CDC Corporation (NASDAQ:CHINA)
Q3 2006 Earnings Call
November 14, 2006 5:00 pm ET
Monish Bahl - Director of IR
Peter Yip - CEO
Xiaowei Chen - Executive Director and CFO of China.com
Eric Musser - President of CDC Software
Verome Johnston - CFO
Ed Neumann - Oppenheimer
Martin Schutz - HIRG
Mark Hume - JMP Securities
Kevin Sonich - RK Capital
Kevin Dede - Merriman
Good afternoon. My name is Ginny and I will be your conference operator today. At this time, I would like to welcome everyone to the CDC Corporation's Q3 2006 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (Operator Instructions). Thank you. It is now my pleasure to turn the floor over to your host, Monish Bahl, Director of Investor Relations for CDC Software. Sir, you may begin your conference.
Thank you. Good evening everyone, and thank you for joining us today to discuss our results for the third quarter of 2006 and provide guidance for the remainder of the year as well as for 2007.
With us today is Mr. Peter Yip, Chief Executive Officer of CDC Corporation, and Peter is going to be joining us from London. He's also joined by Dr. Xiaowei Chen, Executive Director and Chief Financial Officer of China.com, who is calling us from Beijing; and Eric Musser, President of CDC Software, who is calling us from India; as well as our CFO Verome Johnston joining me here at Atlanta. Please note that this conference will be recorded and available for playback on the Internet by visiting our corporate website at www.cdccorporation.net.
As customary before we begin, I would like to remind you that certain statements made during the conference call and webcast may constitute forward-looking statements which are based on management's current expectations and beliefs and are subject to a number of risks and uncertainties that could cause actual results to differ materially, including risks that may be beyond the company's control. This includes, but is not limited to economic factors affecting business spending as well as the risks referred to in the company's filings with the Securities and Exchange Commission.
Now, it is my pleasure to introduce Mr. Peter Yip, Chief Executive Officer of CDC Corporation. Peter, please go ahead.
Thank you, Monish and good evening everyone. We are very pleased with the results we have posted for third quarter as both of our primary business are doing very well. We are continuing to expand our global footprint primarily through organic revenue growth as well as strategic acquisitions. We now have the global scale, the infrastructure and the management team as well as a very strong balance sheet needed to maintain and to pursue our aggressive growth strategy. In addition, we are making very good progress on our strategy to unlock shareholder value within CDC. We will discuss this later in the call.
First, let me turn in to the financial highlight and revenue trends. We continue to deliver strong revenue growth driven by organic growth and to a lesser degree by acquisitions. In the third quarter, we have grown revenue 26% on a year-over-year basis and our adjusted net income is now at $10.1 million and we have generated year-to-date cash flow in excess of $28 million.
Now I want to take a minute before we get into detail of the call to give you a high level view of our company. In software, we have developed a very good formula for success. We are leveraging global solution on a global basis. This means that we have taken companies that were once horizontal in their approach and we focused them on specific vertical industry. This vertical industry strategy is doing very well for us as evidenced by our continue growth in new license sales in the past several quarters. In fact, new license sale were at a record high for the company in a very seasonally weak quarter of Q3.
Also consolidation in the software space in the past few years has put us in a very good position as many of our former competitors have been acquired and investment in the business virtually disappear. This put us in a very sweet spot in the software sector.
In China, we are becoming a new media company in the China marketplace. We are focused on entertainment for young adults and professionals, which are a multi-billion dollars opportunity. With our reputation and with our global reach, we feel we are very well positioned indeed to succeed in this enormous market.
As we have announced yesterday, we have entered into a transaction to sell 168 million of exchangeable convertible bonds. This convertible deal was structured in a manner that we believe unlocks strategy value in a creative manner. Even though we continue to believe we are still very under value, and we will continue to work very hard to look for additional ways to enhance value for our shareholders.
Let me give you some highlights of the convertible deal, which including a very attractive coupon on an annual basis of 3.75% and an ability to unlock shareholder value in some of our subsidiaries. For example, upon an initial public offering of either CDC Software or CDC Games, the convertible notes become exchangeable into common share of those companies. The exchange price will be determined based upon the IPO price for CDC Software or the IPO price for CDC Games and is set at a discount to the IPO price depending upon the length of time before these two companies can complete their IPO. In the event no IPO of either CDC Software or CDC Games occurs within two years. The convertible notes will become convertible into CDC Corporation common share. The conversion price was initially set at $10.37 per share, which represent a premium of over 60% to the CDC stocks, most recent 10-day average closing price. This conversion price, we believe, is very beneficial throughout existing CDC shareholders, as it helps to reduce any potential dilution. In the event an IPO of CDC Software or IPO of CDC Games is not consummated.
