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CDC Corporation (NASDAQ:CHINA)

Q4 2006 Earnings Call

March 29, 2007 8:30 am ET

Executives:

Monish Bahl - Director of Investor Relations

Peter Yip - Executive Vice Chairman and CEO

Xiaowei Chen – CEO, CDC Games & CFO, China.com, Inc.

Eric Musser – President, CDC Software

Verome Johnston – CFO, CDC Software

Analysts:

Michael Latimore - Raymond James

Robin Roberts - Jayhawk Capital Management

Lang Tao – SIG

Patrick Walravens - JMP Securities

Derrick Wood - Pacific Growth Equities

Mark McCall – Rockcrest Capital

Presentation:

Operator

Welcome everyone to the CDC corporation fourth quarter and year end conference 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. If you would like to pose a question during this time, please press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. It is now my pleasure to turn the floor to your host Monish Bahl, Director of Investor Relations.

Sir, you may begin your conference.

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Monish Bahl

Thank you. Good morning everyone and thank you for joining us today to discuss our results for the fourth quarter and year end 2006. With us today is Mr. Peter Yip, Chief Executive Officer of CDC Corporation and he is calling us today from Beijing. He is joined today by Dr. Xiaowei Chen, CEO of CDC games and Mr. Eric Musser, President of CDC software as well as our CFO, Verome Johnston.

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 this conference call and webcast may constitute forward looking statements which are based on managements current expectations and beliefs and are subject to a number of risks and uncertainties that would 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 effecting business spending as well as the risks referred to in the company’s filing with the SEC.

Now it is my pleasure to introduce Mr. Peter Yip, Chief Executive Officer of CDC Corporation. Peter, please go ahead.

Peter Yip

Thank you Manish and good morning everyone. We are very very pleased with the results we have posted for the fourth quarter in year end 2006.

Overall, our primary businesses are doing very well indeed. We are continuing to gain market share on a worldwide basis primarily through organic revenue growth as well through smaller strategic acquisitions. We now have the global scale and we have the infrastructure and management team, as well as the very strong balance sheet needed to maintain and continue to pursue our aggressive growth strategies.

We had a record revenue quarter in the fourth quarter and a very good geographic balance. For example, our 2006 revenue of $309 million was broken down as follows: 44% in North America, 34% in Asia Pacific including China, and 22% in Europe, Middle-East, and Africa, which also have very healthy growth margins of 54.6%.

Turning 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 fourth quarter, we grew revenue 43% on a year over year basis and our adjusted net income is now at $8.9 million or $0.70 per share.

I want to take a minute before we get into the details of the call to give you a high level view of our company, as we get asked by investors what exactly CDC Corporation is.

The best way to think about CDC is that we are a company focused in several high growth areas around the world. We have taken an approach similar to private equity, but we are focused on organic growth and development with our acquisitions. Not milking cash of our businesses and not taking out huge debt, which is what traditional private equity buyers are known for. This long term growth strategy makes us more appealing to potential acquisition candidates as they know we will continue to grow the business and we will continue to build a customer base over time and therefore this approach helps us make acquisitions at good prices with a good portion of the acquisition consideration based on an earn out. Ultimately, this is a win-win situation for CDC shareholders.

Our current business segment includes the following global software businesses with an emphasis on ERP, CRM, and business intelligence and performance management. This business is doing very well as for second consecutive quarter. We had a record license sales quarter. Our vertical focus has resulted in very good organic sales and our synergistic acquisition is very complimentary as Eric Musser, our President of CDC software will discuss later in the call.

In China, we are becoming a new media company in the marketplace. We are focused on entertainment for young adults and professionals, which is a multi billion dollar consumer market opportunity. With our reputation and our global reach, we feel we are very well positioned to succeed in this enormous consumer market in China of free line businesses here in China including games, mobile applications, and our portal businesses. Overall, we are very pleased with our results and our position in the market. We are doing everything we can to enhance and to maximize shareholder value.

With that, I will now like to turn over the presentation to Dr. Chan for an operation update on our China new media business.

Xiaowei Chen

Thank you Peter. As we previously announced in late 2006, we completed the internal reorganization of CDC games that makes CDC a direct subsidiary of CDC Corporation. We believe this restructing is a win-win for all parties involved. For China.com inc., it allows the company to concentrate its resources on its established and growing NBAS and portal businesses which are currently aligned in turns of target audiences to allow us to meet our market strategies and infrastructure requirements.

For CDC Corporation, it requires an asset with significant growth potential. I will discuss in detail about each of our business units in a moment but first I would like to highlight our Q4 financials.

We generated $20.9 million in revenue in the fourth quarter which represents a 78% increase from $11.7 million in the same quarter last year, a 24% increase from $16.9 million in the last quarter. For the whole year, our revenue was $68.6 million which represents a 58% increase from $43.4 million in 2005.

