UMC 联华电子

Operator

Welcome everyone, to UMC's 2010 Q4 earnings conference call. (Operator Instructions) I would now like to introduce Mr. Richard Yu, Head Investor Relations at UMC. Mr. Yu, you may begin.

Richard Yu

Thank you, and welcome to UMC's conference call for the fourth quarter of 2010. With me today is the CEO of UMC, Dr. Shih-Wei Sun; and the CFO, Mr. Chi-Tung Liu. During this conference we may make forward-looking statements based on management's current 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 security authorities. I'd now like to introduce UMC's CFO, Mr. Chi-Tung Liu to explain our Q4 2010 business results.

Chi

Thank you, Richard. For the fourth quarter of 2010, revenue was NT$31.32 billion, a 4.1% quarter-over-quarter decrease from NT$32.65 billion in Q3 2010, and that's a 12.9% year-over-year increase from NT$27.75 billion in Q4 2009. Gross margin was 32.1%, with 21.1% in operating margin. The net income was NT$6.42 billion, and NT$0.52 earnings per ordinary shares. In 2010, revenue for the full year was NT$120.43 billion, with NT$23.9 billion net income and NT$1.91 earnings per shares. So that is a short summary for the results on Q4, 2010. More details are available in the quarterly report, which has been posted on our website. I would now turn the call over to Dr. Sun.

Shih

Thanks, Chi-Tung. With the Chinese New Year around the corner now, I would like to take this opportunity to wish everybody the best for a happy and a prosperous New Year. Again, thank you all for joining us today. As always, we appreciate your interest in UMC. I will start with a brief summary of UMC's 2010 fourth quarter operating results and share with you our general operating status. After that, I will provide you with the guidance for the first quarter of 2011. We will then have the Q&A session to answer your questions. First of all, I would like to reaffirm you of this dedication to the customer-driven development of advanced technologies and the foundry manufacturing solutions. This commitment has led to considerable success in our efforts to broaden our customer base, optimize product mix and boost profit capability. For 2010, wafer shipments reached a record high of approximately 4.52 million 8-inch equivalent wafers, with revenue hitting another record high of NT$120.4 billion. Full year operating profit, EPS and a ROE of 11% also reached the highest levels in recent years. 2010 capital expenditures were $1.8 billion. With the expansion of high-end capacities, 65-nanometer and below revenue contribution for the fourth quarter alone reached 35%, with 40-nanometer products increasing to 5% of the total revenue. Revenue contribution from 65-nanometer and below products for the full year grew an impressive 170% as well. After experiencing growth momentum for over a year-and-a-half at UMC, we anticipate revenue for the first quarter of 2011 to decline slightly due to appreciation of NT dollar, certain customers undergoing product and technology node transitions and other seasonal adjustments. UMC is optimistic about demand for high-end chips this year, with revenue contribution from 40-nanometer growing quarterly in 2011 to become our main revenue driver. We will also begin 28-nanometer customer product pilot around the middle of this year, to satisfy customers' technology and capacity requirements while ensuring both stable growth and long-term ROE. We plan to invest about the same amount of CapEx as last year. Looking ahead in 2011, UMC will build upon its solid foundation and will continue advancing its technologies and service quality to provide its global customers the most appropriate foundry solutions. Now let me provide you with the guidance for the first quarter of 2011. Wafer shipments show us low single digit percentage decline. Wafer ASP in US dollars will decline in the low to mid single digit percentage range. Capacity utilization will be approximately 90%. Gross margin will be over 25%. The consumer segment will be relatively weaker than the computer and the communication segments. 2011 CapEx budget is approximately $1.8 billion. That concludes my comments. We are now ready for questions.

Operator

(Operator Instructions) Your first question comes from the line of Randy Abrams of Credit Suisse.

Randy Abrams

I wanted to know if you could elaborate on the node transition you were talking about at some customers. Is that a one-quarter transition that's taking place, and is that a mix? And maybe if you can elaborate the transition that is going on in the business and if that's a one-quarter event?

Shih

So that was mentioned in our press. It's just certain customers are having their products transitioned. And those are node transitions. Some have some lag or priority to support it. Whether it's one quarter or not, we are managing it with our customers closely. So we expect second quarter mix will continue to improve.

Randy Abrams

And if you could clarify I guess the 8-inch versus 12-inch, if there's a meaningful difference on utilization between the two?

Shih

It's about similar.

Randy Abrams

Okay, similar. And capacity growth, I want to make sure from the afternoon conference, 12-inch and 8-inch, if you could review what capacity growth for both of them will be in 2011 and if that's a year-end to year-end or a total-year capacity growth number.

Shih

The total year capacity for this year for overall UMC will grow by 11%, 25% for 12-inch.

Randy Abrams

Okay, 25% for 12-inch. So 8-inch won't grow very much year-over-year.

