聯華電子 (UMC) 2008 Q2 法說會逐字稿

Welcome, everyone, to UMC's 2008 Q2 earnings conference call.

(Operator instructions).

Today, I would like to introduce Mr.

Chitung Liu, CFO of UMC.

Mr.

Liu, you may begin.

Thank you, and hello to everyone.

This is Chitung.

We are happy to -- that you could join us for today, for our conference call.

We are hosting this conference call from Taipei, and with me here are Dr.

Shih-Wei Sun, CEO of UMC, and Mr.

Bowen Huang, Senior IR Manager.

During today's conference call, we will first review our financial results for the second quarter in 2008.

Then Dr.

Sun will provide UMC's future direction, after he's on board as CEO.

Then, an update on our business and forward-looking guidance, followed lastly with a Q&A session.

Before beginning this presentation, I would like to remind everyone of 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 these risks, please refer to UMC's filings with the SEC in the US and the ROC Securities Authority.

For the second quarter in 2008, revenue was TWD 25.2 billion, representing a 5.1% quarter-over-quarter increase, from TWD 24 billion in Q1 2008, and a 0.6% year-over-year increase, from TWD 25.1 billion in second quarter 2007.

Gross profit for the quarter was TWD 5.8 billion, or 23% of revenue, compared to TWD 3.6 billion, or 14.9% of first quarter '08 revenues.

Operating profit was TWD 2.3 billion, or 9.3% of revenue, compared to TWD 190 million, or 0.8% of first quarter '08 revenue.

Net income was TWD 2.4 billion in 2008 second quarter, compared to a net income of TWD 206 million in Q1 '08.

EPS for the quarter was TWD 0.19, and earnings per ADS were US $0.032.

You can look for more information within the financial data that accompanied our press release today.

Now, let me turn the call over to Shih-Wei, and he will provide you with UMC's direction, the business update, and outlook for the third quarter of 2008.

Shi-Wei, please.

Thank you, Chitung.

Hello, everyone, and welcome again to our conference call, and thank you for joining us today.

As always, we appreciate your interest in UMC.

During this conference call, I will begin with a brief introduction on the direction of the Company, and then provide you with a brief summary of our operating results of the second quarter.

You all should have seen our press release by now, so I'm going to keep these remarks short.

Following this, we will leave the rest of the time for your questions.

To begin with, we have been facing strong headwinds, due to the global macroeconomic situation.

We saw subprime issues in the U.S., high inflation from oil and the material price increase, and the weakening U.S.

dollar, all leading into the potential concern of a stagflation in the macroeconomy.

These challenges have led us to have a more conservative outlook for the upcoming quarter.

Now let's look at the UMC situation.

UMC is in a leading foundry position.

There are four pillars that UMC needs to sustain to be a successful foundry.

They are, first, independent R&D capability.

For example, UMC's 45 and the 40 nanometer is now at the pilot and qualification stage.

The progress on 32 and 20 nanometer is also quite good.

The second item is on manufacturing excellence.

The third item, dedicated employees.

And the fourth item, strong financial structure with low debt ratio and a strong cash position.

UMC does possess all of these core competencies, and is well positioned to weather the cycles in the semiconductor industry.

Having said all of this, UMC has been aligning our teams and efforts.

The alignment is to focus on customer-based solutions.

UMC internal organization's efforts, metrics, have to align to customers', with additional efficiency enhancement, cost control, at the same time emphasizing teamwork and execution.

We are expecting to increase UMC business share from key customers.

Using 65 nanometer as an example, UMC has successfully qualified the customer products since March 2006, with (inaudible), power and performance reaching the industry benchmark.

Many designs and the pilots are in the pipeline now.

Along with our CapEx discipline, UMC will improve profitability and the long-term ROE, but all above efforts with focus back on customer service.

In terms of strengthening UMC's R&D collaboration, UMC is joining SEMATECH, to focus on research and the developments for exploratory technologies on 300 millimeter wafers, including 22 nanometer and beyond process generations.

The combination of UMC's 300 millimeter manufacturing experience, process technology expertise, and SEMATECH's wealth of knowledge in the field of semiconductor R&D will help ourselves and the industry to better handle the challenges of migration to a next generation processes.

(inaudible), of my summary of UMC's direction.

