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, 20042005

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

(Address of principal executive offices)

Registrant’s telephone number, including area code

886-2-8770-7966886-2- 8770-7966

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

None

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

Ordinary shares par value NT$10 per share

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

None

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report:

50,343,642 ordinary shares

50,154,000 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.    Yes  ¨    No  x

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.    Yes  ¨    No  x

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.    Yes  x    No  ¨

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):

Indicate by check mark which financial statement item the Registrantregistrant has elected to follow.

¨  Item 17x  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).    ¨  Item 18Yes    x  No

TABLE OF CONTENTS

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$10, (iii) “CESL” are to Cambridge Entertainment Software Limited (previously known as Grand Virtual International Limited), a company incorporated under the laws of British Virgin Islands, and (iv) “Hoshin GigaMedia” are to Hoshin GigaMedia Center, Inc., a company incorporated under the laws of Taiwan, Republic of China, or ROC.(“R.O.C.”), and (v) “FunTown” are to our online casual games business operated through Hoshin GigaMedia and FunTown World Limited, a company incorporated under the laws of the British Virgin Islands. All references in this annual report to “U.S. dollar”,dollar,” “$” 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 the following statements:

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 toupdate 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 historically been reported in New Taiwan dollars. Effective January 1, 2004, we adopted the United StatesU.S. dollar as our reporting currency because operations denominated in the United States dollarU.S. dollars have represented an increasing portion of our business following the acquisition of our entertainment software business. Comparative financial information has been recast as if the United StatesU.S. dollar had been used as our reporting currency for the periods ended and as of December 31, 2001, 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:

Assets and liabilities in 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 averageweighted-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, is translated using weighted averageweighted-average exchange rates.

A. Selected Financial Data

The selected consolidated balance sheet data as of December 31, 20032004 and 20042005 and the selected consolidated statement of operations data for the years ended December 31, 2002, 2003, 2004 and 20042005 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 and 2002,2003, and the selected consolidated statement of operations data for the years ended December 31, 20002001 and 20012002 have been derived from our audited consolidated financial statements for the years ended December 31, 20002001, 2002 and 2001,2003, which are not included in this annual report. The audited consolidated financial statements for the years ended December 31, 20002001, 2002 and 20012003 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—”Operating5 — “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, 2001, 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/loss per share amounts)

As of December 31,

(in thousands)

B. Capitalization and Indebtedness

Not applicable.

C. Reasons for the Offer and Use of Proceeds

Not applicable.

D. Risk Factors

Risks Related to Our Business

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. 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. Our limited operating history as an entertainment software provider and market conditionsan online casual games business operator, and the unproven long-term potential of those business models make predictingevaluating our results of operationsbusiness and prospects difficult and we may incur substantial losses in 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:

time.

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 thehave a limited relevant operating history as an entertainment software developer and an online casual games operator for you to evaluate. It is also difficult to evaluate our prospective business, because we acquired in 2004. Any write-off of goodwill inmay not have sufficient experience to address the futurerisks frequently encountered by companies using new and unproven business models and entering new and rapidly evolving markets, including the online gaming and online casual games markets. These risks may have a negative impact oninclude our financial results.potential failure to:

If we are unsuccessful in addressing any of the risks listed above, our business and financial 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 competitorsthose with:

COMPETITION IN THE MUSIC DISTRIBUTION BUSINESS. Taiwan’s retail music distributionENTERTAINMENT SOFTWARE AND INTERNET GAMING BUSINESSES. The Internet entertainment software industry is fragmentedcharacterized by rapid technological change and competitive. In additionwe face significant and intense competition from online entertainment software design houses and application service providers. Given the relatively low barriers to our Rose Recordsentry into the software industry and Tachung Records chains,the increasing popularity of Internet-based businesses, there are severala large number of potential competitors from many different segments of software and Internet industries. Traditional entertainment service providers, many of which have significant financial resources, might expand and provide Internet-based entertainment services. Such Internet service providers and other recordentertainment service providers may also develop and offer the underlying software solutions and tools to others in direct competition with us. Ultra Internet Media, S.A. (“UIM”), a provider of Internet gaming services, is the sole licensee of our entertainment software business. 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. Accordingly, we are exposed to competition in the Internet gaming industry, which is also characterized by low barriers to entry, rapid technological change and ever-changing consumer preferences.

Furthermore, some of our competitors and competitors of UIM are more established, enjoy greater market recognition, are substantially larger and have substantially greater resources and distribution chains operatingcapabilities than we do. There is no assurance that we or UIM will be able to compete successfully with existing and future competitors, which could have a material adverse effect on our business, financial condition or results of operations. See Item 4 — “Information on the Company — Entertainment Software Business — Competition” for additional information.

COMPETITION IN THE ONLINE CASUAL GAMES BUSINESS. Our main competitors in Taiwanthe online casual games business are casual games operators in 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.

We expect more companies to enter the online casual games industry in Greater China and a wider range of casual games to be introduced to the Greater China market, given the relatively low entry barriers to the online casual 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 convenience stores, individual music stores and night markets. Hypermarket chains, suchname recognition. We may not be able to devote adequate 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 to the same degree as Carrefour and specialty entertainment chains, such as FNAC, reflect a small, but growing, segmentnumber of the market; some of theseour 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 downloadsmay be able to do. We cannot assure you that we will be able to compete successfully against any new 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.existing competitors. In addition, the prevalent practice of physical andincreased competition we anticipate in the online piracy in Taiwan presents a continuing threat to the music distributioncasual games industry in Taiwan. Competition may reduce sales at music stores, put pressurethe 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 gross margins, increase operating expenses and reduce profit margins. There can be no assurance that the retail musicour business, will continue to be a viable business, that retail stores will continue to be a primary distribution channel for recorded music,financial condition or that we will continue to compete successfully within the retail music store sector or the retail music business generally.results of operations.

COMPETITION IN THE BROADBAND ISP BUSINESS. Our main competitors in the consumer broadband ISPInternet 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 NCICNCIC’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 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

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 online entertainment business segments. Some of these strategies relate to new services or products for which there are no established markets in Taiwan or China, or relate to services or products in which we lack experience and expertise. 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, represent related but new lines of business that may 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 transactions may require us to expend significant management and other resources. Any transaction 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 liquidity and result in significant dilution of 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, 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, which reduced our profitability in both years. Any write-off of goodwill in the future may have a negative impact on our financial results.

Additional risks associated with acquisitions include the following:

Our entertainment software business hasWe have a sole licensee,history of losses and any adverse effect on its business could have an adverse effect on our revenues, operating results and financial conditioncannot assure you that we will not incur substantial losses in future periods

AllWe incurred net losses in each of our previous fiscal years except 2004 and 2005, in which we recorded net income of US$1.7 million and US$6.3 million, respectively. Our losses were primarily the result of the substantial costs incurred in operating our broadband Internet access and music distribution businesses and declining revenues from our entertainment software business are derived from UIM, currently sole licenseemusic distribution business. We may incur substantial losses in the future.

Unauthorized use of our software products,intellectual property by third parties, and the resultsexpenses 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 intothe intellectual property, whether owned by us or licensed to us, could adversely affect our financial statements asbusiness 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 forevolving. In particular, the nine months ended December 31, 2004. See Item 5 — “Operatinglaws and Financial Reviewenforcement procedures of Taiwan, Hong Kong, the PRC and Prospects — A. Operating Results — Overview — Consolidation of UIM Under FIN 46(R)” for more details. Wecertain other countries are uncertain or do not own any sharesprotect intellectual property rights to the same extent as do the laws and enforcement procedures of UIM or control its managementthe 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 itsdiversion 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 performanceand could have a directmaterial adverse effect on our business, operatingfinancial 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

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 includerespective businesses include:

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:

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 businessprincipal businesses are characterized by rapid technological changes,change, and our inabilityfailure to respond quickly and sufficiently to new Internet technologies or standards may have a material adverse effect on our business

The markets for our entertainment software business, online casual games business and broadband ISP business and entertainment software are characterized by rapid technological advances, evolving industry standards, changes in user requirements and frequent new service introductions and enhancements.

The online gaming and online casual 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 casual games programming or operations could render our gaming services and games obsolete or unattractive.

We use internally developed software systems that support nearly all aspects of our billing and payment transactions in our online casual 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.

The number of consumer subscribers of our broadband ISP services declined from approximately 108,000 in 2002 to approximately 95,00080,500 in 2004.2005. 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 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 ISPentertainment software business, online casual games business, and entertainment softwarebroadband ISP 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. 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 entertainment software business

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. 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. Moreover, current laws, which predate or are incompatible with Internet commerce, may be enforced in a manner that restricts the electronic commerce market. However,In addition, 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 StatesU.S. 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.

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 ourthe cost of doingconducting our business or could otherwise have a material adverse affect on our business, revenues, operating results and financial condition.

Our entertainment software business has a sole licensee, and any adverse effect on its business could have a material adverse effect on our revenues, operating results and financial condition

All of our revenues from our entertainment software business are derived from UIM, currently the sole licensee of our software products. 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 aredo not control its management and hence have no control over its business decisions. A decision by UIM to terminate its contract with us or any adverse effect on its business, operating results or financial performance could have a direct material adverse effect on our business, operating 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.

The worldwide legal and regulatory environment in which our entertainment software business operates is characterized by uncertainties that could adversely affect our business and operating results

Our software entertainment business includes software development and the provision of application services for Internet gaming. UIM, which operates an online gaming business and also sub-licenses our software products to third parties, is the sole licensee of our entertainment software products and we earn fees from UIM based upon its revenues. Each of these businesses is subject to 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 entertainment software business operates, we cannot assure you that our operations as an application service provider to the gaming industry, or the Internet gaming services provided by UIM, are in compliance with all laws and regulations of the jurisdictions where our entertainment software products are used, 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 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 licensee) and thus subject our Company to gaming laws and regulations in such jurisdictions.

U.S. regulation of the online gaming industry could have a substantial impact on UIM’s business and consequentially our entertainment software business

Our Company, UIM and the online gaming industry as a whole may be affected by pending legislation in the U.S. Congress that, if enacted, would prohibit the use of communication facilities and financial transactions in connection with Internet gambling. The current administration adheres to the view that Internet gambling is already prohibited by the Federal Wire Act and other federal laws. In addition, Internet gambling currently constitutes illegal gambling activity in all 50 U.S. states, including those states where other forms of gambling are legal. Because many U.S. citizens continue to participate in Internet gambling despite these prohibitions, Congressional opponents of Internet gambling have unsuccessfully proposed legislation over the past several years with the intent of restricting the means available for participation in this activity. In the current Congress, three bills affecting Internet gambling are under consideration:

We continue to monitor the progress of this legislation through the Congress since the passage of this legislation could potentially impact the revenues of UIM. Although UIM operates outside of the U.S. jurisdiction and maintains that it does not purposefully solicit or accept gambling transactions that would violate current U.S. law, a substantial impairment of UIM’s revenues could affect the continued operation of our entertainment software business.

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. If the United States or other jurisdictions adopt laws which restrict their citizens from participating in Internet gaming offered outside their jurisdictions, on the grounds of public morals, public order or otherwise, the business of UIM, and our business, could be materially and adversely affected.