Shih

We'll focus on the capacity conversion.

Randy Abrams

Okay, that makes sense. And then, the blended pricing, you had positive mix for a number of quarters this year. If you could talk about the pricing outlook into the coming year. And I guess, one, if there is a way to offset the material move in the NT dollar. And then, even for the core business if you see positive benefit either from mix or a continued firm pricing environment. So if you can talk about what you see going into this year.

Shih

We'll certainly focus on this coming quarter, Q1. So the blended ASP shift is mainly from the mix. As far as the pricing or pricing erosion, it's way under control.

Randy Abrams

If I could, a last question, I think some fabless companies have reported a bit of inventory build this results season so far. I guess if you could assess where your customers are at, if you are getting any hesitation or if you think they are still enamored? They need to rebuild inventory, or where are you seeing that front right now?

Chi

From the recent earnings reports you can also observe, some companies are having higher inventory. But that's the trend which has been continuing from Q2 or Q3 from 2009. Overall speaking, everybody is quite cautious about their inventory level. So we believe they are higher level, but quite healthy at this moment.

Operator

(Operators Instructions) Your next question comes from the line of Mehdi Hosseini of Susquehanna.

Mehdi Hosseini

Your CapEx commentary is quite interesting when compared to some of the newcomers with a very aggressive spending. Can you remind us what is your strategy, how do you view the competition? And is this CapEx kind of a minimum and would therefore be revised as your customer or the momentum improves?

Shih

As you see, we are trying very hard to build a self-sustainable business model. So our depreciation plus profit will sustain our ongoing CapEx plus the reasonable cash dividend payout ratio. So under that assumption, our long-term CapEx to revenue ratio, four year average is about 30% to 35%, even though this year is quite high. I'll say, maybe around 45% of our revenue ratio. Under this assumption, we are still able to provide our customers timely and adequate solutions. Another factor we are trying very hard working on is on our capacity conversion from the mature node to the advanced node. In addition, with this kind of a CapEx, we are pretty good. We can move our independent R&D capability, the 28nm I mentioned earlier in the afternoon, we are going to do customer-pilot in the mid of this year and volume production next year. Even 20nm is well on the way. I don't see any caging item at all.

Mehdi Hosseini

I am sorry; you said a pilot line for 28nm middle of this year, right?

Shih

Yes.

Mehdi Hosseini

Just as a quick follow-up and to the extent that you can help me, your new competitor is obviously relying on an entirely different manufacturing architecture and hoping that they could change it to gateless as they migrate to 20nm in the next several years. As you continue to engage with your customers about the long term capacity need, is that technology difference an obstacle for your customers to diversify their foundry partners? Or how should we think about your customers' strategy as they look at foundry suppliers that have actually increased?

Shih

I guess you probably mixed us with somebody else. 20nm, we are gateless. Even 20nm, we are not only gateless, we are high gateless. So we are pretty much mainstream. We are on our way on a technology alignment and the migration.

Mehdi Hosseini

I guess what I was trying to figure out is as you talk to your customers about the long-term capacity requirement and with the global foundry and gate-first architecture, how do your customers communicate with you about the global foundry and their approach? Is this something that you would consider as a significant risk to your business relationship with your customers, or is that something that global foundry has yet to prove that equity scale before you become concerned?

Shih

First of all, we don't talk with the other competitors too much. But I think our approach is a great advantage here for UMC's position.

Operator

(Operator Instructions) Your next question comes from the line of Steven Pelayo of HSBC.

Steven Pelayo

I am curious if you could help us understand your 45-nanometer activity. I think you've already said you want to get to 10% of revenues by the end of this year. But can we talk about the number of customers and the number of products that are being worked on and how that's changed over the last quarter or two?

Shih

For 40-nanometer, we have around 40 product tape-outs and 20 of them are in production today approximately from about 15 customers, and they are certainly more in the pipeline.

Steven Pelayo

When you look at your fourth quarter results, you guys obviously had strength in IDMs, strength in U.S. and Europe and obviously weakness in fabless in Asia, a pretty significant Asia revenue fall-off. So help me understand what that's going to look like in Q1. Do we have to continue to count on these U.S., European IDMs or would Asia fabless come back? How should I be thinking about that?

Shih

I don't have the exact breakout of reported numbers next quarter on Q1 situation, but as I mentioned in the afternoon, because of the new killer applications, the U.S. and the European customers, because they are in vicinity to the system companies, I guess they have a better handle on the new specs and the new applications. Also, they are the early adopters of the advanced technologies. So this way, these things are getting stronger. But I think it's actually quite typical. Give us some time today; Asian design houses, they will catch up aggressively.

Steven Pelayo

I am curious about your expectations as you look throughout 2011. Do you feel like your mix will return back up again as you get into 2Q and that ASPs maybe returned to the fourth quarter levels. Help me understand your ASP outlook as you go through 2011.

