GigaMedia Limited
Q2 2006 Earnings Call Transcript

Published: 8 Aug 2006

[Operator:]

Good day ladies and gentlemen and thank you for standing by. Welcome to the GigaMedia Limited Conference Call to discuss second quarter 2006 financial results. (Operator Instructions) I would now like to turn the presentation 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 second 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 August 8, 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

[Arthur Wang:]

Thanks Brad and thank you all for joining us. We are very pleased today to report our second quarter 2006 financial results, the best ever for GigaMedia. Second quarter revenues from continuing operations were up 92% year-over-year to $21 million. Net profit climb 819% to a record $11.2 million. Consolidated EBITDA grew 391% to $13.6 million, also an all-time high. To add some perceptive, now halfway through 2006 our operating margin has expanded to 21.9% from just 14.8% in the fourth quarter of 2005. For the first six months of 2006, net profit has grown to $14.4 million, more than double our full year 2005 net income and we have delivered an EPS for the first half of $0.28, up from $0.13 for the full year 2005. Before speaking about our major business units, let me highlight a few points about the second quarter. First, operating results. While our big net income numbers takes the headline, the most important news today is the strong growth in our operating income all driven by the organic growth of our core businesses. Quarter over quarter, our operating income in Q2 climbed 40% from Q1 of this year. We have concentrated much time and attention on continuing to improve our execution and we are pleased with the progress we are making. We look forward to further gains built on continued solid execution. Second, momentum. We are very excited, very energized by the momentum we have developed in our European Poker products. Poker revenues grew 62% in Q1 of this year; and then, another 65% in Q2. 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, restructuring nearly complete. For the past two-and-a-half years the new management at Giga has been busy. On the one hand, restructuring and transitioning out of our legacy businesses and at the same time, building the new GigaMedia, focused on the high growth, high margin online entertainment sector. With the sale of our ADSL unit in the second quarter, our transition from the old Giga is nearly complete. As a management team, we look forward with enthusiasm, with vigor, to a single pointed focus on growing the new GigaMedia. Let me now briefly review the performance of our core businesses, and then add a few updates about our 2006 growth initiatives. The entertainment software business had an excellent quarter. Multi-player poker has grown rapidly, and in the second quarter for the first time, contributed over half of our entertainment software revenues. Active, real money players on Everest Poker jumped 50% over Q1, driving net profit for the entire division, up 41% over the first quarter. In the second half, we will be working hard to build on and accelerate this growth. In September, we will host the finals of the Everest Poker European Championship, bringing regional and single country champions together for the finale in Barcelona. In addition, we will continue to sponsor seats for third-party tournaments, such as the World Poker Tour and the World Series of Poker currently underway. Our marketing initiatives are showing high returns on investment, and we therefore plan to increase our marketing and brand-building activities. Turning now to FunTown where quarterly performance was unfortunately impacted by seasonality, in particular by end of school year exam season and to a lesser extent, by World Cup fever. Despite this, our net profit held steady. During Q2, we expanded our suite of games and added 311,000 new players, increasing peak concurrent users to over 34,000. In the second half, we planned to drive our growth with the launch of several new games and by building on our strategic partnerships with Wretch and T2CN. Wretch is a leading community and blog site in Asia, currently ranked 32nd in the world in terms of daily traffic, according to Internet metric firm, Alexa. Under the terms of our strategic partnership, we combined Wretch’s strength in blogs, online photo sharing and other community offerings with FunTown’s leading MahJong and other online casual games. We have already begun by sharing traffic and users, and plan to further enrich our respective offerings and communities. In May, we formed an exclusive partnership and made the strategic investment in T2CN, a leading game portal and operator of the largest online sports game in China. Our partnership, which we target to launch by quarter’s end, will bring our number one FunTown, MahJong and other Asian games to the 28 million registered users of T2CN in China, an important expansion of our China market reach. Before I turn the call over to Thomas, I would like to provide a quick update on our real money MahJong product. During the first half, we have taken FunTown’s leading MahJong games and added real money, cash wager functionality, drawing on the extensive experience of our real money software operations. Our product is now ready in beta release and upon contemplation of final quality assurance testing, we look forward to a rollout later this quarter. The initial contribution will be small, but we remain highly optimistic about the medium and long-term prospects for this business. On top of these growth initiatives, we also continue to consider strategic acquisitions in the online entertainment sector that would drive long-term growth and be accretive to our earnings. In sum, at this half year mark, we are happy to report that our business restructuring is nearly complete. Our growth today gives us confidence in our strategic direction and execution plans. We are executing well, generating strong momentum in high margin, high growth businesses. We are indeed building a new GigaMedia's with growing shareholder value as its cornerstone. Thank you very much. Let me now turn the call over to Thomas Hui, our CFO.