All of our entertainment software revenues are derived from UIM which, in turn, derives its revenues from end users in non-U.S. jurisdictions, exposing us to regulatory risks associated withand cultural and linguistic barriers in such jurisdictions

UIM is an operator of an online entertainment business and all of our entertainment software business conducted inrevenues are derived from its operations. UIM’s revenues are derived substantially from non-U.S. jurisdictions

jurisdictions. All of our entertainment software revenues is derived from licensing and support fees inare also derived from non-U.S jurisdictions. We currently provide user interface and end-userlicensee support to UIM in 16 languages. Our ability to further expand our business in certain countries will require modification of our products, particularly domestic language and currency support. Once a licensee has posted its gaming site on the Internet, the site is available to users around the world. To be able to further expand our business we expect we will require modification of our products, particularly domestic language and currency support. However, there can be no assurance that we will be able to sustain or increase revenues derived from international operations or that we will be able to penetrate linguistic, cultural or other barriers to new foreign markets.

In addition to uncertainty regarding the local legal status of Internet gaming in other jurisdictions, there are certain difficulties and inherent risks faced by our subsidiary, CESL,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, of jurisdictions in which we or our subsidiaries operate,UIM operates, and in which our licensee’s customers are located could have a material adverse effect on our business, revenues, operating results and financial condition.

Online gaming is a relatively new industry and therefore, we do not know if the market will continue to develop and our products and services will continue to be in demandgrow

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 entertainment software business will depend on the widespread adoption of the Internet for commercial transactions. There can be no assurance that entertainment on the Internet will become widespread.

All of ourthe revenues from our entertainment software business to date have been derived from the licensing of our online entertainment software and the support of our associated services through our licensing subsidiary.services. Our continued success will depend in large partlargely upon the success of our online entertainment software. If the market fails to develop, develops more slowly than expected, or becomes saturated with competitors or if our services do not achieve market acceptance, our business, revenues, operating results and financial condition could be materially adversely affected.

We may be vulnerable to delays or interruptions due to our reliance on otherinfrastructure and related services provided by third parties

Our electronic commerce product for handling transactions over the Internet relies on ISPISPs to allow the customers of UIM, our licensee’s customerslicensee, 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.

Our ability to process e-commerce transactions depends on bank processing and credit card systems. In order to prepare for certain types of system problems, we are developing a formal disaster recovery plan. Nevertheless, any system failure, including network, software or hardware failure, which causes a delay or interruption in our e-commerce services could have a material adverse effect on our business, revenues, operating results and financial condition.

The licensee of our entertainment software depends on credit card transactions for a substantial portion of the deposits or payments by their customers

Our entertainment software business derives all of its revenues from its licensee.licensee, UIM. A substantial portion of the deposits or payments made to our licensee are made through credit card transactions. If credit card companies were to stop processing online gaming transactions, either generally or in jurisdictions where our licensee operates, our entertainment software business could be materially and adversely affected.

Many issuing banks of major credit cards decline authorization to U.S. persons who attempt to use their credit cards for online gaming. We may be adversely affected by the provisions of the U.S. Patriot Act. Both 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.

DefectsUndetected programming errors or defects in our software, services and games and the proliferation of cheating programs could materially and adversely affect our entertainment software and applicationonline casual games businesses, financial condition and results of operations

Our software, 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.games may contain undetected programming errors or other defects. These risks include the risk oferrors or other defects in our software and application service or system failures, which could result in losses to our licensee (in the case of our entertainment software 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 sole 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. Security breaches could expose us to litigation and possible liability for failing to secure confidential customer information and could harm our or our licensee’s 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 casual games business

Online casual games are a new and evolving entertainment concept in Asia. The level of demand and market acceptance of our online casual games is subject to a high degree of uncertainty. Our future operating results will depend on numerous factors beyond our control. These factors include:

Our ability to plan for product development and distribution and promotional activities will be significantly affected by our ability to anticipate and adapt to relatively rapid changes in consumer tastes and preferences. Currently, two of the most popular types of online casual 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 and their status as one of the most popular types of online casual games in Greater China’s online casual 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 casual games in general or, in particular, the online board and card games that we operate, will likely adversely affect our business, financial condition and results of operations.

In addition, we expect that as we introduce new online casual games, a certain 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.

Currently there are no clear laws or regulations in Greater China governing virtual asset property rights and therefore, it is not clear what liabilities, if any, online game operators may have for 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 Greater China governing virtual asset property rights. In case 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.

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 22 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:

See Item 4 — “Information on the Company — B. Business Overview — Broadband ISP Business — Industry Overview” for additional information.

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. These requirements are expected to apply to our annual report on Form 20-F beginning in the fiscal year ending December 31, 2006. We are following an internal plan of action for compliance. Our efforts to implement standardized internal control procedures and develop the internal tests necessary to verify the proper application of the internal control procedures and their effectiveness will be a key area of focus for our board of directors, our audit committee and our senior management. We cannot be certain as to the timing of completion of our evaluation, testing and any remedial actions or the impact of the same on our operations. If we do not achieve compliance with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 in a timely manner, our independent auditors may not be able to provide a written attestation as to the effectiveness of our internal control over financial reporting and we could be subject to sanctions or investigation by regulatory authorities, such as the Commission.

We are not yet required to comply with the Section 404 requirements. Nonetheless, in 2004, we requested our independent auditors to evaluate our internal controls over financial reporting, and they identified certain material weaknesses in our internal controls, which we have subsequently rectified. However, there is no guarantee that we will not have weaknesses in our internal controls 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.

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 anticipate that we will incur considerable costs and use significant management and other resources in an effort to comply with Section 404 and other requirements of the Sarbanes-Oxley Act.

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:

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 believedepend 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 forwill be able to attract or retain the taxable year 2004 andkey 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 sharesShares

Based upon an analysis of our income and assets for the 2004 taxable year,Although we do not believe that we were a passive foreign investment company for the 2004 taxable year and we may continue toshould be classified as a passive foreign investment company for the 2005 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 StatesU.S. Federal Income Tax Considerations Forfor U.S. Holders — Passive Foreign Investment Company Rules”.Rules.” If you are a U.S. person holding our shares,Shares, (or have held our sharesShares during a taxable year in respect of which we were classified as a passive foreign investment company and you continue to hold such sharesShares or portion thereof) and we continue to beare 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 StatesU.S. Federal Income Tax Considerations Forfor U.S. Holders — Passive Foreign Investment Company Rules”.Rules.”

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 January 1, 2004 arehave been reported in U.S. currency, which is subject to fluctuations in respect of the currencies of the countries in which we operate. The operations of UIM, our entertainment software licensee, are conducted in most major currencies, including U.S. dollars, British poundpounds 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 casual games business are conducted in NT dollars, Hong Kong dollars and Renminbi. Our broadband ISP business is conducted mainly in NT dollars. Accordingly, fluctuations in the exchange raterates of world currencies could have a positive or negative effect on theour 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 has significant influence in determining the outcome of any corporate transaction or other matters submitted to theour shareholders for approval, and their interests may conflict with your interests

MembersAs of March 31, 2006, members of the Koo family currently beneficially ownowned approximately 21.45%21.34 percent of our outstanding shares. Accordingly, suchthe members of the Koo family have significant influence in determining the outcome of any corporate transaction or other matters submitted to theour 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 distributionentertainment software business and our entertainment softwareonline casual 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 thusand 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 Chinathe PRC

Our principal executive offices, anda major portion of our operations in respect ofonline casual games business and our broadband ISP and music distribution businessesbusiness are located in Taiwan and substantially all of our net revenues in respect of our broadband ISP and music distributionthese businesses are derived from customers in Taiwan. Taiwan, as part of the Republic of China,R.O.C., has a unique international political status. The People’s Republic of China or the PRC,(“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 online casual games and broadband ISP and music distribution businesses.

We may be subject to heightened scrutiny by Taiwan’s Fair Trade Commission due to our sizeable share of the recorded music retail distribution market 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 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 to distribute dividends to us may be subject to restrictions under the laws of Singapore and Taiwan laws

We are a holding company, and some of our assets constitute our ownership interests in our subsidiaries in Taiwan, including Hoshin GigaMedia Rose Recordswhich owns the Taiwan-based operations of our online casual games business and Tachung Records.our broadband ISP 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 theseour 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 corporate and tax regulations, 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.

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 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 adversely affect the price of our sharesShares

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 kindan acquisition bid may allow you to sell your sharesShares 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 entertainment software business. We can offer no assurance that our efforts will prove to be sufficient or that third parties will not infringe upon or misappropriate our proprietary rights. We may have to engage in litigation to enforce and protect our trade secrets and other intellectual property rights. We may also be sued for allegedly infringing the rights of others or to determine the scope and validity of their intellectual property rights. Any litigation involving proprietary rights could be costly, require us to seek licenses from third parties and prevent us from selling our products and services, any of which could have a material adverse effect on us.

We are subject to the R.O.C. Alternative Minimum Tax Act

On January 1, 2006, the R.O.C. government enacted the R.O.C. Alternative Minimum Tax Act (the “AMT Act”). The alternative minimum tax (“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. We currently do not expect the AMT to have a material effect on our income tax expense in 2006. However, the actual AMT may differ significantly from management’s estimates and have an adverse effect on our financial condition and results of operations.

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. Since January 1, 2005, the sale prices of our Shares on the NASDAQ National Market have ranged from US$1.30 to US$10.39 per share and the last reported sale price on June 15, 2006 was US$7.02. 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. In addition, our issuance of approximately US$15 million zero coupon convertible notes, 50 percent of which are due January 1, 2008 and 50 percent of which are due January 1, 2009 in conjunction with our acquisition of FunTown, may encourage short selling in our Shares by market participants because the conversion of the convertible notes could depress the price of our Shares.

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 TunHuaTunhwa 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 publiclydirectly offer its shares to investors outside of Taiwan. To enable usit to offer ourits shares to international investors, we wereGigaMedia 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 sharesShares on February 24, 2000. Our sharesShares trade on the NASDAQ National Market under the symbol “GIGM”.“GIGM.” We were the first Internet company based in Taiwan to list on the NASDAQ National 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 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 casual games portal.

See NoteNotes 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 ProspectusProspects — 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 software and provide application services, own and distribute recorded music.operate an online games portal, and provide broadband Internet access services. Our entertainment software business is operated through our subsidiary CESL. Our Taiwan online casual games business is operated through Hoshin GigaMedia. Our Hong Kong and PRC online casual games business is operated through our subsidiary FunTown World Limited. Our Taiwan broadband ISP businesses are operated through our subsidiary, Hoshin GigaMedia, which focuses on consumer users, and Hoshin GigaMedia’s subsidiary, Koos Broadband Telecom Limited, or KBT,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 of broadband Internet access services in Taiwan. Since acquiring Taiwan’s two largestdisposing of our music store chains, Rose Recordsdistribution business in 2005 and Tachung Records, in 2002, andacquiring an entertainment software provider in 2004 and an online casual games portal in 2006, we have become a diversified provider of entertainment services and broadband Internet access 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 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 shareholder’s subsidiaries, Grand Virtual, Inc., Grand Virtual Limited and Grand Virtual (Alderney) Limited, for an all-cash consideration of US$32.5 million. To help ensure a smooth transition and the continued expansion of our entertainment software business 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 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 application services through its wholly-owned subsidiary Internet Media Licensing Limited or IML, software solutions and application services(“IML”), in Montreal, for clients operating in the dynamic and rapidly expanding Internet-based entertainment markets worldwide. Our entertainment software business generated revenues of approximately US$11.5 and US$22.5 million and operating income of approximately US$2.8 and US$6.0 million during the nine months ended December 31, 2004.

2004 and for the year ended December 31, 2005, respectively.