Many of you have been asking why we raised so much cash given our already very strong balance sheet. We are looking at investing significantly into our businesses over the next 12 to 18 months. Some of this investment include additional investment into research and development, which we believe is very important for us to continue to grow; to continue to develop products and functionality for our customer base. We are also looking for investment into our global sales and support infrastructure as well as strategic acquisitions.
On the acquisition front, we are making significant progress, which I will speak to you later in the call.
With that, I am now turning over to Dr. Chen for her presentation and operating update on China.com
Thank you, Peter. We continue to evolve the China.com business into a successful new media company in an emerging yet rewarding market. As many of you know, we have three primary lines of new media businesses in the Chinese market: Online games by CDC Games, mobile value-added services through CDC Mobile, and our portals of www.china.com and www.hongkong.com.
Our online games business maintained its healthy growth momentum. We have seen a lot of success in our current game Yulgang, and are now ramping up our pipeline for three new releases over the next 12 months. I would describe the opportunity in the China gaming market as an emerging opportunity in a market with enormous potential. We have distinct competitive advantages, including being the first company to offer a free-to-play model, which now others are trying to replicate. Another key differentiator is that we have established a strong distribution network and continuing to strengthen it with strong player demand. We are committed to further enhancing our market position and exploring new opportunities in the promising China gaming market.
Our second business line, CDC Mobile provides mobile value-added services in China, which is another core strategic line of business for China.com, Inc. This business was impacted by regulatory changes similar to all our peers in the industry. However, since these changes took place in July, we have been reversing the downturn and growing again on a month-over-month basis organically. Over time, we believe this will prove to be a healthy correction in the market and it weeds out the weaker players and positions us well over the next 12 months.
Another important strategic line of business, which is where the company has its roots, is our portal, www.china.com and www.hongkong.com. I'll be going into a bit more detail about each of these businesses in a moment.
But first, just to highlight our Q3 financials, we generated $16.9 million in revenue in the quarter, which is up 42% compared to the same quarter last year and our net income for the quarter was $2.3 million, a 527% increase over the same quarter last year.
Now, let's first focus specifically on the games business. Currently, the results driven by Yulgang are strong. After three consecutive quarters of robust growth, Yulgang maintained healthy performance in Q3 2006. Registered user number increased to 37 million in Q3 2006, up 23% from 30 million in Q2 2006. The number of virtual items that have been sold in the game climbed 29% higher to 27.4 million. Server groups throughout China supporting Yulgang and the Group's other online games numbered 54, up 13% from 48 server groups in Q2 2006.
Leveraging the momentum created by Yulgang, we have licensed three new games during the quarter to strengthen our China gaming pipeline. First, Special Force; second, Stone Age II; and third, Lord of the Rings Online: Shadows of Angmar.
Special Force is a first person shooter online game from Korea. It allows players to create their own elite military units with customized weapons and equipments selected from those used by Special Force from around the world. It was a top-ranked online game in Korean Internet cafe for 52 consecutive weeks.
Stone Age II is licensed from Japan, which is set in the pre-historic era and players roam a world of volcanoes, deserts, and jungle populated by dinosaurs and spirits. It encourages cooperation between players by rewarding teamwork. Players work together to build villages, capture and raise dinosaurs and look for treasure. Stone Age II enjoys strong recognition among Chinese gamers due to the huge success of the first edition of Stone Age. Following the pioneering footstep of Yulgang, both Special Force and Stone Age II will be free-to-play with players paying for virtual merchandise.
Lord of the Rings Online: Shadows of Angmar is the first and only massively multiplayer online role-playing game or MMORPG based on the literary works of J.R.R. Tolkien. It allows players to explore the most famous fantasy world of all time, fight the evil minions of the Dark Lord Sauron and advance their heroes by adventuring through the vast reaches of Middle-earth. Gamers can adventure solo or choose from thousands of players online to forge their own fellowship, as they face the hideous monsters and fight epic battles to defend Middle-earth.
The Group aims to leverage our Yulgang's growing base of 37 million registered users, its extensive coverage of distribution channels and 54 server groups to support the operation of the new game.
Now, about our mobile business. As noted in prior announcements, we were alerted in June to policy changes for all subscription services on China Mobile's Monternet platform. The changes, which are being implemented under the policy directives of China's Ministry of Information Industry, aim to address industry-wide objectives, including reducing customer complaints, increasing customer satisfaction and promoting the healthy development of the MVAS industry and CMCC's Monternet.
As expected, our July revenue from mobile services and applications experienced 39% month-on-month decline, and 29% decrease compared to the same period last year. However, we have already begun a healthy recovery by the middle of the quarter and have shown sequential growth on a monthly basis since the downturn occurred. We have achieved sequential organic growth in both, August and September, and the growth trend is still continuing. The main reason for this growth can be attributed to our proactive revamp of our service offering and marketing channels, as well as exploring new cooperation opportunities with mobile operators in China.
