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United Microelectronics Corp. (NYSE:UMC)

Q4 2008 Earnings Call

February 10, 2009 8:00 am ET

Executives

Chitung Liu - Chief Financial Officer

Shih-Wei Sun - Chief Executive Officer

Analysts

Randy Abrams - Credit Suisse

Shailesh Jaitly - Nomura Securities

Pranab Sarmah - Daiwa Securities

Patrick Lau - J.P. Morgan Securities

Steven Pelayo - HSBC

Operator

Welcome everyone to UMC’s 2008 Q4 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 (Operator Instructions). 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 www.umc.com under the Investor Relations/Investor Events section.

I would like to introduce Mr. Chitung Liu, CFO of UMC. Mr. Liu, you may begin.

Chitung Liu

Thank you, operator and hello to everyone. This is Chitung. We are happy that you could join us for our conference call today. With me here are Dr. Shih-Wei, CEO of UMC; and Mr. Bowen Huang, Senior IR Manager. I will first review our financial results for the fourth quarter and then Dr. Sun will update 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. Certain business 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 U.S. and the ROC Securities authorities.

Now for the fourth quarter of results; for Q4, 2008 revenue was $18.54 billion, representing a 25.1% quarter-over-quarter decrease from NT$24.75 billion in Q3 2008, and 32.9% year-over-year decrease from NT$27.62 billion in Q4, 2007. Gross profit for the quarter was $1.9 billion or 10.2% of revenue, compared to $4.37 billion or 17.6% of third quarter ‘08 revenues.

Operating loss was $1.17 billion or 6.3% of revenue compared to an operating profit of NT$947 million or 3.8% of third quarter ‘08 revenue. Net loss was NT$23.51 in Q4 ‘08 mainly due to a net non-operating loss of NT$21.78.

UMC always follows financial accounting standards strictly and we hope our financial report can timely reflect the company’s overall financial status. The net non-operating losses of NT$21.78 billion in Q4 ‘08, we can separate into three main parts.

First, under the impact of global financial crisis, we recognized investment loss of NT$12.32 billion and other than temporary losses on financial assets of NT$2.82 billion pursuant to ROC GAAP, SFAS No. 5 and SFAS No. 34 respectively.

Second, the impairment loss of goodwill and idle assets totaling NT$4.07 billion were recognized pursuant to SFAS No. 35. Lastly, the loss on decline in market value of inventory NT$2.68 billion was recognized pursuant to SFAS No. 10. However, UMC had net cash inflow of NT$10.93 billion during Q4, since all of the aforementioned non-operating losses were non-cash charges.

Loss per ordinary share for the quarter was NT$1.18 per share and loss per ADS was US$0.276. You can look for more details reviewing the financial data at on our Press Release today.

Now let me turn the call over to Dr. Shiwei Sun and he will provide you with UMC’s business update and outlook for the first quarter of 2009.

Shiwei Sun

Thank you Chitung, and welcome to our quarterly conference call today. It’s nice to meet everyone again on the air and then we always appreciate your participation and your interest in UMC. First of all I will touch base on the highlights of the Q4 operating results, then provides further details on our performance and the key activities impacting our business in Q1, 2009.

The global economic recession impacted UMC significantly in Q4 ‘08 characterized by a sharp drop in customer demand in customer demand during the quarter. Customers still remain conservative about end market demand and are strictly controlling their purchase orders and inventory levels. However, UMC’s internal indicators have shown signs that the demand drop may have already bottomed out, and we are closely watching for signs of recovery.

In the second half of our 2008, UMC took solid steps towards enhancing UMC operations including improving production efficiency, implementing cost rationalization policies and streamlining human resource allocation. Through cost-control measures, we have lowered our operating breakeven point to approximately 60% utilization rate. Going forward, we will continue to enhance execution and monitor results to look for areas that can be further improved upon.

Despite a cost control measures UMC, R&D for advanced technologies remains on schedule as originally planned. Many customers are adopting our 40 and 45 nanometer technologies with customer products currently in pilot production, using low-power and high-performance logic processes. In addition, we have already demonstrated a high-k/metal-gate technology with yielding 45 nanometer SRAM test products. This is an important milestone for UMC’s high-k/metal-gate technology.

