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AU Optronics Corporation (NYSE:AUO)

Q1 2007 Earnings Call

April 24, 2007 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

Paul Peng, Senior VP and General Manager of IT Display Business Group

Analysts:

Andrew Abrams - Avian Securities

Chung Ong - JL Capital

Nick Teo - Macquarie Securities

Darice Liu – Maxim Group

Chung Ten – Neskie Capital(?)

Frank Wang – Morgan Stanley

Pranab Sharma - Daiwa Securities

Tore Minusook – Moon Capital(?)

Lee Ang Lynn – JP Morgan(?)

Presentation

Operator

Welcome to AU Optronics Corporation’s Q1 2007 results conference call. Operator instructions. I would now like to turn the call over the Ms Julie Chan, Senior Manager of the Finance Division. Please proceed.

Julie Chan - Senior Manager of Finance Division

Thank you. Good morning and good evening to all participants. This is Julie Chan. On behalf of AUO, I would like to welcome everyone to AUO's Q1 2007 results conference call. Joining here with me we have Dr. Hui Hsiung, Executive VP; Mr. Max Cheng, CFO; and Dr. David Su, Senior VP and General Manager for TV Display Consumer Products Display, Mr Paul Peng, Senior VP and General Manager of IT Display Business Group. As always, we will spend the next hour or so to review our quarterly results, discuss some of performance highlights, trends of the industry and conclude with our Q2 outlook. After that we will take your questions.

Before we begin, I would 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 principles generally accepted 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 on Form 20-F filed with the US Securities and Exchange Commission.

AUO undertakes no obligation to update any forward-looking statements whether as a result of new information, future events, or otherwise. Please take a few minutes to read the disclaimer. And now, please turn to slide number three of AUO’s presentation material.

Allow me to begin with some general comments on the market. We are seeing some positive signs of pricing stabilization as well as improvement in the supply demand environment in the market. In Q1 2007, demand for notebook monitor panel shipments improved and exceeded our expectation. Our TV panel segment was in line to our guidance. However, pricing decline in this quarter was more than our expectation. AUO’s audit consolidated revenue declined 14.7% sequentially, reported at NT$18.7 billion, equivalent to US$2.4 billion for the quarter, mainly due to a 4.1% decline on large size panel shipments as well as a 10.8% decline on ASP per square meter, combining the impact of seasonal weakness and the qualification of the acquired QDI capacity that is still in progress. Our Q1 2007 fab loading rate was at about the 80% level.

In addition to that, panel pricing also experienced a significant drop. As a result we reported our gross margin as 0.4%, operating margin at negative 5.3%, net margin at negative 6.3% and EBITDA margin at 18.5% and an operating loss of NT$4.2 billion; net loss of NT$5.1 billion.

Our basic EPS for the quarter was a loss of NT$0.67 per common share and US$0.20 per ADS. One account I would like to bring to your attention is our operating expense.

Our operating expense was managed to be 4.8% lower than the previous quarter. One of the big contributions was that most of our panels were shipped by sea, that does help our opex, however it did bring our goods in transit due days higher, which we will discuss later.

Slide number four. On the balance sheet highlight, cash in short-term investments as of March 31st totaled NT$23.5 billion, decreased by NT$22.3 billion from the previous quarter. Inventory in terms of absolute dollars increased 5.4%. Total inventory turnover days increased slightly to 49 days, mainly again due to the longer goods in transit since a higher portion of our TV shipments were shipped by sea to reduce our operating expense.

During this quarter the company paid back (a total of about 9 billion CB and ECD?). As a result, both short-term debt and long-term debt decreased by NT$5.8 billion and NT$2.6 billion. AUO’s net debt to equity ratio was 86.1%.

Slide number five. Cash flow highlights. During the quarter, operating cash inflow was NT$14.5 billion, mainly supported by depreciation and amortization of NT$19.2 billion; offset slightly by the net loss during the quarter. Net cash used in investing activities totaled NT$27.7 billion, mainly for the capital expenditure of NT$26.1 billion. The net financing activities during the quarter was NT$8.4 billion, mainly due to the draw down of CB and ECB. As a result, AUO ended the quarter with a net cash outflow of NT$21.7 billion.

