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, ~~2004~~

2006

Commission File Number: 000-30540

GIGAMEDIA LIMITED

(Exact name of registrant as specified in its charter)

REPUBLIC OF SINGAPORE

(Jurisdiction of incorporation or organization)

14^th14th Floor, 122 TUNHWA NORTH ROAD, TAIPEI, TAIWAN, R.O.C.

(Address of principal executive offices)

Registrant’s telephone number, including area code

~~886-2-8770-7966~~

886-2- 8770-7966

Securities registered or to be registered pursuant to Section 12(b) of the Exchange Act:

~~None~~


Title of Each Class		Name of Each Exchange on Which Registered

Ordinary Shares		The NASDAQ Stock Market LLC

Securities registered or to be registered pursuant to Section 12(g) of the Exchange Act:

~~Ordinary shares, par value NT$10 per share~~

None

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’s classes of capital or common stock as of the close of the period covered by the annual report:

~~50,154,000~~

51,495,156 ordinary shares ~~par value NT$10 per share.~~

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yeso

Noþ

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Yeso Noþ

Note — Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.

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:~~days. Yesxþ Noo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer¨o

Accelerated filerþ Non-accelerated filero

Indicate by check mark which financial statement item the ~~Registrant~~registrant has elected to follow. oItem 17þ¨ Item 18

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).xo Yesþ

TABLE OF CONTENTS


			~~Page~~
~~PART I~~
~~ITEM 1.~~	Page
PART I		2
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS	3	2
ITEM 2.	OFFER STATISTICS AND EXPECTED TIMETABLE		3	2
ITEM 3. KEY INFORMATION	~~KEY INFORMATION~~	2		3
ITEM 4.	INFORMATION ON THE COMPANY		13	20
ITEM 5. 4A. UNRESOLVED STAFF COMMENTS		44
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS	26	44
ITEM 6.	DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES		38	70
ITEM 7.	MAJOR SHAREHOLDERS AND ~~RELATED PARTY~~RELATED-PARTY TRANSACTIONS		43	76
ITEM 8. FINANCIAL INFORMATION	~~FINANCIAL INFORMATION~~	76		44
ITEM 9.	THE OFFER AND LISTING		46	78
ITEM 10. ADDITIONAL INFORMATION	~~ADDITIONAL INFORMATION~~	80		47
ITEM 11.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		55	93
ITEM 12.	DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES		56

~~PART II~~				93
~~ITEM 13.~~ PART II		93
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES	57	93
ITEM 14.	MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS		57	94
ITEM 15.	CONTROLS AND PROCEDURES		57	94
ITEM ~~16A.~~ 16. [RESERVED]		95
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT	58	95
ITEM 16B.	CODE OF ETHICS		58	95
ITEM 16C.	PRINCIPAL ACCOUNTANT FEES AND SERVICES		58	96
ITEM 16D.	EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES		59	96
ITEM 16E.	PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS		59

~~PART III~~				96
~~ITEM 17.~~ PART III		97
ITEM 17. FINANCIAL STATEMENTS	59	97
ITEM 18. FINANCIAL STATEMENTS		97
~~FINANCIAL STATEMENTS~~ITEM 19. EXHIBITS	59	97
~~ITEM 19.~~ SIGNATURE	~~EXHIBITS~~	100
60EX-1.3 AMENDED MEMORANDUM AND ARTICLES OF ASSOCIATION OF GIGAMEDIA LIMITED
					EX-4.42 AMENDED AND RESTATED SHAREHOLDERS' AGREEMENT
~~SIGNATURE~~EX-4.43 SHARE PURCHASE AGREEMENT
EX-4.44 SHARE PURCHASE AGREEMENT
63EX-4.45 SHARE PURCHASE AGREEMENT
EX-4.46 SHARE PURCHASE AGREEMENT
EX-4.47 SUBSCRIPTION AGREEMENT
EX-4.48 TERMINATION AGREEMENT
EX-4.49 LICENSE AND DISTRIBUTION AGREEMENT
EX-4.50 THIRD AMENDMENT TO LICENSE AGREEMENT
EX-4.51 SHAREHOLDERS' AGREEMENT DEC 7, 2006
EX-4.52 SHAREHOLDERS' AGREEMENT DATED FEB 2, 2007
EX-12.1 CERTIFICATION BY CEO
EX-12.2 CERTIFICATION BY CFO
EX-13.1 CERTIFICATION BY CEO
EX-13.2 CERTIFICATION BY CFO
EX-15.1 CONSENT OF PRICEWATERHOUSECOOPERS
EX-15.2 CONSENT OF GHP HORWATH

USE OF CERTAIN TERMS

In this annual report, all references to (i) ~~“we”, “us”, “our”,~~“we,” “us,” “our,” “our Company” or “GigaMedia” are to GigaMedia Limited and, unless the context requires otherwise, its subsidiaries, (ii) “Shares” are to ordinary shares of our Company, ~~par value NT$10,~~ (iii) “CESL” are to Cambridge Entertainment Software Limited (previously known as Grand Virtual International Limited), a company incorporated under the laws of the British Virgin Islands, ~~and~~ (iv) “Hoshin GigaMedia” are to Hoshin GigaMedia Center Inc., a company incorporated under the laws of Taiwan, Republic of China, ~~or ROC.~~(“R.O.C.”), (v) “FunTown” are to our online games business operated through Hoshin GigaMedia and FunTown World Limited, a company incorporated under the laws of the British Virgin Islands, and (vi) “T2CN” are to T2CN Holding Limited, a company incorporated under the laws of the British Virgin Islands. All references in this annual report to “U.S. ~~dollar”,~~dollar,” “$” and “US$” are to United States dollars and all references to “NT dollar” and “NT$” are to New Taiwan dollars.

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

This annual report contains forward-looking statements that involve risks and uncertainties. These statements include certain projections and business trends that are “forward-looking” within the meaning of the U.S. Private Securities Litigation Reform Act 1995. These statements are generally indicated by the use of forward-looking

terminology such as ~~“believe”, “expect”, “anticipate”, “estimate”, “plan”, “project”, “may”,~~“believe,” “expect,” “anticipate,” “estimate,” “plan,” “project,” “may,” “will” or other similar ~~words.~~words, and include, among others, the following statements:

	•		We believe that our cross-marketing relationships with certain well-known companies will increase the recognition of our online game brands.

	•		To cope with competition, we aim to develop new features and services that we think our players will pay for and enjoy.

	•		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; and

	•		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 2007.

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.~~report, including those described under Item 3D, “Risk Factors” and those detailed from time to time in other filings with the U.S. Securities and Exchange Commission (the “Commission”). We undertake no obligation to ~~release publicly any versions to~~update or revise any forward-looking statements to reflect events or circumstances after the date of this annual report or to reflect the occurrence of unanticipated ~~event.~~events. Given this level of uncertainty, you are advised not to place undue reliance on such forward-looking statements.

PART I

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

Our consolidated financial statements ~~have~~were historically ~~been~~ reported in New Taiwan dollars. Effective January 1, 2004, we adopted the ~~United States~~U.S. dollar as our reporting currency because operations denominated in ~~the United States dollar have~~U.S. dollars represented an increasing portion of our business following the acquisition of our software licensing and online entertainment ~~software~~ business. Comparative financial information has been recast as if the ~~United States~~U.S. dollar had been used as our reporting currency for the periods ended and as of December 31, 2002 ~~2003~~ and ~~2004.~~
2003.

The financial information for the periods presented has been translated from NT dollars to U.S. dollars 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

2002 2003 2004 2005 2006
Year-end 34.75 33.97 31.71 32.85 32.60
Weighted-average 34.55 34.40 33.41 32.19 32.54

Assets and liabilities inon our balance sheet denominated in non-U.S. dollars are translated into U.S. dollars using year-end exchange rates. Income and expense items in our statement of operations denominated in non-U.S. dollars are translated into U.S. dollars using the ~~weighted average~~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 provided in this annual report, isare translated using ~~weighted average~~

weighted-average exchange rates.
Transactions in 2007 denominated in non-U.S. dollars are translated into U.S. dollars using the year-end exchange rate for 2006.

A. Selected Financial Data

The selected consolidated balance sheet data as of December 31, ~~2003~~2005 and ~~2004~~2006 and the selected consolidated statement of operations data for the years ended December 31, ~~2002, 2003~~2004, 2005 and ~~2004~~2006 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, ~~2000, 2001~~2002, 2003 and ~~2002,~~2004, and the selected consolidated statement of operations data for the years ended December 31, ~~2000~~2002, and ~~2001~~2003 have been derived from our audited consolidated financial statements for the years ended December 31, ~~2000~~2002, 2003 and ~~2001,~~2004, which are not included in this annual report. The audited consolidated financial statements for the years ended December 31, ~~2000~~2002 and ~~2001~~2003 were stated in NT dollars. We have converted certain information in such financial statements into USU.S. 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 Item ~~5—”Operating~~5 — “Operating and Financial Review and Prospects” and the consolidated financial statements and the notes to those statements included elsewhere in this annual report.
The profit and loss statements for the years ended December 31, 2002, 2003, and 2004 have been restated to reflect the results of our music distribution business, which was sold in September 2005, as discontinued operations. Certain prior-year amounts have been reclassified to conform to the current-year presentation. These reclassifications had no effect on the result of operation or shareholders’ equity as previously reported.

For the Years Ended December 31,

(in thousands except for ~~income/~~earnings/loss per share amounts)

2002 2003 2004 2005 2006
US$ US$ US$ US$ US$
STATEMENT OF OPERATIONS DATA:
OPERATING REVENUES
Software licensing and online entertainment revenues 0 0 11,434 22,511 55,019
Online game revenues 0 0 0 0 18,692
Internet access and service revenues 19,144 19,396 21,303 21,589 20,537
Other revenues 122 117 107 87 44

Total operating revenues 19,266 19,513 32,844 44,187 94,292

OPERATING COSTS
Cost of software licensing and online entertainment revenues 0 0 (1,592 ) (3,327 ) (7,824 )
Cost of online game revenues 0 0 0 0 (3,667 )
Cost of Internet access and service revenues (18,947 ) (15,093 ) (13,873 ) (13,568 ) (11,449 )
Cost of other revenues (1,008 ) (1,022 ) (644 ) (488 ) (391 )

Total operating costs (19,955 ) (16,115 ) (16,109 ) (17,383 ) (23,331 )

GROSS PROFIT (689 ) 3,398 16,735 26,804 70,961

OPERATING EXPENSES
Product development and engineering expenses (1,865 ) (1,211 ) (2,513 ) (3,562 ) (5,738 )
Selling and marketing expenses (4,095 ) (2,432 ) (6,310 ) (10,777 ) (30,123 )
General and administrative expenses (4,155 ) (5,162 ) (5,657 ) (7,892 ) (12,421 )
Bad debt expenses (869 ) (128 ) 220 (207 ) (715 )
Impairment loss on intangible assets (2,334 ) 0 0 0 0
Impairment loss on property, plant and equipment 0 (1,557 ) 0 0 0

(13,318 ) (10,490 ) (14,260 ) (22,438 ) (48,997 )

Income (loss) from operations (14,007 ) (7,092 ) 2,475 4,366 21,964

Income (loss) from continuing operations (10,617 ) (9,799 ) 1,253 6,490 30,784

Income (loss) from discontinued operations (7,849 ) (4,296 ) 429 (154 ) 0

Net income (loss) (18,466 ) (14,095 ) 1,682 6,336 30,784

Earnings (loss) per share (in dollars)
Basic:
Income (loss) from continuing operations (0.21 ) (0.20 ) 0.02 0.13 0.60
Income (loss) from discontinued operations (0.16 ) (0.08 ) 0.01 0 0

Net income (loss) (0.37 ) (0.28 ) 0.03 0.13 0.60

Diluted:
Income (loss) from continuing operations (0.21 ) (0.20 ) 0.02 0.12 0.51
Income (loss) from discontinued operations (0.16 ) (0.08 ) 0.01 0 0

