聯華電子 (UMC) 2008 Q3 法說會逐字稿

Hello, and welcome everyone to today's UMC's 2008 quarter three earnings conference call.

All lines will be placed on mute to prevent background noise.

After the presentation, there will be a question-and-answer session.

Please follow the instructions given at that time if you would like to ask a question.

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

Webcast replay will be available within an hour after the conference is finished.

Please visit our website www.umc.com under Investor Relations/Investor Events.

I would like to introduce Mr.

Chitung Liu, CFO of UMC.

Mr.

Liu, you may please begin.

Thank you, and welcome everyone for attending our third quarter earnings conference call.

We are hosting this conference call from Taipei.

And here with me are Dr.

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

Bowen Huang, Senior IR Manager.

I will first review our financial status for the third quarter, and then Dr.

Sun will update our business and forward-looking guidance, followed lastly with a Q&A session.

Before we get started, I would like to remind you all of UMC's 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 the risks that may be beyond Company's control.

For these risks, please refer to UMC's filings with the SEC in the US and the ROC Securities Authority.

Now the third quarter result.

For the third quarter in 2008, revenue was TWD24.75 billion, representing a 1.9% quarter-over-quarter decrease from TWD25.24 billion in second quarter 2008, and a 20.2% year-over-year decrease from TWD31.03 billion in third quarter 2007.

Gross profit for the quarter was TWD4.37 billion, or 17.6% of the revenue.

This is compared to TWD5.8 billion, or 23% of second quarter '08 revenue.

Operating profit was TWD947 million or 3.8% of revenue, compared to TWD2.34 billion or 9.3% of second quarter '08 revenue.

Net loss in third quarter was TWD1.41 billion, mainly due to a TWD3.22 billion of impairment loss, compared to a net income of TWD2.4 billion in second quarter 2008.

Loss per ordinary share for the quarter were TWD0.11, and loss per ADS were $0.017.

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

Now, let me turn the call over to Dr.

Sun, and he will provide you with UMC's business outlook and update for the fourth quarter of 2008.

Thank you, Chitung.

I would like to welcome everyone to our third quarter conference call.

We appreciate your participation on this call and your interest in UMC.

First of all, I will touch base on the highlights of Q3 operating results, then provide further details on our performance and the key activities impacting our business in Q4 2008.

UMC's Q3 results were in line with our previous guidance with 883,000 8-inch equivalent wafers shipped, an overall utilization rate for the quarter at 79%.

Customer demand for advanced 90 nanometer and 65 nanometer technologies remained steady, with revenue from 90-nanometer-and-below processes slightly rising to 38%.

Looking ahead to Q4, we see the environment is more challenging than we previously anticipated.

Customers have adopted a cautious attitude with regard to their wafer demand forecasts due to uncertainty related to the current global economic situation.

UMC's strength in financial structure, capital position, independent technology development, and manufacturing capabilities will enable us to overcome the challenges of the current global economic crisis.

Our management has a wealth of experience dealing with the extremes of the business cycles.

And UMC's strategy of delivering customer-driven foundry solutions is designed to maximize benefits and profits for UMC and its customers over the long term.

We will continue to invest in developing advanced process technologies and expand our manufacturing capacity wherever necessary to increase our market share, and the penetration to business from our key foundry customers.

Currently, 45 nanometer and 40 nanometer are being prepared for pilot production this year.

The development for the 28 nanometer process is progressing smoothly in Fab 12A.

We also announced on Monday on the successful manufacturing of our fully functional 28 nanometer SRAM.

At the same time, we continue to make significant achievements in enhancing productivity, while successfully implementing cost control measures, and we anticipate further improvements going forward.

I would like to emphasize that our cost control measures will have no negative impact on our advanced technology research and development, and the procurement of the necessary equipment.

These and other important investments will continue as planned so that we will emerge from the current economic slowdown with even stronger longer-term competitiveness.

We will continue to pursue our foundry strategy, and are optimistic about the prospects of future growth and profitability, once the global economy stabilizes and the consumer confidence returns.