In August, CDC Mobile won a contract from Beijing Mobile for the exclusive rights to design, develop and operate the graphic channel of "Beijing in my hand," which features and promotes popular local product through the download of WAP pictures. CDC Mobile was also awarded the contract from Jiangsu Wuxi Mobile to send MMS on its behalf to its VIP customers. These contracts further demonstrate CDC Mobile’s leadership position in the MVAS sector. The rapidly recovering revenues, combined with adjustments to our operating strategy to reduce operating expenses and become more efficient has minimized the overall impact of the regulatory changes.
Also in early August, the group announced the acquisitions of TimeHeart Science Technology Limited and Beijing TimeHeart Information Technology Limited, or collectively TimeHeart Group. TimeHeart Group is engaged in the mobile services and applications business with full lines of mobile services and application products.
After the acquisition, it will be not only accretive to us in revenue and earnings, but complementary to our product lines and customer base. Also, the price earning ratio is approximately 4.5. We believe it is the opportune time to acquire synergistic mobile service providers and the acquisition will provide the group with the opportunity to further expand its market share. MVAS is our core business unit and will provide us with further growth opportunities. Looking forward, we believe the MVAS industry will further consolidate towards a smaller group of more stable service providers, which will ultimately benefit CDC Mobile's business in the long run.
Turning on to our portals. During the quarter, the China.com portal has expanded its sale force and has acquired more advertising contracts and reputable clients, including Volvo, Honda and Dell. During last quarter's announcement, we told you about our partnership with Google, and after two months of this partnership, Google is now expanding its presence on China.com beyond the text search functions, when it launches video ads in China.com's English channel, serving primarily multinational companies investing in China. This is the first time Google video access will enter China's Internet space.
The China.com portal has also been appointed by Jilin Government as the exclusive web sponsor of the 2007 Asian Winter Games, which will be held in the city. This winter game is the first sports event in Asia, where all athletes have to register online and also the first time to be broadcast on Internet media in Asian Winter Game's history. And, the games are to be held in January of 2007.
Our portal business continues to strengthen its role as a strategic foundation for the group. Our online video program, The Straight Show, has achieved wide popularity among Chinese Internet users. The program has been downloaded 5 million times during this quarter. The Straight Show is specifically positioned as mobile content for the 3G era. It will provide synergistic support on MVAS business. In addition, our portal's military channel continues its stronghold as China's number one military channel. It will perform as a strong platform to promote Special Force, a first-person shooter game operated by the online games business of the group.
To further strengthen our position as the leading portal for Chinese professionals, we proactively launched a $20 million Web 2.0 Developer Program during the quarter. The group seeks to establish strategic relations with leading local Web 2.0 companies to accelerate the development of interactive and individualized tools, specifically for Chinese professionals. The companies who are currently evaluating include community-based web portal, innovative search technologies, vertical industry application websites and others.
As part of the strategic partnership, our development partners will also be able to leverage the extensive market coverage of the group, including millions of growing subscribers of our MVAS and portal businesses, as well as the 37 million registered users of our online games business.
I would now like to turn over the presentation to Mr. Eric Musser to continue our operational summary with a focus shifting now to CDC Software.
Thank you, Xiaowei, and good everyone. I am delighted to be speaking with you today and look forward to your questions at the end of the call. As Peter mentioned earlier, we believe we have defined the formula for success. This formula is based on hybrid model to leverage just two key ingredients; vertical software solutions and horizontal business services.
The first of these ingredients is our expertise and focus on providing vertical software solutions. Today we offer vertical CRM solutions targeted at industry such as financial services, construction and manufacturing. We also have enterprise solutions targeted at the process manufacturing industries, including food and beverage, pharmaceuticals, and chemicals. As we grow organically and through our acquisitions, we will seek underperforming, horizontally focused software companies with good products.
In addition, we are seeking smaller companies that are well performing, that have a good vertical or geographic focus that fit with our model; such as MVI, our recent acquisition I will speak to you later. We will convert these companies into high performing vertical specialists as we have already demonstrated with our prior acquisitions, and integrate the well performing ones to leverage cross-selling capabilities.
The other key ingredient in our formula for success is our unique business services. Many of our customers speak of broad range of consulting services beyond those directly linked to implementing our software applications. For these services, those companies typically turn to a trusted advisor rather than their software vendors. Because of our deep vertical expertise, we often become a trusted advisor, and in turn we are in unique position to deliver these additional services. As a result, the value we deliver to our customers have enhanced, which further raises a competitive barriers effectively locking out the general competitors.
We also offer these same services to companies that do not have our software. This helps to diversify our revenues and provide additional opportunities for cross-selling our software applications. As a result of this unique formula, we have a very high degree of customer success, and we enjoy win rates with new logo customers that are much higher than industry averages. Our record software license revenues posted for Q3 is great evidence of the power of our approach. In addition to better execution overall, we enjoyed better predictability in revenues and earnings visibility than typical enterprise software companies. With this hybrid model that combines vertical software solutions and horizontal business services, we believe we have found the formula for success as our company grows going forward.