We operate Taiwan’s two largest music store chains, Rose Records and Tachung Records,our broadband ISP business through our subsidiary G-Music.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 2006, we had 22 cable system partners, through which we had access to more than 3.1 million Taiwanese households, as well as approximately 417,000 small and medium-sized enterprises (“SMEs”). In addition, another of our subsidiaries, KBT, provides broadband services to corporate customers. On May 15, 2005,2006, we operatedentered into an asset purchase and sale agreement and a total of 45 stores.service agreement with Webs-TV Digital International Corporation (“Webs-TV”) to sell our ADSL business and provide certain telecom and consulting services on a transitional basis. 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 distributionbroadband ISP business generated revenues of approximately US$6721.7 million and operating income of approximately US$542 thousand2.1 million in 2004.

Broadband2005. Our ADSL business generated approximately US$9.4 million in revenues in 2005, which represented approximately 43 percent of our broadband ISP Business

Our Services

revenues and approximately 21 percent of our consolidated revenues.

We acquired FunTown, an online casual 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 5 million registered users and an offering of 41 casual games and services in Greater China as of June 15, 2006. 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 when launched in Taiwan in 2006. FunTown has strong research and development capabilities and has developed over 90 percent of its games in-house. FunTown also provides value-added services, such as tournaments, personal contact lists and social networking to help build a strong player community.

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 broadband Internet accesscertain 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$17.9 million. Approximately US$9.7 million of the price is for the ADSL business and is payable from May 16, 2006 through July 31, 2007. Approximately US$8.2 million represents fees for bandwidth, consulting and other support services to consumer and corporate customersbe provided by Hoshin GigaMedia on a transitional basis through various technologies and products including ADSL, cable modems, leased-line, virtual private network and other value-added services.

Access ServicesOfferings

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 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 73,8002007, and is payable from May 16, 2006 through December 31, 2007. The transferred ADSL business includes our ADSL-related equipment, business contracts, and subscription contracts between Hoshin GigaMedia and approximately 62,000 ADSL subscribers, as comparedwell as the right to 77,837 ADSL subscribers as at December 31, 2003.

CABLE MODEMS. We also offer our broadband Internet access services via cable modems at transmission speeds of up to 6 Mbps. Our cable modem-based broadband access services allow subscribers to more efficiently use (1) bandwidth-intensive multimedia applications, such as interactive games, high-quality audio, video and distance learning applications, and (2) electronic commerce applications, such as retailing, financial services and online software distribution. We reached an agreement in principle in May 2004 with our cable partners to equally share revenues, thus providing our cable partners with additional economic incentives to promote two-way cable services through their systems. Two-way cable systems allow us to offer subscribers higher upstream transmission speeds and “always on” Internet access capabilities. As at December 31, 2004, we had 20,720 cable modem-based broadband customers, as compared to 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 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 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%brand 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.

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.five years.

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:

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:

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, while we have only managed to capture approximately 2% of the market share. The primary basis for competition is price. The availability of similar services at competitive prices has made it difficult for us to attract and retain customers.

We also compete with other broadband technologies, including integrated services digital networks and wireless and satellite data services. We believe that our access services have both technological and cost advantages over these alternative broadband means. Also, we believe that our cable modem business offers a product which is to some extent differentiable from competing ADSL services, and are seeking to further develop this business by restructuring the terms of our agreements with our cable partners. In the cable modem-based Internet access market, we believe that our close relationships with a large number of cable partners and our exclusive access to a substantial portion of Taiwan’s households and businesses provide us with a competitive advantage. Our competitors in Internet access services include all four fixed-line operators in Taiwan.

We also face competition in corporate ISP from fixed-line service providers, including Chunghwa Telecom, Taiwan Fixed Network, Sparq’s NCIC and Asia Pacific Online and other Internet access service provider in Taiwan.

Some of our major competitors, including Chunghwa Telecom, have advantages over us in terms of financial and marketing resources, established customer relationships, brand awareness, customer access and telecommunications infrastructure.

Entertainment Software Business

Overview

We operate our entertainment software business through our subsidiary, CESL, and through its wholly-owned subsidiaries, CIDC and IML. CESL develops and licenses software solutions and application services to clients operating in the dynamic and rapidly expanding Internet-based entertainment markets. CESL offers a wide array of products and services, including online entertainment and social networking. CESL’s software solutions and services also offer great expansion capabilities. CESL can help 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 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-edgemodern 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, Simplified Chinese, Japanese and Korean.

Our software products are specially designed to enable our clients to manage the online entertainment properties and offer online entertainment to visitors of their online entertainment properties. We currently provide the following entertainment software products:

Online Entertainment Management — these are tools that enable our existing and potential clients to offer online entertainment software, monitor end-user behavior, and potentially to monetize the traffic and patronage generated by the end users. Our integrated and comprehensive multi-lingual e-commerce system facilitates Internet-based transaction processing and can provide detailed analysis of transaction records of our diversified international end users. In addition, there are promotional tools that help build player loyalty and increase retention rates.

Online Entertainment Modules — — these are customizable entertainment modules that run on Microsoft Windows 95/98/NT/2000/ME/XP and feature a realistic 3-D environment, selectable background music, and local language interface. In late 2004 we developed 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 tutorialnew suite of poker 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 chanceboth “ring games” and games of skill which end users can download freely and play on their computers.tournaments.

Our Services

In addition to licensing our software products to our licensee, UIM, we offer a variety of application services and consulting services for backend operation. These services include:

Infrastructure Design Services – –

Transaction Processing Design ServiceServices ––

Customer Support Services – –

Custom Gaming Software Development Services–

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 partythird-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 specificallyWe 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-languagenative language experts are involved in every step of the process to ensure cultural fidelity in everything from content to graphics to interfaces and controls.

Our Licensee

We currently have one licensee,Our software entertainment business is dependent upon UIM, our sole licensee. UIM is a third-party online entertainment operator to which we license our software and provide application services and consultation services for its Internet property and infrastructure, including Web site design, payment gateways, and database and operating systems, in return for a fixed percentage of UIM’s gross receipts. UIM operates exclusively from computer servers located in the Kahnawake Territory in Canada under a gaming license issued by the Kahnawake Gaming Commission, subject to continuing compliance with strict licensing requirements.

In spite of the fact that

While we have no equity shareholding in UIM, we incorporatedconsolidated UIM’s assets, liabilities and results of operations as of and for the nine months ended December 31, 2004 intoand for the year ended December 31, 2005 in our consolidated financial statements.statements in accordance with the requirements under FIN 46(R). See Item 5 — “Operating and Financial Review and Prospects — Overview — Consolidation of UIM Under FIN 46(R)” for additional information.

Seasonality

Due We are entitled 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.

fees from UIM based upon its revenues.

Competition

Our success depends, in part, upon our ability to enhance our products and services to keep pace with technological developments, respond to evolving customer requirements and achieving continued market acceptance.

Online entertainment software design houses and application service providers are our primary competitors. However, given the low barrierbarriers 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 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 of 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 serviceservices and such Internet service providers and entertainment service providers may also develop and offer the underlying software solutions and tools to others, and thus directly compete with UIM and us.

Faced with our known competitors, and most likely several new competitors whichthat 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: includingentry, including: brand, technology, financial stability and resources, proven track record, regulatory compliance, independent oversight and transparency of business practices in our industry.

Music DistributionOnline Casual Games Business

Overview

We operate a music distributionour online casual games business through our indirect ownershipsubsidiary FunTown, a leading Asian casual games portal with operations throughout Greater China.

FunTown offers a broad range of Taiwan’s two largest musiconline casual games and services, which we develop in-house or license from third parties. The online games offered by FunTown include MahJong and numerous varieties of card, chess, and table games, most of which cater specifically to Asian audiences. FunTown also provides services, such as game clubs for players, tournaments related to FunTown’s online casual games, and social networking, all of which are intended to help build a strong player community. As of May 30, 2006, FunTown had approximately five million registered members, approximately 30,000 peak concurrent users and 19,000 average concurrent users.

Our online casual 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 casual 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 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 chains, Rose Records and Tachung Records.payment system, customer service center, game content management and marketing platform. Our stores sell recorded musictechnological 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 9,200 offline distribution points. Additionally, in 2005, we processed approximately 888,000 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 computers. Our games are also available on mobile phones, Intel Viiv platform and on certain airlines. We expect FunTown’s games to be offered on Microsoft’s Xbox 360 in Taiwan in 2006.

In March 2006, we entered into a subscription rights 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. We are in discussions with Wretch on the implementation of this arrangement.

Our Products

In general, online casual games are games with simple rules, that are easy to learn and play, and can be completed in short sessions. Online casual games appeal to a broader and larger consumer market segment than multi-player online role-playing games (“MMORPGs”), which are more complex, require much greater time to learn and often involve large groups of players competing simultaneously online.

FunTown offers more than 40 online casual games in the following categories: MahJong, Chinese poker, Chinese chess, table games, social games, and arcade games. These games are real-time and multi-player capable.

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 multiplayer 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 level, and can then invite friends to play on the same table online. Players can compete with anyone throughout FunTown’s Greater China network.

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, Taiwan which is open to anyone belonging to one of FunTown’s MahJong guilds. In 2005, more than 200 guilds and 30,000 players participated in the event and attended the tournament.

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 skill or stakes level.

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 which offers a virtual playground for players to meet other players through their online “avatars.” Players can purchase virtual items, such as clothing, 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.

Arcade Games

FunTown offers a collection of arcade-like games similar to historically popular and “classic” games commonly offered in arcades, such as Tetris. In addition, FunTown is broadening its arcade games offering to include sports action games, such as an obstacle running game that was recently launched called Tales Runner.

Table Games

FunTown currently only offers nine-ball in its table game category. Nine-ball is a contemporary variation of pocket billiards. FunTown may add more table games in the future, depending on player surveys and feedback.

Our Services

FunTown provides many gaming 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 casual 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.

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 DVDs, VCDscompete and ancillary equipmentwin prizes. The platform has a 3-D 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 principle sources of revenue for the online casual 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:

To use our fee-based online casual 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:

•

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.

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:

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 deal with inappropriate player behavior such as personal stereo headphones.cheating and fighting. 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

The simple and short-session nature of our online casual games enables us to attract more mature players than players of MMORPGs. As of May 30, 2006, we had approximately five million registered players and over 100,000 paying players in the month of May 2006. Majority of our players are 25 to 45 years old, with approximately 55 percent male and 45 percent female.

Our Sources of Products and Services

We mainly develop our games and services in-house to have better control of the game features and allow for seamless integration with our games platform. Occasionally, we outsource the game development to local game studios to expedite the development process and time to market. More recently, we began to license games to expand the scope of our games offering, particularly in the Arcade Games category. As of June 15, 2005,2006, we operatedonly licensed one game, Tales Runner, from Nowcom in Korea. The game licensing cost consists of an upfront fee and an ongoing licensing fee equal to a totalpercentage of 45 stores. Accordingrevenues from the licensed game.

We continue to aggressively expand our estimate, we had a market share of over 30% of Taiwan’s physical music distribution business in 2004. While seekingproducts and services offerings by developing and launching new games, updated games and community features on our platform. We are currently working with Microsoft to preservelaunch FunTown’s online MahJong on the Xbox 360. In order to support our market share,product development capabilities and develop our proprietary online casual games, we have also taken steps to improve the operating resultsa strong research and financial conditiondevelopment team composed of this business by reducing costs, improving our management information systemsapproximately 70 employees in Taipei and inventory management with a view to operating this business more efficiently, and increasing our operating margins.Shanghai.

We hold our music distribution business through G-Music Limited, our 58.58% owned subsidiary. We acquired the stores operated by Rose Records and Tachung Records in a series of transactions in February 2002, September 2002 and December 2002, and have consolidated the results of operations of the acquired businesses from the respective dates of acquisition.

