GigaMedia Limited
Q1 2006 Earnings Call Transcript

Published: 11 May 2006

[Operator:]

Good day ladies and gentlemen and thank you for standing by. Welcome to the GigaMedia Limited Conference Call to discuss the first quarter 2006 financial results. At this time, all participants are in a listen-only mode. Following the full presentation, instructions will be given for the question and answer session. If any one needs assistance at anytime during the conference, please press “*” followed “0” for operator assistance. As a reminder, this conference is being recorded today, the 11th of May 2006. I would now like to turn the presentation over to your host, 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 2006 Results Conference Call for GigaMedia Limited. First, I want to apologize for the delay in distributing our press release today. We had a few technical difficulties. 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 2005. This presentation is being made on May 11, 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 our 2006 first quarter business activities and financial performance, followed by a strategic overview and comments on outlook. Thomas Hui will then provide details on our financial results during the first quarter period. After the speaker presentations, we will go into question and answer session. With that, I’d like to turn the call over to Arthur, our CEO.

[Arthur Wang:]

Thanks Brad and thank you all for joining us today. We are very pleased to report today our first quarter 2006 financial results, the best ever for GigaMedia. First quarter revenue from continuing operations was up 82% year-over-year to $18.3, net profit grew 210% to a record $3.2 million, and consolidated EBITDA grew 131% to $4.9 million, also an all time high. Today, I’d like to highlight just a few points about the first quarter before turning to a discussion of our strategic developments. First, our strong first quarter financial performance was driven by strong growth and strong execution of our Everest Poker and traditional gaming software business. In the first quarter, we made excellent progress in our strategic concentration on the giant non-English language market place, offering our Everest Poker and Everest Casino software in end-to-end native language solutions in 11 languages. Revenues from the Everest Poker software business grew over 60% quarter-on-quarter from the fourth quarter of 2005. Active real money customers jumped 53% from the fourth quarter, altogether driving a 30% sequential quarter-on-quarter increase in net income. Everest Poker user revenue growth continues to be driven by marketing and brand only initiatives. First quarter saw the launch of the Everest Poker European Championship, a series of country-by-country players and online poker tournaments in Europe. Response has been great with every tournament thus far a complete sellout. In addition, Everest Poker hosted as exclusive sponsor the Finale of the French Poker Tour at the Aerodrome in Paris, and continues to sponsor satellite tournaments of the European Poker Tour and the World Poker Tour. To reward customer loyalty and increased life-time player values, a new customer loyalty reward program was released in the first quarter. On balance, this was a very strong growth strong for Everest Poker and gaming software business reflecting strong execution in Europe. I want to emphasize that we are seeing the early returns from our investment in Everest Poker and look forward to continued strong growth. Second, our newly acquired FunTown MahJong in Asian casual business contributed strongly to our first quarter performance. In the first quarter, the post-acquisition period generally considered the most sensitive in M&A deal, we are happy to report that FunTown performed ahead of budget exceeding both internal revenue and net income targets, delivering net income of $1.2 million in the first quarter of revenues of $4.3 million. During