Now, let me provide you with the guidance for the fourth quarter 2008.

Wafer shipments to decrease by approximately 25 percent points.

Wafer ASP in NT dollars to increase by approximately 5 percent points.

Capacity utilization rates, approximately 55%.

Profitability, sales -- gross margin rate to be approximately 10%.

Sales breakdown by three major applications remains unchanged.

2008 CapEx, capacity expenditure budget, $400 million to $500 million, which is reduced from $500 million to $700 million originally planned.

That's all for my report.

Now let's begin the question-and-answer session.

Well, Operator, please give the Q&A instruction, please.

Would you like to start the Q&A now?

Yes, please.

All right, sorry about that.

Okay, we will now begin the question-and-answer session.

(Operator Instructions).

And the first question is from [Khoresh Iraman] of ING Equity.

Please go ahead, sir.

In the last quarter, you had outlined a proposal to renegotiate prices with customers, and with a stronger dollar and weaker economy and lower energy prices, to what extent is there a change to that outlook?

And how do you think the ASPs trend after the Q4?

As for our pricing strategy with customers, there is always a continuity.

Actually, our pricing in many cases are longer term, based on our partnership with our customers.

It's not much affected by the month-to-month, or quarter-to-quarter commodity or oil price fluctuations.

And in terms of CapEx for 2009, it may be a bit early to talk about it, but qualitatively, is that likely to remain as low as it was in 2008 which was a historical low mark for UMC, given your revenue levels?

Well, no, actually in this today's economic situation, because of UMC's excellent financial strength, we are considering different ways.

First of all, we will not slow down our R&D efforts at all.

For the critical areas of capacity expenditure, we will just move forward.

So we haven't decided.

We may be more aggressive in gaining more market share.

But we haven't decided the final numbers.

We will share with you probably in the next quarterly conference.

Okay, great, thanks.

Next question is from Randy Abrams of Credit Suisse.

Please go ahead, sir.

Yes.

Thank you, and good evening.

I wondered if you could elaborate on the productivity and cost control measures for operating expenses in the next few quarters, what's your expectation.

And then for the cost of goods sold, if you could maybe talk about depreciation, how you expect it in the fourth quarter in 2009.

And then also non-depreciation expense, what the productivity measures could do to the non-depreciation expense.

There are quite a few questions there, I will try to -- if I can remember.

The first one is the productivity improvement.

It's a constant effort to challenge the factory floor to squeeze more capacity.

For example, the scanner's [throughput], which is the most expensive tool we have.

So if you can do better, that's great; you reduce the investment.

Secondly, the cycle time improvement, which is a huge effort we are investing now.

If you can squeeze the cycle time, it's equivalent to increasing the capacity.

So we're doing many things.

So actually we are investing more on the automation for the factory to squeeze the cycle time, and it has capacity -- equivalent capacity.

As far as the other operating expenses, that we're trying very hard to reduce the -- actually, it's on improvement trend if you look at the quarter-by-quarter numbers, I believe.

What's the other question --?

Well, I can take on the depreciation questions.

First of all, for the first quarter, we expect to see a mild depreciation decline; around 2% to 3%, quarter-over-quarter.

That will put the whole 2008 depreciation to be about 1% to 2% less than that of 2007.

Looking to 2009, we are expecting to see some 8% depreciation decline for the whole year versus 2008.

However, I also want to emphasize that given that our -- the wafer in the pipeline, the work-in-process is actually decreasing.

And therefore, the WIP carry a little less [fixed costs], and that will put more burden on the cost of goods sold, in terms of the share of fixed costs on a pro-rata basis.

So the cost of goods sold may continue to deteriorate on a pro-rata basis given the slowing WIP situation; just want to remind you of the current situation.

Okay, thank you.

And on the AMD's new foundry company they announced; maybe talk about your view and how it changes the landscape, and more specifically, for UMC on the graphics business, if you had any discussion with AMD on the ongoing graphics business you're supplying.