Let me now give you an overview of CDC games. Yogai, our China’s first major game with pay to play for merchandise in online games, has demonstrated lasting and growing popularity since its commercial launch in July 2005. Revenue from the game increased 27% to U.S. $10.7 million in Q4 compared to Q3. Registered users increased 16% to $42.9 million in Q4 compared to Q3 2006. As of the end of February 2007, registered users for the game had grown again to 46.5 million. The number of virtual items sold in the game increased 5% to 28.7 million units in Q4 compared to Q3. Server groups throughout China supporting Yogai and the groups other online games numbered at 57 million. Again, up 6% from 54 server groups in Q3.

At this point, we are also very pleased to announce that we have signed a definitive agreement to make a strategic investment in Endgame Corporation, the developer of Yogai. Through this outputting investment, CDC Games become Endgame’s largest external investor and has obtained exclusive distribution rights for Endgames next MMRPG, Wind Forest Fire Mountain, or WFFM in China.

WFFM is ranked as one of the top ten most anticipated games in China with many of the core designers of WFFM from the original Yogai projects. In addition, we also extended the license of Yogai to 2010 in China.

When looking at CDC Games, we believe what makes us truly unique in this market are several major differentiation factors. First, we are the first and one of the most successful companies to introduce and successfully implement the free to play model in China.

Next we have a very strong new games pipeline, in addition to the four new games to be launched in 2007 which I will tell you a little bit later, the company has also invested in a number of game developers such as Gorilla Banana, Orime Fury, Possibility Space, Endgame, and Abandon Mobile.

That brings us to our unique and last international development program and geographic expansion which I will speak to later. Leveraging on our centralized online gaming platform, CDC looks to deliver four new games in 2007 to the estimated 100 million game players in China. Special Force, Stone Age Two, Lord of the Rings Online, and most recently Chaos (inaudible).

Special Force is a first person shooter online game from Korea. It's the towline to an online gaming Korean Internet Café for 52 consecutive weeks.

We have also just acquired the distribution rights of Chaos Gem which is a casual adventure based action MMRPG. The game play is unique as it is a horizontal scroller giving it a console game feel. It is currently in open beta in its home country and performed well winning the Best Desk Game of the Month Award. There are two game modes: the story mode and the player versus player mode.

Lord of the Rings Online is the first and only massively multi player MMRPG game based on the literary works of J.R.R. Tolkien. This will be a time based model.

Stone Age Two which was voted most anticipated game of 2007 by game players in China and is licensed from Japan. It enjoyed strong recognition of Chinese gamers due to the huge success of Stone Age One.

Beside the four games anticipated to launch in 2007, we have several others giving us a very exciting pipeline. All On Theory, one of the most anticipated global online game titles for 2008 will be out in the first quarter of 2008. An innovative cross platform game across mobile and online, Freaky Preachers, will be launched in the first half of 2008. And one of the top five anticipated MMRPGs in Korea for 2008, For the Blood, will be distributed by CDC games in both India and China during the third quarter of 2008.

In order to increase CDC games operating margins over the long term, we've formed a strategy to evolve from just a leading online game publisher in China to also a leading global developer of online games. We aim to become part owners of top intellectual property rather than just a mere licensee. We believe by helping the firm, the development of online gaming partnership with game development partners will bring unique titles to the China market as well as enable us to export them to the world.

Therefore in August 2006 we announced an online game developer program which includes $20 million earmarked for investment in strategic game development partners. We have since expanded this to a $100 million fund through the establishment of a subsidiary to be named CDC Games Studio. The developer program of CDC Games Studio will focus on investment of strategic partners to accelerate the development of new and original online games for not only the China market but will also extend to include the development of games for additional targeted geographies.

The original games developer program included an investment in Gorilla Banana, the leading games developer in Korea. Gorilla Banana is working on Red Blood which is a top five most anticipated game in Korea for 2008. CDC games will have exclusive rights to distribute in China and India.

We view India as the world's next emerging games market and this expansion will further help CDC Games differentiate itself from competitors in China. This is also viewed as the first step in a continued extension which will establish a global infrastructure established by the CDC family company (inaudible) including offices in over 30 countries and more than 400 software engineers and developers in India.

In March, CDC also signed a letter of intent in an additional development partner possibility space. A developer of free to play online games founded by industry games veteran, Gauge Diander and Fonju. Gauge is a games programmer who has been credited on Blizzard’s StarCraft and in studio Age of Mythologies. And Fonju is a well known creative art director for both the game and Hollywood featured film industries including positions at Lucas Film, PA, and Liquid Entertainment.

As an important recognition of our achievements, CDC Games won multiple awards at the Third China Game Industry Annual Conference including top ten most popular games of 2006 for Yogai. This is the second year in a row for Yogai having previously received the award for top ten most popular games of 2005. The other awards received by CDC Games included most anticipated game of 2007 for Stone Age Two and top ten games operators’ award.

And for the first time this year the company will be operating outside China extending into India, Vietnam, Thailand, and Australia. We believe this geographic expansion will diversify and accelerate our revenue base. As we have discussed in the past, CDC Mobile as well as the rest of the mobile industry was impacted by policy changes in China's Ministry of Information Industry whose aim was to address industry wide objective including reducing customer complaints, increasing customer satisfaction, and promoting the healthy development of the entire sector.