For AUO’s business analysis, slide number six, revenue breakdown by product application. Due to seasonality, TV total sales accounted for 35% of Q1 revenue. Monitors were 31%. Notebook markers were 21%. AV and mobile devices contributed 10% of revenue. The remaining 3% was supporting our general display.

Slide number seven, blended ASP per large-size panel shipment. During the quarter AUO shipped 15.9 million large-size panels, amounting to a 4.1% QoverQ decline due to seasonality, while blended ASP per unit shipment fell 10.8%, mark at UD$141. Blended ASP experienced an erosion of 5.9% for TV panels, and about 10.3% for PC panels.

Slide number 8, by area analysis. Blended ASP per 1,000 sq meter also decreased at a severe 10.8% QoverQ to US$1,310. Slide number nine, due to seasonality, small and medium-sized panel shipments declined 9.8% in this quarter. Revenue decreased 14.5% to NT$6.5 billion, primarily due to more panels being sold at sell level.

Slide number 10, as for AUO's monthly capacity planning for the June 2007 quarter, the only capacity changes are L6B and L7A. For L6B, it was 60K in March and we expect to ramp up to 70K in June. As for our GEN 7.5, it will ramp up to about 40K by June 2007.

Lastly, I would like to share with you our expectations on the Q2 outlook. Based on the current business, we do expect our large panel shipment to increase by low teens percentage QoverQ. PC panel shipments expect to increase by about 10%. TV panel shipments expect to experience also an increase by mid-20%. For small and medium panel shipments, we expect them to grow about 25% in Q2. For pricing, we expect the blended ASP for PCs to be improved by mid single digits QoverQ and blended ASP for TV to experience flat to low single digit percentage improvements.

Our overall loading rate is expected to be at the 95% level. This ends my presentation. We shall use the remaining time to take your questions. Operator?

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Questions-and-Answer Session

Operator

Operator instructions. Your first question comes from Mr. Andrew Abrams with Avian Securities.

Q - Andrew Abrams - Avian Securities

I wonder if you could talk a little bit about the progress at QDI, where you were in Q1 and what you were waiting for. Was it qualification from customers? Was it still some changeover in some of the fabs? Where do you think you’ll be in Q2? Also, can you talk about Q2 depreciation, so we get some numbers there?

A - Dr. Hui Hsiung

Andrew, this is Hui Hsiung answering your first question. In terms of QDI consolidation, we expect to complete pretty much already within Q1. Q2, we start afresh. That means all the new capacity acquired through this merger, the process as well as the new product already designed in with our customers. As a result, in Q2 especially toward May and June months, all our newly acquired capacity will be pretty much loaded so that is the status of the consolidation.

A - Max Cheng

Regarding the depreciation for the Q1, that was NT$19.2 billion and I guess Q2 would be a little bit higher so that could be NT$19.5 billion.

Operator

Your next question comes from the line of Mr. Chung Ong - JL Capital.

Q - Chung Ong - JL Capital

I just wanted to check with you on your TV sites – you guided flat to upper mid single digits on the ASP. Is that correct?

A - Max Cheng

Yes.

Q - Chung Ong - JL Capital

Was that on a like for like basis?

A - Dr. David Su

This is David. To answer your question, for the blended ASP we guided slightly up and actually this is a product mix issue. On a size for size consideration, on smaller size especially for the 20 inch range, the 26 inch more or less stayed flat with some price increases. 32 certainly, the price increased, and 40 inch television will stay flat for a while.

Q - Chung Ong - JL Capital

Right. You also guided shipment increases. I just want to understand, what do you see is different versus this time last year that you are so confident on pricing and shipment increases?

A - Dr. David Su

Is this concerning order applications?

Q - Chung Ong - JL Capital

Mainly on the TV and PC side.

A - Max Cheng

The main difference between this year and last year is the inventory. If we look at the inventory at the end of our first quarter, last year we still had a pretty large inventory across the pipeline. This year, in almost every part of the value chain we found the inventory is healthy. That has pretty much set the tone for Q2. What we are seeing today is the reason that we fully loaded our fabs – as it comes around to demand, part of the demand comes from real increases QoverQ in demand for both PC and TV. Another part comes from the restocking of inventories throughout the pipeline. This is really a combination of the two. The background is from Q3, it’s expected that we should have a shortage across order applications. This restocking occurred at the earliest stage. If inventory was not so healthy we wouldn’t see such an early demand.