So first in terms of the AMD, the foundry company, it's a new effort.

I guess, they are trying to build a new factory in New York State and they are having factory interest.

Now, first they will focus on supplying, I believe, AMD on the processor business.

So we are still kind of -- wait and see to see how their foundry strategy will evolve.

I guess it may still take some time.

So we are watching carefully.

In terms of impact on UMC, I guess, it should not be, because we are not part of the IBM camp.

So probably the impact was first on IBM camp member foundries, that's our -- it's my personal view.

The second question is on graphic.

Oh, graphic.

Well, AMD, we are still -- because they're providing AMD with graphics, and so they're customers still today, yes.

Okay.

The European revenue went down, it looks like, about 50% sequentially.

Is that the IDM -- is that more IDM outsourcing just pulling in, or is there anything more longer term in nature taking place with the European base?

The decline today is broad-based, as I mentioned earlier, it's across three sector; they all have dropped because of the economic impact.

And certainly, if IBM has their own internal factory, they can do manufacturing, they will have some additional impacts.

For us, we see the impact is quite broad-based.

Okay, and just one last question.

The ASPs, I think in third quarter, the income statement was TWD32.2.

You're guiding 5% higher NT dollar ASP or -- or 5% improvement in wafer price in NT dollar.

So is that implying a 5% off the TWD32.2 -- or maybe walk through with what's happening with the ASPs into fourth quarter?

If we use US dollar base, we are looking for something like 1% increase in ASP because of the mix improvement.

And about 4% will come from NT dollar depreciation impact, and that -- based upon our assumption that's 32.5 in whole quarter four.

Okay, thank you.

Okay, the next question is from Bill Lu of Morgan Stanley.

Please go ahead with your question.

Yes, hi, there, good evening.

And thanks for taking my question.

I guess my first question is given that the utilization rates in the fourth quarter is going to be below 60%, any opportunities to look at some of the near-term cost cuts in terms of fab closures or shutdowns, or layoffs; anything like that that could impact costs in the short term?

Actually we're doing everything we can to reasonably reduce our operation costs, while not affecting our long-term capacity in these, and there are many, many activities internally being executed now.

The fab closure is definitely not an option.

Yes.

Okay.

So I know you probably don't want to talk about details.

But can you just help me with where OpEx would be in the fourth quarter relative to the third quarter?

Well, as the CEO mentioned, hopefully through the efforts of cost reduction, they have been on a steady downward trend, if you will.

And I think our expectation is not going to see the operating expenses to increase on a quarter-over-quarter basis; at least it will stay at the current level of the [cap].

But the room for significantly reduction in one single quarter, it will be rather difficult given the high fixed-cost content of our operation -- business model.

So through our continuous effort, we hope the cost -- on the variable cost side, we're going to see a steady reducing trend.

Understood.

When you said the flat quarter-on-quarter, that's on absolute terms, not percentage terms, correct?

Absolute terms, yes.

Okay, great.

Second question is that, Chitung, I think you said that depreciation expenses next year would be about 8% lower than it is this year.

I don't know if my math is correct, but that to me translates into roughly a CapEx of between $500 million and $600 million.

Is that kind of the right math?

Well, we do have our internal rough figure in order to come out with this 8% calculation.

But I just want to emphasize that the newly revised down number for '08 of $400 to $500 million is really at a historical low point of our CapEx trends.

So you can factor in a pretty similar number for your -- I mean, it's not for now, for 2009, so that we will give you more concrete numbers next quarter when we talk about '09 CapEx.

Great, thank you.

And then just one last clarification.

I know you talked about going to the fourth quarter, that ASP has an impact from the ForEx.

Is there a impact on the margin side as well?

It will certainly help the margin a little bit as well.

The real [sum] normally is if we see 1% of NT dollars depreciation, maybe we will see a 0.5% increase in our profit margins.

Great, thank you very much.

We now go on to Bhavin Shah of JPMorgan, please go ahead sir.

Yes, thank you.