We are also an industry leader in 28 nanometer, having independently developed the foundry industry’s first fully functional 20 nanometer SRAM chip. This technology breakthrough will further enhance our long-term competitiveness.

UMC has independent R&D and solid and manufacturing capabilities backed by a healthy financial structure and supported through sufficient operating capital. We will continue to strengthen the development of our advanced technologies and follow our customer driven foundry solution strategy, to provide customized solutions to our global foundry customers.

Now let me provide you with the guidance for the first quarter of 2009. First, wafer shipments to decrease by approximately 40% to 42%. Second, wafer ASP in NT dollar to decrease by approximately 3% to 5%. We are still able to sustain positive cash flow generation in Q1. We also observe weakness across the three major applications. For 2009 CapEx budget, it will not exceed US$400 million.

That’s it for my report. Now let’s begin the Q-&-A session. Operator, please give the Q-&-A instruction. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Randy Abrams - Credit Suisse.

Randy Abrams - Credit Suisse

Yes that you. Could you talk a bit more, you mentioned end markets they were off, going down in the first quarter? Maybe talk if any end markets are falling off more or less than the average and when you talk about seeing some signs of orders improving. Is that across end markets or is it more specific to certain market?

Chitung Liu

I think the answer for both questions are pretty much across the board.

Randy Abrams - Credit Suisse

Okay and then in terms of magnitude, because you’ve had such a sharp fall in first quarter. Do you think it’s possible we get a double-digit sequential rebound into second quarter? Do you think it’s going to be a very modest roll off, the bottom in first quarter?

Chitung Liu

You are correct, because we dropped so much, the rebound there. If you are talking about double-digit, it’s possible, but Q2 is still some distance away, so it’s possible. So, we can discuss that in the next quarterly conference call.

Randy Abrams - Credit Suisse

Okay and maybe, you talk a bit more about the 3% to 5% decline in NT dollar pricing? How much of that is mix, maybe following backward aligning edge. How much is the step down with new contracts into ’09? And what’s your expectation for pricing this year relative to last year and even say relative to 2007, where pricing was more challenging?

Chitung Liu

At far as separating the mix versus Q1 price erosion in our new year, I don’t have the number with me today. As far as 2009 pricing pressure, as you can see today’s market situation is pretty tough, the pressure will be there. So, I don’t have a quantitative number with me at this moment.

Randy Abrams - Credit Suisse

Okay and I guess just lastly, if you could talk a bit about your expectations for 45-nanometer ramping up, whether it could be even meaningful in the second half or do you think it’s more 2010?

Chitung Liu

Well I think at this movement for us 45 in 2009, we’re mostly doing pilot engineering, as far as realizing significant revenue, I think it will be next year.

Operator

Your next question comes from the line of Shailesh Jaitly - Nomura Securities.

Shailesh Jaitly - Nomura Securities

Firstly, if you could give some more color on the CapEx. Of the $400 million what proportion of that is going to be spent on 45-nanometer tools? And also if you could detail, what kind of capacity growth are you looking at in 2009?

Chitung Liu

For that CapEx, I think $400 million we mentioned this afternoon in Taipei conference. Mostly there would be allocated to advanced technology. I’m sorry, your question is --.

Shailesh Jaitly - Nomura Securities

45-nanometer

Chitung Liu

Yes mostly 40-nanometer for us and throughout $400 million R&D CapEx, around 30% will be R&D, around 60% will be for 12-inch capacity expansion.

Shailesh Jaitly - Nomura Securities

What kind of capacity growth are you looking at, in 2009?

Chitung Liu

2009, so far in the first part, we don’t plan to spend much capacity, as the quantity, however we are doing aggressive mix change. So, we are converting some older technology to more advanced 65 and 55.

Shailesh Jaitly - Nomura Securities

Okay and Chitung there has been talk about some rush orders coming from the consumer segment; first if you could verify that, and secondly are you seeing that continuing?

