聯華電子 (UMC) 2006 Q4 法說會逐字稿

Welcome to the UMC fourth quarter 2006 earnings results conference call.

This is Michelle, the moderator for this conference call. [OPERATOR INSTRUCTIONS].

For your information, this conference call is now being broadcast live over the Internet.

A replay of the call will be available at www.umc.com under the Investor Relations/Investor Events section through Tuesday, April 3, 2007.

Also, a telephone replay of the call will be available from 10.00 am New York time, and will run until midnight on February 8, 2007.

To access the replay, please call 888-286-8010 or 617-801-6888.

If you are calling from outside the U.S., the access code will be 53065078 any time during this period.

I would now like to turn the conference over to Mr. Chitung Liu of UMC.

Please proceed, sir.

Thank you, Michelle.

Welcome and thank you for attending our fourth quarter earnings conference call.

We are hosting this conference call from Taipei and here to help report our results are Dr. Jackson Hu, Chairman and CEO of UMC, and Mr. Bowen Huang, Senior IR Manager.

Later on, we will first review our financial results for the fourth quarter and full year 2006, and then Dr. Hu will update our business and forward-looking guidance, followed lastly with the Q&A session.

Before beginning this presentation, I would like to remind everyone about our Safe Harbor policy.

That is, certain statements made during the course of our discussion today may constitute forward-looking statements, which are based on management's current expectations and beliefs and are subject to a number of risks and uncertainties that could cause actual results to differ materially, including risks that may be beyond the Company's control.

For this reason, please refer to UMC's filing with the SEC in the U.S. and the ROC security authorities.

Now, I would like to provide a short summary of our results for the fourth quarter of 2006.

Quarter-over-quarter revenues decreased by 6.2% to TWD26.1b and a 5% year-over-year increase compared to fourth quarter in 2005.

Gross profit for the quarter was TWD5.5b, representing a 20.9% gross margin.

Operating profit was TWD1.4b, which operating margin of 5.3% for this quarter.

Net income was TWD5.7b, which decreased by 33.8% quarter-over-quarter, but increased 86.9% compared to net income in Q4 2005.

EPS for the quarter was TWD0.33 and earnings per ADS were US$0.051.

For year 2006, year-over-year revenues increased by 14.7% to TWD104b.

Gross margin and operating margin for 2006 were 19.9% and 5.9% respectively, compared to 12.3% and -3% in 2005.

Net income for 2006 was TWD32.6b, an increase of 364.2% year-over-year.

The full year EPS was TWD1.81, and earnings per ADS were US$0.278.

You can look for more details within the financial data that accompany our press release today.

Now, let me turn over the call to Jackson and he will provide you with the business update and outlook for the first quarter in 2007.

Thank you, Chitung.

Hello, everyone, and thank you again for joining us today.

As always, we appreciate your interest in UMC.

First, I'm going to spend a few minutes to share our industry overview with everyone.

Generally, we believe that the foundry market will experience milder growth in 2007.

The inventory correction is ongoing in the first quarter of 2007, but it should come back smoothly in the second quarter.

Most of our customers are expecting demand to be strong in the second half.

The latest industry trend is the acceleration of IDMs adopting a fab-lite and fabless strategy.

Some have decided to shut down part of their internal staff and use foundries.

Some have ceased investing in manufacturing capacity for advanced processes, while others have stopped advanced process technology development and have focused their resources on product designs.

We believe that this is a positive industry trend and a win-win situation for both IDMs and foundries, and a strong endorsement of foundry R&D capabilities.

In recent years, UMC has successfully developed 90 nanometer and 65 nanometer products through joint efforts between our R&D teams and our IDM and fabless customers.

With 45 nanometer development now progressing smoothly, we anticipate an even closer partnership with our IDM customers and partners for advanced technology development, and this will clearly contribute to our long-term growth prospects.

Secondly, the capital reduction plan that we recently announced is another topic that has generated great interest.

We decided to carry out this capital reduction after careful evaluation.

We have determined that the cash flows generated from UMC's future operations will be sufficient for the continued expansion of advanced manufacturing capacity, including our second 300 millimeter fab in Taiwan's Tainan Science Park.

