October 27, 2006
VIA FACSIMILE AND EDGAR
- -----------------------
Ms. Kathleen Collins
Accounting Branch Chief
Division of Corporation Finance
Mail Stop 7010
Securities and Exchange Commission
100 F Street N.E.
Washington, D.C. 20549
RE: GigaMedia Limited (File No. 000-30540)
Form 20-F for the Fiscal Year Ended December 31, 2005
Form 6-K Filed on March 24, 2006
Form 6-K Filed on May 17, 2006
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Dear Ms. Collins:
On behalf of GigaMedia Limited, a company limited by shares,
incorporated under the laws of the Republic of Singapore (the "Company"), set
forth below are the Company's responses to the comments of the staff of the
Securities and Exchange Commission (the "Staff") to the above-referenced Form
20-F (the "2005 20-F") and Forms 6-K of the Company set forth in your letter
dated October 4, 2006 (the "Comment Letter"). For the convenience of the Staff,
each comment in the Comment Letter is reprinted in bold and italics and is
followed by the corresponding response of the Company. Capitalized terms used
herein and not otherwise defined shall have the meaning given to them in the
Company's response letter dated September 5, 2006.
Ms. Kathleen Collins
October 27, 2006
Page 2 of 10
Form 20-F for the Fiscal Year Ended December 31, 2005
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Report of Independent Registered Public Accounting Firm, page F-2
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1. We note your response to our prior comment no. 1. Tell us when the
amendment will be filed. Also, confirm that PricewaterhouseCoopers is
reissuing their opinion.
As set out in the first paragraph of the Company's response letter of
September 5, 2006, and as discussed in the telephone conversation of
Alec P. Tracy, Esq. of Skadden, Arps, Slate Meagher & Flom LLP with
Ms. April Coleman, the Company plans to file an amended Form 20-F once
all comments are resolved, in order to avoid multiple amendments that
may confuse investors.
The Company further advises the Staff that in connection with the
initial filing of the 20-F, PricewaterhouseCoopers ("PwC") had
delivered to the Company a duly signed audit report. However, due to a
clerical error, the signature of PricewaterhouseCoopers was omitted
from the Edgar version of the 20-F. In that regard, the Company also
respectfully refers the Staff to PricewaterhouseCoopers's consent,
that was filed as Exhibit 15 to the 20-F, in which PwC consented to
the incorporation by reference of its report into the Company's
registration statement on Form S-8.
PricewaterhouseCoopers has advised the Company that PwC will reissue
its report on the consolidated financial statements of the Company as
of December 31, 2004 and for each of the two years ended December 31,
2004 and 2003, which was dated May 26, 2005, except as to the change
in presentation basis for the discontinued operation as described in
Note 1, which is as of December 9, 2005. PricewaterhouseCoopers will
also furnish a consent, to be dated concurrently with the filing of
the 20-F/A, in which PwC will consent to the incorporation by
reference of its report into the Company's S-8.
Consolidated Statements of Operations, page F-5
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2. We note your response to our previous comment no. 3 and your breakdown
of cost of revenues for the Company's entertainment and online
business. We further note your discussion of UIM's Web site operators
("partners") on page 20 of your response, where you indicate that the
partners typically earn from 20% to 25% of the net gaming revenues.
Notwithstanding your response
Ms. Kathleen Collins
October 27, 2006
Page 3 of 10
to our FIN 46R comment below, tell us how you account for the amounts
paid to partners including how you account for the "negative balances"
incurred by certain partners when the players' winnings exceed their
losses. Given the pricing structure paid to your partners and assuming
UIM incurs other costs in addition to the partner fees, please explain
the 13.9% and 14.7% cost of revenues for your entertainment and online
business in fiscal 2004 and 2005, respectively.
The amounts paid to the Web site operators (or "Partners") represent a
referral fee or sales commission, which UIM pays to Partners who
provide URLs or links on the Partners' websites to the UIM website in
order to attract players and promote gaming volume. The Company
believes the sales commissions paid to the Partners is more
appropriately classified as a selling and marketing expense and not as
cost of revenues, since Partner involvement is limited to providing
the website link.