Q - Chung Ong - JL Capital

Right. Just on the TV side, do you see the

incremental increase in 42 inch being greater than 32 inch, or is it about the same?

A - Dr. David Su

This is David. In terms of the quantity, for Q1 compared with Q2, certainly the 32 inch will stay for the most the same ratio as in Q1. However, for larger sizes like the 37 inch, 40 inch and 42 inch, it will increase.

Q - Chung Ong - JL Capital

You’ll increase the percentage as a percent of your total units?

A - Dr. David Su

Yes.

Q - Chung Ong - JL Capital

Right. Okay. Do you actually see any component shortages? There were rumors of a glass substrate problem.

A - Max Cheng

This is only a possibility. This is not yet confirmed. Possibly toward the second half, two materials that are vulnerable are glass and (porous filaments?), but it’s too early to say it’s a real shortage or just a supply problem. In the past we experienced similar situations and it always turned out to be just tighter. I wouldn’t say it’s a definite, but those two components tend to be more likely if supply is a constraint.

Q - Chung Ong - JL Capital

Is there any truth to the plant shutting down in Taiwan?

A – Julie Chan

No.

Q - Chung Ong - JL Capital

In terms of your component price down, can you just give us an idea, how much was the price down in Q1 and what are you expecting in Q2 on your cost of materials?

A - Dr. David Su

It was about 3-5% for Q1 and Q2 as well.

A - Max Cheng

Maybe I’ll add some comments. I think as far as – if it’s only the material costs down, it’s like 3-5% quarterly. That is achievable and Q2 is no exception. I think another contribution will be, as I indicated earlier, in Q2 we have a slew of new models, designed and to be mass produced so it goes on cost of models. There is a pretty high ratio of such models that are facing up during Q2, so this will contribute to additional material costs. Of course the fixed costs will be down due to a higher loading rate.

Q - Chung Ong - JL Capital

Will it be down to cheaper components or a better gross margin?

A - Max Cheng

It is a lower cost of materials for those models.

Q - Chung Ong - JL Capital

Is this on the TV side or PC side you’re talking about?

A - Max Cheng

It’s across various applications.

Q - Chung Ong - JL Capital

The last thing I want to check with you is on your capex blend. I’ve seen talks about you guys going 8G and whatever – can you just talk about your capex blend?

A - Max Cheng

Capex blend for 2007 would be around 90. There will be many for our 7.5 GEN, we call that 7A – many for that. The other main pocket for us would be another GEN 6 fab. We are going to expand the fab from 60K to 90K. Those will be the two main projects for this year.

Q - Chung Ong - JL Capital

What about the future plans? Are you looking to skip 8G or what’s the plan?

A - Dr. Hui Hsiung

At this point, we have not had a definite plan in terms of the next generation but because we do have a delay in GEN 8, by the time we decide it’s likely we’ll skip GEN 8.

Q - Chung Ong - JL Capital

That would be GEN 9 then would it? Or GEN 10?

A - Dr. Hui Hsiung

It could be either. It’s really – pretty much, it’s a matter of whether we are targeting a 60 inch or a 65 inch. That’s the main difference between these two generations.

Q - Chung Ong - JL Capital

Apart from your expertise, who else in your competitors are actually looking at GEN 9 or GEN 10?

A - Dr. Hui Hsiung

It’s still too early to say. I think only one Japanese company are getting closer to a GEN 10 decision. I think GEN 9 so far is still only being discussed. Not materialized.

Operator

Your next question comes from the line of Nick Teo - Macquarie Securities.

Q - Nick Teo - Macquarie Securities

I have a couple of questions. The first one is regards to your comments on the conference earlier this afternoon about doing more sell production – more like a foundry model. I’m just wondering what kind of percentage you have in mind in terms of a target to sell front-end production? The second question is regards to operating expense. You mentioned that the operating expense in Q1 was down because AUO uses sea freight versus air freight. In Q2, do you expect to switch back to air freight again? If so, would the operating expenses rise significantly? Those are the two questions I have, thanks.

