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AU Optronics Corp. (AUO)

Q3 2006 Earnings Call

October 25, 2006 8:00 am ET

Executives

Julie Chan - Senior Manager of Finance Division

Dr. Hui Hsiung - EVP

Max Cheng - CFO

Dr. David Su - VP and GM of Consumer Electronics Display Business Group

Analysts

Tony Sandhu - HSBC

Chung Ong - JL Capital

C.J. Muse - Lehman Brothers

Andrew Abrams - Avian Securities

Gary Hsueh - CIBC World Markets

Jeff Su - Merrill Lynch

Presentation

Operator

Welcome to AU Optronics Corporation Third Quarter 2006 Results Conference Call. The conference call will be recorded and webcast at the request of AU Optronics. Any objections, please hang up now. A copy of the presentation for AU Optronics' third quarter 2006 results announcement can be found and downloaded from its website, www.auo.com under Investors. Replay will be available until October 30. You can access the reply by dialing 1-888-286-8010 and use the access code 26788191. You can also access the webcast through the company's website at www.auo.com. At the end of this conference we will conduct a question-and-answer session. (Operator Instructions).

At this time, I would now like to turn the call over to Ms. Julie Chan, Senior Manager of Finance Division. Please proceed, ma'am.

Julie Chan

Thank you. Good morning and good evening to all participants. This is Julie Chan, Senior Finance Manager of AUO. On behalf of AUO, I would like to welcome everyone to AUO's third quarter '06 earnings conference call. Joining with me here we have Dr. Hui Hsiung, Executive VP; Mr. Max Cheng, CFO; and Dr. David Su, VP and General Manager of Consumer Electronics Display Business Group. As always, we would spend the next one hour also to review our third quarter earning results, discuss some of performance highlights, trends of the industry and conclude with our outlook for fourth quarter. After that we will take your questions.

Before we begin, I will like to state the management's comments about AUO's current expectations made during this conference call are forward-looking statements subject to significant risks and uncertainties, and that actual results may differ materially from those contained in the forward-looking statements.

The financial results we discuss today have been prepared on a consolidated basis in accordance with accounting principle, generally a subsidy in Taiwan, the ROC GAAP. You should be cautioned that these accounting principles differ in many aspects from the US GAAP. Information as to those factors that could cause actual results to differ materially from AUO's forward-looking statements may be found on AUO's annual report Form 20-F filed with the US Securities and Exchange Commission.

AUO takes -- undertakes no obligation to update any forward-looking statements whether as a result of a new information, future events, or otherwise. Please take a few minutes to read the disclaimer.

And now, please turn to slide number three of our presentation material.

Driven by increased seasonal demand across all segments and improving market condition, AUO's unaudit consolidated revenue totaled NT$71.3 billion, equivalent to US$2.2 billion represents a 17.1% Q-over-Q increase in Q2 '06. In terms of shipments, large sized panel shipments increased 24.6% reported as $12.6 million higher than the company's earlier guidance.

Small and medium-sized panel also rose by 15.1% recorded $20.8 million.

Operating income improved 61.9% Q-over-Q from NT$1.4 billion to NT$2.1 billion in this quarter. Net income was more than tripled to NT$613 million form NT$182 million in Q2 '06. In terms of probability margin, operating margin improved marginally to 2.9%, and EBITDA margin decreased slightly to 19.5%. Our basic EPS represented NT$0.10 for common shares and US$0.03 per ADS for the quarter

Slide number four. On the balance sheet highlight, during this quarter in preparation of acquiring QDI, short-term investment increased by 34.3% Q-over-Q from NT$21.8 billion to NT$29.3 billion. Inventory in the absolute dollars increased 10% Q-over-Q to NT$28.2 billion, primarily to support the shipments increased during the quarter. In terms of the inventory turnover days, it decreased slightly to 38 days from 40 days.

Long-term debt increased by NT$29.1 billion, mainly to support Q3 '06 capital expenditure of NT$21.8 billion, and preparation for QDI's term-loan NT$12 billion due in Q4 '06. AUO's debt to equity ratio and net debt to equity ratio rose to 81.2%, and 64.2% respectively.

Next slide, slide number 5 please. On the cash flow highlights. During the quarter, AUO generated NT$10.6 billion; operating cash inflow, mainly from net income of NT$612 million; depreciation and amortization of NT$11.8 billion; and remaining NT$4.1 billion subtracted from net changes in working capital.