Below is an analysis of the selling and marketing expense line items
and the ratio of Partner sales commissions to total revenue of the
entertainment software business segment:
------------------------------------------------- -- ------------------- -- -------------------
| Account Descriptions | | Year ended 2004 | | Year ended 2005 |
| -------------------------------------------------|--|-------------------|--|-------------------|
| Partner commission expenses of the
entertainment software business segment | | $2,582,633 | | $5,560,940 |
| -------------------------------------------------|--|-------------------|--|-------------------|
| All other sales and marketing expenses of the
entertainment software business segment | | 862,115 | | 2,481,293 |
| -------------------------------------------------|--|-------------------|--|-------------------|
| Total selling and marketing expenses of the
entertainment software business segment | | 3,442,749 | | 8,042,233 |
| | | | | |
| -------------------------------------------------|--|-------------------|--|-------------------|
| Total software licensing and online | | $11,433,803 | | $22,511,460 |
| entertainment revenue per the financial | | | | |
| statements | | | | |
------------------------------------------------- -- ------------------- -- -------------------
Ms. Kathleen Collins
October 27, 2006
Page 4 of 10
------------------------------------------------- -- ------------------- -- -------------------
| Account Descriptions | | Year ended 2004 | | Year ended 2005 |
| -------------------------------------------------|--|-------------------|--|-------------------|
| Partner commissions of the entertainment | | 23% | | 25% |
| software business segment as a % of total | | | | |
| software licensing and online entertainment | | | | |
| revenue | | | | |
------------------------------------------------- -- ------------------- -- -------------------
Partner commission expenses that are generated from the Company's
online casino operations are recognized when end-users place wagers
and are based upon a percentage of the resulting net house win. These
commission expenses are classified as selling and marketing expenses.
If, however, the house loses, the Partner loses its entitlement to a
commission from the transaction resulting in a "negative balance" or
negative commission; this negative commission is calculated using a
percentage that is consistent with that applied to net house wins, and
is recorded as a reduction of selling and marketing expenses in the
period the transaction (the "net house loss") is incurred. Partner
commission expenses relating to the Company's online multi-player
poker platform are recognized when games are played and are based upon
a percentage of the transaction fees charged to end users, which are
independent from house risks. Accordingly, negative partner
commissions do not occur within the multi-player poker platform.
The Company also advises the Staff that instances of net houses losses
are uncommon, which explains why negative commission expenses from
individual partners were not material in relation to total Partner
commission expenses. Negative commission expenses were approximately
$53,000 and $92,000 for the nine months ended December 31, 2004 and
for the full year ended December 31, 2005, respectively.
Note 3. Variable Interest Entity, page F-17
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3. We note your response to our previous comment no. 3. Please note that
we have not yet concluded as to whether the UIM is within the scope of
FIN 46R and we are still analyzing your response as to whether the
partners are variable interest holders pursuant to paragraph B22 of
FIN 46R. Regardless, we disagree with your conclusions as to which
party (if any) is the primary beneficiary in this arrangement.
Therefore, with regards to your analysis of the primary
Ms. Kathleen Collins
October 27, 2006
Page 5 of 10
beneficiary, please explain the following:
o In your analysis of whether UIM is a VIE (page 19 of your
response) you indicate that the expected losses for the
software licensing contract period are US$4.173 million. Does
this represent the expected losses for the entire contract or
just UIM's equity investor's share of the expected losses? In
this regard, we note your analysis of the primary beneficiary
on page 21 of your response, where you indicate that the
expected losses are US$6.766 million. Please explain.
o You indicate that considering the fact that UIM's equity at
risk was only US$250,000, which was insufficient to absorb
the expected loss as calculated, UIM's equity investor was
deemed not the primary beneficiary. Please note that the
expected losses are only limited to the equity at risk in
determining whether UIM is a variable interest, not in
determining whether UIM is the primary beneficiary. Please
explain.
o We further note that the Company concluded that CESL was the
primary beneficiary. Pursuant to paragraph 14 of FIN 46R,
however, an enterprise that will absorb a majority of the
entity's expected losses, receive a majority of the entity's
expected residual returns, or both shall consolidate a VIE.