A - Dr. Hui Hsiung

Okay. I think answering your second question first, we don’t have any plans to switch back to air freight. That’s why we pretty much figured out a pipeline in terms of transit. We do have materials in between Taiwan and China as well as in between Taiwan and Europe or even Mexico. We’re going to try to use sea freight throughout this year. This is our intention. In terms of sales business, I think this will be a process – probably a long process that will go through many years. The general direction is we think that that end of production is primarily labor intensive and a lower value add. We will use two possible methods – one is outsourcing. That means we still ship modules, but the second part of outsourced. The second part of this model is we shop for so-called open sales – that means the IT is founded on the sale. In 2007, most of such a business model is still in the medium to small size – in particular cell phones – and that is a relatively high percentage of the sales business. Larger size is only the beginning, at probably overall less than 10% which is open sale business. We don’t have, at this point, a particular schedule like at what point we’ll implement or at what percentage of sale budget. But the general direction is towards, probably at the end of the day, probably 50% or so. But this may take a few years to reach. I think the reason we do this is also considering from AUO’s point of view – at the back end of the operations, the margins should not be as thin as at the front end of the operation. We are doing this while watching closely how to maintain the margins so our ROE is not reduced by such operations.

Operator

Your next question comes from the line of Darice Liu – Maxim Group.

Q - Darice Liu – Maxim Group

In terms of capacity, you mentioned earlier changing 6G monthly capacity by year end to about 90,000 units. Can you talk about what your year-end capacity plans are for 7A?

A - Max Cheng

By the end of this year it will be around 60k only.

Q - Darice Liu – Maxim Group

What is the maximum capacity for that fab?

A - Max Cheng

For this year it would be 50K. By the end of next year we’ll try to expand the fab to maybe like 75K by marginal capex. That would be the maximum of that fab. Our next one would be 7B, that’s another fab that we are – it’s under construction at this point.

Q - Darice Liu – Maxim Group

When do you believe that you’ll make decisions in terms of what generation site 7B will be? You mentioned earlier possibly GEN 9 or GEN 10.

A - Max Cheng

No, 7B will still be GEN 7.5, simply because we expect within the next few years, the main stream flat TV size will continue to be between 30 inches and 40-something inch – like 32 inch, 37 inch, 40 inch, 42 inch and 46 inch or 47 inch. These sizes will dominate the TV market, we believe, for many years. In that sense, we do need to deal with a significant amount of GEN 7.5 capacity.

Q - Darice Liu – Maxim Group

Okay. You mentioned it’s under construction. Can you update us what the timeline is for that fab ramping up?

A - Max Cheng

7B, basically we would target maximum production in the year 2009.

Q - Darice Liu – Maxim Group

From a manufacturing standpoint, your peers are trying to lower production costs through new process steps like (half mast tone and color filter in-jet printing?). I was wondering if you would follow suit with similar initiatives?

A - Dr. Hui Hsiung

In terms of inkjet printing and color filter, we are undecided but we will use our current investment for the conventional. It’s only the new generation where we will consider the inkjet printers. That’s actually still, at least at this point, not yet mature. So there is some degree of risk involved.

Q - Darice Liu – Maxim Group

The last question – there’s been a lot of interest in (active matrix LEDs?) recently with announcements on products. Can you talk about whether or not you still have some programs there?

A – Julie Chan

Is your question related to 2008?

Q - Darice Liu – Maxim Group

Yes.

A - Max Cheng

We put that program on hold. We think it’s still a few years away in terms of maturity, in particular if it needs to compete with LCD, I think it won’t be so quick. We put it on hold and we’ll watch its development.

Operator

Your next question comes from the line of Chung Ten – Neskie Capital(?)

Q - Chung Ten – Neskie Capital(?)

My first question just relates to your cost reduction. I think we’ve seen your cost reduction slow since Q4 in Q1 when you acquired QDI. Could you talk a little bit more about what we could expect in terms of your cost reduction over the rest of this year?