Some media and investment analysts have speculated that our capital reduction is in preparation for a buyout of UMC by private equity funds.

Our answer to this speculation is a clear and emphatic no.

Although it is straightforward, we plan to return cash to our shareholders, so that they can use that for their own investment purposes.

This move is in line with the current capital markets trend.

Furthermore, with the reduced total number of shares, EPS will improve.

As for our business outlook, over the past three years we have concentrated our efforts on the development of advanced process technology and the improvement of product yields.

This enabled us to expand our customer portfolio and significantly increase our 300 millimeter utilization, surpassing 90% utilization in Q3 of 2006.

When demand picks up again later this year, we expect to experience similar positive results.

The number one goal for everyone within UMC is to greatly increase capacity utilization, to improve the Company's profits.

Continuous progress for advanced technology will also help further extend our customer base and increase utilization rates.

We also see the improvement on costs as all six 8 inch fabs in Hsinchu will be fully depreciated by the end of 2007.

As long as we strategically time our capacity expansion, we will see the [inaudible] rewards.

I believe that with our cost interaction, income from our operations will account for the majority of our revenue in coming years.

Now, let me provide you the guidance for first quarter 2007.

Wafer shipments are expected to decrease by 5 to 6%.

Wafer ASP, in U.S. dollars, is expected to decrease by 5 to 6%.

The capacity utilization rate will be approximately 70%.

As for profitability, approaching operating breakeven point.

The percentage of revenues from 90 nanometer and below is expected to exceed 20%.

Sales breakdown by the three major applications remains unchanged; the communication segment is expected to remain the largest, followed by consumer and then the computers.

Our 2007 CapEx budget will be within the range from US$1b to US$1.2b.

Now, I will turn the call over to the Operator and we will begin the Q&A session.

[OPERATOR INSTRUCTIONS].

And our first question comes from the line of Robert Maire of Needham.

Please proceed.

Yes.

Could you give us a little more detail as to your utilization rates, perhaps by geometry or a little bit more granularity?

And when will you expect utilization to bottom?

Are we assuming, or should we assume, that it's bottoming here in the first quarter, beginning of the first quarter, end of the first quarter, or what's your sense of that?

Yes, let me answer your second question first.

Yes, we expect that the utilization will be at the bottom in this quarter, and then it will start to increase in Q2.

And the capacity utilization rate by technology, the more mature technology will be better than the average.

The advanced technology will be below average.

Okay.

Are you seeing less take-outs of product at the leading edge, or the take-outs picking up, or --?

No, the take-outs of the advanced technology, including 90 nanometer and 65 nanometer, continues.

Okay.

And one follow-up question in terms of you mentioned IBM going to a fab-lite strategy.

Do you have any view as to what that means to UMC in terms of revenue, or potential revenue, or is there any way to quantify that further?

At this moment, it's a little early to quantify, but in general we believe that we will have more foundry business coming to UMC.

And we have been discussing with [multiple] of them.

Okay, thank you.

And our next question comes from the line of Mark Fitzgerald of Banc of America Securities.

Please proceed.

Thank you.

Can you give us some idea of what the CapEx budget for this year is going to be used for?

It will be mainly used for 12 inch capacity and 12 inch R&D.

As mentioned in our report, you can see 81% will be for 12 inch fab, 16% for R&D, so that adds up as 97%.

Only 3% will be for maintenance for 8 inch fabs.

Okay.

And then can you give us some idea, currently, how your business breaks out between IDMs and fabless companies, and with them, how you might expect that to go over the year?

I think for last quarter the percentage for fabless accounted for 63% and 37% for IDM.

And moving forward, we expect that percentage probably will increase for IDM.

When getting into the second half, the IDMs tend to increase their demand strongly.

Thank you.

And our next question comes from the line of Steven Pelayo of HSBC.

Please proceed.

Yes, a couple of questions, first on your gross margin.

There's two areas I want to look at.

Your depreciation was down about 9% quarter-over-quarter.

Could you just talk a little bit about the profile of that depreciation over 2007, your full-year expectation for depreciation?

And then secondarily, the other component of gross margin is your variable gross margin, excluding depreciation.

That looks like that was up quite a bit.