Net income (loss) (0.37 ) (0.28 ) 0.03 0.12 0.51

   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

2002 2003 2004 2005 2006
US$ US$ US$ US$ US$
BALANCE SHEET DATA:
Total current assets 82,812 77,709 67,726 70,204 64,176
Property, plant and equipment-net 21,264 15,636 15,056 10,747 10,098
Goodwill 731 — 29,607 29,243 55,187
Intangible assets-net 6,964 6,199 8,372 2,704 23,067
Total assets 135,138 119,792 125,977 113,519 182,619
Total shareholders’ equity (net assets) 104,169 90,363 95,971 100,648 134,087
Common shares, no par value, and additional paid-in capital 239,004 239,004 287,657 287,920 289,495
Number of issued shares (basic, in thousands) 50,154 50,154 50,154 50,344 51,495
Dividend declared per share (in dollars) 0 0 0 0 0
Presentation of financial information for the financial years ended December 31, 2002 to December 31, 2005 has been reclassified to conform with the current year presentation for the year ended December 31, 2006.
B. Capitalization and Indebtedness
Not applicable.
C. Reasons for the Offer and Use of Proceeds
Not applicable.
D. Risk Factors
~~We have a history of losses and cannot assure you that we will not incur substantial losses in future periods~~
~~We 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.~~
Risks Related to Our history of losses was a result of the substantial costs we incurred in operating our broadband Internet access services and music distribution business and the decrease in revenues from our music distribution business. Business
Our limited operating history as an software licensing and ~~market conditions~~online entertainment provider and an online games operator, and the unproven long-term potential of those business models make ~~predicting~~evaluating our ~~results~~business and prospects difficult
     We acquired our software licensing and online entertainment business, CESL, in April 2004 and our online games business, comprised of ~~operations difficult,~~the game platforms of FunTown and ~~we may incur substantial losses~~T2CN, in January 2006 and June 2007, respectively. We launched new poker software products in 2004, which generated approximately 2 percent, 18 percent and 56 percent of total software licensing and online entertainment revenues in 2004, 2005 and 2006, respectively. In addition, the ~~future.~~
~~We may have operating losses in the future and we may not be able to sustain net profitability due to several factors, including:~~
~~declines in revenues from our music distribution business;~~
~~increased selling and marketing expenses;~~
~~further decreases in the value~~senior management teams of our ~~prior investments, including~~different businesses and our ~~entertainment software business and marketable securities;~~
~~additional acquisition activities related to the growth and development~~employees have worked together at our Company for only a relatively short period of ~~our entertainment software business;~~time.
~~greater levels of product development expenses;~~
~~potential or actual loss of key clients and business partners;~~
~~our potential decision to exit current low-margin businesses, which if taken will cause revenues to decline; and~~
~~our potential decision to discontinue certain products and services or 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.~~     As a result, we wrote off goodwill associated with the music distribution business in the amount of US$7.0 million in 2002 and US$738 thousand in 2003, which reduced our profitability in 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. Any write-off of goodwill in the future may have a ~~negative impact on~~limited relevant operating history as a software licensing and online entertainment developer and an online games operator for you to evaluate. It is also difficult to evaluate our prospective business, because we may not have sufficient experience to address the risks frequently encountered by companies using new and unproven business models and entering new and rapidly evolving markets, including the online gaming and online games markets. These risks may include our potential failure to:
retain existing customers or attract new customers;
license, develop, or acquire additional online games that are appealing to consumers;
anticipate and adapt to changing consumer preferences;
4
adapt to competitive market conditions;
adapt to regulatory changes;
respond to technological changes or resolve unexpected service interruptions in a timely manner;
adequately and efficiently operate, upgrade and develop our transaction and service platforms; or
maintain adequate control of our expenses.
If we are unsuccessful in addressing any of the risks listed above, our business and financial ~~results.~~
condition will be adversely affected.
Our 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 additional competition from ~~additional~~ potential competitors, including ~~competitors~~those with:
significantly greater technological, financial, sales and marketing resources;
larger customer bases and longer operating histories;
greater name recognition; and
more established relationships with ~~music label companies, cable~~distribution partners, advertisers, content and application providers and/or other strategic ~~partners~~partners.
Competition in the software licensing and online entertainment business
     The Internet gaming software industry is characterized by rapid technological change and we face significant and intense competition from online gaming software design houses and application service providers. Given the relatively low barriers to entry into the software industry and the increasing popularity of Internet-based businesses, we face a large number of potential competitors from many different segments of software and Internet industries. Traditional entertainment service providers, many of which have financial resources significantly greater than ours, might expand and provide Internet-based entertainment services. Such Internet service providers and other entertainment service providers may also develop and offer the underlying software solutions and tools to others in direct competition with us.
     We are also exposed to competition in the Internet gaming industry through our licensees, such as UIM, as license fees with respect to gaming software provided by us typically include a variable fee based on revenues earned by such licensees from the operation of the licensed software. Our major licensee is Ultra Internet Media, S.A. (“UIM”), a provider of Internet gaming services. Although we do not have any equity ownership interest in UIM, in accordance with FIN 46(R), we consolidate its assets, liabilities and results of operations in our financial statements and are entitled to fees from UIM based upon its revenues. For additional information, see Item 5 — “Operating and Financial Review and Prospects — Certain Significant Events Affecting Our Results of Operations for 2004, 2005 and 2006 — Consolidation of UIM under FIN 46(R)”. Our licensees (including UIM), face strong competition in the online gaming industry.
     Furthermore, some of our competitors and competitors of our licensees (including UIM) are more established, enjoy greater market recognition, are substantially larger and have substantially greater resources and distribution capabilities than we ~~have.~~
~~COMPETITION IN THE MUSIC DISTRIBUTION BUSINESS. Taiwan’s retail music distribution industry~~do. There 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~~we or our licensees (including UIM) will ~~continue to~~ be ~~a viable business, that retail stores will continue to be a primary distribution channel for recorded music, or that we will continue~~able to compete successfully ~~within~~with existing and future competitors, which could have a material adverse effect on our business, financial condition or results of operations. See Item 4 — “Information on the ~~retail music store sector~~Company — Software Licensing and Online Entertainment Business — Competition” for additional information.
5
     Finally, as a result of the Unlawful Internet Gambling Enforcement Act (the “UIGEA”) and subsequent closing of the online gaming market in the United States, we and our licensees (including UIM) face increasing competition from entertainment service providers in our markets in Continental Europe, which are also increasingly subject to regulation from governmental authorities. There is no assurance that we or our licensees (including UIM) will be able to compete successfully with existing and future competitors, which could have a material adverse effect on our business, financial condition or results of operations. See Item 4 — “Information on the ~~retail music~~Company — Software Licensing and Online Entertainment Business — Competition” for additional information.
Competition in the online games business ~~generally.~~
~~COMPETITION IN THE BROADBAND ISP BUSINESS.~~
     Our main competitors in the ~~consumer~~online games business are casual game operators in Taiwan, Hong Kong, the People’s Republic of China (“PRC”) and Macau, or Greater China, including Shanda Interactive Entertainment Ltd. (“Shanda”), Nineyou (Shanghai Everstar Online Entertainment Co., Ltd.), Tencent Holdings Limited, Ourgames.com (Beijing Globalink Computer Technology Co., Ltd.) and Chinagames.net. Our competitors also include massively multi-player online role-playing game operators in Taiwan, including Gamania Digital Entertainment Co., Ltd. (“Gamania”) and Soft-World International Corporation.
     We expect more companies to enter the online games industry in Greater China and a wider range of online games to be introduced to the Greater China market, given the relatively low entry barriers to the online games industry. Our competitors vary in size and include large companies such as Shanda, many of which have significant financial, marketing and game development resources as well as name recognition. We may not be able to devote the same degree of resources to designing, developing or acquiring new games, undertaking extensive marketing campaigns, adopting aggressive pricing policies, paying high compensation to game developers or compensating independent game developers as a number of our competitors may be able to do. We cannot assure you that we will be able to compete successfully against any new or existing competitors.
     In June 2007, we acquired control over a majority of the voting rights of T2CN, an online game operator and distributor in the PRC. There is increasing regulation over the online games industry in the PRC, most notably, the “Opinions on the Development and Management of Online Games” and the “Anti-Internet Addiction Regulations”, which (among other things) regulate the online game products allowed to be distributed and operated in China, and require online game operators to install features to identify online game players and to discourage the playing of online games through limiting the time which players may spend on a game and the game awards which may be made to players which have spent more than a specified consecutive number of hours online.
     As a result of the above, the increased competition we anticipate in the online games industry may reduce the number of our users or growth rate of our user base, reduce the average number of hours played by our users, or cause us to reduce usage fees. All of these competitive factors could have a material adverse effect on our business, financial condition and results of operations.
Competition in the Internet access service business
     Our main competitors in the retail broadband ~~ISP~~Internet service provider (“ISP”) business are fixed-line service providers and other ISPs in Taiwan that offer asymmetrical digital subscriber line ~~or ADSL,~~(“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, which are all ~~Internet service providers.~~ISPs. 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 covered 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~~NCIC’s Sparq 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~~opportunities 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 All 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, whichthese competitive factors could have a material ~~and~~ adverse effect on our business, financial condition or results of operations. ~~See Item 4 — “Information~~In recent years, we have experienced a reduction in the number of our new consumer subscribers and our total consumer subscribers, in line with our ongoing strategy to shift resources away from this legacy business. Consistent with our focus on online entertainment, we have retained financial advisors to explore the sale of this legacy business.
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Our business could suffer if we do not successfully manage current growth and potential future growth
     We are pursuing a number of growth strategies, including leveraging our customer base to develop additional sources of revenues and exploring opportunities to expand into new software licensing and online entertainment business segments. Some of these strategies relate to new services or products for which there are no established markets, or relate to services, products or markets in which we lack experience and expertise. For example, we are currently expanding our online games business to include massively multi-player online role-playing games, or MMORPGs, starting withHellgate:LondonandPhantasy Star Universe, which we have licensed in certain territories and expect to launch in the second half of 2007. We are also expanding our online poker software business into new European markets such as Greece, Poland, Finland and Hungary. We cannot assure you that we will be able to deliver new products or services on a commercially viable basis or in a timely manner, or at all.
     Our growth to date has placed, and our anticipated further expansion of our operations will continue to place, a significant strain on our management, systems and resources. In addition to training and managing our workforce, we will need to continue to develop and improve our financial and management controls and our reporting systems and procedures, including those of acquired businesses. We cannot assure you that we will be able to efficiently or effectively manage the growth of our operations, and any failure to do so may limit our future growth and materially and adversely affect our business, financial condition and results of operations.
Our business strategy, which contemplates growth through acquisitions and strategic investments, exposes us to significant risks
     As a component of our growth strategy, we intend to continue to enhance our business development, including our game content offerings, by acquiring other businesses that complement our current online businesses, or which represent related but new lines of business that we believe to be appropriate areas of expansion, or that we believe may benefit us in terms of user base, product or content offering. We also intend to make selective strategic investments. We will continue to examine the merits, risks and feasibility of potential transactions, and expect to search for additional acquisition opportunities in the future.
     Such search and examination efforts and any related discussions with third parties, may or may not lead to future acquisitions and investments. Our reported financial results may be affected by any such acquisitions and/or investments, including any acquisitions or dispositions undertaken by us in anticipation of or in connection with any such acquisitions and/or investments. Our ability to grow through such acquisitions and investments will depend on the ~~Company — Entertainment Software Business — Competition” for additional information.~~availability of suitable acquisition candidates at an acceptable cost, our ability to reach agreement with acquisition candidates or investee companies on commercially reasonable terms, the availability of financing to complete larger acquisitions or investments and our ability to obtain any required governmental approvals. In addition, the benefits of an acquisition or investment transaction may take considerable time to develop and we cannot assure you that any particular acquisition or investment will produce the intended benefits.
     Furthermore, the identification and completion of any such transaction may require us to expend significant management and other resources, and may require that we expend a significant portion of our cash reserves and/or issue a substantial amount of new equity, which could adversely affect our financial condition and
7
~~Our entertainment software~~
liquidity and result in significant dilution of our shareholders’ interests. The impact of dilution may restrict our ability to consummate further acquisitions. We may also incur debt and losses related to the impairment of goodwill and other intangible assets upon or following the acquisition of another business, ~~has~~which could negatively impact our results of operations. For example, we wrote off goodwill associated with our music distribution business in the amount of US$7.0 million in 2002 and US$0.7 million in 2003, respectively, which reduced our profitability in both years. Any write-off of goodwill in the future may have a ~~sole licensee, and any adverse effect on its business could have an adverse effect~~negative impact on our ~~revenues,~~financial results.
     Additional risks associated with acquisitions include the following:
It may be difficult to assimilate the operations and personnel of an acquired business into our own business;
Management, information, and accounting systems of an acquired business would be different from our current systems and would need to be successfully integrated;
Our management must devote its attention to assimilating the acquired business, which diverts attention from other business concerns;
Suppliers, vendors and/or distributors may renegotiate or cancel contracts with us following the acquisition of a business;
We may enter markets in which we have limited prior experience. For example, in December 2006, we entered into a strategic alliance with Infocomm Asia Holdings Pte Ltd (“Infocomm Asia”), an online gaming operator and distributor operating ~~results~~primarily in the Southeast Asian region and ~~financial condition~~
~~All~~in June 2007, we also acquired control of a majority of the voting rights over T2CN, an online casual sports game operator in China, a business in which we had limited prior experience; and
We may lose some of our ~~revenues from our entertainment software business are derived from UIM, currently sole licensee~~key employees or key employees of an acquired business.
Unauthorized use of our ~~software products,~~intellectual property by third parties, and the ~~results~~expenses incurred in protecting our intellectual property rights, may adversely affect our business
     We regard our copyrights, service marks, trademarks, trade secrets, patents and other intellectual property as critical to our success. Unauthorized use of ~~which have been consolidated into~~the intellectual property, whether owned by us or licensed to us, could adversely affect our ~~financial statements as~~business and reputation.
     We rely on trademark, patent and copyright law, trade secret protection and confidentiality agreements with our employees, customers, business partners and others to protect our intellectual property rights. Despite our precautions, it may be possible for third parties to obtain and use the intellectual property used in our business without authorization.
     The validity, enforceability and scope of protection of intellectual property in Internet-related industries are uncertain and ~~for~~evolving. In particular, the ~~nine months ended December 31, 2004. See Item 5 — “Operating~~laws and ~~Financial Review~~enforcement procedures of Taiwan, Hong Kong, the PRC and ~~Prospects — A. Operating Results — Overview — Consolidation of UIM Under FIN 46(R)” for more details. We~~certain other countries are uncertain or do not ~~own any shares~~protect intellectual property rights to the same extent as do the laws and enforcement procedures of ~~UIM or control its management~~the United States. Moreover, litigation may be necessary in the future to enforce our intellectual property rights. Future litigation could result in substantial costs and ~~hence have no control over its~~diversion of our resources, which could disrupt our business ~~decisions. A decision by UIM to terminate its contract with us or any adverse effect on its business, operating results or financial performance~~and could have a ~~direct~~material adverse effect on our business, ~~operating~~financial condition and results and financial performance. Further, any significant increase in UIM’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.
of operations.
Our results of operations are subject to significant fluctuations ~~which may adversely affect our business and financial results~~
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Our 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. The key factors affecting each of our ~~music distribution business include~~respective businesses include:
Software licensing and online entertainment business: availability of Internet infrastructure, competition from existing and new competitors, the ~~frequency~~revenues, expenses and results of operations of our customer and major licensee, UIM, and the regulatory restrictions applicable to the Internet gaming industry.
Online games business: existing and new competitors, the pace of rollout of new games and price competition in the industry, regulatory and other risks arising in connection with ~~which “hit” music titles are introduced, the seasonality of market demand for~~ our ~~retail music products and our ability to enter into and maintain strategic alliances with major record companies. The main factors affecting our broadband~~ China operations.
Internet access service ~~provider, or ISP, business include~~business: price competition in the Internet access business, the rate at which new customers subscribe to our services, subscriber turnover rates and the 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 Internet gaming industry.services.
     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.
~~Our efforts to improve the performance of our music distribution business may be unsuccessful~~
We 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, CD 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 business associated with home copying and Internet downloading~~
The 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 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 may be substantially diminished by open-access proposals, which would require our exclusive cable partners to grant our competitors access to their systems
We have entered into exclusive agreements with 11 out of 19 of our cable partners granting us the exclusive right to provide services through their cable systems. As per new regulations in Taiwan, our cable partners must obtain leased-circuit licenses to provide 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 cable partners’ cable systems that compete with our services;~~
~~our rights as the exclusive broadband Internet access provider over these cable partners’ systems could be lost; and~~
~~our business, financial condition and results of operations would likely be adversely affected.~~
~~See Item 4 — “Information on the Company — B. Business Overview — Music Distribution Business — Industry Overview” for additional information.~~
The markets for our ~~broadband ISP business and entertainment software business~~principal businesses are characterized by rapid technological ~~changes,~~change, and ~~our inability~~failure to respond quickly and sufficiently to new Internet technologies or standards may have a material adverse effect on our business
The markets for our ~~broadband ISP~~software licensing and online entertainment business, online games business and ~~entertainment software~~Internet access service business are characterized by rapid technological advances, evolving industry standards, changes in user requirements and frequent new service introductions and enhancements.
     The online gaming and online games industries, in particular, are subject to rapid technological change. We need to anticipate the emergence of new technologies and games, assess their acceptance and make appropriate investments accordingly. If we are unable to do so, new technologies in online gaming and online games programming or operations could render our gaming software and online games obsolete or unattractive.
     We use internally developed software systems that support nearly all aspects of our billing and payment transactions in our online games business. All of our businesses may be adversely affected if we are unable to upgrade our systems quickly enough to accommodate future traffic levels, to avoid obsolescence or to successfully integrate any newly developed or acquired technology with our existing systems. Capacity constraints could cause unanticipated system disruptions and slower response times, affecting data transmission and game play. These factors could, among other things, cause us to lose existing or potential customers and existing or potential game developer partners.
     In April 2007, the PRC government issued regulations intended to discourage online game-players from spending excessive amounts of time playing online games. Pursuant to these regulations, Internet game operators have been ordered to install anti-addiction software features on games offered in the PRC by mid-July 2007, which will (among other features) limit the number of points and other benefits which can be awarded to game players after they have been online in excess of specified periods of time. Internet game operators will also be required to adopt real-name registration, which will require online game players to register their real identity information before they will be allowed to play online games. If we cannot adapt our games and software systems to comply with the requirements of these regulations before the stipulated timeframe, the PRC authorities are entitled to order that our non-complying games be shut down.
     The number of consumer subscribers offor our ~~broadband ISP services declined~~Internet access service business decreased from approximately 108,000 in 2002 to approximately ~~95,000~~11,447 in ~~2004.~~2006, and revenues from our Internet access service business declined from approximately US$21.6 million in 2005 to US$20.6 million in 2006, mainly due to a decrease in the number of consumer subscribers and a corresponding decrease in revenues from such customers. If we are unable to effectively use leading technologies, continue to develop our technological expertise, enhance our current services and continue to improve the performance, features and reliability of our products and services, or we are unable to
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respond quickly and sufficiently to new technologies or standards, we may not be able to attract new customers and our business and financial results may be materially and adversely affected.
Our ~~broadband ISP~~software licensing and online entertainment business, online games business, and ~~entertainment software~~Internet access service business depend on the reliability of our network infrastructure, which is subject to physical, technological, security and other risks
The development and operation of our online networks are subject to physical, technological, security and other risks which may result in interruption in service or reduced capacity for customers. These risks include physical damage, power loss, telecommunications failure, capacity limitation, hardware or software failures or defects and breaches of security by computer viruses, break-ins or otherwise. The occurrence of any of these events could result in interruptions, delays or cessation in service to users of our online services, which could have a material adverse effect on our business and operating results. For example, in February 2007, an earthquake off the coast of Taiwan damaged several undersea optic-fiber cables linking countries such as Malaysia, Singapore, Australia, Japan, South Korea, China, the United States and Europe, causing disruptions in Internet traffic worldwide. 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 possible 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. Internet and online service providers have, in the past, 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 be required 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 entertainment software business operates embodies uncertainties that could adversely affect our business and operating results~~
UIM, the sole licensee of our software products and our business 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 our licensee. 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. Due to the uncertainties in the worldwide legal and regulatory environment in which our 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 we operate, or that changes in such laws and regulations, or in their interpretation, will not adversely affect our business and operating results. 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 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 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.
The adoption of new laws or changes to or the application of existing laws relating to Internet commerce may affect the growth of our software licensing and online entertainment ~~software business~~
and online games businesses
In addition to regulations pertaining specifically to online entertainment, we may become subject to a number of laws and regulations that may be adopted with respect to the 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 may be enacted. For example, in order to counter alleged net addiction, in March 2007, the PRC government prohibited the opening of any new cyber-cafes for the rest of 2007, and in April 2007, it issued regulations to discourage online game-players from spending excessive amounts of time playing online games. Pursuant to these regulations, Internet game operators have been ordered to install anti-addiction software features on games offered in the PRC by mid-July 2007, which will (among other features) limit the number of points and other benefits which can be awarded to game players after they have been online in excess of specified periods of time. Internet game operators will also be required to adopt real-name registration, which will require online game players to register their real identity information before they will be allowed to play online games. If we cannot adapt our games and software systems to comply with the requirements of this regulation before the stipulated timeframe, the PRC authorities are entitled to order that non-complying games be shut down.
     Current laws, which predate or are incompatible with Internet commerce, may also be enforced in a manner that restricts the electronic commerce market. In addition, the application of such pre-existing laws regulating communications or commerce in the context of the Internet and electronic commerce is uncertain.
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The adoption of new laws or regulations 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~~the cost of ~~doing~~conducting our business or could otherwise have a material adverse affect on our business, revenues, operating results and financial condition.
The worldwide legal and regulatory environment in which our software licensing and online entertainment business operates is characterized by uncertainties that could adversely affect our business and operating results
     Our software licensing and online entertainment business includes software development and the provision of application services for Internet gaming. We ~~are~~license our gaming software to operators of online gaming businesses and to UIM, which also sub-licenses our software products to third parties. Fees earned by us typically comprise an upfront license fee and a periodic license fee based on the revenues earned from the operation of the licensed software. Each of these businesses is subject to ~~risks associated~~applicable laws and regulations relating to online gaming and electronic commerce in various jurisdictions throughout the world, and it is in many cases uncertain which governments have authority to legislate or regulate different aspects of these industries. Moreover, the Internet gaming industry is still in an early stage of development and the worldwide legal and regulatory environment in which the businesses operate remains highly fluid and subject to change. While most foreign jurisdictions have some form of legal framework applicable to games of chance, few provide clear guidance on how this framework applies to Internet gaming. Issues such as determining the physical location of a gaming event and significant differences among the gaming laws and “Cyberlaws” of various countries all make traditional concepts of jurisdiction and conflicts of 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.
     Due to the uncertainties in the worldwide legal and regulatory environment in which our gaming software business operates and the potential for aggressive legal steps by certain governments to protect online gaming business in their jurisdiction, we cannot assure you that our operations as an application service provider to the gaming industry, or the Internet gaming services provided by our licensees (including UIM), are in compliance with all laws and regulations of the jurisdictions where our ~~entertainment~~gaming software ~~business conducted~~products are used, or that changes in ~~non-U.S. jurisdictions~~
~~All of our revenues is derived from licensing~~such laws and ~~support fees~~regulations, or in ~~non-U.S jurisdictions. We currently provide user interface and end-user support in 16 languages. Our ability to further expand~~their interpretation, will not adversely affect our business and operating results. UIM, our major licensee, currently holds a gaming license issued by the Kahnawake Gaming Commission in Canada. However, certain ~~countries will~~jurisdictions in which UIM operates may require ~~modification of our products, particularly domestic language~~local licensing in the future, and ~~currency support. Once a licensee has posted its gaming site on the Internet, the site is available to users around the world. However,~~ there can be no assurance that weit will be ~~able~~successful in its efforts to ~~sustain~~obtain a gaming license from these jurisdictions, and that as a result UIM would not face the potential loss of key partners and service providers. Also, the substantial uncertainties in the global regulatory environment relating to online gaming expose us to the risk that regulatory authorities in various jurisdictions will determine that our Company provides online gaming services (rather than only providing software and application services to our licensees) and thus subject our Company to gaming laws and regulations in such jurisdictions.
     In Europe, several countries, led by the United Kingdom, have adopted a clear legal framework for online gaming utilizing licensing and regulation. But in some European countries, in particular where there are state-owned gaming monopolies, primarily related to lotteries and online sports betting, governments have taken action or ~~increase revenues derived~~introduced legislation aimed at banning foreign online gaming operators, which could have a material adverse effect on our licensees and consequently on our Company. For example, the French governmental authorities have passed legislation effective from ~~international operations~~March 2007, prohibiting operators other than certain specified state-owned enterprises from operating Internet gaming sites in France. Additionally, advertising restrictions have been placed on the promotion of online gaming sites with effect from September 2007, and the proposed implementation of the legislation also requires warnings to be placed on online gaming sites. In addition, new banking restrictions have been adopted, which require financial institutions with electronic payment systems to identify and block restricted transactions. As of June 15, 2007, regulations required to implement these laws and the banking restrictions have not been adopted.
     Such actions have generally been declared in violation of European Union ("EU") law which governs the EU and its 27 member nations. According to rulings by both the EU Commissioner of Internal Markets and the European Court of Justice, such actions by member nations are illegal violations of the freedom to provide services and of establishment as protected by the Treaty of the European Union.
     There can be no assurance, however, that the rulings of the European Commission or ~~that we~~the European Court of Justice will be ~~able~~enforced in a timely manner without disruption to ~~penetrate linguistic, cultural or other barriers to new foreign markets.~~the business of our licensees (including UIM).
11
~~In addition to uncertainty regarding the local legal status of Internet gaming in other jurisdictions, there~~
Our business is international and therefore faces associated risks
     There are certain difficulties and inherent risks faced by our ~~subsidiary, CESL,~~licensees (including UIM), in doing business internationally, including the burden of complying with multiple and conflicting 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 the political and economic stability, regulatory and taxation structures, and the interpretation thereof, ofin jurisdictions in which we or our ~~subsidiaries~~licensees operate, and in which our ~~licensee’s~~licensees’ customers are located could have a material adverse effect on our business, revenues, operating results and financial condition.
Our software licensing and online entertainment business is dependent on one master 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 software licensing and online entertainment business have historically been derived from UIM, our master licensee which sub-licenses our software products to third parties. Although we do not have any ownership interest in UIM, we consolidate its assets, liabilities and results of operations in our financial statements and are entitled to fees from UIM based upon its revenues. We do not control its management and hence have no control over its business decisions. Any adverse effect on UIM’s business, operating results or financial performance could have an adverse effect on our business, operating results and financial performance. In December 2006, we agreed to license certain of our gaming software for use on Web sites to be launched and operated by a subsidiary of the Carmen Media Group.
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~~
grow
Both the Internet entertainment 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 software licensing and online 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 and online gaming will become widespread.
All of ~~our~~the revenues from our software licensing and online entertainment ~~software~~ business to date have been derived from the licensing of our online ~~entertainment~~gaming software and ~~the~~ support of our associated ~~services through our licensing subsidiary.~~services. Our continued success will depend ~~in large part~~largely upon the success of our online ~~entertainment~~gaming 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~~infrastructure and related services provided by third parties
Our electronic commerce product for handling transactions over the Internet relies on ~~ISP~~ISPs to allow ~~our licensee’s~~the customers of licensees 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 onout our business.
For example, in February 2007, an earthquake off the coast of Taiwan damaged several undersea optic-fiber cables linking countries such as Malaysia, Singapore, Australia, Japan, South Korea, China, the United States and Europe, causing disruptions in Internet traffic worldwide.
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~~licensees of our ~~entertainment~~gaming software ~~depends~~depend on credit card transactions for a substantial portion of the deposits or payments by their customers
Our software licensing and online entertainment ~~software~~ business ~~derives~~has historically derived all of its revenues from its ~~licensee.~~major licensee, UIM. A substantial portion of the deposits or payments ~~made~~ to ~~our licensee~~UIM 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,~~licensees operate, our software licensing and online entertainment ~~software~~ business could be materially and adversely affected.
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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
Undetected programming errors or defects in our software, services and ~~application service~~games and the proliferation of cheating programs could materially and adversely affect our software licensing and online entertainment and online games businesses, financial condition and results of operations
     Our software, services and games may contain undetected programming errors or ~~system failures, which~~other defects. These errors or other defects could result in losses to our ~~licensee,~~licensees (in the case of our software licensing and online entertainment business), 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.
     In addition, parties unrelated to us may develop Internet cheating programs that enable our users to acquire superior features for their game characters that they would not have otherwise. Furthermore, certain cheating programs could cause the loss of a character’s superior features acquired by a user. The occurrence of undetected errors or defects in our games, and our failure to discover and disable cheating programs affecting the fairness of our game environment, could disrupt our operations, damage our reputation and detract from the game experience of our users. As a result, such errors, defects and cheating programs could materially and adversely affect our business, financial condition and results of operations.
We could be liable for breaches of security on our Web sites and fraudulent transactions by users of our Web sites
     Currently, a portion of our transactions are conducted through our Web sites and Web sites of UIM, our major licensee. In such transactions, and those conducted on our FunTown platform, secured transmission of confidential information (such as customers’ credit card numbers and expiration dates, personal information and billing addresses) over public networks is essential to maintain consumer confidence. Our current security measures may not be adequate. In addition, we and our licensees may face internal fraud, including potential unauthorized usage of customer credit card information by our employees and those of our licensees. While we have taken steps to prevent this, including the implementation of payment card industry data security standards, these measures may not be adequate. Security breaches could expose us to litigation and possible liability for failing to secure confidential customer information and could harm our or our licensees’ reputation and ability to attract customers.
We face the risks of changing consumer preferences and uncertainty of market acceptance of our new products in our online games business
     Online games are a new and evolving entertainment concept in Asia. The level of demand and market acceptance of our online games is subject to a high degree of uncertainty. Our future operating results will depend on numerous factors beyond our control. These factors include:
the popularity of existing and new online games operated by us;
the introduction of new online games, competing with or replacing our existing online games;
general economic conditions, particularly economic conditions adversely affecting discretionary consumer spending;
changes in customer tastes and preferences;
the availability of other forms of entertainment; and
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critical reviews and public tastes and preferences, all of which change rapidly and cannot be predicted.
     Our ability to plan for product development and distribution and promotional activities will be significantly affected by how well we anticipate and adapt to relatively rapid changes in consumer tastes and preferences. Currently, two of the most popular types of online games in Greater China are online board and card games. However, there is no assurance that these games will continue to be popular in Greater China or that their status as one of the most popular types of online games in Greater China’s online games industry will not be replaced by new and different types of online or other games in the future. A decline in the popularity of online games in general or, in particular, the online board and card games that we operate, as well as in other genres of online games, such as MMORPGs, is likely to adversely affect our business, financial condition and results of operations.
     In addition, we expect that as we introduce new online games, a portion of our existing customers will switch to the new games. If this transfer of players from our existing games exceeds our expectations, we may have to adjust our marketing, pricing and other business plans and, as a result, our growth and profitability could be materially and adversely affected.
We are exposed to risks associated with operating our online games business in the PRC
     In January 2006, we completed our acquisition of FunTown, an online game operator operating in Taiwan, Hong Kong and the PRC. In June 2007, we also acquired control over a majority of the voting rights in T2CN, an online sports game operator. Both FunTown and T2CN operate in the PRC, and are accordingly subject to risks which apply to online games businesses operating in the PRC, which include the following:
the limited use of personal computers in the PRC and the relatively high cost of Internet access with respect to per capita gross domestic product may limit the development of the online games business in the PRC and impede the growth of FunTown and T2CN;
if the PRC government finds that the operating agreements establishing the structure for FunTown or T2CN’s operations in the PRC do not comply with PRC government restrictions on foreign investment in the online game industry, the operating agreements may not be enforced, and FunTown or T2CN could be subject to severe penalties;
our contractual arrangements with T2CN and its shareholders may not be as effective in providing operational control as compared to direct ownership. In addition, these arrangements may be difficult to enforce;
the PRC government has promulgated regulations on investments made by PRC companies and residents in offshore companies and reinvestments in the PRC made by such offshore companies. These measures may have a significant impact on the business and operations of FunTown or T2CN which may be subject to more restrictive governmental supervision;
the laws and regulations governing the online game industry and related businesses in the PRC are developing and subject to future changes. If FunTown, T2CN or any of our subsidiaries which operate in the PRC fail to obtain or maintain all applicable permits and approvals, their, or our, business and operations would be materially and adversely affected;
the PRC government has announced its intention, and has begun, to intensify its regulation of Internet cafes, where online game-players access the Internet and online games. Intensified government regulation of Internet cafes could restrict FunTown or T2CN’s ability to maintain or increase its revenues and expand its customer base;
currently there are no laws or regulations in the PRC governing virtual asset property rights and therefore, it is not clear what liabilities, if any, online game operators may have in respect of virtual assets;
the PRC’s economic, political and social conditions, as well as government policies, could affect FunTown or T2CN’s business;
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uncertainty in the PRC legal system;
restrictions on currency exchange may limit FunTown or T2CN’s ability to utilize its revenues effectively; and
inflation in China could negatively affect the profitability and growth of FunTown or T2CN.
     Our provision of online games and online game-related content on our Web sites in the PRC is subject to various Chinese laws and regulations relating to the telecommunications industry, Internet and online gaming, and is regulated by various government authorities, including the Ministry of Information Industry, the Ministry of Culture, the Administration of Press and Publication and the State Administration of Industry and Commerce. The principal PRC regulations governing the provision of Internet content and online gaming services include (among others) the Telecommunications Regulations (2000), the Administrative Rules for Foreign Investments in Telecommunications Enterprises (2001), the Administrative Measures for Telecommunications Business Operating Licenses (2001), the Tentative Measures for Administration of Internet Culture (2003), the Tentative Measures for the Administration of Internet Publications (2002), the Opinions on the Development and Management of Online Games (2005) and the Anti-Internet Addiction Regulations (2007).
     We may be affected by these regulations, which (among other things) seek to regulate the content of online games and discourage online game players from spending excessive amounts of time playing online games. This may (among other things) reduce the number of our users or the growth rate of our user base or the online games market in the PRC, reduce the average number of hours played by online game players, or cause us to reduce usage fees or other charges in connection with our online games business. In addition, such regulations may require us to incur substantial costs of compliance in modifying or adapting our game software to comply with the regulatory requirements. This may adversely affect our business, financial condition and results of operations.
      PRC regulations also limit foreign equity ownership of companies providing Internet content services, which includes operating online games, to 50 percent of the equity of such company, and prohibit foreign ownership of companies which distribute Internet culture products (which include online game products) and Internet publications within the meaning of the Tentative Measures for Internet Culture Administration (2003) and the Tentative Measures for the Administration of Internet Publications (2002), respectively. Such companies are also required to be licensed under the applicable licensing regulations. FunTown and T2CN are considered foreign or foreign-invested enterprises under PRC law and accordingly are ineligible to apply for the licenses required to operate online games in the PRC or to provide Internet information content, such as online advertising. In order to comply with foreign ownership restrictions, certain PRC entities, which hold the licenses and approvals that are required to operate their respective online games businesses in the PRC, have operated, and are operating, online games businesses in the PRC in accordance with a series of contractual agreements which they entered into with FunTown and T2CN.
     We believe that the ownership structure and the business and operation models of FunTown and T2CN with respect to their contractual arrangements with the respective PRC entities mentioned above comply with all existing PRC laws, rules and regulations. In addition, no consent, approval or license is required under any of the existing laws and regulations of the PRC for the respective ownership structures, businesses and operations of FunTown and T2CN. There are however, substantial uncertainties regarding the interpretation and application of current or future PRC laws and regulations. Accordingly, we cannot assure you that the PRC regulatory authorities will not ultimately take a view contrary to the above. If we, FunTown or T2CN, or any of our subsidiaries with operations in the PRC are found to be in violation of any existing or future PRC laws or regulations, the relevant regulatory authorities would have broad discretion to deal with such violations, including the revocation of the business and operating licenses of FunTown, T2CN or those of the PRC entities which are licensed to operate online games in the PRC, discontinuing or restricting our, FunTown or T2CN’s operations, requiring FunTown or T2CN to restructure their respective ownership structures or operations or taking other regulatory or enforcement actions, including the levying of fines, that could be harmful to our business.
There are no clear laws or regulations governing virtual asset property rights, in particular, in Greater China, and therefore, it is not clear what liabilities, if any, online game operators may have in respect of virtual assets
     In the course of playing online games, some virtual assets, such as special equipment, player experience grades and other features of our users’ game characters, are acquired and accumulated. Such virtual assets can be important to online game players. In practice, virtual assets can be lost for various reasons, often through unauthorized use of users’ IDs by other users and occasionally through data loss caused by delay of network service or by a network crash. Currently there are no clear laws and regulations in governing virtual asset property rights, in particular, in Greater China, where we operate our online games business. In the case
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of a loss of virtual assets, we may be sued by online game players and could be held liable for damages, which may negatively affect our business, financial condition and results of operations.
Failure to achieve and maintain effective internal control could have a material adverse effect on our business, results of operations and the trading price of our Shares
     We are subject to reporting obligations under the U.S. securities laws. The Commission, as required by Section 404 of the Sarbanes-Oxley Act of 2002, has adopted rules requiring public companies to include a report of management on such companies’ internal control over financial reporting in its annual report, which contains an assessment by management of the effectiveness of such company’s internal control over financial reporting. In addition, an independent registered public accounting firm for a public company must attest to and report on management’s assessment of the effectiveness of the company’s internal control over financial reporting. Our annual report does not include an attestation report of a registered public accounting firm regarding internal controls over financial reporting, which is not required to be provided until the filing of our annual report for the financial year ended December 31, 2007.
     Our management conducted an evaluation of the effectiveness of our internal controls over financial reporting and concluded that our internal controls over financial reporting were effective as of December 31, 2006. However, there is no guarantee that we will not have weaknesses in our internal control over financial reporting in the future. If we are unable to successfully address such significant deficiencies in our internal control over financial reporting, our ability to report our financial results on a timely and accurate basis may be adversely affected. In the event that deficiencies that have been or might be identified are not remediated within the required period, we may again determine that we have a material weakness in internal control over financial reporting and, consequently, that our internal control over financial reporting is not effective to ensure that material information relating to our Company and its subsidiaries is made known to our management, including our chief executive officer and chief financial officer, particularly during the period when our periodic reports are being prepared or to provide reasonable assurance that our financial statements are fairly presented in conformity with the accounting principles generally accepted in the United States.
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     Our failure to achieve and maintain effective internal control over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the trading price of our Shares. Furthermore, we may need to incur additional costs and use significant management and other resources in an effort to comply with Section 404 and other requirements of the Sarbanes-Oxley Act going forward.
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;
enhance and expand the range of products and services we offer; and
respond to competitive pressures and perceived opportunities, such as investment, acquisition and international expansion activities.
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 — “Operating and Financial Review and Prospects — B. Liquidity and Capital ~~Resources”.~~
Resources.”
We ~~believe~~depend on our key personnel, and our business and growth prospects may be severely disrupted if we lose their services
     Our future success is heavily dependent upon the continued service of our key executives and other key employees. In particular, we rely on the expertise, experience and leadership ability of our chief executive officer, Arthur Wang, and our chief financial officer, Thomas Hui, in our business operations, and rely on their personal relationships with our employees, the relevant regulatory authorities, and our game and service suppliers. We also rely on a number of key technology officers and staff for the development and operation of our online games. In addition, as we expect to focus increasingly on our online games businesses, we will need to continue attracting and retaining skilled and experienced professionals to maintain our competitiveness.
     If one or more of our key personnel are unable or unwilling to continue in their present positions, we may not be able to easily replace them and may incur additional expenses to recruit and train new personnel. As a result, our business could be severely disrupted, and our financial condition and results of operations could be materially and adversely affected. Furthermore, since our industry is characterized by high demand and intense competition for talent, we may need to offer higher compensation and other benefits in order to attract and retain key personnel in the future. We cannot assure you that we ~~were a passive foreign investment company for~~will be able to attract or retain the ~~taxable year 2004 and~~key personnel that we will need to achieve our business objectives.
We may ~~continue to~~ be classified as a passive foreign investment company for ~~the taxable year 2005.~~U.S. federal income tax purposes. 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,~~Shares
     Although we do not believe ~~that~~ we ~~were a passive foreign investment company for the 2004 taxable year and we may continue to~~should be classified as a passive foreign investment company for the 2007 taxable year, ~~2005.~~no assurances may be given that we will not be classified as a passive foreign investment company in the current or any future taxable year. For a discussion of the factors that will affect whether or not we are classified as a passive foreign investment company, see Item 10 — “Additional Information — E. Taxation — ~~United States~~U.S. Federal Income Tax Considerations ~~For~~for U.S. Holders — Passive Foreign Investment Company ~~Rules”.~~Rules.” If you are a U.S. person holding our ~~shares,~~Shares, (or have held our ~~shares~~Shares during a taxable year in respect of which we were classified as a passive foreign investment company and you continue to hold such ~~shares~~Shares or portion thereof) and we ~~continue to be~~are classified as a passive foreign investment company and you 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 and will require annual reporting. See Item 10 — “Additional Information — E. Taxation — ~~United States~~U.S. Federal Income Tax Considerations ~~For~~for U.S. Holders — Passive Foreign Investment Company ~~Rules”.~~Rules.”
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Fluctuations in the exchange rates between U.S. dollar and other currencies in which we doconduct our business could adversely affect our profitability
~~Our financial results since~~
     Since January 1, 2004, ~~are~~we have reported our financial results in U.S. currency, which is subject to fluctuations in respect of the currencies of the countries in which we operate. The operations of UIM, our ~~entertainment software~~major licensee, are conducted in most major currencies, including U.S. dollars, British ~~pound~~pounds sterling and Euros, and we earn revenues from these sources in such currencies, as well as incurring expenses in U.S. dollars and Canadian dollars. The operations of our online games business are conducted in NT dollars, Hong Kong dollars and Renminbi. Our Internet access service business is conducted mainly in NT dollars. Accordingly, fluctuations in the exchange ~~rate~~rates of world currencies could have a positive or negative effect on ~~the~~our reported ~~results of our entertainment software business.~~results. Given the constantly changing currency exposures and the substantial volatility of currency exchange rates, we cannot predict the effect of exchange rate fluctuations upon future operating results. There can be no assurance that we will not experience currency losses in the future, which could have a material adverse effect on our business, revenues, operating results and financial condition.
~~Our controlling shareholder~~
We are controlled by the Koo family, which has significant influence in determining the outcome of any corporate transaction or other matters submitted to ~~the~~our shareholders for approval, and their interests may conflict with your interests
~~Members~~
     As of June 15, 2007, members of the Koo family ~~currently~~ beneficially ~~own~~owned approximately ~~21.45%~~20.44 percent of our outstanding shares. Accordingly, ~~such~~the members of the Koo family have significant influence in determining the outcome of any corporate transaction or other matters submitted to ~~the~~our 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 consumer spending, political stability as well as the occurrence of natural disasters and epidemics
Our operating results and financial condition, particularly in relation to our ~~music distribution~~software licensing and online entertainment business and our ~~entertainment software~~online games business, are directly dependent upon general economic conditions and levels of consumer spending. 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 the businesses of our customers. Similar 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. Past economic downturns have resulted in lower levels of consumer spending ~~thus~~and have 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,~~cash flows, profitability or financial condition.
There are economic risks associated with doing business in Taiwan, particularly due to the tense relationship between Taiwan and ~~China~~
the PRC
Our principal executive offices, a major portion of our online games business and our ~~operations in respect of our broadband ISP and music distribution businesses~~Internet access service business are located in Taiwan and substantially all of our net revenues in respect of ~~our broadband ISP and music distribution~~these businesses are derived from customers in Taiwan. Taiwan, as part of the Republic of China, has a unique international political status. The ~~People’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 in Taiwan’s affairs. Relations between Taiwan and the PRC and other factors affecting the political or economic conditions of Taiwan could also affect our ~~broadband ISP~~online games and ~~music distribution~~Internet access service businesses.
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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 in Taiwan, which could result in new regulations that may negatively impact our results of operations
Since we hold a sizeable market share of Taiwan’s recorded music retail distribution market, we could be deemed a monopoly by Taiwan’s Fair Trade Commission. This could result in heightened scrutiny
The ability of our music distribution 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.
~~Our subsidiary’s ability~~subsidiaries to distribute dividends to us may be subject to restrictions under the laws of Singapore, Taiwan and ~~Taiwan laws~~
the PRC
We are a holding company, and some of our assets constitute our ownership interests in our subsidiaries in Taiwan, including Hoshin GigaMedia ~~Rose Records~~which owns the Taiwan-based operations of our online games business and ~~Tachung Records.~~our Internet access service business. Accordingly, part of our primary internal sources of funds to meet our cash needs is our share of the dividends, if any, paid by ~~these~~our subsidiaries, including those in Taiwan. The distribution of dividends from these subsidiaries in Taiwan to us is subject to restrictions imposed by ~~Taiwan and Singapore~~the applicable corporate and tax regulations in these countries, which are more fully described in Item 5—5 — “Operating and Financial Review and Prospects — B. Liquidity and Capital Resources — Dividends from Our Subsidiaries in ~~Taiwan”.~~Taiwan.” In addition, although there are currently no foreign exchange control 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.
      In June 2007, we acquired control over a majority of the voting rights in T2CN, an online games operator and distributor which operates its business primarily in the PRC. Accordingly, going forward, we may be subject to further restrictions imposed by PRC corporate, tax and exchange control regulations which are applicable to T2CN and its business.
We 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 rights
Our corporate affairs are governed by our Memorandum and Articles of Association 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~~
Anti-takeover 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, which ~~may~~could adversely affect the price of our ~~shares~~
Shares
There 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 ~~30%~~30 percent or more of our voting shares must extend a takeover offer for the remaining voting shares. A person holding between ~~30%~~30 percent and ~~50%~~50 percent 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 together with parties acting in concert with him acquires additional voting shares in excess of 1%1 percent of the total number of voting shares in any six-month period. These provisions may discourage or prevent transactions that involve an actual or threatened change of control of our Company. This may harm you because ~~a transaction of that kind~~an acquisition bid may allow you to sell your ~~shares~~Shares at a price above the prevailing market price.
You 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.
We 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 software licensing and online entertainment ~~software~~ business. We
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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.
Risks Related to our Shares
The price of our Shares has been volatile historically and may continue to be volatile, which may make it difficult for holders to resell the Shares when desired or at attractive prices
     The trading price of our Shares has been and may continue to be subject to wide fluctuations. In 2006, the sale prices of our Shares on the NASDAQ Global Market have ranged from US$2.90 to US$12.38 per share and the last reported sale price on June 15, 2007 was US$14.66. Our Share price may fluctuate in response to a number of events and factors. In addition, the financial markets in general, and the market prices for Internet-related companies in particular, have experienced extreme volatility that often has been unrelated to the operating performance of such companies. These broad market and industry fluctuations may adversely affect the price of our Shares, regardless of our operating performance.
ITEM 4. INFORMATION ON THE COMPANY
A. History and Development of our Company
Our 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 company registration number is 199905474H. Our principal executive offices are located at 14th Floor, 122 ~~TunHua~~Tunhwa North Road, Taipei 10595, Taiwan, and our telephone number is ~~country/city code 886/2 and number 8770-7966.~~886-2-8770-7966. Our Web site address is: ~~www.giga.net.tw.~~
http://www.gigamedia.com.tw.
Prior to ~~the finalization of our acquisition of Taiwan’s two leading music store chains in February,~~ September ~~and December of~~ 2002, all our operations were conducted primarily through our wholly-owned subsidiary, Hoshin GigaMedia. Hoshin GigaMedia ~~commenced operations in October 1997 and~~ was incorporated in October 1998 in Taiwan. Hoshin GigaMedia, as an unlisted Taiwanese company, could not ~~publicly~~directly offer its shares to investors outside of Taiwan. To enable usit to offer ~~our~~its shares to international investors, ~~we were~~GigaMedia was incorporated in Singapore in September 1999 and acquired ~~99.99%~~99.99 percent of Hoshin GigaMedia in November 1999. In October 2002, weGigaMedia acquired the ~~0.01%~~remaining 0.01 percent of Hoshin ~~GigaMedia we did not own.~~
GigaMedia.
We completed the initial public offering of our ~~shares~~Shares on February ~~24,~~18, 2000. Our ~~shares~~Shares trade on the NASDAQ ~~National~~Global Market under the symbol ~~“GIGM”.~~“GIGM.” We were the first Internet company based in Taiwan to list on the NASDAQ ~~National~~Global Market.
In September 2002, we acquired Rose Records (formerly known as Point Records Co., Ltd.) and Tachung Records (formerly known as Music King Co., Ltd.), ~~Taiwan’s~~ two of the largest music store chains ~~respectively,~~in Taiwan, with a view to expanding our business to retail entertainment services.
     Under new management in 2004, we began to restructure our Company to achieve profitability, generate growth and enhance shareholder value.
In April 2004, we acquired the business and operations of Grand Virtual, Inc. and related affiliates, a privately-held ~~entertainment~~gaming 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.
     In September 2005, we sold all of our ownership interest in the Rose Records and Tachung Records music store chains with a view to eliminating our non-core operations.
     In order to enhance our position in the online entertainment market, in January 2006, we acquired FunTown, an Asian online games business.
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     In April 2006, we entered into a strategic alliance with, and subscribed for 7.5 million convertible voting preferred shares of, T2CN, one of China’s leading online sports game operators. Subsequently, between February 2007 and June 2007, we acquired 18.1 million common shares of T2CN, subscribed for an additional 7.5 million convertible voting preferred shares and entered into a voting trust arrangement with a shareholder of T2CN pursuant to which we acquired control over a further 0.85 million common shares of T2CN. As of June 15, 2007, we own approximately 18.1 million common shares and 15 million convertible voting preferred shares of T2CN, and also control voting rights with respect to 0.85 million common shares of T2CN, which in aggregate represent a controlling interest of 51.12 percent of the total outstanding voting rights of T2CN. The financial results of T2CN will only be consolidated in our financial results for the year ended December 31, 2007.
     In May 2006, we disposed of our ADSL business, which formed a part of our Internet access service business.
     In December 2006, we entered into a strategic alliance with Infocomm Asia, an operator and distributor of online games in Southeast Asia, in connection with which we acquired preferred shares convertible into an interest of approximately 32.26 percent of the issued ordinary shares of Infocomm Asia, which was subsequently diluted in February, 2007 due to Infocomm Asia securing additional equity investors. As of June 15, 2007, convertible preferred shares held by us in Infocomm Asia are convertible into a post-dilution interest of approximately 28.43 percent in the ordinary shares of Infocomm Asia. Upon conversion of the convertible securities held by us, we expect that we will become the largest shareholder of Infocomm Asia.
See ~~Note~~Notes 4 and 5 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”.~~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~~Prospects — B. Liquidity and Capital ~~Resources”.~~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”.~~
Resources.”
B. Business Overview
We are a holding company and, through several subsidiaries, ~~provide broadband Internet access services,~~ develop and license ~~entertainment~~online gaming software and provide application services, own and ~~distribute recorded music.~~operate an online games business, and provide broadband Internet access services. Our software licensing and online entertainment business is operated through our subsidiary CESL. Our Taiwan ~~broadband ISP~~online games business is operated through Hoshin GigaMedia. Our Hong Kong and PRC online games business is operated through T2CN and our subsidiary, FunTown World Limited. Our Taiwan Internet access service businesses are operated through our subsidiary, Hoshin GigaMedia, which focuses on ~~consumer~~retail users, and Hoshin GigaMedia’s subsidiary, Koos Broadband Telecom ~~Limited, or KBT,~~Co., Ltd. (“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 controls Taiwan’s two largest music store chains.
Prior to 2002, our primary business was the ~~provisions~~provision of broadband Internet access services in Taiwan. Since disposing of our music distribution business in 2005 and acquiring ~~Taiwan’s two largest music store chains, Rose Records and Tachung Records, in 2002, and an entertainment~~a gaming software provider in 2004 and an online games business in 2006, we have become a ~~diversified~~major provider of online entertainment ~~services and broadband Internet access~~software services.
We operate our broadband ISP business via our subsidiary Hoshin GigaMedia, which provides Internet access service and broadband content with multiple delivery technologies. Our access products consist of ADSL and cable modem offerings, giving us the ability to deliver broadband connections island-wide. We offer broadband Internet access at speeds of up to 100 times faster than traditional dial-up services. Through our 19 cable system partners, we have access to more than 3.1 million Taiwan households, as well as approximately 417,000 small and medium-sized enterprises, or SMEs. In addition, another of our subsidiary, KBT, provides broadband services to corporate customers. Our broadband ISP business generated revenues of approximately US$21.4 million and operating income of approximately US$1.0 million in 2004.
We acquired our software licensing and online entertainment ~~software~~ business in a private transaction from the founding shareholders of GV Enterprise Voting Trust in April 2004 with a view to enhancing our portfolio of entertainment products. In this transaction, we acquired all the outstanding and issued shares of some of the founding
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shareholder’s subsidiaries, Grand Virtual, Inc., Grand Virtual Limited and Grand Virtual (Alderney) Limited, for an all-cash consideration of US$32.5 ~~million.~~million, excluding related transaction costs. To help ensure a smooth transition and the continued expansion of our software licensing and online entertainment ~~software~~ business in the future, we also retained the experienced management, engineering and operation teams of these companies. Since the acquisition, we have restructured the business and currently operate our software licensing and online entertainment ~~software~~ business through our subsidiary CESL, which develops and provides software solutions through its wholly-owned ~~subsidiaries,~~subsidiary Cambridge Interactive Development Corporation ~~or CIDC,~~(“CIDC”), in Cambridge, MA and in Montreal, Canada, and application services through its wholly-owned subsidiary Internet Media Licensing Limited ~~or IML, software solutions and application services~~(“IML”), for clients operating in the ~~dynamic and rapidly~~ expanding Internet-based entertainment markets worldwide. Our software licensing and online entertainment ~~software~~ business generated revenues of approximately US$~~11.5~~22.5 million and US$55.0 million and operating income of approximately US$~~2.8~~6.0 million ~~during~~and US$16.8 million for the ~~nine months~~years ended December 31, ~~2004.~~
2005 and 2006, respectively.
We ~~operate Taiwan’s two largest music store chains, Rose Records~~acquired FunTown, an online games business, in January 2006 to strengthen our online entertainment business. Founded in 1998, FunTown is one of the leading casual games platforms in Asia, with over 9 million registered users and ~~Tachung Records, through our subsidiary, G-Music. As~~an offering of more than 40 casual games and services in Greater China as of June 15, ~~2005, we operated~~2007. FunTown generates revenues through access fees and also through the sales of various in-game items. FunTown’s games can be played on personal computers, mobile phones and airplane entertainment consoles and are expected to be available on the Xbox 360 in the second half of 2007. FunTown has strong research and development capabilities and has developed over 90 percent of its online casual games in-house. FunTown also provides value-added services, such as tournaments, personal contact lists and social networking to help build a ~~total of 45 stores.~~strong player community. Our estimated market share of the physical music distribution industry in Taiwan in 2004 was over 30%. While seeking to preserve 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 distributiononline games business generated revenues of approximately US$6718.7 million and operating income of approximately US$~~542 thousand~~5.6 million for the year ended December 31, 2006.
     In December 2006, we entered into a strategic alliance with Infocomm Asia, a Southeast Asian online gaming platform offering game titles such asGranado EspadaandHellgate: London, both under exclusive licenses for most of Southeast Asia.
     Between April 2006 and June 2007, we acquired control over approximately 51.12 percent of the voting rights in ~~2004.~~
~~Broadband ISP Business~~
T2CN, an online sports game operators operating mainly in the PRC. T2CN is one of the leading online sports and casual game operators in China and operatesFreeStyle, an online sports game in China. T2CN is currently led by a management team with a strong track record in China’s online game industry, and has close marketing partnerships with international brands such as Coca Cola, Nike and Nokia. The financial results of T2CN will only be consolidated in our financial results for the year ended December 31, 2007.
     We operate our legacy Internet access service business through our subsidiary Hoshin GigaMedia, which provides Internet access services. In 2005, our access products consisted of ADSL and cable modem offerings, giving us the ability to deliver broadband connections island-wide. As of June 2007, we had 26 cable system partners, through which we had access to more than 3.8 million Taiwanese households, as well as approximately 520,000 small and medium-sized enterprises (“SMEs”). In addition, another of our subsidiaries, KBT, provides broadband services to corporate customers. On May 15, 2006, we entered into an asset purchase and sale agreement and a service agreement with Webs-TV Inc. (“Webs-TV”), previously known as Webs-TV Digital International Corporation to sell our ADSL business and provide certain telecom and consulting services on a transitional basis. Our ~~Services~~
~~We provide broadband~~Internet access service business generated revenues of approximately US$20.6 million and operating income of approximately US$4.2 million in 2006. Our ADSL business, which we disposed of in May 2006, generated approximately US$3.0 million in revenues in 2006, which represented approximately 15 percent of our Internet access services ~~to consumer~~revenues and ~~corporate customers through various technologies and products including ADSL, cable modems, leased-line, virtual private network and other value-added services.~~
~~Access Service~~s~~Offerings~~
~~ADSL. GigaMedia’s ADSL services offer different levels of performance from 1Mbps download with 64Kbps upload to 8Mbps download with 640 Kbps upload. The high performance~~approximately 3 percent of our products is designed to better support file sharing, video and other broadband Internet applications. We were the first company in Taiwan to offer ADSL services with a standard fixed IP-address feature, which enables users to build their own multimedia Web sites, participate in online meetings, set up servers and utilize voice-over-IP. As at December 31, 2004, we had 73,800 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 2004consolidated revenues. Consistent 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 25,103 cable modem-based broadband customers as at December 31, 2003.
CORPORATE ACCESS SERVICES. We also 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.
~~Markets of Access Services~~
CONSUMER ACCESS SERVICES. Our two-way cable modem-based broadband service packages are offered at approximately US$35.90 per subscriber per month for premium service; approximately US$25.50 per subscriber per month for a mid-tier package; and approximately US$12.00 per subscriber per month for basic service. We also offer selected subscribers discountsfocus on their monthly access fees and quarterly or yearly payment options to further promote our access services. We recognize our revenues from access fees net of split with cable partners and these discounts. In the future, our product mix may change in response to market dynamics.
During 2004, we offered different tiers of ADSL service options with monthly access fees per subscriber ranging from approximately US$8.90 to approximately US$44.90 for consumer users which have from time to time been revised for promotional purposes, including providing subscribers periods of free Internet access service. Unlike our cable access fees, our ADSL access revenues are not shared.
The number of subscribers of our broadband Internet ISP services continued to decline during 2004. The table below sets forth the number of our subscribers on the dates specified. Despite the decline in the number of our subscribers in 2004, our access revenues increased by 6% for 2004 as compared to that for 2003, primarily because of an increase in revenue from turnkey cable modem services. We do not expect to see significant growth in our subscriber base in 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. KBT offers and sells dedicated and high-speed Internet access to corporate customers over fiber optical Ethernet 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 monthly fees for access services and other value-added services depending on the level of bandwidth and type of services provided.
~~Other Services~~
~~As part of our Internet services we provide various other value-added services including free electronic mail, bulletin boards and photo albums.~~
~~Our Broadband Network — Cable and ADSL Network~~
We began upgrading our island-wide backbone network, which is based primarily on Gigabit Ethernet technologies and covers 20 major districts out of a total 25 districts in Taiwan, from early 2004 and completed the upgrade in early 2005. In addition, we built small regional data centers to host 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 and applications; and~~
~~the provision of a cost-efficient infrastructure to cache data.~~
NETWORK OPERATIONS CENTERS. We provide centralized network management through our network operations centers, which represents the nerve center of our whole network. Our centers use advanced proprietary network management tools and systems to monitor the network infrastructure 24 hours a day, 7 days a week, enabling us to effectively address network problems before they adversely affect our subscribers.
~~Data Backbone~~
Ongoing privatization of the telecommunications market by Taiwan’s government has expanded the number of telecommunications operators. Including Chunghwa Telecom, there are currently four fixed-line telecommunications operators in Taiwan. It is our policy to continually monitor the usage pattern, adjust the network architecture, and select better leased-line circuits providers to optimize the user experience and service economics.
Private peer-to-peer relationships among ISPs (i.e., private direct cable connections as opposed to public Internet connections) 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 with most of Taiwan’s major networks and 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, we had one of the best aggregate peering bandwidth among all commercial organizations in 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 our traffic. This enhances the efficiency of our network and allows us to provide better, faster access services to our subscribers.
Through our peering arrangements with several Internet service providers and networks, we currently connect to Taiwan’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 Internet through a direct trans-Pacific submarine cable 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. In 2005, we completed the upgrade of our infrastructure from STM-1 and STM-4 connections to Gigabit Ethernet-based connections to provide faster connections.
~~Information System~~
We have established a versatile, scalable, real-time information system that integrates service provisioning, customer management, billing, data gathering and usage tracking functions. With independent multiple processing layers, we are able to quickly respond to increases in user, subscriber or service data by expanding our information system’s capacity on demand.
~~Sales And Marketing~~
~~CONSUMER ACCESS SERVICES. We plan to continue utilizing bundled marketing with our strategic partners to minimize costs. 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.~~
Turnkey 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 customer service specialists to provide free consultancy and “turnkey” solutions. We believe that direct sales contact and site visits to existing cable partners and referrals 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 solution, KBT is able to provide corporate 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. 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 subscribers 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 office savings accounts, pre-payment or over-the-counter payment at 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, whileonline entertainment, we have ~~only managed~~retained financial advisers to ~~capture approximately 2%~~explore the sale 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~~this legacy business.
Software Licensing 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 software licensing and online 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 online entertainment markets. CESL offers a wide array of products and services, including online entertainment and social networking. CESL’s software solutions and
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services also offer great expansion capabilities. CESL can help existing and potential 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~~helps existing and potential clients who license our software and services to 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~~modern 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 user interfaces and localization in 16 major languages including English, French, German, Italian, Spanish, Portuguese, Norwegian, Swedish, Danish, Dutch, Greek, ~~Hebrew, Traditional Chinese,~~Finnish, Polish, Hungarian, Simplified Chinese, ~~Japanese~~ and ~~Korean.~~
Japanese.
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~~gaming software products:
Online Entertainment Management— these are tools that enable our existing and potential clients to offer online ~~entertainment~~gaming 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/XPXP/VISTA and feature a realistic 3-D environment, selectable background music, and local language interface. In ~~late~~ 2004 we developed and launched 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~~new suite of software that enables players to compete against each other 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.~~
real time.
Our Services
In addition to licensing our software products to ~~licensee,~~our licensees, including UIM, we offer a variety of application services and consulting services for backend ~~operation.~~operations. These services include:
Infrastructure Design Services — –
Infrastructure Design: Architecture design of servers, routers, firewalls, network software and management tools required for ~~a 24x7~~an Internet property.
Site Creation: Creation and branding of our client’s Internet property, customized to match our ~~licensee’s~~licensees’ unique ~~identity~~identities and creative ~~theme.~~themes.
Transaction Processing Design ~~Service~~Services —–
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~~processes 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.~~issues.
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Platform ~~technical support:~~Technical Support: Consultation during periodic maintenance to update, patch, and fine-tune the system performance of our software solutions.
Custom Gaming Software Development Services —–
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~~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~~
     We have developed expertise as well as necessary infrastructure to make our products suitable for the local markets in which we operate, 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. Ouralong with our in-house teams of ~~native-language~~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.
UIM
Our ~~Licensee~~
~~We currently~~software licensing and online entertainment business is dependent upon our major licensee, UIM. The following is a brief description of UIM’s business. Since we have ~~one licensee,~~no equity interest in UIM ~~a third-party~~and do not exercise any control over it, the information below has been obtained from publicly available sources, and in part was provided to us by officers of UIM. Though we have no reason to believe the information below is inaccurate, we could not independently verify the accuracy thereof.
     UIM is an online entertainment operator ~~to which we license~~that provides online gaming services, including online casinos and virtual poker rooms. By utilizing our software, UIM offers these services through several Web sites, including Everest Casino (www.everestcasino.com) and Everest Poker (www.everestpoker.com). While each of these Web sites carries a unique appearance and theme, the services provided by each of them is substantially similar. UIM markets its Web sites, in part, through Affiliated Web Attractions’ “United Partner Program” (www.affiliatedweb.com), which also utilizes our software. Under this program, private and commercial owners of Web sites are invited to place on their Web sites banners containing links to UIM’s Web sites, in return for fees based on the revenues generated by users that have been directed to UIM’s Web site from such banners. Our software package also includes the platform to operate this aspect of the business.
     UIM is located in and 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 applicable licensing requirements. See “— Regulation — Regulation Relating to Online Gaming.” In addition to licensing our software, we provide UIM with application services and ~~consultation~~consulting 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~~
     Although we do not have noany equity ~~shareholding~~ownership interest in UIM, we ~~incorporated~~consolidated UIM’s assets, liabilities and results of operations as of and for the nine months ended December 31, 2004 ~~into~~and for the years ended December 31,
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2005 and 2006 in our consolidated financial ~~statements.~~statements in accordance with the requirements under FIN 46(R). We are entitled to fees from UIM based upon its revenues. 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
     The Internet gaming software industry is characterized by rapid technological change. 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~~gaming software design houses and application service providers are our primary competitors. However, given the low ~~barrier~~barriers to entry ofin the 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~~gaming software ~~design and~~ design/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 Internet-based entertainment service and such~~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~~in direct competition with us.
     We are also exposed to competition in the Internet gaming industry through our licensees, such as UIM, as license fees with respect to gaming software provided by us typically include a variable fee based on revenues earned by such licensees from the operation of the licensed software. Our licensees (including UIM), face tough competition in the online gaming industry, which is also characterized by low barriers to entry, rapid technological change and ever-changing consumer preferences. New entrants to the online gaming sector, market consolidation and aggressive marketing and pricing by competitors may lead to a significant decline in the customer base, revenues and margins of our licensees. Any future liberalization of licensing or regulation of online gaming in countries where they generate significant revenues is likely to lead to increased competition, including competition from companies that do not currently offer online gaming services. For example, as a result of the UIGEA and subsequent closing of the online gaming market in the United States, we and our licensees (including UIM) face increasing competition from entertainment service providers in our markets in Continental Europe, which are also increasingly subject to regulation from governmental authorities.
     Furthermore, some of our competitors and competitors of our licensees (including UIM) are more established, enjoy greater market recognition, are substantially larger and have substantially greater resources and distribution capabilities than we do.
Faced with our known competitors, and most likely several new competitors ~~which~~that 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~~differentiate us from our competitors, including: brand, technology, financial stability and resources, proven track record, regulatory compliance, independent oversight and transparency of business practices in our industry.
~~Music Distribution~~
Online Games Business
*
Overview
We operate ~~a music distribution~~our online games business through our ~~indirect ownership~~subsidiaries Hoshin GigaMedia and FunTown World Limited. Hoshin GigaMedia operates our online games business in Taiwan, and T2CN and FunTown World Limited operate our online games business in Hong Kong and the PRC.
     FunTown offers a broad range of ~~Taiwan’s two largest music distribution chains, Rose Records~~online games and ~~Tachung Records. Our stores sell recorded music~~services, which we develop in-house or license from third parties. The online games offered by FunTown include casual games such as MahJong and numerous varieties of card, chess, and table games, most of which cater specifically to Asian audiences, as well as ~~DVDs, VCDs~~advanced casual games.
* We only acquired control over a majority of the voting rights in T2CN in June 2007. Owing to the recent nature of this development, we have not provided information relating to T2CN and ~~ancillary equipment~~its business.
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We plan to launch MMORPGs in late 2007. FunTown also provides services, such as game clubs for players, tournaments related to FunTown’s online games, and social networking, all of which are intended to help build a strong player community. As of May 31, 2007, FunTown had approximately 9.6 million registered members, and approximately 41,350 peak concurrent users and 20,500 average concurrent users in the month of May 2007.
     Our online games allow users access to a broad continuum of online entertainment, from traditional Asian games that are instantly recognizable and easy to learn and play, to more advanced online games that allow users to interact with each other in virtual worlds by assuming characters they may customize. We believe that the traditional appeal, and interactive and group-oriented nature of these games, combined with our brand, our community-focused services and the large size of our user base, contributes to retaining our current users and attracting new users.
     Our operating platform includes our technological infrastructure, distribution and payment system, customer service center, game content management and marketing platform. Our technological infrastructure consists of a server network throughout Greater China, the architecture of which is easily scalable to accommodate business growth and increased future user demand. Our distribution and payment network in Taiwan includes approximately 12,905 physical distribution points. Additionally, in 2006, we processed approximately 920,500 online transactions for virtual point cards. Our customer service system includes a 24-hour call center and a walk-in customer service center. In addition, our most popular online games have separate game content management teams that manage the operation of the games and the online community for the games.
     Currently, our games and services are primarily accessed through personal ~~stereo headphones.~~computers. Our games are also available on mobile phones, the Intel Viiv platform and on certain airlines. We expect FunTown’s games to be offered on Microsoft’s Xbox 360 in Taiwan in the second half of 2007.
     In March 2006, we entered into a co-operation agreement with Wretch Co., Ltd. (“Wretch”) pursuant to which we entered into a strategic alliance with Wretch for the development of an online entertainment community by combining Wretch’s strengths in blogs, online photo sharing and other community offerings with FunTown’s leading MahJong and other online casual game offerings. In connection with this, we also entered into a subscription rights agreement with Wretch and certain shareholders of Wretch, pursuant to which we obtained the right to subscribe for an equity interest in Wretch under certain circumstances. In 2006, Yahoo! Taiwan agreed to acquire Wretch, which acquisition was completed in May 2007. In connection with this transaction, we agreed to terminate our right to subscribe for an equity interest in Wretch, in consideration for a cash payment and the formation of a strategic partnership with Yahoo! Taiwan. Our right to subscribe for an equity interest in Wretch was terminated on May 8, 2007, the closing date of the acquisition of Wretch by Yahoo! Taiwan, and we were paid approximately US$0.6 million in connection with such termination. Under the strategic co-operation arrangement, we have continued to co-operate with Wretch under the original strategic alliance, which was expanded to include strategic co-operation with Yahoo! Taiwan, to develop a co-branded Web site with co-marketing of FunTown’s games on key Yahoo! Taiwan properties. Direct links to the co-branded Web site are prominently featured throughout Wretch, and have been placed on Yahoo! Taiwan’s online game and messenger homepages with banner advertisement rights designed to attract users to the co-branded Web site. Members of Yahoo! Taiwan are able to directly access FunTown’s games on the co-branded Web site with their Yahoo! login information.
     In December 2006, we entered into a strategic partnership with Infocomm Asia, a Southeast Asian online games operator and distributor offering blockbuster titles such asGranado EspadaandHellgate: London, both under exclusive license for most of Southeast Asia. We also secured an exclusive license to offer and operateHellgate: London, an online game anticipated to be launched in 2007, in the territories of Taiwan, Hong Kong and Macau. We will operateHellgate: Londonin partnership with Infocomm Asia through a strategic joint venture, Dragongate Enterprises Limited (“Dragongate Enterprises”), in which we hold a 70 percent interest and Cyber Gateway Pte. Ltd. (a wholly-owned subsidiary of Infocomm Asia) holds a 30 percent interest.
     In February 2007, we secured an exclusive license from the Toppig Corporation, a Korean company, to offer and operateNanaimo, an online action role-playing game expected to be launched in late 2007, in the territories of Taiwan and Hong Kong.
     In March 2007, we also secured an exclusive license from the SEGA Corporation to offer and operatePhantasy Star Universe, an online action role-playing game which is expected to be launched in the second half of 2007, in the territories of Taiwan and Hong Kong.
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Our Products
     FunTown offers more than 40 online multi-player casual games in the following categories: MahJong, Chinese poker, Chinese chess, table games, social games, puzzle-style games, advanced casual games and chance-based games, and intends to launch certain MMORPGs in late 2007. These games are real-time and multi-player capable.
     In general, online casual games are games with simple rules that are easy to learn and play, and which can be completed in short sessions. MMORPGs are more complex, require much greater time to learn and often involve large groups of players competing simultaneously online.
MahJong
     MahJong is a traditional and highly popular Chinese social game, often played on holidays, at social gatherings and during special occasions, such as weddings. It is widely played in Japan, Korea, Greater China and other parts of Asia. Similar to poker, MahJong is a multi-player game, consisting of four players per game. FunTown offers different local versions of MahJong for players in the PRC, Hong Kong and Taiwan. Players select a table, based on either skill or stakes, and can then invite friends to play on the same table online. Players can compete with anyone throughout FunTown’s Greater China network. Virtual currency is purchased in order to play these games, and may be used to play other FunTown games or to purchase virtual items, if not used to play the games, but may not be redeemed for cash.
     Special offline events are held from time to time to stimulate interest and foster group solidarity among the many MahJong guilds that players can join online. FunTown organizes a large annual MahJong tournament in Taipei which is open to anyone belonging to one of FunTown’s MahJong guilds. In 2006, more than 400 guilds and 30,000 players participated in the event and attended the tournament. In December 2006, we also obtained the exclusive right to co-host the MahJong World Championship together with the World MahJong Organization. In conjunction with the World MahJong Organization, we intend to establish and operate a series of regional qualifying MahJong tournaments in Asia, Europe and North America for the MahJong World Championship.
Chinese Poker
     As with MahJong, there are several varieties of poker played in different regions of Greater China. FunTown offers many different Chinese poker games popular in various regions of Greater China. FunTown’s players can select their desired poker table based on the level of skill or stakes. Virtual currency is purchased in order to play these games, and may be used to play other FunTown games or to purchase virtual items, if not used to play the games, but may not be redeemed for cash.
Chinese Chess
     FunTown also offers various popular Chinese chess games. Players can select from opponents online based on different skill levels.
Social Games
     FunTown has a unique social networking and matching game called “FunTown Village”, which offers a virtual playground for players to meet other players through their online “avatars.” Players can purchase virtual items, such as clothing and accessories, to enhance the appeal of their online “avatars.” We plan to introduce more such virtual items to address the strong social interests of our players and to help increase FunTown’s overall appeal as a distinct game community and brand.
Puzzle-Style Games
     FunTown also operates a platform known as “Osuke Playground”, which offers a collection of puzzle-style games and matching games similar to historically popular and classic games such asBejeweled. In addition, Osuke Playground also offers some table games such as nine-ball, a contemporary variation of pocket billiards. These games are designed with online multi-player features which allow players to pit their skills against one another. In addition, like all other games offered by FunTown, the Osuke Playground games are integrated into our FunTown platform with
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features such as a player-to-player messaging system, virtual currency and avatars. The more popular games in Osuke Playground include “Magical Blocks”, “Happy Link”, “Zoo Match” and “Fortress 2.”
Advanced Casual Games
     FunTown has broadened its games offering to include sports action games and arcade-style games, such as a multi-player obstacle running game that was launched in June 2006 calledTales Runner. In February 2007, we also secured an exclusive license from the Toppig Corporation to offer and operateNanaimo, an online action role-playing game expected to be launched in late 2007, in the territories of Taiwan and Hong Kong.Nanaimois a free, easy-to-play game set in a cartoon world and is filled with action, community activities and collectibles.
Chance-Based Games
     To enhance the varieties of FunTown products, FunTown also offers chance-based games for users, who purchase virtual currency in order to play the games. Virtual currency purchased may be used to play other FunTown games or to purchase virtual avatar items, if not used to play the games, which include bingo, lotto, horse racing, Sic-Bo, and various different kinds of slot games, but may not be redeemed for cash.
MMORPGs
     In December 2006, we, through our 70 percent owned subsidiary, Dragongate Enterprises, secured an exclusive license to offer and operateHellgate: London, an online action-driven role-playing game expected to be launched in late 2007, in the territories of Taiwan, Hong Kong and Macau. In the game, the player creates a heroic character and completes quests and battles to advance through experience levels and branching skill paths. A robust, flexible skill and spell system, highly customizable appearances and a massive variety of randomly generated equipment allow players to create their own unique heroes.Hellgate: Londonis a creation of Flagship Studios, an online game development studio founded in 2003 by a team of executives and developers renowned for numerous best-selling games and multiple Game-of-the-Year Awards to their credit, including the worldwide best-selling Diablo®, Starcraft® and Warcraft® games.
     In March 2007, we also secured an exclusive license from the SEGA Corporation to offer and operatePhantasy Star Universe, an online and offline action role-playing game expected to be launched in the second half of 2007, in the territories of Taiwan and Hong Kong.Phantasy Star Universeis the long-awaited sequel to SEGA’s critically-acclaimed role-playing game seriesPhantasy Star. In the game, players customize their size and appearance, vehicles, weapons and helper robots to create their own unique characters. Players can join forces and exchange game items with each other to complete quests and battles, and build their characters into powerful warriors.
Our Services
     FunTown provides many online game services to its players to enhance their playing experiences and support the development of a strong player community.
Player Clubs
     We offer player clubs in which FunTown players can form their own club, invite players with similar interests or skill levels to join, and organize online and offline events for club members. Player clubs complement the strong social qualities of online games by helping to build and maintain an online game community.
Tournaments
     Tournaments are one of the most important services provided by FunTown. Players can organize and participate in clubs and compete in weekly online club tournaments. On an annual basis, FunTown also sponsors large-scale real-person tournaments where players attend the tournament in person and compete online via computers provided on the tournament premises. For example, FunTown organizes a large annual MahJong tournament in Taipei, Taiwan which is open to anyone belonging to one of FunTown’s MahJong guilds. In 2006, more than 400 guilds and 30,000 players participated in the event and attended the tournament. In December 2006, we also obtained the exclusive right to co-host the MahJong World Championship together with the World MahJong Organization. In conjunction with the World MahJong Organization, we intend to establish and operate a series of
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regional qualifying MahJong tournaments in Asia, Europe and North America for the MahJong World Championship.
Friends and Family
     The FunTown platform has a unique personal contact feature, similar to the contact list of instant message programs, which enables players to see when their personal network of friends and family are online. This enables players to invite people in their network to play online games together.
Social Networking
     FunTown’s platform is designed to be an attractive forum in which to make friends and have fun, as well as compete and win prizes. The platform has a virtual town hall, in which players may interact, meet new people or even get married. FunTown’s social networking features help build an important online community.
Avatars
     To help players customize their persona online and increase their overall entertainment experience, FunTown also offers many in-game items which may be purchased by players for their online personas, or avatars, in order to create their own unique look while participating in the online community. The items for sale for avatars include facial expressions, clothes and accessories. These items are particularly popular with younger players, who like to customize their avatars to express themselves and establish unique identities and distinct fashions in the online community.
Our Pricing, Distribution and Payment
     Our principal sources of revenue for online games are access fees and fees for sale of in-game items. We offer flexible pricing to suit different players’ playing habits. We have both hourly and monthly access fee pricing schemes to cater to light-usage and heavy-usage players, respectively.
     We also charge players fees for the purchase of various in-game items, mainly virtual coins and customized avatars.
     FunTown has both physical and virtual distribution channels for its games:
• Physical distribution channels. Physical distribution channels include convenience chain stores such as 7-11, and Internet cafés. At these locations, users may purchase pre-paid cards with varying amounts of credits to play FunTown’s suite of casual games. In addition, players may purchase game packs to play specific games on FunTown’s platform.
• Virtual distribution channels. Virtual distribution channels consist of various Web sites, including FunTown’s official Web site. Users may purchase game credits through online sites with their credit card or bill via their telecom carrier.
     To use our fee-based online games, a customer must register an account in our system. Once registered, the customer may log onto our network, select and activate the games the customer wishes to play, and then charge his or her account using a prepaid card or prepaid online points. Customers only need to maintain one account, which provides information regarding the customer’s available prepaid game credits and payment history.
Our Marketing
     Our marketing strategy is to capitalize on our established brand and utilize our large existing user base and distribution network to retain our existing users and attract new users. We employ a variety of traditional and online marketing programs and promotional activities to promote our games, which include:
• In-Game Events. We organize in-game events for our users, which we believe encourages the development of virtual communities among our users and increases user interest in our games. Examples of in-game events include special challenges or features introduced to the game environments for a scheduled period.
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In addition, we use in-game events to introduce users to new features of our games. We may also post announcements in the game environment to promote new features, other improvements to the games, and in-game events.
• In-Game Marketing. We may conduct in-game marketing programs from time to time, including online contests for prizes.
• Cross-Marketing. We have cross-marketing relationships with popular consumer brands, technology companies and major telecom carriers. We believe that our cross-marketing relationships with certain well-known companies, including Intel Corporation (“Intel”) and Microsoft Corporation (“Microsoft”), will increase the recognition of our online game brands.
• Open Beta Testing. Our open beta testing system tests both the operation of new games under open market conditions and introduces new games to users. During open beta testing, we do not charge users to play the new game. Open beta testing provides an initial user base and creates initial interest and word-of-mouth publicity to support the commercial launch of the game.
• Offline Events/Promotions. From time to time we distribute free game-related posters, promotional prepaid cards for beginners, and game-related souvenirs at trade shows, selected Internet cafés and other locations. We may conduct events at popular venues to stage exhibitions, distribute software and game content-related merchandise, and interact directly with our user base. Furthermore, we may sponsor select media events, such as industry-related awards shows and TV shows, to promote our brand names and our games.
• TV Commercials.We use TV commercials to attract potential customers and to promote our games and brand.
• Marketing Research.We use various qualitative and quantitative market research methods to analyze our target market and to differentiate our product offerings from those of our competitors.
• Game Magazine Advertisements.We also advertise certain of our games in various game magazines. From time to time, we also collaborate with such magazines in various promotions, including giving away copies of certain games free of charge with each magazine sold.
• Direct Marketing.We use telemarketing and email correspondence to inform our users of new products, promotions, and other product related services.
     We also regard customer service as a key marketing tool and we are committed to providing superior customer service to our users. We provide service to our customers through three principal channels:
our call center in FunTown’s offices in Taiwan, which serves our customers 24 hours a day, seven days a week;
our walk-in customer service centers in Taipei and Hong Kong; and
e-mail and facsimile letters.
     In addition, we offer bulletin board services that allow users to post questions to, and receive responses from, other users.
     We have game masters dedicated to our most popular games. Game master responsibilities include organizing in-game events, troubleshooting and actively monitoring the online game environment. Game masters are available to respond to players’ inquiries, initiate “bug” reporting and removal processes, as well as to identify, record and
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deal with inappropriate player behavior such as cheating. We believe that our provision of game masters to monitor the gaming environment is an important element in maintaining our customer loyalty and efficiently addressing technical problems as they arise.
Our Players
     As of June 15, ~~2005, we operated a total of 45 stores. According to our estimate,~~2007, we had ~~a market share~~over 9 million registered players of our online games, and we recorded over ~~30%~~123,500 paying players, approximately 41,350 peak concurrent users and 20,500 average concurrent users, all in the month of ~~Taiwan’s physical music distribution business in 2004. While seeking~~May 2007. The majority of our online game players are 25 to ~~preserve~~35 years old, and consist of approximately 55 percent male and 45 percent female players.
Our Sources of Products and Services
     Historically, we developed our ~~market share, we~~games and services in-house to 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 operationsbetter control of the ~~acquired businesses from~~game features and allow for seamless integration with our games platform. Occasionally, we outsource game development to game studios to expedite the ~~respective dates of acquisition.~~
~~Industry Overview~~
~~Taiwan’s retail music distribution industry is relatively fragmented. In addition~~development process and time 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 downloadsmarket. More recently, we have also begun to ~~emerge in recent years as competitive distribution channels.~~
~~While no formal industry statistics are available, based on information provided~~license games to ~~us by record companies and knowledge~~expand the scope 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~~
games offering. As of June 15, ~~2005,~~2007, we ~~operated 45 stores. These stores range~~hold licenses for the operation of five games in ~~size~~various territories,Tales Runner,Fortress 2,Hellgate: London,Phantasy Star UniverseandNanaimo. Game licensing costs consist typically of an upfront fee, and an ongoing licensing fee equal to a percentage of revenues earned from the licensed games.
     We continue to aggressively expand our products and services offerings by developing and launching new games, updating games and community features on our platform. We are currently working with Microsoft to launch FunTown’s online MahJong on the Xbox 360, which is expected to be launched in the second half of 2007. In order to support our product development capabilities and develop our proprietary online games, we have a strong research and development team composed of 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~~72 employees 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~~Shanghai 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,~~2007.
Our Technology and Infrastructure
     We have a scalable and modular platform that enables us to increase our game offerings and services. The platform consists of several key modules: authentication, billing, game management, customer service, and the basic platform operation. Since our platform was designed with scalability in mind, we ~~had 20 music stores~~have a unified user account system, which allows our players to use one single account to access all FunTown games. Our billing and game management modules are flexible enough to integrate both in-house developed and licensed games. Our customer service module enables us to assist our players both 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 proportionoutside of the ~~physical music distribution will comprise more specialized areas of music, such as classical~~games.
     As technologies advance and ~~jazz.~~
~~In light of~~enable people to access the ~~trends~~Internet in new ways, we ~~perceive in this business, we~~plan to expand our offerings to match these new access technologies and platforms. We are ~~in the process of altering~~currently working with Microsoft to develop some of our ~~stores into combined stores format. Combined stores~~available games for use on the Xbox 360 platform, with Intel to make some of our games and services available on its Viiv technology for digital home media centers; and Chunghwa Telecom to offer certain of our popular game titles on its media-on-demand system. We also have created games for use on other wireless mobile phone platforms. In addition to these new technologies, our games are ~~stores co-located~~currently available to air travelers on certain airlines, enabling players to play with other ~~businesses that we believe share~~passengers travelling on 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~~flight.
Competition
      Our main competitors in the online games business are casual game operators in Greater China, including Shanda, Nineyou (Shanghai Everstar Online Entertainment Co., Ltd.), Tencent Holdings Limited, Ourgames.com (Beijing Globalink Computer Technology Co., Ltd.), International Games System Co., Ltd and ~~two combined stores with an arcade~~Chinagames.net. Our competitors also include massively multi-player online role-playing 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~~operators in Taiwan, ~~CD purchases from major record~~including Gamania Digital Entertainment Co., Ltd. (“Gamania”) and Soft-World International Corporation.
     We expect more companies ~~are~~to enter the online games industry in ~~general not returnable for full credit. The principal exception relates~~Greater China and a wider range of online games to ~~major record releases, where~~be introduced to the ~~first batch~~Greater China market, given the relatively low entry barriers to the online games industry. Our competitors vary in size and include large companies such as Shanda, many of ~~purchases are usually returnable for full credit. CD purchases from suppliers other than major record companies are usually returnable for full credit.~~
~~Sales~~which have significant financial, marketing 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 postersgame development resources as well as ~~record company-sponsored promotional events. In 2004,~~name recognition. To cope with competition, we ~~recognized a total amount of US$1.5 million in promotional~~aim to develop new features and ~~advertising revenues.~~
services that we think our players will pay for and enjoy. We ~~successfully launched a co-branded credit card during~~also work on strengthening 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 offeringsappeal of our ~~stores to meet customer needs.~~
~~Management Information System~~
~~We have implemented our new point~~online games platform through building player communities, honorary titles, virtual badges and banners 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,honor, 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.virtual assets.
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~~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~~
     We rely on copyrights, trademarks, trade secrets and other intellectual property laws, as well as non-competition, confidentiality and license agreements with our employees, suppliers, business partners and others to protect our intellectual property rights. Our employees are generally required to sign agreements acknowledging that all inventions, trade secrets, works of authorship, developments and other processes generated by them on our behalf are our property, and assign to us any ownership rights that they may claim in those works.
     As of June 15, 2007, we were the owner of 37 software copyrights and 34 trademarks registered with various government agencies throughout Greater China and Taiwan. We also hold licenses for the operation of five online games, includingTales Runner, Fortress 2, Hellgate: London, Phantasy Star UniverseandNanaimo.
Internet Access Services Business
Our Services
     We provide broadband Internet access services to consumer and corporate customers through various technologies and products including, cable modems, leased-lines, virtual private network and other value-added services.
Internet Access Services Offerings
     CABLE MODEMS. We offer our broadband Internet access services for consumers via cable modems at transmission speeds of up to 6 Mbps. Our cable modem-based broadband access services allow subscribers to use bandwidth-intensive multimedia applications, such as interactive games, high-quality audio, video and distance learning applications, and electronic commerce applications, such as retailing, financial services and online software distribution more efficiently. We reached an agreement in principle in May 2004 with certain of our cable partners to whom we provide bandwidth on an exclusive basis to equally share revenues, thus providing our cable partners with increased economic incentives to promote two-way cable services through their systems. In September 2005, we started providing to certain of our exclusive cable partners, cable modem services that they could sell under their own brand name. Two-way cable systems allow us to offer subscribers higher upstream transmission speeds and “always on” Internet access capabilities. As of December 31, 2006, we had 11,447 cable modem-based broadband customers, as compared to 17,600 cable modem-based broadband customers as of December 31, 2005.
     CORPORATE INTERNET ACCESS SERVICES. We also offer dedicated and high-speed Internet access services to corporate customers over fiber optical lines. Our target customers include ISPs, Internet content providers (“ICPs”), corporations, SMEs and cyber cafés. Our corporate ISP services include leased-line services, ranging from 1 Mbps to 1 Gbps, virtual private network and other value-added services.
     ADSL. On May 15, 2006, we entered into an asset purchase and sale agreement and a transition service agreement with Webs-TV to sell our ADSL business and provide certain transition services. Under the agreements, Webs-TV purchased our ADSL business and agreed upon services in an all cash transaction with a total price of approximately US$18.1 million (including VAT). Approximately US$8.9 million of the price was for the ADSL business and approximately US$0.9 million of the price was for the right to use our ADSL brand for five years. Both are payable from May 15, 2006 through July 31, 2007. The remaining US$8.3 million of the total price represents fees for bandwidth, consulting and other support services to be provided by Hoshin GigaMedia on a transitional basis through December 31, 2007, and is payable from May 15, 2006 through February 28, 2008. The transferred ADSL business includes our ADSL-related equipment, business contracts, and subscription contracts between Hoshin GigaMedia and approximately 62,000 ADSL subscribers. Cash proceeds received in 2006 from the sale of the ADSL business, net of transaction costs and VAT, were approximately US$3.3 million, and cash proceeds to be received in 2007 related to such sale, net of VAT, will be approximately US$5.0 million.
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Markets for Internet Access Services
     CONSUMER INTERNET ACCESS SERVICES. Our two-way cable modem-based broadband service packages are offered at approximately US$33.80 per subscriber per month for premium service; approximately US$24.58 per subscriber per month for a mid-tier package; and approximately US$19.97 per subscriber per month for a 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 our revenues from access fees net of the split with cable partners and these discounts. In the future, our product mix may change in response to market dynamics.
     The number of subscribers of our two-way cable modem-based broadband services declined gradually due to competition. The table below sets forth the number of our subscribers on the dates specified. Our access revenues increased in 2006 compared to 2005, primarily due to the growth of our corporate broadband business, which offset declines in our retail broadband business. We do not expect to see significant growth in our subscriber base in the future, in line with our ongoing strategy to shift resources away from this legacy business. Consistent with our focus on online entertainment, we have retained financial advisers to explore the potential sale of this legacy business.

