GigaMedia Strategic Alliance and Q3 2009 Financial Results Conference Call Transcript



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GigaMedia Strategic Alliance Conference Call, December 21, 2009

Caution

The conference call recording is available via the GigaMedia web site. This transcript of the call is presented here on a best effort basis. If in doubt, please check with the original conference call audio recording. All remarks, questions and responses are index in this transcript by the time into the call. Tags like "25m25s" means 25 minutes and 25 seconds into the call. The tags such as "QA01", "Tqa01", etc., appearing in brackets following a bold name, are named anchors in document for linking to a specific point in the transcript. Permission to reuse without restriction is granted to all.

Update version 0.51, December 23, 2009.

Questions and Answers

Operator: And your first question comes from the line of Andrey Glukhov of Brean Murray. Please proceed.

Andrey (QA01 - 26m25s): Yes, thank-you for taking the question. I guess first of all on the Asian online games business, which obviously will be the key business unit for 2010, right now it is operating at what looks like -10% operating margin, and the revenue base you guys are guiding is going to be slightly lower in Q4. When do you think it is going to turn profitable?

Thomas (Tqa01 - 26m54s): Hi Andrey this is Thomas here. Thank-you for the questions. The negative operating margin as Quincy outlined is primarily related to some of the new game launches. Obviously there are marketing costs associated with those game launches and also there are fixed expenses that are associated with services purchases and other items that Quincy has outlined. Now, as, if you look the underlying businesses, the existing products for both FunTown and T2CN as we have talked about in our prepared remarks, those business are certainly profitable, they have been profitable, they are still profitable, now with respect with these new games we have launched this year, we will be monitoring their performances as part of our year end process we will be strategic financial and operational adjustments to the games depending on the results and the performance of the games and as such adjustments happen we believe we can quite quickly turn ourselves, the whole unit to be profitable again.

Andrey (QA02 - 28m10s): Ok, but to ramp up the revenue base in this unit, in 2010, we certainly will probably need additional IP launches, so at this point can you guys talk about, what you have on the hopper for next year and I guess what game for next year you are most excited about?

Thomas (Tqa02 - 28m36s): At this stage, in our prepared remarks and in our press release we have identified obviously the next generation FreeStyle game FreeStlye Manager, and a series of additional games to our FunTown casual platform. There are a number of games we have, we are in discussion and at this stage we are not prepared to disclose the name of those yet.

Andrey (QA03 - 28m59s): Ok, and then, real quick on the poker business, so, if I understand how it will flow through the P&L correctly, we will book essentially a sizeable minority interest in the remaining 40% stake in the unit for 2010. First is that correct? And secondly, to the extent this deal will impact the P&L, what, how do you expect the margin in that business to evolve in 2010 after France liberalizes the market and introduces the marketing regime?

Quincy (Qqa01 - 29m38s): Hi Andrey, this is Quincy, perhaps I take care of the accounting implication on that, Right now we anticipate that the deal will be closed some time in Q1. Before the deal is closed will still need to consolidate 100% as what we have been doing in 20009. But after the deal is complete, then we will hold 40% interest. That remaining 40% interest will be under equity accounting. So we only share the part of the profit before taxation of the whole section and its related taxation. And the one time gain will, the amount will be determined based on the fair value at the time of the closing and the deducted our cost base and our transaction cost then we will have a one time gain in 2010.

Arthur (Aqa01 - 30m37s): Andrey, this is Arthur, with respect to France, naturally, we can't predict operating margins at this time but, our perspective is as follows, ah, market share numbers are hard to come by in this industry but NetClick is clearly one the top sport betting firms in France. Everest is one of the top poker firms in France. Both of these things is entirely clear. Together, it is quite possible we are number 1, and the benefits we see of being number 1 as France opens and regulates our opportunity to capture dominate market share and we are very excited about that possibility and the margins that would bring.

Andrey: Ok, thank-you.

Operator: And your next question comes from the line of Atul Bagga from Think Equity. Please proceed.

Atul (QA04 - 31m31s): Hey guys, thanks for taking my call. A couple of questions for you. So on, can you highlight the synergies that you are expecting from this combination of Mangas and Everest?

Arthur: I'm sorry Atul, we couldn't hear you perfectly. Can you repeat again?

Atul: Sure, can you guys explain a little bit the synergies that you guys are talking about with the combination of Mangas and Everest? Where can we expect to see synergies and how much margins can we see?