Industry OverviewOur 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 expansion in mind, we have a unified user account system, which allows our players to use one single account to access all the games, whether self-developed or licensed, and services offered. Our billing and game management modules are flexible enough to integrate both in-house and licensed games. Our customer service module enables us to assist our players both in and outside of the games.

Taiwan’s retail music distribution industry is relatively fragmented.As technologies advance and enable people to access the Internet in new ways, we plan to expand our offerings to match these new access technologies and platforms. We are currently working with Microsoft to have some of our games available on the Xbox 360 platform. We are also working with Intel to include our games and services in Intel’s new Viiv technology for digital home media centers. In addition to our Rose Records and Tachung Records chains, there are several other record distribution chains operating in Taiwan. Hypermarket chains, such as Carrefour and specialty entertainment chains, such as FNAC, reflect a small, but growing, segment of the market, with the balance consisting of convenience stores, individual music stores and night markets. Alternative distribution methods, such as Internet sale of physical recorded music and Internet-based music downloads have also begun to emerge in recent years as competitive distribution channels.

While no formal industry statistics are available, based on information provided to us by record companies and knowledge of our own revenues, we estimate that our share in 2004 of the physical music distribution market was over 30%. This does not include Internet-based music downloads or illegal physical or online piracy, which we believe to be significant but about which we do not have reliable information.

The retail music distribution industry in Taiwan has been undergoing significant change in recent years. The development ofthese new technologies, such as Internet-based music downloading and changing consumer buying habits, have contributedour games are currently available 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 continuesair travelers on certain airlines, enabling players to experience relatively high levels of physical and online music piracy, which has further eroded the retail music distribution industry.

We believe that these changes are likely to continue to impact the retail music distribution industry going forward. Historically, purchases of popular music have constituted a significant portion of ours and our competitors’ sales. Going forward, we anticipate that an increasing proportion of these sales is likely to be effected through alternative distribution channels, particularly Internet-based downloading. Consequently, we anticipate that an increasing proportion of physical music distribution will comprise specialized areas of music, such as classical and jazz, whose purchasers demand the higher sound quality of physical recordings and who we believe are generally less price-sensitive than purchasers of popular music.

Taiwan’s retail music distribution industry has also been affected in recent years by relatively lower levels of new popular artists and albums than has been the case in some prior periods, which we believe has adversely affected our sales and those of our competitors.

Stores

As of June 15, 2005, we operated 45 stores. These stores range in size from approximately 500 square feet to approximately 5,000 square feet. The stores typically offer a broad selection of album titles across a range of musical genres.

Our stores are located principally in Taipei, Taichung, Kaoshiung and Taiwan’s other major urban areas, although we also operate certain stores in rural areas. Historically, we have sought to locate our stores in high-traffic areas and near transportation hubs such as Mass Rapid Transit, railway and bus stations, with a view to attracting young purchasers of popular music. These areas also tend to be characterized by higher store rental costs. As of June 15, 2005, we had 20 music stores in the North of Taiwan, six in Central Taiwan and six in the South of Taiwan. In addition, 13 of our Rose records retail outlets are located in either hypermarkets or department stores throughout Taiwan.

We believe that in the future, younger purchasers of popular music are likely to turn increasingly to alternative music distribution channels, such as Internet-based downloads, and that an increasing proportion of the physical music distribution will comprise more specialized areas of music, such as classical and jazz.

In light of the trends we perceive in this business, we are in the process of altering some of our stores into combined stores format. Combined stores are stores co-locatedplay with other businesses that we believe sharepassengers 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 and two combined stores with an arcade game provider. As of June 2005, we have already converted another seven stores which were identified as loss makers into either a combined store or share rental format.

We are also currently updating and improving our Internet Web site which will offer and sell physical CDs, DVDs and VCDs to retail purchasers. Revenues from our Internet store represents a small fraction of our total music distribution revenues.

Purchasing and Distribution

As of the fourth quarter of 2004, all procurement has been centralized at our headquarters in Taipei, which we believe will strengthen our position in negotiating terms, discounts and in-store advertising with the major record companies. From the data collected by our POS system, we will be able to identify fast-selling CDs which we should purchase more of, and be alerted when inventories of slow-moving CDs become too high.

Currently, merchandise purchased by our retail music stores is also separately distributed by the major record companies or the other suppliers, as the case may be, directly to our individual retail music stores. Following the centralization of our procurement, we expect our suppliers to continue to ship the merchandise directly to each of our retail music stores.

Consistent with retail music industry practice in Taiwan, CD purchases from major record companies are in general not returnable for full credit. The principal exception relates to major record releases, where the first batch of purchases are usually returnable for full credit. CD purchases from suppliers other than major record companies are usually returnable for full credit.

Sales and Marketing

The primary source of revenues for our retail music stores is the sale of recorded music on CDs. Each of our stores carries a wide selection of CDs purchased from major and independent record companies, which, except for new releases and special promotions, are generally arranged in our stores according to genre and alphabetically by artist or group. Our music stores also receive promotional and advertising revenues from store media, that is, in-store promotion by record companies. Record companies typically allocate a portion of their album marketing budgets as promotional and advertising revenues to music stores in return for prominent in-store placement of CDs and/or posters as well as record company-sponsored promotional events. In 2004, we recognized a total amount of US$1.5 million in promotional and advertising revenues.

We successfully launched a co-branded credit card during the beginning of the fourth quarter of 2004 and have a current total of approximately 45 thousand active cards. We believe that a co-branded credit card will help promote sales and, more importantly, build customer loyalty. We will also be able to collect valuable data regarding our customers’ music preferences, for example, jazz or classical music, which will help us to tailor the offerings of our stores to meet customer needs.

Management Information System

We have implemented our new point of sale, or POS, system for our retail music stores. This is a centralized management information system that allows tracking from purchase through to sale, providing us with real-time information on what is being sold at each of our retail music stores. The new POS system is expected to enable us to manage a centralized purchasing system, perform inventory swap among our stores and monitor our inventory movement more accurately and efficiently. We believe that implementation of our POS system should ultimately enable us to achieve a more efficient division of labor between staff performing stock-taking and other operational functions and more knowledgeable sales staff to improve customer service.

flight.

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 businessdirectly with Asia Records and Guan Nan Records. Our music stores also compete with independentother online casual games operators and convenience stores.portals in Greater China, some of which may have significantly greater resources than us. Given the low barriers to entry, they can easily copy the format, features, strategy, and business model of our casual games portal. To cope with competition, we aim to develop new features and services that we think our players will pay for and enjoy. We are also facing increasing competition from hypermarkets, such as Carrefour,work on strengthening the appeal of our portal through building player community, honorary titles, virtual badges and banners of 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.

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.

virtual assets.

Intellectual Property and Proprietary Rights

While we regardWe 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, 2006, we were the owner of 33 software copyrights and 32 trademarks registered with various government agencies throughout Greater China.

Broadband ISP 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.

Access ServicesOfferings

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, 2005, we had 17,600 cable modem-based broadband customers, as compared to 20,720 cable modem-based broadband customers as of December 31, 2004.

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, 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$17.9 million. Approximately US$9.7 million of the price is for the ADSL business and is payable from May 16, 2006 through July 31, 2007. Approximately US$8.2 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 16, 2006 through December 31, 2007. The transferred ADSL business includes our ADSL-related equipment, business contracts, and subscription contracts between Hoshin GigaMedia and approximately 62,000 ADSL subscribers, as well as the right to use our ADSL brand for five years.

Markets of Access Services

CONSUMER ACCESS SERVICES. Our two-way cable modem-based broadband service packages are offered at approximately US$33.50 per subscriber per month for premium service; approximately US$24.40 per subscriber per month for a mid-tier package; and approximately US$19.80 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 broadband Internet ISP services continued to decline during 2005. The table below sets forth the number of our subscribers on the dates specified. Our access revenues increased in 2005 compared to 2004, primarily due to the growth of our corporate broadband business, which offset declines in our consumer broadband business. We do not expect to see significant growth in our subscriber base in the future.

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, 2005, we had 10 cable partners under non-exclusive contracts and one cable partner under an exclusive contract 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, 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.

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:

In connection with the sale of our ADSL business, we have given Webs-TV the right to co-locate their equipment, which is necessary for the ADSL operation, 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 rightsnetwork 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. As per our service agreement with Webs-TV, we will provide the same amount and level of data bandwidth service to Webs-TV’s ADSL subscribers until the end of 2007. The economic scale of our broadband network will not be affected by the sale of our ADSL business until the end of 2007.

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 (“TWNIC”), 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. We primarily use the following means to market our services:

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 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 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 very 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 approximately 80 percent of the market share in 2005, while we have only managed to capture approximately 2 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 is dependent primarily on the innovative skills, technological expertiseclose relationships with a large number of cable partners and management abilitiesour 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.

Some of our employees rather than on patent, copyrightmajor competitors, including Chunghwa Telecom, have certain competitive advantages over us, including financial and trademark protection,marketing resources, established customer relationships, brand awareness, customer access and accordingly, we do not consider any particular intellectual property or proprietary right to be material to our business.

telecommunications infrastructure.

Regulation

Regulation Relating to Online Gaming

Our software entertainment business includes software development and the provision of application services for Internet gaming. UIM, which operates an online gaming business and also sub-licenses our software products to third parties, is the sole licensee of our entertainment software products and we earn fees from UIM based upon its revenues. Each of these businesses is 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 entertainment software products are used.

Our Company, UIM and the online gaming industry as a whole may be affected by pending legislation in the U.S. Congress that, if enacted, would prohibit the use of communication facilities and financial transactions in connection with Internet gambling. The current administration adheres to the view that Internet gambling is already prohibited by the Federal Wire Act and other federal laws. In addition, Internet gambling currently constitutes illegal gambling activity in all 50 U.S. states, including those states where other forms of gambling are legal. Because many U.S. citizens continue to participate in Internet gambling despite these prohibitions, Congressional opponents of Internet gambling have unsuccessfully proposed legislation over the past several years with the intent of restricting the means available for participation in this activity. In the current Congress, three bills affecting Internet gambling are under consideration:

We continue to monitor the progress of this legislation through the Congress since the passage of this legislation could potentially impact the revenues of UIM. Although UIM operates outside of U.S. jurisdiction and maintains that it does not purposefully solicit or accept gambling transactions that would violate current U.S. law, a substantial impairment of UIM’s revenues could affect the continued operation of our entertainment software business.

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. If the United States or other jurisdictions adopt laws which restrict their citizens from participating in Internet gaming offered outside their jurisdictions, on the grounds of public morals, public order or otherwise, the business of UIM, and our business, could be materially and adversely affected.

It is unclear what steps the U.S. government 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 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 entertainment software business provides online gaming services (rather than only providing software and application services to our licensee) and thus subject our Company to the gaming laws and regulations in such jurisdictions.

Regulations Relating to Online Casual 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.

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.

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 regulateregulated Taiwan’s telecommunications industry primarily under the Telecommunications LawAct of Taiwan.

The Telecommunications Law authorizes the Directorate General of Telecommunications to regulatehas 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 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.

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 LawAct 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 fluctuationsincrease rate of the consumer productprice 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. The Directorate General of Telecommunications adopted Fixed Network Regulations in 1999 to govern the issuance of fixed network communication licenses. Type I fixed network communications licenses are subdivided into comprehensive network, local network, long distance network, international network and lease-circuit licenses. 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.