the first quarter, FunTown released new games and a new 3-D virtual community called FunTown Village where players can chat, shop, trade items, gift gifts, and even get married. Most importantly, during the first quarter, FunTown added over 220,000 new users, increasing both average and peak concurrent user numbers. We remain very excited about the prospects for the FunTown casual game portal. I’m also happy to announce today that we have successfully completed out strategic investment into casual game operator T2CN Holding, operator of the largest online sports game in China. Let me first summarize the primary terms of our investment. GigaMedia has made a $15 million investment and obtained preferred shares convertible into a minority safe in T2CN along with customary preferred share rights and productions and is seen on the board of T2CN. GigaMedia and T2CN will together offer FunTown’s existing games to the large T2CN user base on a revenue sharing arrangement. Giga will become T2CN’s exclusive provider for FunTown’s existing games and be the preferred provider for games newly developed by GigaMedia. Our investment in T2CN was made at an attractive valuation representing a multiple of 8.65 times forward earnings, i.e., full year 2006 earnings. Our investment will be accounted for on a cost basis. Our partnership and co-ownership of T2CN is a major step for GigaMedia in China. It is the first of several steps we are currently contemplating. Strategically, we become the exclusive provider of online games to one of the most exciting and fastest growing companies in China with 21 million registered users, 6.9 million users active in the last 30 days and over 250,000 piece and current users. We plan to roll out FunTown games to this large user base during the third quarter. I would also like to emphasize that T2CN is the leader in online casual sports games. We see strong potential for Giga and T2CN to grow this high value market sector, especially given the increasing popularity of sports in China at the upcoming 2008 Beijing Summer Olympics. Online sports games is an untapped area in China and we are very enthusiastic about growing in this attractive sector. Finally, we believe that the true pedigree of T2CN can be seen from the marketing partnerships with premier international brands such as Coca-Cola and the NBA. We are proud to be a partner and co-owner of this exciting company. I’m also happy to report that we are on schedule for a third quarter launch of our Real Money MahJong at Asian Game Business. MahJong is a traditional game of choice for over a billion people, a huge untapped market and a huge opportunity for GigaMedia. We intend to leverage FunTown’s number one MahJong position by bringing Real Money MahJong to this market. We’ve received strong interest from a broad of gaming operators and we are currently in serious discussions with the premier names in global online gaming. With the strongest portfolio of traditional Asian games and a position of market leadership, GigaMedia is well positioned to build a dominant Asian online entertainment brand leveraging our market leading FunTown casual games and a now strengthened platform that includes 21 million users of T2CN holdings. We believe that long-term winners will have full range offerings of online games running the continual from games of fun, games of skill, games played for prizes, games played in tournaments, all the way to real money gaming. In this manner, it is possible to monetize along the entire continuum and cross-sell players reducing the major variable cost, customer acquisition. Our goals here will be a comprehensive entertainment destination operating under a dominant Asian online entertainment brand. Finally, a word about our share price, which you may have noticed is increased in the first quarter. Simply put, our policy as a management team is not to comment on our share price level or movement, except to say the following

