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GigaMedia Limited (NASDAQ:GIGM)

Q1 2007 Earnings Call

May 22, 2007 8:00 am ET

Executives

Brad Miller - Director, Investor Relations

Arthur M. Wang - Chief Executive Officer, Director

Thomas T. Hui - Chief Financial Officer, Director

Analysts

Traci Mangini - ThinkEquity Partners

Todd Eilers - Roth Capital Partners

Andrew Schopick - Nutmeg Securities

Craig Platner - Elm Ridge Capital

Bill Garrison - Ironworks Capital

Presentation

Operator

Good day, ladies and gentlemen and thank you for standing by. Welcome to the GigaMedia Limited conference call to discuss first quarter 2007 financial results. (Operator Instructions) I would now like to turn the conference over to Mr. Brad Miller. Please go ahead, Mr. Miller.

Brad Miller

Thank you. This is Brad Miller, Investor Relations Director of GigaMedia. Welcome to our first quarter 2007 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 May 22, 2007. The contents 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 1Q business activities and financial performance. Thomas Hui will then provide details on our financial results during the period. After the speaker presentations, we will go into a question-and-answer session.

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

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Arthur M. Wang

Thanks, Brad and thank you all for joining us today. We are very pleased to report our strong first quarter results today, with revenue climbing 95% year over year to $36.1 million and net income soaring 167% over last year to reach $8.5 million. In our gaming software business, we continue to hit new company records with Everest Poker, and in Asia our casual game platform continues to deliver solid results in the context of heavy investments which should drive strong ongoing results. Overall, an outstanding quarter.

Thomas will go through our financial results in more detail. Please allow me to highlight a few points of particular note concerning our first quarter.

First, our poker and traditional gaming software business. Once again, we had a very strong quarter driven by Everest Poker. Top line revenues grew by nearly 50% from the fourth quarter, a remarkable sixth straight quarter of 50% Q-over-Q growth. Active real money player numbers followed suit with a 54% increase over Q4. Today, Everest Poker is the fourth largest poker site in the world and the second-largest in the world if you exclude sites that continue to accept United States players, despite the U.S. prohibition.

And we are working hard to do better. In the second quarter, we have signed a deal with ESPN in Europe to air the Everest Poker Minute, a series of one-minute poker shows offering poker tips, interviews with top players and the like. Next week we will unveil a new Everest Poker lobby and release Everest Poker in a fully localized Greek language product, our 15th language offering, more than any other site.

In addition, the 2007 Everest Poker European Championship has kicked off with initial events in Holland and Sweden. This month will see the Everest Poker Austrian Open Championship and in something totally new, the Everest Poker Japan Cup, the first online/offline poker tournament in Japan. We are also launching a new affiliate management system to continue to drive our affiliate marketing efforts.

Our product offering has also broadened with our release of real money Mahjong software in the first quarter. Mahjong is a traditional Asian game often called the poker of Asia. We have taken our market leading play-for-fun Mahjong software and licensed it out on a real money basis and expect our initial licensee to launch commercial operations very shortly. This summer, our Mahjong software will be joined by a suite of Japanese-specific gaming products, such as Pachinko, Pachislo, and Japanese variants of poker.

I am tremendously excited about the potential for Asian games, especially in the large Japanese market. Overall, we have built a well-known and well-respected online brand, a pan-European online entertainment brand and platform serving the 350 million consumers in the European community and soon to be joined by Asia, with a localized offering of 15 languages. We plan to continue to invest building this brand and platform to enhance our entertainment offerings, and by doing so to increase our ability to monetize on the platform as revenue and operating leverage increase.

Next, our Asian casual games business; we had a very good first quarter and an even better quarter in context of the serious investments we made in the business. In Q1, we increased our equity stake in China casual game platform T2CN, taking for the first time a control position in the company. T2CN is the operator of the largest online sports game in China and we are excited about the opportunity to build T2 into a major player in China online entertainment.

In Q1, we also kicked off the initial marketing for the red red, hot hot Hellgate London game, which has been the runaway star of industry game shows. We are very much looking forward to the launch of Hellgate London later this year.

More recently, we have licensed Fantasy Star Universe PSU from industry titan Sega Games. PSU is the long-awaited sequel to Sega’s award-winning Fantasy Star Online series of roleplaying games. We are also very much looking forward to launching PSU later this year.

