, so you had to kind of catch up amortization in the quarter.

Daniel M. Wu

Yeah, relatively speaking. It’s not like -- it’s basically they have to perform a very detailed analysis, look through each of the thing and based on the industry practice and based on the recent requirement of U.S. GAAP by the SEC to come up with a valuation breakdown. And that particular valuation breakdown was provided to us before the end of the year of 2007 and within GAAP, the GAAP requirement that you have to finalize this within 12 months of the acquisition period.

James Mitchell - Goldman Sachs

Got it, and I apologize for bombarding you with these technical questions. Thank you.

Daniel M. Wu

Yeah, I enjoy technical questions. I think Jason and Dr. Tan enjoy more strategic questions.

Operator

From Piper Jaffray, your next question comes from the line of Aaron Kessler. Please proceed.

Analyst for Aaron Kessler - Piper Jaffray

Hi, Jason, Daniel and Dr. Tan. This is Paul for Aaron. Two quick questions; what is driving the modest growth acceleration in the commercial network? And then secondly, I was hoping you could provide us with some color on your GAAP gross margin expectations for each segment for this year, for 2008.

Daniel M. Wu

Let me quickly respond and see if Dr. Tan wants to add something. I think we have discussed a little bit before that the commercial location network growth will be driven by continued network expansion in our current network coverage, as well as growth by expanding our coverage of urban consumer eyeballs by installing digital frames into various locations, which we are currently undertaking. So we believe the expansion of the coverage of the network, as well as price increase, which we will continue to implement, will drive the revenue growth.

I’m not sure if that answers your first question, Aaron.

Analyst for Aaron Kessler - Piper Jaffray

Yes, and the second one on the gross margins?

Daniel M. Wu

Sure. Gross margin is actually, on a GAAP basis -- let me put it this way; GAAP will be affected by intangible asset amortization but today, all the intangible asset amortization, the majority of the intangible asset amortization has been finalized and reflected in Q4 quarterly results, excluding CGEN. So it’s hard for us to give you a particular number because the CGEN intangible amortization is an estimate. It’s not based on a finalized third party valuation report.

But we actually expect all our business gross margin will improve on a year-over-year basis except, which I -- let me just run through the segments for you. Commercial location network, we believe the gross margin will continue to improve on a year-over-year basis. The frame media business, we continue to expect margin to improve on a year-over-year basis. The in-store network, given the CGEN acquisition, we have gained a very dominant market position and we expect the business will improve materially on a year-over-year basis. And these are basically for our commercial location network.

And for the Internet advertising, as you see the trend in Q4 versus Q3, we have made very significant improvement on the gross margin sequentially and we continue to believe in 2008, gross margin for the Internet advertising will continue to improve as we continue to increase the percentage of revenue contribution from higher margin pay-by-performance business.

And for the mobile advertising, it’s less certain. The reason why is because there’s a lot of new business initiatives we are undertaking. We believe in the long-term, the mobile advertising market was not based on a push-based business model, because in the long-term mobile devices will gradually transform into a media access device, so mobile terminal, it becomes a wireless Internet terminal. So most of the advertising media coming from consumer usage of those particular media, such as e-mails, such as content, such as instant message, rather than from a passive, push-based advertising delivery method.

So we believe during this, the industry continued to change and transform, Focus Media mobile will continue to look for new opportunities and new business model, and we’ll continue to invest in the growth of this business.

So we believe the margin will be healthy but we can’t give you a specific relative year-over-year comparison of that margin, but we believe that margin will be healthy going forward as well.

Dr. Tan Zhi

Let me add one point on the commercial network part. Last year, we have tried the frame 2.0 in the residential area, installed some test place and received very good feedback from customers. This year, we started deploy 2.0 on the commercial location, commercial area in the -- each building. We have installed the testing in 15 cities. We received very good, very positive feedback. We believe this year we will put more effort on those things and will increase some customer feedback, a good [part] and also give customers a longer time to view those advertisings. So we believe that we will also add some good points on our commercial network part.

Analyst for Aaron Kessler - Piper Jaffray

Thank you.

Operator

From Morgan Stanley, your next question comes from the line of Richard Ji. Please proceed, sir.

