Earnings Labs

GigaMedia Limited (GIGM)

Q3 2007 Earnings Call· Wed, Nov 14, 2007

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Transcript

Operator

Operator

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

Brad Miller

Management

Thank you. This is Brad Miller, investor relations director of GigaMedia. Welcome to our third 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, President and COO. 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 2007. This presentation is being made on November 14, 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 3Q 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

Management

Thanks, Brad. We are very pleased to report today our strong third quarter 2007 financial results. Third quarter performance was strong in every business unit, driving consolidated third quarter revenue up 76% year over year to $43 million, operating income up 66% over last year to $10 million, and a fully diluted, non-GAAP EPS of $0.17 per share, excluding non-cash share-based compensation. Equally importantly, we made great progress in Q3 in positioning GigaMedia for continued strong long-term growth in our two primary growth areas -- real money gaming software and our Asian online games platforms. Thomas will go through our financial results in more detail in a moment. I would like to highlight a few developments with an eye towards our future growth prospects. First, our poker and casino software business -- the third quarter was another record quarter for our real money gaming software business, with both year over year and quarter over quarter growth in both financial and operating metrics. Moreover, during the third quarter, Everest Poker was recognized by the online gaming industry and awarded one of its highest honors, the Poker Operation of the Year, at the 2007 E-Gaming Review Awards Ceremony in London. We are very proud of this recognition and appreciative of the regard and esteem from the online gaming industry. But I must emphasize; we view this recognition not as grounds to become complacent but rather as inspiration to strengthen our resolve, our commitment to build the very best online entertainment firm. Despite the seasonal slowdown, the third quarter was very active, with a continuation of the Everest Poker European Championships, the Everest Poker Avalanche tournaments, sponsorship of numerous satellite events throughout Europe, and the conclusion of the Everest Poker Japan cup with a live finale on Tinian Island. All told, these activities…

Thomas T. Hui

Management

Thanks, Arthur. I would like to begin today’s comments by highlighting GigaMedia's key achievements during the quarter. I will then review our consolidated financial results and discuss our business unit financials. Overall, we delivered solid performance inline with our expectations in the third quarter of 2007. In our poker software business, despite the negative impact of seasonality, we were again able to deliver growth. We achieved this strong performance as a result of the growing popularity of Everest Poker, whose quality and success was demonstrated in Q3 with its award as Poker Operation of the Year, as Arthur has mentioned. In our Asian online game business, we continue to drive top line growth while strengthening our game pipeline and continuing to integrate with T2CN. We scored regional rights to highly anticipated game titles and increased our ownership level at T2CN. Now let me quickly summarize our consolidated results in Q3 2007. Consolidated revenue grew 76% year over year, or 7% sequentially to $43 million. This growth was due to continued record performance in our poker software business, complemented by increased contribution from our Asian online game business, which represented 23% of our total revenues in Q3. Consolidated gross profit increased 80% from the same period last year, or 4% sequentially to $33.2 million as a result of the consolidated revenue growth. Our consolidated gross profit margin was 77.1% in Q3, down from 79.4% in the previous quarter, reflecting a sequential increase in game licensing and royalty costs in our Asian online games business. Consolidated operating income rose 66% year over year to $10 million, and was approximately flat sequentially. Operating margin declined to 23.3% in Q3 as a result of the increase in operating costs and selling and marketing expenses in the Asian online game business. Consolidated net income in…

Brad Miller

Management

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

Operator

Operator

(Operator Instructions) Your first question comes from the line of Alice Yapp from Citigroup. Please proceed.

Alice Yapp - Citigroup

Analyst

Good morning. Congratulations on a great quarter. I have a couple of questions. First of all, given many big competitors are getting more aggressive, switching their focus towards the non-English countries, we understand that you are one of the early movers but given the larger budgets these bigger competitors have, do you expect any impact to your European gaming business in the coming quarters? And what are your strategies to continue to grow and defend your leading position?