Chitung Liu

As I mentioned it in the first question, we are seeing the rush orders across the board actually, on all three segments and as far as they are going to continue we are closely watching. Sorry, let me get back to you earlier question about the 45-nanometer capacity and if the situation goes well we’ve planned to allocate to about 20% of our Fab 12A’s capacity to 45-nanometer.

Shailesh Jaitly - Nomura Securities

I understand, and at this junction if you looking at all your product mix. Would it be fair, to assume that LCD drivers has pretty much fallen close to zero or is there further any chance of any declaims there?

Chitung Liu

I don’t think it’s falling to zero. LCD driver is very important part of our offering. I think as far the percent maybe, I don’t know 5% to 6%, below 10%.

Shailesh Jaitly - Nomura Securities

5% to 6% in 4Q ‘08, is it?

Shiwei Sun

Yes

Operator

Your next question comes from Pranab Sarmah - Daiwa Securities

Pranab Sarmah - Daiwa Securities

That you for taking my question. My first question is, when you mentioned about your internal indicators are showing some signed of bottoming out. What are the indicators you are monitoring out here?

Chitung Liu

Pretty much booking, billing and rates of incoming POS

Pranab Sarmah - Daiwa Securities

Could you elaborate a date about the book-to-bill? How much above variety at this point and when you saw that to as about 30?

Chitung Liu

Those are the internal trending numbers. We never normalize with respect to that industry and if there is any, but we saw clearly the early signs of rush orders being improved.

Pranab Sarmah - Daiwa Securities

Second one is, basically on 40 - 45 nanometer process technology. How many customers do you have at this point and how many products are on the tip-out phase and what do you expect to commercialize by year-end?

Chitung Liu

We are engaging approximately 10 customers. As I mentioned in Taipei, both low power and high performance. We have our customer products going through pilot stage and so far so for the progress is good. I think the natural course of the new technology will goes through the, what we called shuttle program, many customers will have the IP servicing on a shuttle goes those efforts in 2009.

Pranab Sarmah - Daiwa Securities

When you expect your first commercial product to start at 40, 45 nanometer?

Shih-Wei Sun

You mean production or?

Pranab Sarmah – Daiwa Securities

Production, commercial production

Shih-Wei Sun

Probably it will happen; it depended on the nation of the product. Some will have a long samplings stages etc.., probably in mid of this year we will have the first one, more volume production.

Pranab Sarmah – Daiwa Securities

Chitung, could you give us guidance on depreciation for 2009, how we should model out and also tax guidance for 2009?

Chitung Liu

Yes, for depreciation, it would be roughly 10% lower than that of last year and in the first quarter alone you will see quite a significant drop. We are talking about 4% to 5% sequential drop in depreciation in Q1. As for our tax, I think most of the non-operating losses I just highlighted during the early presentation was non-cash basis and it hasn’t been realized, so it cannot be used for our tax deduction and therefore we still pay tax for ’08, around 10% minimum tax. As for ‘09 I think, it’s also safe to use 10% as the tax rate.

Operator

Your next question comes from the line of Patrick Lau - J.P. Morgan Securities.

Patrick Lau - J.P. Morgan Securities

Hi, good evening Shih-Wei and Chitung. I’ve got a few questions; first, would you please tell us, I mean when we look at the total revenue and total shipment, we found the ASPH or you is quite different from the chart you provided. So, is that above 5% in other revenue out of wafer revenue, is it correct thinking?

Shih-Wei Sun

For every quarter, the other revenue is actually quite different and sometime it could be pretty wide range, between 5% to 10% that’s considered normal. Most of the other revenue is service basis. So, they tend to have higher margin than the foundry business. So, it is difficult to predict the other revenue.

Patrick Lau - J.P. Morgan Securities

Okay, so for the 4Q ‘08 other revenue would be still 5% to 10%? Thank you.

Shih-Wei Sun

Yes, roughly around 5%.

Patrick Lau - J.P. Morgan Securities

Secondly, would you please give us some color about how UMC is doing so good to reach 50% operating break-even, say in terms of COGS and OpEx for example?