As the newly appointed CEO of UMC, I am happy to report that in Q2 2008, UMC saw improvements in revenue, gross margin, and operating margin, as compared to Q1.

These results were in line with our previously released guidance.

Customer demand for the (inaudible) the 90 and the 65 nanometer generations remained steady, with combined revenue from these process nodes totaling 36%.

Looking forward to Q3, we see that the environment is more challenging than we previously expected.

In general, customers have adopted a cautious attitude, due to the rising uncertainty in the global economy.

We will continue to monitor the situation closely, and adjust our operations accordingly.

The guidance for the third quarter is, wafer shipments to be flat from previous quarter.

Wafer ASP in U.S.

dollars to decrease by approximately zero to two percent points.

Impact from currency fluctuation is 0% to minus 2% on revenue.

Capacity utilization rates, approximately 80%.

Profitability -- gross profit margin -- to be in high teen percentage points.

The consumer segment is expected to be the strongest, followed by the communication and the computer segments.

2008 CapEx budget, U.S.

$500 million to $700 million.

So going forward as CEO, my top priority is to ensure that UMC's foundry solutions deliver the greatest benefits to our global customer base.

This will enable us to increase our market share among our key foundry customers, maximize profitability, and long-term return on equity.

That's all for my report.

Now let's begin the Q&A session.

Thank you.

Thank you.

We will now begin our question and answer session.

(Operator instructions).

Okay, our first question is from Steven Pelayo from HSBC.

Steven, please go ahead with your question.

Great.

Thank you.

I'm a little unclear on your gross margin guidance for the third quarter.

You're guiding down, I guess more than 300 basis points, on revenues down maybe a couple of percentage points, it looks like.

That seems more aggressive than what would normally apply here.

Is your depreciation and your cost of goods sold going back up?

Are your variable costs going back up?

Are there some yield issues?

I really just don't understand why gross margin is going to fall so significantly on such a minor revenue decline.

Okay, hi, Steven.

Most of the potential decrease to drive down our revenue in third quarter are pricing related.

You see there's a blended ASP in U.S.

dollars, due to the mix change, or the NT dollar is changing rate fluctuation against U.S.

dollars.

Or, we are take out our pure profit, given their moving direction.

And as we -- in the meantime, we also need to have counted the WIP, the work in process wafers, to determine the unit cost per wafer in a given quarter.

So in a way, that could suggest we take a relatively more conservative, weak forecast for the following quarter, in order to have slightly above average cost structure in the third quarter.

Okay, just to clarify.

In the June quarter, your depreciation and cost of goods sold managed to fall about 7% sequentially.

Does that remain at that level, going into the September quarter?

It should be in a similar level, probably around 5% or so.

Okay.

So then all of it comes from the other part, non-depreciation.

Great.

Thank you.

Thank you.

Our next question is from Pranab Sarmah from Daiwa [Security].

Pranab, please go ahead with your question.

Yes, thank you very much for the question.

First, Dr.

Sun, my question to you would be, since you've become the new CEO, what you are going to do that improve that image of UMC for -- among the investors, number one?

And also, to improve the image of UMC among your customers?

So, thanks a lot for the question.

For UMC's direction, we will continue to emphasize our core competence.

And as I mentioned earlier, make more focus on the customer-related service, from a foundry point of view.

So if we can do those well, and as I also mentioned in the report, we will probably do much better in increasing the share from our major customers, to strengthen our fundamentals.

And do you have any plans for the (technical difficulty)?

What would be, that benchmark could be?

As of today, our goal is, we need to do a much better job in long-term ROE, but that's certainly our direction.

We don't have any specific goal at this point of time.

Okay, thank you.

Thank you.

Next in the queue, we have Donald Lu from Goldman Sachs.

Donald, please go ahead with your question.

Oh, hi.

Good evening.

Can you give us a guidance on the percentage of revenues will be from 65 nanometer in Q3?

It will be -- in between 5% to 7%.

Five to seven.

Okay, great.

Thanks.

Thank you.

Next in the queue, we have Randy Abrams from Credit Suisse.

Randy, please go ahead with your question.

Yes, hi.

Good evening.

I wanted to ask to clarify the utilization in the second quarter.

I think the simple math, it would be closer to 80%, but the reported number is 85%.