Thomas T. Hui

Management

Thank you for the question. Yes, you are absolutely right. We do see competition increasing as some of our competitors finish their exit of the U.S. market and actually move into some of our markets. But as we’ve been highlighting in the past few quarters, it is not as if these competitors were not in our market before. They were always there. We’ve always been competing with them and as we have demonstrated time and again in our quarterly results, both from a revenue perspective and also customer acquisition in terms of actual growth in the number of customers, that we are actually able to compete quite successfully against our competition. In this quarter, for example, despite the seasonal slowness in some of the numbers that are being reported by some of our competitors, we actually grew our active paying customers in the same market that we are competing in against them. Now, we do see customer acquisition costs in certain selected markets going up but again, because of our established affiliate networks and our ability to market nimbly and the fact that we have already build up the Everest Poker brand, we feel that we have every bit of an advantage to compete with our competitors.

Alice Yapp - Citigroup

Analyst

Okay, great. My next question is regarding Hellgate: London. Can you provide us the latest update on the launch in Singapore and the U.S.? And how should we incorporate those early results in the model? I know the [IHH] is only in the equity income line, but just in the early results, how should we expect that?

Arthur M. Wang

Management

The initial launch of Hellgate: London was probably a little premature. The game was released and there were a lot of technical problems and also the online functionality, some of the key things about the game, the player versus player mode -- go online and attack your friends or enemies, the guild system, the ability to join up and form gangs or guilds and go fight together as a group against others, some of the chat functionality -- many of these things were not incorporated in the initial release and will actually only be released in upcoming enhancement patches, which are expected to be released over the next month or two. So the -- we believe that the initial performance of the game is not reflective of the actual ultimate operating results that are obtainable from this game, and in fact, we are very, very excited by what we see in the game. The game play itself, the graphics, and our own initial internal evaluations suggest that Hellgate will perform very, very well in our marketplaces when we launch in the second or third quarter of next year. At that time, we think that any of the initial bugs and feature limitations will be solved, so we’re quite excited about the game. The most important thing about Hellgate is that it fits in the action segment or category of games, which is still one of the hottest and most important segments in Asia, so we are feeling very, very confident about the game.

Alice Yapp - Citigroup

Analyst

Okay, good. And then I have just one quick question; in terms of the non-operating income line, there’s a big increase this quarter. Can you elaborate a little bit on that?

Thomas T. Hui

Management

This was actually due to at T2CN level, there was a cancellation of certain [warrant] liabilities that was originally on T2CN’s book due to the conversion of the convertible [inaudible] shares and the warrants were originally attached to the [prep] shares. When the [prep] shares converted, the warrants were extinguished. So T2CN generated a gain, and also there was a termination of a game licensing contract and that also generated a game. I think the $1.5 million or so you saw there is primarily because of these two items.

Alice Yapp - Citigroup

Analyst

So it’s only a one-time event, right?

Thomas T. Hui

Management

And because these two items at the T2CN level, so the net income impact was about $880,000 as we talked about, to our financials.

Alice Yapp - Citigroup

Analyst

Okay, and it will not occur next quarter?

Thomas T. Hui

Management

Well, I mean, they don’t have more warrants to cancel, so no, this is one-time, yes.

Alice Yapp - Citigroup

Analyst

Okay, and then can you give us some update on the T2CN business? What should we expect for the game Freestyle going forward? It seems like it is declining. And other launch dates on the pipeline. Thank you.

Thomas T. Hui

Management

The business is actually, in terms of Freestyle, again the primary game now is steady, roughly flat and we can expect it to be steady in the near future. You see actually a pick-up in revenue in the financials we just reported and that was because of an increase in in-game advertising revenue we secured during the quarter. We expect that to continue and T2CN is in the process of launching a game which will be fully launched before the year-end, probably in the next month or so, a tennis game, as we have talked about in Q2 earnings release. This will incrementally add to the revenue and help improve the margins. In the first quarter next year and the first quarter to second quarter, they will be launching a snowboarding game, again following the general direction of sports related games. Again, that will be a game we believe has incremental revenue potential and actually will be able to help increase the margins there.