Chitung, first question that I had was, in 2001 we had -- the foundries had two back-to-back quarters of pretty big 25% kind of decline.

I know it's very tough to have a view on the first quarter now, but how do you assess the risk of that happening this time of having another big quarterly drop for the foundries in first quarter?

You mean Q1 '09?

Yes, please.

For Q1 '09, probably our visibility is quite shallow.

However, [overall] speaking, because of the overall economic situation, the visibility is shallow, but the trend, we do not see a very -- definitely we cannot see a very -- situation that we're -- recovered in near future.

Okay.

Well, again, the visibility is quite shallow.

The overall current customer's inventory level should be quite low.

So we will give you a more clear picture in the next conference call.

Okay.

Second, how would UMC weigh the options on a cash dividend?

I guess, is there any -- I mean, obviously it depends on the earnings -- is there any specific minimum dollar absolute number, or it's not -- I mean, how should I think about the cash dividend policy going forward?

Dividend policies always try to pay out a majority of our dividend in the form of cash.

However, I just want to remind you that for 2008, the cash dividend is constrained by our return earnings.

And return earnings not only coming from the full year's earnings, but also you need to factor in the reduction from our Treasury shares cancellation, which we just did about two months ago.

We cancelled about 2.6% of our insurance shares of which also we got in from TWD3 billion reduction in our return earning.

So that will further reduce our capability to pay out cash for the following years, rather than the full-year earnings.

Okay, great.

And then I just wanted to understand your comment about you want to continue with a focus on developing technology.

How do you look at this in terms of strategy for 45 nanometer and so on?

I mean, when you think about -- you've answered that you're still working out the CapEx for next year, but is the plan to have a certain minimum capacity for 45 nanometer, is that how I should I think about it?

We will continue our independent R&D capability.

I mentioned earlier in the script; 45/40 nanometer is at the pilot stage now.

28 nanometer -- we just produced a functional SRAM at the 28 nanometer.

In the meantime, we're preparing a capacity for 45/40 nanometer next year for early customers to [ramp].

And we will have a -- [seeking] for quite a reasonable share for the 45/40 business in the foundry domain.

In the future, the incremental investment for the 45/40, comparing to the 65, we are definitely trying to manage that.

That's also the reason why I mentioned on the first question, we are still determining next year's CapEx, whether we want to be aggressive or conservative based on the customers' requirements, especially on the advanced technology node.

Okay, thank you.

Okay.

(Operator Instructions) And we'll now go over to Donald Lu of Goldman Sachs.

Please go ahead, sir.

Yes, good evening.

I have a question on UMC's strategy to gain market share, especially at 65 nanometer.

And I think at the last conference call, Mr.

Sun has indicated that UMC wants to gain market share at large customers going forward.

And we are reading news reports that UMC is making progress.

I just want to see; number 1, whether there's further progress in that front.

And number 2 is when do we expect to see any initial result from this market share gain at 65/90 nanometer.

And number 3 is whether the cost would significantly increase before we see the revenue benefit?

The 65 nanometer is definitely one of our focus.

We are working very hard with all the teams' different efforts; from manufacturing floor, the sales and marketing team.

So it's a concerted effort working with our partners.

It's -- but again, we have to earn the business, it's just not like we want to gain a market share or get it.

So we are working very hard on that.

But overall speaking, we're gaining ground.

And also it's impacted by this very serious economic downturn.

So customer will have a different situation case-by-case.

Well, our intention -- and the goal doesn't change at all.

So gaining early additional tape-out engagements across different domains of the business is our number one priority today.

Okay.

And I think in the afternoon, Mr.

Sun, you have commented that consolidation would be good for the industry, and this has been a topic that people have been talking about for many years.

And now, I think the urgency seems to be more apparent than ever.

What is preventing foundries from going to consolidate in the past, and probably in the future?

You see, consolidation for foundry or manufacturing entities are always a huge challenge.

And also they are a bit of complicated process you need to go through.