Does that imply you're building inventory into third quarter, now that wafer shipments are flat?

Or could you maybe walk through the difference in utilization, and what that implies for inventory?

So, (inaudible), one or two customers did a quarter end push out in terms of delivery, so you are correct.

Our wafer manufactured during the June quarter is higher, slightly higher, than the number of wafers shipped in the June quarter.

Some of the wafer will be pushed into the third quarter.

Okay.

On that -- like if you look at third quarter, I'm curious what your expectation would be, even directionally, into fourth quarter, with third quarter coming in a bit weaker than the last few years.

Do you expect fourth quarter, if we take, say, '06 and '07 down, say, high single digits?

Is that an approximate range?

Or maybe directionally, how do you see fourth quarter shaking out at this stage?

So today, we are seeing a weaker than expected third quarter.

As far as today, we don't have much visibility in Q4 yet.

Okay.

If I could ask the -- and one follow up question to (inaudible).

In second quarter, on the non-depreciation COGS, it went down sequentially, even though the shipments went up.

Was there a one-time benefit that affected the second quarter margins, let's say, or pulling back into third quarter?

No.

There's no so-called one-time event, in terms of cost structure in the June quarter.

Most of the decline -- if you come to the depreciation, there's about 7% quarter-over-quarter decline in the part of cost of goods sold related depreciation.

If you take out depreciation, most of the benefit comes from our cost reduction program, which has been initiated late last year, and we do see pretty good results in the first quarter and the second quarter.

Going to third quarter and fourth quarter, I'm not so sure if we can see the same magnitude of cost reduction, but the whole customer-related control effort will continue into the rest of the year.

Okay.

And one more question, just on the demand outlook.

You mentioned, I think, communications and PCs relatively weaker.

Could you maybe go a step further on applications, say, wireless versus networking, and then for PCs, I guess, graphics, driver ICs, peripherals -- just how some of the applications are looking?

So those are just general comments.

In the consumer area, demand seems to be stronger, followed by the communication and computer segments.

In terms of the communication segment, handset base band is -- the demand is weaker.

And for computer area, the chipset plus graphics is becoming relatively weaker.

On the consumer side, the set-top box, DSC, and flash controllers are experiencing a stronger market demand, in the third quarter.

Okay.

Thank you for that.

Thank you.

Our next question is from [Mevin Chia] from JPMorgan.

Mevin, please go ahead with your question.

Mevin Chia, from JPMorgan, your line is now open to ask a question.

Yes, I think -- is my line open?

Yes.

OK, this is Bhavin Shah.

Shih-Wei, just our first question is on the book value and the balance sheet.

So there is recognition of a change in the -- I guess, well, unrealized gain or loss in the investments.

Again, just remind me of the treatment, actually, when you do the final realized gain or sell.

That entry is the worst, and taken to the income statement?

If it's available for sale for short-term, we would do mark to market on a quality basis, so it will affect both the income statement as well as the balance sheet.

If it is a long-term under equity, then we were doing payment under equity method, then we would do a so-called impairment test each quarter.

If there is an impairment, that one also goes into P&L, so -- as well as the balance sheet.

Right.

So the drop in book value in this quarter and last quarter, they're pretty significant.

But I don't see that impact on the P&L.

So just -- why I'm just trying to understand how that works.

Yes.

That's not impairment-related.

Okay.

So you do have to value both types of investment, long-term investment as well, so that would only appear in the balance sheet.

So that (inaudible), sorry?

I don't understand.

Oh, for listed long-term investments.

So -- but, so that is not related to impairment, right?

So that's --

It's not related to impairment.

Right, so that's -- so that's related to what?

Sorry.

That's related to listed, long-term assets.

Oh, listed assets.

Okay, okay.

So basically, when you actually realize the gain or sale, would the -- will that then, in that case, it goes to P&L, right?

Only realized.

Only realized.

Yes, okay.

Okay.

Got it.

And the second question was the margin improvement.

Did -- as you explained earlier, there's some push out from a couple of customers, so we put out, and we first (inaudible) the gap.

Did that contribute to the margin upside at all, or --

That's not really related to margin.

Okay.

And as far as the depreciation, you mentioned that the third quarter will be about within 5% of second quarter?