Number of Subscribers
Date 2004 2005 2006
31-Mar 18,798 18,645 16,417
30-Jun 18,495 17,929 15,154
30-Sep 18,454 17,386 13,185
31-Dec 18,440 16,534 11,447
     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 revenue sharing arrangements. As of December 31, 2006, we had exclusive agreements with 11 out of our 26 cable partners granting us the exclusive right to provide Internet access services through their cable systems.
     CORPORATE ACCESS SERVICES. KBT offers and sells dedicated and high-speed Internet access to corporate customers over fiber optical Ethernet MAN infrastructure. KBT offers various speeds of leased-line services, ranging from 1Mbps to 1Gbps, to different kinds of subscribers like ISPs, ICPs, corporations, SMEs and cyber cafés. KBT charges its customers monthly fees for access services and other value-added services depending on the level of bandwidth and type of services provided. As of June 2007, KBT has more than 600 corporate users, and the business contributes more than 40 percent of the revenues from our Internet access service business.
Other Services
     As part of our Internet services, we provide various other value-added services including free electronic mail, bulletin boards and photo albums.
Our Broadband Network — Cable and ADSL Network
     In early 2005, we completed the upgrade of our island-wide backbone network, which is based primarily on Gigabit Ethernet technologies and covers 20 major districts out of a total 25 districts in Taiwan. In addition, we built small regional data centers to host 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:
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the provision of key community services, including electronic mail, photo albums and personal Web hosting, to subscribers;
the management of network performance;
the replication of content and applications; and
the provision of a cost-efficient infrastructure to cache data.
     In connection with the sale of our ADSL business, we have given Webs-TV the right to co-locate their equipment into our network operation centers.
     NETWORK OPERATIONS CENTERS. We provide centralized network management through our network operations centers, which represent the nerve center of our whole network. Our centers use advanced proprietary ~~rights~~network management tools and systems to monitor the network infrastructure 24 hours a day, 7 days a week, enabling us to effectively address network problems before they adversely affect our subscribers.
Data Backbone
     Ongoing privatization of the telecommunications market by Taiwan’s government has expanded the number of telecommunications operators. Including Chunghwa Telecom, there are currently four fixed-line telecommunications operators in Taiwan. It is our policy to continually monitor the usage pattern, adjust the network architecture, and select better leased-line circuits providers to optimize the user experience and service economics.
     Private peer-to-peer relationships among ISPs (i.e., private direct cable connections as ~~important,~~opposed to public Internet connections) 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 with most of Taiwan’s major networks and ISPs, providing us with what we believe to be the one of the most comprehensive array of Internet connections in Taiwan. According to the Taiwan Network Information Center, as of April 2006, we had one of the best aggregate peering bandwidth arrangements among all commercial organizations in Taiwan. Our extensive peering arrangements have enabled us to route most of our traffic over the less congested private peering links. This enhances the efficiency of our network and allows us to provide better, faster access services to our subscribers.
     Through our peering arrangements with several Internet service providers and networks, we currently connect to Taiwan’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 Internet through a direct trans-Pacific submarine cable link. As competition in the trans-Pacific submarine cable segment provides better price economics, we are able to significantly increase our bandwidth without incurring additional cost. In 2005, we completed the upgrade of our infrastructure from STM-1 and STM-4 connections to Gigabit Ethernet-based connections to provide faster connections.
Information System
     We have established a versatile, scalable, real-time information system that integrates service provisioning, customer management, billing, data gathering and usage tracking functions. With independent multiple processing layers, we are able to respond to increases in user, subscriber or service data by expanding our information system’s capacity on demand.
Sales and Marketing
     CONSUMER ACCESS SERVICES. We plan to continue utilizing bundled marketing with our strategic partners to minimize costs.
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     TURNKEY CABLE MODEM SERVICES. For cable operators that are interested in providing or improving upon their cable Internet services, we have formed a team of sales personnel, network engineers, backend software engineers and customer service specialists to provide consultancy and turnkey solutions. We believe that direct sales contact and site visits to existing cable partners and referrals by our existing cable partners are the most efficient methods of marketing our cable modem services.
     CORPORATE ACCESS SERVICES. With an optical Ethernet MAN infrastructure and solution, KBT is able to provide corporate customers, one-megabit increment, on-demand leased-line services. We primarily use a direct sales force to reach our potential customers.
Customer Service
     We provide our subscribers with a comprehensive range of customer service, including assistance on cable modem installations, 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. Our subscribers may also contact us via electronic mail or through accessing our interactive self-service Web site. Our general customer service staff assists 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.
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 highly competitive. 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 over 80 percent of the market share in 2006, while we have only managed to capture approximately 1 percent 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, in particular, WiMax). In the cable modem-based Internet access market, we believe that our ~~future success~~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 services from fixed-line service providers, including Chunghwa Telecom, Taiwan Fixed Network, NCIC’s Sparq and Asia Pacific Online and other Internet access service providers in Taiwan.
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     Some of our major competitors, including Chunghwa Telecom, have certain competitive advantages over us, including financial and marketing resources, established customer relationships, brand awareness, customer access and telecommunications infrastructure.
Intellectual Property and Proprietary Rights
     As of June 15, 2007, we held 21 trademarks and two patents registered in Taiwan.
Regulation
Regulation Relating to Online Gaming
     Our software licensing and online entertainment business includes software development and the provision of application services for Internet gaming. We are dependent on UIM for all of the revenues from our software licensing and online entertainment business. UIM operates an online gaming business and also sub-licenses our software products to third parties. We earn fees from UIM based upon its revenues. In December 2006, we also entered into a licensing agreement with a subsidiary of the Carmen Media Group, an online entertainment provider, pursuant to which we licensed certain of our gaming software for use on Web sites to be launched and operated by such subsidiary. Each of these businesses is ~~dependent~~subject to applicable laws and regulations relating to online gaming and electronic commerce in various jurisdictions.
     We are incorporated in Singapore and 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, the end users of our software products, including the online gaming customers of UIM and its sub-licensees are located around the world and it is, in many cases, uncertain which governments have authority to legislate or regulate different aspects of these industries. Moreover, the Internet gaming industry is still in an early stage of development and the worldwide legal and regulatory environment in which the businesses operate therefore remains highly fluid and subject to change. While most foreign jurisdictions have some form of legal framework applicable to games of chance, few provide clear guidance on how this framework applies to Internet gaming. Issues such as determining the physical location of a gaming event as well as significant differences in the gaming laws and “Cyberlaws” of various countries all make traditional concepts of jurisdiction and conflicts of 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 make it impossible to assess whether our status or operations as an application service provider to the online gaming industry, or the Internet gaming services provided by UIM, are in compliance with all laws and regulations of the jurisdictions where our gaming software products are used.
     In the United States, the current administration adheres to the view that Internet gambling is already prohibited by the Federal Wire Act and other federal laws, such as the Patriot Act. Under the Patriot Act, both U.S. and non U.S. banks which process online gaming transactions for U.S. persons may face potential criminal proceedings, as U.S. jurisdiction extends to non-U.S. banks that have correspondent accounts in the United States. Internet gambling activity also constitutes illegal gambling activity in all 50 U.S. states, including those states where other forms of gambling are legal.
     In addition, the UIGEA became law in the United States in September 2006. The UIGEA prohibits the use of communication facilities and financial transactions in connection with Internet gambling by restricting the payment methods for such activities and by imposing criminal penalties on Internet gambling businesses which accept wagers or payment in violation of such restrictions. The UIGEA also criminalizes any gambling business which arises from using a communication facility to transmit bets or wagers, or to transmit information assisting in the placing of bets and wagers, to or from the United States, and prevents gambling businesses from accepting credit cards or other bank instruments in connection with illegal Internet gambling. The UIGEA also directs various federal agencies to develop regulations that would require financial institutions with electronic payment systems to establish policies and procedures to identify and block restricted transactions, and creates judicial procedures through which federal agencies could obtain injunctions directing interactive computer services to remove or disable access to online sites that violate the law.
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     In November 2004, the World Trade Organization (“WTO”) found that the United States was in violation of its commitments under the General Agreement on Trade in Services (“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 obligations of the United States under the GATS, but also that the United States 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 existing federal legislation regarding Internet gambling on horseracing, the United States 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 United States bring its legislation into conformity with its obligations under the GATS. In March 2007, the WTO issued a report which found that the United States had failed to bring its legislation into conformity with its obligations under the GATS.
     It is unclear what steps the U.S. government will take following the decision of the Appellate Body of the WTO and the March 2007 report 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 prompt a change in U.S. online gaming policy. A number of states are lobbying/petitioning the federal authorities to ensure they retain the ability to regulate state gaming and that this ability is not affected by the WTO decision.
     Finally, substantial uncertainties in the global regulatory environment relating to online gaming expose our Company to a real risk that regulatory authorities in various jurisdictions may determine that our software licensing and online entertainment business provides online gaming services (rather than only providing software and application services to our licensees) and thus subject our Company to the gaming laws and regulations in such jurisdictions.
     In Europe, several countries, led by the United Kingdom, are adopting a regulated online gaming approach. However, opposing views are present in Europe. Some European countries, where there are state-owned gaming monopolies, primarily related to lotteries and online sports betting, have taken action or introduced legislation aimed at banning foreign online gaming operators, which could have a material adverse effect on our licensees and consequently on our Company. For example, the French governmental authorities has passed legislation effective from March 2007, prohibiting operators other than certain specified state-owned enterprises from operating Internet gaming sites in France. Additionally, advertising restrictions have been placed on the ~~innovative skills, technological expertise~~promotion of online gaming sites with effect from September 2007, and ~~management abilities~~the proposed implementation of ~~our employees rather than on patent, copyright and trademark protection, and, accordingly, we do not consider any particular intellectual property or proprietary right~~the legislation also requires warnings to be ~~material~~placed on online gaming sites. In addition, new banking restrictions have been adopted, which require financial institutions with electronic payment systems to identify and block restricted transactions. As of June 15, 2007, regulations required to implement these laws and the banking restrictions have not been adopted.
     Such actions by these European Union (“EU”) member states are in contrast with rulings from the European Court of Justice and have prompted the European Commission (“EC”) to look at creating new legislation that could harmonize online gaming within the EU, in line with the EU’s principles regarding the European single market. There is no indication that any such legislation will be introduced in the near term.
     For additional information on the regulatory environment relating to online gaming, please see Item 3, “Key Information — Risk Factors — The worldwide legal and regulatory environment in which our ~~business.~~software licensing and online entertainment business operates is characterized by uncertainties that could adversely affect our business and operating results.”
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~~Regulation~~
Regulations Relating to Online Games in Taiwan
     At present, there is no specific law in Taiwan governing online game services, nor are there any specific licensing requirements imposed on Internet content providers in connection with offering online game services. The National Communications Commission (the “NCC”) was established in March 2006. It is anticipated that the NCC will overhaul the regulatory framework in the communications sector and may enact new regulations governing Internet content.
Rating of Internet Content. The Government Information Office, which was the agency in charge of Internet content prior to establishment of the NCC, promulgated the Regulations for the Rating of Internet Content in April 2004, as amended in October 2005. In general, Internet content shall not include any illegal or banned materials. To avoid negative impact on the physical or mental development of children or adolescents, Internet content containing any of the following materials shall be rated as restricted and shall not be viewed by those below the age of 18: (i) excessive depiction of gambling, robbery or other criminal offenses; (ii) excessive depiction of suicide; (iii) depiction involving terror, blood or cruelty which is presented in an matter acceptable to adults; or (iv) depiction of sexual acts or sexual obscenity which does not embarrass or disgust adults in general. If Internet content is in violation of the Regulations for the Rating of Internet Content, competent authorities may order the relevant Internet service providers to restrict access to children or adolescents or remove the offending content and impose an administrative fine on the offenders.
Computer Software Ratings.The Ministry of Economic Affairs announced in July 2006 the Regulations Governing Computer Software Rating which took effect in January 2007. Computer software includes the game software which can be installed in computers. The provider of computer software shall identify the rating of the computer software when it provides it to users. There are four ratings: (i) Mature Audience Only (not suitable for those below the age of 18); (ii) Parental Guidance Advisable (not suitable for those below the age of 12; parental guidance is advisable for those between the age of 12 to 18) (iii) Parental Guidance Strongly Suggested (not suitable for those below the age of 6; guidance from parents, teachers or adults is strongly suggested for those between the age of 6 to 12); and (iv) General Audience (suitable for all ages).
Online Game Contract Template. The Ministry of Economic Affairs, which is the industrial authority in charge of online games, published a model contract template for online game services in February 2006 for reference only. However, under the Consumer Protection Act, the industrial authority can prescribe the terms and conditions that shall be, and shall not be, set forth in a model contract. It is unclear at this stage whether the Ministry of Economic Affairs will require that the template be used as a model contract.
Regulations Relating to Online Games in the PRC
     Our provision of online games and online game-related content on our Web sites in the PRC is subject to various Chinese laws and regulations relating to the telecommunications industry, Internet and online games, and is regulated by various government authorities, including the Ministry of Information Industry, the Ministry of Culture, the Administration of Press and Publication and the State Administration of Industry and Commerce. The principal PRC regulations governing the provision of Internet content and online games services include (among others) the Telecommunications Regulations (2000), the Administrative Rules for Foreign Investments in Telecommunications Enterprises (2001), the Administrative Measures for Telecommunications Business Operating Licenses (2001), the Tentative Measures for Administration of Internet Culture (2003), the Tentative Measures for the Administration of Internet Publications (2002), the Opinions on the Development and Management of Online Games (2005) and the Anti-Internet Addiction Regulations (2007).
     Under these regulations, a foreign investor is currently prohibited from owning more than 50 percent of the equity in a PRC entity which provides value-added telecommunications services. Internet content provision services are classified as value-added telecommunications businesses, and a commercial operator of such services must obtain a value-added telecommunications business operating license, or an ICP license, from the appropriate telecommunication authorities in order to carry on its operations in the PRC.
     In addition, since online games fall within the definition of “Internet culture products” under the Tentative Measures for Internet Culture Administration (2003), a commercial operator of online games must, in addition to the ICP license, obtain an Internet culture operation license from the appropriate Ministry of Culture for its operation of online games, and foreign investors are restricted from owning equity in such entities. The provision of online games is also deemed an Internet publication, within the meaning of the Tentative Measures for Internet Publication Administration (2002), and therefore, an online game operator must also obtain the approval of the relevant press and publication administrative authorities, as well as the appropriate licenses, in order to carry on its online games business in the PRC. Foreign investors are also restricted from owning equity in entities which provide Internet publications. Further, no online game products involving (among others) obscenity, gambling, violence, superstition or illegal money-collecting transactions are allowed to be produced and circulated in the PRC, and all imports of online games are required to be approved by the Ministry of Culture and be registered and recorded in accordance with relevant PRC law. If games are imported without such approval, the Ministry of Culture may impose penalties on the non-complying operator, which include the revocation of its Internet culture operation license. In addition, online game operators are required to develop identification verification and reorganization software for online game products, to restrain youths from playing online games and limit their playing time, and to reform gaming rules which might induce online gaming addiction (including adoption of real-name registration systems).
     In April 2007, the PRC governmental authorities also passed the “Anti-Internet Addiction Regulations”, with the purpose of discouraging online game-players from spending excessive amounts of time playing online games. Pursuant to these regulations, Internet game operators have been ordered to install anti-addiction software features on games offered in the PRC by mid-July 2007, which will (among other features) limit the number of points and other benefits which can be awarded to game players after they have been online in excess of specified periods of time. Internet game operators will also be required to adopt real-name registration, which will require online game players to register their real identity information before they will be allowed to play online games.
Telecommunications Regulation Inin Taiwan
The NCC was established in March 2006 to act as the regulator of the telecommunications and broadcasting industry. Prior to the establishment of the NCC, the Ministry of Transportation and Communications and the Directorate General of Telecommunications of Taiwan ~~regulate~~regulated Taiwan’s telecommunications industry primarily under the Telecommunications ~~Law~~Act of Taiwan.
The ~~Telecommunications Law authorizes the~~ Directorate General of Telecommunications ~~to regulate~~has been merged into the NCC, while the Ministry of Transportation and Communications remains responsible for industrial policy and promotion of the telecommunications industry.
     The Telecommunications Act regulates 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 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 Type II 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 simple voice ~~simple~~ resale, Internet
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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. Hoshin GigaMedia’s license is due to expire in 2008. KBT’s license is due to expire in 2012.
Tariff Regulation. Type II operators are required to announce their business regulations with respect to the terms for provision of services, including tariffs for major rates and charges. Any changes to the business regulations must be filed with the ~~Directorate General of Telecommunications~~NCC 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 the operator’s business plans.
Change in Business. Under Taiwan’s Regulations Governing Type II Telecommunications Operators, any change of type or scope of business must be approved by the ~~Directorate General of Telecommunications.~~NCC. For change of the systems structure stated in the business plan, a report shall be filed with the ~~Directorate General of Telecommunications~~NCC for ~~recordation~~recording 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~~NCC 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 used by a Type II operator must also satisfy technical standards adopted by the ~~Directorate General of Telecommunications.~~NCC.
Regulation of Type I 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,~~Act, 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~~Act 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~~increase rate of the consumer ~~product~~price index promulgated by the Directorate General of Budget, Account and Statistics under the Executive Yuan of ~~Taiwan.~~
Taiwan minus adjusted coefficient.
Liberalization of Type I Fixed Network ~~Licensing~~Licensing.. The Directorate General of Telecommunications adopted the Regulations Governing Fixed Telecommunications Network Business (“Fixed Network ~~Regulations~~Regulations”) in 1999 to govern the issuance of fixed network communication ~~licenses.~~licenses and the business conducts of fixed network business operators. Type I fixed network communications licenses are subdivided into comprehensive network, local network, long distance network, international network and lease-circuit licenses. These regulations 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.
The NCC promulgated the amendments to the Fixed Network Regulations on May 21, 2007 whereby the NCC lowers the threshold for a cable TV system operator to operate a local telecommunications network within its franchise area on the one hand and allows a fixed network operator to operate a multimedia content transmission platform (to broadcast programmed channels) on the other.
Content Liability. ~~In the event that the~~If content sent, transmitted or received via the Internet through an operator’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 iswas 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 Inin Taiwan
Regulation on Shareholding. ~~Respectively in~~In 2000 and 2001 the Cable Radio and Television ~~and Broadcast Law has been~~Act were modified. Under the modified regulations, the original ~~regulation~~regulations of “a single shareholder cannot own more than ~~10%~~10 percent of the total
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issued shares of a cable ~~operator”,~~operator,” and “no shareholder and its related parties may collectively own more than ~~20%~~20 percent of a cable operator’s total issued shares” ~~has been~~were eliminated. Instead, the shares of a cable operator directly or indirectly held by foreign shareholders cannot exceed ~~sixty (60)~~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)~~20 percent of all outstanding shares of the cable operator.
Operating ~~Licenses.~~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~~NCC 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~~The NCC conducts a 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~~NCC 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’s license.
Market Share Limitations. Under the Cable Radio and Television ~~and Broadcast Law,~~Act, the number of subscribers of all affiliated cable operators may not exceed one-third of the total number of cable television subscribers 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. Under the Cable Radio and Television ~~and Broadcast Law,~~Act, the ~~Government Information Office~~NCC 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. Under the Regulation Governing Fixed Network Business described above, cable operators must obtain leased-circuit licenses issued by the ~~Directorate General of Telecommunications~~NCC in order to lease their circuits to companies that provide services through their cable systems. The Directorate General of Telecommunications (which was replaced by the NCC in March 2006) began to accept applications for these licenses from cable operators in June 1999 and most of the cable operators have been granted with leased-circuit licenses to lease out their cable 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~~network business market (such as in leased-circuit business) may be required by the ~~Directorate General of Telecommunications~~NCC 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~~NCC on the cable partners having exclusive relationships with us will eliminate the benefits associated with our exclusive rights.
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~~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. Organizational Structure
We 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 our ~~music distribution business in 2002~~software licensing and ~~our~~online entertainment ~~software~~ business in April 2004 and our online games business in January 2006, we became a ~~diversified~~major provider of ~~broadband Internet access services,~~online entertainment software services. In September 2005, we sold our interest in our land-based music distribution business. The organization chart and ~~application services and music products. The~~the table below ~~sets~~set forth ~~for each of~~ our ~~principal subsidiaries,~~business structure and the name, year and country of incorporation for each of our principal subsidiaries and our percentage holding and principal activities as of June 15, ~~2005:~~2007:
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Entity
   Year of
Incorporation

Place of Incorporation /Operation
   Our Percentage
Holding

Principal 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
*As of June 15, 2007, we own approximately 18.1 million common shares and 15 million convertible voting preferred shares of T2CN, and also control voting rights with respect to 0.85 million common shares of T2CN, which in aggregate represent a controlling interest of 51.12 percent of the total outstanding voting rights of T2CN. The financial results of T2CN will only be consolidated in our financial results for the year ended December 31, 2007.
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Place of Our
Year of Incorporation Percentage
Entity Incorporation Operation Holding Principal Activities
Held by our Company

GigaMedia International Holdings Limited 2004 British Virgin Islands 100 % Holding company

Hoshin GigaMedia Center Inc. 1998 Taiwan 100 % Cable-based Internet access services and FunTown online games portal

Held by Hoshin

GigaMedia Center Inc

Koos Broadband Telecom Co., Ltd. 2001 Taiwan 100 % Broadband Internet access services targeting business clients

Held by GigaMedia

International Holdings Limited

Cambridge Entertainment Software Limited 2004 British Virgin Islands 100 % Holding company

FunTown World Limited 2005 British Virgin Islands 100 % Holding company

GigaMedia Asia Limited 2005 British Virgin Islands 100 % Holding company

GigaMedia Asia Pacific Limited 2006 British Virgin Islands 100 % Holding company

GigaMedia Finance International Limited 2000 Cayman Islands 100 % Holding company

GigaMedia Global Limited 2004 British Virgin Islands 100 % Online game company

GigaMedia (HK) Limited 2004 Hong Kong 100 % Holding company

Skyace Pacific Limited 2006 British Virgin Islands 100 % Holding company

Held by FunTown World Limited

FunTown Hong Kong Limited 1999 Hong Kong 100 % Online games portal

Held by GigaMedia Asia Limited

GigaMedia China Limited 2005 British Virgin Islands 100 % Holding company

Held by Skyace Pacific Limited

Dragongate Enterprises Limited 2006 British Virgin Islands 70 % Online game developer and operator
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Place of Our
Year of Incorporation Percentage
Entity Incorporation Operation Holding Principal Activities
Held by Cambridge

Entertainment Software Limited

Cambridge Interactive Development Corporation 1997 U.S.A. 100 % Software developer and application service provider

Cambridge Interactive Development Corporation (Quebec) Inc. 2005 Canada 100 % Financial and management services

Internet Media Licensing Limited 2005 British Virgin Islands 100 % Software developer and application service provider

Held by GigaMedia

China Limited

T2CN Holding Limited 2004 British Virgin Islands 51.12 %* Online game developer and operator
* As of June 15, 2007, we own approximately 18.1 million common shares and 15 million convertible voting preferred shares of T2CN, and also control voting rights with respect to 0.85 million common shares of T2CN, which in aggregate represent a controlling interest of 51.12 percent of the total outstanding voting rights of T2CN. Owing to the recent nature of this development, we have not provided information relating to T2CN and its business.
D. Property, Plant and Equipment
Our principal executive office and operating office are located at ~~14th Floor,~~14F, No. 122 ~~TunHua~~Tunhwa North Road, Taipei 10595, Taiwan, where we lease approximately ~~24,310~~24,368 square ~~feet.~~feet of office space. We also lease office and other space, ~~as well as~~including space for our servers, in various other locations.
     We operate our software licensing and online entertainment business from ~~G-Music’s~~CESL’s headquarters at ~~10F, No. 171, Chen-Kung Road, Sanchung City, in Taipei County~~100 Cambridge Park Drive, Cambridge, MA 02140, U.S.A., where we lease approximately ~~12,756~~34, 674 square feet, and from the offices of Cambridge Interactive Development Corporation (Quebec) Inc. at 1550 Metcalfe Street, Suite 1510, Montreal, Quebec, H3A 1X6, Canada, where we lease approximately 1,638 square feet.
     We operate our online games business from FunTown’s office in Taiwan at 8F, No. 22, Lane 407, Sec. 2, Tiding Blvd., Taipei 114, Taiwan, where we lease approximately 28,235 square feet, and FunTown’s Hong Kong office at Suite 1403-1405 Sunbeam Plaza, 1155 Canton Rd. KL, Hong Kong, where we lease approximately 4,831 square feet.
     We operate our legacy Internet service and access business from Hoshin GigaMedia’s office at 4F, No.57, Dongxing Road, Taipei 110, Taiwan, where we lease approximately 9,272 square feet, and from KBT’s ~~offices~~office at 6F, No. 20, Lane 478, Rueiguang Road, Neihu District, Taipei 114, Taiwan, where we lease approximately ~~13,060~~13,092 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. The leases typically provide for a term of between three to five years with no renewal option. All of our retail music store leases are on a fixed-rate basis. The terms of 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 4A. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
A. Operating Results
Unless 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.
Overview
     We are a holding company. We operate three principal businesses through our subsidiaries:
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Our software licensing and online entertainment business is operated through our subsidiary, CESL. CESL is a software developer and support services provider. CESL develops software for online entertainment services. As a software developer and support services provider, CESL offers software solutions for online entertainment, which it licenses to UIM under a software license and support service contract.
Our online games business is operated through our subsidiaries Hoshin GigaMedia and FunTown World Limited.
Our Taiwan Internet access service business is operated through our subsidiary, Hoshin GigaMedia, which focuses on consumer users, and Hoshin GigaMedia’s subsidiary, KBT, which focuses on corporate users.
     In 2006, we recorded total operating revenues of approximately US$94.3 million, an increase of approximately US$50.1 million year-over-year, resulting mainly from our software licensing and online entertainment business which had an increase in operating revenues of approximately US$32.5 million year-over-year and the acquisition of FunTown in January 2006. We recorded net income of approximately US$30.8 million, an increase of approximately US$24.5 million year-over-year, and our total costs and expenses increased by approximately US$32.5 million year-over-year to US$72.3 million.
     Prior to April 2004, our main business was to provide broadband Internet access services in Taiwan. Since we did not acquire our software licensing and online entertainment business until April 2004, our historical financial results prior to fiscal 2004 did not reflect the financial results of our software licensing and online entertainment business. As we did not acquire our online games business until January 2006, our historical financial results prior to fiscal year 2006 do not reflect the financial results of our online games business.
Software Licensing and Online Entertainment Business.We acquired our software licensing and online entertainment 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 and the years ended December 31, 2005 and 2006. Our software licensing and online entertainment business generated revenues of approximately US$55.0 million, gross profit of approximately US$47.2 million, and operating income of approximately US$16.8 million in 2006.
     We are dependent on our licensee, UIM, whose financial results were incorporated into our 2004, 2005 and 2006 consolidated financial statements pursuant to FIN 46(R) although we do not own any equity in UIM. See “— A. Operating Results — Overview — Consolidation of UIM Under FIN 46(R).” Under the terms of the licenses granted by us to our licensees (including UIM), we are entitled to a share of the revenues of such licensees and as such, we bear certain economic risks with respect to, and derive certain economic benefits from, their operations.
     Online gaming software design houses and application service providers are our primary competitors. However, given the low barriers to entry in the 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 entertainment 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 differentiate our product offerings from those of our competitors, including: brand, technology, financial stability and resources, proven track record, regulatory compliance, independent oversight and transparency of business practices in our industry.
Online Games Business.We operate our online games business through our subsidiaries Hoshin GigaMedia and FunTown World Limited. FunTown is a leading casual games business with operations throughout Greater China. We acquired FunTown in January 2006 and incorporated results of the business into our consolidated financial statements as of and for the year ended December 31, 2006. Our online games business generated revenues of approximately US$18.7 million, a gross profit of approximately US$15.0 million, and operating income of approximately US$5.6 million in 2006. As we did not acquire our online games business until January 2006, our historical financial results prior to fiscal year 2006 do not reflect the financial results of our online games business.
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     In March 2006, we entered into a strategic alliance with Wretch for the development of an online games community. This strategic alliance was expanded in December 2006 to include the formation of a strategic partnership with Yahoo! Taiwan in connection with its acquisition of Wretch which was completed in May 2007. We have developed a co-branded Web site with Yahoo! Taiwan to co-market our online games on key Yahoo! Taiwan properties. Direct links to the co-branded Web site are also prominently featured throughout Wretch, and have been placed on Yahoo! Taiwan’s online game and messenger homepages with banner advertisement rights designed to attract users to the co-branded Web site. Members of Yahoo! Taiwan are able to directly access FunTown’s games on the co-branded Web site with their Yahoo! login information.
     In December 2006, we entered into a strategic alliance with Infocomm Asia, a Southeast Asian online games operator and distributor offering blockbuster titles such asGranado EspadaandHellgate: London, both under exclusive license for most of Southeast Asia. We also secured an exclusive license to offer and operateHellgate: London, an online game anticipated to be launched in 2007, in the territories of Taiwan, Hong Kong and Macau. We will operateHellgate: London through a strategic joint venture, Dragongate Enterprises, in which we hold a 70 percent interest and Cyber Gateway Pte. Ltd. (a wholly-owned subsidiary of Infocomm Asia) holds a 30 percent interest.
     Online casual game operators in Taiwan and the PRC are currently our primary competitors. We also expect to compete in the future with online casual game and MMORPG operators throughout Greater China. Given the low barriers to entry in the online game industry and the increasing popularity of Internet-based businesses, there are a large number of potential competitors scattered throughout many different segments of the software and Internet industries. In addition to the aforementioned competitors, traditional entertainment service providers and other entities, many of which have significant financial resources and name brand recognition, may provide online game 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 differentiate our product offerings from those offered by our competitors, including: brand, technology, financial stability and resources, proven track record, independent oversight and transparency of business practices in our industry.
Internet Access Service Business.In 2006, we operated a major broadband ISP and provided broadband Internet access service with multiple delivery technologies in Taiwan targeting both consumer and corporate customers. Our Internet access service business generated revenues of approximately US$20.6 million, gross profit of approximately US$8.7 million, and operating income of approximately US$4.2 million in 2006.
     Our consumer 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 2006, consumer access revenues through Hoshin GigaMedia were approximately US$13.7 million.
     In May 2006, we sold our ADSL business to Webs-TV. See “Business Overview.” The resulting decrease in monthly ADSL revenues will be partially offset for the transition period from May 16, 2006 to December 31, 2007 by service revenues from Web-TV for the provision of certain bandwidth and consulting services on a transitional basis. Following the sale of our ADSL business, our retail ISP business is primarily composed of our cable modem broadband business, which accounted for approximately 16 percent of our ISP access revenues in 2006.
     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.
     Our corporate ISP services include leased-line, virtual private networks and other value-added services. Internet access service revenues from our corporate ISP business grew from US$6.5 million in 2005 to US$6.8 million in 2006, and accounted for approximately 33 percent of total Internet access service revenues in 2006. Internet access service revenues from our consumer ISP business declined 9 percent from US$15.1 million in 2005 to US$13.7 million in 2006, and accounted for approximately 67 percent of total Internet access service revenues in 2006 as compared to 70 percent of our Internet access service revenues in 2005.
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     Our Internet access service 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 us. The availability of similar services at competitive prices has made it difficult for us to attract and retain customers. We do not expect to see significant growth in our subscriber base in the future, in line with our ongoing strategy to shift resources away from this legacy business. Consistent with our focus on online entertainment, we have retained financial advisors to explore the sale of this legacy business.
Subsequent Events
     We entered into the following transactions after December 31, 2006.
Acquisition of Controlling Interest in T2CN
     On April 27, 2006, we entered into certain agreements for the formation of a strategic partnership with T2CN, an online casual sports game operator in the PRC, pursuant to which we made an initial investment of US$15 million for the acquisition of 7.5 million shares of convertible preferred stock, subject to customary preferred share rights and protections. Pursuant to a shareholder agreement which we entered into with T2CN and certain of its shareholders in April 2006, which was restated and amended in November 2006, we were granted the right to elect one member to the board of directors of T2CN, and acquired certain veto rights over the management of T2CN. We were also granted rights to subscribe for additional convertible preferred shares of T2CN, based on the financial performance of T2CN in each of the twelve-month periods ended March 31, 2007 and December 31, 2007. In addition, we provided shareholders with an aggregate of approximately 52.92 percent of the issued share capital of T2CN with an option to sell their shares to us within two years from May 8, 2006 at a price equivalent to 8.65 times the net operating income of T2CN per share, subject to certain adjustments.
     In February 2007, we agreed to acquire up to 18.1 million common shares of T2CN, representing 32.39 percent of the outstanding voting rights of T2CN at that date, for a consideration which was to be determined based on the financial performance of T2CN in the first half of 2007 as follows:
(a) US$1.05 per common share if the adjusted net operating income of T2CN for the first half of 2007 was not more than US$1 million;
(b) US$1.25 per common share if the adjusted net operating income of T2CN for the first half of 2007 was between US$1 million and US$1.5 million; or
(c) US$1.45 per common share if the adjusted net operating income of T2CN for the first half of 2007 was not less than US$2.5 million.
     Total consideration payable is in the range of US$19.0 million to US$26.3 million, and is to be paid in two instalments. The first instalment of US$9.4 million and 173,814 shares of our common stock was paid on completion of the acquisition of the shares, with the remaining consideration, ranging from US$7.8 million to US$15.0 million to be paid on August 15, 2007. The consideration for the acquisition is subject to adjustment based on the financial performance of T2CN in the first half of 2007. Following this acquisition, we held approximately 45.79 percent of the total voting rights of T2CN, including voting rights associated with preferred shares held by us.
     In May 2007, we subscribed for an additional 7.5 million convertible preferred shares of T2CN, pursuant to our rights to subscribe for additional convertible preferred shares under the shareholders’ agreement. In June 2007, we also entered into a voting trust agreement with a shareholder of T2CN, pursuant to which we obtained voting rights over an additional 0.85 million common shares of T2CN. We also notified T2CN of our intention to exercise our conversion rights over the convertible voting preferred shares held by us, which conversion is expected to take place in July 2007.
     As of June 15, 2007, we own approximately 18.1 million common shares and 15 million convertible voting preferred shares of T2CN, and also control voting rights with respect to 0.85 million common shares of T2CN, which in aggregate represents a controlling interest of 51.12 percent of the total outstanding voting rights of T2CN. The financial results of T2CN will only be consolidated in our financial results for the year ended December 31, 2007.
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Termination of Subscription Agreement with Wretch
     On December 12, 2006, Hoshin GigaMedia entered into an agreement with Wretch to terminate the subscription rights agreement we signed on March 10, 2006, in connection with, and subject to, the acquisition of Wretch by Yahoo! Taiwan. Under this termination agreement, we gave up our right to acquire a 20 percent equity stake in Wretch if and when Wretch increased its share capital within three years of the date of the subscription right agreement, and we would no longer be obligated to provide Wretch with certain free Internet services after December 31, 2006. Our right to acquire Wretch shares was terminated on May 8, 2007, the closing date of the acquisition of Wretch by Yahoo! Taiwan. Pursuant to the termination agreement, Hoshin GigaMedia obtained compensation from Wretch in the amount of approximately US$0.6 million (NT$20 million) (including VAT).
     In connection with the termination of the subscription rights agreement, we also entered into a co-operation agreement with Yahoo! Taiwan. Under the strategic co-operation arrangement, we have continued to co-operate with Wretch under the original strategic alliance, which has been expanded to include strategic co-operation with Yahoo! Taiwan, to develop a co-branded Web site with co-marketing of FunTown’s games on key Yahoo! Taiwan properties. Direct links to the co-branded Web site are prominently featured throughout Wretch, and have been placed on Yahoo! Taiwan’s online game and messenger homepages with banner advertisement rights designed to attract users to the co-branded site. Members of Yahoo! Taiwan are able to directly access FunTown’s games on the co-branded Web site with their Yahoo! login information.
Investment in Softstar Entertainment Inc.
     In June 2007, we entered into certain agreements for the formation of a strategic alliance with Softstar Entertainment Inc. (“Softstar”), a games design house and online game operator in Taiwan, pursuant to which we made an initial investment of NT$60 million (or approximately US$1.8 million) for the acquisition of 10 million convertible preferred shares, subject to customary preferred share rights and protections. These shares are convertible into an interest of approximately 16.1 percent of the issued common shares of Softstar based on its issued common share capital as of June 11, 2007, and are subject to transfer restrictions for a period of three years from June 11, 2007. Pursuant to these agreements, we obtained the right to nominate one director and one supervisor to the board of Softstar, subject to our holding at least 10 percent of the total number of outstanding shares issued by Softstar on a fully diluted basis. The convertible preferred shares are entitled to receive cumulative dividends accrued at the rate of 3 percent per annum. The convertible preferred shares shall be converted on the third anniversary of the issue date of the shares, or June 11, 2010, into common shares of Softstar on a 1:1 basis, and will be registered with the Gre Tai Securities Market, which is an over-the-counter securities market in Taiwan.
Certain Significant Events Affecting Our Results of Operations for 2004, 2005 and 2006
Change in Reporting Currency and Basis of Presentation
Our consolidated financial statements ~~have~~were historically ~~been~~ reported in New Taiwan dollars. Effective January 1, 2004, we adopted the ~~United States~~U.S. dollar as our reporting currency because operations denominated in the ~~United States~~U.S. dollar have represented an increasing portion of our business following the acquisition of our software licensing and online 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~~Rates.”
Discontinued Operations
Divestiture — Music Distribution Business
     On September 29, 2005, we sold our land-based music distribution business to Nextbase International Limited. The music distribution business has been accounted for as a discontinued operation under U.S. GAAP and, therefore, the results of operations for all periods presented have been restated to reflect the result of the music distribution business as a discontinued operation.
     See Note 1, “Business Overview, Basis of Presentation, and Summary of Significant Accounting Policy” of our consolidated financial statements for further information.
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     Summary select financial information for ~~2002~~discontinued operations is as follows:

2004 2005
(in US$ thousands)
Revenues $ 66,975 $ 37,907

Income (loss) before tax and minority interest income $ 752 $ (1,861 )

Income tax (benefit)/expenses $ 5 $ (1 )

Minority interest income (loss) $ 318 $ (796 )

Income (loss) from discontinued operations $ 429 $ (154 )

     Major classes of assets and ~~2003~~liabilities which comprised the music distribution business at the date of disposal, September 29, 2005, included the following:

(in US$ thousands)
Cash (including restricted cash) $ 3,098
Accounts receivable 1,842
Inventory 6,679
Other current assets 683
Property and equipment 1,666
Intangible assets 4,689
Other assets 1,553

Total Assets $ 20,210

Accounts payable $ 11,239
Other liabilities 1,945

Total liabilities $ 13,184

Divestiture of our ADSL Business
     On May 15, 2006, we entered into an asset purchase and sale agreement and a transition service agreement with Webs-TV to sell our ADSL business and provide certain transition services. Under the agreements, Webs-TV purchased our ADSL business and agreed upon services in an all cash transaction with a total price of approximately US$18.1 million (including VAT). Approximately US$8.9 million of the price is for the ADSL business, and approximately US$0.9 million of the price is for the right to use our ADSL brand for five years. Both are payable from May 15, 2006 through July 31, 2007. Approximately US$8.3 million represents fees for bandwidth, consulting and other support services to be provided by Hoshin GigaMedia on a transitional basis through December 31, 2007, and is payable from May 15, 2006 through February 28, 2008. Cash proceeds received in 2006 from the sale of the ADSL business, net of transaction costs and VAT, were approximately US$3.3 million. We expect to receive approximately US$5.0 million in 2007 related to this sale, net of transaction costs and VAT. The transferred ADSL business includes our ADSL-related equipment, business contracts, and subscription contracts between Hoshin GigaMedia and approximately 62,000 ADSL subscribers. For further information, please see Note 4 of our financial statements.
     Our results of continuing operations in 2006 included a pre-tax one-time gain from the sale of the ADSL business of US$7.7 million, which was recorded in non-operating income. The ADSL business does not qualify under FAS 144 as a component that may be reported as discontinued operations since the operations and cash flows of ~~December 2002~~our ADSL business cannot be clearly distinguished operationally and ~~December 2003 presented in this annual report are different~~for financial reporting purposes from ~~that presented in~~the rest of our ~~annual reports for 2002 and 2003.~~
ISP business. Therefore, we have not reported the sale of or ADSL business as discontinued operations.
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~~ 51,” (“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
49

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 online entertainment ~~software~~ operations. The contract allows us to charge a percentage of UIM gross receipts resulting from UIM’s online entertainment operations. The percentage of gross receipts varies depending upon the software and support services selected by UIM. We analyzed the provisions of FIN 46(R) as it relates to contractual relationships and determined that we ~~are a~~were and continue to be the primary beneficiary of ~~a software licensee,~~ UIM. As a result of ~~this~~such determination, we have incorporated the results of UIM into our consolidated financial statements as of and for nine months ended December 31, 2004, and as of and for the years ended December 31, 2005 and 2006, even though we ~~do not~~ own ~~any~~none of UIM’s equity. UIM’s net assets as of December 31, ~~2004~~2005 and 2006 were approximately US$~~414 thousand~~0.6 million and US$0.8 million, respectively, and the consolidation of UIM resulted in an increase in our assets and liabilities of approximately US$~~1.6~~3.5 million and US$~~1.2~~2.9 million in 2005, respectively, and US$12.8 million and US$12.1 million in 2006, 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. Through our subsidiaries, we provide broadband Internet access services, develop online entertainment software and provide application services, and distribute recorded music. Our Taiwan 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, which controls Taiwan’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 April 2004, our main business was to provide broadband Internet access services and distribute recorded music in Taiwan. Since we did not acquire our entertainment software business until April 2004, our historical financial results prior to fiscal 2004 did not reflect the financial results of our entertainment software business and year-over-year comparison of this business segment is not included in this annual report. Also a full-year consolidation of this business would have a much greater impact on our financial results than as presented in this annual report.
~~Broadband ISP Business.~~ We operate a major broadband ISP and provide broadband Internet access service with multiple delivery technologies in Taiwan targeting both consumer and corporate customers. Our broadband ISP business generated revenues of approximately US$21.4 million and operating income of approximately US$1.0 million in 2004.
Our consumer 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 broadband Internet 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 seeking 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, CESL, which develops Internet-based entertainment software and provides 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, which owns Taiwan’s two largest retail music distribution chains, Rose Records and Tachung Records. We acquired our interests in 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. 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 changing 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.
~~Application of~~ Critical Accounting Policies

The 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 U.S., or U.S. GAAP. The preparation of these financial statements requires us 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 our Company, which are those that are most important to the portrayal of the financial condition and results of operations of our Company, and require management’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.

~~Acquisition~~Acquisitions

~~During 2002, we acquired Taiwan’s two leading music store chains, Rose Records and Tachung Records for approximately US$18.3 million for a 58.58% ownership stake in these businesses.~~

During 2004, we acquired Grand Virtual, Inc. and certain of its affiliates in a private transaction from the founding shareholders of GV Enterprise Voting Trust, through our wholly-owned subsidiary, CESL, for an all-cash consideration of US$32.5 million.

On December 19, 2005, we entered into a definitive agreement with TWP to acquire FunTown. In January 2006, we completed the acquisition of FunTown and purchased certain assets and assumed certain liabilities of FunTown for a total consideration of approximately US$43 million, which included cash payments of approximately US$27.2 million and zero coupon convertible notes in the aggregate principal amount of approximately US$15 million with a valuation premium on the convertible notes of approximately US$0.8 million as determined by a third-party valuer. The transaction also included an incentive in the form of an additional amount to be paid by GigaMedia on April 1, 2007, which amount was to be determined based on the increase of adjusted pre-tax income of FunTown in 2006 as compared to 2005 as follows:

(i)

If the increase in 2006 was 30 percent or more, an additional payment of US$5 million;

(ii)

If the increase in 2006 was 15 percent or above but less than 30 percent, a reduced incentive payment; or

(iii)

If the increase in 2006 was less than 15 percent, no additional payment.

Adjusted pre-tax income of FunTown includes certain pre-agreed upon non-GAAP adjustments to the GAAP pre-tax income. At December 31, 2006, we accrued an additional payment of US$5 million, which was subsequently paid in April and May 2007, since the adjusted pre-tax income of FunTown in 2006 increased more

than 30 percent as compared to 2005. We also redeemed the zero coupon convertible notes in full between July and September 2006.

In the absence of a quoted market price for ~~the shares of~~ these businesses, the acquisition prices of these businesses were determined based on management’s estimates for the fair value of the acquired net assets, including goodwill and ~~amortizable~~ intangibles. ~~The actual fair value of such acquired net assets may differ significantly from management’s estimates.~~ We determined the purchase price allocation based on estimates of the fair values of the tangible and intangible assets acquired and liabilities assumed at the date of acquisition. 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 the assets acquired and liabilities assumed ~~are~~is recorded as goodwill.

The actual fair value of such acquired net assets may differ significantly from management’s estimates.

Revenue Recognition

We ~~recorded~~recognize revenues 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.

We enter into multiple-element revenue arrangements, which may include any combination of services, software, and/or products. To the extent that a deliverable in a multiple-element arrangement is subject to specific guidance (e.g. leased cable modems and Internet access-related equipment solutions which are subject to Statement of Financial Accounting Standards (FAS) No. 13, “Accounting for Leases,” and online gaming software that is subject to the American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) No. 97-2, “Software Revenue Recognition,”) whether and/or how to separate multiple deliverable arrangements into separate units of accounting (separability) and how to allocate the arrangement consideration among those separate units of accounting (allocation) for that deliverable is accounted for in accordance with such specific guidance. All other deliverables in multiple-element arrangements are accounted for in accordance with EITF 00-21 “Revenue Arrangements with Multiple Deliverables.”

In addition to the aforementioned general policies, we have adopted specific revenue recognition policies for each major category of revenue.

Software Licensing and Online Entertainment Revenues

We record revenues from ~~broadband~~our software licensing and online entertainment business from licensing our software and providing support services. These revenues are recognized monthly as a fixed percentage of our licensees’ gross receipts. Under the provisions of FIN 46(R), the results of UIM, our major licensee, have been incorporated into our 2004, 2005 and 2006 consolidated financial statements. UIM and GigaMedia are separately owned. (See Note 3 of our financial statements for additional information). Our software licensing and support service revenues are based upon a percentage of gross receipts generated by UIM’s online gaming operations, and are recognized monthly. Software licensing and support service revenues we receive from providing such services to UIM have been eliminated in consolidation.

Multiple-element revenue arrangements involving UIM’s provision of software and software-related elements to customers are accounted for in accordance with SOP 97-2. UIM earns revenues by providing and promoting online games of skill and chance that are available on its gaming software, which may be downloaded free of charge. Generally, UIM operates online casino destinations in which players place bets against the house, and also operates an online multi-player poker platform in which players place bets among themselves, for which UIM charges a small transaction fee in each game played. Accordingly, revenues earned by UIM comprise mainly net house win and transaction fees. UIM’s online gaming service is inseparable from the software element involved and UIM does not sell each element separately. UIM’s online gaming service does not involve significant production, modification, or customization of the gaming software. Revenues derived from UIM’s online gaming software platform incorporated in our financial statements in accordance with FIN 46(R) are recognized at the time the games are played and are net of player earnings. Player account balances are presented as current liabilities, which are first accrued for in full upon the receipt of player deposits, and increased or decreased based on player activities, including player wins, losses, withdrawals and refunds. Transaction fee revenues derived from UIM’s online multi-player poker platform are recognized as services are provided. Residual expenses and commissions are charged to expenses as incurred.

Online Game Revenues

Online game revenues are related to our online games business in Asia.

Online game revenues are collected through the sale of online game points, pre-paid cards, and game packs. Virtual online game points are sold directly to end-users who can make the payments through credit cards or channel partners such as telecommunication service operators. Physical pre-paid cards and game packs are sold through distributors and convenience stores. Proceeds from sales of online game points, physical cards and game packs, net of sales discounts, are deferred when received and revenue is recognized upon the actual usage of the playing time or in-game services by the end-users; over the estimated useful life of virtual items; or when the sold game points expire and are no longer eligible to access the online games or products in accordance with our published game points expiration policy.

Revenue recognized on the sales of virtual online game points is reported on a gross basis, which includes service fees paid to channel partners for payment processing. Fixed percentage fees retained by channel partners for payment processing related to our online game services are recognized as cost of online game revenues.

Internet Access Service Revenues

Internet access service revenues include revenues derived from cable modem Internet access services, ~~as well as fee-based~~ADSL Internet access service business, which we sold in May 2006 (see Note 4 of our financial statements for additional information), Internet access services to corporate customers, IP bandwidth services to cable operators which ~~mainly include subscription~~enable them to offer their own cable modem services, ~~for videostreaming~~ and ~~paid email~~Internet access-related services, including non-refundable activation fees, billing and consulting services, and other value-added services. ~~Such~~

Cable modem, ADSL, and corporate revenues are ~~recognized for~~recorded net of discounts, and in the ~~period~~case of our cable modem and corporate services, net of fees paid to our cable partners in ~~which the service is performed, if no significant company obligations remain~~accordance with revenue sharing agreements in effect between our Company and ~~collection of the receivables is reasonably assured.~~our cable partners. 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~~our balance sheet and ~~amortizes~~amortize such revenues over the subscription period. ~~We contract with third party content providers for certain services~~Revenues related to ~~subscribed content transmitted~~provision of bandwidth to ~~our users and record~~cable operators are recognized either on the ~~fees charged~~basis of revenue sharing from cable operators, or on the basis of the subscriber numbers, or by the ~~third parties~~level of bandwidth usage. Non-refundable activation fees are combined with our Company’s Internet access revenues as ~~cost~~a single unit of ~~revenues.~~

~~We recorded revenues~~accounting. Since the activation fees are not in exchange for services performed that represent the culmination of a separate earnings process, such fees are deferred in accordance with the Staff Accounting Bulletin Topic 13 “Revenues Recognition.” As part of our ~~entertainment software business through licensing~~Internet access-related services, our ~~software~~Company also provides a variety of value-added services, including billing, consulting, co-location, and ~~providing support~~VPN services to corporate customers, and premium mail, Web storage space, and online photo albums, to retail customers. The value-added services are not bundled together as a group of services within one contract, nor are they bundled with any of our Company’s broadband access services. ~~These~~

All Internet access service revenues are recognized ~~monthly as~~on a ~~fixed percentage of a licensee’s gross receipts. The results of UIM, our licensee, as of and~~straight-line basis over the subscription period or for the ~~nine months ended December 31, 2004 have been incorporated into~~period in which the service is performed if no significant Company obligations remain and collection of the receivables is reasonably assured.

Our Company also provides cable modem equipment and Internet access-related equipment solutions to our ~~consolidated financial statements. Software licensing~~subscribers on an operating lease basis. The rental service is bundled with the access service contract. Pursuant to EITF 00-21 and ~~support services~~FAS 13, the contract considerations are allocated among/between the FAS 13 deliverable and non-FAS 13 deliverable(s) based on their relative fair values. For the leased cable modem, the amounts attributable to the rental elements are negligible and rental revenue is recognized over the same period as the access service is rendered. Our Company therefore does not allocate the FAS 13 deliverable separately from the total contract considerations. For leased Internet access related equipment solutions, the FAS 13 element is separated from the contract considerations and reported under the caption, “Other Revenues.”

Other Revenues

Other revenues ~~we received~~consist of sales of other Internet access-related products and rental income from ~~UIM have been eliminated in consolidation. See “— A. Operating Results — Overview — Consolidation~~the lease of ~~UIM Under FIN 46(R)” above. UIM generates revenues by providing~~Internet access-related equipment to subscribers of our Company’s Internet access service business, and ~~promoting online games of chance and skill. Revenues~~ are recognized ~~upon receipt. End-user account balances~~when products are ~~recognized as current liabilities and~~delivered or services 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.~~

provided.

Discontinued Operations

For 2004 and 2005, a portion of our Company’s 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~~were recognized at the point of sale to the consumer, at which time payment iswas tendered.

Our Company’s policy was to not accept sales refunds or exchanges.

We disposed of our music distribution business in September 2005, and as a result have classified the income from these revenue-generating activities as part of discontinued operations.

Deferred Revenues

Deferred revenues consist of the prepaid fees related to our online games business, and the advance payment receipts related to Internet access services.

Prepaid fees related to our online games business are recognized as revenues upon the actual usage of the playing time or in-game services by the end-users; over the estimated useful life of virtual items; or when the sold game points expire and are no longer eligible to access the online games or products in accordance with our published game points expiration policy.

The advanced payment receipts related to Internet access services are deferred and amortized over the relevant subscription period.

Operation Costs

Cost of sales consists primarily of online entertainment and online game processing costs, online game royalties, production costs for prepaid game cards, amortization of intangible assets, customer service department costs for our online game and Internet access businesses, Internet access engineering costs, Internet access bandwidth costs, and depreciation, maintenance and other overhead expenses directly attributable to the provision of software licensing and online entertainment, online game, and Internet access service revenues.

Allowance for Doubtful Accounts

An allowance for doubtful accounts is provided based on ~~management’s~~an evaluation of collectibility of notes receivable, accounts ~~receivables~~receivable and other receivables. ~~The actual value~~

Classification of ~~such acquired net assets may differ significantly from management’s estimates.~~
Marketable Securities
~~Our~~

All of 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 or securities that management intends to sell within one year. Securities classified as non-current ~~including non-equity method investments,~~include securities that have a maturity of more than one year or securities that management does not intend to sell within one year. ~~These investments~~Marketable securities principally consist of debt securities and equity securities of public and privately held companies and investment funds. Debt securities and equity securities of public 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. Equity securities in non-publicly traded companies are primarily accounted for using the cost method. Unrealized losses that are considered ~~other than temporary~~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$~~29.0~~20.4 million and US$~~34.3~~13.8 million of investments classified as current marketable securities as of December 31, ~~2003~~2005 and ~~2004. The~~2006, respectively. As of December 31, 2005 and 2006, the balances of unrealized gains from these securities were approximately US$00.3 million and US$~~577 thousand respectively,~~0.6 million, respectively. There

is no unrealized loss for current marketable securities as ofat December 31, ~~2003 and 2004.~~2006. 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 investment of approximately US$2.9 million ~~investment~~ in Gamania Digital Entertainment Co., Ltd.~~, or Gamania.~~ (“Gamania”). Our investment represented ~~4,905 thousand~~4,905,000 shares or approximately ~~3.32%~~3 percent ownership in Gamania. We ~~have~~had no ability to exercise significant influence over Gamania’s operating and financial policies. The market price of Gamania’s shares ~~has~~had 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~~2005, our investment in Gamania shares was classified as marketable securities-current, as a result of our agreement with JSDWAY Digital Technology Co., Ltd (“JSDWAY”) regarding the purchase and ~~2004,~~sale of Gamania shares. Pursuant to the ~~balance~~agreement, we granted JSDWAY an option to buy, at NT$18.70 per share, a total of ~~unrealized losses was~~4,905,000 common shares of Gamania owned by us, and JSDWAY granted us an option to sell to JSDWAY, at NT$18.70 per share, the Gamania shares owned by us. JSDWAY also provided a deposit as a guarantee for fulfillment of its payment obligations under the aforementioned agreement. Due to this arrangement with JSDWAY, the Gamania securities were classified as marketable securities-current and marked-to-market at NT$18.70 per share in our consolidated financial statements for 2005. In December 2006, we entered into a termination agreement with JSDWAY to terminate the option agreement, and thereafter sold all of the Gamania Shares in the public market recording an after tax gain on the sale of approximately US$~~460 thousand~~2.1 million.

We had approximately US$0 million and US$0,25 million of investments classified as non-current marketable securities as of December 31, 2005 and 2006, respectively. ~~See Note 12~~As of December 31, 2006, our non-current marketable securities consisted primarily of our ~~consolidated financials statements~~investments in RMC, T2CN and Infocomm Asia.

Rock Mobile (Cayman) Corporation (“RMC”)

On December 31, 2005, we exchanged all of our 3,000,000 Rock Internet Corporation (“RIC”) shares for ~~2004~~646,859 ordinary shares, or a 1.04 percent shareholding in RMC, a company headquartered in Mainland China that provides music-related digital entertainment content and services through mobile networks and telecommunication devices. RIC had a 24.02 percent effective beneficial shareholding in RMC before the share exchange. As of December 31, 2006, we held an approximate 0.88 percent direct shareholding in RMC. Our shareholding in RMC was diluted in 2006 as a result of RMC’s new share issuance during the year. In 2002 and 2003, this investment had been considered impaired due to the downturn in the music industry and the significant operating losses incurred by RIC, and the investment balance was fully written off.

T2CN

Pursuant to a strategic investment agreement and a preferred share purchase agreement, both dated April 27, 2006, we acquired 7,500,000 voting convertible preference shares of T2CN for an aggregate consideration of US$15 million. These shares are convertible into 7,500,000 ordinary shares, representing an approximate 19.02 percent interest in the issued share capital of T2CN as of the date of the agreement. Pursuant to a shareholders’ agreement which we entered into with T2CN and certain of its shareholders in April 2006, which was subsequently amended and restated in November 2006, we also obtained the right to elect one director to the board of directors of T2CN, and acquired certain veto rights over the management of T2CN. We were also granted rights to subscribe for additional ~~information.~~
~~Merchandise Inventory~~
~~Inventory is stated at the lower~~convertible preferred shares 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, by adjusting the gross inventory cost with inventory provisions. In some instances, these provisions can have a material effectT2CN, based on the financial ~~results~~performance of T2CN in each of the twelve-month periods ended March 31, 2007 and December 31, 2007. In addition, we provided shareholders with an ~~annual~~aggregate of approximately 52.92 percent of the issued share capital of T2CN with an option to sell their shares to us within 2 years from May 8, 2006 at a price equivalent to 8.65 times the net operating income of T2CN per share, subject to certain adjustments. Such put price can be settled in cash or ~~interim period. In order to determine such provisions, we estimate~~in our shares. We have evaluated the terms of the put option and determined that the fair value of ~~merchandise inventory~~such put option is immaterial.

The convertible preferred shares have an initial liquidation preference equal to 1.2 times the original investment plus compound annual interest of 15 percent, are entitled to receive cumulative dividends, at 8 percent per annum on the aggregate nominal value of ordinary shares into which the preferred shares may be converted, and ~~record any provision if estimated market value~~are redeemable at their original issue price starting December 31, 2009.

They are convertible into T2CN common shares on a one-for-one basis, subject to certain adjustments, and shall be automatically converted upon the closing of a qualified public offering or the election of the holders of at least 50

percent of the outstanding preferred shares. The embedded conversion options of the preferred shares do not meet the definition of derivative instruments under FAS 133 “Accounting for Derivatives Instruments and Hedging Activities,” (“FAS 133”) and are not bifurcated from the preferred share investment. We have applied the guidance provided in EITF 02-14 “Whether an Investor Should Apply the Equity Method of Accounting to Investment Other Than Common Stock,” (“EITF 02-14”) to determine whether our preferred share investments are in substance common shares which should be accounted for under the equity method. Given that our preferred shares have substantive liquidation preferences over those of T2CN’s common shares, we have accounted for our preferred share investment in T2CN under the cost method.

We assessed potential impairment of our T2CN investment, and concluded that no write-down was required as of December 31, 2006.

In February 2007, we acquired 18.1 million shares of T2CN, representing 32.39 percent of the outstanding voting rights of T2CN at that date, for a total consideration in the range of US$19.0 million to US$26.3 million. The consideration for the acquisition is ~~below cost and if inventory~~subject to adjustment based on the financial performance of T2CN in the first half of 2007. In May 2007, we exercised our right under the shareholders’ agreement to subscribe for an additional 7.5 million convertible preference shares in T2CN. In June 2007, we also entered into a voting trust agreement with a shareholder of T2CN, pursuant to which we obtained voting rights over an additional 0.85 million common shares of T2CN. We also notified T2CN of our intention to exercise our conversion rights over the convertible voting preferred shares held by us, which conversion is ~~obsolete. Actual inventory loss may differ significantly from management’s estimates. Through merchandising and other initiatives, we attempt~~expected to take place in July 2007.

As of June 15, 2007, we own approximately 18.1 million common shares and 15 million convertible voting preferred shares of T2CN, and also control voting rights with respect to 0.85 million common shares of T2CN, which in aggregate represents a controlling interest of 51.12 percent of the ~~steps necessary~~total outstanding voting rights of T2CN.

Infocomm Asia

Pursuant to ~~increase~~a share subscription agreement dated December 7, 2006, we acquired 500,000 voting convertible preference shares of Infocomm Asia for an aggregate consideration of US$10 million. These shares are convertible into 500,000 ordinary shares, representing an approximate 32.26 percent interest in the ~~sell-off~~issued share capital of ~~slower moving merchandise~~Infocomm Asia as of December 7, 2006, which would make our Company the largest shareholder of Infocomm Asia on an as converted basis. We also obtained the right to ~~eliminate~~elect one director to the board of directors of Infocomm Asia. The purchase price may be settled in cash or ~~lessen~~shares at our Company.

The convertible preferred shares have an initial liquidation preference which equals the ~~effect~~subscription price of ~~any inventory provisions.~~$10 million, are entitled to receive cumulative dividends, at 8 percent per annum, and are redeemable within five years of their issuance date. The redemption amount is the preferred share issuing cost plus interest accrued at the rate of 10 percent per annum.