[Thomas T. Hui:]

Thanks Arthur. Now, let us turn to look at our financial performance for the first quarter. I will begin by taking you through our consolidated results and follow that with a more detailed look at each of our business units. Starting with our consolidated income statement. GigaMedia delivered the company’s best ever results in the first quarter of 2006. Consolidated revenues grew a better than expected 82% from the same period last year or 55% quarter-over-quarter to $18.3 million. Operating income for the first quarter rose 88% sequentially to $3.3 million with an operating income margin expanding to 18% from 14.8% last quarter. There were two key drivers for the significant growth of our revenue and operating income. First, strong and better than expected revenue growth in our Poker software products, and second, the addition of our high-margin online casual game business, FunTown. As a result, net income jumped 210% from the first quarter last year or 34% sequentially to a record $3.2 million, which resulted in an earnings per common share of $6.3. To put that in perspective, in one quarter we have now generated more than half of our full year net profit from last year. We also finished the quarter with a healthy balance sheet. At the end of the first quarter, we have cash, cash equivalents, and current marketable securities of $42.3 million. Net operating cash flow for the period was $3.9 million. Even after adjusting for the $5 million second payment for the FunTown acquisition and the $15 million investment in T2CN in the second quarter, we still have a solid balance sheet with ample liquidity. In summary then, with our high-margin online entertainment business, CESL and FunTown, driving rapid growth in our revenues, we were able to enhance overall operating margins and significantly increase bottom line. To break down these consolidated results in more detail, let’s now look at our business results. Poker and traditional gaming software business, CESL. The Poker and traditional gaming software business delivered exceptional performance in the first quarter. Our Poker software vertical has delivered dramatic growth resulting in an all time high in revenues and profitability for CESL. For the period, this generated $8.8 million in revenue, a 105% growth from the first quarter last year. Operating income increased 197% from the same period in 2005 and net income reached $2.4 million, representing 115% growth year-over-year or 30% growth sequentially. Operating margins decreased from the level achieved in the fourth quarter 2005 as a result of increased marketing spending by our licenses in building out the brand, but still we remained at a healthy 28%. Net income for the quarter benefitted from the improved terms in GigaMedia’s revenue sharing agreement with our licensees for the Poker software products. During the period we continued to invest in scaling up and developing new products in the Poker and traditional gaming software businesses. Capital expenditure amounted to approximately $565,000 of which 46% related to software capitalization. Let me now briefly review our two products in the entertainment software business, Poker software and traditional gaming software. First Poker; growth in the first quarter was impressive and we continue to be optimistic and excited of our market opportunities. Revenue from our Poker software products were $3.6 million, up 62% from the previous quarter. Poker now represents 41% of CESL’s revenues. Approximately 29,000 active real-money customers play average Poker during the first quarter, up 53% sequentially. We continue to work closely with our licensees to capitalize on what we see as excellent growth opportunities in the non-English speaking Western European countries. Our licensees have moved rapidly and effectively to build the Everest Poker brand through sponsorship and numerous Poker tours and tournaments. In addition, this proprietary tour is now underway, the Everest Poker European Championships, which covers seven countries and runs from March through September. All of these activities are driving impressive growth which we expect to continue in 2006. The traditional gaming software business also delivered a solid quarterly performance. First quarter revenues from the traditional gaming software business were $5.2 million. This represented a 23% increase from the first quarter in 2005. The increase in revenues was primarily related to the launch of new video slot machine games. Now, the online casual game business, FunTown. This quarter’s results included for the first time financial results of our online casual game business, which was acquired in January 2006. FunTown delivered solid performance in the first quarter. Revenues in the period were $4.3 million, net income was $1.2 million, and operating margin was a healthy 27.6%. I should highlight that the first quarter operating income and net income of FunTown includes a $322,000 amortization expense related to the intangible asset acquired as a result of the acquisition of FunTown. On an EBITDA basis, FunTown generated $1.6 million in the first quarter or 38% EBITDA margin. First quarter capital expenditure totaled approximately $333,000 of which approximately 74% related to software capitalization. While we are very pleased with this initial performance of our new online casual game growth platform, to drive steady growth and expand our user base, we are focused on developing our product pipeline. In the second quarter, FunTown relaunched a number of new games including Tales Runner, a 3-D adventure racing game, which we expect to further broaden FunTown’s customer base. We are also focused on growing on FunTown’s business through strategic partnership. Our strategic partnership with top Taiwan community blogs by Wretch joins the 4 million members of FunTown with the over 2 million members of Wretch broadening and enriching the entertainment and community offerings for the members of both portals. As a result of our new strategic partnership with T2CN in China, we can now offer FunTown’s game to T2CN’s 21 million registered users. We look forward to working closely with T2CN to expand our customer reach in China. Lastly, the broadband ISP business

[Brad Miller:]

Thanks Tom. Operator, we would now like to move into the question and answer session, so operator please open the call up to questions at this point.

[Operator:]

Thank you sir. Ladies and gentlemen, if you would like to ask a question or make comment, please press “*” followed by “1” on your touchtone telephone. Questions will be taken in the order they are received. You may press “*” and “1” to begin. I’ll take a moment to compile the questions. Sir, your first question comes from the line of Traci Mangini from ThinkEquity Partners.

[Traci Mangini:]

Thank you. Hi guys and congratulations on a fantastic quarter. A couple of questions. On the Poker side of the business, can you tell us what your peak real money players are at this time?