That's only the part of cost of goods sold.

Got it.

Company-wide depreciation, which will include operating expenses such as R&D related depreciation, there will be only about 2% also.

I see.

And any color on Q4, how the depreciation may work (inaudible)?

I think for the whole year, year 2008, versus 2007, that depreciation will be about 2% less.

And 2009 over 2008, we are talking -- explaining about 10% depreciation decline in '09.

'09, 10% decline?

Yes.

Okay, okay.

Thank you.

Yes.

Thank you.

Next in the queue, we have Steven Pelayo from HSBC.

Steven, please go ahead with your question.

Well, my question's been answered, but if I could just try to get some clarification here.

In the third quarter, if you're guiding total revenues relatively flat to down here, after ASPs and currency impacts, and the computing segment is the worst relative performer, could you kind of help me understand historically -- shouldn't the PC segment be seasonally one of your stronger segments in the third quarter?

Why would you think it's so relatively underperforming, and how significant is the decline in PCs, relative to the flattish or maybe sequential growth in consumer?

So for Q3, PC segment, the reason for us Q3 is relatively weaker is because some of our key customers are adjusting inventory.

And also, the end demand is relatively weaker.

This is what we see from UMC for this third quarter, which is certainly different from the past years.

And also, we in general attribute it to the global macroeconomic situation.

Okay, thank you.

Thank you.

Next in the queue, we have [Chun Tam], from [Nesti Capital].

Chun, please go ahead with your question.

Hello.

Good evening.

I've got one question regarding your operating expenses.

I noticed that your operating expenses in both Q1 and Q2 have declined about 7% year-over-year, compared to last year, and this is in spite of the fact that you started accounting for employee bonuses in 2008.

So I just wanted to get a little more detail on that.

What is leading to the decline in operating expenses, and also, what do you see happening for the rest of the year, and if you have any outlook for 2009 as well?

Thank you.

Yes, as I mentioned earlier, we initiated a cost reduction program -- actually, a more intense one, in the late -- last year.

So the benefit, we have seen in the margins, in Q1, Q2, largely attributed to the cost reduction program.

That goes to operating expenses line as well.

So I think more tighter budget control on SG&A as well as other related items, are the main reason.

As I mentioned, all the effort will be continued into the rest of the year, but we are not very sure if we can continue to push down the operating expenses on the same magnitude.

So I think it's safe for you to budget similar operating expenses as second quarter for the rest of the year.

And as for employee program -- employee benefit of bonus, so far, we have budgeted about TWD 180 million, up to mid-year 2008.

And the majority, actually, is in the line of cost of goods sold -- only some in the operating expenses.

About two thirds being cost of goods sold, one third in operating expenses.

Okay, thank you.

And just regarding your budget control and your cost reduction program, does any of that impact on your R&D spending for process development?

No.

For the cost reduction efforts, it's mostly from the cost of goods sold, like Chitung mentioned, from factory point of view.

On the operation expense side, there are really lots of a central support function, we are driving the efficiency.

R&D side, we are not really -- R&D also engaging across the board efficiency enhancement, but we are not reducing the R&D investment at all.

Okay.

Thank you very much.

Thank you.

Thank you.

Our next question is from Randy Abrams from Credit Suisse.

Randy, please go ahead with your question.

Yes, I wanted to ask a follow-up on the utilization, if you could talk about leading edge versus lagging edge, second quarter, and then third quarter, which is -- what the relative trends for each are.

And then pricing-wise, what do you see for ASPs firming up, leading edge and lagging edge, relative to the past with -- what are the talk about higher costs getting passed through, and trying to push more pricing out to customers?

So from a loading point of view, both 12" and other (inaudible) leading edge technologies has better loading, relatively to the overall company loading.

In terms of the pricing, we are, we mentioned earlier -- today, our operation focus is focusing on our customer service.

We try to provide better service to customers, as far as pricing.

It's on the demand and supply situation, and we're working with customers on a partnership point of view instead of a near-term tactical pricing adjustment.

Okay.

Do you see ASPs firming up relative to the recent trend?

It depends on the segment and application -- 8", 6", 12", there's such a broad spectrum.

Each case is somewhat different.

Okay.

Is one area doing better than the other, in broad strokes?

Like 12" versus 8" and 6"?