[Thomas Hui:]

Thanks Arthur. Let me turn now to look at our financial performance for the second quarter. I will begin by taking you through our consolidated results and follow that with a look at each business unit. Starting with our consolidated income statement, GigaMedia delivered significant organic growth and achieved the Company’s best ever results in the second quarter of 2006. Consolidated revenues grew 92% year-over-year, or 15% quarter-over-quarter to $21 million. Operating income for the second quarter rose 40% sequentially to $4.6 million, with our operating income margin expanding to 21.9% from 18% last quarter. There were two key drivers for the significant growth of our revenue and operating income

[Brad Miller:]

Thank you, Thomas. We will now move into the 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.

[Traci Mangini:]

Thank you. I just have a couple of questions. With respect to FunTown, I know you said why it was down sequentially, but can you give us a sense of how it was trending in the first two months of the quarter?

[Thomas Hui:]

You mean the second quarter?

[Traci Mangini:]

Right, in the first two months of the quarter. Just trying to get a sense of how significant the impact was in June.

[Thomas Hui:]

Most of the downturn was coming from the month of May and June for the first part of the week, because of the exam season, as we have mentioned, so even in the month of May, we do see some downturn. On top of that, in June, the World Cup also, to a lesser extent, but it also impacted us.

[Traci Mangini:]

Can you give us a sense of what you think the seasonality will be in the third quarter? Will it mirror that of online gaming or will it start to trend up?

[Thomas Hui:]

We think the seasonality is not similar to the online gaming portion because seasonality is primarily coming from the exam seasons, which are now over, so for our third Q, it should have the kind of seasonality we see in the online gaming software business.

[Traci Mangini:]

Is there anything at this point that you can help us as far as trying to quantify the impact of T2CN?

[Arthur Wang:]

Not at this time, Traci. We are launching this quarter and we are trying to develop a partnership with them. We think they are a very with-it company with a very exciting product space in China and we are confident that there will be some contribution but not at this time, with respect to quantification.

[Traci Mangini:]

As for the real-money Mahjong, can you give us your strategy with respect to geographic penetration, given all the recent activities in the U.S. market?

[Arthur Wang:]

As we noted in our earnings release, Giga derives none of its revenue from United States sources, and this has always been our practice and will continue to be our practice, so we will be focusing upon the non-English language markets outside of the United States and also outside of the U.K. for our poker product. There will be, again, no concentration, no focus, no entry into the U.S. market.

[Traci Mangini:]

Then, Thomas, for you, just in terms of the minority interest, I would have expected that number to be quite a bit higher, given the seasonal revenues. Has there been any change in the revenue share agreement with UIM, or is there something else impacting that number?

[Thomas Hui:]

No, there is no change in the revenue sharing agreement with UIM. The percentage remained the same. Obviously, as the revenue goes up, as you can see, our overall cost in terms of selling and marketing and also operating costs goes up, and that is primarily because of the seasonal business. A large part of those costs are bear by UIM, so while they also enjoy the increase in benefit, but because of the increase in marketing expenses from their part is what is driving a lot of these costs. They do not enjoy such a great benefit in terms of minority costs, minority interest, i.e. net income impact.

[Traci Mangini:]

Okay, and we should look for those types of marketing expenses to continue, given the tournaments, et cetera, that are coming up in the second half of the year?

[Thomas Hui:]

Yes. In fact, I think as both Arthur and I mentioned, in addition to a new product launch, turning up the volume on marketing initiatives is one thing that we are embarking on for the second-half of the year, given the momentum of the business, so yes, we will definitely be looking at increasing marketing spend to advertise.

[Traci Mangini:]

Lastly, are there any updates you can give us -- I know you mentioned you are still working on some expansion, potential expansion within China. Is there anymore detail you can share in that regard?

[Arthur Wang:]

We have some very interesting things underway, Traci, but I am afraid we are not able to speak of them at present.

[Traci Mangini:]

That is fair. Thank you.

[Operator:]

Your next question comes from the line of Mr. Chang with Forum Technology Research. Please proceed.

[Mr. Chang:]

Good evening, Arthur and Tom. Congratulations on very good results. Arthur, could you elaborate more regarding your real money Mahjong? You mentioned you are in beta testing and you mentioned you will rollout the product in this current quarter. I am just wondering how you will do it.

[Arthur Wang:]

We are considering a couple of different approaches. Because of the high level of interest in the product, we have some interesting proposals before us. I am afraid that as we are in negotiations currently, it would probably be best for me to defer on that question until a little bit later.

[Mr. Chang:]

I see. For the traditional game product, which means the online casino side of the business, are you -- previously you indicated you have quite big seasonality. This year, what you see this year, because you have new, four-star offerings, should we expect less of seasonality from that product line?