Richard Ji - Morgan Stanley

Hi, Jason, Dr. Tan, and Daniel. Good morning. I have two questions. Let me start with the advertising pricing trends and your comment on your expected pricing trend. Before the Olympics, do we expect another price hike? And given that Jason and your senior management team are confident about the gross outlook, advertising gross outlook post the Olympics, would you expect a similar kind of pricing trend afterwards? Thank you.

Jason N. Jiang (Translation)

Focus Media's commercial location network pricing strategy or pricing policy is pretty much based on the network expansion of the media coverage as well as supply/demand from customers. We do not have a special price for any particular event. Our goal is to continue to maintain the competitiveness of our network, both in terms of effectiveness as well as relatively speaking, or relatively to other media exists in China.

Jason believes we will have a price increase in the middle of 2008 but that price increase is consistent with historical practice and has nothing to do with 2008 Olympics. We expect during the 2008 Olympics period, Focus Media [as a lifestyle] media, we do not particularly own the rights to broadcasting [those events]. Our business will be similar to historical levels. Of course, as the media, overall media industry in China continues to grow, we’ll benefit from that.

Jason also believes after the Olympics in 2009, we will continue to see price increases on January 1st as well as July 1st, consistent with historical practice. He expects those pricing policies to continue for the next few years.

Richard Ji - Morgan Stanley

Sure. That’s very helpful. My follow-up question is again obviously regarding your mobile advertising business, which has received a lot of press attention these days. Can you help us to understand what is the current split between your push versus pull business and also what part of the business would you expect to be impacted by the current [price]? And if so, what are the current measures you are taking to counter or mitigate such impact? Thank you.

Daniel M. Wu

Today, if you understand our push business, it still accounts for a majority of our mobile advertising, mobile handset advertising business. However, there’s two components of the push business. One is a large percentage of that is actually corporate or enterprise messaging, which basically is message delivered based on, for corporate, based on their internal business needs. So that is -- we expect that business to continue to grow as those demands we think in China will continue to grow.

The business will be affected -- you know, the non-consent based, non-permission based push advertising message, we believe that business, given Focus Media has clearly stated our company policy to prohibit any of our subsidiaries sending SMS/MMS messages without receiving mobile users explicit permission, we expect our mobile handset advertising business will be affected in Q2 of 2008, given we will put a very strict control in terms of what good business conduct we need to do for Focus Media.

However, we expect, as we stated in the press release yesterday, we continue to expect the new form of mobile advertising business will continue to grow steadily, such as the enterprise message services and the other type of WAP based advertising business and instant message based advertising business, as well as Bluetooth based advertising business.

So those businesses, we believe there is a lot of potential. As you see actually in Q4, our gross margin decreased slightly versus Q3 for the mobile handset advertising business. This is due to some of the investments we are making of some of the business contracts or business deals we have structured with large business partners, such as MSN. So we will be actually providing exclusive advertising, mobile advertising content for two large mobile content providers, such as MSN as well as the KhongZhong type.

So we will continue to see those deals. We will continue to grow. Those are actually not push-based advertising. It’s more similar to the Internet type of advertising, so as people use -- let’s say if you go to any website, if you use any website, content like Yahoo! or Google, you actually do receive some form of advertising and we actually are moving our business model towards that particular form.

We believe in the long-term the form of mobile advertising will be actually similar to the form of Internet advertising. However, there are new different technologies you can leverage with a mobile device, such as -- so you will see Bluetooth technology, you will see instant message technology -- so all this technology can enhance the type of mobile advertising business model we can employ in our business. So we continue to expect those new innovative areas of mobile advertising to grow in 2008.

Richard Ji - Morgan Stanley

Thank you. That’s very helpful. Thanks.

Operator

Your next question comes from the line of Jason Helfstein from Oppenheimer. Please proceed.

Jason Helfstein - Oppenheimer

Two model questions and then a question for Jason; first, the gross margins for in-store were obviously weak in the quarter. It seemed that was one-time, but just talk to that. And then, you spoke bullishly on the in-store margins for 2008. Will that be back-end loaded? So that’s my first question.

The second, it looked like sales and marketing in the quarter excluding stock-based comp as a percent of revenues increased to 13% of revenues from 11 in the third quarter. I’m wondering what’s behind that increase. Is it becoming more competitive for sales people? Are you having to increase your sales compensation or what drove that?

