================================================================================UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 20-F
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31,
20022004Commission File Number: 000-30540
GIGAMEDIA LIMITED
(Exact(Exact name of registrant as specified in its charter)
REPUBLIC OF SINGAPORE
(Jurisdiction(Jurisdiction of incorporation or organization)
14th Floor, 122
TUNHUATUNHWA NORTH ROAD, TAIPEI, TAIWAN, R.O.C.(Address(Address of principal executive offices)
Registrant'sRegistrant’s telephone number, including area code
886-2-8770-7966
Securities registered or to be registered pursuant to Section 12(b) of the Exchange Act:
None
Securities registered or to be registered pursuant to Section 12(g) of the Exchange Act:
Ordinary shares, par value NT$10 per share
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
None
Indicate the number of outstanding shares of each of the
issuer'sissuer’s classes of capital or common stock as of the close of the period covered by the annual report:50,154,000 ordinary shares, par value NT$10 per share.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes
[X]x No[ ]¨Indicate by check mark which financial statement item the Registrant has elected to follow. Item 17
[ ]¨ Item 18[X] ================================================================================x
PAGEPage ITEM 1.
Identity of Directors, Senior Management and Advisers............................................. 1IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS 3 ITEM 2.
Offer Statistics and Expected Timetable........................................................... 1OFFER STATISTICS AND EXPECTED TIMETABLE 3 ITEM 3.
Key Information................................................................................... 1KEY INFORMATION 3 ITEM 4.
Information on the Company........................................................................ 19INFORMATION ON THE COMPANY 13 ITEM 5.
Operating and Financial Review and Prospects...................................................... 36OPERATING AND FINANCIAL REVIEW AND PROSPECTS 26 ITEM 6.
Senior Management and Employees................................................................... 51DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 38 ITEM 7.
Major Shareholders and Related Party Transactions................................................. 57MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 43 ITEM 8.
Financial Information............................................................................. 60FINANCIAL INFORMATION 44 ITEM 9.
The Offer and Listing............................................................................. 63THE OFFER AND LISTING 46 ITEM 10.
Additional Information............................................................................ 64ADDITIONAL INFORMATION 47 ITEM 11.
Quantitative and Qualitative Disclosures about Market Risk........................................ 76QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 55 ITEM 12.
Description of Securities Other than Equity Securities............................................ 77DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES 56 ITEM 13.
Defaults, Dividend Arrearages and Delinquencies................................................... 78DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES 57 ITEM 14.
Material Modifications to the Rights of Securitiy Holders and Use of Proceeds..................... 78MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS 57 ITEM 15.
Controls and Procedures........................................................................... 78CONTROLS AND PROCEDURES 57 ITEM 16A.
Audit Committee Financial Expert.................................................................. 78AUDIT COMMITTEE FINANCIAL EXPERT 58 ITEM 16B.
Code of Ethics.................................................................................... 78CODE OF ETHICS 58 ITEM 16C.
Principal Accountant Fees and Services............................................................ 78PRINCIPAL ACCOUNTANT FEES AND SERVICES 58 ITEM 16D.
EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES 59 ITEM 16E.
PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS 59 PART III......................................................................................................... 79IIIITEM 17.
Financial Statements.............................................................................. 79FINANCIAL STATEMENTS 59 ITEM 18.
Financial Statements.............................................................................. 79FINANCIAL STATEMENTS 59 ITEM 19.
Exhibits.......................................................................................... 80 SIGNATURES....................................................................................................... 84 CERTIFICATIONS .................................................................................................. 85EXHIBITS 60 63 USE OF CERTAIN TERMS
In this annual report, all references to (i)
"we"“we”,"us"“us”,"our"“our”, “our Company” or"GigaMedia"“GigaMedia” are to GigaMedia Limited and, unless the context requires otherwise, its subsidiaries, (ii)"Koos Group" are to a group of companies controlled by members of the Koo family, (iii) "Shares"“Shares” are to ordinary shares of ourcompany,Company, par value NT$10, (iii) “CESL” are to Cambridge Entertainment Software Limited (previously known as Grand Virtual International Limited), a company incorporated under the laws of British Virgin Islands and (iv)"Hoshin Gigamedia"“Hoshin GigaMedia” are to HoshinGigamediaGigaMedia Center Inc., a company incorporated under the laws of Taiwan, Republic of China, or ROC. All references in this annual report to"US dollar"“U.S. dollar”,"$"“$” and"US$"“US$” are to United States dollars and all references to"NT dollar"“NT dollar” and"NT$"“NT$” are to New Taiwan dollars.DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This annual report contains forward-looking statements that involve risks and uncertainties. These statements are generally indicated by the use of forward-looking terminology such as
"believe"“believe”,"expect"“expect”,"anticipate"“anticipate”,"estimate"“estimate”,"plan"“plan”,"project"“project”,"may"“may”,"will"“will” or other similar words. These forward-looking statements are based on our own information and on information from other sources we believe to be reliable. Our actual results may differ materially from those expressed or implied by these forward-looking statements as a result of risk factors and other factors noted throughout this annual report. We undertake no obligation to release publicly any versions to any forward-looking statements to reflect events or circumstances after the date of this annual report or to reflect the occurrence of unanticipated event. Given this level of uncertainty, you are advised not to place undue reliance on such forward-looking statements.ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
Not applicable.
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
Not applicable.
ITEM 3. KEY INFORMATION
EXCHANGE RATES In this annual report, weExchange Rates
Our consolidated financial statements have
translated certainhistorically been reported in New Taiwan dollars. Effective January 1, 2004, we adopted the United States dollaramountsas our reporting currency because operations denominated in the United States dollar have represented an increasing portion of our business following the acquisition of our entertainment software business. Comparative financial information has been recast as if the United States dollar had been used as our reporting currency for the periods ended and as of December 31, 2002, 2003 and 2004.The financial information for the periods presented has been translated based on the following exchange rates:
2000 2001 2002 2003 2004 Year-end
33.08 34.95 34.75 33.97 31.71 Weighted average
31.24 33.83 34.55 34.40 33.41 Assets and liabilities in our balance sheet denominated in non-U.S. dollars are translated into U.S. dollars
for the convenienceusing year-end exchange rates. Income and expense items in our statement ofinvestors. All translations from New Taiwanoperations denominated in non-U.S. dollarsto United States dollars were made (unless otherwise indicated) on the basis of the noon buying rate in The City of New York, or the Noon Buying Rate, of NT$34.70 = US$1.00 on December 31, 2002, which was the last trading day in 2002. All amountsare translated intoUnited StatesU.S. dollarsas described above areusing the weighted average exchange rates. See Note 1 of our consolidated financial statements for additional information. Certain other operating financial information denominated in non-U.S. dollars, not included in our consolidated financial statements and providedsolely for the convenience of the reader, and we make no representation that the New Taiwan dollar or United States dollar amounts referred toin this annual reportcould have been or could actually be converted into United States dollars or New Taiwan dollars at that rate or at any other particular rate, or at all. The following table sets forth the Noon Buying Rates for New Taiwan dollars expressed in New Taiwan dollar per US$1.00 for the periods indicated below. 1
AVERAGE YEAR ENDED DECEMBER 31, (OF MONTH-END RATES) HIGH LOW AT PERIOD-END - --------------------------- -------------------- ---- --- -------------(of month-endrates) (of month-endrates) 1998....................... 33.50 34.39 32.20 32.27 1999....................... 32.28 33.17 31.39 31.39 2000....................... 31.37 33.17 30.48 33.17 2001....................... 33.91 35.13 32.23 35.00 2002....................... 34.53 35.11 33.46 34.70is translated using weighted average exchange rates.
MONTH ENDED AVERAGE RATES HIGH LOW AT PERIOD-END - --------------------------- ----------------- ---- --- -------------(NT$ per US$1.00) January 31, 2003........... 34.57 34.76 34.40 34.61 February 28, 2003.......... 34.73 34.82 34.61 34.78 March 31, 2003............. 34.72 34.80 34.58 34.75 April 30, 2003............. 34.82 34.98 34.79 34.85 May 31, 2003............... 34.70 34.85 34.60 34.71 June 30, 2003 ............. 34.63 34.70 34.52 34.61 July 2003 (through July 11, 2003)............. 34.41 34.58 34.25 34.35A.
SELECTED FINANCIAL DATASelected Financial DataThe selected consolidated balance sheet data as of December 31,
20012003 and20022004 and the selected consolidated statement of operations data for the years ended December 31,2000, 20012002, 2003 and20022004 have been derived from our audited consolidated financial statements included elsewhere in this annual report. The selected consolidated balance sheet data as of December 31,1998, 19992000, 2001 and2000,2002, and the selected consolidated statement of operations data for the years ended December 31,19982000 and19992001 have been derived from our audited consolidated financial statements for the years ended December 31, 2000 and 2001, which are not included in this annual report. The audited consolidated financial statements for the years ended December 31, 2000 and 2001 were stated in NT dollars. We have converted certain information in such financial statements into US dollars for inclusion in this annual report for the convenience of investors using the exchange rates provided under “Exchange Rates” above. The consolidated financial statements have been prepared and presented in accordance with generally accepted accounting principles in the United States, or U.S. GAAP. The selected consolidated financial data set forth below should be read in conjunction with Item5. "Operating5—”Operating and Financial Review andProspects"Prospects” and the consolidated financial statements and the notes to those statements included elsewhere in this annual report.2For the Years Ended December 31,
(in(in thousands except for income/loss per share amounts)
1998 1999 2000 2001 2002 ---- ---- ---- ---- ---------------------- STATEMENT OF OPERATIONS NT$ NT$ NT$ NT$ NT$ US$ ------- -------- --------- --------- --------- ---------- DATA:OPERATING REVENUES Sales/rental/installation 152 16,831 126,810 7,490 1,864,128 53,721 Access revenues 277 19,661 155,035 389,801 638,916 18,413 Web development revenues - 1,429 28,978 7,190 - - Advertising and promotional revenues - 71 26,762 5,039 32,801 945 Other revenues 3,000 - 3,603 1,432 19,964 575 ------- -------- --------- --------- --------- ---------- Total 3,429 37,992 341,188 410,952 2,555,809 73,654 ------- -------- --------- --------- --------- ---------- COSTS AND EXPENSES Costs of sales/rental/installation 577 24,429 278,974 143,420 1,686,256 48,595 Operating costs 120,788 238,113 987,331 1,636,820 634,872 18,296 Web development expenses - 1,150 23,182 12,233 - - Product development and engineering 11,568 20,939 56,625 106,458 64,444 1,857 Selling and marketing expenses 39,816 84,192 383,948 285,590 427,310 12,314 General and administrative expenses 572,823 328,440 235,934 215,663 211,944 6,108 Bad debt expenses - 892 1,686 40,250 32,167 927 Impairment loss on goodwill - - - - 242,938 7,001 Impairment loss on intangible assets - - - - 80,627 2,324 Other costs 2,145 - 3,881 1,203 - - ------- -------- --------- --------- --------- ---------- Total 747,717 698,155 1,971,561 2,441,637 3,380,558 97,422 ------- -------- --------- --------- --------- ---------- NET LOSS 739,236 657,933 1,206,372 1,811,324 637,990 18,386 LOSS PER SHARE-BASIC AND ======= ======== ========= ========= ========= ========== DILUTED (IN DOLLARS) Net Loss 20.53 18.06 24.73 36.12 12.72 0.37 ======= ======== ========= ========= ========= ==========
December 31 --------------------------------------------------------------------------- 1998 1999 2000 2001 2002 ---- ---- ---- ---- ---------------------- BALANCE SHEET DATA: NT$ NT$ NT$ NT$ NT$ US$ ------- --------- --------- --------- --------- ----------Total Current Assets 237,609 1,170,428 8,066,547 6,132,875 2,877,715 82,931 Property, plant and equipment-net 56,734 170,981 535,090 705,570 738,938 21,295 Intangible assets-net - - 948,004 12,631 242,012 6,974 Total assets 340,883 2,869,142 9,710,398 8,062,552 4,696,038 135,333 Total shareholders' equity 297,498 1,514,433 9,357,436 7,845,126 3,619,877 104,319
2000 2001 2002 2003 2004 US$ US$ US$ US$ US$ STATEMENT OF OPERATIONS DATA:
OPERATING REVENUES
Sales/rental
4,059 221 53,956 74,390 65,594 Software licensing and online entertainment revenues
0 0 0 0 11,434 Access revenues
4,963 11,522 18,493 18,829 20,960 Promotional and advertising revenues
857 149 949 1,595 1,501 Other revenues
1,043 255 578 538 330 Total
10,922 12,147 73,976 95,352 99,819 COSTS AND EXPENSES
Costs of sales/rental/installation
(8,930 ) (4,239 ) (48,808 ) (65,238 ) (52,627 ) Operating costs
(31,729 ) (48,420 ) (18,376 ) (18,120 ) (15,586 ) Web development expenses
(742 ) (362 ) 0 0 0 Product development and engineering expenses
(1,813 ) (3,147 ) (1,865 ) (1,211 ) (2,513 ) Selling and marketing expenses
(12,290 ) (8,442 ) (12,368 ) (14,530 ) (17,630 ) General and administrative expenses
(7,552 ) (6,375 ) (6,134 ) (7,973 ) (8,200 ) Bad debt expenses
(54 ) (1,190 ) (931 ) (156 ) (247 ) Impairment loss on goodwill
0 0 (7,032 ) (738 ) 0 Impairment loss on intangible assets
0 0 (2,334 ) 0 0 Impairment loss on property, plant and equipment
0 0 0 (1,557 ) 0 Total
(63,110 ) (72,175 ) (97,848 ) (109,523 ) (96,803 ) Income (Loss) from continuing operations
(38,616 ) (53,536 ) (20,600 ) (17,222 ) 2,163 Net Income (Loss)
(38,616 ) (53,542 ) (18,466 ) (14,095 ) 1,682 Income (loss) per share (in dollars) from continuing operations
(0.79 ) (1.07 ) (0.41 ) (0.34 ) 0.04 Net Income (loss) per share (in dollars) – basic and diluted
(0.79 ) (1.07 ) (0.37 ) (0.28 ) 0.03 As of December 31,
(in thousands)
2000 2001 2002 2003 2004 US$ US$ US$ US$ US$ BALANCE SHEET DATA:
Current Assets
243,850 175,476 82,812 77,709 67,726 Property, plant and equipment- net
16,176 20,188 21,264 15,636 15,056 Intangible assets-net
28,658 361 6,964 6,199 8,372 Total Assets
293,543 230,688 135,138 119,792 125,977 Total Shareholders’ Equity
282,873 224,468 104,169 90,363 95,971 Capital stock amount (common shares)
15,565 15,565 15,565 15,565 15,565 Number of shares (basic, in thousands)
50,154 50,154 50,154 50,154 50,154 Dividend declared per share (in dollars)
0 0 0 0 0 B.
CAPITALIZATION AND INDEBTEDNESSCapitalization and IndebtednessNot applicable.
C.
REASONS FOR THE OFFER AND USE OF PROCEEDSReasons for the Offer and Use of ProceedsNot applicable.
3D.
RISK FACTORS RISKS RELATING TO OUR FINANCIAL CONDITION AND BUSINESS WE HAVE A LIMITED OPERATING HISTORY, WHICH MAY MAKE IT DIFFICULT FOR YOU TO EVALUATE OUR BUSINESSRisk FactorsWe
began offering our services in Taiwan in late 1998. Accordingly, wehave alimited operatinghistoryupon which you can evaluate our business. In addition, our operating history in respectofoffline music distribution is even more limited since we only acquired our two music store chains in 2002. As an early stage company in the newlosses andrapidly evolving market for broadband Internet access services, we face numerous risks and uncertainties. Some of these risks relate to our ability to: - deploy our services in a cost effective manner; and - enter into additional agreements with cable partners to expand our services to new markets. Our financial success will depend on the commercial acceptance and profitability of our services. If we are unsuccessful in addressing these risks or in executing our business strategy, our business and financial results will suffer. If we encounter significant problems with our billing and collection process, our business, financial condition and results of operations could be materially and adversely affected. WE MAY FAIL TO SUCCESSFULLY CONSOLIDATE THE TWO ACQUIRED MUSIC STORE CHAINS, AND MAY NOT BE ABLE TO SUCCESSFULLY INTEGRATE THESE OFFLINE BUSINESSES WITH OUR ONLINE BUSINESSES, WHICH MAY ADVERSELY AFFECT OUR BUSINESS AND OUR REVENUES In February and September of 2002, we finalized the acquisition of Taiwan's two leading music store chains and are now in the process of streamlining and consolidating their operations. As we had been focused on the online businesses in the past, the offline business is relatively new for us in many respects, including the business model, markets and management expertise. Wecannot assure you thatour efforts to consolidate these chains will be successful or thatwe willbe able to successfully integrate our online operations with our offline businesses, which may adversely affect our business and our results of operations. In addition, the offline music businessnot incur substantial losses inTaiwan has been negatively affected by piracy in recent years, which may continue to harm this industry and adversely affect our offline music distribution business and our revenues going forward. WE HAVE A HISTORY OF LOSSES, AND AS WE PLAN TO EXPAND OUR BUSINESS, WE EXPECT TO INCUR SUBSTANTIAL LOSSES AND EXPERIENCE SUBSTANTIAL NEGATIVE CASH FLOWS FROM OPERATIONS AT LEAST THROUGH 2003 We have never been profitable.future periodsWe have incurred net losses in each of our previous fiscal years except 2004, in which we recorded our first ever full-year profit with net income of US$1.7 million. Our history of losses was a result of the substantial costs
to create and introducewe incurred in operating our broadband Internet access servicesto operate these services,andto growmusic distribution business and the decrease in revenues from our music distribution business.We incurred a net loss of approximately NT$638 million (US$18.4 million) in 2002 and as of December 31, 2002, we had an accumulated net loss of approximately NT$5.1 billion (US$145.7 million).Our limited operating history and market conditions make predicting our results of operationsincluding operating expenses, difficult. We expect todifficult, and we may incur substantial losses in the future.We may have operating losses in the future and
experience substantial negative cash flowswe may not be able to sustain net profitability due to several factors, including:declines in revenues fromoperations at least through 2003. The principal costsour music distribution business;increased selling and marketing expenses;further decreases in the value ofoperating and potentially growingourbusiness will include: - substantial direct and indirect selling, marketing and promotional costs; - system operational expenses,prior investments, includingthe cost of leasingourInternet backbone; - costs associated with the upgrading of equipment andentertainment softwarein response to changes in technology; 4- costs in connection with the acquisition and installation of the equipment and software necessary to enable our cable partners to offer our services; - costs in connection with our efforts in streamlining the two music store chains that we acquired in 2002 and in integrating our offlinebusiness andonlinemarketable securities;additional acquisition activities related to the growth and development of our entertainment software business;greater levels of product development expenses;potential or actual loss of key clients and- costs in connection with any acquisitions, divestituresbusiness partners;our potential decision to exit current low-margin businesses, which if taken will cause revenues to decline; andour potential decision to discontinue certain products and services orbusiness alliances that we may engage in.to dispose of certain investments.In addition, after the adoption of a new accounting standard in 2002, we are required to perform annual impairment tests of
goodwill and other intangible assets.goodwill. As a result, we wrote off goodwill associated with the musicbusinesses we acquired in 2002distribution business in the amountofNT$242.9of US$7.0 million in 2002 and US$738 thousand in 2003, which reduced our profitability in2002.both years. As of December 31, 2004, we carry goodwill in the amount of US$29.6 million associated with the entertainment software business we acquired in 2004. Anysimilarwrite-off of goodwill in the future may have a negative impact on our financial results.If anyOur businesses face intense competition, which may adversely affect our revenues, profitability and planned business expansion
We face competition from many competitors, and we expect to face competition from additional potential competitors, including competitors with:
significantly greater technological, financial, sales and marketing resources;larger customer bases and longer operating histories;greater name recognition; andmore established relationships with music label companies, cable partners, advertisers, content and application providers and/or other strategic partners than we have.COMPETITION IN THE MUSIC DISTRIBUTION BUSINESS. Taiwan’s retail music distribution industry is fragmented and competitive. In addition to our Rose Records and Tachung Records chains, there are several other record distribution chains operating in Taiwan as well as convenience stores, individual music stores and night markets. Hypermarket chains, such as Carrefour and specialty entertainment chains, such as FNAC, reflect a small, but growing, segment of the market; some of these competitors have greater financial and other resources than us, and have been expanding into our markets. Alternative distribution channels, such as Internet sale of physical recorded music and Internet-based music downloads or streaming, which enjoy lower inventory and distribution costs, have also begun to emerge in recent years as competitive distribution channels and have adversely affected our popular music sales. Going forward, we anticipate that an increasing proportion of popular music sales is likely to continue to be effected through such alternative distribution channels, particularly Internet-based downloading, which will further erode our sales of popular music. Further, we expect continued growth in competing home entertainment options, including the Internet and large numbers of television and music channels offered by cable companies. In addition, the prevalent practice of physical and online piracy in Taiwan presents a continuing threat to the music distribution industry in Taiwan. Competition may reduce sales at music stores, put pressure on gross margins, increase operating expenses and reduce profit margins. There can be no assurance that the retail music business will continue to be a viable business, that retail stores will continue to be a primary distribution channel for recorded music, or
expenses isthat we will continue to compete successfully within the retail music store sector or the retail music business generally.COMPETITION IN THE BROADBAND ISP BUSINESS. Our main competitors in the consumer broadband ISP business are fixed-line service providers and other ISPs in Taiwan that offer asymmetrical digital subscriber line, or ADSL, broadband services, including Chunghwa Telecom’s HiNet, the overwhelmingly dominant provider of broadband services; Taiwan Fixed Network, a fixed-line service provider; and Seednet, SoNet and Asia Pacific Online, all Internet service providers. Our competitors also include cable-based Internet access companies that have developed their own cable-based services and market those services to cable operators and those that are seeking to contract with cable operators to bring their services into geographic areas that are not
accompaniedcovered by an exclusive relationship between our Company and our cable partners. Our corporate ISP business faces competition from fixed-line service providers, including Chunghwa Telecom, Taiwan Fixed Network, Sparq’s NCIC and Asia Pacific Online. In recent years, we have experienced a reduction in the number of our new consumer subscribers and our total consumer subscribers. The primary basis of competition in the Internet access business industry is price. We can offer no assurance that we will be able to attract new subscribers or retain existing subscribers, as a result of which our revenues may decline. Due to this intense competition, there may be a limited market opportunity for our broadband access services. We cannot assure you that we will be successful in achieving widespread acceptance of our services before our competitors offer services similar to our current or prospective offerings, which might preclude or delay purchasing decisions by potential subscribers or cause us to lose our existing subscribers.COMPETITION IN THE ENTERTAINMENT SOFTWARE BUSINESS. The Internet entertainment software industry is characterized by rapid technological change and we face significant and intense competition from online entertainment software design houses and application service providers. However, given the low barrier to entry of software industry and the increasing popularity of Internet-based businesses, there are a large number of potential competitors from many different segments of software and Internet industries. We also face the likelihood of new competitors entering this industry, including traditional entertainment service providers, many of which have significant financial resources. Traditional entertainment service providers might expand and provide an Internet-based entertainment service and such internet service providers and entertainment service provider may also develop and offer the underlying software solutions and tools to others, and thus directly compete with us. Some of our competitors and those of Ultra Internet Media, S.A., or UIM, our sole licensee, are more established, enjoy greater market recognition, are substantially larger and have substantially greater resources and distribution capabilities than we do. There is no assurance that we or UIM will be able to compete successfully with existing and future competitors, which could have a material and adverse effect on our business, financial condition or results of operations. See Item 4 — “Information on the Company — Entertainment Software Business — Competition” for additional information.
Our entertainment software business has a sole licensee, and any adverse effect on its business could have an adverse effect on our revenues, operating results and financial condition
All of our revenues from our entertainment software business are derived from UIM, currently sole licensee of our software products, the results of which have been consolidated into our financial statements as of and for the nine months ended December 31, 2004. See Item 5 — “Operating and Financial Review and Prospects — A. Operating Results — Overview — Consolidation of UIM Under FIN 46(R)” for more details. We do not own any shares of UIM or control its management and hence have no control over its business decisions. A decision by UIM to terminate its contract with us or any adverse effect on its business, operating results or financial performance could have a direct adverse effect on our business, operating results and financial performance. Further, any significant increase in
revenues, thenUIM’s liabilities or decrease in its assets would adversely affect our balance sheet. We continue to explore developing business relations with other clients but there is no assurance that such efforts will be successful.Our results of operations are subject to significant fluctuations, which may adversely affect our business and financial results
could be materially and adversely affected. WE MAY NEED TO LOWER PRODUCT PRICES IN OUR OFFLINE BUSINESS UNIT AND REDUCE ACCESS FEES IN OUR ONLINE BUSINESS UNIT IN THE FUTURE TO REMAIN COMPETITIVE. REVENUES FROM OTHER SOURCES MAY NOT BE SUFFICIENT TO COVER THE DECREASES IN THESE REVENUES The overall recorded music market is declining in Taiwan and pricing pressure is strong. We believe this situation will remain for the foreseeable future and that we may need to lower our prices on recorded music compact discs, or CDs, to remain competitive. In addition, with an increased number of broadband Internet access service providers in Taiwan, we believe that pricing pressure on access fees will remain intense. This pressure may require us to lower our access fees from time to time in order to remain competitive. Revenues from other sources of our operations and businesses may not be sufficient to cover decreases in our CD sales revenues and access service revenues. WE MAY NOT BE ABLE TO ATTRACT AND RETAIN SUBSCRIBERS OF OUR ONLINE BUSINESS SERVICES AND, AS A RESULT, OUR REVENUES MAY DECLINE Our ability to increase the number of residential and commercial subscribers of our online business services and our ability to retain these subscribers will depend on a number of factors, many of which are beyond our control. These factors include: - the speed at which we are able to deploy our services, particularly if we cannot obtain on a timely basis adequate supplies of cable modems or necessary telecommunications circuitry; - the impact of our marketing efforts on new and existing subscribers; and - the willingness of cable operators to enter into or to continue agreements with us. In addition, our service is currently priced at a premium to many other dial up Internet access services and we charged subscribers higher access fees after our cable partners upgraded their cable systems from one-way systems to two-way systems. Many subscribers may not be willing to pay a premium for our service. Because of these factors, our actual revenues or the rate at which we will add new subscribers may differ from past increases or your expectations. OUR RESULTS OF OPERATIONS ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS, WHICH MAY ADVERSELY AFFECT OUR BUSINESS AND FINANCIAL RESULTS 5Our revenues, expenses and results of operations have varied in the past and may fluctuate significantly in the future due to a variety of factors, many of which are beyond our control.
These factors include: -The key factors affecting ourofflinemusic distributionbusiness: -business include the frequency with which “hit” music titles are introduced, the seasonality of market demand for ourofflineretail musicproducts; - frequency of introduction of high-demand offline music products; - amount of write-off as a result of impairment tests; - price competition in the music distribution industry; - our ability to enter intoproducts andmaintain strategic alliance with music label companies; and - economic conditions specific to the music distribution industry, as well as general economic and market conditions. - factors affecting our online businesses: - the rate at which new customers subscribe to our services; - changes in our operating expenses including, in particular, personnel expenses; - price competition in the Internet and cable industries; - capital expenditures and costs related to infrastructure expansion; - the rate at which our cable partners convert their systems from one-way to two-way cable systems; - subscriber turnover rates; - our ability to protect our systems from telecommunications failures, power loss and software-related system failures; - the introduction of new products or services by us or our competitors; - the rate at which cable operators enter into contracts with us to provide services for additional cable systems; - the pace of the rollout of our service to our cable partners; -our ability to enter into and maintain strategic alliances withcontent providers;major record companies. The main factors affecting our broadband Internet service provider, or ISP, business include price competition in the Internet access business, the rate at which new customers subscribe to our services, subscriber turnover rates and- economic conditions specificthe pace of rollout of our service. The key factors affecting our entertainment software business include availability of Internet infrastructure, existing and new competitors, the retainment of key licenses by our licensee, our relationship with our licensee and the regulatory restrictions applicable to the Internetand cable industries, as well as general economic and market conditions.gaming industry. In addition, our operating expenses are based on our expectations of the future demand for our services and are relatively fixed in the short term. We may be unable to adjust spending quickly enough to offset any unexpected demand shortfall. A shortfall in revenues in relation to our expenses could have a material and adverse effect on our business and financial results.6WE ARE DEPENDENT ON OUR CABLE PARTNERS FOR DISTRIBUTION OF SOME OF OUR INTERNET ACCESS SERVICES, AND WE MAY NOT BE ABLE TO ESTABLISH OR MAINTAIN GOOD RELATIONSHIPS WITH THEM We deliver someOur efforts to improve the performance of our
broadbandmusic distribution business may be unsuccessfulWe operate Taiwan’s two largest music store chains. This business experienced substantial operating losses in 2002 and 2003 in line with a decline in the value of worldwide sales of recorded music. Illegal downloading of music from the Internet,
access servicesCD ROM piracy, industrial piracy, economic recession, bankruptcies of record wholesalers and retailers and growing competition for consumer discretionary spending and retail shelf space may all be contributing to a declining recorded music industry. We have taken steps with a view to improving the performance of this business, including, among other things, reducing costs, improving our management information systems with a view to operating the business more efficiently and improving our operating margins, and implementing a store sharing strategy to lower fixed costs for the stores and generate extra revenues. In 2004, our music distribution business recorded an operating income of US$542 thousand, representing a US$7.6 million turnaround from an operating loss of US$7.1 million in 2003, mainly due to a decrease in costs and expenses to approximately US$66.4 million in 2004 from approximately US$82.9 million in 2003. Total revenues decreased to approximately US$67.0 million in 2004 from approximately US$75.8 million in 2003. However, we cannot assure you that our strategies for our music distribution business will continue to be successful. This business may still incur losses in the future, which would likely have a material and adverse effect on our financial condition and results of operations.The nature of the music industry and the impact of technological innovations and the prevalence of piracy could materially and adversely affect our business, financial condition or results of operations
Our music distribution business is affected by the release of “hit” music titles, which can create trends in sales distinctive to the music industry. It is not possible to determine the timing of these cycles or the future availability of “hit” titles. Also, retail music sales in Taiwan are typically higher during the Chinese New Year and in the summer due to increased store traffic and buying by students and youths on school vacation. Rose Records and Tachung Records are similarly exposed to this trend in seasonality of sales, and rely heavily on the Chinese New Year and summer sales to achieve annual financial targets. Any disruption in sales during this period could have an adverse affect on our revenues from the music distribution business.
Our business is also affected by changes in music entertainment technology. While technological advances such as CDs have had a favorable impact on industry growth in the past, there is no assurance that future advances will continue to have a favorable impact on distributors of music entertainment product. While DVD–Audio, DualDisc and downloadable digital files are thought to represent potential new avenues for growth, no significant new legitimate audio format has yet emerged to take the place of the CD. Moreover, the Internet and cable set-top boxes, coupled with high quality digital recording technologies, facilitate and encourage direct downloading of recorded music by consumers, reducing the demand for CDs, thus negatively impacting the physical retail music distribution channels.
We may have difficulty addressing the threats to our
subscribers throughbusiness associated with home copying and Internet downloadingThe combined effect of the decreasing cost of electronic and computer equipment and related technology such as CD burners and the conversion of music into digital formats have made it easier for consumers to create unauthorized copies of our
cable partners' cable systems,recordings in the form of, for example, CDs and MP3 files. We believe that in the future, younger purchaser of popular music are likely to turn increasingly to alternative music distribution channels, such as Internet-based downloads, and that an increasing proportion of the physical retail music distribution will comprise more specialized areas of music, such as classical and jazz. A substantial portion of our revenues comes from the sale of audio products that are potentially subject to unauthorized consumer copying and widespread dissemination on the Internet without an economic return to us.Organized industrial piracy may lead to decreased sales
The global organized commercial pirate trade is a significant threat to the music industry. Worldwide, industrial pirated music (which encompasses unauthorized physical copies manufactured for sale but does not include Internet downloads or home CD burning) is estimated to have generated over US$4.5 billion in revenues in 2003, according to International Federation of the Phonographic Industry, or IFPI. IFPI estimates that 1.1 billion pirated units were manufactured in 2003. According to IFPI estimates, approximately 35% of all music CDs sold worldwide in 2003 were pirated. Unauthorized copies and piracy contributed to the decrease in the volume of legitimate sales and put pressure on the price of legitimate sales. They have had, and may continue to have, an adverse effect on our business.
The benefits of our exclusive agreements with certain cable partners
share the revenue frommay be substantially diminished by open-access proposals, which would require ourservices that are derived from such subscribers. Given the contractual and business relationships between our company and ourexclusive cable partners to grant ourcable partners' interests may not always coincide with our interests, and conflicts of interest concerning the split of revenues and other matters exist between our company and our cable partners. THE FAILURE OF OUR CABLE PARTNERS TO MAINTAIN THEIR OPERATING LICENSES CAN INTERRUPT DELIVERY OF OUR ONLINE SERVICES Cable operators are subjectcompetitors access toextensive regulations in Taiwan. In the event that any of our cable partners fails to continue to comply with applicable laws or regulations, it may be required to suspend or terminate its cable television business, which would prevent us from servicing our subscribers through its cable system. THE BENEFITS OF OUR EXCLUSIVE AGREEMENTS WITH THE CABLE PARTNERS MAY BE SUBSTANTIALLY DIMINISHED BY OPEN-ACCESS PROPOSALS, WHICH WOULD REQUIRE OUR EXCLUSIVE CABLE PARTNERS TO GRANT OUR COMPETITORS ACCESS TO THEIR SYSTEMStheir systemsWe have entered into exclusive agreements with
1911 out of2019 of our cable partners granting us the exclusive right to provide services through their cable systems.Under a regulationAs per new regulations in Taiwan, our cable partners must obtain leased-circuit licenses toleaseprovide their circuits to us in order for us to provide two-way cable services. In addition, any holder of leased-circuit licenses, including any of the cable partners having exclusive relationships with us, may be required to grant our competitors access to its cable system if it is deemed to be a dominant leased-circuit operator. In that event:-other Internet and online service providers could potentially provide services over these cablepartners'partners’ cable systems that compete with our services;-our rights as the exclusive broadband Internet access provider over these cablepartners'partners’ systems could be lost; and-our business, financial condition and results of operations would likely be adversely affected.WE RELY ON CONTENT PROVIDED BY THIRD PARTIES TO ATTRACT USERS, AND WE MAY NOT BE ABLE TO ESTABLISH OR MAINTAIN RELATIONSHIPS WITH QUALIFIED PROVIDERS We do not createSee Item 4 — “Information on the
contentCompany — B. Business Overview — Music Distribution Business — Industry Overview” for additional information.The markets for our
Web destination; we acquire it from others. Most of our arrangements for the provision of contentbroadband ISP business and entertainment software business arenot exclusive and are short-term or may be terminated at the convenience of either party. If these relationships terminate or our content providers are not able to adequately perform their obligations, and we are not able to replace them, we could lose our userscharacterized by rapid technological changes, and ourabilityinability toattract advertisers could be adversely affected. This couldrespond quickly and sufficiently to new Internet technologies or standards may have a material adverse effect on ourresultsbusinessThe markets for our broadband ISP business and entertainment software are characterized by rapid technological advances, evolving industry standards, changes in user requirements and frequent new service introductions and enhancements. The number of
operations. In addition,consumer subscribers of our broadband ISP services declined from approximately 108,000 in 2002 to approximately 95,000 in 2004. If wecannot assure you thatare unable to effectively use leading technologies, continue to develop ourexisting relationships withtechnological expertise, enhance ourcontent providers will result in: - sustained business partnerships; - popular content offerings; - significant traffic oncurrent services and continue to improve the performance, features and reliability of ourWeb destination;products and services, or- significant revenues for us,we are unable to respond quickly and sufficiently to new technologies orthatstandards, wewillmay not be able toenter into relationships with additional content providers. 7OUR INDUSTRIES FACE INTENSE COMPETITION, WHICH MAY ADVERSELY AFFECT OUR REVENUES, PROFITABILITY AND PLANNED BUSINESS EXPANSION We face competition from many competitors,attract new customers andwe expect to face competition from additional potential competitors, with: - significantly greater technical,our business and financialsalesresults may be materially andmarketing resources; - larger customer bases, longer operating histories; - greater name recognition;adversely affected.Our broadband ISP business and
- more established relationships with music label companies, cable partners, advertisers, content and application providers and/or other strategic partners than we have. COMPETITION IN THE MUSIC DISTRIBUTION BUSINESS. The music distributionentertainment software businessin Taiwan is fragmented and consists of music store chains, includingdepend on thetwo music store chains we acquired in 2002, and many mid- to small-size music stores and distribution channels. We also compete with music distribution channels that employ modern technology, such as online download and streaming, which enjoy lower inventory and distribution costs. In addition, the prevalent practice of physical and virtual piracy in Taiwan presents a continuing threat to the growth of the music distribution industry in Taiwan. Further, somereliability of ourcompetitors have exclusive distribution arrangements with music label companiesnetwork infrastructure, which is subject to physical, technological, security andtheother risksThe development and operation of
these arrangements prevent us from distributing certain popular music products. Our principal competitorsour online networks are subject to physical, technological, security and other risks which may result inthis industryinterruption in service or reduced capacity for customers. These risks includeAsia Record, Guan Nan Recordphysical damage, power loss, telecommunications failure, capacity limitation, hardware or software failures or defects andCarrefour. COMPETITION IN THE INTERNET ACCESS BUSINESS. Our competitors in the cable-based Internet access market are companies that have developed their own cable-based services and market those services to cable operators. Our principal competitors in this category include Eastern Multimedia Group, SeedNet and Taiwan Broadband. We also compete with other cable-based data service providers that are seeking to contract with cable operators to bring their services into geographic areas that are not coveredbreaches of security byan exclusive relationship between our company and our cable partners. Our competitors also include fixed-line service providers in Taiwan that offer asymmetrical digital subscriber line,computer viruses, break-ins orADSL, broadband services, including Chunghwa Telecom's HiNet, the current market leader. In addition, we face competition from other cable modem service providers for partnerships with cable operators and from providers of other types of data and Internet services for users. We also compete with other broadband technologies, including integrated services digital network, wireless and satellite data services. In addition, EraNet and AsiaCast have begun to offer satellite Internet access services in Taiwan. We also compete with traditional narrowband Internet service providers, which provide basic Internet access to residential and commercial users and businesses, generally using existing telephone networks. While not offering the advantages of broadband Internet access, these services are widely available and less expensive. Moreover, competitors with high-speed telecommunications technologies are offering diversified packages of telecommunications services, including Internet access, and could bundle these services together, putting us at a competitive disadvantage. Widespread commercial acceptanceotherwise. The occurrence of any of thesecompeting technologiesevents could result in interruptions, delays orcompetitors' products could significantly reduce the potential customer base forcessation in service to users of our online services, which could have a material adverse effect on our businessfinancial conditionandresultsoperating results. An increase in the volume of usage of online services could strain the capacity of our software and hardware employed, which could result in slower response time or system failures. We do not have redundant facilities in the event of an emergency, but we have a variety of backup servers at our primary site to deal with system failures.While we have implemented industry-standard security measures, our network may still be vulnerable to unauthorized access, computer viruses, denial of service attacks and other disruptive problems. A party that is able to circumvent security measures could misappropriate proprietary information and, perhaps, most importantly, cause interruptions in our operations.
See Item 4. " Information onInternet and online service providers have, in theCompany--B. Business Overview--Competition". Due to this intense competition, therepast, experienced and may, in the future, experience, interruptions in service as a result of the accidental or intentional actions of Internet users, current and former employees or others. We may bea limited market opportunity forrequired to expend significant capital or other resources to protect against the threat of security breaches or to alleviate problems caused by such breaches. There can be no assurance that any measures implemented will not be circumvented in the future.The worldwide legal and regulatory environment in which our
broadband access services. We cannot assure youentertainment software business operates embodies uncertainties thatwe will be successful in achieving widespread acceptancecould adversely affect our business and operating resultsUIM, the sole licensee of our
services beforesoftware products and ourcompetitors offer services similarbusiness of software development and application service provision itself are subject to applicable laws and regulations in various jurisdictions. Companies and consumers involved in Internet gaming are located around the world, including the end users of ourcurrentlicensee. As such, it is in many cases uncertain which governments have authority to regulate orprospective offerings, which might preclude or delay purchasing decisions by potential subscribers. 8COMPETITION IN THE CONTENT BUSINESS. The markets for Internet content are extremely competitive and we expect that competition will intensify in the future. We compete with content aggregators and portals. Our competitionlegislate with respect touser traffic, easedifferent aspects ofusethis industry. The Internet gaming industry is still in an early stage of development, andfunctionality include: - Chinese language-based Web portalsas such, the worldwide legal anddestinationsregulatory environment in which the business operates is highly fluid, and subject to change. Most foreign jurisdictions have some form of legal framework applicable to games of chance, but few provide any guidance on how this framework applies to Internet gaming. Issues such asYahoo!Kimo, China.com, Sina.com, Chinatimes, Yam, HiNet,physical location of the gaming event, foreign jurisdictional law, “Cyberlaws”, andSohu; - English language-based Web search“control of the Internet” all make traditional legal andretrieval companies such as Terra Lycos, Yahoo!regulatory laws difficult to apply. In addition, the very nature of Internet gaming creates new andMicrosoft Network; and - retrieval services and products offered by companies such as AltaVista, HotWired Venture's and Inktomi's HotBot, OpenText and Openfind. In the future, we may encounter competition from Internet service providers, Web site operators and Web browser software providers, such as Netscape or Microsoft,unique forms of entertainment thatincorporate search and retrieval features into their offerings. Our competitors may develop Web search and retrieval services that are equal or superior to those we offer our users and may achieve greater market acceptance than our offeringswere neither contemplated nor feasible in thearea of performance, ease of use and functionality. OUR CONTROLLING SHAREHOLDER HAS SIGNIFICANT INFLUENCE IN DETERMINING THE OUTCOME OF ANY CORPORATE TRANSACTION OR OTHER MATTERS SUBMITTED TO THE SHAREHOLDERS FOR APPROVAL, AND THEIR INTERESTS MAY CONFLICT WITH YOUR INTERESTS The Koos Group currently beneficially owns approximately 55.6% of our outstanding shares. Accordingly, the Koos Group has significant influence in determining the outcome of any corporate transaction or other matters submittedpast. Due to theshareholders for approval, including mergers, consolidations and the sale of all or substantially all of our assets, and also the power to prevent or cause a change in control. The interests of the Koos Group may differ from or conflict with your interests. ONE OF OUR DIRECTORS IS ALSO A DIRECTOR OF ONE OF OUR COMPETITORS, AND CONFLICT OF INTERESTS MAY ARISE Taiwan Cement Corporation, a member of the Koos Group, has an approximate 20% equity interest in AsiaCast, which provides broadband Internet access services over satellites. Leslie Koo, one of our directors, is a director of Taiwan Cement and AsiaCast. Under Singapore law, Leslie Koo, as a director of our company, may not provide AsiaCast with non-public information of our company. In addition, under Singapore law, he owes a fiduciary duty to our company and is required to actuncertainties in thebest interest ofworldwide legal and regulatory environment in which ourcompany. OUR AGREEMENT TO USE MICROSOFT AS OUR DEFAULT PROVIDER OF TECHNOLOGY, PRODUCTS AND APPLICATIONS MAY RESULT IN PRODUCT OR SERVICE DEVELOPMENT DELAYS OR PREVENT US FROM FORMING STRATEGIC RELATIONSHIPS WITH OTHER COMPANIES We elected to enter into a Business Co-Operation Agreement with Microsoft in November 1999. Under this agreement, we are required to use Microsoft as our default provider of technology, products and applications, provided that the relevant Microsoft technology, products or applications satisfy general industry standards. We may seek alternative manufacturers or vendors only if Microsoft fails to submit an acceptable proposal within 60 days of our request and if Microsoft fails to deliver to us an acceptable alternative solution within 60 days after we notify Microsoft of its failure to submit the proposal. All of our purchases of technology, products or applications from Microsoft are to be on commercially reasonable terms and conditions. We cannot provide any assurance that technology, products or applications available from Microsoft will always satisfy our product or service development requirements. In addition, we may not always agree with Microsoft regarding the acceptability of a particular proposal. Our obligations under the Business Co-Operation Agreement may delay our ability to purchase products, technology or applications from our desired providers for 120 days. Microsoft's rights as our default provider may also deter other 9leading content providers and market leaders in the Internet industry from forming strategic relationships with us. OUR RELATIONSHIP WITH OUR MAJOR SHAREHOLDERS MAY NOT BENEFIT US IN THE FUTURE, AND THE EXPECTED BENEFITS TO BE DERIVED FROM OUR AFFILIATIONS WITH OUR MAJOR SHAREHOLDERS MAY NEVER MATERIALIZE We have entered into alliances with several members of the Koos Group. These alliances have enabled us to obtain services relating to our access and content businesses. We expect to enter into additional alliances with members of the Koos Group in the future as we expand our operations. However,entertainment software business operates, we cannot assure you that our status or operations as an application service provider to the gaming industry is in compliance with all laws and regulations of the jurisdictions in which wewill succeed in entering into such alliancesoperate, or that changes in such laws and regulations, or in their interpretation, will not adversely affect our business and operating results. Also, thealliancessubstantial uncertainties in the global regulatory environment relating to online gaming expose us to a real risk of regulatory authorities in various jurisdictions considering us as providing online gaming services rather than only providing software and application services to our licensee and hence subjecting us to gaming regulations in such jurisdiction.Our Company and the industry as a whole may be affected by efforts by members of the U.S. Congress to ban certain Internet gambling. Early in the 108th Congress, U.S. Congressman Jim Leach (R-IA) introduced HR 21, the Unlawful Internet Gambling Funding Prohibition Act, which attempts to prohibit Internet gambling by forbidding the use of credit instruments of United States banks from being used to make bets or wagers over the Internet. Shortly afterwards, U.S. Senator Jon Kyl (R-AZ) introduced similar legislation, S-627 in the U.S. Senate. In June 2003, HR 21 was reintroduced as HR 2143 by U.S. Congressman Spencer Bachus (R-AL) without any civil and criminal sanctions in order to bypass the U.S. House of Representatives Committee on Judiciary. After a very close vote on an amendment to HR 2143, the House of Representatives passed that legislation. In late October 2003, the U.S. Senate’s Committee on Banking, Housing, and Urban Affairs placed an amended version of S-627 on the Senate Legislative Calendar under General Orders. We continue to monitor this situation since the passage of this legislation could have a substantial impact on the business of our licensee and ultimately our Company. If this legislation passes and becomes law, it would have an immediate detrimental effect on the industry and would pose a serious threat to the continued operation of our entertainment software business.
In November 2004, the World Trade Organization, or WTO, found that the U.S. was in violation of its commitments under the General Agreement on Trade in Services, or GATS, by not allowing operators of online gaming services licensed in Antigua and Barbuda to access U.S. markets. The decision was appealed and, in April 2005, the Appellate Body of the WTO found that the provisions of the Wire Act, Travel Act and Illegal Gambling Business Act are inconsistent with the
Koos Group's membersU.S.’s obligations under the GATS, but also that the U.S. had shown that such measures are necessary to protect public morals or maintain public order and therefore fall within an exception to its general obligations. However, the Appellate Body further found that, in the light of U.S. legislation in respect of online gambling on horseracing, the U.S. had failed to demonstrate that the Wire Act, Travel Act and Illegal Gambling Business Act are applied equally to both foreign and domestic providers of online gambling services for horseracing and therefore recommended that the U.S. bring its legislation into conformity with its obligations under the GATS.It is unclear what steps the U.S. will take following the decision of the Appellate Body of the WTO and whether the threat of any sanction or fine relating to a failure to implement the recommendation of the Appellate Body would be
beneficialsufficient tous. We have also entered intolead to astrategic alliance with Microsoft, onechange in U.S. online gaming policy. A number of states are lobbying/petitioning the U.S. authorities to ensure they retain the ability to regulate state gaming and that this ability is not affected by the WTO decision.The adoption of new laws or changes to or the application of existing laws relating to Internet commerce may affect the growth of our
principal shareholders. This alliance is intendedentertainment software businessIn addition to
give us accessregulations pertaining specifically tothe latest Internet technologiesonline entertainment, we may become subject to a number of laws andproducts, to distribute our content through Microsoft Network and to provide us with significant co-development opportunitiesregulations that may be adopted with respect toInternet-basedthe Internet and electronic commerce. Moreover, current laws, which predate or are incompatible with Internet commerce, may be enforced in a manner that restricts the electronic commerce market. However, the application of such pre-existing U.S. and international laws regulating communications or commerce in the context of the Internet and electronic commerce is uncertain.Moreover, it may take years to determine the extent to which existing laws relating to issues such as intellectual property ownership and infringement, libel and personal privacy are applicable to the Internet. The United States Federal Trade Commission and government agencies in certain states of the United States have been investigating certain Internet companies regarding their use of personal information. We could incur additional expenses if these agencies choose to investigate, or if any new regulations regarding the use of personal information are introduced affecting the way in which we do business.
New laws and regulations that address issues such as user privacy, pricing, online content regulation, taxation, advertising, intellectual property, information security, and the characteristics and quality of online products and services
and applications. We cannot assure you that our alliance with Microsoft willmay besustainedenacted.The adoption of new laws or
prove beneficialregulations relating to the Internet, or particular applications or interpretations of existing laws, could decrease the growth in the use of the Internet, decrease the demand for our products and services, increase our cost of doing business or could otherwise have a material adverse affect on our business, revenues, operating results and financial condition.We are subject to risks associated with all of
operations. If Microsoft decidesour entertainment software business conducted in non-U.S. jurisdictionsAll of our revenues is derived from licensing and support fees in non-U.S jurisdictions. We currently provide user interface and end-user support in 16 languages. Our ability to
terminatefurther expand our business in certain countries will require modification of our products, particularly domestic language and currency support. Once a licensee has posted itsrelationship with our company,gaming site on the Internet, the site is available to users around the world. However, there can be no assurance that wemay notwill be able toobtain equivalent technologies on terms acceptable to us. OUR TRANSACTIONS WITH AFFILIATES MAY NOT BENEFIT US AND MAY HARM OUR COMPANY We have entered into several transactions with our affiliates. Our policy is that transactions with affiliates are to be conducted on an arm's-length basis and on terms substantially as favorable to us as with non-affiliates. However, we cannot assure you that all our future transactions with affiliates will be beneficial to us. 12 out of our 20 cable partners are members of the Koos Group cable television network, a member of the Koos Group, our controlling shareholder. We cannot assure you that future transactions between our company and those related cable partners will be on arm's-length terms,sustain or increase revenues derived from international operations or that wecould not have obtained more favorable termswill be able to penetrate linguistic, cultural or other barriers to new foreign markets.In addition to uncertainty regarding the local legal status of Internet gaming in
negotiationsother jurisdictions, there are certain difficulties and inherent risks faced by our subsidiary, CESL, in doing business internationally, including the burden of complying withindependent third parties. See Item 7. "Major Shareholdersmultiple andRelated Party Transactions--Related Party Transactions". WE MAY NOT BE ABLE TO DEVELOP THE GIGAMEDIA BRAND AND ATTRACT USERS TO USE OUR SERVICES, WHICH MAY HARM OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS Maintainingconflicting regulatory requirements, foreign exchange controls, potential restrictions or tariffs on gaming activities that may be imposed, potentially adverse tax consequences and tax risks. Changes in theGigaMedia brand is critical topolitical and economic stability, regulatory and taxation structures, and the interpretation thereof, of jurisdictions in which we or ourability to expandsubsidiaries operate, and in which ouruser base and our revenues. We believe that the importance of brand recognition will increase as the number of broadband Internet Web sites in Taiwan grows. In order to attract and retain our users, we intend to substantially increase our expenditures for creating and maintaining brand loyalty. Our success in promoting and enhancing the GigaMedia brand will also depend on our success in providing high-quality content, features and functionality. If we fail to promote our brand successfully or if visitors to our Web destination do not perceive our services to be of high quality, the value of the GigaMedia brand could be diminished. Thislicensee’s customers are located could have a materialandadverse effect on our business, revenues, operating results and financial condition.Online gaming is a relatively new industry and therefore, we do not know if the market will continue to develop and our products and services will continue to be in demand
Both the Internet and online gaming industries are relatively new industries that continue to rapidly evolve and are characterized by an increasing number of market entrants. The demand and market acceptance for recently introduced products and services are typically subject to a high level of uncertainty. The success of our entertainment software business will depend on the widespread adoption of the Internet for commercial transactions. There can be no assurance that entertainment on the Internet will become widespread.
All of our revenues from our entertainment software business to date have been derived from the licensing of our online entertainment software and the support of our associated services through our licensing subsidiary. Our continued success will depend in large part upon the success of our online entertainment software. If the market fails to develop, develops more slowly than expected, or becomes saturated with competitors or if our services do not achieve market acceptance, our business, revenues, operating results and financial condition could be materially adversely affected.
We may be vulnerable to delays or interruptions due to our reliance on other parties
Our electronic commerce product for handling transactions over the Internet relies on ISP to allow our licensee’s customers and servers to communicate with each other. If all of the ISPs experienced lengthy service interruptions, it would prevent communication over the Internet and would greatly impair our ability to carry on business.
Our ability to process e-commerce transactions depends on bank processing and credit card systems. In order to prepare for certain types of system problems, we are developing a formal disaster recovery plan. Nevertheless, any system failure, including network, software or hardware failure, which causes a delay or interruption in our e-commerce services could have a material adverse effect on our business, revenues, operating results and financial condition.
The licensee of
operations. WE MAY NEED ADDITIONAL CAPITAL IN THE FUTURE AND IT MAY NOT BE AVAILABLE ON ACCEPTABLE TERMSour entertainment software depends on credit card transactions for a substantial portion of the deposits or payments by their customersOur entertainment software business derives all of its revenues from its licensee. A substantial portion of the deposits or payments made to our licensee are made through credit card transactions. If credit card companies were to stop processing online gaming transactions, either generally or in jurisdictions where our licensee operates, our entertainment software business could be materially and adversely affected.
Many issuing banks of major credit cards decline authorization to U.S. persons who attempt to use their credit cards for online gaming. We may be adversely affected by the provisions of the U.S. Patriot Act. U.S. and non-U.S. banks which process online gaming transactions for U.S. persons face potential criminal proceedings under the U.S. Patriot Act, as U.S. jurisdiction under the Patriot Act extends to non-U.S. banks that have correspondent accounts in the United States. This could result in issuing banks deciding not to process online gaming transactions generally. For example, following pressure from Eliot Spitzer, in June 2002 Citibank started to block credit card payments to known online gaming sites and, later that year, the Delaware payment processing firm PayPal stopped processing payments for the purposes of online gaming. In addition, it is possible that other jurisdictions may enact legislation or take other actions which result in credit card companies being unwilling or unable to process online gaming transactions.
Furthermore, there is a higher incidence of fraud associated with online credit card payments than with respect to other types of transactions, which could further discourage issuing banks from processing online gaming transactions.
Defects in our entertainment software and application services could harm our reputation and thus our business
The performance of our entertainment software and application service is critical to the success of our entertainment software business, which is subject to serious potential risks. These risks include the risk of defects in our software and application service or system failures, which could result in losses to our licensee, end users and to us; and the risk from claims resulting from losses to end users, which could damage our reputation and subject us to liability.
We may need additional capital in the future and it may not be available on acceptable terms
The development of our business may require significant additional capital in the future to:
-fund our operations;- finance the substantial investments in equipment and corporate infrastructure needed for our growth; -enhance and expand the range of products and services we offer;10- enhanceandexpand our music distribution business; and -respond to competitive pressures and perceived opportunities, such as investment, acquisition and international expansion activities.To date, our cash flow from operations has been insufficient to cover our expenses and capital needs. For 2002, cash used in operating activities totaled approximately NT$5,279 thousand (US$153 thousand).We cannot assure you that additional financing will be available on terms favorable to us, if at all. If adequate funds are not available on acceptable terms, we may be forced to curtail or cease our operations. Moreover, even if we are able to continue our operations, any failure to obtain additional financing could have a material and adverse effect on our business, financial condition and results of operations and we may need to delay the deployment of our services. See Item
5. "Operating5 — “Operating and Financial Review and Prospects--— B. Liquidity and CapitalResources"Resources”.We believe that we were a passive foreign investment company for the taxable year 2004 and we may continue to be classified as a passive foreign investment company for the taxable year 2005. As a result, unless you determine to make a “qualifying electing fund” or mark-to-market election, you may be subject to materially adverse tax consequences with respect to our shares
Based upon an analysis of our income and assets for the 2004 taxable year, we believe that we were a passive foreign investment company for the 2004 taxable year and we may continue to be classified as a passive foreign investment company for the taxable year 2005. For a discussion of the factors that will affect whether or not we are classified as passive foreign investment company, see Item 10 — “Additional Information — E. Taxation — United States Federal Income Tax Considerations For U.S. Holders — Passive Foreign Investment Company Rules”.
IF WE FAIL TO MANAGE OUR GROWTH, OUR BUSINESS MIGHT BE HARMED To manageIf you are a U.S. person holding ourgrowth,shares, (or have held our shares during a taxable year in respect of which wemustwere classified as a passive foreign investment company and you continueto: - implementto hold such shares or portion thereof) andimprove our operational, financialwe continue to be a passive foreign investment company andmanagement information systemsyou do not determine to make a “qualifying electing fund” or mark-to-market election, you will be subject to special U.S. federal income tax rules that may have materially adverse tax consequences andour operational facilities; - enhance our distribution efficiency; - hire, train and retain additional qualified personnel; - expand and upgrade core technologies; and - effectively manage our relationships with our subscribers, supplierswill require annual reporting. See Item 10 — “Additional Information — E. Taxation — United States Federal Income Tax Considerations For U.S. Holders — Passive Foreign Investment Company Rules”.Fluctuations in the exchange rates between U.S. dollar and other
third parties.currencies in which we do our business could adversely affect our profitabilityOur
growth could place a significant strain onfinancial results since January 1, 2004 are reported in U.S. currency, which is subject to fluctuations in respect of the currencies of the countries in which we operate. The operations of ourservicesentertainment software licensee are conducted in most major currencies, including U.S. dollars, British pound sterling andsupport operations, salesEuros andadministrative personnel, and other resources. We could also experience difficultieswe earn revenues from these sources inmeeting demand for our products and services. Additionally, if we are unable to provide training and support for our products and services,such currencies, as well as incurring expenses in U.S. dollars. Accordingly, fluctuations in theimplementation process will be longer and customer satisfaction may be lower. We cannot assure you that our systems, procedures or controls will be adequate to support our operations or that our management will be capableexchange rate ofexploiting fully the market for our products and services. The failure to manage our growth effectivelyworld currencies could have amaterial adversepositive or negative effect onour business, financial condition andthe reported results ofoperations. WE DEPEND ON OUR KEY PERSONNEL AND WE MAY HAVE DIFFICULTY ATTRACTING AND RETAINING SKILLED EMPLOYEES Ourour entertainment software business. Given the constantly changing currency exposures and the substantial volatility of currency exchange rates, we cannot predict the effect of exchange rate fluctuations upon futuresuccess depends on the continued service of our key personnel. We do not carry key person insurance on most of our personnel. The loss of the services of any of our executive officers or other key employees could have a material adverse effect on our business, financial condition and results of operations. Although we have employment contracts with our executive officers and other senior officers, none of our key personnel is bound by a non-competition agreement. Our future success also depends on our ability to attract, retain and motivate highly skilled employees, particularly engineering and technical personnel. Competition for qualified employees in our industry is intense. We may notoperating results. There can beable to retain our key employees or attract, assimilate or retain other highly qualified employees in the future. From time to time we have experienced, and we expect to continue to experience, difficulty in hiring highly skilled employees. WE MAY BE SUBJECT TO CLAIMS BASED ON THE CONTENT WE PROVIDE, INCLUDING COPYRIGHT OR TRADEMARK INFRINGEMENT AND OTHER SIMILAR CLAIMS 11Part of our business involves supplying information to users over the cable systems of our cable partners. Accordingly, we face the same types of risks that apply to all businesses that publish or distribute information, such as potential liability for copyright or trademark infringement and other similar claims. A number of third parties have claimed that they hold patents covering various forms of online transactions or online technologies. In addition, our errors and omissions and liability insurance may not cover potential patent or copyright infringement claims and may not adequately indemnify us for any liability that may be imposed. In addition, we may be held liable for our content under law and regulations covering the issues of national security, public safety, privacy and defamation. The law in Taiwan requires that a telecommunications service provider, including an Internet service provider like our company, take all proper and necessary measures to safeguard the privacy of its users. The law in Taiwan relating to information transmitted over the Internet generally places liability for obscene or defamatory content or content in violation of public order or national security on original authors and not the companies providing Internet services, unless a company is involved in the preparation of the information or provides a forum to display such information that it knows or has reason to know to be obscene or defamatory or against public order or national security. We, however, cannot assure you that the relevant law in Taiwan would not be interpreted differently against our company or that any new law or regulation that broadens our liabilities would not be implemented in the future. In that event, our business, financial condition and results of operations could be adversely affected. WE MAY BE SUBJECT TO CLAIMS BASED ON PRODUCTS SOLD ON OUR NETWORK, INCLUDING PRODUCT LIABILITY AND PERSONAL INJURY CLAIMS We have entered into arrangements to offer third-party products and services on our network. These arrangements may subject us to additional claims, including product liability or personal injury from the products and services, even if we do not ourselves provide the products or services. These claims may require us to incur significant expenses in their defense or satisfaction. While our agreements with these parties often provideno assurance that we willbe indemnified against such liabilities, such indemnification maynotbe adequate. Our insurance policies do not cover potential product liability and personal injury claims to which we are exposed or may not be adequate to indemnify us for all liability that may be imposed. Any imposition of liability that is not covered by insurance or is in excess of insurance coverage could have a material adverse effect on our business, financial condition and results of operations or could resultexperience currency losses in theimposition of criminal penalties. In addition, the increased attention focused on liability issues as a result of these lawsuits and legislative proposals could impact the overall growth of Internet use. RISKS RELATING TO OUR TECHNOLOGIES OUR SUCCESS IN ATTRACTING AND RETAINING SUBSCRIBERS WILL DEPEND ON OUR ABILITY TO INCREASE THE CAPACITY AND MAINTAIN THE SPEED OF OUR NETWORK, WHICH MAY VARY We face risks related to our ability to increase the transmission capacity of our network to meet expected subscriber levels while maintaining superior performance. While peak downstream data transmission speeds across the cable infrastructure approach 10 Mbps in each 6 MHz channel, actual downstream data transmission speeds are likely to be significantly slower, depending on a variety of factors, including the type and location of content, Internet traffic, the number of active subscribers on a given cable network node, the number of 6 MHz channels allocated to our company by our cable partners, the capabilities of the cable modems used and the service quality of the cable partners' facilities. The actual data transmission speed that a subscriber realizes also will depend on the subscriber's hardware, operating system and software configurations. We cannot assure you that we will be able to achieve or maintain a speed of data transmission sufficiently high to enable us to attract and retain our planned number of subscribers, especially as the number of subscribers grows. Because subscribers will share the available capacity on a cable network node, we may underestimate the capacity we need to provide in order to maintain peak transmission speeds. A perceived or actual failure to achieve or maintain sufficiently high speed data transmission could 12significantly reduce subscriber demand for our services and have a material adverse effect on our business and financial condition. WE DEPEND ON A DATA TRANSMISSION INFRASTRUCTURE LARGELY MAINTAINED BY THIRD PARTIES OR SUBJECT TO DISRUPTION BY EVENTS OUTSIDE OUR CONTROL Our success will depend upon the capacity, reliability and security of the infrastructure used to carry data between our subscribers and the Internet. A significant portion of that infrastructure is owned by third parties. Accordingly, we have no control over its quality and maintenance. For example, we rely on our cable partners to maintain their cable infrastructures. We also rely on other third parties to provide a connection from the cable infrastructure to the Internet. For ADSL services, we rely on Chunghwa Telecom to provide connections. Currently, we lease our telecommunications backbone from Chunghwa Telecom and from KG Telecom to support the exchange of traffic between our data servers, which are computers on a network that store information, the cable infrastructure and the Internet. We are dependent on Hewlett-Packard Company for network management software, Hewlett-Packard Company and Compaq Computer Corporation for systems management software to operate regional data centers remotely and Microsoft Corporation for advanced database management software, server and browser software. Although we believe that there are alternative suppliers for each of these equipment and technologies, it could take a significant period of time to substitute their equipment and technologies. The loss of any of our relationships with these suppliers could have a material adverse effect on our business, financial condition and results of operations. OUR OPERATIONS ARE VULNERABLE TO NATURAL DISASTERS AND OTHER EVENTS, WHICH CAN INTERRUPT OUR SERVICES Our online business operations depend on our ability to avoid damages from fires, earthquakes, floods, power losses, telecommunications failures, network software flaws, transmission cable cuts and similar events. The occurrence of any of these events could interrupt our services. For instance, our operations were interrupted for approximately 30 hours by a flood in Taipei in 2001. Critical services were restored within two days. In addition, in Taichung, a city located in central Taiwan, our operations were interrupted for approximately two weeks because of an earthquake in September 1999. We cannot recover any of the damages we incurred during such interruption because we do not carry any business interruption insurance. The failure of the Internet backbone, our servers, or any other link in the delivery chain, whether from operational disruption, natural disaster or otherwise, resulting in an interruption in our operations could have a material adverse effect on our business and financial results. OUR ONLINE BUSINESS NETWORK MAY BE VULNERABLE TO SECURITY RISKS, WHICH MAY MAKE OUR SERVICES LESS ATTRACTIVE AND RELIABLE Despite our implementation of industry-standard security measures, our or our cable partners' networks or those of Chunghwa Telecom may be vulnerable to unauthorized access, computer viruses and other disruptive problems. Internet and online service providers in the past have experienced, and in thefuture,may experience, interruptions in service as a result of the accidental or intentional actions of Internet users. Moreover, we have no control over the security measures that our cable partners and subscribers adopt. Unauthorized access could also potentially jeopardize the security of confidential information stored in the computer systems maintained by us and our subscribers. These events may result in liability to us or harm to our subscribers. Eliminating computer viruses and alleviating other security problems may require interruptions, delays or cessation of service to our subscribers,which could have a material adverse effect on our business,and financial results. In addition, the threat of these and other security risks may deter potential subscribers from purchasing our services, which could have a material adverse effect on our business, financial condition andrevenues, operating resultsof operations. OUR ONLINE BUSINESS IS DEPENDENT ON LICENSED TECHNOLOGY, AND WE MAY BE UNABLE TO OBTAIN OR MAINTAIN DESIRABLE LICENSED TECHNOLOGY 13With respect to our online business, we currently own and also license technology from third parties. We have licensed a number of software from Microsoft Corporation and Portal Information Network, Inc. for our service, content publishing and billing operations. As we continue to introduce new services that require new technology, we anticipate that we may need to license additional third-party technology. We cannot provide any assurance that these technology licenses will be available to us on commercially reasonable terms, if at all. In addition, it is possible that in the course of using new technology, we may inadvertently breach the technology rights of others and face liabilities for such breach. Our inability to obtain any of these technology licenses or inadvertent breach of others' technology rights could delay or compromise the introduction of new services and could materially and adversely affect our businessand financial condition.WE ARE EXPERIENCING BACKLOGS IN ESTABLISHING DIGITAL SUBSCRIBER LINE, OR DSL, LEASED LINE SERVICES FOR POTENTIAL CUSTOMERS DUE TO LIMITED AVAILABILITY OF ADSL SWITCH PORTS FROM CHUNGHWA TELECOM, WHICH MAY ADVERSELY AFFECT OUR BUSINESS AND REVENUESOur
DSL leased line service business is currently dependent oncontrolling shareholder has significant influence in determining theavailabilityoutcome ofADSL switch ports offered by Chunghwa Telecom. These switched ports allow subscribers to connectany corporate transaction or other matters submitted to theInternet via Chunghwa Telecom's network. Dueshareholders for approval, and their interests may conflict with your interestsMembers of the Koo family currently beneficially own approximately 21.45% of our outstanding shares. Accordingly, such members of the Koo family have significant influence in determining the outcome of any corporate transaction or other matters submitted to
highthe shareholders for approval, including mergers, consolidations and the sale of all or substantially all of our assets, and also the power to prevent or cause a change in control. The interests of such members of the Koo family may differ from or conflict with your interests.Our transactions with affiliates may not benefit us and may harm our Company
We have entered into several transactions with our affiliates. Our policy is that transactions with affiliates are to be conducted on an arm’s-length basis and on terms as favorable to us as with non-affiliates. However, we cannot assure you that all our future transactions with affiliates will be beneficial to us.