[Thomas T. Hui:]

Traci, this is Thomas here. We have not released that figure. Our peak players actually including both real money and free players was about 8000 for the quarter. We have not at this stage broken that down into real money versus non-real money for the market place.

[Traci Mangini:]

Okay, just for some perspective, though, can you give us a sense of your top three or four markets, where you rank from hit wise numbers or some other market data?

[Arthur Wang:]

Traci, this is Arthur. First of all, thanks very much. As you know, in the online world, market share numbers are difficult and potentially unreliable, but in the first quarter our entire market place is France, Germany, Sweden, we believe we are a top five player and possibly better, but we would be reluctant to be too certain at this time.

[Traci Mangini:]

Okay, but would it be fair to say that as time is moving on you’re moving up that list as opposed to moving up and down?

[Arthur Wang:]

Yes, we have a number of marketing initiatives underway and some exciting plans, which we hope will begin to definitely move the needle up and move us up that ladder.

[Traci Mangini:]

Okay, and then with respect to marketing, you saw a big spike in the marketing from the fourth quarter to the first quarter, was a lot of that due to CESL and these marketing initiatives or was some of that FunTown as well?

[Thomas T. Hui:]

Traci, this is Thomas here. Yes, you’re absolutely correct. On a quarter-on-quarter basis selling and marketing went from $3.3 million to about $5.6 million, a jump of about $2.4 million here. Actually, a large part of this, more than half of this, is coming from FunTown, and you can imagine FunTown’s business, the selling and marketing probably being the biggest causes and expenses item. And CESL, as we mentioned in our prepared remarks, because of the initiatives taken on by the licensees to actively promote in brand, the selling and marketing expenses also increased, but of the bulk of the increase is coming from FunTown.

[Traci Mangini:]

Okay, and I apologize if I missed this because I did hear you touch on it noting on the poker revenue share, is that a number that you disclosed or getting near to disclosing?

[Thomas T. Hui:]

Yes, as we’ve indicated to you and the market place before, we only launched product last year. We didn’t think that the number were steady enough number. We’ll be working with our licensees and now we have adjusted it to actually our favor, and now the revenue sharing percentage is 16%.

[Traci Mangini:]

And I note that you didn’t disclose this number, so maybe you want to do it now, on the revenue share with T2CN, is there anything you can share with us on how we might try and quantify what that relationship will mean?

[Arthur Wang:]

The reason why we haven’t done that is we are fixing up some interesting and creative structures there, but it will be covered by market warmth and at this time we’re not ready to release any numbers.

[Traci Mangini:]

Okay, and then maybe just an update on the ISP business and I know you’ve been looking at strategic alternatives for the consumer side, but maybe just press on a time line for that. And then also the corporate side of the business, over the last couple of quarters, I know you guys have been hopeful about getting that to improve a little bit, but are you still thinking of maybe hanging on to that piece a little bit longer?

[Thomas T. Hui:]

First of all, on the consumer side of the business, yes, we think that we’re actively and proactively looking at strategic alternatives, and we hope that we will have some action within the next quarter definitely. And on the corporate side of the business, as we mentioned before, on this side we see competitive pressure mounting, but we still see it a less competitive and a little more compelling to us comparing to the consumer side, and if you look at the numbers we did, fourth quarter last year was a bad quarter as we mentioned. We did see a slight pick up in the first quarter in terms of the revenue, and coming into the second quarter we think the trend of increasing revenue will continue, so that is probably an area that we will hang on to at least from the short-term perspective.

[Traci Mangini:]

Okay, and then just lastly, Arthur, on the last call you mentioned, I think it was during the Q&A that Dynasty had been trying to contact you guys. I’m just curious, anything you can share about that?

[Arthur Wang:]

Not at this time, I’m afraid.

[Traci Mangini:]

Okay, that’s fine, thank you.

[Operator:]

Sir, your next question comes from the line of Chang Qui from Forun Technology Research.