All told, today we have an online game platform that spans greater China with large user numbers. Over 65 million registered users, over 8 million users active in a given month and on top of this, in Southeast Asia we are the largest shareholder of Infocomm Asia Holdings, with about a 30% equity interest. We believe the market opportunity in Southeast Asia is similar to that of China three or four years ago, and Infocomm Asia has secured three big titles for the region; Hellgate London, Emil Chronicle Online, and Granado Espada from the developer of the previous Southeast Asia favorite, Ragnarok Online.

All told, we are building an online game platform with an enormous footprint, providing the ability to deliver entertainment to users on a scale and with the efficiency of broadcast television. I emphasize that this platform, which we initially monetized with online games, will provide us with the opportunity to deliver a wide variety of entertainment for ourselves and our future partners.

In sum, we finished the first quarter with a strong strategic position and excellent operational momentum. Today’s results reflect but the early returns from our investment into building a dominant online entertainment platform. We are building a new GigaMedia with growth shareholder value as its cornerstone.

We thank you for your interest and continued support.

Thomas T. Hui

Thanks, Arthur. Let’s now look in more detail at the financial performance of our business in the first quarter. I will start with our consolidated results and then review each business unit.

Overall, we delivered strong performance in the first quarter of 2007. We continued to drive strong organic growth with our world-leading poker software business. At the same time, we acquired T2CN to further expand the platform reach of our Asian online game business. We also began initial promotion of our Triple A title, Hellgate London.

Let me quickly summarize our consolidated results in Q1. Consolidated revenues grew 95% year over year or 20% quarter over quarter to $36.1 million. The driver of our sequential revenue growth was record performance in our poker software business. Consolidated gross profit increased 118% to $28.8 million from the same period last year and increased 22% sequentially. Our consolidated gross profit margins grew to 79.7% in Q1 from 78.3% in the previous quarter.

Operating income rose 164% year over year and 8% sequentially to $8.7 million. The quarter-over-quarter increase in our consolidated operating income was due to the growth in consolidated revenue and gross profit, as mentioned before, which more than offset the sequential decline in our consolidated operating margin from 26.7% in Q4 2006 to 24% in Q1 2007. This sequential decrease in our operating margin was the result of margin decreases in our Asian online game business and our legacy broadband ISP business, and an increase in non-cash share-based compensation expense, which together more than offset the increase in operating margin of our gaming software business during the quarter.

Net income climbed 167% year over year to $8.5 million, resulting in fully diluted earnings per share of $0.14. Non-GAAP net income, excluding share-based compensation expense, was $8.7 million, or $0.15 per fully diluted share. Quarter over quarter, net income declined to 14% but this comparison is distorted by the impact in the fourth quarter of a one-time after tax gain of approximately $1.9 million related to the sale of certain marketable securities.

We continue to maintain our financial strength during the first quarter. Quarter over quarter, our cash, cash equivalents, and current marketable securities increased from $36.2 million to $48 million. Operating cash flow for the period increased to $11 million from $9.1 million last quarter. Cash payments during Q1 related to our strategic investment in T2CN amounted to $9.4 million. Capital expenditure was $1.2 million for the quarter, and we recorded total debt of $21.1 million at the end of the first quarter.

Let’s now look at our business unit performance. The gaming software business, CESL; the business unit once again delivered all-time highs in revenue and net income. During the first quarter, the business unit generated $26.3 million in revenue, representing 198% growth year over year and 33% growth sequentially.

Gross profit grew to 34% from last quarter. Operating income increased 45% sequentially. Operating income margin increased to 33.1% from 30.3% in the previous quarter, as revenue growth exceeded increases in our selling and marketing expenses.

Net income grew to $8.3 million, a 246% improvement year over year, or 41% growth sequentially.

Let me quickly break this down further into results for our poker software business and our casino software business.

Our poker business again achieved record results and remained the major force behind our gaming software business. Revenues from our poker software products were $19.1 million, up 47% sequentially. Poker revenues represented 73% of CESL’s total revenues. This growth was largely driven by increases in new player sign-ups on Everest Poker. Approximately 138,000 active depositing real money customers played Everest Poker during the first quarter, up 53% sequentially. During the quarter, approximately 68,000 new depositing real money players were added.

Key factors driving Everest Poker user and revenue growth were efficient online and offline marketing and brand building initiatives. During the first quarter, Everest Poker continued a high profile $1 million tournament called Avalanche. Everest also launched television commercials and held weekly $100,000 tournaments.