We also expect the outlook for the NBS sector to continue to be difficult in the new term with net-revenue and earnings impact on all major players in the sector. Despite the industry wide regulatory impact, our NBS business has achieved success and is continuing a recovery.

Our NBS revenue in Q4 '06 was $7.1 million, an increase of 11% compared to Q3 of '06. Gross margin in Q4 '06 also increased to 64% from 57% in the previous quarter. In the fourth quarter we completed the acquisition of Timecards. We believe this acquisition complements our current mobile services and applications platform and provides the groups with the opportunity to further extend our market share.

To prepare for 3G in China, CDC Corporation announced the creation of a $100 million investment program whereby mobile units will seek strategic investment opportunities in leading 3G content providers in northeast Asia and Europe as well as the creation of new original content by the 3G market place. As part of our 3G strategy, we're creating original content for mobile phone. Our online video program, the Straight Show, which was designed as a Chinese version of the Daily Show as in the US, has received wide popularity among Chinese internet users. The Straight Show is specifically positioned as mobile content for the 3G era.

NBS is our core business unit and provides us growth opportunities. We believe the industry will consolidate toward a smaller group of more stable service providers which will ultimately provide opportunities to our NBS business in the long run. We will employ the strong cash position to selectively acquire the logistic and earnings of the credit companies in the industry and to become one of the market leaders in the new era of the industry.

The photo business is where we started and we continue to look for opportunities to leverage the great brand. In December of 2006 we were appointed by government as the exclusive west sponsor of the 2007 Asia Winter Games. The Asia Winter Games was the first formal event in Asia where all athletes registered online and also the first time broadcasted on internet media in Asia Winter Game's history.

We have also a $20 million Web 2.0 developer program. The group seeks to establish strategic relations with leading local Web 2.0 companies to accelerate the development of innovative products and services, targeted specifically for the China market.

In January 2007, as part of the Web 2.0 developer program, and in preparation for 3G arrival in China, the china.com portal acquired a 5% interest in (inaudible) holdings limited, a leading web supply zero online community in China. This investment will enable our NBS business unit to become one of the first movers in integrating Web 2.0 with 3G services in China.

The china new media business continues to broaden their expertise through strategic composition in organic growth and we look forward to an exciting 2007. With that I will turn the call to Eric Mustard, the president of our software group.

Eric Musser

Thank you and good morning everyone. I'm delighted to be speaking with you today and look forward to your questions at the end of the call.

CDC software is now established itself as the leading provider of enterprise software solutions and business services for targeted vertical industries. This is a highly differentiated strategy in the software industry which has historically been limited to a choice between commodity software in generalized enterprise systems.

We recognize and value vertical industry solutions as a natural evolution and growing trend in the returning markets for enterprise software. Our position as an established vertical industry specialist gives us a significant competitive advantage. I firmly believe that we are at the right place at the right time.

In addition to the competitive advantages we enjoy through our vertical industry specialization and applications, our formula for success includes several other key ingredients. First, we further differentiate our business with unique business services offerings.

Many of our customers seek a broad range of consulting services beyond those directly linked to their software applications. For these services most companies typically turn to a trusted advisor rather than their software vendors but because of our deep vertical expertise we often become a trusted advisor and in turn we are in a unique position to deliver these services.

As a result the value we deliver to customers is enhanced which further raises the competitive barriers effectively locking out the generalist competitors. We also offer these same services to companies that do not have our software. This helps to further diversify our revenues and provides additional opportunities for cross selling our software applications.

Another key ingredient in our formula for success is our targeted growth strategy. As we supplement our organic growth with acquisitions, our primary targets are those that add depth to our solutions vertical industries and those that enable our expansion into new vertical industries. Our acquisition strategy is very different from that of the typical consolidators. They most often use a slash and burn approach. Unlike the typical consolidators that acquire depressed companies and focus on operating cost and product investments to maximize short term profits on maintenance revenue, we seek to grow our companies by enhancing their competitive position with vertically specialized solutions. We believe that this approach is clearly more desirable and valuable from the perspective of the customer and much more viable as a growth strategy in the long run.

We think the results of this strategy speak for themselves. For the second quarter in a row we are reporting record software license revenue. This is a healthy indicator of our business and because we continue to drive 40-50% of our software sales with new and local customers. Also because of our growing reputation because of our software success in our targeted vertical industries, most of our prospects are finding us rather than us finding them.

Let’s take a look at several of the successes we’re having with our acquire, focus, and grow strategy. The first example is a company we acquired in May 2006. C360 is a leading developer of add-on applications, developer tools and vertical extension for the Microsoft dynamic CRM platform.

Since the acquisition ten months ago, we have substantially grown the business in terms of new customers, customer expansions, distributors and products. Specifically the customer base has grown by 45%. We’ve sold over 100,000 software licenses, expanded the base of distributors by nearly one third and launched 12 new products.

In addition 75% of C360 sales are now coming from indirect channels which consist of distributors and bars. We believe this channel will have positive strategic consequences to C36 software in the future. Clearly we’re growing this business very successfully, we’re now seeing the positive payback from our investments in growth oriented strategy and believe the best is yet to come.

Now let’s take a look at NVI, a company we acquired just five months ago. NVI is the leading provider of real time performance management solutions that are specialized for the requirements of food and beverage, pharmaceuticals and consumer product industries. Basically the solution proves the performance of the plant floor within a factory. This product provides additional capabilities to any enterprise application focused around the specific needs of factories.

This solution not only integrates with our own Ross enterprise suite, but has also seen substantial integration with SAP, Oracle, and other ERP applications. Our initial go to market strategy has been to sell to Ross install base where we’ve made immediate sales to the same industries.

In addition NVI adds new ERP agnostic product dimension to our manufacturing software portfolio in a rapidly growing market segment which allows us to serve the business needs of larger customers in our chosen vertical segments.

Since the acquisition we’ve reduced the average sale cycle by 50%. The sale cycle for NVI has been expanded by 100% and we conservatively estimate that the market exposure for NVI for North America has increased by more than 200%.

In addition, for comparative purposes, the license revenue for NVI for fourth quarter 2006 has seen a six and a half fold increase as compared with the fourth quarter of 2005. Despite all this success we’re still in the early stages of this acquisition and expect to report continued significant organic growth in this business well into the future.

Finally, let’s take a look at Respond, a company we acquired last month. Respond is a leading provider of complaint and feedback management systems that are largely deployed in the financial services industry and other customer service intensive industries. The company has seen a lot of success in Europe, specifically in the UK. Its customers include financial powerhouses such as Barclays, just to name a few.

The solution has delivered compelling ROI to its customers and investors can read the case studies on our web site. In fact Actfin has achieved a savings of £1 million per year using our solution. We will integrate this solution to our CRM solutions and leverage our CRM sales force and sell this in North America. We see significant potential for organic growth and expect to drive success with this acquisition just like we are doing with similar prior acquisitions.

CDC Software is continuing a major geographic and operational expansion within China and India. At the end of 2006 CDC Software had over 500 people evenly split between India and China. We expect these numbers to grow in 2007. CDC Software is currently working on opening a second center in China and expanding its existing locations in the UC Center in Bangalore, India. This expansion has already started with the work forces in both countries. As we continue to develop local beach head in these countries CDC Software was able to add 30 new customers in China in Q4 2006. We are also actively pursuing a channel strategy for all CDC software products into India and we will speak about this more throughout the year.

Turning now to our performance metrics for the quarter. Clearly we believe our success in reflected in our results. Taking a look at our key operational metrics for Q4, once again we see our top line revenue growth was driven by new customers as well as additional business from our current customers. We signed 281 software deals with new logo customers during the quarter which accounted for 53% of our software license revenue. Our software sales performance was very strong during the quarter and in fact our software license revenues were a record for the company for the second consecutive quarter. We generated 14.8 million in license revenues in Q4 which is a 45% increase year over year.

Worldwide over 406 customers upgraded or purchased additional software licenses. Our industry focus and continued investments in industry specific applications is highly valued by our existing customers which is reflected in our customer satisfaction and maintenance renewal rates of over 90%. During the quarter nearly 58% of our revenues came from the Americas, 28% from Europe and 14% from Asia pacific countries. This is a typical mix for us and we expect this mix to continue in 2007.

And with that I’ll turn the call over to Verome to share our financial results for CDC Corporation overall.

Verome Johnston

Thank you Eric, and good morning everyone. I’ll quickly run over some of the key financial highlights of the fourth quarter. CDC Corporation generated revenues of $89 million, which is a 43% increase from the year ago quarter. CDC Software had revenues of $68.1 million a 35% year over year increase. The new China Media business China.com had revenues of $20.9 million a 79% increase compared to the fourth quarter of last year.

Fourth quarter adjusted net income was $8.8 million. This was a healthy increase of 38% over the same quarter last year and for the quarter adjusted net earning per share was $0.07.

From a housekeeping perspective you may have noticed a new line item in our cost of revenues which is amortization. We periodically review our practices on income statement line out classification. Historically the company has recorded amortization of purchase technology and tangibles as component of operating expenses within the line item of depreciation and amortization expense on our statement of operations. We have reviewed industry practice and believe that classifying amortization as a component of cost of revenues is a much better practice that will make us more comparable to our peers. Prior year amounts have been reclassified to conform to the current year presentation. There is no effect on operating income, GAAP net income or adjusted net income.

The full year amortization expense is $5 million in 2005 and approximately $7.2 million in 2006. This is about 2% of revenue.

Regarding our earnings per share, our share count increased in the quarter due to the exchangeable bond venture we issued in Q4. We finished the quarter with about 128 million shares on a fully diluted basis.

I would now like to discuss some of the balance sheet metrics. We finished the fourth quarter with non-GAAP net cash of about $196 million which is up from the last quarter of $191 million, despite our recent acquisitions and investments. We net out the exchangeable bond for the determination of non-GAAP net cash. I would also like to update you on our share of buy back programs.

As of December 31, 2006, we have repurchased approximately 6.1 million shares at a total cost basis of approximately $27.9 million. We still have $12.1 million left in the $40 million dollar share buy back previously approved by our board. We will look to be opportunistic in our future buy backs under our plan.

I would like to turn the call over to Peter for closing remarks.

Peter Yip

At this time, we are reiterating our guidance for 2007. Based on the company expectations, CDC Corporation anticipates revenue in the range of $415 million to $420 million for fiscal 2007, an increase of over 35% compared to 2006 revenue. The company anticipates adjusted net income of $57-62 million for fiscal year 2007.

In summary, we believe that the company structure is much improved and the operating unit is well positioned for continued success in their target markets in 2007 and beyond. The environment is right and the stars are aligned for our business unit. We will continue to execute, we will continue to grow both organically and through target acquisitions. At this point, we are ready to take your questions.

Question-and-Answer Session:

Monish Bahl

Thank you Peter. Ladies and Gentleman, we’re ready to take your questions but Operator, before you queue everyone up, there were three questions that have come up online that we would like to address quickly. The first question relates to the share buy-back, so Peter could you comment on the share buy back. The second question is with regards to the (inaudible) status. And the third question is for Eric, and it deals with organic growth in the software business and what are the implications for that. Thank you.

Peter Yip

Yeah, let me take the question on the share buy-back as well as on (inaudible). On the share buy back, we believe our stock is extremely undervalued relative to its sum of parts where you look at each of our businesses and compare to its peers. And we’ll continue to be very aggressive with the share buy-back as long as it is within our trading window and within the SEC and Nasdaq regulations. On the (inaudible) status, I must apologize that I cannot comment beyond what we have said in the previous quarter. Our in-house SEC counsel has said that we cannot comment any further. Thank you very much.

Eric Musser

So Peter, let me pick up the last question and I didn’t get the specifics there, but it related to the organic growth in software group. We are seeing great organic growth throughout software. And it’s really based upon the sales efforts across the board on a worldwide basis. We’re seeing that as we continue to add new logo accounts. New logos are what drive the software business for us and we continue to see this 40-50% of our license revenue attributed to new logos or new customers. And these customers are directly in the verticals that we’re targeting today.

And very interesting, we’re seeing the move from in the past, where we had to find all of these customers, now these prospects are coming to us. And so, the dynamics for us and sales cycles changed significantly and we see this continuing through 2007. We have good visibility into 2007 and we believe this organic growth will hold into the future. Monique, do you want to finish up with additional questions that might be coming in?

Question-and-Answer Session

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Operator

Thank you. At this time, I would like to remind everyone, if you would like to pose a question, press star and then the number one on your phone key pad. We’ll pause for just a moment to compile the Q&A roster.

Our first question is coming from Mike Latimore from Raymond James. Please go ahead.

Michael Latimore - Raymond James

Yes, good morning everybody and great quarter and year there. With regards to the new customers you’re winning the software business, what is the main sort of driver behind a new customer…if they have a Legacy product that just needs upgrading or they don’t have a product, or is that that they maybe have Sierra, Emory, or (inaudible) division and want to go enterprise-wide. Can you give a little more color as to just what’s going on in the market from those standpoints?

Eric Musser

Mike, this is Eric, I’ll take that one Peter.

What we’re seeing, on the Sierra M side, a lot of the Sierra M buyers have bought Sierra M, two maybe three times and they might have a large enterprise system and bought thousands of users a couple years ago and never deployed those because of the complexity. Then they might have moved to a very simple solution, on-demand solutions that didn’t quite meet the needs of all their users, and so they still have large populations of people that are going un-served. So as a result of that, offering very verticalized solutions for those groups has allowed us to accelerate our sales capabilities.

We’ll look at an example in financial services, our win rates in financial services are over 70%, so on average we’re winning three out of every four deals. That’s an incredible number. Historically, we’ve never seen those numbers before.

Then we turn to the Enterprise software for process manufacturing, and we see that our verticalized solutions and our traditional competitors are no longer there. We’ve seen a lot of consolidation happen through private equity, and a lot of those guys are no longer competing in the marketplace and/or we see that not the focus that we have from some of the bigger players like SAP or Oracle out there.

So we get back to your question that says what are they doing, what are they replacing? Some of them are replacing older systems out there, but there is still a very large base of customers in process manufacture that just have homegrown systems or systems that have been patched together. And so, with that there’s great opportunity for expansion in that market.

Michael Latimore - Raymond James

Thanks, and I think historically, you’ve seen through this no decision as being a competitor here, are customers going down the path and then looking at a new system but then decide not to make a decision? Can you talk a little bit about that dynamic? Has it changed much in the last 6-12 months?

Eric Musser

It hasn’t changed much, but here during our sales kick-off meeting in January, I know we’re talking about 2006 here, but in January we had our sales kick-off, and one of the education processes and coaching that we went through was related to how do you manage some no decisions, how do you manage through that to make sure that doesn’t happen to you in a sales cycle. That’s still our largest competitor out there today.

Michael Latimore - Raymond James

OK, and this last question on the Respond group. I know it’s a recent acquisition here, but maybe you can talk a little about what you’re seeing there in terms of new customers, people outside the UK, being able to cross-sell that product, just a little more color in that and whether you have retained most of those employees?

Eric Musser

Yes, the employees, we’ve retained that group and it’s a key organization for us as we move forward and so the management team is intact. Really, to look at it, we’re doing similar activities with what we did with MPI. We had a great product in Respond in the European market. We have an amazing infrastructure worldwide to sell and we’re now starting to push that Respond product first into North America and then into other geographies. And what we are seeing, we are seeing demand out there and we are gearing up and as he said, this is very early for us and it’s just one month into this acquisition cycle. But expect more as we talk about Q1 and Q2 related to Respond.

Michael Latimore - Raymond James

OK thanks and a great year there.

Operator

Thank you. Your next question is coming from Robin Roberts with Jay Hawke. Please go ahead.

Robin Roberts - Jayhawk Capital Management

Hi, congratulations for a great year. Peter, as related to that question of share buy-back, I agree with you that your stock price is well below your intrinsic value, so if I look at the sum of all parts and just apply three times revenue for software, that means software is about $1 billion of value and if I apply a group average of four times revenue to gains, that’s about $600 million of value added. And other businesses you have plus cash, the intrinsic value of your company should be north of $20 per share and yet your stock price is below $10. So, there must be some misperception or misunderstanding on the street for wondering perspective investors. What are the common misperceptions you see and how do you plan to dispel those misperceptions going forward?

Peter Yip

Thank you Robin. This is a fantastic question to say enough. I agree with your assessment in term of the true value of this company and we're doing everything we can in term of getting our message across while meeting many analysts. And even with the progress we make and unfortunately we're still a…many people consider us undercover if you will. We have five analysts currently covering our stock and we're making progress let me assure you that. We're getting a lot of attention and our stock is trading much better than a year ago. It's almost ten times.

Our average trading volume is over $3 million per day and we certainly have made a lot of progress moving our stock prize for the past 12 months. We're heading in the right direction and certainly I'll agree with you, if we have ten analysts double what we have today, our stock will most certainly reflect trading the way we are today. But we are heading the right direction. I'm very pleased and thank you very much for your question and your comment.

Robin Roberts - Jayhawk Capital Management

OK, just a follow up question that's related to the software business. What is the adjusted operating margin for this software business in '06 and where do you think you can get the operating margin in '07?

Peter Yip

Let me turn this to Eric. He is running our software business.

Eric Musser

So, a couple things. One is we've really not gone forward with details related to operating margins but we do see operating margin expansion as we move forward into 2007 specifically related to a couple different functions that are going on across our organization. One is I spoke of a little bit related to India and China. We have been doing more and more work from India and China and adding more services to our customers.

An example of that is we're doing a lot of remote database activity, we're doing system performance. Typically in the past we would send somebody on sight to do that and then we did that remotely in North America and now we're doing that from our India center. In addition to that we are doing some amazing development projects for customers in many different vertical industries that we have and typically that was done on shore, on site before, and now they are being done off shore and that is providing increase in margin for us.

As we see this move forward and we see expansion in our services we will also see expansion in our margins. The other part to this is that the growth and just the size of our business will help us with margin expansion. So today I think that we've built up some amazing infrastructure in the organization today that will allow us to scale up without seeing the same related cost occur in the business itself and that will help us.

Robin Roberts - Jayhawk Capital Management

OK. My next question is in relation to games. Can you give us some detail that is related to the timeline as your new games release in '07 and as related to the new games based on the beta test you have done and were so preliminary marketing feedback? I was wondering what levels you can do in the games business in '07.

Xiaowei Chen

For the games business, Peter let me take this question. Robin thank you for your question and I must apologize your second part of the question was not entirely clear, but let me first tell you about our new games pipeline and timing.

Our next game coming up is Special Force. This game is currently in close beta two and we expect to have open beta test and commercial launch at latest by May. It is a highly anticipated game and when it rolls out it will be the first first-person shooter game in China and we have a great number of marketing plans, very innovative and creative marketing plans, and we're currently in the process of talking to a number of big brand co-marketing partners or sponsors in the China market and we are currently making a TV series based on this game with the same name. So our co-marketing sponsor will have their branding opportunities not only as commercial items in the game but also as prop placement in the TV series as well as being the sponsor of our competition that will be organized across China.

So we have a lot of anticipation for this game. And for the rest of 2007 in addition to Yogai that is running now and Special Force that will roll out in May that I talked a little bit about in the earlier part of this call, that we just signed on yesterday. It is a game that is already in open beta in Korea, its home country, and its’ already won the game of the month award in Korea and we are expecting to launch it in either the later part of Q2 or at latest by early part of Q3.

And then we have Stone Age Two which has won the most anticipated game award of 2007 and that will be rolled out definitely in 2007 potentially in Q3 or Q4, and then we have Lord of the Rings which by the way will be in open beta in North America and Europe later of April, I think it's April 26th that it will go into open beta in North America and Europe. We will launch it in China in some time of Q4 of '07.

So all together we are looking at Yogai which itself is still growing very openly. We most recently made our daily revenue record on Valentine's Day and then in addition we have four new games coming out in 2007 and I apologize Robin, the phone line was static and I didn't hear the second part of your question.

Robin Roberts - Jayhawk Capital Management

Yeah my second part of the question is as related to the new games releases and based on the market reception data you have so far and also your beta test results, roughly what levels of revenue do you think you can do in the games business in '07?

Xiaowei Chen

We have already given our full year guidance in the earlier part of the call. Our games business is an integral part of the full year guidance and we are very confident that we can deliver such numbers.

Robin Roberts - Jayhawk Capital Management

OK. Thank you.

Operator

Thank you. Your next question is coming from Lang Tao with SIG. Please go ahead.

Lang Tao – SIG

Thank you. Two questions. Can you give me the cash flow for the 2006 and also the CapEx and the net cash released in the oppositions and what is your plans for the CapEx as related to cash outflow in '07? And my second question is on the gaming part (inaudible) when you guys say open a new game is that mainly (inaudible)and not the earlier contribution so is it true that (inaudible) in 2008?

Peter Yip

Let me answer the game question and Xiaowei will answer on the cash flow and the CapEx. Why don't you go first?

Xiaowei Chen

Thank you. Actually I was just going to say maybe it's my line that is static? I cannot hear Lang speaking and I know it must have something to do with me but I really cannot hear the question. Do you mind repeating your second question?

Lang Tao – SIG

Yes. My second question is on the timing of the game. So is my understanding correct that we are going to see definitive contribution of your games in 2008 rather than 2007?

Xiaowei Chen

Oh you're talking about the contribution of the games that's incorporated to now?

Lang Tao – SIG

Yes.

Xiaowei Chen

Sorry I'm trying to understand your question. You're saying that if we're in closed beta do we think that most will be in 2008 as opposed to 2007?

Lang Tao – SIG

Sorry, that was not my question. My question is (inaudible).

Xiaowei Chen

Timing of these new games?

Lang Tao – SIG

Yes, the revenue contribution of the new games. Not just the close but the open ones.

Xiaowei Chen

I apologize, I can only answer your question as I guess what your question is. You would like me to comment on the timing of revenue contribution as opposed to launch of the game?

Lang Tao – SIG

Yes, exactly.

Xiaowei Chen

OK. Generally the conventional, let me give you the experience of Yogai. In Yogai we had closed data for about a month, open data for about a month, and then commercial launch for a month after open data. So in other words you basically start collecting revenue two months after you start closed data. For a game such as Special Force we think we are going to significantly shorten the span between the timing of open data and commercial launch because of the test that we’re doing now in open data is the virtual items. So when that is tested and stable there is no reason why we cannot start open data and commercial launch at the same time. So I hope that answers your question, Neil. I really apologize for the static of the line.

Lang Tao – SIG

Yeah. That’s good.

Operator

Thank you. Your next question is coming from Patrick Walravens with JMP Securities. Please go ahead.

Patrick Walravens - JMP Securities

Thank you very much and congratulations on the results. So my first question is how do you accelerate sales of the pivotal products in China?

Eric Musser

So Pat, thanks for your question. The acceleration in China for us is specifically happening in a couple of areas related to the CRM as well as the enterprise solutions for process manufacturing. I think that you’ve probably seen the announcement that we’ve put out, probably about a couple of months ago for the actuall end of 2006 related to Edmond Lau who’s now running China for me. Since then we’ve put in a number of programs, grassroots programs in order to accelerate and add a (inaudible) channel partners. You’re probably familiar with the program and fund that we’ve put into place to help in marketing as well as sales with channel partners that are out there.

So a couple of things are happening. One is we are looking at the financial services area for our CRM products and we did a partnership with Excel that we are in the early stages of and that has been moving forward very nicely. We’ve also seen over the past year that investments into process manufacturing specifically for ERP are starting to bear some fruit. As you’ve seen we’ve added continued new customers every single quarter in China. If I look in, going back historically, we would see you know how Ross or Pivotal combined might have done one deal in China as a result of a multi national being sold. Today we’re doing anywhere between 20-35 deals a quarter in China. And that continues to grow for us.

Patrick Walravens - JMP Securities

Thank you and my second question is also in the China area which is how do you build more of the IT services capabilities out here? Out here being a little confusing… in Beijing today? How do you build up more of the China-based IT services capabilities?