Our operating results and financial condition are affected by general economic conditions, levels of
current demand for such services, a significant portionconsumer spending, political stability as well as the occurrence ofour potential DSL customers are currently required to wait approximately 7 days for Chunghwa Telecom to make these ports available before they can begin subscribingnatural disasters and epidemicsOur operating results and financial condition, particularly in relation to our
DSL leased line service. If this delay causes us to lose potential customers or inhibits our ability to attract new customers, our DSL leased linemusic distribution businessmay sufferand ourrevenues may be adversely affected. RISKS RELATING TO OUR INDUSTRIES THE INTERNET ACCESS SERVICE MARKET IS CHARACTERIZED BY RAPID TECHNOLOGICAL CHANGES, AND OUR TECHNOLOGIES MAY NOT BE POPULAR AND MAY BECOME OBSOLETE The market for our Internet access services is characterized by rapid technological advances, evolving industry standards, changes in user requirementsentertainment software business, are directly dependent upon general economic conditions andfrequent new service introductions and enhancements. For example, a numberlevels ofbroadband technologies, such as ADSL services, have demonstrated competing technological advantages against our broadband Internet access services and may become more popular products with our subscribers in the future. If technologies or standards applicable to our services become obsolete or fail to gain widespreadconsumeracceptance, then our business and financial results will be materially and adversely affected. We have acquired headend, cable modem and other related capital equipment. The technology underlying that equipment is continuing to evolve. It is possible that the equipment we acquire could become obsolete prior to the time we would otherwise intend to replace it, which could have a material adverse effect on our business, financial condition and results of operations. THE INTERNET MARKET IN TAIWAN IS A DEVELOPING MARKET, AND SERVICES WE ARE OFFERING OR INTEND TO OFFER MAY NOT BE WIDELY ACCEPTED IN TAIWAN, WHICH WOULD ADVERSELY AFFECT OUR FUTURE REVENUES AND BUSINESS EXPANSION The market for Internet services in Taiwan is still under development. Our future results of operations from access services will depend substantially upon the increased use of the Internet in Taiwan for information, publication, entertainment, distribution and commerce. Despite growing interest in the commercial possibilities for the Internet, businesses and consumers in Taiwan may be deterred from purchasing Internet access services for the following reasons: - inconsistent quality of service; - lack of availability of cost-effective service; 14- a limited number of local access points for corporate users; - the need to deal with multiple and frequently incompatible vendors; and - a lack of tools to simplify Internet access and use. The adoption of the Internet for commerce and communications, particularly by those individuals and enterprises that have historically relied upon alternative means of commerce and communication, generally requires understanding and acceptance of a new way of conducting business and exchanging information. Critical issues concerning the commercial use of the Internet in Taiwan such as security, reliability, cost, ease of deployment, administration and quality of service may affect the adoption of the Internet to solve business needs. For example, the cost of access may prevent many potential users in Taiwan from using the Internet. In addition, consumers will have to be confident that adequate security measures will prevent fraud and protect electronic sale transactions conducted over the Internet. THE TELECOMMUNICATIONS INFRASTRUCTURE IN TAIWAN, WHICH IS NOT AS WELL-DEVELOPED AS IN THE UNITED STATES OR EUROPE, MAY LIMIT THE GROWTH OF THE INTERNET AND ADVERSELY AFFECT OUR BUSINESS Access to the Internet requires a relatively advanced telecommunications infrastructure. The telecommunications infrastructure in Taiwan is not as well-developed as in the United States or Europe. The quality and continued development of the telecommunications infrastructure in Taiwan will have a substantial impact on our ability to deliver our services and on the market acceptance of the Internet in Taiwan in general. If further improvements to the telecommunications infrastructure are not made, the Internet will not gain broad market acceptance in Taiwan. If access to the Internet in Taiwan does not continue to grow or grows more slowly than we anticipate, our business, financial condition and results of operations will be materially and adversely affected. POLITICAL, ECONOMIC AND REGULATORY RISKS OUR BUSINESS MAY BE HARMED, AND OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS MAY BE ADVERSELY AFFECTED, BY CHANGES IN GENERAL ECONOMIC AND BUSINESS CONDITIONS RESULTING FROM THE TERRORIST ACTIVITIES, POLITICAL UNREST AND MILITARY ACTIONS THAT TAKE PLACE OUTSIDE TAIWAN We are exposed to the risks of politicalspending. Political unrest, war, acts of terrorism and other instability, as well as natural disasters such as earthquakes and typhoons which are common in Taiwan, can result in disruption to our business or thebusinessbusinesses of our customers.The following recent events illustrate these risks: - On September 11, 2001, terrorist attacks on the United States caused significant loss of life and property damage and disruptions in the U.S. market and in global markets. - The recent announcement of withdrawal by North Korea from the Nuclear Non-Proliferation Treaty and a series of steps taken by North Korea to escalate the dispute with the United States, including restarting a small reactor, test-firing short-range missiles and threatening to test-fire a ballistic missile, has raised international tensions. - Diplomatic and financial responses to the war between Iraq and the United States and its allies are still being formulated, and any of such responses could materially and adversely affect us in ways we cannot predict at this time. Occurrence of any similar activitySimilar occurrences in the future could result in increased volatility in or damage to the global financial markets, which in turn may adversely affect our business and results of operations.15THERE ARE ECONOMIC RISKS ASSOCIATED WITH DOING BUSINESS IN TAIWAN, PARTICULARLY DUE TO THE TENSE RELATIONSHIP BETWEEN TAIWAN AND CHINAPast economic downturns have resulted in lower levels of consumer spending, thus negatively impacted our sales and profit. There can be no assurance that rising interest rates, an economic recession, other adverse economic developments, or natural disasters or epidemics will not have a material adverse effect on our cashflow, profitability or financial condition.There are economic risks associated with doing business in Taiwan, particularly due to the tense relationship between Taiwan and China
Our principal executive offices and our operations in respect of our broadband ISP and music distribution businesses are located in Taiwan and all of our net revenues in respect of our broadband ISP and music distribution businesses are derived from customers in Taiwan. Taiwan, as part of the Republic of China, has a unique international political status. The
People'sPeople’s Republic of China, or the PRC, asserts sovereignty over mainland China and Taiwan and does not recognize the legitimacy of the Taiwan government. Although significant economic and cultural relations have been established during recent years between Taiwan and the PRC, the PRC government has indicated that it may use military force to gain control over Taiwan if Taiwan declares independence or if any foreign power interferes inTaiwan'sTaiwan’s affairs. Relations between Taiwan and the PRC and other factors affecting the political or economic conditions of Taiwan could also affect ourbusinessbroadband ISP and music distribution businesses.We may be subject to heightened scrutiny by Taiwan’s Fair Trade Commission due to our sizeable share of the recorded music retail distribution market
price and the liquidity of our shares. WE MAY BECOME SUBJECT TO BURDENSOME GOVERNMENT REGULATIONS AND LEGAL UNCERTAINTIES AFFECTING THE INTERNET, WHICH COULD INCREASE OUR COSTS OF DOING BUSINESS AND PREVENT US FROM DELIVERING OUR PRODUCTS AND SERVICES OVER THE INTERNET To date, governmental regulationsin Taiwan,have not materially restricted use of the Internet. However, the legal and regulatory environment that pertains to the Internet is uncertain and may change. Uncertainty andwhich could result in new regulationscould increasethat may negatively impact ourcostsresults ofdoing business and prevent us from delivering our products and services over the Internet. The growth of the Internet may also be significantly slowed by these regulations. This could delay growth in demand for our network and limit the growth of our revenues. In addition to new laws and regulations being adopted, existing laws may be applied to the Internet. New and existing laws may cover issues that include: - sales and other taxes; - user privacy; - pricing controls; - characteristics and quality of products and services; - consumer protection; - antitrust and fair trade; - cross-border commerce; - libel and defamation; - copyright, trademark and patent infringement; - national security and public safety; - pornography; and - other claims based on the nature and content of Internet materials. WE MAY BE SUBJECT TO HEIGHTENED SCRUTINY BY TAIWAN'S FAIR TRADE COMMISSION DUE TO OUR CONTROL OF OVER 50% OF THE RECORDED MUSIC DISTRIBUTION MARKET IN TAIWAN, WHICH COULD RESULT IN NEW REGULATIONS THAT MAY NEGATIVELY IMPACT OUR RESULTS OF OPERATION 16operations Since we hold a
majoritysizeable market share ofTaiwan'sTaiwan’s recorded music retail distribution market, wemaycould be deemed a monopoly byTaiwan'sTaiwan’s Fair Trade Commission. This could result in heightened scrutiny of our music distributionoperations and regulations.operations. Any existing or new regulations that govern the activities of a monopoly could restrict the scope of our music distribution business, which could negatively impact our financial condition and results of operations.CURRENCY FLUCTUATIONS BETWEEN NEW TAIWAN DOLLARS AND U.S. DOLLARS COULD INCREASE OUR COSTS RELATIVE TO OUR REVENUES, WHICH COULD ADVERSELY AFFECT OUR PROFITABILITY Historically, all of our revenues and a majority of our expenses and liabilities have been denominated in New Taiwan dollars, the currency of Taiwan. We also generate expenses and liabilities in U.S. dollars. In the future, weOur subsidiary’s ability to distribute dividends to us may
also conduct business in additional foreign countries and generate revenues, expenses and liabilities in other foreign currencies. As a result, we arebe subject tothe effects of exchange rate fluctuations with respect to any of these currencies. We have not entered into agreements or purchase instruments to hedge our exchange rate risks although we may do so in the future. If we do so in the future, these agreements and instruments may not help us to hedge our exchange rate risks. ANY FUTURE OUTBREAK OF SEVERE ACUTE RESPIRATORY SYNDROME, OR SARS MAY MATERIALLY AND ADVERSELY AFFECT OUR BUSINESS AND RESULTS OF OPERATIONS Since March 2003, several economies in Asia, including China, Hong Kong,restrictions under Singapore and Taiwanhave been affected by the outbreak of SARS, a highly contagious form of atypical pneumonia. SARS has caused damage to the trade and tourism industries as well as to the economies and financial markets of the affected countries, including Taiwan. So far the SARS outbreak has not had a significant negative impact on our operating results. Any economic downturn as a result of any future SARS outbreak may have an adverse effect on consumer confidence, and may in turn result in a decrease in the demand for our products and services, which would adversely and materially affect our business and results of operations. RISKS RELATING TO OUR SHARES WE BELIEVE THAT WE WERE A PASSIVE FOREIGN INVESTMENT COMPANY FOR THE TAXABLE YEAR 2002 AND ARE LIKELY TO BE TREATED AS A PASSIVE FOREIGN INVESTMENT COMPANY FOR THE TAXABLE YEAR 2003. AS A RESULT, YOU MAY BE SUBJECT TO MATERIALLY ADVERSE TAX CONSEQUENCES WITH RESPECT TO OUR SHARES Based on the composition of our assets and the nature of our income, we believe that for U.S. federal income tax purposes we were a passive foreign investment company for the taxable year 2002 and are likely to be treated as a passive foreign investment company for the taxable year 2003 unless the market value of our shares increases significantly or we make substantial active investments, or both, during the taxable year 2003. We have limited control over the market value of our shares and do not currently have plans to make significant active investments. If you are a U.S. person holding our shares, because we are a passive foreign investment company, you will be subject to special U.S. federal income tax rules that may have materially adverse tax consequences and will require annual reporting. See Item 10. "Additional Information - E. Taxation - United States Federal Income Tax Considerations For U.S. Holders - Passive Foreign Investment Company Rules". WE DEPEND ON DIVIDENDS FROM OUR SUBSIDIARY IN TAIWAN TO MEET OUR CASH NEEDS, AND OUR SUBSIDIARY'S ABILITY TO DISTRIBUTE DIVIDENDS TO US MAY BE SUBJECT TO RESTRICTIONS UNDER SINGAPORE AND TAIWAN LAWSlawsWe are a holding company, and some of our
primaryassets constitute our ownership interests in our subsidiaries in Taiwan, including HoshinGigamedia,GigaMedia, Rose Records and Tachung Records. Accordingly, our primary internal sources of funds to meet our cash needs is our share of the dividends, if any, paid by these subsidiaries in Taiwan. The distribution of dividends from these subsidiaries in Taiwan to us is subject to restrictions imposed by Taiwan and Singapore corporate and tax regulations, which are more fully described in Item5. "Operating5— “Operating and Financial Review and Prospects--— B. Liquidity and Capital Resources--— Dividends from Our Subsidiaries inTaiwan"Taiwan”. In addition, although there are currently no foreign exchange17control regulations, which restrict the ability of our subsidiaries in Taiwan to distribute dividends to us, the relevant regulations may be changed and the ability of these subsidiaries to distribute dividends to us may be restricted in the future. WE ARE A SINGAPORE COMPANY, AND BECAUSE THE RIGHTS OF SHAREHOLDERS UNDER SINGAPORE LAW DIFFER FROM THOSE UNDERWe are a Singapore company, and because the rights of shareholders under Singapore law differ from those under U.S.
LAW, YOU MAY HAVE DIFFICULTY PROTECTING YOUR SHAREHOLDER RIGHTSlaw, you may have difficulty protecting your shareholder rightsOur corporate affairs are governed by our
memorandumMemorandum andarticlesArticles ofassociationAssociation and by the laws governing corporations incorporated in Singapore. The rights of our shareholders and the responsibilities of members of our board of directors under Singapore law are different from those applicable to a corporation incorporated in the United States and, therefore, our shareholders may have more difficulty protecting their interests in connection with actions by the management, members of our board of directors or our controlling shareholders than they would as shareholders of a corporation incorporated in the United States.THERE ARE ANTI-TAKEOVER PROVISIONS UNDER THE SINGAPORE COMPANIES ACT THAT MAY DELAY, DETER OR PREVENT A FUTURE TAKEOVER OR CHANGE OF CONTROL OF OUR COMPANY, WHICH MAY ADVERSELY AFFECT THE PRICE OF OUR SHARESThere are anti-takeover provisions under the Singapore
CompaniesSecurities and Futures Act (Chapter50)289) and the Singapore Code on Take-overs and Mergers that may delay, deter or prevent a future takeover or change of control of ourcompany.Company, which may adversely affect the price of our sharesThere are provisions under the Singapore Securities and Futures Act (Chapter 289) and the Singapore Code on Take-overs and Mergers that may delay, deter or prevent a future takeover or change of control of our Company. Anyone acquiring an interest, either on his own or together with parties acting in concert with him, in
25%30% or more of our voting shares must extend a takeover offer for the remaining voting shares. A person holding between25%30% and 50% of our voting shares, either on his own or together with parties acting in concert with him, must also make a takeover offer if that person acquires additional voting shares in excess of3%1% of the total number of voting shares in any12-monthsix-month period. These provisions may discourage or prevent transactions that involve an actual or threatened change of control of ourcompany.Company. This may harm you because a transaction of that kind may allow you to sell your shares at a price above the prevailing market price.YOU MAY BE SUBJECT TO SINGAPORE TAXESYou may be subject to Singapore taxes
You should consult your tax advisors concerning the overall tax consequences of acquiring, owning or selling the shares. Singapore tax law may differ from the tax laws of other jurisdictions, including the United States.
18We may be subject to claims of intellectual property right infringement, and our limited intellectual property protection causes us to be vulnerable to competitors infringing upon or misappropriating our proprietary rights
As a distributor of Internet content, we face the same types of risks that apply to all businesses that publish or distribute information, such as potential liability for copyright, patent or trademark infringement, defamation, indecency and other similar claims. Any imposition of liability that is not covered by insurance, is in excess of insurance coverage or for which we are not indemnified by a content provider, could have a material adverse effect on our business and results of operations.
We rely on a combination of copyright and trademark laws, trade secret protection, confidentiality and non-disclosure agreements, and other contractual provisions to protect our proprietary software, trade secrets and similar intellectual property. These are especially critical to our entertainment software business. We can offer no assurance that our efforts will prove to be sufficient or that third parties will not infringe upon or misappropriate our proprietary rights. We may have to engage in litigation to enforce and protect our trade secrets and other intellectual property rights. We may also be sued for allegedly infringing the rights of others or to determine the scope and validity of their intellectual property rights. Any litigation involving proprietary rights could be costly, require us to seek licenses from third parties and prevent us from selling our products and services, any of which could have a material adverse effect on us.
ITEM 4. INFORMATION ON THE COMPANY
A.
HISTORY AND DEVELOPMENT OF OUR COMPANYHistory and Development of our CompanyOur legal and commercial name is GigaMedia Limited. We were incorporated in September 1999 as a company limited by shares organized under the laws of the Republic of Singapore. Our Singapore
in September 1999.company registration number is 199905474H. Our principal executive offices are located at 14th Floor, 122 TunHua North Road, Taipei, Taiwan, and our telephone number is(886) 2-8770-7966.country/city code 886/2 and number 8770-7966. OurwebsiteWeb site address is: www.giga.net.tw.We are a holding company and, priorPrior to the finalization of our acquisition of
Taiwan'sTaiwan’s two leading music store chains in February, September andSeptemberDecember of 2002,respectively,all our operations were conducted primarily through ourwholly ownedwholly-owned subsidiary, HoshinGigamedia Center Inc., orGigaMedia. HoshinGigamedia. Hoshin GigamediaGigaMedia commenced operations in October 1997 and was incorporated in October 1998 in Taiwan. HoshinGigamedia,GigaMedia, as an unlisted Taiwanese company, could not publicly offer its shares to investors outside of Taiwan. To enable us to offer our shares to international investors, we were incorporated in Singapore in September 1999 and acquired100%99.99% of HoshinGigamediaGigaMedia in November 1999. In October 2002, we acquired the 0.01% of Hoshin GigaMedia we did not own.We completed the initial public offering of our shares on February 24, 2000. Our shares trade on the
NasdaqNASDAQ National Market under the symbol"GIGM"“GIGM”. Wearewere the first Internet company based in Taiwan to list onNasdaq.the NASDAQ National Market.In
February and September of2002, wefinalized agreements to acquireacquired Rose Records (formerlydescribedknown as Point Records Co., Ltd.) and Tachung Records (formerlydescribedknown as Music King Co., Ltd.),Taiwan'sTaiwan’s two largest music store chains, respectively, with a view to expanding our business toofflineretail entertainment services.In April 2004, we acquired the business and operations of Grand Virtual, Inc. and related affiliates, a privately-held entertainment software developer and application service provider, through CESL, our wholly-owned subsidiary incorporated in the British Virgin Islands, with a view to enhancing our diversified entertainment products portfolio.
See Note 4 of our consolidated financial statements for additional information.
For a description of the important events in the development of our business since the beginning of our last three financial years to the date of this annual report, see Item 5 — “Operating and Financial Review and Prospects — A. Operating Results”. A description of our principal capital expenditures and divestitures, since the beginning of our last three financial years to the date of this annual report is set forth in Item 5 — “Operating and Financial Review Prospectus — B.
BUSINESS OVERVIEWLiquidity and Capital Resources”. Information concerning the principal capital expenditures and divestitures currently in progress is also described in Item 5 — “Operating and Financial Review and Prospect — B. Liquidity and Capital Resources”.B. Business Overview
We are a holding company and, through several subsidiaries,
distribute recorded music andprovide broadband Internet access services, develop andonlinelicense entertainment software and provide application services,in Taiwan.and distribute recorded music. Ourcore offlineTaiwan broadband ISP businesses are operated through our subsidiary, Hoshin GigaMedia, which focuses on consumer users, and Hoshin GigaMedia’s subsidiary, Koos Broadband Telecom Limited, or KBT, which focuses on corporate users. Our entertainment software business is operated through our subsidiary CESL. Our music distribution business is operated through our subsidiary G-Music Limited, or G-Music, which controlsTaiwan'sTaiwan’s two largest music store chains.Our online broadband businesses are operated through our subsidiary Hoshin GigaMedia, and Hoshin GigaMedia's subsidiary Koos Broadband Telecom Limited, or KBT, which are focused on consumer and corporate users, respectively.Prior to 2002, our primary business was
to providethe provisions of broadband Internet access services in Taiwan.After we acquired Taiwan'sSince acquiring Taiwan’s two largest music store chains, Rose Records and Tachung Records, in 2002, and an entertainment software provider in 2004, webecamehave become a diversified provider of entertainment services and broadband Internet accessservices in Taiwan. Our online/offline business model provides us with multiple distribution channels.services.We
believe this business model will provide us deep customer relationships and the ability to meet future market demand as technology drives new media and entertainment industry change. Offline, weoperateTaiwan's two largest music store chains, Rose Records and Tachung Records, throughoursubsidiary G-Music. These two music store chains together hold approximately 50% market share in recorded music business in Taiwan. The two music store chains had consolidated revenues, post acquisition, in 2002 of approximately NT$1.9 billion (US$54.5 million). We intend to establish a dominant offline market position designed to leverage the strength of GigaMedia's online business in new areas, generate improved revenue growth and accelerate profitability. Online, we operate a leadingbroadband ISP business via our subsidiary Hoshin GigaMedia, which provides Internet access service and broadband content with multiple delivery technologies. Our access products consist ofpremiumADSL and cable modemand ADSLofferings, giving us the ability to deliversuperiorbroadband connections island-wide.Our cable modem is a world-class platform capable of offeringWe offer broadband Internet access at speeds of up to 100 times faster than traditional dial-up services.With 20Through our 19 cable system partners,our cable modem business passeswe have access to more than 3.1 million Taiwan households, as well as approximately 417,000 small andmedium businesses. In addition, we offer interactive Chinese-language multimedia Web sites through our Web destination http://www.gigigaga.com. 19medium-sized enterprises, or SMEs. In addition, another subsidiaryof ourcompany, Koos Broadband Telecom Limited, orsubsidiary, KBT, provides broadbandservice exclusivelyservices to corporate customers. Ourstrategic investors includebroadband ISP business generated revenues of approximately US$21.4 million and operating income of approximately US$1.0 million in 2004.We acquired our entertainment software business in a private transaction from the
Koos Group,founding shareholders of GV Enterprise Voting Trust in April 2004 with amajor conglomerateview to enhancing our portfolio of entertainment products. In this transaction, we acquired all the outstanding and issued shares of some of the founding shareholder’s subsidiaries, Grand Virtual, Inc., Grand Virtual Limited and Grand Virtual (Alderney) Limited, for an all-cash consideration of US$32.5 million. To help ensure a smooth transition and the continued expansion of our entertainment software business inTaiwan's manufacturing, finance, telecommunications, media,the future, we also retained the experienced management, engineering andcable industries. OUR PRODUCTS AND SERVICES We provide both offlineoperation teams of these companies. Since the acquisition, we have restructured the business andonline products and services. Offline, we sell primarily recorded music through Rose Records and Tachung Records, Taiwan's two leading music distribution chains. Online, we provide two types of Internet access servicescurrently operate our entertainment software business through ourcable-based broadband networksubsidiary CESL, which develops andADSL devices, respectively. In addition, we provide contentprovides, through its wholly-owned subsidiaries, Cambridge Interactive Development Corporation, or CIDC, andother onlineInternet Media Licensing Limited, or IML, software solutions and application servicesthrough our Web destination. OFFLINE - MUSIC DISTRIBUTION SERVICES AND ENTERTAINMENT PRODUCTS In 2002, we acquired, through GigaMedia'sfor clients operating in the dynamic and rapidly expanding Internet-based entertainment markets worldwide. Our entertainment software business generated revenues of approximately58%-owned subsidiary G-Music, 100%US$11.5 million and operating income ofTaiwan'sapproximately US$2.8 million during the nine months ended December 31, 2004.We operate Taiwan’s two
leadinglargest music store chains, Rose Records and TachungRecords. RoseRecords,operates 35 stores located throughout Taiwan, while Tachung Records operatesthrough our subsidiary, G-Music. As of June 15,stores in Taiwan. Stores are evenly distributed from north to south throughout Taiwan, with approximately 3772005, we operated a totalemployees, including 335 store employees and 42 office employees. We plan to open three additional stores withinof 45 stores. Our estimated market share of thenext 3-6 months. Together, the twophysical musicstore chains hold a dominant market position and had combined sales, post acquisition, of approximately NT$1.9 billion in 2002. Our strong market position enables us to leverage relationships with large international music labels, and we expect to be able to reduce our acquisition costs in 2003 on a per unit basis because of this factor. Results of Rose Records and Tachung Records are consolidated from the respective closing dates of each transaction. Our two music store chains currently sell mostly recorded music CDs. In addition, our music store chains also offer audio cassette products, music video (including VCD, DVD and pre-recorded videocassettes), video games and other complementary products (including electronics, accessories, blank tapes and CD-Rs). We carry approximately 148 different labels in the music stores. The recorded music market and the traditional recorded musicdistribution industryin which these companies operate have experienced a period of relative decline from 1998 through 2002, primarily due to physical piracy, CD burning/ripping, and peer-to-peer, or P2P, applications enabling illegal downloads. However, the market is expected to recover as Taiwan entered the World Trade Organization on January 1, 2002 and may take more aggressive actions against physical and virtual piracy, which was estimated to account for over 50% of total music consumptionin Taiwan in2001. Although total market revenue for recorded music CDs in Taiwan declined from 19982004 was over 30%. While seeking to2002, the combinedpreserve our market share, we have also taken steps to reduce costs and improve our management information systems and inventory management with a view to operating this business more efficiently and increasing our operating margins. Our music distribution business generated revenues ofthese two leading chains increased from an estimated 40%approximately US$67 million and operating income of approximately US$542 thousand in2001 to approximately 45% at the time of acquisition in 2002, leaving the third largest player with less than approximately 5% market share. In addition to revenues from CD sales, our music store chains also receive marketing/sales promotional revenue from record companies. Record companies typically allocate a portion of their album marketing budgets as "marketing/sales promotional revenues" to music stores in return for prominent in-store placement of CDs and posters. Rose Records and Tachung Records received a total amount of NT$30.4 million of such revenues, post acquisition, in 2002. G-Music is seeking alliances within the entertainment industry, including partnerships with online gaming companies and KTV companies, to enhance channel effectiveness and diversify revenues by cross-selling high margin gaming and KTV products in G-Music stores. We therefore expect to diversify G-Music revenues going forward. We also expect G-Music to team up with Videoland, a Koos Group media affiliate, as its media partner going forward. G-Music also plans to evaluate the possibility of entering the mainland China market by seeking alliances with local partners. 20ONLINE - INTERNET ACCESS SERVICES2004.Broadband ISP Business
Our Services
We provide broadband Internet access services to consumer and corporate customers through various technologies and products including ADSL, cable modems, leased-line, virtual private network and
ADSL devices. ACCESS SERVICES OFFERINGS CABLE MODEMS. We offer our cable modem-based broadband subscribers Internet access at transmission speeds of up to 10 Mbps, compared to 56 Kbps for standard dial-up access. Our cable modem-based broadband access services allow subscribers to more efficiently use (1) bandwidth-intensive multimedia applications, such as interactive games, high-quality audio and distance learning, and (2) electronic commerce applications, such as retailing, financial services and online software distribution. Our one-way cable Internet access services, with download at 1.5Mbps and upload at 56Kbps, are available to Internet users on either a monthly flat rate or a metered rate. Our premium two-way package, targeting heavy Internet users, has speeds of up to 6 Mbps download and 256 Kbps upload. A mid-tier package features up to 1.5Mbps download. Our basic two-way package offers the "always-on" feature and has up to 128Kbps of download transmission speed. The basic two-way package taps into light to intermediary Internet users and is expected to increase our market share in the two-way access market.other value-added services.Access ServicesOfferings
ADSL.
GigaMedia'sGigaMedia’s ADSL servicesalsooffer different levels of performance from1.5Mbps1Mbps download with384 Kbps upload;64Kbps upload to768 Kbps8Mbps download with128 Kbps upload; to 512Kbps download with 512Kbps upload; and 512 Kbps download with 64640 Kbps upload. The high performance of our products is designed to better support file sharing, video and other broadband Internet applications. We were the firstand remain the onlycompany in Taiwan to offer ADSL services with a standard fixedIPIP-address feature, which enables users to build their own multimedia Web sites, participate in online meetings, set up servers and utilize voice-over-IP. Asofat December 31,2002,2004, we had73,57373,800 ADSL subscribers, as compared to 77,837 ADSL subscribers as at December 31, 2003.CABLE MODEMS. We also offer our broadband Internet access services via cable modems at transmission speeds of up to 6 Mbps. Our cable modem-based broadband access services allow subscribers to more efficiently use (1) bandwidth-intensive multimedia applications, such as interactive games, high-quality audio, video and distance learning applications, and (2) electronic commerce applications, such as retailing, financial services and online software distribution. We reached an agreement in principle in May 2004 with our cable partners to equally share revenues, thus providing our cable partners with additional economic incentives to promote two-way cable services through their systems. Two-way cable systems allow us to offer subscribers higher upstream transmission speeds and “always on” Internet access capabilities. As at December 31, 2004, we had 20,720 cable modem-based broadband customers, as compared to
59,018 ADSL25,103 cable modem-based broadband customers as at December 31,2001. MARKETS OF ACCESS SERVICES RESIDENTIAL2003.CORPORATE ACCESS SERVICES. We
receive access fees from residential subscribers of our broadbandalso offer dedicated and high-speed Internet access services to corporate customers over fiber optical lines. Our target customers include ISPs, ICPs, corporations, SMEs and cyber cafes. Our corporate ISP services include leased-line services, ranging from 1Mbps to 1 Gbps, virtual private network and other value-added services.As partMarkets of
our revenue sharing arrangements with ourAccess ServicesCONSUMER ACCESS SERVICES. Our two-way cable
partners with respect to each subscriber's monthly access fee, we keep NT$300 of the fee and generally 55% to 65% of any amount in excess of NT$300. We recognize our access revenues net of payments to our cable partners. Our 2-way cablemodem-based broadband service packages are offered atNT$1,199approximately US$35.90 per subscriber per month for premium service;NT$850approximately US$25.50 per subscriber per month for a mid-tier package; andNT$699approximately US$12.00 per subscriber per month for basic service. We also offer selected subscribers discounts on their monthly access fees and quarterly or yearly payment options to further promote our access services. We recognize ourrevenuerevenues from access fees net of split with cable partners and these discounts.We expect to continue to offer periods of free services and discount promotions in 2003. During 2002, we offered our broadband subscribers two types of subscription packages for 1-way cable modem access (1) a flat rate at NT$599 per month and (2) a metered rate at NT$299 for 30 free hours plus NT$0.25 per minute passingIn the30 hour mark, or a metered rate at NT$50 for 100 free minutes plus NT$0.5 per minute passing the 100 minute mark. Going forward,future, our product mix may change in response to market dynamics.As more fully described below,During 2004, we offered
sevendifferent tiers of ADSL service optionsin 2002, increasingwith monthly access fees per subscriber ranging fromfive service options in 2001,approximately US$8.90 to approximately US$44.90 for consumer users which have from time to timehavebeen revised forpromotionpromotional purposes, including providing subscribers periods of free Internet access service. Unlike our cable access fees, our ADSL access revenues are not shared.21- The first package (1.5Mbps download and 1 fixed IP) is priced at NT$1,598 per month, with users paying NT$699 to us and an NT$899 circuit fee to Chunghwa Telecom. - The second package (768Kbps download and 1 fixed IP) is priced at NT$1,199 per month, with users paying NT$399 to us and an NT$800 circuit fee to Chunghwa Telecom. - The third package (512Kbps download and 1 fixed IP) is priced at NT$894 per month, with users paying NT$299 to us and an NT$595 circuit fee to Chunghwa Telecom. - The fourth package (1.5Mbps download and 8 fixed IPs) is priced at NT$1,294 per month, with users paying NT$599 to us and an NT$695 circuit fee to Chunghwa Telecom. - The fifth package (1.5Mbps download and 8 fixed IPs) is priced at NT$7,299 per month, with users paying NT$6,400 to us and an NT$899 circuit fee to Chunghwa Telecom. - The sixth package (768Kbps download and 8 fixed IPs) is priced at NT$3,000 per month, with users paying NT$2,200 to us and an NT$800 circuit fee to Chunghwa Telecom. - The seventh package (512Kbps download ad 8 fixed IPs) is priced at NT$2,399 per month, with users paying NT$1,500 to us and an NT$899 circuit fee to Chunghwa Telecom.The number of subscribers of our broadband Internet
accessISP servicesdeclinedcontinued to decline during2002.2004. The table below sets forth the number of our subscribers on the dates specified. Despite thedeclinesdecline in the number of our subscribers in2002,2004, our access revenues increased by64%6% for20022004 as compared to that for2001,2003, primarilydue to more subscribers using higher specification products.because of an increase in revenue from turnkey cable modem services. We do not expect to see significant growth in our subscriber basegoing forward.
- ------------------------------------------------------------- Date Number of Subscribers - ------------------------------------------------------------- 1999 2000 2001 2002 - -------------------------------------------------------------31-Mar 369 18,630 70,437 128,946 - ------------------------------------------------------------- 30-Jun 687 31,489 82,200 124,919 - ------------------------------------------------------------- 30-Sep 5,294 47,861 99,109 112,242 - ------------------------------------------------------------- 31-Dec 10,548 60,288 119,130 108,016 - -------------------------------------------------------------COMMERCIALin the future.
Number of Subscribers Date 2002 2003 2004 2005 31-Mar 128,946 103,375 103,283 93,775 30-Jun 124,919 100,677 100,740 — 30-Sep 112,242 99,837 97,414 — 31-Dec 108,016 102,940 94,520 — Besides directly providing cable modem-based Internet services under GigaMedia’s brand name to end users, we also provide trunk bandwidth and backend systems, which include a customer provisioning system, billing system and network management system, to cable operators that wish to operate their cable modem-based Internet service under their own brand names, or turnkey cable modem services. We receive fees from these cable systems under various revenues sharing arrangements. As of June 15, 2005, we had nine cable partners to whom we offered turnkey cable modem services.
CORPORATE ACCESS SERVICES.
Our subsidiaryKBTalso receives access fees from subscribers ofoffers and sells dedicated and high-speed Internet accessservices. KBT delivers dedicated and high speed Internet accesstoa select group ofcorporate customers over fiber opticallines. TheEthernet MAN infrastructure. KBT offers various speeds of leased-line services, ranging from 1Mbps to 1Gbps, to different kinds of subscribers like ISPs, ICPs, corporates, SMEs and cyber cafes. KBT charges its customers monthlyfeefees forthis type ofaccessservice ranges from NT$25,000 to NT$200,000,services and other value-added services depending on the level of bandwidthbut the fee is generally discounted by between 25%and50% versus the incumbent fixed line carrier. CONTENT AND OTHER ONLINE SERVICES We believe thattype of services provided.Other Services
As part of our
Web destination is a leading broadband Web destination in Taiwan in terms of content offerings. Our Web destination has experienced rapid increases in the number of registered members and page views since it was launched in April 1999. Our Web destination offers users a wide variety of rich, multimediaInternetcontent in Chinese optimized for broadband access. Our Web destination allows users to personalize across multiple online content channels using only one unified log-in password, which enables the users to customize their own viewing priority and preferences. Through our network, our Web destination delivers to users textual data, near-CD-quality audio and high-quality digital video. In addition, our Web destination provides users with a broad range of communityservicesandwe provide various otheronline services. CONTENT SERVICES. In 2002, we reduced our Web destination offerings from 11 channels in 2001 to 7 channels in 2002, with a view to enhancing margins. Our Web destination currently offers content services through the following hyper-linked interest-specific channels: 22- GigaTV (http://www.gigatv.com.tw), a paid video-on-demand and live broadcasting channel with 300 Kbps and 800 Kbps films and TV programs. - Magic (http://www.gigigaga.com/home/magic), a paid fortune-telling service, operating in cooperation with the top five content providers in the field in Taiwan. - SMS (http://sms.gigigaga.com), a paid service to deliver short messages, and to download ring tones and pictures from Web site to mobile. - Shopping (http://shopping.gigigaga.com), a paid shopping service operated in cooperation with the top nine online shopping Web sites in Taiwan. - Broadband Theater (http://vod.gigigaga.com), a combination of free and paid video-on-demand and live broadcasting channel providing movie films, TV programs, animation and studio films. - PoPo (http://popo.gigigaga.com), a free channel for posting and sharing members' texts, pictures, and audio and video contents with communication function. - Gpaper (http://gpaper.gigigaga.com), a free publishing system to deliver text, pictures, audio/video original content from reporters. COMMUNITY SERVICES. To enable our users to enjoy a comprehensive online experience, our Web destination also features extensive Web-based communityvalue-added services including free electronic mail, bulletin boards andvideophoto albums.Our Broadband Network — Cable and
text integrated chat rooms. These community services are available to all users who are registered members of our Web destination. The registration is free of charge, conducted online and used by us to establish a user database. WEB DEVELOPMENT. We started to de-emphasize this aspect of our business in 2001. We booked no revenue from our Web development business for 2002. Going forward, we may occasionally design and develop Web sites for selected content providers of our Web destination and charge these partners on a project-by-project basis. We expect the Web development revenues going forward will continue to be immaterial to our results of operations. ONLINE ADVERTISING. Our Web destination commenced selling online advertising in September 1999. We outsource some of our advertising. We earn revenues from displaying banner advertisements and broadband sponsorship advertisements on our Web destination and content channels. We currently charge between NT$100 to NT$300 for each 1,000 impressions generated and pay our advertising agents approximately one third of our gross advertising revenues for their services. For the banner advertisement, the average sell-through rate is at NT$15-NT$20 Cost Per Million, or CPM.ADSL NetworkWe began
to de-emphasize this aspectupgrading our island-wide backbone network, which is based primarily on Gigabit Ethernet technologies and covers 20 major districts out ofour businessa total 25 districts in Taiwan, from early 2004 and completed the upgrade in early2001. CABLE NETWORK UPGRADES Currently, our cable partners provide one-way and two-way cable access. Based on our close relationships with our cable partners and our understanding of their plans, we expect two-way homes passed to remain at 560,000 households at the end of 2003. Our cable partners need to obtain additional licenses in order for us to provide two-way cable services through their systems. We currently serve our broadband subscribers through one-way and two-way cable systems. For one-way cable access, the subscriber pays its telephone company for the telephone line supporting the upstream data sent from the subscriber's personal computer to the Internet. We commenced two-way Internet access services in mid-October of 2000 and as of December 31, 2002 provided two-way broadband cable services to 17,308 subscribers. Through two-way cable systems, we provide subscribers with higher upstream transmission speeds and "always on" Internet access capabilities, eliminating the time consuming dial-up procedures. Additionally, unlike standard dial-up access, the high bandwidth nature of cable in two-way cable systems will allow our subscribers to maintain full use of their telephones and televisions while online. Another advantage of two-way cable systems is that subscribers do not need to pay telephone line charges to access the Internet. OUR BROADBAND NETWORK 23NETWORK STRATEGY Our network strategy is to provide a flexible, scalable design that allows us to optimize performance to the subscribers while achieving operating cost efficiencies. MOVING DATA CLOSER TO THE SUBSCRIBERS. A central strategy in our network design is to move data closer to our subscribers to significantly reduce service response time and backbone bandwidth requirements, which directly translates into better subscriber experiences and cost efficiencies. To achieve this, we have adopted a hierarchical, distributed network architecture with proprietary caching and replication technologies to ensure that the information a subscriber wants is always as close as possible within the network. By moving data closer to our subscribers, we overcome the Internet network's duplicative data transfer problem that generates redundant traffic flow, which adversely affects network performance. For example, when a subscriber downloads a video clip from a Web site, the subscriber must "pull" data across the Internet from that Web site to the subscriber's Internet service provider and finally to the subscriber's computer. If the subscriber's neighbor requests the same video clip from that Web site, the neighbor must pull the same data across a similar path. In contrast, because each Web site's Internet content is updated at a fixed time interval, our practice is to transmit the content requested by subscribers in a particular area over our high-speed backbone only once in that time interval and retain it in that area, which is commonly known as "caching", where it can be accessed by every subscriber within that area without re-transmission over the backbone.2005. In addition, weuse our replicating technology, which duplicates information to multiplebuilt small regional data centers totransmit videohost both the cable Internet and ADSL headend equipment in these 20 districts connected by our backbone network. These centers also act as service hubs for:the provision of key community services, including electronic mail, usenet news and personal Web hosting, to subscribers;the management of network performance;the replication of content andother typesapplications; andthe provision ofcontent that require high bandwidtha cost-efficient infrastructure toeach of our regional data centers when the Internet traffic is not busy. This not only moves data closer to our subscribers but also better enables us to maintain bandwidth efficiency within our network. END-TO-END NETWORK MANAGEMENT. We achieve end-to-end network management through our proactive network quality, service and performance management systems. This central management allows us to quickly and efficiently identify and enhance network quality, service and performance and enhances our ability to remedy network problems and eliminate performance bottlenecks before they adversely affect our subscribers. Our end-to-end management covers our whole network: the backbone and Internet connections, regional data centers, cable headends, servers and other components of the network infrastructure that link to the subscriber's home. SCALABILITY. Our network is designed to be scalable to handle increasing numbers of subscribers without any adverse effects on performance or requiring any costly system-wide expansion. As subscriber penetration increases, our cable partners have multiple cost-effective alternatives to increase capacity, including allocating additional 6MHz channels in existing nodes for our service or reducing the number of subscribers sharing a given bandwidth by installing additional nodes, with each node serving a smaller number of subscribers over the same fiber-optic infrastructure. Each node installed by our cable partners generally is capable of carrying up to 33 6MHz channels. We also maintain an automated system that allocates users among all of our available 6MHz channels to achieve a load balance, which maximizes bandwidth utilization. Our scalable data center design also allows us to quickly and cost effectively install additional servers at our regional data centers and at our cable partners' cable headends to enable us to serve a greater number of subscribers. NETWORK REDUNDANCY. Most aspects of our network are redundant to protect service quality. For instance, it is our policy to maintain a number of routers, which receive and transfer data in segments, servers, switches, which select the paths or circuits to be used in the transmission of information, cable headends and other network components that significantly exceeds the number required to allow full usage of our network by our subscribers. Our core network devices are configured in a redundant auto-recovery architecture such that if any of our network device fails, our network will automatically adjust itself around those failure points without affecting the user experience. The backbones of KGEX, a subsidiary of KG Telecommunications, Chunghwa Telecom, and Sparq, our backbone providers, also have redundant features. In addition, we have established connections to international Internet backbones through a direct trans-Pacific submarine cable STM-4 link and another shared link operated by Asia NetCom, or ANC. The establishment of these direct links is intended to ensure that our access to these backbones would not be disrupted even if our existing links 24fail. We also set up our second network operation center, or NOC2, in May 2000, which we moved into a co-location facility of KGEX during 2001. CABLE AND ADSL NETWORK COMPONENTS The primary components of our cable broadband network are our network operations center, regional data centers, Internet backbone and Internet connections, cable headends, subscriber connections and cable modems. We provide cable broadband access by first connecting our subscribers through our cable partners' hybrid fiber-coaxial networks to our cable headends. Each cable headend is connected to one of our regional data centers via our own fiber ring or high speed data-link leased from KGEX, Sparq or Chunghwa Telecom. The regional data centers are linked via a leased synchronous digital hierarchy, or SDH, network to our network operations center, where Internet traffic is routed to various domestic and international networks. The primary components of our ADSL broadband access network are our network operations center, regional data centers, Internet backbone and Internet connections, Broadband Remote Access Servers, or BRAS, and a telecommunications Asynchronous Transfer Mode, or ATM, network. We provide ADSL access by connecting our subscribers through an ATM network, which is currently provided by Chunghwa Telecom. Chunghwa Telecom provides ADSL modems to our subscribers, connects them to Chunghwa Telecom's ATM network, and finally aggregates them in DS3 or STM-1 telecom lines into our BRAS at our regional data centers. Each ATM DS3 connection can aggregate up to 2,000 subscribers and up to 4,000 subscribers for STM-1 connections. The regional data centers are linked via a dedicated leased line to our network operations center, where Internet traffic is routed to various domestic and international networks.cache data.NETWORK OPERATIONS
CENTER.CENTERS. We provide centralized network management through our network operationscenter,centers, which represents the nerve center of our whole network. Ourcenter usescenters use advanced proprietary network management tools and systems to monitor the network infrastructure 24 hours a day,seven7 days a week, enabling us to effectively address network problems before they adversely affect our subscribers.Our network operations center monitors two real-time network management systems: the fault management system and the traffic management system. The fault management system monitors the performance of all components and links of the network to ensure that they operate properly. When a fault is detected, an alarm is set off in the center and engineers either correct the problem from the center or dispatch maintenance staff to the site. The traffic management system is a self-correcting system with pre-set re-routing capabilities. If traffic is congested along a particular trunk line, the system will automatically re-route the traffic by another route, thereby assuring consistently high performance. REGIONAL DATA CENTERS. Our regional data centers are connected to our network operations center through multiple high speed links in an SDH network. These centers act as service hubs for defined geographic areas and: - provide key community services, including electronic mail, usenet news and personal Web hosting, to subscribers; - manage network performance; - replicate content and applications; and - provide a cost-efficient infrastructure to cache data. To improve the speed of the local network and to balance demands on the backbone facilities, we also utilize caching technologies in the regional data centers. By employing high-performance caching servers that store frequently accessed content locally, we are able to reduce the amount of data transmission and corresponding transport costs by as much as 70%. In addition, local caching servers can compile far more comprehensive usage data than is normally attainable on the Internet, which facilitates our usage analysis, 25network troubleshooting and performance tuning. We currently have regional data centers in four geographic areas, covering the major urban areas in Taiwan. CABLE HEADENDS. We install servers, routers, cable routers, switches and other network devices in each cable headend and connect each headend to one of our regional data centers through our own high-capacity digital lines or high speed data-link leased from KGEX, Sparq or Chunghwa Telecom. Our redundant network architecture allows the equipment in the cable headends to function even if some of the connections to the regional data centers are disrupted. Our major suppliers of cable headend equipment include 3Com and Cisco. SUBSCRIBER CONNECTIONS. The last leg of our cable network connection is from our cable headend to the subscriber over our cable partner's cable system. Our cable partners' hybrid fiber-coaxial networks, containing multiple fiber optic lines, transmit data from our cable headends out to cable nodes in each neighborhood and then connect through traditional coaxial cable to our subscribers' homes. Each of these nodes currently provides one-way service to between 6,000 and 12,000 homes, and two-way service to approximately 500-1500 homes. CABLE MODEMS. A cable modem connects to cable television coaxial wiring and attaches to the subscriber's personal computer via standard Ethernet connections, which support data transfer rates of up to 10 Mbps. While peak data transmission speed of a cable modem depends on the specific model and can approach 10-38 Mbps downstream to the subscriber and up to 1.2 Mbps upstream, the performance that subscribers actually experience is often constrained by the capacity of their personal computers and the performance of the Web servers. We currently use cable modems manufactured by 3Com, ASKEY and General Instruments, which we either sell or rent to the subscribers. The North American cable industry has adopted a set of interface specifications, known as "DOCSIS", for hardware and software to support cable-based data delivery using cable modems. All of our systems use DOCSIS compliant equipment. We expect that DOCSIS specifications will make lower cost cable modems more readily available in the retail market in the future and have seen a price drop of approximately 70% in cable modems since 2000. We expect that these developments will: - save us the cost of purchasing and installing cable modems for subscribers; - increase demand for our services; and - lead to a loss of revenue from cable modem sales and rentals. 26DATA BACKBONE. Our high performance, dedicated and redundant backbone network connects all of our regional data centers and the network operations center using multiple DS-3/STM-1/STM-4 lines, which are dedicated phone connections supporting data rates of about 45/155/622 Mbps, leased from KGEX, Sparq, Chunghwa Telecom and our own high speed fiber optic lines. We have designed a scalable network architecture that seeks to take advantage of the existing high speed data backbone operated by KGEX, Sparq and Chunghwa Telecom. Those backbone networks are fully redundant and fully meshed, and its SDH infrastructure supports speeds of up to 622 Mbps. We have also deployed redundant links among our regional data centers to ensure transmission continuity. The diagram below illustrates our data backbone network. [DATA BACKBONE NETWORK DIAGRAM]Data Backbone
Ongoing privatization of the telecommunications market by
Taiwan'sTaiwan’s government has expanded the number of telecommunications operators. Including Chunghwa Telecom, there are currently four fixed-line telecommunications operators in Taiwan.We have switched a portion of our backbone networks from Chunghwa Telecom to KGEX and Sparq for their better service capacity and lower cost.It is our policy to continually monitor the usage pattern,andadjust the network architecture,in orderand select better leased-line circuits providers to optimize the user experience and service economics.PEERING AND INTERNET CONNECTIONS. PeeringPrivate peer-to-peer relationships among ISPs (i.e., private direct cable connections as opposed to public Internet
service providersconnections) have become the most effective solutions to resolve the problems of packet loss and latency resulting from the significant traffic volume through Internet networks. We have peering arrangements witheachmost ofTaiwan'sTaiwan’s major networks andInternet service providers,ISPs, providing us with what we believe to be the one of the most comprehensive Internet connections in Taiwan. According to Taiwan Network Information Center, or TWNIC,Gigamediawe had one of the best aggregate peering bandwidth among all commercial organizations inTaiwan as of June 20, 2003.Taiwan. Our extensive peering arrangements have enabled us to route most of our traffic over the less congested private peering links, through which we passed most of ourtraffic in 2001 and 2002.traffic. This enhances the efficiency of our network and allows us to provide better, faster access services to our subscribers.27Through our peering arrangements with several Internet service providers and networks, we currently connect to
Taiwan'sTaiwan’s Internet backbone from our network operations center. We have installed direct Internet connections at each of our regional data centers to minimize backbone traffic flow and to provide Internet connection redundancies. We currently connect to the international Internetbackbonesthrough a direct trans-Pacific submarine cablelink and a shared link operated by ANC.link. As the competition in the trans-Pacific submarine cable segment provides better price economics, we are able to significantly increase our bandwidth without incurring additional cost. In2002,2005, weupgradedcompleted the upgrade of our infrastructure fromoneSTM-1connectionand STM-4 connections totwo STM-4Gigabit Ethernet-based connections to provide faster connections.INFORMATION SYSTEMInformation System
We have established a versatile, scalable, real-time information system that integrates service provisioning, customer management, billing, data gathering and usage tracking functions.
Our information system enables us to accomplish the following: - Enhance Customer Service. Our information system's customer management feature allows subscribers to modify their personal information, query their billing records and acquire additional services online or by telephone, each on a real-time basis. Our real-time, interactive customer services enable usWith independent multiple processing layers, we are able to quickly respond toour customers' needs and requests, which helps us to attract new subscribers and maintain our existing customers. - Minimize Subscriber Acquisition Cost. Our information system enables us to remotely assist new subscribers to speedily and conveniently install cable modems at their homes or offices without any engineers onsite, thereby reducing our cost. - Offer a Broad Range of Services. Our information system is capable of aggregating payments for a variety of services provided by us or our partners through our Web destination, including access, content, download and pay-per-view services. This enables us to offer a wide variety of content and other online services as well as bundled services to our subscribers without reducing our ability to accurately and timely bill subscribers for these services. Our information system's ability to aggregate payments also minimizes the number of bills our subscribers receive for access and online services, which is more convenient for subscribers. Our scalable information system allows us to quickly and efficiently integrate data and information regarding any new services and their users into our existing database. - Expand Our Capacity Quickly and Efficiently. Our information system consists of a series of multiple processing layers, each layer being independent of the other. Under this multi-layer architecture, when theincreases in user, subscriber or service datarequire an expansion ofby expanding our informationsystem'ssystem’s capacitywe can quickly meet this requirement by expanding the capacity of one layer without affecting the other layers' performance. This structure also reduces our need to conduct costly system-wide upgrades in order to expand our information system's capacity. - Maintain Efficiency in Our Network. Our information system provides our network staff with extensive, real-time informationoneach of our subscribers' Internet usage patterns, which enables them to effectively estimate expected network usage for any particular region at various times of a day. With these estimates our network staff can better optimize the use of our network's bandwidth capacity and maintain its efficiency. INTEGRATED CONTENT PLATFORM AND TECHNOLOGIES Our Web destination provides an integrated content platform, complemented by comprehensive technological support, to our content providers. We believe that our integrated platform and technological support enhance our ability to attract leading international and local content companies to enter into alliances with us. 28CONTENT PLATFORM Our integrated content platform is comprised of modularized, or separable, units. We have designed these modularized units so they can be easily shared across Web sites yet tailored to the specific needs of each content provider. This enables us to provide a wide range of application services to content providers to minimize their efforts in developing and managing Web sites. Our services include: - user community services; - membership management; - personalization of content to users; - real-time access control; - usage tracking; and - comprehensive billing services. CONTENT TECHNOLOGIES We seek to provide content providers with advanced content publishing technologies that enable them to fully utilize the benefits of our broadband infrastructure and deliver sophisticated multimedia Internet content quickly to users. Our proprietary content publishing technology infrastructure is comprised of the following advanced technology building blocks: - Multipoint Replication. This technology replicates content provided by our partners for distribution to our various regional data centers. This arrangement accelerates the transmission access speed to our and our content partners' co-branded Web sites. Utilizing our replication technology, we can effectively manage and distribute multimedia content such as textual data, video, audio and photographs over our network. - Multicasting. This technology enables transmission of high-bandwidth content from one source to multiple receiving points on an ongoing basis without occupying substantial bandwidth, thereby maintaining network efficiency. Currently, we use multicasting technology to continuously update headline and financial audio news and event broadcasting as well as animated or video-based advertisements provided by our content partners. - Automated Content Publishing System. Our automated content publishing system includes three components: Web-based editorial interface, content production and content deployment. This automated system allows us to minimize personnel costs while maintaining an effective and efficient publishing process. Our Web-based editorial interface automatically arranges the content provided by our content providers into appropriate categories and format, which helps our editors to create submission templates and approve content. Content production submits all editor-approved content to our servers to undergo automated testing and qualification processes, including stress testing to examine the impact of distributing the content on our network's performance. Once the content has been tested and qualified, it is deployed by content deployment to regional servers located in our regional data centers. SALES AND MARKETING OFFLINE-MUSIC DISTRIBUTION BUSINESS. We plan to minimize sales and marketing costs going forward by utilizing strategic partners and limiting initiatives to methods proven cost effective, such as newspaper advertisements. Our sales and marketing force is made up of approximately 345 full-time staff. We primarily use the following means to market our services: 29- Store autograph signing events with music artists; - Web-based banners; - Internet newsletters; and - special concert events. We expect our sales and marketing efforts over the next 12 months to remain flat or slightly decrease as a result of tighter expense controls and cross marketing initiatives. ONLINE-ACCESSdemand.Sales And Marketing
CONSUMER ACCESS SERVICES. We plan to continue utilizing bundled marketing with our strategic partners to minimize costs.
Our sales force is made up of approximately 14 full-time staff.We primarily use the following means to market our services:-television, magazine and newspaper advertisements;-Web-based banners;-Internet newsletters;-inserts in cable television guides;-participation in computer, technology and telecommunications tradeshows;-free trial promotions through waiving monthly access fees for one or two months; and-demonstration centers in computer superstores and other locations.We expect ourTurnkey cable modem services. For cable operators that are interested in providing or improving upon their cable Internet services, we will form a team composed of sales personnel, network engineers, backend software engineers and
marketing efforts over the next 12 months to remain flat or slightly decrease as a result of tighter expense controls and cross marketing initiatives. PRODUCT DEVELOPMENT AND ENGINEERING Our product development and engineering efforts focus on design and development of new technologies and products to increase the speed and efficiency of our broadband network architecture and to facilitate the development and distribution of broadband content andcustomer serviceapplications. NETWORK Our product development and engineering efforts with respect to our network focus on: - enhancing transparent caching and replication techniques to improve network performance and efficiency; - enhancing our advanced network management capabilities to identify and address network performance issues before they adversely affect our subscribers; and - developing virtual private network technology solutions to enable secure and scalable end-to-end commercial telecommunications services over our network. INFORMATION SYSTEM Our product development and engineering efforts with respect to our information system focus on: 30- enhancing our real-time billing system and our abilityspecialists to providemicro-payment, consolidated billing, electronic bill presentmentfree consultancy andcollection services; - deploying workflow automation systems“turnkey” solutions. We believe that direct sales contact and site visits tostreamline business processes;existing cable partners and- integrating systemreferrals by our existing cable partners are the most efficient methods of marketing our cable modem services.CORPORATE ACCESS SERVICES. With the unique optical Ethernet MAN infrastructure and
network data into an enterprise-wide data warehouse to perform detailed analysis on user profiles. CONTENT INFRASTRUCTURE Our product development and engineering efforts with respect to our content infrastructure focus on: - developing a modularized content publishing platform to facilitate development of broadband content; - developing customized browsers, Internet applications and tools that integrate our content offerings to enhance each user's broadband experience; - enhancing our automated publishing and content management system to further simplify broadband content development and distribution; and - advancing multicasting technologiessolution, KBT is able to provideefficient transmission of content. CUSTOMER SERVICE AND BILLINGcorporate customers, one-megabit increment, on-demand leased-line service. We primarily use a direct sale force to reach our potential customers.Customer Service and Billing
We provide our subscribers with a comprehensive range of customer service, including assistance on cable modem installations, continuous post-installation technical support and prompt responses to billing and service requests.
Our customer service department is divided into two groups: technical support and general customer service. Our customer service department operates a toll-free help desk with extended hours of
operation to provide customer service.operation. Our subscribers may also contact us via electronic mail or through accessing our interactive self-service Web site. Our general customer service staff assist subscribers with cable modem questions and problems, as well as basic computer and software configuration questions and billing inquiries. Our technical support group handles technical problems referred by the general customer service staff.We typically prepare and mail the bill for our services, which we send to the
subscribersubscribers under our own name and logo, on a monthly basis. We offer our subscribers a wide variety of payment options, including automatic credit card payments, direct debits from their bank accounts and post officesavingsavings accounts, pre-payment or over-the-counter payment atpostal offices.post offices and convenience stores. We also seek to provide detailed information on the bills to enable our subscribers to obtain all relevant information relating to their services.Competition
The Internet access service industry is highly competitive.
We mainly compete with broadband ISPs, which provide basic Internet access to consumer and corporate users generally through the provision of ADSL services using existing telephone networks or cable modem-based services operating over cable television networks. The Internet access service industry in Taiwan is very competitive and challenging. The broadband Internet access service industry in Taiwan is dominated by the main fixed-line telecommunication company, Chunghwa Telecom. Chunghwa Telecom’s HiNet broadband service is the current broadband ISP market leader estimated to have approximately 80% of the market share in 2005, while we have only managed to capture approximately 2% of the market share. The primary basis for competition is price. The availability of similar services at competitive prices has made it difficult for us to attract and retain customers.
We also compete with other broadband technologies, including integrated services digital networks and wireless and satellite data services. We believe that our access services have both technological and cost advantages over these alternative broadband means. Also, we believe that our cable modem business offers a product which is to some extent differentiable from competing ADSL services, and are seeking to further develop this business by restructuring the terms of our agreements with our cable partners. In the cable modem-based Internet access market, we believe that our close relationships with a large number of cable partners and our exclusive access to a substantial portion of Taiwan’s households and businesses provide us with a competitive advantage. Our competitors in Internet access services include all four fixed-line operators in Taiwan.
We also face competition in corporate ISP from fixed-line service providers, including Chunghwa Telecom, Taiwan Fixed Network, Sparq’s NCIC and Asia Pacific Online and other Internet access service provider in Taiwan.
Some of our major competitors, including Chunghwa Telecom, have advantages over us in terms of financial and marketing resources, established customer relationships, brand awareness, customer access and telecommunications infrastructure.
Entertainment Software Business
Overview
We operate our entertainment software business through our subsidiary, CESL, and through its wholly-owned subsidiaries, CIDC and IML. CESL develops and licenses software solutions and application services to clients operating in the dynamic and rapidly expanding Internet-based entertainment markets. CESL offers a wide array of products and services, including online entertainment and social networking. CESL’s software solutions and services also offer great expansion capabilities. CESL can help clients expand geographically through language localization for products and services. Currently, our products and services are available in 16 languages, which include mostly European languages and some Asian languages. CESL can also help clients who license our software and services expand their business through a fully-customizable multi-tiered licensing program to a great number of sub-licensees.
Our Products
Our software products are built upon cutting-edge Internet technologies and capable of providing multi-player gaming platforms, powerful transaction engines, advanced risk management tools, comprehensive online marketing tools, sophisticated data mining and reporting utilities, intuitive graphical interfaces and localization in 16 major languages including English, French, German, Italian, Spanish, Portuguese, Norwegian, Swedish, Danish, Dutch, Greek, Hebrew, Traditional Chinese, Simplified Chinese, Japanese and Korean.
Our software products are specially designed to enable our clients to manage the online entertainment properties and offer online entertainment to visitors of their online entertainment properties. We currently provide the following entertainment software products:
Online Entertainment Management — these are tools that enable our clients to offer online entertainment software, monitor end-user behavior, and potentially to monetize the traffic and patronage generated by the end users. Our integrated and comprehensive multi-lingual e-commerce system facilitates Internet-based transaction processing and can provide detailed analysis of transaction records of our diversified international end users. In addition, there are promotional tools that help build player loyalty and increase retention rates.