To support continued growth, during the quarter we launched three new languages and several new player-facing features, as well as continuing to upgrade and improve our systems to enhance the overall gaming experience for customers.

Our casino software business also delivered strong results. First quarter revenues from the casino software business were $7.2 million. This represented a 39% increase year over year and 5% sequential growth, driven in large part by cross-selling of casino games on Everest Poker.

In sum, our gaming software business is continuing to scale up and benefits from the growing strength of the Everest brand.

Moving on, the Asian online game business, FunTown and T2CN; FunTown continued to deliver solid revenue growth in the first quarter despite the effect of the Chinese New Year holiday and the short month of February during the quarter. Our strategy of expanding our game offerings and increasing our selection of in-game virtual items on our platform has been successful in driving continued revenue growth.

During the quarter, the increased operating expense primarily related to certain long-term growth initiatives, resulting in a lower operating and net income margin. These initiatives include the promotion of Hellgate London and an increased marketing campaign for FunTown during the Chinese New Year holiday period, and the integration of T2CN, our China online game platform. I will talk more about these initiatives in a moment.

Revenues in the period increased 19% year over year and 4% sequentially. Gross profit margin declined to 77.8% from 78.7% last quarter, due largely to an increased revenue mix from licensed games. Operating margin decreased to 15% from 35.1% in the previous quarter due to the Hellgate London promotion, FunTown marketing and the T2CN integration I mentioned before. As a result, net income declined 15% year over year and 43% sequentially.

Despite the immediate negative financial impact, we believe these initiatives will drive long-term growth for our Asian online game business.

Let me now go over these initiatives with more details. First, regarding our current portfolio of online games on the FunTown platform, as I mentioned, during the first quarter we continued a strong mass media marketing initiative, which included a television commercial in Taiwan. We also continued to drive growth in the advanced casual game, Tales Runner. Revenues from Tales Runner were up 75% quarter over quarter. As a result, both the total active paying accounts and the monthly revenue per active paying account increased by 2% sequentially to approximately 107,000 accounts and $17 in ARPU respectively in the first quarter.

Second, we began to promote the highly anticipated game Hellgate London, which is scheduled for launch in late 2007. In February, we took advantage of the highly popular Taipei game show, a five-day event that was attended by tens of thousands of visitors this year, and showcased Hellgate London with an elaborate game display, the largest at the game conference. We received very positive feedback and expect the game will significantly increase our revenues and profitability when launched.

Third, we acquired an additional 39.9% equity stake in China’s online casual game leader, T2CN, in the middle of the first quarter. We have also begun the integration of T2CN with GigaMedia and expect such integration will continue in the second quarter.

As expected, financial contribution from T2CN in the first quarter was modest. In Q1, T2CN generated revenues of $3.5 million and net income of $361,000. However, since we account for our T2CN investment under the equity method, neither our revenue nor operating income benefited from T2CN’s results in the first quarter. During the quarter, we recognized an equity investment income of approximately $58,000, which represents our interest in T2CN’s net income from mid-February through the end of March. We expect to consolidate the results of T2CN in the second quarter of 2007 and we believe that contribution from T2CN will continue to grow going forward.

Finally, a quick review of our broadband ISP business. Revenues, operating income and net income in our legacy broadband ISP business declined quarter over quarter, in line with our expectations. The decline was largely due to decreases in payment we received for bandwidth, consulting and support services related to the sale of our ADSL business in 2006. A decrease in our cable modem subscriber revenues also contributed to this decline.

Looking ahead, we expect the contribution from our ISP business will continue to decline, both in absolute terms and relative to our consolidated financials. This is in line with our ongoing strategy of shifting resources away from this legacy business.

To summarize, in Q1 we made great progress in our goal of building a powerful leading online entertainment platform. We delivered tremendous growth in our gaming software business, particularly in the poker business, and strengthened the long-term growth prospect of our Asian online game business by adding T2CN in China and beginning promotional work for Hellgate London. We are well-positioned, executing strongly and excited about our opportunities and growth prospects in 2007. We are confident in our ability to continue driving growth and building shareholder value. Thank you.

Brad Miller

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.

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question will come from the line of Traci Mangini with ThinkEquity Partners. Please proceed.