Thomas (Tqa03 - 32m5s): Sure Atul this is Thomas here. Now synergies with Mangas come in a few form. First of all, as Arthur mentioned, Mangas currently owns and operates the largest, we believe, sports betting firm in France. And even on a regional basis, i.e. continental Europe, is pretty large offering. Now that is highly complementary to our user base as you know, our user base is primarily poker and casino driven and we lack the fully integrated sports betting offerings to offer to such customers. So synergies #1 will be an increased revenue per customers on a total wallet share basis. Second, in addition to the sports betting offering, Mangas, also through each of their subsidiaries has a pretty sizable when you add them together poker player base. So as part of this deal will be combining the poker liquidity of all Mangas and Everest. So, you will see, upon completion of the deal and integration, you will see a significant increase in the liquidity of the entire Everest platform and the synergies there will come obviously in increased player activity, because now we are able to offer larger and more frequent tournaments, and the like, and also for servicing the other Mangas players, Everest will get economic out of it from a back end perspective. So that is on the revenue side, on the cost front obviously, as we combine these various properties with Mangas, there are a lot of back end functions including cash management, other admin functions, even customer services, to a certain extent, we can pull together and achieve scale and therefore save on cost. So these are the, in a nutshell, the financials of the synergies and maybe Arthur can talk more to the strategic side.

Arthur (Aqa02 - 34m24s): Yes, we believe Atul that we have an opportunity here to create a leader in Europe. Certainly in certain markets we believe we will be in top position, and the family brands we believe can only get stronger, by cross marketing and selling opportunities that it offers. In addition and these are something we believe very strongly in, it is difficult to quantify, however, the partner we have chosen in Europe, I personally believe is the best possible partner for us and we are fortunate to be able to accomplish this deal with them. For the first time we have, as part of our family, the land based casino, and not only a land based casino, the most famous casino in all of Europe. The credibility, the trust, the reputation, that such an institution, essentially backed by the principality of Monaco itself, is enormous for an online business such as ours. And the additional marketing advantages, for example, to be able to host our tournaments and hold championships in the grand casino and to market along with the Monte Carlo casinos there are a whole host of opportunities, that can bring to us potentially. And in addition, we have as a shareholder of Mangas Gaming a team that is very experienced in European media. Stephane Courbit was the head of Endemol for France, and is a well known figure among the media titans in Europe. That type of knowledge, the relationships, the contacts and the media power that they can bring to bear. We also think will have very strong benefits for our business.

Atul (QA05 - 36m38s): Perfect. Thanks for explaining this. Can you guys quantify what would be impact of these synergies, how much you talked about synergies on the revenue side and synergies on the cost side?

Thomas (Tqa04 - 36m54s): Atul at this stage I think we will be a little hesitant to our numeric guidance on the dollar amount of the synergies but for the various factors we have talked about. It is safe to saw that we believe the amount of synergies could be very substantial as you can see from the structure of the deal, other than the initial $100M in the way of down payment, we are tying a lot of our valuation on the future fair market value which obviously is something that we management here believe will have significant upside as a result of both the market turn around the synergies we can create in this process.

Atul (QA06 - 37m42s): Thank-you. Can you guys give us any update on the US markets, the prospects of legalization of online gambling in the US? Is there any further update. Anything you might have heard?

Arthur (Aqa03 - 37m58s): There continues to be a lot of, I would say, baby steps taken. No major developments that I am aware of Atul. California is going to be holding hearings on legalizing poker in February. There has been talk in Ohio and Pennselvania as well as the talk through Barney Frank's office. But no significant developments yet. I should emphasis that this strategic alliance with Mangas also contemplates the future possibility of the United States opening and the Everest team which is based in Boston, will continue to be a the fore front of that. It remains a tremendous opportunity for us.

Atul (QA07 - 38m54s): Just switching gears to the Asia business, you guys were pretty excited with the CIBs that you launched this year, Luna, Holic and Warhammer and these games did not turn out as you were expecting these games to. So looking back in hindsight, do you think your expectation of optimism was misplaced or was it more the operational execution of these games. Where do you think the mismatch was?

Thomas (Tqa05 - 39m25s): I think Atul, that is obviously a very good question. I think each of the factors you identified contribute in different degrees to each of the games. There are certain cases that when we sign-on and we have very high expectations, and in fact, the game has drawn a lot of expectation from the user, and when the games are launched, whether it is in our country of operation or else where in the world, it did not meet expectation that the players had on the games so content issue was certainly one of the issues. But from an operations perspective, and technical perspective, we do also see some challenges, as we indicated in our prepared remarks. As Arthur mentioned, one of the distractions we had was obviously putting together this complex deal for Europe. And that might have also contributed to the spreading of the management attention to a degree that we may not have fully captured some of the opportunity we could have had in Asia. So these are events that we have learned lessons from and we believe the platform we have built so far continue to be of a very high strategic value. And we believe based on these values, the strategic position and also the resources and now more focused management attention we will be able to fully capitalize and build a much bigger and more successful Asian online game platform.

Atul (QA08 - 41m5s): Thanks then, and in your prepared remarks you guys highlighted that you have, you are considering a few M&A moves for the Asia business. My question is this, most of the moves, is it related to acquisition of content, or could it also be related to maybe acquiring a team for operational execution?

Arthur (Aqa04 - 41m20s): The three deals that we have mentioned, that are underway are all operating platforms. One has an important development studio also. We are looking to increase market depth and market penetration, market depth and breath. We are excited to have these opportunities and we hope to be bringing the first of these to the market with news in the first half of January.