Again, like I mentioned in the afternoon, UMC was certainly not ruling out any possibility of an M&A with other foundry entities.

However we have to evaluate if it's the right timing, especially today cash is so important.

UMC has excellent cash and capital position.

But on the other hand, it's such a difficult time; everybody trying their best to conserve cash.

But again, we are moving forward.

Once the situation is correct, we will certainly seriously consider any M&A situation in the foundry domain.

Great.

Thank you very much.

We now go on to Steve Pelayo of HSBC.

Steve, please go ahead.

Great, just a couple of quick questions here.

I understand pricing is a long-term discussion, but even you were suggesting about excess inventories out there, and utilization rate is in the 50%-60% range.

I'm just curious if customers' attitudes -- have they looked to take advantage more of this low utilizationary periods, are the pricing discussions that are going on more intense than what they've been in the past?

I think pricing pressure, I also mentioned in here that pricing pressure is always there, it's constant.

However, I feel at this stage, our customers -- we are really trying to build a longer-term partnership with customers.

Do you see any of your competitors looking to be more optimistic and actually driving price lower?

I cannot comment on competitors' strategy.

But our feeling is -- my feeling is that we are seeing this -- even now it's -- the loading is low, and it's a tough time.

But if you're working with your partner, I think they understand with reasonable -- they are in a tough situation.

They have -- the whole supply chain is under the pressure.

So I think that that if you look at our overall ASP trend, I think it's quite stable now.

Certainly we are doing the product mix improvement.

Overall pricing, I feel, is holding okay.

All right.

And could you talk about with shipments down 25% in the fourth quarter; I'm just curious, what's happening with your customer concentration?

Do you end up having a bunch of smaller customers, or are there two or three that could be 10% of revenue each kind of thing?

What's customer concentration during the -- in the fourth quarter?

The concentration really comes down a little bit in quarter four.

There -- our few larger customers decline a little bit more in Q4.

But the change is not significant at all.

Okay.

And the last question.

Do you expect any more impairment losses as we would go out into the fourth quarter?

UMC does have a larger portfolio in financial assets.

And based upon the accounting policy, we pretty much done all we can -- we can already in the third quarter.

If you take the further impairment loss, it's very difficult to predict.

That largely depends on the market situation.

Whenever it's necessary, we will just follow the accounting principles.

Great.

Thank you.

We now go over to the final question in the queue at the moment, which is from Randy Abrams, of Credit Suisse.

Please go ahead again.

Yes, a couple of follow-ups on the utilization, and the 25% decline, maybe characterize it by leading-edge versus trailing-edge, and then 65% of revenue -- 65 nanometer percent of revenue; how do you see that ramping up?

I guess the question was the utilization rate drop.

I think it's pretty much across the board; 12-inch, 8-inch; they are all -- they're all -- they all got affected.

But 12-inch is relatively more affected in this period of time.

Okay.

And on longer-term technology roadmap; I wanted to get an update on what your plans are for high-k/metal-gates, when do you plan to implement that?

Yes, we had a press release Monday, addressing our successful manufacturing of a 28-nanometer low-leakage process which is silicon-oxy-nitride gate and the poly gate.

And also we have the second introduction for 28-nanometer or the high-k and metal gate.

Well, currently, it's scheduled for pilot production in Q4 2010.

Low-leakage process with the silicon-oxy-nitride gate is scheduled for pilot in Q2 2010, two quarters ahead.

And our high-k/metal gate R&D in our 12A plant in China has been progressing quite well now.

Okay.

And last question, I guess I should assume the employee bonus in last quarters, you want to accrue any for bonus, just want to clarify.

No, we actually reversed all the accrued employee bonus because given the employment [laws], in the third quarter, according to our funding policy, we cannot accrue our employee bonus for the year.

So pretty much all the [two-year] accrued TWD181 million of employee bonus has been reversed in the third quarter.

Okay.

Thanks for that.

Hey, that was -- there is actually two final questions that just jumped in.

One is from Steve Pelayo of HSBC again.

Please go ahead, sir.