Traci Mangini - ThinkEquity Partners

Thank you. Hello. I had a couple of questions, first with respect to Hellgate London. Can you give us a sense of what type of marketing we should expect going forward? Would it be similar levels as to Q1 until you launch? Also, why is it a little bit later launch than maybe we would have originally expected?

Thomas T. Hui

Regarding the marketing budget for Hellgate London, we expect in Q2 we will not be spending as much as we have spent in Q1. However, in Q3 when we are close to the commercial launch, especially right before the commercial launch, there will likely be a lot more marketing expenses to be incurred. Q3 is probably where most of the marketing expense will be spent, and then Q4 is where we see the commercial launch and therefore the revenue impact will come in most likely in Q4.

Traci Mangini - ThinkEquity Partners

Thank you. And then, on the CESL side of the business, some of your competitors out there have been seeing some weakening trends, at least in their first quarter, with respect to poker, particularly for the high rate players and going after them and I know that’s an area you guys have been focusing on, on becoming more competitive in. Do you view this as a concern for Everest or more of an opportunity?

Arthur M. Wang

We naturally would love to have as high value player as we can get. However, that’s just part of a broader matrix of players, so we don’t have a particular strategy to target only one sector. We did not see the kind of margin deterioration or the kind of competitive pressure in Q1 that some of our competitors did.

Traci Mangini - ThinkEquity Partners

Great, and would you expect, like some of them have been announcing that they are going to ratchet up some marketing, that you guys might also follow suit just to maintain your leadership here going forward?

Arthur M. Wang

Yes, I think in Q1, as you see in our numbers, we had a bit higher operating margin than we normally run and I think perhaps we were a little bit -- maybe a little bit conservative with our marketing spend. We will look to deploy that effectively throughout the rest of the year. We believe the market opportunity is still enormous.

Traci Mangini - ThinkEquity Partners

Okay, and is there --

Arthur M. Wang

Traci, just to go back, you had also asked as part of your first question whether we -- why Hellgate London was perhaps launching later than was to be expected. We have not received a final launch date yet from the developers. It is going to be some time this summer in the United States and we will launch shortly thereafter. We understand that Hellgate London is going to be distributed by EA, Electronic Arts, in Europe and North America. I think they are putting together a very big marketing campaign.

Traci Mangini - ThinkEquity Partners

Great. Is there any way you can quantify how big you think the Sega Fantasy Star could be? Should we look at something -- I would assume not on the same level as Hellgate London, but what is your sense of how big that could be?

Thomas T. Hui

Sure. The real strategic significance of PSU is yet another proof of our ability to license a game with a success history from a well-renowned developer, Sega. So after Hellgate London, we are able to score this title which has proven our ability to continue to adopt this strategy of licensed games.

Now, in terms of numerical impact, this is actually part of our strategy as we laid out before in various context to the investor community, that we expect the FunTown business to continue to grow with a two-pronged strategy. One is to increase the contribution from licensed game -- this is outside of Hellgate London because Hellgate London is such an order of magnitude that it should be a separate class on its own. So FunTown continued to license games and increase player monetization through selling of more virtual items.

Now, PSU falls into the first bucket of increased revenue through the increased number of licensed games, and we have a couple more of these in the pipeline, which we expect to close later on this year.

We did also tell the market that we expect, with this two-pronged strategy, FunTown’s revenue should grow hopefully a -- we have an internal target of about 20% to 30% comparing to last year from a revenue basis, and PSU will fit into that strategy.

Traci Mangini - ThinkEquity Partners

Thank you. And then just lastly, Arthur, could you comment -- I know we’ve talked about this before, but just with Electronic Arts and the investment in The9, how do you view that changing if at all the competitive landscape for you guys in mainland China?

Arthur M. Wang

We’re not at all concerned about EA teaming up with The9. EA has made clear that they are not going to be a one-house operator, in particular in China. We believe that there are going to be strong opportunities to operate sports games from both EA and from other operators.

Traci Mangini - ThinkEquity Partners

Great. Thank you very much, you guys.

Operator

Your next question comes from the line of Todd Eilers with Roth Capital Partners. Please proceed.

Todd Eilers - Roth Capital Partners

Just a handful of questions here. First, just a follow-up on Traci’s question earlier on the marketing, it sounds like third quarter might be a little bit higher than second quarter but I saw that as a percent of revenue, it was roughly 37.5%. I know we had talked previously that you had expected that to be maybe in the 30% to 35% of revenue range, but obviously if there are opportunities to maybe grow revenue, you might pursue some additional marketing.

