聯華電子 (UMC) 2011 Q2 法說會逐字稿

Welcome, everyone, to UMC's 2011, Q2 earnings conference call.

All lines have been 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 broadcasted 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 the Investor Relations, Investor Events section.

I would like to introduce Mr.

Richard Yu, Head of Investor Relations at UMC.

Mr.

Yu, you may begin.

Thank you and welcome to UMC's conference call for the second quarter of 2011.

With me today is the CEO of UMC Dr.

Shih-Wei Sun and the CFO Mr.

Chitung Liu.

During this conference we may make forward-looking statements based on management's expectations and beliefs.

These forward-looking statements 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.

I'd now like to introduce UMC's CFO, Mr.

Chitung Liu to explain UMC's Q2 2011 business results.

Thank you, Richard.

For the second quarter of 2011 revenue was TWD28.15b, a 0.1% quarter-over-quarter increase from TWD28.12b in Q1 '11 and a 5.4% year-over-year decrease from TWD29.75b in 2Q 2010.

Gross margin was 23.9%.

Operating margin was 11.8%.

Net income was TWD3.19b.

And earnings per ordinary shares were TWD0.26.

The above is a short main summary for the results on 2Q 2011.

More details are available in the quarterly report which has been posted on our website.

I will now turn the call over to Dr.

Sun.

Thanks, Chitung.

Good morning, good afternoon and good evening, ladies and gentlemen.

In Q2 2011 wafer shipments reached 1.15m, 8-inch equivalent wafers, in line with UMC's guidance.

As we enter the third quarter of 2011, certain macroeconomic factors such as the European and US sovereign debt issues and the emerging market inflation have led to unfavorable global economic conditions.

These macro uncertainties have led customers to adopt a conservative outlook.

Furthermore, customers have adjusted their order patterns in order to consume elevated inventory levels due to overstocking after Japan's March earthquake.

This ongoing situation has negatively impacted the worldwide semiconductor industry, and will offset the high-demand season traditionally seen during the second half of the year.

Consequently, we anticipate UMC's business performance may reflect this weakened demand condition beyond Q3.

During this period we will further enhance our operations through active customer diversification, efficient business execution and aggressive cost control measures.

We will also focus on the opportunities ahead.

UMC's CapEx, which remains at $1.8b for 2011, will support our advanced production ramp.

UMC's R&D efforts will continue in earnest to prepare for customers' future technology requirements.

We will also leverage our foundry technologies to take advantage of the fast-growing mobile communication and the computing markets with high performance, low power consumption requirement.

UMC's volume production 40-nanometer process is expected to reach 10% of revenue by the end of 2011.

We are also smoothly developing our 28-nanometer process and design IP platform, with the first of several 28-nanometer customer products entering pilot production in Q3, 2011.

For 65-nanometer, UMC will benefit from the second wave of new customers, targeting specialty technologies, including analog, high voltage, CMOS image sensor and embedded non-volatile memory products.

We believe, through the leadership of our cohesive, high-caliber management team, healthy capital structure and clearly defined business strategy, UMC will emerge from the downturn stronger and better positioned to capitalize on the business opportunities in 2012 and beyond.

Now let me provide you with the guidance for the third quarter of 2011.

Revenue will show a low teen percentage range, about 10% to 12% decline, mostly driven by lower volume.

Operating margin will be in the low single-digit percentage range.

Capacity utilization will be in the low 70% range.

The consumer and the computer segments will outpace the communications sector.

This concludes my comments.

We are now ready for questions.

Operator, please open the lines up.

Thanks.

Thank you.

(Operator Instructions).

Your first question comes from Kevin Chang from Credit Suisse.

Please ask your question.

Hi.

This is Randy Abrams from Credit Suisse.

The first question follows on a bit from this afternoon, but on your fast-follower strategy, where you've traditionally, or the past couple of years, invested a bit slower on R&D and CapEx to focus on profitability.

Are you starting to tilt back, as you look at 28-nanometer, to be more aggressive now on R&D and CapEx, to start to narrow the gap again.