Chitung Liu

Actually for second part of ‘08, we see lots of our cost cutting efforts, including you mentioned on non-depreciation COGS improvements and operating expense improvement. It varies across the Board efforts.

Also on the depreciation side, we’ll start to see our dimension, pretty continuous decline in our fixed costs and you can also tell by comparing the operating expenses quarter-over-quarter or year-over-year, ‘08 operating expenses along was $2.4 billion less than that of 2007. So, those are all coming from the effect of cost reduction, but that depreciation certainly helps a lot too.

Patrick Lau - J.P. Morgan Securities

So, also Shih-Wei mentioned above the positive cash flow, could you please give us a kind of felling how low it is? Say below 30 or below 25, the feeling like there? Thanks.

Chitung Liu

I think its all dynamic and the reference number were given based upon the quarter one scenario including ASP etc., but currently we had 30% (Inaudible) generating first quarter, we are about to generate some minor positive cash flow. So it’s still positive, but not too far from breakeven.

Operator

Your next question comes from Steven Pelayo - HSBC.

Steven Pelayo – HSBC

Yes, firstly on the fourth quarter non-wafer revenue. Using your shipments time and your ASP, it actually looks like the non-wafer revenue was up significantly quarter-over-quarter, is this kind of a new run rate for this kind of business or help me understand. I understand its variable quarter-over-quarter, but it certainly stepped-up quite a bit quarter-over-quarter?

Chitung Liu

Sometime it involves some delayed revenue and we also have a very low base in Q4, so that cause the ratio percentage revenue to increase, so nothing unusual for Q4.

Steven Pelayo – HSBC

Okay. So, maybe on the outlook, we should think about something about that level, okay. On the operating expenses, you guys managed to decrease the by about 10% quarter-over-quarter in the fourth quarter, now as revenues in the first quarter looking to falling at an accelerating rate. I’m just curious, how much more flexibility do you have on operating expenses, could they fall another 10% quarter-over-quarter?

Chitung Liu

For the coming 2009, I agree with you. We did a lot of work on the second half of last year. The rate of decline in operating expenses will be somewhat smaller.

Steven Pelayo – HSBC

I was actually talking on a quarter-over-quarter basis, looking into the first quarter. Can you flex down with your revenues, very significantly in your operating expenses?

Chitung Liu

Not very substantial, I think it will be pretty good scenario if we can manage to have smaller absolute operating expenses in Q1 versus Q4 last year.

Steven Pelayo – HSBC

Alright, last question is on the inventory write-off of $2.7 billion. I mean at your ASP that you guys have, that took a lot of wafers. Can you give me a little detail behind that, where that was from and lots of customers and any more detail on that? [Multiple Speakers]

Chitung Liu

Wafers, it just the value of the inventory in Q4 last year. They also carry part of the depreciation expenses as well. Given that the capacity utilization rate are significant in Q4 last year and as well as Q1 this year. The per unit per wafer depreciation, each wafer actually jump significantly and by comparing our benchmarking to our selling price, each wafer will have to take a reevaluation of their market price. That’s where the inventory loss comes from.

Operator

Your next question comes from Shailesh Jaitly - Nomura Securities.

.

Shailesh Jaitly - Nomura Securities

Hi, Can you just detail and discuss a bit more on the ASP’s. There is 3% to 5% decline in sequential does appear to be pretty big and normally if you go back in history, this kind of decline is normally accompanied with big volumes. So, volumes are going down, there is lesser business to be had and still there is a massive decline. So, is it primarily the mix or there is something else happening there?

Chitung Liu

It partially mix and mostly our price decline in the beginning of the year when we renegotiate contract with several customers. Maybe our CEO can comment further--

Shih-Wei Sun

It’s is a mix of our product mix shift and also the first quarter of a new year it usually have a large impact on the price erosion.

Shailesh Jaitly - Nomura Security

And also, if you could characterize as to which nodes have you seen pricing more aggressive?

Shih-Wei Sun

I think it’s pretty much on the, I think the high-end node probably get some heaver erosion on price.