[Thomas Hui:]

Yes, what we have seen in the second quarter is what is very encouraging to us. Traditionally, Q2 is weaker for the traditional gaming product than Q1, but as we have indicated in our prepared remarks, we achieved a 10% growth sequentially, and that we attribute primarily to the launch of a, a continuous launch of new games, as we have mentioned, to disclose before we have this game of the month program, where we turn out new games, has been very receptive and that has been generating a lot of new interest. Also, the Everest brand also contributes to the increase, so we think seasonality will still be there, but we hope -- in Q3, but we hope the effect is much more muted this year comparing to previous years.

[Mr. Chang:]

I see. I noticed you did a wonderful job with the online poker side, because some of your peers reported a sequential down quarter on the poker side, so my question for you is the World Cup Soccer, the World Cup impact is there, and maybe also some in the third quarter. For the third quarter, what kind of sequential growth should we expect? Should we expect a double-digit growth in the third quarter again, or it is different?

[Thomas Hui:]

I think the biggest impact in terms of the growth rate in the third quarter is likely going to be the after-spill effect of the World Cup, but the fact that most of the European countries, the citizens of the European countries have long vacations during the month of August, and that was the result of the -- that was obviously the reason why we had all this seasonality. Now, for the poker side, we have been going 60% plus sequentially from a revenue perspective in the past two quarters. We do not think that is going to continue because of the seasonality in the third quarter, but we certainly hope to achieve double-digit growth sequentially.

[Arthur Wang:]

I think double-digits -- I will go on a limb and say double-digit growth definitely, and then how much, we will have to see.

[Mr. Chang:]

I see. Okay. That is great. Thank you.

[Operator:]

Your next question comes from the line of George Mihalos with Gilford Securities. Please proceed.

[George Mihalos:]

Good evening, gentlemen. Congratulations on a very solid quarter. I was wondering if you can speak a little bit as to some of the competitive pressures that the Everest product may be seeing from some of the English-speaking poker incumbents, the Party Pokers of the world and so on and so forth.

[Arthur Wang:]

We definitely see and face competition, and we actually expect that competition to grow. We are heartened by the fact that we have been operating in continental Europe in the non-English language markets for over 8 years. We are an early entrance into those markets. We have end-to-end, full foreign language solutions, and we are going to make it a good fight.

[George Mihalos:]

Fair enough. My final question would be can you update us as to the FunTown X-Box relationship and what is going on there?

[Arthur Wang:]

FunTown has been selected by Microsoft to be one of the first -- to be the first local product to be released, localized product that is part of X-Box Arcade, and Microsoft has already announced this and there have been a number of different press conferences on it. The actual launch of the game, in other words the go live for customer use, is expected at the end of this month.

[George Mihalos:]

Thank you.

[Operator:]

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

[Bill Garrison:]

Thank you. A couple of quick questions. I wanted to ask, with respect to the broadband sale you indicated in the press release, the $7.7 million pre-tax gain. Was there any on an after-tax basis? Was there an effect there?

[Thomas Hui:]

As we have indicated before, the business was sold in Taiwan, obviously, so we can utilize most of our cash carry-forward to offset the income tax effect. However, in the Taiwan context, faced a tax on distributed retainer earnings, and the tax rate is 10%, so you notice that in this quarter, we have an increased income tax expense, and that is primarily related to the 10% probation we have made for the income generated in the Taiwan operation. So in other words, the $7.7 million, if you look at the tax effect, will be 10% of that $7.7 million.

[Bill Garrison:]

Thank you. As well, I wanted to ask about T2CN. It looks like, if I recall, they had 21 million registered users when you started the relationship in May, and they are now up to 28 million. Could you comment at all in terms of what they are seeing to drive that kind of rapid growth in subscribers?

[Arthur Wang:]

T2CN is very clever about marketing partnerships. For example, at their launch, they worked with Coca Cola and did a joint marketing campaign with Coca Cola, whereby within the game itself, if you wanted to get an energy boost and play faster or play better, you could purchase a virtual can of Coca Cola. There were branded Coca Cola basketball courts and the like. In exchange for that, Coca Cola put the freestyle game on every single can of Coke sold in China for a period of time. T2CN is very savvy about using these types of branded and marketing partnerships. Since we did our exclusive joint venture and partnership and investment in T2CN in May, T2CN has launched a nationwide tournament for the freestyle basketball game, and it is a tournament that has attracted a lot of attention. There are some very hot young male and female movie stars associated with the tournament, and I think all of these factors are big contributors.