Alice Yapp - Citigroup

Analyst

Okay, great. Thank you. I’ll get back to the queue. Thanks.

Operator

Operator

The next question comes from the line of James Rhee from Bear Stearns. Please proceed, sir.

James Rhee - Bear Stearns

Analyst

Thank you. Thank you very much for taking the call. Congratulations on the quarter. My questions, I have a few, but the first one is broadly, in terms of the regulatory environment in continental Europe, how would you compare the current status with say 12 months ago? And if you’re willing, what do you think the outlook is perhaps 12 months later? Do you see it liberalizing or do you see it going the other direction? The second question, you mentioned an Electronic Arts title, obviously you can’t mention any details on that specific title. However, do you in your opinion feel it’s just a one-off title or that it could be some type of stronger relationships developing in the future? And I have a follow-up.

Arthur M. Wang

Management

First of all, with respect to the regulatory environment for online gaming in Europe, we are actually very, very pleased with the developments in Europe compared to 12 months ago and looking forward 12 months. We basically see that what I think as the die is cast, that Europe is moving as a single trade block to have an open, regulated but liberal online gaming environment. And country by country, there have been many positive developments in this regard, so looking out 12 months, I see a situation where ultimately we see an open, liberal but regulated operating environment in Europe and that’s the outcome we’d be most happy with for our business. With respect to our deal with EA, at present, we mentioned one title and I’m afraid that’s all we can speak to. Naturally, we think very highly of the firm, EA and their incredible content library and we look to do more things with them. At present, however, all we can speak to is the current deal. We are hoping to do some more things but we’ll have to get back to you on that.

James Rhee - Bear Stearns

Analyst

Okay, thank you. Related to the Pachinko, Pachislo, and the Japan catered software products, you mentioned that it should be testing prior to Christmas, so perhaps a month later. Without getting into hard guidance, what do you think the ramp-up and the consumer adoption would be like for that market? Do you think it would be a rather gradual thing or do you think it would be rather explosive from the beginning?

Arthur M. Wang

Management

We have naturally a very aggressive ramp-up and marketing campaign that we’ve been looking at. However, we as a company policy do not like to give forecasts on businesses which are so early, so young in their development. So at this point in time, I am going to have to pass. But we are very, very optimistic about the prospects in Japan and I personally am hoping that it is a good contributor in 2008.

James Rhee - Bear Stearns

Analyst

Thank you very much, both and I’ll get back in the queue myself.

Operator

Operator

The next question comes from the line of Traci Mangini, ThinkEquity Partners. Please proceed.

Traci Mangini - ThinkEquity Partners

Analyst

Thank you. I had a couple of questions tailing on the Hellgate: London questions. Do you know if other geographies also are delaying their launch, aside from obviously the ones that have already launched?

Arthur M. Wang

Management

We think that Korea is right now in beta stage and they will be launching, I think going commercial at the end of this year, or beginning in January. That is according to schedule, and all along in greater China, we have been planning to launch after North America, Europe, and Korea. In part, this is strategic on our part to take advantage of some of the marketing buzz that happens first, and also to allow some of the early roughages to be smoothed out in the game. Again, I would emphasize that we are really very excited about this game and we think that it has the potential to be as big a hit or bigger than Diablo I and II, which were the biggest hits in history in Taiwan.

Traci Mangini - ThinkEquity Partners

Analyst

Okay, well then, given this new timing, what should we expect in terms of marketing expense supporting the game? I mean, will we still see some in Q4, Q1? Or should we push out the bulk of it into right around the time it will launch Q2, Q3?

Thomas T. Hui

Management

I think it would be that the marketing spend would coincide with the launch. You’ll probably be slightly ahead of the launch but you will not be a full quarter ahead of the launch. So if the launch around Q2, Q3 time, that’s probably when the marketing spend is going to hit.