Shailesh Jaitly - Nomura Security

Understand, and the trend going forward, assuming that you’re expecting a bottom in this quarter, does that mean that going forward you will be a bit more aggressive on pricing as you go into second quarter?

Chitung Liu

Pricing is usually always case-by-case working with our customers also it depend on that technology node. So, we don’t have any strategy or policy on pricing.

Operator

(Operator Instructions) Your next question is a follow-up from Steven Pelayo - HSBC.

Steven Pelayo – HSBC

Your gross margin outlook in the first quarter, I understand your depreciation costs are coming down quarter-over-quarter, but you actually did your a job on the non-depreciation part of costs of goods sold in the fourth quarter.

I guess I was surprised to see that flex so easily, you tend to think that there is still a fair amount of that portion that is the fixed cost. Can you help me understand your gross margin outlook in the first quarter and how you are able to arrive at whatever forecast you’re thinking about our range?

Chitung Liu

Well, we have some personnel rationalization over the past few months and assuming now that the so called leave without pay is becoming like a common practice in the Hsinchu Science Park in Taiwan now, so there further help to reduce our personnel cost a little bit.

As for the first quarter outlook for gross margin given that there will be a new accounting principal SFAS No. 10 and that will actually restore the normal calculation for gross margin a little bit in our view especially given the substantial drop in our capacity utilization that. So all we can give today is, we can still generate positive or we are approaching to the cash flow of break-even point. Although, we still generate positive cash flow and so you can use the EBITDA margin as a reference or benchmark.

Steven Pelayo - HSBC

Okay and then maybe on the net non-operating income line. I understand you had a lot of one-time events in the fourth quarter. How does that look as you gotten in the first quarter? That’s my last question.

Chitung Liu

Okay, for the non-operating side actually, most of the impairment losses on the financial assets, a lot of the stock themselves actually share price also had showed pretty good rebound since the day we did the impairment losses at the end of last year. So personally, I know don’t expect to see any major further layoff in impairment losses in Q1.

On the other hand, we also do not want to sell our financial asset at a large scale. Those are financial investment as a larger scale in Q1. So, there probably won’t be any major capital gain either in Q1, so pretty much even out like zero in Q1.

Operator

Your next question comes from Pranab Sarmah - Daiwa Securities.

Pranab Sarmah - Daiwa Securities

Chitung, could you give us a little bit on your receivable side, whether you have to any write-off on the fourth quarter?

Chitung Liu

Not so much yet, but we are monitoring. Most of our larger customers are still in very good shape and smaller customers sometimes we ask them to put in cash or some valuable asset as deposit before hand. So, the risk is not high, it’s quite small.

Pranab Sarmah - Daiwa Securities

You have recorded about $15.5 billion investment losses on the fourth quarter. From balance sheet, where have you deducted that one because if I see, your long-term investment has comedown only $6 billion?

Chitung Liu

We have provisioned some of the write-off putting under the balance sheet already. Yes, I can send you a bit more detailed answers through email if you like.

Operator

Your next question comes from Steve Pelayo - HSBC.

Steve Pelayo - HSBC

Alright, I’ll sneak in a couple more here. I think you’d say that you had seen some order across all segment. I just want to first make sure that, I heard that correctly, all segments in your opinion have bottomed in and is there any relative strength in one versus the other as you look out in the first quarter?

Chitung Liu

Not particularly. Supporting, all areas we see some size of recovery.

Steven Pelayo – HSBC

Alright and then, when you think about the first quarter from our monthly sales perspective. How do you think about the linearity there? It looks like TSMC’s monthly sales were little strong and what something we’re expecting in the month of January? So, I’m just curious, how you’re looking at it?

Chitung Liu

We mentioned earlier also, February is probably the lowest month for us in Q1.

Steven Pelayo – HSBC

And March is above January, is that correct?

Chitung Liu

Yes.

Operator

There are no further questions at this time.

Shih-Wei Sun

Operator, please we can conclude our call today. So, that concludes our call. Thank you again for joining. If you have any further questions, please do not hesitate to contact us directly. Now back to you operator.

Operator

Once again, thank you for your participation in today’s teleconference conference. You may now disconnect.

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