So it will be less of that fast-follower and start to try to narrow the gap again with TSMC.

Yes.

First of all we are not really fast-follower.

If you are talking about logic technologies, I think the true leader is Intel.

They are defining the process architecture for logic technology generation after generation, starting from [straight] engineering, silicon germanium, high-k metal-gate, etc.

What I meant was the gate-last high-k metal-gate.

So for UMC, with our size and strength, we are trying to provide our customer-driven solution in a timely fashion, also fit into our overall structure, where we are talking about we still try to ratio our R&D spending, in the past few quarters, around 8% or below.

So we are still doing that.

However, on 28-nanometer, you are right, we have not only selected the right technology, which is high-k metal-gate gate last, in addition I mentioned in the afternoon, we are also offering a very competitive 28-nanometer polysilicon -- poly/SiON technology.

We tweaked the performance with a very competitive performance and price ratio.

So, overall speaking, we are trying to do our best to provide timely and adequate solution for our customers.

Okay.

And maybe as a follow on to that, if you could go through -- you touched a bit this afternoon on it, the challenges that you've had on 40-nanometer for a bit more mild ramp and then 28-nanometer with the poly/SiON or high-k metal-gates, if there's new -- if you're starting to see customers from new applications, or diversify out further at 28, where you -- you're attracting some new customers there.

Actually 40-nanometer the ramp, if you compare 65-nanometer, it's not really late.

Our first wave of design customers they are moving along pretty smoothly.

And the impact of economy may slow that down a little bit.

And, in the meantime, we're in the incubation stage for the other 40-nanometer products.

Certainly some of them are second source.

So the design and the process, the tuning and tweaking may take some time.

But we are -- we will be there.

So, I mentioned, by the end of the year around 10 -- so we'll ramp continuously next year.

28, we are grabbing opportunities very well, as I mentioned earlier.

We are not sure exactly if it's like 90-nanometer, the weak node.

Certainly 90-nanometer is a weak node for UMC.

Many customer jumped from 0.13 to 65-nanometer.

We are still trying to understand closely on the development.

Okay.

Thank you again.

Thank you, Randy.

Thank you.

Your next question comes from Dan Heyler from Merrill Lynch.

Please ask your question.

Hi, good evening.

Chitung, I had a question whether or not you could break out the $1.8b, because you haven't changed your CapEx number, but I'm wondering if you could break it out for us again, what the contribution is between the advanced technology 28-nanometer and other capacity-related spend.

8-inch is about 14% and 12-inch, including R&D, is about 86%.

Could you give me the R&D number?

I think R&D is around 15% or less.

Helpful, thanks.

No change at all to the mix?

Not much.

Okay.

First of all, Dan -- perhaps I can make a comment.

Sure.

For the 65-nanometer, 12-inch, we have already done for 65-nanometer investment at this moment.

So most of them, at 12-inch, they are 40- and 28-nanometer related.

Got it.

Thanks for that.

Thank you, Dan.

And then in terms of the revenue, you talked about 10% of revenue by year-end, but we don't know whether revenue is growing or not, as you alluded to earlier, given the uncertainty, macro factors you're not sure whether you'll be getting growth in the fourth quarter, as you said this afternoon.

So could you tell me, in absolute terms, is 40-nanometer revenue growing in the third and fourth quarter?

We have internal numbers of our revenue forecast.

The ratio should be, we are still talking 10% for 40-nanometer.

As far as the exact number, I think 40 is ramping now for us.

Okay.

Because [there's Linux] obviously there's been cancellations and push-on inventory and you're ramping 40, so I was wondering if, in spite of the inventory, whether your 40 is still growing sequentially in 3Q and 4Q.

And it sounds like you believe that it is.

Yes.

Well, that's our target.

And so far -- as I mentioned earlier, certain ramp speeds are related to the some of the design revisions.

And this is becoming more difficult nodes, even for the design and the customers, to get the things -- the final version into production and ramp to volume.

We are at those final stages.

Okay, great.

And finally my question was on 28.

Did you -- in terms of your process partners over the years, is there a different mix of your early ramp process partners at 28 than you've had at 40?