According to the Company's analysis, however, you absorbed
only 38.3% of the total expected losses, which does not
constitute a majority (greater than 50%) as contemplated by
FIN46R. Therefore, it appears based on your analysis that the
Company would be the primary beneficiary. Please explain.
We acknowledge that the Staff have not yet concluded (i) whether UIM
is within the scope of FIN 46R; and (ii) whether the partners are
variable interest holders pursuant to paragraph B22 of FIN 46R. We
would be pleased to provide further explanation and support and to
discuss additional questions from the Staff on these two points via a
conference call, if the Staff believes that such a dialogue would be
helpful to their review.
Ms. Kathleen Collins
October 27, 2006
Page 6 of 10
The following are our responses to the more detailed questions raised
by the Staff in the three bullet points contained in Comment 3:
In response to the first bullet point of the Staff's Comment 3, the
Company submits that the expected loss of $4.173 million (as stated on
page 19 of our previous response) was intended to represent UIM's
equity investors' share of expected loss, whereas on page 21 of our
previous response letter, the expected loss of $6.766 million was
intended to represent the expected losses of all variable interests of
UIM combined. The Company would like to clarify that the original
$6.766 million expected losses was calculated under the assumptions
that UIM has sufficient capital to absorb the expected losses and was
able to fulfill the 45% royalty payment obligation due to CESL.
However, as indicated in our previous response, UIM's equity
investors' capital contribution was only $250,000 and UIM was
considered insufficiently capitalized. Consequently, UIM's equity
investors' variable interest (i.e. their contributed capital) in UIM
would only absorb expected losses up to the fair value of the net
equity, or "equity at risk"; This also limits UIM's ability to pay the
45% royalty obligation due to CESL, thereby, reducing the estimated
cash flows to be allocated to each variable interest holder. We
estimated the fair value of the net equity of UIM to be $637,000 based
on the probability of occurrence of various projected revenue and cost
and expense scenarios. As a result, the remaining expected losses must
be absorbed by the Company through the software and licensing
agreement. Taking UIM's lack of sufficient capital into consideration,
the total expected losses would be reduced and the related allocation
between UIM equity investors and CESL would be revised as follows:
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| (in USD | | | | | | |
|thousands, | Total | | UIM | | | |
|except | expected | % | equity | % | CESL | % |
|percentage | losses | | investors | | | |
|figures) | | | | | | |
|------------------|-------------|------------|-------------|------------|---------------|------------|
|Revised | | | | | | |
|expected | $(4,702) | 100% | $(313) | 6.7% | $(4,388) | 93.3% |
| losses | | | | | | |
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The revised quantitative analysis outlined above is supported by a
detailed quantitative analysis that uses historical metrics and
financial
Ms. Kathleen Collins
October 27, 2006
Page 7 of 10
forecasts for the life of UIM that can be reasonably estimated based
on its existing business operations and relationship with CESL. Our
analysis focused on the expected loss and returns derived from the
variability of UIM's net assets, which primarily concentrates on three
elements: gross receipts, winning payout and commission payments to
various marketing partners. Each of the three elements has 13
different scenarios. In aggregate, the Company developed 2,197
scenarios (i.e., 13 x 13 x 13). For each of the cash flow scenarios,
the expected losses and expected returns are then allocated to the
variable interest holders, based on seniority and their respective
ability to absorb the expected losses. The following table reflects 5
scenarios (out of the 2,197 scenarios) to illustrate how expected
losses are allocated to UIM equity investors and CESL.