Atul (QA09 - 42m5s): And are these deals in China. Can you talk about which geography you guys are looking to make an acquisition.

Arthur (Aqa05 - 42m13s): Naturally we are focused on important geographies. So, but I'd better leave it at that for now.

Atul, thank-you. Arthur, thank-you.

Operator, your next question comes from the line of Warren Lin with Martin Currie. Please proceed.

Warren (QA10 - 42m35s): Hi, thank-you for taking my question. I want to ask you about any policy change in the regulation that is going to happen in Europe as I think you chose such time to sell off 60% stake of gaming software business, I think is there any policy going to change in Europe to impact your business?

Arthur (Aqa06 - 43m15s): Thank you for the question. This is Arthur. What we see happening in Europe, is that country by country, the major market places in Europe are choosing to establish their own regulatory regime and those regulatory requirements and limitations upon operation in that country. Where one time we felt we had an entire European community market place, we know find that each individual country is requiring the establishment of operations, infrastructure, personnel to address that market place. We therefore feel that size and scale is all the more important as well as strong local partners. The question is in Europe, no longer one of legality or illegality. I think it is clear that Europe will be an open market, open but regulated market for online gaming. This was our original thesis, and the original motivation for us to enter Europe as a market place five years ago, when first acquired this business unit. We continue to see that being the case, however, we do see the imposition of operating requirements and regulations country by country. We think however that this is both, in addition to being a cost item, this is also a tremendous opportunity because along with these regulations, often comes the ability to advertise in the mass media, the ability to use, the banking and financial system in ways one was previously not allowed to, to create mass market phenomenon, a mass market business, similar to the way poker was in the United States, which previous to this has always been prohibited in Europe. So, along with the additional cost and additional regulation come additional opportunity. The 350M people in Europe are a very large and wealthy market without the social stigma against gaming or poker that exists in some countries or in some parts of the United States. So, it is an exciting market place still for us, one which we think has enormous potential still, and we are excited to be with Mangas Gaming as our partner to address that opportunity.

Warren (QA11 - 46m5s): So, Mangas can help you to get the license if the regulation become true, you have to apply the license country by country.

Arthur (Aqa07 - 46m15s): Yes, we believe that. Absolutely correct. One reason we are so happy with Mangas we believe that they are a group with strong European relations and strong local knowledge. And that can only be of assistance in getting the licenses early and knowing what to do with those licenses.

Warren (QA12 - 46m5s): And what about the market in the future, if the United States, decides to open and license, but you already sold your site on the gaming business. So that you have to give up the whole market in the future.

Arthur (Aqa08 - 47m10s): Well, again, we were made a 40% shareholder, and first of all I would say that the valuation of the 60% stake we are selling has yet to be determined and will only be determined in the early part of 2012. And so a lot can happen between now and then. A lot of good things we anticipate. So we are looking at a higher valuation certainly then current market opportunity market conditions would offer us. Even after that point though we will continue to be a 40% shareholder and we think of it as having 40% of a much much larger pie than 100% of a smaller pie. We are excited about this partnership, and expect very good things from it.

Warren (QA13 - 47m55s): Ok, and I am curious about the fair valuation, could you explain to me what kind of fair valuation it is? The first down payment is only $100M and I have no idea what kind it is going to be?

Arthur (Aqa09 - 48m20s): Sure, it is much like a little bit like predicting the future. None of us can be certain as to what the condition will be in 2012. We do believe that combining with Mangas, our business, the Everest business will be a much stronger business in 2012 than it is today and we believe therefore that the valuation will reflect that. The determination of fair market value is of course an art, and not a science, but our contract has both us and Mangas, seeking the assistance of outside professionals, investment banks, to help us conduct such evaluations. So, it should reflect, the current condition of the business at that time as well as the market place in which it operates and market conditions.

Warren (QA14 - 48m17s): But, when you sell, when you close the deal, you will be sold out that 60% to Mangas. Will Mangas manage this business or instead of you?

Arthur (Aqa10 - 48m37s): Yes, at closing Mangas will own 60% and they will be the control shareholder. We will have 2 seats on the board of 5 and we will be the 40% shareholder. But as I have mentioned it is our intention to be an active value added minority partner.

Warren (QA15 - 49m47s): And what are you going to do about the US$100M for the first payment. Are you going to pay the cash dividend or you are going to acquire an online game business.

Arthur (Aqa11 - 50m20s): We do not intend at present to issue a cash dividend. As we mentioned we have some exciting merger and acquisition opportunities, that we are pursuing now and it is possible that some of the $100M might be used for that.

Warren (QA16 - 50m37s): Ok, but regarding the gross drivers because you have already sell off 60% of the gaming business to Mangas. And for your online gaming business, according to the path of record it is not easy to make big money. So, I have no idea what the going forward will be.