So we still have the early customers ramping with us.

In the meantime, we are focusing on the more industry standard process, and that's very popular actually.

For example, 28-nanometer high-k metal gate, even going back to the 40-nanometer, 40G, 40LP, that really lowered the engagement barrier for many of our customers.

So actually we got more partners, whether it was earlier or later, it's timely I think.

If we are providing good value for them, it's good for us.

So you're saying, for the 28 leading initial partners is effectively the same group of guys that were with you at 40, or is there --

I mentioned earlier, some earlier ones are the same.

In the meantime we are providing a enhanced -- we're offering our own platform as well, as I mentioned, a tweaked -- enhanced 28-nanometer technology platform.

And also we're working with the IP partners to provide a complete IP suite.

And it's gaining momentum and customers are very interested which provides the best -- very, very competitive performance and price ratio for applications.

Okay, helpful.

And contribution to revenue in 28 by year end was what?

28?

We don't have 28.

Still working on that.

Okay got it.

Thank you.

Thank you.

The next question comes from Robert Lea from Jefferies.

Please ask your question.

Okay, yes.

Thanks for taking my question.

Actually I was going to ask on some of the product mix issues and also the CapEx side.

But that appears to have been asked already a little bit.

But with the $1.8b CapEx spend, to what extent are you committed?

And if the macro environment were to take a further turn for the worse, what degree of flexibility would you have to reduce that number, if you saw fit at the time.

And, in addition, is the fact that you are not actually changing CapEx, even though you face what most people would say is going to be quite a challenging quarter.

Should we view that as a signal that this is a temporary event, impacted by a number of temporary factors which will pass in time?

And to what extent do you have visibility that the business will stabilize into the fourth quarter and first quarter of next year.

Thanks.

For CapEx, it's always forward looking.

As I mentioned earlier, the CapEx investment today they are both 40 and 28-nanometer.

Most are 40- and 28-nanometer related.

So, in the afternoon conference I mentioned, for 2012, not only 40-nanometer will ramp in UMC, 28-nanometer will start to ramp very aggressively, actually steeply next year.

So we're really preparing for the future.

And today's business they are -- we talk about inventory issues, the global macroeconomic concerns.

We will definitely deal with it, but the future investment, actually we are quite excited about the future prospects in the mid to long term.

Yes.

Hi, Robert.

And as for the flexibility we have for CapEx numbers, as we mentioned, it's $1.8b cash-based CapEx budget.

And certainly we have room to slow down the payment if we want to.

However, considering our cash on hand, about $1.5b with all the depreciation come in, it's really no point to slow down the payment unnecessarily.

So I would say the currency impact, along with some payment terms, may alter our final $1.8b number a bit, but there's no intention to change the regular payment terms for the $1.8b number.

Okay.

Thanks for that.

Can I ask a quick follow-up question, just in terms of your current visibility with the communications-related customers, because I guess that is one area, particularly on the feature phone and mainstream handset sector, where both yourselves and other suppliers out there seem to be experiencing some weakness at the moment.

What visibility, if any, do you have on when that situation may stabilize?

Because, like your own business, many of these end customers would typically be experiencing a relatively seasonal strong second half, which doesn't appear to be coming through.

Now clearly some of these customers have their own issues to deal with in addition, which is compounding their problems, but to what extent do you have any visibility at all that things are beginning to stabilize at those key communications customers.

Actually our Q3 revenue decline are a reflection of certain of these issues that you mentioned.

But looking forward to the future, we are closely watching.

But I doubt it will be too much worse.

So it is a possibility that the business could reach some sort of stable state into the fourth quarter?

It's hard to say.

As I mentioned earlier in the afternoon conference, if it was just a inventory correction, it's possible.

But the end demand is really the key issue or concern.

Yes.

So, related to that, everybody who has been impacted by the macro developments that we've seen in Europe and elsewhere, expectations in the sector are being set lower and people, in general, are taking quite a conservative view on life.