Expected
Estimated cash
(in USD cash flows flows to
thousands, to be be Difference - UIM
except allocated allocated estimated Probability equity UIM equity CESL's share CESL's
percentage to variable to losses investor's investor's of estimated expected
figures) interest variable share of expected losses losses
holders interest estimated losses
holders losses
----------- ----------- ------------ ----------- ----------- --------------- --------------- --------------
A B C = A - B D E F = E x D G H = G x D
- -------------- ----------- ----------- ------------ ----------- ----------- --------------- --------------- --------------
1.1.1 $11,881.28 $50,509.2 $(38,627.92) 0.0003% $(637) (0.0021) $(37,990.92) (0.1282)
1.1.2 14,009.94 50,509.2 (36,499.26) 0.0008% (637) (0.0050) (35,862.26) (0.2824)
1.1.3 16,138.59 50,509.2 (34,370.61) 0.0012% (637) (0.0079) (33,733.61) (0.4175)
1.1.4 18,267.25 50,509.2 (32,241.95) 0.0017% (637) (0.0107) (31,604.95) (0.5333)
1.1.5 20,395.90 50,509.2 (30,113.30) 0.0023% (637) (0.0143) (29,476.30) (0.6632)
... ... ... ... ... ... ... ... ...
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Subtotal $(313.3497) $(4,388.4523)
=============== ==============
Expected losses as a percentage of total 6.7% 93.3%
Ms. Kathleen Collins
October 27, 2006
Page 8 of 10
In the second bullet point of Comment 3, the Staff indicates that "the
expected losses are only limited to the equity at risk in determining
whether UIM is a variable interest, not in determining whether UIM is
the primary beneficiary". The Company acknowledges and agrees with the
Staff's comment that "equity at risk" is used to evaluate whether UIM
qualifies as a variable interest entity. However, the Company believes
the characteristics of an insufficient equity investment would impact
the allocation of expected losses and ultimately, the determination of
primary beneficiary, to the extent the equity is not protected. Since
UIM's equity is not protected, UIM's equity investors are exposed to
the expected losses, to the extent of UIM's equity at risk, and
expected returns of the entity. In other words, UIM's equity investors
as a group are obligated to absorb the expected losses on a
first-dollar basis until the equity is depleted. For example, in
Scenario 1.1.1 above, UIM generates $11,881 thousand of cash flows,
which is well below the expected cash flows of $50,509.20 thousand.
The "loss" (or the shortfall from the expected cash flow) in this
scenario of $38,627.92 thousand is first allocated to UIM's equity
investors in the amount of $637,000, which is equivalent to the amount
of "equity at risk". The remainder of the shortfall (i.e., $37,990.92
thousand) is allocated to the other variable interest holder, which is
CESL. This same methodology is repeated for each of the scenarios
(totaling 2,197 scenarios). The expected losses and expected returns
allocated to each variable interest holder are probability-weighted
and totaled, resulting in total expected losses for UIM's equity
investor of $313.3497 thousand and for CESL of $4,388.4523 thousand.
In response to the third bullet point of Comment 3, the revised
expected loss percentages presented in the table above for the UIM
equity investors and CESL are 6.7% and 93.3%, respectively. Because
CESL absorbed the majority (greater than 50%) of UIM's expected
losses, the Company concluded that CESL is the primary beneficiary and
should consolidate UIM.
4. Please keep in mind that based on the Company's response to our FIN
46R comment, we may have additional comments with regards to your
previous responses to the Staff's other comments (i.e. revenue
recognition, Item 4.B disclosures, etc.).
The Company notes the Staff's comment and will await further comments
on that issue.
Ms. Kathleen Collins
October 27, 2006
Page 9 of 10
* * * *
Ms. Kathleen Collins
October 27, 2006
Page 10 of 10
We would be pleased to provide further explanation and
support on Comment 3 and follow up on any additional comments and questions
that the Staff may have. In that regard, the Company and
PricewaterhouseCoopers, would be happy to arrange a call with the Staff at the
Staff's convenience.
If you have any questions regarding the responses to the
Staff's comments, or require additional information, please contact the
undersigned at (886) 2 3518 1101 or Alec P. Tracy in Skadden Arps' Hong Kong
office at (852) 3740 4710. You may also contact Skadden, Arps' New York Office
at (212) 735 3000 and ask to be transferred.
Sincerely,
/s/ Arthur M. Wang
Chief Executive Officer
cc: Alec P. Tracy, Esq.
Skadden, Arps, Slate, Meagher & Flom LLP
Thomas T. Hui
Chief Financial Officer
GigaMedia Limited