Arthur (Aqa12 - 51m15s): It is absolutely true that the online gaming business, online game business is a challenging business. We continue to have very strong platforms we believe in Taiwan, Hong Kong and Macau with the FunTown, and in China with the T2CN platform. We believe that with the right content, and with strong focus on execution, we are going to be able to grow those business, in addition, as you mentioned, we will have, plentiful cash resources, and an opportunity to expand by acquisition. We are very excited about the opportunities we are pursing right now, and about some of the games we have in our pipeline. We look forward to demonstrating, to you and the market place our ability to grow this business in an exciting way.

Warren (QA17 - 52m15s): And last question is that, could you update the strategic alliance with Victor Chandler, that is the latest you have announced you are going to have operating with , how is the progress now and how is, and what...

Arthur (Aqa13 - 52m35s): Unfortunately, Victor Chandler partnership really came into being just as we were entering into our strategic review and our decision to seek a new strategic approach. And so that has never truly been implemented, and transaction will unfortunately be unwound as part of our strategic partnership with Mangas.

Warren (QA18 - 53m15s): Oh, so you are going to change the arrangement, right?

Arthur (Aqa14 - 53m15s): Yes, we are part of the Mangas Gaming family now and that precludes us from being part of the Victor Chandler arrangement.

Operator, and your next question is a re-question from Andrey Glukhov from Brean Murray

Andrey (QA19 - 28m59s): Yes guys, thanks for taking the follow-up. I have a couple of questions on the mechanics of the deal. First of as you are selling 60% of the business, does the cash on the balance of Everest Poker, 60% of it goes to Mangas or you guys retain all of the cash.

Thomas (Tqa06) - 54m10s): The deal is done on a cash free / debt free basis. As you know Cecil, our Everest Poker business, have, has a quite a large cash balance on its balance sheet. Other than the necessary cash for working capital purposes, and the cash which is a one for one match with the liability in the customer deposit side, that all the excess, I think we disclosed that it was about $33M or so, as of the last quarter, and all the cash goes to GigaMedia, 100%.

Andrey (QA20 - 54m50s): Ok. And that entity stand alone is taxed at what rate?

Thomas (Tqa07 - 55m0s): I'm sorry, your question is relating to, ...

Andrey - GigaMedia corporate is essentially, zero tax entity right now, presumably, Everest Poker, standalone, is a profitable entity is now being an European entity. So, what is the stand alone tax rate for that entity?

Thomas (Tqa08 - 55m25s): Ok, two things here Andrey. I am still not sure if I understand whether you are asking the ongoing tax arrangement for this entity on an operating basis,

Andrey - well basically, I am trying to figure out as I model, your minority interest, that entity will be taxed at a certain rate, so I need to flow it through the model.

Thomas (Tqa09 - 55m48s): It will be actually a complicated question Andrey. The reason is because it is related to regulatory question that Arthur just answered, previously, because, the model that is gradually forming a trend of in Europe is with Italy as an example, is an individually taxed country. So, Italy, was the first one and we expect France to follow suit with a similar regime but probably a slightly different tax rate. Now we currently hold a Malta license, as to whether we can rely on the Malta license, as to whether we can rely on the Malta license and enjoy a lot of the tax benefits we currently have, will have to depend on the individual countries regulation and limitation on what you can or can not do by obtaining an onshore license. So, but we think directionally, you probably be not as tax efficient as we are now but to what extent the tax liability will increase depends on the pending jurisdiction.

Andrey (QA21 - 57m5s): Ok. Now as far as the terminal value is concerned, so if we look at the put and the call options on the deal, I guess two things, is there a ceiling and a floor on the valuation, and can we end up in the situation if the business degrades that you going to be forced to give back a portion of the $100M you are getting now?

Arthur (Aqa15 - 57m31s): The $100M is absolute floor. We will never need to give back an penny of that and there is no ceiling to the fair market valuation.

Andrey, ok, and then lastly, I mean, big benefit of this deal, right, is the integration with the sports assets that these guys, ah, sports betting assets these guys are bring to the table. How do you separate the net income, since it is going to be presumably a unified entity going forward?

Thomas (Tqa10 - 58m03s): It will be done on a market turn basis. Obviously in the market place, there are sports book operators which refer customers to poker operations and the other way round. So, in the arrangement here, we have certain mechanisms to regulate the rates but market prices should be a reference.

Andrey (QA22 - 57m5s): Ok, and last I apologies for kind of dragging it on, just so we are very clear on the cash, at the end of Q1 once the transaction is consummated, what do we expect the cash balance on GigaMedia books to be?

Quincy (Qqa02 - 58m45s): Ok, right now in Q3, in our balance sheet we roughly have a cash position of around $96M. As Thomas mentioned, we have roughly $33M reserved for player's deposits. So that is the part of the cash, that today we can not touch. So that the free cash we can move right now is around $63M. At closing before any transaction costs, and adjustment, we will add $100M gross profit in, then before any expenses and deduction, you will see $163M in our balance sheet. But of course, the net increase in free cash is roughly $100M before any kind of transaction expenses.