Now into acquisitions; to better understand our formula in action, we'll take a look at the recent acquisition of a company called MVI Technology. MVI is a leading provider of real time performance management solutions that are specialized for the requirements of food and beverage, pharmaceuticals and chemical industries. The MVI solutions are unique and highly complementary to our existing enterprise software offerings, allowing us to further strengthen our position as a leading provider of industry solutions for process manufacturing. The acquisition of MVI expands our customer base in both the mid market, and with larger Tier-1 companies such as Coors, Heinz, Genentech, Premier Foods and Tetley.
We introduced the MVI acquisition in our process manufacturing user group conference in early October, and immediately it generated a new sales pipeline for 2007 and beyond. Looking ahead, we will expand the market reach for MVI for our global network of direct sales channels and franchise partners to open the door to many new sales opportunities.
Taking a look at our key operating metrics for Q3, once again we see our top line revenue growth was driven by new customers and additional business from our current customers. We signed 237 software deals with new logo customers during the quarter, which resulted in 46% of our software license revenue. At our current rate, we're adding one new enterprise customer to the CDC Software family every business day. Also of particular note during the quarter, we signed 29 new software customers in China.
Our software license revenues performed well during the quarter, and in fact was a record for the company. We generated $11.9 million in license revenues in Q3 which is a 35% increase year-over-year. Worldwide over 316 customers upgraded or purchased additional software licenses. Our industry focus and combined investments in industry-specific applications is highly valued by our existing customers. This is reflected in our customer satisfaction and maintenance renewal rates and ultimately in continued investments from our customers.
During the quarter nearly 60% of our revenues came from the Americas, almost a quarter from Europe and 17% from Asia-Pacific countries. The shifting balance towards North America reflects the typical Q3 slowdown in Europe. We are now driving tighter integration of our direct sales and marketing efforts on a global scale to leverage our success in North America. We also continue to invest in our distribution channels and we anticipate accelerated sales growth in Eastern Europe, Latin America, Asia-Pacific overall, and in China in particular.
As you could see from the results, our formula for success is working well, and we continue to be a solid and predictable in our execution.
Now, I would like to turn the presentation over to Verome Johnston, our CFO.
Thank you, Eric. I'll quickly run through some of the key financial highlights of the third quarter. CDC Corporation generated revenues of $78 million. This is a 26% increase from the year-ago quarter. CDC Software had revenues of 61.4 million, a 23% year-over-year increase; china.com had revenues of $16.9 million, a 42% increased compared to the third quarter of last year. Third quarter adjusted net income was $10.1 million; this is a healthy increase of 214% over the same quarter last year. GAAP net income was $3.1 million, which is a substantial improvement of the last year's $1.2 loss.
I would now like to discuss some of the balance sheet metrics. In the quarter, despite the fact that we generated cash flow from operations, our actual cash usage was about 26 million. This was primary related to the results of our stock buyback program and some small strategic acquisitions that we made in the quarter. In addition, the third quarter is usually cyclically weak from a cash generation perspective.
As you are all aware, we announced a convertible debenture yesterday that allowed an additional 168 million to our existing healthy cash position of 191 million at quarter end. We continue to see improvement in top-line metrics, and our visibility continues to improve as a result of our recurring revenues. In addition, we are seeing an improvement in operating margins as a result of seeing higher revenue growth of higher profit segments, as well as our ability to rationalize costs and leverage our global infrastructure, which includes our offshore capabilities in both China and India. Because of our strong performance in Q3, and our confidence in the performance of the company going forward, we continue to believe that the company harbors additional value that is not currently reflected in our share price. Over the last several months, we have repurchased approximately 6.1 million of our shares for a cost of approximately 27.7 million leaving a little over 12 million left in our existing buyback program for the next year.
With that, I would now like to turn the call back over to Peter for closing remarks.
At this time, we are reconfirming the revised earning guidance that was issue on November 6, which was the second time we upped guidance in both month for the fiscal year 2006. We expect the revenue for CDC Corporation to range between $303 million and $307 million; this represents increase approximately 24% over last year. We expect adjusted net income to range between $32 and $33.3 million, which would be an increase approximately 100% over the same period a year ago. As a result of the success we are seeing and the visibility we are having in our business, we now feel comfortable for the first time ever in our company history of providing all-year guidance. Based on our data today for 2007, we anticipate revenues in the range of $401 to $411 million, a 33% increase over our anticipated 2007 revenue. We anticipate a primary driver of our growth to be organic sales, resulting from the momentum we are building and from the synergies we are generating, as well as some smaller acquisition that are not -- that are very far along in the process of completion, and which we should be consummated in the next few months. We anticipate adjusted net income of $55 million to $60 million for 2007.