Net cash used in investing activities totaled NT$29.6 billion, mainly for the capital expenditure of NT$21.8 billion. The net financing cash of NT$26.7 billion were attributable to the net changes in debt of NT$28.8 billion. As a result, AUO ended the quarter with a net cash inflow of NT$7.7 billion.

Now let’s look at our business analysis. Slide number 6, revenue breakdown by product application. In Q3 '06, percentage of sales from Consumer Electronics Display and Information Technology Display will pretty balanced. Follow these trends of the LCD TV demand trend, TV sales accounted for 30% of our total revenue became the largest shares of AUO business. Monitor was 35%, increased by 1% supported by the improvement of monitor demand during the quarter. Notebook, 14%, decline by 1%. Small and medium-sized business contributed about 11% of our total revenue, and the remaining 4% revenue were supported by general display and others.

Slide number 7, unit shipments and blended ASP on AUO's large-size panels. Again, the unit shipments of the large-size panels had a 24.6% increase to 12.6 million in this quarter, from 10.1 million in the previous quarter. Blended ASP of large-size panels declined by about 5.6% sequentially from US$162 to US$153, while pricing stabilized in mid-quarter blended ASP of PC panel declined 5.9% from US$119 to US$112, and ASP of TV panel decreased 7.2% sequentially from US$349 to US$324 in this quarter.

Slide number 8, by area. Panel shipment per square meter increased significantly by 30.1% Q-over-Q from 1,151K square meter to 1,497K square meter, while the blended ASP per square meter decreased about 12.2% quarter over quarter.

Slide numbered 9, small and medium-sized panel in this quarter improved 15.1% sequentially with shipments of 20.8 million. Revenue, however, decreased slightly to NT$7.7 billion, primarily due to unfavorable pricing, as well as some panel was sold as [semi module].

Slide number 10, AUO's monthly capacity for the December quarter, after combined QDI's facilities together, we have four Gen 3.5 fabs. These four fabs will support monthly of 20K low-temperature polysilicon and 150K amorphous silicon on December monthly. And in one fab Gen 4 remain at 60K monthly. For Gen 5 fabs together represent a monthly of 310K, and two Gen 6 fabs together support monthly of 180K sheets. And lastly, for our Gen 7.5 fab, AUO was successfully ramped 2K in September and expect to ramp up to 10K by year-end. For the more details, please do refer to our slide number 10.

Lastly, before we open the floor for questions, I will like to highlight management's expectation on our Q4 '06. Based on the current business outlook, we expect large panel shipment to increase by about 40% Q-over-Q. On the pro forma combined basis, large panel shipments expect to increase by 10%.

In terms of PC panel shipments, we expect to see an increase of about 40%, on the pro forma combined basis an improvement of 5%. TV panel shipments expectation do expect to be about 50%. On a pro forma basis again -- pro forma combined basis again, we expect to have about 25% on TV panel shipments. For the small and medium panel shipments we expect to experience about 20% Q-over-Q growth.

For pricing, we expect blended ASP for PC expect to increase by mid-single digits Q-over-Q, and blended ASP for TV expect to see a decrease by low single digits percentage Q-over-Q. Overall, our loading rate expect to be more than 95%.

This shall conclude our presentation for today. And operator, please open the floor for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Your first question comes from the line of (inaudible). Please proceed.

Unidentified Analyst

Hi good evening. I would like to ask a question about when you combine QDI in October [into a positive their third] quarter situation in terms of revenue for example, and if possible their profitability when you combine the company? Thank you.

Max Cheng

This is Max Cheng. I'll try to answer your question. Regarding QDI's financial results since that hasn’t been complete yet so I couldn’t answer too much about that at this moment. But for the sales revenue, I guess -- give me a minute -- the sales revenue would be about NT$15.3 billion for the third quarter, NT$15.3 billion.

Unidentified Analyst

Thank you.

Max Cheng

You're welcome.

Operator

(Operator Instructions). Your next question comes from the line of Tony Sandhu with HSBC. Please proceed.

Tony Sandhu - HSBC

Yes, thank you. Max just some more clarification on the guidance. I am a little bit confused here. You gave the Taiwan -- the QDI revenue guidance. Could you give me the annual -- what was their large panel shipment in third quarter?

Max Cheng

Well, the QDI -- the third quarter would be above 3.6 million.

Tony Sandhu - HSBC

3.6 million, okay. So you sold 12.6 million so when you say that you expect the pro forma large panel to be up 10%, you basically mean that it will be 16.2 million plus 10%.

Max Cheng

Yes, 16.2 plus 10%.