Not necessarily.

Also, it's a customer base.

Okay.

And then one follow up, just from the SEMATECH, which you announced recently.

Are there any meaningful implications for R&D spending as far as getting leverage -- either getting leverage from the partnership, or needing to contribute R&D resources to the joint development?

And maybe, what technology nodes do you see some of that development work paying off for you guys?

For SEMATECH, we mentioned in the press release, we are focusing on the exploratory technologies, specifically on 22 nanometer node and beyond.

From R&D cost saving point of view, it is definitely beneficial.

For example, for 22 nanometer, we may have to use extreme UV, or advanced tools, so by joining the 12" R&D consortium in SEMATECH, we may gain the advantage of early engagement.

However, we can probably delay the procurement of R&D to us, of these very expensive demands to R&D to us, until they are really mature for our production purpose.

Okay.

Thank you.

Thank you.

Our next question is from Steven Pelayo from HSBC.

Steven, please go ahead with your question.

I'm curious on your guidance for 2009 depreciation, down about 9%.

That can have a meaningful impact on gross margin next year.

Does that -- is that from an overall perspective, or do you expect the depreciation and cost of goods sold to come down by 9% as well?

And what does that, then, imply for your next year's capital spending?

Basically -- first of all, it's 10%, it's not 9%.

Okay.

And generally speaking, the cost of goods sold related to depreciation, at least for this year and next year, may come down a little bit more than our corporate average.

So the answer is, slightly higher than 10% in the cost of goods sold line.

And as for the CapEx for '09, currently we don't have a target.

Now, of course, 10% is based on internal numbers, but I guess all we can say is, our CapEx will continue to be very discipline managed.

Okay.

And then I'm curious, just on a bigger picture question, the goal to be a little bit more pricing disciplined across the industry that's been all the talk of the last couple of quarters or so.

Given that the industry environment has weakened here, utilization rates have fallen, potentially falling into fourth quarter and then into the seasonally slowest first quarter, I think that's when -- certainly TSMC was hoping to be enacting much more disciplined pricing at that point.

Do you think that strategy is going to be much more difficult to implement, given a much more weaker environment here?

For UMC, we have never engaged in any firming up of our pricings, specifically or across the board.

Again, all the pricing discussion are based on a customer by customer situation, and foundry service based.

So we don't have any general comments on pricing.

Okay.

And then my last one is just to follow up my previous question.

The weaker relative computing performance in the third quarter -- that's all graphics and chipset related?

Is there anything else to that?

It is chipset and graphics related.

Okay.

Thank you.

Thank you.

Thank you.

Our next question is from Donald Lu from Goldman Sachs.

Donald, please go ahead with your question.

Yes.

Can you set some color on whether the third quarter gross margin decrease has anything to do with the cost inflation?

I think Chitung commented that the utility and material costs inflation had a major impact on its margins.

Just on utilities, it's about 0.15 percent point of our total margin rate.

But if the utility continued to go up another 15%, as the government planned, then we will see another 0.15 point negative impact on our profit margin.

So, up to now, we only put in the first phase of price increase, so about 0.15%.

Okay.

How about consumable materials, and the wafer substream?

Are you there -- any inflation there?

Not so much.

Okay.

Thanks.

Thank you.

Our next question is from Dan Heyler from Merrill Lynch.

Dan, please go ahead with your question.

Thank you.

Yes, a couple of follow-ups from today.

Dr.

Sun, on the 65 nanometer, you discussed engagements there, and products in the pipeline.

Are you currently shipping low power 65 nanometer?

Certainly.

Certainly, yes.

Okay.

And then, what portion, I guess, of that total revenue, as you look towards year-end -- I think today you had mentioned that it may be 7% to 8% of revenue by year-end?

Is that a fair assumption?

It's about 5% to 7% mentioned earlier.

So there are a lot of 65 nanometer products in the pipeline, on the final verification stage.

As I mentioned earlier during the day, I think next year it will be much larger scale of ramp on 65.

And how would you see your low power versus performance, given that you've been successful -- some engagements in graphics?

Would you expect your mix of 65 to change at all, relative to 90, would we say?

You know, see more performance-driven product relative to low power?

Or would the mix be about the same as 90?