Online Entertainment Modules — these are customizable entertainment modules that run on Microsoft Windows 95/98/NT/2000/ME/XP and feature a realistic 3-D environment, selectable background music, and local language interface. In late 2004, we developed a multi-lingual multi-player gaming product featuring realistic 3D environments with player-selectable avatars, an exclusive automated training room, a step-by-step interactive gaming tutorial in major languages serving our clients’ key markets around the world. There are many games of chance and games of skill which end users can download freely and play on their computers.
Our Services
In addition to licensing our software products to licensee, we offer a variety of application services and consulting services for backend operation. These services include:
Infrastructure Design Services –
Infrastructure Design: Architecture design of servers, routers, firewalls, network software and management tools required for a 24x7 Internet property.Site Creation: Creation and branding of our client’s Internet property, customized to match our licensee’s unique identity and creative theme.Transaction Processing Design Service–
Payment: Consultation for the design of timely collection and distribution of payments through a variety of channels and merchants.Billing: Consultation for the design of real-time and out-of-band transaction processing and order management.Risk Management: Consultation for design of tools and process for fraud detection, prevention, and management.Customer Support Services –
Infrastructure Consultation Support: Complete round-the-clock consultation support to help clients resolve infrastructure issues related to our design and solutions.Platform technical support: Consultation during periodic maintenance to update, patch, and fine-tune the system performance of our software solutions.Custom Gaming Software Development– Design and development of custom entertainment modules and interfaces for our platform meeting client specific requests.
Our Technology and Infrastructure
Our Universal Gaming Platform is based on a sophisticated modular distributed transaction processing architecture that is designed to be flexible, extensible, scalable and secure. Composed of multiple fault-tolerant distributed modules, our Unix-based backend infrastructure provides the functions of gaming servers, game points management, financial stored-value management, e-commerce engines, a central database and an extensive toolset to handle fraud screening, data mining, player support and partner programs. Being comprehensive and extensible, our Universal Gaming Platform can be used as a generic common platform to support a wide range of online gaming, including skills-based gaming and multi-player gaming. Our multiple real-time gaming server software enables seamless integrated management of all end user registration, account administration, deposit and transactions. With our software, end users on various platforms can communicate securely across the global Internet through multiple real-time gaming servers. To further increase the flexibility of our platform, a transaction server layer encapsulates business logic and abstracts data and third party services, such as payment processors. This allows us to isolate the core processing module with business logic, greatly reducing the amount of development and quality assurance work required when we want to extend the system. Our comprehensive administration tools enable advanced data analysis to deliver high-quality end-user support and licensee management. Our multiple payment processor gateway capabilities provide choice and flexibility to handle the complexities of international markets.
Our long history of developing innovative software solutions specifically for the non-English speaking markets has yielded a deep expertise in localization techniques and processes, as well as a finely-honed infrastructure for building localization into products at the earliest stages of design and development. Our development methodology incorporates localization requirements as an integral part of product design. Our in-house teams of native-language experts are involved in every step of the process to ensure cultural fidelity in everything from content to graphics to interfaces and controls.
Our Licensee
We currently have one licensee, UIM, a third-party online entertainment operator to which we license our software and provide application services and consultation services for its Internet property and infrastructure, including Web site design, payment gateways, and database and operating systems, in return for a fixed percentage of UIM’s gross receipts. UIM operates exclusively from computer servers located in the Kahnawake Territory in Canada under a gaming license issued by the Kahnawake Gaming Commission, subject to continuing compliance with strict licensing requirements.
In spite of the fact that we have no equity shareholding in UIM, we incorporated UIM’s results as of and for the nine months ended December 31, 2004 into our consolidated financial statements. See Item 5 — “Operating and Financial Review and Prospects — Overview — Consolidation of UIM Under FIN 46(R)” for additional information.
Seasonality
Due to the predominantly indoor experience of online entertainment, there is a seasonality pattern observed on user traffic and patronage. Typically, summer is the lower season, while winter is the higher season for online entertainment activities. As a result, seasonality affects the revenues we receive.
Competition
Our success depends, in part, upon our ability to enhance our products and services to keep pace with technological developments, respond to evolving customer requirements and achieving continued market acceptance.
Online entertainment software design houses and application service providers are our primary competitors. However, given the low barrier to entry of software industry and the increasing popularity of Internet-based businesses, there are a large number of competitors scattered throughout many different segments of software and Internet industries. We potentially compete with a number of public and private companies, which provide Internet property architecture design/development, Web design/development, online entertainment software design and development, marketing tools and solutions providers, customer support tools and solutions providers, and e-commerce tools and solutions providers. The diversity of our potential competitors makes it difficult to compile information about the nature of our competitors, their operations and their resources.
Our sole licensee, UIM, also faces tough competition in the online gaming industry. New entrants to the online gaming sector, market consolidation and aggressive marketing and pricing by competitors may lead to a significant decline in UIM’s customer base, revenues and margins. Any future liberalization, licensing or regulation of online gaming in countries where UIM generates significant revenues is likely to lead to increased competition from companies that do not currently offer online gaming services. Traditional Internet service providers and other entities, many of which have significant financial resources and name brand recognition, may provide online entertainment services in the future. Traditional entertainment service providers might expand and provide an
easy-to-understand manner. INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTSInternet-based entertainment service and such Internet service providers and entertainment service providers may also develop and offer the underlying software solutions and tools to others, and thus directly compete with us.Faced with our known competitors, and most likely several new competitors which may be established in the near future, we will continue to improve the principal competitive factors that we believe can create certain barriers to entry: including brand, technology, financial stability and resources, proven track record, regulatory compliance, independent oversight and transparency of business practices in our industry.
Music Distribution Business
Overview
We operate a music distribution business through our indirect ownership of Taiwan’s two largest music distribution chains, Rose Records and Tachung Records. Our stores sell recorded music as well as DVDs, VCDs and ancillary equipment such as personal stereo headphones. As of June 15, 2005, we operated a total of 45 stores. According to our estimate, we had a market share of over 30% of Taiwan’s physical music distribution business in 2004. While seeking to preserve our market share, we have also taken steps to improve the operating results and financial condition of this business by reducing costs, improving our management information systems and inventory management with a view to operating this business more efficiently, and increasing our operating margins.
We hold our music distribution business through G-Music Limited, our 58.58% owned subsidiary. We acquired the stores operated by Rose Records and Tachung Records in a series of transactions in February 2002, September 2002 and December 2002, and have consolidated the results of operations of the acquired businesses from the respective dates of acquisition.
Industry Overview
Taiwan’s retail music distribution industry is relatively fragmented. In addition to our Rose Records and Tachung Records chains, there are several other record distribution chains operating in Taiwan. Hypermarket chains, such as Carrefour and specialty entertainment chains, such as FNAC, reflect a small, but growing, segment of the market, with the balance consisting of convenience stores, individual music stores and night markets. Alternative distribution methods, such as Internet sale of physical recorded music and Internet-based music downloads have also begun to emerge in recent years as competitive distribution channels.
While no formal industry statistics are available, based on information provided to us by record companies and knowledge of our own revenues, we estimate that our share in 2004 of the physical music distribution market was over 30%. This does not include Internet-based music downloads or illegal physical or online piracy, which we believe to be significant but about which we do not have reliable information.
The retail music distribution industry in Taiwan has been undergoing significant change in recent years. The development of new technologies, such as Internet-based music downloading and changing consumer buying habits, have contributed to a significant global reduction in the size of recorded music sales during the past several years. This trend has also adversely affected the retail music distribution industry in Taiwan. In addition, Taiwan continues to experience relatively high levels of physical and online music piracy, which has further eroded the retail music distribution industry.
We believe that these changes are likely to continue to impact the retail music distribution industry going forward. Historically, purchases of popular music have constituted a significant portion of ours and our competitors’ sales. Going forward, we anticipate that an increasing proportion of these sales is likely to be effected through alternative distribution channels, particularly Internet-based downloading. Consequently, we anticipate that an increasing proportion of physical music distribution will comprise specialized areas of music, such as classical and jazz, whose purchasers demand the higher sound quality of physical recordings and who we believe are generally less price-sensitive than purchasers of popular music.
Taiwan’s retail music distribution industry has also been affected in recent years by relatively lower levels of new popular artists and albums than has been the case in some prior periods, which we believe has adversely affected our sales and those of our competitors.
Stores
As of June 15, 2005, we operated 45 stores. These stores range in size from approximately 500 square feet to approximately 5,000 square feet. The stores typically offer a broad selection of album titles across a range of musical genres.
Our stores are located principally in Taipei, Taichung, Kaoshiung and Taiwan’s other major urban areas, although we also operate certain stores in rural areas. Historically, we have sought to locate our stores in high-traffic areas and near transportation hubs such as Mass Rapid Transit, railway and bus stations, with a view to attracting young purchasers of popular music. These areas also tend to be characterized by higher store rental costs. As of June 15, 2005, we had 20 music stores in the North of Taiwan, six in Central Taiwan and six in the South of Taiwan. In addition, 13 of our Rose records retail outlets are located in either hypermarkets or department stores throughout Taiwan.
We believe that in the future, younger purchasers of popular music are likely to turn increasingly to alternative music distribution channels, such as Internet-based downloads, and that an increasing proportion of the physical music distribution will comprise more specialized areas of music, such as classical and jazz.
In light of the trends we perceive in this business, we are in the process of altering some of our stores into combined stores format. Combined stores are stores co-located with other businesses that we believe share the same pool of customers as our customers. As of year end 2004, we have a combined store arrangement with a major operator of a fitness center and two combined stores with an arcade game provider. As of June 2005, we have already converted another seven stores which were identified as loss makers into either a combined store or share rental format.
We are also currently updating and improving our Internet Web site which will offer and sell physical CDs, DVDs and VCDs to retail purchasers. Revenues from our Internet store represents a small fraction of our total music distribution revenues.
Purchasing and Distribution
As of the fourth quarter of 2004, all procurement has been centralized at our headquarters in Taipei, which we believe will strengthen our position in negotiating terms, discounts and in-store advertising with the major record companies. From the data collected by our POS system, we will be able to identify fast-selling CDs which we should purchase more of, and be alerted when inventories of slow-moving CDs become too high.
Currently, merchandise purchased by our retail music stores is also separately distributed by the major record companies or the other suppliers, as the case may be, directly to our individual retail music stores. Following the centralization of our procurement, we expect our suppliers to continue to ship the merchandise directly to each of our retail music stores.
Consistent with retail music industry practice in Taiwan, CD purchases from major record companies are in general not returnable for full credit. The principal exception relates to major record releases, where the first batch of purchases are usually returnable for full credit. CD purchases from suppliers other than major record companies are usually returnable for full credit.
Sales and Marketing
The primary source of revenues for our retail music stores is the sale of recorded music on CDs. Each of our stores carries a wide selection of CDs purchased from major and independent record companies, which, except for new releases and special promotions, are generally arranged in our stores according to genre and alphabetically by artist or group. Our music stores also receive promotional and advertising revenues from store media, that is, in-store promotion by record companies. Record companies typically allocate a portion of their album marketing budgets as promotional and advertising revenues to music stores in return for prominent in-store placement of CDs and/or posters as well as record company-sponsored promotional events. In 2004, we recognized a total amount of US$1.5 million in promotional and advertising revenues.
We successfully launched a co-branded credit card during the beginning of the fourth quarter of 2004 and have a current total of approximately 45 thousand active cards. We believe that a co-branded credit card will help promote sales and, more importantly, build customer loyalty. We will also be able to collect valuable data regarding our customers’ music preferences, for example, jazz or classical music, which will help us to tailor the offerings of our stores to meet customer needs.
Management Information System
We have implemented our new point of sale, or POS, system for our retail music stores. This is a centralized management information system that allows tracking from purchase through to sale, providing us with real-time information on what is being sold at each of our retail music stores. The new POS system is expected to enable us to manage a centralized purchasing system, perform inventory swap among our stores and monitor our inventory movement more accurately and efficiently. We believe that implementation of our POS system should ultimately enable us to achieve a more efficient division of labor between staff performing stock-taking and other operational functions and more knowledgeable sales staff to improve customer service.
Competition
The music distribution business in Taiwan is highly competitive. We believe that the principal bases of competition are store location, selection and price of CDs. We compete in the music chain store business with Asia Records and Guan Nan Records. Our music stores also compete with independent operators and convenience stores. We are also facing increasing competition from hypermarkets, such as Carrefour, as well as specialized entertainment chains, such as FNAC, some of which have greater financial and other resources than our Company. We expect competition from hypermarkets to increase in the future, as this reflects the expected shift in customers from high-traffic areas like bus and train stations to areas with available and accessible parking lots, such as hypermarkets and business areas. Some of our larger competitors have exclusive distribution arrangements with music label companies and the operation of these arrangements prevent us from distributing certain popular music products. In addition, we compete with music distribution channels that employ modern technology, such as online download and streaming, which enjoy lower inventory and distribution costs. Furthermore, the prevalent practice of physical and online piracy in Taiwan presents a continuing threat to the growth of the music distribution industry in Taiwan.
Seasonality
Retail music sales in Taiwan are typically higher during the Chinese New Year and in the summer due to increased store traffic and buying by students and youths on school vacation. Rose Records and Tachung Records are similarly exposed to this trend in seasonality of sales, and rely heavily on the Chinese New Year and summer sales to achieve annual financial targets.
Intellectual Property and Proprietary Rights
While we regard our intellectual property and proprietary rights as important, we believe that our future success is dependent primarily on the innovative skills, technological expertise and management abilities of our employees rather than on patent, copyright and trademark protection, and, accordingly, we do not consider any particular intellectual property or proprietary right to be material to our business.
COMPETITION MUSIC DISTRIBUTION BUSINESS. The music distribution business inRegulation
Telecommunications Regulation In Taiwan
is fragmented and consists of music store chains, including the two music store chains we acquired in 2002, and many mid- to small-size music stores and distribution channels. We also compete with music distribution channels that employ modern 31technology, such as online download and streaming, which enjoy lower inventory and distribution costs. In addition, the prevalent practice of physical and virtual piracy in Taiwan presents a continuing threat to the growth of the music distribution industry in Taiwan. Further, some of our larger competitors have exclusive distribution arrangements with music label companies and the operation of these arrangements prevent us from distributing certain popular music products. Our principal competitors in this industry include Asia Record, Guan Nan Record and Carrefour. ACCESS SERVICE The Internet access service industry is highly competitive. We compete with other broadband technologies, including integrated services digital networks, wireless and satellite data services. We believe that our access services have both technological and cost advantages over these alternative broadband means. We also compete with narrowband Internet service providers, which provide basic Internet access to residential and commercial users, generally using existing telephone networks. Chunghwa Telecom is our major competitor in this market. Although these services are widely available and less expensive, they fail to offer the various advantages of broadband access. In the cable-based Internet access market, we believe that our close relationships with a large number of cable partners and our exclusive access to a substantial portion of Taiwan's households and businesses provide us with a competitive advantage. We also believe that we are one of the leading cable-based broadband Internet access service providers in Taiwan in terms of subscribers. Our competitors in this market include Eastern Multimedia Group, SeedNet and Taiwan Broadband . In the ADSL access market, we compete with HiNet, SeedNet, APOL and Sparq. Some of our major competitors, including Chunghwa Telecom, have advantages over us in terms of financial and marketing resources, established customer relationships, brand awareness, customer access and telecommunications infrastructure. However, we believe that we have competitive advantages over Chunghwa Telecom and other traditional narrowband access service providers in terms of transmission speed and ease of access and use. We believe that we have competitive advantages over other broadband access service providers in terms of: - customer access; - reliability of service; and - customer support. CONTENT SERVICES The content service market is also very competitive. Our Web destination competes with various Internet content providers of different categories of content services, including - Chinese-language Web destinations and portals such as Yahoo! Kimo, China.com, Sina.com, Chinatimes, Yam, HiNet, and Sohu; - English language Web search and retrieval companies such as Terra Lycos, Yahoo! and Microsoft Network; and 32- retrieval services and products offered by companies such as AltaVista, HotWired Venture's and Inktomi's HotBot, OpenText and Openfind. A number of major traditional narrowband content providers, including Yahoo!Kimo and Sina.com, have competitive advantages over us in terms of: - brand awareness; - user access; and - financial and marketing resources. However, we believe that our Web destination's ability to provide a wide variety of multimedia content optimized for broadband access and Taiwanese users enhances our destination's competitiveness in Taiwan's content service market. We also believe that our Web destination is a leading broadband Web destination in Taiwan in terms of content offerings. Broadband content enables us to increase subscribers. REGULATIONS TELECOMMUNICATIONS REGULATION IN TAIWANThe Ministry of Transportation and Communications and the Directorate General of Telecommunications of Taiwan regulate
Taiwan'sTaiwan’s telecommunications industry primarily under the Telecommunications Law of Taiwan.The Telecommunications Law authorizes the Directorate General of Telecommunications to regulate two types of telecommunications companies, Type I operators and Type II operators. Type I operators, such as Chunghwa Telecom, are enterprises that have established their own switching and transmission facilities to provide telecommunications services. These facilities-based services are similar to common carrier services or basic services in the United States. Type II operators, such as Hoshin
Gigamedia,GigaMedia and KBT, comprise all telecommunications operators other than Type I operators, including companies which generate fees from providing Internet access, online information, electronic mail and electronic commerce services.REGULATION OF TYPERegulation of Type II
OPERATORS.Operators. Type II operators typically provide telecommunications services to customers by using the telecommunications facilities of Type I operators and are not permitted to engage in the buildup of telecommunications facilities.-Type II telecommunications services can be further divided into special Type II telecommunications services and general Type II telecommunications services. A special Type II telecommunications license is required for any Type II operator which provides voice simple resale, Internet telephony, and other international telecommunications services by leasing international circuit(s). A general Type II telecommunications license is required for any Type II operator which provides telecommunications services other than those specified above. Hoshin GigaMedia and KBT each hold a general Type II telecommunication license.License. A Type II license is valid for ten years, and may be renewed six months before its expiration. The license is nontransferable. HoshinGigamedia'sGigaMedia’s license is due to expire in 2008.-KBT’s license is due to expire in 2012.Tariff Regulation. Type II operators are required toestablishannounce their business regulations with respect to the terms for provision of services, including tariffs for major rates and charges.These tariffs and anyAny changes to the business regulations must be filed with the Directorate General of Telecommunications before they become effective. Tariff information must include the types of services provided, terms and fee schedules for all service items, rights and obligations of customers, contract termination events and other matters affecting the right and obligations of customers, all to be included in theoperator'soperator’s business plans.-Change in Business. UnderTaiwan'sTaiwan’s Regulations Governing Type II Telecommunications Operators,some changes inany change of type or scope of businessplans of a Type II operator, including its systems plans, linkup plans with foreign value-added network service providers and numbering plans for data or broadband communications,must be approved by the Directorate General of Telecommunications. For change of the systems structure stated in the business plan, a report shall be filed with the Directorate General of Telecommunications for recordation within one month from the effective date of change of such system structure. In addition, Type II operators must report to the Directorate General of Telecommunications and inform their customers in advance of any plan to suspend or terminate any of their businesses.-Technical Standards. Special Type II operators are required to retain qualified senior telecommunications engineers to install and maintain telecommunications equipment. Any telecommunications equipment used33by a Type II operator must also satisfy technical standards adopted by the Directorate General of Telecommunications. REGULATION OF TYPERegulation of Type I
OPERATORS.Operators. Type I operators are more heavily regulated than Type II operators, and the government of Taiwan has broad powers to limit the number of operators and their business scope and markets. Under the Telecommunications Law, Type I operators must satisfy required levels of capital adequacy and, to ensure that they meet their facilities rollout obligations, are subject to pre-licensing merit review of their business plans and tariff rates. In addition, the Telecommunications Law prescribes that any adjustment to the tariff rates of a Type I operator is subject to a price cap set according to the coefficient of the annual fluctuations of the consumer product index promulgated by the Directorate General of Budget, Account and Statistics under the Executive Yuan of Taiwan.LIBERALIZATION OF TYPELiberalization of Type I
FIXED NETWORK LICENSING.Fixed Network Licensing. The Directorate General of Telecommunicationshasadopted Fixed Network Regulations in 1999 to govern the issuance of fixed network communication licenses. Type I fixed network communications licenses are subdivided into comprehensive network, local network, long distance network, international network and lease-circuit licenses. Thesenewregulations have been designed to grant additional comprehensive network licenses to encourage competition with Chunghwa Telecom, which is a state-owned company and currently the dominant fixed-line network operator in Taiwan.CONTENT LIABILITY.Content Liability. In the event that the content sent, transmitted or received via the Internet through an
operator'soperator’s system is found to be obscene, defamatory or in violation of public order or national security, the relevant operator would be liable for the content only if it knew or should have known that the content is obscene, defamatory or in violation of public order or national security. In addition, carriers must provide telecommunications services on a fair and equal basis and may not refuse to receive or transmit telecommunications information unless the content would endanger the national security or offend against the public order of Taiwan.CABLE REGULATION IN TAIWAN REGULATION ON SHAREHOLDING.Cable Regulation In Taiwan
Regulation on Shareholding. Respectively in 2000 and 2001, the Cable Television and Broadcast Law has been modified. Under the modified regulations, the original regulation of
"a“a single shareholder cannot own more than 10% of the total issued shares of a cableoperator"operator”, and"no“no shareholder and its related parties may collectively own more than 20% of a cableoperator'soperator’s total issuedshares"shares” hasalreadybeen eliminated. Instead, the shares of a cable operator directly or indirectly held by foreign shareholders cannot exceed sixty (60) percent of all outstanding shares of the cable operator. Furthermore, foreign shareholders who directly hold shares of a cable operator are limited to foreign corporations and the total shares held by them cannot exceed twenty (20) percent of all outstanding shares of the cable operator.OPERATING LICENSES.Operating Licenses.To obtain an operating license, a cable operator must first apply for a rollout permit. After receiving this permit, the cable operator generally has three years to complete the cable system rollout as set forth in its permit application. Upon the satisfactory completion of the rollout, the Government Information Office will issue an operating license to the cable operator. If the cable operator has not received an operating license before its rollout permit expires, its right to engage in the cable television business will be terminated immediately.
The term of an operating license is nine years. A review committee established by the Government Information Office conducts periodic review of the performance of each licensed cable operator on the basis of its business and operating plans every three years. Following a review, a licensed cable operator may be instructed by the Government Information Office to make requested improvements in its business within a specified period. A failure to timely comply with the instruction could result in revocation of the cable
operator'soperator’s license.MARKET SHARE LIMITATIONS.Market Share Limitations. Under the Cable Television and Broadcast Law, the number of subscribers of all affiliated cable operators may not exceed one-third of the total number of cable television
34subscribers in Taiwan. In addition, the number of all affiliated cable operators may not exceed one-third of the total number of all cable operators in Taiwan. COMPETITION.Competition. Under the Cable Television and Broadcast Law, the Government Information Office is authorized to issue additional licenses in a franchised area if it believes that the existing license holders in that area are engaging in anti-competitive or unfair competition practices. In addition, service fees charged by cable operators must be approved by local government authorities on an annual basis.
OPEN ACCESS REGULATION.Open Access Regulation. Under the Regulation Governing Fixed Network
RegulationBusiness described above, cable operators must obtain leased-circuit licenses issued by the Directorate General of Telecommunications in order to lease their circuits to companies that provide services through their cable systems. The Directorate General of Telecommunications began to accept applications for these licenses from cable operators in June 1999but has not yet issued anyand most of the cable operators have been granted with leased-circuit licenses to lease out their cableoperators.capacities to Type I operators and Type II operators, including Hoshin GigaMedia and KBT. As a condition to holding these licenses, any licensed cable operator that is deemed to be a dominant operator in the fixed net work business market (such as in leased-circuitcarrierbusiness) may be required by the Directorate General of Telecommunications to allow all parties to provide services, including Internet access services, through their cable systems on substantially similar terms. Any imposition of this requirement from the Directorate General of Telecommunications on the cable partners having exclusive relationships with us will eliminate the benefits associated with our exclusive rights.Regulation Relating to Online Gaming
UIM, the sole licensee of our software products, and our business of software development and application service provision are subject to applicable laws and regulations relating to online gaming and electronic commerce in various jurisdictions.
We are incorporated in Singapore and at present the Singapore law does not prohibit us from providing software products and application services to online gaming companies.
UIM operates exclusively in the Kahnawake territory in Canada under a gaming license issued by the Kahnawake Gaming Commission, subject to continuing satisfaction of strict licensee requirements. All of UIM’s gaming transactions take place in Kahnawake. UIM operates exclusively from computer servers in Kahnawake.
However, UIM’s consumers involved in Internet gaming are located around the world, including the end users of our software products. Further, UIM sub-licenses our software products to third parties. As such, it is in many cases uncertain which governments have authority to regulate or legislate with respect to different aspects of this industry.
The Internet gaming industry is still in an early stage of development, and as such, the worldwide legal and regulatory environment in which the business operates is highly fluid, and subject to change. Most foreign jurisdictions have some form of legal framework applicable to games of chance, but few provide any guidance on how this framework applies to Internet gaming. Issues such as physical location of the gaming event, foreign jurisdictional law, “Cyberlaws”, and “control of the Internet” all make traditional legal and regulatory laws difficult to apply. In addition, the very nature of Internet gaming creates new and unique forms of entertainment that were neither contemplated nor feasible in the past. The risks and uncertainties in the worldwide legal and regulatory environment makes it impossible to assess that our status or operations as an application service provider to the gaming industry is in compliance with all laws and regulations of the jurisdictions in which we operate.
Our Company and the industry as a whole may be affected by efforts by members of the U.S. Congress to ban certain Internet gambling. Early in the 108th Congress, U.S. Congressman Jim Leach (R-IA) introduced HR 21, the Unlawful Internet Gambling Funding Prohibition Act, which attempts to prohibit Internet gambling by forbidding the use of credit instruments of United States banks from being used to make bets or wagers over the Internet. Shortly afterwards, U.S. Senator Jon Kyl (R-AZ) introduced similar legislation, S-627 in the U.S. Senate. In June 2003, HR 21 was reintroduced as HR 2143 by U.S. Congressman Spencer Bachus (R-AL) without any civil and criminal sanctions in order to bypass the U.S. House of Representatives Committee on Judiciary. After a very close vote on an amendment to HR 2143, the House of Representatives passed that legislation. In late October 2003, the U.S. Senate’s Committee on Banking, Housing, and Urban Affairs placed an amended version of S-627 on the Senate Legislative Calendar under General Orders. We continue to monitor this situation since the passage of this legislation could have a substantial impact on the business of our licensee and ultimately our Company. If this legislation passes and becomes law, it would have an immediate detrimental effect on the industry and would pose a serious threat to the continued operation of our entertainment software business.
In November 2004, the WTO found that the U.S. was in violation of its commitments under GATS by not allowing operators of online gaming services licensed in Antigua and Barbuda to access U.S. markets. The decision was appealed and, in April 2005, the Appellate Body of the WTO found that the provisions of the Wire Act, Travel Act and Illegal Gambling Business Act are inconsistent with the U.S.’s obligations under the GATS, but also that the U.S. had shown that such measures are necessary to protect public morals or maintain public order and therefore fall within an exception to its general obligations. However, the Appellate Body further found that, in the light of U.S. legislation in respect of online gambling on horseracing, the U.S. had failed to demonstrate that the Wire Act, Travel Act and Illegal Gambling Business Act are applied equally to both foreign and domestic providers of online gambling services for horseracing and therefore recommended that the U.S. bring its legislation into conformity with its obligations under the GATS.
It is unclear what steps the U.S. will take following the decision of the Appellate Body of the WTO and whether the threat of any sanction or fine relating to a failure to implement the recommendation of the Appellate Body would be sufficient to lead to a change in U.S. online gaming policy. A number of states are lobbying/petitioning the U.S. authorities to ensure they retain the ability to regulate state gaming and that this ability is not affected by the WTO decision.
Also, the substantial uncertainties in the global regulatory environment relating to online gaming expose us to a real risk of regulatory authorities in various jurisdictions considering us as providing online gaming services rather than only providing software and application services to our licensee and hence subjecting us to gaming regulations in such jurisdictions.
C.
ORGANIZATION STRUCTUREOrganizational StructureWe are a holding company incorporated in Singapore in September 1999. Prior to 2002, our primary business was to provide broadband Internet access services in Taiwan. After we acquired
Taiwan's two largestour musicstore chains, Rose Recordsdistribution business in 2002 andTachung Recordsour entertainment software business in2002,April 2004, we became a diversified provider ofmusic products andbroadband Internet access services,in Taiwan.entertainment software and application services and music products. The table below sets forth for each of our principal subsidiaries, the name, year and country of incorporation and our percentage holding and principal activities as ofMay 31, 2003:June 15, 2005:
- ---------------------------------------------------------------------------------------------------------------- Entity Year of Place of Our Percentage Holding Principal Activities Incorporation Incorporation/Operation - ----------------------------------------------------------------------------------------------------------------Hoshin GigaMedia 1997 Taiwan 100% Cable based broadband Center Inc. and ADSL Internet access services and Internet content services and other online services - ---------------------------------------------------------------------------------------------------------------- GigaMusic.com Ltd. 2001 Cayman Islands/Taiwan 95% On-line music distribution - ---------------------------------------------------------------------------------------------------------------- G-Music Limited 2002 Cayman Islands/Taiwan 58% Offline music distribution - ---------------------------------------------------------------------------------------------------------------- Koos Broadband 2001 Taiwan 99.9% Broadband Internet Telecom Limited access services targeting business clients - ----------------------------------------------------------------------------------------------------------------
Entity
Year of
IncorporationPlace of Incorporation /Operation
Our Percentage
HoldingPrincipal Activities
Bridgepoint International Limited
2004 British Virgin Islands 100% Holding company Broadnet International Limited
2004 British Virgin Islands 100% Holding company Cambridge Entertainment Software Limited
2004 British Virgin Islands 100% Holding company Cambridge Interactive Development Corporation
1997 U.S.A. 100% Development of software and
provision of application service for
online entertainment services
GigaMedia (HK) Limited
2004 Hong Kong 100% Holding company GigaMedia (Taiwan) Limited
2004 Taiwan 100% Holding company GigaMedia International Holding Limited
2004 British Virgin
Islands
100% Holding company GigaMusic.com.Ltd
2000 Cayman
Islands
100% Online music distribution G-Music Limited
2002 Cayman
Islands
58.58% Holding company Hoshin GigaMedia Center Inc.
1998 Taiwan 100% Cable-based and ADSL Internet
access services and other online
services
Implus International Limited
2004 British Virgin Islands 100% Holding company Internet Media Licensing Ltd.
2005 British Virgin Islands 100% Licensing of software or online
entertainment services
Koos Broadband Telecom Limited
2001 Taiwan 100% Broadband Internet access services
targeting business clients
Music King Co., Ltd.
2000 Taiwan 58.58% Retail music distribution Point Records Co., Ltd.
1997 Taiwan 58.58% Retail music distribution D.
PROPERTY, PLANT AND EQUIPMENTProperty, Plant and EquipmentOur principal executive office and operating office are located at 14th Floor, 122 TunHua North Road, Taipei, Taiwan, where we lease approximately
21,00024,310 square feet. We also lease office and other space, as well as space for our servers, in various otherlocations in Taiwan. In addition, welocations. We operate fromG-Music officesG-Music’s headquarters at 10F, No. 171, Chen-Kung Road, Sanchung City, in Taipei County where we lease approximately7,10012,756 square feet, from KBT’s offices at 6F, No. 20, Lane 478, Rueiguang Road, Neihu District, Taipei, 114, Taiwan, where we lease approximately 13,060 square feet and CESL’s headquarters at 100 Cambridge Park Drive, Cambridge, MA 02140, U.S.A., where we lease approximately 23,774 square feet.As of June 15, 2005, we operated 45 retail music stores. These stores are all leased and range in size from approximately 500 square feet to approximately 5,000 square feet.
We believeThe leases typically provide for a term of between three to five years with no renewal option. All of ourexisting facilitiesretail music store leases areadequate for current requirements and that additional space can be obtainedoncommercially reasonablea fixed-rate basis. The termsto meet future requirements. 35of our 32 leases as of May 31, 2005 expire as follows:
Lease Terms to Expire during
(12 months ending on or about May 31)
Number of Stores 2005 3 2006 7 2007 9 2008 4 2009 4 2010 4 2011 1 ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
A.
OPERATING RESULTSOperating ResultsUnless stated otherwise, the discussion and analysis of our financial condition and results of operations in this section apply to our financial statements as prepared in accordance with U.S. GAAP. You should read the following discussion of our financial condition and results of operations together with the financial statements and the notes to these statements included elsewhere in this annual report.
OVERVIEWChange in Reporting Currency and Basis of Presentation
Our consolidated financial statements have historically been reported in New Taiwan dollars. Effective January 1, 2004, we adopted the United States dollar as our reporting currency because operations denominated in the United States dollar have represented an increasing portion of our business following the acquisition of our entertainment software business. Comparative financial information has been recast as if the United States dollar had been our reporting currency for the periods ended and as of December 31, 2002, 2003 and 2004, and financial information has been translated into United States dollars for all periods presented. See Item 3 — “Key Information — Exchange Rates”. As a result, the financial information for 2002 and 2003 and as of December 2002 and December 2003 presented in this annual report are different from that presented in our annual reports for 2002 and 2003.
Consolidation of UIM Under FIN 46(R)
In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51”, or FIN 46”, which clarifies when a company should consolidate in its financial statements the assets, liabilities and activities of a variable interest entity. FIN 46 provides general guidance as to the definition of a variable interest entity and requires a variable interest entity to be consolidated if a company absorbs the majority of the variable interest entity’s expected losses, or is entitled to receive a majority of the variable interest entity’s residual returns, or both.
The FASB amended FIN 46 by issuing FIN 46(R) in December 2003. In April of 2004, we entered into a software license and support service contract with UIM to provide Internet software support services for UIM’s entertainment software operations. The contract allows us to charge a percentage of UIM gross receipts resulting from UIM’s online entertainment operations. We analyzed the provisions of FIN 46(R) as it relates to contractual relationships and determined that we are a primary beneficiary of a software licensee, UIM. As a result of this determination, we incorporated the results of UIM into our consolidated financial statements as of and for nine months ended December 31, 2004, even though we do not own any of UIM’s equity. UIM’s net assets as of December 31, 2004 were approximately US$414 thousand and the consolidation of UIM resulted in an increase in our assets and liabilities of approximately US$1.6 million and US$1.2 million, respectively. Because we have no equity ownership interest in UIM, the consolidation had no impact on our net income.
Overview
We are a holding
company and through severalcompany. Through our subsidiaries,distribute recorded music andwe provide broadband Internet access services,anddevelop online entertainment software and provide application services,in Taiwan.and distribute recorded music. Ourcore offlineTaiwan broadband ISP businesses are operated through our subsidiary, Hoshin GigaMedia, which focuses on consumer users, and Hoshin GigaMedia’s subsidiary, KBT, which focuses on corporate users. Our entertainment software business is operated through our subsidiary, CESL, which develops software for online entertainment and social networking services and provides application services for turnkey solutions for games of skill and chance. Our music distribution business is operated through our subsidiary G-Music,Limited,which controlsTaiwan'sTaiwan’s two largest music store chains.In 2004, we recorded a net income of approximately US$1.7 million. Our total operating revenues increased by approximately US$4.5 million reflecting our acquisition of our entertainment software business which had operating revenues of approximately US$11.5 million for the nine months ended December 31, 2004 and an increase in our operating revenues of approximately US$1.9 million from our broadband ISP business. Our music distribution business revenues decreased by approximately US$8.9 million reflecting the general downtrend in the retail music industry. We expect this downtrend to continue in the near future. Our total costs and expenses decreased by US$12.7 million.
Prior to
2002,April 2004, ourprimarymain business was to provide broadband Internet access services and distribute recorded music in Taiwan. Since we did not acquirethe two music store chainsour entertainment software business until2002,April 2004, our historical financial results prior toyear 2002fiscal 2004 did not reflect the financial results ofeitherour entertainment software business and year-over-year comparison ofthese music store chains. Currently we are streamlining the operations of the two music store chains. We may incur additional coststhis business segment is not included inconnection with ourthis annual report. Also a full-year consolidation ofthese two music store chains into our current operations, which costs may result in the requirement of additional liquidity and/or negativethis business would have a much greater impact on our financialconditionresults than as presented in this annual report.Broadband ISP Business. We operate a major broadband ISP and
resultsprovide broadband Internet access service with multiple delivery technologies in Taiwan targeting both consumer and corporate customers. Our broadband ISP business generated revenues ofoperations.approximately US$21.4 million and operating income of approximately US$1.0 million in 2004.Our
onlineconsumer ISP business is operated through Hoshin GigaMedia and our corporate ISP business is operated through Hoshin GigaMedia’s subsidiary, KBT. Of the total access revenues recorded for 2004, consumer access revenues through Hoshin GigaMedia were approximately US$16.0 million, while corporate access revenues through KBT were approximately US$5.0 million. Our consumer broadbandbusinessesInternet access products consist of ADSL and cable modem offerings. Our ADSL and cable modem services accounted for approximately 51% and 19% of our ISP access revenues in 2004, respectively.We believe that our cable modem business offers a product which is to some extent differentiable from competing ADSL services, and are
operatedseeking to further develop this business by restructuring the terms of our agreements with our cable partners. We reached an agreement in principle in May 2004 with our cable partners to equally share revenues, thus providing our cable partners with additional economic incentives to promote two-way cable services through their systems. Two-way cable systems allow us to offer subscribers higher upstream transmission speeds and “always on” Internet access capabilities.While revenues from our corporate ISP business represented only approximately 24% of our total access revenues in 2004, they demonstrated a significant growth of 34% from US$3.7 million in 2003, compared to a moderate growth of 6% in our consumer ISP business from US$15.1 million in 2003. Our corporate ISP services include leased-line, virtual private network and other value-added services. We believe our corporate ISP business will become an increasingly important contributor to our total access revenues.
Our broadband ISP business continues to operate in a very competitive and challenging environment. Our principal competitor, Chunghwa Telecom is the dominant provider of broadband services in Taiwan and has significantly greater resources than we do. The availability of similar services at competitive prices has made it difficult for us to attract and retain customers.
Entertainment Software Business. Our entertainment software business generated revenues of approximately US$11.5 million and operating income of approximately US$2.8 million during the nine months ended December 31, 2004. We operate our entertainment software business through our subsidiary,
Hoshin GigaMedia,CESL, which develops Internet-based entertainment software andHoshin GigaMedia'sprovides turnkey solutions for games of skill and chance over our secure, scalable and extensible platform. We acquired our entertainment software business in a private transaction on April 1, 2004 with a view to enhancing our diversified entertainment products portfolio. We have consolidated the results of operations of the acquired business as of and for the nine months ended December 31, 2004. See Note 4 of our consolidated financial statements for additional information.We currently have only one licensee, UIM, whose financial results were incorporated into our consolidated financial statements for and as of nine months ended December 31, 2004 pursuant to FIN 46(R) although we do not own any equity in UIM. We have a revenue sharing arrangement with UIM and as such, we bear certain economic risks with respect to, and derive certain economic benefits from, its operations. See “— A. Operating Results — Overview — Consolidation of UIM Under FIN 46(R)”.
Our software products are built upon cutting-edge Internet technologies and capable of providing multi-player gaming platforms, powerful transaction engines, advanced risk management tools, comprehensive online marketing tools, sophisticated data mining and reporting utilities, intuitive graphical interfaces and localization in 16 major languages.
Online entertainment software design houses and application service providers are our primary competitors. However, given the low barrier to entry of software industry and the increasing popularity of Internet-based businesses, there are a large number of competitors scattered throughout many different segments of the software and Internet industries. In addition to known current competitors, traditional service providers and other entities, many of which have significant financial resources and name brand recognition, may provide online entertainment services in the future, and thus become our competitors.
Faced with our known competitors, and most likely several new competitors which may be established in the near future, we will continue to improve the principal competitive factors that we believe can create certain barriers to entry, including brand, technology, financial stability and resources, proven track record, regulatory compliance, independent oversight and transparency of business practices in our industry.
Music Distribution Business. Our music distribution business continued to operate in a challenging environment in 2004. We have taken steps to reduce costs and improve our management information systems with a view to operating this business more efficiently and increasing our operating margins. During 2004, we closed 10 of our retail stores. We recorded revenues of approximately US$67 million and operating income of approximately US$542 thousand in 2004 as a result of these measures, representing a reversal from an operating loss of approximately US$7.1 million in 2003. However, we believe that our music distribution business is likely to continue to face a difficult operating environment going forward.
We operate our music distribution business through G-Music, our 58.58% owned subsidiary,
KBT,whichare focused on consumer and corporate users, respectively. Offline, we operate Taiwan'sowns Taiwan’s two largest retail musicstoredistribution chains, Rose Records and Tachung Records. We acquired our interests in Rose Recordsthrough our subsidiary G-Music. These businesses were acquiredand Tachung Records in a series of transactions in February 2002, September 2002 andSeptemberDecember 2002, and have consolidated the results of2002, respectively,operations of the acquired businesses from the respective dates of acquisition. See Note 3 of our consolidated financial statements for additional information.Some of the key factors affecting Taiwan’s retail music distribution industry are technological developments and
together hold approximately 50% current market sharechanging consumer buying habits, which have resulted and are likely to continue to result in an increasing proportion of popular music sales being made through alternative distribution channels, particularly Internet-based downloading and streaming. Consequently, we anticipate that an increasing proportion of physical music distribution will comprise specialized areas of music, such as classical and jazz, whose purchasers demand higher sound quality of physical recordings and who we believe are generally less price-sensitive than purchasers of popular music. The prevalent practice of physical and online music piracy is another factor that has eroded the retail music distribution industry in Taiwan.Online, we operate a leading broadband ISP via our subsidiary Hoshin GigaMedia, which provides Internet access service and broadband content with multiple delivery technologies. Our access products consistApplication of
premium cable modem and ADSL offerings, giving us the ability to deliver superior broadband connections island-wide. Our cable modem is a world-class platform capable of offering broadband Internet access at speeds of up to 100 times faster than traditional dial-up services. With 20 cable system partners, our cable modem business passes more than 3.1 million Taiwan households, as well as 417,000 small and medium businesses. In addition, we offer interactive Chinese-language multimedia Web sites through our Web destination http://www.gigigaga.com. In addition, another subsidiary of our company, Koos Broadband Telecom Limited, or KBT, provides broadband service exclusively to corporate customers. APPLICATION OF CRITICAL ACCOUNTING POLICIESCritical Accounting PoliciesThe discussion and analysis of our financial condition and results of operations are derived from our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the
United States of America,U.S., or U.S. GAAP. The preparation of these financial statements requiresour company and our subsidiariesus to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. We continually evaluate our estimates and assumptions, which are based on historical experience and other various factors that we believe are reasonable under the circumstances. The results of these estimates and assumptions form the basis for making judgments about the carrying values of certain assets and liabilities. Our actual results could differ significantly from those estimates under different assumptions and conditions. We believe that the following discussions address the most critical accounting policies applicable to ourcompany,Company, which are those that are most important to the portrayal of the financial condition and results of operations of ourcompany,Company, and requiremanagement'smanagement’s most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.36ACQUISITION PRICEAcquisition
During 2002, we acquired
Taiwan'sTaiwan’s two leading music store chains, Rose Records and Tachung Records for approximatelyNT$638.9US$18.3 million(NT$418.3 millionfor a 58.58% ownership stake incash, NT$88.0 millionthese businesses. During 2004, we acquired Grand Virtual Inc. and certain ofwhich was not paid and recorded as other current liabilities asits affiliates in a private transaction from the founding shareholders ofDecember 31, 2002, and NT$220.6 million in the formGV Enterprise Voting Trust, through our wholly-owned subsidiary, CESL, for an all-cash consideration ofshares in G-Music).US$32.5 million. In the absence of a quoted market price for the shares ofG-Music issued as a portion of the consideration for the acquisitions of Rose Records and Tachung Records,these businesses, the acquisitionpriceprices of thesemusic store chains isbusinesses were determined based onmanagement'smanagement’s estimates for fair value of acquired net assets, including goodwill and amortizable intangibles. The actual fair value of such acquired net assets may differ significantly frommanagement'smanagement’s estimates.REVENUE RECOGNITION For 2002, our revenue was primarily generated from retail salesWe determined the purchase price allocation based on estimates ofoffline music merchandise comprisedthe fair values ofprerecorded music (including compact discsthe tangible andaudio cassettes), video (including DVDintangible assets acquired andprerecorded videocassettes), video games and other complementary products (including electronics, accessories, blank tapes and CD-Rs). Revenue from these retail sales is recognizedliabilities assumed at thepointdate ofsaleacquisition. These estimates were arrived at with the assistance of independent valuation consultants utilizing recognized valuation techniques. Any excess of cost over the net of the amounts assigned to theconsumer, at which time payment is tendered. Thereassets acquired and liabilities assumed areno provisions for uncollectible amounts since payment is received at the time of sale. In addition, we also recordrecorded as goodwill.Revenue Recognition
We recorded revenues from broadband Internet access services, as well as fee-based services, which mainly include subscription services for videostreaming and paid email services. Such revenues are recognized
infor the period in which the service is performed, if no significant company obligations remain and collection of the receivables is reasonably assured. Customers have a choice of paying either monthly or in advance for a certain period of time, for which they receive corresponding discounts. We record any such advanced payment receipts as other current liabilities on the balance sheet and amortizes such revenues over the subscription period. We contract with third party content providers for certain services related tosubscriptionssubscribed content transmitted to our users and record the fees charged by the third parties as cost of revenues.MERCHANDISE INVENTORY AND RETURN COSTSWe recorded revenues for our entertainment software business through licensing our software and providing support services. These revenues are recognized monthly as a fixed percentage of a licensee’s gross receipts. The results of UIM, our licensee, as of and for the nine months ended December 31, 2004 have been incorporated into our consolidated financial statements. Software licensing and support services revenues we received from UIM have been eliminated in consolidation. See “— A. Operating Results — Overview — Consolidation of UIM Under FIN 46(R)” above. UIM generates revenues by providing and promoting online games of chance and skill. Revenues are recognized upon receipt. End-user account balances are recognized as current liabilities and are accrued for in full. The charge in aggregate end-user account balances is recognized monthly as a reduction to receipts, as are end-user disbursements.
For 2004, our revenues were primarily generated from retail sales of music merchandise comprised of pre-recorded music (including compact discs and audio cassettes), video (including DVD and pre-recorded videocassettes), video games and other complementary products (including electronics, accessories, blank tapes and CD-Rs). Revenues from these retail sales are recognized at the point of sale to the consumer, at which time payment is tendered.
Allowance for Doubtful Accounts
An allowance for doubtful accounts is provided based on management’s evaluation of collectibility of notes receivable, accounts receivables and other receivables. The actual value of such acquired net assets may differ significantly from management’s estimates.
Marketable Securities
Our investments in marketable securities are classified as available-for-sale. Marketable securities included in current assets represent securities with a maturity of less than one year. Securities classified as non-current, including non-equity method investments, have maturity of more than one year. These investments principally consist of debt securities and equity securities of public and privately held companies and investment funds, and are stated at fair value with any unrealized gains or losses recorded in accumulated other comprehensive income (loss) in shareholders’ equity until realized. Unrealized losses that are considered other than temporary are included in the current year’s operations. Realized gains and losses, measured against cost, are also included in the current year’s operations. Equity investments in privately held companies are generally carried at cost. Equity investments in companies over which we have the ability to exercise significant influence, but in which we do not hold a controlling interest, are accounted for under the equity method and our proportionate share of income or losses is recorded in non-operating income or expenses. When an equity investee company issues additional shares at an amount over or under the carrying value of the shares held by us and our ownership interest decreases as a result of not fully subscribing to the issuance, the resulting difference between our investment balance and our proportionate share of the investee company’s net equity is recorded in the current year’s operations.
Marketable Securities – Current
We had approximately US$29.0 million and US$34.3 million investments classified as current marketable securities as of December 31, 2003 and 2004. The balances of unrealized gains from these securities were US$0 and US$577 thousand respectively, as of December 31, 2003 and 2004. See Note 9 of our consolidated financial statements for 2004 for additional information.
Marketable Securities – Non-current
As of December 31, 2004, we had an approximately US$2.9 million investment in Gamania Digital Entertainment Co., Ltd., or Gamania. Our investment represented 4,905 thousand shares or approximately 3.32% ownership in Gamania. We have no ability to exercise significant influence over Gamania’s operating and financial policies. The market price of Gamania’s shares has been below our carrying cost for an extended period of time; therefore, we recorded an other-than-temporary loss of US$1.8 million on December 31, 2004. As of December 31, 2003 and 2004, the balance of unrealized losses was US$460 thousand and US$0, respectively. See Note 12 of our consolidated financials statements for 2004 for additional information.
Merchandise Inventory
Inventory is stated at the lower of cost or market value with cost being determined by the weighted average cost method and market value being determined by net realizable value. As with any retailer, economic conditions, cyclical customer demand and changes in purchasing or distribution can affect the carrying value of inventory. As circumstances warrant, we record the lower of cost or market value, or LCM,
asby adjusting the gross inventoryadjustments.cost with inventory provisions. In some instances, theseadjustmentsprovisions can have a material effect on the financial results in an annual or interim period. In order to determine suchadjustments,provisions, weevaluateestimate theage, inventory turns and estimatedfair value of merchandise inventoryby product categoryand record anyadjustmentprovision if estimated market value is belowcost.cost and if inventory is obsolete. Actual inventory loss may differ significantly from management’s estimates. Through merchandising and other initiatives, we attempt to take the steps necessary to increase the sell-off of slower moving merchandise to eliminate or lessen the effect of anyLCM adjustments. We are entitled to return merchandise purchased from major vendors for credit against other purchases from these vendors within one month. These vendors often reduce the credit depending on the typeinventory provisions.Impairment of
merchandise being returned. We record actual and estimated merchandise return charges in cost of sales. Inventories as of December 31, 2002 were mainly acquired through the business combinations of Rose Records and Tachung Records, and were stated at fair value at the acquisition dates. Therefore, no additional reserve is considered necessary. ALLOWANCE FOR DOUBTFUL ACCOUNTS RECEIVABLE Allowance for doubtful accounts receivable is provided based on evaluations of collectibility, aging analyses of the accounts receivable and management's judgment. A considerable amount of judgment is required in assessing the ultimate realization of these receivables, including the current credit-worthiness and the past collection history of each customer. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowance may be recorded. 37FIXED ASSETS AND DEPRECIATION Fixed assets are stated at cost. Major improvements and betterments to existing facilities and equipment are capitalized. Expenditures for maintenance and repairs that do not extend the life of the applicable asset are charged to expense as incurred. Buildings are depreciated over a 50-year term. Fixtures and equipment are depreciated using the straight-line method over their estimated useful lives, which range from three to five years. Leasehold improvements are amortized using the straight-line method over the shorter of their estimated useful lives or the related lease term. IMPAIRMENT OF LONG-LIVED ASSETSLong-Lived AssetsFixed assets and other long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to undiscounted future net cash flows expected to be generated by the asset over its remaining useful life. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. The estimate of fair value is generally based on quoted market prices or on the best available information, including prices for similar assets and the results of using other valuation techniques. During
2002,2004, werecorded andid not record any asset impairmentchargecharges.Impairment of
NT$40.0 million against our aggregate investment in an Internet company, which impairment had reduced the carrying value of our investment to NT$58.5 million as of December 31, 2002. We reviewed the underlying operating performance, and financial conditions of this Internet company in assessing impairment, and concluded an asset impairment charge is necessary to adjust the carrying value of this investment for an other-than-temporary impairment. During 2002, we also recorded an asset impairment charge related to our investment with EMI Music Asia in GigaMusic.com Limited. We invested NT$240.0 million in GigaMusic.com during 2001 and granted EMI Music Asia 5% of total shares in exchange for certain information, rights and content. The total value of the 5% shares granted to EMI amounted to NT$12.6 million and was recorded as an intangible asset. In addition to the 5% ownership of GigaMusic.com Limited, as of December 31, 2002 we paid EMI Music Asia fees of US$2.0 million. EMI Music Asia has not provided the agreed upon products to GigaMusic.com Limited. The Web site of GigaMusic.com has not been launched and no subscriber revenue has been generated from the project. Therefore, the fair value of the intangible asset and the US$2.0 million payment was considered negligible and we wrote down the balance of these assets and recorded an impairment loss of NT$80.6 million in 2002.Intangible AssetsWe have significant amortizable intangible assets arising from the acquisitions of Rose Records, Tachung Records and
Tachung Records.CESL. The amortizable intangible assetsincluding distribution channel and brand names,are amortized on a straight-line basis over estimated useful lives ranging fromfivetwo to fifteen years. As of December 31,2002,2004, thebalancesbalance ofdistribution channel and brand names were NT$96.2 million and NT$145.8 million, respectively.amortizable intangible assets was US$8.4 million. In determining the useful lives and recoverability of the intangibles, assumptions must be made regarding estimated future cash flows and other factors to determine the fair value of the assets, which may not represent the true fairvalue.value of such assets. If these estimates or their related assumptions change in the future, there may be a significant impact on our results of operations in the period of the change incurred.GOODWILLBased on our impairment test performed in 2004, we did not record any intangible assets impairment loss for 2004. However, as the value of intangible assets and its impairment are determined based on a number of assumptions and management’s estimates a change in assumptions and circumstances in the future may have a significant impact on our results of operations in the period when a change occurred.Impairment of Goodwill
Goodwill represents the adjusted amount of the cost of acquisitions in excess of the fair value of net assets acquired in purchase transactions. Effective January 1, 2002, we adopted Statement of Financial Accounting Standards
(SFAS)No. 142,"Goodwill“Goodwill and Other IntangibleAssets".Assets”, or FAS 142. Under the provisions ofSFASFAS 142, goodwill is no longer subject to amortization and potential impairment of goodwill and purchased intangible assets with indefinite useful lives will be evaluated at leastannually.annually using the specific guidance provided by FAS 142. We periodically evaluate the carrying amount of goodwill to determine whether adjustments to these amounts are required based on current events and circumstances. We perform an analysis of the recoverability of goodwill using a cash flow approach consistent with the analysis of the impairment of long-lived assets. We performed an38impairment test of our goodwill and intangible assetsas of December 31,2002. Due to the general market downturn2004 andthe operating performance of the acquired businesses falling below our expectations, werecordedano goodwill impairment lossof NT$242.9 million in the fourth quarter of 2002. The amount of the loss was determined based on an independent appraiser's reportfor 2004. However, asof December 31, 2002. Asthe value of goodwill and its impairment are determined based on a number of assumptions andmanagement'smanagement’s estimatesthea changeofin assumptions and circumstances in the future may have a significant impact on our results of operations in the period when a change occurred.INCOME TAXESIncome Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and tax loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax assets are subject to valuation allowances based upon the
management'smanagement’s estimate of realizability. Due touncertaintythe strong competition we face in our broadband ISP business and the general market downtrend in our music distribution business, it is uncertain whether we are able to realize our deferred tax asset. We have made an allowance for substantially all the value ofrealization, we have provided 100% valuation allowance againstthe aggregate net deferred tax assetsexcept for one subsidiary, KBT, where the realization was considered more than likely.as of December 31, 2004. Actual results may differ significantly frommanagement'smanagement’s estimate.REVENUESDiscussions of Results of Operations
The financial information in relation to the business segments is provided net of inter-segment transactions.
For the Years Ended December 31, 2003 and 2004
Consolidated Results Of Operations
OPERATING REVENUES. Total operating revenues for 2004 grew by 5% to approximately US$99.8 million from approximately US$95.4 million in 2003. The increase was primarily as a result of the acquisition of our entertainment software business in April 2004 which contributed approximately US$11.5 million or 11% of our total revenues in 2004 and an increase in revenues from our broadband ISP business of approximately US$1.9 million to approximately US$21.4 million, which in total contributed approximately 21% of our total revenues in 2004. This was partially offset by a significant decrease in revenues from our music distribution business by approximately US$8.9 million to approximately US$67.0 million in 2004, which business contributed approximately 68% of our total revenues in 2004.
See “Business Segment Results” below for a discussion of revenues by business segments.
COSTS AND EXPENSES. Costs and expenses decreased by 12% to approximately US$96.8 million in 2004 from approximately US$109.5 million in 2003. The decrease in total costs and expenses was mainly due to a 20% decrease in costs and expenses related to our music distribution business and an 18% decrease in costs and expenses related to our ISP broadband business. Our entertainment software business contributed US$8.7 million to our total costs and expenses for the nine months ended December 31, 2004.
See “Business Segment Results” below for a discussion of costs and expenses by business segments.
OPERATING INCOME. We had operating income of US$3.0 million in 2004 compared to operating loss of approximately US$14.2 million for 2003.
NON-OPERATING INCOME (EXPENSES). In
2002,2004, our non-operating expenses decreased to approximately US$0.9 million from approximately US$2.9 million for 2003. This was principally due to a significant increase in investment income to approximately US$1.2 million from approximately US$0.5 million in 2003, an increase in other non-operating income to approximately US$0.5 million from approximately US$0.5 million in other non-operating expenses in 2003 and the recognition of a small loss on disposal of property, plant and equipment of approximately US$0.1 million in 2004, compared to approximately US$0.8 million in 2003. In 2004, wegeneratedrecorded an other-than-temporary impairment loss of approximately US$1.8 million for our investment in Gamania, compared with an other-than-temporary impairment loss recorded in 2003 of approximately US$1.7 million related to our write-off of our investment in Rock Internet Corporation.NET INCOME. We had net income in 2004 of approximately US$1.7 million compared to a net loss of approximately US$14.1 million in 2003.
Business Segment Results
Broadband ISP Business
OPERATING REVENUES. Total operating revenues
primarily from: - Sales/rental/installation (Offline Business)increased by 10% to approximately US$21.4 million in 2004 from approximately US$19.5 million in 2003. Such increase was attributable to an increase in total access revenues, which contributed more than 98% of total revenues.Access Revenues.
We generateAccess revenues increased by 11% to approximately US$21.0 million in 2004 from approximately US$18.8 million in 2003, mainly as a result of the significant growth of our corporate broadband ISP business. Of the total access revenuesprimarilyrecorded for 2004, consumer access revenues through Hoshin GigaMedia were approximately US$16.0 million, while corporate access revenues through KBT were approximately US$5.0 million. While revenues from our corporate ISP business represented only 24% of our total access revenues in 2004, they demonstrated a growth of 34% to approximately US$5.0 million in 2004 from approximately US$3.7 million in 2003, compared to a moderate growth of 6% to approximately US$16.0 million in 2004 in our consumer ISP business from approximately US$15.1 million in 2003.The number of our consumer broadband subscribers decreased from 102,940 as of December 31, 2003 to 94,520 as of December 31, 2004, of which 18,608 were two-way cable modem subscribers and 73,800 were ADSL subscribers. In the fourth quarter of 2004, the average blended access revenues per broadband subscriber per month (ARPU) for access services was approximately US$12.40, as compared to approximately US$12.60 for the fourth quarter of 2003. ARPU for two-way cable modem and ADSL services was approximately US$16.50 and US$11.80, respectively, during the fourth quarter of 2004, as compared to approximately US$17.30 and US$12.00, respectively, for the same services during the fourth quarter of 2003.
Sale/rental revenues. Sale/rental revenues decreased 9% from approximately US$120 thousand for 2003 to approximately US$109 thousand for 2004 resulting mostly from a decrease in sales of
merchandisemodems.COSTS AND EXPENSES. Total costs and expenses decreased by 18% from approximately US$25.0 million in
our offline operations, comprised of prerecorded music (including compact discs and audio cassettes), video (including DVD and prerecorded videocassettes), video games and other complementary products (including electronics, accessories, blank tapes and CD-Rs). - Sales/rental/installation (Online Business). We include under this line item sales from our online business, consisting2003 to approximately US$20.4 million in 2004, mainly as a result of thefollowing: Modemsignificant decline in general and administrative expenses and operating costs, offsetting the increase in selling and marketing expenses.Cost of sales/
rental. We generate revenuesrental/installation. Cost of sales/rental/installation decreased 26% fromproviding cable modemsapproximately US$0.9 million in 2003 toour Internet access services subscribers. To promote our broadband Internet access services, we provide cable modemsapproximately US$0.6 million in 2004, due toour subscribers forarefundable deposit of NT$3,000 for 1-way modems, and a deposit of NT$1,000 for 2-way modems. We experienced a decrease of salesfall in the price of cable modems,in 2002decreased sales as well as the use of refurbished cable modems during 2004.Operating costs.Operating costs decreased by 9% from approximately US$15.2 million for 2003 to approximately US$13.9 million for 2004 due to
decreased sales promotions and an increased emphasis on rentals. Although the number of rentals in 2002 increased, the rental fee declined due to market competition. We expect the conditions to remaindecreases in themedium termprice of leasing bandwidth anddo not foresee significant increasescircuits.Product development and engineering expenses.Product development and engineering expenses decreased by approximately 9% from approximately US$1.2 million in
revenues from modem sales and rentals going forward. We also booked revenues under modems sales2003 to approximately US$1.1 million in2002 from sales2004 as a result of ourADSL retail packs. We sell ADSL packs via telemarketing, online promotions and select store sales. We provide ADSL software to users, while Chunghwa Telecom provides the telecommunications network and ADSL modems to subscribers, connects customers to Chunghwa's transfer mode network and aggregates the telephone lines into our servers. Subscibers are billed by us depending on the package the customer selects. Modem Installation. We earn revenues from the one-time fees we charge for the installation of cable modems at subscribers' homes. For onsite installations, we generally charge a fee of NT$1,000 per installation for 1-way service. There is no installation charge for 2-way service. We generally pay our cable partners NT$500 per installation and recognize our revenues net of these payments. In August 1999, we started charging our subscribers for maintenance services. Charges currently range from NT$500 to NT$1,000 per maintenance visit, plus repair costs, if any. 39- Access fees. In our online business operations, we receive access fees from subscribers of our broadband Internet access services. As part of our revenue sharing arrangements with our cable partners with respect to each subscriber's monthly access fee, we keep NT$300 of the fee and generally 55% to 65% of any amount in excess of NT$300. We recognize our access revenues net of payments to our cable partners under the revenue sharing arrangements. Our 2-way cable broadband service packages are offered at NT$1,199 for premium service; NT$850 for a mid-tier package; and NT$699 for basic service. We also have offered selected subscribers discounts on their monthly access fees and quarterly payment options to further promote our access services. We recognize our revenue from access fees net of split with cable partners and these discounts. We expect to continue to offer periods of free services and discount promotions in 2003. During 2002, we offered our broadband subscribers two types of subscription packages for 1-way cable modem access (1) a flat rate at NT$599 per month and (2) a metered rate at NT$299 for 30 free hours plus NT$0.25 per minute passing the 30 hour mark, or a metered rate at NT$50 for 100 free minutes plus NT$0.5 per minute passing the 100 minute mark. Going forward, our product mix will continue to change in response to market dynamics. As more fully described below, we also offered seven ADSL service options in 2002, increasing from five service options in 2001, which have from time to time been promoted with periods of discounted Internet access service for subscribers to our services. We receive 100% of our ADSL access service fees. Chunghwa Telecom receives 100% of ADSL service circuit fees. - The first package (1.5Mbps download and 1 fixed IP) is priced at NT$1,598 per month, with users paying NT$699 to us and an NT$899 circuit fee to Chunghwa Telecom. - The second package (768Kbps download and 1 fixed IP) is priced at NT$1,199 per month, with users paying NT$399 to us and an NT$800 circuit fee to Chunghwa Telecom. - The third package (512Kbps download and 1 fixed IP) is priced at NT$894 per month, with users paying NT$299 to us and an NT$595 circuit fee to Chunghwa Telecom. - The fourth package (1.5Mbps download and 8 fixed IPs) is priced at NT$1,294 per month, with users paying NT$599 to us and an NT$695 circuit fee to Chunghwa Telecom. - The fifth package (1.5Mbps download and 8 fixed IPs) is priced at NT$7,299 per month, with users paying NT$6,400 to us and an NT$899 circuit fee to Chunghwa Telecom. - The sixth package (768Kbps download and 8 fixed IPs) is priced at NT$3,000 per month, with users paying NT$2,200 to us and an NT$800 circuit fee to Chunghwa Telecom. - The seventh package (512Kbps download and 8 fixed IPs) is priced at NT$2,399 per month, with users paying NT$1,500 to us and an NT$899 circuit fee to Chunghwa Telecom. Our subsidiary KBT also receives access fees from subscribers of high-speed Internet access services. KBT delivers dedicated and high speed Internet access to a selected group of corporate customers over fiber optical lines. The monthly fee for this type of access services ranges from NT$25,000 to NT$200,000, depending on the level of bandwidth, but the fee is generally discounted by between 25% and 50% versus the incumbent fixed line carrier. - Web development. We startedcontinued effort to de-emphasize this aspect of our operations.Selling and marketing expenses.Selling and marketing expenses increased by approximately 18% from approximately US$2.4 million in 2003 to approximately US$2.9 million in 2004, primarily due to reclassification of certain general and administrative expenses as selling and marketing expenses and hiring of additional sales staff in the corporate ISP business, which is partially offset by reduction in marketing expenses and related activities.