A - Dr. David Su

Yes. I think during the past two quarters, it’s true that our cost reduction is slower than before but that’s actually a necessary process for our consolidation. Basically, for the newly-acquired capacity, we do need to do a bit of process tuning as well as new product design for a new product with a lower cost. That process, as I indicated earlier, has pretty much been completed by now. We do expect, starting from Q2, our cost reduction speed will be back to normal.

Q - Chung Ten – Neskie Capital(?)

Okay. Would we see your cost reduction back to normal, or is there a chance that cost reduction could be accelerated as QDI moves towards your AUO corporate average?

A - Dr. David Su

Yes. That’s indeed the direction we’re moving towards, yes.

Q - Chung Ten – Neskie Capital(?)

Okay. My second question relates to your focus on ROE. Could you talk about what you plan to do from a capital management perspective to achieve your ROE targets?

A - Max Cheng

This is Max Cheng. Regarding the ROE, definitely there are several ways we may be able to improve that by things like reducing the capex amount so we can have some extra money and we can reduce our equity size as well. We are thinking about that one but on the other hand, we also have a huge debt. For the next couple of years what we’ll try to do is just reduce the capex amount and try to generate some more cash so we can improve our debt ratio as well as our equity size. We are looking at how we can not just improve the industry environment, by reducing our capex amount, but also reducing the equity side so we can more easily achieve a higher ROE. That’s our thinking at this moment.

A - Dr. Hui Hsiung

Pretty much, during this process, since our capital investment is lower, that also means our fab loading will be high for most of the year.

Q - Chung Ten – Neskie Capital(?)

What do you see now in terms of the industry’s supply and demand balance? I think most people are expecting now a second half shortage. But by the time we reach Q4 of this year, assuming everybody maintains capex discipline. Do you think the industry still needs to maintain a capacity temporization for the industry to stay healthy when it moves into the seasonally weak first half of the year? Is that something that must be ongoing, do you think?

A - Dr. Hui Hsiung

Yes I do. I think next year we’ll see a similar seasonality as this year. In terms of supply and demand, we will also see a similar pattern. The second half will be tight and the first half will be loose. But I think compared to this year, actually, the first half will be slightly tighter than this year.

Q - Chung Ten – Neskie Capital(?)

Okay. Last question – could you give us your unit shipments split by TV, PC and others?

A - Dr. David Su

This is David, answering your question for the shipments. Quantities for TV – in Q1, we shipped out around 2.9 million units. Small to medium size was around 23 million units for Q1.

A - Paul Peng

Mobile we shipped around 5.6 million and desktop we ship around 6.4 million in Q1.

Operator

Your next question comes from the line of Frank Wang with Morgan Stanley.

Q – Frank Wang – Morgan Stanley

For the 2007 capital spending, are you able to break that down between GEN 7 expansion, GEN 6 and maybe the LCD margin assembly?

A - Dr. Hui Hsiung

Frank, you said 2007? Or 2008?

Q – Frank Wang – Morgan Stanley

For 2007 capital spending.

A - Julie Chan

Frank, we don’t have that with us, but like Max highlighted earlier, most of that is to support our increase on our 6C as well as 7.5. If you need some more detail, maybe we can follow up later, but as of now most of that is for that capacity. I think there’s a small portion also supporting our back end. Okay?

Q – Frank Wang – Morgan Stanley

As a follow up to that question, also on the previous question regarding the business model of the front end production compared to the back end operation, are you able to go into a little more detail in terms of as you are increasing the outsourcing of the back end of production? Or are you not investing in the back end as fast as the front end production? How are you able to protect your margin structure for business given that perhaps the customers may actually come back and it seems want more transparency on your overall cost structure?

A - Max Cheng

By itself, it’s expected. I think the back end has many material costs plus some labor costs. I think like I indicated earlier, right now our pricing method is based on value added, so itself, apparently the value added still is in the front end investment as well as in the basic product design itself. We believe at least at this point that the margin can be managed. There is no reason to split the margin between the two processes. They have a very different degree of complexity.

Q – Frank Wang – Morgan Stanley

Then as you’re slowing down your next generation investments, are you seeing the trend of outsourcing the back end module assembly and a customer request for maybe a GEN 9 or GEN 10 investment? Or is it simply that you wanted to improve your capital efficiency on existing statues?