And then my third question for Jason, if you can talk about the logic behind you giving up the CEO position and basically being solely chairman. Thank you.

Daniel M. Wu

Okay, great. Just give us one second. Let me translate.

Let me first of all quickly respond relating to your first two questions and then have Jason address the third one. Regarding the in-store network, we have discussed in previous calls when we discussed the CGEN acquisition. We expect the benefit coming from both revenue increase as well as cost control, because we believe the current level of spending on location contracts is not sustainable and not healthy for the industry to move forward. So what we tried to do is go back to the location owners to structure a mutually beneficial relationship with them, so that will have a very significant impact on the margin going forward, as this is more like a counter trend in 2007, as you see in 2007 what actually drove the margin towards negative territory was because the location costs went up dramatically. So we try to reverse this particular trend.

So you are correct -- in terms of the in-store network gross margin, we expect the discussion with the location provider will be gradual and especially as the revenue will continue to grow quarter over quarter, we expect in this industry, and as we continue to improve the cost structure of this business, the gross margin improvement will be more back-end loaded. I think your analysis is extremely right.

Relating to sales and marketing, I think if you back out the stock compensation expense and look at that, you probably didn’t take into consideration of the intangible amortization expense. As we discussed in the press conference, if you look at for the sales and marketing expense, the intangible -- the sales and marketing expense was $27.8 million. This includes $6 million of acquired intangibles, so $3 million in share-based compensation expense. So in total, if you take out $9 million, that’s roughly 18.8. So it’s possibly -- about 11% of the total revenue.

So it’s relatively speaking similar to the previous quarter and the reason why there are a large amount of intangible advertising expense in the sales and marketing is because in the amortization exercise, there are customer contracts, customer good will which need to be amortized as one of the intangible assets in the acquired entity we purchased during the year.

Jason, I’m not sure if I explained that clearly.

Jason Helfstein - Oppenheimer

Okay, so that’s not in cost of goods sold, it’s in that number?

Daniel M. Wu

It’s in both sale and marketing and cost of goods sold. Location contracts, that would be in cost of goods sold. Let’s say employment contracts, if they are senior management, it really depends on if they are in the sales, marketing, or G&A, so basically the GAAP requirement is that you have to allocate each different line of intangible assets into different line items of your P&L.

Jason Helfstein - Oppenheimer

Okay, yeah, no, that 11% makes sense.

Daniel M. Wu

Okay, great. Jason.

Jason N. Jiang (Translation)

Let me translate first and then Dr. Tan would like to add a couple of points. First of all, Jason said Focus Media today is -- there are four areas our business will focus on, one is digital out-of-home, one is Internet advertising, one is mobile, one is digital TV.

Our digital out-of-home business is already moving to a very stable and dominant market leadership growth stage. The more focus this particular business will need to do to make the efficiency of this business continue to be highlighted through the system and through culture and also through -- make this the coordination of the -- within the company to make this, the benefit of those media assets to be highlighted during our operating performance. So Dr. Tan has a lot of experience in multi-national corporations as well as his knowledge of system implementation, as well as company cultural establishment. So in all those areas, Dr. Tan can contribute a lot to the future growth of Focus Media.

What Jason, he wants to spend his full time in the Internet, mobile advertising, and other new media areas because those areas, the industry is growing very fast and changes rapidly. Focus Media today in those areas has not reached such a strong position as what we have done in the digital out-of-home business. The business model within the Internet as well as mobile are rapidly changing. There is a lot of time required to make fast decisions and to understand, to direct how Focus Media's new business is going to grow within this fast-changing environment.

So Jason, he said, if you look at the press release his current title is Executive Chairman, which means he’s continued working Chairman at Focus Media. Focus Media is his lifetime career, so he believes he will best use his knowledge and experience in developing those new media areas to make the business of Focus Media to become the dominant leader in those new media industry, which we see in the future.

Jason has spent a lot of time to look at those new industries, new media during the past few years and he has a very clear understanding of how those new media will continue to evolve and develop within the next few years, and he believes his skill and knowledge will actually propel Focus Media's growth in those new media areas, especially we believe in 2008 and 2009 and going forward, the Internet advertising as well as the mobile advertising will actually explode going forward from an industry perspective, so we will be well-positioned to become the leader in those new media areas.

Dr. Tan.