Therefore, to what extent is there some upside risk if we do see stronger -- if we do see a little bit of seasonality coming through, if we do see consumers in the main Western economies going out and spending in Christmas, that actually -- is that something that people are really betting on at the moment?

And to what extent do you think it could happen and help to stabilize the business into the year end?

It's definitely possible, but traditionally Q3 is the peak season for foundry, actually preparing for the US Thanksgiving and, globally, the Christmas events.

We still [strive about] getting close, but this Q3 is much weaker than the past.

So as far as the upside risk, we definitely welcome that.

But we need to be very cautious as well.

Okay.

Thanks very much.

Thank you.

The next question comes from Donald Lu from Goldman Sachs.

Please ask your question.

Yes, good evening, Dr.

Sun, Chitung and Richard.

Hi.

Hi.

MY question is a follow up to the last question on Q4 outlook.

I agree the economy is very uncertain.

Have you seen any recent order cut or indication from customers that they are going to really control their inventory in Q4 because of the economy?

And in addition to that is there any particular -- in terms of inventory correction, as you commented it's probably mostly going to complete in Q3.

And is there any signs that is showing any particular area may have lingering correction in Q4?

I guess there are multiple questions there.

If we go back to the inventory in Q4, I can talk about the UMC's Q3 for the different segments.

I think for UMC the stress has been the consumer and computing area.

For example, sensor area are holding up pretty good and hard disk controller, the [read] controller chips are pretty good.

Communication are still weak.

That's where we are.

As far as the customers, inventory control is still happening and we hope it will be all cleared up towards the end of Q3.

But that depends on the demand situation, so we are watching it closely.

And just in your own bookings, in the last, let's say, three four weeks, would that be -- was the weakness mostly happened in -- is things getting more stabilized in the last few weeks or is that still continues to trend lower?

So all right, Donald, let me provide you from a different angle.

Sure.

The monthly revenue trend in our third quarter is going to be trend down month by month.

So our Q4 starting point has to be at the low point of Q3.

And we don't really have visibility towards the end of Q4 so it's difficult for us to comment on the situation for overall Q4 outlook.

Fair enough.

My next question is more on the cash flow side.

I think UMC has been have very healthy positive free cash flow for many years.

And this year, the CapEx is higher, so that the free cash flow probably is going to be negative.

First I want to confirm that's the case.

And the second is going forward, is there any guidance on that, whether the Company will try to maintain a balanced free cash flow or anything related to that.

To have a self-sustained cash flow cycle is always what we try to achieve.

Last year and this year we spent a little bit more CapEx, considering our cash position.

But we also have plenty of room from the debt financing which we did issue an ECB earlier this year to cover the gap and in the meantime we also paid out a pretty handsome cash dividend.

So ultimately we will continue to achieve this self-sustained cash flow cycle, but if necessary we also have room to gear up a little bit if we want to.

But this year I think given the ECB issuance, we should be able to reach cash flow equilibrium in 2011.

And going forward, would you try to maintain an operating cash flow minus CapEx to be relatively neutral or you think next two years is good opportunity because some of your competitors are having a lot of turmoil at the management level?

Cash flow capability definitely is a boundary when we're considering or planning our CapEx.

And as I mentioned we certainly try to achieve the status of self-sustained from cash flow point of view.

But we also have room for gearing up if we want to.

So basically the goal is to reach this self-sustained level.

Okay, great.

Thank you.

Thanks.

Thank you.

Your next question comes from Szeho Ng from BNP.

Please ask your question.

Hi, good evening.

My first question is with regard to the non-operating item in Q3.

Could you share with us what numbers we put in our model?

Normally we would have dividend income in third quarter.

But we also have some non-op earnings tied to the up and downs of the overall stock market.

So I think it's safe and conservative to factor in higher than that quarter two numbers in your Q3 forecast.

So we expect the non-op to be slightly higher than that in our quarter two non op.

Any ballpark number that you would suggest?

I would say slightly higher.

Slightly higher, okay.

All right.

And then second question, do you have any plan to convert the 65-nano capacity for let's say 40-nano, given the fact that 65-nano utilization seems to be coming down.