A - Max Cheng

Like we said, really the GEN 7.5 is a service mostly dipping into our larger TV business, and that’s a relatively small segment of the market. That market is probably dominated by not only brand names, but leading brand names. Currently two of our competitors are investing, and they do have their own TV brand. For them, it’s a reasonable investment. For us, it’s a risk. So at least for the near term in investment we are focused on the mainstream TV sizes that will not hamper our competitiveness, as well as the fulfillment of the majority of customer needs.

Q – Frank Wang – Morgan Stanley

I’m on board with the strategy in terms of slowing down on the net generation fab investments for efficiency. What I’m trying to understand is the idea of implementing some kind of back end, outsourcing some kind of business model – is that a function of the incremental new investments that you are focusing on for 2008? You have some investments in 2009 for the next generation capacity, but is that also a function of your existing back-end outsourcing at the request of customers? Do you want to break that up between the front end and the back end?

A - Max Cheng

Certainly, we haven’t stopped entirely the back end investments. For example, we have a new investment in Shaomang China, and actually we are on schedule with that. They’re now currently awaiting the start of mass production there. It’s really a portfolio – the degree of outsourcing as well, the sale business, is evaluated very carefully and very strategically. We have not opened this model for everyone, just very select customers. Also for example, much of the TV production has been in Europe so instead of shipping the whole hardware to Europe, we ship only the sale to Europe and that actually reduces our inventory burden in terms of the overall portfolio. Even in terms of labor, we found – there is another reason we do that seasonality. It’s very inefficient if we maintain a huge labor force just to fulfill the peak demand of the customer – like per year, you have a peak demand during the second half. Then during the down cycle you have excess labor, so that’s another reason we think we should keep only a reasonable percentage of the back end operations so we can manage the seasonality.

Operator

Operator instructions. Your next question comes from the line of Pranab Sharma - Daiwa Securities.

Q - Pranab Sharma - Daiwa Securities

Thank you for taking my question. My first question is basically on your TV side. Could you give us some color, like how much 40 inch and above TVs you have shipped in Q1 and what is your target for the whole year? What percentage of those panels will be for full high definition TVs? What is the cost difference between production of a full high definition panel and a normal panel and what is the difference in the selling price now?

A - Dr. David Su

This is David. In terms of the yearly shipment target for TVs, we are targeting 18 million units for this year. In Q1, I just mentioned we shipped around 2.8 million. In terms of the size distributions, for the 20 inch category – that’s the 20 inch, 23 inch and 26 inch, they occupy around one third of the quantity we shipped out. In the 30 inch category, that’s including the 32 inch, 37 inch, that occupies around 47% - approaching 50% of our shipments. For 40 inch and above, around 10% of our product portfolio for Q1. Certainly for Q2 and for the following quarters, the portion for sizes above 30 inch will increase to over 60% of our shipment – mainly 32 inch and above. In terms of the OHD and HD ratios, certainly for this year, still a big portion of the product we ship out is still not full HD – however in some particular market specimens, like in the United States, the full HD portion is getting portion. For that particular settlement, the product we’ll ship out to this particular region in the later part of this year will increase. However, in Europe, that portion will not be that significant compared with the portion in the United States. In terms of the cost difference in producing the full HD and the regular HD, so much of it depends on the size of the product. In terms of how it sells there is around $50 difference there.

Q - Pranab Sharma - Daiwa Securities

Sorry, how much?

A - Dr. David Su

About $50. Five-zero.

Q - Pranab Sharma - Daiwa Securities

Is there any target for the full HD portion by Q4 this year? Of your total 40 inch and above shipments?

A - Dr. David Su

Yes. We do have one, but my estimation is around 20%.

Q - Pranab Sharma - Daiwa Securities

My second question is on the monitor side. What percentage of your PC monitor was at 24 inch wide format, and what do you think that segment will reach by Q4 this year?

A - Paul Peng

This is Paul. The 24 inch is still a small portion – around 4-5%. Of course, that could be driving it to the higher number. Basically it’s in the very high end segment now, so we would expect maybe 6-7% in Q2.

Operator

Your next question comes from the line of Chung Ong - JL Capital.