What can we expect for the rest of the year? Should we be looking in maybe the 35% to possibly 40% of revenue range, or should we maybe expect that to drop back into the previous 30% to 35% range? I’m just trying to get a feel for as a percent of revenue going forward?

Thomas T. Hui

Sure, Todd. Our early response to, or my earlier response to Traci’s question was specifically regarding the marketing spend directed towards the Hellgate product. So in the first quarter, we incurred about $480,000 of marketing expense and that number we expect to come down in Q2, but will probably increase quite significantly in Q3. So that is outside of what we have been previously talking about, 30% to 35% range because Hellgate in and of itself is a very big project for us and a very big opportunity.

Now, outside of Hellgate, I think the rest of the business is still -- we pretty much stick to our original estimate of about 30% to 35% being the target range that we are shooting for.

Todd Eilers - Roth Capital Partners

Could you possibly break out how much of the sales and marketing was from the real money business versus the casual online business, and the dollar amount?

Thomas T. Hui

Of the $13 million, from a public disclosure perspective we don’t break them out on a specific dollar amount basis but as we’ve indicated before, most of the selling and marketing -- actually, an overwhelming majority of the selling and marketing is incurred at the online gaming software business. So of the $13.5 million we spent in the first quarter, a significant amount, more than half, an overwhelming majority at the CESL units. And then the rest are primarily at the FunTown units and Hellgate in the first quarter. The ISP business was very little, as we shifted resources away from it.

Todd Eilers - Roth Capital Partners

Okay, and moving on to the poker side of the business, you guys recently made an upgrade to the software product there. I was wondering if -- I know it is still fairly early but I was wondering if you could maybe comment on how the transition to higher stakes tables, how that transition is going at this point. Can you give us any color on that?

Thomas T. Hui

I think it is probably still a little early for us to give any real trends because I think we just did it less than a month ago and there is a one-month grace period and it is just coming about towards the end of that period. We do expect this will improve monetization but we will have to see once the results come up.

Todd Eilers - Roth Capital Partners

Okay, and then following on that, it looked like your average revenue per active player dipped a little bit sequentially in the first quarter. I’m assuming with the migration you are expecting here to higher stakes tables, we should start to expect to see that trend upward throughout the rest of ’07. Is that a good way to look at that?

Thomas T. Hui

Yes, that’s certainly our plan. It was a little lower comparing to the Q4 number but it was higher than any other quarters in 2006. So it was higher than 2006 Q1, Q2, or Q3, so it is still not low and it is within our normal fluctuation band. Obviously we hope that some of these initiatives we took would gradually increase that number.

Todd Eilers - Roth Capital Partners

Okay, and then looking at the second quarter in terms of overall growth on the poker business, obviously seasonally we should be looking at that as a little bit lighter than your fourth quarter and first quarter, but should we still expect to see positive sequential growth in the poker side of the business?

Thomas T. Hui

Certainly. We expect the revenue growth to continue to be robust but because of seasonality, the rate may not be as high as what we had achieved in the first quarter but certainly we would very much expect positive sequential growth.

Todd Eilers - Roth Capital Partners

Okay, and then I wanted to ask a question on the legacy ISP business. Obviously you guys have indicated that you expect revenue to decline going forward there but it looks like your gross margins are still or have been fairly strong there. Should we expect to see that continuing forward, kind of in that 50% gross margin range?

Thomas T. Hui

I think as the revenue continues to come down, the operating margin will come down together with it just because we are losing scale on the business and some of these consulting and supporting bandwidth services were actually the high margin business that are sort of terminating. So the operating margin decreased from 26% in Q4 to about 15% and comparing to last year, 2006 Q1, the operating margin was about 10%. So as revenue continues to come down, we think the 15% operating margin will actually continue to have downward pressure and will continue to come down together with revenue.

Arthur M. Wang

I should add that we’ve mentioned previously that we are in some discussions with potential buyers and that may be the ultimate decision.

Todd Eilers - Roth Capital Partners

Okay, fair enough. I guess last question, your strategy with regard to you mentioned real money game offerings for the Japanese market. Could you maybe provide some additional commentary on that? Maybe some timing, maybe how you plan to offer those types of games? Would you look to do that through UIM or possibly another third party licensing partner like what you’ve done with Mahjong? Could you maybe just talk a little bit about that?