Content Liability. In the event that theIf 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 inIn 2000 and 2001 the Cable Radio and Television and Broadcast Law has beenAct were modified. Under the modified regulations, the original regulationregulations of “a single shareholder cannot own more than 10%10 percent of the total 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 beenwere 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.To obtain an operating license, a cable operator must first apply for a rollout permit. After receiving this permit, the cable operator generally has three years to complete the cable system rollout as set forth in its permit application. Upon the satisfactory completion of the rollout, the Government Information Office will issue an operating license to the cable operator. If the cable operator has not received an operating license before its rollout permit expires, its right to engage in the cable television business will be terminated immediately.

The term of an operating license is nine years. A review committee established by the Government Information OfficeThe 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 OfficeNCC 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 OfficeNCC 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 TelecommunicationsNCC 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 worknetwork business market (such as in leased-circuit business) may be required by the Directorate General of TelecommunicationsNCC 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 TelecommunicationsNCC on the cable partners having exclusive relationships with us will eliminate the benefits associated with our exclusive rights.

Regulation Relating to Online Gaming

UIM, the sole licensee of our software products, and our business of software development and application service provision are subject to applicable laws and regulations relating to online gaming and electronic commerce in various jurisdictions.

We are incorporated in Singapore and at present the Singapore law does not prohibit us from providing software products and application services to online gaming companies.

UIM operates exclusively in the Kahnawake territory in Canada under a gaming license issued by the Kahnawake Gaming Commission, subject to continuing satisfaction of strict licensee requirements. All of UIM’s gaming transactions take place in Kahnawake. UIM operates exclusively from computer servers in Kahnawake.

However, UIM’s consumers involved in Internet gaming are located around the world, including the end users of our software products. Further, UIM sub-licenses our software products to third parties. As such, it is in many cases uncertain which governments have authority to regulate or legislate with respect to different aspects of this industry.

The Internet gaming industry is still in an early stage of development, and as such, the worldwide legal and regulatory environment in which the business operates is highly fluid, and subject to change. Most foreign jurisdictions have some form of legal framework applicable to games of chance, but few provide any guidance on how this framework applies to Internet gaming. Issues such as physical location of the gaming event, foreign jurisdictional law, “Cyberlaws”, and “control of the Internet” all make traditional legal and regulatory laws difficult to apply. In addition, the very nature of Internet gaming creates new and unique forms of entertainment that were neither contemplated nor feasible in the past. The risks and uncertainties in the worldwide legal and regulatory environment makes it impossible to assess that our status or operations as an application service provider to the gaming industry is in compliance with all laws and regulations of the jurisdictions in which we operate.

Our Company and the industry as a whole may be affected by efforts by members of the U.S. Congress to ban certain Internet gambling. Early in the 108th Congress, U.S. Congressman Jim Leach (R-IA) introduced HR 21, the Unlawful Internet Gambling Funding Prohibition Act, which attempts to prohibit Internet gambling by forbidding the use of credit instruments of United States banks from being used to make bets or wagers over the Internet. Shortly afterwards, U.S. Senator Jon Kyl (R-AZ) introduced similar legislation, S-627 in the U.S. Senate. In June 2003, HR 21 was reintroduced as HR 2143 by U.S. Congressman Spencer Bachus (R-AL) without any civil and criminal sanctions in order to bypass the U.S. House of Representatives Committee on Judiciary. After a very close vote on an amendment to HR 2143, the House of Representatives passed that legislation. In late October 2003, the U.S. Senate’s Committee on Banking, Housing, and Urban Affairs placed an amended version of S-627 on the Senate Legislative Calendar under General Orders. We continue to monitor this situation since the passage of this legislation could have a substantial impact on the business of our licensee and ultimately our Company. If this legislation passes and becomes law, it would have an immediate detrimental effect on the industry and would pose a serious threat to the continued operation of our entertainment software business.

In November 2004, the WTO found that the U.S. was in violation of its commitments under GATS by not allowing operators of online gaming services licensed in Antigua and Barbuda to access U.S. markets. The decision was appealed and, in April 2005, the Appellate Body of the WTO found that the provisions of the Wire Act, Travel Act and Illegal Gambling Business Act are inconsistent with the U.S.’s obligations under the GATS, but also that the U.S. had shown that such measures are necessary to protect public morals or maintain public order and therefore fall within an exception to its general obligations. However, the Appellate Body further found that, in the light of U.S. legislation in respect of online gambling on horseracing, the U.S. had failed to demonstrate that the Wire Act, Travel Act and Illegal Gambling Business Act are applied equally to both foreign and domestic providers of online gambling services for horseracing and therefore recommended that the U.S. bring its legislation into conformity with its obligations under the GATS.

It is unclear what steps the U.S. will take following the decision of the Appellate Body of the WTO and whether the threat of any sanction or fine relating to a failure to implement the recommendation of the Appellate Body would be sufficient to lead to a change in U.S. online gaming policy. A number of states are lobbying/petitioning the U.S. authorities to ensure they retain the ability to regulate state gaming and that this ability is not affected by the WTO decision.

Also, the substantial uncertainties in the global regulatory environment relating to online gaming expose us to a real risk of regulatory authorities in various jurisdictions considering us as providing online gaming services rather than only providing software and application services to our licensee and hence subjecting us to gaming regulations in such jurisdictions.

C. 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 and our entertainment software business in April 2004 and our online casual games business in January 2006, we became a diversified provider of broadband Internet access services, entertainment software and application services, online casual games services and broadband Internet access services. In September 2005, we sold our interest in our land-based music products.distribution business. The organization chart and the table below setsset 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, 2005:2006:

Entity		Year of Incorporation		Place of Incorporation Operation		Our Percentage Holding		Principal Activities
Held by our Company
Hoshin GigaMedia Center, Inc.		1998		Taiwan		100%		Cable-based Internet access services and FunTown online casual games portal
GigaMedia Finance International Limited		2000		Cayman Islands		100%		Holding company
GigaMedia International Holdings Limited		2004		British Virgin Islands		100%		Holding company
Cambridge Entertainment Software Limited		2004		British Virgin Islands		100%		Holding company
GigaMedia (Taiwan) Limited		2004		Taiwan		100%		Holding company
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
GigaMedia (HK) Limited		2004		Hong Kong		100%		Holding company
FunTown World Limited		2005		British Virgin Islands		100%		Holding company
GigaMedia Asia Limited		2005		British Virgin Islands		100%		Holding company
Held by FunTown World Limited
FunTown Hong Kong Limited		1999		Hong Kong		100%		Online casual games portal
Held by GigaMedia Asia Limited
GigaMedia China Limited		2005		British Virgin Islands		100%		Holding company

Entity		Year of Incorporation		Place of Incorporation Operation		Our Percentage Holding		Principal Activities
Held by Cambridge Entertainment Software Limited
Cambridge Interactive Development Corporation (Quebec) Inc.		2005		Canada		100%		Financial and management services
Cambridge Interactive Development Corporation		1997		U.S.A.		100%		Software developer and application service provider
Internet Media Licensing Ltd.		2005		British Virgin Islands		100%		Software developer and application service provider

D. Property, Plant and Equipment

Our principal executive office and operating office are located at 14th Floor,14F, No. 122 TunHuaTunhwa North Road, Taipei 10595, Taiwan, where we lease approximately 24,31024,368 square feet.feet of office space. We also lease office and other space, as well asincluding space for our servers, in various other locations.

We operate our casual games business from G-Music’s headquartersFunTown’s office in Taiwan at 10F,8F, No. 171, Chen-Kung Road, Sanchung City, in22, Lane 407, Sec. 2, Tiding Blvd., Taipei County114, Taiwan, where we lease approximately 12,75628,235 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 ISP 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 officesoffice at 6F, No. 20, Lane 478, Rueiguang Road, Neihu District, Taipei 114, Taiwan, where we lease approximately 13,06013,092 square feet andfeet.

We operate our entertainment software business from CESL’s headquarters at 100 Cambridge Park Drive, Cambridge, MA 02140, U.S.A., where we lease approximately 23,774 square feet, and from the offices of Cambridge Interactive Development Corporation (Quebec) Inc. at 1550 Metcalfe Street, Suite 590, Montreal, Quebec, H3A 1X6, Canada, where we lease approximately 1,000 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: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:

In 2005, we recorded net income of approximately US$6.3 million. Our total operating revenues increased by approximately US$11.3 million, mainly from our entertainment software business which had an increase in operating revenues of approximately US$11.1 million and our ISP business which had a slight increase in operating revenues of US$0.3 million. Our total costs and expenses increased by approximately US$9.5 million.

Prior to April 2004, our main business was to provide broadband Internet access services 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. Also, a full-year consolidation of our entertainment software business would have a much greater impact on our financial results than as presented in this annual report.

Entertainment Software Business. 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 and the year ended December 31, 2005. See Note 5 of our consolidated financial statements for additional information. Our entertainment software business generated revenues of approximately US$22.5 million and operating income of approximately US$6.0 million in 2005.

We currently have only one licensee, UIM, whose financial results were incorporated into our 2004 and 2005 consolidated financial statements 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).”

Online entertainment 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 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.

Broadband ISP Business. In 2005, 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 broadband ISP business generated revenues of approximately US$21.7 million and operating income of approximately US$2.1 million in 2005.

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 2005, consumer access revenues through Hoshin GigaMedia were approximately US$14.9 million, while corporate access revenues through KBT were approximately US$6.5 million. Our consumer broadband Internet access products consisted of ADSL and cable modem offerings. Our ADSL and cable modem services accounted for approximately 44 percent and 16 percent of our ISP access revenues in 2005, respectively. In May 2006, we sold our ADSL business to Webs-TV. See “— Subsequent Events — Sale of our ADSL Business.” 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 Webs-TV.

Following the sale of our ADSL business, our retail ISP business is primarily composed of our cable modem broadband business. 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.

While access revenues from our corporate ISP business represented only approximately 31 percent of our total access revenues in 2005, they demonstrated a significant growth of 32 percent from US$5.0 million in 2004, compared to a decline of 7 percent in our consumer ISP access revenues from US$16.0 million in 2004. Our corporate ISP services include leased-line, virtual private networks and other value-added services.

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 us. The availability of similar services at competitive prices has made it difficult for us to attract and retain customers.

Subsequent Events

We entered into the following transactions after December 31, 2005.

Acquisition of FunTown

On January 2, 2006, we completed the acquisition of FunTown and purchased certain assets and assumed certain liabilities of FunTown from TWP Corporation (“TWP”), a subsidiary of Acer, Inc. The total purchase price of approximately US$43 million consisted of cash payments of approximately US$27.2 million and approximately US$15 million zero coupon convertible notes, with a valuation premium on the convertible notes of approximately US$0.7 million as determined by KGI Securities Co. Ltd. The notes are convertible into approximately 4,794,000 shares of our common stock at US$3.1287 per share, with 50 percent maturing on January 1, 2008 and 50 percent maturing on January 1, 2009. The conversion price is subject to customary anti-dilution adjustments. We have the right to redeem the convertible notes, in whole or in part, within the first twelve months after the issue date, together with the accrued interest at five percent per annum. The convertible notes are secured by our shareholding in Hoshin GigaMedia. The transaction also included an incentive in the form of an additional amount to be paid by us on April 1, 2007, which amount will be determined as follows:

FunTown is one of the leading casual games platforms in Asia. FunTown generates revenues through access fees and also through the sales of various in-game items. We acquired FunTown in order to enhance our position in the online entertainment market. See Note 25 of our consolidated financial statements for initial estimated fair values of the assets acquired and liabilities assumed at the date of acquisition; the pro forma condensed balance sheet gives effect to the acquisition of FunTown as if the acquisition had occurred on December 31, 2005.