It's a routine for us when we deal with a node transition, for example as we were converting 0.13 and 90 to 65, at the right time with -- the key is the efficiency.

Usually when you do this type of capacity conversion you have to take care of the efficiency.

You need to spend additional money to do the conversion.

But it's a routine for us.

At the right time we will do it.

But any other thing you can share with us?

Let's say what percentage of your 65-nano do you plan on upgrading?

I don't have the number I can share with you today.

But our 65 is doing okay.

You can see the percentage share is still growing.

Okay, all right.

In percentage, yes.

Thank you.

Okay, all right.

Thanks.

Thank you.

Your next question comes from Dan Heyler from Merrill Lynch.

Please ask your question.

Yes, thanks.

Hi, guys.

Dr.

Sun, I had a quick follow up on the 28.

You talked about your poly/SiON technology.

What area of applications do you anticipate the first ramp in your 28-nanometer?

Will be it be performance driven or do you think it will be more in the low power wireless sector?

Actually the first product is high performance application processor.

Okay, great.

As you look at the technology -- or most of the problems appear to be in low power, based on what we're hearing as were the challenges are.

Could you elaborate on the color there, the 28?

Are we going to see low power adoption come much later down the road versus high performance than we saw say, in 40?

That is the time between performance and low power that may come in fact a bit later than normal.

Actually at 40-nanometer we still have a high performance process, for example, 40G and low power process 40LP.

The process is actually converged into one process at 28-nanometer.

That's the trend.

Because the SoC process, it covers both high performance low power into one process.

So usually -- that's something new for 28-nanometer.

One process probably cover a broad range of applications.

Okay, interesting.

So therefore you would expect the low power ramp to come relatively shortly or in line with your high performance ramp then?

Actually that high performance application process are used mostly for mobile devices.

So these devices are very high performance.

I'm comparing say network processors or FPGAs versus the (multiple speakers) apps processor.

So I'm thinking high performance digital versus low power.

So it's not the networking or FPGA product.

Okay, got it.

Thanks a lot.

Okay, that's it from me, thank you.

Thank you Dan.

Thank you.

Your next question comes from Steven Pelayo from HSBC.

Please ask your question.

Great, thank you.

I'm trying to sort out UMC's relative performance taking into respect your differing customer exposures and your differing technology mix and I guess I'm struggling.

So maybe I want to ask it the other way, to think about it more from an end market exposure.

You have about 50%, 60% of revenues from communications.

Could you really help us understand or have you done the analysis on what percentage of that is more a 3G smartphone world versus a 2G feature phone world?

Chitung, you have the number?

I don't have the exact number.

But we are exposed for both 3G and 2G today and some 3.75G even.

So all kinds of customers and applications.

But we are a foundry manufacturing service provider so I guess we are exposed for all of those stuff.

Okay.

I guess maybe I was thinking your relatively higher exposure to the feature phone world is causing maybe some of the relative underperformance to companies like TSMC.

Yes, that's definitely -- to some extent that's true.

But we are in the transition as well.

Fair enough.

And maybe just an accounting question here.

You guys didn't give gross margin guidance this quarter, focusing more on the operating profit line.

You do have depreciation growing.

Could you just remind me what the target is for the full year and how you see it specifically within the cost of goods sold line in the third quarter and in the second half?

Yes, if you talk about depreciation, the full-year depreciation number will grow year over year but it shouldn't be more than 5%.

And for third quarter, the reason we give operating profit margin instead of gross margin is operating -- profit margin guidance is low single digit.

So we just want to make sure that we are at this moment comfortable with this guidance.

And in terms of the absolute operating expenses in absolute dollars we will show slightly growth from the number of last quarter.

And the depreciation within your cost of goods sold it grew 11% quarter on quarter in 2Q.

What's the outlook for that particular line so I can try to think more about your gross margins in the second half?

Because we did consume some of the inventory in our work in process in second quarter and I think for Q3, it should back to same ratio.

Okay, I'll follow up later.

Thank you.

Thank you.

The next question comes from Donald Lu, Goldman Sachs.

Please ask your question.

Yes.