Tony Sandhu - HSBC

Okay, and similarly for PC panels and TV panels. Okay can you give me the breakdown in QDI for what was the unit shipment in TV panels, I mean I know for AOU it's about 19% what was the number in QDI?

Dr. Hui Hsiung

This is Hui Hsiung. I can give you the combined, for Q3 AOU plus QDI is 12.5 million for PC panels and combined TV panel is 3.0 million.

Tony Sandhu - HSBC

Alright. Thank you very much Dr. Hsiung. Thanks for clarifying that. Just on the price -- on the area shipments in the third quarter for AUO, I understand that the large panel units were up 25% but the area was up 30%. So can you just talk about what happened there? I mean, why the area has grown so much, even though the TV panel units seem to be still very stable at 19% of overall shipment.

Dr. Hui Hsiung

Okay. This is Hui Hsiung trying to answer. In terms of the large panel increase, so the increase of 10 -- increase from 12.6 million in -- I am sorry, from 10 million in Q2 to 12.6 in Q3, so the increase is about 25% and -- but there is a substantial change in product mix from Q2 to Q3. For example, let's look at the TV panel in the second quarter the 32-inch and above accounts for about 46% of our total TV shipment. However, in Q3, this increased to 55, 56. So this is substantial increase in larger sized panel. So that account for larger area increase.

Tony Sandhu - HSBC

Okay. Alright.

Max Cheng

This is similarly for -- my interest is actually quite similar. We, if you look at the 19-inch, Q2 about 42% and Q3 about 47%. So, there also we have the substantial increase.

Tony Sandhu - HSBC

Okay. Okay, that’s it. What do you think, so, is going to happen in the fourth quarter, or do you feel that you're guiding for the units growth to be about 10%. Do you think the area growth will still be about 5 percentage point more?

Max Cheng

It will be even more. I believe that it will be about 20%.

Tony Sandhu - HSBC

Area growth will be 20%. Okay that’s better. Okay. Could you talk a little bit about the CapEx plan for 2007?

Max Cheng

Okay, our guidance for 2007 would be at about NT$90 billion which is a bit lower than this year's total CapEx. If we combine the AUO and the QDI together, the number for the year 2006 would be around 105, or maybe, yes, about NT$105 billion. So it's bit lower than this year.

Tony Sandhu - HSBC

Okay. And where is this - what plans do you have? I mean I know you are going to equip the 7.5G a little bit more but what other plans are there?

Max Cheng

Okay. The main area that we are going to put the CapEx will be at -- we are going to add another 30K for the Gen 6 fab, which we've just acquired from QDI. And then of course next year we will try to expand our Gen 7.5 from 10K to 60K. So that would boost a lot of our capacity on Gen 7.5 and also we’ll try to build new Gen 7.5 facility, but mainly we should -- that the mix prediction for year 2008 but there was of course has acquired a lot of [earning] in the year 2007. Next year that will get (inaudible).

Tony Sandhu - HSBC

So you are not really thinking of how other panel companies are thinking of either going towards 8G or bigger or some people are also thinking of going down to 5.5G, so you bet using 7.5G is a good fab?

Dr. Hui Hsiung

Yes. This is Hui Hsiung. Yes, definitely, we think in the coming at least two years or so the mainstream -- the main growth area will be 40 plus inch. So we will be 20 -- 42 or 46, 47. As 5.5 or Gen 8, I think are suitable for 50 plus inch and that is substantially smaller market segment, and it's going to be competing with plasma display. So that’s a tougher area we believe. So, we believe the 40 plus inch is more important in terms of investment.

Tony Sandhu - HSBC

Okay. Thank you very much sir.

Operator

Your next question comes from the line of [Chung Ong]. Please proceed.

Chung Ong - JL Capital

Hi. Good evening. Can you guide us on what is the EBITDA margin for 3Q and how is it going to be for 4Q?

Julie Chan

Sorry, can you repeat the question?

Chung Ong - JL Capital

Can you guide us what's the EBITDA margin for 3Q and what's it going to be for 4Q?

Max Cheng

Okay. The 3Q is, I guess, that was shown on the presentation material on page 2, page 3. Okay, it is about 19.5% for Q3, but for the Q4 you do -- we do net guide that kind of a number.

Chung Ong - JL Capital

Okay. The other thing I would like to clarify with you is that Hui mentioned that 7.5G were picked even around 20,000 glass substrates?

Max Cheng

Yes.

Chung Ong - JL Capital

Is that on an EBITDA level or operating margin level?