Q - Chung Ong - JL Capital

I just want to check with you, from a strategic point of view, how do you differentiate yourself from other panel makers, because you can talk about size and HD and refresh rates from 12 milliseconds to 6 milliseconds, but all this is becoming quite standard. What else is there to differentiate your panel from your competitors’?

A - Dr. Hui Hsiung

In terms of TV, in terms of new features to differentiate us, we have higher speed, regular products now – but for high end products, we have the so-called ‘double frame rate’. That product tries to improve the motion quality so that’s one area where we have a product that’s ahead of some of our competitors. In terms of the productivity, we have two versions of the product. One is the so-called regular 72% NTSC ratio, the other one is over 92%, which puts it in the premium model. That is one area where we have an advantage. This is a product area we are working. Certainly there are new features of technology in the coming years. We are also working on some so-called (local dealing?) technology – that is to try to improve the contrast ratio or the state of the picture quality. That’s another area we are happy to participate in, in this particular area.

Q - Chung Ong - JL Capital

Does LED backlight improve these three areas?

A - Dr. Hui Hsiung

Certainly the LED will improve the productivity and through proper electronics handling, we can improve the motion quality also. The issue is that LED is still quite expensive at the current stage, but as time goes by, the costs should drop and in AUO we do have a good technical team who are working on these particular areas and we have some so-called high-end product values to implement in this LED technology also.

Q - Chung Ong - JL Capital

When will you be rolling out LED based monitors?

A - Paul Peng

This is Paul. LED applied to the monitor is still too expensive. We have one model but it’s in a very high end model at a very high price. We apply it in very small volume because of the costs and the supply chain is not sufficient to support it.

Q - Chung Ong - JL Capital

What’s the price difference between this and normal monitors?

A - Paul Peng

It’s more than double.

Q - Chung Ong - JL Capital

More than double? Okay.

A - Paul Peng

Yes. The panels we sold are more than double compared to a normal TV.

Q - Chung Ong - JL Capital

The other question I have is what percentage of your TV customers now are non-first-tier or greater China customers?

A - Dr. David Su

This is David answering your question. Our top-10 customers include most of the major TV brand names. In Q1, more than 70% of our shipments – quantity wise, more than 70% and revenue wise more than 75% goes to these top brand names.

Q - Chung Ong - JL Capital

What about if we say greater-China-based customers? Taiwanese, Chinese or Hong-Kong based kind of thing?

A - Dr. David Su

Like I said, the top brands occupy – in terms of revenue – more than 75%, so the reality is that 25%, that’s including so-called greater China, Taiwan and most of Taiwan is OEM for the customers in the USA – that’s channel customers and channel brands, and part of them is for Europe. The majority of that is Taiwan OEM makers for channel brands in the States.

A - Dr. David Su

Am I reading it correctly that your top 10 customers, there is no greater-China-based…?

A - Dr. David Su

Yes, that’s correct.

A – Julie Chan

Time is coming into consideration and while we still have a few more waiting, can we cut the questions short for the following enquiries? Operator, can we take the next one?

Operator

Your next question comes from the line of Tore Minusook – Moon Capital(?).

Q - Tore Minusook – Moon Capital(?)

Thank you for taking my question. I’m trying to understand the cost decline better. Did you guys guide us to a cost decline of 3-5% in Q2?

A - Dr. Hui Hsiung

No. Only the material portion of that. As I indicated, at least three contributors – one is material, two is the facing of a low-cost model. That’s actually a very big reduction there. The third is the reduction of fixed costs due to much higher factory loading compared to Q1.

Q - Tore Minusook – Moon Capital(?)

So, overall if you were to quantify that, you know, COGS per square meter reduction in Q2?

A - Dr. Hui Hsiung

We cannot give you that number.

Q - Tore Minusook – Moon Capital(?)

Okay. To understand it differently, in Q1 what would be the margin gap between the AUO fabs versus QDI fabs?

A - Dr. Hui Hsiung

It’s difficult to quantify that. The reason for our overall higher costs, in particular the higher costs around the QDI fab, is not by itself intrinsically high. I think both Q4 and Q1, we have relatively very low loading in those newly-acquired fabs. Loading is not our problem – the overheads are not particularly high. We certainly did some training in terms of the costs. Like I said earlier, our target is to have a level cost across our production facilities.