In summary, we believe the company structure has much improved and the operating units are well-positioned for continuous effect in the target markets in 2006 and beyond. The environment is right and the stars are aligned for our units. We will continue to execute, we will continue to grow both organically and to a target acquisition, and we’ll prepare for any further changes needed to unlock shareholder value. At this point, we are ready to take your questions.
Thank you, Peter. Ladies and gentlemen, we are ready to take your questions and I would like to request that we take only one question at a time from each participants to allow as many of you as possible to participate during the time that we have remaining. Operator, can you please provide instructions for everyone to get their questions into the queue? Operator?
Thank you. (Operator Instructions).
While we wait, I think everybody got a question from an online delivery, so while the questions are being queued up, let me just go ahead and ask this question now to be answered. This is the first time the company's offering guidance in an out year, what gives your company so much guidance to provide this -- what gives your company so much confidence to provide this guidance?
Well, thank you very much for the question. And as I said it before, this is the first time in our company's history, we feel very good about based on the revenue and particularly our global customer base and as well as the recurrent revenue base of both our software business as well as the online games and mobile business in China. And, maybe now I'll turn over to Eric to add some more in terms of visibility for maintenance as well as the service revenue visibility and our backlog and the pipeline we are building up for the software business, and then later on I'll turn it over to Dr. Chen to talk about the visibility we have in the games and the mobile, as well as our portal business. Eric?
Thanks, Peter. In a way, I guess I'll pay a little bit of what I've been up to over the past couple of weeks here. We had a user group meeting in Chicago recently, and I just finished up a user group meeting in Paris and in India at this point in time. But the biggest thing that's came back from those user group meetings is the confidence that we have in our customer base at this point in time and their willingness to continue to not only do business with us, but to increase their business with us. And, so this is not only from a maintenance perspective, but also from additional services that we are providing. They continue to buy additional services from our outsourced business capabilities. In addition to that, we continue to add additional products that allow them to expand and seek higher levels of value with the product lines. So, this does give us great confidence as we head into the future, and as you have said, this is the first time that we have been able to have the visibility and this visibility is not only because of number one, customers but also visibility into future pipelines as well. And so with that I'll pause and Xiaowei, I'll turn things over to you.
Thanks, Eric. At China.com, all three lines of our main businesses online games, mobile value-added services, and portal are growing strongly. For our online games business, our current game, Yulgang, is maintaining very healthy growth momentum. As I mentioned, our registered user number continues to grow and our virtual items of numbers sold continue to grow, and most importantly our ARPU continues to grow. And this is a very important aspect in our games business, as we continue to figure out the science behind how to promote the virtual items, when to promote them, to whom we promote them. And not only that, we are leveraging Yulgang's current success and we have licensed three very strong new games as I've told you about early on in the call. And all these three new games complement each other in terms of the demographics that they cover. And also we can leverage the current strong distribution channels we have built for Yulgang for these three new games in our pipeline. So, overall, our games business is growing at a very healthy rate and we expect this healthy growth momentum to continue.
In our mobile value-added services unit, as I mentioned, even though the regulatory changes took a hit on just about every player in the mobile industry in July, we have seen a very strong organic growth in sequential months since July. And not only that, we have acquired a company called TimeHeart. We announced the deal and the TimeHeart's product lines and customer basis are very complementary to ours and we expect our mobile value-added services to continue its organic growth. In addition, we are currently very actively looking into a number of acquisitions. We believe that this is an opportune time to acquire as P/E ratios are being depressed by the regulatory changes, and we will continue to use the same criteria as we did for TimeHeart, which is to look for complementary products and customer base that are synergistic to our current business and a low P/E ratio.
In terms of portal, we have also launched $20 million program in looking for investment and partnership for advanced Web 2.0 companies. And our portal is growing healthily in its position as China's leading portal for professionals. So altogether, we have strong confidence in our growth momentum for the coming year.
Thank you. Your first question is coming from [Mr. Ed Neumann] of Oppenheimer. Please go ahead.
Ed Neumann - Oppenheimer
Hi guys. Congratulations on a great quarter. The stock is already being rewarded here in the aftermarket. My question comes around the acquisition strategy. Obviously, you've been very successful in the past with your acquisitions and integrating them. In terms of going forward, you are obviously intending to do a lot more acquisitions. How are we to be reassured that when you make those acquisitions you are doing it in a fashion that you are not growing off too much and you are not growing too fast?