Andrey, ok, that's all I have. Thank-you for taking the call.

Operator: And you have a follow-up question from Atul Bagga with Think Equity. Please proceed.

Atul (QA23 - 58m45s): Hey guys, thanks for taking my follow-up. Very quick, on Mangas, can you give us some sense on the size of this business.

Arthur (Aqa16 - 59m58s): Mangas is a privately held company and we are not therefore able to speak of their size without their authorization. They are, again, one of the leading operators in Europe, and together we believe the Everest business and Mangas will at least in certain key countries be #1 if not close to it.

Atul, just to be clear, when you say #1, are you talking about #1 including the US facing sites or just the sites that operate in Europe alone?

Arthur, I mean #1 including all competitors.

Atul, gotcha.

Atul (QA24 - 58m55s): And Mangas do they have any exposure in the US? Have they accepted any wagers in the US in the past?

Arthur (Aqa17 - 1h58s): No, Mangas has always remained outside of the United States and entirely clean and clear there. We would anticipate that if the United States were to open, Mangas and Everest together would have no problem satisfying any probity requirements or tests.

Atul, prefect, thank-you.

Arthur, thank-you.

Operator, and this concludes the time we have available for questions today. I would now like to turn the call over to Brad Miller for closing remarks.

Brad, thank-you operator and thank-you all again for joining us today. For further information about the company please visit our web site, please visit our Web site at www.gigamedia.com or contact me via e-mail at Brad.Miller@gigamedia.com. Thank-you.

Prepared Remarks

Note: the preparated remarks section will be provided later this week.

Brad Miller: Thank-you. This is Brad Miller, Investor Relations Director at GigaMedia. Welcome to today's conference call to discuss our new strategic alliance with Mangas Gaming as well as our financial results. 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 today's conference call. Forward looking statements are any statements that or 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 20F filed with the US Securities and Exchange Commission in June 2008. This presentation is being made on December 21, 2009. Content of this presentation contains time sensitive information that is accurate only of the time hereof. If any portion of this presentation is rebroadcast, retransmitted, or distributed at a later date, GigaMedia will not be reviewing or updating the material that is contained herein. After the speak presentations today, we will go into a question and answer session. And with that I would like to turn the call over to CEO Arthur Wang.

Arthur (A01 - 1m31s): Thank-you all for joining us. Today I will focus on providing a high level overview of GigaMedia, where we are and where we are heading. I shall begin by reviewing the important transaction we signed and announced just last week, discussing the rational and the benefits to GigaMedia in the near and middle term. Afterwards, I will look at the rest of GigaMedia and outline our plans going forward.

Arthur, First the background for our strategic alliance. Shortly after I joined GigaMedia, seeking a new strategic direction for the firm, we decided to enter the online entertainment business. In April 2004, we took our first step and acquired what is now our Everest Poker and Casino software operation. We paid a grand total of $32.5M for a 100% stake. Over the past 5 years, we have worked hard and grown this business aggressively. Needless to say it has proved to be an outstanding investment. But about 1 year ago, we began another strategic review of this business unit and evaluation of where the market was moving and where we were positioned in relation to such movements. We determined that dispute our rapid growth and position as the 4th largest poker site in the world, a strategic move was necessary.