Eric Musser

There are a couple things that we’re doing. You’re probably aware then, if you’re in China right now, that we’ve continually expanded our feet on the street there, and that’s going on not only directly through our own growth, but also we are looking a number of different acquisitions in China that are very attractive to us that are very much the same as the business that we’ve been acquiring that have been India-based. So, not only are we going to be looking at organic growth within our own business, but also some acquisitions to help fuel that. It’s a key part of our strategy. It’s worked for us in India and we expect to see the same results in China.

It’s been very interesting that we see the differences between India and China from an IT perspective or from an outsource development perspective, India’s had a little bit more experience with this, so it becomes very relevant in the age of the people of the people you can employ and how long they’ve been in the industry. And so, our staff in China tends to be a little bit younger, we tend to augment that with people that have lived in North America for a portion of time, born in China though, we’re bringing them back into China to lead some of those groups for us. But, we have great expectations. I think you’ll see some good results coming out of it when we start talking about 2007 related to China and specifically those areas.

Patrick Walravens - JMP Securities

Great, thanks very much.

Operator

Thank you. Your next question is coming from Derrick Wood with Pacific Growth Equities.

Derrick Wood - Pacific Growth Equities

Good morning. I was hoping you could give us more specifics on the Nokia deal in regards to the Mobile division. Is there anything you could share with us in terms of revenue sharing, marketing costs, the number of handsets you expect to be installed, and what the ’07 revenue may be? And as a follow-up, can you give us an update on your 3G investment initiative and share what opportunities you have found compelling? Thank you.

Xiaowei Chen

I could take this question. Thank you for your questions. In terms of our mobile partnership deal with Nokia, what it is, is that we have a mobile downloadable service that we now imbed into a series of Nokia’s latest products. So Nokia comes out with new products every season, and so in Nokia’s latest line of products, we have our downloadable…essentially it’s like a mobile application that is imbedded in a Nokia handset and it allows the users of these mobile service to be able to download the kind of entertainment and information that they prefer to use such as say, weather forecast and other services. And we have a revenue share agreement with Nokia.

Now, in terms of our 3G investment in China, we are currently positioning ourselves for 3G’s arrival in China. The way we see it, 3G, when it arrives, will change and shape the current Chinese mobile service provider sector in a fundamental way. The previous or maybe even current position of mobile service providers as the middle person between content providers and end user or consumers will be eliminated, because very powerful Chinese mobile operators, namely China Mobile and China UniCom, could just directly partner with the content providers such as music makers or other graphics makers, and directly download the kind of ringtones or wallpaper or internet onto users phones.

Quite frankly, we see in the coming era, mobile phones being used in multiple functions in China, which is far beyond just a communications tool. Young people will use it as basically your MP3, your Google even. So, for us, the whole position or the whole strategy is about moving upwards, up the value chain, more into the content provider area. And that’s why in the earlier part of the call, I talked about us investing in Web 2.0 companies which may not seem to have anything to do with 3G right now, but the idea is that Web 2.0 users can upload their own music videos, their own MTV if you will, and then by investing in 2.0 companies, we allow users to upload their own content.

From here, we actually select the premium quality, intellectual property… we basically package the stars, and we own the IP rights, and we merge Web 2.0 with 3G when 3G arrives in China and this exactly what we’re doing. Now we’re looking into markets across the very narrow strait in Japan where 3G is already arriving, and we’re currently the leading Japanese mobile content and online mobile game provider in Japan.

There’s a lot to be learned from the Japanese market where 3G is already there, and due to legal concerns because we haven’t closed the specific deals yet, I cannot share anymore detailed information here. But, I would like to let you know that we’re very actively positioning ourselves for 3G’s arrival in China, and we’re borrowing a lot of advanced experience by looking into companies in Japan. Thank you for your questions.

Operator

Thank you, your last question is coming from Mark McCall with Rockcrest Capital. Please go ahead.

Mark McCall – Rockcrest Capital

Yes, congratulations on a good quarter. My question is for Eric. It looks like in your business services unit, the gross margins were down a fair amount from the previous quarters, it looks like it’s close to 25% versus 31% which had been the average and obviously it cost you a little bit of margin dollars. Can you outline what happened there and what your expectation is going forward?

Eric Musser

Now, if you take a look at the business services across the board, we’ve continued to increase some of the costs related. We have some costs related to bringing people into North America, and so some of that is related to that. But our expectation for that business is that it continues to do well for us. We see great expansion related to the amount of utilization of those organizations. So, we don’t see any long term fall off of that business. It continues to grow for us, and we do expect to see margin expansion.

Mark McCall – Rockcrest Capital

So from a modeling standpoint, it’s been pretty consistently a low 30’s gross margin business and that’s where modeling should continue forward. So this quarter was fairly one time in nature?

Eric Musser

That is correct.

Mark McCall – Rockcrest Capital

Ok. Thank you.

Operator

Thank you. At this time, we have reached the conclusion of our teleconference. I would like to thank you for your participation and you may now disconnect your lines at this time.

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