Traci Mangini - ThinkEquity Partners

Analyst

Okay, and then just on the same topic of marketing expense and strategy there, while I know you don’t want to make any projections on where the Japanese games can go and how quickly, can you at least give us a sense of the marketing plan for that? Is it still to follow the same path that you did with Poker, minimal marketing up-front and then add to it as you get traction? Is that the idea?

Thomas T. Hui

Management

Yes, we will adopt a similar approach, at least at the outset, utilizing our well-established and expensive affiliate marketing network, which provides us a variable cost way of marketing the product. Once we gain traction, we will -- now we have obviously a much bigger base, both from the product that UIM is operating in Japan and a new product to launch any brand-specific marketing.

Traci Mangini - ThinkEquity Partners

Analyst

On the real money Mahjong, was there anything at all in the quarter from that, be it just regular revenues or any of the up-front payment that was amortized in the quarter?

Thomas T. Hui

Management

No, I mean, it’s negligible -- basically, it’s negligible.

Traci Mangini - ThinkEquity Partners

Analyst

Okay, and going forward, I know you guys have been just rethinking the model that you wanted to use with that platform. Have you come to any conclusions or are you getting more comfortable with this third-party model, given your partner is starting to devote more marketing resources to it?

Arthur M. Wang

Management

We think that the approach is the right approach and we are going to be rolling this out, as we say, much more broadly to a much wider pool of licensees. We think that these licensees, as well as our initial license partner, will all be able to do quite well with this product and as a result, so will we.

Traci Mangini - ThinkEquity Partners

Analyst

Okay, great. And then just lastly on the Asian games business, I know you guys have talked in the past about just the number of different things that are in the pipeline. You mentioned the Electronic Arts. Can you give us a sense of timing for some of the other things you are working on? Are they 2007 announcements? And then if they are, is it something that we don’t really factor in probably realistically until the second half of 2008 in terms of contribution to revenue?

Arthur M. Wang

Management

This is a hard one to answer. Yes, we anticipate having some more good announcements in 2007, so --

Traci Mangini - ThinkEquity Partners

Analyst

Thank you.

Operator

Operator

(Operator Instructions) The next question comes from the line of Todd Eilers, Roth Capital Partners. Please proceed, sir.

Todd Eilers - Roth Capital

Analyst

Just a couple of quick questions; first, with regard to your guidance on the real money gaming business, I believe you said 15% sequential growth in October. Do you guys typically, looking at November and December, do you typically see those months historically as stronger months in terms of growth in the fourth quarter over October? Or are they roughly typically the same? I’m just trying to get a feel for how the fourth quarter shapes up.

Thomas T. Hui

Management

From an historical perspective, we can tell you that November is better than October, October is better than September and December is better than November -- sorry, not in the right order here but yes, as we get to colder months, people tend to go out less and also, some of the marketing we typically put in place only after the summer is over kicks into effect. All those factors -- I can’t say for the industry for sure, but at least from our historical experience, what we’ve seen is a gradually increasing contribution and more business momentum as we move into the year-end months.

Todd Eilers - Roth Capital

Analyst

Okay, great. And then, it looked like your ARPU for the real money business in the quarter dipped around $45 year over year and sequentially declined a little bit. Can you talk to what is going on there? What are your expectations going forward for that number?

Thomas T. Hui

Management

Sorry, Todd, you were referring to which business? I’m sorry, I wasn’t --

Todd Eilers - Roth Capital

Analyst

The real money gaming business, or I’m sorry, your poker.

Thomas T. Hui

Management

The poker business, okay. I think we expect the per player yield to basically be steady. If you look at the numbers in the first -- Q3, it was about $135 and that was around the same range as -- it was in an acceptable fluctuation for Q2 and Q1 as well. We don’t expect that to significantly go up or god down. We expect it to be pretty steady.

Todd Eilers - Roth Capital

Analyst

Okay, and then looking at your casual online business, your gross margins and operating margins came in a little bit below what we were looking for. I know that you guys have the lower margin T2CN business that you are now consolidating, and you also mentioned some increased advertising and marketing costs. How should we look at that going forward? Are the margins, your gross and operating margins for this quarter, do you view those as numbers that are normalized margins? And going forward, would you expect those to remain around those ranges? Or should we anticipate a move one way or the other going forward?