General and administrative expenses.General and administrative expenses decreased by 38% from approximately US$3.6 million in 2003 to approximately US$2.2 million in 2004 due to reclassification of certain general and administrative expenses as selling and marketing expenses.
OPERATING INCOME. We had an operating income of approximately US$1.0 million in 2004, compared to an operating loss of approximately US$5.5 million in 2003.
Entertainment Software Business
We acquired our entertainment software business in
2001. We booked no revenue fromApril 2004 and incorporated into ourWeb developmentconsolidated financial statements as of and for the nine months ended December 31, 2004. As this businessfor 2002. Going forward, we may occasionally design and develop Web sites for selected content providerswas acquired during 2004, year-over-year comparisons of this business segment are not available. See Note 4 of ourWeb destination and charge these partners onconsolidated financial statements for aproject-by-project basis. We expect the Web development revenues going forward will continue to be immaterial to oursummary of unaudited pro-forma results ofoperations. - Advertisingoperations for the years ended December 31, 2003 andpromotional revenue. InDecember 31, 2004 as if the acquisition of ouroffline musicentertainment software businessunit, we receive marketing/sales promotional revenue from record companieshad occurred on January 1, 2003 and 2004. The operating results of our entertainment software business, post-acquisition, forprominent in-store placement of CDs and posters in our store chains. In our online business unit, we earnthe nine months ended December 31, 2004 were as follows:OPERATING REVENUES. Total operating revenues
from displaying banner advertisements and broadband sponsorship advertisementfor the nine months ended December 31, 2004 were approximately US$11.5 million. Based on ourWeb destinations. For 40banner advertisement,revenue-sharing agreement with UIM, we recognized software licensing and support service revenues of approximately US$7.3 million from UIM during theaverage CPM is at NT$15-20 CPM. Wesame period. Such revenues havede-emphasized the online advertisement business since early 2001. - Other. Other revenues are generated from subscription services with respect to our paid online content and special broadband projects. The revenues are expected to vary significantly from time to time.been eliminated in consolidation. See “— A. Operating Results — Consolidation of UIM Under FIN 46(R)”.COSTS AND
EXPENSES During 2002, we incurred two accelerated expenses: one related to goodwill from the acquisitions of Rose RecordsEXPENSES. Costs andTachung Records and the other related to amortization of our licensing payment to our partner EMI Music Asia. Theseexpenses wererecorded under costs and expenses in 2002. Each expense is listed as a separate line item inapproximately US$8.7 million for theConsolidated Statement of Operations included elsewhere in this annual report. Expenses related to goodwill resulted from our adoption of SFAS No. 142 during 2002. In addition to discontinuing the practice of amortizing goodwill against income, this new standard introduces more rigorous criteria for determining the amount of goodwill that may be reflected as an asset on a company's balance sheet. SFAS No. 142 requires companies to perform annual impairment tests of goodwill and other intangible assets. Under the new standard, reductions in the carrying value of goodwill resulting from the application of the new criteria are reported as operating expense in the income statement. Following an independent appraisal of our intangible assets, we wrote off goodwill associated with our music businesses, Rose Records and Tachung Records, that were acquired in 2002, recording an impairment loss of NT$242.9 million (US$7.0 million). In 2001, we and EMI Music Asia invested in GigaMusic to develop a paid online music site. The value of shares of GigaMusic granted EMI in exchange for certain rights and services was recorded as our intangible asset. As ofnine months ended December 31,2002, we performed an impairment test of such intangible asset as well as related payments. Due to the facts that EMI has not provided the agreed-upon products to GigaMusic, the site has not been launched and no subscriber revenue has been generated from the project, the fair value of the intangible asset related to this investment, together with the US$2.0 million dollar payments by us in connection with this investment, was considered negligible. As a result, we wrote down the balance of these assets and recorded an impairment loss of NT$80.6 million (US$2.3 million) in our operating results for 2002. Our2004, consisting mainly of:Operating costs
and expenses consist of the following: - COSTS OF SALES/RENTAL/INSTALLATION. Cost of sales/rental/ installation includes costs of goods sold in our offline music stores. It also includes the cost of cable modems sold and/or provided to our subscribers, as well as ADSL sales, depreciation of cable modems leased to our subscribers and costs incurred in connection with installing cable modems for and providing maintenance services to our subscribers in our online business unit. The cable modems rented to our subscribers are depreciated over a term of three to five years. - OPERATING COSTS.. Operating costsconsist of direct costs associated withwere approximately US$1.6 million for thedaily operation of our offline music business unit. Operating costs also include telecommunications expenses, including charges for domestic and international Internet backbones and telecommunications circuitry; salaries of operating and customer service staff; amortization of technology license fees; depreciation and maintenance of equipment other than cable modems; allocated cost of facilities; and costs associated with contentnine months ended December 31, 2004.Product development and
acquisition. A large portion of our operating costs is relatively fixed in the short term and we expect to be able to decrease our costs and improve our operating margins. - PRODUCT DEVELOPMENT AND ENGINEERING EXPENSES.engineering expenses.Product development and engineering expensesconsist primarily of salarieswere approximately US$1.4 million for the nine months ended December 31, 2004.Selling and
related costs for network design and optimization, information system development and customization and content infrastructure enhancement; 41fees to outside contractors and consultants; allocated cost of facilities; and depreciation and maintenance on the equipment used in our product development and engineering processes. - SELLING AND MARKETING EXPENSES.marketing expenses.Selling and marketing expensesconsist primarily of advertisingwere approximately US$3.4 million for the nine months ended December 31, 2004.General and
promotionaladministrative expensesstore operating costs, including salaries, commissions and related personnel expenses and store rental, and costs associated with the development of sales and marketing materials, direct mail and telemarketing. We expect our selling and marketing expenses to remain flat or slightly decrease going forward as a result of tighter expense controls and cross marketing initiatives. - GENERAL AND ADMINISTRATIVE EXPENSES..General and administrative expensesconsist primarily of salarieswere approximately US$2.2 million for the nine months ended December 31, 2004.OPERATING INCOME. Operating income was approximately US$2.8 million for the nine months ended December 31, 2004.
Music Distribution Business
OPERATING REVENUES. Total operating revenues from our
executive, administrative, financemusic distribution business decreased by 12% to approximately US$67.0 million in 2004 from approximately US$75.8 million in 2003. This decrease was due to an overall market downtrend andhuman resource personnel; fees for professional services; share compensation expenses and cost of computersour strategy tosupport our operations. We recognize compensation associated with equity instruments granted to employees and non-employees in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, (APB 25) and Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, (SFAS 123), respectively, over the vesting period of the instrument.shut down unprofitable stores. In addition,we incur expenses associated with beingconsumers continue to shift to digital music distribution and piracy remains aU.S. listed company, including costsserious challenge to the industry.Sales/rental revenues.Sales/rental revenues decreased by 12% from approximately US$74.3 million in 2003 to approximately US$65.5 million in 2004 due to a general market downtrend and the closing of
directors' and officers' insurance, and increased legal and accounting fees. - BAD DEBT EXPENSE. Allowances for doubtful accounts receivable consist of bad debt reserves for estimated losses resulting from the inabilitya number of ourcustomersstores.Promotional and advertising revenues. Promotional and advertising revenues decreased by 5% from approximately US$1.6 million in 2003 to
make required payments,approximately US$1.5 million in 2004 due to a general market downtrend.COSTS AND EXPENSES. Total cost and expenses decreased by 20% to approximately US$66.4 million from approximately US$82.9 million in 2003. This decrease was attributable to a decrease in sales and better inventory control which
is provided based on evaluations of collectibility, aging analyses oflowered associated costs and inventory provisioning.Sales/rental costs. Sales/rental costs decreased by 19% to approximately US$52.0 million in 2004 from approximately US$64.4 million in 2003, primarily due to a decrease in sales.
Operating costs.Operating costs decreased by 96% to approximately US$122 thousand in 2004 from approximately US$2.9 million in 2003, due to better inventory control, which reduced inventory provisions.
Selling and marketing expenses. Selling and marketing expenses decreased by 12% to approximately US$11.3 million in 2004 from approximately US$12.8 million in 2003, mainly due to strict cost controls in keeping with the
accounts receivablegeneral market downtrend andmanagement's judgment. We record specific allowances for bad debts when we become aware ofaspecific customer's inability to meet its financial obligation to us, such asdecrease in thecasenumber ofbankruptcy filings or deteriorationretail stores operated by us.General and administrative expenses.General and administrative expenses decreased by 10% from approximately US$2.8 million in 2003 to approximately US$2.5 million in 2004 due to strict cost controls in keeping with the general market downtrend.
OPERATING INCOME. Operating income was approximately US$542 thousand in 2004, compared to an operating loss of
financial position. In addition, estimates are usedapproximately US$7.1 million indetermining our allowances for all other customers based on factors such as current trends, the length of time the receivables are past due and historical collection experience. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. In 2001, we made bad debt allowances of 22.7% and 6.4% for accounts receivable related to subscribers and non-subscribers, respectively. In 2002, we made bad debt allowances of 40.7% and 17.4% for accounts receivable related to subscribers and non-subscribers, respectively. DISCUSSIONS OF RESULTS OF OPERATIONS2003.For the Years Ended December 31,
20012002 and2002 CONSOLIDATED RESULTS OF OPERATIONS2003Consolidated Results Of Operations
OPERATING REVENUES. Total operating revenues for
20022003 grew522%29% toNT$2.6 billion (US$73.7 million)approximately US$95.4 million fromNT$411.0approximately US$74 million in2001, mainly2002, primarily due to the contributions of the Rose Records and Tachung Records music store chains thatwerewe acquired in 2002. For2002,2003, theofflineretail music distribution business contributed approximatelyNT$1.9 billion (US$54.5 million)US$75.8 million, or74%80% of our revenues. TheInternet access servicesbroadband ISP business contributed approximatelyNT$638.9US$19.5 million,(US$18.4 million)or25%20% of our revenuesincreased from NT$389.8 million for 2001.in 2003.COSTS AND EXPENSES. Costs and expenses increased by
38%12% toNT$3.4 billion (US$97.4 million)approximately US$109.5 million in20022003 fromNT$2.4 billionapproximately US$97.8 million in2001. The increase was mainly due to (1) the2002. Our costs and expenses in 2003 primarily consisted of cost ofsalessales/ rental/ installation ofNT$approximately US$65.2 million, operating costs of approximately US$18.1 million, product development and engineering expenses of approximately US$1.2 million, selling and marketing expenses of approximately US$14.5 million, general and administrative expenses of approximately US$8.0 million and an impairment loss on property, plant and equipment of approximately US$1.6billion (US$47.0 million) in 2002 derived from the newly acquired off-line business in 2002; and (2) the recorded impairment losses of NT$242.9 million (US$7.0 million) and NT$80.6 million (US$2.3 million) on goodwill and intangibles, respectively, in 2002. This increase was partially offset by the decreases in expenses in relation to share compensation expenses and Microsoft's warrant, from NT$1.1 billion in 2001 to NT$5.3 million (US$153 thousand) in 2002.million.OPERATING LOSS. Operating loss for
20022003 decreased59%by 41% toNT$824.7approximately US$14.2 million(US$23.8 million) 42from NT$2.0 billionapproximately US$23.9 million for2001.2002.NON-OPERATING
INCOME. For 2002,EXPENSES. In 2003, we incurred non-operating expenses of approximately US$2.9 million, compared to a non-operating incomedeclined by 50% to NT$108.7 million (US$of US$3.1million) from NT$219.2million for2001,2002, principally due toaan approximately US$1.7 million write-off of our investment in Rock Internet Corporation and the recognition of a foreign exchange lossresultingof approximately US$0.7 million and loss on disposal of property, plant and equipment of approximately US$0.8 million in 2003, compared to a foreign exchange gain of approximately US$2.7 million and gain on disposal of investment of approximately US$3.3 million, offset by an approximately US$2.0 million loss from the change of our percentage of ownership in G-Music from 100% to58%58.58% as a result of the acquisitions of Rose Records and TachungRecords.Records and an approximately US$1.2 million impairment loss on a long-term investment in Rock Internet Corporation in 2002.NET LOSS. Net loss for
20022003 declined by65%,24% toNT$638.0approximately US$14.1 million(US$18.4 million)fromNT$1.8 billionapproximately US$18.5 million for2001. BUSINESS SEGMENT RESULTS OFFLINE SERVICES We acquired Rose Records and Tachung Records during2002.We began to consolidate the results of operations of Rose Records and Tachung RecordsBusiness Segment Results
Broadband ISP Business
OPERATING REVENUES.Total operating revenues increased slightly by 1% from
the respective closing dates of the acquisitions. Since these businesses were acquired during 2002, year over year comparisons of this business segment are not available. The operating results of GigaMedia's offline music business, post acquisition, were as follows: TOTAL REVENUES. Total revenuesapproximately US$19.3 million in 2002were NT$1.9 billion (US$54.5 million), including retail sales of NT$1.9 billion (US$53.6 million) and advertising and promotional revenues of NT$30.4to US$19.5 million(US$876.1 thousand). COSTS OF SALES. Cost of sales were NT$2.2 billion (US$63.4 million)in2002. OPERATING MARGIN. Operating loss was NT$340.8 million (US$9.8 million) in 2002. NET LOSS. Net loss in 2002 was NT$340.7 million (US$9.8 million). ONLINE SERVICES ACCESS REVENUES.2003.Access revenues. Total access revenues
grew 64%increased slightly fromNT$389.8approximately US$18.5 millionfor 2001in 2002 toNT$638.9approximately US$18.8 million(US$18.4 million) for 2002, primarilyin 2003, due tothe increasemigration ofaccess fees relatingsubscribers tothe continuous rollout of ADSL services and the growth of these subscribers, offset by a reduction in the number of 1-way subscribers in 2002.higher specification products. The number of our broadband subscribers decreased from119,130 as of December 31, 2001 to108,016 as of December 31,2002.2002 to 102,940 as of December 31, 2003. As of December 31,2002,2003, we had17,135 1-way6,653 one-way subscribers,17,308 2-way18,450 two-way subscribers, and73,57377,837 ADSL subscribers. In the fourth quarter of2002,2003, the average blended access fee per broadband subscriber per month (ARPU) for access services wasaround NT$388 (US$11.18),approximately US$12.60, as compared toNT$341US$11.60 for2001.the fourth quarter of 2002. ARPU for1-wayone-way cable services,2-waytwo-way cable services and ADSL serviceswere NT$231, NT$618was US$7.00, US$17.30 andNT$363,US$12.00, respectively, during the fourth quarter of2002,2003, as compared toNT$287, NT$589US$6.70, US$17.90 andNT$312,US$10.50, respectively, for the same services during the fourth quarter of2001.2002.Of the total access revenues recorded for
2002,2003, consumer access revenues through Hoshin GigaMedia were approximatelyNT$562.4US$15.1 million,(US$16.2 million),while corporate access revenues through KBT were approximatelyNT$76.5 million (US$2.2 million). MODEM SALE/RENTAL/INSTALLATION REVENUES. Modem sale/rental/installationUS$3.7 million.Sales/rental revenues. Sales/rental revenues decreased
42%5% fromNT$7.5 millionapproximately US$126 thousand for20012002 toNT$4.4 million (US$126 thousand)approximately US$120 thousand for2002,2003, resulting mostly from a decrease in sales ofmodems, which was partially offset by an increase in modem rentals revenue resulting from an increase in the number of rentals in 2002, but declining rental fees. We terminated free rental promotions on one-way cable service and modem sales in 2001 to controlmodems.COSTS AND EXPENSES. Total costs and
grow margins. 43WEB DEVELOPMENT REVENUES. Web development revenuesexpenses decreased by 23% to approximately US$25.0 million in 2003 fromNT$7.2approximately US$32.5 millionfor 2001 to nil for 2002, as we de-emphasized this aspect of our business. We expect to record Web development revenues going forward on a limited project-by-project basis in the future. ADVERTISING REVENUES. Advertising revenues decreased 52% from NT$5.0 million for 2001 to NT$2.4 million (US$69 thousand) for 2002 as we continued to de-emphasize this aspect of our businessin 2002.OPERATING COST. Operating costsThis decrease was due to a decrease in operating cost, cost of sales/rentals, product development and engineering expenses and selling and marketing expenses.Cost of sales/rental. Cost of sales/rental decreased
61%by 45% from approximately US$1.6 million in 2002 toNT$634.9 million (US$18.3 million) compared to NT$1.6 billion in 2001. There was a decrease in share compensation expense from 2001 of NT$14.1 million to NT$740approximately US$873 thousand in2002. During 2001, we incurred amortization of Microsoft's warrant of NT$943.1 million, including an accelerated expense of approximately NT$428.7 million recognized during the fourth quarter in 2001 related to the remaining amount of the warrant. COST OF MODEM SALES/RENTAL/INSTALLATION. Cost of modem sales/rental/installation decreased 62% from NT$143.4 million for 2001 to NT$54.6 million (US$1.6 million) for 2002,2003, due to a fall in the price of cable modems, decreased salesandas well as the use of refurbished cable modems during2002. WEB DEVELOPMENT EXPENSES. Web2003.Operating costs. Operating costs decreased by 17% from approximately US$18.4 million in 2002 to approximately US$15.2 million in 2003 due to a decrease in the price of leasing bandwidth and circuits.
Product development
expenses decreased from NT$12.2 million for 2001 to nil for 2002, in line with our de-emphasis of this aspect of our business. PRODUCT DEVELOPMENT AND ENGINEERING EXPENSES.and engineering expenses. Product development and engineering expenses decreased39%35% fromNT$106.5approximately US$1.9 millionfor 2001in 2002 toNT$64.4US$1.2 million(US$1.9 million) for 2002,in 2003, primarily due to reduced costs relating to workforce streamlining in20022003 and a de-emphasis on this aspect of our operations.SELLING AND MARKETING EXPENSES.Selling and marketing expenses. Selling and marketing expenses decreased
50%by 41% fromNT$285.6approximately US$4.1 million in20012002 toNT$141.5approximately US$2.4 million(US$4.1 million)in2002,2003, primarily due totightened expenditure controls during 2002significantly reduced advertising in Taiwan’s media for GigaMedia’s broadband services.General and
a decrease in share compensation expense from 2001 of NT$11.9 million to NT$52.4 thousand in 2002. GENERAL AND ADMINISTRATIVE EXPENSES.administrative expenses. General and administrative expensesdecreased 33%increased 7% fromNT$215.7approximately US$3.3 millionfor 2001 to NT$143.5 million (US$4.1 million)in 2002drivento approximately US$3.6 million in 2003.OPERATING LOSS. Operating loss decreased by
reductions58% to approximately US$5.5 million in 2003 from approximately US$13.2 million in 2002.Music Distribution Business
We began to consolidate the results of operations of Rose Records in February 2002 and the results of operations of Tachung Records in October 2002. Consequently, a comparison of the consolidated results of operations of our
workforcemusic distribution business in 2003 andtight expense controls2002 principally reflects the impact of consolidating these businesses for portions of 2002 and all of 2003. This and the impact of SARS on our 2003 results of operations makes it difficult to compare our results of operations in the two periods. We briefly describe below the principal trends affecting the revenues and cost of sales of our underlying music distribution business in 2003:Revenues. Our revenues in the first and second quarters of 2003 were adversely affected by the SARS outbreak, which particularly impacted our sales from April through July. We believe that our competitors were similarly affected. Decisions by major record companies to defer the release of popular titles until it became clear that the SARS outbreak had been contained, contributed to a smaller than usual seasonal increase in revenues during the summer school vacation season and mitigated the effect of seasonality on sales in the fourth quarter.
Cost of sales. Gross margins generally improved through 2003. We believe this principally reflected a combination of fewer popular records being released in 2003 and improved purchasing terms resulting from management changes in the third quarter of 2003.
We present below information on the results of operations of our music distribution business in 2002 and
a decrease2003.OPERATING REVENUES. Total operating revenues from our music distribution business increased by 39% to approximately US$75.8 million in
share compensation expense2003 from2001 of NT$91.4 million to NT$4.0approximately US$54.7 million in 2002.NET NON-OPERATING INCOME. For 2002, non-operating income declined 51% from NT$219.2 millionThis increase was due in part to the fact that we consolidated the results of operations of Rose Records and Tachung Records for2001 to NT$108.5 million (US$3.1 million), primarily due to a decrease in cash and investmentsthe full year of 2003, whereas in 2002,resulting in a lower asset base. We recognized non-operating income as a resultwe had consolidated their results of operations from their respective closing dates of thegainacquisitions, namely, February 2002, September 2002 and December 2002.COSTS AND EXPENSES. Total costs and expenses increased by 28% to approximately US$82.9 million in 2003 from
disposal of short-term investments of NT$62.8approximately US$64.6 million(US$1.8 million), derived primarily fromin 2002. This increase was due in part to oursale of mutual fund beneficiary certificates and the gain from disposal of long-term investments in Gamania and a UBS AG Jersey Bond amounting to NT$51.8 million (US$1.5 million). We also recorded an impairment loss in 2002 in the amount of NT$40.0 million related our long-term investment in Rock Internet Corporation. FOR THE YEARS ENDED DECEMBER 31, 2000 AND 2001 ACCESS REVENUES. Total access revenues grew 151% from NT$155.0 million for 2000 to NT$389.8 million for 2001, primarily related to the rollout of ADSL services and the growth of these subscribers, as well as growth in the number of 2-way subscribers, offsetting a reduction in the number of 1-way subscribers in 2001. The number of our broadband subscribers increased from 60,288 as of December 31, 2000 to 119,130 as of December 31, 2001. At year-end of 2001, we had 42,834 1-way subscribers, 17,278 2-way subscribers, and 59,018 ADSL subscribers. Asconsolidation of thefourth quarterresults of2001, the average access fee per broadband subscriber per monthoperations of Rose Records and Tachung Records foraccess services was around NT$341. Of the total access revenues recorded during 2001, consumer access revenues through Hoshin GigaMedia werefull year 2003.OPERATING LOSS. Operating loss decreased by 28% to approximately
NT$377.5 million, while corporate access revenues through KBT were approximately NT$12.3 million. MODEM SALE/RENTAL/INSTALLATION REVENUES. Modem sale/rental/installation revenues decreased 94% from NT$126.8 million for 2000 to NT$7.5 million for 2001, resulting mostly from termination of cable 44modem subsidization. We terminated free rental promotions on one-way cable service and modem sales in 2001, consistent with our efforts to control costs and grow margins. WEB DEVELOPMENT REVENUES. Web development revenues decreased 75% from NT$28.9 million for 2000 to NT$7.2 million for 2001, as we de-emphasized this aspect of our business. We expect to record Web development revenues going forward on a limited project-by-project basis. ADVERTISING REVENUES. Advertising revenues decreased 81% from NT$26.8 million for 2000 to NT$5.0 million for 2001. The decrease was primarily related to the downturn in advertising markets and de-emphasis of this aspect of our business in 2001. We do not expect advertising revenues to make a significant contribution to our total revenues going forward. OTHER REVENUE. We recognized other revenues generated from special broadband projects. Other revenues decreased 60% from NT$3.6 million for 2000 to NT$1.4 million for 2001. Other revenues are expected to vary significantly from time to time. OPERATING COST. Operating costs increased 66% in 2001 to NT$1.64 billion compared to NT$987.3US$7.1 million in2000, primarily related to three factors: an 83% increase in the amortization of Microsoft's warrant; a 101% increase in telecommunications expenses; and a 159% increase in depreciation of network equipment. During 2001, we incurred amortization of Microsoft's warrant of NT$943.1 million, including an accelerated expense of2003 from approximatelyNT$428.7 million recognized during the fourth quarter in 2001 related to the remaining amount of the warrant. We incurred telecommunications expenses of NT$264.4 million to support the growth of our subscriber base. Depreciation of network equipment other than cable modems also contributed to the increase of our operating costs and other expenses for 2001, amounting to NT$87.9 million. Offsetting these increases in operating costs, amortization of technology license fees decreased 74% from NT$18.7US$9.9 million in2000 to NT$4.9 million in 2001 as the amortization period ended in the second quarter. In addition, content department related expenses declined significantly during 2001 as a result of our restructuring. There was a decrease in share compensation expense from 2000 of NT$20.2 million to NT$14.1 million in 2001. COST OF MODEM SALE/RENTAL/INSTALLATION. Cost of modem sales/rental/installation decreased 49% from NT$279.0 million in 2000 to NT$143.4 million in 2001, due to decreased sales, use of refurbished cable modems,2002.B. Liquidity and
a decline in the price of cable modems of approximately 66% during 2001. WEB DEVELOPMENT EXPENSES. Web development expenses decreased 47% from NT$23.2 million in 2000 to NT$12.2 million in 2001, in line with our suspension of this aspect of our business. We incurred Web development expenses in connection with our design and development of a Web site for one of our content providers during the first quarter of 2001. PRODUCT DEVELOPMENT AND ENGINEERING EXPENSES. Product development and engineering expenses increased 88% from NT$56.6 million in 2000 to NT$106.5 million in 2001, primarily due to share compensation expenses and an increase in staff prior to our restructuring and workforce streamlining in April 2001. SELLING AND MARKETING EXPENSES. Selling and marketing expenses decreased 26% from NT$383.9 million in 2000 to NT$285.6 million in 2001. We achieved lower selling and marketing expenses and increased operating efficiencies in 2001 in part by shifting sales and marketing expenses to GigaMedia's strategic partners and utilizing a bundled marketing approach. Advertising expenses decreased 58% to NT$135.8 million in 2001, resulting from our de-emphasis of our advertising business, an increased focus on direct marketing, and tight cost controls. There was a decrease in share compensation expense from 2000 of NT$17.1 million to NT$11.9 million in 2001. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses decreased 9% from NT$235.9 million in 2000 to NT$215.7 million in 2001. There was a decrease in share compensation expense from 2000 of NT$145.5 million to NT$91.4 million in 2001. 45NET NON-OPERATING INCOME. Non-operating income declined 48% from NT$424.0 million in 2000 to NT$219.2 million in 2001, resulting partially from declining interest rates impacting our interest income. In addition, cash and investments decreased, resulting in a lower asset base. We recognized non-operating income in 2001 largely as a result of net interest income of NT$32.5 million and gain from disposal of short-term investments of NT$201.8 million, derived primarily from our sale of mutual fund beneficiary certificates. We recorded a loss of property, plant and equipment of NT$10.8 million in 2001 for improvements made during our occupancy of offices vacated during 2001. Gain on disposal of long-term investment was NT$11.6 million resulting from the sale of one of our equity investments. Net loss of equity investees was NT$27.8 million during 2001, reflecting the write down of an equity investment whose operations we had deemed impaired and the aforementioned equity investment, which we liquidated during 2001. B. LIQUIDITY AND CAPITAL RESOURCESCapital ResourcesOur principal sources of liquidity consist of cash generated from our operations,
interest generated or derived from the investment instruments we purchased with the proceeds of our initial public offering in 2000 andproceeds generated from the disposal of our investments and interest derived from our investments.We do not relyOur cash and cash equivalents are held primarily in U.S. dollars and NT dollars.Our music distribution business also relies on short-term borrowingsincluding bank loans and commercial paper facilities, or off-balance sheet activitiesto financeour operations, expansions and mergers and acquisitions. Because we historically did not generate positive cash flows from our operations, we have substantially relied on our cash management ability to support ourits operations. Our short-term borrowings were approximately US$284 thousand as of December 31, 2004. In addition, wehave in recent periods reducedcontinued ourworkforce and engaged in corporate restructuringefforts toreducestreamline our operations with a view to reducing the capital requirement of our operations. Our policy with respect to liquidity management is to maintain sufficient cash and cash equivalents to fund operations and strategic transactions, while placing remaining funds in higher yield investment instruments.Our future cash requirements will depend on a number of factors including:
the rate at which we enter into strategic transactions;the rate of which we expand our operations and employee base;the timing of entry into new markets and new services offered;changes in revenue splits with our business partners;the rate at which we invest in improving our products and upgrading and maintaining our network and future technologies;the rate at which subscribers purchase our broadband Internet access services and the pricing of such services;the development of new technologies and products to meet the changing consumer buying habits;inventory management;improvements in our operating margins; andthe effective and efficient marketing and distribution of our products and for acquisition of customers and partners.As a result of our operating, investing and financing activities during 2004, the amount of cash and cash equivalents and marketable securities we held as of December 31, 2004 decreased significantly to approximately US$50.4 million compared to US$79.5 million as of December 31, 2003. Such decrease was primarily attributable to the acquisition of our entertainment software business at an all-cash consideration of US$32.5 million, which we paid for entirely out of our existing cash and cash equivalents, which was partially offset by positive operating cash flows of US$2.4 million in 2004 and net proceeds of US$8.5 million from disposal of marketable securities. We
alsocontinue to seek and review potential merger and acquisition opportunities on an ongoing basis, which may be funded through cash or equity. We do not believe that any potential merger or acquisition that we may be engaged in would alter our goal of preserving sufficient cash and cash equivalents to fund future operations. We believe that our existing cash, cash equivalents, marketable securities and expected cash flow from operations will be sufficient to meet our capital expenditure, working capital, cash obligations under our existing lease arrangements, and other requirements through 2005.OPERATING ACTIVITIES. In 2004, our net cash provided by operating activities amounted to US$2.4 million. This was primarily attributable to collections from customers of US$98.5 million, offset by payments to vendors for the purchases of US$77.2 million and payments for other operating expenses of US$18.9 million.
INVESTING ACTIVITIES. Our
futurenet cashrequirements will depend on a number of factors including: - the expansion and utilization of our music and artist catalog; -used in investing activities in 2004 was US$25.3 million. This was primarily attributable to the acquisition oflicenses to sell/market products; -our entertainment software business of US$32.8 million, including transaction costs, which we largely funded from theeffective and efficient marketing and distributionliquidation of ourproducts; -marketable securities, therate at which subscriberspurchaseour Internet access servicesof property plant and equipment of US$2.6 million and thepricingpurchase ofsuch services; - the rate at which we expandintangible assets of US$663 thousand. In 2003, ouroperations and employee base; - the level of marketing required to acquire new subscribers and cable partners; - the rate at which we invest in upgrading and maintaining our network and future technologies; - the timing of entry into new markets and new services offered; - price competition in the Internet and cable industries; and - changes in revenue splits with our cable partners. Although operating conditions in 2002 were challenging, our financial condition remained stable. As a result of our operating, investing and financing activities during 2002, the amount of cash and cash equivalents we held increased 56% from NT$794.3 million as of December 31, 2001 to NT$1.2 billion (US$35.8 million) as of December 31, 2002. However, at December 31, 2002, cash and cash equivalents, short-term investments and long-term investments totaled NT$2.7 billion (US$78.9 million), down from NT$6.8 billion at December 31, 2001, primarily due to cash distributions as the return of capital to shareholders and the acquisitions of Rose Records and Tachung Records made in 2002. Operating activities. We had significant negative cash flows from operating activities for 2001 and 2002. Cash used in operating activities for 2001 and 2002 was NT$712.3 million and NT$5.3 million (US$153 thousand), respectively. For 2002,net cash used inoperatinginvesting activitieswas primarily the result of a net operating loss of NT$638.0 million (US$18.4 million), largely offset by adjustment of non-cash items, gain 46and loss for short-term investment and changes in working capital.amounted to US$5.0 million.FINANCING ACTIVITIES. Our net
losscash provided by financing activities in20022004 wasadjusted for significant non-cash items, including, among others, depreciation of NT$196.3 million (US$5.7 million), amortization of intangible assets and deferred assets of NT$97.5 million (US$2.8 million), impairment loss on a long-term investment of NT$40.0 million (US$1.2 million), impairment loss on goodwill of NT$242.9 million (US$7.0 million) and impairment loss on intangible assets of NT$80.6 million (US$2.3 million). Investing activities. In 2002, we redeemed short-term investments made in the previous year to support our operations and capital expenditures. We also continued to hold funds in long-term investment instruments and business related securities, which are classified as long-term available-for-sale investments. During 2002, we acquired Taiwan's two leading music store chains, Rose Records and Tachung Records for approximately NT$638.9 million (NT$418.3 million in cash, NT$88.0 million of which was not paid and recorded as other current liabilities as of December 31, 2002, and NT$220.6 million in the form of shares in G-Music). This acquisition is included as an investment activity. During 2002, proceeds from disposal of short-term and long-term investments amounted to NT$4.1 billion (US$118.2 million) and NT$428.8 million (US$12.4 million), respectively. Financing activities. On February 17, 2000, we became the first Taiwan-based Internet company to list on the Nasdaq stock market and raised additional capital of approximately NT$7.8 billion. On January 17, 2002, our shareholders approved a return of capital in the amount ofUS$2 for each ordinary share outstanding and established March 15, 2002 as the record date and March 29, 2002 as the distribution date. The total amount of the return of capital was US$100.3 million, translated into NT$3.5 billion based on the exchange rate at the transaction date. We liquidated short-term investments to support the cash distribution. Other.156 thousand.OTHER. Set forth below are the aggregate amounts, as of December 31,
2002,2004, of our future cash payment obligations under our existing contractual obligations.
Payments Due by Period (in NT$ thousands) ------------------------------------------------------------ Contractual Obligations Total Less than 1 year 1-3 years After 3 years - ----------------------- ----- ---------------- --------- -------------Short-term Loan 93,000 93,000 Operating Lease 580,414 234,650 313,525 32,239 Payable to Equipment Suppliers 441 441 - - ------------------------------------------------------------ Total Contractual Cash Obligations 673,855 328,091 313,525 32,239 ============================================================
Amount of Commitment Expiration Per Period (in NT$ thousands) ------------------------------------------------------------ Other Commercial Commitments Total Less than 1 year 1-3 years After 3 years - ---------------------------- ----- ---------------- --------- -------------Standby Letters of Credit 34,891 34,891 - - ------------------------------------------------------------ Total Other Commercial Commitme 34,891 34,891 0 0 ============================================================47OFF-BALANCE SHEET ARRANGEMENTS Historically, all of our revenues and receivables and a majority of our operating expenses and payables are denominated in NT dollars, which is our functional currency. As our expenses denominated in foreign currencies historically have not been material, we have not used hedging transactions to reduce our exposure to exchange rate fluctuations. We do not engage in any non-derivative financial instruments for speculative purposes. CAPITAL EXPENDITURESCapital Expenditures
We typically finance our capital expenditures through cash holdings. Our gross capital expenditures for equipment and software, furniture and fixtures
declined 12%, from NT$348.2were US$8.8 million, US$1.9 million and US$3.3 million for 2002, 2003 and 2004 respectively. Capital expenditures during 2004 were primarily for the replacement and upgrades of network-related hardware in2001 to NT$304.7 million (US$8.8 million)our consumer and corporate broadband businesses, capitalization of software development for our entertainment software business and also for the point of sale system implemented in2002. The decline was primarily related to the continued execution of stringent cost controls and a managed growth plan during 2002. Approximately 71%every retail store of our music distribution business. Our capitalexpendituresexpenditure plans for 2005 will continue to focus primarily on the replacement and upgrades of network-related hardware in2002 were spent to upgrade both of the two music store chains we acquired in 2002. Gross capital expenditures going forward are expected to remain at a level sufficient to maintain quality service. We expectourcapital expenditures in 2003 to be flat.consumer and corporate broadband businesses and software development for our entertainment software business. We may adjust the amount of our capital expenditures upward or downward based on cash flow from operations, the progress of our expansion plans, and market conditions.We believe that our existing cash, cash equivalents, short-term investments and expected cash flow from operations, will be sufficient to meet our capital expenditure, working capital, cash obligations under our existing lease arrangements, and other requirements through 2003. DIVIDENDS FROM OUR SUBSIDIARIES IN TAIWANDividends From Our Subsidiaries In Taiwan
Under existing laws of Taiwan, dividends, whether in cash or shares of common stock, declared by our subsidiaries incorporated under Taiwan law, including Hoshin GigaMedia, out of retained earnings and distributed to us are subject to Taiwan withholding tax, currently at the rate of 20% for non-Taiwan investors holding a Foreign Investment Approval granted by
Taiwan'sTaiwan’s Ministry of Economic Affairs, such as us, on the amount of any cash dividends or on the par value of any share dividends.FOREIGN CURRENCY EXCHANGE AllForeign Currency Exchange
Effective January 1, 2004, we adopted the U.S. dollar as our reporting currency as operations denominated in the U.S. dollar have represented an increasing portion of our
revenues and receivables and a majoritybusiness following the acquisition of ouroperating expenses and payables are denominated in NT dollars, which is our functional currency. The remaining operating expenses and payables, such as the cost of cable modems and technology license fees, are primarily denominated in U.S. dollars. As a result, ourentertainment software business. Our margins may be impacted by fluctuations of exchangeraterates between the NT dollar and the U.S. dollar, exposing us to foreign currency exchange risks. Because expenses denominated in foreign currencies historically have not been material, we have nottriedsought to reduce our exposure to exchange rate fluctuations by using hedging transactions. However, we may choose so in the future. We recognized a foreign exchangegainloss ofNT$93.9 million (US$2.7 million)US$896 thousand for20022004 anda foreign exchange gain of NT$13.9 million in 2001. RECENT ACCOUNTING PRONOUNCEMENTSUS$723 thousand for 2003.Recent Accounting Pronouncements
In
June 2002,May 2003, theFinancial Accounting Standards Board (FASB)FASB issued Statement of Financial Accounting Standards(SFAS) No.146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No.94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No.146 requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred, rather than at the date of 48commitment to an exit or disposal plan. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. We do not expect that the adoption of SFAS No. 146 will have a material impact on our financial position or results of operations, although SFAS 146 may impact the timing of recognition of costs associated with future restructuring, exit or disposal activities. In December 2002, the FASB issued SFAS No.148, "Accounting for Stock-Based Compensation-Transition and Disclosure-An Amendment of FASB Statement No.123." SFAS No.148 amends SFAS No.123, "Accounting for Stock-Based Compensation," to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No.148 amends the disclosure requirements of SFAS No.123 to require prominent disclosures both in annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. We do not expect that the adoption of SFAS No. 148 will have a material impact on our financial position or our results of operations. In November 2002, the FASB issued Interpretation No. 45 (FIN No. 45), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN No. 45 elaborates on the existing disclosure requirements for most guarantees, including loan guarantees. It also clarifies that at the time a company issues a guarantee, the company must recognize an initial liability for the fair value, or market value, of the obligations it assumes under that guarantee. However, the provisions related to recognizing a liability at inception of the guarantee for the fair value of the guarantor's obligations does not apply to product warranties or to guarantees accounted for as derivatives. The initial recognition and initial measurement provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements of FIN No. 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. We do not believe the adoption of FIN No. 45 will have a material impact on our financial position or results of operations. In November 2002, the Emerging Issues Task Force reached a consensus on Issue No. 00-21 EITF 00-21, "Revenue Arrangements with Multiple Deliverables." EITF 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. We do not believe the adoption of EITF 00-21 will have a material impact on its financial position or results of operations. In January 2003, the FASB issued Interpretation No. 46 FIN No.46, "Consolidation of Variable Interest Entities." Until this interpretation, a company generally included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN No.46 requires a variable interest entity, as defined, to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns. We are currently evaluating the effect of adopting FIN No. 46 on our results of operations and financial position. On May 15, 2003, the FASB issued Statement(“FAS”) No. 150,(SFAS No. 150), "Accounting“Accounting for Certain Financial Instruments with Characteristics of both Liabilities andEquity"Equity” (“FAS No. 150”).SFASFAS No. 150 establishes standards forhow an issuer classifiesclassifying andmeasuresmeasuring as liabilities certain financial instrumentswiththat embody obligations of the issuer and have characteristics of both liabilities and equity.It requires that certain financial instruments be presented as liabilities that were previously presented as equity or as temporary equity. Such instruments include mandatory redeemable preferred and common stocks and certain options and warrants. SFASFAS No. 150 is effective for all financial instrumentsentered intocreated or modified after May 31, 2003 and otherwise isgenerallyeffective at the beginning of the first interim period beginning after June 15, 2003.We are currently evaluating whether SFASThe adoption of FAS No. 150will impact our consolidated financial position and results of operations when adopted. 49INFLATION We dodid notbelieve that inflation in Taiwan, where all of our current business is conducted, has hadhave a material impact onour resultsthe Company’s consolidated financial statements.In November 2004, the FASB issued FAS No. 151, “Inventory Costs, an Amendment of
operations. TAXATIONARB No. 43, Chapter 4,” (“FAS 151”). FAS 151 requires certain abnormal expenditures to be recognized as expenses in the current period. It also requires that the amount of fixed production overhead allocated to inventory be based on the normal capacity of the production facilities. The standard is effective for the fiscal year beginning January 1, 2006. It is not expected that FAS 151 will have a material effect on the Company’s consolidated financial statements.In December 2004, the FASB issued FAS No. 153, “Exchanges of Non-Monetary Assets, an Amendment of APB Opinion No. 29,” (“FAS 153”) effective for non-monetary asset exchanges occurring in the fiscal year beginning January 1, 2006. FAS 153 requires that exchanges of productive assets be accounted for at fair value unless fair value cannot be reasonably determined or the transaction lacks commercial substance. FAS 153 is not expected to have a material effect on the Company’s consolidated financial statements.
In December 2004, the FASB issued FAS No. 123(R), “Share-Based Payment,” (“FAS 123 (R)”). FAS 123(R) requires employee stock options and rights to purchase shares under stock participation plans to be accounted for under the fair-value method, and eliminates the ability to account for these instruments under the intrinsic-value method prescribed by APB Opinion No. 25, which was allowed under the original provisions of FAS 123. FAS 123(R) requires the use of an option-pricing model for estimating fair value, which is amortized to expenses over the requisite periods. The requirements of FAS 123(R) were effective for interim periods beginning after June 15, 2005. The Securities and Exchange Commission (SEC) has postponed the effective date of FAS 123(R), giving companies more time to develop their implementation strategies. Under the SEC’s rule, FAS 123(R) is now effective for public companies for annual, rather than interim, periods that begin after June 15, 2005. The Company plans to adopt FAS 123(R) beginning in fiscal 2006 and is currently evaluating the various transition methods allowed under FAS 123(R).
In March 2004, the FASB approved the consensus reached on the Emerging Issues Task Force Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” (“EITF 03-1”). The objective of EITF 03-1 is to provide guidance for identifying other-than-temporarily impaired investments. EITF 03-1 also provides new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the FASB issued EITF 03-1-1, which delays the effective date of the measurement and recognition guidance in EITF 03-1 until further notice. The disclosure requirements of EITF 03-1 are effective with this annual report for fiscal 2004. The Company has evaluated the impact of the adoption of the accounting provisions of EITF 03-1 and does not expect the adoption of EITF 03-1 will have a significant impact on the Company. During the period of the delay, the Company continues to apply previously adopted accounting policy for determining when a decline in fair value is other than temporary, and records identified loss accordingly, if any.
Taxation
At December 31,
2002,2004, we had net operating losscarry forwardscarryforwards for tax purposes of approximatelyNT$2.6 billion (US$75.1 million),US$84.0 million, which will expire at various times from December 2005 through December2007.2009. At December 31,2002,2004, we had a deferred tax asset ofNT$682.9US$22.5 million,(US$19.7 million),relating principally to our net operating loss. Our ability to realize the value of our deferred tax asset depends on our future earnings, if any, the timing and amount of which are uncertain. We haverecorded a valuationmade an allowance for substantiallyforall theentirevalue of the aggregate net deferred tax asset as a result of those uncertainties.As per the Republic of China Income Tax Law, all retained earnings generated beginning January 1, 1998 by our subsidiaries under Taiwan law and not distributed to us as dividends in the following year are assessed a 10% retained earnings tax. This rule applies primarily to our broadband ISP business and our music distribution business whose principal operating entities are incorporated under Taiwan law.
C. Research, Development and Intellectual Property
We
recorded an income tax benefit ofmake significant investments in research and development to keep pace and remain competitive with technology advancements and product development relating to our entertainment software business. Accordingly approximatelyNT$4.4 million (US$126 thousand) for 2002, which was related to KBT, a subsidiary50% of ourcompany. C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES, ETC.workforce in the entertainment software business is comprised of research and development personnel. While we regard our intellectual property and proprietary rights as important, we believe that our future success is dependent primarily on the innovative skills, technological expertise and management abilities of our employees rather than on patent, copyright and trademark protection, and, accordingly, we do not consider any particular intellectual property or proprietary right to be material to our business.D.
TREND INFORMATIONTrend InformationPlease see
"-Item 3 – “D. Risk Factors”, Item 4 – “Information On the Company” and “ — A. Operating Results- Overview"— Overview” for a discussion of the most recent trends in our operation costs and revenues since the end of2002.2004. In addition, please refer to discussions included in this Item for a discussion of known trends, uncertainties, demands, commitments or events that we believe are reasonable likely to have a material effect on our net operating revenues, income from continuing operations, profitability or capital resources, or that would cause reported financial information not necessarily to be indicative of future operating results or financial condition.50E. Off-balance sheet arrangements
We currently do not engage in any off-balance sheet arrangements.
F. Tabular disclosure of contractual obligations
Payment Due by Period (in US$ thousands) Contractual
ObligationsTotal Less
than 1 year
1-3 years 3-5 years More than
5 years
Operating Lease 8,258 4,018 4,217 23 0 Total Contractual Cash Obligations 8,258 4,018 4,217 23 0 Long-Term Debt Obligations 0 0 0 0 0
Amount of Commitment Expiration Per Period
(in US$ thousands)
Other Commercial Commitments
Total Less
than 1 year
1-3 years 3-5 years More than
5 years
Standby Letters of Credit 0 0 0 0 0 Total Other Commercial Commitments 0 0 0 0 0 ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
A.
DIRECTORS AND SENIOR MANAGEMENTDirectors and Senior ManagementThe following table sets forth information with respect to
allour directors and executive officers as ofJune 1, 2003. BOARD OF DIRECTORS
- ----------------------------------------------------------------------------------------------------------------- Name Age Position Year Appointed to Current Position - -----------------------------------------------------------------------------------------------------------------Nelson Chang 51 Chairman 2002 - ----------------------------------------------------------------------------------------------------------------- Yuanchi Chao 53 Director 2002 - ----------------------------------------------------------------------------------------------------------------- David Chuang 33 Director 2003 - ----------------------------------------------------------------------------------------------------------------- Andre Koo 35 Director 1999 - ----------------------------------------------------------------------------------------------------------------- Jeffrey Koo, Jr 38 Vice Chairman 1999 - ----------------------------------------------------------------------------------------------------------------- Leslie Koo 48 Director 1999 - ----------------------------------------------------------------------------------------------------------------- Richard Lin Yang 73 Director 2001 - -----------------------------------------------------------------------------------------------------------------EXECUTIVE OFFICERS
- --------------------------------------------------------------------------------------------------------------- Name Age Position Year Appointed to Current Position - ---------------------------------------------------------------------------------------------------------------Nelson Chang 51 Chairman 2001 - --------------------------------------------------------------------------------------------------------------- Raymond Chang 32 Chief Executive Officer 1999 - --------------------------------------------------------------------------------------------------------------- Wayne Chen 33 Vice President and General Counsel 2001 - --------------------------------------------------------------------------------------------------------------- Michel Chu 33 Vice President and Chief Technology 1999 Officer - --------------------------------------------------------------------------------------------------------------- Winston Hsia 38 Vice President and Chief Financial Officer 2001 - --------------------------------------------------------------------------------------------------------------- Joseph Shea 37 Vice President and Deputy CFO 2002 - --------------------------------------------------------------------------------------------------------------- Falco Mi 41 Chief Administrative Officer and Vice 2002 President - ---------------------------------------------------------------------------------------------------------------On March 21, 2003, we announced thatJune15, 2005:
Name
Age Position
Year Appointed to
Current Position
WU, Daniel Cheun-Tai
57 Chairman of the Board 2003 BAO, Gilbert
41 Independent non-executive director 2003 CHANG, Nelson
40 Independent non-executive director 2004 DING, Michael Y.J.
48 Independent non-executive director 2003 HSU, Emmet Yu-Jui
42 Independent non-executive director 2003 HU ZEE, Nancy Jing-Ying
46 Independent non-executive director 2003 LEE, Howe Yong
49 Independent non-executive director 2004 LEE, Yichin
44 Independent non-executive director 2003
WANG, Arthur M.
44 Chief Executive Officer and Director 2003 HUI, Thomas T.
33 Chief Financial Officer and Director 2004/2005 CHU, Michel
36 Executive Vice President and Chief Technology Officer 2000 MAI, Falco
43 Executive Vice President and Chief Administrative Officer 2001 SHEA, Joseph
39 Executive Vice President 2002 TSENG, Jennifer
36 Vice President and General Counsel 2003 Mr. Thomas T. Hui was appointed as our
board ofchief financial officer with effect from August 11, 2004 and a director from May 17, 2005. Our former directors,had received a formal offer from our management group, which is referredJeffrey Koo Jr. and Andre Koo, resigned on May 17, 2005 for personal reasons.Biographical information with respect to
as the Management Group in this annual report, comprised of seven senior officerseach of ourcompany, to purchase all shares of our company upon certain termsdirectors andconditions. For detailed information of the proposed management buyout offer, see Item 8. "Financial information - B. Significant changes". In connection with the management buyout offer proposed by the Management Group, we announced on June 5, 2003 thatexecutive officers is set forth below.DANIEL CHUEN-TAI WU is the chairman of
our board of directors, Mr. Nelson Chang had tendered his resignation as our chairman and as a director of our company. The effectiveness of Mr. Chang's resignation is contingent upontheoutcome of the offer made by the Management Group. Mr. Chang's resignation will be effective immediately following the earlier to occur of (a) the completion of the management buyout offer proposed by the Management Group and (b) the rejection of the offer by our board of directors or shareholders (assuming that in the case of a rejection by our board of directors, the proposed management buyout offer will be not submitted to our shareholders for their consideration) and receipt by ourboard of directors ofa formal notice fromGigaMedia Limited. He brings to our Company significant operational experience and extensive business relationships in Taiwan. Dr. Wu is currently theManagement Group that no revised offer will be madechairman of CDIB & Partners Investment Holding Corp. inresponse to such rejection. As of July 15, 2003, Mr. Chang remains chairmanTaiwan and a director and senior executive vice president ofour company. DIRECTORS NELSON CHANG isChina Development Financial Holding Corporation. Previously, he served as the chairman ofGigaMediavarious companies including Videoland Inc. (2002-2004), Grand Pacific Petrochemical Corp. (1994-2004), Biocare Corp. (1997-2003) andHoshin GigaMedia.Precision Semiconductor Mask Corp. (1998-2000). Heis also currently managing director and vice chairman of Chia Hsin Cement Corporation, a listed company on the Taiwan 51Stock Exchange, as well aswas the chief executive officer ofKGI Securities Co.,Wyse Technology Inc. (1990-1994) and the president of Grand Pacific Petrochemical Corp. (1992-1994). Dr. Wu was chairman of Crimson Asia Capital Holdings, Ltd.in Taipei and KG Investments Asia Limited in Hong Kong. Mr. Chang is(1993-2000). Prior to that, Dr. Wu was also the chairman ofWyseMonte Jade Science & TechnologyInc.Association from 1993 to 1994. Dr. Wu received his doctorate inHsin Chu,chemical engineering from the University of Delaware in 1976 and an undergraduate degree in the same discipline from National Taiwanand China Network SystemsUniversity in 1970.GILBERT BAO is an independent non-executive director of our Company. He is also currently vice president of Chung Shing Textile Co., Ltd.
in Taipei. A well respected business leader with extensive industry affiliations, Mr. Chang is also, executive director of Taiwan Cotton Spinners Association, and executive director of Taiwan Manmade Fiber Industry Association. He graduated from theChinese National AssociationUniversity ofIndustry and Commerce, CNAIC; vice chair of the Chinese Taipei Pacific Economic Cooperation Council, PECC, as well as the ROC-USA Economic Council; and chairman of the Chinese Taipei Member Committee of the Pacific Basin Economic Council, PBEC. Mr. Chang receivedSouthern California in 1986.NELSON CHANG is an
MBA degree from New York University in 1976. YUANCHI CHAO (1) is aindependent non-executive director of ourcompany. Mr. Chao currently serves as chairman of Concord Asia Finance Limited, and is a director of each of Touchstone Corporation, LC United Chemical Corporation and Analyst Technology Company, Ltd. He also serves as supervisor of Walsin Lihwa Corporation and Winbond Electronic Corporation. Mr. Chao's experience includes five years of leadership at Dah An Commercial Bank and a three-year term with Occient Corporation. He received his MBA degree from New York University. DAVID CHUANG (1) is a director of our company. Mr. Chuang brings to our company significant expertise in securities law and mergers and acquisitions. He has counseled clients in a number of high profile transactions and corporate events. Among the notable transactions are: the International Commercial Bank of China (ICBC) in its share swap with Mega Financial Holdco (Chiao Tung Bank), Taipeibank in its share swap with Fubon Financial Holdco and United Microelectronics Company's "five-into-one" reverse stock split transaction. Mr Chuang currently serves as a partner at LCS & Partners in Taiwan. Prior to joining LCS, Mr. Chuang was an attorney at the law firms of Jones Day and Tsar & Tsai in Taiwan. Mr. Chuang also served as in-house counsel at Chung Sheng Science & Technology Instititute in Taiwan. He received his undergraduate law degree from Taiwan National University and an L.L.M. degree from Duke University School of Law. ANDRE KOO is a director of our company.Company. He is also currently the managing director ofChailease FinanceShin-Long Construction Co., managing director of Enrich Venture Capital Management Co., Ltd., vice president of X-Legend Entertainment Corp., and vice president of EasyFun Entertainment Corp. Mr. Chang received a master of business administration degree from National Taiwan University.MICHAEL Y.J. DING is an independent non-executive director of our Company. He brings to our Company significant securities and business experience. Mr. Ding is currently president and chief executive officer of Fubon Asset Management Co., Ltd. Prior to that, Mr. Ding was president and
the Chinatrust Hotel Ltd., both of which are membersfund manager of theKoos Group.R.O.C. Fund (listed on the New York Stock Exchange), as well as president of the International Investment Trust Co. in Taiwan, where he also served as chief investment officer and a senior vice president. Mr. Ding was previously chief economist and head of research at Citicorp International Securities Ltd. in Taipei and head of research and information for the Greater China region at McKinsey & Co., Inc. Mr. Ding holds a bachelor of laws degree from Chinese Cultural University and a master’s degree and a doctorate in economics from Indiana University.EMMET YU-JUI HSU is an independent non-executive director of our Company. He is also currently chairman and president of Shihlin Electric and Engineering Corp., Hsinchu Transportation Co. Ltd., and The Ambassador Hotel in Taipei, Taiwan. He majored in business administration at the University Southern California and received a master of business administration degree from Chengchi University in Taiwan.
NANCY JING-YING HU ZEE is an independent non-executive director of our Company. She is a certified accountant in the U.S. and Hong Kong and is currently a director of NHL CPA, Golden Pacific Enterprises Limited, Southwood Limited and Artel Solutions Group Holdings Limited. Ms. Hu is currently the president of
My-Funding Corp.Videoland Inc. and etKING Media Technology Limited. She is also chairman of Ho Wei Communication, which is a subsidiary of Videoland Inc. Ms Hu holds a bachelor’s degree from National Taiwan University, a master’s degrees in sciences from Barry University and a master of business administration degree from Florida International University.HOWE YONG LEE is an independent non-executive director of our Company. He is currently the managing director of Lee Kim Yew (Pte) Ltd., an investment company based in Singapore. He also served as a director of China
Life Insurance Company.Development Corporation in Hong Kong from 1997 to 2000 and as a director of Transmarco Limited in Singapore from 1995 to 1997. Mr.KooLee received aB.A.bachelor of arts degreeandin business administration from the University of Washington in 1984.YICHIN LEE is an
MBA degree from New York University.independent non-executive director of our Company. He is also currently founding partner of CRC Investment Management, LLC. Mr. Lee holds abrother of Jeffrey Koo, Jr.doctorate degree in resource planning anda nephew of Leslie Koo. JEFFREY KOO, JR.management from Stanford University.ARTHUR M. WANG is the chief executive officer and a director of our
company.Company. He isalso currently the chairman of Chinatrust Commercial Bank, the managing director of Crimson Capital Management, Ltd. and the honorary vice chairman of J-Ho Real Estate Development Co. From February 1993 to January 1995, Mr. Koo also served as the executive vice president of Taiwan Fuji-Xerox Corp. Mr. Koo received a B.A. degree from SooChow University in Taiwan and an MBA degree from the University of Pennsylvania. He is the brother of Andre Koo and a nephew of Leslie Koo. LESLIE KOO is a director of our company. He is also currently the president of Taiwan Cement Corporation, a leading cement manufacturer in Taiwan and a member of the Koos Group, the chairman of China Synthetic Rubber Corporation,also a member of the board of Linmark Group, a Hong Kong Stock Exchange listed global sourcing firm, where he serves as chair of the audit committee. Previously, Mr. Wang was an executive director of KGI Asia Limited, the investment banking arm of the Koos Group of Taiwan. At KGI, Mr. Wang served as head of corporate finance. He also served as an investment advisor andthe chairmanboard member ofKG Telecommunications. In addition, Mr. Koo is also serving as the chairmanUFJ Asia Finance Technology Fund of theTaiwan Britain Business Council,UFJ Group (formerly the Sanwa Bank Group of Japan), and as a board member and director of Softbank Investment International (Strategic) Limited, theROC-USA Business Council and a directorHong Kong Stock Exchange listed arm ofthe Sino-British Culture and Economy Association.Softbank Corporation. Mr.Koo received a B.A. degree from the University of Washington and an MBA degree from the University of Pennsylvania. He is an uncle of Jeffrey Koo and Andre Koo. RICHARD LIN YANG (1) adds extensive business experience in the Greater China region to GigaMedia's board. Mr. Yang currently serves as the vice-chairman of Chongqing Da Dah Navigation Co. Ltd. of the - -------- (1) An independent director. 52PRC; director of Chongqing Taipan Storage (Petroleum) Ltd., of the PRC, and Taipan Storage (Petroleum) Pte. Ltd., of Singapore; and as managing director of E-Hsiang Steamship Co. Ltd., of Taiwan. He has also been a non-executive director of EC-Founder (Holdings) Co. Ltd., since 1995. Mr. YangWang received hisbachelor'sbachelor of arts degree from the University of Californiaat Los Angeles. OFFICERS RAYMOND CHANG is chief executive officeranda co-founder of GigaMedia as well as senior vice president of Hoshin GigaMedia. He is also currently a special advisor to Chinatrust Commercial Bank. Prior to joining our company, Mr. Chang worked at Koos Development Corp. as a special assistant to the chairman and at McKinsey & Company. Mr. Chang received a B.A. degree in economics and political science from New York University and an M.P.P.Mhis juris doctorate degree from YaleUniversity. From 1996-1997, Mr. Chang also matriculated atLaw School. He practiced corporate and securities law in theJohn F. Kennedy School of Government of Harvard University. WAYNE CHEN is vice president and general counsel of GigaMedia. Prior to joining our company, he was a senior associate at Simpson Thacher & Bartlett LLP in both itsNew York and Hong Kong offices of Skadden, Arps, Slate, Meagher & Flom LLP.THOMAS T. HUI is the chief financial officer and a director of our Company. Mr. Hui joined GigaMedia from Goldman Sachs (Asia) L.L.C., where he
practiced corporate law.was executive director of the investment banking division. At Goldman Sachs, Mr.Chen has conducted various equityHui originated andequity-linked corporate finance transactions, as well as severalexecuted a broad range of mergers andacquisitionacquisitions and financing transactions in Asia. Prior to working at Goldman Sachs, Mr. Hui served as an investment banker at Merrill Lynch & Co. andleveraged buy-out financings. He has executed various high yield offeringsas a management consultant at McKinsey & Company, both inAsiaHong Kong. Mr. Hui holds a master of engineering degree in electrical engineering from Cornell University andrepresented derivative and Asian-focused private equity funds. Mr. Chen received his lawa bachelor of science degreefrom New York University School of Law and his B.A.inchemistryelectrical engineering from the University ofChicago.Wisconsin – Madison.MICHEL CHU is the chief technology officer and
aan executive vice president of ourcompany.Company. He has extensive experience in Internet-related software development, system engineering and project management. Mr. Chu is responsible for the design, development and implementation of ourcompany'sCompany’s broadband service infrastructure. Mr. Chu receivedan M.S.a master of science degree in electrical engineering from National Taiwan University.WINSTON HSIAFALCO MAI is the
chief financial officer of GigaMedia, as well as the chief financial officer of China Network Systems Co., Ltd., the management company of Koos Group cable entities. Mr. Hsia was formerly chief financial officer and founder of an Internet capital formation business, 01 Inc., in Korea. Prior to that, Mr. Hsia worked for seven years in the fixed income industry, including terms at Peregrine Investment Holdings and Lehman Brothers in Hong Kong. At Lehman Brothers, Mr. Hsia was responsible for fixed income sales to Taiwanese financial institutions and regional central banks. He received an MBA degree in finance from the Wharton School of Business at the University of Pennsylvania in 1992 and his undergraduate degree from the University of California at Berkeley in 1988. FALCO MI ischief administrative officer andaan executive vice president of ourcompany.Company. He is also currently aconsultant atdirector of KGI Securities Co. Ltd in Taipei. Prior to joining ourcompany,Company, Mr.MiMai worked at KGI Securities Co. Ltd in Taipei as a manager of the research department, the equity and sales - proprietary trading department and the derivatives product department. Mr.MiMai was also senior vice president to the general management office, as well as the spokesman from 1993-2001. Mr.MiMai received aB.S.bachelor of science degree in electrical engineering from National Taiwan University.JOSEPH SHEA is an executive vice president
and deputy chief financial officerof ourcompany.Company responsible for strategic and business development. Prior to joining GigaMedia, Mr. Shea was an equity research analyst at Lehman Brothers Asia Limited covering the Internet industry. Before he was at Lehman Brothers, Mr. Shea was a manager at A.T. Kearney (Hong Kong) Limited where he was responsible for project planning and engagement execution for clients based in Asia and Europe. While working at A.T. Kearney, Mr. Shea led severalInternet relatedInternet-related projects. Mr. Shea also held design engineer positions in several major microprocessor design projects at Intel Corporation. Mr. Shea received hisMBAmaster of business administration degree from the University of California at Berkeley. He also holdsan M.S.a masters of science inElectrical Engineeringelectrical engineering from Columbia University as well as aBSbachelors of science inElectrical Engineeringelectrical engineering from Carnegie-Mellon University.JENNIFER TSENG is a vice president and general counsel of our Company. Prior to joining our Company, Ms. Tseng practiced law and presided over a local law firm in Taipei where she conducted general litigation practice across a range of major business disputes and civil litigation, from counseling through trial and appeal. Ms. Tseng received her master of laws degree from School of Law at University of Warwick in the United Kingdom and her bachelor of law degree from Department of Law at National Taiwan University in Taiwan.
B.
COMPENSATION 53Compensation For the year ended December 31,
2002,2004, the aggregate compensation paid by us to all of our executive officers was approximatelyNT$24,341US$994 thousand(US$701 thousand)and the aggregate compensation paid by us to all of our directors was approximatelyNT$2,484 thousand (US$72 thousand).US$202 thousand. The total outstanding number of share options granted to our directors and officers was 7,003,888 for the year ended December 31, 2004.C.
BOARD PRACTICEBoard PracticesNeither we nor any of our subsidiaries has signed any service contract with any of our directors in respect of provision of benefit upon termination of employment.
Each of our directors will remain in his office as a director until:
-he is prohibited from acting as a director by reason of any order made pursuant to the Singapore Companies Act (Chapter 50);-he resigns from his office;-he receives a bankruptcy order made against him;-he is found to be lunatic or of unsound mind; or-he is removed by an ordinary resolution passed by our shareholders in accordance with the provisions of the Singapore Companies Act (Chapter 50).Our board of directors has appointed an audit committee.
TheOur audit committee currently consists ofMessrs. Yuanchi Chao, David ChuangGilbert Bao, Michael Y. J. Ding, andRichard Yang.Yichin Lee. Our audit committee will select andengage,evaluate, on our behalf, the independent public accountantstowho audit our annual financial statements, and will review and approve the planned scope of our annual audit.This committee will also review and approve the terms of proposed material transactions with related parties.In accordance with ourarticlesArticles ofassociation,Association and our audit committee charter, all of the members of our audit committee must be persons who qualify as"independent"“independent” directors for purposes of the rules and regulations ofNasdaq.the NASDAQ National Market. We also have a compensation committee that consists of Daniel Chuen-Tai Wu, Michael Y.J. Ding and Yichin Lee.D. Employees
As of
May 31, 2003, the onlineJune 15, 2005, our consumer broadband ISP businessunit of GigaMediaand our corporate headquarters employed182176 people, excluding part-time and temporarypersonalpersonnel and consultants. Of thetotal: 60176 employees, 110 were employed in our consumer broadbandservicesISP business group, including sales,andmarketing, engineering, customer service and related services;69 were employed in our operational services group, including customer service; 2625 were employed in our technology group;1715 were employed in the chief executive officer’s office; 16 were employed in our finance and control group; and 10 were employed inoperations and general and administration.our administration group. In addition, oursubsidiary KBTcorporate ISP business as of June 15, 2005 employed a total of6766 people. Ourofflinemusic distribution businessunitemployed a total of377303 people as of June 15, 2005, including335244 store employees and4259 office employees. Our entertainment software business had a total of 60 employees as of June 15, 2005.None of our employees is subject to any collective bargaining arrangements, and we consider our relations with employees to be good.