[Chang Qui:]

Good evening Arthur and Tom, and also congratulations on a very good result. I have a few questions. First, Arthur, you mentioned you see a lot of interest from other premier names in the space regarding your games, can you elaborate what’s your plan with them, are you licensing the software through them or have some kind of partnership, so can you elaborate here?

[Arthur Wang:]

It’s a very interesting time, Chang, and I’m afraid at this particular moment there’s going to be a limit to what I can say. We are considering both strategies, both a licensing strategy as well as special partnerships, and we hope to be back to the market place with some more news on that not far too long.

[Chang Qui:]

I see, okay. And for FunTown, the $4.3 million revenue, is that mostly from Taiwan or you have contributions from other geographies?

[Arthur Wang:]

The revenue comes from China, Hong Kong, and Taiwan with the bulk of it coming from Taiwan.

[Chang Qui:]

Yeah, I kind of tried to have a sense of how to size the potential here. Do you have any idea or market information in Taiwan on how much market share FunTown has in terms of the software they are offering or the games they are offering?

[Arthur Wang:]

We believe we are a leading Asian casual game portal, but again with online games and again in the entire internet space, it’s difficult to have strong reliable data as to market share.

[Chang Qui:]

And Tom, maybe this is a question for you. With the investment in T2CN, you have a minority share right now and I think Arthur mentioned earlier that evaluation is 8.6 times 2006 earnings. So, my question for you is that should we ease back equity income in the future quarters?

[Thomas T. Hui:]

Chang, as we have mentioned in our prepared remarks, the investment will be accounted for on a cost basis. So, basically there won’t be equity accounting, therefore no equity participation of the revenues there.

[Arthur Wang:]

But for the present, Chang, we hold our convertible preferred shares and we will continue to hold them in that form for the time being. Naturally, if we do convert to equity, we may revisit this…the accounting treatment may vary.

[Chang Qui:]

And the convertible preferred here, does that carry any increase or no?

[Arthur Wang:]

Yes, it’s an attractive instrument.

[Chang Qui:]

I see. In terms of when you’re completed with the investment, in terms of gain rollout, what kind of a schedule do you see right now?

[Arthur Wang:]

We’re looking to rollout in the third quarter.

[Chang Qui:]

All right, thank you.

[Operator:]

Again, ladies and gentlemen, as a reminder if you would like to ask a question or make a comment, please press “*” followed by “1”. Sir, your next question comes from the line of Jeff Bradshaw from Martin Currie.

[Jeff Bradshaw:]

Hi, Arthur. I’m really glad that things are going as well or perhaps better than I’d hoped. I just have a few questions that I’d be very happy for you to sort of speculate freely about. The first I guess would be the potential for the new offerings from FunTown -- Tales Runner and FunTown Village -- and I’d like to get a sense of whether they are going to be incremental only or whether they could be something more than that. And then, in terms of the T2CN Corporation, I’d be very interested to sort of hear about more how you think that could develop in the long term? Thanks.

[Arthur Wang:]

Sure, thanks Jeff. First on FunTown and Tales Runner and FunTown Village; FunTown Village is a very delightful 3-D virtual world and has a fun quotient in my mind. It makes the experience one not simply cold menu where you’re going to choose a game and go play games, but one where you actually have a little avatar there that buzzes around and goes up to other people, and it’s a fun little virtual world. In addition, there’s a lot of very cute fun things you could do there, buy virtual clothes, trade virtual items, give virtual gifts, propose to strange women, and offer to commingle your chips and points with them or possibly get divorced with them. So, it’s a very fun element and I don’t think of it necessarily as a revolutionary or disruptive type of a technology which entirely changes our business or our model, but it’s a very nice feature. We think it strengthens and increases our community offering and is a nice gateway to a wide variety of enhanced entertainment services. Ultimately what we’re looking to do is to build a comprehensive entertainment destination. The FunTown Village is one of the entry ways into that wide range of entertainment opportunities. So, there are game rooms where you can go in to play games, shops where you can go to the shop, and community areas where you can go an chat, exchange items, exchange photos. So, in many ways it’s a nice gateway and central gathering place. We believe that community is very, very important in the success of an entertainment offering, and this is a nice community gathering point.