Arthur (A02 - 2m48s): Several factors were and remain in play, all arguing for an increase in business size an scale, by way of business combination. First, the trend towards individually regulated country markets in Europe, our primary market place and source of 75% of the revenues of this division meant we need much large size and scale to operate efficiently. As England, then Italy and now France each established separate regulatory regimes, limiting player pools to single country players, and requiring heavy in country investments in infrastructure and personnel, the ability to run an efficient Pan European operation was challenged. Second, the need for tightly integrated full product offerings. Poker, casino, sports book, and other gambling products on the same platform. Though our poker and casino products were competitive, and our Everest brand valuable, without our own storybooks operation tightly integrated into our own platform, it is difficult to realize the necessary synergies. Finally, the continuing challenge from poker competitors operating illegally in the US making 100s of millions annual and using these illegal but enormous resources to compete against us in Europe. Faced with these realities, we embarked on a strategic process, guided by our financial advisors Goldman Sachs, and our legal advisors Skadden, Arps. Over the past year we have been busy with the identification, structuring, negotiation and finally execution of a new strategic alliance. During this process, we looked a our full range of options to maximize shareholder value, including various acquisition opportunities, partial and complete sale alternatives, partnerships, co-operations, and strategic alliances. In the end, we are very pleased to enter into a partnership, a truly strategic alliance, with Mangas Gaming who I believe is the strongest and best partner for GigaMedia. Mangas Gaming is one of the leading online gaming firms in Europe with special strengths in sports betting. With the BetClic, Expekt, and Bet-at-Home brands, Mangas offers gaming services, to over 4M customers in 25 countries. Mangas Gaming is 50/50 jointly owned by superb shareholders. Media powerhouse Stephane Courbit and the Monte Carlo Casino owners SBM. At closing Mangas will be come a 60% shareholder and GigaMedia and active 40% partner. The valuation of this 60% sale will be determined in early 2012 based on then fair market value, a step designed to reflect the true value of the Everest business well after the current year macro economic blues. Mangas will make an initial payment of $100M at closing. The strategic alliance offers with Mangas offers many benefits to GigaMedia in the short and medium term. First fair and full valuation of the Everest Business Unit, based not on today's troubled valuations but instead on fair market value in early 2012. Second, operating synergies: Combining Everest and Mangas gaming platforms together will create one of the largest online gaming players in Europe. GigaMedia expects there are significant cost and revenues synergies from the partnership, including cross marketing of products between Everest Poker and Mangas Gaming clients as well as marketing and operating synergies. Third, geographic synergies: Importantly Mangas Gaming has particular strength in sports betting in certain key market places such as France, long the top market for our Everest Poker, creating a us together to dominant market and brand position and reap the commemorate benefits. Fourth, shareholder strength: One of the key reasons we are so excited about this partnership, is the quality of the partners. With top local knowledge, top local relations and top local reputation. Mangas Gaming brings the best to the table. On the one hand Stephane Courbit, formerly head of France for a European media giant Endemol. On the other the Société des Bains de Mer, I must apologies for my pronunciation. SBM, representing the Principality of Monaco itself, and the owner of the world renowned Le Grand Casino de Monte-Carlo. After building Everest Poker from its humble roots, we now enjoy the allure, the reputation, the trust, of the most famous casino in all of Europe and one of the most famous worldwide. The team is very excited to see where they can grow Everest now. An now on, the top, the top in European knowledge, relations and reputation, I too am very excited about where Everest can grow. In summary, we now feel very confident that our Everest business will continue to grow and realize its position atop the international gaming markets.

Arthur (A03 - 7m41s): Let me turn now to GigaMedia today and our path forward. Overall, 2009 has been a tough year for us without question. In Europe the macro economic challenges continue to slow our business, and create margin pressure. Unfortunately, these macro pressures, combined with the larger strategic process we are undergoing, becretes special challenges for us. Our Everest team, one of the best in the business, faced both personal uncertainty as we explored different strategic paths, and distracting demands from a highly professional but time consuming due diligence process. Fortunately all this is now all finished. In addition, the Everest team were reluctant to cut aggressively, or manage the down turn in light of the wide variety of strategic outcomes. As a result, the short term returns are pretty. But we are confident as the management team that we have made the right call to forge the partnership with Mangas, a highly valued creative alliance.

Arthur (A04 - 8m40s): In Asia, we have also had challenges with some of our new games turning out to be less exciting than promised by the developers. In addition we most also admit that our execution has not met the high standards we are used to, and which we are committed to deliver. Senior management focus on the complex strategic deal in Europe may have also been a distraction.

Arthur (A05 - 8m58s): Looking ahead, we are excited about the prospects for 2010 and plan an aggressive year of internal restructuring, refinements as well as external M&A activity. In Europe, we plan to be active, value added, minority partners. The entire Everest staff will continue and form the basis of the poker division for Mangas Gaming. We will work with the Mangas team to realize the synergies, both cost and revenue offered by the Mangas network. In particular we will work with the key shareholders, Stephane Courbit and the Monte Carlo Casinos, to exploit the relationships, the credibility and the marketing power they bring.

Arthur, In Asia, we will continue to focus and grow on our Asian online entertainment platform. And as management team we will look forward to the greater focus we will now enjoy. Both geographic and business line. We can now concentrate on online entertainment in Asia, where we live, where we have the information, the contacts, the relationships, all to drive our target market places. While in the past year, management has been spread a bit thin geographically, working on identifying the best strategic partner, we this year will be focused on restructuring and refining and growing our business in Asia. Though our Asian business is still a work in progress, we plan to take major steps in 2010, in particular to expand the breath and depth of our market penetration, in several key markets by M&A activity. We have 3 very significant moves underway and look forward to announcing these deals when completed.

Arthur, On balance, we are excited about our new strategic alliance and enthusiastic about aggressively growing our business in Asia, by strong execution, driving organic growth, and M&A. We are committed to building a stronger GigaMedia, with growing shareholder value as its cornerstone. We thank-you for your interest and continued support.

Thomas (T01 - 10m50s): Thanks Arthur and thank-you all for joining us. This is Thomas, let me now turn to business and operational highlights with a brief review of our gaming software and Asian online game business. As expected, the gaming software business faced significant operating challenges in the 2nd and 3rd quarters which are the seasonal low periods in the industry, when online gaming activity traditionally decreases. In addition to this seasonal factor, the economic downturn in Europe and strong competition as continued to impact player behavior and result in revenue pressure. The effects of these factors on online poker in particular were observed industry wide during the summer and fall. Within that context our quarter ARPPPO [Average Revenue per Paying Player Online] in poker decreased 11% in Q2 and in Q3 hit bottom declining a further 4% sequentially. In addition to the decreased player spending, we also experienced sequential decreases in our other player metrics. However, the sequential decreases in active depositing players and new depositing players, noted in our release today, were for the most part superior to our historical trends on a percentage basis. Our key poker metrics were also inline with industry standards, industry trends. To drive growth as Arthur discussed, we have entered into a strategic alliance with Mangas Gaming by selling a 60% stake in our gaming software business. We are confident that this strategic move will significantly increase business momentum and offer substantial upside.