I'm just curious if there is any way we can quantify some of your longer term cost reduction programs.

We are looking at a semiconductor industry that's fairly growing, some are saying declining this year, this coming year.

So if you just imagine a scenario where your revenues were relatively flattish for another year or so, what kind of cost reduction programs would that -- can you quantify what the cost reduction programs would present in terms of opportunity for operating margin expansion?

Are we looking for 200 or 300 bps that at current revenue level -- annual revenue levels, is there any way you can help us try to understand, because for me, I see that this is a story that really needs to get to kind of mid-20% gross margins with 15% spent in OpEx to really be a sustainably profitable story.

I'm trying to get an idea how you are marching toward those types of business structure to allow that kind of margin?

Well, with the cost reduction programs, I think that best we can achieve maybe in single-digit percentage gains in profit margins, so really not that much.

And the most important issue is to gain more business, and as our CEO mentioned, we are focusing on the first-tier customers, taking our fair shares of their business allocations as our near-term target.

So by achieving that, we do expect to see a much significant improvement in the profit margins, and just through cost reduction, that's really a low single-digit improvement.

And when would be the next milestone on that?

Is this something where you feel like in the first quarter or first half next year, where you feel like you've got better visibility on those share gains, or is it farther out?

For the share gain, no, it's affected by this economic situation.

Many customers are pushing out the shipments, controlling their inventories.

So we don't get a clear visibility.

But again our focus is on engineering, engagement and takeoff of the new products, the new business; that's the focus.

In terms of the business gain, it's -- becomes difficult to project at this moment.

Thank you.

The final question is from Pranab Sarmah of Daiwa.

Please go ahead.

Thank you for taking my question.

Dr.

Sun, I have one question.

In this downturn, how you are going to manage your company differently so that you can probably go through -- become a stronger company when the downturn comes back, and probably the mistakes that UMC did in 2001 and '02 doesn't repeat again?

I will answer the first part of the question.

No, actually I can give you a few examples.

In this downturn, we are constantly looking for things we are unable to do when the factories are fully loaded.

And a few examples, we are emphasizing much more on the long-term partnership with customers in this difficult time, instead of squeezing more margin profits.

We are trying to do the longer term with customers.

On the operation side, for example, I mentioned earlier, we are trying to invest even more in terms of automation to improve our cycle-time competitiveness.

So when the business come back, we have more capacity and we are more competitive with better cycle time.

That also boils down to the enhancement capacity.

In terms of organization, we streamline lots of internal organizations, to knock down lots of the organization boundaries.

From cost side, it comes (inaudible) also.

It's a new management team also.

So overall speaking, we are very -- on top of that adding to -- adding up on the UMC's strong financial strengths.

At the right time, we will invest aggressively also.

But we are -- the whole team is actually quite pumped up and excited about -- actually this may give us greater opportunity to do better after the business -- after the economy recovers.

Could you comment a bit on your potential R&D expenses for 2009?

How much -- what will be your plan to -- on your R&D expenses for next year?

Well, we don't have the exact number yet.

In the past few years, I remember, it's around $250 million to $300 million.

We'll probably maintain that level.

But we are -- and that's another kind of a methodology change in our R&D.

We are actually improving significantly on our R&D methodology to do things better, smarter.

That's the key, that's very important.

For example, [28] nanometer; we are independently developing the 28-nanometer technology.

We [still have] quite reasonable R&D spending.

Okay.

And would you be considering -- would you like to participate on the industry consolidation if anything happened because in this downturn, some of the smaller company might find much difficulty on the financial position.

What is your view on the industry consolidation, will you take part in that?

Yes, we mentioned earlier, we are definitely interested in the right possibility at the right time.

So yes, the answer is yes.

But we have to consider overall stockholders' benefits as the bottom line.

Okay.

Okay, thank you very much.

Thank you.

And that concludes our call today, and thank you again for joining.

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

Now back to you, Operator.

Thank you very much.

This now concludes our call.

Thank you all very much for attending.