Subscription Rights for Purchase of Shares of Wretch

On March 10, 2006, our wholly-owned subsidiary Hoshin GigaMedia entered into a subscription rights agreement with Wretch. Wretch is a leading online “community” offering a wide range of community services including blogs, photo albums and bulletin boards. Pursuant to the subscription rights agreement, Hoshin GigaMedia has the 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 the subscription rights agreement. We have also 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 games offerings. In exchange for these rights, Hoshin GigaMedia agreed to provide Wretch with certain free Internet services for three years.

Strategic Investment Agreement with T2CN

On April 27, 2006, we entered into a strategic investment agreement with T2CN, an online casual sports game operator in the PRC, pursuant to which we made an initial investment of US$15 million to acquire 7.5 million shares of convertible preferred stock. We also obtained the right to elect one member to the board of directors of T2CN, along with customary preferred share rights and protections. 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 based on a valuation of 8.65 times the forward net income of T2CN for the 12-month period ending on March 31, 2007, subject to certain adjustments and limitations. Pursuant to this strategic agreement, we and T2CN will together offer FunTown’s existing games to the T2CN user base. We will become T2CN’s exclusive provider for FunTown’s existing games and preferred provider for games newly developed by us.

Sale 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$17.9 million. Approximately US$9.7 million of the price is for the ADSL business and is payable from May 16, 2006 through July 31, 2007. Approximately US$8.2 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 16, 2006 through December 31, 2007. The transferred ADSL business includes our ADSL-related equipment, business contracts, and subscription contracts between Hoshin GigaMedia and approximately 62,000 ADSL subscribers, as well as the right to use our ADSL brand for five years.

Certain Significant Events Affecting Our Results of Operations for 2003, 2004, 2005

Change in Reporting Currency and Basis of Presentation

Our consolidated financial statements have historically been reported in New Taiwan dollars. Effective January 1, 2004, we adopted the United StatesU.S. dollar as our reporting currency because operations denominated in the United StatesU.S. dollar have represented an increasing portion of our business following the acquisition of our entertainment software business. Comparative financial information has been recast as if the United StatesU.S. dollar had been our reporting currency for the periods ended and as of December 31, 2002, 2003, 2004 and 2004,2005, and financial information has been translated into United StatesU.S. dollars for all periods presented. See Item 3 — “Key Information — Exchange Rates”.Rates.” As a result, the financial information for 2002 and 2003the year ended and as of December 2002 and December 2003 presented in this annual report are different from that presented in our annual reports for 2002 and 2003.

Discontinued Operations

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.

Summary select financial information for discontinued operations is as follows:

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 consolidated if a company absorbs the majority of the variable interest entity’s expected losses, or is entitled to receive a majority of the variable interest entity’s residual returns, or both.

The FASB amended FIN 46 by issuing FIN 46(R) in December 2003. In April of 2004, we entered into a software license and support service contract with UIM to provide Internet software support services for UIM’s entertainment software operations. The contract allows us to charge a percentage of UIM gross receipts resulting from UIM’s online entertainment operations. 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 primary beneficiary of a software licensee, UIM. As a result of this determination, we incorporated the results of UIM into our consolidated financial statements as of and for nine months ended December 31, 2004, and as of and for the year ended December 31, 2005, even though we do not own any of UIM’s equity. UIM’s net assets as of December 31, 2004 and 2005 were approximately US$414 thousand0.4 million and US$0.6 million, respectively, and the consolidation of UIM resulted in an increase in our assets and liabilities of approximately US$1.6 million and US$1.2 million in 2004, respectively, and US$3.6 million and US$3.1 million in 2005, 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.

AcquisitionAcquisitions

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$0.7 million as determined by KGI Securities Co. Ltd.

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

Revenue Recognition

We recorded revenues from broadbandour entertainment software business from licensing our software and providing support services. These revenues are recognized monthly as a fixed percentage of our licensee’s gross receipts. The results of UIM, our licensee, have been incorporated into our 2004 and 2005 consolidated financial statements. Software licensing and support services revenues we received from UIM have been eliminated in consolidation. UIM generates revenues by providing and promoting online games of skill and chance. Revenues are recognized upon receipt. End-user account balances are recognized as current liabilities and are accrued for in full. The charge in aggregate end-user account balances is recognized monthly as a reduction to receipts, as are end-user disbursements.

We recorded Internet access revenues from cable modem Internet access services as well as fee-based services,and from our ADSL business, which mainly include subscription services for videostreaming and paid email services.we sold in May 2006. Such revenues are recognized for the period in which the service is performed, if no significant company obligations remain and collection of the receivables is reasonably assured. Customers have a choice of paying either monthly or in advance for a certain period of time, for which they receive corresponding discounts. We record any such advanced payment receipts as other current liabilities on the balance sheet and amortizesamortize such revenues over the subscription period. We contract with third party content providers for certain servicesOther revenues, which consist of subscription revenues and the sale of cable modem and other related to subscribed content transmitted toproducts generated from our users and record the fees charged by the third parties as cost of revenues.

We recorded revenues for our entertainment software business through licensing our software and providing support services. These revenuesbroadband ISP, are recognized monthly as a fixed percentage of a licensee’s gross receipts. The results of UIM, our licensee, as of and for the nine months ended December 31, 2004 have been incorporated into our consolidated financial statements. Software licensing and supportwhen services revenues we received from UIM have been eliminated in consolidation. See “— A. Operating Results — Overview — Consolidation of UIM Under FIN 46(R)” above. UIM generates revenues by providing and promoting online games of chance and skill. Revenues are recognized upon receipt. End-user account balancesprovided or products are recognized as current liabilities and are accrued for in full. The charge in aggregate end-user account balances is recognized monthly as a reduction to receipts, as are end-user disbursements.

For 2004, our revenues were primarily generated from retail sales of music merchandise comprised of pre-recorded music (including compact discs and audio cassettes), video (including DVD and pre-recorded videocassettes), video games and other complementary products (including electronics, accessories, blank tapes and CD-Rs). Revenues from these retail sales are recognized at the point of sale to the consumer, at which time payment is tendered.

delivered.

Allowance for Doubtful Accounts

An allowance for doubtful accounts is provided based on management’s evaluation of collectibility of notes receivable, accounts receivablesreceivable and other receivables. The actual value of such acquired net assetsnotes and accounts may differ significantly from management’s estimates.

Classification of Marketable Securities

Our investments in marketable securities are classified as available-for-sale. Marketable securities included in current assets represent securities with a maturity of less than one year or securities that management intends to sell within one year. Securities classified as non-current including non-equity method investments,represent securities that have maturity of more than one year or securities that management does not intend to sell within one year. These investments principally consist of debt securities and equity securities of public and privately held companies and investment funds, and are stated at fair value with any unrealized gains or losses recorded in accumulated other comprehensive income (loss) in shareholders’ equity until realized. Unrealized losses that are considered other than temporaryother-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$29.034.3 million and US$34.320.4 million of investments classified as current marketable securities as of December 31, 20032004 and 2004. The2005, respectively. As of December 31, 2004 and 2005, the balances of unrealized gains from these securities were approximately US$00.6 million and US$577 thousand respectively, as of December 31, 2003 and 2004.0.3 million, respectively. See Note 910 of our consolidated financial statements for 20042005 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 thousand4,905,000 shares or approximately 3.32%3 percent ownership in Gamania. We have no ability to exercise significant influence over Gamania’s operating and financial policies. The market price of Gamania’s shares has been below our carrying cost for an extended period of time; therefore, we recorded an other-than-temporary loss of US$1.8 million on December 31, 2004. As of December 31, 20032005, 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 balanceagreement, we granted JSDWAY an option to buy, at NT$18.70 per share, a total of unrealized losses was US$460 thousand4,905,000 common shares of Gamania owned by us, and US$0, respectively.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 have been classified as marketable securities–current and marked-to-market at NT$18.70 per share. See Note 1222 of our consolidated financialsfinancial statements for 20042005 for additional information.

Merchandise Inventory

Inventory is stated at the lower of cost or market value with cost being determined by the weighted average cost method and market value being determined by net realizable value. As with any retailer, economic conditions, cyclical customer demand and changes in purchasing or distribution can affect the carrying value of inventory. As circumstances warrant, we record the lower of cost or market value, or LCM, by adjusting the gross inventory cost with inventory provisions. In some instances, these provisions can have a material effect on the financial results in an annual or interim period. In order to determine such provisions, we estimate the fair value of merchandise inventory and record any provision if estimated market value is below cost and if inventory is obsolete. Actual inventory loss may differ significantly from management’s estimates. Through merchandising and other initiatives, we attempt to take the steps necessary to increase the sell-off of slower moving merchandise to eliminate or lessen the effect of any inventory provisions.

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 2004,2005, we did not record any asset impairment charges.

Impairment of Intangible Assets

We have significant amortizable intangible assets arising from the acquisitionsacquisition of Rose Records, Tachung Records and CESL. The amortizable intangible assets are amortized on a straight-line basis over estimated useful lives ranging from two to fifteenten years. As of December 31, 2004,2005, the balance of amortizable intangible assets was US$8.42.7 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 2004,2005, we did not record any intangible assets impairment loss for 2004.2005. 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, 20042005 and recorded no goodwill impairment loss for 2004.2005. 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. Due to the slow market growth and strong competition we face in our broadband ISP business, and the general market downtrend in our music distribution business, it is uncertain whether we are able to realize our deferred tax asset. We have made ana full allowance for substantially all the value of the aggregate net deferred tax assets as of December 31, 2004.2005. Actual results may differ significantly from management’s estimate.

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 casual games industry. The online gaming and online casual 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:

Competition. All of our businesses are in industries that are extremely competitive. Our online gaming and online casual games business are characterized by rapid technological change and we face significant and intense competition from online entertainment software design houses, application service providers and casual games operators. Our broadband ISP business has experienced a reduction in the number of new consumer subscribers and total consumer subscribers due to intense competition in the broadband ISP 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 key items included in our income statement are:

OPERATING REVENUES. Our operating revenues consist of revenues from the entertainment software business and the broadband ISP business. Going forward, it will include revenues from our online casual games business. Revenues from the entertainment software 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. Revenues from the broadband ISP business consist of Internet access revenues, subscription revenues and proceeds from sales of cable modems and other related products.

COSTS AND EXPENSES. Costs and expenses include operating costs, 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, foreign exchange gain or loss and gain or loss on disposal of property, plant and equipment.

INCOME FROM DISCONTINUED OPERATIONS. In September 2005, we completed the sale of our land-based music distribution business. Results for the music distribution operations are reported as discontinued operations in each of the periods presented.

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 theour business segments is provided net of inter-segment transactions.

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 entertainment software 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 broadband ISP 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.

COSTS AND EXPENSES. Costs and expenses increased by approximately 31 percent to approximately US$39.8 million in 2005 from approximately US$30.4 million in 2004. The increase in total costs and expenses was mainly due to a 91 percent increase in costs and expenses related to our entertainment software business, which was attributable to the inclusion of full twelve-month results in 2005 versus nine-month results in 2004 and reflected increased selling and marketing expenses and operating costs 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 entertainment software 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

Entertainment Software Business

We acquired our entertainment software 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 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 years ended December 31, 2003 and December 31, 2004 as if the acquisition of our entertainment software business had occurred on January 1, 2003 and 2004.