One preferred share is convertible into one common share of Infocomm Asia, subject to certain adjustments and limitations, and shall be automatically converted into the common shares of Infocomm Asia upon the closing of a qualified public offering or the election of the holders of at least 70 percent of the same class of outstanding preferred shares. The embedded conversion options of the preferred shares do not meet the definition of derivative instruments under FAS 133, and are not bifurcated from the preferred shares investment.

We have applied the guidance provided in EITF 02-14 to determine whether our preferred share investments are in substance common shares which should be accounted for under the equity method. Given that our preferred shares have substantive liquidation preferences over those of Infocomm Asia’s common shares, we have accounted for our preferred share investment in Infocomm Asia under the cost method.

We assessed potential impairment of our Infocomm Asia investment, and concluded that no write-down was required as of December 31, 2006.

Impairment of Long-Lived Assets

Fixed 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 ~~2004,~~2006, we did not record any asset impairment charges.

Impairment of Intangible Assets

We have significant amortizable intangible assets arising from the ~~acquisitions~~acquisition of ~~Rose Records, Tachung Records~~CESL and ~~CESL.~~Fun Town and the capitalization of software development costs in our software licensing and online entertainment business and online games business. The amortizable intangible assets are amortized on a straight-line basis over estimated useful lives ranging from two to ~~fifteen~~ten years. As of December 31, ~~2004,~~2006, the balance of amortizable intangible assets was US$~~8.4~~12.3 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 fair 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. Based on our impairment test performed in ~~2004,~~2006, we did not record any intangible assets impairment loss for ~~2004.~~2006. 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 No. 142, “Goodwill and Other Intangible ~~Assets”, or~~ Assets,” (“FAS ~~142.~~142”). Under the provisions of FAS 142, goodwill is no longer subject to amortization and the potential impairment of goodwill and purchased intangible assets with indefinite useful lives will be evaluated at least 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 an impairment test of our goodwill as of December 31, ~~2004~~2006 and recorded no goodwill impairment loss for ~~2004.~~2006. However, as the value of goodwill 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.~~
occurs.

Income 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,~~bases. Loss carryforwards and investment credits are measured using the enacted tax ~~loss carryforwards.~~rate and laws that will be in effect in different jurisdictions in which we operate when the differences are expected to reverse. 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’s estimate of ~~realizability.~~realization. Due to the slow market growth and strong competition we face in our ~~broadband ISP~~Internet access service 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 ana full allowance for ~~substantially~~ all ~~the value~~ of the aggregate net deferred tax assets as of December 31, ~~2004.~~2006. Actual results may differ significantly from management’s estimate.

Minority Interest

Minority interest includes 100 percent of the common stock of UIM held by outside shareholders. UIM was deemed a VIE as defined by FIN 46(R) and our Company was considered the primary beneficiary of UIM. Under

the provisions of FIN 46(R), we have incorporated the results of UIM into our 2004, 2005 and 2006 Consolidated Financial Statements, even though we own none of UIM’s equity. For more information, please see Note 3 of our financial statements.

Beginning in December 2006, minority interest also includes 30 percent of the common stock of Dragongate Enterprises. 30 percent of the common stock of Dragongate Enterprises is held by an outside shareholder, Cyber Gateway Pte Ltd, which is 100 percent owned by Infocomm Asia. Infocomm Asia is one of our Company’s investments, and is accounted for using the cost method. For more information, please see Note 12 of our financial statements.

Prior to the sale of the music distribution business on September 29, 2005, minority interest also included 41.42 percent of the common stock of G-Music Limited held by outside shareholders; subsequent to the divestiture of G-Music Limited, related minority interest income was included in discontinued operations.

Share-Based Compensation

Prior to January 1, 2006, we elected to measure stock-based compensation expense using the intrinsic value method 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 the fair-value method of accounting defined in FAS No. 123 “Accounting for Stock-Based Compensation,” (“FAS 123”) were used.

Effective January 1, 2006, we adopted the fair value recognition provisions of FAS No. 123(R), “Share-Based Payment” (“FAS 123(R)”), using the modified prospective method and therefore have not restated results for prior periods. Under this transition method, stock-based compensation expense for the year ended December 31, 2006 includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of January 1, 2006 based on the grant date fair value estimated in accordance with the original provision of FAS 123. Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006, is based on the grant date fair value estimated in accordance with the provision of FAS 123(R). FAS 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods. In connection with the adoption of FAS 123(R), we changed our method of attributing the value of stock-based compensation to expense from the graded-vesting method to the straight-line method. Compensation expense for all share-based payment awards granted on or prior to December 31, 2005 will continue to be recognized using the graded-vesting method, while compensation expense for all share-based payment awards granted subsequent to December 31, 2005 are recognized using the straight-line method. Because our Company had not recorded any compensation cost in our Statement of Operations prior to the adoption of FAS 123(R), no cumulative effect adjustment was recorded upon adoption. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 (“SAB 107”) regarding the SEC’s interpretation of FAS 123(R) and the valuation of share-based payments for public companies. We have applied the provision of SAB 107 in our adoption of FAS 123(R). For more information, please see Note 19 of our financial statements.

Retirement Plan and Net Periodic Pension Cost

Under our defined benefit pension plan, net periodic pension cost, which includes service cost, interest cost, expected return on plan assets, and amortization of unrecognized net transition obligation and gains or losses on plan assets, is recognized based on an actuarial valuation report. Effective December 31, 2006, we adopted the provisions of FAS No. 158, “Employer’s Accounting for Defined Benefit Pension and Other Post-Retirement Plans — An Amendment of FASB Statements Nos. 87, 88, 106, and 132(R),” (“FAS 158”). FAS 158 requires the recognition of the funded status of pension plans and non-pension post-retirement benefit plans (retirement-related benefit plans) as an asset or a liability in the consolidated balance sheets. In addition, the pronouncement requires previously unrecognized items, such as actuarial gains and unrecognized prior service costs or credits, to be recognized on the consolidated balance sheets as a component of other comprehensive income (loss). The provisions of FAS 158 were adopted pursuant to the transition provisions therein. (See Note 17 of our financial statements for additional information, including the incremental effect of the adoption on our Consolidated Financial Statements.)

Under our defined contribution pension plan, net periodic pension cost is recognized as incurred.

Recent Accounting Pronouncements

In March 2006, the FASB issued FAS No. 156, “Accounting for Servicing of Financial Assets — an Amendment of FASB Statement SFAS No. 140, (“FAS 156”). FAS 156 simplifies the accounting for loan servicing rights and the financial instruments used to hedge risks associated with those rights. FAS 156 requires that servicing rights be valued initially at fair value, and subsequently accounted for at either fair value, or amortized over the economic life of the related lease. The provisions of FAS 156 will be effective for fiscal years beginning after September 15, 2006. The adoption of FAS 156 is not expected to have a material impact on our financial statements.

In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (“FIN 48”), which prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. The provisions of FIN 48 will be effective for fiscal years beginning after December 15, 2006. We are in the process of determining what effect, if any, the adoption of FIN 48 will have on our financial statements.

In September 2006, the SEC released Staff Accounting Bulletin (SAB) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” (“SAB 108”), which provided the Staff’s view regarding the process of quantifying financial statement misstatements. SAB 108 requires an entity to quantify misstatements using both a balance sheet and income statement approach to determine if a misstatement is material. Our Company adopted SAB 108 in fiscal 2006, and it did not have a material effect on our financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measures,” (“FAS 157”), which defines fair value, establishes a framework for measuring fair value and expands disclosures about assets and liabilities measured at fair value. The statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. We are in the process of determining what effect, if any, the adoption of FAS No. 157 will have on our financial statements.

In September 2006, the FASB issued FAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Post Retirement Plans — an Amendment of FASB Statements No 87, 88, 106 and 132(R),” (“FAS 158”). FAS 158 improves reporting of obligations for pensions and other post-retirement benefits by recognizing the over-funded or under-funded status of plans as an asset or liability. The pronouncement does not change how plan assets and benefit obligations are measured under FAS 87 and FAS 106 nor does it change the approach for measuring annual benefit cost reported in earnings. Rather, it eliminates the provisions that permit plan assets and obligations to be measured as of a date not more than three months prior to the balance sheet date, instead requiring measurement as of the reporting date. In addition, the pronouncement requires previously unrecognized items, such as actuarial gains and unrecognized prior service costs or credits to be recognized on the balance sheet as a component of other comprehensive income (loss). We adopted FAS No. 158 as of December 31, 2006, and the adoption had no material impact on our financial statements. (See Note 17, “Pension Benefits,” for additional information, including the incremental effect of the adoption on our financial statements.)

In February 2007, the FASB issued FAS No. 159, “The Fair Value Option for Financial Assets and Liabilities,” (“FAS 159”). FAS 159 permits companies to choose to measure many financial instruments and certain other items at fair value. If the fair value option is elected, unrealized gains and losses will be recognized in earnings at each subsequent reporting date. FAS 159 is effective for fiscal years beginning after November 15, 2007. We are in the process of determining what effect, if any, the adoption of FAS No. 159 will have on our financial statements.

Foreign 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 business following the acquisition of our software licensing and online entertainment business. Our financial results may be impacted by fluctuations of exchange rates between the NT dollar and the U.S. dollar, exposing us to foreign currency exchange risks. We have not sought to reduce our exposure to exchange rate fluctuations by using hedging transactions. However, we may choose to do so in the future. We recognized a foreign exchange loss of approximately US$0.8 million for 2004, and a gain of approximately US$0.2 million for 2005 and a loss of approximately US$0.2 million for 2006.

Taxation

At December 31, 2006, we had net operating loss carryforwards for tax purposes of approximately US$12.3 million and US$0.1 million, arising from our Internet access services operations in Taiwan and from our online games business in Hong Kong, respectively. These operating loss carryforwards will expire at various times from December 2007 through December 2009 for Taiwan and infinitely for Hong Kong. At December 31, 2006, we had a deferred tax asset of US$4.0 million, relating principally to our net operating loss. Our ability to realize the value of our deferred tax asset depends on many factors, including (among others) an assessment of our ability to generate taxable income, overall industry outlook and the outlook for the Taiwan and Hong Kong economies. We value our deferred income tax assets on an ongoing basis, and make valuation allowances if, in our assessment, current results suggest that it is more likely than not that a portion or all of our deferred income tax assets will not be realized before their expiration. We determined that valuation allowance was required as of December 31, 2004, 2005 and 2006. The current corporate income tax rate in Taiwan is 25 percent. Any future taxable income derived from Taiwan-based operations exceeding these operating loss carryforwards will be subject to Taiwan income tax.

As per the R.O.C. income tax laws, 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 percent retained earnings tax. This rule applies primarily to our Internet access service business and our online games portal whose principal operating entities are incorporated under Taiwan law.

On January 1, 2006, the R.O.C. government enacted the AMT Act. AMT imposed under the AMT Act is a supplemental tax which is payable if the income tax payable pursuant to the R.O.C. Income Tax Act is below the minimum amount prescribed under the AMT Act. The AMT rate for business entities is 10 percent. The taxable income for calculating the AMT includes most income that is exempted from income tax under various legislations, such as tax holidays and investment tax credits. For example, gains on disposal of marketable securities from our Taiwan-based entities were exempt from income tax based on Taiwan tax laws prior to AMT Act. However, such gains will need to be included for the purpose of calculating the AMT. The AMT did not have a material effect on our income tax expense in 2006.

The majority of our software licensing and online entertainment business is located outside the United States, with the exception of CIDC, an entity registered in Delaware, which is subject to U.S. federal income tax, state tax and local tax. Current U.S. federal income tax rate and state and local tax rates applicable to our business for the year ended December 31, 2006 are 34 percent and 6.8 percent, respectively. Our operations in the United States did not have a significant tax impact on the Company’s consolidated financial statements.

Discussions of Results of Operations

Factors Affecting Our Performance

We believe that the following are the principal factors affecting our results of operations:

Acquisitions and dispositions.We have made several significant acquisitions and dispositions of businesses during the past several years, and may enter into additional acquisition and disposition transactions in the future. Past acquisitions and dispositions have had a significant impact on our results of operations over the past several years, and if we engage in such transactions in the future, the nature, amounts and timing of our revenues, expenses and cash flows and the nature and amounts our assets and liabilities are likely to be materially affected.

Development of online gaming and online games industries.The gaming software and online games industries are in relatively early stages of development. We believe that our results of operations are likely to be affected by developments in these industries, including:

the development and regulation of these industries generally;

our adaptation to technological change;

changing consumer preferences;

	•		legal development affecting these industries, in particular the online gaming industry; and

	•		general economic conditions in the markets where we or our licensees operate.

Competition.All of our businesses are in industries that are extremely competitive. Our gaming software and online games business are characterized by rapid technological change and we face significant and intense competition from online gaming software design houses, application service providers and casual games operators. Our Internet access service business has experienced a reduction in the number of new consumer subscribers and total consumer subscribers due to intense competition in the Internet access services industry in Taiwan. The primary basis of competition in the Internet access business industry is price. Due to this intense competition, there may be a limited market opportunity for our broadband access services.

For each of our businesses, we cannot assure you that we will be successful in adapting to technological developments and achieving widespread acceptance of our services before our competitors offer services similar to our current or prospective offerings. As a consequence, we may lose our existing customers and not expand our client base, which would have a material adverse effect on our revenues and financial condition.

The table below presents, for the periods indicated, information regarding certain revenues and expense items for our consolidated operations. The presentation of financial information for the financial years ended December 31, 2004 and December 31, 2005 has been reclassified to conform with the current year presentation for the year ended December 31, 2006:

For the year ended December 31,
2004 2005 2006
Amount % of Amount % of Amount % of
in US$ total in US$ total in US$ total
Particulars thousands revenues thousands revenues thousands revenues
OPERATING REVENUES

Software licensing and online entertainment revenues 11,434 34.8 22,511 50.9 55,019 58.3
Online game revenues — — — — 18,692 19.8
Internet access and service revenues 21,303 64.9 21,589 48.9 20,537 21.8
Other revenues 107 0.3 87 0.2 44 0.1

Total operating revenues 32,844 100.0 44,187 100.0 94,292 100.0

OPERATING COSTS

Cost of software licensing and online entertainment revenues 1,592 4.8 3,327 7.5 7,824 8.3
Cost of online game revenues — — — — 3,667 3.9
Cost of Internet access and service revenues 13,873 42.2 13,568 30.7 11,449 12.1
Cost of other revenues 644 2.0 488 1.1 391 0.4

Total operating costs 16,109 49.0 17,383 39.3 23,331 24.7

Gross profit 16,735 51.0 26,804 60.7 70,961 75.3

OPERATING EXPENSES

Product development and engineering expenses 2,513 7.7 3,562 8.1 5,738 6.1
Selling and marketing expenses 6,310 19.2 10,777 24.4 30,123 31.9
General and administrative expenses 5,657 17.2 7,892 17.9 12,421 13.2
Bad debt expense (220 ) (0.6 ) 207 0.4 715 0.8

Total operating expenses 14,260 43.5 22,438 50.8 48,997 52.0

Income from operations 2,475 7.5 4,366 9.9 21,964 23.3

NON-OPERATING INCOME (EXPENSES)
(1,143 ) (3.5 ) 2,710 6.1 10,690 11.3

INCOME TAX BENEFIT (EXPENSE) 84 0.3 (436 ) (1.0 ) (1,549 ) (1.6 )

INCOME FROM CONTINUING OPERATIONS 1,253 3.8 6,490 14.7 30,784 32.6

INCOME (LOSS) FROM DISCONTINUED OPERATIONS 429 1.3 (154 ) (0.4 ) — —

NET INCOME 1,682 5.1 6,336 14.3 30,784 32.6

The key items included in our income statement are:

OPERATING REVENUES. Our operating revenues consist of revenues from the software licensing and online entertainment business, online games business and the Internet access service business. Revenues from the software licensing and online entertainment business include revenues of UIM, our licensee, from providing and promoting online games of skill and chance. See “— Consolidation of UIM Under FIN 46(R).” Software licensing and support services revenues received by our subsidiary, CESL, from UIM have been eliminated in consolidation. Online game revenues are related to our online game business in Asia and are collected through the sale of online game points, pre-paid cards and game packs. Revenues from the Internet access service business consist of Internet access revenues, subscription revenues and proceeds from sales of cable modems and other related products.

OPERATING COSTS. Operating costs consist primarily of online entertainment and online game processing costs, online game royalties, production costs for prepaid game cards, amortization of intangible assets, customer service department costs for our online game and Internet access businesses, Internet access engineering costs, Internet access bandwidth costs, and depreciation, maintenance and other overhead expenses directly attributable to the provision of software licensing and online entertainment, online game, and Internet access services revenues.

OPERATING EXPENSES. Operating expenses include product development and engineering expenses, selling and marketing expenses, general and administrative expenses, bad debt expenses, and impairment loss on property, plant and equipment.

NON-OPERATING INCOME (EXPENSES). Non-operating income and expenses consist of interest income and expenses, gain or loss on sales of marketable securities, other-than-temporary impairment of marketable securities, gain on divestiture of business, foreign exchange gain or loss and gain or loss on disposal of property, plant and equipment.

INCOME TAX BENEFITS (LOSSES). Taxes include income tax in various jurisdictions in which our subsidiaries operate and deferred tax assets or liabilities that arise due to the timing differences between book profits and taxable profits that originate in one period and are capable of reversal in one or more subsequent periods. Taxes are measured using the tax rates and laws that have been enacted or subsequently enacted as of the date of the financial statements.

The financial information in relation to ~~the~~our business segments is provided net of inter-segment transactions.

For the Years Ended December 31, ~~2003~~2005 and ~~2004~~
2006

Consolidated Results Of Operations

OPERATING REVENUES. ~~Total operating~~Operating revenues for ~~2004~~2006 grew by 5%approximately 113 percent to approximately US$~~99.8~~94.3 million from approximately US$~~95.4~~44.2 million in ~~2003.~~2005. The increase was primarily as a result of strong revenue growth from the ~~acquisition of our~~software licensing and online entertainment ~~software~~ business, ~~in April 2004~~ which contributed approximately US$~~11.5~~55 million, or ~~11%~~58 percent, of our total revenues in ~~2004 and an increase in revenues from our broadband ISP business of approximately US$1.9 million~~2006 compared to approximately US$~~21.4~~22.5 million ~~which~~ in ~~total contributed approximately 21%~~2005, or 51 percent of our total revenues in ~~2004. This was partially offset by a significant decrease~~2005 and the acquisition of our online games business in ~~revenues from our music distribution business by approximately US$8.9 million to approximately US$67.0 million in 2004,~~January 2006, which ~~business~~ contributed approximately ~~68%~~US$18.7 million, or 20 percent, of our total revenues in ~~2004.~~
~~See “Business Segment Results” below for a discussion of revenues~~2006.

OPERATING COSTS. Operating costs increased by ~~business segments.~~
~~COSTS AND EXPENSES. Costs and expenses decreased by 12%~~approximately 34 percent to approximately US$~~96.8~~23.3 million in ~~2004~~2006 from approximately US$~~109.5~~17.4 million in ~~2003.~~2005. The ~~decrease~~increase in total operating costs was mainly due to a higher level of software licensing and online entertainment business volume in 2006, and the acquisition of our online games business in January 2006 which contributed approximately US$3.7 million of our total operating costs in 2006.

GROSS PROFIT. Gross profit increased by approximately 165 percent to approximately US$71.0 million in 2006 from approximately US$26.8 million in 2005. The increase in gross profit resulted from the strong revenue growth in our software licensing and online entertainment business, the acquisition of our online games business in January 2006 and a significant increase in gross margin from 60.7 percent in 2005 to 75.3 percent in 2006.

OPERATING EXPENSES. Total operating expenses increased by approximately 118 percent to approximately US$49.0 million in 2006 from approximately US$22.4 million in 2005. The increase in total operating expenses was mainly due to a ~~20% decrease~~130 percent increase in ~~costs and~~ expenses related to our ~~music distribution~~software licensing and online entertainment business, which was mainly attributable to the increased selling and ~~an 18% decrease~~marketing expenses as a result of our increased level of business volume, as well as to the acquisition of our online games business in ~~costs and expenses related to our ISP broadband business. Our entertainment software business~~January 2006, which contributed approximately US$~~8.7~~9.4 million toof our total ~~costs and~~operating expenses ~~for the nine months ended December 31, 2004.~~
~~See “Business Segment Results” below for a discussion of costs and expenses by business segments.~~
in 2006.

OPERATING INCOME. ~~We had~~Operating income for 2006 increased by approximately 403 percent to US$22.0 million from approximately US$4.4 million in 2005. The increase was primarily due to strong revenue growth in our software licensing and online entertainment business, the acquisition of our online games business in January 2006, which contributed approximately US$5.6 million income from operations in 2006, and a significant growth in operating income ~~of US$3.0 million~~margin from 9.9 percent in ~~2004 compared~~2005 to ~~operating loss of approximately US$14.2 million for 2003.~~
23.3 percent in 2006.

NON-OPERATING INCOME (EXPENSES). ~~In 2004, our non-operating expenses decreased~~Non-operating income increased in 2006 by approximately 294 percent to approximately US$~~0.9~~10.7 million in 2006 from approximately US$~~2.9~~2.7 million ~~for 2003.~~in 2005. This was principally due to ~~a significant increase~~the sale of our ADSL business to Webs-TV in ~~investment~~May 2006 which contributed approximately US$7.7 million.

INCOME FROM DISCONTINUED OPERATIONS. We had no income from discontinued operations in 2006.

NET INCOME. Net income for 2006 increased by approximately 386 percent to ~~approximately~~ US$~~1.2~~30.8 million from approximately US$~~0.5~~6.3 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, we recorded 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.~~
2005.

Business Segment Results
~~Broadband ISP~~

Software Licensing and Online Entertainment Business

OPERATING REVENUES. Consolidated revenues of our software licensing and online entertainment business include the revenues of UIM, our licensee. Software licensing and support services revenues received by us from UIM have been eliminated in consolidation. Software licensing and support services revenues received by us from UIM increased by 120 percent from US$12.5 million in 2005 to US$27.5��million in 2006. Total operating revenues in 2006 increased by ~~10%~~144 percent to approximately US$~~21.4~~55.0 million from US$22.5 million in ~~2004 from approximately US$19.5 million in 2003.~~2005. Such increase was primarily attributable to anstrong growth in our poker software business, and growth in our traditional online gaming software business in 2006. Revenues from our poker software business grew from approximately US$4.1 million in 2005 to US$30.9 million in 2006 and accounted for approximately 56 percent of our software licensing and online entertainment revenues in 2006 compared to 18 percent in 2005. Revenues from our traditional online gaming software business increased to approximately US$24.1 million in 2006 from US$18.4 million in 2005.

OPERATING COSTS. Cost of our software licensing and online entertainment revenues increased by 135 percent to approximately US$7.8 million in 2006 from US$3.3 million in 2005. The increase was due to higher business volume and the associated increase in payment processing costs in 2006.

GROSS PROFIT. Gross profit increased by 146 percent to approximately US$47.2 million in 2006 from US$19.2 million in 2005. The increase resulted from strong revenue growth in the period.

OPERATING EXPENSES. Total operating expenses increased by approximately 130 percent to approximately US$30.4 million in 2006 from approximately US$13.2 million in 2005. The increase in total ~~access revenues, which contributed more than 98%~~operating expenses resulted from the increased level of ~~total revenues.~~
~~Access Revenues~~.~~Access revenues increased by 11% to approximately US$21.0 million~~business volume in ~~2004 from approximately US$18.8 million~~the period and, in 2003, mainly as a result of the significant growth of our corporate broadband ISP business. 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. 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 modems.~~
COSTS AND EXPENSES. Total costs and expenses decreased by 18% from approximately US$25.0 million in 2003 to approximately US$20.4 million in 2004, mainly as a result of the significant decline in general and administrative expenses and operating costs, offsetting theparticular, an increase in selling and marketing expenses.
Cost of sales/rental/installation. Cost of sales/rental/installation decreased 26% from approximately US$0.9 million in 2003 to approximately US$0.6 million in 2004, due to a fall in the price of cable modems, decreased 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 decreases in the price of leasing bandwidth and circuits.~~

Product development and engineering ~~expenses~~.expenses. Product development and engineering expenses ~~decreased~~increased by approximately ~~9% from~~72 percent to approximately US$~~1.2~~4.3 million in ~~2003 to approximately~~2006 from US$~~1.1~~2.5 million in ~~2004 as a result of~~2005, due to our ~~continued effort~~ongoing efforts to ~~de-emphasize this aspect of~~develop and improve our ~~operations.~~products.

Selling and marketing ~~expenses~~.expenses. Selling and marketing expenses increased by approximately ~~18% from~~175 percent to approximately US$~~2.4~~22.1 million in ~~2003 to approximately~~2006 from US$~~2.9~~8.0 million in ~~2004,~~2005, primarily due to ~~reclassification of certain general~~an increase in commissions to partners due to growth in revenue, and ~~administrative expenses as selling~~an increase in advertising 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.~~
promotion expenses.

General and administrative ~~expenses~~.expenses. General and administrative expenses ~~decreased~~increased by ~~38% from~~49 percent to approximately US$~~3.6~~4.0 million in ~~2003~~2006 from US$2.7 million in 2005 due to increases in salaries and professional fees.

OPERATING INCOME. Operating income in 2006 increased 182 percent to approximately US$~~2.2~~16.8 million from US$6.0 million in ~~2004~~2005. The increase was primarily due to ~~reclassification~~strong revenue growth and an expansion of operating margin from 26.5 percent in 2005 to 30.5 percent in 2006. Operating income does not reflect certain ~~general and administrative expenses as selling and marketing~~corporate headquarter expenses.
~~OPERATING INCOME. We had an operating~~ For a reconciliation of business segment results to our consolidated net income, please see Note 24 of ~~approximately US$1.0 million in 2004, compared to an operating loss of approximately US$5.5 million in 2003.~~
~~Entertainment Software~~our financial statements.

Online Games Business

We acquired our ~~entertainment software~~online games business in ~~April 2004~~January 2006 and incorporated results of the business into our consolidated financial statements as of and for the ~~nine months~~year ended December 31, ~~2004.~~2006. As this business was acquired ~~during 2004, year-over-year~~in 2006, year over year comparisons of this business segment are not ~~available.~~available, and total revenues, operating costs, gross profit, operating expenses, operating income, and net income figures for the 2005 and 2006 periods may not be comparable. See Note 45 of our consolidated financial statements for a summary of unaudited pro-forma results of operations for the years ended December 31, ~~2003~~2005 as if the acquisition of our online games business had occurred on January 1, 2005.

For the year ended December 31, 2006, the online games business recorded total operating revenue of US$18.7 million, operating costs of US$3.7 million, gross profit of US$15.0 million, operating expenses of US$9.4 million (comprising product development and engineering expenses, selling and marketing expenses, general and administrative expenses and bad debt expenses of US$0.9 million, US$5.5 million, US$2.5 million and US$0.5 million, respectively) and operating income of US$5.6 million, respectively.

Internet Access Service Business

OPERATING REVENUES. Total operating revenues decreased 5 percent to approximately US$20.6 million in 2006 from approximately US$21.7 million in 2005. Such decrease was attributable to the disposal of our ADSL business in May 2006, the impact of which on our revenues has been partially offset by fees received for the provision of consulting, support and bandwidth services related to the sale and transition of the business, and the decrease of our consumer access revenue through Hoshin GigaMedia. Of the total Internet access service revenues recorded for 2006, our consumer access revenues through Hoshin GigaMedia decreased by 9 percent to approximately US$13.7 million in 2006 from US$15.1 million in 2005, while corporate access revenues through KBT increased by 4 percent to approximately US$6.8 million in 2006 from US$6.5 million in 2005.

The number of our retail broadband subscribers decreased from 80,541 as of December 31, 2005 to 11,447 as of December 31, 2006 as a result of our sale of the ADSL business. The average blended access revenues per retail broadband subscriber per month (ARPU) for access services in the fourth quarter of 2006 was approximately US$14.80, as compared to approximately US$11.36 for the fourth quarter of 2005. The increase in ARPU is due to the sale of our ADSL business, which had a lower blended ARPU rate.

OPERATING COSTS. Operating costs decreased by 16 percent from approximately $14.1 million for 2005 to approximately US$11.8 million for 2006 due to decreases in depreciation, and customer service costs. We terminated the customer service representative department servicing the ADSL business in August 2006 following the sale of our ADSL business.

GROSS PROFIT. Gross profit increased by 15 percent to approximately US$8.7 million in 2006 from US$7.6 million in 2005. The increase was due to decreased operating costs, which led to an expansion in gross margin from 35.2 percent in 2005 to 42.5 percent in 2006.

OPERATING EXPENSES. Total operating expenses decreased by 17 percent from approximately US$5.5 million in 2005 to US$4.6 million in 2006, mainly as a result of declines in product development and engineering expenses, and in selling and marketing expenses.

Product development and engineering expenses. Product development and engineering expenses decreased by approximately 52 percent from approximately US$1.0 million in 2005 to approximately US$0.5 million in 2006 as a result of our continued effort to de-emphasize this aspect of our operations.

Selling and marketing expenses. Selling and marketing expenses decreased by approximately 10 percent from approximately US$2.7 million in 2005 to approximately US$2.5 million in 2006, primarily due to a slight decline in promotional expenses.

General and administrative expenses. General and administrative expenses decreased by 13 percent from approximately US$1.5 million in 2005 to US$1.3 million in 2006 due to centralizing of certain back-office functions in our headquarters.

OPERATING INCOME. Operating income increased by 97 percent from approximately US$2.1 million for 2005 to US$4.2 million in 2006. The increase was primarily due to decreases in operating costs and expenses which resulted in an increase in operating margin from 9.8 percent in 2005 to 20.3 percent in 2006. Operating income does not reflect certain corporate headquarter expenses. For a reconciliation of business segment results to our consolidated net income, please see Note 24 of our financial statements.

For the Years Ended December 31, 2004 and 2005

Consolidated Results Of Operations

OPERATING REVENUES. Total operating revenues for 2005 grew by approximately 35 percent to approximately US$44.2 million from approximately US$32.8 million in 2004. The increase was primarily a result of strong revenue growth from the software licensing and online entertainment business, which contributed approximately US$22.5 million, or 51 percent, of our total revenues in 2005 compared to approximately US$11.5 million in 2004 (which only included nine months of results from this segment), or 35 percent of our total revenues in 2004, and a slight increase in revenues from our Internet access service business to approximately US$21.7 million in 2005, which in total contributed approximately 49 percent of our total revenues in 2005, compared to approximately US$21.4 million in 2004.

OPERATING COSTS. Total operating costs increased by approximately 8 percent from approximately US$16.1 million in 2004 to approximately US$17.4 million in 2005. The increase in operating costs was mainly due to the inclusion of full twelve-month results from our software licensing and online entertainment business in 2005 versus nine-month results in 2004 as well as increased operating costs as a result of an increased level of business volume in our software licensing and online entertainment business.

GROSS PROFIT. Gross profit increased by 60 percent to approximately US$26.8 million in 2005 from US$16.7 million in 2004, primarily due to the inclusion of full twelve-month results from our software licensing and online entertainment business in 2005 versus nine-month results in 2004 as well as an increased gross margin.

OPERATING EXPENSES. Total operating expenses increased by approximately 57 percent to approximately US$22.4 million in 2005 from approximately US$14.3 million in 2004. The increase was attributable to the inclusion of full twelve-month results from our software licensing and online entertainment business in 2005 versus nine-month results in 2004 and reflected increased selling and marketing expenses as a result of our increased level of business volume.

OPERATING INCOME. Operating income for 2005 increased by approximately 76 percent to approximately US$4.4 million from approximately US$2.5 million for 2004. The increase was primarily due to strong revenue growth from, and an increase in operating margin in, our software licensing and online entertainment business.

NON-OPERATING INCOME (EXPENSES). We had non-operating income in 2005 of approximately US$2.7 million compared to non-operating expenses of approximately US$1.1 million in 2004. This was principally due to a foreign exchange gain of approximately US$0.2 million in 2005 compared to a foreign exchange loss of approximately US$0.8 million in 2004, as well as an increase of approximately US$1.1 million in other non-operating revenues which included a gain of approximately US$0.6 million on the sale of our Internet content business gigigaga.com.tw and a reversal of US$0.5 million on the provision of a class action lawsuit. See Note 23

of our consolidated financial statements for 2005 for additional information. In addition, we had no other-than-temporary impairment loss in 2005, compared with an other-than-temporary impairment loss of approximately US$1.8 million for our investment in Gamania in 2004.

INCOME FROM DISCONTINUED OPERATIONS. In September 2005, we completed the sale of our land-based music distribution business. The transaction price, net of transaction costs, was US$5.02 million. The cash proceeds, net of transaction costs and cash transferred, was US$3.25 million. Results for the music distribution operations are reported as discontinued operations in each of the periods presented. In 2005, we recorded an operating loss of approximately US$1.1 million and a gain on the sale of the business of approximately US$0.9 million.

NET INCOME. Net income for 2005 increased by approximately 277 percent to approximately US$6.3 million from approximately US$1.7 million in 2004.

Business Segment Results

Software Licensing and Online Entertainment Business

We acquired our software licensing and online entertainment business in April 2004 and incorporated it into our consolidated financial statements as of and for the nine months ended December 31, 2004 and for the year ended December 31, 2005. As a result, total revenues, operating costs, gross profit, operating expenses, operating income, and net income figures for 2004 and 2005 periods may not be comparable. See Note 5 of our consolidated financial statements for a summary of unaudited pro-forma results of operations for the year ended December 31, 2004 as if the acquisition of our software licensing and online entertainment ~~software~~ business had occurred on January 1, ~~2003 and~~ 2004. ~~The operating results of our entertainment software business, post-acquisition, for the nine months ended December 31, 2004 were as follows:~~

OPERATING REVENUES. Total operating revenues ~~for~~in 2005 increased by 97 percent to approximately US$22.5 million from US$11.5 million in 2004. Such increase was attributable to the ~~nine months ended December 31, 2004 were approximately US$11.5 million. Based on~~inclusion of full twelve-month results of our ~~revenue-sharing agreement with UIM, we recognized~~ software licensing and ~~support service~~online entertainment business in 2005 versus nine-month results in 2004, strong growth in our poker software business, and growth in our traditional online gaming software business in 2005. Revenues from our poker software business grew from approximately US$0.2 million in 2004 to US$4.1 million in 2005 and accounted for 18 percent of our revenues ofin the software licensing and online entertainment business in 2005 compared to 2 percent in 2004. Revenues from our traditional online gaming software business increased in 2005 to approximately US$~~7.3~~18.4 million from ~~UIM during the same period. Such revenues have been eliminated~~US$11.2 million in ~~consolidation. See “— A. Operating Results — Consolidation~~2004, which was attributable to combinations of ~~UIM Under FIN 46(R)”.~~
~~COSTS AND EXPENSES. Costs~~targeted promotions (bonuses) and ~~expenses were~~a game-of-the-month campaign. These initiatives increased player acquisition and retention rates.

OPERATING COSTS. Total operating costs increased by 109 percent to approximately US$~~8.7~~3.3 million ~~for the nine months ended December 31, 2004, consisting mainly of:~~
~~Operating costs~~. ~~Operating costs were approximately~~in 2005 from US$1.6 million ~~for~~in 2004. Such increase was attributable to the ~~nine months ended December 31,~~inclusion of full twelve-month results of our software licensing and online entertainment business in 2005 versus nine-month results in 2004, and a higher level of business volume in 2005.

GROSS PROFIT. Gross profit increased by 95 percent to approximately US$19.2 million in 2005 from US$9.9 million in 2004.
Such increase was due to the inclusion of full twelve-month results in 2005 versus nine-month results in 2004 and reflected our increased level of business volume.

OPERATING EXPENSES. Total operating expenses increased by 84 percent to approximately US$13.2 million in 2005 from US$7.1 million in 2004. Such increase was attributable to the inclusion of full twelve-month results of our software licensing and online entertainment business in 2005 versus nine-month results in 2004, and operating expenses increasing as a result of our revenue growth in 2005.

Product development and engineering ~~expenses~~.expenses. Product development and engineering expenses ~~were~~increased by approximately ~~US$1.4 million for the nine months ended December 31, 2004.~~
~~Selling and marketing expenses~~.~~Selling and marketing expenses were approximately US$3.4 million for the nine months ended December 31, 2004.~~
~~General and administrative expenses~~.~~General and administrative expenses were 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 music 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 and our strategy to shut down unprofitable stores. In addition, consumers continue to shift to digital music distribution and piracy remains a serious 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 a number of our stores.~~
Promotional and advertising revenues. Promotional and advertising revenues decreased by 5% from approximately US$1.6 million in 2003 to 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 lowered 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 general market downtrend and a decrease in the number of retail stores operated by us.
~~General and administrative expenses~~.~~General and administrative expenses decreased by 10% from approximately US$2.8 million in 2003~~79 percent to approximately US$2.5 million in 2005 from approximately US$1.4 million in 2004 due to ~~strict cost controls~~the inclusion of full twelve-month results of our software licensing and online entertainment business in ~~keeping with~~2005 versus nine-month results in 2004, as well as our ongoing efforts to develop and improve our products.

Selling and marketing expenses. Selling and marketing expenses increased by approximately 134 percent to approximately US$8.0 million in 2005 from approximately US$3.4 million in 2004, primarily due to the ~~general market downtrend.~~inclusion

of full twelve-month results of our software licensing and online entertainment business in 2005 versus nine-month results in 2004, and an increase in commissions to partners due to growth in revenue and competitive pressure within the industry.

General and administrative expenses. General and administrative expenses increased by 19 percent to approximately US$2.7 million in 2005 from approximately US$2.2 million in 2004 due to the inclusion of full twelve-month results of our software licensing and online entertainment business in 2005 versus nine-month results in 2004.

OPERATING INCOME. Operating income ~~was~~in 2005 increased 115 percent to approximately US$~~542 thousand~~6.0 million from US$2.8 million in 2004. The increase was primarily due the inclusion of full twelve-month results of our software licensing and online entertainment business in 2005 versus nine-month results in 2004, ~~compared~~and strong revenue growth from the launch of new games which led to an increase in operating ~~loss~~margin from 24 percent to 26 percent. Operating income does not reflect certain corporate headquarter expenses. For a reconciliation of ~~approximately US$7.1 million in 2003.~~
~~For the Years Ended December 31, 2002 and 2003~~
business segment results to our consolidated net income, please see Note 24 of our financial statements.

~~Consolidated Results Of Operations~~Internet Access Service Business

OPERATING REVENUES. Total operating revenues ~~for 2003 grew 29%~~increased by 1 percent to approximately US$~~95.4~~21.7 million in 2005 from approximately US$7421.4 million in ~~2002, primarily due~~2004. Such increase was attributable to ~~the contributions~~an increase in total access revenues, which contributed more than 99 percent of ~~the Rose Records and Tachung Records music store chains that we acquired in 2002. For 2003, the retail music distribution business contributed approximately US$75.8 million, or 80% of~~total revenues from our ~~revenues. The broadband ISP business contributed approximately US$19.5 million, or 20% of our~~Internet access service business.

INTERNET ACCESS SERVICE REVENUES. Internet access service revenues ~~in 2003.~~
~~COSTS AND EXPENSES. Costs and expenses~~ increased by ~~12%~~1 percent to approximately US$~~109.5~~21.6 million in ~~2003~~2005 from approximately US$~~97.8~~21.3 million in 2002. Our costs and expenses in 2003 primarily consisted of cost of sales/ rental/ installation of 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$1.6 million.
~~OPERATING LOSS. Operating loss for 2003 decreased by 41% to approximately US$14.2 million from approximately US$23.9 million for 2002.~~
NON-OPERATING EXPENSES. In 2003, we incurred non-operating expenses of approximately US$2.9 million, compared to a non-operating income of US$3.1 million for 2002, principally due to an approximately US$1.7 million write-off of our investment in Rock Internet Corporation and the recognition of a foreign exchange loss of 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% to 58.58%2004, mainly as a result of the ~~acquisitions of Rose Records and Tachung 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 2003 declined by 24% to approximately US$14.1 million from approximately US$18.5 million for 2002.~~
~~Business Segment Results~~
~~Broadband ISP Business~~
~~OPERATING REVENUES~~.~~Total operating revenues increased slightly by 1% from approximately US$19.3 million in 2002 to US$19.5 million in 2003.~~
Access revenues. Total access revenues increased slightly from approximately US$18.5 million in 2002 to approximately US$18.8 million in 2003, due to migration of subscribers to higher specification products. The numbersignificant growth of our broadband subscribers decreased from 108,016 as of December 31, 2002 to 102,940 as of December 31, 2003. As of December 31, 2003, we had 6,653 one-way subscribers, 18,450 two-way subscribers, and 77,837 ADSL subscribers. In the fourth quarter of 2003, the average blendedcorporate Internet access fee per broadband subscriber per month (ARPU) for access services was approximately US$12.60, as compared to US$11.60 for the fourth quarter of 2002. ARPU for one-way cable services, two-way cable services and ADSL services was US$7.00, US$17.30 and US$12.00, respectively, during the fourth quarter of 2003, as compared to US$6.70, US$17.90 and US$10.50, respectively, for the same services during the fourth quarter of 2002.
service business. Of the total Internet access service revenues recorded for ~~2003, consumer~~2005, retail Internet service and access revenues through Hoshin GigaMedia were approximately US$15.1 million, while corporate Internet service and access revenues through KBT were approximately US$~~3.7~~6.5 million.
~~Sales/rental revenues. Sales/rental~~ While revenues from our corporate ISP business represented only 30 percent of our total Internet access service revenues in 2005, they demonstrated a growth of 47 percent to approximately US$6.5 million in 2005 from approximately US$4.4 million in 2004, compared to a decline in revenues of 11 percent to approximately US$15.1 million in 2005 in our consumer ISP business from approximately US$16.9 million in 2004.

The number of our retail broadband subscribers decreased from 94,520 as of December 31, 2004 to 80,541 as of December 31, 2005, of which 16,534 were two-way cable modem subscribers and 62,937 were ADSL subscribers. In the fourth quarter of 2005, the average blended internet service and access revenues per retail broadband subscriber per month (ARPU) for access services was approximately US$11.36, as compared to approximately US$12.40 for the fourth quarter of 2004. ARPU for two-way cable modem and ADSL services was approximately US$16.30 and US$10.50, respectively, during the fourth quarter of 2005, as compared to approximately US$16.50 and US$11.80, respectively, for the same services during the fourth quarter of 2004.

OPERATING COSTS. Total operating costs associated with the cost of Internet and service revenues decreased 5%by 3 percent from approximately US$~~126 thousand~~14.5 million for ~~2002~~2004 to approximately US$~~120 thousand~~14.1 million for ~~2003, resulting mostly~~2005 due to decreases in depreciation and amortization, and customer service costs, partially offset by an increase in bandwidth costs.

GROSS PROFIT. Gross profit increased by 11 percent from aapproximately US$6.9 million in 2004 to approximately US$7.6 million in 2005. Such increase was attributable to the increase in operating revenues and the decrease in ~~sales of modems.~~
~~COSTS AND~~the operating costs in the period.

OPERATING EXPENSES. Total ~~costs and~~operating expenses decreased by ~~23%~~7 percent from approximately US$5.9 million in 2004 to approximately US$~~25.0~~5.5 million in ~~2003 from approximately US$32.5 million~~2005, mainly as a result of declines in ~~2002. This decrease was due to a decrease in operating cost, cost of sales/rentals, product development~~general and ~~engineering~~administrative expenses and in selling and marketing expenses.
Cost of sales/rental. Cost of sales/rental decreased by 45% from approximately US$1.6 million in 2002 to approximately US$873 thousand in 2003, due to a fall in the price of cable modems, decreased sales as well as the use of refurbished cable modems during 2003.
~~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 and engineering expenses. Product development and engineering expenses decreased ~~35%~~by approximately 6 percent from approximately US$~~1.9~~1.1 million in ~~2002~~2004 to approximately US$~~1.2~~1.0 million in ~~2003, primarily due~~2005 as a result of our continued effort to ~~reduced costs relating to workforce streamlining in 2003 and a de-emphasis on~~de-emphasize this aspect of our operations.

Selling and marketing expenses. Selling and marketing expenses decreased by ~~41%~~approximately 5 percent from approximately US$~~4.1~~2.9 million in ~~2002~~2004 to approximately US$~~2.4~~2.7 million in ~~2003,~~2005, primarily due to ~~significantly reduced~~a moderate decline in our advertising ~~in Taiwan’s media for GigaMedia’s broadband services.~~
expenses.

General and administrative expenses. General and administrative expenses ~~increased 7%~~decreased by 30 percent from approximately US$~~3.3~~2.2 million in ~~2002~~2004 to approximately US$~~3.6~~1.5 million in ~~2003.~~
2005 due to centralizing of certain back-office functions in our headquarters.

OPERATING ~~LOSS.~~INCOME. Operating ~~loss decreased~~income increased by ~~58%~~121 percent from approximately US$1.0 million for 2004 to approximately US$~~5.5~~2.1 million ~~in 2003 from approximately US$13.2 million in 2002.~~
~~Music Distribution Business~~
~~We began~~for 2005. Operating income does not reflect certain corporate headquarter expenses. For a reconciliation of business segment results 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~~our consolidated ~~results of operations~~net income, please see Note 24 of our music distribution business in 2003 and 2002 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:
~~Revenue~~s. 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 2003.~~
OPERATING REVENUES. Total operating revenues from our music distribution business increased by 39% to approximately US$75.8 million in 2003 from approximately US$54.7 million in 2002. This increase was due in part to the fact that we consolidated the results of operations of Rose Records and Tachung Records for the full year of 2003, whereas in 2002, we had consolidated their results of operations from their respective closing dates of the acquisitions, 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 approximately US$64.6 million in 2002. This increase was due in part to our consolidation of the results of operations of Rose Records and Tachung Records for full year 2003.
~~OPERATING LOSS. Operating loss decreased by 28% to approximately US$7.1 million in 2003 from approximately US$9.9 million in 2002.~~
financial statements.

B. Liquidity and Capital Resources

Our principal sources of liquidity consist of cash generated from our operations, proceeds generated from the disposal of our investments and other assets, bank borrowings, and interest derived from our investments. Our cash and cash equivalents are held primarily in U.S. dollars and NT dollars.Our music distribution business also relies on short-term borrowings to finance its operations. Our short-term borrowings were approximately US$284 thousand as of December 31, 2004. In addition, we continued our efforts to streamline our operations with a view to reducing the capital requirement of our operations.dollars. 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 revenues and cost splits with our business partners;

	•		the rate at which we invest in improving our products and upgrading and maintaining our network and future technologies; and

	•		the rate at which we grow and monetize our customer bases.

~~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; and~~

~~the 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,~~2006, the amount of our cash and cash equivalents ~~and marketable securities we held~~ as of December 31, ~~2004~~2006 decreased ~~significantly~~ to approximately US$~~50.4~~22.4 million compared to US$~~79.5~~41.7 million as of December 31, ~~2003.~~2005. Such decrease was primarily attributable to the cash outflows for our investments in 2006, and partially offset by operating cash flow and bank borrowings. In 2006, our cash used in the purchase of FunTown amounted to US$26.8 million (net of cash acquired). We also issued approximately US$15 million of zero coupon secured convertible notes in connection with such acquisition, which were fully redeemed in July and September 2006. Our acquisition of ~~our entertainment software business at~~FunTown also included an ~~all-cash consideration~~incentive payment in the form of an additional variable amount to be determined based on the pre-tax income of FunTown in 2006, subject to a maximum limit of US$~~32.5 million, which~~5 million. In April and May 2007, we paid ~~for entirely out~~US$5 million of such incentive payment. In 2006, we also made cash payments of US$15 million in connection with our acquisition of 7.5 million convertible preferred shares of T2CN, US$10.0 million in connection with our strategic investment in Infocomm Asia, and US$2.5 million in connection with the licensing ofHellgate: London, an online game expected to be launched in 2007.

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, 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.~~obligations under our existing lease arrangements through 2007. We continue to seek and review potential merger and acquisition opportunities on an ongoing basis, which may be funded through cash on our balance sheet, bank borrowings 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,~~2006, our net cash provided by operating activities amounted to US$~~2.4~~29.4 million. This was primarily ~~attributable to collections~~ from ~~customers~~income from continuing operations of US$~~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~~30.8 million.

INVESTING ACTIVITIES. Our net cash used in investing activities in ~~2004~~2006 was US$~~25.3~~47.9 million. This was primarily ~~attributable~~due to ~~the~~our acquisition of our entertainment software business of US$32.8 million, including transaction costs, which we largely funded from the liquidation of our marketable securities, the purchase of property plant and equipment of US$2.6 millionFunTown and the purchase of ~~intangible assets~~marketable securities of US$~~663 thousand. In 2003, our net cash used in investing activities amounted to~~42.5 million, which was offset by the sale of other marketable securities of US$~~5.0~~26.7 million.

FINANCING ACTIVITIES. Our net cash ~~provided by~~used in financing activities in ~~2004~~2006 was US$~~156 thousand.~~
1 million. This was primarily due to redemption of our convertible notes of US$15 million, which was offset by bank borrowings of US$12.9 million.

OTHER. Set forth below are the aggregate amounts, as of December 31, ~~2004,~~2006, of our future cash payment obligations under our existing contractual obligations.

Capital Expenditures

We typically finance our capital expenditures through cash holdings. Our gross capital expenditures for equipment, ~~and software,~~ furniture and fixtures, software, intangible assets and other deferred assets were US$~~8.8~~3.4 million, US$~~1.9~~4.0 million and US$~~3.3~~5.7 million for ~~2002, 2003~~2004, 2005 and ~~2004~~2006, respectively. Capital expenditures during ~~2004~~2006 were primarily for ~~the replacement and upgrades of network-related hardware in our consumer and corporate broadband businesses, capitalization of~~capitalized software development for our software licensing and online entertainment ~~software~~ business and ~~also for the point of sale system implemented in every retail store of our music distribution~~online games business. Our capital expenditure plans for ~~2005~~2007 will continue to focus primarily on ~~the replacement and upgrades of network-related hardware in our consumer and corporate broadband businesses and~~ software development for our software licensing and online entertainment ~~software~~business and for our online games 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.

Indebtedness

As of December 31, 2006, we have unsecured loans of US$6.1 million and secured loans of US$6.7 million. The weighted-average interest rate on total short-term loans as of December 31, 2006 was 2.48 percent. We also pledged time deposits of US$2.7 million, and a net value of land and buildings of US$1.7 million as collateral for secured bank loans as of December 31, 2006. All of our bank loans are one-year revolving facilities.

The following table sets out certain information in respect of our outstanding loans as of December 31, 2006:


(in US$ thousands)				As at
Name	Nature	Interest rate range	Maturity date of Facility	December 31, 2006

China Trust Commercial Bank	Unsecured revolving facility	2.35% - 2.45%	March 10, 2007		6,135
China Trust Commercial Bank	Secured revolving facility	1.735% - 1.865%	March 10, 2007		2,117
Taishin International bank	Secured revolving facility	2.90% - 2.95%	September 30, 2007		4,601

					12,853

Dividends From Our Subsidiaries Inin 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%~~20 percent for non-Taiwan investors holding a ~~Foreign Investment Approval~~foreign investment approval granted by Taiwan’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~~
~~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~~ An additional tax of our business following the acquisition of our entertainment software business. Our margins may be impacted by fluctuations of exchange rates 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 not sought to reduce our exposure to exchange rate fluctuations by using hedging transactions. However, we may choose so in the future. We recognized a foreign exchange loss of US$896 thousand for 2004 and US$723 thousand for 2003.
~~Recent Accounting Pronouncements~~
In May 2003, the FASB issued Statement of Financial Accounting Standards (“FAS”) No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“FAS No. 150”). FAS No. 150 establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. FAS No. 150 is effective for all financial instruments created or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of FAS No. 150 did not have a material impact10 percent 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 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, 2004, we had net operating loss carryforwards for tax purposes of approximately US$84.0 million, which will expire at various times from December 2005 through December 2009. At December 31, 2004, we had a deferred tax asset of US$22.5 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 have made an allowance for substantially all the value 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~~will be imposed on retained earnings which are not distributed to ~~us as dividends in~~shareholders by the end of the year 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.the close of the tax year.

C. Research, Development, Patents and ~~Intellectual Property~~
Licenses, etc.

We make ~~significant~~ investments in research and development to keep pace and remain competitive with technology advancements and product development relating to our software licensing and online entertainment ~~software~~business and our online games business. ~~Accordingly approximately 50% of~~We do not believe our ~~workforce in the entertainment software business is comprised of~~expenditure for research and development ~~personnel. While we regard our intellectual property~~for 2004, 2005 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.
2006 was material.

D. Trend Information

Please see Item 3 –— “D. Risk ~~Factors”,~~Factors,” Item 4 –— “Information Onon the Company” and “ — A. Operating Results — Overview” for a discussion of the most recent trends in our operation costs and revenues since the end of ~~2004.~~2006. 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.

E. ~~Off-balance sheet arrangements~~
WeOff-Balance Sheet Arrangements

Other than as disclosed in Note 22 of our financial statements, we currently do not ~~engage~~have (a) any obligation under a guarantee contract that has any of the characteristics identified in paragraph 3 of FASB Interpretation No. 45,Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others(“FIN 45”), as may be modified or supplemented, excluding the types of guarantee contracts described in paragraphs 6 and 7 of FIN 45; (b) a retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity or market risk support to such entity for such assets; (c) any ~~off-balance sheet arrangements.~~obligation under a derivative instrument that is both indexed to the company’s own stock and classified in stockholders’ equity, or not reflected, in the company’s statement of financial position or (d) any obligation, including a contingent obligation, arising out of a variable interest (as referenced in FASB Interpretation No. 46,Consolidation of Variable Interest Entities, as may be modified or supplemented) in an unconsolidated entity that is held by, and material to, the company, where such entity provides financing, liquidity, market risk or credit risk support to, or engages in leasing, hedging or research and development services with, the company.