E.
SHARE OWNERSHIP SHARE OWNERSHIP OF DIRECTORS AND EXECUTIVE OFFICERSShare OwnershipShare Ownership of Directors and Executive Officers
The tables below set forth information as to our
directors'directors’, and executiveofficers'officers’ share ownership in ourcompanyCompany as ofMay 20, 2003. 54June 15, 2005:
Person
Number of
Common Shares
Number of Shares
Issuable upon
exercise of options
WU, Daniel Chuen-Tai
0 * BAO, Gilbert T.C.
0 * CHANG, Nelson
0 * DING, Michael Y.J.
0 * HSU, Emmet Yu-Jui
0 * HU ZEE, Nancy Jing-Ying
0 * LEE, Howe yong
0 * LEE, Yichin
0 * WANG, Arthur M.
18,690 2,500,000 HUI, Thomas T.
18,044 1,500,000 CHU, Michel
417,461 * MAI, Falco
* * SHEA, Joseph
* * TSENG, Jennifer
* *
- ------------------------------------------------------------------------------------------------------- NUMBER OF NUMBER OF SHARES ISSUABLE COMMON UPON EXERCISE EXERCISE PRICE DIRECTOR SHARES OF OPTIONS (US$) EXPIRATION DATE - -------------------------------------------------------------------------------------------------------LESLIE KOO (1) 100,000 24.3 2005 - ------------------------------------------------------------------------------------------------------- JEFFREY KOO, JR. (1) 100,000 24.3 2005 - ------------------------------------------------------------------------------------------------------- ANDRE KOO (1) 100,000 24.3 2005 - -------------------------------------------------------------------------------------------------------* Less than 1% - ------------------- (1) See discussions of beneficial ownership of this personAll options to our directors and executive officers were granted pursuant to the 2002 Plan and the 2004 Plan as defined under “Employee Share Option Plans” below pursuant to which the exercise price for the options is US$0.79 and the options expire in
our company in "--Beneficial Ownership" below.
- ----------------------------------------------------------------------------------------------------- NUMBER OF NUMBER OF SHARES ISSUABLE EXECUTIVE COMMON UPON EXERCISE EXERCISE PRICE OFFICER SHARES OF OPTIONS (US$) EXPIRATION DATE - -----------------------------------------------------------------------------------------------------MICHEL CHU 408,000 0 N/A N/A - ----------------------------------------------------------------------------------------------------- JOSEPH SHEA 0 0 N/A N/A - ----------------------------------------------------------------------------------------------------- RAYMOND CHANG 275,000 0 N/A N/A - ----------------------------------------------------------------------------------------------------- WINSTON HSIA 0 0 N/A N/A - ----------------------------------------------------------------------------------------------------- WAYNE CHEN 0 0 N/A N/A - -----------------------------------------------------------------------------------------------------BENEFICIAL OWNERSHIP2014.Beneficial Ownership
As of
May 20, 2003, LeslieJune 15, 2005, Jeffrey Kooheld beneficiary ownership of 13,145,313Jr. and Andre Koo jointly owned 10,799,999 common shares or approximately26.21%21.45% ofcommon shares ofourcompany, consisting of 4,616,389common shares throughlegal entity Robustos Capital Investments Ltd., 3,687,271 shares through legal entity JKK Inc., 3,257,143 shares through TCC International Limited and 1,584,510 common shares through KGEX.com Co., Ltd., respectively. As of May 20, 2003, Jeffrey Koo and Angelo Koo jointly owned 14,742,856 common shares or approximately 29.40% of common shares of our company through legal entitiesBest MethodInc., Golden Pacific Equities Ltd., and Kudos Fund. The above Koo's family directors beneficially own approximately 27,888,169 shares in our company, representing approximately 55.61% of our outstanding shares. Our directors and executive officers as a group beneficially own approximately 28,571,169 shares in our company, representing 56.97% of our outstanding shares.Limited.Other than
theas stated above,Koo family directors,no other director or executive officer beneficially owns of record more than 1% of the outstanding shares of ourcompany. EMPLOYEE SHARE OPTION PLANSCompany. See Item 7 — “Major Shareholders and Related Party Transactions” below.Employee Share Option Plans
During
2000,1999, we adopted the1999GigaMedia Limited Employee Share Option Plan, or the 1999 Plan. Pursuant to the551999 Plan, up to two million common shares may be granted to employees of our company.Company. The 1999 Plan is administered by a committee designated by our board of directors. The committee as plan administrator has complete discretion to determine the exercise price for the option grants,- to determine which eligible individuals are to receive option grants, the time or times when options grants are to be made, the number of shares subject to grant and the maximum term for which any granted option is exercisable.During 2000,At the June 2002 annual general meeting of shareholders, the shareholders of the Company approved the GigaMedia Limited 2002 Employee Share Option Plan, or the 2002 Plan, under which up to three million common shares of the Company have been reserved for issuance. All employees, officers, and directors of the Company are eligible to participate in the 2002 Plan. The 2002 Plan is administered by a committee designated by the board of directors. The committee as plan administrator has complete discretion to determine the exercise price for the option grants, to determine which eligible individuals are to receive option grants, the time or times when options grants are to be made, the number of shares subject to grant and the maximum term for which any granted option is exercisable.
In August 2004, options to purchase
1,111,440three million shares ofour company'sthe Company’s common stock were granted and exercisable upon granting at an exercise price of $0.79 pursuant to the 2002 Plan. All options granted under the 2002 Plan expire in 2014.At the June 2004 annual general meeting of shareholders, the shareholders of the Company approved the GigaMedia Limited 2004 Employee Share Option Plan, or the 2004 Plan, under which up to seven million common shares of the Company have been reserved for issuance. All employees, officers, and directors of the Company are eligible to participate in the 2004 Plan. The 2004 Plan is administered by a committee designated by the board of directors. The committee as plan administrator has complete discretion to determine the exercise price for the option grants, to determine which eligible individuals are to receive option grants, the time or times when options grants are to be made, the number of shares subject to grant and the maximum term for which any granted option is exercisable.
In August 2004, options to purchase 5,462,530 shares of the Company’s common stock were granted at an exercise price of
US$24.3, a 10% discount$0.79 pursuant to theinitial public offering price2004 Plan. These options were subject to two vesting schedules. In accordance with the terms ofUS$27,the first vesting schedule, 3,863,888 options were vested and exercisable upon granting. In accordance with the terms of the second vesting schedule, 399,663 optionsto purchase 836,470 shares of our company's common stockweregranted at an exercise price of US$15, representing fair value at the date of grant.vested and exercisable upon granting. Theoptions expire on the date of termination of employment or five years from the date of grant if not exercised. Also, theremaining 1,198,979 options arenot transferable other than on death, and are exercisable in three annual installments of 30%, 30%, and 40% commencing onevested 25% per year from thedate ofgrantwhen the specific employees complete one, two, or three years, respectively, of service with us. We grant fixed awards with pro rata vesting, and computes compensation expenses along with the vesting periods. Unearned compensation for outstandingdate. All options granted under the19992004 Planasexpire in 2014.See Note 17 of
December 31, 2001 and 2002 amounted to NT$5.3 million and nil. In June 2001, we cancelled all outstanding stock options granted in 2000 under the 1999 Plan, resulting in the recognition of compensation expense in the amount of NT$53.3 millionour consolidated financial statements for2001. Total compensation expense recorded in 2001 for all options amounted to NT$130.8 million which consists of amortization of options outstanding during 2001, net of forfeitures. We recognized the amortization of compensation expenses in 2002 in the amount of NT$5.3 million. During 2001, we adopted the 2001additional information.Employee Share
OptionPurchase PlanAt the June 2004 annual general meeting of shareholders, the shareholders of the Company approved the GigaMedia Limited 2004 Employee Share Purchase Plan, or the
2001 Plan,2004 ESPP, under which up tothreetwo million common shares of the Company have been reserved for issuance. Pursuant to the 2004 ESPP, the Company offered its shares to qualified employees at favorable conditions and established a restricted period of six months during which employees may not transfer the shares after purchasing them. To be eligible, employees must be employed by the Company or its subsidiaries and the customary employment shall be no less than 20 hours per week. Employees are also subject to certain restrictions on the amount that may begrantedinvested to purchase the shares and to other terms and conditions of the 2004 ESPP. The 2004 ESPP is a one-time plan and is administered by a committee designated by the board of directors. In March 2005, there were 189,642 shares subscribed by eligible employees at a purchase price of approximately $1.39 per share.See Note 17 of our
company. There were no options granted under the 2001 Plan and the 2001 Plan was cancelled in June 2002. During 2002, we adopted no employee share option plan. SHARE INCENTIVE PROGRAM In order to provide appropriate equity incentives to our employees, in October 1998 and the first half of 1999, Hoshin Gigamedia issued an aggregate of 4.679 million shares of Hoshin Gigamedia to some of our employees at no cost, generally subject to a three-year vesting schedule. Following our acquisition of 100% of Hoshin Gigamedia, these shares of Hoshin Gigamedia were exchangeableconsolidated financial statements for4.679 million shares of our company, subject to the original vesting schedule. We do not plan to issue shares to our employees in the future for compensation purposes, other than shares issued upon the exercise of our employee share options. 56additional information. ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
A. Major Shareholders
The following table sets forth information known to us with respect to the ownership of our shares as of
May 20, 2003June 15, 2005 by (1) each shareholder known by us to own more than 5% of our shares and (2) all directors and executive officers as a group.
Name of Owner
Shares Owned Percentage of
Shares Owned
Best Method Limited(1) 10,799,999 21.45% Goldsky Asset Limited 3,597,500 7.15% Directors and executive officers as a group (7 persons) 493,226 0.98%
PERCENTAGE OF NAME OF OWNER(1) SHARES OWNED SHARES OWNED - ------------------------------------------------ ------------ -------------Best Method Inc.(2)............................. 10,799,999 21.53% Robustos Capital Investments Ltd (2) ........... 4,616,389 9.2% JKK Inc.(2) (3)................................. 3,687,271 7.4%(3) Batterymarch Financial Management Corp. 3,039,000 6.1% Kudos Fund(2)................................... 3,600,000 7.2% TCC International Limited(2).................... 3,257,143 6.5% Leslie Koo(4)................................... 13,145,313 26.21%Jeffrey Koo, Jr. and Angelo Koo(5) 14,742,856 29.4% Directors and executive officers as a group (13 persons) ....................................... 28,571,169 56.97%Andre Koo jointly own 10,799,999 common shares of our Company.- --------------- (1) As at May 20, 2003 Microsoft Corporation held 2.8% shares of our company, decreased from 8.2% as at March 15, 2002, and ceased to be a major shareholder of our company. (2) A member of the Koos Group. The Koos Group is controlled by members of the Koo family, which includes three of our directors: Jeffrey Koo, Jr., Leslie Koo and Andre Koo. (3) In December 2000, JKK Inc. transferred 1,584,510 shares to KGEX.com Co. Ltd., which decreased JKK ownership percentage from 25.2% to 22%. In February 2003, JKK transferred 4,616,389 shares to Robustos Capital Investments Ltd. In addition, JKK has pledged but not sold 3,687,271 of their remaining shares. (4) Leslie Koo owns these shares through several legal entities, consisting of 4,616,389 shares through Robustos Capital Investments Ltd., 3,687,271 shares through JKK Inc., 3,257,143 shares through TCC International Limited and 1,584,510 shares through KGEX.com Co., Ltd. (5) Jeffrey Koo and Angelo Koo jointly own 14,742,856 common shares of our company, consisting of 10,799,999 shares owned through Best Method Inc., 342,857 shares through Golden Pacific Equities Ltd., and 3,600,000 shares through Kudos Fund.As of
May 20, 2003,June 15, 2005, we had50,154,00050,343,642 ordinary shares outstanding, out of which21,582,83135,452,917 shares were listed on theNasdaqNASDAQ National Market and not held by our major shareholders and directors or executive officers as disclosed above and in Item6 "Senior6. — “Directors, Senior Management and Employees-— E. ShareOwnership"Ownership”, representing43.0%approximately 70.42% of our total outstanding shares. As ofMay 20, 2003,June 15, 2005, the21,582,83135,452,917 shares listed on theNasdaq,NASDAQ National Market were held by2187 record holders, including nominee holders, with the registered address in the United States.None of our major shareholders have different voting rights from those of our other
shareholders of us. There are no arrangements known to us, the operation of which may at a subsequent date result in a change of control of our company. 57RELATED PARTY TRANSACTIONS We fromshareholders.B. Related Party Transactions
From time to time, we have engaged in a variety of transactions with our affiliates in the normal course of business. Our policy is that such transactions have been conducted on terms as
favourablefavorable to us as obtainable at the time in a comparablearm'sarm’s length transaction with a non-affiliate.KOOS GROUP CABLE OPERATORS For 2000,China Trust Commercial Bank
Pursuant to an arrangement between our wholly-owned subsidiary KBT and China Trust Commercial Bank since September 2001, KBT charges China Trust Commercial Bank a monthly leased-line fee. This fee totaled approximately US$300 thousand in each of 2002, 2003 and 2004. The fee was US$88 thousand for the five months ended May 31, 2005.
Our total bank deposits with China Trust Commercial Bank as of
June 24,December 31, 200316, 16, 12and122004, and May 31, 2005 amounted to US$13.83 million, US$2.98 million and US$1.95 million, respectively.China Life Insurance Co., Ltd
Our subsidiary Hoshin GigaMedia leases its main office premises from China Life Insurance Co., Ltd. under an operating lease that expires in 2005. Hoshin GigaMedia incurred rental expense of US$374 thousand, US$372 thousand, US$392 thousand and US$169 thousand with China Life Insurance Co., Ltd. for the years ended December 31, 2002, 2003 and 2004, and the five months ended May 31, 2005, respectively; deposits out with the transactions were US$87 thousand, US$95 thousand and US$95 thousand as of December 31, 2003 and 2004, and May 31, 2005, respectively.
Gamania Digital Entertainment Co., Ltd.
Our subsidiary KBT incurred bandwidth cost of approximately US$116 thousand, US$171 thousand, US$272 thousand, and US$182 thousand for the years ended December 31, 2002, 2003, and 2004, and the five months ended May 31, 2005, respectively, for bandwidth provided by Gamania.
United Advertising Company, Ltd
Our subsidiary Point Records held a short-term loan in the amount of US$284 thousand and US$1,563 thousand at an annual interest rate of 3.5% to 4% due to the United Advertising Company, Ltd as of December 31, 2004 and May 31, 2005, respectively. Total interest expenses for the year ended December 31, 2004 and the five months ended May 31, 2005 were US$396 and US$8,695, respectively.
Our subsidiary Hoshin GigaMedia incurred advertising expenses of approximately US$188 thousand with United Advertising Company, Ltd. for the year ended December 31, 2004.
Best Method Limited
On March 31, 2004, we entered into an agreement with our major shareholder, Best Method Limited, and a former major shareholder, JKK, Inc., with regard to a warrant issued to Microsoft Corporation by GigaMedia. In September 2004, Microsoft Corporation returned the warrant unexercised.
See Note 19 of our
cable partners, respectively, were membersconsolidated financial statements for additional information on related party transactions.C. Interests of Experts and Counsel
Not applicable.
A. Consolidated Statements and Other Financial Information
Financial Statements
Please refer to Item 18 “Financial Statements.”
Information on Legal or Arbitration Proceedings
In December 2001, a class action lawsuit was filed in the United States District Court for the Southern District of New York against the Company in connection with the initial public offering of its stock. There are approximately 300 issuers who are defendants in this class action.
The complaint alleged that the Company violated Section 11 and Section 15 of the
KoosSecurities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934, or the Exchange Act, and Rule 10b-5 promulgated thereunder. On February 19, 2003, the court issued an opinion and order on defendants’ motion to dismiss.As to the Company, the Rule 10b-5 claims were dismissed without prejudice while the Section 11 claims survived the motion.
In June 2004, the plaintiffs and issuer defendants, including us, presented the executed settlement agreement to Judge Scheindlin during a court conference. Subsequently, the plaintiffs and issuer defendants made a motion for preliminary approval of the settlement agreement. The key terms of the settlement agreement include:
the insurers of the issuers will provide an undertaking that guarantees that plaintiffs in the approximately 298 settling actions will recover a total of US$1 billion;the insurers will pay up to US$15 million for the notice costs arising from the settlement;the issuers shall assign their interest in certain claims against the underwriters to a litigation trust, represented by plaintiffs’ counsel; andthe plaintiffs shall release all of the settling issuer defendants, including the Company and its individual defendants, from all claims relating to this action.Neither the Company nor the Company’s defense attorney is able to assess the likelihood of an unfavorable outcome and determine as to the amount or range of potential loss, if any. The Company has entered into an annually renewable insurance policy with American Insurance Group
cable television network. As partwith US$10 million of liability coverage in which the Company is required to pay a US$500 thousand deductible.Accordingly, the Company recorded a provision of US$500 thousand in 2003, representing the Company’s deductible amount related to these claims. The Company believes that the insurance coverage is sufficient to cover the liability arising from the settlement and claim.
On February 15, 2005, the court issued an opinion and order granting preliminary approval to the settlement agreement subject to a narrowing of the proposed bar order as to only contribution claims. The principal effect of the narrower bar order is that it does not bar claims for contractual indemnity. On May 2, 2005, the issuer defendants submitted an amendment to the settlement that conforms to the court order. Negotiation is proceeding between the issuers and the underwriters to broaden the bar order to include a mutual bar of contractual indemnity claims.
The court will schedule a fairness hearing on the proposed settlement and subsequently will decide whether to grant final approval to the settlement agreement. The settlement agreement is subject to the approval of the District Court.
In March 2003, we commenced arbitration proceedings in Singapore by submitting a Notice of Arbitration to the Singapore International Arbitration Center, or the SIAC to resolve certain contractual dispute in connection with a strategic agreement entered into between our Company, EMI Music Asia, or EMI and GigaMusic.com Limited, or GigaMusic.com. On December 31, 2003, a Final Settlement Agreement and Release, or the Settlement Agreement was entered into by our Company, EMI and GigaMusic.com to resolve and settle all disputes relating to this matter. The Settlement Agreement became effective on February 25, 2004, following a resolution approved by a meeting of our
revenue sharing arrangementsboard of directors. Pursuant to the Settlement Agreement, we paid EMI US$400 thousand while EMI returned to us 5% ownership in GigaMusic.com and a letter of credit for the amount of US$1.0 million issued to EMI in accordance withthese partners, we generally pay them (1) 35% to 45%said strategic agreement. The arbitration proceedings were withdrawn and settled in March 2004.In March 2004, the landlord of
each subscriber's monthly access fee in excessthe premises ofNT$300 and (2) NT$500 per cable modem installation. These payments totaled approximately NT$38.2 million, NT$45.6 million, and NT$48.0 million (US$1.38 million) for 2000, 2001 and 2002, respectively. The termone of ouragreementsretail music stores filed a lawsuit in the District Court of Panchiao, Taipei Country against our subsidiary Point Records and Ta-Lai Records Company, a subsidiary of Tachung Records (collectively, the “Defending Entities”). The complaint alleged that the Defending Entities defaulted on monthly rental payments under the lease agreement and also breached the covenant against sub-letting the premises. The complaint claimed that the landlord had suffered damages amounting potentially to an amount in NT dollars equivalent to approximately US$173 thousand plus back rent at an amount in NT dollars equivalent to US$5,986 per month since February 1, 2004. The Defending Entities negotiated withthese cable partners is generally nine years,the landlord about the terms andwe have generally been granted exclusive rightsconditions for a settlement during 2004 and, at the same time, accrued US$173 thousand as provision for the rental lawsuit. As of February 2005, the total amount of monetary damage alleged by the landlord aggregated touse their cable systems to provide Internet access services. In June 1999, we extended an NT$40 million cash advance to two of our cable partners that are members ofapproximately US$252 thousand. On March 7, 2005, theKoos Group cable television network. This advance was fully reimbursed in September 1999. We did not earn any interest from this transaction. MICROSOFT Hoshin Gigamedia and MicrosoftDefending Entities entered into aBusiness Co-Operation Agreement in November 1999 pursuantsettlement agreement with the landlord before the court.Pursuant to
which: - Microsoftthe settlement agreement, the landlord agreed toinclude some of our content on a narrowband version ofreduce theMicrosoft Networkclaim amount tobe developed for Taiwan; -an amount in NT dollar equivalent to US$202 thousand and release theparties agreedsubsidiary from the lawsuit, provided that the settlement fund was received by the landlord before March 31, 2005. The subsidiary has remitted the settlement fund tocreate a co-branded broadband version of Microsoft Network for Taiwan; -theparties agreed to jointly develop shopping channels to be made available in Taiwanlandlord on thenarrowband version of Microsoft Networkdue date and settled theco-branded broadband version of Microsoft Network; - Hoshin Gigamedia agreed to accept Microsoft as its default technology provider; - the parties agreed to a number of access revenue sharing arrangements, including (1) sharing revenues derived from electronic commerce channels jointly developed and (2) paying Microsoft 2% of our gross cable-based Internet access revenues in consideration for our use of its licensed software; and - Hoshin Gigamedia undertook to spend $1 million on advertising services over a three-year period ending in November 2002. No products have been developed or are expected to be developed pursuant to this agreement. This agreement terminates on the date upon which Microsoft no longer holds a majority of our shares initially purchased pursuant to the Share and Warrant Purchase Agreement dated as of October 27, 1999. Hoshin Gigamedia has also entered into a content license agreement with MSNBC Interactive News, L.L.C., a subsidiary of Microsoft, pursuant to which MSNBC has granted Hoshin Gigamedia a non-exclusive license to use and transmit a selected portion of its news content.lawsuit.In November 1999, we issued a warrant to Microsoft in connection with the purchase by Microsoft of
4four million of our shares for$35US$35 million. The warrantiswas exercisable for five years and initiallyentitlesentitled Microsoft to purchase up to 10 million of our shares at$6.60US$6.60 per share. As a result of a special distribution of US$2.00 per share by GigaMedia in March 2002, the warrant provided that Microsofthas not exercisedhad the right to elect either (i) an adjustment to the terms of the warrant such that the warrant thereafter would represent the right to acquire 33,529,412 shares at US$1.97 per share, or (ii) a cash payment (the “Anti-Dilution Fee”) equal to US$20 million (the per share special distribution amount multiplied by the number of shares originally covered by the warrant). In March 2004, Microsoft notified GigaMedia of its purported election to receive the Anti-Dilution Fee. GigaMedia informed Microsoft that such purported election was untimely and therefore ineffective. In July 2004, we entered into an agreement with Microsoft to settle this dispute. Pursuant to the settlement, Microsoft would receive a cash payment and would return the warrant to our Company for cancellation, releasing all rights and claims related to the warrant.For further information see note 5 of the Consolidated Financial Statements. 58CHINATRUST COMMERCIAL BANK Pursuant to an arrangement between our wholly-owned subsidiary KBT and Chinatrust Commercial Bank sinceIn September2001, KBT charges Chinatrust Commercial Bank a monthly leased line fee. This fee totaled approximately NT$886 thousand and NT$950 thousand (US$27.3 thousand) in 2001 and 2002, respectively. GRAND PACIFIC SECURITIES INVESTMENT TRUST CO., LTD. We purchased beneficiary certificates of fixed-income open-end mutual funds that are managed by the Grand Pacific Securities Investment Trust Co., Ltd., a member of the Koos Group. For 1999 and 2000, these purchases totaled NT$100 million and NT$700 million, respectively. We did not pay any fees or commissions to Grand Pacific in connection with these purchases. We sold all beneficiary certificates in 2000 at a gain of NT$14,549 thousand and repurchased additional beneficiary certificates. As of December 31, 2001, the Grand Pacific Securities Investment Trust Co., Ltd. was no longer affiliated with the Koos Group because the Koos Group disposed of all of their shares in Grand Pacific Securities Investment Trust Co., Ltd. in 2001. RAYMOND CHANG During 2001, we provided our CEO, Raymond Chang, a two-year loan in the amount of approximately NT$18.5 million at an annual interest rate of 4.45%. On June 2, 2003, we agreed with Mr. Chang that the loan will be due by December 31, 2003 and that interest will continue to accrue at 4.45% per annum until full payment is received. Mr. Chang began making payments against interest and principal on June 2, 2003. 59ITEM 8. FINANCIAL INFORMATION A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION FINANCIAL STATEMENTS Please refer to Item 18 for a list of all financial statements as part of this annual report on Form 20-F. INFORMATION ON LEGAL OR ARBITRATION PROCEEDINGS We are currently a party to a legal proceeding related to our initial public offering, as described below. As the proceeding relates to misconduct by the underwriters and not GigaMedia, we do not expect that the ultimate outcome of this legal proceeding will have a materially adverse effect on our financial position or overall trends in results2004, certain of ouroperations. However, if an unfavorable ruling were to occur, there exists the possibility of a material adverse impact on the results of operations. In December 2001, a class action lawsuit was filed againstprincipal shareholders fully indemnified usand our directors and some officers on behalf of purchasers of our common stock between February 17, 2000 and December 6, 2000 inclusive. There are over 300 issuers who are defendants in this class action. The complaint alleges that we violated Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunderin connection with theinitial public offering of our stock or our IPO. The complaint further alleges that the prospectus used for our IPO was materially false and misleading because it failed to disclose, among other things (i) the underwriters had solicited and received excessive and undisclosed commissions from certain investor in exchange for which the underwriters allocated to those investors substantial portion of the restricted number of our shares issued in connection with our IPO; and (ii) the underwriters had entered into agreements with customers whereby the underwriters agreed to allocate our shares to those customers in our IPO in exchange for which the customer agreed to purchase additional GigaMedia shares in the aftermarket at pre-determined prices. The plaintiffs claim damages in an unspecified amount, including class damages and statutory compensation in an amount to be determined at trial, including interest, costs and attorneys' fees. On or around April 19, 2002, the plaintiffs filed amended complaints against us. On July 1, 2002, the underwriter defendants filed their motion to dismiss the amended complaints. Subsequently, on July 15, 2002, the issuer defendants filed their motion to dismiss the amended complaints. The parties completed the briefing on the motions to dismiss,settlement and thecourt held oral argument on the motions to dismiss on November 1, 2002. On October 17, 2002, a settlement consideration was proposed that the insurers, on behalf of the defendant directors and officers, shall severally pay the sum of US$100 million for the benefits of the plaintiffs in the class action. On February 19, 2003, the court issued an Opinion and Order on defendants' motions to dismiss, which granted the motions in part and denied the motions in part. As to our company, the Rule 10b-5 claims were dismissed without prejudice while the Section 11 claims survived the motion. As the litigationwarrant has been returned by Microsoft isstill at a very early stage, neither we nor our attorney is able to assess the likelihood of an unfavorable outcome and can determine as to the amount or range of potential loss, if any. However, we intend to vigorously defend ourself against allegations. We have entered into an insurance policy with American Insurance Group with US$10 million of liability coverage. In addition, we have requested the underwriters of our IPO for reimbursement for all cost, expenses, losses and/or damages incurred by us in connection with such lawsuit. Accordingly, as of December 31, 2002, management believes that the potential liability, if any, will be covered by the insurance policy, and hence we have not recorded any provision related to these claims. 60unexercised. Except for the above-referenced litigation, we are not aware that any of our directors, any member of our senior
managementsmanagement or any of our affiliates is a party to any current or pending legal proceedings the outcome of which is expected to have a material adverse effect on us.In addition, G-Music was involved in an administrative proceeding instituted by the Taiwan Fair Trade Commission with respect to G-Music's acquisition of Rose Records and Tachung Records in 2002. The Fair Trade Commission approved such acquisition but fined NT$3 million in total for alledged violation by us of certain regulations during the process of the acquisition. We paid and expensed the NT$3 million fine in 2002. DIVIDEND POLICYDividend Policy
We have never declared nor paid any dividends on our shares. We anticipate that we will continue to retain any earnings for use in the operation of our business and we do not intend to pay dividends in the foreseeable future.
B.
SIGNIFICANT CHANGES On March 21, 2003, we announced that our board of directors had received a formal offer from our management group, orSignificant ChangesExcept as disclosed in this annual report, no significant change has occurred since the
Management Group, comprised of seven senior officersdate of ourcompany, to purchase all shares of our company for US$1.20 per share. On June 12, 2003, the Management Group submitted an amended offer, or the Amended Offer, to our board of directors. The Amended Offer was structured as a scheme of arrangement under Singapore law whereby GigaMedia was expected to return capital and cancel all outstanding shares of GigaMedia other than those held by the Management Group, either directly or through a separate legal entity formed by the Management Group. In addition, the Amended Offer increased the purchase price from US$1.20 per share to US$1.30 per share. Terms of the Amended Offer are subject to the following conditions: (a) the negotiation and execution of a definitive agreement and other related agreements mutually acceptable in form and substance to GigaMedia and the Management Group; (b) the scheme of arrangement being sanctioned and approved by a court of competent jurisdiction in Singapore; (c) disclosure documents complying with Rule 13e-3 of the U.S. Securities Exchange Act of 1934 being filed and approved by the U.S. Securities and Exchange Commission; (d) the receipt of an opinion from GigaMedia's independentconsolidated financialadvisor to the effect that the transactions contemplated in the Amended Offer are fair to GigaMedia's shareholders; (e) the receipt of all necessary consents from third parties and the making of any necessary foreign or domestic governmental filings, and the expiration of any specified waiting periods thereunder without challenge; and (f) the Amended Offer being accepted by GigaMedia's shareholders (i) holding not less than 75% of GigaMedia's outstanding shares, and (ii) representing a majority in number of members present; in each case, present and voting at a shareholders' meeting that is duly called and fulfills the quorum requirements under Singapore law and GigaMedia's constituting documents to ratify the transaction. As stated in our March 21, 2003 annoucement, GigaMedia's board of directors had formed a special committee made up of four directors, including Nelson Chang, chairman of GigaMedia, Yuanchi Chao, David Chuang and Richard Lin Yang to review the offer made by the Management Group. The Amended Offer required that our board of directors respond, by the end of the business day, Taipei, Taiwan time, on June 20, 2003, which date was subsequently extended by the Management Group to July 14, 2003, to the Management Group whether our board of directors agreed to continue discussions with the Management Group. Under the proposal made by the Management Group as of June 30, 2003, in the event that our board of directors did not revert by July 14, 2003, the Management Group was entitled to terminate all discussions on the Amended Offer. The board of directors did not revert by July 14, 2003. Therefore, the Management Group is entitled to terminate discussions on the Amended Offer. However, our board of directors has not received a formal notice from the Management Group whether the Management Group will terminate the discussion, extend the deadline again or revise the terms of the offer. We cannot assure you that the management buyout offer will proceed on terms and conditions set forth in such offer, or at all. We will make an appropriate announcement in the event that GigaMedia enters 61into any definitive agreement on the offer with the Management Group. In the meantime, we urge you to exercise caution when dealing with Gigamedia shares and you should not take any action that may be prejudicial to your interests in our company. In addition, in connection with the management buyout offer made by the Management Group, we announced on June 5, 2003 that the chairman of our board of directors, Mr. Nelson Chang had tendered his resignation as our chairman and as a director of our company. The effectiveness of Mr. Chang's resignation is contingent upon the outcome of the offer made by the Management Group. Mr. Chang's resignation will be effective immediately following the earlier to occur of (a) the completion of the management buyout offer proposed by the Management Group and (b) the rejection of the offer by our board of directors or shareholders (assuming that in the case of a rejection by our board of directors, the proposed management buyout offer will be not submitted to our shareholders for their consideration) and receipt by our board of directors of a formal notice from the Management Group that no revised offer will be made in response to such rejection. Although the Management Group is entitled to terminate discussions on the management buyout offer because our board of directors did not revert to the Management Group by July 14, 2003, as of July 15, 2003 our board has not received a formal notice from the Management Group that no revised offer will be made and Mr. Chang remains chairman and a director of our company. 62statements. ITEM 9. THE OFFER AND LISTING
MARKET PRICE INFORMATION FOR OUR SHARES Our shares have been listedA. Offer and
traded on the Nasdaq since February 24, 2000.listing detailsThe following table shows, for the periods indicated, the high and low closing prices for the shares as quoted on the
Nasdaq,NASDAQ National Market, as well as the total trading volume and the average daily trading volume for such shares.
Common Shares ------------------------------------------------------------------------------------ High Low Total Trading Volume Average Daily Trading Volume Year Ended December 31, ---- --- -------------------- ---------------------------- 2000 (in US$) (in thousands shares) - --------------------------------------------------------------------------------------------------------------------First quarter $ 90.80 $ 51.40 24,450 815 - -------------------------------------------------------------------------------------------------------------------- Second quarter $ 50.77 $ 11.92 16,454 261 - -------------------------------------------------------------------------------------------------------------------- Third quarter $ 12.88 $ 7.08 12,768 203 - -------------------------------------------------------------------------------------------------------------------- Fourth quarter $ 8.50 $ 2.70 9,610 153 - --------------------------------------------------------------------------------------------------------------------
Common Shares ------------------------------------------------------------------------------------ High Low Total Trading Volume Average Daily Trading Volume Year Ended December 31, ---- --- -------------------- ---------------------------- 2001 (in US$) (in thousands shares) - --------------------------------------------------------------------------------------------------------------------First quarter $ 4.05 $ 2.53 1,710 86 - -------------------------------------------------------------------------------------------------------------------- Second quarter $ 2.84 $ 1.13 5,656 94 - -------------------------------------------------------------------------------------------------------------------- Third quarter $ 1.42 $ 0.67 7,546 126 - -------------------------------------------------------------------------------------------------------------------- Fourth quarter $ 2.70 $ 0.86 4,556 76 - --------------------------------------------------------------------------------------------------------------------
Common Shares ------------------------------------------------------------------------------------ High Low Total Trading Volume Average Daily Trading Volume Year Ended December 31, ---- --- -------------------- ---------------------------- 2002 (in US$) (in thousands shares) - --------------------------------------------------------------------------------------------------------------------First quarter 0.56 0.45 28,046,529 445,183 - -------------------------------------------------------------------------------------------------------------------- Second quarter 1.25 0.67 6,221,250 98,750 - -------------------------------------------------------------------------------------------------------------------- Third quarter 1.30 0.63 4,967,104 77,611 - -------------------------------------------------------------------------------------------------------------------- Fourth quarter 0.84 0.42 9,813,312 153,333 - --------------------------------------------------------------------------------------------------------------------
Common Shares ------------------------------------------------------------------------------------ High Low Total Trading Volume Average Daily Trading Volume Year Ended December 31, ---- --- -------------------- ---------------------------- 2003 (in US$) (in thousands shares) - --------------------------------------------------------------------------------------------------------------------January 1.52 0.69 18,753,399 893,019 - -------------------------------------------------------------------------------------------------------------------- February 1.03 0.73 3,897,489 205,131 - -------------------------------------------------------------------------------------------------------------------- March 1.05 0.66 5,203,926 247,806 - -------------------------------------------------------------------------------------------------------------------- April 0.94 0.86 3,954,426 188,306 - -------------------------------------------------------------------------------------------------------------------- May 0.96 0.87 2,977,128 141,768 - -------------------------------------------------------------------------------------------------------------------- June (through June 24) 1.27 0.9 15,189,900 893,524 - --------------------------------------------------------------------------------------------------------------------Source: Yahoo! 63
Common Shares Year Ended December 31, 2001
High Low Total Trading Volume Average Daily
Trading Volume
(in US$) (in thousands shares) First quarter
$ 4.00 $ 1.97 3,271 53 Second quarter
$ 2.83 $ 1.12 4,398 70 Third quarter
$ 1.41 $ 0.60 7,942 137 Fourth quarter
$ 2.76 $ 0.89 4,687 73 Common Shares Year Ended December 31, 2002
High Low Total Trading Volume Average Daily
Trading Volume
(in US$) (in thousands shares) First quarter
$ 2.88 $ 2.30 9,492 161 Second quarter
$ 1.25 $ 0.67 6,215 99 Third quarter
$ 1.30 $ 0.63 4,967 78 Fourth quarter
$ 0.84 $ 0.42 9,801 153 Common Shares Year Ended December 31, 2003
High Low Total Trading Volume Average Daily
Trading Volume
(in US$) (in thousands shares) First quarter
$ 1.52 $ 0.66 27,796 456 Second quarter
$ 1.21 $ 0.86 22,647 359 Third quarter
$ 2.98 $ 1.17 176,987 2,765 Fourth quarter
$ 3.35 $ 1.44 88,187 1,378 Common Shares Year Ended December 31, 2004
High Low Total Trading Volume Average Daily
Trading Volume
(in US$) (in thousands shares) First quarter
$ 2.07 $ 1.33 65,310 1,053 Second quarter
$ 1.87 $ 1.06 32,044 517 Third quarter
$ 1.43 $ 0.70 30,869 482 Fourth quarter
$ 2.43 $ 1.30 62,102 970 Common Shares Year Ended December 31, 2005
High Low Total Trading Volume Average Daily
Trading Volume
(in US$) (in thousands shares) January
$ 1.86 $ 1.39 7,546 377 February
$ 1.65 $ 1.49 3,343 176 March
$ 1.70 $ 1.30 5,414 246 April
$ 1.60 $ 1.39 6,082 290 May
$ 1.56 $ 1.38 4,201 200 June (only through June 28)
$ 2.48 $ 1.65 40,827 2,041 B. Plan of Distribution
Not applicable.
C. Markets
Our shares have been listed and traded on the NASDAQ National Market since February 24, 2000.
D. Selling Shareholders
Not applicable.
E. Dilution
Not applicable.
F. Expenses of the issue
Not applicable.
ITEM 10. ADDITIONAL INFORMATION
A.
SHARE CAPITALShare CapitalNot applicable.
B.
MEMORANDUM AND ARTICLES OF ASSOCIATIONMemorandum and Articles of AssociationOur current Memorandum and Articles of Association were adopted on
September 13, 1999. UnderJune 30, 2000.The principal purpose of our Company is that of investment holding. Our Company’s objects and purposes are set out in full in Clause 3 of our Memorandum of Association. Subject to the provisions of the Singapore Companies Act (Chapter 50) and any other written law in Singapore and our Memorandum and Articles of Association, we have
thefull capacity to carry on or undertake any business or activity, do any act or enter into any transaction andthefor such purposes, full rights, powers andprivileges of a natural person.privileges.The following is a summary of certain provisions of our Articles of Association.
DIRECTORS
Each of our directors will remain in his office as a director until:
-He is prohibited from acting as a director by reason of any order made pursuant to the Singapore Companies Act (Chapter 50);-He resigns from his office;-He receives a bankruptcy order made against him;-He is found to be lunatic or of unsound mind; or-He is removed by an ordinary resolution passed by our shareholders in accordance with the provisions of the Singapore Companies Act (Chapter 50).Any significant related party transactions require prior approvals from our audit committee which consists solely of independent directors.A director of our
companyCompany who is directly or indirectly interested in a transaction, contract or arrangement with ourcompanyCompany shall, as soon as practicable after the relevant facts have come to his knowledge, disclose the nature of his interest at a meeting of the board of directors.ASubject to such disclosure, a director shallnotbe entitled to voteon a transactionin respect of any contract or arrangement in which hehasis interested and he shall be taken into account in ascertaining whether amaterial interestquorum is present.Our directors may borrow or raise money from time to time for the purpose of our Company or secure the payment of such sums as they think fit and
that director shall not be counted inmay secure thequorum present at the meeting forrepayment or payment of suchtransaction. However, a director may vote and be counted in the quorum regarding a transaction in which such director has a non-material interest. The questionsums by mortgage or charge upon all or any ofmaterialityour property orthe question of the entitlement of any director to vote at a meeting may be resolved by the interested director voluntarily abstaining from votingassets or by thechairmanissue ofthe meeting. Directorsdebentures (whether at par or at discount or premium) or otherwise as they mayvote on any proposals or arrangements concerning the benefit of our employees which may relate to both directors and employees of us, so long as any director does not have any privilege or advantage not generally grantedthink fit.Subject to the
class of persons to which such benefit scheme relates. In addition, any of our directors may vote on any contract forSingapore Companies Act (Chapter 50), thepurchase or maintenance for any director or directors of our company of insurance against liability. Our Board of Directors may exercise all the powers of our company to borrow any sum of money, to give guarantees or indemnities, to mortgage or charge our undertaking, property and uncalled capital, or to issue debentures or other securities for any debt, liability or obligation of our company. Theremuneration of the directorsof our company isshall be determined from time to time by ourcompensation committee. The directors' remuneration shall be deemedCompany in general meeting. Any director who is appointed toaccrue from day to day. Non-executiveany executive office or serves on any committee or who otherwise performs or renders services, which in the opinion of the directorsof our companyare outside his ordinary duties as a director, may, subject toretirement by rotation.the Singapore Companies Act (Chapter 50), be paid such extra remuneration as the directors may determine.Our
Directorsdirectors are not required to hold any of our shares by way of qualification. ADirectordirector who is not a shareholder of us is nevertheless entitled to attend and speak at shareholders meetings.64AUDIT COMMITTEE
Our
Audit Committee willaudit committee and board of directors have the ultimate authority and responsibility to select andengage,evaluate, on our behalf, the independent public accountantstowho audit our annual financialstatements, andstatements. Our audit committee will review and approve the planned scope of our annual audit.This committee will also review and approve the terms of proposed material transactions with related parties.In accordance with ourarticlesArticles ofassociation,Association, all of the members of ourAudit Committeeaudit committee must be persons who qualify as"independent"“independent” directors for purposes of the rules and regulations of theNasdaq.NASDAQ National Market.The
Audit Committeeaudit committee is currentlyconsistedconsists of Messrs.Yuanchi Chao, David ChuangGilbert Bao, Michael Y. J. Ding andRichard Yang.Yichin Lee. We intend to fully comply with the requirements of the U.S. Sarbanes-Oxley Act of 2002 and the rules of the U.S. Securities and Exchange Commission thereunder andNasdaq'sthe NASDAQ National Market’s requirements relating to audit committees.DIVIDENDS
Our
Board of DirectorsCompany maydeclare dividendsbypassingan ordinary resolutionat an Annual General Meeting.declare dividends but no dividend shall be payable except out of the profits of our Company or in excess of the amount recommended by the directors. Our profits available for dividend and determined to be distributed shall be applied to pay dividends to shareholders according to their respective rights and priorities. Except for shares with special rights as to dividends, all dividends shall be declared and paid according to the amounts paid upor deemed paid upon shares.All dividends unclaimed
for one yearafter having been declared may be invested or otherwise made use of by ourBoardboard ofDirectorsdirectors forthe benefit of us until claimed.our benefit. If any dividend has not been claimed for six yearsafter becoming due for payment,from the date of declaration, such dividend may be forfeited and shall revert to us. However, ourBoard of Directorsdirectors mayforfeit such dividend. Afterat any time thereafter at their absolute discretion annul any such forfeitureno shareholder or other person shall have the right to claim such dividend, but our Board of Directors may determine toand pay thewhole or part of suchdividend so forfeited to theshareholder or otherpersonwho could have claimed that dividend immediately before it was forfeited.entitled thereto prior to the forfeiture. No dividend shall bear interest against us.LIQUIDATION DISTRIBUTION
In the case of a winding up of our
companyCompany and in accordance withrequirements ofapplicable laws, our shareholders may pass a special resolution to authorize a liquidator to divide and distribute our assets to our shareholders or, authorize the liquidator to vest the whole or part of our assets in trustees upon such trusts for the benefit ofthe contributoriesour shareholders but so that no shareholder will be compelled to accept shares or other securities on which there is any liability.SHAREHOLDERS'SHAREHOLDERS’ MEETINGS
We are required to hold an annual general meeting once in every calendar year and not more than 15 months after the preceding annual general meeting. The directors may convene an extraordinary general meeting whenever they think fit, and they must do so upon the request in writing of shareholders representing not less than 10% of our paid-up share capital. In addition, two or more shareholders holding not less than 10% of our issued share capital may call a meeting of our shareholders. Unless otherwise required by law or by our
articlesArticles ofassociation,Association, voting at general meetings is by ordinary resolution, requiring an affirmative vote of a simple majority of those present and voting. An ordinary resolution suffices, for example, in respect of appointments of directors. A special resolution, requiring an affirmative vote of at least 75% of those present and voting, is necessary for certain matters under the Singapore Companies Act (Chapter 50), such as an alteration of ourarticlesArticles ofassociation.Association. Subject to the Singapore Companies Act (Chapter 50), at least 21days'days’ advance written notice specifying the intention to propose a special resolution must be given of every general meeting convened for the purpose of passing a special resolution. Subject to the Singapore Companies Act (Chapter 50), at least 14days'days’ advance written notice must be given of every general meeting convened for the purpose of passing an ordinary resolution.65VOTING RIGHTS
Voting at any meeting of our shareholders is by a poll. On a poll every shareholder who is present in person or by proxy has one vote for every share held by him.
SHARE CAPITAL
We generally have the right by obtaining a general mandate at the
Annual General Meetingannual general meeting to repurchase not more than 10% of our own shares in issue.Our
Boardboard ofDirectorsdirectors may make a capital call on our shareholders with respect to the amounts unpaid on their shares and the shareholders are required to pay thecall in one sum or by installment to the personamount called at thetimetime(s) and place as appointed by theBoardboard ofDirectors.directors. TheBoardboard ofDirectorsdirectors may revoke a call or postpone the time previously fixed for the call payment.We have the right, by ordinary resolution, to increase our capital by a sum and the number of shares as the resolution prescribes.
We may by ordinary resolution:
(i) consolidate and divide some or all of our share capital into shares of a larger nominal value than our existing shares; upon such consolidation, our Board of Directors may determine, as between the holders of shares to be consolidated, which particular shares are to be consolidated into each consolidated share, and may appoint a third party to sell any fractions of shares resulting from such consolidation and distribute ratably the net proceeds of such sale to the shareholders who would otherwise be entitled to a fraction or fractions of shares; (ii) subject to applicable law, sub-divide some or all of our shares into shares of a smaller nominal value than is fixed by our Memorandum of Association and determine that, as between the holders of the divided shares, different rights or restrictions which we may apply to new shares may apply to some of those divided shares; or (iii)
(i) consolidate and divide some or all of our share capital into shares of a larger nominal value than our existing shares;
(ii) subject to the Singapore Companies Act (Chapter 50), sub-divide some or all of our shares into shares of a smaller nominal value than is fixed by our Memorandum of Association, provided always that in such sub-division, the proportion between the amount paid and the amount (if any) unpaid on each reduced share shall be the same as it was in the case of the share from which the reduced share is derived;
(iii) cancel any shares which have not been taken or agreed to be taken by any person or which have been forfeited at the date of the passing of the resolution and reduce the amount of our share capital by the amount of the shares so cancelled; or
(iv) subject to the Singapore Companies Act (Chapter 50) and our Articles of Association, convert any class of our shares into any other class of shares. We may also by special resolution reduce our share capital and any capital redemption reserve fund and any share premium account in any manner as authorized by law.
We are not required to provide any sinking fund pursuant to our Articles of Association. There was no provision discriminating against any existing or prospective holder of shares as a result of such shareholder owning a substantial number of our shares.
There was no limitation on the rights of non-resident or foreign shareholders to hold or exercise voting rights on the shares.
MODIFICATION OF RIGHTS
We may vary or abrogate any special rights attached to any class of our shares by a special resolution passed at a separate meeting of holders of the shares of that class or, where the necessary majority for such special resolution is not obtained at the meeting, with the consent in writing of the holders of three-fourths in nominal value of the issued shares of that class
or by a special resolution passed at a separate meetingwithin two months ofholders of the shares of that class.such meeting.TRANSFER OF SHARES
Subject to our
articlesArticles ofassociation,Association, our shares are freely transferable but our directors may, in their absolute discretion, decline to register any transfer of our shares on which we have a lien. All of our outstanding shares have been fully paid. In addition, our directors may refuse, at their discretion, to register or transfer shares to a transferee of whom they do not approve. Shares may be transferred by a duly signed instrument of transfer in the usual common66form or in a form approved by our directors. Our directors may decline to register any transfer of shares evidenced in certificated form unless, among other things, it has been duly stamped and is presented for registration together with the share certificate and other evidence of title as they may require. We will replace worn-out or defaced certificates for shares upon production thereof to the directors and upon payment of such fee as specified in our Articles of Association. We will replace lost, destroyed or destroyedstolen certificates for shares upon, among other things, the applicant furnishing evidence and such indemnity as the directors may require.TAKEOVERS
The acquisition of shares of public companies is regulated by
inter alia,the SingaporeCompaniesSecurities and Futures Act (Chapter50)289) and the Singapore Code on Take-overs and Mergers. Any person, either on his own or together with parties acting in concert with him, acquiring an interest in25%30% or more of our voting shares is obliged to extend a takeover offer for the remaining shares which carry voting rights, in accordance with the provisions of the Singapore Code on Take-overs and Mergers."Parties“Parties acting inconcert" will be presumed toconcert” include a company and its related and associated companies, a company and its directors, including their close relatives and related trusts, a company and its pension funds and employee share schemes, a person and any investment company, unit trust or other fund whose investment such person manages on a discretionaryfundsbasis and a financialadvisersadvisor and its client in respect of shares held bythemthe financial advisor and all the funds managed bythemthe financial advisor on a discretionary basis where the shareholdings of the financialadviseradvisor and any of those funds in the client total 10% or more of the client’s equity sharecapital of the acquiring party.capital. The offer must be in cash or be accompanied by a cash alternative at not less than the highest price, excluding stamp duty andcommission,dealing costs, paid by the offeror or parties acting in concert with him for shares of that class within the preceding12six months. A mandatory takeover offer is also required to be made if a person holding between25%30% and 50%, both inclusive, of the voting shares, either on his own or together with parties acting in concert with him, acquires additional shares representing more than3%1% of the voting shares in any12-monthsix-month period.C.
MATERIAL CONTRACTSMaterial ContractsThe following are summaries of our material contracts entered into over the past
2two years. However, these summaries may not contain all the information important to you. For more complete information, you should read the entire agreements, which have been included as exhibits to this annual report or incorporated into this annual report by reference to our annual reports on Form 20-F and Form 20-F/A (File No. 000-30540) filed with the Commission onJune 28, 2001August 15, 2003 and June28, 2002. ACQUISITION AGREEMENTS TO ACQUIRE ROSE RECORDS AND TACHUNG RECORDS, TAIWAN'S TWO LEADING MUSIC STORE CHAINS, ENTERED INTO AS OF FEBRUARY 2002 WITH RESPECT TO ROSE RECORDS AND SEPTEMBER 2002 WITH RESPECT TO TACHUNG RECORDS. We finalized agreements in February 2002 in the case of Rose Records and in September 2002 in the case of Tachung Records to acquire through our directly-owned subsidiary, G-Music Limited, all of the ownership interests of Rose Records Co., Ltd. and Tachung Records Co., Ltd. The total purchase price was NT$638.9 million, consisting of NT$418.3 million in cash, NT$88.0 million of which was not paid and recorded as other current liabilities as of30, 2004.Settlement Agreement, dated December 31,
2002,2003, among EMI, GigaMusic.com andNT$220.6 million in the form of shares in G-Music. The value of G-Music common stock was determined based on management's estimate of the fair value of G-Music common stockGigaMediaOn December 31, 2003, we entered into a Settlement Agreement with EMI and GigaMusic.com to resolve and settle all disputes in connection with the
acquisitions. The valuestrategic agreement entered into between our Company, EMI and GigaMusic.com as ofthe net tangible assets and the amortizable intangible assets of the companies acquired was NT$370.6 million at the acquisition dates. We currently own approximately 58% of G-Music after the shares issued to the selling shareholders of Rose Records and Tachung Records. STRATEGIC ALLIANCE AGREEMENT ENTERED INTO AS OF MARCH 11, 2001 WITH GAMANIA DIGITAL ENTERTAINMENT CO.May 14, 2001. Under thestrategic alliance agreement,Settlement Agreement, we agreed tocooperatively provide broadband ISP service targeting Gamania's online game subscribers. Gamaniapay EMI US$400 thousand while EMI agreed toprovide all productsreturn to us 5% ownership of GigaMusic.com andservicesa letter of credit for the amount of US$1.0 million issued to EMI in accordance with the strategic agreement. The Settlement Agreement became effective on February 25, 2004, following amost favorable pricing basis, and all new online games onresolution approved by aminimum one-month exclusive access basis. 67We retain the exclusive advertising rights to the co-branded site and share with Gamania a commission of 10% monthly ISP access fee per related subscriber if certain sales milestones are achieved. COMMERCIAL AGREEMENT ENTERED IN TO AS OF APRIL 20, 2001 WITH ROCK INTERNET CORPORATION, OR RIC Under the commercial agreement, we can obtain licensing of RIC Content, on a preferential and most favored nation basis, for use on PC/Internet, wireless and interactive television platforms and jointly promote service and products by on-line and off-line advertising and promotional activities. We are entitled to receive 3% of all gross revenue as a referral fee from RIC's e-commerce sale and RIC shall receive 50% of advertising revenues generated from the co-branded site. Under this agreement, RIC shall purchase an aggregate of US$1.5 millionmeeting of ourservices within 3 yearsboard ofthe signing date. Upon the failuredirectors.Stock Purchase Agreement, dated as of
RIC's performance, Rock Music Group, the major shareholder of RIC, is obligated to assume the purchase obligationMarch 17, 2004, by andother obligations of RIC. STRATEGIC ALLIANCE AGREEMENT, ENTERED INTO AS OF MAY 14, 2001, AMONG US, GIGAMUSIC.COM LIMITED, AND EMI MUSIC ASIA (A DIVISION OF EMI GROUP HONG KONG LIMITED) In May 2001,among GigaMedia International Limited, GV Holding Company, and Alexander Saidakovsky, Alexander Ganelis and Daniil UtinOn March 17, 2004, we entered into a
strategic allianceStock Purchase Agreement through our wholly-owned subsidiary, GigaMedia International Limited, with GV Holding Company, and Alexander Saidakovsky, Alexander Ganelis and Daniil Uti to acquire all of the issued and outstanding shares of Grand Virtual Inc. and related affiliates in a private transaction for an all-cash consideration of US$32.5 million.End User License Agreement dated April 1, 2004 by and among IML and UIM
On April 1, 2004, we entered into an End User License Agreement with UIM pursuant to which we granted a non-exclusive, non-transferable, world-wide license to UIM to use our software and certain operational and support services for a licensing fee based on a revenue sharing arrangement between us and UIM. The agreement is for a term of ten years.
Purchase and Sale Agreement, dated June 23, 2005, between Hoshin GigaMedia Center Inc. and Webs-TV.net Digital International Corporation, or Webs-TV
On June 23, 2005, we entered into an agreement with
EMIWebs-TV tojointly pursueassign our Internet content businessopportunities, developat a consideration of ane-commerce marketplaceamount in NT dollars equivalent to approximately US$670 thousand and, formusic in Taiwan, and support the businessa period ofGigaMusic.com Limited, our subsidiary. Under the strategic alliance agreement, GigaMusic.com Limited will be responsible for the infrastructure, costs and implementation of all projects. EMI's supporting responsibilities include providing access to EMI content and EMI artists, access to EMI management expertise and industry know-how, and certain additional technology, resources and funding support. EMI will be grantedten years commencing from January 1, 2006, apercentageportion of theoutstanding share capital of GigaMusic.com Limited on a fully diluted basis. Under the terms of the agreement, GigaMedia is required to make non-recoupable payments to EMI in the amount of US$1,000,000 on March 1, 2001, March 1, 2002 and March 1, 2003, respectively. EMI has not provided the agreed-upon products to GigaMusic.Com. The Web site of GigaMusic.Com has not been launched and no subscribernet revenuehas beengenerated from theproject. We made the US$1,000,000 payments due March 1, 2001 and March 1, 2002, and terminatedgigigaga.com.tw website being transferred. Pursuant to the agreement,on March 1, 2002. We intend to: - require a returnwe will transfer to Webs-TV all properties relating to the operation ofownership interest in GigaMusic to us; - foregoourpayment obligation of US$1,000,000 due March 1, 2003;gigigaga.com.tw website, including fixed assets, the gigigaga logo, and- restructure the arrangement or demand a refund of the US$2,000,000 paid. In April 2003 we were granted an injunction by Taipei District Court to stop payment of the disputed US$1 million due March 1, 2003. We anticipate arbitration to commence in January 2004.our content and data.D.
EXCHANGE CONTROLSExchange ControlsThere are currently no foreign exchange regulations which restrict the export or import of our capital and the ability of
Hoshin Gigamedia and G-Musicour subsidiaries to distribute dividends to us. There are no limitations on the right of a non-resident or foreign owner to hold or vote the shares imposed by Singapore law or by ourarticlesArticles ofassociation.Association.E.
TAXATION SINGAPORE TAX CONSIDERATIONS TAXATION OF DIVIDENDS RECEIVED BY SINGAPORE RESIDENT SHAREHOLDERSTaxationSingapore Tax Considerations
Taxation of Dividends received by Singapore Resident Shareholders
Dividends paid by us would be taxable in Singapore if they are received
68in Singapore or if they are considered, in the hands of a particular shareholder, to be derived in Singapore (for example if they constitute the income of a trade or business carried out in Singapore). Under the Singapore-Taiwan Tax Treaty, if a dividend is paid by a company which is tax resident in Taiwan to a person who is tax resident in Singapore, the tax on the dividend shall not exceed an amount which, together with the corporate income tax on the profits of the company paying the dividends, constitutes 40% of that part of the taxable income out of which the dividends are paid. The term
"corporate“corporate income taxpayable"payable” shall be deemed to include the corporate income tax that would have been paid but for the reduction or exemption under the laws designed to promote economic development.If our shareholder, whether a company or an individual, receiving or deriving such dividends is tax resident in Singapore, he would be entitled to foreign tax credits under the Singapore-Taiwan Tax Treaty and, if the recipient is a company which owns not less than 25% of our shares, the tax credit will include underlying tax paid by us. Singapore foreign tax credit is limited to the lower of the foreign tax suffered and the Singapore tax payable on the net foreign income (after attributable and allowable expenses).
In addition, the Singapore Minister for Finance announced during the budget for the financial year 2003 on 28 February 2003 that certainCertain foreign dividends received by a Singapore residentperiodperson on or after 1 June 2003 will, however, be exempt from tax. The main conditions to be satisfied for such exemption(as contained in a circular published by the Inland Revenue Authority of Singapore on 21 May 2003)are that:(a) the dividends are received from a jurisdiction with a
headlinemaximum tax rate on the trade or business income of a company of at least 15%; and(b) the dividends themselves, or the income from which they are paid, have been subject to tax in the foreign
jurisdiction. Under the current provisions of the Income Tax Act (Chapter 134 of Singapore), thejurisdiction or have been exempted from tax under an incentive granted for substantive business activities.The normal tax rate for corporate profits is
22%20% for the year of assessment20032004 (i.e. for the income earned in the financial year or other basis period ended2002)2005).The marginalResident individuals are subject to tax at progressive rates. Based on proposals made by the Government in the 2005 Budget, the maximum individual tax rate would be 21% forindividuals ranges from 0% to 22%, depending ontheamountyear ofchargeable income.assessment 2006 and 20% for the year of assessment 2007.If our shareholders are corporations, our shareholders will be regarded as being tax resident in Singapore if the control and management of our
shareholders'shareholders’ business is exercised in Singapore. For example, if ourshareholders'shareholders’ board of directors meets and conducts the business of ourshareholders'shareholders’ company in Singapore, our shareholders will be regarded as tax residents of Singapore. If our shareholders are individuals, our shareholders will be regarded as being tax resident in Singapore in a year of assessment if, in the preceding year, our shareholders were physically present in Singapore or exercised an employment in Singapore (other than as directors of a company) for 183 days or more or if our shareholders had resided in Singapore.GAINS ON DISPOSAL OF SHARESAll foreign-sourced income received (except for income received through a partnership in Singapore) in Singapore on or after 1 January 2004 by tax resident individuals will be exempt from tax.
Gains on Disposal of Shares
Singapore does not impose a tax on capital gains. However, there are no specific laws or regulations which deal with the
characterisationcharacterization of capital gains and hence, gains may be construed to be of an income nature and subject to tax if they arise from activities which the Inland Revenue Authority of Singapore regards as the carrying on of a trade or business in Singapore.STAMP DUTYStamp Duty
There is no stamp duty payable in respect of the issuance and holding of shares. Where existing shares are acquired in Singapore, stamp duty is payable on the instrument of transfer of the shares at the rate of S$2.00 for every S$1,000 of the consideration for, or market value of, the shares, whichever is higher. The stamp duty is borne by the purchaser unless there is an agreement to the contrary. Where an instrument is executed outside Singapore, or no instrument of transfer is executed, no stamp duty is payable on the acquisition of existing shares. However, stamp duty would be payable if an instrument of transfer which is executed outside Singapore is received in Singapore.
Under Singapore law, our directors may not register a transfer of
69shares unless the instrument of transfer has been duly stamped. SINGAPORE ESTATE DUTY If our shareholders are individuals who are not domiciled inSingapore
Singapore estate duty will be imposed on the value of immovable properties situated in Singapore owned by such individual, subject to specific exemption limits. Previously, movable assets of non-domiciles were also included.Estate DutyWith respect to deaths occurring on or after 1 January 2002, the movable property of persons who are not domiciled in Singapore at the time of death are exempt from estate duty. Therefore, an individual holder of shares who is not domiciled in Singapore at the time of his or her death will not be subject to Singapore estate duty on the value of our shares.
If our shareholders are individuals who are domiciled in Singapore, Singapore estate duty is imposed on the value of most immoveable property situated in Singapore and on most movable property, wherever it may be situated, subject to specific exemption limits. Accordingly, our shares held by an individual domiciled in Singapore are subject to Singapore estate duty upon such an
individual'sindividual’s death. Singapore estate duty is payable to the extent that the value of our shares aggregated with any other assets subject to Singapore estate duty exceeds S$600,000. Unless other exemptions apply to the other assets, for example, the separate exemption limit for residential properties, any excess beyond S$600,000 will be taxed at 5% on the first S$12,000,000 of theindividual'sindividual’s Singapore chargeable assets and thereafter at 10%.Individuals should consult their own tax advisors regarding the Singapore estate duty consequences of their ownership of our shares.
UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS FORUnited States Federal Income Tax Considerations for U.S.
HOLDERSHoldersThe following is a
summarydiscussion ofthe material United Statescertain U.S. federal income taxconsequencesconsiderations forbeneficial owners ofinvestors in our shares that are U.S.holders and non-residents of Singaporepersons (as defined below) that hold the shares as a capitalassets and are not vendors carryingasset. This discussion is based on U.S. federal income tax law as in effect on the date hereof which is subject to change, possibly on atraderetroactive basis. This discussion is for general information only and does not address all of the tax considerations that may be relevant to you inshares in Singapore. Youlight of your particular circumstances or if you area U.S. holdersubject to special treatment under theInternal Revenue CodeU.S. federal income tax laws including if you are:-a bank;a broker-dealer;a financial institution or an insurance company;a tax-exempt entity;a person holding shares as part of a straddle, hedge, conversion or other integrated investment;a person owning, actually or constructively, 10% or more of the combined voting power of all classes of our stock; ora person whose “functional currency” is not the United States dollar.This discussion does not address any U.S. state, local or foreign or any U.S. federal estate, gift or alternative minimum tax consideration of a holder of our shares.