OPERATING REVENUES. Total operating revenues 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 inclusion of full twelve-month results of our entertainment software 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 in 2005 compared to 2 percent in 2004. Revenues from our traditional online gaming software business increased in 2005 to approximately US$18.4 million from US$11.2 million in 2004, which was attributable to combinations of targeted promotions (bonuses) and a game of the month campaign. These initiatives increased player acquisition and retention rates.

COSTS AND EXPENSES. Total costs and expenses increased by 91 percent to approximately US$16.6 million in 2005 from US$8.7 million in 2004. Such increase was attributable to the inclusion of full twelve-month results of our entertainment software business in 2005 versus nine-month results in 2004, and operating costs and selling and marketing expenses increasing as a result of our revenue growth in 2005.

Operating costs. Operating costs increased by 109 percent to approximately US$3.3 million in 2005 from US$1.6 million in 2004. The increase was due to the inclusion of full twelve-month results of our entertainment software business in 2005 versus nine-month results in 2004, and a higher level of business volume in 2005.

Product development and engineering expenses. Product development and engineering expenses increased by approximately 79 percent to approximately US$2.5 million in 2005 from approximately US$1.4 million in 2004 due to the inclusion of full twelve-month results of our entertainment software business in 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 inclusion of full twelve-month results of our entertainment software 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 entertainment software business in 2005 versus nine-month results in 2004.

OPERATING INCOME. Operating income in 2005 increased 115 percent to approximately US$6.0 million from US$2.8 million in 2004. The increase was primarily due the inclusion of full twelve-month results of our entertainment software business in 2005 versus nine-month results in 2004, and strong revenue growth from the launch of new games which led to an increase in operating margin from 24 percent to 26 percent. 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.

Broadband ISP Business

OPERATING REVENUES. Total operating revenues increased by 1 percent to approximately US$21.7 million in 2005 from approximately US$21.4 million in 2004. Such increase was attributable to an increase in total access revenues, which contributed more than 99 percent of total revenues from our broadband ISP business.

Access Revenues.Access revenues increased by 2 percent to approximately US$21.4 million in 2005 from approximately US$21.0 million in 2004, mainly as a result of the significant growth of our corporate broadband ISP business. Of the total access revenues recorded for 2005, consumer access revenues through Hoshin GigaMedia were approximately US$14.9 million, while corporate access revenues through KBT were approximately US$6.5 million. While revenues from our corporate ISP business represented only 31 percent of our total access revenues in 2005, they demonstrated a growth of 32 percent to approximately US$6.5 million in 2005 from approximately US$5.0 million in 2004, compared to a decline of 7 percent to approximately US$14.9 million in 2005 in our consumer ISP business from approximately US$16.0 million in 2004.

The number of our consumer 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 access revenues per 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.

COSTS AND EXPENSES. Total costs and expenses decreased by 4 percent from approximately US$20.4 million in 2004 to approximately US$19.6 million in 2005, mainly as a result of declines in general and administrative expenses, operating costs and in selling and marketing expenses.

Operating costs.Operating costs decreased by 3 percent from approximately US$14.5 million for 2004 to approximately US$14.1 million for 2005 due to decrease in depreciation and amortization, and customer service costs, partially offset by increase in bandwidth costs.

Product development and engineering expenses.Product development and engineering expenses decreased by approximately 6 percent from approximately US$1.1 million in 2004 to approximately US$1.0 million in 2005 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 5 percent from approximately US$2.9 million in 2004 to approximately US$2.7 million in 2005, primarily due to a moderate decline in our advertising expenses.

General and administrative expenses.General and administrative expenses decreased by 30 percent from approximately US$2.2 million in 2004 to approximately US$1.5 million in 2005 due to centralizing of certain back-office functions at the headquarters.

OPERATING INCOME. Operating income increased by 121 percent from approximately US$1.0 million for 2004 to approximately US$2.1 million for 2005. 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, 2003 and 2004

Consolidated Results Ofof Operations

Consolidated results for 2003 and 2004 have been restated to reflect the results of our music distribution business as discontinued operations, since we sold this business in September 2005. Certain prior year amounts have been reclassified to conform to the current-year presentation.

OPERATING REVENUES. Total operating revenues for 2004 grew by 5%68 percent to approximately US$99.832.8 million from approximately US$95.419.5 million in 2003. The increase was2003, primarily as a result ofdue to the acquisition of our entertainment software business in April 2004 which contributed approximately US$11.5 million, or 11% of our total revenues in 2004 and an increase in revenues from our broadband ISP business of approximately US$1.9 million to approximately US$21.4 million, which in total contributed approximately 21%35 percent of our total revenues in 2004. This was partially offset by a significant decrease in revenues from our music distribution business by approximately US$8.9 million to approximately US$67.0 million in 2004, whichThe broadband ISP business contributed approximately 68%US$21.4 million, or 65 percent of our total revenues in 2004.

See “Business Segment Results” below for a discussion of revenues by business segments.

COSTS AND EXPENSES. Costs and expenses decreasedincreased by 12%14 percent to approximately US$96.830.4 million in 2004 from approximately US$109.526.6 million in 2003. The decrease2003 as a result of the acquisition of our entertainment software business in total costs and expensesApril 2004, which was mainly due to a 20%partially offset by the decrease in costs and expenses related to our music distribution business and an 18% decrease inof the broadband ISP business. Our costs and expenses related to our ISP broadband business. Our entertainment software business contributedin 2004 primarily consisted of operating costs of approximately US$8.716.1 million, to our total costsproduct development and engineering expenses for the nine months ended December 31, 2004.

See “Business Segment Results” below for a discussion of costsapproximately US$2.5 million, selling and marketing expenses by business segments.

of approximately US$6.3 million, and general and administrative expenses of approximately US$5.7 million.

OPERATING INCOME. We had operatingOperating income offor 2004 was approximately US$3.02.5 million, in 2004 compared to an operating loss of approximately US$14.27.1 million forin 2003.

NON-OPERATING INCOME (EXPENSES).EXPENSES. In 2004, our non-operating expenses decreased by 56 percent to approximately US$0.91.1 million from approximately US$2.92.6 million for 2003. This was principally due to a significant increase in investment income togain on sale of marketable securities of approximately US$1.2 million in 2004 from approximately US$0.5 million in 2003, an increase in other non-operating income to approximately US$0.50.1 million from approximately US$0.5 million in 2004 compared to other non-operating expenses of US$0.6 million in 2003, and the recognition of a small loss on disposal of property, plant and equipment of approximately US$0.1 million44,000 in 2004, compared to a loss on disposal of property, plant, and equipment of approximately US$0.80.5 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.

INCOME FROM DISCONTINUED OPERATIONS. In 2004, income from discontinued operations was US$0.4 million compared to loss of US$4.3 million in 2003 due to the fact that we reduced operating costs and expenses and improved our management information systems which reduced inventory costs.

NET INCOME. We had net income in 2004 of approximately US$1.7 million compared to a net loss of approximately US$14.1 million in 2003.

Business Segment Results

Entertainment Software Business

We acquired our entertainment software business in April 2004 and incorporated results of the business into our consolidated financial statements as of and for the nine months ended December 31, 2004. As this business was acquired during 2004, year-over-year comparisons of this business segment are not available. See Note 5 of our consolidated financial statements for a summary of unaudited pro-forma results of operations for the years ended December 31, 2003 and December 31, 2004 as if the acquisition of our entertainment software business had occurred on January 1, 2003 and 2004.

Broadband ISP Business

OPERATING REVENUES. Total operating revenues increased by 10%10 percent to approximately US$21.4 million in 2004 from approximately US$19.5 million in 2003. Such increase was attributable to an increase in total access revenues, which contributed more than 98%98 percent of total revenues.

Access Revenues.Access revenues increased by 11%11 percent to approximately US$21.0 million in 2004 from approximately US$18.8 million in 2003, mainly as a result of the significant growth of our corporate broadband ISP business. Of the total access 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%24 percent of our total access revenues in 2004, they demonstrated a growth of 34%34 percent to approximately US$5.0 million in 2004 from approximately US$3.7 million in 2003, compared to a moderate growth of 6%6 percent 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)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%18 percent 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 the 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%10 percent from approximately US$15.216.1 million for 2003 to approximately US$13.914.5 million for 2004 due to decreases in the price of leasing bandwidth and circuits.

Product development and engineering expenses.Product development and engineering expenses decreased by approximately 9%9 percent from approximately US$1.2 million in 2003 to approximately US$1.1 million in 2004 as a result of our continued effort to de-emphasize this aspect of our operations.

Selling and marketing expenses.Selling and marketing expenses increased by approximately 18%18 percent from approximately US$2.4 million in 2003 to approximately US$2.9 million in 2004, primarily due to reclassification of certain general and administrative expenses as selling and marketing expenses and hiring of additional sales staff in the corporate ISP business, which iswas partially offset by a reduction in marketing expenses and related activities.

General and administrative expenses.General and administrative expenses decreased by 38%38 percent from approximately US$3.6 million in 2003 to approximately US$2.2 million in 2004 due to reclassification of certain general and administrative expenses as selling and marketing expenses.

OPERATING INCOME. We had an operating income of approximately US$1.0 million in 2004, compared to an operating loss of approximately US$5.5 million in 2003.

Entertainment Software Business

We acquired our entertainment software Operating income does not reflect certain corporate headquarter expenses. For a reconciliation of business in April 2004 and incorporated intosegment results to our consolidated financial statements as of and for the nine months ended December 31, 2004. As this business was acquired during 2004, year-over-year comparisons of this business segment are not available. Seenet income, please see Note 424 of our consolidated financial statementsstatements.

Seasonality

Due to the predominant indoor nature of online entertainment, there is a seasonality pattern observed on user traffic and patronage for our online gaming and online casual games businesses. Summer is typically a summaryslower season, while winter is generally a higher season for online entertainment activities. MahJong and Chinese poker games are traditionally played during Chinese New Year, and we typically experience high player traffic during this period of unaudited pro-forma results of operations fortime. We generally observe high traffic during all major Chinese holidays. As a result, seasonality affects the years ended December 31, 2003 and December 31, 2004 as if the acquisitionrevenues of our 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 the nine months ended December 31, 2004 were approximately US$11.5 million. Based on our revenue-sharing agreement with UIM, we recognized software licensing and support service revenues of approximately US$7.3 million from UIM during the same period. Such revenues have been eliminated in consolidation. See “— A. Operating Results — Consolidation of UIM Under FIN 46(R)”.

COSTS AND EXPENSES. Costs and expenses were approximately US$8.7 million for the nine months ended December 31, 2004, consisting mainly of:

Operating costs. Operating costs were approximately US$1.6 million for the nine months ended December 31, 2004.

Product development and engineering expenses.Product development and engineering expenses were 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 to approximately US$2.5 million in 2004 due to strict cost controls in keeping with the general market downtrend.

OPERATING INCOME. Operating income was approximately US$542 thousand in 2004, compared to an operating loss of approximately US$7.1 million in 2003.

For the Years Ended December 31, 2002 and 2003

online casual games business.

Consolidated Results Of OperationsInflation

OPERATING REVENUES. Total operating revenues for 2003 grew 29% to approximately US$95.4 million from approximately US$74 million in 2002, primarily due to the contributions 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 our revenues. The broadband ISP business contributed approximately US$19.5 million, or 20% of our revenues in 2003.

COSTS AND EXPENSES. Costs and expenses increased by 12% to approximately US$109.5 million in 2003 from approximately US$97.8 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 lossInflation has not had a material affect 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% 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 number 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 blended 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.