F. Tabular ~~disclosure~~Disclosure of ~~contractual obligations~~

   Payment Due by Period (in US$ thousands)
Contractual
Obligations
   Total

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
Contractual Obligations

Payment Due by Period (in US$ thousands)
Less than More than
Contractual Obligations Total 1 year 1-3 years 3-5 years 5 years
Operating leases 3,886 1,876 1,945 65 0
Minimum guarantee against royalties 6,500 2,500 2,500 1,500 0
Total contractual cash obligations 10,386 4,376 4,445 1,565 0
Other long-term obligations 605 0 534 71 0
Other liabilities — Accrued pension liabilities 434 0 0 0 434

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

A. Directors and Senior Management

The following table sets forth information with respect to our directors and executive officers as of ~~June15, 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
June 15, 2007:

Year
Appointed to
Current
Name Age Position Position
WU, Daniel Chuen-Tai 59 Chairman of the Board 2003
BAO, Gilbert 43 Independent Non-Executive Director 2003
CHANG, Nelson 42 Independent Non-Executive Director 2004
DING, Michael Y.J. 50 Independent Non-Executive Director 2003
HSU, Emmet Yu-Jui 44 Independent Non-Executive Director 2003
HU ZEE, Nancy Jing-Ying 48 Independent Non-Executive Director 2003
LEE, Howe Yong 51 Independent Non-Executive Director 2004
LEE, Yichin 46 Independent Non-Executive Director 2003
WANG, Arthur M. 46 Chief Executive Officer and Director 2003
HUI, Thomas T. 35 Chief Financial Officer and Director 2004/2005
CAHILL, Robert J. 41 Head of Software Licensing and Online Entertainment Business 2004
CHOU, Samuel 46 Head of Online Games Business 2007
CHU, Michel 38 Executive Vice President and Chief Technology Officer 2000
HUANG, Kenny Ching-Kun 42 Senior Vice President 2004
MAI, Falco 45 Executive Vice President and Chief Administrative Officer 2001
SHEA, Joseph 41 Executive Vice President 2004
TARN, Chen-Wen 47 Head of Internet Access Service Business 2003
TSENG, Jennifer 38 Senior Vice President and General Counsel 2004

Mr. ~~Thomas T. Hui~~Samuel Chou was appointed as head of our ~~chief financial officer with effect from August 11, 2004 and a director from May 17, 2005. Our former directors, Jeffrey Koo Jr. and Andre Koo, resigned~~online games business on ~~May 17, 2005 for personal reasons.~~
April 20, 2007.

Biographical information with respect to each of our directors and executive officers is set forth below.

DANIEL CHUEN-TAI WU is the chairman of the board of directors of ~~GigaMedia Limited.~~our Company. He brings to our Company significant operational experience and extensive business relationships in Taiwan. Dr. Wu is currently the chairman of CDIB & Partners Investment Holding Corp. in Taiwan and a director and senior executive vice president of China Development Financial Holding Corporation. Previously, he served as the chairman of various companies including CDIB & Partners Investment Holding Corp from 2004 to 2006, Videoland Inc. ~~(2002-2004),~~from 2002 to 2004, Grand Pacific Petrochemical Corp. ~~(1994-2004),~~from 1994 to 2004, Biocare Corp. ~~(1997-2003)~~from 1997 to 2003 and Precision Semiconductor Mask Corp. ~~(1998-2000).~~from 1998 to 2000. He was the chief executive officer of Wyse Technology Inc. ~~(1990-1994)~~from 1990 to 1994 and the president of Grand Pacific Petrochemical Corp. ~~(1992-1994).~~from 1992 to 1994. Dr. Wu was chairman of Crimson Asia Capital Holdings, Ltd. ~~(1993-2000).~~from 1993 to 2000. Prior to that, Dr. Wu was also the chairman of Monte Jade Science & Technology Association from 1993 to 1994. Dr. Wu received his doctorate in chemical engineering from the

University of Delaware in 1976 and an undergraduate degree in the same discipline from National Taiwan University 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., ~~executive director~~general supervisor of Taiwan ~~Cotton~~ Spinners Association, and ~~executive director~~chairman of Taiwan Manmade Fiber Industry Association. He graduated from the University of Southern California in 1986.

NELSON CHANG is an independent non-executive director of our Company. He is also currently the managing director of Shin-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~~Master of ~~business administration~~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 chairman of Fubon Securities Investment Consulting Co. Ltd. Prior to that, Mr. Ding was 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. 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~~Bachelor of ~~laws~~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 of Southern California and received a ~~master~~Master of ~~business administration~~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 Videoland Inc. ~~and etKING Media Technology Limited.~~ She is also chairman of Ho Wei Communication, which is a subsidiary of Videoland Inc. MsShe is a certified accountant in the United States and Hong Kong and is currently a director of NHL CPA and ETKING Media Technology Limited. Ms. Hu holds a bachelor’s degree from National Taiwan University, a master’s ~~degrees~~degree in ~~sciences~~computers from Barry University and a ~~master~~Master of ~~business administration~~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 Development Corporation in Hong Kong from 1997 to 2000 and as a director of Transmarco Limited in Singapore from 1995 to 1997.~~ Mr. Lee received a ~~bachelor~~Bachelor of ~~arts~~Arts degree in business administration from the University of Washington in 1984.

YICHIN LEE is an independent non-executive director of our Company. He is also currently ~~founding partner~~managing director of ~~CRC Investment~~Giant Management Consulting, LLC. of Taiwan and a founder of AMIA, Inc., an education consultancy based in Belmont, California. Mr. Lee holds a doctorate degree in resource planning and management from Stanford University.

ARTHUR M. WANG is the chief executive officer and a director of our Company. He is 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 a managing partner of 698 Capital Limited, an Asian investment firm, as well as an executive director of KGI Asia Limited ~~the investment banking arm of the Koos Group of Taiwan.~~(“KGI”). At KGI, Mr. Wang served as head of corporate finance. He also served as an investment advisor and board member of UFJ Asia Finance Technology Fund of the UFJ Group (formerly the Sanwa Bank Group of Japan), and as a board member and director of Softbank Investment International (Strategic) Limited, the Hong Kong Stock Exchange listed arm of Softbank Corporation. Mr. Wang received his ~~bachelor~~Bachelor of ~~arts~~Arts degree from the University of California, Los Angeles and his ~~juris doctorate~~Juris Doctorate degree from Yale Law School. He practiced corporate and securities law in the New 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. (“Goldman Sachs”), where he was an executive director of the investment banking division. At Goldman Sachs, Mr. Hui originated and executed a broad range of mergers and acquisitions and financing transactions in Asia. Prior to working at Goldman Sachs, Mr. Hui served as an investment banker at

Merrill Lynch & Co. and as a management consultant at McKinsey & Company, both in Hong Kong. Mr. Hui holds a ~~master~~Master of ~~engineering~~Engineering degree in electrical engineering from Cornell University and a ~~bachelor~~Bachelor of ~~science~~Science degree in electrical engineering from the University of Wisconsin –— Madison.

ROBERT J. CAHILL is the head of the software licensing and online entertainment business of our Company. Mr. Cahill is the chief executive officer of CESL. Prior to joining our Company, Mr. Cahill served as the chief financial officer for Smarterkids.com. He also previously served in the finance group for Gensym Corporation and as an audit manager at Ernst & Young, LLC. Mr. Cahill received a Master of Business Administration degree from Bentley College and a Bachelor of Science degree in business administration from the University of Massachusetts.

SAMUEL CHOU is the head of the online games business of our Company. Mr. Chou became the chief executive officer and president of online games and entertainment of GigaMedia in April 2007. Mr. Chou was chairman and chief executive officer of Warner Music for the Greater China Region from 2004 to 2006. Prior to that, Mr. Chou was managing director of Warner Music in Taiwan. Mr. Chou was also previously the chairman of the International Federation of the Phonographic Industry in Taiwan. Mr. Chou received his Master of Business Administration degree from the National Giao Tung University as well as a Bachelor of Sociology degree from National Taiwan University.

MICHEL CHU is the chief technology officer and an executive vice president of our 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 our ~~Company’s~~ broadband service infrastructure. Mr. Chu received a ~~master~~Master of ~~science~~Science degree in electrical engineering from National Taiwan University.

KENNY CHING-KUN HUANG is a senior vice president of our Company. He has experience in investment banking, the television and cable industry, as well as the Asian gaming industry. Mr. Huang is responsible for the promotion and business development of our gaming software in Asia. Mr. Huang received his Master of Business Administration from the University of California, Irvine.

FALCO MAI is the chief administrative officer and an executive vice president of our Company. He is also currently the chairman of KGI Futures Co. Ltd., and a director of KGI Securities Co. Ltd in ~~Taipei.~~Taipei, Global Securities Finance Corporation and Taiwan Futures Exchange. Prior to joining our Company, Mr. Mai worked at KGI Securities Co. Ltd in Taipei as a manager of the research department, the equity and ~~sales -~~ sales—proprietary trading department and the derivatives product department. Mr. Mai was also senior vice president to the general management office, as well as the spokesman from ~~1993-2001.~~1993 to 2001. Mr. Mai received a ~~bachelor~~Bachelor of ~~science~~Science degree in electrical engineering from National Taiwan University.

JOSEPH SHEA is an executive vice president of our Company responsible for strategic and business development. Prior to joining ~~GigaMedia,~~us, 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 also a manager at A.T. Kearney (Hong Kong) Limited (“A.T. Kearney”) 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 several Internet-related projects. Mr. Shea also held design engineer positions in several major microprocessor design projects at Intel Corporation. Mr. Shea received his ~~master~~Master of ~~business administration~~Business Administration degree from the University of California, at Berkeley. He also holds a ~~masters~~Master of ~~science~~Science in electrical engineering from Columbia University as well as a ~~bachelors~~Bachelor of ~~science~~Science in electrical engineering from Carnegie-Mellon University.

CHEN-WEN TARN is the head of the Internet access service business of our Company. Prior to joining us, Mr. Tarn was a full professor of the National Taiwan University of Science and Technology. Mr. Tarn holds a doctorate degree in electrical and computer engineering from Syracuse University.

JENNIFER TSENG is a senior vice president and general counsel of our Company. Prior to joining ~~our Company,~~us, Ms. Tseng practiced law and presided over a local law firm in Taipei where she conducted a general litigation practice across a range of major business disputes and civil litigation, from counseling through trial and appeal. Ms. Tseng received her ~~master~~Master of ~~laws~~Laws degree from School of Law at the University of Warwick in the United Kingdom and her ~~bachelor~~Bachelor of ~~law~~Law degree from the Department of Law at the National Taiwan ~~University in Taiwan.~~University.

B. Compensation

For the year ended December 31, ~~2004,~~2006, the aggregate compensation paid by us to all of our executive officers was approximately US$~~994 thousand~~0.9 million and the aggregate compensation paid by us to all of our directors, including the CEO and CFO, was approximately US$~~202 thousand.~~1.0 million. The total outstanding number of share options granted to our directors and officers was ~~7,003,888 for~~7,057,587. For information on stock option plans, see Item 6 “Directors, Senior Management and Employees — E. Share Ownership.” For information on total amounts set aside by the ~~year ended December 31, 2004.~~
Company to provide pension and retirement benefits, see Note 17 of our consolidated financial statements.

C. Board Practices
~~Neither 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. Our audit committee currently consists of ~~Gilbert Bao,~~ Michael Y. J. Ding, Gilbert Bao and Yichin Lee. Our audit committee will select and evaluate, on our behalf, the independent public accountants who audit our annual financial statements, and will review and approve the planned scope of our annual ~~audit.~~audit, subject to the appointment, replacement or removal from office of our independent public accountants been approved by our shareholders at our Annual General Meeting. In accordance with our Articles of Association and our audit committee charter, all of the members of our audit committee must be persons who qualify as “independent” directors for purposes of the rules and regulations of the NASDAQ ~~National~~Global Market.

We also have a compensation committee that consists of Daniel Chuen-Tai Wu, Michael Y.J. Ding and Yichin Lee.
Our compensation committee reviews and evaluates the compensation and performance of executive officers, and our Company’s general compensation plans and other employee benefit plans, and performs other duties and responsibilities pursuant to the compensation committee charter. In accordance with our compensation committee charter, all of the members of the compensation committee are qualified independent directors pursuant to the requirements of the NASDAQ Global Market.

D. Employees

In the years ended December 31, 2004, 2005 and 2006, our total employees were 608, 323 and 503, respectively. As of ~~June 15, 2005, our consumer broadband ISP business and our corporate headquarters employed 176 people,~~May 31, 2007, we had a total of 555 employees, excluding part-time and temporary personnel and consultants. Our corporate headquarters employed 92 people. Our Internet access service business employed 134 people, including 60 people in Hoshin GigaMedia and 74 people in our subsidiary, KBT. Our software licensing and online entertainment business had 111 employees. Our online games business had 218 employees. Of the ~~176~~total 555 employees, ~~110~~444 were ~~employed~~ in ~~our consumer broadband ISP business group, including sales, marketing, engineering, customer service~~Asia, 7 were in Europe and ~~related services; 25~~104 were ~~employed~~ in our technology group; 15 were employed in the chief executive officer’s office; 16 were employed in our finance and control group; and 10 were employed in our administration group. In addition, our corporate ISP business as of June 15, 2005 employed a total of 66 people. Our music distribution business employed a total of 303 people as of June 15, 2005, including 244 store employees and 59 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.~~
North America.

E. Share Ownership

Share Ownership of Directors and Executive Officers

The tables below set forth information as to our directors’, and executive officers’ share ownership in our Company as of ~~June 15, 2005:~~May 31, 2007:

Number of Shares
Number of Issuable upon
Person Common Shares 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. * 2,500,000
HUI, Thomas T. * 1,200,000
CAHILL, Robert J. 0 *
CHOU, Samuel 0 0
CHU, Michel * *

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 Shares
Number of Issuable upon
Person Common Shares exercise of options
HUANG, Kenny Ching-Kun * *
MAI, Falco * *
SHEA, Joseph * *
TARN, Chen-Wen * *
TSENG, Jennifer * *
* Less than 1%1 percent
All options granted 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~~below. The options expire in 2014.
Beneficial Ownership
~~As of June 15, 2005, Jeffrey Koo Jr. and Andre Koo jointly owned 10,799,999 common shares or approximately 21.45% of our common shares through Best Method Limited.~~
~~Other than as stated above, no other~~
     No director or executive officer beneficially owns of record more than 1%1 percent of the outstanding shares of our Company. See Item 7 — “Major Shareholders and ~~Related Party~~Related-Party Transactions” below.
Employee Share Option Plans
~~During 1999, we adopted the GigaMedia Limited Employee Share~~
2002 Option Plan or the 1999 Plan. Pursuant to the 1999 Plan, up to two million common shares may be granted to employees of our 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.
At the June 2002 annual general meeting of shareholders, the shareholders of ~~the~~our Company approved the GigaMedia Limited 2002 Employee Share Option Plan ~~or the 2002 Plan,~~(the “2002 Plan”) under which up to ~~three million~~3,000,000 common shares of ~~the~~our Company ~~have been~~were reserved for issuance. All employees, officers, directors, advisors and ~~directors~~consultants of ~~the~~our 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 ~~three million~~3,000,000 shares of ~~the~~our Company’s common stock were granted and ~~exercisable upon granting~~vested at an exercise price of ~~$0.79~~US$0.79 pursuant to the 2002 Plan. As at December 31, 2006, no option had been exercised or cancelled. All options granted under the 2002 Plan expire inon June 29, 2014.
The maximum contractual term under the 2002 Plan is approximately 10 years. Termination of employment will not affect rights of exercise under vested options.
2004 Option Plan
At the June 2004 annual general meeting of shareholders, the shareholders of ~~the~~our Company approved the GigaMedia Limited 2004 Employee Share Option Plan ~~or the 2004 Plan,~~(the “2004 Plan”) under which up to ~~seven million~~7,000,000 common shares of ~~the~~our Company ~~have been~~were reserved for issuance. All employees, officers, directors, advisors and ~~directors~~consultants of ~~the~~our 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~~our Company’s common stock were granted at an exercise price of ~~$0.79~~US$0.79 pursuant to the 2004 Plan. These options were subject to two vesting schedules. In accordance with the terms of the first vesting schedule, 3,863,888 options were vested and exercisable upon granting. As at December 31, 2006, 95,000 options were cancelled, 389,000 options had been exercised and the number of outstanding options under the first vesting schedule was 3,379,888 options. In accordance with the terms of the second vesting schedule, 1,598,642 options were granted, of which 399,663 options were vested and exercisable upon granting. The remaining 1,198,979 options ~~are~~will be vested ~~25%~~at a rate of 399,661 options per year from the grant date. As at December 31, 2006, 309,229 options were cancelled, 559,655 options had been exercised and the number of outstanding options under the second vesting schedule was 729,758 options.
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     In May 2005, options to purchase 100,000 shares of our Company’s common stock were granted at an exercise price of US$1.45 pursuant to the 2004 Plan. In accordance with the terms of the vesting schedule, 25,000 options were vested and exercisable upon granting. The remaining 75,000 options will be vested at the rate of 25,000 options per year from the grant date. As at December 31, 2006, no options had been exercised or cancelled.
     In December 2005, options to purchase 1,805,655 shares of our Company’s common stock were granted at an exercise price of US$2.55. These options were subject to two vesting schedules. In accordance with the terms of the first vesting schedule, 1,570,655 options were vested and exercisable upon granting. As at December 31, 2006, 23,000 options had been cancelled and 202,859 options had been exercised under the first vesting schedule. In accordance with the terms of the second vesting schedule, 94,000 options will vest and be exercisable in December 2007. The remaining 141,000 options will vest and be exercisable in December 2008. As at December 31, 2006, no such option under the second vesting schedule had been exercised or cancelled.
     The maximum contractual term under the 2004 Plan is 10 years. Termination of employment will not affect exercise rights under vested options. Unvested options will be cancelled upon termination of employment. All options granted under the 2004 Plan expire inon June 29, 2014.
~~See Note 17~~
2006 Equity Incentive Plan
     At the June 2006 annual general meeting of shareholders, the shareholders of our Company approved the GigaMedia Limited 2006 Equity Incentive Plan (the “2006 Plan”) under which up to one million common shares of our Company have been reserved for issuance. The 2006 Plan is administered by a committee designated by the board of directors. The committee as plan administrator has complete discretion to determine the grant of awards under the 2006 Plan.
     In December 2006, we granted 115,000 restricted stock units (“RSUs”) to our employees. These RSUs were subject to two schedules for the lapsing of restrictions on transfer. 25,000 RSUs are subject to the terms of the first lapsing schedule, under which the restrictions on transfer shall lapse with respect to the first 33 percent of the RSUs upon granting with the remaining 67 percent of the RSUs vesting over a two-year period so long as the employee is employed by or providing services to our Company. 90,000 RSUs are subject to the terms of the second lapsing schedule, under which the restrictions on transfer shall lapse over a three-year period, beginning April 1, 2007 so long as the employee is employed by or providing services to our Company.
     The maximum contractual term under the 2006 Plan is 10 years. In the event that the employee’s employment with or service to our Company is terminated prior to the lapsing of restrictions with respect to any portion of the RSUs, such portion of the RSUs shall become forfeited.
     All options and RSUs are expected to be settled by issuing new shares.
Options
     No options were exercised before 2005. In 2006, 1,151,514 options were exercised, and cash received from the exercise of stock options was US$1.3 million, which resulted in no significant tax benefit realized on a consolidated basis.
     There were no stock-based compensation expenses recorded in 2004 and 2005 as all options were granted to employees at prices in excess of the common stock market price at the date of grant. The impact resulting from our adoption of FAS 123(R) to our 2006 consolidated financial statements for ~~additional information.~~
income before income taxes and net income was US$(310) thousand, and US$(250) thousand, respectively. The impact on basic and diluted earnings per share for 2006 was US$(0.005) and US$(0.004) per share, respectively.
Employee Share Purchase Plan
At the June 2004 annual general meeting of shareholders, the shareholders of ~~the~~our Company approved the GigaMedia Limited 2004 Employee Share Purchase Plan ~~or the 2004 ESPP,~~(the “2004 ESPP”) under which up to ~~two million~~2,000,000 common shares of ~~the~~our Company ~~have been~~were reserved for issuance. Pursuant to the 2004 ESPP, ~~the~~our Company offered its shares to qualified employees aton favorable ~~conditions~~terms and established a restricted period of six months during which employees
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may not transfer the shares after purchasing them. To be eligible, employees must be employed by ~~the~~our 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~~US$1.39 per share.
~~See Note 17 of our consolidated financial statements for additional information.~~
ITEM 7. MAJOR SHAREHOLDERS AND ~~RELATED PARTY~~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 ~~June 15, 2005~~March 31, 2007 by (1) each shareholder known by us to own more than 5%5 percent 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%

Shares Percentage of
Name of Owner Owned Shares Owned
Best Method Limited (1) 10,799,999 20.53 %
Directors and executive officers as a group (10 persons) 402,222 0.76 %
(1) Through Best Method Limited, Jeffrey Koo, Jr. and Andre Koo jointly ~~own~~have a beneficial ownership of 10,799,999 common shares of our Company.
As of ~~June 15, 2005,~~May 31, 2007 we had ~~50,343,642~~52,732,357 ordinary shares outstanding, ~~out~~ of which ~~35,452,917~~41,530,136 shares were listed on the NASDAQ ~~National~~Global Market and not held by our major shareholders and directors or executive officers as disclosed above and in Item ~~6. —~~6 “Directors, Senior Management and Employees — E. Share ~~Ownership”,~~Ownership,” representing ~~approximately 70.42%~~0.76 percent of our total outstanding shares. As of ~~June 15, 2005, the 35,452,917~~May 31, 2007, 41,292,442 shares listed on the NASDAQ ~~National~~Global Market were held by 8730 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.
B. ~~Related Party~~Related-Party Transactions
~~From time~~
     In the course of operating our business, we provide Internet access services to ~~time, we have engaged in a variety~~certain of our affiliates. We believe such transactions with ~~our~~ affiliates were not material. As of May 31, 2007, we had a credit line and loan in an amount of NT$400 million (approximately US$12.3 million) from the normal course of business. Our policy is that such transactions have been conducted on terms as favorable to us as obtainable at the time in a comparable arm’s length transaction with a non-affiliate.
China Trust Commercial ~~Bank~~
~~Pursuant to an arrangement between our wholly-owned subsidiary KBT and~~Bank. As of May 31, 2007, we also had deposits in 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 December 31, 2003 and 2004, 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~~7.3 million (including US$~~1,563 thousand at an annual interest rate~~3.8 million 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 consolidated financial statements for additional information on related party transactions.~~
restricted cash).
C. Interests of Experts and Counsel
Not applicable.
ITEM 8. FINANCIAL INFORMATION
A. Consolidated Statements and Other Financial Information
Financial Statements
Please refer to Item 18 “Financial Statements.”
Information on Legal or Arbitration Proceedings
Class Action
In December 2001, a class action lawsuit was filed in the ~~United States~~U.S. District Court for the Southern District of New York against ~~the~~our Company in connection with the initial public offering of its stock. ~~There are approximately 300 issuers who are defendants in this class action.~~
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The complaint alleged that ~~the~~our Company violated ~~Section~~Sections 11 and Section 15 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 ~~or the Exchange Act,~~ and Rule 10b-5 promulgated thereunder. In October 2002, the plaintiffs voluntarily dismissed their claims against the individual defendants without prejudice. On February 19, 2003, the court issued an opinion and order on the defendants’ motion to ~~dismiss.~~
dismiss, which granted the motions in part and denied the motions in part. As to ~~the~~our 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,~~our Company, presented the executed settlement agreement to ~~Judge Scheindlin~~the judge 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 US$1 billion;
2) the insurers will pay up to US$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 trust, represented by plaintiffs’ counsel; and
4) the plaintiffs shall release all of the settling issuer defendants. If plaintiffs are successful in recovering more than US$1 billion from the underwriters, the issuer defendants ~~including~~will not be obligated to pay any additional amounts. If the ~~Company~~plaintiffs recover less than US$1 billion from the underwriters, the insurers will pay the deficit between US$1 billion 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 with 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 arisingreceived from the ~~settlement and claim.~~
underwriters.
On February 15, 2005, the ~~court~~judge 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,~~In July 2005, the ~~issuer defendants~~settling parties reached agreement and submitted ~~an amendment~~modifications to the settlement ~~that conforms to~~agreement in accordance with the ~~court order. Negotiation is proceeding~~court’s opinion.
     The underwriter defendants are not part of the settlement between the issuers and the ~~underwriters~~plaintiffs. The underwriter defendants have continued to ~~broaden~~defend the ~~bar order~~action and discovery has proceeded. In April 2006, plaintiffs and JPMorgan Chase & Co., one of the underwriter defendants, announced that it had signed a memorandum of understanding (the “JPMorgan Chase MOU”) to settle the action for approximately US$425 million. This proposed settlement does not include ~~a mutual bar of contractual indemnity claims.~~
~~The~~the other underwriter defendants.
     On April 24, 2006, the court ~~will schedule~~held a fairness hearing on the proposed ~~settlement and subsequently will decide whether to grant final approval to the settlement agreement. The settlement agreement~~Issuers’ Settlement, which is subject to the ~~approval~~court’s approval. As of this date, the ~~District Court.~~
~~In March 2003, we commenced arbitration proceedings~~court has not issued its ruling.
     On June 23, 2006 and October 12, 2006, the court held meetings with the legal counsels involved in ~~Singapore by submitting a Notice of Arbitration~~the case to discuss the proposed settlement. Subsequent to these meetings, the parties submitted an amendment to the ~~Singapore International Arbitration Center, or~~Issuers’ Settlement, which included the ~~SIAC~~following terms: (1) waiving insurers’ rights under the settlement agreement to ~~resolve certain contractual dispute in connection with a strategic agreement entered into between our Company, EMI Music Asia, or EMI~~recoup notice and ~~GigaMusic.com Limited, or GigaMusic.com. On December 31, 2003, a Final Settlement Agreement~~defense cost, which is likely to exceed US$60 million; 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(2) waiving 50 percent of ~~our board 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 the JPMorgan Chase MOU (US$425 million) which would operate as an offset to the US$~~1.0 million~~1 billion guarantee. These changes were designed to address potential problems that the judge may have had with the proposed settlement.
     On December 5, 2006, the United States Court of Appeals for the Second Circuit issued ~~to EMI~~an opinion vacating the District Court’s class certification of a litigation class in ~~accordance with said strategic agreement. The arbitration proceedings were withdrawn and settled in March 2004.~~
~~In March 2004, the landlord~~that portion of the ~~premises of one of our retail music stores filed a lawsuit in~~case between the plaintiffs and the underwriter defendants. Because the Second Circuit’s opinion was directed to the class certification by 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 with the landlord about the terms and conditions for a settlement during 2004 and, at the same time, accrued US$173 thousand as provision for the ~~rental lawsuit. As of February 2005,~~plaintiffs’ litigation against the ~~total amount of monetary damage alleged~~underwriter defendants, the opinion’s effect on the proposed class to be certified by the ~~landlord aggregated to approximately US$252 thousand. On March 7, 2005, the Defending Entities 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 an amount in NT dollar equivalent to US$202 thousand and release the subsidiary from the lawsuit, provided that the settlement fund was received by the landlord before March 31, 2005. The subsidiary has remitted the settlement fund to the landlord on the due date and settled the lawsuit.
~~In November 1999, we issued a warrant to Microsoft~~District Court in connection with the ~~purchase~~Issuers’ Settlement is unclear.
     On December 15, 2006, the District Court held a conference with all counsel in the IPO Securities Class Action to discuss the impact of the foregoing opinion. In the conference, the District Court agreed to stay all proceedings, including discovery and consideration of the Issuers’ Settlement and the JPMorgan Chase MOU, pending further decisions from the Second Circuit.
     On January 5, 2007, plaintiffs filed a petition in the Second Circuit for rehearing and rehearing en banc regarding the decision on class certification (the “Petition”). On January 24, 2007, the Second Circuit entered an order instructing the underwriter defendants to submit a brief in response to the Petition. On February 7, 2007, the underwriter defendants filed a brief in opposition to the Petition. On April 6, 2007, the Second Circuit rendered its decision which denied the Petition. On April 23, 2007, the District Court held a conference in which the following issues were discussed:
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• Class Certification: The plaintiffs are considering a new class definition, which is regarded as a priority by the District Court;
• Tolling Agreement: The plaintiffs requested tolling agreements for class members in the focus cases from the underwriters. If the underwriters do not agree to toll the plaintiffs’ claims, the plaintiffs may file individual actions. In such case, the underwriters may want to have these claims arbitrated;
• Settlements: The District Court indicated that the issuers settlement cannot stand in its present form, and any further discussions on the settlement between the issuers and the plaintiffs should depend on the plaintiffs’ new proposed class definition; and
• Discovery: The stay of discovery is continuing and will be addressed by the District Court at the next conference.
     On May 30, 2007, the District Court held a conference in which the following issues were discussed:
• New Class Definition: the plaintiffs proposed a new class definition and moved for class certification;
• Statutes of Limitation: the underwriters refused to agree to toll the statute of limitations on plaintiffs’ claims, which caused plaintiffs to file a motion of individuals to intervene as plaintiffs in a focus case in which the plaintiffs think that the statue of limitations is close to running;
• Issuers’ Settlement: Since the settlement in its present form is not viable, the issuers will ask the District Court to deny the motion to approve the settlement without prejudice to application to the District Court regarding any future settlement; and
• Discovery: There were unresolved issues regarding the scope of discovery and may further be discussed at the next conference.
     The parties are currently in a process of meeting and conferring to discuss the issues raised by ~~Microsoft~~the court in the recent court conferences.
     Neither we, nor our legal counsel, are able to assess the likelihood of ~~four million~~the outcome, nor can we determine the amount or range of ~~our shares for~~potential loss, if any. We had an insurance policy with American Insurance Group with US$~~35 million. The warrant was exercisable for five years and initially entitled Microsoft to purchase up to~~ 10 million of liability coverage when the class action lawsuit was made. According to the insurance policy, our ~~shares at~~Company is required to pay a US$~~6.60 per share. As~~500,000 deductible. We recorded a ~~result of a special distribution~~provision of US$~~2.00 per share by GigaMedia~~500,000 in ~~March 2002, the warrant provided~~2003, representing our deductible amount, related to these claims. In 2005, our legal counsel advised that ~~Microsoft had the right~~it is unlikely that we will have to ~~elect either (i) an adjustment~~pay any remaining, unused portion of our deductible with respect to the ~~terms~~claims. Accordingly, we reversed the provision of ~~the warrant such~~US$500,000 in 2005. We believe that the ~~warrant thereafter would represent~~insurance coverage is sufficient to cover 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. In September 2004, certain of our principal shareholders fully indemnified us in connection withliability arising from the settlement and ~~the warrant has been returned by Microsoft is unexercised.~~
Except for the above-referenced litigation, we are not aware that any of our directors, any member of our senior management 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.
claim.
Dividend Policy
We have ~~never~~not declared nor paid any dividends on our ~~shares.~~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
Except as disclosed in this annual report, no significant change has occurred since the date of our consolidated financial statements.
ITEM 9. THE OFFER AND LISTING
A. Offer and listing details
The following table shows, for the periods indicated, the high and low closing prices for ~~the shares~~our Shares as quoted on the NASDAQ ~~National Market, as well as the total trading volume and the average daily trading volume for such shares.~~Global Market.
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   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

Common Shares
Year Ending December 31, 2002 High Low
(in US$)
First quarter $ 2.88 $ 2.30
Second quarter $ 1.25 $ 0.67
Third quarter $ 1.30 $ 0.63
Fourth quarter $ 0.84 $ 0.42

Common Shares
Year Ending December 31, 2003 High Low
(in US$)
First quarter $ 1.52 $ 0.66
Second quarter $ 1.21 $ 0.86
Third quarter $ 2.98 $ 1.17
Fourth quarter $ 3.35 $ 1.44

Common Shares
Year Ending December 31, 2004 High Low
(in US$)
First quarter $ 2.07 $ 1.33
Second quarter $ 1.87 $ 1.06
Third quarter $ 1.43 $ 0.70
Fourth quarter $ 2.43 $ 1.30

Common Shares
Year Ending December 31, 2005 High Low
(in US$)
First quarter $ 1.86 $ 1.30
Second quarter $ 2.48 $ 1.38
Third quarter $ 2.66 $ 1.68
Fourth quarter $ 2.99 $ 1.76

Common Shares
Year Ending December 31, 2006 High Low
(in US$)
First quarter $ 6.01 $ 2.90
Second quarter $ 10.39 $ 6.13
Third quarter $ 12.38 $ 7.30
Fourth quarter $ 11.06 $ 8.86

Year Ending December 31, 2007 High Low
(in US$)
First quarter $ 14.34 $ 9.28
Second quarter (only through June 15, 2007) $ 15.97 $ 13.92
B. Plan of Distribution
Not applicable.
C. Markets
Our ~~shares~~Shares have been listed and traded on the NASDAQ ~~National~~Global Market since February ~~24,~~18, 2000.
     Under Rule 4350(l) of the NASDAQ rules, all securities listed on NASDAQ must be eligible for a direct registration program operated by a registered clearing agency. We are required to comply with the requirements of this rule by January 1, 2008. In order to fulfil the direct registration program eligibility requirements, we are required (among others) to amend our constitutional documents to allow for the issue of non-certificated securities.
     We are incorporated in the Republic of Singapore and are subject to the Singapore Companies Act (Cap.50). We are advised by our Singapore counsel that under the Singapore Companies Act, Singapore-incorporated companies are required to issue physical share certificates to its registered shareholders, and there are no exceptions to or exemptions from this requirement that would enable us to amend our constitutional documents to allow for the issue of non-certificated securities. Therefore, we will not be able to comply with the provisions of Rule 4350(l).
     Under Rule 4350(a)(1), as a foreign private issuer, we are allowed to follow our home country practice in lieu of the requirements set out in the rule, subject to certain exceptions. We will be relying on this rule for an exemption from the requirements of Rule 4350(l). We have informed the NASDAQ Global Market about our election to comply with the laws of Singapore in lieu of the direct registration system provisions of Rule 4350(l).
D. Selling Shareholders
Not applicable.
E. Dilution
Not applicable.
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F. Expenses of the issue
Not applicable.
ITEM 10. ADDITIONAL INFORMATION
A. Share Capital
Not applicable.
B. Memorandum and Articles of Association
Our current Memorandum and Articles of Association were first adopted on ~~June 30, 2000.~~
our date of incorporation, being September 13, 1999, and have been amended since that date.
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) (the “Singapore Companies Act”) and any other written law in Singapore and our Memorandum and Articles of Association, we have full capacity to carry on or undertake any business or activity, do any act or enter into any transaction and for such purposes, full rights, powers and 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 is prohibited from acting as a director by reason of any order made pursuant to the Singapore Companies Act;
• He ceases to be a director by virtue of any of the provisions of the Singapore Companies Act or the Articles of Association of our Company;
• He resigns from his office;
• He receives a bankruptcy order made against him;
• He has a receiving order made against him or suspends payment or compounds with this creditors generally;
• He is found to be a 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.
~~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).~~
A director of our Company who is directly or indirectly interested in a transaction, contract or arrangement with our Company 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. Subject to such disclosure, a director shall be entitled to vote in respect of any contract or arrangement in which he is interested and he shall be taken into account in ascertaining whether a quorum 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 may secure the repayment or payment of such sums by mortgage or charge upon all or any of our property or assets or by the issue of debentures ~~(whether at par or at discount or premium)~~ or otherwise as they may think ~~fit.~~fit, provided that the directors shall not carry into effect any proposals for disposing of the whole or substantially whole of our Company’s undertaking or property unless those proposals have been approved by our Company in general meeting.
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Subject to the Singapore Companies Act, ~~(Chapter 50),~~ the remuneration of the directors shall be determined from time to time by our Company in general meeting. Any director who is appointed to any executive office or serves on any committee or who otherwise performs or renders services, which in the opinion of the directors are outside his ordinary duties as a director, may, subject to the Singapore Companies Act, ~~(Chapter 50),~~ be paid such extra remuneration as the directors may determine.
Our directors are not required to hold any of our ~~shares~~Shares by way of qualification. A director who is not a shareholder of us is nevertheless entitled to attend and speak at shareholders meetings.
AUDIT COMMITTEE
Our audit committee and our board of directors have the ultimate authority and responsibility to select and evaluate, on our behalf, the independent public accountants who audit our annual financial ~~statements.~~statements, subject to the appointment, replacement or removal from office of our independent public accountants being approved by our shareholders at our Annual General Meeting. Our audit committee will review and approve the planned scope of our annual audit. In accordance with our Articles of Association, all of the members of our audit committee must be persons who qualify as “independent” directors for purposes of the rules and regulations of the NASDAQ ~~National~~Global Market.
The audit committee is currently consists of Messrs. Gilbert Bao, Michael Y. J. Ding and Yichin Lee. We ~~intend to fully comply~~are in compliance with the requirements of the U.S. Sarbanes-Oxley Act of 2002 and the rules of the U.S. Securities and Exchange Commission thereunder and the NASDAQ ~~National~~Global Market’s requirements relating to audit committees.
DIVIDENDS
Our Company may by an ordinary resolution 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 up on shares.
All dividends unclaimed after having been declared may be invested or otherwise made use of by our board of directors for the benefit of our ~~benefit.~~Company. If any dividend has not been claimed for six years from the date of declaration, such dividend may be forfeited and shall revert to ~~us.~~our Company. However, ~~our~~the directors may at any time thereafter at their absolute discretion annul any such forfeiture and pay the dividend so forfeited to the person entitled thereto prior to the forfeiture. No dividend shall bear interest against ~~us.~~
our Company.
LIQUIDATION DISTRIBUTION
In the case of a winding up of our Company and in accordance with applicable 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 of our shareholders but so that no shareholder will be compelled to accept shares or other securities on which there is any liability.
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%~~10 percent of the voting rights of our ~~paid-up share capital.~~Company. In addition, two or more shareholders holding not less than ~~10%~~10 percent of ~~our~~the total number of issued ~~share capital~~shares (excluding treasury shares) may call a meeting of our shareholders. Unless otherwise required by law or by our Articles of 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%~~75 percent of those present and voting, is necessary for certain matters under the Singapore Companies Act, ~~(Chapter 50),~~ such as an alteration of our Articles of Association. Subject to the Singapore Companies Act, ~~(Chapter 50),~~ at least 21 days’ advance written notice specifying the intention to propose a special resolution must be given of every general meeting convened for the
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purpose of passing a special resolution. Subject to the Singapore Companies Act, ~~(Chapter 50),~~ at least 14 days’ advance written notice must be given of every general meeting convened for the purpose of passing an ordinary resolution.
VOTING 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 meeting to repurchase not more than ~~10%~~10 percent of our own ~~shares~~Shares in issue.
Our board of directors may make a capital call on our shareholders with respect to the amounts unpaid on their shares and the shareholders are required to pay the amount called at the time(s) and place as appointed by the board of directors. The board of directors 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;~~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,~~Shares, 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; and
(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~~or any ~~capital redemption~~undistributable 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.~~
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~~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 within two months of such meeting.
TRANSFER OF SHARES
Subject to our Articles of Association, our ~~shares~~Shares are freely transferable but our directors may, in their absolute discretion, decline to register any transfer of our ~~shares~~Shares on which we have a lien. All of our outstanding ~~shares~~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 common form 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 certificate of payment of stamp duty (if any), the share ~~certificate~~certificates to which the transfer relates and other evidence of title as they may require. We will replace worn-out or defaced share 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 stolen share certificates ~~for shares~~ upon, among other things, the applicant furnishing evidence and such indemnity as the directors may require.
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~~TAKEOVERS~~
TAKEOVERS
The acquisition of shares of public companies is regulated by the Singapore Securities and Futures Act (Chapter 289) and the Singapore Code on Take-overs and Mergers. Any person, either on his own or together with ~~parties~~persons acting in concert with him, acquiring an interest in ~~30%~~30 percent 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~~Unless the contrary is established, “persons acting in concert” are presumed to include a company and its related and associated companies and a person who has provided financial assistance (other than a bank in the ordinary course of business) to such company or any of its related and associated companies for the purchase of voting rights, 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 discretionary basis and a financial advisor and its client in respect of shares held by the financial advisor and all the funds managed by the financial advisor on a discretionary basis where the shareholdings of the financial advisor and any of those funds in the client total ~~10%~~10 percent or more of the client’s equity share capital. The offer must be in cash or be accompanied by a cash alternative at not less than the highest price, excluding stamp duty and dealing costs, paid by the offeror or ~~parties~~persons acting in concert with him for shares of that class within the preceding six months. A mandatory takeover offer is also required to be made if a person holding between ~~30%~~30 percent and ~~50%,~~50 percent, both inclusive, of the voting shares, ~~either on his own~~ or ~~together with parties~~any person acting in concert with him, acquires additional shares representing more than 1%1 percent of the voting shares in any six-month period.
AMENDMENTS TO THE ARTICLES OF ASSOCIATION
     It should be noted that the Singapore Companies Act has been amended with effect from January 30, 2006 resulting in significant changes to the company law regime. These amendments include the abolition of the concepts of par value and authorized capital, and allowing repurchased shares to be held as treasury shares. With the abolition of the concept of par value pursuant to the Companies (Amendment) Act 2005, shares of a company no longer have any par or nominal value. The concepts of share premium and the issue of shares at a discount have also been abolished. Our Articles of Association were amended at the annual general meeting of our Company on June 29, 2006 to take into account changes to the Singapore Companies Act arising from the Companies (Amendment) Act 2005.
C. Material Contracts
The following are summaries of our material contracts entered into over the past two 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 tofrom our annual ~~reports~~report on Form ~~20-F and Form~~ 20-F/A ~~(File No. 000-30540)~~ filed with the Commission on ~~August 15, 2003 and June 30, 2004.~~
December 8, 2006.
~~Settlement Agreement, dated December 31, 2003, among EMI, GigaMusic.com and GigaMedia~~
On December 31, 2003, we entered into a Settlement Agreement with EMI and GigaMusic.com to resolve and settle all disputes in connection with the strategic agreement entered into between our Company, EMI and GigaMusic.com as of May 14, 2001. Under the Settlement Agreement, we agreed to pay EMI US$400 thousand while EMI agreed to return to us 5% ownership of GigaMusic.com and a 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 a resolution approved by a meeting of our board of directors.
~~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~~
On March 17, 2004, we entered into a Stock 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$32.5 million.
~~End User~~End-User License Agreement, dated April 1, 2004, ~~by and among~~between IML and UIM, as amended by the Second Amendment to the End-User License Agreement, dated March 1, 2006 and the Third Amendment to the End-User License Agreement, dated March 1, 2007.
On April 1, 2004, weIML entered into an ~~End User License Agreement~~end user license agreement with UIM pursuant to which weIML granted a non-exclusive, ~~non-transferable, world-wide~~non transferable, world wide license to UIM to use our software and certain operational and support services for a licensing fee based on a ~~revenue~~revenues sharing arrangement between us and UIM. The agreement is for a term of ten years.
     In March 2007, we amended the terms of the end user license agreement between ourselves and UIM. Pursuant to the terms of the amended agreement, UIM will pay us royalties based on revenues earned at the rate of 42 percent of gross revenues derived from our games of chance software and 17.5 percent of gross revenues derived from our multi-player game software.
Purchase and Sale Agreement, dated June 23, 2005, between Hoshin GigaMedia ~~Center Inc.~~ and ~~Webs-TV.net Digital International Corporation, or~~ Webs-TV
On June 23, 2005, we entered into an agreement with Webs-TV to assign our Internet content business atfor a consideration of an amount in NT dollars equivalent to approximately US$~~670 thousand~~0.7 million and, for a period of ten years
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commencing from January 1, 2006, a portion of the net ~~revenue~~revenues generated from the gigigaga.com.tw ~~website being~~Web site will be transferred. Pursuant to the agreement, we ~~will transfer~~have transferred to Webs-TV all properties relating to the operation of our gigigaga.com.tw ~~website,~~Web site, including fixed assets, the gigigaga logo, and our content and data.
Share Purchase Agreement, dated September 17, 2005, between GigaMedia and Nextbase International Ltd.
     On September 17, 2005, we entered into an agreement with Nextbase International Ltd. to sell our 9,262,501 shares in G-Music Limited (the “Target Shares”) which accounted for 58.58 percent of the total issued and outstanding shares in G-Music Limited. The total purchase price for all the Target Shares was approximately US$5.15 million.
Asset Sale and Purchase Agreement, dated December 19, 2005, between GigaMedia, FunTown World Limited, Hoshin GigaMedia and TWP
     On December 19, 2005, through our wholly-owned subsidiaries, FunTown World Limited and Hoshin GigaMedia, we entered into a definitive agreement with TWP to acquire FunTown. On January 2, 2006, we completed the acquisition of FunTown and purchased certain assets and assumed certain liabilities of FunTown from TWP. The total purchase price of approximately US$43 million consisted of cash payments of approximately US$27.2 million and zero coupon convertible notes in the aggregate principal amount of approximately US$15 million, representing a valuation premium of US$0.8 million as determined by a third-party valuer. The convertible notes were issued on January 1, 2006 by our Company to TWP, in the aggregate principal amount of approximately NT$494 million (US$15 million) with 50 percent maturing on January 1, 2008 and 50 percent maturing on January 1, 2009 and were convertible into 4,794,323 shares of our common stock at US$3.1287 per share (The conversion price is subject to adjustment for stock dividend, stock split, reserve stock split, recapitalization, merger, and other dilution). We have the right to redeem the convertible notes, in whole or in part, within 12 months after the issue date, together with the accrued interest at 5 percent per annum. On January 1, 2006, we pledged our share holdings in Hoshin GigaMedia as collateral for the notes. Direct transaction costs amounting to approximately US$110 thousand were included as part of the acquisition cost.
     The transaction also included an incentive in the form of an additional amount to be paid by GigaMedia on April 1, 2007, which amount will be determined as follows:
(i) If the growth of the adjusted pre-tax net income of FunTown in 2006 is 30 percent or more, the additional payment will be US$5 million;
(ii) If the growth of the adjusted pre-tax net income of FunTown in 2006 is 25 percent or above but less than 30 percent, the additional payment will be US$4.17 million;
(iii) If the growth of the adjusted pre-tax net income of FunTown in 2006 is 20 percent or above but less than 25 percent, the additional payment will be US$3.33 million;
(iv) If the growth of the adjusted pre-tax net income of FunTown in 2006 is 15 percent or above but less than 20 percent, the additional payment will be US$2.5 million; and
(v) If the growth of the adjusted pre-tax net income of FunTown in 2006 is less than 15 percent, no additional payment will be made by GigaMedia.
Put-Call Option Agreement, dated December 21, 2005, between Hoshin GigaMedia and JSDWAY
     On December 21, 2005, our wholly-owned subsidiary, Hoshin GigaMedia, entered into a put-call option agreement with JSDWAY. As of the date of the put-call option agreement, Hoshin GigaMedia owns 4,905,000 common shares (the “Put-Call Shares”) of Gamania. According to the put-call option agreement, JSDWAY granted Hoshin GigaMedia an option to sell to JSDWAY the Put-Call Shares at the price of NT$18.7 (US$0.57) per share exercisable before December 21, 2006, and Hoshin GigaMedia granted JSDWAY an option to buy from Hoshin GigaMedia the Put-Call Shares at the price of NT$18.7 (US$0.57) per share exercisable before December 21, 2006. As of December 31, 2005, neither Hoshin GigaMedia nor JSDWAY had exercised the put-call option agreement.
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This put-call option agreement was terminated on December 4, 2006. See Note 9, “Marketable Securities – Current” of our consolidated financial statements for further information.
Subscription Rights Agreement, dated March 10, 2006, between Hoshin GigaMedia, Wretch and the shareholders of Wretch
     On March 10, 2006, our wholly-owned subsidiary, Hoshin GigaMedia, entered into a subscription rights agreement with Wretch and its shareholders. Wretch is a leading online “community” offering a wide range of community services including blogs, photo albums and bulletin boards. According to the subscription rights agreement, Hoshin GigaMedia was granted a right to acquire up to a 20 percent equity stake in Wretch with a valuation based on a pre-agreed formula if and when Wretch increases its share capital within three years of the date of this subscription rights agreement. In exchange for these rights, Hoshin GigaMedia agreed to provide Wretch with certain free Internet services for three years.
Series A Preferred Share Purchase Agreement, dated April 27, 2006, between GigaMedia China Limited and T2CN and certain shareholders of T2CN
     On April 27, 2006, our wholly-owned subsidiary, GigaMedia China Limited (“GigaMedia China”), entered into a share purchase agreement with T2CN, an online casual sports games operator in the PRC, pursuant to which GigaMedia China made an initial investment of US$15 million to acquire 7.5 million shares of convertible preferred stock. The convertible preferred shares have an initial liquidation preference, are entitled to receive cumulative dividends at 8 percent per annum, and are redeemable starting December 31, 2009. The preferred shares are convertible into common shares of T2CN on a 1 : 1 basis, subject to certain adjustments.
Strategic Partnership Agreement, dated April 27, 2006, between T2CN and GigaMedia China
     On April 27, 2006, through our wholly-owned subsidiary, GigaMedia China, we entered into a strategic partnership agreement with T2CN. Pursuant to this strategic partnership agreement, GigaMedia and T2CN will together offer FunTown’s existing games to the T2CN user base. GigaMedia will become T2CN’s exclusive provider for FunTown’s existing games and preferred provider for games newly developed by GigaMedia.
Shareholders’ Agreement, dated April 27, 2006, between GigaMedia China, T2CN and certain shareholders of T2CN, as amended and restated by the Amended and Restated Shareholders’ Agreement dated November 25, 2006
     In connection with our strategic partnership with T2CN and subscription for preferential shares in T2CN, in April 2006, we entered into a shareholders’ agreement with T2CN and certain shareholders of TC2N to regulate our relationship with the ordinary shareholders of T2CN, which was subsequently amended and restated in November 2006. Pursuant to these agreements, we obtained the right to elect one member to the board of directors of T2CN, along with customary preferred share rights and protections, and acquired certain veto rights over the management of T2CN. We were also granted rights to subscribe for additional convertible preferred shares of T2CN, based on the financial performance of T2CN in each of the twelve-month periods ended March 31, 2007 and December 31, 2007. In addition, we provided shareholders of T2CN with an aggregate of approximately 52.92 percent of the issued share capital of T2CN with an option to sell their shares to us within two years from May 8, 2006 at a price equivalent to 8.65 times the net operating income of T2CN per share, subject to certain adjustments.
Asset Purchase and Sale Agreement, dated May 15, 2006, between Hoshin GigaMedia and Webs-TV
     On May 15, 2006, our wholly-owned subsidiary, Hoshin GigaMedia, entered into an agreement with Webs-TV, a Taiwan digital content provider, to sell GigaMedia’s ADSL business. Under the agreement, Webs-TV purchased our ADSL business in an all cash transaction with a total price of approximately US$8.9 million for our ADSL business and approximately US$0.9 million for the right to use our ADSL brand for five years. Both are payable from May 15, 2006 through July 31, 2007. The transferred ADSL business includes GigaMedia’s ADSL-related equipment, business contracts, and subscription contracts between Hoshin GigaMedia and approximately 62,000 ADSL subscribers.
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Service Agreement, dated May 15, 2006, between Hoshin GigaMedia and Webs-TV
     In connection with the sale of our ADSL business, we agreed on May 15, 2006 to provide Webs-TV with the following support and administrative services that are necessary for the ADSL business on a transitional basis: bandwidth, consulting and other support services through December 31, 2007. For these services, Webs-TV shall pay us a fee of approximately US$8.3 million which is payable from May 15, 2006 through February 28, 2008. The term of this agreement is from May 15, 2006 to December 31, 2007.
Subscription Agreement, dated December 7, 2006, between GigaMedia Asia Pacific Limited and Infocomm Asia
     On December 7, 2006, we entered into a subscription agreement with Infocomm Asia, an online game operator based in Singapore, through our wholly-owned subsidiary GigaMedia Asia Pacific Limited (“GigaMedia Asia Pacific”). Pursuant to this agreement, we made an investment of US$10 million to subscribe for 500,000 voting convertible preferred shares on an as-convertible basis, approximately representing 32.26 percent of the total issued and outstanding common shares of Infocomm Asia, making us the largest shareholder of Infocomm Asia.
Termination Agreement, dated December 12, 2006, between Hoshin GigaMedia, KBT, Wretch and certain shareholders of Wretch
     On December 12, 2006, we entered into an agreement with Wretch and certain of its shareholders to terminate the subscription rights agreement dated March 10, 2006 entered into between Hoshin GigaMedia, Wretch and its shareholders. Pursuant to this agreement, Wretch agreed to make a one-time termination payment of NT$1.5 million (or US$46 thousand) to us, an indemnification fee comprised of a fixed fee of NT$20 million (or US$0.6 million) (including VAT tax) and a variable fee, which amount was to be determined based on the final acquisition price to be paid by a third party investor for the acquisition of all the issued share capital of Wretch as follows:
(a) if the final acquisition price exceeded US$24 million but was less than or equal to US$36 million, the additional payment would be equal to 18 percent of US$24 million;
(b) if the final acquisition price exceeded US$36 million but was less than or equal to US$48 million, the additional payment would be equal to the sum of US$2,160,000 and 16 percent of US$ 36 million; and
(c) if the final acquisition price exceeded US$48 million, the additional payment would be equal to the sum of US$4,080,000 and 14 percent of US$48 million.
     Pursuant to the agreement, we are also not obligated to provide Wretch with certain free Internet services after December 31, 2006. In 2007, we received approximately US$0.6 million from Wretch as a result of this agreement.
License and Distribution Agreement, dated December 13, 2006, between Dragongate Enterprises and HanbitSoft Inc.
     In December 2006, Dragongate Enterprises, our 70:30 joint venture with Cyber Gateway Pte. Ltd. (which is a wholly-owned subsidiary of Infocomm Asia), entered into an agreement with HanbitSoft Inc. (“HBS”)pursuant to which HBS granted an exclusive sub-license to Dragongate Enterprises for the operation, marketing, hosting and distribution of a multi-player online role playing game known asHellgate: Londonin Taiwan, Hong Kong and Macau. Under the agreement, Dragongate Enterprises is to pay a non-refundable license fee of US$2.5 million, a non-refundable minimum guarantee against royalties of US$6.5 million and certain royalties on a revenue-sharing basis as set out in the agreement. We also committed to spend not less than US$10 million on related marketing, promotion and advertising activities.
Share Purchase Agreements, dated January 1, 2007 to January 17, 2007, between GigaMedia China Limited and certain shareholders of T2CN
     In January 2007, we entered into a series of share purchase agreements with certain shareholders of T2CN representing 32.39 percent of the issued voting rights of T2CN, pursuant to which we agreed to acquire shares held by them in T2CN for a purchase price per share to be determined as follows:
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(a) US$1.05 per share if the net operating income of T2CN for the first half of 2007 is not more than US$1 million;
(b) US$1.25 per share if the net operating income of T2CN for the first half of 2007 is equal to US$1.5 million; or
(c) US$1.45 per share if the net operating income of T2CN for the first half of 2007 is equal to US$2.5 million,
to be adjusted on a pro rata basis if actual net operating income for such period were to fall between the three thresholds set out above.
Shareholders’ Agreement, dated December 7, 2006, as amended on February 2, 2007, between GigaMedia Asia Pacific, Bodhi China and India LLC, Etherfast Pte Ltd, Global Star International Development Limited, Commerzbank Infocomm Segregated Portfolio, Infocomm Investments Pte Ltd, Management Capital International Ltd and Infocomm Asia
     On February 2, 2007, we entered into an agreement with Infocomm Asia and its shareholders to regulate the affairs of Infocomm Asia. Pursuant to the agreement, we and other shareholders holding Class B shares in Infocomm Asia are entitled to convert such shares into ordinary shares at any time. Each Class B share is convertible into one ordinary share of Infocomm Asia, subject to certain adjustment provisions as set out in the agreement. Alternatively, holders of Class B shares are entitled to require Infocomm Asia to redeem their shares in cash upon the earlier of the 5^th anniversary from January 12, 2007 or the redemption of any Class A shares. The redemption price for any Class B share is stipulated to be 100 percent of the issue price, plus interest accrued at the rate of 10 percent on the issue price per annum compounded annually, less any declared and paid dividends thereon. In the event that the redemption is triggered by the redemption of any Class A shares, holders of Class B shares are first entitled to the payment of a premium equal to the sum of US$10 per Class B share to be redeemed and the compound interest payable on the Class B shares as stipulated above, less any declared and paid dividends on such Class B shares. The Class B shares may also be automatically converted into ordinary shares upon the election of 75 percent of Class B shareholders, or the occurrence of a qualifying initial public offering of Infocomm Asia as set out in the agreement.
D. Exchange Controls
There are currently no foreign exchange regulations which restrict the export or import of our capital and the ability of our 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 our Articles of Association.
E. Taxation
Singapore Tax Considerations
Taxation of Dividends received by Singapore Resident Shareholders
Dividends paid by us would be taxable in Singapore if they are received in 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%~~40 percent of that part of the taxable income out of which the dividends are paid. The term “corporate income tax 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%~~25 percent of our shares, the tax credit will include underlying tax paid by us.
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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). Certain foreign dividends received by a Singapore resident person on or after June 1, ~~June~~ 2003 will, however, be exempt from tax. The main conditions to be satisfied for such exemption are that:
(a) the dividends are received from a jurisdiction with a maximum tax rate on the trade or business income of a company of at least ~~15%;~~15 percent; and
(b) the dividends themselves, or the income from which they are paid, have been subject to tax in the foreign jurisdiction or have been exempted from tax under an incentive granted for substantive business activities.
The normal tax rate for corporate profits is ~~20%~~20 percent for the year of assessment ~~2004~~2007 (i.e. for the income earned in the financial year or other basis period ended ~~2005)~~2006). With effect from year of assessment 2008 as announced in the 2007 budget, the corporate tax rate is reduced to 18 percent. Resident individuals are subject to tax at progressive rates. Based on proposals made by the ~~Government~~government in the ~~2005 Budget,~~2006 budget, the maximum individual tax rate would be ~~21%~~20 percent for the year of 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’ business is exercised in Singapore. For example, if our shareholders’ board of directors meets and conducts the business of our 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.
All foreign-sourced income received (except for income received through a partnership in Singapore) in Singapore on or after January 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 characterization 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 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 shares unless the instrument of transfer has been duly stamped.
Singapore Estate Duty
With respect to deaths occurring on or after January 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.~~
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~~Shares held by an individual domiciled in Singapore
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are subject to Singapore estate duty upon such an individual’s death. Singapore estate duty is payable to the extent that the value of our ~~shares~~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%5 percent on the first S$12,000,000 of the individual’s Singapore chargeable assets and thereafter at ~~10%.~~
10 percent.
Individuals should consult their own tax advisors regarding the Singapore estate duty consequences of their ownership of our shares.
~~United States~~
U.S. Federal Income Tax Considerations for U.S. Holders
The following is a discussion of certain U.S. federal income tax considerations for investors in our ~~shares~~Shares that are U.S. persons (as defined below) that hold the shares as a capital asset. 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 a retroactive basis. This discussion is for general information only and does not address all of the tax considerations that may be relevant to you in light of your particular circumstances or if you are subject to special treatment under the U.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 percent or more of the combined voting power of all classes of our stock; or
• a person whose “functional currency” is not the U.S. dollar.
~~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; or~~
~~a 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, or other entity treated as a corporation, created or organized under the laws of the United States or any political subdivision thereof;
• an estate the income of which is subject to U.S. federal income taxation regardless of its source; or
• a trust if (1) it is subject to the primary supervision of a court within the United States and one or more U.S. persons have the authority to control all substantial decisions of the trust, or (2) has otherwise elected to be treated as a U.S. person under the Internal Revenue Code.
~~a corporation, or other entity treated as a corporation, created or organized under 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) it was in existence on August 20, 1996, was treated as a U.S. person on the previous day, and elected to continue to be so treated.
If a partnership (including any entity treated as a partnership for U.S. federal income tax purposes) holds our ~~shares,~~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,~~Shares, you are urged to consult your tax advisors as to the particular U.S. federal income tax consequences as applicable to you.
You are urged to consult your tax advisor concerning the particular U.S. federal, state, local and foreign income and other tax considerations regarding the ownership and disposition of the shares including the application of the passive foreign investment company rules discussed below. Investors should review the discussion below under “Passive Foreign Investment Company Rules” carefully.
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Taxation of Dividends
Except 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~~U.S. 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. A non-corporate recipient of dividend income will generally be subject to tax on dividend income from a “qualified foreign corporation” at a maximum U.S. federal tax rate of ~~15%~~15 percent 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 to any dividend it pays on stock which is readily tradable on an established securities market in the United States. There is currently no tax treaty in effect between the United States and Singapore. Our shares are expected to be readily tradable on the NASDAQ ~~National~~Global Market, an established securities market in the United States. Distributions, if any, in excess of current and accumulated earnings and profits will constitute a return of capital and will be applied against and reduce the holder’s tax basis in such shares. To the extent that distributions are in excess of such basis, the distributions will constitute capital gain as discussed below. U.S. corporate holders will generally not be eligible for the dividends received deduction for distributions to domestic corporations in respect of distributions on shares.
The amount of any distribution paid in a currency other than the ~~United States~~U.S. dollar will equal the ~~United States~~U.S. 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 the distribution regardless of whether the foreign currency is actually converted into ~~United States~~U.S. 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~~U.S. dollar value on the date of receipt. Any gain or loss you realize when 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.
Holders may generally elect to claim a credit against their ~~United States~~U.S. federal income tax 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.
Sale 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 date of sale or disposition, the shares were held by the holder for more than one year and will generally be treated as gain or loss from ~~United States~~U.S. sources for foreign tax credit purposes. The ~~claim of a deduction in respect~~deductibility 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”,~~ (“PFIC”) for any taxable year if either (i) at least ~~75%~~75 percent of our gross income is passive income or (ii) at least ~~50%~~50 percent 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 assets for the ~~2004~~2007 taxable year as reasonably approximated for purposes of applying the PFIC rules, we do not believe ~~that~~ we ~~were~~should be classified as a PFIC for the ~~2004~~2007 taxable year. Whether we ~~continue to be~~are classified as a PFIC in the current or any future taxable year will be determined on the basis of, among other things, our asset values (including, among other items, the level of our cash, cash equivalents and short-term investments), and gross income (including whether such income is active versus passive income as specially determined under the PFIC rules) for such taxable year, which assets, and gross income are subject to change from
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year to year. In January 2006, we acquired FunTown for cash (plus other consideration) and in between April 2006 and June 2007, we acquired control over a majority of the voting rights in T2CN, consideration for which mainly comprised cash. We ~~have positioned our entertainment software business to service clients operating in the dynamic and rapidly expanding Internet-based entertainment markets. In addition, we~~will continue to investigate ~~business~~ opportunities, ~~and we~~which may ~~acquire a business~~give rise to the acquisition of additional businesses for cash, thereby reducing our cash or other investment assets. If we ~~are to realize~~acquire additional ~~value through the conduct of our entertainment software business or if we acquire a business~~businesses for cash, we may, in turn, mitigate our risk of ~~continuing to be classified as a PFIC~~being or ~~we may eventually no longer continue to be~~becoming classified as a PFIC. Because the determination of whether we are a PFIC is a factual determination made 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 a PFIC for any taxable year during your holding period of our shares, the PFIC tax rules discussed below generally will apply in future years even if we cease to be a PFIC in subsequent years. U.S. holders who are individuals will not be eligible for reduced rates of taxation on any dividends, if we are a PFIC in the taxable year in which such dividends are paid or in the preceding taxable year.
If we were classified as a PFIC for any taxable year during which you held shares, and unless you make ~~a “qualifying electing fund” election (a “QEF election”) or~~ a mark-to-market election (as described below), you will generally be subject to special tax rules that have a penalizing effect, regardless of whether we remain a PFIC, on (i) any excess distribution that we make to you (which generally means any distribution received by you in a taxable year that is greater than ~~125%~~125 percent of the average annual distributions received by you in the three preceding taxable years or your holding period for the shares, if shorter), and (ii) any gain realized on the sale or other disposition, including a pledge, of shares. Under these PFIC rules:
~~the excess distribution or gain would be allocated ratably to~~
• the excess distribution or gain would be allocated ratably over your holding period for the shares;
• the amount allocated to the current taxable year and any taxable year prior to the first taxable year in which we are classified as a PFIC (a “pre-PFIC year”) would be taxable as ordinary income;
• the amount allocated to each prior taxable year, other than the current taxable year or a pre-PFIC year, would be subject to tax at the highest tax rate in effect applicable to you for that year; and
• the interest charge generally applicable to underpayments of tax would be imposed on the tax attributable to each prior taxable year, other than the current taxable year or a pre-PFIC year.
~~the amount allocated to the current taxable year and any taxable year prior to the first taxable year in which we are classified as a PFIC would be treated as 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, would be subject to tax at the highest tax rate in effect applicable to you for that year; and
the interest charge generally applicable to underpayments of tax would be imposed on the tax 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.
~~As a further~~ alternative to the foregoing rules, a holder of “marketable stock” in a PFIC may make a mark-to-market election, provided that the shares are actively traded on a “qualified exchange.” Under applicable Treasury regulations, a “qualified exchange” includes a national securities exchange that is registered with the ~~SEC~~Commission or the national market system established under the Securities and Exchange Act of 1934 (i.e., the NASDAQ ~~National~~Global Market). In addition, we believe that, based on the current level of trading activity of our shares on the NASDAQ Global Market, our shares should qualify as being actively traded, but no assurances may be given in this regard. If you make this election, you will generally (i) include as income for each taxable year the excess, if any, of the fair market value of your shares at the end of the taxable year over the adjusted tax basis of the shares and (ii) deduct as a loss the excess, if any, of the adjusted tax basis of the shares over the fair market value of the shares at the end of the taxable year, but only to the extent of the amount previously included in income as a result of the mark-to-market election. Your adjusted tax basis in the shares would be adjusted to reflect any income or loss resulting from the mark-to-market election. If you make a mark-to-market election in respect of a corporation classified as a PFIC and such corporation ceases to be classified as a PFIC, you will generally not be required to take into account the gain or loss described above during any period that such corporation is not classified as a PFIC.
     The “QEF Election”, which serves as a further alternative to the foregoing rules, is not available.
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~~Shares during any taxable year in respect of which we were classified as a PFIC and continue to hold such shares (or any portion thereof), who have not previously determined to make a mark-to-market election, and who are now considering the making of a ~~QEF or~~ mark-to-market election, special tax rules may apply relating to purging the PFIC taint of such shares. You are urged to consult your tax advisor concerning the ~~United States~~U.S. federal income tax consequences of purchasing, holding, and disposing our ~~shares~~Shares if we are or become classified as a PFIC, including the possibility of making a ~~QEF or~~ mark-to-market ~~election~~election.
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Information 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~~U.S. office of a broker is subject to both ~~United States~~U.S. backup withholding and information reporting unless you certify as to your ~~non-United States~~non-U.S. status under penalties of perjury or otherwise establish an exemption. ~~United States~~U.S. 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~~non-U.S. broker. However, ~~United States~~U.S. 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~~
• a U.S. person;
• a foreign person 50 percent or more of whose gross income is effectively connected with a U.S. trade or business for a specified three-year period;
• a “controlled foreign corporation” for U.S. 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 percent of the income or capital interest in the partnership; or
• such foreign partnership is engaged in a U.S. trade or business;
~~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 foreign 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~~non-U.S. 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~~U.S. federal income tax liability, provided you furnish the required information to the Internal Revenue Service.
F. Dividends and Paying Agents
Not applicable.
G. Statements by Experts
Not applicable.
H. Documents on Display
The ~~U.S. Securities and Exchange~~ Commission ~~or the SEC,~~ allows us to “incorporate by reference” the information we file with the ~~SEC.~~Commission. This means that we can disclose important information to you by referring you to another document filed separately with the ~~SEC.~~Commission. 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.~~Commission in prior filings. You may read and copy this annual report, including the ~~exhibit(s)~~exhibits incorporated by reference in this annual report, at the ~~SEC’s~~Commission’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. ~~20549 and at the SEC’s regional offices in New York, New York and Chicago, Illinois.~~20549. You can also request copies of this annual report, including the ~~exhibit(s)~~exhibits incorporated by reference in this annual report, upon payment of a duplicating fee, by writing for information on the operation of the ~~SEC’s~~Commission’s Public Reference Room.
     You may also request a copy of our Commission filings, at no cost, upon written request to our investor relations department at 14th Floor, No. 122, Tunhwa North Road, Taipei 10595, Taiwan, R.O.C., or e-mail to: Brad.miller@GigaMedia.com.tw. A copy of each report submitted in accordance with applicable U.S. law is also available for public review at our principal executive offices.
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I. Subsidiary Information
Not applicable.
ITEM 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
Our subsidiaries conclude most of their 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 and the value of these assets and liabilities are subject to foreign currency risks resulting from fluctuations in exchange rates between the foreign-denominated currency and the measurement currency. ~~Because expenses denominated in foreign currencies historically have not been material, we~~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, ~~2004,~~2006, we had bank deposits ~~and restricted cash~~ of approximately US$~~7.7~~0.3 million denominated in foreign 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 approximately US$~~750 thousand~~0.2 million and unrealized foreign exchange ~~loss~~gain of approximately US$~~146~~17 thousand in ~~2004.~~
2006.
As of December 31, ~~2004,~~2006, we had available-for-sale marketable securities of approximately US$~~27.2~~1.4 million denominated in foreign currencies other than measurement currencies of the entities holding such assets. Changes in the value of these marketable securities resulting from movements in foreign exchange rates are reported in the separate component of shareholders’ equity until realized. As of December 31, ~~2004,~~2006, unrealized foreign exchange ~~loss~~gain for these marketable securities ~~were~~was approximately US$~~508~~5 thousand.
Interest Rate Sensitivity
Our exposure to interest rates relates primarily to our investments in marketable ~~securities.~~securities, and short-term loans. As of December 31, ~~2004,~~2006, we had approximately US$~~31.3~~13.8 million of investment 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. As of December 31, 2006, we had approximately US$12.9 million of short-term loans, with a weighted average interest rate of approximately 2.48 percent. Increases in interest rates of the loans will increase our interest expenses. 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 Risk
We are also exposed to other market risk, which is mainly derived from our investments in ~~Gamania,~~Softstar, Infocomm Asia and RMC, as well as other investee companies and investment funds. Changes in the stock price, the performance or the net asset value of these companies and investment funds might have significant impact on our financial positions or operating results.
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not applicable.
PART II
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
     None.
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~~None.~~
~~ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS~~
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
Not applicable.
~~ITEM 15.~~
ITEM 15. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer and our chief financial officer, has evaluated the effectiveness of our disclosure controls and 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. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable, rather than absolute, assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based ~~on such~~upon that evaluation and taking into account the foregoing, our chief executive officer and chief 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,~~providing reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported on a timely basis 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~~
Management’s Annual Report on Internal Control Over Financial Reporting
     Management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in ~~connection~~accordance with ~~their audit~~generally accepted accounting principles in the United States of America. Our internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our ~~consolidated~~assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles in the United States of America, and that receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
     Because of its inherent limitations, internal control over financial reporting may not prevent or detect all misstatements. Also, projections of any evaluation of the effectiveness of internal control to future periods are subject to the risk that controls may become inadequate because of changes in conditions, and that the degree of compliance with the policies or procedures may deteriorate. Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2006. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Frameworks. Based on our assessment and those criteria, our management has determined that our internal control over financial reporting as of December 31, 2006 was effective.
     As of December 31, 2006, with regards to the scope of our assessment, we excluded FunTown from our assessment of internal control over financial reporting because it was acquired in a business combination purchase during 2006. FunTown’s total assets, total revenues, and net income represent approximately US$54.5 million, US$18.7 million and US$5.5 million respectively, of our total assets, total revenues and net income in 2006. We also did not extend our assessment to UIM, which was consolidated based on FIN46(R), because we do not control UIM and do not have the right or authority to assess, modify or dictate its internal controls. The consolidation of UIM resulted in an increase in assets, liabilities, and revenues of approximately US$12.8 million, US$12.1 million and US$27.5 million, respectively, as of and for the year ended December 31, ~~2004~~2006. Accordingly, our conclusions regarding the effectiveness of our disclosure controls and procedures and internal control over financial reporting do not extend to the disclosure controls and procedures and internal control over financial reporting of FunTown and UIM. However,
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our internal control is adequate to ensure that ~~they had identified certain~~the financial information for such excluded businesses is reflected properly in our financial statements.
Attestation Report of the Registered Public Accounting Firm
     Our annual report does not include an attestation report of a registered public accounting firm regarding internal control over financial reporting, which is not required to be provided until the filing of our annual report for the financial year ended December 31, 2007. Nonetheless, in 2006, we requested our independent auditors to evaluate our internal controls over financial reporting, and there were no material weaknesses identified in our internal controls. ~~Specifically our auditors noted: (1) deficiencies~~
Changes 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:~~
Internal Control Over Financial Reporting
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~~     During the year ended December 31, ~~2004, certain other weaknesses~~2006, there have not been any significant changes in our ~~current~~ internal control ~~processes. Specifically, our auditors noted~~over financial reporting 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; and~~
~~procedures for income tax accounting and approval of short-term loans.~~
~~Nevertheless, our auditors advised us that such weaknesses did not~~have materially affected, or are reasonably likely to materially 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~~control over 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 included in this annual report is recorded, processed, summarized and reported, as 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 implementation of the reporting requirements of Section 404 of the U.S. Sarbanes-Oxley Act of 2002. PricewaterhouseCoopers and our 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 matter 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 our Company have been detected.
reporting.
ITEM 16. [Reserved]
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
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 chairman of Fubon Securities Investment Consulting Co. Ltd. Prior to that, Mr. Ding was president and chief executive officer of Fubon Asset Management Co. Ltd., ~~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
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. The code of ethics was amended on December 19, 2005 in order to conform certain provisions in it with our newly adopted antifraud policy. Our code of ethics is available on our Web site at http://~~ir.giga.net.tw/code%20of%20business%20conduct.htm.~~www.gigamedia.com.tw/code.htm. If we further 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~~investor relations department at 14th Floor, No. 122, Tunhwa North Road, ~~Sungshan Chiu,~~ Taipei 10595, Taiwan, R.O.C. ~~10595,~~, or e-mail to: Brad.miller@GigaMedia.com.tw.
     On December 19, 2005, our board of directors adopted an antifraud policy for the purpose of preventing fraud schemes, including fraudulent financial reporting, misappropriation of assets, any fraud committed by senior management, and information technology fraud. According to our antifraud policy, our audit committee is responsible for monitoring the implementation of our antifraud policy and procedures, and an antifraud taskforce is assigned by our audit committee to be responsible for the hotline management, risk assessment, complaint investigation and resolution, and reporting to our chief executive officer, chief financial officer and audit committee.
     On May 10, 2006, our audit committee adopted a whistleblower program pursuant to our antifraud policy. The whistleblower program enables all employees to know how and when to use the whistleblower hotline, and communicate or report, on a confidential or anonymous basis, without fear of retribution, concerns related to wrongdoings or violations, and ensures that all reported incidents are properly investigated.
95
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table summarizes the aggregate fees billed to us by ~~PricewaterhouseCoopers in Taiwan and Singapore~~GHP Horwath, P.C. during the fiscal years ended December 31, ~~2003~~2005 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
2006.