Thomas (T02 - 12m30s): In our Asian online game business, we are continuing to build a Pan Asian from our existing positions in Greater China and South East Asia. Some of our new MMORPG game launches in 2009 did not meet our expectations and currently plans are underway to rebuild our pipeline and our growth momentum. And we are confident we will deliver improved performances as we move ahead. Overall results in the 2nd and 3rd quarters were mixed in the Asian online game business with solid performance in existing game offerings and disappointing results in new games. In China: T2CN's, leading sports game offering Fresstyle showed a modest decline in user numbers with peak concurrent users of approximately 85,000 in the 3rd quarter. This represented a 10% decrease from the 2nd quarter. In line with the expectation, given that the 2nd quarter benefited from strong marketing during the week long labor day holiday [May 2009]. To drive growth in 2010, T2CN will launch Freestyle Manager, a new game in the Freestyle franchise. We expect this game to be well received in China. Further to this, during the 3rd quarter, we made an investment in the developer of Freestyle, JCEntertainment. JCEntertainment and GigaMedia will increase strategic co-operation to further develop the Freestyle series of sports game with a focus on capturing growth opportunities in China. In Taiwan and Hong Kong, FunTown casual game offerings continued to deliver strong performance driving the unit's 13% year on year revenue growth in Q3. Average monthly revenue per active paying account was $24.7 in the 3rd quarter representing strong monitorization of FunTown's leading Mahjong and other casual game offerings. To drive growth in 2010 we are building our casual game success by adding many new products to the platform include a 3rd flash version of our popular Mahjong offering and a number of casino style games on a play for fun basis.

Thomas (T03 - 14m40s): Turning now from existing core games to new game initiatives in the 2nd and 3rd quarter, which involved Holic, Warhammer online and Luna online. Unfortunately, we have faced a number of challenges this year with our new game launches. These challenges included content issues, illegal player activities or hacking issues, and other technical and operational issues. As a result of such challenges, each of the 3 games currently has a user base much smaller than we anticipated and contributed to the under performance of our Asian online gaming business in the 2nd and 3rd quarter. We are carefully monitoring performances of these games and we'll continue to adjust our marketing and operating strategies.

Thomas (T04 - 15m28s): Looking ahead, we have been working hard to rebuild our pipeline for 2010 and beyond maintaining a strong focus on markets in Greater China and SouthEast Asia. In addition to the new Freestyle Manager and the addition of casual games to Funtown, I mentioned earlier, we also expect to launch several other game titles later this coming year putting the business back on a solid growth momentum for 2010. Having taken the decision to put more management focus on winning in Asia, we intend to continue development and expansion of the Asian game business going forward. More than ever before we have the resources and financial flexibility necessary to expand our business here regionally here in Asia. Geographic and portfolio expansion combined with a focus on streamline business processes leveraging scale and enhancing execution will all be elements of GigaMedia's long term growth success.

Thomas, thank-you and that concludes my remarks. I will now turn the call over to Quincy for a review of our financial performances.

Quincy (Q01 - 16m31s): Thank-you Thomas. This is Quincy. I would like to take the next few minutes to review our Q2 and Q3 consolidated results and I will spend some time to highlight each of our core business units, that is gaming software business and Asian online gaming business. The financial results in both quarters were worst than expected. 2nd and 3rd quarter revenues were 37.7M and 37.2M respective. 2nd quarter net income was $128,000 while 3rd quarter was a net lose of $2.4M. With fully diluted gap EPS of nil in the 2nd quarter and lose per share of $0.04 in the 3rd quarter. Consolidated revenue for the 2nd quarter and 3rd quarter, as mentioned before, were $37.7M and $37.2M respectively. These represent sequential quarterly decreases of 15% and 1% and also reflect traditional seasonality factors on both gaming software business and Asian online game business. In addition, the gaming software business, continued to be negatively impacted by the global economic downturn on player spending and strong competitive pressures including challenges from US facing sites. Gross margin was 79% in Q1 while declining to 76% in Q2 and 75% in Q3. These were attributable to the following reasons: First, gross profit margin of gaming software business decreased slightly as fixed costs did not decrease in line of revenue decline. Secondly, gross margins in Asian online game business, decreased most significantly due to the increase cost from newly launched licensed games coupled with less than expected revenue generated there from. And thirdly, revenue contribution from gaming software business, which used to enjoy a high gross margin decreased, during the 2 quarters concerned.