Arthur M. Wang

Sure. First let me say that Japan, 125 million people, the world’s second-largest economy, and a huge traditional Asian gaming business. Mostly Pachinko, Pachislo, as well as Mahjong and some Japanese-specific games. So we see an enormous market opportunity there.

We are extremely excited to be releasing a whole suite of Japanese products, including Pachinko and Pachislo and Japanese variants of Poker together with our Mahjong game, but a single and multiplayer basis. We expect to launch this summer and our plan is to utilize our current primary licensee UIM to be the sole licensee of these games.

Todd Eilers - Roth Capital Partners

Okay, great. I look forward to seeing that. I think it’s a great opportunity as well. Thanks a lot, Arthur, Thomas. Take care.

Operator

(Operator Instructions) Your next question will come from the line of Andy Schopick at Nutmeg Securities. Please proceed.

Andrew Schopick - Nutmeg Securities

Thank you and good morning. I have a couple of specific financial questions and a couple of which are accounting related. I want to be sure I have the share-based comp expense right. I am just totaling some numbers quickly. It looks to me like it was about 291,000 versus 48,000 a year ago in the first quarter. Can you confirm that and can you give us any kind of general guidance on what you expect share-based comp to be for the full year?

Thomas T. Hui

Yes, I can confirm that share-based comp for the first quarter of 2007 was $291,000 and for the previous quarter, the quarter ended December 31, 2006, it was $169,000 and a year ago it was $47,000.

We don’t expect this -- we expect the share-based comp to gradually increase but not in any significant order of magnitude in the next few quarters.

Andrew Schopick - Nutmeg Securities

So something slightly in excess of $1 million for the year?

Thomas T. Hui

Yes.

Andrew Schopick - Nutmeg Securities

Okay. I would like to ask a question about the debt, the current short-term debt that is on the balance sheet. What are your plans for either reducing or paying down that debt over the course of the year? Certainly you seem to have the cash flow to be able to do that.

Thomas T. Hui

A few things. I think taking down such the short-term debt is part of our treasury decision. We do have access to fairly cheap capital from a debt perspective, given our operation share in the Taiwan context, which is flood with liquidity. That is point number one.

Point number two is the various business units we operate in the various geographic locations, we try to operate them separately and try to have the capital and funding need separately, so that’s part of our treasury management. Obviously we have total flexibility in moving funds across the business unit, but at this stage we think that this level of debt, given our cash flow, given our capital level and also given the interest rate we are paying on this debt is actually quite healthy. So we don’t have any short-term view of significantly reducing or increasing this position unless certain strategic things come up.

Andrew Schopick - Nutmeg Securities

Okay, and the other question I really want to ask is about T2CN and my understanding of the accounting going forward. Had this been accounted for under the equity method in the first quarter, effectively you would have captured about -- I’m just looking for these numbers here, I think it was about $3.5 million of revenue, and then you would have had I assume a minority interest line deducting out the minority interest of the $361,000, so effectively you would have captured about $180,000 of net income, and of course the equity investment income would just go away.

So going forward, is that what we’re going to see? Are we going to see the revenue associated with T2CN fully captured at the top line and then a minority interest line deduction, if you will, for the net income of that operation?

Thomas T. Hui

Sure. In the first quarter, as we mentioned, we account for the T2CN investment under the equity method and that means we only captured our proprietor share of the net income as the equity investment line, so there’s no impact on revenue, no impact on operating profit.

You are absolutely right. Had we accounted for this on a consolidation basis, then we would have $3.5 million more in revenue and we would have somewhere around $300,000 more in operating profit, but then we would not have the $58,000 investment income but we would have a minority interest around half of the net income, depending on our percentage. Our converted percentage would be around 15%, so it would be about $180,000 net minority interest, so our net income net net would increase about $130,000.

Andrew Schopick - Nutmeg Securities

Yes, so can you give us any guidance on the T2CN outlook for the year in terms of what we can anticipate in terms of revenue and potential net income margin? Do you wish to comment at all on that because it is going to have an effect on your quarters going forward?

Arthur M. Wang

Absolutely. We’ve increased our position at T2CN and actually taken a control position because we very much believe in what we can do at T2CN. By themselves, they’ve got a lot of good things going. We are not in a position to give quantity to forecast, but I think T2 is going to have a much bigger rest of the year than they did first quarter and it is going to be a good contributor.