Dr. Hui Hsiung

Either EBITDA or operation margin or the total?

Max Cheng

Okay, that will be at the operating margin.

Chung Ong - JL Capital

Right. One more thing I need to check with you is that I'd just noticed that by going around in Singapore, where the TFT panel the glass is non-reflective; whereas, plasma is reflective glass. Is there a reason why there is this difference? Is there a reason why, say, plasma can use non-reflective glass or --?

Dr. David Su

This is David. Answer to your question for traditional plasma, because they have a inside use of phosphor coating so and the bright MVNI condition tend to have reflection from this coating phosphor. So, the bright contrast tends to decrease, so they need to have a cover glass to cover on top of the regular panel. So, plasma is (inaudible) this problem and certainly they have some solution to resolve this, this coating is anti-reflection glass, and we call it EMI glass, or put some special coating on the glass. So, that's what the plasma people is doing now to solve this.

Chung Ong - JL Capital

2.2 plasma TV, we can actually see non-reflective glass, is it -- is it correct?

Dr. David Su

Yes, because of the -- we -- that was the intrinsic property of this plasma panel, if you don't have this cover glass, you tend to see this reflectivity from this phosphorus coating.

Max Cheng

Yes, let me add. Actually, even TFT-LCD you can add anti-reflection coating, so intrinsically the plasma has higher reflectivity, so that's why it has a bad contrast ratio on the bright room light. But in both case, you can add anti-reflection to reduce that reflectivity. But as always, I think TFT will have a better performance under the bright room contrast.

Chung Ong - JL Capital

Right, okay. No, because I was just curious, and I go around I just feel like plasma doesn’t seem to have that anti-reflection kind of appeal, and I’m just curious like the difference between, say, a 40, 42-inch TV. If you add that anti-reflection, how much cost does it add? Is it significant or not so significant?

Max Cheng

It's -- there are some costs added. Certainly it's not significant in such a way that it become a bigger cost premium, but the fact is that even -- in the plasma, even you have the anti-reflection coating is still not sufficient to reduce the reflection that you feel is comparable with TFT-LCD.

Chung Ong - JL Capital

Okay, right.

Max Cheng

This is like -- each one of the drawback of plasma.

Chung Ong - JL Capital

Right, okay. One last thing is, is there any plans for BenQ to dispose off the AUO shares or is management helping them in any way?

Dr. Hui Hsiung

You mean, are we going to have any plan to take more BenQ's share?

Chung Ong - JL Capital

No, actually it's the other way around.

Max Cheng

The other way round. Whether BenQ would sell AUO's shares?

Chung Ong - JL Capital

Yes, because usually, if that's the case they will ask management to help out with something.

Dr. Hui Hsiung

I guess that would be their decision, we do no get involved there any kind of decision at this moment.

Max Cheng

We haven’t heard about anything like this up to now.

Chung Ong - JL Capital

Right, okay. All right, thank you. Thank you very much.

Operator

Your next question comes from the line of C.J. Muse with Lehman Brothers, please proceed.

C.J. Muse - Lehman Brothers

Yes, good evening. Quick question here. I guess, if you are expecting loading at 95 plus percent for 4Q, how do you feel inventory exiting 2006? And how are you planning to run your business in terms of loadings, I guess, as you -- from 1Q to-date?

Max Cheng

So you meant the inventory turnover. May be -- let me try to answer your question from the turnover days. What we try to mention with it as well as we could, such as 40 days at this moment. Because after the Q4 we were going to merge -- I mean, consolidate QDI's inventory. So, I guess we would spend a while to back to the 40 day or 35 days. Maybe by end of this year we may not reach this kind of level, but I don’t think we will get far away from that target.

Dr. Hui Hsiung

This is Hui Hsiung. I just like to add that as the percentage of TV business increased, because the TV manufacturing, for example, in Europe or in North America is away from China. So, we do expect the material in-transit in our panel obviously will increase, that percentage will increase. So, that we are likely to increase the inventory when we increase the ratio of TV business.

C.J. Muse - Lehman Brothers

Okay. That makes sense there. And I just then in terms of how you think about 1Q over the first half of the year, there is a lot of talks and concern around seasonality and will we see the same type of inventory build that we saw last year or will we see a more rational approach to utilization rates? What are your thoughts on that?

Max Cheng

That we always will. We follow the same guideline as we did in the past few years. We pretty much build to demand -- from customer demand because I cannot build to order, because usually we receive the purchase order about one month ahead. So, that’s insufficient, the lead time. So, usually we build based on customers' two to three months forecast, and so that has been working pretty well. We can avoid building or padding up of inventory that way.