Was it just increasing material costs, or more scrap?

How should I be thinking about that?

This is Chitung, and our depreciation expenses for 2007 is likely to be 10% less than that of full year 2006.

And from 2008, the depreciation expenses will start to increase a little bit because of more content in 12 inch wafer fabs.

As for variable costs, we haven't really looked into the breakdown yet, but in Q4 they are a little bit more bonus for our employees.

At least that's part of the reason.

As for the wafer, prime wafer, the price has increased by average about 5% also, but it's quite an insignificant part of our overall costs.

So it may be a combination of the two factors I just mentioned.

Okay.

Then just one other question here.

There was some feedback, I guess, from the earlier meeting today, talking a little bit about the profile of 2007 and the recovery off of you're down, roughly, about 10 or 11%, I guess, for the March quarter.

If you still think we've got some slight growth, if you will, in 2007, that suggests either a pretty rapid snap back in the second quarter.

It seemed like the feedback I was hearing was you guys were thinking more of a modest recovery off of the 1Q level, and just a much stronger second half.

Is that the way I should understand it, it's just being a much more back-end loaded year?

Actually, we need more time for Q2.

This industry, as you can -- we all experienced in the past, it can change very rapidly.

Okay, sure.

Currently, Q2 indicates a steady return.

Okay.

And then maybe my last question is just there seems to be a lot of discussion out here about potential pricing pressures on the leading edge, and there is some speculation that maybe UMC would be at greater risk of it, as SMIC and Chartered potentially come more aggressively at you guys.

Could you talk a little bit about the pricing pressure, primarily at the leading edge?

As far as the [inaudible] is concerned, I believe it's due to our good yield.

Our prices should be very reasonable, so what you described may not be true.

Okay.

I'm sorry, I had one other final question.

The non-operating income line, could you help us think about that a little bit, the profile of 2007, your expectations for the first quarter?

That's my last question.

No, we don't have any set target or plan for the whole year 2007.

As far as for Q1 2007, we don't have any active plan to dispose of our non-core assets.

So for analyst modeling purpose, we think it's okay to put in a zero non-operating income for Q1 2007.

Okay, great, thank you.

And our next question comes from the line of Arnold Lu of Goldman Sachs.

Please proceed.

Hi, it's Donald Lu here.

Good evening, Jackson and Chitung.

The first question is it looks -- seems like in Q1 your 90 nanometer revenue still represents over 20% of total sales, similar to Q3.

Why does the ASP decrease so much?

We did point out last time that the 0.13 micron node has some drop in terms of total percentage by technology.

Also, the overall revenue, actually, also, there is a fall.

Revenue is coming down.

So even though it's a similar percentage, still in absolute terms, it's still coming down.

Right, but the ASP is a function of product mix and the overall pricing pressure.

I'm just trying to figure out which part is playing a major role here.

So you're referring that the 0.13 micron revenue will continue to decline more than the overall revenue decline in Q1?

It seems in Q1 that is the case.

It may change in Q2.

Is that because customers are migrating to 90 nanometer, or is that a function of inventory correction?

Both, actually both.

Okay, great.

And also in Q4, from your reported results, it seems like the weakening you see from IDM customers in the U.S. are in the consumer area.

So can you elaborate which kinds of products really you're seeing weakness in Q4?

Well, the weaker spot in Q4, including MP3, if you want to categorize by products, but in the communications segment we do see some customers performing well, but some customers may go through some kind of inventory correction.

So if you are talking about particularly in consumer segment, we can identify MP3 as one of the weaker ones.

Okay.

Another question is on the tax rate.

If we're excluding any non-investment gains in '07, what kind of tax rate should we be using?

On the core profit, i.e. profit from the core operations, we do expect the tax rate of 5 to 8% to be the range for 2006, as well as 2007.

However, we have a bigger component of non-operating income in 2006 which is a straight 10% minimum tax, so that's why our blended tax rate in '06 is a bit higher than 5 to 8%.

In fact, it's about 9%.

Yes.

Talking about the recovery, based on your customers' feedback, which segments do you expect to see recovery first at this point?

Probably communications, especially wireless.