Quincy (Q02 - 18m52s): Now lets take a look into some of the key line items. Product development and engineering expenses: on a quarterly sequential comparison product development and engineering expenses decreased by $1.1M to $2.9M in Q2 and increased by $700K to $3.6M in Q3. Decrease in Q2 was largely due to a reduction in head count by the end of Q1 while increase in Q3 was due to less amount being capitalized for projects in the 3rd quarter from our gaming software business.

Quincy (Q03 - 19m40s): Selling and Marketing Expenses: Compared to Q1, Q2 expense level held steady at $18.2M. The savings of $1.2M from affiliate partners commission in gaming software business as a result of revenue decline was offset by $1.3M increase in advertising and promotion campaign related to new games launched in Asian online gaming business. Compared to Q2, Q3 selling and marketing expenses grew by $1.4M, around 8%, to $19.6M. The increase was mainly due to heavy advertising and promotion expenses incurred in Asian online gaming business for the launches of the new games.

Quincy (Q04 - 20m29s): When we look at G&A expenses, they have been held steady in Q2 and Q3 at around $7.6M to $7.7M during the period. Next, lets take a look at each business unit's performance.

Quincy (Q05 - 20m44s): Gaming Software Business - Traditionally, European summer holiday is a low season. Apart from this, both global economic downturn and strong competition, have negatively impacted the operating environment compared to previous quarters, Q2 revenue declined 18% and Q3 revenue declined 3% sequentially. For each vertical, quarter over quarter comparison, poker revenues decreased 90% in Q2 and 9% in Q3. As both active deposit real money customers and ARPPO decreased quarter over quarter. Casino revenues, declined 15% in Q2 while increasing 11% in Q3. While there were a continuos decrease in players number in both quarters, the average revenue from active playing account in Q3 has improved. To face challenging operating environment, management focused on cost control and efficiency improvement. However, revenue decline outpaced the cost and expenses reduction. The operating margin decreased to 9% in Q2 from 15% in Q1 and then further declined to 4.7% in Q3.

Quincy (Q06 - 22m10s): Now lets turn to our Asian online game business. Quarter over quarter, Q2 revenues declined 8% compared with Q1. We had a strong result in Q1 due to seasonal promotion during the Chinese New Year and resolution of a hacking incident for Freestyle occurred in Q4 of 2008. Q3 growth margin increased by 1% primarily attributable to revenue contributions from new games of Warhammer and Luna. As for Funtown, revenue decreased 5% and 3% in Q2 and Q3 respectively. Revenue from new games of Warhammer and Holic offset by seasonal decrease in casual game revenue.

Quincy (Q07 - 22m58s): As for T2CN, revenue declined 12% in Q2 while growth 8% in Q3. Increase in Q3 was due to launch of the new game Luna Online. Both monthly playing users and ARPPO grew 1% quarter over quarter in Q3. Regarding operating costs, since most games licensing costs are relatively fixed in nature, for example, licensing fee, bandwidth costs, certification, software amortization, and payroll costs. These expenses increased in Q2 and Q3 due to the launch of the new games. Coupled with less than expected revenue return for these new games launch, gross profit margins decreased from 71% in Q1 to 65% in Q2 and 60% in Q3. Total selling and market expenses trend up quarter over quarter in Q2 and Q3, mainly reflecting the mass media promotion and advertising expenses in relation to the support of launch for Warhammer and Luna. Therefore operating margin went down in both Q2 and Q3 owing the above mentioned reasons.

Quincy (Q08 - 24m20s): As to the outlook for Q4, we expect revenues in the gaming software business to benefit from a high single digit or a low double digit favorable seasonal growth. At the same time we anticipate a low double digit quarterly sequential revenue decrease from Asian from Asian online games business in the absence of new games in the 4th quarter. In addition, as part of our annual revenue and evaluation exercise on intangibles and investments, management expects to record non cash write-offs in the region of $35M to $45M in the 4th quarter related to certain legacy games, games intangibles, under performing games and game investments. Not withstanding the challenge that we had in 2009, we are well positioned for further growth and expansion when the strategic alliance with Mangas is complete. We will not only anticipate a one time substantial gain on the sale of the 60% interest, but also we will enjoy the upside on the enlarged business from the remaining 40% interest that we will hold. With the substantial improvement in cash position, after the deal is complete, we also have sufficient financial resources to grow our Asian online gaming business through M&A means on top of our organic growth initiatives. Thank-you.

Brad, Thanks Quincy. Operator we will now move into a question and answer session.



Transcript Note

Please note that links in the above prepared remarks have been added to assist reader.

Also, the term ARPPO is assumed to mean Average Revenue per Paying Player.

Extra Links

Biblitz at Monte Carlo For more about Monte Carlo, please see ASK Biblitz about Monte Carlo, a look at the Rise and Rise of the Cote d'Azur as the world's most glamous gambling destination made famous through a 100 years of literature, including the stories of PJ Wodehouse, Mark Twain, Francoise Sagan and countless movies.

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