Shih

We don't have an overall yearly kind of a forecast. But as I mentioned earlier, the 40-nanometer continued gross momentum quarter-by-quarter, reaching 10% of revenue in the second half of this year. So also mentioned, because of the mix improvement from Q2, I think the mix (inaudible) will continue to improve?

Steven Pelayo

I guess where I am getting at here is given the increased concentration of U.S. and Europe in IDMs, does that make it more difficult I guess? Do we need everybody firing on all cylinders to kind of surpass the previous peak in revenue that you were doing back in 3Q? And if that's true, I need to weigh one quarter, two quarters, three quarters, how shall I be thinking about that?

Chi

We will focus on the coming quarter first. As Shih-Wei Sun mentioned, we expect the enhancements on mix improvement to kick in, in Q2. In terms of the magnitude and numbers, we will have to wait until the next quarter.

Steven Pelayo

I know you guided your depreciation to be up less than 10% in 2011. Fourth quarter, a portion in cost of goods sold was actually lower than what I'd thought. So is there a step function up here in Q1 to try to get that going? What would be your first quarter depreciation and cost of goods sold?

Chi

Roughly you can model in about 10% sequential increase.

Operator

Your next question comes from the line of Sam Wang of Gartner.

Sam Wang

I just have one simple question. I understand that this quarter's guided number that your 12-inch total capacity will increase monthly by about 4,300 wafers. Do you expect this will be the singular case for next few quarters?

Shih

I don't have the exact number. But for the overall UMC capacity increase, I have the rough number. For Q2, we have the largest percentage increase. I think over 5% capacity increased quarter-over-quarter. The other quarter, it's about 2-ish kind of a percentage every quarter, I mean Q1, Q3 and Q4.

Sam Wang

Okay.

Operator

Your next question comes from the line of Pranab Sarmah of Daiwa Capital.

Pranab Sarmah

I have two questions. First one is could you give some color on the linearity on the first quarter revenue, how you look on the monthly basis starting from January onwards?

Chi

Because of the less working days in February, so the February was a trough for the Q1.

Pranab Sarmah

So March will be above the January? That is what we can look at?

Chi

February is lower

Pranab Sarmah

Then the second one is it looks like your capacity expansion in 2011 will be slightly lower than your peers. Do you fear you are going to lose some of the market share in 2011?

Chi

Again, our strategy is really balancing the market share and profitability. And also again, as I mentioned, we are working very hard on the capacity conversion. Last year, you can see we were doing pretty good on converting lots of 12-inch capacity to 65-nanometer. And we plan to do a similar on 40-nanometer and moving forward.

Pranab Sarmah

Would it fair to say at least on the advanced technology, 65-nanometer and 40-nanometer you would be able to maintain your market share? Or how do you look in that area?

Chi

I cannot project those kinds of numbers at this moment, because I really don't know the competitors' situation.

Pranab Sarmah

Last one is could you give us some color like out of your communication business how many percentage is going to smartphone-related area, because that is a high growth area now, and what percentage of their revenue is going to tablet-related product, any rough color?

Chi

Communication covers a lot of business.

Pranab Sarmah

Basically it's a high-growth area. In future if you can just give us some color, that could be helpful

Chi

I don't know the number. Also, somebody mentioned that tablet should belong to the computing segment. So it's very gray now.

Operator

Your next question comes from the line of Aaron Husock of Lanexa Global.

Aaron Husock

Maybe just to clarify, I think I heard you say that the gross margin in Q1 will be over 25%. When I was reading some notes from some of the analysts talking about earlier call in Taiwan, they were talking about gross margin guidance of low-30s in Q1.Could you just clarify what you think your gross margin will be in Q1?

Shih

We said in the press, it's over 25%.

Aaron Husock

Ok, so you're saying over 25% and not saying lower thirty's.

Shih

Over 25%, yes.

Aaron Husock

Could you walk me through why the gross margin falls so much in Q1 compared to Q4 when it seems like your utilizations are holding in pretty well and pricing is not down that much.

Shih

The biggest portion is the NT dollar appreciation. We are assuming approximately a 7% impact from the NT dollar appreciation. And also, we guided some relatively minor ASP decline.

Aaron Husock

When you look at your guidance for a small ASP decline, are you starting to see GlobalFoundries and Samsung foundry come up more in customer conversations as these are the companies that made large CapEx this year? Are customers starting to use them as pricing leverage against you or not really?

Shih

Operator

(Operator Instructions) There are no audio questions at this time. I'd like to turn it over to management for closing remarks.

Shih

Thank you, everyone, for your interest in UMC. Please feel free to contact directly if you have additional questions.

Operator

Thank you. If you would like to participate in UMC's conference, there will be a webcast replay within an hour. Please visit www.umc.com under the Investor Relations Investor Event section. You may now disconnect.