Dr. Tan Zhi

Under Jason’s leadership in the past three years, the company has grown so fast and through this growth, we certainly have demonstrated the business model works. It really provides the customer with a very good value.

However, after such a long, fast growth, the company reached to a certain size and at this size, we do need to watch ourselves, not only to our ability to expand the market share but also make the operation well-organized.

Myself, in the past 10 years, myself I have been working in several multi-national companies and my own experience is not only on mergers/acquisitions but also integration, so therefore I would like to put more effort to do more integration to make the company more systematically and build a team, build a system, build the culture to make sure the company can go to the next level, next stage, so the company will succeed in the future mergers/acquisitions.

So my ability is not on a certain target, not like Jason. [We’re excited and we are experienced] to searching for new targets, expanding into new markets and new territories. Myself, my experience is to maintain, to work on the operations, make the operation work, make the system produce results. That’s my job.

I think with the partner with Jason, we will achieve such a goal.

Jason Helfstein - Oppenheimer

Thank you very much for the thorough answers.

Operator

Your final question will come from the line of Eddie Leung from Merrill Lynch. Please proceed, sir.

Eddie Leung - Merrill Lynch

Good morning, Jason, Dr. Tan, Daniel, and Jie. My questions would be more on an overview of the advertising stage in China. How do the various developments in the television sector, such as digital TV and growth of our local televisions, et cetera, et cetera, impact the overall advertising landscape in China? Thanks.

Daniel M. Wu

Okay, thanks. One second, let me translate.

Jason N. Jiang (Translation)

This is Daniel Wu. Let me translate for Jason. Jason believes there are many, many different forms of new media emerging in China, which is very healthy for the new media industry. I think more and more advertisers recognize that those new media are very effective in a way, compared to the traditional media, and there is more and more advertiser spending being allocated to those new media.

But there are two main categories of new media, from his perspective. One type what we call mainstream new media, and those type of media are basically people interact on a daily basis, it has a very large scale, so if you look at those, this particular category, Focus Media commercial location network, residential network, in-store network, as well as Internet and mobile advertising all fall into this particular media. Basically this is part of people’s daily life.

Then, the second category of new media is what we call complementary new media or niche media, and this type of media are basically either people don’t interact with this particular media on a daily basis. They may go to a particular place once every month or once every two weeks, so there is no frequent interaction of this media. Or alternatively, it’s a very small scale, such as one of the examples is you can get a list of 50,000 people within a very small city and those -- it’s very targeted but there is a very limiting effect on the scale.

So we believe if you look at third-party marketing research, the mainstream new media will actually getting a much more larger share of the growth of this market and will actually be viewed very positively by the advertisers as well as professional market researchers. The niche media will continue to exist but they won’t be able to grow to a very large scale.

Eddie Leung - Merrill Lynch

Just a very quick follow-up; can you also comment on the opportunities brought by digital TV?

Jason N. Jiang (Translation)

This is Daniel Wu here. Let me translate. Once digital TV is deployed in a particular city, for consumers, there will be 125 channels rather than before, there may be 50, 60 channels. So from a consumer point of view, there will be more choice. This actually in a way dilutes the media reach of a particular channel, so from that perspective, this will benefit mainstream new media, such as Focus Media's commercial location network because we are the only choice for share this particular eyeball. So with digital TV, you are not going to see people watch more TV but people will actually watch more different channels, so that particular trend will benefit our digital out-of-home business.

The second point is the digital TV also brings a lot of the new media advertising opportunity because there will be additional ways for advertising delivery, and so that’s where Focus Media wants to get involved because we view those new opportunities, given the sales and marketing network Focus Media has already built and given the relationship with advertisers we already built. Given our knowledge of the new technology, we’ll be able to participate in the trend of this digital TV upgrade and we’ll be able to structure new partnerships, new business models. We’ll make Focus Media a credible player, one of the leading players in the digital TV advertising market.

Okay, thank you very much, Ed.

Eddie Leung - Merrill Lynch

Thank you.

Daniel M. Wu

Thanks, everyone. We’ll close this call, Operator.

Operator

This concludes the Q&A session. I’ll now turn the call back over to Jie Chen.

Jie Chen

Thank you. See you next quarter.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Focus Media Q4 2007 Earnings Call Transcript

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts