GigaMedia Ltd (GIGM) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the GigaMedia Limited conference call to discuss the third quarter 2006 financial results. [OPERATOR INSTRUCTIONS]. I would now like to turn the conference over to Mr. Brad Miller. Please go ahead, Mr. Miller.

Thank you. This is Brad Miller, Investor Relations Director of GigaMedia. Welcome to our third quarter 2006 results conference call for GigaMedia Limited. Here again to speak with you and answer your questions today are Arthur Wang, our CEO, and Thomas Hui, our CFO.

Before I turn it over to today's speakers, I would like to remind you that a number of forward-looking statements will be made during this conference call. Forward-looking statements are any statements that are not historical facts. These forward-looking statements are based on the current expectations of GigaMedia and there can be no assurance that such expectations will prove to be correct.

Because forward-looking statements involve risks and uncertainties, GigaMedia's actual results could differ materially from these statements. Information about factors that could cause and in some cases have caused such differences can be found in GigaMedia's Annual Report on Form 20-F filed with the U.S. Securities and Exchange Commission in June 2006.

This presentation is being made on November 9, 2006. The content of this presentation contains time-sensitive information that is accurate only as of the time hereof. If any portion of this presentation is rebroadcast, retransmitted or redistributed at a later date, GigaMedia will not be reviewing or updating the material that is contained therein.

The agenda for today's call includes, first, a review by Arthur Wang of 2006 Q3 business activities and financial performance. Thomas Hui will then provide details on our financial results during the third quarter period. After the speaker presentations, we will go into a question and answer session.

And with that, I would like to turn the call over to Arthur, our CEO.

Thanks, Brad, and thank you all for joining us. We were delighted with our performance in the third quarter. Consolidated net profit was $6.5m, up 270% year-over-year, driven by record operating income of $6m, a 441% jump from last year. To put these numbers into context, in this quarter alone, we generated more profit than all of last year.

Today's results provide proof positive of the enormous potential of our international strategy to build the dominant online entertainment provider serving the giant, non-English language markets of the world.

In just over two years, we have traveled far from our starting position as a legacy ISP and music retailer. We are thrilled with our progress to date and have great confidence that we are on track for more record performance in the quarters ahead of us.

Before speaking about our major business drivers, let me highlight a few points. First, operating results. Once again, the most important news today is the strong growth in our operating income, which climbed over $6m for the first time in our Company's history. Noteworthy, the growth of 31% sequentially over the previous three-month period. We've concentrated much time and attention on continuing to improve our execution and are pleased with the progress we are making. We look forward to further gains built on continued solid execution.

Second, early returns. In past quarters, I've maintained that the performance of Everest Poker and our casino software in Continental Europe represented only the very early returns on our investments. I think our third quarter results provide strong support for this proposition. Poker revenues climbed another 40% while we doubled the number of active players, both as compared to Q2. Moreover, we remain very excited by the momentum we are seeing. In the third quarter, we added 31,000 new money depositing players. We are committed to continue to drive this growth to capitalize on these early results, to capture significant market share in countries across Europe.

Third, the impact of new U.S. regulation. On October 13, the U.S. adopted a new ban on Internet gaming. As we have previously noted, GigaMedia does now and has always generated all its revenue from markets outside the United States. And therefore, we anticipate no adverse financial impact from this new law.

Let me briefly describe for you now our primary growth drivers as well as what we are doing to deliver continued strong growth in 2007.

First, our traditional poker and gaming software business. From the start, our strategy has been to bypass the crowded, and now prohibited, U.S. market and focus on the enormous non-English language community by offering our end-to-end software solution in 11 languages. In the early days, it was difficult to speak with certainty about the potential for Everest Poker in Europe. Would players in Europe take to poker as they have in the U.S.? While the market is still very young, I think today's results provide solid proof of the market potential. By leveraging our first mover advantage in Continental Europe and over seven years of experience in these markets, we've enjoyed dramatic growth.

Much of our success has come from the strength of our suite of products. We continually innovate our online poker and traditional casino products. In our poker business, we've added new features, such as hand history tracking, so that players may keep a record of their hands. And we are now finishing a player notes feature for players to record observations about competitors.

In our casino software business, we offer at least one new game a month. New games such as video slots and updated versions of popular games have kept interest high and proved very popular. Complementing all of this are ongoing code enhancements and scalability improvements.

Our success has also been related to highly effective marketing, which again leverages our deep experience in international markets. Everest Poker and Everest Casino have become, in a short period of time, leading brands in our target markets. During the third quarter, we saw the launch of a major mass media campaign utilizing both television and web advertisements.

These initiatives will continue in the fourth quarter and be joined by the launch of the Everest Poker Nordic Summit. Following the hugely successful and overbooked Everest Poker European Championship, a tour which recently concluded in a finale in Barcelona, we are very excited about the rollout of this new tour in Scandinavia.

Let me turn now to our second growth driver, our Asian games business. The second quarter -- the third quarter has been very busy with many initiatives. Let me highlight just two. First, we expanded our market reach beyond our traditional strongholds of Taiwan and Hong Kong into Mainland China and launched a new casual game platform called T2Fun with our strategic partner and investing company T2CN, operator of the leading sports casual game in China. T2Fun offers over 70 casual games and has tens of thousands of daily visitors. Though, for the time being, we expect limited revenue contribution.

Second, we've been focused on strengthening our game pipeline by working with leading game studios and publishers to bring exciting top titles to the Asian market. Given our proven leadership in casual games, we believe we are well positioned to secure and operate such killer titles, which promise strong growth for our core casual game platform.

Turning now to real money MahJong and other cash wager games, our planned third quarter launch has been delayed due to a number of uncertainties involving potential partners, in light of the major change in gaming environment in the United States. Now that the situation has become clear, we are excited to proceed and have entered into a preliminary agreement with a leading player in global online gaming, and expect to report our first revenue contribution, albeit small, during this fourth quarter. We expect this business to ramp up considerably in the first half of 2007 and become a major contributor for the full year.

On top of these growth initiatives, we continue to consider strategic acquisitions in the online entertainment sector that would drive long-term growth and be accretive to our earnings.

In sum, in the third quarter the new Giga continued to deliver strong performance. Our growth today gives us confidence in our strategic direction and operational plans. We are executing well, generating strong momentum in high margin, high growth businesses. We are indeed building a new GigaMedia and look forward to growing shareholder value with your continued support.

Let me now turn the call over to our CFO, Thomas Hui.

Thanks, Arthur. Let me turn now to look at our financial performance for the third quarter, starting first with our consolidated results and moving later to look at each business unit.

GigaMedia again delivered excellent organic growth in the third quarter of 2006. Simply put, this is a blowout quarter. We achieved record results in top line revenue and operating income. Given that we delivered performance this strong during our weakest quarter seasonally, we are very excited about the future growth prospects for our business.

Let me quickly summarize the results for this quarter. Consolidated revenue grew 118% year-over-year or 15% quarter-over-quarter to $24.2m. Operating income rose 441% year-over-year and 31% sequentially to $6m, with our operating income margin expanding to 25% from 21.9% last quarter.

The key drivers for the significant growth of our revenue and operating income was record performance in our poker software product. More on the exciting performance of this business in a moment.

The net income jumped 278% year-over-year to $6.5m, resulting in fully diluted earnings per share of $0.11. As you will recall, our second quarter net income benefited from a one-time gain as a result of the sale of the ADSL business in May this year. If we remove the effect of one-time gains, our $6.5m net income this quarter also represents a significant improvement over the last quarter.

We also strengthened our balance sheet in the quarter. During the quarter we grew our cash, cash equivalents and current marketable securities from $30.7m to $35m. Net operating cash flow for the period was $8m. Capital expenditure was flat at $1.3m for the quarter.

As you will note, during the period we redeemed the full amount of the $15m convertible bond outstanding, which was issued in relation to our acquisition of FunTown at the beginning of the year. This early redemption resulted in two major financial benefits. First, it removed the potential dilutive effect of the convertible bond. And second, it generated a one-time gain of $627,000 in the quarter. The redemption was financed by internally generated operating cash flow and short-term bank loans. As a result, we recorded total debt of $12.7m at the end of the third quarter.

Overall, then, our 3Q results point to a strong business with high margins and high growth that is continuing to gain momentum. We are enthusiastic about our progress to date and confident that we will be able to sustain strong growth by continuing to methodically build on our online entertainment platforms.

Let's now look at our business unit performance. The poker and traditional gaming software business, CESL. The third quarter is traditionally the weakest period for this business. Despite this, the business unit delivered all-time highs in revenues and net income. This was clearly an exceptional quarter.

During the third quarter, the business unit generated $14.7m in revenue, representing 157% year-over-year growth and 26% growth sequentially. Operating income increased 203% from the same period in 2005 and 29% sequentially. Net income grew to $4.5m, a 240% improvement year-over-year or 34% growth sequentially.

Let me quickly break this down further into results for our poker software business and our traditional gaming software business. Our poker business again achieved record results. Revenues from our poker software products were $8.4m, up 40% sequentially. Poker revenues represented 57% of CESL's total revenue. This growth was driven by the increase in number of poker players on our platform. During the quarter, we added approximately 31,000 new depositing real money poker players. Approximately 61,000 active depositing real money customers played Everest Poker during the third quarter, up 40% sequentially.

The traditional gaming software business also delivered strong results. Third quarter revenues from the traditional gaming software business were $6.4m. This represented a 38% increase year-over-year and 11% sequential growth. During the quarter, we continued to capitalize on our unique ability to offer gaming software in 16 native languages, as well as extensive relationship and deep experience from over seven years of focusing on the Continental European markets.

Our strategy has also leveraged development by our licensees of the Everest brand, whose Everest Poker and Everest Casino Gaming Solutions are exclusively powered by our software. Everest Poker user and revenue growth has been driven by high-profile marketing and brand-building initiatives. During the fourth quarter, our licensees will be kicking off another exciting poker tour, the Everest Poker Nordic Summit, which targets Scandinavian players.

Also driving growth were additional initiatives in the third quarter. On the product side, we completed significant code enhancements, launched product upgrades and optimized player bonuses and conversion rates. In marketing, television ads were launched and search engine optimization efforts were strengthened to better capture demand in our targeted markets. All of these actions continue to fuel strong growth in our business and strengthen our leading position in Continental Europe.

Moving on to the online casual game business, FunTown. FunTown delivered solid performance in the third quarter. During the period, we increased our marketing and product investments in the platform to strengthen our brand. As a result of these initiatives, we began to generate some momentum in our top line and experienced a slight reduction in our operating margin.

Revenues in the period increased 6% sequentially, while net income declined 1% sequentially. Operating margin decreased to 28% from 31.3% in the previous quarter, and EBITDA margin was a healthy 38.2%.

Let me briefly go over a few of the key initiatives in the period. During the third quarter, we increased our marketing initiatives, which include the launch of a large mass media campaign with television commercials in Taiwan focused on our leading MahJong offering and traditional board games. We also held our annual land-based MahJong tournament, a huge marketing event for us. Our tournament was once again attended by thousands of participants and hundreds of our member guilds, all competing for game-related prizes.

On the product side, we continue our program of monthly release of new avatar and virtual items, which allows us to incorporate real-world styles and events into our games. In addition, our newly licensed racing game, Tales Runner, is beginning to yield results. It's now one of the top performing online games in Hong Kong. We expect contributions from Tales Runner to increase in the fourth quarter.

Overall, we see great opportunity for our online casual game business in Greater China. We are well positioned to capitalize on our number one position in Taiwan through increased licensing of third party developed games, including top titles from leading international developers.

We also expect to grow geographically through our partnership with T2CN, a leader in online sports games in China. T2CN recently announced an exciting joint venture with a leading online game developer and operator in Korea named CJ Internet. We expect this joint venture to provide access to a very deep online game pipeline.

Finally, a quick word on our legacy ISP business. As we have indicated previously, we view this as a non-core business. We have decided to explore the sale of the business and have retained financial advisors.

To summarize, in our weakest quarter seasonally, we outperformed, achieving record operating results. Our growth momentum in the fourth quarter remains strong in each of our core business lines. On top of this, we continue to pursue strategic acquisitions and transactions that will be accretive to our results. Much exciting work is ahead of us and we look forward to sharing it with you, as we continue to strengthen our business and grow shareholder value.

Thank you.

Thanks, Thomas. We will now move into a question and answer session. Operator, at this point we would like to open the call up to questions.

[OPERATOR INSTRUCTIONS]. Your first question comes from the line of Traci Mangini with ThinkEquity Partners.

Thanks. Hello. Congratulations, by the way. That was a fantastic quarter. I just had a couple of questions. First off, with respect to the real money MahJong, is there any more detail that you can give us with respect to, say, geographic focus with this partnership and also economics?

Sure. Thanks, Traci. As we're in the process of finalizing our business arrangement, there's a limited amount that I can speak to at present. We look forward to making a major announcement shortly. And I would say that we believe our products are very strong and the market's interest is very high. So we remain very confident in our real money MahJong and Asian game strategy.

Okay. Is your strategy also to -- is it going to be an exclusive with this one particular party? Or will you also look for other partnerships as well?

At this point, we're considering a non-exclusive arrangement where we will have the flexibility to work with other partners also.

Okay, great. And then just on the CESL business, obviously there's always been competition in your markets, but I would imagine it's certainly heating up with the changes in the U.S. laws here. Is there anything that gives you concern with respect to that? And is there any change to your strategy over there to try and combat that increase in competition?

Sure. This is what I would say. Tough competition in our markets is nothing new. As a management team, we always take competition very seriously. But actually net/net we think the recent prohibitions in the U.S. probably are a benefit to GigaMedia. First of all, the prohibitions have literally wiped out many of our direct competitors. Those that have survived are weakened, faced with a very challenging task of realigning their cost structures and then turning to drive growth in new and foreign markets without necessarily the localized products, and certainly without the large cash flow streams that used to come from the United States market.

In our target marketplaces in Europe, for example, it is sensible to speak of it as one geography but it is in truth many, many disparate countries, markets, languages. Quite a challenging market.

So I guess I would say that, yes, we expect there to be more competition in 2007 but we feel stronger overall. And we continue to have significant confidence, I think, in our ability to grow our business in Europe.

Great, thank you. And then, with respect to the operating margin in the CESL business, it looked like it jumped up quite attractively in the third quarter. I would imagine with the -- with more marketing, maybe increased marketing in the fourth quarter, that would trend back to more normalized levels or --?

Yes, Traci, the operating margin was 31.6% in Q3, which is comparable to the Q2 31%. As we have indicated to the market, we feel the market potential warrants quite a bit of investment at this stage for us to continue to expand our platform and leadership position. And the high 20s to 30s kind of margin is where we're aiming for. And as we continue to turn up the volume of marketing, yes, there is a chance that this 31% could go back down to around 30%. But it will be around the high 20s to low 30s.

Okay. And I didn't see if you released it. Did you give the peak and current player base for the poker network?

Let me just look for that.

No, Traci. It was not in our formal release. Let's see if we can provide that here.

Okay.

It was about 19,000.

And that's all real money?

Yes. Well, actually, no, I think this includes everything, yes.

Okay. And then with FunTown, is there any more information you can give on the T2Fun and how you plan to monetize that?

Well, at present, Traci, we're -- we've only just introduced the platform to the market in the third quarter and we're using this period to build it out, to ramp it up. And so at present we're offering it on essentially a play for free basis. There's some very limited monetization. But we're looking first to grow the platform.

Okay. And then just a very last question on the divestiture of the ISP. At one point you had hoped to dispose of that before year-end. Is there any timing update you can share with us?

As we mentioned in our release, we have retained a financial advisor and we are in discussions with a potential purchaser. But at this point in time, that's all we can say.

Okay. Thank you so much.

Thank you.

Thank you.

Your next question comes from the line of Chang Qiu with Forun Technology Research.

Right. Good evening, Arthur and Tom. Congratulations on very good results.

Thanks, Chang.

Yes, I have a few questions. Given the summer months are weaker months for you and you achieved 40% sequential growth on the poker side and 11% growth on the traditional games side, what you can give us as guidance for Q4 and also Q1, the traditionally stronger quarters in terms of revenue growth?

Chang, I will say the following. The 40% sequential growth we achieved on the poker product obviously already, as we have mentioned multiple times in past calls, already [inherently] at 40% already got affected by seasonality. You remember that the Q2 versus Q1 sequential growth was 65%, so it's already a reduced growth rate. We believe that we have the effect of seasonality in it.

So we certainly hope to achieve a higher than 40% growth rate in this quarter, Q4 versus Q3, and we are on track to doing so. But we've not been happy to give our exact numerical guideline at this stage. So that's how we would see the growth in this next coming quarter.

That's for the poker side. What about the traditional gaming side, the casino side?

Yes. I think traditional gaming side, we also observed a growth of 11% sequentially without the historical effect of seasonality. Primary reason, one of which is the spillover effect from the Everest Poker business, with the whole Everest brand-building initiative there. So we are seeing some crossover of players moving from the poker player games to the casino games.

So if that continues, we think that we can again increase the growth rate more than what we had achieved sequentially in Q3. But again, the seasonality factor did not come in and so that would have masked already the typical 20% to 30% growth, Q4 versus Q3, historically. So we don't think we can go to that level of high growth rate but hopefully achieve a high single digit to 10% kind of growth rate on a sequential basis.

Okay. Another issue is how confident are you regarding your growth in terms of a sustainable growth, which means maybe this quarter maybe some of your competitors get too worried about the U.S. [legislature] and somehow you maybe benefit in that regard? Or there are other issues here?

Well, Chang, I have to say definitely that many of our toughest competitors in Europe have been very occupied with the situation in the United States. It had a dramatic effect on their business. Many of them lost 60, 70, 80% of their revenue. Several of them have gone bankrupt. Those of them that have survived are facing a major restructuring.

We don't discount them in any way. We think that they're going to be very focused now on Europe and competition will increase. But we think we too are a stronger organization and are beginning to get the advantages of size and scale. All of this, of course, leveraging upon our longer in-country experience. So we are prepared to face the competition and we think we're still going to be able to drive very strong growth.

Okay. Or in another word, because of your newer products and your focus in the Continental Europe, the non-English speaking part of the market, you believe you can sustain the growth for quite some time?

Yes. We -- as far as we can see, we are very confident in continuing to drive growth and continuing to deliver record results for our Company.

Okay. Okay, that's great. The FunTown part looks like, so far, the past three quarters tracking below expectations. Or maybe you will have a huge fourth quarter to achieve your year -- early in the year you have a nice 20 to 30% kind of growth.

Yes, the results of FunTown in the second quarter, as we noted, were below our expectations. We really live by the credo, the motto, here of quarterly growth. And we spent a great deal of time in the third quarter making sure that we would continue to see growth. And we think that we put in place a number of measures which will continue to drive the numbers in Q4. So I think overall we're on track for the year.

I see. So in other words, can you give us some detailed update regarding, say, FunTown and Xbox? Or maybe in that regard?

As far as I know, we're awaiting the final certification from Microsoft. We're still on track to be the first local Asian game released for Xbox 360 as part of Microsoft Live Arcade. And I don't have the exact date yet for launch but we've already been part of Microsoft's -- a lot of Microsoft's local publicity promotion events and the like. And I think it's awaiting some final approvals now.

Okay, okay, that's great. Another question relates with your poker and casino business. The minority income looks like the income shared by your partner, UIM, looks like it was much less than what we modeled. I just wonder have you changed the revenue sharing here or is there any other issues here?

Chang, we have not changed the revenue-sharing model. The revenue-sharing percentage is the same. The reason why UIM's net income is much less, as you can see from the minority interest line, was because a large chunk -- most of the marketing expenses are borne by UIM, as they own obviously the customer-facing relationship.

So because this quarter we increased a lot of the marketing initiatives, as both Arthur and I have talked to, that increased their expense. But as you can see, on the revenue side it has picked up. And again, they view this as a long-term investment. That's the reason why they're willing to put in the expense now with larger customer base for future revenue benefits.

Or the shareholders, should we worry that if they get too little, less income and then they are not motivated enough?

Yes, obviously this is a very friendly relationship. First of all, we have a contractual relationship with them that binds in our relationship. And secondly, obviously the economics will be worked -- they will discuss with us and we will discuss with them in terms of the product and marketing initiatives, in order to make it profitable for both parties.

Like you say, we worry about that too. Obviously we want to make sure they also make enough money, that they will be motivated. And they have been very motivated, as far as we're concerned, from all the time that we've been working together.

Chang, this is Arthur. I would say -- I think that we and UIM and most who would look at the marketplace are very excited about the possibilities in Europe. I think in the early days, again, it was a bet. You never know for certain whether a certain -- a given product will take in the marketplace.

I think, where we are now, we see that market potential has been proven. There's been very clear proven content. And because of this, I think there's a great deal of enthusiasm about spending money, to building this market, to building on this brand and to monetize perhaps more in the future as the scale advantages show up.

Okay, great. Thanks a lot.

Thanks, Chang.

Your next question comes from the line of Bill Garrison with Ironworks Capital.

Yes. Thank you for taking my questions and congratulations as well. I wanted to ask if you might be able to provide a little bit more detail on -- with respect to your national MahJong tournament you described. I guess, just as a starting point, is that more a marketing event or is that profitable to FunTown? And then, sure, if there's any details in terms of the player experience you might be able to share, it would be helpful.

Sure. Bill, we treat that as a marketing event and also as a thank you to our customer base in Taiwan. So the event itself is not set up to be like the World Series of Poker or the like, which we -- although we will be hosting a World Series of MahJong in 2007.

This event is cast almost as a family day. We take over the largest stadium we can -- largest indoor facility we can find. And it is a day of game play, dancing, drumming, music, food, all centered around, of course, the suite of FunTown games. And so there are prizes offered, cash prizes offered. I think the total prize is about TWN1m. So that's the nature of the event.

Okay.

Now, I mentioned the World Series of MahJong. We believe very much that, in particular as an incentive for real money MahJong play, that an international championship event would be very exciting and very successful, both as a marketing tool to drive customers to our real money MahJong offering as well as a successful event in and of itself. We are in talks with a number of television networks who are very interested in hosting this event, as well as with a number of different venues. As you know, in Asia Macao is becoming a major gambling center. A lot of new casinos, a lot of interest in using events such as this to attract people to Macao. And so we look forward to a lot of fun with respect to putting on an event of this sort.

Okay. Very good. And then just a couple of quick ones on the poker side. Have you disclosed, or can you disclose, the percentage of players who come to the casino first from the poker site? Or are you getting new players in the casino product on its own? Any details you can share in terms of the overlap there?

We have not -- Bill, we have not disclosed such metrics. But I did mention in the prepared remarks that there is a cross-selling effect from the poker players to the casino players. Previously we were at the early stage of the poker product and also at the early stage of having a common brand, Everest Poker and Everest Casinos. So we did not have a mature set of enough data to do such analysis. We are beginning to see a trend and it is a single-digit crossover. It's a high-single-digit crossover. As we have more confidence in such trends, we will be making more disclosure to the marketplace.

Okay. And lastly, I guess, obviously impressive momentum through September and then we had the change in the U.S. regulatory environment. Any observations you could make about the kind of activity in the quarter to date in terms of are new players coming to -- is a lot of the growth from new players to the poker market? Or are you getting perhaps shifts of market share from European players who'd previously have been more active in the U.S.-focused markets?

Yes, Bill. As we have indicated, because we have not -- we don't have any U.S. source revenue, the legislation had no impact -- no negative impact on our revenue. We don't anticipate any.

Now, subsequent to the October 13 passing -- looking at October, both in terms of number of players signing in and also the revenue tracking comparing to September, that is before the passing of the new U.S. legislation, we are still seeing double-digit growth, in fact similar to accelerating growth. We're not 100% sure whether this is new players just coming into the market or these are players from other sites. But we're still not taking any U.S. ones, so if they are from other sites, it will be coming from the European customer base. But we're not seeing -- the important thing here is we're not seeing negative impact. In fact, we're seeing the results continue to grow very significantly.

Okay. Very good. Thank you and congratulations again.

Thank you.

Thank you.

[OPERATOR INSTRUCTIONS]. Your next question comes from the line of Alicia Yap with Bear Stearns.

Hello? Alicia?

Ma'am, please check the mute button on your headset. Ma'am, your line is open. Sir, there are no further questions in the queue.

Sorry, operator. Did you say no more questions?

Yes. There are no further questions in queue.

Okay. The question from Alicia dropped off the line?

It did. But she's re-queued up for questions. Let me go ahead and open her line. Ms. Yap, your line is open.

Hello? Okay, operator, that's fine. I think we'd like to conclude the call at this point. Thank you, everyone, for joining us. If you have any additional questions, or for further information, please visit our website at www.gigamedia.com.tw for Taiwan. Thank you.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.