Good to hear from you, Ed. Thank you for your question. On this I would for the software side acquisition, as I said it before, we have very healthy pipeline and we learn to be very disciplined over the years in terms of what we can and cannot do, I should say, what we could digest and we cannot digest. And we have proven to ourselves that the experiences we have in acquiring Pivotal, Ross and several other smaller software company. And I would also ask Eric to comment in term of our integration process, how we pick on a company, how we ensure that before we complete the acquisitions doing the due diligence in term of the integration strategy, the synergistic value that we were observing and those are some of the key criteria for us before proceeding in any acquisitions. And on a mobile front, I ask Dr. Chen to comment on how much work we put-in in term of even for the TimeHeart deal, which took us couple of months now. And before even get the investment community approval that we thought to in term of how that would add value, how that would complement both in the products as well as geographically in a big country like China. Eric, maybe you can comment first.
Thanks, Peter, and Ed thanks very much for the question. If we take a look, today I would say that we have a much tighter process than we have ever had in the organization before, for not only reviewing deals that are in the pipeline, for possible acquisition, but making sure that our plans tighter than they have ever been in the past. We have the capability today to walk through and take a look at a very formula-based driven approach to how we take on a new organization. And we look at a couple of things. We take a look at how we could take those products and move them into existing distribution channels that we have today. And that’s a very important part as we look at acquisitions, how can we accelerate the growth that they are seeing in the marketplace. In addition to that, for those companies that may have older products, we are looking at how can we leverage selling new additional products into that customer base. Today, we are expanding our center in India and that’s why I am here at this point in time. And at the same time, we do also have offshore capabilities in China. And so, being able to provide these organizations with lower costs, high quality resources is a key part of our strategy and we expect this to pay dividend as we move into the future. I can guarantee you, we are very much a disciplined organization today and we are looking out for the value for our shareholders, customers and employees as we move forward. Xiaowei?
Thanks, Eric. One example, as Peter mentioned, in our acquisition strategy is TimeHeart. We actually started looking at possible potential targets of acquisition in the mobile value added services industry from very early on in the years, starting February of this year. And we looked over more than 20 companies, but we knew that the regulatory changes may be coming in late June and we waited till after the regulation -- the regulatory changes hit to see what effects they would take on our potential targets. And TimeHeart clearly stood out as a company that has not only survived the regulatory changes, but their product lines are positioned very well for the future. Having said that, we are very prudent in our acquisition strategy. As I mentioned, the P/E ratio that we're paying for is 4.5, and not only that, only 10% of that is in cash. In other words, we are paying for the company's earnings in just about two quarters earnings of this company in cash and the stock prices that we have given are tied to future performance targets. More importantly, we are very diligent in the due diligence works that we have done. Due to the regulatory changes, we have checked over about every qualification for these companies in China in terms of their mobile value-added services licenses and their products. We expect ourselves to continue this kind of strategy in future, smaller acquisitions of mobile value-added services, as I mentioned, it is an opportune time to acquire. We do not think that we are biting off more than we can chew, as over -- as Peter mentioned, over the past four-five months, we've had very intimate and close discussions with the management of TimeHeart. Even before the company is -- even before the deal is officially closed, we've had integrated meetings, business meetings in which we discussed strategies going forward and the CEO has been advising me on the complementary product lines that we can run together.
Ed Neumann - Oppenheimer
Great, thank you. Continued prudence.
Thank you. Your next question is coming from Martin Schutz of HIRG. Please go ahead.
Martin Schutz - HIRG
My congratulations as well, my questions have been answered. But, I was wondering if you might address your views as to, in the wake of the strength that you had for licenses in CDC Software for last couple of quarters, how you are confident that you are not -- perhaps you haven’t drained a little bit of the pipeline for Q4, and that you will see the normal end of your seasonality? Thank you.
This is Eric, and thank you for the question, and we appreciate the feedback there. If we take a look at what's going on, and I look at the past 12 months and compare that to three or four years ago, and look at these different software entities we had, and looked at them I would say that 90% of our deals used to come from must making a call. We typically call that, an outbound lead that, we had to pickup the phone, find the lead and make a call in order to close business. Today, if we take a look at what we've done with our vertical penetration and marketing, today half of our leads coming in the door are inbound leads, and that just a tremendous push. That allows us to change the dynamics incredibly, and that is really what's giving us confidence that we are gaining penetration in market and the verticals that we serve and CRM, financial services continues to be a phenomenal space for us. Food and life sciences, especially chemicals on the process manufacturing side, these pipelines are good pipelines for us. They continue to grow. We continue to have some visibility into 2007. And so, with that, we do not believe that we drained the well in Q3. We do have additional business to move forward into Q4 and we remain confident about, not only Q4, but also 2007.
Martin Schutz - HIRG
Thank you. Your next question is coming from Patrick Walravens of JMP Securities. Please go ahead.