And last question is, for your advanced technology capacity right now, how much percentage is capable of doing -- for your total 12 inch capacity, how much is capable of doing 90 and how much it was doing 65?

Can we answer you in a different way?

Let me give you the overall breakdown by technology and you can actually calculate by the fab capacity data we've provided in the quarterly report.

Basically, by end of '06 we had roughly 2% of capacity available to do 65, 15% available to do 90, and 17% available to do 0.13.

By the end of --

Sorry, what [multiple speakers]?

Sorry?

Yes, sorry, I missed how much for 0.13?

0.13 is roughly 17%, one-seven.

Thank you.

Sorry for that.

And by end of '07, with our current CapEx budget, we expect to see about 3% of capacity to be capable of 65, 19%, one-nine, to be capable of doing 90, and 16% will be able to do 0.13.

Great.

Thank you very much.

Thank you.

And our next question comes from the line of Gavin Duffy of AG Edwards.

Please proceed.

Thanks a lot.

A lot of my questions have already been answered, but maybe you can clarify just a little bit.

When you say that there is still an inventory correction going on in Q1, is that mostly consumer or is that communications?

Both.

Both?

Okay.

And then the communications, you said it's going to -- it's wireless that's still clearing it out?

Yes, but in the meantime I have to point out some wireless customers actually have very strong demand, so it depends on who you talk about.

Okay, no, that's fair.

And obviously you're talking about getting utilization rates back up, so I guess your CapEx is going to be pretty heavily weighted towards the back half of the year?

Yes.

Is all the CapEx going to be used for technology buys, as opposed to capacity?

If you are referring to 65 capable capacity, yes, mostly.

Some R&D [may even fall] 45.

That's correct.

Okay.

Thank you very much.

And our next question comes from the line of Ivan Goh of Dresdner Kleinwort.

Please proceed.

Hi, good evening, a couple of questions.

The first one is the utilization guidance of 70%, is that based on installed capacity or available capacity?

Available capacity, which is installed capacity minus maintenance, roughly 5%.

Okay.

The second question is can you perhaps give some idea of what kind of capacity growth will you have for the full year of 2007?

Based upon the current CapEx, it's roughly 8%.

And most of that will come up in the second half, I presume?

Yes, it's more weighted in the second half.

But Q1, as you can see, we're already getting about 3% Q-O-Q growth in capacity, compared to Q4 of last year.

Okay.

And can you perhaps detail how much of your revenues in the fourth quarter of Q4 was 65 nanometer and how much of that will be 65 nanometer in the first quarter, and in the fourth quarter of '07?

Certainly I think for 90 nanometer in the smaller geometry, it accounted for 21%, in which 1% was for 65 -- 2%, excuse me. 2% was for 65.

That was Q4.

In Q4?

Yes.

And what kind of upward trend would you expect?

Maybe can you give an idea what you think it would be by the fourth quarter of '07?

Well, it's a little too early to forecast that.

Okay.

Can you talk about what kind of R&D you expect in the first quarter?

There was a sharp jump in the fourth quarter.

What do you think it would be in the fourth quarter, and if you can help, what kind of budget do you have for R&D for the full year of '07?

For the overall SG&A, including R&D, Q4 generally we will have higher bonus expenses and -- as we're approaching to the year end.

At the same time, Q4 we have a little bit more R&D wafer running.

In Q1, the overall SG&A expense, including R&D, should be a small drop, maybe in between the level of Q3 and Q4.

Okay.

Well, that's it for now.

I'll come back if I have other questions.

Thank you.

Thank you.

And our next question comes from the line of Pranab Sarmah of Daiwa Securities.

Please proceed.

Good afternoon.

I have a couple of questions.

Could you give us a little bit of color on how the monthly sales will look like from now onwards, as and when we move towards the second quarter?

February, because of less working days, certainly will be the bottom in Q1.

We already see a recovery starting from March and, again, we will report our January numbers tomorrow.

Okay.

So January will continue to decline and it will reach a bottom in February, then you will see a recovery from March, right?

Yes.

That's our current expectation.

Current expectation?

Okay, fair enough.

And a second one is on your 65 nanometer.

You said that only 3% of your capacity by end of the year will be 65 nanometer.