Andrew Schopick - Nutmeg Securities

Can you tell us what T2CN revenues were in 2006?

Thomas T. Hui

2006 was not a good benchmark because the main revenue contributor, Freestyle, was only launched in full functionality in the first quarter of 2006 and it suffered from some hack issues during the summer. If you look at the fourth quarter, it is roughly a similar level as what we had achieved in Q1.

Andrew Schopick - Nutmeg Securities

Thank you.

Operator

Your next question comes from the line of Craig Platner with Elm Ridge Capital. Please proceed.

Craig Platner - Elm Ridge Capital

Good afternoon. I just had a quick question on your balance sheet. I was trying to determine what GigaMedia owns versus what’s UIM’s balance sheet. Is there a way of kind of looking at the assets and the liabilities and dividing them up between what you own or what GigaMedia shareholders own and what UIM shareholders own?

Thomas T. Hui

No, not on a balance sheet, items-by-items basis, no. But if you look at the -- we only have basically, if you look at just on our balance sheet, then we have a minority interest line. That would be composed of -- well, before this quarter, it would all be UIM. The minority interest would basically be UIM’s equity that we don’t own because we own 0% of UIM, so that would be their equity base. But this quarter, the $1.3 million minority interest includes both the UIM equity and also the 30% of the Dragon Gate entity, which is the entity that all the Hellgate London license and is going to operate Hellgate London. So that number is the combination of the both. If you want to me to break it down again and do that for you, that is 715 is UIM and $600,000 is Dragon Gate.

Craig Platner - Elm Ridge Capital

Okay but UIM is doing something like $14 million a quarter or so in revenue. Is that right?

Thomas T. Hui

If you take their revenue minus the licensing fee they need to pay to us, I believe -- I have to look at that number but I think the order magnitude sounds about right.

Craig Platner - Elm Ridge Capital

Right, so you have them -- is this minority interest income or loss line that you are reporting on your income statement, is that essentially a record of their loss in the quarter?

Thomas T. Hui

No, the income statement line again is because it is composed of two line items, so UIM makes about $130,000 gain in the quarter and then the Hellgate London operation incurred a loss of about $0.5 million because of the marketing expense and the minority interest share, 30% of that $500,000 is about $150,000, so net net, that’s why you have a negative minority interest line. So UIM makes a gain of $130,000 in the quarter.

Craig Platner - Elm Ridge Capital

On $14 million of sales or so?

Thomas T. Hui

Yes.

Craig Platner - Elm Ridge Capital

Okay, and is that sustainable, your relationship with them on a $14 million revenue base, earning basically break even?

Arthur M. Wang

We have a very strong relationship with them and a long-term binding contract.

Craig Platner - Elm Ridge Capital

Thanks very much.

Operator

(Operator Instructions) Your next question will come from the line of Bill Garrison with Ironworks Capital. Please proceed.

Bill Garrison - Ironworks Capital

Thank you. I wondered if there was any additional detail that you could provide just with respect to the rollout with your first licensee on the real money Mahjong? I know we talked about it last quarter and I know you said you expect it along shortly, but I’m just trying to understand a little bit of the dynamics there. I’m wondering if you could provide any additional details.

Arthur M. Wang

Sure. Our initial licensee is an independent third party. When we delivered the software, that’s sort of all we are allowed to do or know, but we do have regular communication and my understanding is that they are doing some more preparations. They’ve got a big marketing blitz prepared and I guess they are launching later than we had originally hoped but maybe they are launching better. That’s as far as, as much visibility as we have. We will be expanding our range of licensees after an initial period of exclusivity which we’ve offered to them.

Bill Garrison - Ironworks Capital

Okay, and I believe, I think I’ve heard where that is just like a 30-day exclusivity. Is that correct?

Arthur M. Wang

No, the exclusivity period is longer. I believe it’s three months.

Bill Garrison - Ironworks Capital

Would that period apply to other regions, for example, in Japan?

Arthur M. Wang

No, it doesn’t apply to Japan whatsoever.

Bill Garrison - Ironworks Capital

Okay, and secondly, just looking at your 8 million active users per month on your casual game side, could you break that down at all in terms of FunTown and other, T2CN and just what the composition of that looks like?

Arthur M. Wang

I believe the larger 60%, 70% or so from memory is in China, maybe 80% with the T2 platform and the rest is with FunTown.