[Bill Garrison:]

Finally, I wanted to ask a follow-up on the real-money Mahjong. From a rollout standpoint, there is talk about partnerships and things like that. Would you be able to launch initially -- could you do that without a partner, or could you just expand a little bit in terms of what you are thinking there from a strategic standpoint?

[Arthur Wang:]

There has been a high level of interest in the product and in partnering with GigaMedia. We are considering a number of different approaches, ranging along a continuum, at one end from an exclusive partnership with a, for example, a major player, major global player to a situation where we might work with a number or be associated with a number of different players. So a number of different alternatives are before us and we are evaluating those with respect to what will bring about the best long-term development of this product and create the greatest long-term results for Giga. I hope that is not too vague, but at the present moment, I think it is best that we limit our discussion. We are actually in some sensitive negotiations.

[Bill Garrison:]

Thank you very much, and congratulations.

[Operator:]

(Operator Instructions) Your next question comes from the line of Alicia Yap with Bear, Stearns. Please proceed.

[Alicia Yap:]

Good evening, Arthur and Thomas. A couple questions on the Mahjong FunTown business. There are three parts of my question. The first part is, since we only have two quarters of your numbers, can you give us some color on how we are going to see the seasonality for the full year? For example, the third quarter and the fourth quarter. The second part is for your active paying players this quarter has actually decreased from your first quarter. Is it because of the seasonality of the revenue? How is it related to the maximum concurrent user, because that actually increased from the first quarter? The third part is if you can elaborate a little bit on the composition of this Mahjong business, and then if you can lease out some of your competitors. Thank you.

[Thomas Hui:]

Alicia, I will take a stab at the first two questions of yours, probably in reverse order, so that we just get the numbers out of the way first. In terms of the number of active paying customers that we have disclosed to the market, it is about 117,000 in the first quarter and about 110,000 in the second quarter, so that is a fairly consistent number and not a big decrease there. Obviously the slight decrease was partly due to the seasonality. The reason why the maximum concurrent user increased quite a bit was because of the fact that we launched a new game in the second quarter, Tales Runner, which is a game we licensed from a Korean developer. This is a running game and quite a lot of Tales players played. Now, the game is free to play, and then the revenue model is sale of in-game items, similar to the freestyle basketball on T2CN. Since we launched the game towards the end of the second quarter, so it is [well-based], the large increase in the maximum number of concurrent players, there has not been a real significant impact on the number of paying customers during the quarter. So that explains the reason for the different trends of the player numbers.

[Alicia Yap:]

I see. What is the portion of the breakdown between the MahJong and this Tales Runner? I know it is small right now, but is it going to be like 80%, 20%, breakdown?

[Thomas Hui:]

It is still primarily -- the Mahjong product is the bulk of the players, so it is probably even more than the 80-20 numbers you mentioned. It is a few thousand players, concurrent players for the Tales Runner. I think that was before the end of the second quarter. On your first question regarding seasonality, we think second quarter is absolute -- should be the bottom of the seasonality. We see third quarter coming up, and then once we launch new products in the second-half of the year, we think this business will continue to pick up momentum, and we hope to increase our revenue that way, but we do not think seasonality is similar to, again one of the earlier questions from Traci, it is not similar to the [inaudible] business of our ours, where the third quarter is the lowest throughout the year. Therefore, the FunTown business we think May, June and this year, especially, because of the impact of the World Cup, second quarter is going to be the worst quarter. So from that perspective, we see that revenue coming back up from the second quarter level.

[Alicia Yap:]

What about fourth quarter? Would that be because of the holiday season, will that be increased?

[Thomas Hui:]

Technically, fourth quarter and first quarter is stronger for us because of the Chinese New Year holidays, but again, we have a series of products to be launched in the second-half of this year, so with the new product launch, we think the revenue has upside potential from the current level.

[Alicia Yap:]

Okay.

[Arthur Wang:]

On competition, we have many competitors who offer Mahjong products. Some of them target different market spaces, some of them are more cartoon like, some of them are I think an attempt to copy us and what we put out there. What we maintain, and I think our numbers speak for it, that our product most is an advanced, late generation product which has an optimized user playing experience. I think that is the reason why we continue to grow the product and continue to enjoy large market share.

[Alicia Yap:]

Can you maybe just give us who you see is the most, you know, you most fear?

[Arthur Wang:]

Again, our product is a market leader. We see many products out there that continue to refine and operate themselves. We will continue to develop our product and make sure it is as good or better than anyone else’s offering and defend our market share.

[Alicia Yap:]

Thank you.

[Operator:]

At this time, there are no further questions in queue. I would now like to turn the call over to management for closing remarks.

[Brad Miller:]

Thank you, Operator, and thank you all again 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, for Taiwan. Thank you.

[Operator:]

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.