[Jeff Bradshaw:]

And how does the revenue look from FunTown Village?

[Arthur Wang:]

The Village itself is free to enter but different elements of the Village do cost money. Naturally, for example, getting married costs money, we all know this, and the giving of gifts of course involves a transfer of money from you to others, of course, purchase of virtual items, articles of clothing. Articles of virtual clothing which sell for about $50 actually sell quite well. Again, it’s a platform or a gateway for a wide variety of virtual entertainment alternatives…moving on to Tales Runner. Tales Runner is an absolutely delightful name. We did not write it ourselves. We licensed it from a Korean software developer, and it’s a game where one adopts a funny character of what appears to be a large bunny rabbit type of creature with legs, and one competes in a variety of general races with other players -- snowboarding, running, jumping, doing a variety of different activities. I find it very adorable. In the closed Beta launches the results are very good, so we think that this is a potential big hit for us. The nature of the game, if we were to categorize it, falls into what we are calling advanced casual games. So, looking at our strength in traditional table, board, and chess games, we are now looking to roll out games which are more traditionally similar to console games, games you might find on Xbox 360 or the PS3 games with high graphic content and a very rich visual environment with 3-D movement and 3-D environment, which one moves and plays in. So, this type of game is on a multiplayer online player is relatively new, and we believe it has strong potential.

[Jeff Bradshaw:]

And that revenue structure?

[Arthur Wang:]

Revenue structure will be as with our other casual games. It will be on a pay to play, either by way of subscription or on a pay to play basis as well as sale of in game items. T2CN is in my mind a fabulous company, a company with a very, very talented management team. They have built out their platform very rapidly with great success and in partnership with some of the premier international brands. Many members of the management team come from the operating level from some of the other leading game companies in China and in Asia, and they bring with them a great deal of hands-on execution experience. We are very excited to partner with them and to use their expertise and their platform to roll out the FunTown House, and we see many, many areas of cooperation and growth. One of the areas in which they’ve done very well is running very, very large scale province wide or countrywide tournaments, and we believe that the running of such tournaments, which we do sometimes here in Taiwan, will have great potential and exciting opportunities for us to expand and to increase the popularity and the stickiness of our games in China.

[Jeff Bradshaw:]

Do you know what their playing customer base is?

[Arthur Wang:]

Yes. Their model is primarily the sale of in game items. For example, in their leading game, which is an online basketball game called Freestyle, the game model works as follows

[Jeff Bradshaw:]

That’s great, thank you very much.

[Operator:]

Sir, you have a followup question from the line of Chang Qui from Forun Technology Research.

[Chang Qui:]

Arthur, again, for your traditional gaming business, the Casino business, should we expect because of your new game offerings some of the seasonal weakness offset by the newer games?

[Arthur Wang:]

Chang, this is Arthur. I believe that there will still remain a seasonal effect, and this is a factor of life for the entire industry. Whether or not our new games and our Poker offering and the growth of that will mask some of the seasonality, we’ll have to see. But regardless of what the numbers show there, and regardless of whether online stays flat or continues to go up, there will be implicit in that number some seasonality. I personally believe that that’s capable.

[Chang Qui:]

I see, all right, thank you.

[Operator:]

Again ladies and gentlemen as reminder, if you would like to ask a question, please press “*” followed by “1”. Sir, at this time you have no additional questions. I’ll turn the call back to you for closing remarks.

[Brad Miller:]

Okay, thank you all of joining us again 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 for Taiwan. Thank you.

[Operator:]

Ladies and gentlemen, this concludes the presentation. You may now disconnect. Have a good day.