Yes, we -- that's definitely our goal, to have a more diversified customer base, and having more high performance customers, and it's happening.

Okay, great.

And then, I guess, as you look at this potential for rising utility costs, I guess is one element, in addition to industry slowdown.

But do you think you can pass on some of these costs?

This is, you know, I guess a pretty impressive end situation, where we've seen this kind of inflation in the industry.

Is there any precedent where we've seen foundries able to pass on some of these costs that are being shared across the industry?

You're asking the past experience, or (inaudible)?

Well, do you think -- is there a precedent of that happening?

And do you think you can kind of pass these costs on going forward?

So, I don't recollect in the past away -- foundry has been passing the inflation cost to the customer.

But again, it's a -- I agree with you that utility, everything, is becoming more expensive because of inflation.

However, the supply/demand situation in the foundry domain still exists.

So where do you strike the balance, is really critical.

Okay, great.

And then, my last question was for Chitung -- it was more of a technical question.

On the share count, Chitung, for the fully diluted outstanding shares, could you give us the third quarter forecast for fully diluted outstanding shares?

Sorry about that.

It will be -- first of all, it's in the report, okay?

In the press release.

What -- yes --

And I'm going to read the numbers.

It's 13,856,573.

Okay, the reason why I ask is, it was in the second quarter press release as well, and it was close to that number, but what I noted, when you actually reported second quarter, the fully diluted number was significantly lower.

So I'm wondering why, in March, it was over [13], and then it dropped in your reported number.

Would we see this [13.585] number go down again in the third quarter, and if so, why?

Well, we do have a schedule to cancel about 2% of our treasury shares by the end of this year, so it depends when we will cancel those shares.

And we're also scheduled to pay some stock dividends in August, September timeframe.

So it will be kind of net/net impact, so it shouldn't be too much change.

So should we model the second quarter fully diluted shares, which is more in the [12 to 12] range, or do we do the June number?

Well, if you talk about fully diluted, it will be [13.5] something.

Okay.

Including the potential stock dividend, and treasury cancellations?

Yes.

Okay, thank you.

Thank you.

Our next question is from Pranab Sarmah, from Daiwa Security.

Pranab, please go ahead with your questions.

Yes, thank you for taking my questions.

The question is on, mainly on the 45 nanometer.

Dr.

Sun, like -- could you give us some color, like how many customers you have really and getting 45 nanometer currently, and what -- how many products you are basically doing prototype at this point?

So, for 45 nanometer, we have at least six customers engaging with us, and with both low power and high performance, doing the test chips today.

And you expect to go for mass productions by -- what timeframe, at least for the first product?

That depends on the nature of the product.

Some of the products, the ramp was -- would be slower.

Some are quick.

But both will happen.

Both the high performance, low power will happen next year, in terms of the volume ramp.

And in second quarter, at 65 nanometer, how many customers do you have really with that order?

Our 55 (inaudible), so many customers engaging, at least.

And commerce output for how many people?

It looks like a quite small number, it's only --

Yes.

The production mass -- it's around ten products in mass production.

And at least 40 products in a takeoff stage.

Thank you, Dr.

Sun.

Thank you.

Thank you.

There are currently no more questions in the queue.

(Operator instructions).

We have a question from Roland, from JPMorgan.

Roland, please go ahead with your question.

Yes, regarding to your income tax rate in second quarter, it was pretty low.

So can you explain how -- the reason they are less?

And how should we model it in 3Q?

Well, minimum tax in Taiwan currently is about 10%, and given that we have some tax credit for our cooperation, theoretically, if most of our profit is coming from cooperation, the tax rate should be -- stay at a similar level like it is right now.

But on the other hand, if we have more so-called disposal income from the share divestment, and that's a straight 10% tax, no credit to offset that, the tax will become higher if we do that.

Thank you.

Thank you.

There are no further questions.

We can now begin closing comments.

Mr.

Liu, please go ahead.

Thank you.

So I think that concludes our call today, and thanks again for joining.

If you have any further question, please do not hesitate to contact us directly, and we will come back in the next quarter.

Thank you.

Operator, back to you.

Thank you for your participation in UMC's conference.

There will be a webcast replay within an hour.

Please visit www.umc.com, under the Investor Relations / Investor Events.

You may now disconnect.

Goodbye.