C.J. Muse - Lehman Brothers

Great, thank you.

Operator

(Operator Instructions). Your next question comes from the line of Andrew Abrams with Avian Securities. Please proceed.

Andrew Abrams - Avian Securities

Good evening. I wonder if you could talk a little bit about your pricing expectations for fourth quarter and then moving into first quarter and then perhaps a little bit about when you think QDI margins will be up to what we would call standard AUO margins, you know, if you could give us some timeframe there?

Max Cheng

I think on price, I can make some -- I think earlier QDI already gave you the Q4 guideline, that’s pretty much what we think. For PC panel, notebook, and monitor we'll continue to increase unit price, both October and November. TV, because, during the Q2, the TV price is up a little bit more. So, we will see even in the Q4 the prices kind of stabilized, but it's still relative. Quarter-on-quarter we still see a slight -- a low single digit price drop. So that’s the PC -- TV situation. So Q1, we don’t have any guideline for Q1 yet, but theoretically Q1 is -- it's not seasonality, usually it drops somewhat --

Andrew Abrams - Avian Securities

Was there a big change from the beginning of the third quarter to the end of the third quarter for you guys? How did that -- how did it play out for you in terms of pricing. I realize early in the quarter pricing was pretty bad. Was that consistent for you guys across the quarter or did you see a big up move in pricing on both the monitor and the TV side or just the monitor side?

Max Cheng

Actually, the monitors prices bottom out in August. And for notebook they bottom out in almost September. So, it's, I am sorry there -- for monitor the bottom month is July, so August and September we have a price increase. But for notebook it's one month later. The price increase is starting from actually September, so one month later, and this price increase will continue till next, I mean, October and November. TV, we see by and large now the TV prices kind of flat, may be toward the end of the year December may be some slight going down. So I am just stating the third quarter seasonality.

Dr. Hui Hsiung

Come on, pose the second question.

Andrew Abrams - Avian Securities

Could you talk a little bit about the QDI margins and may be give us your timetable for bringing those margins up to AUO numbers?

Dr. David Su

Okay, I guess you know one has been doing this for a while so the talk is quite clear, we know how to do that. So it's just a matter of time, we can reach the same standard like AUO margin we have at this moment. But there's still some commitment with QDI's customers at this moment, so still have to carry QDI's model for a while, that will might impact our margin a little bit, and also we've got to change some process of their fab and also improve the yield rate. So it would take time before we see the same standard margin, and also we have to change the small line, I mean the Gen 3.5 for the small/medium-sized process, so that will also take a while. But at the end you know I guess again it’s a matter of time, if that wont happen in Q4 this year, definitely I do hope we can see a big improvement in first half of next year. We do hope that will be the trend line we can see some different profitability by then.

Andrew Abrams - Avian Securities

Thank you. And last just, would you expect any write-offs in fourth quarter in connection with the QDI acquisition? Is there anything that you know of now that you are going to be doing?

Dr. David Su

No. I -- at least -- I am not aware of any major item that’s going to write-off for the time being, especially the pricing environment is in favor of us because the price of HAS is going up. So even the inventory may be a bit high, but I guess that won't become a big problem because of this pricing environment.

Andrew Abrams - Avian Securities

Terrific. Thank you very much.

Operator

The next question comes from the line of Tony Sandhu with HSBC. Please proceed.

Tony Sandhu - HSBC

Thank you once again. Just want to talk a little bit about the balance sheet in regard to this CapEx of 90 billion next year and the debt position seems to be a bit high. What are your thoughts there, Max, on how things are going to proceed with, kind of, earlier comments that potentially pricing in the first quarter could be seasonally weak as well again?

Max Cheng

Okay. For the CapEx 90 billion in year 2007 while we try to have the cash flow a bit like a depreciation we could generate about NT$80 billion. So which mean we just short of about 10 billion. Because we might still have some earnings in year 2007, so I don’t think the debt ratio for next year would increase too much from existing level. After the QDI, I guess, the debt ratio -- the net debt ratio were bit -- quite high about 80% from 64% that AUO along by end of September. So, 80% of net debt ratio at this moment is little bit accessible for us because we had been change order of covenant that we signed with those of term loan with the banks already. So, 80% or 90% is still accessible for those banks. And from cash flow viewpoint because we have about NT$120 billion available bank facility, so that could support any kind of cash requirement for us in next few years. So, I don't think we are going to have certain problem in term of the cash flow or in term of the covenant. So, I believe for the debt ratio we can maintain that kind of level for a while, hopefully because we have some earning in next year we also could improve that kind of a debt ratio to lower level.