Q - Tore Minusook – Moon Capital(?)

In terms of selling prices of the panels – QDI panels…

A - Dr. Hui Hsiung

They are the same. They are actually - the reason we need to redesign is that those designs tend to be more expensive. That’s why we pretty much refresh order models.

Q - Tore Minusook – Moon Capital(?)

My other question was on the utilization. It seems like your utilization of 80% in Q1 was a little bit lower than your initial guidance of 85%. But then your unit cost came in in line, if not slightly better. What was the reason?

A - Dr. Hui Hsiung

Actually, the actual loading was less than 5%. The difference between two quarters is closer to 2-3% rather than 5%. It’s not a significantly different loading. The reason we ship… Actually the shipment… The output was depending on the product mix, so that by itself – the unit by itself really doesn’t tell you the whole story. We did increase – even our unit shipment was less. Our total area has increased during Q1 because of the introduction of 40-plus inch TVs.

Q - Tore Minusook – Moon Capital(?)

My last question is on the inventory. At the current level, is that a level that you guys feel comfortable with? Or would you rather see it lower than this at this point in the quarter?

A - Dr. Hui Hsiung

We’ll see it lower. We don’t feel comfortable with this. We think we can lower it.

Q - Tore Minusook – Moon Capital(?)

Okay. Any target for inventory by the end of Q2?

A - Max Cheng

You mean the amount or the days?

Q - Tore Minusook – Moon Capital(?)

The days.

A - Max Cheng

We do hope you can go back to 40-45 days, that kind of level. It would be very difficult to come back to a thirty-something, but I guess 40 should be the first target we should hit.

Q - Tore Minusook – Moon Capital(?)

Based on your current unit projection and your loading rate, do you think your inventory days could go back down to a low 40 days by the end of Q2?

A - Max Cheng

Yes. Because there is still some shipments higher than Q1, actually it could be quite a high percentage of the gross. I guess if we keep the same amount as Q1, then definitely the turnover days should be lower. We do hope we can go back to the low 40s.

A - Julie Chan

Basically I should also mention that about 10% of the inventory was actually more or less goods in transit, because AUO’s booking record means we cannot bill our customer until they receive them. That 10% will be then about 4.5 days relatively speaking in inventory turnover.

Q - Tore Minusook – Moon Capital(?)

Got you. Thank you, Julie. Thank you, everyone.

Operator

Your next question comes from the line of Lee Ang Lynn – JP Morgan(?).

Q - Lee Ang Lynn – JP Morgan(?)

I just want to double check on the capacity for next year on the 7.5G – is that 75K and that’s all?

A - Dr. Hui Hsiung

On the 7G capacity we have not had a final number yet but it won’t be so high. 75K is too high. That’s probably closer to our full capacity for that. You’re asking on our first fab, right?

Q - Lee Ang Lynn – JP Morgan(?)

I’m saying that by 2008 you’ll be 70K.

A - Dr. Hui Hsiung

That’s true. This year, it will be 60K and the next year it will be incremental. It will increase incrementally with a relatively small amount of investment – we can up that capacity to its maximum.

Q - Lee Ang Lynn – JP Morgan(?)

YoverY, 2008 over 2007 on the capacity, growth will be less than 20% - is that fair?

A - Dr. Hui Hsiung

Yes, for 2008, yes. It’s pretty small compared to - up to 2007, we had a very high annual growth in terms of our total area. 2008, the first year was probably lower than 20%.

Q - Lee Ang Lynn – JP Morgan(?)

One last question – I just want to double check the 40 inch shipment target for 2007?

A - Dr. David Su

For 2007, this year’s target for sizes above 40 inch is over 15% of our shipment – so around 18%.

Operator

At this time there are no further questions. I’d now like to turn the call over to Ms Julie Chan for closing remarks.

Julie Chan

Thank you very much for your participation on AUO’s earnings call. We thank you for your support. Thanks. If you have any questions, please contact us on ir@auo.com.

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Source: AU Optronics Q1 2007 Earnings Call Transcript
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