I have a question on depreciation again.

Chitung, can you give us an estimate on depreciation next year assuming your CapEx will be relatively flat or whatever number?

Is there just a directional thing we can have?

I can tell you from the other angle again.

This year we do have expiring depreciation carried over the last four five years.

So we do see some of our existing facility have significant reduction in the depreciation expenses.

That probably won't repeat again next year.

So we do expect to see the depreciation increase in terms of percentage to be relatively higher than that of this year.

And because we don't have a final number for CapEx next year, so it's difficult for us to give you a percentage right now.

Okay.

And do we know like what's the difference in terms of the depreciation come out of line this year relative to next year, like the difference?

The difference is quite big.

Currently we are talking about more than TWD1b.

TWD1b.

Okay, thank you.

And another question is on the tax rate.

Is there any update on that for this year and next year?

I think this year and next year will always be in the range between 8% to 10%.

Okay.

So it will be relatively stable.

Yes.

Okay, great.

And the final question is I find that your last press release with Cypress on this embedded Flash is quite interesting.

And it seems like a pretty new product, if I'm correct.

What would be the application for that thing?

What kind of product would that be used on?

Actually this 65-nanometer embedded Flash is using what we call Sonos technology.

It's an extension from Cypress 0.13 Sonos product.

It's used broadly on their PSoC product lines for all the controller, etc., etc.

But now they are working -- they have been working with us on 65-nanometer for many years.

And the good thing for this, we are allowed to promote this technology to other customers as a broad-based IP and macro for broad-based application.

It's very competitive from performance cost terms consideration.

So we are quite excited.

When would you think you will see revenues coming from this technology?

I think we are -- it's already all confirmed and verified.

I don't have the number.

I think early next year or -- yes, early next year probably the case with Cypress.

Okay, great.

Thank you.

Thank you.

Thank you.

Your next question comes from Steven Pelayo from HSBC.

Just a quick follow up.

As you guys were realigning the Company for better returns over time, you actually managed to deliver [a good] quarter, I think 30% plus gross margin and 10% double-digit plus ROE.

Now we've got to prove ourselves maybe through a mid-cycle correction or a downturn here.

So could you help us understand really what's different today to make you weather the downturn, or even better, maybe quantify a little bit more on customer diversification or breakeven levels?

Or maybe just try to help to understand how UMC will weather a pullback better this time.

So from a technology perspective, I mentioned we are in the transition from -- many of our 65 customers are moving on to 40.

But I mentioned earlier we are still in a transition phase doing the final design and tuning for these things.

And 65 will have a second wave of our products.

And 40, we are providing 40G, 40LP those technologies and 28 I mentioned next year we are probably are ramping together with 40.

So in the long run it's quite exciting.

But this you said mid cycle inventory correction, we just have to deal with very efficiently and then transition smoothly to the next cycle.

And Steven, we do have a very cohesive management team and we're pacing ourselves.

And if you look our CapEx number we do feel we are one of the most disciplined ones.

So basically we are focusing on addressable market with a very clear target.

So I guess that's the key difference compared to the last time cycle.

Okay.

And then maybe if you could just talk a little about customer types as well because I know you guys have been working a lot on diversifying your customers beyond these top three of the past.

Maybe remind us again how many are above 5% revenues or minus.

I think even a year or two ago, you talked about really wanting to focus more on US fabless as well.

I want to hear how this potential downturn is different than the last one for UMC.

I think our top-10 customers has about 70% of our revenue.

We have three 10% revenue customers and four 5% revenue customers.

And customer diversification, as Chitung mentioned, we are really -- the difference is we are really focusing on the addressable customers in addressable markets.

In certain area, if there is a disconnect in the timing on technology or service we can provide, we tend not to spend too much resources.

So that's in essence where we are.

Okay, good luck.

Thank you.

Thank you.

There are no further questions at this time.

Sir, please continue.

Thank you again for your interest in UMC.

Please feel free to contact us directly if you have additional questions.

Operator, back to you for the closing remarks.

Thank you, sir.

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 section.

You may now all disconnect.

Goodbye.