Tony Sandhu - HSBC

Okay. So no real plan to kind of bring up some equity here in the near term?

Max Cheng

Yeah. Hopefully, we don’t need to do that. As long as the CapEx could be managed bit low or close to the cash flow from depreciation, then I don't think we are in such kind of a rush position to improve the debt ratio.

Tony Sandhu - HSBC

Okay, okay, excellent. And I know there was -- the earlier question was talking about the first quarter '07 the seasonality and there were comments that the visibility is still -- on a firm basis it's still about 4 to 6 weeks. I mean, can you give us some sense of what you are thinking at the moment in terms of first half '07. Is it going to be weak for PC panels, is Vista going to have an impact, and is TV demand potentially going to continue or there is going to be a big drop off? What is the company thinking at the moment from just your internal side, not -- and talking to customers.

Dr. Hui Hsiung

Generally speaking, next year the capacity increase actually matched pretty well with the demand increase. As you all probably know, the capital expenditure of the TFT makers have slowed down next year. So that we feel in terms of supply area in general, the supply area, we do expect a pretty substantial growth. It is around 40% also, actually it should be more than 40%. But capacity growth is about 40%. So we are seeing as the whole year is pretty balanced year in terms of supply and demand. However, due to this technology, in particular the TV panel technology, we do expect the first half is kind of a looser and the second half is tight supply. So this is -- we will see this unbalance the first half and the second half, but, even so we don’t expect a substantial unbalance is pretty much similar to this year. You will have the first half is a little bit over and the second half is tight. I think this -- and it will continue to be so. In fact, what really happened is that because of the percentage of TV panel business increased, we -- the technology will dominate in the future in terms of supply/demand balance -- supply -- it will be dictated by the technology. So, in fact, it's actually quite predictable in the next couple of years. So we -- up to now we still see -- for example, TV panel demand, we still see about 60% increase. But if you convert it into display area it could be 80%, because TV is shifting up the size. But even monitor, LCD monitor is doing the same thing. So, even the monitor does slow down, the growth of monitor does slow down starting from this year. But we will continue to see the larger and larger market size, so the total area growth will be -- probably, I would say, 25 or even 30% increase for monitor. So -- but total area growth, as I said earlier, could still be over 40%. So, it’s not a small -- even within the monitor slow down, but it's not that slow the whole industry.

Tony Sandhu - HSBC

So, you see the move from -- now is the move from 19, but you see a big move to, let's say, 22 or 24 wide in the next year. Is that --?

Dr. Hui Hsiung

We do, actually we do. We no doubt moving toward a wide format. For AUO, already we've had our -- Q4, for example, Q4 our wide format will be -- actually it already happened in September. Our wide format is almost 20%, almost. That means Q4 will be closer to one quarter of our total monitor shipments. So, you can imagine by the end of the next year, we are almost certainly over 40 or even 50% in Q4 next year. So, that is very [new result] we see a major trend is shifting towards a wide format. I think next year will be helped by Microsoft Vista. So, this is a kind of new driver for the monitor, not only in quantity, but also in terms of the area is larger and wide format started, as 19-inch, but is our largest size.

Tony Sandhu - HSBC

Thank you, that is very useful. Just one potentially more question on the cost reduction side. It seems to be very impressive on an area basis, when we do the numbers that -- excluding depreciation, even those costs are down quite aggressively. Do you think that continues, when you talk to -- obviously the procurement talks to the component vendors. Do you think that continues into the fourth quarter and into 2007?

Dr. Hui Hsiung

Yes, we are being consistently, in terms of material cost consistently about 3% to 5% each quarter. So we believe we can continue to do that in Q4 and the next year.

Tony Sandhu - HSBC

And just one last question for Max. Max, what do you think depreciation just for standalone AUO in the fourth quarter, and then AUO plus QDI in the fourth quarter?

Max Cheng

Okay. If we combined two companies together, for the first quarter will be around NT$185 billion. So AUO alone, I guess would be 100 billion.

Tony Sandhu - HSBC

For fourth quarter?

Max Cheng

For the fourth quarter, yes. I'm sorry, for the combined basis, it would be at 182 billion. AUO -- I'm sorry, 18 billion.

Tony Sandhu - HSBC

Okay.

Max Cheng

I'm sorry. AUO alone would be 12.6 billion.