Thomas T. Hui

Management

I think of the current game portfolio, we don’t see too big a fluctuation from the current set of numbers, but this business is one whereby in both the China market and Taiwan market we operate, when you launch new games, most of the marketing dollars will be incurred up-front and the accounting treatment of those marketing dollars are such that you have the expenses as you spend them. So what would happen is when we have a big game, such as Hellgate: London or Holic, when we launch that, in that particular month of that particular quarter, you might see actually a lower margin because of that timing difference I just mentioned. But over a long period of time, when you normalize it, we certainly think that the margin should not be lower than the current levels.

Todd Eilers - Roth Capital

Analyst

Okay. That does it for me, guys. Thanks a lot.

Operator

Operator

Your next question comes from Bill Garrison, Ironworks Capital. Please proceed, sir.

Bill Garrison - Ironworks Capital

Analyst

Thank you. A handful of questions; I guess with regard to your T2CN ownership increasing to 58%, is that -- can that still move higher from there or is that the end state ownership of that entity?

Arthur M. Wang

Management

We anticipate increasing that ownership position.

Bill Garrison - Ironworks Capital

Analyst

Okay. All right, and within the Asian online games business, you talk about additional expense for a mass media marketing campaign. Could you elaborate on the geographic focus of those marketing dollars?

Arthur M. Wang

Management

In Q3, it was a lot of additional marketing dollars were spent in Taiwan promoting FunTown’s games, services, and products. And going forward, again it depends on the launch schedule of the various games. As I just mentioned, T2CN will be launching a game in the next month or so. This a tennis game and so there will be some marketing dollars, so it really depends on the new game launch schedule.

Bill Garrison - Ironworks Capital

Analyst

Okay, and at this point in time, could you update me on the extent to which the FunTown offerings are available or will be available on the T2CN platform? For example, the play for fun Mahjong, is that available at the T2CN level at this point in time? And if not, will it be in the near future?

Arthur M. Wang

Management

They are not available currently. They plan to be, as part of our new platform integration and we are looking forward to be able to take all of our games cross-platform and essentially for our games to be platform independent. We think this will be one of the key advantages of having a pan-Asian platform, the ability to offer all of our games -- to develop once and offer throughout the region.

Bill Garrison - Ironworks Capital

Analyst

Okay, and is there a timeline for when that platform might be available?

Arthur M. Wang

Management

There are many different modules or many different elements of a platform and the first component, some of the component pieces have already been finished and other component pieces are scheduled to be rolled out in the first quarter, and there will be a continuing development scheduled for both development and rollout extending over the course of the next 12 months.

Bill Garrison - Ironworks Capital

Analyst

Okay, and just a couple more; I guess as a follow-up on the October strength in the poker business, could you provide any further comment in terms of whether or not that strength was due to marketing initiatives over the summer and an increase in new players, or more of an emphasis on tournaments or just a better mix of business, or a little bit of everything?

Arthur M. Wang

Management

I’m afraid at this point in time, all that we are releasing is the increase in average daily players, as we put into our release. But suffice it to say, we’re looking at a very strong fourth quarter.

Bill Garrison - Ironworks Capital

Analyst

And lastly, just to clarify, on real money Mahjong, has the initial period of exclusivity with your initial licensee expired at this point in time?

Arthur M. Wang

Management

Yes, it has.

Bill Garrison - Ironworks Capital

Analyst

All right. Thank you very much.

Operator

Operator

(Operator Instructions) At this time, I am showing you have no further questions. I would now like to turn the call over to Mr. Brad Miller.

Brad Miller

Management

Thank you, everyone. Thank you for joining us. 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. Thank you.

Operator

Operator

Thank you for your participation in today’s conference. This concludes the presentation and you may now disconnect. Thank you. Get the Top 5 Stocks to Buy Now :

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Management