Mark Hume - JMP Securities
It's actually [Mark Hume] filling in for Pat. I had a question on the CDC software side of things. I see that as far as the model is, 60% of the revenues this quarter came in from the Americas. I was just wondering, Eric, if you could comment on what you feel like the future model would be and what you guys are kind of targeting a year out, two years out, as far as what percentage would be coming from the Americas and what would be coming from Europe and Asia, and specifically China? And, then also if you -- and that if you could comment on how you're kind of get to that model, whether there will be acquisitions in the China area or how you are planning on hitting that target?
Yeah, thanks for the question. I think that that's a good point and thank you for pointing this out. If we take a look at it, typically we're running about 50% in North America, about a third in EMEA and about 20% in Asia. And this quarter changed a little bit slight towards North America and that we had a down quarter in Europe, and the fact is that we've seen this every year. I have been in the organization now close to 14 years and every year we go through the same thing. And, it is really due to the holiday season that occurs in Europe that causes the percentage uptick in North America. And, so we are looking for a more balanced approach as we move forward into the future. And, we have seen -- if you watch the customer numbers that we have, we have seen an uptick in the number of customers that are coming out of Asia, specifically out of China, and we are ramping up additional activities in China today. So, we do expect an increase into the Asian market. In addition, we are looking at acquisitions. We have a number of acquisitions that we've been talking to, and -- in the Asia area, and we hope that’s going to increase as we move forward in time.
Secondly, the other point related to Europe is, is that we were a little bit later in getting going on our vertical strategies in Europe, and so what we have seen in other regions is as we moved our vertical strategies forward, we have been able to see an uptick and an increase in the penetration that we have into those verticals as well as an increase in the software license sales in the new business, and so, our expectations are this will continue and -- as we continue to roll out our vertical strategy, and so we will see a more balanced approach as we move into the future. I expect that Q4 to get back towards closer to what we were before, 50% in North America, third in Europe, and 20% in Asia. And as we move into the future, more balanced approach on a worldwide basis. Thank you.
Mark Hume - JMP Securities
Your next question comes from Kevin Sonich of RK Capital. Please go ahead.
Kevin Sonich - RK Capital
Thanks. Just regarding the recent deal, based on the pipeline of acquisition that you have been talking about, did you feel that you needed to raise that money to have adequate cash for the deals you are already looking at or was it a little bit more opportunistic based on strong demand and very attractive terms and better to do it while you can?
Kevin, this is Peter Yip. Thank you for the question. We see a very strong pipeline as Eric mentioned, particularly the company that would help us to expand our vertical strategy as well geographically. It's good money in term of the -- as I mentioned the structure of the convertible bond is -- I can only comment what we disclosed because as you know the SEC regulation forbidding the -- before we actually close the convertible note to comment any further then what we have disclosed already. So I just repeat in term of what we have disclosed particularly in term of the conversion premium, the 60% is comparatively -- over the past several years -- if you look at all the convertible note bonds for the past several years on an average about 20% to 25%. So that is a good indication in term of investor understanding, beginning to understand our story and seeing the potential for that [coupon] opportunity for the two IPO for both CDC Software and CDC Games. And certainly, we are very pleased with the coupon, as I'd mentioned it before, any time you get a coupon on a debt that is below, way below the time rate and that’s an achievement, if you will. So, it is a combination of both factors that you mentioned in term of very inexpensive capital quest.
The fact that's giving us a lot more flexibility, if you will, and looking at small acquisition as well as potentially some big acquisition normally that we won't look at because we don't have the cash on hand. And as you know, there are many still opportunity in the software space and certainly we will be stronger in front of any of the Board member of the target company, say, gentlemen, now, we have the money; we are not depending on any future financing in order to come out with a proposal for you that will be attractive to your Board and to your shareholder. So that is a kind of a war chest that any of our competitor would like to have and certainly we are getting it. And that reason also giving us that kind of confidence in term of continuing, making investment in our existing business, continue driving organic growth and absolutely looking at any possibility in term of acquisition that we can on a very disciplined approach the way we have been doing it. So as Dr. Chen said, if you look at 20 companies, we do one. In the software space, believe me, every single software company out there I have looked at and when they are available I am there right next door and we don’t do many of them. But they are certainly the one we really want. Now we have been able to go after them and with that kind of cash we have today we will be much more in a position to be able to look at those opportunity much closer than we have before.
Kevin Sonich - RK Capital
I hope I have answered your question Kevin.
Kevin Sonich - RK Capital
Yes, thank you.
And we do have time for one more question coming from Kevin Dede of Merriman. Please go ahead.
Kevin Dede - Merriman
First let me offer my congratulations on a very strong quarter. I was hoping you might be able to -- if I understand you correctly, you are expecting 33% growth next year. And I was just hoping you might discuss how or whether or not you are comfortable with the infrastructure of the company, whether you feel you can support that kind of growth? What you think you might need to development in terms of human resources and what you think the available market might be able to provide you in terms of the human resources that you might need to meet the goals that you have set?