Tony Sandhu - HSBC

12.6?

Max Cheng

12.6.

Tony Sandhu - HSBC

Okay. So this is the 7.5G depreciation kicking in into the fourth quarter?

Max Cheng

That’s right.

Tony Sandhu - HSBC

Okay, thank you. Thank you very much again.

Max Cheng

You are welcome.

Operator

(Operator Instructions). Your next question comes from the line of Gary Hsueh with CIBC World Markets. Please proceed.

Gary Hsueh - CIBC World Markets

Hi, thanks for taking my question. I actually jumped on the call very late, just a few quick questions that you might have already answered. Number one, do you have any visibility on your CapEx budget for 2007, and number two, I heard some comments about your strategy in terms of CapEx deployment. Do you also look at it in terms of its ratio to the depreciation budget, and so given depreciation running, I guess around NT$120 billion, is that sort of the number we should expect for CapEx in ‘07? Any thoughts there would help?

Max Cheng

Okay, for the year 2007 we believe the CapEx amount would be around NT$90 billion. For the second question --

Dr. Hui Hsiung

Depreciation.

Max Cheng

I am sorry could you say it again your, what was your second question?

Gary Hsueh - CIBC World Markets

Yeah, is there a strategy in terms of CapEx spending relative to depreciation. It sounds example like at 90 billion your below depreciation. So in terms of a steady state run rate for CapEx over the next few years, is it your plan to kind of spend below your depreciation rate?

Max Cheng

I guess you know unless we are going to come out some ultimate new technology such as Gen 9, Gen 10, otherwise we would maintain a lower CapEx amount for the year 2008. I mean may be we would see a -- gradually CapEx would come down. I mean it's the [tickle bit] year 2006.

Gary Hsueh - CIBC World Markets

Okay. And relative to your 90 billion CapEx in '07, I've got to assume, it sounds like it's pretty much first-half loaded where you are trying to ramp the 7.5G in terms of phase two expansion for seasonal patterns in the back half of next year, is that right?

Max Cheng

Yes.

Gary Hsueh - CIBC World Markets

Okay. And when do you expect to order equipment to kind of fulfill that capacity ramp next year, is that equipments needed to be ordered in December or March by the latest?

Max Cheng

Okay, for the -- we have a -- Gen 7.5, the first fab actually is moving -- actually for -- we move in from first quarter, second quarter this year, and then you know we try to develop that fab from 10K by end of this year, 10K to 60K third quarter next year and then we will add another new fab starting from Q4 next year, and then may be by Q3 '08 we can bring up to 40K that will be the capacity. So the first fab would be 60K, second fab of our Gen 7.5 will be 40K total it would be at 100. So, the schedules -- the lead time would be above one year.

Gary Hsueh - CIBC World Markets

You might have already ordered the equipment for the 60K expansion for your Gen 7.5 fab?

Max Cheng

60K yes there have been concerns. For the 40K the second phase of the 40K, yes the orders I guess have been pretty --

Gary Hsueh - CIBC World Markets

Okay thank you.

Operator

Your next question comes from the line of Jeff Su with Merrill Lynch. Please proceed.

Jeff Su - Merrill Lynch

Yes hi. Good evening. I just had a couple of quick questions. First one is for Max on just the -- could you give us some guidance for the operating expense into the fourth quarter?

Max Cheng

Okay, actually we are not quite sure about that number at this moment. I guess the number would increase to NT$55 billion for fourth quarter. That is our estimate at this moment.

Jeff Su - Merrill Lynch

Okay, 5.5 billion.

Max Cheng

I am sorry 5.5 billion

Jeff Su - Merrill Lynch

Okay.

Max Cheng

Looks really odd.

Jeff Su - Merrill Lynch

No problem.

Max Cheng

Okay, yeah NT$5.5 billion, around that.

Jeff Su - Merrill Lynch

And then -- okay, and then my second question I guess is trying to get a had on sort of I guess the QDI trends roughly speaking from third quarter to fourth quarter. Could you guys also highlight sort of the inventory situation of QDI as well as the utilization rate? I guess both of those kind of go hand-in-hand, I guess just generally the trend from third quarter to fourth quarter that you guys expect or are trying to drive QDI to do?

Dr. Hui Hsiung

Yeah, this is Hui Hsiung answering your question. In general, Q3 QDI has three fabs, and I think the main fab of concern is that they are fifth-generation, and those two fabs in Q3 loading rate was roughly 60% some, that's less than 70% and in Q4 it will be pretty much lower or they will be over 95%, both of them.