As used in this discussion, the term “U.S. person” means:
an individual who is a citizen or resident of the United States;-a corporation, orpartnershipother entity treated as a corporation, created or organizedin orunder the laws of the United States or any political subdivision thereof;-an estate the income of which is subject to United States federal income taxation regardless of its source;-a trust if (1) it is subject to the primary supervision of a court within the United States and one or more United States persons have the authority to control all substantial decisions of the trust, or (2) ithas a valid electionwas ineffect under applicable United States Treasury regulations to beexistence on August 20, 1996, was treated as aUnited States person. This summary is basedU.S. person oncurrent law, which is subjectthe previous day, and elected tochange, possibly on a retroactive basis. It is for general purposes only and you should not consider itcontinue to betax advice. This summary does not representso treated.If a
detailed description of all the United Statespartnership (including any entity treated as a partnership for U.S. federal income taxconsequences to you in light of your particular circumstances. In addition, it does not represent a detailed description of the United States federal income tax consequences applicable to you if you are subject to special treatment under the United States federal income tax laws including if you are: - a dealer in securities or currencies; 70- a trader in securities if you elect to use a mark-to-market method of accounting for your securities holdings; - a financial institution or an insurance company; - a regulated investment company; - a real estate investment company; - a tax-exempt organization; - a person liable for alternative minimum tax; - a person holding shares as part of a hedging, integrated or conversion transaction, constructive sale or straddle; - a person owning, actually or constructively, 10% or more of our voting stock; or - a U.S. holder whose "functional currency" is not the United States dollar. We cannot assure you that a later change in law will not alter significantly the tax considerations that we describe in this summary. If a partnershippurposes) holds our shares, the tax treatment of a partner in such partnership will generally depend upon the status of the partner and the activities of the partnership. If you are a partner of a partnership holding our shares, youshouldare urged to consult your taxadvisors.advisors as to the particular U.S. federal income tax consequences as applicable to you.You
shouldare urged to consult yourowntax advisor concerning the particularUnited StatesU.S. federal, state, local and foreign income and other taxconsequences to you ofconsiderations regarding the ownership and disposition of the sharesas well asincluding theconsequences to you arisingapplication of the passive foreign investment company rules discussed below. Investors should review the discussion below underthe laws“Passive Foreign Investment Company Rules” carefully.Taxation of
any other taxing jurisdiction. TAXATION OF DIVIDENDSDividendsExcept as discussed below with respect to the passive foreign investment company tax rules, the amount of distributions you receive on your shares (other than certain pro rata distributions of shares or rights to subscribe for shares) will generally be treated as dividend income to you if the distributions are made from our current and accumulated earnings and profits as calculated according to United States federal income tax principles. You will include such dividends in your gross income as ordinary income on the day you actually or constructively receive them. The amount of any distribution of property other than cash will be the fair market value of such property on the date it is distributed.
YouA non-corporate recipient of dividend income willnotgenerally beentitledsubject toclaimtax on dividend income from adividends received deduction“qualified foreign corporation” at a maximum U.S. federal tax rate of 15% rather than the marginal tax rates generally applicable to ordinary income so long as certain holding period requirements are met. A non-U.S. corporation (other than a passive foreign investment company) generally will be considered to be a qualified foreign corporation (i) if it is eligible for the benefits of a comprehensive tax treaty with the United States which the Secretary of Treasury of the United States determines is satisfactory for purposes of this provision and which includes an exchange of information program or (ii) with respect todistributions you receive from us. With respect to U.S. holders who are individuals, certain dividends received from a foreign corporation before January 1, 2009,any dividend it pays onshares (or ADSs backed by such shares) that arestock which is readily tradable on an established securities market in the United States. There is currently no tax treaty in effect between the United Statesmay be subject to reduced rates of taxation.and Singapore. Our shares arelistedexpected to be readily tradable on theNasdaq Stock Market'sNASDAQ National Market,which we believe isan established securities market in the UnitedStates for purposesStates. Distributions, if any, in excess ofthese rules. However, there can be no assurance that our sharescurrent and accumulated earnings and profits will constitute a return of capital and will bereadily tradableapplied against and reduce the holder’s tax basis inthis or later years (orsuch shares. To the extent thatwedistributions are in excess of such basis, the distributions willhave ADSs that are readily tradable on an established securities market in any given year). Individuals that do not meet a minimum holding period requirement during which they are not protected from the risk of loss or that elect to treat the dividend incomeconstitute capital gain as"investment income" pursuant to section 163(d)(4) of the Internal Revenue Codediscussed below. U.S. corporate holders will generally not be eligible for thereduced rates of taxation regardless of the trading status of our shares or ADSs. U.S. holders who are individuals will not be eligible for reduced rates of taxation on anydividends receivedfrom us priordeduction for distributions toJanuary 1, 2009, if we are a passive foreign investment company (see "--Passive Foreign Investment Company Rules" below)domestic corporations inthe taxable year in which such dividends are paid or in the preceding taxable year. 71You should consult your own tax advisors regarding the applicationrespect ofthese rules given your particular circumstances.distributions on shares.The amount of any
dividenddistribution paid in a currency other than the United States dollar will equal the United States dollar value of the foreign currency you receive, calculated by reference to the exchange rate in effect on the date you actually or constructively receive thedividenddistribution regardless of whether the foreign currency is actually converted into United States dollars. If you do not convert the foreign currency you receive as a dividend on the date of receipt, you will have a basis in such foreign currency equal to its United States dollar value on the date of receipt. Any gain or loss you realizeifwhen you subsequently sell or otherwise dispose of such foreign currency generally will be ordinary income or loss from sources within the United States for foreign tax credit limitation purposes.Dividends we pay with respectHolders may generally elect to
shares will generally constitute foreign source income and generally will be considered "passive income" or, for certain holders, "financial services income", which you generally are required to treat separately from other types of income in computing your foreign taxclaim a creditallowable underagainst their United States federal income taxlaws.liability for Singapore tax withheld from dividends received in respect of the shares. The rules relating to the determination of the foreign tax credit are complex and prospective purchasers are urged to consult their personal tax advisors to determine whether and to what extent they would be entitled to such credit. Holders that do not elect or are not permitted to claim foreign tax credits may instead claim a deduction for Singapore tax withheld. You will not be eligible for a foreign tax credit for the underlying Singapore taxes on profits paid by us with respect to such dividends.PASSIVE FOREIGN INVESTMENT COMPANY RULES BasedSale or other disposition of shares.Except as discussed below with respect to the passive foreign investment company tax rules, a holder generally will recognize capital gain or loss for U.S. federal income tax purposes upon a sale or other disposition of our shares in an amount equal to the difference between the amount realized from the sale or disposition and the holder’s adjusted tax basis in the shares. Such gain or loss generally will be long-term (taxable at a reduced rate for individuals) if, on the
currentdate of sale or disposition, the shares were held by the holder for more than one year andprojected compositionwill generally be treated as gain or loss from United States sources for foreign tax credit purposes. The claim of a deduction in respect of a capital loss may be subject to limitations.Passive Foreign Investment Company Rules
In general, we will be classified as a “passive foreign investment company”, or a “PFIC”, for any taxable year if either (i) at least 75% of our gross income is passive income or (ii) at least 50% of the value (determined on the basis of a quarterly average) of our assets produce or are held for the production of passive income. Based upon an analysis of our income and
valuation of ourassetsincluding goodwill,for the 2004 taxable year, we believe that we were apassive foreign investment companyPFIC for the 2004 taxable year. Whether we continue to be classified as a PFIC in the current or any future taxable year2002,will be determined on the basis of, among other things, our asset values (including, among other items, the level of our cash, cash equivalents andabsent significant capital expenditures or a significant increase in our stock price this year, or both, itshort-term investments), and gross income (including whether such income islikely that we will remain aactive versus passiveforeign investment companyincome as specially determined under the PFIC rules) forthesuch taxable year,2003.which assets, and gross income are subject to change from year to year. We havelimited control overpositioned our entertainment software business to service clients operating in themarket value of our sharesdynamic anddo not currently have plans to make significant active investments.rapidly expanding Internet-based entertainment markets. In addition, webelieve that onecontinue to investigate business opportunities and we may acquire a business for cash, thereby reducing our cash ormoreother investment assets. If we are to realize additional value through the conduct of oursubsidiaries were passive foreign investment companiesentertainment software business or if we acquire a business for cash, we may mitigate our risk of continuing to be classified as a PFIC or we may eventually no longer continue to be classified as a PFIC. Because thetaxable year 2002 and will remain passive foreign investment companies for the taxable year 2003. You will be treated as an indirect shareholderdetermination ofyour proportionate interest in the shares of such subsidiaries. Passive foreign investment company statuswhether we are a PFIC is a factual determinationthat ismadeannually.annually and because there are uncertainties in the application of the relevant rules, there can be no assurance we will not be classified a PFIC in the current or any future taxable year. Provided we are apassive foreign investment companyPFIC for any taxable year during your holding period of our shares, thepassive foreign investment companyPFIC tax rules discussed below generally will apply in future years even if we cease to be apassive foreign investment companyPFIC in subsequent years. U.S. holders who are individuals will not be eligible for reduced rates of taxation on any dividends,received from us prior to January 1, 2009,if we are apassive foreign investment companyPFIC in the taxable year in which such dividends are paid or in the preceding taxable year.In general,If we were classified as a
company is considered a passive foreign investment companyPFIC for any taxable yearif either: - at least 75% of its gross income is passive income, or - at least 50% of the value of its assets is attributable to assets that produce or areduring which you heldfor the production of passive income. The 50% of value test is based on the average of the market value of our assets for each quarter during the taxable year. If we own at least 25%, by market value, of another company's stock, we will be treated, for purposes of the passive foreign investment company tax rules, as owning our proportionate share of the assetsshares, andreceiving our proportionate share of the income of that company. As a U.S. holder of shares in a passive foreign investment company,unless you make a “qualifying electing fund” election (a “QEF election”) or a mark-to-market electionas discussed below,(as described below), you will generally be subject topassive foreign investment companyspecial tax rules thatapply to: -have a penalizing effect, regardless of whether we remain a PFIC, on (i) any"excess distributions" on your shares (generally,excess distribution that we make to you (which generally means anydistributionsdistribution received by youon the shares duringin a taxable year thatareis greater than 125% of the average annual distributions72received by you in the three preceding taxable years or if shorter,your holding period for theshares)shares, if shorter), and-(ii) any gain realized on the sale or other disposition, including a pledge, ofyour shares (including the pledging of your shares as security for a loan). If, as we expect, one or more of our subsidiaries are treated as passive foreign investment companies, a distribution from any of such subsidiaries to us, a disposition of any of such subsidiaries by us, or a transaction through which your indirect ownership of any of such subsidiaries is decreased (including additional offerings of our shares) may be treated as a distribution or disposition subject to the passive foreign investment company tax rules even though you may not actually have received any cash associated with such distribution, disposition, or transaction. If this were the case, however, you would be entitled to increase your basis in the shares you directly own to reflect the gain realized upon such distributions or dispositions. Moreover, you would not be taxed when we distributed to you the income that you already included in income for tax purposes.shares. Under thesepassive foreign investment company tax rules, -PFIC rules:the excess distribution or gainwillwould be allocated ratablyoverto your holding period forour shares, -the shares;the amount allocated to the current taxable year and any taxable year prior to the first taxable year in which wewereare classified as apassive foreign investment company willPFIC would be treated asordinary income, and -income;the amount allocated to each taxable year beginning with the first taxable year in which we are classified as a PFIC, other than the current taxable year,willwould be subject to tax at the highest tax rate in effectfor your class of taxpayerapplicable to you for thatyearyear; andthe interest charge generally applicable to underpayments of taxwillwould be imposed on theresultingtax attributable to each taxable year beginning with the first taxable year in which we are classified as a PFIC, other than the current taxable year.As an alternative to the foregoing rules and upon your request, we will provide you with information to enable you to make a QEF election under which, generally in lieu of being subject to the penalizing PFIC rules described above, your pro rata share of our earnings for any particular taxable year, as determined for United States federal income tax purposes would be currently included in your gross income despite the fact that we may not have made any actual dividend distributions for such taxable year.
OnAs a further alternative to the
other hand, if ourforegoing rules, a holder of “marketable stock” in a PFIC may make a mark-to-market election, provided that the shares areregularlyactively traded on a “qualified exchange.” Under applicable Treasury regulations, a “qualified exchange” includes a national securities exchangeyou may make an election to mark your shares tothat is registered with the SEC or the national marketwhich will result in tax consequences that differ from those discussed with regard tosystem established under thepassive foreign investment company tax rules above. Our shares are listed onSecurities and Exchange Act of 1934 (i.e., theNasdaq Stock Market'sNASDAQ NationalMarket which is a national securities exchange for purposes of the mark-to-market election, although there can be no assurance that our shares will be "regularly traded"Market). If you makean effective mark-to-marketthis election,each yearyou will generally (i) includeinas incomeas ordinary income (rather than capital gain)for each taxable year the excess, if any, of the fair market value of yourpassive foreign investment companyshares at the end of the taxable year overyourthe adjusted tax basisinof the shares andwill be permitted to(ii) deduct asan ordinarya lossthe amount ofthe excess, if any, of the adjusted tax basis ofsuchthe shares overtheirthe fair market value of the shares at the end of the taxable year, but only to the extent of thenetamount previously included in income as a result of the mark-to-market election. Your adjusted tax basis in the shareswillwould be adjusted to reflect anysuchincome or lossamounts. Any gain or loss onresulting from thesale of the shares will be ordinary income or loss, except that such loss will be ordinary loss only to the extent of the previously included netmark-to-marketgain.election. If you make a mark-to-market electionitin respect of a corporation classified as a PFIC and such corporation ceases to be classified as a PFIC, you will generally not beeffective forrequired to take into account the gain or loss described above during any period that such corporation is not classified as a PFIC.If you own shares during any year that we are a PFIC, you must file an annual IRS Form 8621. In the case of investors who have held our shares during any taxable year
forin respect of whichthe election is madewe were classified as a PFIC andall subsequent taxable years, unless thecontinue to hold such sharesare no longer regularly traded on a national securities exchange or the Internal Revenue Service consents(or any portion thereof), who have not previously determined tothe revocation of the election. It is unclear how the mark-to-market rules apply to a passive foreign investment company whose shares are "marketable stock," but that owns one or more subsidiary passive foreign investment companies whose shares are not "marketable stock." Thus, even if you have mademake a mark-to-market election,youand who are now considering the making of a QEF or mark-to-market election, special tax rules maybe requiredapply relating torecognize taxable income with respect to our equity holdings in any subsidiary passive foreign investment companies upon a distribution from anypurging the PFIC taint of suchsubsidiaries to us, a disposition of any such subsidiaries by us, or a transaction through which your indirect ownership of any such subsidiaries is decreased (including additional offerings of our shares) even though you may not 73actually have received any cash associated with such taxable income.shares. You are urged to consult yourowntax advisoras toconcerning theavailabilityUnited States federal income tax consequences of purchasing, holding, anddesirabilitydisposing our shares if we are or become a PFIC, including the possibility of makingsuchamark-to-market election. WhetherQEF ornot you make amark-to-market electionany gain or loss from the sale or other disposition of your shares generally will be United States source income or loss for purposes of foreign tax credit limitations. A U.S. holder of shares in a passive foreign investment company can sometimes avoid the passive foreign investment company tax rules described above by electing to treat the company as a "qualified electing fund" under section 1295 of the Internal Revenue Code. This option is not available to you because we do not intend to comply with the requirements necessary to permit you to make this election. You must file United States Internal Revenue Service Form 8621 for every year in which you hold shares in a passive foreign investment company. INFORMATION REPORTING AND BACKUP WITHHOLDINGInformation Reporting and Backup Withholding
In general, unless you are an exempt recipient such as a corporation and demonstrate this when required, information reporting will apply to dividend payments that we make to you paid within the United States (and in some cases, outside of the United States). Additionally, if you fail to provide your taxpayer identification number, or fail either to report in full dividend and interest income or to make the necessary certifications, you will be subject to backup withholding.
In general, payment of the proceeds from the sale of shares to or through a United States office of a broker is subject to both United States backup withholding and information reporting unless you certify as to your non-United States status under penalties of perjury or otherwise establish an exemption. United States information reporting and backup withholding generally will not apply to a payment made outside the United States of the proceeds of a sale of shares through an office outside the United States of a non-United States broker. However, United States information reporting requirements (but not backup withholding) will apply to a payment made outside the United States of the proceeds of a sale of shares through an office outside the United States if the broker is:
-a United States person;-a foreign person 50% or more of whose gross income is effectively connected with a United States trade or business for a specified three-year period;-a"controlled“controlled foreigncorporation"corporation” for United States tax purposes; or-a foreign partnership, if at any time during its tax year:-one or more of its partners are U.S. holders (as defined in U.S. Treasury regulations) who in the aggregate hold more than 50% of the income or capital interest in the partnership; or-such foreign partnership is engaged in a United States trade or business;unless the broker has documentary evidence in its files that you are a non-United States person or you otherwise establish an exemption.
Any amounts withheld under the backup withholding rules will be allowed as a refund or a credit against your United States federal income tax liability, provided you furnish the required information to the Internal Revenue Service.
INHERITANCE AND GIFT TAX 74As discussed in "-- Singapore Tax Considerations", Singapore estate duty may be imposedF. Dividends and Paying Agents
Not applicable.
G. Statements by Experts
Not applicable.
H. Documents on
holders of shares. You should consult your own tax advisor regarding the effect of such taxes on your particular situation. F. DIVIDENDS AND PAYING AGENTS Not applicable. G. STATEMENTS BY EXPERTS Not applicable. H. DOCUMENTS ON DISPLAYDisplayThe U.S. Securities and Exchange Commission, or the SEC, allows us to
"incorporate“incorporate byreference"reference” the information we file with the SEC. This means that we can disclose important information to you by referring you to another document filed separately with the SEC. The information incorporated by reference in this annual report is considered to be part of this annual report. We therefore incorporate by reference in Item 19 of this annual report certain exhibits, which we filed with the SEC before. You may read and copy this annual report, including the exhibit(s) incorporated by reference in this annual report, at theSEC'sSEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549 and at theSEC'sSEC’s regional offices in New York, New York and Chicago, Illinois. You can also request copies of this annual report, including the exhibit(s) incorporated by reference in this annual report, upon payment of a duplicating fee, by writing for information on the operation of theSEC'sSEC’s Public Reference Room.I.
SUBSIDIARY INFORMATIONSubsidiary InformationNot applicable.
75ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss related to adverse changes in market prices, including interest rates and foreign exchange rates, of financial instruments. We are exposed to various types of market risks, including changes in interest rates and foreign currency exchange rates, in the normal course of business.
FOREIGN CURRENCY EXCHANGE AllForeign Currency Exchange
Our subsidiaries conclude most of
our revenuestheir business transactions in their own measurement currencies, therefore the foreign currency risks derived from operations are not significant. However, we hold some assets or liabilities in foreign currency other than measurement currency andreceivablesthe value of these assets anda majority of our operating expenses and payablesliabilities aredenominated in NT dollars, which is our functional currency. The remaining operating expenses and payables, such as the cost of cable modems and technology license fees, are primarily denominated in U.S. dollars. As a result, our margins may be impacted by fluctuations of exchange rate between NT dollar and U.S. dollar, exposing ussubject to foreign currency risks resulting from fluctuations in exchangerisks.rates between the foreign-denominated currency and the measurement currency. Because expenses denominated in foreign currencies historically have not been material, we have not tried to reduce our exposure to exchange rate fluctuations by using hedging transactions. However, we may choose to do so in the future.As of December 31,
2002,2004, we had bank deposits and restricted cashshort-term investments and long-term investmentsof approximately US$7.7 million denominated inUS dollarsforeign currencies other than measurement currencies of the entities holding such assets. These assets are subject to foreign currency exchange risk. We recorded a realized foreign exchange loss of US$16.4 million.750 thousand and unrealized foreign exchange loss of US$146 thousand in 2004.As of December 31,
2002,2004, wealsohadaccounts payableavailable-for-sale marketable securities of approximately US$27.2 million denominated inUS dollarsforeign currencies other than measurement currencies ofUS$98.7 thousand. We realized athe entities holding such assets. Changes in the value of these marketable securities resulting from movements in foreign exchange rates are reported in the separate component of shareholders’ equity until realized. As of December 31, 2004, unrealized foreign exchange lossof NT$19.9 million in 2000, a foreign exchange gain of NT$5.2 million in 2001 and a foreign exchange gain of NT$131.9 million (US$3.8 million) in 2002 related to currency fluctuations. Unrealized foreign exchange gainsfor these marketable securities wereNT$151.4 million in 2000 and NT$8.7 million in 2001, with an unrealized exchange loss of NT$38.0 million (US$1.1 million) in 2002. INTEREST RATE SENSITIVITYapproximately US$508 thousand.Interest Rate Sensitivity
Our exposure to interest rates relates primarily to our
short-terminvestmentsand short-term loans.in marketable securities. As of December 31,2002,2004, we hadshort-term investmentsUS$31.3 million ofNT$855.3 million (US$24.6 million). These short-term investments consist predominantly of beneficiary certificates of open and fixed income mutualinvestment in fixed-income or money market investment funds. These investments are subject to interest rate risk in that the value of their holdings in debt instruments will fall if market interest rates increase. Declines in interest rates over time will, however, reduce our interest income from our bank deposits.In addition, we have entered into short-term loan agreements for the working capital needs of our offline business. As of December 31, 2002, the balance of our short-term loans was NT$93.0 million (US$2.7 million), bearing an interest rate of 6.25% per annum.We have not entered into any interest rate swaps, caps or any hedge contracts to modify our exposure to interest rate fluctuations. However, we do not expect significant risk associated with the fluctuations of interest rate of short-term loans due to their short-term maturity period.OTHER MARKET RISKOther Market Risk
We are also exposed to other market risk, which is mainly derived from our
currentinvestments in Gamania,andother investeecompanies.companies and investment funds. Changes in the stock price, the performance or theperformancenet asset value of these companies and investment funds might have significant impact on our financial positions or operating results.76ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not applicable.
77ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
None.
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
Not applicable.
ITEM 15. CONTROLS AND PROCEDURES
Within 90 days prior to the date of this annual report, an evaluation has been carried out under the supervision andOur management, with the participation of our
management, including Mr. Raymond Chang,chief executive officer and ourChief Executive Officer, and Mr. Winston Hsia, our Chief Financial Officer, ofchief financial officer, has evaluated the effectivenessof the design and operationof our disclosure controls andprocedures.procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this annual report. Based onthatsuch evaluation, ourChief Executive Officerchief executive officer andChief Financial Officerchief financial officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act and are effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.In February 2005, our audit committee was notified by our independent auditors PricewaterhouseCoopers in connection with their audit of our consolidated financial statements for the year ended December 31, 2004 that they had identified certain material weaknesses in our internal controls. Specifically our auditors noted: (1) deficiencies in current inventory costing and measuring and monitoring inventory status, including calculation of inventory costing and related cost of sales on the lump sum averaged basis rather than as an item by item basis; inadequate formula set up in the calculation spreadsheet for inventory costing, lack of controls surrounding obsolete and excess inventory and lack of cycle counts to monitor the inventory status throughout the year, and (2) lack of adequate documentation on the status of legal proceedings and an effective communication procedure to deliver the contract review results to the accounting department and reflecting the results on the financial statements.
Our management responded promptly to their findings by undertaking these remedial measures:
We finished the roll-out of our new point of sale, or “POS” system, in January 2005. The new POS system allows us to (1) track and account for inventory cost on a per-unit basis, (2) significantly increase the level of automation in the inventory costing process and (3) better manage the issues of obsolete and excess inventory by monitoring and analyzing the level and mix of our inventory using data provided by the POS system.We have begun the implementation of certain new legal documentation process, including a control log sheet of all material legal proceedings maintained by the general counsel’s office, which is designed to monitor the development of outstanding litigations and to ensure timely disclosure of estimates for the probable influences of litigations in our financial statements.In May 2005, our independent auditors identified, in connection with their audit for the year ended December 31, 2004, certain other weaknesses in our current internal control processes. Specifically, our auditors noted that we had weaknesses in respect of:
pre-approval process for the authorization of our audit and non-audit services by our audit committee;review procedures for the identification of a related party; andprocedures for income tax accounting and approval of short-term loans.Nevertheless, our auditors advised us that such weaknesses did not affect their opinion that our consolidated financial statements present fairly, in all material respects, our financial position, results of operations and cash flows for the periods covered. In response to our auditors’ findings, our senior management under the supervision of our audit committee has directed further evaluation of our internal controls and moved to strengthen controls process and procedures as soon as practicable to address these and any other issues that might be identified through our evaluation including the adoption of an audit committee charter. We are undertaking all necessary remedial measures and will take further action to improve any conditions that may result in weaknesses in the future, should we identify such other conditions.
Based on their evaluation as of December 31, 2004, our chief executive officer and chief financial officer have concluded that the remedial actions undertaken to date have been effective and further steps can be taken to improve our disclosure controls and procedures.
Our chief executive officer and chief financial officer believe that, subject to the limitations noted above, our disclosure controls and procedures are effective in ensuring that material information required to be
disclosedincluded in this annual report is recorded, processed, summarized and reported,withinas well as is communicated to our management, on a timely basis.We have also commenced, with assistance from our independent advisors, PricewaterhouseCoopers and Resources Global Professionals, the
time period specified in the rules and formsimplementation of theSecuritiesreporting requirements of Section 404 of the U.S. Sarbanes-Oxley Act of 2002. PricewaterhouseCoopers andExchange Commission. Thereour management were involved in scoping the significant accounts, disclosures and processes of each of our business units, mapping these significant accounts to financial assertions and documenting our existing controls over all relevant assertions relating to all significant accounts and disclosures in our financial statements. Currently Resources Global Professionals is performing tests on our key controls and procedures to verify the proper application of our major systems and processes. We have been improving our policies and processes as necessary with a view to achieving compliance with Section 404 by the effective date.Our disclosure controls and procedures, no
significant changesmatter how well designed and operated, can provide only reasonable, not absolute, assurance of achieving the objectives of the control system. As such, disclosure controls and procedures or internal control systems may not prevent all error and all fraud. In addition, the design of a control system must reflect the fact that there are resource constraints, the benefits of controls must be considered relative to their costs and our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, at ourinternal controls or in other factors that could significantly affect the internal controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.Company have been detected.ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
Not applicable.Our board of directors has determined that Mr. Michael Y. J. Ding, a member of our audit committee, qualifies as an audit committee financial expert in accordance with the requirements of Item 16A of Form 20-F. Mr. Ding has served as an independent director of our board and a member of our audit committee since July 30, 2003. Mr. Ding is currently president and chief executive officer of Fubon Asset Management Co., Ltd. Prior to that, Mr. Ding was president and fund manager of the R.O.C. Fund (listed on the New York Stock Exchange), as well as president of the International Investment Trust Co. in Taiwan, where he also served as chief investment officer and a senior vice president. Prior to that, Mr. Ding was a chief economist and head of research at Citicorp International Securities Ltd. in Taipei and head of research and information for the Greater China region at McKinsey & Co., Inc.
ITEM 16B. CODE OF ETHICS
Not applicable.We have adopted a code of ethics, as defined in Item 16B of Form 20-F. Our code of ethics applies to our chief executive officer, chief financial officer and persons performing similar functions as well as to our directors, other officers, employees and consultants. Our code of ethics is available on our Web site at http://ir.giga.net.tw/code%20of%20business%20conduct.htm. If we amend any provisions of our code of ethics that apply to our chief executive officer, chief financial officer or persons performing similar functions, or if we grant any waiver of such provisions, we will disclose such amendment or waiver on our Web site at the same address. We will also provide any person without charge a copy of our code of ethics, upon written request to our Investor Relations Department at 14th Floor, No. 122, Tunhwa North Road, Sungshan Chiu, Taipei, Taiwan R.O.C. 10595, or e-mail to: Brad.miller@GigaMedia.com.tw.
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table summarizes the aggregate fees billed to us by PricewaterhouseCoopers in Taiwan and Singapore during the fiscal years ended December 31, 2003 and December 31, 2004
Year Ended December 31, 2003 2004 (in US$) Audit Fees 141,916 323,394 Audit-Related Fees 0 113,000 Tax Fees 16,467 17,000 Other Fees 6,287 0 A. Audit Fees
Audit fees consist of fees billed for our statutory consolidated financial statements and the statutory financial statements of our subsidiaries.
B. Audit-Related Fees
Audit-related fees consist of fees billed for assurance and related services that are reasonably related to the performance of the audit or review of our financial statements, such as accounting consultation and audits in connection with our acquisition in 2004.
C. Tax Fees
Tax fees include fees billed for tax compliance services, including the preparation of original and amended tax returns.
D. All Other Fees
All other fees are fees billed for services provided by the principal accountant, other than the services reported as audit fees, audit-related fees and tax fees above, consisting of fees billed for business registration service performed before May 30, 2005.
E. Audit Committee Pre-Approval Policies and Procedures
In May 2005, we adopted our audit committee charter. Consistent with SEC policies regarding auditor independence, our audit committee is directly responsible for the appointment, compensation, retention and oversight of the work of auditors engaged to provide us with audit, review or attest services. Our audit committee has sole discretion to review and pre-approve the appointment of auditors and to set their fees for the performance of audit and non-prohibited non-audit services in accordance with the Sarbanes-Oxley Act of 2002 and the SEC rules and regulations promulgated thereunder.
The appointment of our independent auditors, PricewaterhouseCoopers, as well as the scope of each audit, audit-related or non-prohibited non-audit service provided pursuant to such appointment and our auditors’ fees for all such services were approved by either our board of directors or our audit committee, which have ultimate authority and responsibility for the evaluation and appointment of our auditors pursuant to our articles of association.
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
Not applicable.
78ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
Not applicable.
We have elected to provide financial statements for fiscal year
20022004 and the related information pursuant to Item 18.Our consolidated financial statements and the report thereon by our independent accountants listed below are attached hereto as follows:
Page ----(a) Report of Independent Accountants.........................................Registered Public Accounting FirmF-1 (b) Consolidated Balance Sheets as of December 31, 20012003 and2002..............2004F-2 (c) Consolidated Statements of Operations for the years ended F-4 December 31, 2000, 20012002, 2003 and2002....................................................... F-42004(d) Consolidated Statements of Shareholders'Shareholders’ Equity for theF-5 years ended December 31, 2000, 20012002, 2003 and2002.......................................... F-52004(e) Consolidated Statements of Cash Flows for the years ended F-6 December 31, 2000, 20012002, 2003 and2002....................................................... F-62004(f) Notes to the Consolidated Financial Statements............................StatementsF-7 79EXHIBIT INDEX
1.1 Memorandum of Association of our company* 1.2 Articles of Association of our company* 4.1 Microsoft Commercial Internet System License Agreement between Hoshin Gigamedia Center Inc., dated April 1, 1998* 4.2 License Agreement between Portal Information Network, Inc. and Hoshin Gigamedia Center Inc., dated May 23, 1998* 4.3 Broadband Internet over Cable Service Agreement between Hoshin Gigamedia Center Inc. and Prosperity CATV Inc., dated May 12, 1999 (including English summary)* 4.4 Broadband Internet over Cable Service Agreement between Hoshin Gigamedia Center Inc. and Everlasting Cable TV Co., dated June 16, 1999 (including English summary)* 4.5 Broadband Internet over Cable Service Agreement between Hoshin Gigamedia Center Inc. and Lee Kwan Cable TV Co., dated June 16, 1999 (including English summary)* 4.6 Broadband Internet over Cable Service Agreement between Hoshin Gigamedia Center Inc. and Wonderful Cable TV Co. Ltd., dated June 16, 1999 (including English summary)* 4.7 Broadband Internet over Cable Service Agreement between Hoshin Gigamedia Center Inc. and Powerful CATV Co. Ltd., dated May 14, 1999 (including English summary)* 4.8 Broadband Internet over Cable Service Agreement between Hoshin Gigamedia Center Inc. and Netwave Cable TV Inc., dated April 16, 1999 (including English summary)* 4.9 Broadband Internet over Cable Service Agreement between Hoshin Gigamedia Center Inc. and New Visual Wave CATV Inc., dated August 18, 1999 (including English summary)* 4.10 Broadband Internet over Cable Service Agreement between Hoshin Gigamedia Center Inc. and Da Fung CATV Co. Ltd., dated July 6, 1999 (including English summary)* 4.11 Broadband Internet over Cable Service Agreement between Hoshin Gigamedia Center Inc. and Gaho Cable Co. Ltd., dated May 12, 1999 (including English summary)* 4.12 Broadband Internet over Cable Service Agreement between Hoshin Gigamedia Center Inc. and TeleFirst Cable Communication Co. Ltd., dated May 19, 1999 (including English summary)* 804.13 Broadband Internet over Cable Service Agreement between Hoshin Gigamedia Center Inc. and Chun-Chien Cable Television Co. Ltd., dated January 1, 2000 (including English summary)* 4.14 Broadband Internet over Cable Service Agreement between Hoshin Gigamedia Center Inc. and Twinstar CATV Co. Ltd., dated April 16, 1999 (including English summary)* 4.15 Broadband Internet over Cable Service Agreement between Hoshin Gigamedia Center Inc. and Sun Crown CATV Co. Ltd., dated April 16, 1999 (including English summary)* 4.16 Broadband Internet over Cable Service Agreement between Hoshin Gigamedia Center Inc. and Shinyeongan CATV Co. Ltd., dated May 21, 1999 (including English summary)* 4.17 Broadband Internet over Cable Service Agreement between Hoshin Gigamedia Center Inc. and Chung Lian Inc., dated April 16, 1999 (including English summary)* 4.18 Broadband Internet over Cable Service Agreement between Hoshin Gigamedia Center Inc. and Gang Du Cable TV Co. Ltd., dated April 16, 1999 (including English summary)* 4.19 Broadband Internet over Cable Service Agreement between Hoshin Gigamedia Center Inc. and Union Cable TV Co. Ltd., dated May 14, 1999 (including English summary)* 4.20 Broadband Internet over Cable Service Agreement between Hoshin Gigamedia Center Inc. and North Taoyuan CATV Company, dated August 9, 1999 (including English summary)* 4.21 Broadband Internet over Cable Service Agreement between Hoshin Gigamedia Center Inc. and Top Cable TV System Co., dated November 1, 1999 (including English summary)* 4.22 Broadband Internet over Cable Service Agreement between Hoshin Gigamedia Center Inc. and Shin Ho Cable TV Co. Ltd., dated May 13, 1999 (including English summary)* 4.23 Broadband Internet over Cable Service Agreement between Hoshin Gigamedia Center Inc. and Shuang Shing Cable TV Co., dated June 16, 1999 (including English summary)* 4.24 Broadband Internet over Cable Service Agreement between Hoshin Gigamedia Center Inc. and Hai Sun Cable Broadcasting System Co. Ltd., dated August 9, 1999 (including English summary)* 4.25 Broadband Internet over Cable Service Agreement between Hoshin Gigamedia Center Inc. and Tien Wai Tien CATV Co., Ltd., dated October 25, 1999 (including English summary)* 4.26 Share and Warrant Purchase Agreement among GigaMedia Limited, Hoshin Gigamedia Center Inc., Microsoft Corporation, Koos Develop Corp., Chester Koo and Leslie Koo, dated October 27, 1999* 814.27 Registration Rights Agreement among GigaMedia Limited and Microsoft Corporation, dated November 23, 1999* 4.28 Shareholders' Agreement among GigaMedia Limited, Microsoft Corporation, Koos Develop Corp., Kudos Fund, Best Method Inc., TCC International, Mr. Chester Koo, Mr. Leslie Koo, Mr. Kent Yen, Mr. Raymond Chang, Mr. Yichun Chang, Mr. Chris Tung and Mr. Michel Chu, dated November 23, 1999* 4.29 Business Co-Operation Agreement among Hoshin Gigamedia Center Inc. and Microsoft Corporation, dated November 1, 1999* 4.30 Warrant, dated November 23, 1999, issued to Microsoft Corporation* 4.31 Strategic Alliance Agreement among GigaMedia Limited, Hoshin Gigamedia Center Inc., and Gamania Digital Entertainment Co., LTD., dated March 1, 2001** 4.32 Commercial Agreement among GigaMedia Limited, Hoshin Gigamedia Center Inc., and Rock Internet Corporation, dated April 20, 2001** 4.33 Strategic Alliance Agreement among GigaMedia Limited, GigaMusic.com Limited, and EMI Music Asia (a division of EMI Group Hong Kong Limited), dated May 14, 2001+** 4.34 Stock Purchase Agreement among Tachung Records and certain shareholders of Rose Records, dated as of January 29, 2002*** 4.35 Stock Purchase Agreement among G-Music Limited and all shareholders of Tachung Records, dated as of February 4, 2002*** 4.36 Amendment to Stock Purchase Agreement, dated as of April 4, 2002, to the Stock Purchase Agreement among Point Records Co., Ltd. and certain shareholders of Point Records Co., Ltd, dated as of January 29, 2002 4.37 Amendment to Stock Purchase Agreement, dated as of September 20, 2002, to the Stock Purchase Agreement among Music King Co., Ltd. and selling shareholders of Music King Co., Ltd., dated as of February 4, 2002 8.1 List of Subsidiaries 13.1 Certification by our Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 13.2 Certification by our Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 82- --------------------- * Incorporated by reference from the Registration Statement on Form F-1, file number 333-11416 filed with the Securities and Exchange Commission on February 2, 2000. ** Incorporated by reference from the annual report on Form 20-F, file number 000-30540 filed with the Securities and Exchange Commission on June 28, 2001. *** Incorporated by reference from the annual report on Form 20-F, file number 000-30540 filed with the Securities and Exchange Commission on June 28, 2002. + Does not contain portions for which confidential treatment has been requested. 83SIGNATURES
1.1 Memorandum of Association of our Company 1.2 Articles of Association of our Company 4.1 Microsoft Commercial Internet System License Agreement between Hoshin GigaMedia Center Inc., dated April 1, 1998* 4.2 License Agreement between Portal Information Network, Inc. and Hoshin GigaMedia Center Inc., dated May 23, 1998* 4.3 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center Inc. and Prosperity CATV Inc., dated May 12, 1999 (including English summary)* 4.4 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center Inc. and
Everlasting Cable TV Co., dated June 16, 1999 (including English summary)*
4.5 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center Inc. and Lee Kwan Cable TV Co., dated June 16, 1999 (including English summary)* 4.6 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center Inc. and Wonderful Cable TV Co. Ltd., dated June 16, 1999 (including English summary)* 4.7 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center Inc. and Powerful CATV Co. Ltd., dated May 14, 1999 (including English summary)* 4.8 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center Inc. and Netwave Cable TV Inc., dated April 16, 1999 (including English summary)* 4.9 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center Inc. and New Visual Wave CATV Inc., dated August 18, 1999 (including English summary)* 4.10 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center Inc. and Da Fung CATV Co. Ltd., dated July 6, 1999 (including English summary)* 4.11 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center Inc. and Gaho Cable Co. Ltd., dated May 12, 1999 (including English summary)* 4.12 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center Inc. and TeleFirst Cable Communication Co. Ltd., dated May 19, 1999 (including English summary)* 4.13 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center Inc. and Chun-Chien Cable Television Co. Ltd., dated January 1, 2000 (including English summary)* 4.14 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center Inc. and Twinstar CATV Co. Ltd., dated April 16, 1999 (including English summary)* 4.15 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center Inc. and Sun Crown CATV Co. Ltd., dated April 16, 1999 (including English summary)* 4.16 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center Inc. and Shinyeongan CATV Co. Ltd., dated May 21, 1999 (including English summary)* 4.17 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center Inc. and Chung Lian Inc., dated April 16, 1999 (including English summary)* 4.18 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center Inc. and Gang Du Cable TV Co. Ltd., dated April 16, 1999 (including English summary)*
4.19 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center Inc. and Union Cable TV Co. Ltd., dated May 14, 1999 (including English summary)* 4.20 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center Inc. and North Taoyuan CATV Company, dated August 9, 1999 (including English summary)* 4.21 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center Inc. and Top Cable TV System Co., dated November 1, 1999 (including English summary)* 4.22 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center Inc. and Shin Ho Cable TV Co. Ltd., dated May 13, 1999 (including English summary)* 4.23 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center Inc. and Shuang Shing Cable TV Co., dated June 16, 1999 (including English summary)* 4.24 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center Inc. and Hai Sun Cable Broadcasting System Co. Ltd., dated August 9, 1999 (including English summary)* 4.25 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center Inc. and Tien Wai Tien CATV Co., Ltd., dated October 25, 1999 (including English summary)* 4.26 Share and Warrant Purchase Agreement among GigaMedia Limited, Hoshin GigaMedia Center Inc., Microsoft Corporation, Koos Develop Corp., Chester Koo and Leslie Koo, dated October 27, 1999* 4.27 Registration Rights Agreement among GigaMedia Limited and Microsoft Corporation, dated November 23, 1999* 4.28 Shareholders’ Agreement among GigaMedia Limited, Microsoft Corporation, Koos Develop Corp., Kudos Fund, Best Method Limited, TCC International, Mr. Chester Koo, Mr. Leslie Koo, Mr. Kent Yen, Mr. Raymond Chang, Mr. Yichun Chang, Mr. Chris Tung and Mr. Michel Chu, dated November 23, 1999* 4.29 Business Co-Operation Agreement among Hoshin GigaMedia Center Inc. and Microsoft Corporation, dated November 1, 1999* 4.30 Warrant, dated November 23, 1999, issued to Microsoft Corporation* 4.31 Strategic Alliance Agreement among GigaMedia Limited, Hoshin GigaMedia Center Inc., and Gamania Digital Entertainment Co., LTD., dated March 1, 2001** 4.32 Commercial Agreement among GigaMedia Limited, Hoshin GigaMedia Center Inc., and Rock Internet Corporation, dated April 20, 2001** 4.33 Strategic Alliance Agreement among GigaMedia Limited, GigaMusic.com Limited, and EMI Music Asia (a division of EMI Group Hong Kong Limited), dated May 14, 2001+** 4.34 Stock Purchase Agreement among Tachung Records and certain shareholders of Rose Records, dated as of January 29, 2002*** 4.35 Stock Purchase Agreement among G-Music Limited and all shareholders of Tachung Records, dated as of February 4, 2002*** 4.36 Amendment to Stock Purchase Agreement, dated as of April 4, 2002, to the Stock Purchase Agreement among Point Records Co., Ltd. and certain shareholders of Point Records Co., Ltd, dated as of January 29, 2002**** 4.37 Amendment to Stock Purchase Agreement, dated as of September 20, 2002, to the Stock Purchase Agreement among Music King Co., Ltd. and selling shareholders of Music King Co., Ltd., dated as of February 4, 2002**** 4.38 Final Settlement Agreement and Release, dated as of December 31, 2003, entered into among EMI Music Asia, GigaMusic.com Limited and GigaMedia Limited***** 4.39 Stock Purchase Agreement, dated as of March 17, 2004, by and among GigaMedia International Limited, GV Holding Company, and Alexander Saidakovsky, Alexander Ganelis and Daniil Utin***** 4.40 Purchase and Sale Agreement between Hoshin GigaMedia Center Inc. and Webs-TV.net Digital International Corporation, dated June 23, 2005 4.41 End User License Agreement between Internet Media Licensing Limited and Ultra Internet Media S.A., dated April 1, 2004
8.1 List of Subsidiaries***** 11 Code of ethics adopted by the registrant on April 21, 2004***** 12.1 Certification by our Chief Executive Officer pursuant to Rule 13a-14(b) of the Securities Exchange Act 12.2 Certification by our Chief Financial Officer pursuant to Rule 13a-14(b) of the Securities Exchange Act 13 Certifications by our Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 15 Consent of PricewaterhouseCoopers, Independent Registered Public Accounting Firm
* Incorporated by reference from our Registration Statement on Form F-1, file number 333-11416 filed with the SEC on February 2, 2000.
** Incorporated by reference from our annual report on Form 20-F, file number 000-30540 filed with the SEC on June 28, 2001.
*** Incorporated by reference from our annual report on Form 20-F, file number 000-30540 filed with the SEC on June 28, 2002.
**** Incorporated by reference from our annual report on Form 20-F, file number 000-30540 filed with the SEC on July 15, 2003.
***** Incorporated by reference from our annual report on Form 20-F, file number 000-30540 filed with the SEC on June 30, 2004.
+ Does not contain portions for which confidential treatment has been requested. The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual
report. GIGAMEDIA LIMITED By: /s/ WINSTON HSIA - -------------------------- Winston Hsia Chief Financial Officer Date: July 15, 2003 84CERTIFICATIONS I, Raymond Chang, certify that: 1. I have reviewed this annualreport onForm 20-F of GigaMedia Limited; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, includingitsconsolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c. presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.behalf.
GIGAMEDIA LIMITED By: /s/ Thomas Hui
Thomas Hui Chief Financial Officer Date:
July 15, 2003 BY: /s/ Raymond Chang ------------------------ Raymond Chang Chief Executive Officer 85I, Winston Hsia, certify that: 1. I have reviewed this annual report on Form 20-F of GigaMedia Limited; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c. presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: July 15, 2003 By : /s/ Winston Hsia ------------------------ Winston Hsia Chief Financial Officer 86GIGAMEDIA LIMITED CONSOLIDATED FINANCIAL STATEMENTS ANDJune 30, 2005REPORT OF INDEPENDENT
ACCOUNTANTS DECEMBER 31, 2001 AND 2002 AND FOR THE YEARS ENDED DECEMBER 31, 2000, 2001 AND 2002REPORT OF INDEPENDENT ACCOUNTANTSREGISTERED PUBLIC ACCOUNTING FIRMTo the
boardBoard ofdirectorsDirectors andshareholdersShareholdersof GigaMedia Limited:
We have audited the accompanying consolidated balance
sheetsheets of GigaMedia Limited and its subsidiaries as of December 31,2002,2004 and 2003, and the related consolidated statements ofoperations, of shareholders'income, shareholders’ equity andofcash flows for each of theyear then ended.three years in the period ended December 31, 2004. These financial statements are the responsibility of theCompany'sCompany’s management. Our responsibility is to express an opinion on these financial statements based on ouraudit. The financial statements of the Company as of December 31, 2001 and for each of the two years in the period ended December 31, 2001 were audited by other independent accountants whose report dated March 25, 2002 expressed an unqualified opinion on those statements. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the 2002 consolidated financial statements referred to above present fairly, in all material respects, the financial position of GigaMedia Limited and its subsidiaries at December 31, 2002, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. PricewaterhouseCoopers Taipei, Taiwan April 24, 2003, except for Note 22, c. as to which the date is May 1, 2003 F-1INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders of GigaMedia Limited We have audited the accompanying consolidated balance sheet of GigaMedia Limited as of December 31, 2001, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the two years in the period ended December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on ouraudits.We conducted our audits in accordance with
auditingthe standardsgenerally accepted inof theUnited States of America.Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the
consolidatedfinancial position of GigaMedia Limited and its subsidiaries at December 31,2001,2004 and 2003, and theconsolidatedresults of their operations and their cash flows for each of thetwothree years in the period ended December 31,2001,2004 in conformity with accounting principles generally accepted in the United States of America.DIWAN, ERNST & YOUNG CERTIFIED PUBLIC ACCOUNTANTSBy: /s/ PricewaterhouseCoopers
Taipei, Taiwan
R. O. C. March 25, 2002 F-2May 26, 2005
GIGAMEDIA LIMITED
CONSOLIDATED BALANCE SHEETS
December 31,
20012003 and2002 (in2004(in thousands except for par value amount)
December 31 ------------------------------------------- 2001 2002 ----------- -------------------------- ASSETS NT$ NT$ US$ - ---------------------------------------------------------------- ----------- ---------- ---------- (Unaudited) (Note 1)CURRENT ASSETS Cash and cash equivalents $ 794,346 $1,241,157 $ 35,768 Short-term investments 5,028,719 855,273 24,648 Notes and accounts receivable (net of allowance for doubtful accounts of NT$26,728 and NT$54,056 as of December 31, 2001 and 2002, respectively) 103,293 127,603 3,677 Receivable from related parties 2,912 5,705 164 Inventories-net 52,499 360,216 10,381 Prepaid expenses 23,155 19,869 573 Restricted cash 40,950 100,414 2,894 Note receivable from officer - 18,534 534 Other current assets 87,001 148,944 4,293 ----------- ---------- -------- Total Current Assets 6,132,875 2,877,715 82,931 ----------- ---------- -------- LONG-TERM INVESTMENTS 994,898 641,088 18,475 ----------- ---------- -------- PROPERTY, PLANT AND EQUIPMENT-NET Land 22,224 22,224 641 Building 37,869 37,869 1,091 Information, communication equipment and software 564,181 720,691 20,769 Modems rented 69,102 80,553 2,321 Office furniture and fixture 76,275 106,191 3,060 Transportation equipment 6,697 7,793 225 Leasehold improvements 79,801 106,867 3,080 ----------- ---------- -------- Sub-total 856,149 1,082,188 31,187 Less: Accumulated depreciation (179,579) (344,930) (9,940) Construction in process 429 - - Prepayment for equipment 28,571 1,680 48 ----------- ---------- -------- Net 705,570 738,938 21,295 ----------- ---------- -------- GOODWILL - 25,389 732 ----------- ---------- -------- INTANGIBLE ASSETS-NET 12,631 242,012 6,974 ----------- ---------- -------- OTHER ASSETS Deferred assets 107,808 87,353 2,517 Refundable deposits-out 22,005 82,960 2,391 Restricted cash 34,950 - - Note receivable from officer 18,534 - - Others 33,281 583 17 ----------- ---------- -------- Total Other Assets 216,578 170,896 4,925 ----------- ---------- -------- TOTAL ASSETS $ 8,062,552 $4,696,038 $135,333 =========== ========== ========
December 31 2003 2004 ASSETS CURRENT ASSETS
Cash and cash equivalents (Notes 8 and 19)
$ 35,294 $ 13,233 Marketable securities-current (Note 9)
28,956 34,284 Notes and accounts receivable-net (Note 10)
4,093 5,838 Receivable from related parties (Note 19)
603 128 Inventories-net (Note 11)
4,804 10,488 Prepaid expenses
1,368 680 Restricted cash (Note 14)
1,926 1,506 Other current assets
665 1,569 Total Current Assets
77,709 67,726 Marketable securities-noncurrent (Note 12)
15,260 2,893 PROPERTY, PLANT AND EQUIPMENT-NET
Land
654 701 Building
1,115 1,194 Information and communication equipment
16,533 20,450 Modems rented
2,431 2,421 Office furniture and fixture
2,288 2,662 Transportation equipment
274 325 Leasehold improvements
3,301 3,734 Sub-total
26,596 31,487 Less: Accumulated depreciation
(11,003 ) (16,722 ) Prepayment for equipment
43 291 Net
15,636 15,056 GOODWILL (Note 4 and 5)
— 29,607 INTANGIBLE ASSETS-NET (Note 4 and 6)
6,199 8,372 OTHER ASSETS
Deferred assets (Note 13)
1,202 349 Refundable deposits-out
3,201 1,960 Others
585 14 Total Other Assets
4,988 2,323 TOTAL ASSETS
$ 119,792 $ 125,977 The accompanying notes are an integral part of these consolidated financial statements.
F-3GIGAMEDIA LIMITED
CONSOLIDATED BALANCE SHEETS-(Continued)
December 31,
20012003 and2002 (in2004(in thousands except for par value amount)
December 31 ------------------------------------------- 2001 2002 ----------- -------------------------- LIABILITIES & SHAREHOLDERS' EQUITY NT$ NT$ US$ - ---------------------------------------------------------- ----------- ---------- ----------- (Unaudited) (Note 1) CURRENT LIABILITIESShort-term loans $ - $ 93,000 $ 2,680 Notes and accounts payable 69,772 470,646 13,563 Payable to related parties 3,780 20,511 591 Accrued compensation 44,984 44,610 1,286 Accrued expenses 41,177 53,150 1,532 Other current liabilities 15,421 118,395 3,412 ----------- ----------- --------- Total Current Liabilities 175,134 800,312 23,064 ----------- ----------- --------- OTHER LIABILITIES Refundable deposits 20,057 23,622 681 Accrued pension liabilities 9,410 25,047 722 ----------- ----------- --------- Total Other Liabilities 29,467 48,669 1,403 ----------- ----------- --------- Total Liabilities 204,601 848,981 24,467 ----------- ----------- --------- MINORITY INTERESTS 12,825 227,180 6,547 ----------- ----------- --------- COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY Common shares, NT$10 dollars par value; authorized 80,000 shares; issued 50,154 shares on December 31, 2001 and 2002 501,540 501,540 14,454 Warrant outstanding 1,543,270 1,543,270 44,475 Additional paid-in capital 10,048,181 6,532,703 188,262 Accumulated deficit (4,416,770) (5,054,760) (145,670) Accumulated other comprehensive income 168,905 97,124 2,798 ----------- ----------- --------- Total Shareholders' Equity 7,845,126 3,619,877 104,319 ----------- ----------- --------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 8,062,552 $ 4,696,038 $ 135,333 =========== =========== =========
December 31 2003 2004 LIABILITIES & SHAREHOLDERS’ EQUITY CURRENT LIABILITIES
Short-term loans (Note 15 and 19)
$ — $ 284 Notes and accounts payable
16,788 14,002 Payable to related parties (Note 19)
407 51 Accrued compensation
1,418 1,655 Accrued expenses (Note 19)
3,255 3,346 Other current liabilities
2,242 3,902 Total Current Liabilities
24,110 23,240 OTHER LIABILITIES
Refundable deposits
806 930 Deferred tax liabilities (Note 18)
— 386 Accrued pension liabilities (Note 16)
992 1,184 Total Other Liabilities
1,798 2,500 Total Liabilities
25,908 25,740 MINORITY INTERESTS
3,521 4,266 COMMITMENTS AND CONTINGENCIES (Note 20)
SHAREHOLDERS’ EQUITY
Common shares, NT$10 dollars par value; authorized 80,000 thousand shares; issued 50,154 thousand shares on December 31, 2003 and 2004 (Note 17)
15,565 15,565 Warrant outstanding (Note 19 and 21)
48,653 — Additional paid-in capital
223,439 272,092 Accumulated deficit
(167,241 ) (165,559 ) Accumulated other comprehensive loss
(30,053 ) (26,127 ) Total Shareholders’ Equity
90,363 95,971 TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$ 119,792 $ 125,977 The accompanying notes are an integral part of these consolidated financial statements.
F-4GIGAMEDIA LIMITED
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended December 31,
2000, 20012002, 2003 and2002 (in2004(in thousands except for income/loss per share amounts)
2000 2001 2002 ------------ ------------ ---------------------------- NT$ NT$ NT$ US$ ------------ ------------ ------------ ------------ (Unaudited) (Note 1)OPERATING REVENUES Sales/rental/installation $ 126,810 $ 7,490 $ 1,864,128 $ 53,721 Access revenues 155,035 389,801 638,916 18,413 Web development revenues 28,978 7,190 - - Advertising and promotional revenues 26,762 5,039 32,801 945 Other revenues 3,603 1,432 19,964 575 ------------ ------------ ------------ ------------ Total 341,188 410,952 2,555,809 73,654 ------------ ------------ ------------ ------------ COSTS AND EXPENSES Costs of sales/rental/installation (278,974) (143,420) (1,686,256) (48,595) Operating costs (987,331) (1,636,820) (634,872) (18,296) Web development expenses (23,182) (12,233) - - Product development and engineering expenses (56,625) (106,458) (64,444) (1,857) Selling and marketing expenses (383,948) (285,590) (427,310) (12,314) General and administrative expenses (235,934) (215,663) (211,944) (6,108) Bad debt expenses (1,686) (40,250) (32,167) (927) Impairment loss on goodwill - - (242,938) (7,001) Impairment loss on intangible assets - - (80,627) (2,324) (3,881) (1,203) - - ------------ ------------ ------------ ------------ Total (1,971,561) (2,441,637) (3,380,558) (97,422) ------------ ------------ ------------ ------------ Loss from operations (1,630,373) (2,030,685) (824,749) (23,768) ------------ ------------ ------------ ------------ NON-OPERATING INCOME (EXPENSES) Interest income 187,055 32,486 34,905 1,006 Foreign exchange gains-net 131,557 13,868 93,941 2,707 Gain on disposal of short-term investments 114,577 201,826 62,787 1,810 Gain on disposal of long-term investments - 11,639 51,791 1,493 Impairment loss on long-term investments - - (40,000) (1,153) Loss resulting from change of ownership percentage in a majority-owned subsidiary - - (67,468) (1,944) Interest expense (4,114) (1,085) (1,392) (40) Share of loss of equity investees (13,801) (27,837) - - Loss on disposal of property, plant and equipment - (10,778) (30,593) (882) Others 8,727 (957) 4,687 135 ------------ ------------ ------------ ------------ Subtotal 424,001 219,162 108,658 3,132 ------------ ------------ ------------ ------------ LOSS BEFORE INCOME TAXES AND MINORITY INTERESTS (1,206,372) (1,811,523) (716,091) (20,636) INCOME TAX BENEFIT - 393 4,383 126 ------------ ------------ ------------ ------------ NET LOSS BEFORE MINORITY INTEREST (1,206,372) (1,811,130) (711,708) (20,510) MINORITY INTEREST (INCOME) LOSS - (194) 73,718 2,124 ------------ ------------ ------------ ------------ NET LOSS ($ 1,206,372) ($ 1,811,324) ($ 637,990) ($ 18,386) ============ ============ ============ ============ LOSS PER SHARE-BASIC AND DILUTED (IN DOLLARS) Net loss ($ 24.73) ($ 36.12) ($ 12.72) ($ 0.37) ============ ============ ============ ============ WEIGHTED AVERAGE SHARES USED TO COMPUTE NET LOSS PER SHAER Basic and diluted 48,791 50,154 50,154 50,154 ============ ============ ============ ============
2002 2003 2004 OPERATING REVENUES (Note 19)
Sales/rental
$ 53,956 $ 74,390 $ 65,594 Software licensing and on-line entertainment revenues
— — 11,434 Access revenues
18,493 18,829 20,960 Promotional and advertising revenues
949 1,595 1,501 Other revenues
578 538 330 Total
73,976 95,352 99,819 COSTS AND EXPENSES (Note 19)
Costs of sales/rental/installation
(48,808 ) (65,238 ) (52,627 ) Operating costs
(18,376 ) (18,120 ) (15,586 ) Product development and engineering expenses
(1,865 ) (1,211 ) (2,513 ) Selling and marketing expenses
(12,368 ) (14,530 ) (17,630 ) General and administrative expenses
(6,134 ) (7,973 ) (8,200 ) Bad debt expenses
(931 ) (156 ) (247 ) Impairment loss on goodwill (Note 5)
(7,032 ) (738 ) — Impairment loss on intangible assets (Note 21)
(2,334 ) — — Impairment loss on property, plant and equipment (Note 7)
— (1,557 ) — Total
(97,848 ) (109,523 ) (96,803 ) Income (loss) from operations
(23,872 ) (14,171 ) 3,016 NON-OPERATING INCOME (EXPENSES)
Interest income
1,010 419 170 Gains on sales of marketable securities
3,316 488 1,230 Other-than-temporary impairment on marketable securities (Note 12)
(1,158 ) (1,701 ) (1,833 ) Loss resulting from change of ownership percentage in a majority-owned subsidiary
(1,953 ) — — Interest expense
(40 ) (37 ) (7 ) Foreign exchange gains (loss)
2,719 (723 ) (896 ) Loss on disposal of property, plant and equipment
(885 ) (846 ) (106 ) Others
136 (509 ) 510 Subtotal
3,145 (2,909 ) (932 ) INCOME (LOSS) BEFORE INCOME TAXES AND MINORITY INTERESTS
(20,727 ) (17,080 ) 2,084 INCOME TAX BENEFIT (EXPENSES) (Note 18)
127 (142 ) 79 NET INCOME (LOSS) BEFORE MINORITY INTERESTS
(20,600 ) (17,222 ) 2,163 MINORITY INTEREST (INCOME) LOSS
2,134 3,127 (481 ) NET INCOME (LOSS)
$ (18,466 ) $ (14,095 ) $ 1,682 EARNINGS (LOSS) PER SHARE (IN DOLLARS) (Note 2)
Basic:
Income (loss) from continuing operations
$ (0.41 ) $ (0.34 ) $ 0.04 Net income (loss)
$ (0.37 ) $ (0.28 ) $ 0.03 Diluted:
Income (loss) from continuing operations
$ (0.41 ) $ (0.34 ) $ 0.04 Net income (loss)
$ (0.37 ) $ (0.28 ) $ 0.03 WEIGHTED AVERAGE SHARES USED TO COMPUTE EARNINGS (LOSS) PER SHARE (Note 2)
Basic
50,154 50,154 50,154 Diluted
50,154 50,154 51,701 The accompanying notes are an integral part of these consolidated financial statements.
F-5GIGAMEDIA LIMITED
CONSOLIDATED STATEMENTS OF
SHAREHOLDERS'SHAREHOLDERS’ EQUITYFor the Years Ended December 31,
2000, 20012002, 2003 and2002 (in2004(in thousands)
Issuance of common shares ------------------------- Warrant Additional Shares Amount outstanding paid-in capital ---------- ---------- ----------- --------------- NT$ NT$ NT$Balance as of January 1, 2000 40,000 $ 360,000 $ 1,543,270 $ 1,010,237 Components of comprehensive loss: Net loss in 2000 - - - - Unrealized gain on available-for-sale securities - - - - Total comprehensive loss Issuance of common shares 10,154 101,540 - 7,660,341 Issuance of refundable shares - 40,000 - 1,064,000 Amortization of unearned compensation - - - 182,776 ---------- ---------- ----------- --------------- Balance as of December 31, 2000 50,154 501,540 1,543,270 9,917,354 Components of comprehensive loss: Net loss in 2001 - - - - Reclassification adjustments for gains realized in operations - - - - Unrealized gain on available-for-sale securities - - - - Total comprehensive loss Amortization of unearned compensation - - - 130,827 ---------- ---------- ----------- --------------- Balance as of December 31, 2001 50,154 501,540 1,543,270 10,048,181 Components of comprehensive loss: Net loss in 2002 - - - - Reclassification adjustments for gains realized in operations Unrealized gain on available-for-sale securities - - - - Total comprehensive loss Capital returns - - - (3,521,814) Refund of expenses from NASDAQ in relation to the initial public offering - - - 1,055 Amortization of unearned compensation - - - 5,281 ---------- ---------- ----------- --------------- Balance as of December 31, 2002 50,154 501,540 1,543,270 6,532,703 ========== ========== =========== ===============
Accumulated other Accumulated comprehensive deficit income Total ------------ ----------------- ------------- NT$ NT$ NT$Balance as of January 1, 2000 ($ 1,399,074) $ - $ 1,514,433 Components of comprehensive loss: Net loss in 2000 (1,206,372) - (1,206,372) Unrealized gain on available-for-sale securities - 717 717 ------------- Total comprehensive loss (1,205,655) ------------- Issuance of common shares - - 7,761,881 Issuance of refundable shares - - 1,104,000 Amortization of unearned compensation - - 182,776 ------------ ----------------- ------------- Balance as of December 31, 2000 (2,605,446) 717 9,357,435 Components of comprehensive loss: Net loss in 2001 (1,811,324) - (1,811,324) Reclassification adjustments for gains realized in operations - (717) (717) Unrealized gain on available-for-sale securities - 168,905 168,905 ------------- Total comprehensive loss (1,643,136) Amortization of unearned compensation - - 130,827 ------------ ----------------- ------------- Balance as of December 31, 2001 (4,416,770) 168,905 7,845,126 Components of comprehensive loss: Net loss in 2002 (637,990) - (637,990) Reclassification adjustments for gains realized in operations (148,773) (148,773) Unrealized gain on available-for-sale securities - 76,992 76,992 ------------- Total comprehensive loss (709,771) ------------- Capital returns - - (3,521,814) Refund of expenses from NASDAQ in relation to the initial public offering - - 1,055 Amortization of unearned compensation - - 5,281 ------------ ----------------- ------------- Balance as of December 31, 2002 (5,054,760) 97,124 3,619,877 ============ ================= =============
Issuance of common shares Warrant
outstanding
Additional
paid-in capital
Accumulated
deficit
Accumulated other
comprehensiveincome (loss)
Total
Shares Amount 2002
Balance as of January 1, 2002
50,154 $ 15,565 $ 48,653 $ 323,563 $ (134,680 ) $ (28,633 ) $ 224,468 Net loss
— — — — (18,466 ) — (18,466 ) Components of other comprehensive income (loss):
Net unrealized loss on marketable securities
— — — — — (2,038 ) (2,038 ) Foreign currency translation adjustment
— — — — — 329 329 Total comprehensive loss
(20,175 ) Capital returns
— — — (100,308 ) — — (100,308 ) Refund of expenses from NASDAQ in relation to the initial public offering
— — — 153 — — 153 Amortization of unearned compensation
— — — 31 — — 31 Balance as of December 31, 2002
50,154 15,565 48,653 223,439 (153,146 ) (30,342 ) 104,169 2003
Net loss
— — — — (14,095 ) — (14,095 ) Components of other comprehensive income (loss):
Net unrealized loss on marketable securities
— — — — — (1,861 ) (1,861 ) Foreign currency translation adjustment
— — — — — 2,150 2,150 Total comprehensive loss
— — — — — — (13,806 ) Balance as of December 31, 2003
50,154 15,565 48,653 223,439 (167,241 ) (30,053 ) 90,363 2004
Net income
— — — — 1,682 — 1,682 Cancellation of warrant
— — (48,653 ) 48,653 — — — Components of other comprehensive income (loss):
Net unrealized loss on marketable securities
— — — — — (357 ) (357 ) Foreign currency translation adjustment
— — — — — 4,283 4,283 Total comprehensive income
— — — — — — 5,608 Balance as of December 31, 2004
50,154 $ 15,565 $ — $ 272,092 $ (165,559 ) $ (26,127 ) $ 95,971 The accompanying notes are an integral part of these consolidated financial statements.