Year Ended December 31,
2005 2006
(in US$) (in US$)
Audit Fees
360,959 492,922
Audit-Related Fees
2,245 0
Tax Fees
11,967 32,515
Other Fees
0 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.~~
2005.
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~~above. No other fees were billed ~~for business registration service performed before May 30, 2005.~~
during 2005 and 2006
E. Audit Committee Pre-Approval Policies and Procedures
In May 2005, we adopted our audit committee charter. Consistent with ~~SEC~~the Commissions’ 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~~Commission rules and regulations promulgated ~~thereunder.~~
thereunder, subject to the appointment, replacement or removal from office of our independent public accountants been approved by our shareholders at our Annual General Meeting.
The appointment of our independent auditors, ~~PricewaterhouseCoopers,~~GHP Horwath, P.C., 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.~~
committee.
~~ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES~~
ITEM 16D.EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
Not applicable.
~~ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS~~
ITEM 16E.PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
Not applicable.
96
PART III
ITEM 17. FINANCIAL STATEMENTS
We have elected to provide financial statements for fiscal year ~~2004~~2006 and the related information pursuant to Item 18.
ITEM 18. FINANCIAL STATEMENTS
Our consolidated financial statements and the ~~report~~reports thereon by our independent ~~accountants~~registered public accounting firms listed below are attached hereto as follows:

Page
Page
(a) ~~Report~~Reports of Independent Registered Public Accounting ~~Firm~~Firms F-1, F-2
(b) Consolidated Balance Sheets as of December 31, ~~2003~~2005 and ~~2004~~2006 ~~F-2~~F-3
(c) Consolidated Statements of Operations for the years ended December 31, 2004, 2005 and 2006 ~~F-4~~
~~December 31, 2002, 2003 and 2004~~ F-5
(d) Consolidated Statements of Shareholders’ Equity for the ~~F-5~~
years ended December 31, ~~2002, 2003~~2004, 2005 and ~~2004~~2006 F-7
(e) Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2005 and 2006 ~~F-6~~
~~December 31, 2002, 2003 and 2004~~ F-8
(f) Notes to the Consolidated Financial Statements ~~F-7~~F-10
ITEM 19. EXHIBITS
EXHIBIT INDEX
1.1 Memorandum of Association of our ~~Company~~Company*
1.2 Articles of Association of our Company*
1.3 Amended Memorandum and 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~~4.14 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~~4.15 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center, Inc. and Shinyeongan CATV Co. Ltd., dated May 21, 1999 (including English summary)**
97
~~4.17~~4.16 Broadband Internet over Cable Service Agreement between Hoshin GigaMedia Center, Inc. and Chung Lian Inc., dated April 16, 1999 (including English summary)**
~~4.18~~4.17 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~~4.18 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~~4.19 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~~4.20 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~~4.21 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~~4.22 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~~4.23 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~~4.24 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~~4.25 Registration Rights Agreement among GigaMedia Limited and Microsoft Corporation, dated November 23, 1999**
~~4.28~~4.26 Shareholders’ Agreement among GigaMedia Limited and 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~~4.27 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~~4.28 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~~4.29 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~~4.30 End User License Agreement between Internet Media Licensing Limited and Ultra Internet Media S.A., dated April 1, ~~2004~~2004*******
4.31 Purchase and Sale Agreement between Hoshin GigaMedia Center, Inc. and Webs-TV, Digital International Corporation, dated June 23, 2005*******
4.32 Put-Call Option Agreement between Hoshin GigaMedia Center, Inc. and JSDWAY Digital Technology Co. Ltd., dated December 21, 2005*
4.33 Assets Sale and Purchase Agreement among GigaMedia Limited, FunTown World Limited, Hoshin GigaMedia Center, Inc. and TWP Corporation, dated December 19, 2005*
4.34 Share Purchase Agreement between GigaMedia Limited and Nextbase International Limited, dated September 17, 2005*
4.35 Subscription Rights Agreement between Hoshin GigaMedia Center, Inc. Wretch Co., Ltd. and the shareholders of Wretch Co. Ltd, dated March 10, 2006*
4.36 Series A Preferred Share Purchase Agreement among T2CN Holding Limited, GigaMedia China Limited, and certain shareholders of T2CN, dated April 27, 2006*
4.37 Shareholders’ Agreement among T2CN Holding Limited and the Shareholders dated April 27, 2006*
4.38 Strategic Partnership Agreement between T2CN Holding Limited and GigaMedia China Limited, dated April 27, 2006*
4.39 Assets Purchase and Sale Agreement between Hoshin GigaMedia Center, Inc. and Webs-TV Digital International Corporation, dated May 15, 2006*
4.40 Service Agreement between Hoshin GigaMedia Center, Inc. and Webs-TV Digital International Corporation, dated May 15, 2006*
4.41 Second Amendment to the End User License Agreement between Internet Media Licensing Limited and Ultra Internet Media S.A., dated March 1, 2006*
4.42 Amended and Restated Shareholders’ Agreement between T2CN Holding Ltd., certain shareholders of T2CN, GigaMedia China Limited, Marvel City Investments Limited, Patriot Capital Limited, TAE LLC and Ant Bridge No. 2 Venture Capital Secondary Investment Limited Partnership, dated November 25, 2006
98
4.43 Share Purchase Agreement between GigaMedia China Limited, Newmargin T2CN Investment Ltd. and Shanghai Newmargin Venture Capital Co., Ltd dated January 1, 2007
4.44 Share Purchase Agreement between GigaMedia China Limited and Chengwei (China) Investment Company, Greg. Wei Gang Ye, and Jia Yi Wan, dated January 1, 2007
4.45 Share Purchase Agreement between GigaMedia China Limited and certain shareholders of T2CN, dated January 17, 2007
4.46 Share Purchase Agreement between GigaMedia China Limited, Shanghai Newmargin Venture Capital Co. Ltd. and Newmargin Happydigital Investment Partners Inc., dated January 1, 2007
4.47 Subscription Agreement between GigaMedia Asia Pacific Limited and Infocomm Asia Holdings Pte. Ltd., dated December 7, 2006
4.48 Termination Agreement between Hoshin GigaMedia Center Inc., Koos Broadband Telecom Co., Ltd, Wretch Co., Ltd and certain shareholders of Wretch Co., Ltd, dated December 12, 2006
4.49 License and Distribution Agreement between Dragongate Enterprises Limited and HanbitSoft Inc., dated December 13, 2006
4.50 Third Amendment to the End User License Agreement dated March 1, 2007, between Internet Media Licensing Limited and Ultra Internet Media, S.A.
4.51 Shareholders’ Agreement between GigaMedia Asia Pacific Limited, Management Capital International Ltd, Infocomm Investments Pte Ltd, Commerzbank Infocomm Segregated Portfolios, Global Star International Development Limited and Etherfast Pte Ltd, dated December 7, 2006.
4.52 Shareholders’ Agreement, between GigaMedia Asia Pacific Limited, Bodhi China and India Investments LLC, Etherfast Pte Ltd, Global Star International Development Limited, Commerzbank Infocomm Segregated Portfolio, Infocomm Investments Pte Ltd, Management Capital International Ltd and Infocomm Asia, dated February 2, 2007
4.53 2006 Equity Incentive Plan********
8.1 List of Subsidiaries*~~****~~
11 Code of ethics adopted by the registrant on April 21, 2004*****2004, as amended on December 19, 2005*
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)~~Rule13a-14(b) of the Securities Exchange Act
13 ~~Certifications~~
13.1 Certification by our Chief Executive Officer ~~and~~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
1515.1 Consent of PricewaterhouseCoopers, Independent Registered Public Accounting Firm
15.2 Consent of GHP Horwath, P.C., Independent Registered Public Accounting Firm.
* Filed with the Commission with the original 2005 annual report on Form 20-F of GigaMedia, Ltd. on June 28, 2006.
** Incorporated by reference from our Registration Statement on Form F-1, file number 333-11416 filed with the ~~SEC~~Commission on February 2, 2000.
*** Incorporated by reference from our annual report on Form 20-F, file number 000-30540 filed with the ~~SEC~~Commission on June 28, 2001.
****** Incorporated by reference from our annual report on Form 20-F, file number 000-30540 filed with the ~~SEC~~Commission on June ~~28, 2002.~~30, 2004.
******* Incorporated by reference from our annual report on Form 20-F, file number 000-30540 filed with the ~~SEC~~Commission on ~~July 15, 2003.~~June 30, 2005.
******** Incorporated by reference from our ~~annual report~~Registration Statement on Form ~~20-F,~~S-8, file number ~~000-30540~~333-142963 filed with the ~~SEC~~Commission on ~~June 30, 2004.~~May 15, 2007
+ Does not contain portions for which confidential treatment has been requested.
99
SIGNATURE
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 on its behalf.
GIGAMEDIA LIMITED
~~GIGAMEDIA LIMITED~~
By:
/s/ ~~Thomas Hui~~
Arthur Wang
~~Thomas Hui~~

Arthur Wang
Chief ~~Financial~~Executive Officer
Date: June 29, 2007
100
~~Date: June 30, 2005~~
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
~~To the~~
Board of Directors ~~and Shareholders~~
of
GigaMedia ~~Limited:~~
Limited
We have audited the accompanying consolidated balance sheets of GigaMedia Limited and ~~its~~ subsidiaries (the “Company”) as of December 31, ~~2004~~2006 and ~~2003,~~2005, and the related consolidated statements of ~~income,~~operations, shareholders’ equity, and cash flows for each of the ~~three~~ years in the two-year period ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
     We conducted our audits in accordance with auditing standards of the Public Company Accounting Oversight Board (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 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 financial position of GigaMedia Limited and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America.
     As discussed in Notes 1 and 19 to the consolidated financial statements, effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123(R),Share-Based Payment.
/s/GHP Horwath, P.C.
Denver, Colorado
April 23, 2007;
May 8, 2007 as to Note 25a;
and June 1, 2007 as to Note 25b
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
   of GigaMedia Limited:
     We have audited the accompanying consolidated statements of operations, of shareholders’ equity and of cash flows of GigaMedia Limited and its subsidiaries for the year ended December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our ~~audits.~~
audit.
We conducted our ~~audits~~audit in accordance with the standards of the 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~~audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the ~~financial position of GigaMedia Limited and its subsidiaries at December 31, 2004 and 2003, and the~~ results of their operations and their cash flows of GigaMedia Limited and its subsidiaries for ~~each of~~ the ~~three years in the period~~year ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America.
~~By: /s/ PricewaterhouseCoopers~~
/s/ Pricewaterhouse Coopers
Taipei, Taiwan

May 26, 2005, except as to the change in presentation basis for the discontinued operation as described in Note 1, which is as of December 9, 2005
F-2
GIGAMEDIA LIMITED
CONSOLIDATED BALANCE SHEETS

December 31, ~~2003~~2005 and ~~2004~~2006

(in thousands ~~except for par value amount)~~)

December 31
2005 2006
ASSETS
CURRENT ASSETS
Cash and cash equivalents (Note 8) $ 41,731 $ 22,372
Marketable securities-current (Note 9) 20,404 13,816
Notes and accounts receivable-net (Note 10) 6,443 15,076
Inventories-net (Note 11) 58 123
Prepaid expenses (Note 22) 274 3,196
Restricted cash (Note 13) — 2,697
Other receivable (Note 4) 1,231 6,268
Other current assets 63 628

Total Current Assets 70,204 64,176

Marketable securities-noncurrent (Note 12) — 25,000

PROPERTY, PLANT AND EQUIPMENT
Land 676 682
Building 1,153 1,162
Information and communication equipment 20,647 18,200
Modems rented 2,085 2,010
Office furniture and fixtures 1,445 1,919
Transportation equipment 369 368
Leasehold improvements 1,841 2,157

28,216 26,498
Less: Accumulated depreciation (17,469 ) (16,400 )

10,747 10,098

GOODWILL (Notes 5 and 6) 29,243 55,817

INTANGIBLE ASSETS-NET (Notes 5 and 7) 2,704 23,067

OTHER ASSETS
Deferred assets 91 217
Refundable deposits 500 838
Prepaid royalty (Note 22) — 3,374
Other (Note 20) 30 32

Total Other Assets 621 4,461

TOTAL ASSETS $ 113,519 $ 182,619

F-3

   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


GIGAMEDIA LIMITED
CONSOLIDATED BALANCE SHEETS-(Continued)
December 31, 2005 and 2006
(in thousands )

December 31
2005 2006
LIABILITIES & SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES
Short-term loans (Note 14) $ — $ 12,853
Notes and accounts payable 1,427 1,751
Accrued compensation 1,194 3,458
Accrued expenses 1,791 4,786
Other current liabilities (Note 15 and 20) 6,245 22,359

Total Current Liabilities 10,657 45,207

OTHER LIABILITIES
Refundable deposits 831 752
Accrued pension liabilities (Note 17) 819 434
Convertible notes (Note 16) — —
Others — 605

Total Other Liabilities 1,650 1,791

Total Liabilities 12,307 46,998

MINORITY INTERESTS 564 1,534

COMMITMENTS AND CONTINGENCIES (Note 22) — —

SHAREHOLDERS’ EQUITY
Common shares, no par value, and additional paid-in capital; issued 50,344 thousand and 51,495 thousand shares on December 31, 2005 and 2006 (Note 18) 287,920 289,495
Accumulated deficit (Note 18) (159,223 ) (128,439 )
Accumulated other comprehensive loss (28,049 ) (26,969 )

Total Shareholders’ Equity 100,648 134,087

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $ 113,519 $ 182,619

The accompanying notes are an integral part of these consolidated financial statements.
F-4
GIGAMEDIA LIMITED
CONSOLIDATED ~~BALANCE SHEETS-(Continued)~~STATEMENTS OF OPERATIONS

For the Years Ended December 31, ~~2003~~2004, 2005 and ~~2004~~2006

(in thousands except for ~~par value amount)~~earnings per share amounts)

2004 2005 2006
OPERATING REVENUES
Software licensing and online entertainment revenues $ 11,434 $ 22,511 $ 55,019
Online game revenues — — 18,692
Internet access and service revenues 21,303 21,589 20,537
Other revenues 107 87 44

Total 32,844 44,187 94,292

OPERATING COSTS
Cost of software licensing and online entertainment revenues (1,592 ) (3,327 ) (7,824 )
Cost of online game revenues — — (3,667 )
Cost of Internet access and service revenues (13,873 ) (13,568 ) (11,449 )
Cost of other revenues (644 ) (488 ) (391 )

(16,109 ) (17,383 ) (23,331 )

GROSS PROFIT 16,735 26,804 70,961

OPERATING EXPENSES
Product development and engineering expenses (2,513 ) (3,562 ) (5,738 )

Selling and marketing expenses (6,310 ) (10,777 ) (30,123 )
General and administrative expenses (5,657 ) (7,892 ) (12,421 )
Bad debt expenses 220 (207 ) (715 )

(14,260 ) (22,438 ) (48,997 )

INCOME FROM OPERATIONS 2,475 4,366 21,964

NON-OPERATING INCOME (EXPENSES)
Interest income 140 411 722
Gains on sales of marketable securities 1,230 850 2,189
Other-than-temporary impairment of marketable securities (Note 12) (1,833 ) — —
Interest expense (4 ) — (582 )
Foreign exchange gain (loss) (765 ) 151 (161 )
Gain (loss) on disposal of property, plant and equipment (44 ) 204 (37 )
Gain on divestiture of business (Note 4) — — 7,668
Other (Note 16) 133 1,094 891

(1,143 ) 2,710 10,690

INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES AND MINORITY INTERESTS 1,332 7,076 32,654
F-5

   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


2004 2005 2006
INCOME TAX BENEFIT (EXPENSES) (Note 20) 84 (436 ) (1,549 )

INCOME FROM CONTINUING OPERATIONS BEFORE MINORITY INTERESTS 1,416 6,640 31,105
MINORITY INTERESTS INCOME (163 ) (150 ) (321 )

INCOME FROM CONTINUING OPERATIONS 1,253 6,490 30,784

INCOME (LOSS) FROM DISCONTINUED OPERATIONS 429 (154 ) —

$ 1,682 $ 6,336 $ 30,784

EARNINGS PER SHARE (Note 2)
Basic:
Income from continuing operations $ 0.02 $ 0.13 $ 0.60
Income from discontinued operations 0.01 — —

Net income $ 0.03 $ 0.13 $ 0.60

Diluted:
Income from continuing operations $ 0.02 $ 0.12 $ 0.51
Income from discontinued operations 0.01 — —

Net income $ 0.03 $ 0.12 $ 0.51

WEIGHTED AVERAGE SHARES USED TO COMPUTE
EARNINGS PER SHARE (Note 2)
Basic 50,154 50,312 50,921

Diluted 51,701 55,059 61,114

The accompanying notes are an integral part of these consolidated financial statements.
F-6
GIGAMEDIA LIMITED
CONSOLIDATED STATEMENTS OF ~~OPERATIONS~~SHAREHOLDERS’ EQUITY

For the Years Ended December 31, ~~2002, 2003~~2004, 2005 and ~~2004~~2006

(in ~~thousands except for income/loss per share amounts)~~

   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


thousands)

Accumulated
Common shares other
and additional paid-in Accumulated comprehensive
capital Warrant deficit income
Shares Amount outstanding (Note 18) (loss) Total
2004
Balance as of January 1, 2004 50,154 $ 239,004 $ 48,653 ($167,241 ) ($30,053 ) $ 90,363
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 50,154 287,657 — (165,559 ) (26,127 ) 95,971
2005
Issuance of common shares for employee stock purchase plan 190 263 — — — 263
Net income — — — 6,336 — 6,336
Components of other comprehensive income (loss):
Net unrealized loss on marketable securities — — — — (333 ) (333 )
Foreign currency translation adjustment — — — — (1,589 ) (1,589 )

Total comprehensive income — — — — — 4,414

Balance as of December 31, 2005 50,344 287,920 — (159,223 ) (28,049 ) 100,648
2006
Issuance of common shares from exercise of stock options 1,151 1,265 — — — 1,265
Stock-based compensation — 310 — — — 310
Net income — — — 30,784 — 30,784
Components of other comprehensive income (loss):
Net unrealized gain on marketable securities — — — — 335 335
Adjustment to initially apply FAS 158 — — — — 235 235
Foreign currency translation adjustment — — — — 510 510

Total comprehensive income — — — — — 31,864

Balance as of December 31, 2006 51,495 $ 289,495 $ — ($128,439 ) ($26,969 ) $ 134,087

The accompanying notes are an integral part of these consolidated financial statements.
F-7
GIGAMEDIA LIMITED
CONSOLIDATED STATEMENTS OF ~~SHAREHOLDERS’ EQUITY~~CASH FLOWS

For the Years Ended December 31, ~~2002, 2003~~2004, 2005 and ~~2004~~2006

(in thousands)

2004 2005 2006
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,682 $ 6,336 $ 30,784
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation 4,675 4,203 3,167
Amortization 2,545 2,202 2,876
Stock-based compensation — — 310
Provision for bad debt expenses 247 307 715
Provision for (reversal of) inventory loss (300 ) 507 36
Gain on divestiture of business — (911 ) (7,668 )
Loss on physical inventory 9 — —
Loss (gain) on disposal of property, plant and equipment 106 (204 ) 37
Gain on sale of marketable securities (1,230 ) (958 ) (2,189 )
Premium from debt securities — (3 ) (7 )
Interest income from premium of convertible notes — — (140 )
Gain on early redemption of convertible notes — — (625 )
Transfer property, plant, and equipment, and deferred assets to expenses — — 34
Cash dividend to minority interest shareholders of variable interest entity — — (100 )
Minority interests income (loss) 481 (646 ) 321
Other-than-temporary impairment on marketable securities 1,833 — —
Net changes in operating assets and liabilities:
Notes and accounts receivable 699 (2,193 ) (5,723 )
Inventories (5,531 ) 3,186 (45 )
Prepaid expenses 730 185 (2,422 )
Other receivables (236 ) (695 ) (62 )
Other current assets 145 28 (376 )
Notes and accounts payable (4,089 ) (1,371 ) 69
Accrued expenses (924 ) (1,177 ) 2,419
Accrued compensation 236 (18 ) 2,264
Other current liabilities 981 2,663 7,694
Accrued pension liabilities 309 62 (150 )
Others 22 19 (1,776 )

Net cash provided by operating activities 2,390 11,522 29,443

CASH FLOWS FROM INVESTING ACTIVITIES:
Decrease (increase) in restricted cash 419 176 (2,697 )
Proceeds from disposal of marketable securities 69,352 36,970 26,700
Divestiture of business, net of cash transferred — 3,253 3,318
Purchase of property, plant and equipment (2,587 ) (2,652 ) (2,716 )
Proceeds from disposal of property, plant and equipment 415 949 8
Purchase of marketable securities (60,834 ) (20,184 ) (42,509 )
Purchase of intangible assets (663 ) (1,005 ) (2,583 )
Acquisitions, net of cash acquired (32,797 ) — (26,760 )
Decrease (increase) in refundable deposits 1,450 42 (197 )
Increase (decrease) in other assets 1 (16 ) (82 )
Increase in deferred assets (193 ) (331 ) (368 )
Cash recognized on initial consolidation of variable interest entity 94 — —

Net cash provided by (used in) investing activities (25,343 ) 17,202 (47,886 )

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from (repayment of) short-term loan 269 (284 ) 12,853
Redemption of convertible notes — — (15,000 )
Increase (decrease) in refundable deposits 125 268 (80 )
Acquisition of minority interests (238 ) — —
F-8

   Issuance of common shares

Warrant
outstanding

Additional
paid-in capital

Accumulated
deficit

Accumulated other
comprehensive
income (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




2004 2005 2006
Cash received from the exercise of stock options — — 1,265
Issuance of common shares for employee stock purchase plan — 263 —

Net cash provided by (used in) financing activities 156 247 (962 )

Exchange difference 736 (473 ) 46

NET (DECREASE)/INCREASE IN CASH AND CASH EQUIVALENTS (22,061 ) 28,498 (19,359 )
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 35,294 13,233 41,731

CASH AND CASH EQUIVALENTS AT END OF YEAR $ 13,233 $ 41,731 $ 22,372

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid during the year $ 7 $ — $ 581

Income tax paid during the year $ 9 $ 323 $ 455

NON-CASH FINANCING AND INVESTING ACTIVITIES:
Unrealized holding gain (loss) on available-for-sale securities ($357 ) ($333 ) $ 335

Issuance of convertible notes as acquisition consideration — — $ 15,000

Adjustment to acquisition purchase price — — $ 5,000

Divestiture of business — — $ 4,966

The accompanying notes are an integral part of these consolidated financial statements.
F-9
~~GIGAMEDIA LIMITED~~
~~CONSOLIDATED STATEMENTS OF CASH FLOWS~~
~~For~~
Notes to the ~~Years Ended December 31, 2002, 2003 and 2004~~
~~(in thousands)~~

   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.~~
Consolidated Financial Statements
NOTE 1. BUSINESS OVERVIEW, BASIS OF PRESENTATION, AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business Overview
GigaMedia Limited (referred to herein as GigaMedia, our Company, we, us, or our) is a major provider of online entertainment software and services, with headquarters in Taipei, Taiwan. We are a holding company and through several subsidiaries develop and license software for online entertainment, operate a leading casual game portal, and provide broadband Internet access.
In April 2004, we acquired a software developer and support service business through Cambridge Entertainment Software Limited (“CESL”). CESL develops software for online entertainment services. As a software developer and support service provider, CESL offers software solutions for online entertainment, which it licenses under a software license and support service contract.
In January 2006, we acquired from TWP Corporation, which is a subsidiary of Acer, Inc., an online casual game business marketed under the brand FunTown (“FunTown”). FunTown is a leading Asian online casual game portal.
We also operate a broadband Internet service provider (“ISP”) via our subsidiary Hoshin GigaMedia Center, Inc. (“Hoshin GigaMedia”), which provides Internet access service with multiple delivery technologies to consumers in Taiwan. Our access products consist of ADSL, which business we sold in May 2006 (see Note 4, “Divestitures,” for additional information), and cable modem offerings. Hoshin GigaMedia’s subsidiary, Koos Broadband Telecom Co., Ltd. (“KBT”), provides broadband services to corporate subscribers in Taiwan.
Basis of Presentation
On September 29, 2005, we sold our legacy land-based music distribution business to Nextbase International Limited. (See Note 4, “Divestitures,” for additional information.) The music distribution business has been accounted for as a discontinued operation under accounting principles generally accepted in the United States of America (GAAP) and, therefore, the results of operations of the music distribution business have been removed from our Company’s results of continuing operations for all periods.
Principles of Consolidation

The Consolidated Financial Statements include the accounts of GigaMedia ~~Limited (GigaMedia or the Company)~~ and ~~its~~our wholly-owned and majority-owned ~~subsidiaries.~~subsidiaries after elimination of all inter-company accounts and transactions. In addition, the accounts of ~~variable interest entities (VIEs)~~a variable-interest entity (“VIE”) as defined by the Financial Accounting Standards Board ~~(FASB)~~(“FASB”) Interpretation No. 46(R) ~~(see Note 3, “Variable Interest Entity,~~(“FIN 46(R)” ~~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 significant influence over operating and financial policies (generally 20-50% ownership), are accounted for using the equity method.(See Note 3, “Variable-Interest Entity.”) 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~~our Company and ~~its~~our subsidiaries have historically been reported in New Taiwan ~~(NT)~~(“NT”) dollars. Effective January 1, 2004, ~~the Company~~we adopted the U.S. dollar as ~~its~~our reporting currency as operations denominated in the U.S. dollar have represented an increasing portion of ~~the Company’s~~our business following the acquisition of ~~the~~our Company’s entertainment software business. (See Note 4,5, “Acquisitions.”) As a result of this change, ~~the Company will record a~~we recorded cumulative translation ~~adjustment~~adjustments to other comprehensive income. ~~The cumulative~~Cumulative translation adjustments in ~~2002, 2003,~~2004, 2005, and ~~2004~~2006 were ~~$33~~$27 million, ~~$31~~$28 million, and ~~$27~~$28 million, ~~respectively. Comparative financial information has been recast as if the U.S. dollar had always been used as the Company’s reporting currency,~~respectively, and financial information has been translated into U.S. dollars
F-10
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~~expense items are translated at weighted-average rates of exchange prevailing during the year. Cumulative translation adjustments resulting from this process are charged or credited to 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. dollar and the NT dollar for 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

2004 2005 2006
Year-end 31.71 32.85 32.60
Weighted average 33.41 32.19 32.54
Use of Estimates
The preparation of financial statements in accordance with ~~accounting principles generally accepted in the U.S.~~GAAP requires management to make estimates and assumptions that affect certain reported amounts and disclosures in the Consolidated Financial Statements and accompanying notes. Actual results could differ significantly from those estimates.
Revenue Recognition
General
~~The~~
Our Company recognizes revenues in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial 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~~
Multiple-Element Arrangement
Our Company enters into multiple-element revenue arrangements, which may include any combination of services, software, and/or products. To the extent that a deliverable in a multiple-element arrangement is subject to specific guidance (e.g. leased cable modems and Internet access-related equipment solutions which are subject to Statement of Financial Accounting Standards (FAS) No. 13, “Accounting for Leases,” (“FAS 13”) (see, “Internet Access and Service Revenue” and “Other Revenues”), online entertainment software that is subject to the ~~Company’s major categories~~American Institute of ~~revenue transactions.~~
Certified Public Accountants (AICPA) Statement of Position (SOP) No. 97-2, “Software Revenue Recognition,” (“SOP 97-2”) (see “Software Licensing and Online Entertainment Revenues,” below)), whether and/or how to separate multiple deliverable arrangements into separate units of accounting (separability) and how to allocate the arrangement consideration among those separate units of accounting (allocation) for that deliverable is accounted for in accordance with such specific guidance. All other deliverables in multiple-element arrangements are accounted for in accordance with EITF 00-21 “Revenue Arrangements with Multiple Deliverables,” (“EITF 00-21”).
In addition to the aforementioned general policies, the following are the specific revenue recognition policies for each major category of revenue.
~~Sales~~Software Licensing and Online Entertainment Revenues
~~Sales consist of retail sales generated from the Company’s music distribution business~~
Software licensing and ~~sales of cable modem and other related products generated from the Company’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 collected 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 cable modems and other related products are recognized upon delivery.~~
~~Internet Access Revenues: Cable Modem and ADSL~~
~~Internet access~~online entertainment revenues are related to software we develop and license and support services we provide for use within the online entertainment industry.
F-11
Under the provisions of FIN 46(R), the results of a software licensee of our Company, Ultra Internet Media (“UIM”), for the nine months ended December 31, 2004, and for the years ended December 31, 2005 and 2006 have been incorporated into our Consolidated Financial Statements. UIM and GigaMedia are separately owned. (See Note 3, “Variable-Interest Entity,” for additional information.) Our software licensing and support service revenues are based upon a percentage of gross receipts generated by UIM’s online gaming operations, and are recognized monthly. Software licensing and support service revenues we receive from providing such services to UIM have been eliminated in consolidation.
Multiple-element revenue arrangements involving UIM’s provision of software and software-related elements to customers are accounted for in accordance with SOP 97-2. UIM generates revenue by providing and promoting online games of skill and chance that are available on its free download gaming software. UIM’s online gaming service is inseparable from the software element involved and UIM does not sell each element separately. UIM’s online gaming service does not involve significant production, modification, or customization of the gaming software. Revenues derived from UIM’s online gaming software platform, which revenues we incorporate in our financials in accordance with FIN 46(R), are recognized at the time games are played and are net of player winnings. Player account balances are presented as current liabilities, which are first accrued for in full upon the receipt of player deposits, and increased or decreased based on player activities, including player wins or losses, withdrawals and refunds. Transaction fee revenues derived from UIM’s online multi-player poker platform are recognized as services are provided. Residual expenses and commissions are charged to expenses as incurred.
Online Game Revenues
Online game revenues are related to our online casual game business in Asia.
Online game revenues are collected through the sale of online game points, pre-paid cards, and game packs. Virtual online game points are sold directly to end-users who can make the payments through credit cards or channel partners such as telecommunication service operators. Physical pre-paid cards and game packs are sold through distributors and convenience stores. Proceeds from sales of online game points, physical cards and game packs, net of sales discounts, are deferred when received and revenue is recognized upon the actual usage of the playing time or in-game services by the end-users; over the estimated useful life of virtual items; or when the sold game points expire and are no longer eligible to access the online games or products in accordance with our published game points expiration policy.
Revenue recognized on the sales of virtual online game points is reported on a gross basis, which includes service fees paid to channel partners for payment processing. Fixed percentage fees retained by channel partners for payment processing related to our online game services are recognized as cost of online game revenues.
Internet Access and Service Revenues
Internet access and service revenues include revenues derived from cable modem ~~and~~Internet access services, ADSL Internet access service business, which we sold in May 2006 (see Note 4, “Divestitures,” for additional information), Internet access services ~~provided by the Company. Revenues~~to corporate customers, IP bandwidth services to cable operators which enable them to offer their own cable modem services, and Internet access-related service, including non-refundable activation fees, billing and consulting services, and other value-added services.
Cable modem, ADSL, and corporate revenues are recorded net of discounts, and in the case of our cable modem and corporate services, net of fees paid to our cable partners in accordance with revenue sharing agreements in effect between ~~GigaMedia~~our Company and our cable partners. ~~Cable modem and ADSL revenues are recognized for the period of time for which the Company provides services to the customer.~~ Customers have a choice of paying
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either monthly or in advance for a certain period of time, for which they receive corresponding discounts. ~~The Company records~~We record any such advanced payment receipts as other current liabilities on ~~the~~our balance sheet and ~~amortizes~~amortize such revenues over the subscription period.
~~Software Licensing and On-Line Entertainment~~ Revenues
~~Software licensing and on-line entertainment revenues are~~ related to ~~software~~provision of bandwidth to cable operators are recognized either on the basis of revenue sharing from cable operators, or on the basis of the subscriber numbers, or by the level of bandwidth usage. Non-refundable activation fees are combined with our Company’s Internet access revenues as a single unit of accounting. Since the activation fees are not in exchange for services performed that represent the culmination of a separate earnings process, such fees are deferred in accordance with the Staff Accounting Bulletin Topic 13 “Revenues Recognition”. As part of our Internet access-related services, our Company ~~develops~~also provides a variety of value-added services, including billing, consulting, co-location, and ~~support~~VPN services to corporate customers, and premium mail, Web storage space, and online photo albums, to retail customers. The value-added services are not bundled together as a group of services within one contract, nor are they bundled with any of our Company’s broadband access services.
All the ~~Company provides for use within the on-line entertainment industry. Software licensing~~Internet access and ~~support~~ service revenues are recognized on a straight-line basis over the subscription period or for the period in which the service is performed if no significant Company obligations remain and collection of the receivables is reasonably assured.
Our Company also provides cable modem equipment and Internet access-related equipment solutions to our subscribers on an operating lease basis. The rental service is bundled with the access service contract. Pursuant to EITF 00-21 and FAS 13, the contract considerations are allocated among/between the FAS 13 deliverable and non-FAS 13 deliverable(s) based ~~upon a fixed percentage~~on their relative fair values. For the leased cable modem, the amounts attributable to the rental elements are negligible and rental revenue is recognized over the same period as the access service is rendered. Our Company therefore does not allocate the FAS 13 deliverable separately from the total contract considerations. For leased Internet access related equipment solutions, the FAS 13 element is separated from the contract considerations and reported under the caption, “Other Revenues.”
Other Revenues
Other revenues consist of ~~a licensee’s gross receipts,~~sales of other Internet access-related products and rental income from the lease of Internet access-related equipment to subscribers of our Company’s Internet access and service business, and are recognized ~~monthly.~~
~~Under~~when products are delivered or services are provided.
Discontinued Operations
For 2004 and 2005, a portion of our Company’s revenues were 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 were recognized at the ~~provisions~~point of ~~FIN 46(R),~~sale to the ~~results~~consumer, at which time payment was tendered. Our Company’s policy was to not accept sales refunds or exchanges.
We disposed of ~~Ultra Internet Media (UIM),~~our music distribution business in September 2005, and as a ~~licensee~~result have classified the income from these revenue-generating activities as part of ~~the Company, as of and for the nine months ended December 31, 2004 have been incorporated into the Consolidated Financial Statements. UIM and GigaMedia are separately owned.~~discontinued operations. (See Note ~~3, “Variable Interest Entity,~~4, “Divestitures,” for additional information.) ~~Software licensing~~
Deferred Revenues
Deferred revenues consist of the prepaid fees related to our online games business, and ~~support service revenues from UIM have been eliminated in consolidation.~~the advance payment receipts related to Internet access services.
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~~UIM generates revenue by providing and promoting on-line~~
Prepaid fees related to our online games ~~of chance and skill. Revenue is recognized upon receipt. Player account balances~~business are recognized as ~~current liabilities~~revenues upon the actual usage of the playing time or in-game services by the end-users; over the estimated useful life of virtual items; or when the sold game points expire and are ~~accrued~~no longer eligible to access the online games or products in accordance with our published game points expiration policy.
The advanced payment receipts related to Internet access services are deferred and amortized over the relevant subscription period.
Operation Costs
Cost of sales consists primarily of online entertainment and online game processing costs, online game royalties, production costs for ~~in full. The change in aggregate player account balances is recognized monthly as a reduction~~prepaid game cards, amortization of intangible assets, customer service department costs for our online game and Internet access businesses, Internet access engineering costs, Internet access bandwidth costs, and depreciation, maintenance and other overhead expenses directly attributable to ~~receipts, as are player disbursements. Residual expenses~~the provision of software licensing and ~~commissions are charged to expense as incurred.~~
online entertainment, online game, and Internet access services revenues.
Fair Value of Financial Instruments
~~The~~
Our 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~~at amounts which approximate their fair ~~value.~~
values.
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~~deposits and bank acceptances with original maturities of three months or less are considered to be cash equivalents.
Marketable Securities
~~The~~
All of our Company’s 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 or securities that management intends to sell within one year. Securities classified as ~~non-current, including non-equity method investments,~~noncurrent include securities that have a maturity of more than one year or securities that management does not intend to sell within one year. ~~These investments~~Marketable securities principally consist of debt securities and equity securities of public and privately held companies and investment funds. Debt securities and equity securities of public 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. Equity investments in non-publicly traded companies are primarily accounted for using the cost method. Unrealized losses that are considered ~~other than temporary~~other-than-temporary are included in the current year’s operations. Realized gains and losses, measured against weighted-average 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 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 the Company’s 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 the Company and the Company’s ownership interest decreases as a result of not fully subscribing to the issuance, the resulting difference between the Company’s investment balance and its proportionate share of the investee company’s net equity is recorded in the current year’s operations.
Allowance for Doubtful Accounts
An allowance for doubtful accounts is provided based on an evaluation of collectibility of notes receivable, accounts ~~receivables~~receivable and other receivables.
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Inventories
Inventories are carried at the lower of cost or market value using the weighted average cost 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 Equipment
Property, plant and equipment are stated at cost, less accumulated depreciation. Depreciation is provided on a straight-line basis over useful lives that correspond to items as follows:
~~Item~~
~~Years~~
~~Building~~
Item Years
Buildings 50
Information and communication equipment
2 to 5
Modems rented
3 to 5
Office furniture and equipment
3 to 5
Transportation equipment
3 to 5
Leasehold improvements
5
Leasehold 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.
Intangible Assets and Goodwill
~~The~~
Our Company’s intangible assets ~~all hold~~with definite lives ~~and~~ are being amortized by athe straight-line method over their estimated useful lives, ranging from two to 1510 years. Our Company’s intangible assets with an indefinite useful life are not amortized. The recoverability of intangible assets is evaluated periodically and takes into account events or circumstances that warrant revised estimates of useful lives or that indicate that impairment exists.
In conjunction with the implementation of ~~Statement of Financial Accounting Standards (FAS)~~FAS No. 142, “Goodwill and Other Intangible Assets,” ~~(FAS 142) which became effective January 1, 2003,~~(“FAS 142”), all goodwill, including goodwill related to acquisitions prior to July 1, 2002, ~~are~~is no longer amortized and potential impairment of goodwill and purchased intangible assets with indefinite useful lives ~~have~~has been evaluated using the specific guidance provided by FAS 142. This impairment analysis has been performed at least annually, 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~~difference 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~~ has been evaluated using the guidance provided by FAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” ~~(FAS 144) which became effective January 1, 2003.~~(“FAS 144”). 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. When an impairment is identified, the carrying amount of the asset is reduced to its estimated fair value.
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Software Cost
~~The Company capitalizes certain computer software~~
We recognize costs to develop our online entertainment and online game products in accordance with FAS No. 86, “Accounting for Costs of Computer Software to be Sold, Leased or Otherwise Marketed.” As such, costs are capitalized after technological feasibility has been ~~established. These costs~~established, until such time when product is available for general release to customers. Costs incurred prior to the establishment of technological feasibility are expensed when incurred and are included in product development and engineering expense. Capitalized amounts are amortized ~~utilizing a~~using the straight-line method, which is applied over ~~the economic lives of the related products, not~~periods ranging from three to ~~exceed four~~five years. ~~The Company performs periodic~~Periodic reviews are performed 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 consist primarily of compensation, depreciation, and amortization, and are expensed as incurred.
Advertising
Advertising costs are expensed as incurred. Advertising costs incurred in ~~2002, 2003~~2004, 2005 and ~~2004~~2006 totaled $1.4 million, ~~$727~~$915 thousand and ~~$1.4~~$6.6 million, ~~respectively.~~
respectively (including amounts of $83 thousand, and $93 thousand, reported in discontinued operations in 2004 and 2005, respectively).
Stock-Based Compensation
~~The Company has~~
Prior to January 1, 2006, we elected to measure stock-based compensation expense using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” ~~(APB 25)~~(“APB 25”), as interpreted, with pro-forma disclosures of net income (loss) and earnings (loss) per share, as if the fair-value method of accounting defined in FAS No. 123 “Accounting for Stock-Based Compensation,” ~~(FAS 123)~~(“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 value of the award and is recognized over the service period, which is usually the vesting period. Had ~~the~~our Company determined the stock-based compensation expense for ~~the Company’s~~our stock options based upon the fair-value as determined by the Black-Scholes option-pricing model at the grant date for the years ended December 31, ~~2002, 2003~~2004 and ~~2004, the Company’s~~2005, our net income (loss) and earnings (loss) per share would have been as the following pro-forma ~~amount indicated as follows:~~amounts indicate:

(in US$ thousands, Years Ended December 31,
except per share figures) 2004 2005
Net income (loss)

As reported $ 1,682 $ 6,336
Less: Stock compensation expense, net of related tax effects (3,421 ) (1,951 )

Pro-forma $ (1,739 ) $ 4,385

Earnings (loss)per share:
As reported — basic $ 0.03 $ 0.13
As reported — diluted 0.03 0.12
Pro-forma — basic (0.03 ) 0.09
Pro-forma — diluted (0.03 ) 0.08
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(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 ~~17, “Shareholders’ Equity and Share Options,~~19, “Share-Based Compensation,” for the assumptions and methodology used to determine the fair value of stock-based compensation.)
For the ~~years~~year 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~~we incurred a pro-forma net loss for 2004.
Effective January 1, 2006, we adopted the ~~respective years.~~
fair value recognition provisions of FAS No. 123(R), “Share-Based Payment” (“FAS 123(R)”), using the modified prospective method and therefore have not restated results for prior periods. Under this transition method, stock-based compensation expense for the year ended December 31, 2006 includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of January 1, 2006 based on the grant date fair value estimated in accordance with the original provision of FAS 123. Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006, is based on the grant date fair value estimated in accordance with the provision of FAS 123(R). FAS 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods. In connection with the adoption of FAS 123(R), we changed our method of attributing the value of stock-based compensation to expense from the graded-vesting method to the straight-line method. Compensation expense for all share-based payment awards granted on or prior to December 31, 2005 will continue to be recognized using the graded-vesting method, while compensation expense for all share-based payment awards granted subsequent to December 31, 2005 are recognized using the straight-line method. Because our Company had not recorded any compensation cost in our Statement of Operations prior to the adoption of FAS 123(R), no cumulative effect adjustment was recorded upon adoption. In March 2005, the Securities and Exchange Commission (the “SEC”) issued Staff Accounting Bulletin No. 107 (“SAB 107”) regarding the SEC’s interpretation of FAS 123(R) and the valuation of share-based payments for public companies. We have applied the provision of SAB 107 in our adoption of FAS 123(R). (See Note 19, “Share-based Compensation,” for additional information.)
Retirement Plan and Net Periodic Pension Cost
~~The Company’s~~
Under the defined benefit pension ~~plans cover substantially all of the full-time employees, which excludes temporary and short-term contract employees, located in Taiwan. The~~plan, net periodic pension cost, ~~is computed based on an actuarial valuation and~~which includes service cost, interest cost, expected return on plan assets, and amortization of unrecognized net ~~asset/~~transition obligation ~~at transition, amortization~~and gains or losses on plan assets, is recognized based on an actuarial valuation report. Effective December 31, 2006, our Company adopted the provisions of ~~prior service cost~~FAS No. 158, “Employer’s Accounting for Defined Benefit Pension and ~~amortization~~Other Post-Retirement Plans — An Amendment of FASB Statements Nos. 87, 88, 106, and 132(R),” (“FAS 158”). FAS 158 requires the recognition of the funded status of pension ~~gain~~plans and non-pension post-retirement benefit plans (retirement-related benefit plans) as an asset or ~~loss. The~~a liability in the Consolidated Balance Sheets. In addition, the pronouncement requires previously unrecognized ~~net assets or obligation at transition is amortized equally over 15 years. The~~items, such as actuarial gains and unrecognized prior service ~~cost is amortized over~~costs or credits, to be recognized on the average remaining service period of the participating employees expected to receive benefits under the pension plan as of the date of amendment of the plan. Amortization of unrecognized net gain or loss (excluding asset gains and losses not yet reflected in market-related value) is includedConsolidated Balance Sheets as a component of ~~net pension cost for a year if, as~~other comprehensive income (loss). The provisions of FAS 158 were adopted pursuant to the beginning of the year, that unrecognized net gain or loss exceeds 10% of the greater of the projected benefit obligation or the market-related value of plan assets. If amortization is required, the minimum amortization is that excess divided by the average remaining service period of active employees expected to receive benefits under the plans. The Company also has a defined contribution plan which covers substantially all of the employees located in the U.S.transition provisions therein. (See Note ~~16,~~17 “Pension Benefits,” for additional ~~information.~~information, including the incremental effect of the adoption on our Consolidated Financial Statements.)
Under our defined contribution pension plan, net periodic pension cost is recognized as incurred.
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’ equity. ~~The~~
F-17
Our Company’s comprehensive income (loss) consists of net income or loss, foreign currency translation ~~adjustment, as well as~~adjustments, unrealized gains and losses on marketable ~~securities.~~
securities, unrecognized actuarial gains or losses, and unrecognized transition assets or obligations arising from the adoption of FAS 158.
Accounting for Income Taxes
~~The Company has~~
We have adopted FAS No. 109, “Accounting for Income Taxes,” ~~(FAS 109)~~(“FAS 109”). Under 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, loss carry forwards~~liabilities. Loss carryforwards and investment credits are 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 amount that will more likely than not be realized. In assessing the likelihood of realization, management considers estimates of future taxable income.
Earnings (Loss) Per Share
~~The Company computes~~
We compute earnings (loss) per share in accordance with FAS No. 128, “Earnings Per Share,” ~~(FAS 128)~~(“FAS 128”). Under the provisions of FAS 128, basic earnings 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. Diluted earnings 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 common shares outstanding during the period. Potential common shares, composed of incremental common shares issuable upon the exercise of warrants and ~~stock options,~~share-based compensation and the assumed conversion of convertible debt, are included in the computation of diluted earnings or loss per share to the extent such shares are dilutive.
Minority Interest
Minority interest consists of ~~100%~~100 percent of the common stock of UIM held by outside shareholders. UIM was deemed a VIE as defined by FIN 46(R) and ~~the~~our Company was considered the primary beneficiary of UIM. Under the provisions of FIN 46(R), ~~the Company has~~we have incorporated the results of UIM into ~~its~~our 2004, 2005 and 2006 Consolidated Financial Statements, even though ~~the Company owns~~we own none of UIM’s equity. (See Note 3, ~~“Variable Interest~~“Variable-Interest Entity,” for more information.) ~~Minority~~
Beginning in December 2006, minority interest also ~~consists~~includes 30 percent of ~~41.42%~~the common stock of Dragongate Enterprises Limited (“Dragongate Enterprises”). 30 percent of the common stock of Dragongate Enterprises is held by an outside shareholder, Cyber Gateway Pte Ltd (Cyber Gateway), which is 100 percent owned by Infocomm Asia Holdings Pte Ltd (“Infocomm Asia”). We also own 500,000 voting preferred shares of Infocomm Asia. (See Note 12, “Marketable Securities — Noncurrent,” for additional information.)
Prior to the sale of the music distribution business on September 29, 2005, minority interest also included 41.42 percent 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. In February 2004, EMI returned its 5% ownership in GigaMusicshareholders; subsequent to the ~~Company. (See Note 21, “Litigation,” for additional information.)~~
divestiture of G-Music Limited, related minority interest income is included in discontinued operations.
Reclassification
The presentation of certain prior years’ information has been reclassified to conform with current year presentations.
F-18
Recent Accounting Pronouncements
In ~~May 2003,~~March 2006, the FASB issued FAS No. ~~150,~~156, “Accounting for ~~Certain~~Servicing of Financial ~~Instruments with Characteristics~~Assets — an Amendment of ~~Both Liabilities~~FASB Statement SFAS No. 140,” (“FAS 156”). FAS 156 simplifies the accounting for loan servicing rights and ~~Equity,” (FAS 150). It establishes classification and measurement standards for three types of freestanding~~the financial instruments used to hedge risks associated with those rights. FAS 156 requires that ~~have characteristics~~servicing rights be valued initially at fair value, and subsequently accounted for at either fair value, or amortized over the economic life 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.~~related lease. The provisions of FAS ~~150 are~~156 will be effective for ~~(1) instruments entered into or modified~~fiscal years beginning 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.September 15, 2006. The adoption of FAS ~~150, as modified by FSP FAS 150-3,~~156 is not expected to have a material impact on our Consolidated Financial Statements.
In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (“FIN 48”), which prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. The provisions of FIN 48 will be effective for fiscal years beginning after December 15, 2006. We are in the process of determining what effect, if any, the adoption of FIN 48 will have on our Consolidated Financial Statements.
In September 2006, the SEC released Staff Accounting Bulletin (SAB) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” (“SAB 108”), which provided the Staff’s view regarding the process of quantifying financial statement misstatements. SAB 108 requires an entity to quantify misstatements using both a balance sheet and income statement approach to determine if a misstatement is material. Our Company adopted SAB 108 in fiscal 2006, and it did not have a material effect on ~~the Company’s~~our Consolidated Financial Statements.
In ~~November 2004,~~September 2006, the FASB issued FAS No. ~~151, “Inventory Costs, an Amendment of ARB No. 43, Chapter 4,~~157, “Fair Value Measures,” ~~(FAS 151).~~ (“FAS ~~151 requires certain abnormal expenditures to~~157”), which defines fair value, establishes a framework for measuring fair value and expands disclosures about assets and liabilities measured at fair value. The statement will be ~~recognized as expenses~~effective for financial statements issued for fiscal years beginning after November 15, 2007. We are in the ~~current period. It also requires that~~process of determining what effect, if any, the ~~amount~~adoption 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~~No. 157 will have ~~a material effect~~ on ~~the Company’s~~our Consolidated Financial Statements.
In ~~December 2004,~~February 2007, the FASB issued FAS No. ~~153, “Exchanges of Non-Monetary~~159, “The Fair Value Option for Financial Assets ~~an Amendment of APB Opinion No. 29,~~and Liabilities,” ~~(FAS 153)~~(“FAS 159”). FAS 159 permits companies to choose to measure many financial instruments and certain other items at fair value. If the fair value option is elected, unrealized gains and losses will be recognized in earnings at each subsequent reporting date. FAS 159 will be effective for ~~non-monetary asset exchanges occurring~~fiscal years beginning after November 15, 2007. We are in the ~~fiscal year beginning January 1, 2006. FAS 153 requires that exchanges~~process 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~~determining what 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 ofif any, the adoption of ~~the accounting provisions of EITF 03-1 and does not expect the adoption of EITF 03-1~~FAS No. 159 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.our Consolidated Financial Statements.
F-19
NOTE 2.EARNINGS (LOSS) PER SHARE

(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, 2002 and 2003, 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 net loss for the respective years.

For the years end December 31,
(in US$ thousands, except per share figures) 2004 2005 2006
Weighted average outstanding shares

Basic 50,154 50,312 50,921
Effect of dilutive securities
Employee share-based compensation 1,547 4,747 7,509
Convertible notes — — 2,684

Diluted 51,701 55,059 61,114

Earnings Per Share — Basic

Income from continuing operations $ 1,253 $ 6,490 $ 30,784
Income (loss) from discontinued operations, net of taxes 429 (154 ) —

Net income $ 1,682 $ 6,336 $ 30,784

Earnings per share
Continuing operations $ 0.02 $ 0.13 $ 0.60
Discontinued operations 0.01 — —

$ 0.03 $ 0.13 $ 0.60

Earnings Per Share — Diluted

Income from continuing operations $ 1,253 $ 6,490 $ 30,784
Interest charges associated with convertible notes — — 288

Income from continuing operations after assumed conversion of convertible notes 1,253 6,490 31,072

Income (loss) from discontinued operations, net of taxes 429 (154 ) —

Net income after assumed conversion of convertible notes $ 1,682 $ 6,336 $ 31,072

Earnings per share
Continuing operations $ 0.02 $ 0.12 $ 0.51
Discontinued operations 0.01 — —

$ 0.03 $ 0.12 $ 0.51

NOTE 3. ~~VARIABLE INTEREST~~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
F-20
on whether a company has adopted FIN 46. In April of 2004, ~~the~~our 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~~us to charge a percentage of UIM gross receipts resulting from UIM’s ~~on-line~~online entertainment operations. The ~~Company~~percentage of gross receipts varies depending upon the software and support services provided to UIM. We analyzed the provisions of FIN 46(R) as it relates to contractual relationships and determined that ~~it was~~we were and continue to be a primary beneficiary of ~~a software licensee,~~ UIM. As a result of ~~the~~such determination, ~~by the Company that GigaMedia is a primary beneficiary of UIM, the Company has~~we have incorporated the results of UIM into ~~its~~our 2004, 2005, and 2006 Consolidated Financial Statements, even though ~~the Company owns~~we own none of UIM’s ~~equity.~~equity, and recorded goodwill arising from the consolidation of UIM totaling $209 thousand. UIM’s net assets as of December 31, ~~2004~~2005 and 2006 were approximately ~~$414~~$564 thousand and ~~the~~$784 thousand, respectively. The consolidation of UIM resulted in ~~an increase~~increases in assets and liabilities of approximately ~~$1.6~~$3.5 million and ~~$1.2~~$2.9 million, respectively, in 2005, and $12.8 million and no$12.1 million, respectively, in 2006.
NOTE 4.DIVESTITURES
Divestiture – Music Distribution Business
In September 2005, we completed the sale of our land-based music distribution business. The transaction price, net of transaction costs, was $5.02 million. The cash proceeds, net of transaction costs and cash transferred, was $3.25 million. Results for the music distribution operations are reported as discontinued operations in 2004 and 2005. In 2005, such amount was negative $154 thousand, which included an after-tax loss from music distribution business, net of minority interest, of $1.07 million and a gain on the sale of the business of $911 thousand. (See Note 1, “Business Overview, Basis of Presentation, and Summary of Significant Accounting Policies” – “Basis of Presentation,” for additional information.)
Summarized select financial information for discontinued operations is as follows:

(in US$ thousands) 2004 2005
Revenue $ 66,975 $ 37,907

Income (loss) before tax and minority interest income $ 752 $ (1,861 )

Income tax (benefit)/expense $ 5 $ (1 )

Minority interest income (loss) $ 318 $ (796 )

Income (loss) from discontinued operations $ 429 $ (154 )

Major classes of assets and liabilities which comprised the music distribution business at the date of disposal, September 29, 2005, included the following:

(in US$ thousands)
Cash (including restricted cash) $ 3,098
Accounts receivable 1,842
Inventory 6,679
Other current assets 683
Property and equipment 1,666
Intangible assets 4,689
Other assets 1,553

Total assets $ 20,210

Accounts payable $ 11,239
Other liabilities 1,945

Total liabilities $ 13,184

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Divestiture – ADSL Business
In May 2006, we sold our ADSL Internet access and service business to Webs-TV Digital International Corporation (“Webs-TV”). The total transaction price of approximately $18.1 million consisted of a cash payment of approximately $8.9 million related to the purchase of the ADSL business, and a cash payment of approximately $9.2 million related to the provision of certain agreed upon services, including bandwidth, billing, and consulting services, and the right to use GigaMedia’s ADSL brand for a period of five years. (See Note 22, “Commitments and Contingencies,” for additional information.) Cash proceeds in 2006 from the sale of the ADSL business, net of transaction costs and VAT, were approximately $3.3 million, and cash proceeds to be received in 2007 related to the sale, net of VAT, will be approximately $5.0 million. Such cash to be received in 2007 related to the sale is included in other receivables.
Our results of continuing operations in 2006 included a pre-tax one-time gain from the sale of the ADSL business of $7.7 million, which was recorded in non-operating income. The ADSL business does not qualify under FAS 144 as a component that may be reported as discontinued operations since the operations and cash flows of our ADSL business cannot be clearly distinguished operationally and for financial reporting purposes from the rest of our ISP business. Therefore, we have not reported the sale of our ADSL business as discontinued operations.
NOTE 5.ACQUISITIONS
Acquisition – FunTown
On January 2, 2006, GigaMedia acquired, through Hoshin GigaMedia, certain assets and liabilities of FunTown from TWP Corporation. The total purchase price of approximately $43 million consisted of a cash payment of approximately $27.2 million and convertible notes in the aggregate principal amount of $15.0 million with a yield to maturity of 0 percent per annum excluding any contingent interest, representing a valuation premium of $756 thousand as determined by a third-party valuation. Direct transaction costs amounting to approximately $110 thousand were included as part of the acquisition cost. The convertible notes were issued on January 1, 2006 by our Company to TWP Corporation, in the aggregate principal amount of approximately NT$494 million ($15.0 million) with 50 percent maturing on January 1, 2008 and 50 percent maturing on January 1, 2009 and were convertible into 4,794,323 shares of our common stock at $3.1287 per share. (The conversion price was subject to adjustment for stock dividends, stock splits, reverse stock splits, recapitalizations, mergers, and other dilutions.) On January 1, 2006, we pledged our share holdings in Hoshin GigaMedia as collateral for the convertible notes. These convertible notes were fully redeemed in July and September, 2006. (See Note 16, “Convertible Notes,” for more information.)
The transaction also included an incentive in the form of an additional amount to be paid by GigaMedia on April 1, 2007, which amount was to be determined based on the increase of adjusted pre-tax income ~~impact. The impact~~ of ~~consolidating UIM within~~FunTown in 2006 as compared to 2005 as follows:
(i) If the increase in 2006 was 30 percent or more, an additional payment of $5 million;
(ii) If the increase in 2006 was 15 percent or above but less than 30 percent, a reduced incentive payment;
(iii) If the increase in 2006 was less than 15 percent, no additional payment.
Adjusted pre-tax income of FunTown includes certain pre-agreed upon non-GAAP adjustments to the ~~Company’s~~GAAP pre-tax income. At December 31, 2006, we accrued an additional payment of $5 million since the adjusted pre-tax income of FunTown in 2006 increased more than 30 percent as compared to 2005.
F-22
In connection with the acquisition, including the incentive payment, we recorded goodwill of $26.6 million, which was assigned to our online game segment. Such goodwill amount is deductible for tax purposes. In 2006, we have elected not to deduct the goodwill amortization. Upon the closing of the acquisition on January 2, 2006, results of FunTown’s operations were included in our Consolidated Financial Statements ~~was immaterial~~under the online games business. The identified intangible assets are being amortized on a straight-line basis over their useful lives and the overall weighted-average life is 7.47 years.
The total purchase price allocation of the acquisition, including the incentive payment, is shown as follows:

Amortization life Original Price Total
(in US$ thousands) (in years) amount adjustment allocation
Cash acquired $ 463 $ — $ 463
Accounts receivable 3,626 — 3,626
Other current assets 106 — 106
Fixed assets / non-current assets 628 — 628
Intangible assets —
Trade name and trademark N/A 10,795 — 10,795
Customer relationships 9 5,546 — 5,546
Completed technology 7 2,301 — 2,301
Self-developed software 5 1,534 — 1,534
Others 5 73 — 73
Goodwill N/A 21,409 5,000 26,409

Total assets acquired 46,481 5,000 51,481

Current liabilities (3,501 ) — (3,501 )
Noncurrent liabilities (1 ) — (1 )

Total liabilities assumed (3,502 ) — (3,502 )

Total purchase price $ 42,979 $ 5,000 $ 47,979

The following unaudited pro-forma information presents a summary of the results of operations of our Company as of December 31, 2005 as if the acquisition had occurred on January 1, 2005.

Year ended
(in US$ thousands, December 31, 2005
except per share figures) Unaudited
Net revenue $ 61,219
Income from operations 8,949
Net income 11,279
Basic earnings per share 0.22
Diluted earnings per share 0.20
The above unaudited pro-forma financial information includes adjustments for interest expense associated with the ~~period presented.~~
~~NOTE 4.ACQUISITIONS~~
convertible notes, amortization and depreciation of identified assets.
Acquisition -— CESL
On April 1, 2004, GigaMedia acquired, through GigaMedia International Limited ~~(GMIL)~~(“GMIL”), a wholly-owned subsidiary of ~~GigaMedia,~~our Company, 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
F-23
transaction costs. Subsequent to the acquisition, GMIL was renamed Cambridge Entertainment Software ~~Limited (CESL).~~Limited. CESL is a software developer and ~~application~~support service provider. CESL develops software for ~~on-line~~online entertainment services. As ~~an application~~a software developer and support service provider, CESL offers ~~“turnkey”~~software solutions for ~~on-line~~online entertainment, which it licenses under ~~revenue sharing agreements.~~a software license and support service contract. The acquisition of CESL strengthened ~~the~~our Company’s ~~diversified~~online 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~~we 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~~our Consolidated Financial Statements under the entertainment software business. The identified intangible assets ~~will be~~are being amortized on a straight-line basis over their useful lives and the overall weighted-average life is 3.85 years.
In 2005, our Company recorded a decrease in deferred tax liabilities with a corresponding offset in goodwill totaling $364 thousand.
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


Amortization life Original Total
(in US$ thousands) (in years) amount Price adjustment allocation
Cash acquired $ 21 $ — $ 21
Accounts receivable 1,186 — 1,186
Other current assets 127 — 127
Fixed assets / non-current assets 450 — 450
Intangible assets
Completed technology 3 1,300 — 1,300
Trade name and trademark 10 700 — 700
Non-competition agreement 5 200 — 200
Others 2-4 373 — 373
Goodwill N/A 29,398 (364 ) 29,034

Total assets acquired 33,755 (364 ) 33,391

Current liabilities (573 ) — (573 )
Noncurrent liabilities (364 ) 364 —

Total liabilities assumed (937 ) 364 (573 )

Total purchase price $ 32,818 $ — $ 32,818

The following unaudited pro-forma information presents a summary of the results of operations of ~~the~~our Company as of December 31, ~~2003 and~~ 2004 as if the acquisition had occurred on January 1, ~~2003 and~~ 2004.

Year ended December 31
(in US$ thousands, 2004
except per share figures) Unaudited
Net revenue $ 102,668
Income (loss) from operations 4,440
Net income (loss) 3,103
Basic earnings (loss) per share 0.06
Diluted earnings (loss) per share 0.06
F-24

(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~~NOTE 6.
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 brands of Rose Records and Tachung Records. The acquisitions provided the Company meaningful presence in the music entertainment market. This factor, among others, contributed to a purchase price in excess of fair market value of the net tangible assets and intangible assets acquired, and as a result, the Company recorded goodwill in connection with the transactions.
The total purchase price of $18.3 million for a 58.58% equity interest consisted of $6.3 million in G-Music common stock, representing 6,550 thousand shares and $12.0 million in cash consideration. The value of G-Music common stock was determined based on the management’s estimate of the fair value of G-Music common stock in connection with the acquisitions.
~~Total purchase price has been allocated as follows:~~

(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 are amortized on a straight-line basis over their useful lives. Goodwill of $7.7 million represents the excess of the 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’s consolidated statements of operations since the completion of the acquisitions. The following unaudited pro-forma information presents a summary of the results of operations of the Company as of December 31, 2002 as if the acquisitions occurred on January 1, 2002:

(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


Software
licensing and
online
(in US$ thousands) entertainment Online game Total
Balance as of December 31, 2004 $ 29,607 $ — $ 29,607
Post-acquisition adjustment (364 ) — (364 )

Balance as of December 31, 2005 29,243 — 29,243

Acquisition — 21,409 21,409
Post-acquisition adjustment — 5,000 5,000
Translation adjustment — 165 165

Balance as of December 31, 2006 $ 29,243 $ 26,574 $ 55,817

Goodwill is tested annually for impairment using a fair value approach, at the “reporting unit” level. A reporting unit is an operating segment, or a component of an operating segment, as defined in FAS 142.
Following the acquisition of the Company’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 Company therefore recorded goodwill impairment losses of $7.0 million and $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, 2004 were primarily a result of the acquisition of CESL. (See Note 4, “Acquisitions,” for additional information.)~~ No impairment of goodwill has been identified during ~~2004.~~
2004, 2005, and 2006.
NOTE 6.7.INTANGIBLE ~~ASSETS-NET~~ASSETS — NET
The following table summarizes ~~the~~our Company’s intangible assets, by major asset class:

December 31, 2005
Gross carrying Accumulated
(in US$ thousands) amount amortization Net
Completed technology $ 1,300 $ (758 ) $ 542
Trade name trademark and non-competition agreement 900 (193 ) 707
Capitalized software cost 2,155 (753 ) 1,402
Other 66 (13 ) 53

Total $ 4,421 $ (1,717 ) $ 2,704

F-25

(in US$ thousands)

   December 31, 2003
   Gross carrying
amount
   Accumulated
amortization
Impairment
   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
amount
   Accumulated
amortization
Impairment
   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 amortizes~~

December 31, 2006
Gross carrying Accumulated
(in US$ thousands) amount amortization Net
Completed technology $ 3,619 $ (1,523 ) $ 2,096
Trade name trademark and non-competition agreement 11,841 (307 ) 11,534
Capitalized software cost 6,333 (1,910 ) 4,423
Customer relationships 5,589 (621 ) 4,968
Other 66 (20 ) 46

Total $ 27,448 $ (4,381 ) $ 23,067

We amortize the cost of intangible assets over their estimated useful lives. ~~Amortizable intangible~~Intangible assets are tested for impairment based on undiscounted cash flows and, if 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, 2003~~2004, 2005 and ~~2004,~~2006, total amortization ~~expenses~~expense of intangible assets were ~~$455 thousand, $914~~$1.5 million, $1.8 million, and $2.7 million, respectively (including amounts of $941 thousand and ~~$1.5 million, respectively,~~$732 thousand reported in discontinued operations in 2004 and 2005, respectively), which included respective amortization of capitalized software costs of ~~$0, $0,~~$191 thousand, $473 thousand, and ~~$191 thousand.~~$1.2 million. As of December 31, ~~2004,~~2006, based on the current amount of intangibles subject to amortization, the estimated amortization expense for each of the succeeding five years is as follows:


Amount
(in US$ thousands)
2005
   $ 1,813
2006
   1,738
2007
   1,029
2008
   501
2009
   406

   $ 5,487


Amount
(in US$ thousands)
2007 $ 2,860
2008 2,321
2009 1,944
2010 1,637
2011 1,035

$ 9,797

~~NOTE 7.IMPAIRMENT LOSS ON PROPERTY, PLANT AND EQUIPMENT~~
Due to rapid technological development in broadband Internet access services and 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 8.CASH AND CASH EQUIVALENTS

December 31,
(in US$ thousands) 2005 2006
Checking and savings accounts $ 36,831 $ 22,372
Time deposits 4,900 —

Total $ 41,731 $ 22,372

F-26

(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 9.MARKETABLE ~~SECURITIES-CURRENT~~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~~

December 31,
2005 2006
Percentage Percentage
(in US$ thousands) Amount held Amount held
Available-for-sale securities
Debt securities due within one year $ 4,957 — $ — —
Open-end funds 12,655 — 13,816 —
Equity Securities — Gamania Digital
Entertainment Co., Ltd. (“Gamania”) 2,792 3.34 — —

Total $ 20,404 $ 13,816

All of our Company’s marketable securities — current are classified as available-for-sale. As of December 31, ~~2003~~2005 and ~~2004,~~2006, the balances of unrealized gains for marketable securities — current ~~available-for-sale securities~~ were $0$276 and ~~$577~~$610 thousand, respectively. During ~~2002, 2003~~2004, 2005 and ~~2004,~~2006, realized gains from disposal of marketable ~~securities-current~~securities — current amounted to ~~$1.8 million, $488~~$351 thousand, $850 thousand, and ~~$351 thousand,~~$2.2 million, respectively.
~~NOTE 10.NOTES AND ACCOUNTS RECEIVABLE-NET~~

( 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 11.INVENTORIES-NET~~

( 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~~ On 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 12.MARKETABLE SECURITIES-NONCURRENT~~

( in US$ thousands )

   December 31,
   2003
   2004
   Amount
   Percentage
held
   Amount
   Percentage
held
Debt 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 - noncurrent are classified as available for sale, of which investment in~~ the SG Bond Fund was classified as marketable securities - current as of December 31, 2004, since the maturation of the SG Bond Fund became within one year. (See Note 9, “Marketable Securities – Current.”) The unrealized gains on investments in the SG Bond Fund as of December 31, 2003 were $1.4 million.
In 2001, the Company invested $10.7 million in Gamania, which accounted for 9.92% ownership of Gamania. During 2002, the Company disposed of 3,457 thousand shares of Gamania at an average selling price of approximately $2.24 (NT$77.43) per share and recognized a disposal gain of $1.5 million. During 2003, the Company received stock dividends of 1.4 million shares. The Company has no ability to exercise significant influence over Gamania’s operating and financial policies. The market price of Gamania shares ~~has~~had been below ~~the Company’s~~our carrying cost for an extended period of time; therefore, ~~the Company~~we recorded an other-than-temporary loss of $1.8 ~~million on~~million.
There is no unrealized loss for marketable securities — current at December 31, ~~2004.~~2006. The following table summarizes the unrealized losses and fair value of our investments with unrealized losses that were not deemed to be other-than-temporarily impaired at December 31, 2005:

Less than 12 months
(in US$ thousands) Fair Value Unrealized Losses
Debt securities
Freddie Mac N1206 $ 4,957 $ (36 )

The unrealized losses on the debt securities were primarily caused by an increase in interest rates, which were higher at December 31, 2005 than when we purchased the debt securities. We expected that these unrealized losses were not other-than-temporary, and had the intent and ability to hold these securities with unrealized losses until a recovery of fair value. In 2006, our debt securities matured, repayment was made at maturity value, and we recorded no loss.
On December 21, 2005, our Company entered into a put-call option agreement with an independent third party JSDWAY Digital Technology Co., Ltd., (“JSDWAY”) regarding the purchase and sale of shares of Gamania owned by us. From the period December 21, 2005 to December 21, 2006, we granted JSDWAY an option to buy, at NT$18.70 per share, a total of 4,905,000 common shares of Gamania owned by our Company, and JSDWAY granted us an option to sell to JSDWAY, at NT$18.70 per share, the Gamania shares owned by our Company. JSDWAY also provided a deposit to our Company to guarantee fulfillment of its payment obligations under the aforementioned agreement. Due to this arrangement with JSDWAY, the Gamania securities had been classified as marketable securities – current and marked to market at NT$18.70 per share.
On December 4, 2006, our Company entered into a termination agreement with JSDWAY to terminate the put-call option agreement regarding the purchase and sale of shares of Gamania. We then sold all of our Gamania shares in the public market in December 2006, which resulted in gains of $2.1 million. (See Note 21, “Related-Party Transactions,” for additional information.)
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NOTE 10.NOTES AND ACCOUNTS RECEIVABLE – NET

December 31,
(in US$ thousands) 2005 2006
Notes and accounts receivable $ 8,127 $ 16,971
Less: Allowance for doubtful accounts (1,684 ) (1,895 )

Net $ 6,443 $ 15,076

For the years ended December 31,
(in US$ thousands) 2004 2005 2006
Allowance for doubtful accounts
Balance at beginning of year $ 1,731 $ 2,050 $ 1,684
Acquisition — — 163
Additions: Bad debt expenses 247 203 715
Less: Write-offs (73 ) — (681 )
Divestiture — Music distribution business — (489 ) —
Translation adjustment 145 (80 ) 14

Balance at end of year $ 2,050 $ 1,684 $ 1,895

NOTE 11.INVENTORIES — NET

December 31,
(in US$ thousands) 2005 2006
Cable modems $ 100 $ 142
Merchandise 12 20

Subtotal 112 162
Less: Allowance for inventory market value decline and obsolescence (54 ) (39 )

Total $ 58 $ 123

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For the years ended December 31,
(in US$ thousands) 2004 2005 2006
Allowance for inventory market value decline and obsolescence
Balance at beginning of year $ 2,080 $ 1,912 $ 54
Additions: Charges for (reversal of) obsolete items (300 ) 33 36
Reductions: Written-off allowance for inventory market value decline and obsolescence — (1,554 ) (53 )
Divestiture — Music distribution business — (298 ) —
Translation adjustment 132 (39 ) 2

Balance at end of year $ 1,912 $ 54 $ 39

NOTE 12.MARKETABLE SECURITIES – NONCURRENT

December 31,
2005 2006
Percentage Percentage
(in US$ thousands) Amount held Amount held
Equity Securities:
T2CN Holding Limited (“T2CN”) $ — — $ 15,000 13.41
Infocomm Asia Holdings Pte Ltd. (“Infocomm Asia”) — — 10,000 32.26
Rock Mobile (Cayman) Corporation (“RMC”) — 1.04 — 0.88

Total $ — $ 25,000

All of our Company’s marketable securities — noncurrent are classified as available-for-sale. All of which are privately held companies and are accounted for using the cost method.
T2CN
On April 27, 2006, our Company entered into a strategic investment agreement with T2CN, an online casual sports game operator in China, pursuant to which GigaMedia made an investment of $15 million to acquire 7,500,000 voting preferred shares convertible into 7,500,000 common shares, or an approximately 19.02 percent interest in T2CN. We also obtained the right to elect one member to the board of directors and certain veto rights in the management of T2CN.
The convertible preferred shares have an initial liquidation preference equal to 1.2 times the original investment plus compound annual interest of 15 percent, are entitled to receive cumulative dividends, at 8 percent per annum on the aggregate nominal value of ordinary shares into which the preferred shares may be converted, and are redeemable at their original issue price starting December 31, 2009.
The preferred shares are convertible into T2CN common shares on 1:1 basis, subject to certain adjustments, and shall be automatically converted upon the closing of a qualified public offering or the election of the holders of at least 50 percent of the outstanding preferred shares. The embedded conversion options of the preferred shares do not meet the definition of derivative instruments under FAS 133 “Accounting for Derivatives Instruments and Hedging Activities,” (“FAS 133”) and are not bifurcated from the preferred share investment.
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In connection with the acquisition of T2CN preferred shares, our Company provided T2CN’s key shareholders, representing 52.92 percent ownership interest, an option to sell their common shares to us within two years from the closing of the strategic investment agreement. The agreed upon put price per share was equal to 8.65 times the net operating income per share, subject to certain adjustments. Such put price can be settled in cash or GigaMedia’s shares. We have evaluated the terms of the put option and determined that the fair value of such put option is immaterial. (See Note 22, “Commitments and Contingencies,” for related disclosure.)
We have applied the guidance provided in EITF 02-14 “Whether an Investor Should Apply the Equity Method of Accounting to Investment Other Than Common Stock,” (“EITF 02-14”) to determine whether our preferred share investments are in substance common shares which should be accounted for under the equity method. Given that our preferred shares have substantive liquidation preferences over those of T2CN’s common shares, we have accounted for our preferred share investment in T2CN under the cost method.
We assessed potential impairment of our T2CN investment, and concluded that no write-down was required as of December 31, 2006.
Infocomm Asia
On December 7, 2006, our Company entered into a subscription agreement with Infocomm Asia, an online game operator based in Singapore. Pursuant to the terms of the agreement, we have invested $10 million in Infocomm Asia and obtained 500,000 voting preferred shares convertible into an approximate 32.26 percent holding in Infocomm Asia’s common shares, making our Company the largest shareholder of Infocomm Asia on an as converted basis. We also obtained one board seat on Infocomm Asia’s board of directors.
The convertible preferred shares have an initial liquidation preference which equals the subscription price of $10 million, are entitled to receive cumulative dividends, at 8 percent per annum, and are redeemable within five years of their issuance date. The redemption amount is the preferred share issuing cost plus interest accrued at the rate of 10 percent per annum.
One preferred share is convertible into one common share of Infocomm Asia, subject to certain adjustments and limitations, and shall be automatically converted into the common shares of Infocomm Asia upon the closing of a qualified public offering or the election of the holders of at least 70 percent of the same class of outstanding preferred shares. The embedded conversion options of the preferred shares do not meet the definition of derivative instruments under FAS 133, and are not bifurcated from the preferred shares investment.
We have applied the guidance provided in EITF 02-14 to determine whether our preferred share investments are in substance common shares which should be accounted for under the equity method. Given that our preferred shares have substantive liquidation preferences over those of Infocomm Asia’s common shares, we have accounted for our preferred share investment in Infocomm Asia under the cost method.
We assessed potential impairment of our Infocomm Asia investment, and concluded that no write-down was required as of December 31, 2006.
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RMC
On December 31, 2005, we exchanged all of our 3,000,000 Rock Internet Corporation (“RIC”) shares for 646,859 ordinary shares, or a 1.04 percent shareholding of RMC, a company headquartered in Mainland China that provides music-related digital entertainment content and services through mobile networks and telecommunication devices. RIC had a 24.02 percent effective beneficial shareholding in RMC before the share exchange. As of December 31, ~~2003 and 2004,~~2006, we held an approximate 0.88 percent direct shareholding in RMC. Our shareholding in RMC was diluted in 2006 as a result of RMC’s new share issuance during the ~~balance of unrealized losses was $460 thousand and $0, respectively.~~
~~The investment in RIC was accounted for under the cost method.~~year. In 2002 and 2003, this investment was considered impaired due to the downturn in the ~~Internet~~music industry and the significant operating ~~loss~~losses incurred by ~~RIC. Impairment losses of $1.2 million and $1.7 million were recognized in 2002 and 2003, respectively,~~RIC, and the investment balance was written down to ~~$0 as~~$0.
The share exchange was entered into without a change of ~~December 31, 2003. There is no evidence~~interest in substance. In accordance with FASB Technical Bulletin No. 85-5, we account for our ownership in RMC after the exchange based on its existing carrying cost of ~~any recovery of impairment in 2004.~~
$0.
NOTE 13.~~DEFERRED ASSETS~~

( 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 periods: royalty and license fees, one to three years; network setup cost, five years. Network setup cost is comprised of costs incurred in setting up the leased network.
~~NOTE 14.~~RESTRICTED CASH
Restricted cash recorded in current assets as of December 31, ~~2003 and 2004~~2006 consisted of the following:

(in US$ thousands)
Restricted cash — current assets Time deposit pledged to China Trust Commercial Bank as a guarantee for bank loan $ 2,697

As of December 31, 2005, we had no restricted cash.
NOTE 14.SHORT-TERM LOANS

(in US$ thousands) Range of December 31,
Name Nature interest rate Due Date 2006
China Trust Commercial Bank Unsecured loans 2.35%~2.45 % Mar. 10, 2007 $ 6,135
China Trust Commercial Bank Secured loans 1.735%~1.865 % Mar. 10, 2007 2,117
Taishin International Bank Secured loans 2.90%~2.95 % Sept. 30, 2007 4,601

$ 12,853

* As of December 31, 2006, the weighted-average interest rate on total short-term loans was 2.48 percent.
We pledged time deposits of $2.7 million, and a net value of land and buildings of $1.7 million as collateral for secured bank loans as of December 31, 2006.
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( in US$ 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~~
NOTE 15.OTHER CURRENT LIABILITIES

December 31,
(in US$ thousands) 2005 2006
Player account balances $ 2,087 $ 9,527
Deferred revenue 2,434 3,222
Incentive payment for FunTown acquisition (See Note 5, “Acquisitions”) — 5,000
Other 1,724 4,610

Total $ 6,245 $ 22,359

NOTE 16.CONVERTIBLE NOTES
On January 1, 2006 we issued convertible notes, in relation to the acquisition of FunTown, to TWP Corporation in the aggregate principal amount of approximately NT$494 million ($15.0 million) with 50 percent maturing on January 1, 2008 and 50 percent maturing on January 1, 2009. These notes were convertible into 4,794,323 shares of our common stock at $3.1287 per share. (The conversion price is subject to adjustment for stock dividends, stock splits, reserve stock splits, recapitalizations, mergers, and other dilutions.) On January 1, 2006, we pledged our share holdings in Hoshin GigaMedia as collateral for the notes. Under the agreement, GigaMedia had an option to redeem the convertible notes, in whole or in part, within the first twelve months after the issue date, together with the ~~litigation between~~accrued interest at 5 percent per annum.
On July 6, 2006, our Company repurchased a portion of convertible notes from TWP Corporation with an aggregate face value of NT$380 million (approximately $11.5 million) and related accrued interest, resulting in a gain of approximately $487 thousand. On September 4, 2006, we repurchased the remainder of our convertible notes, with an aggregate face value of approximately NT$113.7 million (approximately $3.5 million) and related accrued interest, resulting in a gain of approximately $138 thousand. The gain realized from the retirement of these convertible notes was included in other non-operating income. The pledge of our shareholdings in Hoshin GigaMedia was released upon the repurchase.
NOTE 17.PENSION BENEFITS
Our Company and EMI in March 2003, an unconditional and irrevocable standby letter of credit issued by ABN AMRO Bank in the amount of $1 million was provided by the Company in favor of EMI. This standby letter of credit was guaranteed by a time deposit that matured on January 30, 2004. (See Note 21, “Litigation,” for further information.)
~~NOTE 15.SHORT-TERM LOANS~~

( in US$ thousands )
Name
   Nature
   Weighted-average
interest rate
December 31,
      2003
   2004
United Advertising Company, Ltd.
   Unsecured loans    4 % $ —      $ 284


~~NOTE 16.PENSION BENEFITS~~
~~The Company and its~~our subsidiaries have defined benefit and defined contribution pension plans that cover substantially all ~~full-time employees, and which exclude temporary and short-term contract~~of our employees.
Defined Benefit Pension Plan
Effective December 31, 2006, we adopted FAS 158. (See Note 1, “Business Overview, Basis of Presentation, and Summary of Significant Accounting Policies.”) The following table presents the incremental effect of applying FAS 158 on our Consolidated Balance Sheets:
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~~The Company has enacted provisions for employees’ retirement~~

Before After
(in US$ thousands) Application of Application of
At December 31, 2006: FAS No. 158 Adjustments* FAS No. 158
Other assets $ 90 $ (58 ) $ 32

Total assets 182,677 (58 ) $ 182,619

Accrued pension liabilities 727 (293 ) $ 434

Total liabilities 47,291 (293 ) $ 46,998

Accumulated other comprehensive loss (27,204 ) 235 $ (26,969 )

Total stockholders’ equity 133,852 235 $ 134,087

* Adjustments are primarily comprised of previously unrecognized gains/(losses) and transition obligations.
We have a defined benefit pension plan in accordance with the Labor Standards Law of the Republic of China for ~~the~~our employees located in ~~Taiwan. The provisions state that~~Taiwan, covering substantially all full-time employees for services provided prior to July 1, 2005, and employees who have elected to remain in the defined benefit pension plan subsequent to the enactment of the Labor Pension Act on July 1, 2005. Under the defined benefit pension plan, employees are entitled to two base points for every year of service for the first 15 years and one base point for every additional year of service, up to a maximum of 45 base points. The pension ~~obligation~~payment to ~~employee~~employees is computed based on years of service and average ~~salary~~salaries or wages for the six months prior to approved retirement.
~~The Company uses~~
We use a December 31 measurement date for ~~its~~our defined benefit pension plan. The following tables set forth the actuarial assumptions of ~~the Company’s~~our defined benefit pension plan:

(in US$ thousands) 2005 2006
Change in benefit obligation
Benefit obligation at beginning of year $ 941 $ 449
Divestitures of music distribution business (328 ) —
Service cost 88 12
Interest cost 21 16
Plan participants’ contribution — —
Actuarial gain (255 ) 103
Curtailment — (42 )
Benefits paid — —
Exchange diff. (18 ) 3

Benefit obligation at end of year $ 449 $ 541

F-33

(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 )


(in US$ thousands) 2005 2006
Change in plan assets
Fair value of plan assets at beginning of year $ — $ 50
Actual return on plan assets — 2
Employer contribution — 83
Plan participants’ contributions 49 —
Benefit paid — —

Fair value of plan assets at end of year $ 49 $ 135

Accumulated benefit obligation $ (364 ) $ (443 )

(in US$ thousands)
Funded status
$ (399 ) $ (406 )
Unrecognized net actuarial gain (461 ) NA
Unrecognized prior service cost — NA
Unrecognized transition obligation 82 NA

Net amount recognized $ (778 ) NA

Amounts recognized in ~~the statement of financial position~~our Consolidated Balance Sheets 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 )


Pension Benefits
(in US$ thousands) 2005 2006
Accrued benefit cost $ (811 ) $ (406 )
Deferred pension cost (other assets) 33 NA
Accumulated other comprehensive income — (235 )

Net amount recognized $ (778 ) NA

Information for pension plans with an accumulated benefit obligation in excess of plan assets ~~were~~at December 31, 2005 was as follows:

(in US$ thousands)

   2003
2004

Projected benefit obligation
   $ (1,019 ) $ (941 )
Accumulated benefit obligation
   (589 ) (500 )
Fair value of plan assets
   —   —

(in US$ thousands)
Projected benefit obligation $ (449 )
Accumulated benefit obligation (364 )
Fair value of plan assets 49
The net periodic benefit cost for the plans included the following components:
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(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



(in US$ thousands) 2004 2005 2006
Service cost $ 249 $ 88 $ 12
Interest cost 39 21 16
Expected return on plan assets — — (4 )
Amortization of transition obligation 8 4 4
Amortization of prior service cost 28 — —
Amortization of net (gain) loss (15 ) (20 ) (47 )

Net periodic benefit cost $ 309 $ 93 $ (19 )

Curtailment loss (gain) $ — $ — $ (42 )

Assumptions
Weighted-average assumptions used to determine benefit obligations and net periodic pension costs at December 31, ~~2002, 2003~~2004, 2005 and ~~2004~~2006 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~~

2004 2005 2006
Discount rate 3.50 % 3.50 % 2.75 %
Rate of return on plan assets N/A 3.50 % 2.75 %
Rate of compensation increase 3.00 % 1.00 % 1.00 %
Discount rate. The discount rate assumptions used for defined benefit plan ~~was not funded. Therefore, no asset allocation disclosure was required~~accounting reflect the rates of return on high-quality, fixed income investments currently available and ~~the contribution is~~ expected to be ~~approximately $95 thousand~~available during the period to maturity of the pension benefits. In countries where there is no deep market in ~~2005.~~such bonds, the market yields (at the balance sheet date) on government bonds are used. For our defined benefit plan in Taiwan, markets for high-quality, long-term bonds are not generally as well developed, and the government owned Central Trust of China is the only funding vehicle for statutory pension scheme. Therefore, the yield of government issued bonds and the interest rate from the Central Trust of China are often used as the benchmark for developing the discount rate, with adjustment made to take into consideration the differences in maturities.
Rate of return on plan assets. The rate of return on plan assets is determined by using the interest rate from the Central Trust of China as a base. All of our pension assets are deposited and managed by the government owned Central Trust of China. Under R.O.C. regulations, government authorities collect the cash contribution from companies as a Labor Retirement Fund and determine asset allocations and investment policy. Participants are guaranteed to receive a minimum rate of return not lower than the interest rate of two-year term time deposits from the Central Trust of China.
Rate of compensation increase. The rate of compensation increases is determined by our Company, based upon our actual rate of compensation increase during a year, and the long-term plans for such increases.
Starting July 1, 2005, we have contributed an amount equal to 2 percent of the salaries and wages paid to our employees located in Taiwan to a pension fund (the “Fund”). The Fund is administered by a pension fund monitoring committee (the “Committee”) and deposited in the Committee’s name in the Central Trust of China in Taiwan. Our Company makes pension payments from our account in the Fund unless the Fund is insufficient, in which case, we make payments from internal funds as payments become ~~due and also maintains~~due. We maintain a normal, highly liquid working capital balance to ensure payments are made timely.
F-35
We expect to make a contribution of $71 thousand to our pension fund in 2007. The benefits expected to be paid from ~~2005~~2007 through ~~2009~~2011 are $0, and in aggregate ~~for 2010 and thereafter~~from 2012 to 2016 are ~~$70~~$53 thousand.
Defined Contribution Pension Plan
~~In connection with~~
Pursuant to the ~~acquisition~~new “Labor Pension Act” enacted on July 1, 2005, our Company set up a defined contribution pension plan for our employees located in Taiwan. For eligible employees who elect to participate in the defined contribution pension plan, we contribute no less than 6 percent of ~~CESL,~~ the ~~Company~~employees’ salaries and wages paid each month to the employees’ individual pension accounts at the Bureau of Labor Insurance. Benefits accrued are portable upon termination of service. Pension payments to employees are made either by monthly installments or in a lump sum from the accumulated contributions and earnings in employees’ individual accounts.
We have also provided a defined contribution plan for employees located ~~outside of Taiwan.~~in North America. Participants under ~~50 years~~the age of ~~age~~50 are allowed to defer up to ~~$9,000~~$10 thousand of their ~~own~~ annual compensation to the plan, ~~while~~whereas participants over the age of 50 are ~~limited~~allowed to ~~deferrals of~~defer up to ~~$10,500. For all employees who elect to make deferrals under the plan, CESL makes a matching employer contribution in~~$12.5 thousand annually. Our Company contributes an amount ~~limited~~equal to 3%the lesser of ~~each~~3 percent of the participant’s ~~deferral. In 2004,~~compensation or 100 percent of the amount deferred by the employee.
The defined contribution expenses pursuant to ~~this plan~~the plans in Taiwan and North America for the ~~nine-month period starting April 1,~~years ended December 31, 2004, ~~equalled~~2005, and 2006 were $42 ~~thousand. This plan is fully funded at~~thousand, $216 thousand, and $496 thousand, respectively.
NOTE 18.SHAREHOLDERS’ EQUITY
Effective January 30, 2006, Singapore law was amended to eliminate the ~~end~~concept of ~~each pay period.~~
~~NOTE 17.SHAREHOLDERS’ EQUITY AND SHARE OPTIONS~~
par value and authorized shares. As a result, our Balance Sheets and Shareholders’ Equity Statements presentation have been revised accordingly. As of December 31, ~~2004, the authorized capital of the~~2006, our Company ~~was $24.42 million (NT$800 million), represented by 80 million common shares with par value of NT$10 per share. As of December 31, 2004, there were 50,154,000~~had 51,495,156 common shares issued and outstanding.
In accordance with R.O.C. law, an appropriation for legal reserve amounting to 10 percent of a company’s net profit is required until the reserve equals the aggregate par value of such Taiwan company’s issued capital stock. As of December 31, 2005 and 2006, the legal reserves of Hoshin GigaMedia, which represent a component of our accumulated deficits, were $339 thousand, and $526 thousand, respectively. The reserve can only be used to offset a deficit or be distributed as a stock dividend of up to 50 percent of the reserve balance when the reserve balance has reached 50 percent of the aggregate paid-in capital of Hoshin GigaMedia.
NOTE 19. SHARE-BASED COMPENSATION
Effective January 1, 2006, we adopted the fair value recognition provisions of FAS 123(R), using the modified prospective transition method and therefore we have not restated prior periods’ results. Under this transition method, stock-based compensation expense for 2006 included compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of FAS 123. Stock-based compensation expense for all share-based payment awards granted after January 1, 2006 is based on the grant-date fair value estimated in accordance with the provisions of FAS 123(R). FAS 123(R) requires companies to estimate the fair value of shared-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as
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~~On January 17, 2002,~~
expense over the ~~Company’s shareholders approved a return~~requisite service periods. In connection with the adoption of ~~capital in~~FAS 123(R), we changed our method of attributing the ~~amount~~value of ~~$2 for each ordinary share outstanding on March 15, 2002. On March 29, 2002,~~stock-based compensation that we record to expense from the ~~Company returned capital~~graded-vesting method to the ~~shareholders in an amount of $100.3 million.~~
~~1999 Share Option Plan~~
~~During 1999,~~straight-line method. Compensation expense for all share-based payment awards granted on or prior to December 31, 2005 will continue to be recognized using the ~~Company adopted~~graded-vesting method while compensation expense for all share-based payment awards granted subsequent to December 31, 2005 is recognized using the ~~GigaMedia Limited 1999 Employee Share Option Plan (the 1999 Plan). Pursuant~~straight-line method. As share-based compensation expense is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. We estimated the 1999 Plan, up to two million common shares may be granted to employees of the 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 priceforfeiture rate for 2006 based on our historical experience. In our Company’s pro-forma information required under FAS 123 for the ~~option grants,~~years prior to ~~determine which eligible individuals~~2006, our Company accounted for forfeitures as they occurred.
The following table summarizes the total stock-based compensation expense recognized in our Consolidated Statement of Operations:

(in US$ thousands) 2006
Cost of Internet access and services revenues $ 20
Product development & engineering expenses 127
Selling and marketing expenses 67
General and administrative expenses 96

Pre-tax stock-based compensation expense 310
Income tax benefit 60

Total stock-based compensation expense $ 250

There were no significant capitalized stock-based compensation costs at December 31, 2006.
Summarized below are ~~to receive option grants,~~ the ~~time or times when options grants are to be made, the number~~general terms of ~~shares subject to grant and the maximum term for which any granted option is exercisable.~~
our stock-based compensation plans.
2002 Share Option Plan
At the June 2002 annual general meeting of shareholders, the shareholders of ~~the~~our Company approved the GigaMedia Limited 2002 Employee Share Option Plan (the ~~2002 Plan)~~“2002 Plan”) under which up to three million common shares of ~~the~~our Company have been reserved for issuance. All employees, officers, directors, supervisors, advisors, and ~~directors~~consultants of ~~the~~our 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 three million shares of ~~the Company’s~~our common stock were granted and exercisable upon granting at an exercise price of $0.79 pursuant to the 2002 Plan. Through the end of 2006, no option had been exercised or cancelled. The maximum contractual term under the 2002 Plan is approximately 10 years. Termination of employment will not affect the rights to exercise vested options. 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~~our Company approved the GigaMedia Limited 2004 Employee Share Purchase Plan (the ~~2004 ESPP)~~“2004 ESPP”) under which up to two million common shares of ~~the~~our Company have been reserved for issuance. Pursuant to the 2004 ESPP, ~~the Company~~we have offered ~~its~~our shares to qualified employees at favorable conditions and established a restricted period
F-37
of six months during which employees may not transfer the shares after purchasing them. To be eligible, employees must be employed by ~~the Company~~us or ~~its~~our 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~~our Company approved the GigaMedia Limited 2004 Employee Share Option Plan (the ~~2004 Plan)~~“2004 Plan”) under which up to seven million common shares of ~~the~~our Company have been reserved for issuance. All employees, officers, directors, supervisors, advisors, and ~~directors~~consultants of ~~the~~our 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~~our Company’s common stock were granted at an exercise price of $0.79 pursuant to the 2004 Plan. These options were subject to two vesting schedules. In accordance with the terms of the first vesting schedule, 3,863,888 options were vested and exercisable upon granting. By the end of 2006, 95,000 options had been cancelled, 389,000 options had been exercised, and the number of outstanding options under the first vesting schedule was 3,379,888 options. In accordance with the terms of the second vesting schedule, 1,598,642 options were granted, of which 399,663 options were vested and exercisable upon granting. The remaining 1,198,979 options are vested ~~25%~~399,661 options per year from the grant date.
By the end of 2006, 309,229 options had been cancelled, 559,655 options had been exercised, and the number of outstanding options under the second vesting schedule was 729,758 options.
In May 2005, options to purchase 100,000 shares of our Company’s common stock were granted at an exercise price of $1.45. In accordance with the terms of the vesting schedule, 25,000 options were vested and exercisable upon granting. The remaining 75,000 options are vested 25,000 options per year from the grant date. By the end of 2006, no such option had been exercised or cancelled.
In December 2005, options to purchase 1,805,655 shares of our Company’s common stock were granted at an exercise price of $2.55. These options were subject to two vesting schedules. In accordance with the terms of the first vesting schedule, 1,570,655 options were vested and exercisable upon granting. By the end of 2006, 23,000 options had been cancelled, 202,859 options had been exercised under the first vesting schedule. In accordance with the terms of the second vesting schedule, 94,000 options are vested and exercisable in December 2007. The remaining 141,000 options are vested and exercisable in December 2008. By the end of 2006, no such option under the second vesting schedule had been exercised or cancelled.
The maximum contractual term under the 2004 Plan is 10 years. Termination of employment will not affect the rights to exercise vested options. Unvested options will be cancelled upon termination of employment. All options granted under the 2004 Plan expire on June 29, 2014.
F-38
~~Total compensation expense recorded in 2002, 2003~~
2006 Equity Incentive Plan
At the June 2006 annual general meeting of shareholders, the shareholders of our Company approved the GigaMedia Limited 2006 Equity Incentive Plan (the “2006 Plan”) under which up to one million common shares of our Company have been reserved for issuance. The 2006 Plan is administered by a committee designated by the board of directors. The committee as plan administrator has complete discretion to determine the grant of awards under the 2006 Plan.
In December 2006, we granted 115,000 restricted stock units (“RSUs”) to employees of our Company. These RSUs were subject to two schedules for the lapsing of restrictions on transfer. 25,000 RSUs are subject to the terms of the first lapsing schedule, under which the restrictions on transfer shall lapse with respect to the first 33 percent of the RSUs upon granting with the remaining 67 percent of the RSUs vesting over a two-year period so long as the employee is employed by or providing services to our Company. 90,000 RSUs are subject to the terms of the second lapsing schedule, under which the restrictions on transfer shall lapse over a three-year period, beginning April 1, 2007 so long as the employee is employed by or providing services to our Company.
The maximum contractual term under the 2006 Plan is 10 years. In the event that the employee’s employment with or service to our Company is terminated prior to the lapsing of restrictions with respect to any portion of the RSUs, such portion of the RSUs shall become forfeited.
All options and ~~2004 for all~~RSUs are expected to be settled by issuing new shares.
Options
No options ~~amounted to $153 thousand, $0~~were exercised before 2005. In 2006, 1,151,514 options were exercised, and ~~$0, respectively, which consisted~~cash received from the exercise of ~~amortization of options outstanding during the respective years, net of forfeitures. Unearned compensation for outstanding~~stock options was ~~$0 as~~$1.3 million, which resulted in no significant tax benefit realized on a consolidated basis.
The impact resulting from our adoption of ~~December 31, 2003~~FAS 123(R) to our 2006 Consolidated Financial Statements for income before income taxes and ~~2004.~~ net income was $(310) thousand, and $(250) thousand, respectively. The impact on basic and diluted earnings per share for 2006 was $(0.005) and $(0.004) per share, respectively.
There were no stock-based compensation expenses recorded in 2004 and 2005 as all options were granted to employees at prices in ~~2002 or 2003.~~
~~The pro-forma disclosures~~excess of net income (loss) and earnings (loss) per share required under FAS 123 were disclosed in “Stock-Based Compensation” under Note 1, “Significant Accounting Policies.” In computing this pro-forma impact, the ~~fair value for these options was estimated~~common stock market price at the date of ~~grant using~~grant.
Prior to adoption of SFAS 123(R), our Company used the Black-Scholes ~~option-pricing~~formula to estimate the value of stock options granted to employees. We continue to use this option valuation model following our adoption of FAS 123(R). There is no stock options granted in 2006 and the following summarizes the weighted-average assumptions in the model:

For the years ended December 31, 2004 2005 2006
Option term (years) 3.35 3.35 3.35
Volatility 92.94 % 85.74 % 85.74 %
Risk-free interest rate 2.92 % 3.17 % 3.17 %
Dividend yield 0 % 0 % 0 %
Weighted-average fair value of option granted 0.45 0.56 0.56
Option term. The expected term of the options granted represents the period of time that they are expected to be outstanding. Our Company estimates the expected term of options granted based on historical experience with grants and option exercises.
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Expected volatility rate. For options granted prior to December 31, 2004, an analysis of historical volatility was used to develop the ~~following 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
estimate of expected volatility. However, with the divestiture of our land-based music distribution business in 2005, we do not believe historical stock price volatility is representative of our future stock trends. Therefore, for options granted during 2005, we applied the concept of “mean-reversion tendency” and excluded the period during which the divested business accounted for the majority of volatility for the estimate of expected volatility,which was calculated by weight-averaging the adjusted historical volatility of GigaMedia and the average mean volatility of our Company’s peer groups.
Risk-free interest rate. The risk-free interest rate is based on three-year U.S. Treasury bonds for the expected term of the options.
Expected dividend yield. The dividend yield is based on our Company’s current dividend yield.
Option and grant transactions during the last three years ~~were~~are summarized as follows:

   2002
   2003
   2004

   Weighted Avg.
Exercise Price
   No. of Shares
(in thousands)
   Weighted Avg.
Exercise Price
   No. of Shares
(in thousands)
   Weighted Avg.
Exercise Price
   No. 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







2004 2005 2006
Weighted- Aggregate
Weighted No.of Weighted No.of Weighted No.of Average Intrinsic
Avg. Shares Avg. Shares Avg. Shares Remaining Value
Exercise (in Exercise (in Exercise (in Contractual (in
Price thousands) Price thousands) Price thousands) Term thousands)
Balance at January 1, $ 23.50 473 $ 2.00 8,844 $ 1.11 10,000
Options granted 0.79 8,463 2.49 1,905 — 0
Options exercised — — — — 1 (1,152 )
Options Forfeited/canceled /expired 0.79 (92 ) 15.13 (749 ) 1.48 (59 )

Balance at December 31, $ 2.00 8,844 $ 1.11 10,000 $ 1.11 8,789 7.49 $ 76,083

Exercisable at December 31, $ 2.18 7,737 $ 1.09 9,170 $ 1.08 8,318 7.49 $ 72,285

Vested and expected to vest at December 31, 2006 $ 1.11 8,783 7.49 $ 76,029

The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between GigaMedia’s closing stock price on the last trading day of 2006 and the fair value of the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders and all option holders had they exercised their options on December 31, 2006. This amount changes based on the fair market value of GigaMedia’s stock. The total intrinsic value of options exercised for the years ended December 31, 2004, 2005, and 2006 were $0, $0, and $8.8 million, respectively.
The following table sets forth information about stock options outstanding at December 31, ~~2004:~~2006:
F-40

   Options outstanding
   Options currently exercisable
Range of exercise price
   Number of
shares
   Weighted average
remaining
contractual life
   Weighted average
exercise price
   Number 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



Options outstanding Options currently exercisable
Weighted average
Range of No. of Shares remaining Weighted average No. of Shares
exercise price (in thousands) contractual life exercise price (in thousands)
$0.79 7,109 7.49 years $ 0.79 6,910
$1.45 100 7.49 years $ 1.45 63
$2.55 1,580 7.49 years $ 2.55 1,345

8,789 8,318

RSUs
Nonvested RSUs as of December 31, 2006 and unit movement during 2006 were as follows:

Number of units Weighted-average
(in thousands) grant date fair value
Nonvested at December 31, 2005 — —
Granted 115 $ 9.81
Vested (8 ) $ 9.81
Forfeited — —

Nonvested at December 31, 2006 107 $ 9.81

The fair value of RSUs is determined and fixed on the grant date based on our stock price. The fair value of RSUs granted during the year ended December 31, 2006 was $1.1 million. The total fair value of RSUs vested during the year ended December 31, 2006 was $81 thousand.
As of December 31, 2006, there was $960 thousand of unrecognized compensation cost related to nonvested RSUs. That cost is expected to be recognized over a weighted-average period of 2.25 years. Our Company received no cash from employees as a result of employees vesting and the release of RSUs.
NOTE ~~18.~~20.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


For the years ended December 31,
(in US$ thousands) 2004 2005 2006
Income (loss) from continuing operations before income taxes
U.S. operations $ (4,392 ) $ 516 $ 865
Non-U.S. operations 5,724 6,560 31,789

Total income (loss) from continuing operations before income taxes $ 1,332 $ 7,076 $ 32,654

Income tax provision (benefit) from continuing operations by geographic operation ~~was~~is as follows:
F-41

( 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 )




For the years ended December 31,
(in US$ thousands) 2004 2005 2006
U.S. operations $ (88 ) $ 304 $ 366
Non-U.S. operations 4 132 1,183

$ (84 ) $ 436 $ 1,549

The components of income tax provision (benefit) from continuing operations by taxing jurisdiction ~~were~~are 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 )




For the years ended December 31,
(in US$ thousands) 2004 2005 2006
U.S. federal

Current $ 7 $ 233 $ 266
Deferred (19 ) 17 8

(12 ) 250 274

U.S. state and local:

Current 12 60 90
Deferred (88 ) (6 ) 2

(76 ) 54 92

Non — U.S.:

Current 4 132 1,199
Deferred — — (16 )

4 132 1,183

Total income tax provisions (benefit) $ (84 ) $ 436 $ 1,549

A reconciliation of ~~the Company’s~~our continuing operations effective tax rate to the statutory U.S. federal tax rate ~~was~~is as follows:
F-42

(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 %


For the years ended December 31,
(in US$ thousands) 2004 2005 2006
Federal statutory rate 34.00 % 34.00 % 34.00 %
State and local — net of federal tax benefit 6.27 % 6.91 % 6.78 %
Foreign tax differential (9.00 %) (15.91 %) (8.28 %)
Valuation allowance for deferred tax assets (25.00 %) (25.00 %) (25.00 %)
Other (12.58 %) 6.16 % (2.76 %)

Effective rate (6.31 %) 6.16 % 4.74 %

The provision for income taxes attributable to discontinued operations is as follows:

For the years ended December 31,
(in US$ thousands) 2004 2005
Provision on income from discontinued operations $ 5 $ (1 )

Provision on gain on disposal of discontinued operations $ — $ —

Significant components of ~~the Company’s~~our deferred tax assets and liabilities consisted of the following:

December 31,
(in US$ thousands) 2005 2006
Deferred tax assets:
Net operating loss carryforwards $ 9,458 $ 3,082
Unrealized foreign exchange (gain) loss 3 (1 )
Allowance for inventory market value decline and obsolete items 14 10
Allowance for doubtful accounts 400 397
Pension expense 197 162
Investment credits 175 104
Property, plant & equipment 149 272
Others — 21

10,396 4,047
Less: valuation allowance $ (10,396 ) $ (4,032 )

Deferred tax assets — net $ — $ 15

F-43

(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~~

December 31,
(in US$ thousands) 2005 2006
Deferred tax liabilities:
Depreciation and amortization $ 11 $ 39
Others (5 ) (43 )

Deferred tax liabilities — net $ 6 $ (4 )

For the years ended December 31,
(in US$ thousands) 2004 2005 2006
Valuation allowance:
Balance at beginning of year $ 21,316 $ 22,499 $ 10,396
Additions: charged to (realization of) valuation allowance (336 ) (5,863 ) (6,443 )
Divestiture — (5,405 )
Exchange difference 1,519 (835 ) 79

Balance at end of year $ 22,499 $ 10,396 $ 4,032

We do not believe that sufficient objective, positive evidence currently exists to conclude that realization of deferred tax assets is more likely than ~~not.~~not since our Internet access and service operations face slow market growth and strong market competition. As a result, ~~the Company has~~we have provided a valuation allowance covering substantially all of the deferred tax assets arising from ~~its broadband ISP~~our Internet access and ~~music distribution~~service operations in Taiwan.
In 2005 and 2006, we applied for investment tax credits and research and development tax credits.
As at December 31, ~~2004, the Company~~2006, we had net operating loss ~~carry forwards~~carryforwards of approximately ~~$84.0 million.~~$12.3 million and $84 thousand, arising from our Internet access and service operations in Taiwan and from our online games business in Hong Kong, respectively. Currently, ~~the~~ net operating ~~loss~~losses can be carried forward for five ~~years.~~years in Taiwan and infinitely in Hong Kong. A breakdown of the expiration of GigaMedia’s net operating loss ~~carry forwards~~carryforwards is as follows:

(in US$ thousands)
Year incurred Amount Expiring year
2002 $ 8,533 2007
2003 3,463 2008
2004 273 2009
2006 84 Infinity

Total $ 12,353

NOTE 21.RELATED-PARTY TRANSACTIONS
In the course of operating our business, we provide Internet access services to, or source services from, our Company’s business partners. These partners include companies in which we hold an interest, and
F-44
companies with which members of our board, senior managers of our Company, and our major shareholders or beneficial owners are associated. Business with such companies was ~~as follows:~~

(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 19.RELATED PARTY TRANSACTIONS~~
~~A. Related Parties and Relationships~~
~~GigaMedia’s policy is that all~~not material from the viewpoint of our Company.
Except for the following transactions, ~~with related parties must be conducted on terms as favorable~~we were not a party to ~~the Company as obtainable at the time in a comparable arm’s-length~~any transaction with any related party that did not arise in the ordinary course of business or that was material to us.
The former chairman of China Trust Commercial Bank, who resigned from China Trust Commercial Bank in 2006, was considered to be 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~~beneficial owner of our Company stock in 2005 and 2006, and was a director in 2005. As of December 31, 2005 and 2006, we had deposits in China Trust Commercial Bank, in the amount of $31.7 million, and $4.0 million (including $2.7 million in restricted cash), respectively. As of December 31, 2006, we had short-term loans in the amount of $8.3 million, bearing interest ranging from 1.735 percent to 2.45 percent, due to ~~changes~~China Trust Commercial Bank. (See Note 14, “Short-term Loans.”)
We own 500,000 voting preferred shares of Infocomm Asia and we are entitled to nominate one board member on Infocomm Asia’s board of directors. As of December 31, 2006, we had a receivable due from Cyber Gateway, which is 100 percent owned by Infocomm Asia, totalling $750 thousand. This receivable is associated with our joint venture with Cyber Gateway in Dragongate Enterprises, and is included in other receivables.
In December 2006, we resigned from the board of directors of Gamania. Following our resignation from such board, we sold in the ~~Company’s directors and senior management during 2003 and 2004,~~public market all of our Gamania shares, which prevented such directors and senior management from exercising significant influence or controls over the Company. As a result, transactions with the following parties were not subject to the related party transaction disclosure and were shown as $0resulted in ~~the 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.~~
gains of $2.1 million. (See Note 9, “Marketable Securities – Current,” for additional information.)
~~B. Transactions with Related Parties~~NOTE 22.
a. ~~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 above transactions were summarized as follows:~~

(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 the 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.~~
d. ~~The Company incurred sales commission expenses with its cable partners of $72 thousand and $57 thousand for the years ended December 31, 2002 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 Systems Co., Ltd.~~
f. 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 $374 thousand, $372 thousand and $392 thousand with China Life Insurance Co., Ltd. for the years ended December 31, 2002, 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 20.~~COMMITMENTS AND CONTINGENCIES
~~(a)~~ ~~Operating Leases~~
~~Future minimum payments~~
(a) Operating Leases
We lease certain offices under ~~operating leases, including those with a related party as disclosed in Note 19, for the Company’s office and store premises consisted~~lease agreements that expire at various dates through 2011. One of the lease agreements, which expires in 2008, provides for a three-year renewal option; two of them, which both expire in 2010, provide for a 10-year renewal option. The following is a schedule of future minimum lease payments required under these operating leases, as of December 31, ~~2004:~~

Year

Amount
(in US$ thousands)
2005
   $ 4,018
2006
   2,311
2007
   1,591
2008
   315
2009 and after
   23
2006:

Amount
Year (in US$ thousands)
2007 $ 1,876
2008 873
2009 534
2010 538
2011 65
Rental expense for the above operating leases amounted to ~~$5.1~~$7.1 million, ~~$7.3~~$5.3 million and ~~$7.1~~$2.5 million for the years ended December 31, ~~2002, 2003~~2004, 2005 and 2006, respectively (including rental expense amounts of $5.9 million, and $3.4 million reported in discontinued operations in 2004 ~~respectively.~~and 2005, respectively).
(b) Webs-TV Services Related Commitment
F-45
In May 2006, our Company entered into an assets purchase and sale agreement and a service agreement with Webs-TV to sell GigaMedia’s ADSL business and provide agreed upon services. The sale of the ADSL business was completed in 2006; consideration in the sale consisted of a cash payment of approximately $8.9 million. The payment term for the sale proceeds is from May 2006 to July 2007. (Please see Note 4, “Divestitures,” for additional information.) In addition to purchasing the ADSL business from GigaMedia, Webs-TV also purchased agreed upon services such as bandwidth, consulting, and other support services that run through December 31, 2007, as well as the right to use GigaMedia’s ADSL brand for five years. The sale of such services and the right to use our brand name was an all cash transaction with a total price of approximately $9.2 million. The payment term for fees derived from the agreed upon services and the right to use GigaMedia’s ADSL brand is from May 2006 to February 2008.
(c) HanbitSoft Inc. License and Distribution Agreement
In December 2006, our Company entered into a license and distribution agreement with HanbitSoft Inc. (“HBS”) to acquire a license to publish and distribute in certain territories in Asia an online game entitled “Hellgate: London.” In accordance with the agreement, we paid to HBS a non-recoupable license fee of $2.5 million in December 2006 and recorded current and non-current prepaid royalties in the amount of approximately $417 thousand and approximately $2.1 million, respectively. In addition, we are required to pay a non-refundable minimum guarantee against royalties in the amount of $6.5 million based on the following schedule:
~~(b)~~(i) ~~Contingencies~~ $2.5 million during the 12-month period immediately following the commercial release date, which shall be paid to HBS on the earlier of either March 31, 2007 or the launch date in the territory (this amount was paid on March 30, 2007);
(ii) $2 million during the second 12-month period following the commercial release date;
(iii) $2 million during the third 12-month period following the commercial release date.
As of December 31, 2006, we recorded an initial payment of $2.5 million related to the minimum guarantee, as current and non-current prepaid royalties in the amounts of $1.25 million and $1.25 million respectively. The remaining payments totaling $4 million are contingent upon the commercial release in the territory and have not been recorded as of December 31, 2006.
GigaMedia has also committed to support related marketing, promotion and advertising activities. The minimum marketing expenditure shall be not less than $10 million based on the following schedule:
(i) For the period from the agreement date to the commercial release date, a sum of not less than $5 million;
(ii) For the remaining period after the commercial release date, a sum of not less than $5 million.
(d) World Series of MahJong Partnership Agreement
In December 2006, our Company entered into a partnership agreement with the World MahJong Organization to serve as the exclusive co-host of the World Series of MahJong for five years. GigaMedia and the World MahJong Organization will together establish and operate a series of regional qualifying tournaments in Asia, Europe and North America, culminating in the grand finale, the World MahJong Championship. Under the agreement, GigaMedia has agreed to spend no less than $1 million in sponsorship fees in 2007, of which $200 thousand are to be paid to the World MahJong Organization as licensing expense for the World Series of MahJong. As of December 31, 2006, we had paid $150 thousand to the World MahJong Organization, and recorded such payment in current prepaid expenses.
F-46
Pursuant to the agreement, the World MahJong Organization authorizes GigaMedia as the exclusive software developer of online MahJong games that follow the International Mahjong Competition Rules. GigaMedia plans to construct an online platform to provide coaching tips on the International Mahjong Competition Rules and certification of official player rankings.
(e) T2CN Put Option
In connection with the acquisition of T2CN preferred shares on April 27, 2006, our Company provided T2CN’s key shareholders, representing 52.92 percent ownership interest, an option to sell their common shares to us within two years from the closing of the strategic investment agreement. The ~~Company~~put price per share agreed upon was equal to 8.65 times the net operating income per share, subject to certain adjustments. Such put price can be settled in cash or GigaMedia’s shares. We have evaluated the terms of the put option and determined that the fair value of such put option is immaterial.
(f) Contingencies
We are subject to legal proceedings and claims that arise in the normal course of business. ~~The Company believes~~We believe the ultimate liabilities with respect to these actions will not have a material adverse effect on ~~the Company’s~~our financial condition, results of operations or cash flows. (See Note ~~21,~~23, “Litigation,” tofor additional information.)
NOTE 23.LITIGATION
In December 2001, a class action lawsuit was filed in the ~~Company’s Consolidated Financial Statements included herein.~~United States District Court for the Southern District of New York (“District Court”)
~~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.
against our Company in connection with the initial public offering of our stock.
The complaint alleged that ~~the Company~~we violated ~~Sections~~Section 11 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 October 2002, the plaintiffs voluntarily dismissed the individual defendants without prejudice. On February 19, 2003, the court issued an opinion and order on defendants’ ~~motion~~motions to ~~dismiss.~~dismiss, which granted the motions in part and denied the motions in part. As to GigaMedia, the Rule 10b-5 claims were dismissed without prejudice while the Section 11 claims survived the motion.
Discovery in the actions commenced.
In June 2004, the plaintiffs and issuer defendants, including ~~the~~our Company, presented the executed settlement agreement (the “Issuers’ Settlement”) to ~~Judge Scheindlin~~the judge 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~~Issuers’ Settlement include: 1) the insurers of the issuers will provide an undertaking ~~that guarantees~~to guarantee that plaintiffs ~~in the approximately 298 settling actions~~ will recover a total of $1 ~~billion dollars;~~billion; 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 trust, represented by plaintiffs’ counsel; and 4) the plaintiffs shall release all of the settling issuer defendants. That is, if plaintiffs are successful in recovering more than $1 billion from the underwriters, the issuer defendants ~~including GigaMedia~~will not be obligated to pay any additional amounts. If the plaintiffs recover less than $1 billion from the underwriters, the insurers will pay the deficit between $1 billion 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 can 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 with $10 million of liability coverage in which the Company is required to pay a $500 thousand deductible. Accordingly, the Company has recorded 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 arisingreceived from the ~~settlement and claim.~~
underwriters.
On February 15, 2005, ~~Judge Scheindlin~~the judge 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. In July 2005, the settling parties reached agreement and submitted modifications to the settlement agreement in accordance with the court’s opinion.
F-47
The ~~principal effect~~underwriter defendants are not part of the ~~narrower bar order is that it does not bar claims for contractual indemnity. Negotiation is proceeding~~settlement between the issuers and the ~~underwriters~~plaintiffs. The underwriter defendants have continued to ~~broaden~~defend the ~~bar order~~action and discovery has proceeded. In April 2006, plaintiffs and JPMorgan Chase & Co., one of the underwriter defendants, announced that they had signed a memorandum of understanding (the “JPMorgan Chase MOU”) to settle the action for approximately $425 million. This proposed settlement does not include ~~a mutual bar of contractual indemnity claims.~~
~~The~~the other underwriter defendants.
On April 24, 2006, the court ~~will schedule~~held a fairness hearing on the proposed ~~settlement and subsequently will decide whether to grant final approval to the settlement agreement. The settlement agreement~~Issuers’ Settlement, which is subject to the ~~approval~~court’s approval. As of this date, the court has not issued its ruling.
On June 23, 2006 and October 12, 2006, the court held meetings with the legal counsels involved in the case to discuss the proposed settlement. Subsequent to these meetings, the parties submitted an amendment to the Issuers’ Settlement, which included the following terms: (1) waiving insurers’ rights under the settlement agreement to recoup notice and defense cost, which is likely to exceed $60 million; and (2) waiving 50 percent of the ~~District 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~~amount of the ~~5% shares granted to EMI amounted to $368 thousand and was recorded~~JPMorgan Chase MOU ($425 million) which would operate as an ~~intangible asset. In addition~~offset to the ~~5% ownership of GigaMusic,~~$1 billion guarantee. These changes were designed to address potential problems that 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 accordancejudge may have had with the ~~terms~~proposed settlement.
On December 5, 2006, the United States Court of Appeals for the Second Circuit issued an opinion vacating the District Court’s class certification of a litigation class in that portion of the ~~agreement. However, in March 2002,~~case between the ~~Company sent a notice to EMI to terminate the agreement. The notice also required EMI to return its ownership interest in GigaMusic~~plaintiffs and the ~~cumulative amount of $2 million paid in separate installments June 2001 and March 2002~~underwriter defendants. Because the Second Circuit’s opinion was directed to the class certification by the ~~Company.~~
As of December 31, 2002, the Company performed an impairment test of the EMI intangible asset as well as the cumulative amount of $2 million in payment. Due to the fact that EMI had not provided the agreed-upon products to GigaMusic, the site had not been launched and no subscriber revenue had been generated from the project, the fair value of the intangible asset and the cumulative amount of $2 million in payment was considered negligible. The Company therefore wrote down the balance of these assets and recorded 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 for the plaintiffs’ litigation against the underwriter defendants, the opinion’s effect on the ~~additional $1 million scheduled for payment~~proposed class to ~~EMI. The Company commenced arbitration proceedings~~be certified by ~~submitting a Notice of Arbitration to~~ the ~~Singapore International Arbitration Center to resolve the disputes~~District Court in connection with the ~~strategic agreement~~Issuers’ Settlement is unclear.
On December 15, 2006, the District Court held a conference with all counsel in the IPO Securities Class Action to discuss the impact of the foregoing opinion. In the conference, the District Court agreed to stay all proceedings, including discovery and consideration of the Issuers’ Settlement and the JPMorganChase MOU, pending further decisions from the Second Circuit.
On January 5, 2007, plaintiffs filed a petition in the Second Circuit for rehearing and rehearing en banc regarding the decision on class certification (the “Petition”). On January 24, 2007, the Second Circuit entered ~~into~~an order instructing the underwriter defendants to submit a brief in response to the Petition. On February 7, 2007, the underwriter defendants filed a brief in opposition to the Petition. On April 6, 2007, the Second Circuit rendered its decision which denied the Petition. On April 23, 2007, the District Court held a conference in which the following issues were discussed: 1) Class Certification: The plaintiffs are considering a new class definition, which is regarded as a priority by the District Court. 2) Tolling Agreement: The plaintiffs requested tolling agreements for class members in the focus cases from the underwriters. If the underwriters do not agree to toll the plaintiffs’ claims, the plaintiffs may file individual actions. In such case, the underwriters may want to have these claims arbitrated. 3) Settlements: The District Court indicated that the issuers settlement cannot stand in its present form, and any further discussions on the settlement between the issuers and the plaintiffs should depend on the plaintiffs’ new proposed class definition. 4) Discovery: The stay of discovery is continuing and will be addressed by the District Court at the next conference.
Neither we, nor our legal counsel, are able to assess the likelihood of the outcome, nor can we determine the amount or range of potential loss, if any. We had an insurance policy with American Insurance Group with $10 million of liability coverage when the class action lawsuit was made. According to the insurance policy, our Company ~~GigaMusic, and EMI.~~
On December 31, 2003, 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 agreedis required to pay ~~EMI the sum~~a $500 thousand deductible. We recorded a provision of ~~$400~~$500 thousand ~~and EMI agreed~~in 2003, representing our deductible amount, related to ~~return~~these claims. In 2005, our legal counsel advised that it is unlikely that we will have to pay any remaining, unused portion of our deductible with respect to the ~~Company 5% ownership~~claims. Accordingly, we reversed the provision of $500 thousand in ~~GigaMusic~~2005. We believe that
F-48
the insurance coverage is sufficient to cover the liability arising from the settlement and a letter of credit issued to EMI in accordance with the previous agreement. The parties agreed to finally and forever settle and release each other from any and all claims arising out of or in connection with this matter. The Settlement Agreement became effective on February 25, 2004 pursuant to a resolution approved in the Company’s board of directors’ meeting.
~~The consideration of $400 thousand paid to EMI consisted of 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.
claim.
NOTE ~~22.~~ 24.SEGMENT INFORMATION
Segment data
~~Prior to 2002, the Company managed its business and measured results based on a single Internet-related service industry segment. Due~~
Subsequent to the ~~acquisitions~~sale of ~~Rose Records~~the music distribution business in 2005, we realigned our reportable business segments. In compliance with FAS 131 “Disclosures about Segments of an Enterprise and ~~Tachung Records in 2002 and the acquisition of CESL in April 2004, the Company has three~~Related Information,” we have identified reportable segments: a ~~broadband ISP~~software licensing and online entertainment business ~~segment; a music distribution~~segment, an online games business ~~segment;~~segment, and an ~~entertainment software~~Internet access and service business segment. The ~~broadband ISP~~software licensing and online entertainment business segment mainly derives its revenues from ~~Internet-related services, including (1)~~developing and licensing online games of chance and skill. The online games business segment mainly derives its revenue from recognizing the usage of playing time or in-game items and services. The Internet access ~~(2) sales of cable modems,~~ and ~~(3) advertising and other services. The music distribution~~service business segment mainly derives its revenues from the sales of compact audio discs, video compact discs, digital versatile discs, audio and videocassettes, and related accessories from its directly-owned stores in Taiwan. The entertainment software business segment mainly derives its revenues from on-line games of chance and skill.
~~The Company’s~~providing Internet-related services.
Our 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’s~~our method of internal reporting and are not necessarily in conformity with accounting principles generally accepted in the U.S. Management measures the performance of each segment based on several metrics, including revenues and income or loss from operations. The software licensing and online 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~~“Variable-Interest Entity,” ~~to the Consolidated Financial Statements included herein.~~for additional information.) CESL develops, licenses and provides support services for software used within the ~~on-line~~online entertainment industry. UIM operates ~~on-line~~online entertainment activities. Revenues from the software licensing and online entertainment ~~software~~ business segment are derived from ~~on-line~~online games of chance and skill and are presented net of end-user winnings.
F-49
Financial information for each reportable segment was as follows as of and for the years ended December 31, ~~2002, 2003~~2004, 2005, and ~~2004:~~2006:

Software
Internet licensing and
access and online
(in US$ thousands) service entertainment Total
2004:

Segment profit or loss:

Net revenue from external customers $ 21,390 $ 11,454 $ 32,844

Income from operations $ 959 $ 2,777 $ 3,736

Interest income $ 45 $ 6 $ 51

Interest expenses $ — $ 4 $ 4

Gain on sales of marketable securities $ 1,222 $ — $ 1,222

Foreign exchange gain (loss) $ 533 $ 8 $ 541

Other-than-temporary loss on marketable securities $ (1,833 ) $ — $ (1,833 )

Depreciation $ 3,895 $ 267 $ 4,162

Amortization, including intangible assets $ 1,060 $ 521 $ 1,581

Income tax expenses ( benefit ) $ — $ (87 ) $ (87 )

Segment assets:

Additions to property, plant and equipment $ 1,866 $ 567 $ 2,433

Additions to intangible assets $ — $ 3,327 $ 3,327

Additions to goodwill $ — $ 29,607 $ 29,607

Total assets $ 29,861 $ 38,476 $ 68,337

F-50

(in US$ thousands)

   Broadband
ISP
Music
Distribution
Entertainment
Software
   Total

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
ISP
Music
Distribution
Entertainment
Software
   Total

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
ISP
Music
Distribution
Entertainment
Software
Total

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


Software
Internet licensing and
access and online
(in US$ thousands) service entertainment Total
2005:

Segment profit or loss:

Net revenue from external customers $ 21,676 $ 22,511 $ 44,187

Income from operations $ 2,123 $ 5,957 $ 8,080

Interest income $ 5 $ 92 $ 97

Interest expenses $ — $ — $ —

Gain on sales of marketable securities $ 466 $ — $ 466

Foreign exchange gain (loss) $ (144 ) $ 9 $ (135 )

Depreciation $ 3,651 $ 266 $ 3,917

Amortization, including intangible assets $ 413 $ 1,023 $ 1,436

Income tax expenses ( benefit ) $ 110 $ 325 $ 435

Segment assets:

Additions to property, plant and equipment $ 1,782 $ 474 $ 2,256

Additions to intangible assets $ — $ 1,005 $ 1,005

Additions to goodwill $ — $ — $ —

Total assets $ 31,344 $ 45,413 $ 76,757

F-51

Software
Internet licensing and
access and online
(in US$ thousands) service entertainment Online game Total
2006:

Segment profit or loss:

Net revenue from external customers $ 20,581 $ 55,019 $ 18,692 $ 94,292

Income from operations $ 4,185 $ 16,772 $ 5,618 $ 26,575

Share-based compensation $ 85 $ 82 $ 101 $ 268

Gain on divestiture of business $ 7,668 $ — $ — $ 7,668

Interest income $ 6 $ 212 $ 20 $ 238

Interest expenses $ 154 $ — $ 1 $ 155

Gain on sales of marketable securities $ 2,119 $ — $ 4 $ 2,123

Foreign exchange gain (loss) $ (39 ) $ (27 ) $ (1 ) $ (67 )

Depreciation $ 2,400 $ 517 $ 250 $ 3,167

Amortization, including intangible assets $ 145 $ 1,292 $ 1,423 $ 2,860

Income tax expenses ( benefit ) $ 1,026 $ 415 $ 108 $ 1,549

Segment assets:

Additions to property, plant and equipment $ 750 $ 1,701 $ 738 $ 3,189

Additions to intangible assets $ — $ 1,172 $ 21,359 $ 22,531

Additions to goodwill $ — $ — $ 26,409 $ 26,409

Total assets $ 58,589 $ 56,850 $ 54,457 $ 169,896

The reconciliations of segment information to ~~GigaMedia~~GigaMedia’s consolidated totals were as follows:
F-52

(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


2004 2005 2006

Income (loss) from operations:

Total segments $ 3,736 $ 8,080 $ 26,575
Adjustment* (1,261 ) (3,714 ) (4,611 )

Total GigaMedia consolidated $ 2,475 $ 4,366 $ 21,964

Share-based compensation

Total segments $ — $ — $ 268
Adjustment* — — 42

Total GigaMedia consolidated $ — $ — $ 310

Interest income:

Total segments $ 51 $ 97 $ 238
Adjustment* 89 314 484

Total GigaMedia consolidated $ 140 $ 411 $ 722

Interest expense:

Total segments $ 4 $ — $ 155
Adjustment* — — 427

Total GigaMedia consolidated $ 4 $ — $ 582

Gain on sales of marketable securities:

Total segments $ 1,222 $ 466 $ 2,123
Adjustments* 8 384 66

Total GigaMedia consolidated $ 1,230 $ 850 $ 2,189

Foreign exchange gain (loss):

Total segments $ 541 $ (135 ) $ (67 )
Adjustments* (1,306 ) 286 (94 )

Total GigaMedia consolidated $ (765 ) $ 151 $ (161 )

Depreciation:

Total segments $ 4,162 $ 3,917 $ 3,167
Adjustments* 7 — —

Total GigaMedia consolidated $ 4,169 $ 3,917 $ 3,167

Amortization:

Total segments $ 1,581 $ 1,436 $ 2,860
Adjustments* — — 16

Total GigaMedia consolidated $ 1,581 $ 1,436 $ 2,876

Income tax benefit (expense):

Total segments $ 87 $ (435 ) $ (1,549 )
Adjustments* (3 ) (1 ) —

Total GigaMedia consolidated $ 84 $ (436 ) $ (1,549 )

Total assets:

Total segments $ 68,337 $ 76,757 $ 169,896
Adjustment** 57,640 36,762 12,723

Total GigaMedia consolidated $ 125,977 $ 113,519 $ 182,619

F-53
As discussed above, the reportable segments of our Company have been realigned subsequent to the divestiture of the music distribution business. The corresponding segment profit or loss information for 2004 has been restated to conform to the current year presentation. All income (loss) related to our divested music business has been excluded from the reconciliation of our segment totals to the GigaMedia consolidated totals.
* Adjustment items include corporate and certain back-office costs and expenses not attributable to any specific segment.
** Adjustment items include total corporate ~~total~~ assets, the divested music distribution business segment and ~~elimination.~~eliminations.
Major Customers
No single customer represented ~~10%~~10 percent or more of GigaMedia’s total net revenues in any period presented.
Geographic Information
Revenue from unaffiliated customers by geographic region ~~was~~is as follows:

(in US$ thousands)
Geographic region/country
   2002
   2003
   2004
Taiwan
   $ 73,976    $ 95,352    $ 88,364
Canada
   —      —      11,455

(in US$ thousands)
Geographic region/country 2004 2005 2006
Taiwan $ 21,390 $ 21,676 $ 37,435
Canada 11,454 22,511 55,019
Hong Kong — — 1,831
Others — — 7
Net long-lived assets by geographic region ~~was~~are 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




(in US$ thousands) December 31,
Geographic region 2004 2005 2006
Asia $ 14,672 $ 10,156 $ 55,378
North America 1,309 1,351 2,419
Europe 1,797 — —
Latin America 35,257 31,187 31,185

Total $ 53,035 $ 42,694 $ 88,982

Note ~~23.~~25.SUBSEQUENT EVENTS
a. On December 12, 2006, our wholly-owned subsidiary Hoshin GigaMedia entered into an agreement with Wretch Co., Ltd. (“Wretch”) to terminate the subscription rights agreement we signed on March 10, 2006, as Wretch was in the process of being acquired by an independent third party. Under this termination agreement, we gave up the subscription rights to acquire up to a 20 percent equity stake in Wretch if and when Wretch increases its share capital within three years of the date of the subscription right agreement, and we will no longer be obligated to provide Wretch with certain free Internet services after December 31, 2006. Our right to acquire Wretch shares was terminated on May 8, 2007, the closing date of the acquisition of Wretch. Pursuant to the termination agreement, Hoshin GigaMedia obtained compensation from Wretch in the amount of approximately $613 thousand (NT$20 million) (including VAT tax).
F-54
~~ALFY Settlement Agreement~~
b. On February 12, 2007, our Company, through our wholly-owned subsidiary GigaMedia China Limited, acquired 18,118,926 common shares of T2CN at the following purchase price.
(i) $1.05 per share if the adjusted net operating income of T2CN for the first half of 2007 is not more than $1 million;
(ii) $1.25 per share if the adjusted net operating income of T2CN for the first half of 2007 is between $1.0 million and $1.5 million; or
(iii) $1.45 per share if the adjusted net operating income of T2CN for the first half of 2007 is not less than $2.5 million.
     The first payment was paid on February ~~21, 2005,~~12, 2007, which consisted of $9.4 million in cash and 173,814 shares of common stock of GigaMedia. The remaining purchase price, ranging from US$7.8 million to US$15.0 million, is to be paid in cash on August 15, 2007.
     Pursuant to a shareholder agreement which we entered into with T2CN and certain of its shareholders in April 2006, which was amended and restated in November 2006, we were also granted rights to subscribe for additional convertible preferred shares of T2CN, based on the ~~Company~~financial performance of T2CN during each of the twelve month periods ending March 31, 2007 and December 31, 2007. In May 2007, we acquired an additional 7,500,000 convertible preference shares in T2CN for an all-cash consideration of US$75 thousand, pursuant to our exercise of such rights.
     Effective June 1, 2007, we also entered into a ~~final settlement~~voting trust agreement ~~(the Settlement)~~ with ~~Alfy, Inc. (ALFY)~~a shareholder of T2CN, pursuant to ~~solve royalty payment issues arising from certain agreements, including a development agreement and license, dated January 29, 2001 and~~which we obtained voting rights over 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~~additional 1.28 percent of the ~~License Agreements~~outstanding voting rights of T2CN.
     As of June 1, 2007, we own 18,118,926 common shares and 15,000,000 convertible voting preferred shares of T2CN, and also control voting rights with respect to ~~reduce~~850,000 common shares of T2CN, which in aggregate represents a controlling interest of 51.12 percent of the total minimum guaranteed royalty payment to $100 thousand. Revenue produced from 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 Company eliminated future minimum guaranteed royalty payments and maintenance costs.outstanding voting rights of T2CN.
F-55
~~F-37~~


	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


	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	—


Entity	Year of Incorporation	Place of Incorporation /Operation	Our Percentage Holding	Principal 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


			Place of	Our
	Year of		Incorporation	Percentage
Entity	Incorporation		Operation	Holding			Principal Activities
*Held by our Company*

GigaMedia International Holdings Limited		2004	British Virgin Islands		100	%	Holding company

Hoshin GigaMedia Center Inc.		1998	Taiwan		100	%	Cable-based Internet access services and FunTown online games portal

*Held by Hoshin*
*GigaMedia Center Inc*

Koos Broadband Telecom Co., Ltd.		2001	Taiwan		100	%	Broadband Internet access services targeting business clients

*Held by GigaMedia*
*International Holdings Limited*

Cambridge Entertainment Software Limited		2004	British Virgin Islands		100	%	Holding company

FunTown World Limited		2005	British Virgin Islands		100	%	Holding company

GigaMedia Asia Limited		2005	British Virgin Islands		100	%	Holding company

GigaMedia Asia Pacific Limited		2006	British Virgin Islands		100	%	Holding company

GigaMedia Finance International Limited		2000	Cayman Islands		100	%	Holding company

GigaMedia Global Limited		2004	British Virgin Islands		100	%	Online game company

GigaMedia (HK) Limited		2004	Hong Kong		100	%	Holding company

Skyace Pacific Limited		2006	British Virgin Islands		100	%	Holding company

*Held by FunTown World Limited*

FunTown Hong Kong Limited		1999	Hong Kong		100	%	Online games portal

*Held by GigaMedia Asia Limited*

GigaMedia China Limited		2005	British Virgin Islands		100	%	Holding company

*Held by Skyace Pacific Limited*

Dragongate Enterprises Limited		2006	British Virgin Islands		70	%	Online game developer and operator


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


(in US$ thousands)
Cash (including restricted cash)	$	3,098
Accounts receivable		1,842
Inventory		6,679
Other current assets		683
Property and equipment		1,666
Intangible assets		4,689
Other assets		1,553

Total Assets	$	20,210

Accounts payable	$	11,239
Other liabilities		1,945

Total liabilities	$	13,184


	For the year ended December 31,
	2004						2005						2006
	Amount			% of			Amount			% of			Amount			% of
	in US$			total			in US$			total			in US$			total
Particulars	thousands			revenues			thousands			revenues			thousands			revenues
OPERATING REVENUES
Software licensing and online entertainment revenues		11,434			34.8			22,511			50.9			55,019			58.3
Online game revenues		—			—			—			—			18,692			19.8
Internet access and service revenues		21,303			64.9			21,589			48.9			20,537			21.8
Other revenues		107			0.3			87			0.2			44			0.1

Total operating revenues		32,844			100.0			44,187			100.0			94,292			100.0


OPERATING COSTS
Cost of software licensing and online entertainment revenues		1,592			4.8			3,327			7.5			7,824			8.3
Cost of online game revenues		—			—			—			—			3,667			3.9
Cost of Internet access and service revenues		13,873			42.2			13,568			30.7			11,449			12.1
Cost of other revenues		644			2.0			488			1.1			391			0.4

Total operating costs		16,109			49.0			17,383			39.3			23,331			24.7


Gross profit		16,735			51.0			26,804			60.7			70,961			75.3


OPERATING EXPENSES
Product development and engineering expenses		2,513			7.7			3,562			8.1			5,738			6.1
Selling and marketing expenses		6,310			19.2			10,777			24.4			30,123			31.9
General and administrative expenses		5,657			17.2			7,892			17.9			12,421			13.2
Bad debt expense		(220	)		(0.6	)		207			0.4			715			0.8

Total operating expenses		14,260			43.5			22,438			50.8			48,997			52.0


Income from operations		2,475			7.5			4,366			9.9			21,964			23.3


NON-OPERATING INCOME (EXPENSES)		(1,143	)		(3.5	)		2,710			6.1			10,690			11.3

INCOME TAX BENEFIT (EXPENSE)		84			0.3			(436	)		(1.0	)		(1,549	)		(1.6	)

INCOME FROM CONTINUING OPERATIONS		1,253			3.8			6,490			14.7			30,784			32.6

INCOME (LOSS) FROM DISCONTINUED OPERATIONS		429			1.3			(154	)		(0.4	)		—			—

NET INCOME		1,682			5.1			6,336			14.3			30,784			32.6


	Payment Due by Period (in US$ thousands)
Contractual Obligations	Total	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


	Payment Due by Period (in US$ thousands)
			Less than						More than
Contractual Obligations	Total		1 year		1-3 years		3-5 years		5 years
Operating leases		3,886		1,876		1,945		65		0
Minimum guarantee against royalties		6,500		2,500		2,500		1,500		0
Total contractual cash obligations		10,386		4,376		4,445		1,565		0
Other long-term obligations		605		0		534		71		0
Other liabilities — Accrued pension liabilities		434		0		0		0		434


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


				Year
				Appointed to
				Current
Name	Age		Position	Position
WU, Daniel Chuen-Tai		59	Chairman of the Board		2003
BAO, Gilbert		43	Independent Non-Executive Director		2003
CHANG, Nelson		42	Independent Non-Executive Director		2004
DING, Michael Y.J.		50	Independent Non-Executive Director		2003
HSU, Emmet Yu-Jui		44	Independent Non-Executive Director		2003
HU ZEE, Nancy Jing-Ying		48	Independent Non-Executive Director		2003
LEE, Howe Yong		51	Independent Non-Executive Director		2004
LEE, Yichin		46	Independent Non-Executive Director		2003
WANG, Arthur M.		46	Chief Executive Officer and Director		2003
HUI, Thomas T.		35	Chief Financial Officer and Director		2004/2005
CAHILL, Robert J.		41	Head of Software Licensing and Online Entertainment Business		2004
CHOU, Samuel		46	Head of Online Games Business		2007
CHU, Michel		38	Executive Vice President and Chief Technology Officer		2000
HUANG, Kenny Ching-Kun		42	Senior Vice President		2004
MAI, Falco		45	Executive Vice President and Chief Administrative Officer		2001
SHEA, Joseph		41	Executive Vice President		2004
TARN, Chen-Wen		47	Head of Internet Access Service Business		2003
TSENG, Jennifer		38	Senior Vice President and General Counsel		2004


			Number of Shares
	Number of		Issuable upon
Person	Common Shares		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.		*		2,500,000
HUI, Thomas T.		*		1,200,000
CAHILL, Robert J.		0		*
CHOU, Samuel		0		0
CHU, Michel		*		*


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	*	*


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%


	Shares		Percentage of
Name of Owner	Owned		Shares Owned
Best Method Limited (1)		10,799,999		20.53	%
Directors and executive officers as a group (10 persons)		402,222		0.76	%


(1)		Through Best Method Limited, Jeffrey Koo, Jr. and Andre Koo jointly ~~own~~have a beneficial ownership of 10,799,999 common shares of our Company.

	•		Class Certification: The plaintiffs are considering a new class definition, which is regarded as a priority by the District Court;

	•		Tolling Agreement: The plaintiffs requested tolling agreements for class members in the focus cases from the underwriters. If the underwriters do not agree to toll the plaintiffs’ claims, the plaintiffs may file individual actions. In such case, the underwriters may want to have these claims arbitrated;

	•		Settlements: The District Court indicated that the issuers settlement cannot stand in its present form, and any further discussions on the settlement between the issuers and the plaintiffs should depend on the plaintiffs’ new proposed class definition; and

	•		Discovery: The stay of discovery is continuing and will be addressed by the District Court at the next conference.

	•		New Class Definition: the plaintiffs proposed a new class definition and moved for class certification;

	•		Statutes of Limitation: the underwriters refused to agree to toll the statute of limitations on plaintiffs’ claims, which caused plaintiffs to file a motion of individuals to intervene as plaintiffs in a focus case in which the plaintiffs think that the statue of limitations is close to running;

	•		Issuers’ Settlement: Since the settlement in its present form is not viable, the issuers will ask the District Court to deny the motion to approve the settlement without prejudice to application to the District Court regarding any future settlement; and

	•		Discovery: There were unresolved issues regarding the scope of discovery and may further be discussed at the next conference.


	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


	Common Shares
Year Ending December 31, 2002	High		Low
	(in US$)
First quarter	$	2.88	$	2.30
Second quarter	$	1.25	$	0.67
Third quarter	$	1.30	$	0.63
Fourth quarter	$	0.84	$	0.42


	Common Shares
Year Ending December 31, 2003	High		Low
	(in US$)
First quarter	$	1.52	$	0.66
Second quarter	$	1.21	$	0.86
Third quarter	$	2.98	$	1.17
Fourth quarter	$	3.35	$	1.44


	Common Shares
Year Ending December 31, 2004	High		Low
	(in US$)
First quarter	$	2.07	$	1.33
Second quarter	$	1.87	$	1.06
Third quarter	$	1.43	$	0.70
Fourth quarter	$	2.43	$	1.30


	Common Shares
Year Ending December 31, 2005	High		Low
	(in US$)
First quarter	$	1.86	$	1.30
Second quarter	$	2.48	$	1.38
Third quarter	$	2.66	$	1.68
Fourth quarter	$	2.99	$	1.76


	Common Shares
Year Ending December 31, 2006	High		Low
	(in US$)
First quarter	$	6.01	$	2.90
Second quarter	$	10.39	$	6.13
Third quarter	$	12.38	$	7.30
Fourth quarter	$	11.06	$	8.86


Year Ending December 31, 2007	High		Low
	(in US$)
First quarter	$	14.34	$	9.28
Second quarter (only through June 15, 2007)	$	15.97	$	13.92

	•		He is prohibited from acting as a director by reason of any order made pursuant to the Singapore Companies Act;

	•		He ceases to be a director by virtue of any of the provisions of the Singapore Companies Act or the Articles of Association of our Company;

	•		He resigns from his office;

	•		He receives a bankruptcy order made against him;

	•		He has a receiving order made against him or suspends payment or compounds with this creditors generally;

	•		He is found to be a 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.


	(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,~~Shares, 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; and


	(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