Of the total access revenues recorded for 2003, consumer access revenues through Hoshin GigaMedia were approximately US$15.1 million, while corporate access revenues through KBT were approximately US$3.7 million.

Sales/rental revenues. Sales/rental revenues decreased 5% from approximately US$126 thousand for 2002 to approximately US$120 thousand for 2003, resulting mostly from a decrease in sales of modems.

COSTS AND EXPENSES. Total costs and expenses decreased by 23% to approximately US$25.0 million in 2003 from approximately US$32.5 million in 2002. This decrease was due to a decrease in operating cost, cost of sales/rentals, product development and engineering expenses and selling and marketing expenses.

Cost of sales/rental. Cost of sales/rental decreased 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% from approximately US$1.9 million in 2002 to US$1.2 million in 2003, primarily due to reduced costs relating to workforce streamlining in 2003 and a de-emphasis on this aspect of our operations.

Selling and marketing expenses. Selling and marketing expenses decreased by 41% from approximately US$4.1 million in 2002 to approximately US$2.4 million in 2003, primarily due to significantly reduced advertising in Taiwan’s media for GigaMedia’s broadband services.

General and administrative expenses. General and administrative expenses increased 7% from approximately US$3.3 million in 2002 to approximately US$3.6 million in 2003.

OPERATING LOSS. Operating loss decreased by 58% to approximately US$5.5 million in 2003 from approximately US$13.2 million in 2002.

Music Distribution Business

We began to consolidate the results of operations of Rose Records in February 2002 and the results of operations of Tachung Records in October 2002. Consequently, a comparison of the consolidated results of operations of our 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 operationsoperation for 2003, 2004 and 2005 as the countries in the two periods. We briefly describe below the principal trends affecting thewhich we operate or earn significant revenues and cost of sales of our underlying music distribution business in 2003:

Revenues. Our revenues in the first and second quarters of 2003 were adversely affected by the SARS outbreak, which particularly impacted our sales from April through July. We believe that our competitors were similarly affected. Decisions by major record companies to defer the release of popular titles until it became clear that the SARS outbreak had been contained, contributed to a smaller than usual seasonal increase in revenues during the summer school vacation season and mitigated the effect of seasonality on sales in the fourth quarter.

Cost of sales. Gross margins generally improved through 2003. We believe this principally reflected a combination of fewer popular records being released in 2003 and improved purchasing terms resulting from management changes in the third quarter of 2003.

We present below information on the results of operations of our music distribution business in 2002 and 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.

did not experience any material inflationary trends.

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 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:

As a result of our operating, investing and financing activities during 2004,2005, the amount of our cash and cash equivalents and marketable securities we held as of December 31, 2004 decreased significantly2005 increased to approximately US$50.441.7 million compared to US$79.513.2 million as of December 31, 2003.2004. Such decreaseincrease was primarily attributable to our operating cash flow of US$11.4 million, investing cash flow of US$17.2 million, which includes cash proceeds from the acquisitionsale of our entertainment softwaremusic distribution business at an all-cash consideration of US$32.53.3 million, which we paid for entirely outnet of transaction costs and cash transferred. In 2006, our cash used in the purchase of FunTown amounted to US$27.2 million and our sale of our existing cashADSL business totaled US$9.7 million, of which approximately US$4.5 million is expected to be received in 2006 and cash equivalents, which was partially offset by positive operating cash flows ofapproximately US$2.45.2 million in 2004 and net proceeds2007. We issued approximately US$15 million zero coupon convertible notes in January 2006, which may be redeemed by us within 12 months of US$8.5 million from disposal of marketable securities.the issuance. We continue to seek and review potential merger and acquisition opportunities on an ongoing basis, which may be funded through cash or equity. We do not believe that any potential merger or acquisition that we may be engaged in would alter our goal of preserving sufficient cash and cash equivalents to fund future operations. We believe that our existing cash, cash equivalents, marketable securities and expected cash flow from operations will be sufficient to meet our capital expenditure, working capital, cash obligations under our existing lease arrangements, and other requirements through 2005.

2006.

OPERATING ACTIVITIES. In 2004,2005, our net cash provided by operating activities amounted to US$2.411.4 million. This was primarily attributable to collections from customersincome from operations of US$98.56.3 million offset by payments to vendors for the purchasesplus non-cash depreciation and amortization of US$77.2 million and payments for other operating expenses of US$18.96.4 million.

INVESTING ACTIVITIES. Our net cash used infrom investing activities in 20042005 was US$25.317.2 million. This was primarily attributable to the acquisition of our entertainment software business of US$32.8 million, including transaction costs, which we largely fundedgenerated from the liquidationsale of our marketable securities of US$37.0 million, which was offset by the purchase of property plant and equipmentother marketable securities of US$2.6 million and the purchase of intangible assets of US$663 thousand. In 2003, our net cash used in investing activities amounted to US$5.020.2 million.

FINANCING ACTIVITIES. Our net cash provided by financing activities in 20042005 was US$156 thousand.

247,000.

OTHER. Set forth below are the aggregate amounts, as of December 31, 2004,2005, 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$8.82.1 million, US$1.93.4 million and US$3.34.0 million for 2002, 2003, 2004 and 20042005, respectively. Capital expenditures during 20042005 were primarily for the replacement and upgrades of network-related hardware in our consumer and corporate broadband businesses and capitalization of software development for our entertainment software business and alsobusiness. For 2005, the capital expenditure for the point of sale system implemented in every retail store of our music distribution business.business was approximately US$0.5 million. Our capital expenditure plans for 20052006 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 entertainment software business and for our online casual 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.

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 Approvalforeign 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 of our business following the acquisition of our entertainment software business. Our marginsfinancial 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. 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 to do so in the future. We recognized a foreign exchange loss of approximately US$896 thousand0.8 million for 2004 and a gain of approximately US$723 thousand0.2 million for 2003.2005.

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 impact 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’sCommission’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 plansWe adopted this new standard on January 1, 2006, using the modified prospective method and the Black-Scholes valuation model. Because we had not recorded any compensation cost in our statement of operations prior to adoptthe adoption of FAS 123(R) beginning, no cumulative effect adjustment was recorded upon adoption. Our adoption of FAS 123(R) may have a material impact on our net income and net income per share.

In May 2005, the FASB issued FAS No. 154, “Accounting Changes and Error Corrections,” (“FAS 154”), a replacement of Accounting Principles Board (“APB”) Opinion No. 20 and FAS No. 3. FAS 154 changes the requirement for the accounting for and reporting of a change in accounting principles. FAS 154 applies to all voluntary changes in accounting principles. It also applies to changes required by an accounting pronouncement if the pronouncement does not include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed. The provisions of FAS 154 will be effective for accounting changes made in fiscal 2006 andyears beginning after December 15, 2005. It is currently evaluating the various transition methods allowed undernot expected that FAS 123(R).

154 will have a material effect on our consolidated financial statements.

In March 2004,2005, the FASB approvedissued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations, an Interpretation of FASB Statement No. 143, ‘Accounting for Asset Retirement Obligations,’” (“FIN 47”). FIN 47 generally applies to long-lived assets and requires a liability to be recognized for a conditional asset retirement obligation if the consensus reachedfair value of that liability can be reasonably estimated. A conditional asset retirement obligation is defined as a legal obligation to perform an activity associated with an asset retirement in which the timing and/or method of settlement are conditional on a future event that may or may not occur or be within the control of the company. A liability should be recognized when incurred (based on its fair value at that date), which generally would be upon the acquisition or construction of the related asset. Upon recognition, the offset to the liability would be capitalized as part of the cost of the asset and depreciated over the estimated useful life of that asset. FIN 47 is effective no later than December 31, 2005. We adopted FIN 47 in the fourth quarter of 2005 without material effect on our financial position or results of operations.

In September 2005, the Emerging Issues Task Force Issue No. 03-1,(“EITF”) ratified EITF 04-13, “Accounting for Purchases and Sales of Inventory with the Same Counterparty,” (“EITF 04-13”). This issue addresses the circumstances under which two or more inventory purchase and sales transactions with the same counterparty should be viewed as a single exchange transaction and whether there are circumstances under which such non-monetary exchanges should be accounted for at fair value. The adoption of EITF 04-13 is effective for new or modified agreements for fiscal periods beginning after March 15, 2006. It is not expected that EITF 04-13 will have a material effect on our consolidated financial statements.

In November 2005, FASB Staff Position (“FSP”) 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” was issued. The FSP addresses the determination as to when an investment is considered impaired, whether that impairment is other-than-temporary, and the measurement of an impairment loss. This FSP also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The guidance in this FSP amends FASB Statement No. 115, “Accounting for Certain Investments in Debt and Equity Securities” and APB Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock.” (“EITF 03-1”). The objective of EITF 03-1FSP applies to investments in debt and equity securities and cost-method investments. The application guidance within the FSP includes items to consider in determining whether an investment is impaired, in evaluating if an impairment is other-than-temporary and recognizing impairment losses equal to provide guidancethe difference between the investment’s cost and its fair value when an impairment is determined. The FSP is required for identifying other-than-temporarily impaired investments. EITF 03-1 also provides new disclosure requirements for investments that are deemed to be temporarily impaired. all reporting periods beginning after December 15, 2005. Earlier application is permitted. We do not anticipate the amendment will have a material effect on our consolidated financial statements.

In September 2004,February 2006, the FASB issued EITF 03-1-1,FAS No. 155, “Accounting for Certain Hybrid Financial Instruments,” (“FAS 155”). FAS No. 155 amends Financial Accounting Standards Board Statements Nos. 133 and 140. The statement applies to certain hybrid financial instruments, which delaysare instruments that contain embedded derivatives. The new standard establishes a requirement to evaluate beneficial interests in securitized financial assets to determine if the effectiveinterests represent freestanding derivatives or are hybrid financial instruments containing embedded derivatives requiring bifurcation. This new standard also permits an election for fair value re-measurement of any hybrid financial instrument containing an embedded derivative that otherwise would require bifurcation under Financial Accounting Standards Board Statement No. 133. The fair value election can be applied on an instrument-by-instrument basis to existing instruments at the date of the measurementadoption 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 doescan be applied to new instruments on a prospective basis. It is not expect the adoption of EITF 03-1expected that FAS 155 will have a significant impactmaterial effect 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.

Taxation

At December 31, 2004,2005, we had net operating loss carryforwards for tax purposes of approximately US$84.038 million, whicharising from our broadband ISP operations in Taiwan. These operating loss carryforwards will expire at various times from December 20052006 through December 2009. At December 31, 2004,2005, we had a deferred tax asset of US$22.510.4 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 ana full allowance for substantially all the value of the aggregate net deferred tax assetassets as a result of those uncertainties.

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 Republic of China Income Tax Law,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%10 percent retained earnings tax. This rule applies primarily to our broadband ISP business and our music distribution businessonline casual games portal whose principal operating entities are incorporated under Taiwan law.

The majority of our entertainment software 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 are 34 percent and 6.3 percent, respectively. Our operations in the United States did not, and are not expected to, have a significant tax impact on the Company’s consolidated financial statements.

C. Research, Development and Intellectual Property

We make significant investments in research and development to keep pace and remain competitive with technology advancements and product development relating to our entertainment software business. Accordingly approximately 50% ofbusiness and our workforce in the entertainment software business is comprised ofonline casual games portal. We do not believe our expenditure for research and development personnel. While we regard our intellectual propertyfor 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.2004 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 2004.2005. 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 arrangementsOff-Balance Sheet Arrangements

We currently do not engage in any off-balance sheet arrangements.

F. Tabular disclosureDisclosure of contractual obligationsContractual Obligations