F-6GIGAMEDIA LIMITED
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31,
2000, 20012002, 2003 and2002 (in2004(in thousands)
2000 2001 2002 -------------- -------------- --------------------------- NT$ NT$ NT$ US$ -------------- -------------- ------------- ----------- (Unaudited) (Note 1)CASH FLOWS FROM OPERATING ACTIVITIES: Net loss ($ 1,206,372) ($ 1,811,324) ($ 637,990) ($ 18,386) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation 55,595 127,978 196,346 5,658 Amortization 542,891 1,090,932 97,459 2,809 Provision for bad debt expenses 1,686 40,250 32,167 927 Provision for inventory loss 3,482 19,324 22,175 639 Share of net loss of equity investees 13,801 27,837 - - Loss on disposal of property, plant and equipment - 10,778 30,593 882 Gain on disposal of short-term investments (114,577) (201,826) (62,787) (1,810) Gain on disposal of long-term investments - (11,639) (51,791) (1,493) Share compensation expenses 182,776 130,827 5,281 152 Minority interests income (loss) - 194 (73,718) (2,124) Impairment loss on goodwill - - 242,938 7,001 Impairment loss on intangible assets - - 80,627 2,324 Impairment loss on long-term investments - - 40,000 1,153 Loss resulting from change of ownership percentage in a majority-owned subsidiary - - 67,468 1,944 Net changes in operating assets and liabilities: Proceeds from disposal of short-term investments 915 - - - Notes and accounts receivable (58,040) (76,842) (35,142) (1,013) Receivable from related parties (17,715) 16,595 (2,793) (80) Inventories (56,999) 37,228 35,226 1,015 Prepaid expenses (23,735) 3,697 3,286 95 Other current assets (46,411) (31,275) 117,881 3,397 Refundable modem deposits (4,007) 1,342 - - Notes and accounts payable 121,038 (17,265) (115,577) (3,331) Payable to related parties (4,103) (15,974) 16,731 482 Accrued expenses 61,066 (55,736) (41,137) (1,186) Accrued compensation 30,815 3,410 (374) (11) Other current liabilities 10,173 (253) 12,215 352 Accrued pension liabilities 1,731 5,844 15,637 451 Licenses payable (307) (6,408) - - ------------ ------------ ----------- --------- Net cash used in operating activities (506,297) (712,306) (5,279) (153) ------------ ------------ ----------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Decrease (increase) in restricted cash 109,900 (75,900) (24,514) (706) Increase in investments-purchase of investments (30,000) (962,194) - - Proceeds from disposal of long-term investments - 22,500 428,806 12,358 Purchase of property, plant and equipment (419,704) (348,193) (304,741) (8,782) Proceeds from disposal of property, plant and equipment - 481 149,592 4,311 Proceeds from disposal of short-term investments 5,304,527 14,181,171 4,101,247 118,192 Purchase of short-term investments (12,298,190) (11,763,672) - - Purchase of intangible assets - - (35,110) (1,012) Acquistions, net of cash acquired - - (311,987) (8,991) (Increase) decrease in refundable deposits-out (16,363) 4,965 (60,955) (1,757) Decrease (increase) in other assets 13,525 (33,295) 84,016 2,421 Increase in note receivable from officer - (18,534) - - Increase in deferred assets (104,882) (155,636) (61,290) (1,767) Payable to equipment suppliers - (50,134) - - ------------ ------------ ----------- --------- Net cash (used in) provided by investing activities (7,441,187) 801,559 3,965,064 114,267 ------------ ------------ ----------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Increase in bank borrowing - - 4,220 122 Repayment of bank borrowing (75,000) - - - Proceeds from issuance of common shares 7,761,881 - - - Increase in refundable deposits - - 3,565 103 Decrease in lease obligations (39,152) (13,187) - - Capital returns - - (3,521,814) (101,493) Refund of IPO expenses from NASDAQ - - 1,055 30 ------------ ------------ ----------- --------- Net cash provided by (used in) financing activities 7,647,729 (13,187) (3,512,974) (101,238) ------------ ------------ ----------- --------- NET (DECREASE)/INCREASE IN CASH AND CASH EQUIVALENTS (299,755) 76,066 446,811 12,876 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 1,018,035 718,280 794,346 22,892 ------------ ------------ ----------- --------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 718,280 $ 794,346 $ 1,241,157 $ 35,768 ============ ============ =========== ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Interest paid during the year $ 4,114 $ 1,085 $ 1,392 $ 40 ============ ============ =========== ========= Income tax paid during the year $ 16,124 $ 16,979 $ 882 $ 25 ============ ============ =========== ========= NON-CASH FINANCING AND INVESTING ACTIVITIES: Issuance of shares of a consolidated subsidiary for business combinations $ - $ - $ 220,606 $ 6,358 ============ ============ =========== ========= Acquisition costs in the form of payable as of year-end $ - $ - $ 88,000 $ 2,536 ============ ============ =========== ========= Unrealized holding gain on available-for-sale securities $ 717 $ 168,188 $ 76,992 2,219 ============ ============ =========== ========= Intangible assets from investment activities $ - $ 12,631 $ - $ - ============ ============ =========== =========
2002 2003 2004 CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)
$ (18,466 ) $ (14,095 ) 1,682 Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:
Depreciation
5,683 5,240 4,675 Amortization
2,821 2,229 2,545 Provision for bad debt expenses
931 156 247 Provision for (reversal of) inventory loss
642 3,169 (300 ) Gain on physical inventory
— — 9 Loss on disposal of property, plant and equipment
885 846 106 Gain on disposal of marketable securities
(3,316 ) (488 ) (1,230 ) Share compensation expenses
153 — — Minority interests income (loss)
(2,134 ) (3,127 ) 481 Impairment loss on goodwill
7,032 738 — Impairment loss on intangible assets
2,334 — — Other-than-temporary impairment on marketable securities-noncurrent
1,158 1,701 1,833 Impairment loss on property, plant and equipment
— 1,557 — Loss resulting from change of ownership percentage in a majority-owned subsidiary
1,953 — — Net changes in operating assets and liabilities:
Notes and accounts receivable
(1,011 ) (495 ) 597 Receivable from related parties
(80 ) (63 ) 475 Inventories
1,014 2,591 (5,531 ) Prepaid expenses
95 (783 ) 730 Other current assets
3,392 3,719 (464 ) Notes and accounts payable
(3,326 ) 2,933 (3,743 ) Payable to related parties
481 (197 ) (356 ) Accrued expenses
(1,184 ) 1,691 (914 ) Accrued compensation
(11 ) 105 236 Other current liabilities
351 (1,243 ) 981 Accrued pension liabilities
449 255 309 Deferred tax liabilities
— — 22 Net cash (used in) provided by operating activities
(154 ) 6,439 2,390 CASH FLOWS FROM INVESTING ACTIVITIES:
(Increase) decrease in restricted cash
(710 ) 1,018 419 Proceeds from disposal of marketable securities
131,120 103,947 69,352 Purchase of property, plant and equipment
(8,821 ) (1,913 ) (2,587 ) Proceeds from disposal of property, plant and equipment
4,330 310 415 Purchase of marketable securities
— (107,226 ) (60,834 ) Purchase of intangible assets
(1,016 ) — (663 ) Acquisitions, net of cash acquired
(9,030 ) — (32,797 ) Decrease (increase) in refundable deposits-out
(1,764 ) (749 ) 1,450 Increase (decrease) in other assets
2,432 (335 ) 1 Decrease in note receivable from officer
— 171 — Increase in deferred assets
(1,774 ) (189 ) (193 ) Cash recognized on initial consolidation of variable interest enity
— — 94 Net cash provided by (used in) investing activities
114,767 (4,966 ) (25,343 ) CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short-term loan
122 — 2,098 Repayment of short-term loan
— (2,703 ) (1,829 ) Increase in refundable deposits
103 109 125 Acquisition of minority interests
— — (238 ) Capital returns
(100,308 ) — — Refund of IPO expenses from NASDAQ
31 — — Net cash (used in) provided financing activities
(100,052 ) (2,594 ) 156 Exchange difference
(1,572 ) 698 736 NET (DECREASE)/INCREASE IN CASH AND CASH EQUIVALENTS
12,989 (423 ) (22,061 ) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR
22,728 35,717 35,294 CASH AND CASH EQUIVALENTS AT END OF YEAR
$ 35,717 $ 35,294 $ 13,233 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid during the year
$ 40 $ 36 $ 7 Income tax paid during the year
$ 26 $ — $ 9 NON-CASH FINANCING AND INVESTING ACTIVITIES:
Issuance of shares of a consolidated subsidiary for business combinations
$ 6,385 $ — $ — Acquisition costs in the form of payable as of year-end
$ 2,547 $ — $ — Unrealized holding gain (loss) on available-for-sale securities
$ 2,216 $ (1,925 ) $ (357 ) The accompanying notes are an integral part of these consolidated financial statements.
F-7GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE)NOTE 1.
THE COMPANY ANDSUMMARY OF SIGNIFICANT ACCOUNTINGPOLICES THE COMPANY GigaMedia Limited ("GigaMedia" or the "Company") was incorporated in Singapore in September 1999.POLICIESPrinciples of Consolidation
The
Company was listed on Nasdaq Stock Market's National Market ("NASDAQ") in New York, USA on February 17, 2000. The Company's principal shareholders are members of the Koos Group, one of the conglomerates in Taiwan. GigaMedia is a provider of on-line and off-line entertainment services and products in Taiwan. On-line business segment includes broadband Internet access services through multiple delivery technologies. The Company's access products consist of premium cable modem and Asymmetric Digital Subscriber Line offerings. The Company also provides Internet content services through the Web site, www.gigigaga.com, which is a Chinese-language broadband Web destination. Off-line business segment includes the sale of compact disc, video compact disc, digital versatile disc, audio and video cassettes, and related accessories through its 50 directly owned stores in Taiwan. ACQUISITIONS OF ROSE RECORDS AND TACHUNG RECORDS In February 2002, September 2002 and December 2002, the Company acquired all of the outstanding stock of 17 companies, which owned 50 music chain stores under the distribution system of Rose Records and Tachung Records, through its directly-owned subsidiary, G-Music Limited ("G-Music"). Accordingly, the Company has included the results of the acquirees from the respective acquisition dates in its consolidated results of operations. See Note 3 for further discussion of the Company's acquisition activities. PRINCIPLES OF CONSOLIDATION The consolidated financial statementsConsolidated Financial Statements include the accounts of GigaMedia Limited (GigaMedia or the Company) and its wholly-owned andcontrolledmajority-owned subsidiaries.AllIn addition, the accounts of variable interest entities (VIEs) as defined by the Financial Accounting Standards Board (FASB) Interpretation No. 46(R) (see Note 3, “Variable Interest Entity,” for additional information) are included in the Consolidated Financial Statements. Investments in business entities in which the Company does not have control, but has the ability to exercise significantintercompany transactionsinfluence over operating andaccount balances have been eliminated. F-8GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) CONVENIENCE TRANSLATION INTO US DOLLARSfinancial policies (generally 20-50% ownership), are accounted for using the equity method. The accounting policy for other investments in securities is described in Note 1 within “Marketable Securities.” Other investments are accounted for using the cost method.Reporting Currency and Foreign Currency Translation
The Consolidated Financial Statements of the Company and its subsidiaries
maintain their accounting records and prepare their financial statementshave historically been reported in New Taiwan("NT")(NT) dollars.The United States ("US")Effective January 1, 2004, the Company adopted the U.S. dollaramounts disclosedas its reporting currency as operations denominated in the2002 financial statements are presented solely for the convenienceU.S. dollar have represented an increasing portion of thereaderCompany’s business following the acquisition of the Company’s entertainment software business. (See Note 4, “Acquisitions.”) As a result of this change, the Company will record a cumulative translation adjustment to other comprehensive income. The cumulative translation adjustments in 2002, 2003, and 2004 were $33 million, $31 million, and $27 million, respectively. Comparative financial information has been recast as if the U.S. dollar had always been used as the Company’s reporting currency, and financial information has been translated into U.S. dollars for all periods presented. Assets and liabilities denominated in non-U.S. currency are translated to U.S. dollars at year-end exchange rates. Income and expenses items are translated at weighted-average rates of exchange prevailing during therate of NT$34.70year. Cumulative translation adjustments resulting from this process are charged or credited toUS$1.00,other comprehensive income in shareholders’ equity. Gains and losses on foreign currency transactions are included in other income and expenses.Exchange rates between the U.S.
Federal Reserve Bank of New York noon buying exchange rate on December 31, 2002. Such translation amounts are unauditeddollar andshould not be construed thatthe NT dollaramounts represent, or have been, or could be, converted into US dollars at that or any other rate. USE OF ESTIMATESfor the periods reported in the Consolidated Financial Statements were as follows:
2002 2003 2004 Year-end
34.75 33.97 31.71 Weighted average
34.55 34.40 33.41 Use of Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the
United StatesU.S. requires management to make estimates and assumptions that affect certain reported amounts and disclosures in theamounts reported in GigaMedia's financial statementsConsolidated Financial Statements and accompanying notes. Actual results could differ significantly from thoseassumptions. REVENUE RECOGNITIONestimates.Revenue Recognition
General
The Company recognizes revenues in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 101,
("SAB No. 101"), "Revenue“Revenue Recognition in FinancialStatements."Statements,” (SAB 101) and Staff Accounting Bulletin No. 104, “Revenue Recognition,” (SAB 104). Revenue is recognized when persuasive evidence of an arrangement exists, delivery occurs or services are rendered, the sales price is fixed or determinable and collectibility is reasonably assured. The following policies apply to theCompany'sCompany’s major categories of revenue transactions.Sales/rental/installation Sales/rental/installationIn addition to the aforementioned general policies, the following are the specific revenue recognition policies for each major category of revenue.
Sales
Sales consist of retail sales generated from the
Company's off-lineCompany’s music distribution business and salesrental and installationof cable modem and other related products generated from theCompany's on-lineCompany’s broadband ISP business.Retail sales consist mainly of sales that occurred at GigaMedia’s music retail chain stores, which accounted for more than 90% of the Company’s total retail sales. These revenues are
derivedcollected in either cash or via credit card payment, which pose no or very limited credit risk. The remaining retail sales revenues are generated from our store-in-store locations inside hypermarkets and third-party chain stores. The hypermarket and third-party chain store-related revenues are recognized on a monthly basis and collected within 30 days of the date of issuance of the invoices. Even though our partners are reputable, major hypermarkets and third-party chain stores in Taiwan, and there has not been any collection issue in the past, we still establish a provision policy for receivables over 90 days.Revenues from the sales
of entertainment merchandise to the customers from the music chain stores. Revenue is recognized at the point of sale to the consumer, at which time payment is tendered. There are no provisions for uncollectible amounts since payment is F-9GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) received at the time of sale. In addition, no provision for sales returns is made as the Company does not grant the customers any right of return. Revenues from the saleof cable modems and other related productsand installationare recognized upondeliverydelivery.Internet Access Revenues: Cable Modem and
successful completion of installation. Cable modems can be rented for a flat rate on a monthly basis until the customers petition to discontinue such service. Revenues from the monthly rental of cable modems are recognized over the same period as the access service is rendered. As part of the revenue sharing arrangements with cable partners, installation revenue is recorded net of fees paid to cable partners. Internet access cable modems and Asymmetric Digital Subscriber Line ("ADSL")ADSLInternet access revenues are
recognized inrelated to cable modem and ADSL Internet access services provided by theperiod the services are rendered.Company. Revenues are recorded net of discounts,either for a monthly flat rate (which includes unlimited access) or on a charge-per-minute basis. Free months are offeredand inconnection with promotional discounts. Because these free months are usually given atthebeginningcase ofa subscription period, no revenue is recognized during the months the free access has been provided, as the continuance of the customer is not assured. As part of the revenue sharing arrangements withour cablepartners, access revenue is recordedmodem services, net of fees paid to our cable partners in accordance with revenue sharing agreements in effect between GigaMedia and our cable partners.The Company introduced premium ADSL service in the second quarter of 2001. Chunghwa Telecom Co., Ltd. ("CHTC") provides the telecommunications networkCable modem and ADSLmodems to subscribers, connects customers to CHTC's transfer mode network and aggregates the telecom lines into the Company's servers. Each subscriber is billed at a fixed fee, NT$595 dollars~NT$899 dollars per month billed by CHTC and NT$299 dollars~NT$6,400 dollars per month billed by the Company, depending on the package the customer subscribes. Revenue is recognized when the Company bills the customer as services have been provided. Web development Web developmentrevenues arederived fromrecognized for thedesign and development of Internet websites and are recognized when work is performed. F-10GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) Advertising, promotional and other revenues Advertising revenues are derived from the sales of advertising services and sponsorships in which the Company delivers advertisements for a fixed fee on the Company's Web Sites and those of the advertising affiliates. Advertising revenue is derived principally from short-term advertising contracts in which the Company may guarantee a minimum number of impressions to advertisers over a specificperiod of time for which the Company provides services to the customer. Customers have a choice of paying either monthly or in advance for a certain period of time, for which they receive corresponding discounts. The Company records any such advanced payment receipts as other current liabilities on the balance sheet and amortizes such revenues over the subscription period.Software Licensing and On-Line Entertainment Revenues
Software licensing and on-line entertainment revenues are related to software the Company develops and support services the Company provides for use within the on-line entertainment industry. Software licensing and support service revenues are based upon a fixed
fee. Advertising revenuespercentage of a licensee’s gross receipts, and are recognizedpro rata overmonthly.Under the
contracted period, calculated based onprovisions of FIN 46(R), thepercentageresults ofimpressions delivered over the total guaranteed impressions. In addition,Ultra Internet Media (UIM), a licensee of the Company,also generates promotionalas of and for the nine months ended December 31, 2004 have been incorporated into the Consolidated Financial Statements. UIM and GigaMedia are separately owned. (See Note 3, “Variable Interest Entity,” for additional information.) Software licensing and support service revenues fromits vendorsUIM have been eliminated in consolidation.��
UIM generates revenue by providing and promoting on-line games of
music products, including in-store signagechance andin-store music-playing for the artists designated by the vendors for a short period for each music album.skill. Revenue is recognizedwhen services are provided. Other revenue consists of subscription revenue and commission fees in connection with services provided for the development of a broadband infrastructure for a real estate project. Revenuesupon receipt. Player account balances are recognizedwhen servicesas current liabilities and areprovided. CASH EQUIVALENTSaccrued for in full. The change in aggregate player account balances is recognized monthly as a reduction to receipts, as are player disbursements. Residual expenses and commissions are charged to expense as incurred.Fair Value of Financial Instruments
The Company’s financial instruments, including cash and cash equivalents, marketable securities, accounts receivable, accounts payable, short-term debt and accrued liabilities are carried with value approximates to the fair value.
Cash Equivalents
Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash, and so near to their maturity that they present insignificant risk from changes in interest rates. Commercial paper, negotiable certificates of deposit, time deposit and bank acceptances with original maturities of three months or less are considered to be cash equivalents.
FOREIGN CURRENCY TRANSACTIONSMarketable Securities
The
Company and its subsidiaries maintain their accounting recordsCompany’s investments inNew Taiwan ("NT") Dollars, the national currency of the Republic of China (the "ROC"). Transactions denominated in foreign currenciesmarketable securities arerecorded in NT dollars using the exchange rates in effect at the date of transactions. Assets and liabilities denominated in foreign currencies are translated into NT dollars using the exchange rate in effect at the balance sheet date. Foreign exchange gains or losses areclassified as available-for-sale. Marketable securities included innon-operating income or expense. F-11GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) FAIR VALUE OF FINANCIAL INSTRUMENTS The Company's financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities are carried at cost, which approximates their fair value due to the short-termcurrent assetsrepresent securities with a maturity of
these instruments. INVESTMENTS Investmentsless than one year. Securities classified as non-current, including non-equity method investments, have maturity of more than one year. These investments principally consist of debt securities and equity securities of public andprivately-held securities. Investments in debt securitiesprivately held companies andequity securitiesinvestment funds, and areclassified as available-for-sale investments. Accordingly, the investments are carriedstated at fair valueand thewith any unrealized gainsandor lossesarerecordedasin accumulated other comprehensive income (loss) in shareholders’ equity until realized. Unrealized losses that are considered other than temporary are included in thestockholders' equity.current year’s operations. Realized gains and losses, measured against cost, are also included in the currentyear'syear’s operations.Equity investments in
privately-heldprivately held companies are generally carried at cost. Equity investments in companies over which the Company has the ability to exercise significant influence, but in which the Company does not hold a controlling interest, are accounted for under the equity method and theCompany'sCompany’s proportionate share of income or lossesareis recorded in non-operating income or expenses.When an equity investee company issues additional shares at an amount over or under the carrying value of the shares held by the Company and the
Company'sCompany’s ownership interest decreases as a result of not fully subscribing to theissue,issuance, the resulting difference between theCompany'sCompany’s investment balance and its proportionate share of the investeecompany'scompany’s net equity is recorded in the currentyear'syear’s operations.ALLOWANCE FOR DOUBTFUL ACCOUNTSAllowance for Doubtful Accounts
An allowance for doubtful accounts is provided based on
thean evaluation of collectibilityand aging analysisof notes receivable, accounts receivables and other receivables.INVENTORIESInventories
Inventories are carried at the lower of cost or market value using the weighted average cost
F-12GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE)method, while net realizable value is used to determine the market value. An allowance for loss on obsolescence and decline in market value is provided, when necessary.PROPERTY, PLANT AND EQUIPMENTProperty, Plant and Equipment
Property, plant and equipment are stated at cost less accumulated depreciation. Depreciation is provided on
thea straight-line basis overthe followingusefullives:lives that correspond to items as follows:
Building......................................................Item
Years Building
50 yearsInformation and communication equipment
and software.............2 to 5 Modems rented
3 to 5 years Modems rented ................................................ 3 to 5 yearsOffice furniture and equipment
...............................3 to 5 yearsTransportation equipment
.....................................5 yearsLeasehold
improvements........................................improvements5 yearsLeasehold improvements are depreciated over the life of the lease or the assets, whichever is shorter. Improvements and replacements are capitalized and depreciated over their estimated useful lives, while ordinary repairs and maintenance are expensed as incurred.
IMPAIRMENT OF LONG-LIVED ASSETS Long-lived assets, such as property, plantIntangible Assets and
equipment, goodwill and purchasedGoodwillThe Company’s intangible assets all hold definite lives and are amortized by a straight-line method over their estimated useful lives, ranging from two to 15 years. The recoverability of intangible assets is evaluated
for impairment wheneverperiodically and takes into account events orchanges incircumstances that warrant revised estimates of useful lives or that indicatethe carrying value of an asset may not be recoverable. Anthat impairmentloss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset plus net proceeds expected from disposition of the asset, if any, are less than the carrying value of the asset. When an impairment is identified, the carrying amount of the asset is reduced to its estimated fair value. Effective January 1, 2002, inexists.In conjunction with the implementation of Statement of Financial Accounting Standards
("SFAS")(FAS) No. 142, “Goodwill and Other Intangible Assets,” (FAS 142) which became effective January 1, 2003, all goodwill, including goodwill related to acquisitions prior to July 1,2001, will2002, are no longerbeamortized and potential impairment of goodwill and purchased intangible assets with indefinite useful liveswill behave been evaluated using theF-13GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE)specific guidance provided bySFAS No.FAS 142. This impairment analysiswill behas been performed at leastannually. Also effective January 1, 2002, potentialannually, or whenever events or changes in circumstances indicate that the carrying value might not be recoverable from related future undiscounted cash flows. Impairment is measured as the differences between the carrying amounts and the fair value of the assets, and is recognized as a component of income (loss) from operations.Impairment of Long-Lived Assets
Potential impairment of long-lived assets other than goodwill and purchased intangible assets with indefinite useful lives
will behas been evaluated using the guidance provided bySFASFAS No. 144,"Accounting“Accounting for the Impairment or Disposal of Long-LivedAssets."Assets,” (FAS 144) which became effective January 1, 2003. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to undiscounted future net cash flows expected to be generated by the asset over its remaining useful life. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. The estimate of fair value is generally based on quoted market prices or on the best available information, including prices for similar assets and the results of using other valuation techniques.ADVERTISINGWhen an impairment is identified, the carrying amount of the asset is reduced to its estimated fair value.Software Cost
The Company capitalizes certain computer software costs, after technological feasibility has been established. These costs are amortized utilizing a straight-line method over the economic lives of the related products, not to exceed four years. The Company performs periodic reviews to ensure that unamortized software costs remain recoverable from future revenue. (See Note 6, “Intangible Assets–Net,” for additional information.)
Product Development and Engineering
Research, product development and engineering costs are expensed as incurred.
Advertising
Advertising costs are expensed as incurred. Advertising costs incurred in
2000, 20012002, 2003 and20022004 totaledNT$322,513, NT$135,831$1.4 million, $727 thousand andNT$48,701,$1.4 million, respectively.STOCK-BASED COMPENSATIONStock-Based Compensation
The Company
measureshas elected to measure stock-based compensation expensefor its stock-based employee compensation planusing the intrinsic valuemethod. Ifmethod prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (APB 25), as interpreted, with pro-forma disclosures of net income (loss) and earnings (loss) per share, as if thefairfair-value method of accounting defined in FAS No. 123 “Accounting for Stock-Based Compensation,” (FAS 123) were used. FAS 123 establishes a fair-value-based method of accounting for stock-based employee compensation plans. Under the fair-value method, compensation cost is measured at the grant date based on the valuebased method had been applied in measuring stockof the award and is recognized over the service period, which is usually the vesting period. Had the Company determined the stock-based compensation expense for thepro forma effect onCompany’s stock options based upon the fair-value as determined by Black-Scholes option-pricing model at the grant date for the years ended December 31, 2002, 2003 and 2004, the Company’s netlossincome (loss) andnet lossearnings (loss) per share would have been as the pro-forma amount indicated as follows:
Years Ended December 31, ------------------------------------------- 2000 2001 2002 ----------- ------------ ----------- NT$ NT$ NT$Net loss As reported ($1,206,372) ($1,811,324) ($ 637,990) Stock compensation expense (145,807) (751,857) - ----------- ------------ ----------- Pro forma ($1,352,179) ($2,563,181) ($ 637,990) =========== =========== =========== Net loss per share (in dollars): As reported-basic and diluted ($ 24.73) ($ 36.12) ($ 12.72) Pro forma-basic and diluted ($ 27.71) ($ 51.11) ($ 12.72)
(in US$ thousands, except per share figures)
Years Ended December 31, 2002 2003 2004 Net income (loss)
As reported
$ (18,466 ) $ (14,095 ) $ 1,682 Less: Stock compensation expense, net of related tax effects
— — (3,421 ) Pro-forma
$ (18,466 ) $ (14,095 ) $ (1,739 ) Earnings (loss) per share (in US$):
As reported - basic
$ (0.37 ) $ (0.28 ) $ 0.03 As reported - diluted
(0.37 ) (0.28 ) 0.03 Pro-forma - basic and diluted
(0.37 ) (0.28 ) (0.03 ) (See Note
15-"Shareholders'17, “Shareholders’ Equity and ShareOptions"Options,” for the assumptions and methodology used to determine the fair value of stock-based compensation.F-14GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) RETIREMENT PLAN)For the years ended December 31, 2002, 2003 and 2004, pro-forma diluted loss per share included only weighted-average common shares outstanding as the inclusion of additional potential common shares would have been anti-dilutive since the Company incurred a pro-forma net loss for the respective years.
Retirement Plan
The
Company's fundedCompany’s defined benefit pension planscoverscover substantially all of theregular employees.full-time employees, which excludes temporary and short-term contract employees, located in Taiwan. The net pension cost is computed based on an actuarial valuation and includes service cost, interest cost, expected return on plan assets and amortization of net asset/obligation at transition, amortization of prior service cost and amortization of pension gain or loss. The unrecognized net assets or obligation at transition is amortized equally over 15 years. The unrecognized prior service cost is amortized over the average remaining service period of theparticipatedparticipating employees expected to receive benefits under the pension plan as of the date of amendment of the plan.The amortizationAmortization of unrecognized net gain or loss (excluding asset gains and losses not yet reflected in market-related value) isthe excessincluded as a component of net pension cost for a year if, as of the beginningbalanceof the year, that unrecognized net gain or lossoverexceeds 10% of the greater of the projected benefit obligation or the market-related value of planassetsassets. If amortization is required, the minimum amortization is that excess divided by the average remaining service period of active employees expected to receivebenefitbenefits under theplan. COMPREHENSIVE INCOME (LOSS)plans. The Company also has a defined contribution plan which covers substantially all of the employees located in the U.S. (See Note 16, “Pension Benefits,” for additional information.)Comprehensive Income (Loss)
Comprehensive income (loss) is defined as the change in equity of a company from transactions and other events and circumstances, excluding transactions resulting from investments from owners and distributions to owners. Comprehensive income (loss) is recorded as a component of
shareholders'shareholders’ equity. TheCompany'sCompany’s comprehensive income (loss) consists of netearningsincome or loss, foreign currency translation adjustment, as well as unrealized gains and losses onavailable-for-salesmarketable securities.ACCOUNTING FOR INCOME TAXESAccounting for Income Taxes
The Company has adopted
SFASFAS No. 109,"Accounting“Accounting for IncomeTaxes."Taxes,” (FAS 109). UnderSFAS No.FAS 109, the asset and liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on the differences between financial reporting and tax bases of assets and liabilities, losscarryforwardscarry forwards and investment creditsandare measured using the enacted tax rate and laws that will be in effect when the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amountexpected tothat will more likely than not be realized.LOSS PER SHAREIn assessing the likelihood of realization, management considers estimates of future taxable income.Earnings (Loss) Per Share
The Company computes
lossearnings (loss) per share in accordance withSFASFAS No. 128,"Earnings per F-15GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) Share."“Earnings Per Share,” (FAS 128). Under the provisions ofSFAS No.FAS 128, basicnet incomeearnings or loss per share is computed by dividing the net income or loss available to common shareholders for the period by the weighted average number of common shares outstanding during the period. Dilutednet incomeearnings or loss per share is computed by dividing the net income or loss for the period by the weighted average number of common shares and potential commonshare equivalentsshares outstanding during the period.Common share equivalents,Potential common shares, composed of incremental common shares issuable upon the exercise of warrants and stock options, are included in the computation of dilutednet incomeearnings or loss per share to the extent such shares are dilutive.MINORITY INTERESTMinority Interest
Minority interest
represents the outside shareholders' 0.01% ownershipconsists of 100% of the common stock ofKoos Broadband Telecom Co.UIM held by outside shareholders. UIM was deemed a VIE as defined by FIN 46(R) and the Company was considered the primary beneficiary of UIM. Under the provisions of FIN 46(R),Ltd., 5% ownershipthe Company has incorporated the results of UIM into its 2004 Consolidated Financial Statements, even though thecommon stockCompany owns none ofGigaMusic.com Limited andUIM’s equity. (See Note 3, “Variable Interest Entity,” for more information.) Minority interest also consists of 41.42% of the common stock of G-Music Limited held by outside shareholders. Prior to February 2004, minority interests also included 5% ownership of GigaMusic.com Limited (GigaMusic) held by EMI Music Asia (EMI), a division of EMI Group Hong Kong Limited.RECLASSIFICATIONIn February 2004, EMI returned its 5% ownership in GigaMusic to the Company. (See Note 21, “Litigation,” for additional information.)Reclassification
The presentation of certain prior
yearyears’ information has been reclassified to conform with current yearpresentation. RECENT ACCOUNTING PRONOUNCEMENTSpresentations.Recent Accounting Pronouncements
In May 2003, the FASB issued FAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity,” (FAS 150). It establishes classification and measurement standards for three types of freestanding financial instruments that have characteristics of both liabilities and equity. Instruments within the scope of FAS 150 must be classified as liabilities within the Company’s Consolidated Financial Statements and be reported at settlement date value. The provisions of FAS 150 are effective for (1) instruments entered into or modified after May 31, 2003, and (2) pre-existing instruments as of July 1, 2003. In November 2003, through the issuance of FASB Staff Position No. FAS 150-3 (FSP FAS 150-3), the FASB indefinitely deferred the effective date of certain provisions of FAS 150, including mandatorily redeemable instruments as they relate to minority interests in consolidated finite-lived entities. The adoption of FAS 150, as modified by FSP FAS 150-3, did not have a material effect on the Company’s Consolidated Financial Statements.
In November 2004, the FASB issued FAS No. 151, “Inventory Costs, an Amendment of ARB No. 43, Chapter 4,” (FAS 151). FAS 151 requires certain abnormal expenditures to be recognized as expenses in the current period. It also requires that the amount of fixed production overhead allocated to inventory be based on the normal capacity of the production facilities. The standard is effective for the fiscal year beginning January 1, 2006. It is not expected that FAS 151 will have a material effect on the Company’s Consolidated Financial Statements.
In December 2004, the FASB issued FAS No. 153, “Exchanges of Non-Monetary Assets, an Amendment of APB Opinion No. 29,” (FAS 153) effective for non-monetary asset exchanges occurring in the fiscal year beginning January 1, 2006. FAS 153 requires that exchanges of productive assets be accounted for at fair value unless fair value cannot be reasonably determined or the transaction lacks commercial substance. FAS 153 is not expected to have a material effect on the Company’s Consolidated Financial Statements.
In December 2004, the FASB issued FAS No. 123(R), “Share-Based Payment,” (FAS 123 (R)). FAS 123(R) requires employee stock options and rights to purchase shares under stock participation plans to be accounted for under the fair-value method, and eliminates the ability to account for these instruments under the intrinsic-value method prescribed by APB Opinion No. 25, which was allowed under the original provisions of FAS 123. FAS 123(R) requires the use of an option-pricing model for estimating fair value, which is amortized to expenses over the requisite periods. The requirements of FAS 123(R) were effective for interim periods beginning after June
2002,15, 2005. The Securities and Exchange Commission (SEC) has postponed theFinancial Accounting Standards Board ("FASB") issued Statementeffective date ofFinancial Accounting Standards No. 146 ("SFAS No. 146")FAS 123(R),"Accountinggiving companies more time to develop their implementation strategies. Under the SEC’s rule, FAS 123(R) is now effective forCosts Associated with Exit or Disposal Activities." SFAS No. 146 addresses financial accountingpublic companies for annual, rather than interim, periods that begin after June 15, 2005. The Company plans to adopt FAS 123(R) beginning in fiscal 2006 andreporting for costs associated with exit or disposal activities and nullifiesis currently evaluating the various transition methods allowed under FAS 123(R).In March 2004, the FASB approved the consensus reached on the Emerging Issues Task Force Issue No.
94-3, "Liability Recognition03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” (EITF 03-1). The objective of EITF 03-1 is to provide guidance forCertain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires that a liabilityidentifying other-than-temporarily impaired investments. EITF 03-1 also provides new disclosure requirements forcosts associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred, rather than at the date of commitment to an exit or disposal plan. SFAS No. 146 is effective for exit or disposal activitiesinvestments that areinitiated after December 31, 2002. The Company does not expect that the adoption of SFAS No. 146 will have a material impact on the Company's financial position or results of operations, although SFAS 146 may impact the timing of recognition of costs associated with future restructuring, exit or disposal activities. F-16GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE)deemed to be temporarily impaired. InDecember 2002,September 2004, the FASB issuedStatement of Financial Accounting Standards No.148 ("SFAS No. 148"), "Accounting for Stock-Based Compensation-Transition and Disclosure-An Amendment of FASB Statement No. 123." SFAS No. 148 amends Statement of Financial Accounting Standards No.123 ("SFAS No. 123"), "Accounting for Stock-Based Compensation," to provide alternative methods of transition for a voluntary change toEITF 03-1-1, which delays thefair value based method of accounting for stock-based employee compensation. SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures both in annual and interim financial statements about the method of accounting for stock-based employee compensation and the effecteffective date of themethod used on reported results. The Company has included the disclosures required by SFAS No. 148measurement and recognition guidance inNote 1-"The Company and Summary of Significant Accounting Policies" and Note 15-"Shareholders' Equity and Share Options." In November 2002, the FASB issued Interpretation No. 45 ("FIN No. 45") "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN No. 45 elaborates on the existing disclosure requirements for most guarantees, including loan guarantees. It also clarifies that at the time a company issues a guarantee, the company must recognize an initial liability for the fair value, or market value, of the obligations it assumes under that guarantee. However, the provisions related to recognizing a liability at inception of the guarantee for the fair value of the guarantor's obligations does not apply to product warranties or to guarantees accounted for as derivatives. The initial recognition and initial measurement provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002.EITF 03-1 until further notice. The disclosure requirements ofFIN No. 45EITF 03-1 are effective with this annual report forfinancial statements of interim or annual periods ending after December 15, 2002.fiscal 2004. The Companydoes not believehas evaluated the impact of the adoption ofFIN No. 45 will have a material impact on its financial position or results of operations. In November 2002,theEmerging Issues Task Force reached a consensus on Issue No. 00-21 ("EITF 00-21"), "Revenue Arrangements with Multiple Deliverables." EITF 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. Theaccounting provisions of EITF00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company03-1 and does notbelieveexpect the adoption of EITF00-2103-1 will have amaterialsignificant impact onits financial position or results of operations. F-17GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) In January 2003,theFASB issued Interpretation No. 46 ("FIN No. 46") "Consolidation of Variable Interest Entities." Until this interpretation, a company generally included another entity in its consolidated financial statements only if it controlledCompany. During theentity through voting interests. FIN No. 46 requires a variable interest entity, as defined, to be consolidated by a company if that company is subject to a majorityperiod of therisk ofdelay, the Company continues to apply previously adopted accounting policy for determining when a decline in fair value is other than temporary, and records identified lossfrom the variable interest entity's activities or entitled to receive a majority of the entity's residual returns. Management is currently evaluating the effect of adopting FIN No. 46 on its results of operations and financial position.accordingly, if any.NOTE 2.
LOSSEARNINGS (LOSS) PER SHARE
For the years end December 31, -------------------------------------------- 2000 2001 2002 ----------- ----------- ----------- (in thousand shares)Average outstanding shares, beginning of year 40,000 50,154 50,154 Add: Issuance of shares for cash in February 2000 8,791 - - ----------- ----------- ----------- Average outstanding shares, end of year 48,791 50,154 50,154 =========== =========== =========== Loss before income tax and minority interests $(1,206,372) $(1,811,523) $ (716,091) Minority interest (income) loss - (194) 73,718 Income tax benefit - 393 4,383 ----------- ----------- ----------- Net loss $(1,206,372) $(1,811,324) $ (637,990) =========== =========== =========== Loss per share-basic and diluted (in dollars) $ (24.73) $ (36.12) $ (12.72) =========== =========== ===========
(in US$ thousands, except share figures)
For the years end December 31, 2002 2003 2004 Weighted average outstanding shares
Basic
50,154 50,154 50,154 Effect of dilutive securities Employee stock options
— — 1,547 Diluted
50,154 50,154 51,701 Income (loss) before income tax and minority interests
$ (20,727 ) $ (17,080 ) $ 2,084 Minority interest (income) loss
2,134 3,127 (481 ) Income tax benefit (expense)
127 (142 ) 79 Net income (loss)
$ (18,466 ) $ (14,095 ) $ 1,682 Earnings (loss) per share
Basic
$ (0.37 ) $ (0.28 ) $ 0.03 Effect of dilutive securities:
Employee stock options
— — — Diluted
$ (0.37 ) $ (0.28 ) $ 0.03 For the years ended December 31,
2000, 20012002 and2002,2003, diluted loss per share included only weighted-average common shares outstanding as the inclusion of additional potential commonstock equivalentsshares would have beenantidilutiveanti-dilutive since the Company incurred a net loss for the respective years.NOTE 3. VARIABLE INTEREST ENTITY
In January 2003, the FASB issued FIN 46, which addressed the consolidation by business enterprises of VIEs, to which the usual conditions of consolidating a controlling financial interest do not apply. As defined in FIN 46, variable interests are contractual, ownership or other interests in an entity that change with changes in the entity’s net asset value. Variable interests in an entity may arise from financial instruments, service contracts, guarantees, leases, or other arrangements with the VIE. An entity that will absorb a majority of the VIE’s expected losses if they occur, receive a majority of the entity’s expected residual returns if they occur, or both, is considered the primary beneficiary of the VIE. The primary beneficiary must include the VIE’s assets, liabilities and results of operations in its consolidated financial statements. FIN 46 became immediately effective for all VIEs created after January 31, 2003.
The FASB amended FIN 46 by issuing FIN 46(R) in December 2003. FIN 46(R) is an update of FIN 46 and contains different implementation dates based on types of entities subject to the standard and based on whether a company has adopted FIN 46. In April of 2004, the Company entered into a software license and support service contract with UIM to provide Internet software support services for UIM’s entertainment software operations. The contract allows for the Company to charge a percentage of UIM gross receipts resulting from UIM’s on-line entertainment operations. The Company analyzed the provisions of FIN 46(R) as it relates to contractual relationships and determined that it was a primary beneficiary of a software licensee, UIM. As a result of the determination by the Company that GigaMedia is a primary beneficiary of UIM, the Company has incorporated the results of UIM into its 2004 Consolidated Financial Statements, even though the Company owns none of UIM’s equity. UIM’s net assets as of December 31, 2004 were approximately $414 thousand and the consolidation of UIM resulted in an increase in assets and liabilities of approximately $1.6 million and $1.2 million and no net income impact. The impact of consolidating UIM within the Company’s Consolidated Financial Statements was immaterial for the period presented.
NOTE 4.ACQUISITIONS
Acquisition - CESL
On April 1, 2004, GigaMedia acquired, through GigaMedia International Limited (GMIL), a wholly-owned subsidiary of GigaMedia, all of the issued and outstanding shares of Grand Virtual Inc. and selected affiliates in a private transaction for an all-cash consideration of $32.5 million, excluding related transaction costs. Subsequent to the acquisition, GMIL was renamed Cambridge Entertainment Software Limited (CESL). CESL is a software developer and application service provider. CESL develops software for on-line entertainment services. As an application service provider, CESL offers “turnkey” solutions for on-line entertainment, which it licenses under revenue sharing agreements. The acquisition of CESL strengthened the Company’s diversified entertainment product portfolio and revenue base. CESL’s software provides GigaMedia a secure, scalable technology platform that can be used to provide a range of entertainment services and develop highly efficient business models. These factors, among others, contributed to a purchase price in excess of the fair market value of the net tangible assets and intangible assets acquired. As a result, the Company recorded goodwill of $29.4 million, which was assigned to the entertainment software segment and is non-deductible for tax purposes.
Upon the closing of the acquisition, results of operations of CESL were included in the Company’s Consolidated Financial Statements under the entertainment software business. The identified intangible assets will be amortized on a straight-line basis over their useful lives and the overall weighted-average life is 3.85 years.
The purchase price allocation of the acquisition was shown as follows:
(in US$ thousands)
Amount Amortization life
(in years)
Cash acquired
$ 21 Accounts receivable
1,186 Other current assets
127 Fixed assets / non-current assets
450 Intangible assets
Completed technology
1,300 3 Trade name and trademark
700 10 Non-competition agreement
200 5 Others
373 2-4 Goodwill
29,398 N/A Total assets acquired
33,755 Current liabilities
(573 ) Noncurrent liabilities
(364 ) Total liabilities assumed
(937 ) Total purchase price
$ 32,818 The following unaudited pro-forma information presents a summary of the results of operations of the Company as of December 31, 2003 and 2004 as if the acquisition had occurred on January 1, 2003 and 2004.
(in US$ thousands, except per share figures)
Year ended December 31 2003 2004 Unaudited Net revenue
$ 106,776 $ 102,668 Income (loss) from operations
(8,374 ) 4,440 Net income (loss)
(8,298 ) 3,103 Basic earnings (loss) per share
(0.17 ) 0.06 Diluted earnings (loss) per share
(0.17 ) 0.06 The above unaudited pro-forma financial information includes adjustments for the amortization and depreciation of identified assets.
Acquisition - G-Music
In February 2002, September 2002 and December 2002, the Company acquired, through its directly-owned subsidiary, G-Music, all of the outstanding stock of 17 companies, which owned 50 music chain stores under the distribution
systembrands of Rose Records and TachungRecords, through its directly-owned subsidiary, G-Music.Records. The acquisitionshave gainedprovided the Company meaningful presence in theoff-linemusic entertainmentF-18GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) market, enhanced the Company's bargain power with vendors, and are consistent with the Company's strategy of building a diversified entertainment business. These factorsmarket. This factor, among others, contributed to a purchasepricesprice in excess of fair market value of theacquirees'net tangible assets and intangible assets acquired, and as a result, the Companyhasrecorded goodwill in connection with the transactions.As the individual business combinations are considered immaterial to the Company, but material in the aggregate, all information in relation to the acquisitions is disclosed in aggregate.The total purchase price of
NT$638,904$18.3 million for a 58.58% equity interest consisted ofNT$220,606$6.3 million in G-MusicCommon Stock,common stock, representing 6,550 thousand shares andNT$418,298$12.0 million in cashconsideration, NT$88,000 of which was not paid and recorded as other current liabilities as of December 31, 2002.consideration. The value of G-MusicCommon Stockcommon stock was determined based on themanagement'smanagement’s estimate of the fair value of G-MusicCommon Stockcommon stock in connection with the acquisitions.Total purchase price has been allocated as follows:
NT$ ---------Cash acquired $ 18,311 Inventories, net 365,118 Property, plant and equipment, net 105,158 Other tangible assets acquired 285,364 Amortizable intangible assets: Brandnames 150,875 Distribution channel 106,851 Goodwill 268,327 Short-term bank loans (88,780) Notes and accounts payable (516,451) Other tangible liabilities assumed (55,869) --------- Total $ 638,904 =========Amortizable
(in US$ thousands)
Amount Amortization life
(in years)
Cash acquired
$ 524 Inventories, net
10,441 Property, plant and equipment, net
3,007 Other tangible assets acquired
8,160 Amortizable intangible assets:
Brand names
4,314 15 Distribution channel
3,056 5 Goodwill
7,673 N/A Short-term bank loans
(2,539 ) Notes and accounts payable
(14,768 ) Other tangible liabilites assumed
(1,598 ) Total purchase price
$ 18,270 The identified intangible assets
acquired have estimatedare amortized on a straight-line basis over their usefullives as follows: brandnames - 15 years; distribution channel - five years.lives. Goodwill ofNT$268,327$7.7 million represents the excess of theF-19GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE)purchase price over the fair value of the net tangible and intangible assets acquired and is not deductible for tax purposes.The results of operations of the acquirees have been included in the
Company'sCompany’s consolidated statements of operations since the completion of the acquisitions. The following unauditedpro formapro-forma information presents a summary of the results of operations of the Company as of December 31,2001 and2002 as if the acquisitions occurred on January 1,2001:
For the years ended December 31, -------------------------------- 2001 2002 ------------ ------------ (Unaudited) NT$ NT$Net revenues $ 3,606,979 $ 3,834,289 Loss from operations $(2,221,609) $ (854,184) Net loss $(1,876,740) $ (650,607) Net loss per share-basic and diluted (in dollars) $ (37.42) $ (12.97)The unaudited pro forma financial information2002:
(in US$ thousands, except per share figures)
For the year ended
December 31, 2002(Unaudited ) Net revenues
$ 110,981 Loss from operations
(24,723 ) Net loss
(18,831 ) Net loss per share-basic and diluted
(0.37 ) NOTE 5.GOODWILL
(in US$ thousands)
For the years ended December 31, 2002 2003 2004 Balance as of January 1,
$ — $ 731 $ — Acquisitions
7,673 — 29,607 Impairment
(7,032 ) (738 ) — Translation adjustment
90 7 — Balance as of December 31,
$ 731 $ — $ 29,607 Goodwill is
not intended to representtested annually for impairment using a fair value approach, at the “reporting unit” level. A reporting unit is an operating segment, orto be indicativea component of an operating segment, as defined in FAS 142.Following the acquisition of the
consolidated results of operations or financial conditionCompany’s music distribution business (see Note 4, “Acquisitions,” for additional information), the Company determined that the goodwill of the Company’s music distribution business was impaired due to a general market downturn. The Companythat would have been reported had the acquisitions been completed astherefore recorded goodwill impairment losses ofthe dates presented,$7.0 million andshould not be taken as representative of the future consolidated results of operations or financial condition of the Company. NOTE 4. GOODWILL$738 thousand in 2002 and 2003, respectively. Such impairment losses for each year were determined based on an independent appraiser’s report. The goodwill carrying amount was completely written off at December 31, 2003.The changes in the carrying amount of goodwill for the year ended December 31,
2002 are as follows:
Total --------- NT$Balance as of January 1, 2002 $ - Acquisitions 268,327 Impairment (242,938) --------- Total $ 25,389 =========F-20GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) The Company performed an impairment test of its goodwill and intangible assets as of December 31, 2002. Due to the general market downturn and the operating performance2004 were primarily a result of theacquired business fell below the Company's expectations, the Company recorded aacquisition of CESL. (See Note 4, “Acquisitions,” for additional information.) No impairment of goodwillimpairment loss of NT$242,938 in the fourth quarter of 2002. The amount of loss was determined based on an independent appraiser's report as of December 31, 2002. The fair value of the reporting unit giving rise to the impairment loss was estimated using the expected present value of future cash and income method.has been identified during 2004.NOTE
5.6.INTANGIBLEASSETS - NETASSETS-NETThe following table summarizes the
Company'sCompany’s intangible assets,net:
December 31, 2001 ---------------------------------------------- Gross carrying Accumulated amount amortization Net -------------- ------------ -------- NT$ NT$ NT$EMI-content, licenses and others $ 12,631 $ - $ 12,631 ======== ======= ========
December 31, 2002 ---------------------------------------------- Gross carrying Accumulated amount amortization Net -------------- ------------ -------- NT$ NT$ NT$Brandnames $ 150,875 ($ 5,029) $ 145,846 Distribution channel 106,851 ( 10,685) 96,166 --------- --------- --------- $ 257,726 ($ 15,714) 242,012 ========= ========= =========a.by major asset class:
(in US$ thousands)
December 31, 2003 Gross carrying
amountAccumulated
amortizationImpairment Net Brand names
$ 4,441 $ (444 ) $ — $ 3,997 Distribution channel
3,145 (943 ) — 2,202 $ 7,586 $ (1,387 ) — $ 6,199
(in US$ thousands)
December 31, 2004 Gross carrying
amountAccumulated
amortizationImpairment Net Brand names
$ 4,758 $ (793 ) $ — $ 3,965 Distribution channel
3,370 (1,685 ) — 1,685 Completed technology
1,300 (325 ) — 975 Trade name trademark and non-competition agreement
900 (83 ) — 817 Capitalized software cost
1,150 (279 ) — 871 Other
65 (6 ) — 59 Total
$ 11,543 $ (3,171 ) $ — $ 8,372 The Company
recognized an intangible asset attributable to a Business Cooperation Agreement with Microsoft Corporation ("Microsoft")amortizes the cost ofapproximately NT$1,543,270, equal to the fair value of a warrant issued to Microsoft to purchase up to 10 million shares of the Company's common stock. The exercise price was initially set at US$6.60 per share and may be adjusted as disclosed in the following paragraph. The fair value of the warrant was based on the Black-Scholes valuation model with the following assumptions: fair value per common share of US$8.75 dollars, expected volatility of 44%, dividend yield of 0, risk free interest rate of 6% and an expected life of five years. The intangible asset was being amortized over a three-year period using the straight-line method. Upon the occurrence of certain events, including a special distribution to our shareholders, the terms of the warrant give Microsoft the option to either adjust the exercise price or demand a cash payment in lieu of such an adjustment. As a result of a special distribution of $2.00 per share by the company in 2002, the warrant gave Microsoft the right to either adjust the exercise price downward to approximately $1.60 per share or to demand a cash payment equal to the per share distribution multiplied by the number of shares covered by the warrant. As of the date hereof, Microsoft has made no election. F-21GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) Additionally, in accordance with the Business Cooperation Agreement, the Company had the following transactions with Microsoft: * GigaMedia agreed to pay Microsoft 2% of gross revenues from the sale of cable-modem based access services; * GigaMedia agreed to spend US$1 million on advertising services over a three-year period ended in November 2002. As of December 31, 2001, due to the following reasons, management determined that the intangible asset derived from the Business Cooperation Agreement with Microsoft was impaired: (1) No products defined in the agreement (e.g., co-branded broadband version or shopping channels) have been created or developed or are in development with Microsoft. (2) Compared to the carrying value of the intangible, the revenue generated from the agreement in 2001 is insignificant. (3) The market has undergone significant changes since the Company's IPO in February 2000, and Microsoft may not be interested in entering Taiwan's Internet market due to the current worldwide economic downturn. (4) The relationship with Microsoft may not benefit the Company in the future, and the expected benefits to be derived from Microsoft are not likely to materialize. (5) The economic life of the intangible has expired as no products are under development or are expected to be launched at any time in the future. Accordingly, the carrying value of NT$428,686 was written off in 2001 and recorded F-22GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) as operating cost in the statement of operations. b. The Company entered into a three-year license agreement with Microsoft Corporation on April 1, 1998 for technologies related to cable-based Internet broadband access. License fees under the agreement amounted to US$1,450 thousand dollars and were fully amortized in 2001 based on a three-year amortization period. c. The Company entered into a three-year license agreement with Portal Information Network, Inc. on May 1, 1998 for technologies related to billing and customer management of the Company's subscribers. License fees under the agreement amounted to US$300 thousand dollars and were fully amortized in 2001 based on a three-year amortization period. d. In 2001, GigaMedia entered into a three-year agreement with EMI Music Asia ("EMI"), a division of EMI Group Hong Kong Limited, to establish GigaMusic.Com Limited ("GigaMusic"), which is registered in the Cayman Islands. The Company invested NT$239,990 in GigaMusic during 2001. The Company holds 95% of total shares; EMI holds 5% of total shares in exchange for: * EMI providing access to EMI management expertise and industry know-how; * EMI providing content; * EMI granting licenses and rights (non-exclusive and non-transferable) to GigaMusic.Com to use EMI's licensed products and artists including streaming EMI's licensed samples (i.e. 30-music-length videos from newly released album), displaying EMI's licensed materials, previews of newly released licensed recordings, and promotional downloads of licensed recordings. In addition to the 5% ownership of GigaMusic, the Company paid EMI a one-time non-recoupable initiation fee equal to US$1,000,000 on June 30, 2001 and the Company made two additional non-recoupable payments to EMI in the amount of US$1,000,000 on March 1, 2002 and March 1, 2003. The total value of the 5% shares granted to EMI amounted to NT$12,631 and was F-23GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) recorded as an intangible asset. In addition to the 5% ownership of GigaMusic, the Company paid EMI a non-recoupable fee of US$1,000 thousand dollars in June 2001 and March 2002, respectively, and recorded as other assets. The Company was required to pay an additional payment of US$1,000 thousand dollars in March 2003 in accordance with the terms of the agreement. However, in March 2002, the Company sent a notice to EMI to terminate the agreement, including requiring EMI to return the ownership interest in GigaMusic and US$2,000 thousand dollars paid in June 2001 and March 2002 to the Company. In addition, the Company has obtained a preliminary injunction order from Taipei District Court on the additional US$1,000 thousand dollars scheduled to pay to EMI in March 2003. See Note 22 - "Subsequent Events" for the legal actions the Company has taken subsequent to December 31, 2002. As of December 31, 2002, the Company performed an impairment test of the EMI intangible asset as well as the US$2,000 thousand dollars payments. Due to EMI has not provided the agreed-upon products to GigaMusic, the site has not been launched and no subscriber revenue has been generated from the project, the fair value of the intangible asset and the US$2,000 thousand dollars payments was considered negligible and the Company wrote down the balance of these assets and recorded an impairment loss of NT$80,627 in the current year's operation results. e. As a result of the acquisition transactions mentioned in Note 3,intangible assetsincluding brandnames and distribution channel, amounting to NT$257,726 were recorded by the Company. Theover their estimated useful lives. Amortizable intangible assets areboth amortizabletested for impairment based on undiscounted cash flows and,have original estimated useful lives as follows: brandnames-15 years; distribution channel-five year. Forif impaired, written down to fair value based on discounted cash flows or appraised values. No impairment of intangible assets has been identified during any of the periods presented. The net carrying amount of intangible assets increased by $2.2 million for the year ended December 31, 2004, primarily due to the acquisition of CESL.For the years ended December 31, 2002,
the2003 and 2004, total amortization expenses of intangible assets wereNT$15,714.$455 thousand, $914 thousand, and $1.5 million, respectively, which included respective amortization of capitalized software costs of $0, $0, and $191 thousand. As of December 31,2002, the Company performed an impairment test based on an independent appraisal report and considered that the carrying amount of the intangible assets approximate their fair value. Accordingly, no impairment loss was recorded in 2002. As of December 31, 2002,2004, based on the current amount of intangibles subject to amortization, the estimated amortization expense for each of the succeeding five years is as follows:2003: $31,428; 2004: $31,428; 2005: $31,428; 2006: $31,428;
Amount
(in US$ thousands)
2005
$ 1,813 2006
1,738 2007
1,029 2008
501 2009
406 $ 5,487 NOTE 7.IMPAIRMENT LOSS ON PROPERTY, PLANT AND EQUIPMENT
Due to rapid technological development in broadband Internet access services and
2007: $20,743. F-24GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE)the Company’s related decision to phase out one-way Internet access services, the Company had expected to dispose of certain broadband and communication equipment. Accordingly, the Company compared the carrying amount of one-way broadband equipment with undiscounted future net cash flows expected to be generated by these assets over their remaining lives and deemed that the equipment was unrecoverable and impaired. Therefore, for the year ended December 31, 2003, the Company recorded impairment charges of $1.6 million, measured as the amount by which the carrying value exceeded the fair value of this equipment based on quoted market prices in accordance with FAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” The Company assessed potential impairment of its property, plant and equipment and deemed no write-down was required at the balance sheet date of 2004.NOTE
6.8.CASH AND CASHEQUIVALENT'SEQUIVALENTS
December 31, -------------------------- 2001 2002 ----------- ---------- NT$ NT$Petty cash $ 470 $ 11,714 Checking and savings accounts 92,969 283,859 Time deposits 700,907 945,584 ----------- ---------- Total $ 794,346 $1,241,157 =========== ==========
(in US$ thousands)
December 31, 2003 2004 Petty cash
$ 427 $ 333 Checking and savings accounts
5,727 8,292 Time deposits
29,140 4,608 Total
$ 35,294 $ 13,233 NOTE
7. SHORT-TERM INVESTMENTS
December 31, -------------------------- 2001 2002 ----------- ---------- NT$ NT$Available-for-sale securities: Debt securities due within one year $ - $ 69,500 Open-end funds 3,524,943 785,773 Goldtree investment funds 1,503,776 - ----------- ---------- Total $ 5,028,719 $ 855,273 =========== ==========Short-term investments9.MARKETABLE SECURITIES-CURRENT
( in US$ thousands )
December 31, 2003 2004 Available-for-sale securities:
Debt securities due within one year
$ — $ 3,514 Open-end funds
28,956 30,770 Total
$ 28,956 $ 34,284 Marketable securities-current are classified as
available-for-sale securities.available-for-sale. As of December 31,20012003 and2002,2004, the balances of unrealized gains for current available-for-sale securities wereNT$136,201$0 andNT$1,214,$577 thousand, respectively. During2000, 20012002, 2003 and2002,2004, realized gains from disposal ofshort-term investmentsmarketable securities-current amounted toNT$114,577, NT$201,826$1.8 million, $488 thousand, andNT$62,787,$351 thousand, respectively.NOTE
8.10.NOTES AND ACCOUNTSRECEIVABLE
December 31, -------------------------- 2001 2002 ----------- ----------- NT$ NT$Notes and accounts receivable $ 130,021 $ 181,659 Less: Allowance for doubtful accounts (26,728) (54,056) ----------- ----------- Net $ 103,293 $ 127,603 =========== ===========F-25GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE)RECEIVABLE-NET
For the years ended December 31, --------------------------------- 2000 2001 2002 -------- --------- --------- NT$ NT$ NT$Allowance for doubtful accounts Balance at beginning of year $ 892 $ 2,578 $ 26,728 Additions: Bad debt expenses 1,686 40,250 31,611 Less: Write-off - (16,100) (4,283) -------- --------- --------- Balance at end of year $ 2,578 $ 26,728 $ 54,056 ======== ========= =========
( in US$ thousands )
December 31, 2003 2004 Notes and accounts receivable
$ 5,824 $ 7,888 Less: Allowance for doubtful accounts
(1,731 ) (2,050 ) Net
$ 4,093 $ 5,838
( in US$ thousands )
For the years ended December 31, 2002 2003 2004 Allowance for doubtful accounts
Balance at beginning of year
$ 765 $ 1,556 $ 1,731 Additions: Bad debt expenses
931 156 247 Less: Write-off
(140 ) (18 ) (73 ) Translation adjustment
— 37 145 Balance at end of year
$ 1,556 $ 1,731 $ 2,050 NOTE
9.11.INVENTORIES-NET
December 31, ------------------------- 2001 2002 --------- ----------- NT$ NT$Cable modems $ 74,180 $ 69,795 Merchandise 1,125 335,402 --------- ----------- Subtotal 75,305 405,197 Less: Allowance for inventory market value decline and obsolescence (22,806) (44,981) --------- ----------- Net $ 52,499 $ 360,216 ========= ===========
For the years ended December 31, --------------------------------- Allowance for inventory market value decline and obsolescence 2000 2001 2002 -------- --------- --------- NT$ NT$ NT$Balance at beginning of year $ - $ 3,482 $ 22,806 Additions: Charges for inventory market value decline and obsolete items 3,482 19,324 22,175 -------- --------- --------- Balance at end of year $ 3,482 $ 22,806 $ 44,981 ======== ========= =========
( in US$ thousands )
December 31, 2003 2004 Cable modems
$ 1,582 $ 1,686 Merchandise
5,302 10,714 Subtotal
6,884 12,400 Less: Allowance for inventory market value decline and obsolescence
(2,080 ) (1,912 ) Total
$ 4,804 $ 10,488
( in US$ thousands )
For the years ended December 31, 2002 2003 2004 Allowance for inventory market value decline and obsolescence
Balance at beginning of year
$ 652 $ 1,294 $ 2,080 Additions: Charges for (reversal of) inventory market value decline and obsolete items
642 3,169 (300 ) Reductions: Written-off allowance for inventory market value decline and obsolescence
— (2,423 ) — Translation adjustment
— 40 132 Balance at end of year
$ 1,294 $ 2,080 $ 1,912 A significant portion of the Company’s total gross merchandise as at December 31, 2004 was returnable to vendors, subject to certain terms and conditions. Charges for (reversal of) inventory market value decline and obsolete items are a component of operating costs.