Bill Garrison - Ironworks Capital

Okay, and it looks like you as well had a pretty significant step up in the number of registered users. I think I saw a $50 million number in your last quarterly release. Are those trends as robust as it would appear?

Arthur M. Wang

Yes. We have significant size, significant scale and very popular mass market games. Again, this is our target to be a broad-based casual game operator rather than to be a specialist in running smaller sized but highly intensive MMO type of games. We look to have a very, very large user base, player base from which to build our platform on.

Bill Garrison - Ironworks Capital

Lastly, I’m familiar with the Pachinko market in Japan. I guess I’m learning quickly here on Pachislo. Could you at all describe that kind of market as it exists in Japan today?

Arthur M. Wang

Sure. Pachislo appears to me, and I have to tell you that it’s -- there’s tremendous subtlety in what superficially is a very simple game, but Pachislo is I would say a cross between a slot machine and a Pachinko machine. It includes elements of Pachinko, like the balls moving around but also wheels that spin in the middle as well as some visual storylines that give clues and have different aspects on a visual screen up above. So it would be like modern generation slot machines but with the traditional Pachinko elements also.

Bill Garrison - Ironworks Capital

Is that a relatively new market?

Arthur M. Wang

Is it relatively new compared to Pachinko and it is becoming an important segment in Pachinko parlors say in Japan.

Bill Garrison - Ironworks Capital

Thank you very much.

Operator

Your next question is a follow-up from the line of Andrew Schopick with Nutmeg Securities. Please proceed.

Andrew Schopick - Nutmeg Securities

Thank you once again. I do want to come back to T2CN, just anticipating what I think might be some confusion going forward, that you will basically include the consolidated performance of T2CN as part of your Asian online gaming business segment. When we see the future earnings releases, it will be included in that area? I just want to be sure that I understand how you are going to be reporting this or where we should be looking for it going forward, and whether or not you care to give any type of objectives or goals that you have for an operating margin associated with T2CN in the future, or what you think this business can achieve.

Thomas T. Hui

To your first question, the answer is yes. The T2CN investment income actually in the first quarter has already been classified under the Asian online game business segment. Upon consolidation, the revenue and the entire P&L will also go under this business segment, and that is in accordance with U.S. GAAP because that’s how we manage the business.

On the second question, as Arthur earlier mentioned, at this stage we are unwilling to give numerical guidance. But if you look at the Q1 numbers, directionally the Q1 numbers have about a 10% net income margin and that, compared to other operators, we think has room for upward improvement.

Andrew Schopick - Nutmeg Securities

Thank you again.

Operator

Your next question is a follow-up from the line Craig Platner with Elm Ridge Capital. Please proceed.

Craig Platner - Elm Ridge Capital

Thank you very much. I just wanted to ask quickly, who owns UIM?

Arthur M. Wang

UIM is owned by a corporation and it is I think has some beneficial shareholders based in Hong Kong.

Craig Platner - Elm Ridge Capital

Is there a way you could put a name on that partner of yours?

Arthur M. Wang

The exact holding company I think is [GB] Online Experiences, something of that sort.

Craig Platner - Elm Ridge Capital

Do you know who the owners of that holding company --

Arthur M. Wang

Yes, we have met them and the like.

Craig Platner - Elm Ridge Capital

Okay. Are the UIM results audited?

Arthur M. Wang

Yes, as part of our consolidated financial statements, UIM numbers are audited and consolidated. The main reason for this is because of some new accounting laws that were released, accounting rules that were release in the wake of some of the Enron and WorldCom situation, where the SEC and the financial supervisory bodies were trying to make sure that closely related, off balance sheet third parties, that investors got a chance to take a look at their financials also, that the entire financial picture might be better represented by an overall inclusion. As an unintended consequence of that, certain businesses such as UIM are required to be consolidated, and naturally we are in compliance with that and I guess in one way, it just shows -- it gives a better picture of the overall business and more visibility into our operations.

Operator

At this time, there are no more questions in the queue. I would like to turn the call back over to Mr. Brad Miller for closing remarks.

Brad Miller

Thank you again, everyone, for joining us today. For further information about GigaMedia or if you have questions and would like to contact the company, please visit our website at www.gigamedia.com.tw as in Taiwan. Thank you.

Operator

Ladies and gentlemen, this concludes your presentation. You may now disconnect and have a great day.

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Source: GigaMedia Q1 2007 Earnings Call Transcript
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