No, that's 2%.

Yes, 2% for Q4.

No, at the end of 2007 how much it will be?

3%.

3%?

Okay.

And any capacity on 45 nanometer by end of 2007?

There will be definitely capacity for R&D.

Only for R&D?

Yes.

Okay.

And onto last quarter, if you say you got quite a good order from communication customers.

Despite that, your product mix has deteriorated quite rapidly on fourth quarter of '06.

Any particular reason behind that, like whether your computer-related customers' product mixes are deteriorating, or consumer-related customers' product mix are deteriorating?

Could you give us some color there?

Actually, some large communication customers started inventory correction in December.

So that means that product mix deterioration in fourth quarter was mainly due to the communication customers' product mix deterioration?

That's probably the largest.

Largest one?

Okay.

Thank you very much.

[OPERATOR INSTRUCTIONS].

And our next question comes from the line of Steven Pelayo of HSBC.

Please proceed.

Yes, just one more question on your capital spending.

It looks like you're talking about flat to up in 2007.

You just grew about 15% in '06.

I think you're at 8% capacity growth in '07, if I heard you correct.

You're running at 70% utilization rate, and you're only talking about mild growth.

I guess I'm trying to figure out why being so aggressive with flat to up CapEx and such aggressive capacity plans when you're running at a lower utilization rate and only talking of mild growth this year.

Well, the demand for the advanced technology, demand forecast, will be very strong for the second half.

So [we base our effect] on customers' forecasts that we plan for the capacity expansion.

Okay, fair enough.

Thank you.

And our next question comes from the line of Randy Abrams of Credit Suisse.

Please proceed.

Yes.

I wanted to ask one more question on the mix.

Your revenue from Asian customers rebounded well in the fourth quarter.

I wanted to see what's your expectation, if you expect that to continue growing faster than the Company average or if it'll grow in absolute terms heading into the first quarter?

Can you repeat your question, please?

Yes.

The question related to revenue by geography.

Percent from Asia increased significantly in the fourth quarter.

I wanted to see your sense for the first quarter, if you expect that rebound from Asian customers to continue to grow in absolute terms or as a percent of revenue.

Okay, I got it.

Yes, your statement is correct.

We expect the Asia contribution to be stronger in Q1.

Okay.

A second follow-up on -- you mentioned about the IDMs in your prepared remarks about a positive on the outsourcing.

Could you talk about, for UMC on the R&D, if you anticipate over medium term any need to scale up investment in R&D, if some of your IDM customers stop some of their internal process development?

Actually, for the near term we don't have to.

We have been purchasing equipment for R&D in the past, doing 45 nanometer and 32 nanometer even.

And moving forward that may change but, at least in the near term, like this year, we don't expect to see that happen.

Okay.

And one final question on the operating -- or the non-operating investment income.

I think you mentioned a starting point as we can model zero for first quarter.

Is that part of a change in strategy, at least over the next few quarters, that that's going to slow down significantly?

Or do you expect to at least, on a quarterly basis, to start getting those reasonable streams coming in?

Is it a one-quarter blip now?

No.

Basically what we said was Q1 we don't have any active or aggressive plan to dispose our non-core assets, so that's why for modeling reasons it's okay to put in zero.

However, to gradually dispose of our non-core assets is our set policy, although we don't have a timeline or a target, so we will continue to do that through the rest of the year.

It's just for Q1 and Q2, the Chinese New Year holidays and we just don't have any plan for now.

Okay.

Thanks a lot, guys.

Thanks.

And gentlemen, at this time, I'm currently showing we have no further audio questions.

Okay.

So now we will conclude our call and thank you again for joining.

If you have any further questions, please do not hesitate to contact us directly.

And now back to you, Michelle.

Thank you, sir.

A link to the replay of this call will be available until the end of Tuesday, April 3, 2007, on the Investor Relations section of our website.

A dial-in version of the replay can be accessed by calling 888-286-8010 if you are in the U.S., or at 617-801-6888 for international callers.

The dial-in replay will be available until midnight on February 8, 2007.

The access code is 53065078.

If you have any additional questions, please feel free to contact us directly.

Thank you all again and good day.