NOTE
10. LONG-TERM INVESTMENTS F-26GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS12.MARKETABLE SECURITIES-NONCURRENT
( in US$ thousands )
December 31, 2003 2004 Amount Percentage
heldAmount Percentage
heldDebt securities:
Societe Generale Bond Fund (SG Bond Fund)
$ 11,217 — $ — — Equity Securities:
Gamania Digital Entertainment Co., Ltd. (Gamania)
4,043 3.09 2,893 3.32 Rock Internet Corporation (RIC)
— 4.35 — 4.35 Sub-total
4,043 2,893 Total
$ 15,260 $ 2,893 Marketable securities -
(Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE)
December 31, ----------------------------------- 2001 2002 ---------------- ---------------- NT$ % NT$ % -------- ----- -------- -----Debt securities: UBS AG Jersey Bond ("UBS Bond") $173,265 - $ - - Societe General Bond Fund ("SG Fund") 353,833 - 370,365 - -------- -------- Sub-total 527,098 370,365 -------- -------- Equity Securities: Gamania Digital Entertainment Co., Ltd. ("Gamania") $369,280 9.92% $212,203 3.25% Rock Internet Corporation ("RIC") 98,520 4.35% 58,520 4.35% -------- -------- Sub-total 467,800 270,723 -------- -------- Total $994,898 $641,088 ======== ========In 2001, the Company purchased SG Fund and UBS Bond for NT$333,701 and NT$160,693, respectively. These debt securitiesnoncurrent are classified aslong-term available-for-sale investmentsavailable for sale, of which investment in the SG Bond Fund was classified asmanagement does not intend to sell thesemarketable securitiesfor use in- currentoperations. Accordingly, the Company revalued these debt securities at fair market value at the balance sheet date and recognized the unrealized gainsasaccumulated other comprehensive income. Asof December 31,2001 and 2002,2004, since thebalancesmaturation of the SG Bond Fund became within one year. (See Note 9, “Marketable Securities – Current.”) The unrealized gains ontheseinvestmentswere NT$32,704 and NT$36,665, respectively. Forin theyear endedSG Bond Fund as of December 31,2002, the Company disposed UBS Bond with a gain of NT$444.2003 were $1.4 million.In 2001, the Company invested $10.7 million in Gamania, which accounted for
NT$369,280 at an average cost9.92% ownership ofNT$70 dollars per share. The Company acquired 3,768 thousand shares at NT$90 dollars per share from certain shareholders of Gamania ("Offering Shareholders") and 1,508 thousand shares at NT$20 dollars per share directly fromGamania.During 2001 and 2002, the Company received stock dividends of 369 thousand shares and 1,319 thousand shares, respectively.During 2002, the Company disposed of 3,457 thousand shares of Gamania at an average selling price of approximatelyNT$77.43 dollars$2.24 (NT$77.43) per share and recognized a disposal gain ofNT$51,347 in$1.5 million. During 2003, thecurrent year's operations.Company received stock dividends of 1.4 million shares. The Company has no ability to exercise significant influence overGamania'sGamania’s operating and financial policies.These equity securities are classified as long-term available-for-sale investments as management does not F-27GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) intend to sell these securitiesThe market price of Gamania shares has been below the Company’s carrying cost foruse in current operations. Accordingly,an extended period of time; therefore, the Companyrevalued these equity securities at fair market value atrecorded an other-than-temporary loss of $1.8 million on December 31, 2004. As of December 31, 2003 and 2004, the balancesheet dateof unrealized losses was $460 thousand andrecognized$0, respectively.The investment in RIC was accounted for under the
unrealized gain as accumulated other comprehensive income. As Gamania went publiccost method. In 2002 and 2003, this investment was considered impaired due to the downturn in the Internet industry and the significant operating loss incurred by RIC. Impairment losses of $1.2 million and $1.7 million were recognized in 2002 and 2003, respectively, and theCompany adopted Gamania's quoted market priceinvestment balance was written down to $0 as of December 31,2002 to determine the fair value of this investee. As of December 31, 2002, the balance of unrealized gain was NT$59,245. As of December 31, 2001, Gamania was a privately-held company, and management believed that the fair value of this investment approximated its cost. Therefore, no unrealized gain or loss on this investment was recorded as of December 31, 2001. On April 30, 2001, the board of directors of Dynamix held a meeting and resolved to dissolve Dynamix as of June 30, 2001. Therefore, during 2001 the Company wrote off the value of its investment in the amount of NT$20,343,746. In addition, at April 30, 2001, the Company had uncollected receivables from Dynamix in the amount of NT$16,100,000 which were also written off in 2001. The Company's equity in net losses of its partially owned equity affiliates in 2000, 2001 and 2002 was NT$13,801,459 and NT$27,837,259, and NT$0, respectively. In 2001, the Company disposed of its long-term investment in Mediacoding by selling its shares to RIC, the parent company of Mediacoding. Proceeds from the sale were NT$22,500,000, the Company's original investment, and the carrying value was NT$10,861,282. Therefore the Company recorded a gain on disposal of long-term investment in the amount of NT$11,638,718. During 2001, the Company recognized investment loss from Mediacoding in the amount of NT$7,493,513. In 2001, the Company invested in RIC, which is a private company engaged in providing on-line music services, for NT$98,520. The Company has no ability to exercise significant influence over RIC's operating and financial policies. For the year ended December 31, 2001, the value of the stock is not readily determinable, therefore this investment is recorded at historical cost. Management believed the fair value of this investment approximated the cost. During the year ended December 31, 2002, due to the down trend of Internet industry and the investee has incurred significant losses since incorporation, management concluded that the impairment loss the Company had suffered was other-than-temporary. Accordingly, the carrying value of the investment was written off to its fair value, which was F-28GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) approximately its net worth as (1) the investee is a private company and hence there2003. There is noquoted market value to determine its fair value; (2) based on management's evaluation, the carrying valueevidence ofthe assets and liabilitiesany recovery ofthe investee company approximate its fair value. As a result, animpairmentloss of NT$40,000 was recognizedin2002 in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets."2004.NOTE
11.13.DEFERRED ASSETS
December 31, ------------------- 2001 2002 -------- -------- NT$ NT$Cable modems $ 38,440 $ 5 Software, royalty and license fees 36,749 51,652 Network development cost 32,619 23,819 Other - 11,877 -------- -------- Total $107,808 $ 87,353 ======== ========
( in US$ thousands )
December 31, 2003 2004 Royalty and license fees
$ 724 $ 115 Network setup cost
395 186 Other
83 48 Total
$ 1,202 $ 349 Deferred assets are stated at cost and amortized on a straight-line basis over the following
period: software,periods: royalty and licensefees-onefees, one to three years;cable modems-15 months;networkdevelopment cost-fivesetup cost, five years.The Company provides cable modems on a free basis to its customers for subscribing to Internet access lines for a period of 15 months.Networkdevelopmentsetup cost is comprised of coststo buildincurred in setting up thecable.leased network.NOTE
12.14.RESTRICTED CASHRestricted cash recorded in current assets
and other assetsas of December 31,20012003 and2002 consist2004 consisted of the following:F-29GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE)
December 31, ------------------- 2001 2002 -------- -------- NT$ NT$Restricted cash-current assets Time deposit pledged to ABN AMRO for standby letter of credit maturing on April 1, 2002 $ 34,950 $ - Time deposit pledged to ABN AMRO for standby letter of credit maturing on April 1, 2003 - 34,891 Time deposit pledged to CHTC for refundable deposit maturing on February 28, 2002 6,000 - Time deposit pledged to Hua Nan Commercial Bank as a guarantor for inventory purchases - 28,000 Time deposit pledged to Fubon Commercial Bank for short-term loans - 37,523 -------- -------- Total $ 40,950 $100,414 ======== ========
December 31, --------------- 2001 2002 ------- ------ NT$ NT$Restricted cash-other assets Time deposit pledged to ABN AMRO for standby letter of credit maturing on April 1, 2003 $34,950 $ - ======= ======According to
( in US$ thousands )
December 31, 2003 2004 Restricted cash-current assets
Time deposit pledged to AMN AMRO for standby letter of credit maturing on January 30, 2004
$ 1,025 $ — Time deposit pledged to Hua Nan Commercial, China Trust Commercial and Ta Chong Bank as a guarantor for inventory purchases
883 1,290 Time deposit pledged to Hua Nan Commercial Bank for refundable deposit maturing on January 14, 2005
18 19 Funds restrained by preliminary injunction from court for a lease lawsuit
— 197 Total
$ 1,926 $ 1,506 In connection with the
agreement mentioned in Note 5,litigation between the Companypaidand EMIa one-time, non-recoupable initiation fee equal to US$1,000,000 on June 30, 2001 and the Company made an additional non-recoupable payment to EMI in the amount of US$1,000,000 on March 1, 2002. The Company was required to pay an additional payment of US$1,000 thousand dollarsin March 2003,in accordance with the terms of the agreement. However, in March 2002, the Company sent a notice to EMI to terminate the agreement, including requiring EMI to return the ownership interest in GigaMusic and US$2,000 thousand dollars paid in June 2001 and March 2002 to the Company. In addition, the Company has obtained a preliminary injunction order from Taipei District Court on the additional US$1,000 thousand dollars scheduled to pay to EMI in March 2003. In 2001, the Company provided twoan unconditional and irrevocable standbylettersletter of credit issued by ABN AMROBANKBank in the amount ofUS$1,000,000 each$1 million was provided by the Company in favor of EMI.These twoThis standbylettersletter of creditwerewas guaranteed bytwo certificates ofa time depositmaturingthat matured onF-30GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) April 1, 2002January 30, 2004. (See Note 21, “Litigation,” for further information.)NOTE 15.SHORT-TERM LOANS
( in US$ thousands ) Name
Nature Weighted-average
interest rateDecember 31, 2003 2004 United Advertising Company, Ltd.
Unsecured loans 4 % $ — $ 284 NOTE 16.PENSION BENEFITS
The Company and
April 1, 2003, respectively. See Note 22 - "Subsequent Events" for the legal actions the Company has taken subsequent to December 31, 2002. NOTE 13. SHORT-TERM LOANS
December 31, -------------------------- Nature Pledged assets 2001 2002 - ------------- -------------------------- ---------- ----------- NT$ NT$Secured loans Time deposits (see Note 12) $ - $ 93,000 ========== =========== Interest rate - 6.25% ========== ===========NOTE 14. PENSION BENEFITS Asits subsidiaries have defined benefit and defined contribution pension plans that cover substantially allof the Company'sfull-time employees,are located in Taiwan, theand which exclude temporary and short-term contract employees.Defined Benefit Pension Plan
The Company has enacted provisions for
employees'employees’ retirement in accordance with the Labor Standards Law of the Republic ofChina.China for the employees located in Taiwan. The provisions state that employees are entitled to2two base points for every year of service for the first 15 years and1one base point for every additional year of service, up to a maximum of 45 base points.An employee'sThe pension obligation to employee is computed based on years of service and average salary or wages for the6six months prior to approved retirement.The Company uses a December 31 measurement date for its defined benefit pension plan. The following
tabletables set forth the actuarial assumptions of theCompany'sCompany’s defined benefit pension plan:
2000 2001 2002 ---- ---- ----Discount rate (weighted averages) 6.00% 4.25% 4.00% Expected return on plan assets (weighted averages) 6.00% 4.00% 3.25% Rate of compensation increase (weighted averages) 5.00% 4.50% 3.38%The following provides a reconciliation of projected benefit obligations and funded status
(in US$ thousands)
2003 2004 Change in benefit obligation
Benefit obligation at beginning of year
$ 865 $ 1,105 Service cost
218 249 Interest cost
35 39 Plan participants’ contribution
— — Actuarial gain
(120 ) (518 ) Benefits paid
— — Exchange Diff.
21 66 Benefit obligation at end of year
$ 1,019 $ 941 Effective January 1, 2004, Koos Broadband Telecom Co., Ltd., one of the subsidiaries of the Company, adopted FAS No. 87, “Employers’ Accounting for Pensions,” (FAS 87). According to an independent actuarial valuation, the adoption of FAS 87 resulted in an increase in pension benefit obligation of $86 thousand as of January 1, 2004.
(in US$ thousands)
2003 2004 Change in plan assets
Fair value of plan asset at beginning of year
$ — $ — Actual return on plan assets
— — Employer contribution
— — Plan participants’ contributions
— — Benefit paid
— — Fair value of plan asset at end of year
$ — $ — (in US$ thousands)
Funded status
$ (1,019 ) $ (941 ) Unrecognized net actuarial gain
(98 ) (724 ) Unrecognized prior service cost
352 348 Unrecognized transition obligation
(22 ) 149 Net amount recognized
$ (787 ) $ (1,168 ) Amounts recognized in the statement of financial position consisted of the following:
(in US$ thousands)
Pension Benefits 2003 2004 Accrued benefit cost
$ (992 ) $ (1,184 ) Deferred pension cost (other assets)
205 16 Accumulated other comprehensive income
— — Net amount recognized
$ (787 ) $ (1,168 ) Information for pension plans with an accumulated benefit obligation in excess of plan
and the components ofassets were as follows:
(in US$ thousands)
2003 2004 Projected benefit obligation
$ (1,019 ) $ (941 ) Accumulated benefit obligation
(589 ) (500 ) Fair value of plan assets
— — The net periodic benefit cost
recognized. F-31GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE)
2001 2002 -------- --------- NT$ NT$Vested benefit obligation $ - $ - ======== ========= Accumulated benefit obligation $ 3,738 $ 14,346 ======== =========
2001 2002 --------- --------- NT$ NT$Projected benefit obligation at January 1, $ 3,567 $ 11,079 Service cost 5,191 6,834 Interest cost 383 665 Benefit obligation arising from the acquistions - 15,445 Actuarial gain on projected benefit obligation - (3,961) Unrecognized loss 1,668 - Amortization of loss 270 - --------- --------- Projected benefit obligation at December 31, $ 11,079 $ 30,062 ========= =========
December 31, ----------------------- 2001 2002 --------- --------- NT$ NT$Fair value of plan assets $ - $ - Projected benefit obligation (11,079) (30,062) --------- --------- Funded status (11,079) (30,062) Unrecognized transition obligations - 2,231 Unrecognized prior service cost - 12,900 Unrecognized loss (gain) 1,669 (2,356) Additional liability - (7,760) --------- --------- Accrued pension liabilities ($ 9,410) ($ 25,047) ========= =========Netfor the plans included the following components:
(in US$ thousands)
2002 2003 2004 Service cost
$ 198 $ 218 $ 249 Interest cost
19 35 39 Expected return on plan assets
— — — Amortization of transition obligation
5 5 8 Amortization of prior service cost
4 27 28 Amortization of net (gain) loss
2 (11 ) (15 ) Net periodic benefit cost
$ 228 $ 274 $ 309 Assumptions
Weighted-average assumptions used to determine benefit obligations and net periodic pension
cost includescosts at December 31, 2002, 2003 and 2004 were as follows:
2002 2003 2004 Discount rate
4.00 % 3.50 % 3.50 % Rate of return on plan assets
N/A N/A N/A Rate of compensation increase
3.38 % 3.00 % 3.00 % At December 31, 2004, this plan was not funded. Therefore, no asset allocation disclosure was required and the
following components: F-32GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE)contribution is expected to be approximately $95 thousand in 2005. The Company makes payments from internal funds as payments become due and also maintains a normal, highly liquid working capital balance to ensure payments are made timely. The benefits expected to be paid from 2005 through 2009 are $0, and in aggregate for 2010 and thereafter are $70 thousand.
For the years ended December 31, -------------------------------------- 2000 2001 2002 ---------- --------- --------- NT$ NT$ NT$Service cost $ 1,611 $ 5,191 $ 6,834 Interest cost 120 383 665 Amortization of unrecognized net transition obligation loss - 270 160 Amortization of unrecognized prior service cost - - 156 Amortization of unrecognized pension loss - - 77 ---------- --------- --------- Net periodic pension cost $ 1,731 $ 5,844 $ 7,892 ========== ========= =========Defined Contribution Pension Plan
In connection with the acquisition of CESL, the Company provided a defined contribution plan for employees located outside of Taiwan. Participants under 50 years of age are allowed to defer up to $9,000 of their own annual compensation to the plan, while participants over 50 are limited to deferrals of up to $10,500. For all employees who elect to make deferrals under the plan, CESL makes a matching employer contribution in an amount limited to 3% of each participant’s deferral. In 2004, the defined contribution expenses pursuant to this plan for the nine-month period starting April 1, 2004 equalled $42 thousand. This plan is fully funded at the end of each pay period.
NOTE
15. SHAREHOLDERS'17.SHAREHOLDERS’ EQUITY AND SHARE OPTIONSAs of December 31,
2002,2004, the authorized capital of the Company wasNT$800,000$24.42 million (NT$800 million), represented by80,000 thousand80 million common shares with par value of NT$10dollarsper share. As of December 31,2002, 50,154 thousand2004, there were 50,154,000 common shareswereissued and outstanding.On January 17, 2002, the
Company'sCompany’s shareholders approved a return of capital in the amount ofUS$2 dollars$2 for each ordinary share outstanding on March 15, 2002. On March 29, 2002, the Company returnedthecapital to the shareholders in an amount ofUS$100,308 thousand dollars translated into NT$3,521,814 based on$100.3 million.1999 Share Option Plan
During 1999, the
exchange rate at the transaction date. For the year ended December 31, 1999, 210 thousand shares of option were granted and vested immediately at the option price of zero dollars. In addition, 2,819 thousand shares of option were granted which are exercisable at the option price of zero dollars and, subject to termination of employment, expire three years from the date of grant, are not transferable other than on death, and are exercisable in three annual installments of 30%, 35% and 35% commencing one year from the date of grant when the specific employees complete one, two, or three years of services with Hoshin GigaMedia, the Company's wholly-owned subsidiary. During 2000, TheCompany adopted the GigaMedia Limited 1999 Employee Share Option Plan (the"Plan")1999 Plan). Pursuant to the 1999 Plan, up to2two million common shares may be granted to employees of theF-33GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE)Company. The 1999 Plan is administered by a committee designated by the board of directors. The committee as plan administrator has complete discretion to determine the exercise price for the option grants, to determine which eligible individuals are to receive option grants, the time or times when options grants are to be made, the number of shares subject to grant and the maximum term for which any granted option is exercisable.During 2000,2002 Share Option Plan
At the June 2002 annual general meeting of shareholders, the shareholders of the Company approved the GigaMedia Limited 2002 Employee Share Option Plan (the 2002 Plan) under which up to three million common shares of the Company have been reserved for issuance. All employees, officers, and directors of the Company are eligible to participate in the 2002 Plan. The 2002 Plan is administered by a committee designated by the board of directors. The committee as plan administrator has complete discretion to determine the exercise price for the option grants, to determine which eligible individuals are to receive option grants, the time or times when options grants are to be made, the number of shares subject to grant and the maximum term for which any granted option is exercisable.
In August 2004, options to purchase
1,111 thousandthree million shares of theCompany'sCompany’s common stock were granted and exercisable upon granting at an exercise price of $0.79 pursuant to the 2002 Plan. The expiration date of the options is June 29, 2014.2004 Share Purchase Plan
At the June 2004 annual general meeting of shareholders, the shareholders of the Company approved the GigaMedia Limited 2004 Employee Share Purchase Plan (the 2004 ESPP) under which up to two million common shares of the Company have been reserved for issuance. Pursuant to the 2004 ESPP, the Company offered its shares to qualified employees at favorable conditions and established a restricted period of six months during which employees may not transfer the shares after purchasing them. To be eligible, employees must be employed by the Company or its subsidiaries and the customary employment shall be no less than 20 hours per week. Employees are also subject to certain restrictions on the amount that may be invested to purchase the shares and to other terms and conditions of the 2004 ESPP. The 2004 ESPP is a one-time plan and is administered by a committee designated by the board of directors. In March 2005, there were 189,642 shares subscribed by eligible employees at a purchase price of approximately $1.39 per share.
2004 Share Option Plan
At the June 2004 annual general meeting of shareholders, the shareholders of the Company approved the GigaMedia Limited 2004 Employee Share Option Plan (the 2004 Plan) under which up to seven million common shares of the Company have been reserved for issuance. All employees, officers, and directors of the Company are eligible to participate in the 2004 Plan. The 2004 Plan is administered by a committee designated by the board of directors. The committee as plan administrator has complete discretion to determine the exercise price for the option grants, to determine which eligible individuals are to receive option grants, the time or times when options grants are to be made, the number of shares subject to grant and the maximum term for which any granted option is exercisable.
In August 2004, options to purchase 5,462,530 shares of the Company’s common stock were granted at an exercise price of
US$24.3 dollars, a 10% discount$0.79 pursuant to theinitial public offering price (US$27 dollars), and2004 Plan. These options were subject topurchase 837 thousand sharestwo vesting schedules. In accordance with the terms of theCompany's common stockfirst vesting schedule, 3,863,888 options weregranted at an exercise pricevested and exercisable upon granting. In accordance with the terms ofUS$15 dollars (fair value atthedate of grant). During 2001, 1,467 thousand shares of option granted in 2000second vesting schedule, 399,663 options werecancelled or forfeited by employees. Unearned compensation for outstandingvested and exercisable upon granting. The remaining 1,198,979 optionsas of December 31, 2001 and 2002 amounted to NT$5,281 and NT$0, respectively. During 2001,are vested 25% per year from theCompany accelerated the amortization of share compensation expenses in relation to thegrant date.All options granted
in 2000.under the 2004 Plan expire on June 29, 2014.Total compensation expense recorded in
2000, 20012002, 2003 and20022004 for all options amounted toNT$182,776, NT$130,827$153 thousand, $0 andNT$5,281,$0, respectively, whichconsistsconsisted of amortization of options outstanding during the respective years, net of forfeitures. Unearned compensation for outstanding options was $0 as of December 31, 2003 and 2004. There were no options granted in20012002 or2002. Pro forma information regarding2003.The pro-forma disclosures of net income (loss) and earnings (loss) per share
isrequiredby FASB No.under FAS 123"Accounting for Stock-Based Compensation", and has been determined as ifwere disclosed in “Stock-Based Compensation” under Note 1, “Significant Accounting Policies.” In computing this pro-forma impact, theCompany had accounted for its employee stock options under the fair value method required by that Statement. Thefair value for these options was estimated at the date of grant using the Black-Scholes option-pricing model based on therisk-free interest rate of 5.06% to 6.2%, assuming no dividendsfollowing assumptions:
For the years ended December 31,
2002 2003 2004 Option term (years)
5 5 3.35 Volatility
41.34%~58.77% 41.34%~58.77% 92.94% Risk-free interest rate
5.06%~6.2% 5.06%~6.2% 2.92% Dividend yield
0% 0% 0% Weighted-average fair value option granted
0 0 0.45 Option and
an option life of five years. Volatility ofgrant transactions during thestock in a range of 41.34 to 58.77 has been reflected in the option pricing calculation. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, this option valuation model requires the input of highly subjective assumptions including the F-34GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) expected stock price volatility. For the purposes of SFAS No. 123's fair value method for pro forma disclosures, the estimated fair value of the option is amortized to expense over the option-vesting period. The Company's pro forma information islast three years were summarized as follows:
For the years ended December 31, -------------------------------------------- 2000 2001 2002 ------------ ------------ ---------- NT$ NT$ NT$Net loss As reported ($ 1,206,732) ($ 1,811,324) ($ 637,990) Pro forma ($ 1,352,179) ($ 2,563,181) ($ 637,990) Loss per share As reported ($ 24.73) ($ 36.12) ($ 12.72) Pro forma ($ 27.71) ($ 51.11) ($ 12.72)The status of the Company's stock option plan is summarized below.
Number of Weighted average shares exercise price --------------- ---------------- (in thousands) US$Outstanding at January 1, 2000 2,694 $ - Granted 1,948 20.31 --------------- Outstanding at December 31, 2000 4,642 8.52 Cancelled (1,457) 19.31 Forfeited (18) 20.31 --------------- Outstanding at December 31, 2001 3,167 3.54 Expired (2,694) - --------------- Outstanding at December 31, 2002 473 23.50 ===============
2002 2003 2004 Weighted Avg.
Exercise PriceNo. of Shares
(in thousands)Weighted Avg.
Exercise PriceNo. of Shares
(in thousands)Weighted Avg.
Exercise PriceNo. of Shares
(in thousands)Balance at January 1,
$ 23.50 473 $ 23.50 473 $ 23.50 473 Options granted
— — — — 0.79 8,463 Options exercised
— — — — — — Options canceled/expired
— — — — 0.79 (92 ) Balance at December 31,
$ 23.50 473 $ 23.50 473 $ 2.00 8,844 Exercisable at December 31,
$ 23.50 473 $ 23.50 473 $ 2.18 7,737 The following table sets forth information about stock options outstanding at December 31,
2002: F-35GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE)2004:
Weighted Number of average Weighted Number of Outstanding shares remaining average exercisable share Range of exercise as of contractual exercise as of price December 31, 2002 life price December 31, 2002 - ----------------- ------------------ ----------- -------- -----------------US$15.0 40,930 2.09 years US$15.0 35,970 US$24.3 432,100 2.09 years US$24.3 312,100 ------------------ ----------------- 473,030 348,070 ================== =================
Options outstanding Options currently exercisable Range of exercise price
Number of
sharesWeighted average
remaining
contractual lifeWeighted average
exercise priceNumber of
shares$15.00
40,930 0.09 years $ 15.00 40,930 $24.30
432,100 0.09 years $ 24.30 432,100 $0.79
8,370,280 9.49 years $ 0.79 7,263,551 8,843,310 7,736,581 NOTE
16.18.INCOME TAXES
2002 2003 2004 Income (loss) from continuing operations before income taxes
U.S. operations
$ — $ — $ (4,392 ) Non-U.S. operations
(20,727 ) (17,080 ) 6,476 Total income (loss) from continuing operations before income taxes
$ (20,727 ) $ (17,080 ) $ 2,084 Income tax provision (benefit) by geographic operation was as follows:
( in US$ thousands )
For the years ended December 31, 2002 2003 2004 U.S. operations
$ — $ — $ (88 ) Non-U.S. operations
(127 ) 142 9 $ (127 ) $ 142 $ (79 ) The
benefit forcomponents of incometaxes consiststax provision (benefit) by taxing jurisdiction were as follows:
( in US$ thousands )
For the years ended December 31, 2002 2003 2004 U.S. federal
Current
$ — $ — $ 7 Deferred
— — (19 ) — — (12 ) U.S. state and local :
Current
— — 12 Deferred
— — (88 ) — — (76 ) Non U.S. :
Current
(127 ) 142 9 Deferred
— — — (127 ) 142 9 Total income tax provisions (benefit)
$ (127 ) $ 142 $ (79 ) A reconciliation of the
following:Company’s continuing operations effective tax rate to the statutory U.S. federal tax rate was as follows:
2000 2001 2002 ---------- --------- --------- NT$ NT$ NT$Income tax benefit computed at the ROC statutory rate (185,739) (210,914) (149,068) Non-deductible items 31,936 20,829 26,707 Benefit from operating losses note recorded 153,804 189,692 117,978 --------- --------- --------- Total benefit (expense) for income taxes $ - $( 393) $ 4,383 ========= ========= =========
(in US$ thousands)
For the years ended December 31, 2002 2003 2004 Federal statutory rate
34.00 % 34.00 % 34.00 % State and local - net of federal tax benefit
— — 6.27 % Foreign tax differential
(9.00 )% (9.00 )% (9.00 )% Valuation allowance for deferred tax assets
(25.00 )% (25.00 )% (25.00 )% Other
(0.61 )% 0.83 % (2.48 )% Effective rate
(0.61 )% 0.83 % 3.79 % Significant components of the
Company'sCompany’s deferred tax assets and liabilitiesconsistconsisted of the following:F-36GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE)
December 31, ----------------------- 2001 2002 --------- --------- NT$ NT$ --------- ---------Deferred tax assets: Organization costs $ 3,809 $ 1,859 Net operating loss carryforwards 462,033 651,854 Share of net loss of equity investee 5,086 - Unrealized foreign exchange loss (gain) 3,844 (2,807) Valuation allowance for inventory 4,964 11,245 Valuation allowance for notes and accounts receivable 10,395 12,723 Pension expense 1,893 3,867 Investment credits - 4,154 --------- --------- Sub-total 492,024 682,895 Less: valuation allowance (491,631) (678,119) --------- --------- Deferred tax assets - net $ 393 $ 4,776 ========= =========
For the years ended December 31, ------------------------------------ 2000 2001 2002 ---------- ---------- --------- NT$ NT$ NT$Valuation allowance: Balance at beginning of year $ 74,610 $ 259,713 $ 491,631 Additions: charged to valuation allowance 185,103 231,918 186,488 ---------- ---------- --------- Balance at end of year $ 259,713 $ 491,631 $ 678,119 ========== ========== =========
(in US$ thousands)
December 31, 2003 2004 Deferred tax assets:
Organization costs
$ 1 $ 1 Net operating loss carryforwards
18,593 20,990 Unrealized foreign exchange (gain) loss
92 9 Allowance for inventory market value decline and obsolete items
1,979 741 Allowance for doubtful accounts
402 381 Pension expense
127 191 Investment credits
122 186 Accrued expenses
— 47 21,316 22,546 Less: valuation allowance
(21,316 ) (22,499 ) Deferred tax assets - net
$ — $ 47 (in US$ thousands)
December 31, 2003 2004 Deferred tax liabilities:
Property, plant & equipment
$ — $ (55 ) Intangible assets
— (331 ) Net noncurrent deferred tax liabilities
$ — $ (386 )
(in US$ thousands)
For the years ended
December 31,
2002 2003 2004 Valuation allowance:
Balance at beginning of year
$ 14,067 $ 19,514 $ 21,316 Additions: charged to (realization of) valuation allowance
5,367 1,354 (336 ) Exchange difference
80 448 1,519 Balance at end of year
$ 19,514 $ 21,316 $ 22,499 Due to a history of losses from its broadband ISP and music distribution operations in Taiwan, the Company does not believe that sufficient objective, positive evidence currently exists to conclude that realization of deferred tax assets is more likely than not. As a result, the Company has provided a valuation allowance covering substantially all of the deferred tax
assets. As of December 31, 2001assets arising from its broadband ISP and2002, the balances of deferred tax assets were NT$393 and NT$4,776, respectively, which were related to one of the Company's subsidiaries, because this subsidiary's management believed that the realization of deferred tax assets was more than likely. The Company recorded the deferred tax assetsmusic distribution operations inthe other current assets in the balance sheet. F-37GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE)Taiwan.As at December 31,
2002,2004, the Companyhashad net operating losscarryforwardscarry forwards of approximatelyNT$2,607,416$84.0 million. Currently, the net operating loss can be carried forward for five years.The expiring years areA breakdown of the expiration of GigaMedia’s net operating loss carry forwards was as follows:
Amount ------------ Occurred year NT$ Expiring year - ------------- ------------ -------------1998 $ 23,948 2003 1999 241,858 2004 2000 783,886 2005 2001 961,453 2006 2002 596,271 2007 ------------ Total $ 2,607,416 ============
(in US$ thousands) Year occurred
Amount Expiring year 2000
$ 24,720 2005 2001
30,276 2006 2002
10,399 2007 2003
4,961 2008 2004
13,606 2009 Total
$ 83,962 NOTE
17.19.RELATED PARTY TRANSACTIONSA. Related Parties and Relationships
The CompanyGigaMedia’s policy is
a member of the Koos Group, a conglomerate in Taiwan. In the normal course of business,that all transactions with related parties must be conducted on terms as favorable to the Companyconducted certainas obtainable at the time in a comparable arm’s-length transaction with a non-related party. GigaMedia’s related parties are listed below:
Names of related parties
China Trust Commercial Bank
Chailease Finance Co., Ltd.
China Life Insurance Co., Ltd.
Gamania Digital Entertainment Co., Ltd. (Gamania)
Dynamix Media Technologies, Inc.
Taiwan Fuji Xerox Co., Ltd. (Xerox)
Raymond Chang
Shu-Yun Huang
Grand Cathay Securities Corp.
Videoland Inc.
Union Advertising Company, Ltd.
United Advertising Company, Ltd.
Getop Automatic Systems Inc.
Voyages Television Travel Service Taiwan Ltd (Voyages Television Travel)
My-Funding Corp.
MegaMedia Company
Best Method Limited
The companies listed below were not related parties due to changes in the Company’s directors and senior management during 2003 and 2004, which prevented such directors and senior management from exercising significant influence or controls over the Company. As a result, transactions with the following
companiesparties were not subject to the related party transaction disclosure andindividuals affiliated withwere shown as $0 in theKoos Group and individuals: F-38GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) Names of related parties Cycloria Incorporated ("Cycloria") TeleFirst Cable Communication Co., Ltd. ("TeleFirst") Everlasting CATV Inc. ("Everlasting") Wonderful CATV Co., Ltd. ("Wonderful") Hoshin Home Center Co., Ltd. ("HHCC") SunCrown CATV Co., Ltd. ("SunCrown") Prosperity CATV Co., Ltd. GaHo Cable Co., Ltd. Twin Stars CATV Co., Ltd. Liguan CATV Co., Ltd. New Visual Wave Cable Communications ("New Visual Wave") Chun-Chien CATV Co., Ltd. ("Chun-Chien") GangDu CATV Co., Ltd. ("GangDu") Ching Lian Incorporated ("Ching Lian") China Trust Commercial Bank Chailease Finance Co., Ltd. ("Chailease") China Life Insurance Co., Ltd. China Securities Co., Ltd. KG Communication Co., Ltd. Dynamix Media Technologies, Inc. ("Dynamix") KGEx.Com China Securities Co., Ltd. Taiwan Fuji Xerox Co., Ltd. China Network Systems Co., Ltd. ("China Network System") Raymond Chang Shu-Yun Huang The Company had transactions with the following principal shareholder: Names of related parties Microsoft Corporation ("Micorsoft")current period.
Names of previously related parties
TeleFirst Cable Communication Co., Ltd. (TeleFirst)
Everlasting CATV Inc. (Everlasting)
Wonderful CATV Co., Ltd. (Wonderful)
SunCrown CATV Co., Ltd. (SunCrown)
Prosperity CATV Co., Ltd. (Prosperity)
GaHo Cable Co., Ltd. (GaHo)
Twin Stars CATV Co., Ltd.
Liguan CATV Co., Ltd.
New Visual Wave Cable Communications
GangDu CATV Co., Ltd. (GangDu)
Ching Lian Incorporated (Ching Lian)
China Securities Co., Ltd.
KGEx.Com
China Network Systems Co., Ltd.
B. Transactions with Related Parties
a. Sales to related parties: F-39GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE)
Fora. Sales to related parties:
(in US$ thousands) For the years ended December 31, Related Parties
2002 2003 2004 China Trust Commercial Bank
$ 294 $ 296 $ 305 China Securities Co., Ltd.
199 323 — KGEx.com
94 — — China Life Insurance Co., Ltd
— — 32 Xerox
— 63 76 Voyages Television Travel
— — 42 Others
139 20 55 Total
$ 726 $ 702 $ 510
b. Non interest-bearing receivables from related parties resulting from the years ended December 31, --------------------------------- Related Parties 2000 2001 2002 - ----------------------------- -------- ------- ------- NT$ NT$ NT$Dynamix $ 26,143 $ 7,190 $ - China Trust Commercial Bank 4,747 7,114 10,156 China Life Insurance Co. Ltd. 2,100 1,846 2,075 KG Communication Co. 5,400 - - China Securities Co., Ltd. 1,080 960 6,881 KGEx.com - - 3,248 Others 2,331 1,120 2,712 -------- ------- ------- Total $ 41,801 $18,230 $25,072 ======== ======= =======above transactions were summarized as follows:b.
(in US$ thousands) December 31, Related Parties
2003 2004 China Trust Commercial Bank
$ 52 $ 79 Xerox
— 8 Voyages Television Travel
— 33 Others
179 8 Total
$ 231 $ 128
c. As part of revenue sharing arrangements with cable partners, payments to related parties for installation and access services are summarized as follows:
Fortheyears ended December 31, ------------------------------------ Related Parties 2000 2001 2002 - ------------------------- ---------- --------- --------- NT$ NT$ NT$Everlasting $ 2,146 $ 2,198 $ 5,928 Wonderful 2,045 2,661 4,060 GangDu 2,391 3,333 3,933 ChingLain 3,095 2,683 2,976 TeleFirst 3,042 2,578 4,178 New Visual Wave - 2,416 290 KGEx.Com - 15,135 29,034 Others 7,302 7,403 11,923 ---------- --------- --------- Total $ 20,021 $ 38,407 $ 62,322 ========== ========= =========Company’s cable partners, payments to related parties for installation and access services were summarized as follows:
(in US$ thousands)
Related Parties
For the years ended December 31 2002 2003 2004 Everlasting
$ 172 $ 227 $ — Wonderful
117 154 — GangDu
114 114 — ChingLain
86 99 — TeleFirst
121 174 — KGEx.Com
840 1,005 — Others
354 562 — Total
$ 1,804 $ 2,335 $ — Access and installation revenue was recorded net of these payments.
c. Purchases of property, plant and equipment from related parties are summarized as follows:
Ford. The Company incurred sales commission expenses with its cable partners of $72 thousand and $57 thousand for the years ended December 31, ------------------------------------ Related Parties 2000 20012002- ------------------------------- ---------- --------- ---------- NT$ NT$ NT$and 2003, respectively.
e. The Company incurred expenses of $126 thousand and $101 thousand for the years ended December 31, 2002, and 2003, respectively, for consulting services provided by China Network System $ - $ 4,314 $ - ========== ========= ==========Systems Co., Ltd.d. The Company purchased beneficiary certificates managed by the Grand Pacific Securities Investment Trust Co., Ltd. for NT$700,000 in 2000. These beneficiary F-40GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) certificates were also sold in 2000 at a gain of NT$14,549. As of December 31, 2001, the Grand Pacific Securities Investment Trust Co., Ltd. was no longer affiliated with the Koos Group because the Koos Group disposed of all of their shares of Grand Pacific Securities Investment Trust Co., Ltd. e. The Company incurred sales commission expense of NT$7,307, NT$39,048 and NT$2,493 for the years ended December 31, 2000, 2001 and 2002, respectively, with its cable partners. f. The Company incurred expenses of NT$2,078 and NT$4,354 for the years ended December 31, 2001 and 2002, respectively, for consulting services provided by China Network System. g. Receivables
f. The Company leases its office premises from related parties resulting from the above transactions are summarized as follows (non interest-bearing):
December 31, ------------------------- Related Parties 2001 2002 - --------------------------- ---------- ---------- NT$ NT$China Trust Commercial Bank $ 775 $ 1,753 HHCC 1,630 - Others 507 3,952 ---------- ---------- Total $ 2,912 $ 5,705 ========== ==========h. Payables to related parties resulting from the above transactions are summarized as follows (non interest-bearing):
December 31, ------------------------- Related Parties 2001 2002 - ------------------------------ ---------- ---------- NT$ NT$China Life Insurance Co., Ltd. $ - $ 9,677 TeleFirst 269 - Everlasting 467 2,547 Wonderful 581 - GangDu 254 337 SunCrown 216 478 KGEx.COM - 5,536 Others 1,993 1,936 ---------- ---------- Total $ 3,780 $ 20,511 ========== ==========i. Please refer to Note 5 for transactions with Microsoft. F-41GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) j. As of December 31, 2001 and 2002, receivable due from the Company's CEO, Mr. Raymond Chang, in the amount of NT$18,534 was derived from a two-year loan agreement, bearing interest as 4.45% per annum, signed between Mr. Chang and the Company on May 1, 2001. As the loan is to be due within one year from the balance sheet date, as of December 31, 2002, the total outstanding balance of NT$18,534 was accounted for as current assets. k. As of December 31, 2002, the Company's indirectly-owned subsidiary, Tachung Records, had receivables of NT$88,000 from its former shareholders and the receivables were recorded as "other current assets" in the balance sheet. An executive officer of the Company's subsidiary, Shu-Yun Huang, was one of the debtors and, in accordance with the acquisition agreements with these former shareholders, Shu-Yun Huang was required to be responsible for collecting the receivables as of December 31, 2002. These receivables were fully collected subsequent to December 31, 2002. l. The Company leases its office premises from China Life Insurance Co., Ltd. under an operating lease that expires in 2005. The Company incurred rental expense of NT$3,491, NT$47,567 and NT$12,910under an operating lease that expires in 2005. The Company incurred rental expense of $374 thousand, $372 thousand and $392 thousand with China Life Insurance Co., Ltd. forthe years ended December 31, 2000 and 2001 and 2002, respectively. m. Total deposits in bank with related parties are summarized as follows:
Forthe years ended December 31,-------------------------------- Related Parties 20012002,--------------- ---- ---- NT$ NT$China Trust Commercial Bank-Total $570,209 $683,746 ======== ========2003 and 2004, respectively; deposits out with the transactions were $87 thousand and $95 thousand for the years ended December 31, 2003 and 2004, respectively.
g. The Company incurred expenses, for advertising services, insurance services, etc. for the year ended December 31, 2004, which were summarized as follows:
(in US$ thousands)
Expense
Related Parties 2002 2003 2004 Advertising expense
United Advertising Co., Ltd $ — $ — $ 188 Insurance expense
China Life Insurance Co., Ltd — — 40 Other
— — 9 $ — �� $ — $ 237
h. The Company incurred bandwidth cost of $116 thousand, $171 thousand, and $272 thousand for the years ended December 31, 2002, 2003, and 2004, respectively, for bandwidth provided by Gamania. Accrued expenses resulting from such transactions were $28 thousand as of December 31, 2003 and 2004.
i. Non interest-bearing payables to related parties were summarized as follows:
(in US$ thousands)
Related Parties
December 31, 2003 2004 KGEx.COM
$ 259 $ — Everlasting
35 — GangDu
10 — SunCrown Company
22 — United Advertising Co, Ltd
— 10 My-Funding Corp.
— 3 China Life Insurance Co, Ltd
— 11 Gamania
— 26 Others
81 1 Total
$ 407 $ 51
j. As of December 31, 2003, receivables due from the Company’s former CEO, Mr. Raymond Chang, in the amount of $372 thousand, was derived from a two-year loan agreement, bearing interest as 4.45% per annum, signed between Mr. Chang and the Company on May 1, 2001. The loan was fully repaid on June 15, 2004.
k. Total deposits in bank with a related party were summarized as follows:
(in US$ thousands)
Related Parties
December 31, 2003 2004 China Trust Commercial Bank
$ 13,829 $ 2,981
l. As of December 31, 2004, the Company held a short-term loan in the amount of $284 thousand, bearing interest at 4% per annum, due to United Advertising Company, Ltd. (See Note 15, “Short-Term Loans.”) Total interest payable and interest expense as of and for the year ended December 31, 2004 were $0 and $396, respectively.
m. On March 31, 2004, the Company entered into an agreement with its major shareholder, Best Method Limited, and a former major shareholder, JKK, Inc., with regard to a warrant issued to Microsoft Corporation by GigaMedia. In September 2004, Microsoft Corporation returned the warrant unexercised. (See Note 21, “Litigation,” for additional information.) As a result, the Company transferred the warrant of $48.7 million to additional paid-in capital. NOTE
18. FINANCIAL INSTRUMENTS The carrying amount of the Company's cash and cash equivalents approximates their fair value because of the short maturity of these instruments. The carrying value of receivables and payables approximates their market values based on their short-term maturities. The carrying value of the Company's available-for-sale investments approximates market based on the quoted market price or fair value of the securities at year-end. No cash dividends F-42GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) were received during the three-year period ended December 31, 2002. NOTE 19.20.COMMITMENTS AND CONTINGENCIES(a) Operating Leases
(a) Operating Leases Future minimum payments under operating leases, including those with a related party as disclosed in Note
17,19, for theCompany'sCompany’s office and store premises consisted of the following as of December 31,2002:2004:
year NT$ - -------------- -----------------2003 $ 234,650 2004 169,964 2005 95,528 2006 48,033 2007 and after 32,239
Year
Amount
(in US$ thousands)
2005
$ 4,018 2006
2,311 2007
1,591 2008
315 2009 and after
23 Rental expense for the above operating leases amounted to
NT$39,791, NT$78,411$5.1 million, $7.3 million andNT$175,715$7.1 million for the years ended December 31,2000, 20012002, 2003 and2002,2004, respectively.(b) Contingencies In December 2001,
(b) Contingencies The Company is subject to legal proceedings and claims that arise in the normal course of business. The Company believes the ultimate liabilities with respect to these actions will not have a
class action lawsuit was filed againstmaterial adverse effect on theCompany on behalfCompany’s financial condition, results ofpurchasers of its common stock between February 17, 2000 and December 6, 2000 inclusive. There are over 300 issuers who are defendants in this class action.operations or cash flows. (See Note 21, “Litigation,” to the Company’s Consolidated Financial Statements included herein.)NOTE 21.LITIGATION
a. In December 2001, a class action lawsuit was filed in the United States District Court for the Southern District of New York against the Company in connection with the initial public offering of its stock. There are approximately 300 issuers who are defendants in this class action. The complaint
allegesalleged thatGigaMediathe Company violated Sections 1112(a)(2)and Section 15 of the Securities Exchange Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder.In connection with the initial public offering of its stock (GigaMedia IPO), the complaint further alleges that the Prospectus was materially false and misleading because it failed to disclose, among other things (i) the Underwriters had solicited and received excessive and undisclosed commissions from certain investor in exchange for which the Underwriters allocated to those investors material portions of the restricted number of GigaMedia shares issued in connection with the GigaMedia IPO; and (ii) the Underwriters had entered into agreements with customers whereby the underwriters agreed to allocate GigaMedia shares to those customers in the GigaMedia IPO in exchange for which the customer F-43GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) agreed to purchase additional GigaMedia share in the aftermarket at pre-determined prices. The plaintiffs claim damages in an unspecified amount, including class damages and statutory compensation in an amount to be determined at trial, interest, costs and attorneys' fees. On or around April 19, 2002, the plaintiffs filed amended complaints against the Company. On July 1, 2002, the underwriter defendants filed their motion to dismiss the amended complaints. Subsequently, on July 15, 2002, the issuer defendants filed their motion to dismiss the amended complaints. The parties completed the briefing on the motions to dismiss, and the court held oral argument on the motions to dismiss on November 1, 2002. On October 17, 2002, a settlement consideration was proposed that the insurers, on behalf of the defendant directors and officers, shall severally pay the sum of US$100 million for the benefits of the Classes.On February 19, 2003, the court issued anOpinionopinion andOrderorder ondefendants' motionsdefendants’ motion todismiss, which granted the motions in part and denied the motions in part.dismiss. As to GigaMedia, theCompany, the RoleRule 10b-5 claims were dismissed without prejudice while the Section 11 claims survived the motion.AsIn June 2004, the plaintiffs and issuer defendants, including the Company, presented the executed settlement agreement to Judge Scheindlin during a court conference. Subsequently, the plaintiffs and issuer defendants made a motion for preliminary approval of the settlement agreement. The key terms of the settlement agreement include: 1) the insurers of the issuers will provide an undertaking that guarantees that plaintiffs in the approximately 298 settling actions will recover a total of $1 billion dollars; 2) the insurers will pay up to $15 million for the notice costs arising from the settlement; 3) the issuers shall assign their interest in certain claims against the underwriters to a litigation
is still at a very early stage, neithertrust, represented by plaintiffs’ counsel; and 4) the plaintiffs shall release all of the settling issuer defendants, including GigaMedia and its individual defendants, from all claims relating to this action.Neither the Company nor the
Company's defendantCompany’s defense attorney is able to assess the likelihood of an unfavorable outcome and can determine as to the amount or range of potential loss, if any.However, the Company intends to vigorously defend itself against allegations.The Company has entered into an annually renewable insurance policy with American Insurance Group withUS$10$10 million of liabilitycoverage. In addition,coverage in which the Company is required to pay a $500 thousand deductible. Accordingly, the Company hasrequestedrecorded a provision of $500 thousand in 2003, representing the Company’s deductible amount, related to these claims. The Company believes that the insurance coverage is sufficient to cover the liability arising from the settlement and claim.On February 15, 2005, Judge Scheindlin issued an opinion and order granting preliminary approval to the settlement agreement subject to a narrowing of the proposed bar order as to only contribution claims. The principal effect of the narrower bar order is that it does not bar claims for contractual indemnity. Negotiation is proceeding between the issuers and the underwriters to broaden the bar order to include a mutual bar of contractual indemnity claims.
The court will schedule a fairness hearing on the proposed settlement and subsequently will decide whether to grant final approval to the settlement agreement. The settlement agreement is subject to the approval of the
GigaMedia IPO for reimbursement for all cost, expenses, losses and/or damages incurredDistrict Court.
b. In November 1999, GigaMedia issued a warrant to Microsoft Corporation (Microsoft) in connection with a share purchase and business cooperation agreement. In September 2004, Microsoft returned the warrant unexercised.
c. In 2001, GigaMedia entered into a three-year agreement with EMI to establish GigaMusic, which is registered in the Cayman Islands. The Company invested $7 million in GigaMusic during 2001. The Company held 95% of the total shares; EMI held 5% of the total shares in exchange for:
* EMI providing access to EMI management expertise and industry know-how;
* EMI providing content; and
* EMI granting licenses and rights (non-exclusive and non-transferable) to GigaMusic to use EMI’s licensed products and artists, including streaming EMI’s licensed samples, displaying EMI’s licensed materials, previews of newly released licensed recordings, and promotional downloads of licensed recordings. The total value of the 5% shares granted to EMI amounted to $368 thousand and was recorded as an intangible asset. In addition to the 5% ownership of GigaMusic, the Company paid EMI non-recoupable fees of $1 million in June 2001 and March 2002, respectively, which were recorded as other assets. The Company was required to pay an additional payment of $1 million in March 2003 in accordance with the terms of the agreement. However, in March 2002, the Company sent a notice to EMI to terminate the agreement. The notice also required EMI to return its ownership interest in GigaMusic and the cumulative amount of $2 million paid in separate installments June 2001 and March 2002 by the
Company in connection with such lawsuit. Accordingly, asCompany.As of December 31, 2002,
management believes that the potential liability, if any, will be covered by the insurance policy, and hencethe Companyhas not recorded any provision related to these claims. 20. CONCENTRATION OF RISKS Concentrationperformed an impairment test ofCredit Risk The Company's on-line business provides Internet access and on-line content services over F-44GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE)theInternet to customers located in various cities in Taiwan. The Company requires a security deposit from those customers who lease cable modems for potential damages to the cable modemEMI intangible asset as well asuncollected monthly charges at termination, but generally doesthe cumulative amount of $2 million in payment. Due to the fact that EMI had notperform credit evaluations of its customers. Asprovided theCompany's off-line business requires cash or credit card payments atagreed-upon products to GigaMusic, thepoint of sale. Accordingly,site had not been launched and no subscriber revenue had been generated from theCompany's exposure to credit risk of its off-line business is considered remote. Noneproject, the fair value of theCompany's customers accounted for over 10%intangible asset and the cumulative amount ofnet operating revenues$2 million in2002 orpayment was considered negligible. The Company therefore wrote down the balance ofnotesthese assets andaccounts receivable asrecorded an impairment loss of $2.3 million in the current year’s operational results.On March 28, 2003, the Company obtained a preliminary injunction order from Taipei District Court on the additional $1 million scheduled for payment to EMI. The Company commenced arbitration proceedings by submitting a Notice of Arbitration to the Singapore International Arbitration Center to resolve the disputes in connection with the strategic agreement entered into by the Company, GigaMusic, and EMI.
On December 31,
2002. Cash Risk2003, the Company and GigaMusic and EMI signed a final settlement agreement and release (the Settlement Agreement) to resolve and settle all disputes relating to this litigation. Under the Settlement Agreement, the Company agreed to pay EMI the sum of $400 thousand, and EMI agreed to return to the Company 5% ownership in GigaMusic and a letter of credit issued to EMI in accordance with the previous agreement. TheCompany maintains cash, cash equivalentsparties agreed to finally andshort-termforever settle andlong-term investmentsrelease each other from any and all claims arising out of or in connection withvarious financial institutions, majority of which are located in Taiwan.this matter. TheCompany's policy is designedSettlement Agreement became effective on February 25, 2004 pursuant tolimit exposure to any one institution. The Company performs periodic evaluations of the relative credit standing of those financial institutions that are considereda resolution approved in theCompany's investment strategy.Company’s board of directors’ meeting.The
Company has not sustained material credit losses from instruments held in financial institutions. Concentrationconsideration ofExchange Rate Risk The exchange rate risk$400 thousand paid to EMI consisted ofthe Company's on-line business is mainly derived from purchases of cable modems from internationally reputable vendors with US dollar-denominated pricing and payments for professional fees and commission expenses denominated in US dollars. Fluctuations in exchange rates between the US dollar and the NT dollar will subject the Company to exchange rate risk. The Company's off-line business purchases inventories from vendors in Taiwan. The purchases are denominated in NT dollars. Hence, the Company does not have exposure to exchange rate risk for off-line business. F-45GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) All of the Company's operations are located in Taiwan and all of its sales are denominated in NT dollars. Accordingly, the Company does net have exposure to exchange rate risk from its sales transactions.two components:
(i) The payment for obtaining 5% ownership in GigaMusic, which was $238 thousand based on the fair value of GigaMusic’s net assets as of December 31, 2003; and
(ii) The payment to EMI to return the letter of credit, which payment was estimated to be $162 thousand and was expensed in 2003.
d. In March 2004, the landlord of the premises of one of the Company’s retail music stores filed a lawsuit in the District Court of Panchiao, Taipei County against the Company. The complaint alleged that the Company defaulted on monthly rental payments under the lease agreement and also breached the covenant against subletting the premises. The complaint claimed that the landlord had suffered damages amounting potentially to $150 thousand plus back-rent at $5,986 per month since February 1, 2004. The Company negotiated with the landlord about the terms and conditions for a settlement during 2004 and, at the same time, accrued $173 thousand as provision for the rental lawsuit. As of February 2005, the total amount of monetary damage alleged by the landlord was aggregated to $252 thousand. On March 7, 2005, the Company entered into a settlement agreement with the landlord before the court. Pursuant to the settlement agreement, the landlord agreed to reduce the claim amount to $202 thousand and release the Company from the lawsuit, provided that the settlement fund was received by the landlord before March 31, 2005. The Company has remitted the settlement fund to landlord on the due date and settled the lawsuit. NOTE
21.22. SEGMENT INFORMATIONSegment data
Prior to 2002, the Company managed its business and measured results based on a single Internet-related service industry segment. Due to the acquisitions of Rose Records and Tachung Records
commencing fromin 2002 and the acquisition of CESL in April 2004, the Company hastwothree reportable segments:on-linea broadband ISP business segment; a music distribution business segment; and an entertainmentsegment and off-line entertainmentsoftware business segment.On-line entertainmentThe broadband ISP business segment mainly derivesitits revenues from Internet-related services, including (1)internetInternet access, (2) salesrental and installationof cable modems,(3) web development,and(4)(3) advertising andothers. Off-line entertainmentother services. The music distribution business segment mainlyderivedderives its revenues from the sales of compactdisc,audio discs, video compactdisc,discs, digital versatiledisc,discs, audio andvideo cassettes,videocassettes, and related accessories from its50directly-owned stores in Taiwan. TheCompany'sentertainment software business segment mainly derives its revenues from on-line games of chance and skill.The Company’s management relies on an internal management reporting process that provides revenue and segment information for making financial decisions and allocating resources. The results are based on the
Company'sCompany’s method of internal reporting and are not necessarily in conformity with accounting principles generally accepted in theUnited States of America.U.S. Management measures the performance of each segment based on several metrics, including income or loss from operations. The entertainment software business segment includes the financial conditions and results of CESL and the operations of UIM, which was consolidated as a result of applying FIN 46(R). (See Note 3, “Variable Interest Entity,” to the Consolidated Financial Statements included herein.) CESL develops, licenses and provides support services for software used within the on-line entertainment industry. UIM operates on-line entertainment activities. Revenues from the entertainment software business segment are derived from on-line games of chance and skill and are presented net of end-user winnings.Financial information for each reportable segment was as follows as of and for the
year ended December 31, 2002: F-46GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE)
On-line Segment Off-line Segment Total --------------- ---------------- ---------------- NT$ NT$ NT$2002: SEGMENT PROFIT OR LOSS: Net revenue from external customers $ 665,656 $ 1,890,153 $ 2,555,809 =============== ================ ================ Loss from operations ($ 455,595) ($ 340,839) ($ 796,434) =============== ================ ================ Interest income $ 17,940 $ 3,894 $ 21,834 =============== ================ ================ Interest expenses $ - ($ 1,392) ($ 1,392) =============== ================ ================ Depreciation ($ 166,373) ($ 29,973) ($ 196,346) =============== ================ ================ Amortization, including intangible assets ($ 75,994) ($ 21,465) ($ 97,459) =============== ================ ================ Income tax benefit $ 4,383 $ - $ 4,383 =============== ================ ================ Impairment loss on goodwill and intangible assets ($ 80,627) ($ 242,938) ($ 323,565) =============== ================ ================ SEGMENT ASSETS: Additions to property, plant and equipment, net $ 89,060 $ 215,681 $ 304,741 =============== ================ ================ Additions to intangible assets $ 35,110 $ 257,726 $ 292,836 =============== ================ ================ Additions to goodwill $ - $ 268,327 $ 268,327 =============== ================ ================ Total assets $ 2,508,511 $ 1,201,854 $ 3,710,365 =============== ================ ================For theyears ended December 31,20002002, 2003 and2001, the Company only has one reportable segment. Accordingly, all assets, liabilities and operating results of the Company were attributed to on-line entertainment segment.2004:
(in US$ thousands)
Broadband
ISPMusic
DistributionEntertainment
SoftwareTotal 2002: Segment profit or loss: Net revenue from external customers
$ 19,267 $ 54,709 $ — $ 73,976 Impairment loss on goodwill and intangible assets
$ 2,334 $ 7,031 $ — $ 9,365 Loss from operations
$ 13,187 $ 9,865 $ — $ 23,052 Interest income
$ 519 $ 113 $ — $ 632 Interest expenses
$ — $ 40 $ — $ 40 Gain on sales of marketable securities
$ 2,273 $ 3 $ — $ 2,276 Foreign exchange gain (loss)
$ 294 $ (27 ) $ — $ 267 Depreciation
$ 4,816 $ 867 $ — $ 5,683 Amortization, including intangible assets
$ 2,200 $ 621 $ — $ 2,821 Income tax benefit
$ 127 $ — $ — $ 127 Segment assets: Additions to property, plant and equipment
$ 2,563 $ 6,207 $ — $ 8,770 Additions to intangible assets
$ 1,010 $ 7,417 $ — $ 8,427 Additions to goodwill
$ — $ 7,722 $ — $ 7,722 Total assets
$ 72,187 $ 34,586 $ — $ 106,773 (in US$ thousands)
Broadband
ISPMusic
DistributionEntertainment
SoftwareTotal 2003: Segment profit or loss: Net revenue from external customers
$ 19,513 $ 75,839 $ — $ 95,352 Impairment loss on property, plant and equipment
$ 1,557 $ — $ — $ 1,557 Impairment loss on goodwill
$ — $ 738 $ — $ 738 Loss from operations
$ 5,490 $ 7,079 $ — $ 12,569 Interest income
$ 227 $ 72 $ — $ 299 Interest expenses
$ — $ 36 $ — $ 36 Gain on sales of marketable securities
$ 488 $ — $ — $ 488 Foreign exchange gain (loss)
$ (362 ) $ (86 ) $ — $ (448 ) Depreciation
$ 4,633 $ 607 $ — $ 5,240 Amortization, including intangible assets
$ 1,253 $ 976 $ — $ 2,229 Income tax expenses
$ 139 $ 3 $ — $ 142 Segment assets: Additions to property, plant and equipment
$ 1,724 $ 213 $ — $ 1,937 Total assets
$ 70,451 $ 25,396 $ — $ 95,847
(in US$ thousands)
Broadband
ISPMusic
DistributionEntertainment
SoftwareTotal 2004:
Segment profit or loss:
Net revenue from external customers
$ 21,390 $ 66,975 $ 11,454 $ 99,819 Income from operations
$ 959 $ 542 $ 2,777 $ 4,278 Interest income
$ 45 $ 30 $ 6 $ 81 Interest expenses
$ — $ 2 $ 4 $ 6 Gain on sales of marketable securities
$ 1,222 $ — $ — $ 1,222 Foreign exchange gain (loss)
$ 533 $ (131 ) $ 8 $ 410 Other-than-temporary loss on marketable securities
$ (1,833 ) $ — $ — $ (1,833 ) Depreciation
$ 3,895 $ 507 $ 267 $ 4,669 Amortization, including intangible assets
$ 1,060 $ 964 $ 521 $ 2,545 Income tax expenses ( benefit )
$ — $ 5 $ (87 ) $ (82 ) Segment assets:
Additions to property, plant and equipment
$ 1,866 $ 568 $ 567 $ 3,001 Additions to intangible assets
$ — $ — $ 3,327 $ 3,327 Additions to goodwill
$ — $ — $ 29,607 $ 29,607 Total assets
$ 29,861 $ 24,300 $ 38,476 $ 92,637 The
reconciliationreconciliations of segment information to GigaMedia consolidated totalswaswere asfollows for the year ended December 31, 2002: F-47GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE)follows:
(in US$ thousands)
2002 2003 2004 Income (loss) from operations:
Total segments
$ (23,052 ) $ (12,663 ) $ 4,278 Adjustment*
(820 ) (1,508 ) (1,262 ) Total GigaMedia consolidated
$ (23,872 ) $ (14,171 ) $ 3,016 Interest income:
Total segments
$ 632 $ 299 $ 81 Corporate and unallocated Interest income
378 120 89 Total GigaMedia consolidated
$ 1,010 $ 419 $ 170 Gains on sales of marketable securities:
Total segments
2,276 488 1,222 Adjustments**
1,040 — 8 Total GigaMedia consolidated
3,316 488 1,230 Foreign exchange gains (loss):
Total segments
267 (448 ) 410 Adjustments**
2,452 (275 ) (1,306 ) Total GigaMedia consolidated
2,719 (723 ) (896 ) Income tax benefit:
Total segments
127 (142 ) 82 Adjustments**
— — (3 ) Total GigaMedia consolidated
127 (142 ) 79 2002 2003 2004 Total assets:
Total segments
$ 106,773 $ 95,847 $ 92,637 Adjustment**
28,365 23,945 33,340 Total GigaMedia consolidated
$ 135,138 $ 119,792 $ 125,977
2002 -------------- NT$LOSS FROM OPERATIONS: Total segments ($ 796,434) Corporate and unallocated* Adjustment items include corporate costs and expenses (28,315) -------------- Total GigaMedia consolidated ($ 824,749) ============== INTEREST INCOME: Total segments $ 21,834 Corporate and unallocated interest income 13,071 -------------- Total GigaMedia consolidated $ 34,905 ============== TOTAL ASSETS: Total segments $ 3,710,365 Corporate and unallocatednot attributable to any specific segment.
** Adjustment items include corporate total assets 985,673 -------------- Total GigaMedia consolidated $ 4,696,038 ==============and elimination.Major Customers
No single customer represented 10% or more of
GigaMedia'sGigaMedia’s total net revenues in any period presented.Geographic Information
AllRevenue from unaffiliated customers by geographic region was as follows:
(in US$ thousands) Geographic region/country
2002 2003 2004 Taiwan
$ 73,976 $ 95,352 $ 88,364 Canada
— — 11,455 Net long-lived assets by geographic region was as follows:
(in US$ thousands) December 31, Geographic region
2002 2003 2004 Asia
$ 21,264 $ 15,636 $ 14,672 North America
— — 1,309 Europe
— — 1,797 Latin America
7,695 6,199 35,257 Total
$ 28,959 $ 21,835 $ 53,035 Note 23.SUBSEQUENT EVENTS
ALFY Settlement Agreement
On February 21, 2005, the Company entered into a final settlement agreement (the Settlement) with Alfy, Inc. (ALFY) to solve royalty payment issues arising from certain agreements, including a development agreement and license, dated January 29, 2001 and an amendment to the development agreement and license, dated September 25, 2001 (together referred to as the License Agreements). Pursuant to the final Settlement, ALFY agreed to early termination of the
Company's operations are located in TaiwanLicense Agreements andits revenues are all derivedto reduce the total minimum guaranteed royalty payment to $100 thousand. Revenue produced fromcustomers located in Taiwan. Accordingly,licensed ALFY content significantly decreased after 2002, and the cost to localize, maintain, and update the licensed ALFY content site became burdensome to the Company. By entering into the final settlement agreement, the Companyis not applicable to disclose the geographic information in any period presented. NOTE 22. SUBSEQUENT EVENTS a. Management buyout proposal On March 21, 2003, the Company's management group, comprised of all seven senior officers of the Company, made an offer to the Company's board of directors to purchase all of the shares of the Company for US$1.20 dollars per share. F-48GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) The proposed management buy-out would be implemented pursuant to a scheme of arrangement as provided under Singapore laweliminated future minimum guaranteed royalty payments andis contingent upon certain conditions as specified in the offer letter, including the ability of the management team to secure funding. GigaMedia's board of directors has formed a special committee to review the offer made by GigaMedia management. b. Litigation with EMI On March 28, 2003, the Company commenced arbitration proceedings by submitting a Notice of Arbitration to the Singapore International Arbitration Center (the "SIAC") to resolve the disputes in connection with the strategic agreement entered into by the Company, GigaMusic.com, and EMI. In the Notice of Arbitration, the Company sought the following relief: (a) An order that EMI return to the Company a Share Certificate, issued by GigaMusic.com, representing 50,000 shares, or 5% ownership, of GigaMusic.com; (b) An order that EMI pay the Company the sum of US$2 million dollars; (c) An order that EMI be restrained from presenting the letter of credit of US$1 million dollars to ABN AMRO Bank N.V. Taipei, Taiwan and from withdrawing another US$1 million dollars and that EMI return this letter of credit to the Company; (d) An order that EMI pay the Company damages, which are to be assessed, for EMI's breach of contract; (e) An order that EMI pay the Company's legal costs and expenses of, and incidental to, the arbitration including but not limited to all fees paid and/or payable to the arbitrator and the SIAC; and (f) Any such further or other relief that the arbitrator should deem fit or just in the circumstances. As the Company is still in the initial stage of the arbitration and EMI's defence and counterclaim, if any, are unknown at this stage, the Company's management cannot provide an accurate evaluation of the likelihood of a favorable or unfavorable outcome. However, based on the information currently available, management and the Company's attorney believe that the F-49GIGAMEDIA LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (EXPRESSED IN THOUSANDS OF NT DOLLARS, EXCEPT AS INDICATED OTHERWISE) Company has a good stand for making the claim. c. Notes receivable from officer In accordance with the terms of the loan agreement entered into with the Company's CEO as mentioned in Note 17, when the loan is due on May 1, 2003, upon the request of the borrower and after engaging a new loan agreement, the loan can be renewed for two year. However, in order to comply with related regulations, the loan has not been renewed and, as a result, the Company has commenced actions to seek prompt repayment of such loan from the borrower. F-50maintenance costs.F-37