Kevin let me answer the first part of the question then I would direct it to Eric to talk about the recent recruitment we have particular with almost every other -- what 10 days a software company disappears; we have hired a number of very key employee for the past several quarters now from our former competitors, and I think we have disclosed some of them, including the recent hire we recruited from SSA and so forth. And here we correct, indeed we believe we have the core infrastructure today in place, especially the area we need to continue to strengthen, and I would ask Eric to comment geographically which area and functionally which area we have to continue to recruit better people. And I think we have to show a track record that we have been able to attracting very talent executive to join a growing family of businesses.
In addition, I would also ask Dr. Chen to comment about China, our infrastructure regarding the games and mobile space and how we could continue to support the kind of growth we are facing. Particularly to [comment online] games, we are talking about on a global infrastructure that take us couple of years to build. Its not a too good matter to have over 50 set of group of service to be set up on a nationwide basis to support the kind of concurrent user we have for our multiplayer games, such as the one we have servicing in China today, as well as the office infrastructure, the marketing and sales support in over 32 cities in the country. It is something that we have -- taking us much longer than we would have liked to for the past almost five, six years that we will be up into China. So, we think that we have the infrastructure in place and we are in the position also recruiting additional people. And let me ask, because it’s a very important question, a very fine question, Kevin, I thank you very much for you asking and let me turn over to Eric for more color.
Great, thank you very much. It is a good question and first I'd like to just really congratulate and think about the teams that we have. We have some amazing teams here within the organization. Gary running the ERP process manufacturing business; Bruce on the supply chain, I mean on CRM business. These teams, I believe are some of the best in the world and world-class organizations and they continue to execute for us. That being said, we do continue to expand the breadth of the organization, the infrastructure in the organization, as I mentioned earlier I'm here today in India working through some expansion in our development and outsourcing capabilities. And we also take a look at our business services groups as well and we are looking for additional talent to help us expand, not only throughout North America but also into Europe. We feel confident about the landscape there. If we take a look at it, the best thing that just gets me geared up everyday is that our door is being pounded on by many people who want to get in the organization and see the success -- see the momentum that we are having and they realize it. This market is very, very close and as a result of that the industry understands when there is success, and we believe that we are at the very beginning of that. And as a result we are seeing attraction in a good market for people coming aboard and future growth to the organization. We don’t see any issues with continuing to grow. We will continue to build the infrastructure, but we think that we have a very solid team onboard today. And so with that, Xiaowei, I'll turn things over to you.
Yes, thanks Eric. Thank you, Kevin for the very relevant question. I think you really hit a key point because human resource is what drives the growth. In our games business, we currently have closer to 300 people, and we are looking to hire 350 more by the end of 2007, and that is largely due to the continuing rolling-on of our new games pipeline. And in China as you may be aware that even though it’s a vast country with 1.3 billion people, good talents are actually hard to find and we have been very fortunate, and that we have been able to attract great talents from fresh recruitments and also from recruitments from our competitors, and that is evident in not only our games business, but also in our portal and mobile value-added services business. And I think largely it's success that attracts more talents, because young people -- young talents would like to work for an upcoming strongly growing company and we are very proud to continue this growth momentum. In addition to hiring more people, which we are now renting additional floor spaces in neighboring buildings; we are also considering moving some of our customer service people to a different neighboring city, where we currently already have customer service people in mobile value-added services sector, and we also hope that by moving to new development zones, we can continue to enjoy tax advantages policies. So, overall in China, the business is growing very fast, and we are continuing to recruit talents, and we are leveraging this as one of our advantages.
Kevin Dede - Merriman
Very good. You mentioned perhaps moving some customer service folks, would that conflict with potentially disaggregating the various businesses, that software games business over time?
No, because currently our mobile value-added services, customer service people are already in the neighboring city to Beijing, Tianjin and they've been there for the last three years. We have a growing team of customer service people for our games business, and that is crucial because as players play online, they also have questions about, how I could get this to turn faster or how could I get this virtual item better? So, we have tremendous team of customer service people on-hand and continuing to recruit more. And we think that potentially consolidating our customer service people of games into a neighboring city would provide us with better management logistics of having our customer service people in one. And we are also in the process of launching mobile games and so really, having the mobile customer service people and games service people in one location, would facilitate even better synergies between mobile and game.
Kevin Dede - Merriman
Very good. Well thank you very much for taking my questions, and congratulations again on a very strong quarter.
Thank you. At this time, if you did miss any portion of today's call, you may dial into the digital replay, which will available starting this evening at 7 pm Eastern Time. For domestic parties, please dial into 877-519-4471 or for international parties, please dial into 973-341-3080 and enter the pin number of 7744290. Thank you ladies and gentlemen, this does conclude tonight's CDC Corporation's Q3 2006 earnings call. You may now disconnect your lines at this time and have a wonderful week.
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