Jeff Su - Merrill Lynch

Okay and then I guess also just the second part then on the inventory situation at QDI, I guess, exiting third quarter. And how do we stand? I know in the second quarter, last time you guys said it was quite high. And part of the reason for low end utilization in 3Q was to try to get rid of it. I know the numbers could not help, but can you just give us a general feel of how the inventory situation in QDI is currently?

Max Cheng

Okay. I guess, it still be high, higher than the AUO I think. But it's not very far. So I would say maybe give us one quarter or two quarter where we can have a very healthy inventory kind of a deal, the quality. But, by end of the third quarter because their financial report hasn’t completed yet so, very difficult to give you the number. Even for the OpEx value the NT$5.5 billion they are just my --that is my best guess. So far I do not have the reference point to give you a better number than that.

Jeff Su - Merrill Lynch

Okay. No problem, understood. And thank you very much.

Max Cheng

Okay. Thank you, Jeff.

Operator

Your next question is a follow-up question from the line of [Chung Ong] with JL Capital. Please proceed.

Chung Ong - JL Capital

Hi. I’m sorry. Do you have a breakdown of your investment losses?

Max Cheng

Amount of NT$1.3 billion, 700 million will be the long-term investment loss mainly from BenQ's based on the equity method accrued. And then the other NT$650 million will be the interest expenses.

Chung Ong - JL Capital

Right, okay. So --

Max Cheng

And that will be, yes, NT$1.3 billion.

Chung Ong - JL Capital

Okay. So there is no breakdown between Toppan or QDI?

Max Cheng

Okay, yes. That would be about 600 million would be BenQ, and then would be around 100 million from the CFI, the color filter company, joint venture with Toppan.

Chung Ong - JL Capital

Okay. What about QDI? QDI is not included in there.

Max Cheng

QDI is -- it's nothing to do with our financial report before September.

Chung Ong - JL Capital

Okay, I see, right. The other thing is, I am just wondering if you have any, like in-house estimate, when will like 42-inch TFT panel costs to become cheaper in plasma kind of panel. Do you have anything forecast?

Dr. David Su

This is David. I will try to answer your question for 42-inch LCD compared with plasma. I think this is -- we are quite sure this is -- next year is going to be a big competition between plasma and LCD. But not judging from the pricing, I think even though now the price is crossing the performance of this LCD TV panel, that is much better than the plasma. So, I think even with a little bit price difference for LCD with plasma, LCD -- 42 LCD still could change to beat the plasma. I think we are quite confident next year 42-inch LCD will win the market.

Max Cheng

I can add. As far as we know the -- on the market 42-inch of plasma and 42-inch LCD are pretty much the same price. But, the majorities of the plasma is actually HD and LCD is HD the 10 AD line. So, the resolution of LCD is higher. Nonetheless, the price is very close, and in terms of the costs, actually already LCD panel price cost is already very close to plasma -- I think plasma slightly less. However the plasma -- the system costs is higher than LCD because it’s a higher power and also Dave mentioned about the filter in front of the plasma. So --

Chung Ong - JL Capital

Right.

Max Cheng

You add all this together; the two -- that cost is very, very close to each other. So, when the cost is so close and price is close but performance is -- for LCD its higher resolution and also higher contrast ratio and so on I think at least for the 40-inch range, 40 and 46 -- plasma doesn’t have 46, the 42-inch range, from what we've collected data now is winning the -- already LCD is winning -- its taken away the market very quickly from the plasma.

Chung Ong - JL Capital

Am I reading it correctly that you are saying that the plasma HD and TFT HD 42-inch price is very close?

Max Cheng

Yeah.

Chung Ong - JL Capital

On the handling base, though.

Max Cheng

Is -- we are doing -- is less than US$100. The difference is less than US$100.

Chung Ong - JL Capital

HD versus HD, right?

Max Cheng

The plasma -- yes, it's HD. Every plasma, even the full HD plasma, full HD is much more costly, over the performance the price is much less. It's just an intrinsic imitation of plasma.

Chung Ong - JL Capital

Right, okay. All right, thank you. Thank you very much.

Operator

At this time there are no questions in queue. I would now like to turn the call back over to management for closing remarks.

Julie Chan

Thanks you all participants for AUO's conference call and we thank you for your support. If you have any questions, please do write to us at ir@auo.com. Thanks for your interest and support. Good night.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Thank you and have a good day.

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Source: AU Optronics Q3 2006 Earnings Call Transcript
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