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AU Optronics (NYSE:AUO)

Q3 2012 Earnings Call

October 25, 2012 8:00 am ET

Executives

Pearl Lin

Andy Yang - Chief Financial Officer

T. K. Wu - Vice President and General Manager of Consumer Product Display Business Group

Michael K. C. Tsai - Vice President, Head of Video Solutions and General Manager of Information Technology Business Group

Analysts

Brian John White - Topeka Capital Markets Inc., Research Division

Jeffrey Su - Macquarie Research

Andrew Abrams - Avian Securities, LLC, Research Division

Jerry Tsai - HSBC, Research Division

Harsh Agarwal - JP Morgan Chase & Co, Research Division

Chris Lin - Daiwa Securities Capital Markets Co. Ltd., Research Division

Jamie Yeh - Barclays Capital, Research Division

Operator

Welcome to AU Optronics Corporation Third Quarter 2012 Results Conference Call. The conference will be recorded and webcasted at the request of AU Optronics. Any objections, please hang up now. A copy of the presentation for AU Optronics Corporation third quarter 2012 results announcement can be found and downloaded from its website, auo.com, under Investors. Thank you.

Ms. Pearl Lin, Senior IR Manager, you may begin.

Pearl Lin

Good morning and good evening. My name is Pearl Lin, the IR Officer of AU Optronics. On behalf of AUO, I would like to welcome everyone to join our Year 2012 Third Quarter Results Conference Call.

Joining me here, we have AUO's President Mr. Paul Peng; CFO, Mr. Andy Yang; VP and General Manager of Video Solutions business group, Mr. Michael Tsai; VP and General Manager of Mobile Solutions business group, Mr. T.K. Wu. This conference call will take around 1 hour.

Before we go into the Q&A session, please allow me to recap some of the key points of our third quarter 2012 results, and provide you with our expectation of the fourth quarter outlook.

As always, before we begin AUO's results conference call, I would like to remind you that AUO's financial results have been prepared on a consolidated basis in accordance with the ROC Taiwan GAAP. Please also take a minute to read the disclaimer in Slide #2 of our presentation material.

Now please move to Slide #3, quarterly income statement. Our larger-size panel shipment increased 4.6% Q-o-Q to 33.2 million units, while small and medium panel shipment went up 11.1% to 42.2 million units. As a result, our Q3 revenue increased by 8% Q-o-Q to TWD 102.8 billion. On the other hand, operating loss reduced to TWD 9.1 billion in Q3, while operating margin improved by 2.1% to a negative 8.9%.

This quarter, the company has recognized an additional antitrust provision for TWD 6.7 billion in the nonoperating expenses. And hence, our loss before tax reached TWD 16.3 billion, while net loss was TWD 16.5 billion.

Slide #4, balance sheet. As of end Q3 2012, AUO's cash and cash equivalents decreased by TWD 7.9 billion to TWD 77.6 billion, while total debt also reduced around TWD 13.9 billion.

The company also managed our inventory proactively and reduced our inventory dollar amount by 7% to TWD 47.3 billion. As a result, the inventory turnover days reduced by 6 days to 43 days.

In addition, with the decrease of equity amount as a result of the net loss, our net debt-to-equity ratio increased slightly to 91.8% this quarter.

Slide #5, cash flow highlights. With better working capital management, our Q3 cash flow from operating activities came in at TWD 15.9 billion cash inflow. Net cash from investing activities, which primary was capital -- CapEx expenditure, was around TWD 9.95 billion cash outflow. Cash flow from financing activities in Q3 was TWD 13.6 billion cash outflow, mainly due to the debt repayment. As a result, net change in cash in Q3 was cash outflow of TWD 7.9 billion.

Slide #6, revenue breakdown by product application. In Q3, TV panels represent 46% of our total revenue; followed by notebook panels at 19%; monitor panels at 15%; consumer products at 14%; and the remaining 6% of revenue is supported by other business.

Compared to last quarter, TV panel as percentage of revenue went up 4%, while notebook panel up 1%, monitor panels down 2% and consumer products down 1%.

Next slide, Slide #7. For our total class area, Q3 shipment per area increased by 12% to 5.3 million square meters. And ASP per square meter came down 4.2% Q-o-Q to USD 616, mainly due to product mix changes.

Slide #8, small and medium products. Our Q3 small and medium shipment in area increased by 21.9% to 159,200 square meters, and our small and medium revenue improved by 12.2% to TWD 11.6 billion.

Slide #9, AUO's capacity by segment. We decided not to ramp any new capacity in Q4, so our total capacity in area remains stable compared to last quarter.

Now I would like to share with you the company's expectation of our Q4 outlook. Based on our current business outlook, the company forecast its larger-size panel shipment to be down mid-single-digits percentage Q-o-Q. On a product mix-adjusted basis, larger panel ASP per unit is expected to increase in mid-single-digit percentage Q-o-Q. For small and midsized panels, the company forecasts its small and medium panel shipment to be down mid- to high-single-digit percentage Q-o-Q in units. On the other hand, we expect our overall loading rate in Q4 to be slightly higher compared to that of Q3.

Please note that the above is our current best forecast based on our current business outlook. They may be changed, subject to the actual market supply/demand and economic condition.

Looking back to the third quarter, thanks to a greater improvement in panel supply and demand, the average pricing for TV panels sequentially recovered. The company's utilization rate also steadily increased, while it's days of inventory also decreased substantially.

However, the improvement of the company's profitability was lower than expected due to a couple of the reasons. First, with an eye on the long-term competitiveness, the company continued to create [ph] a new technology, and currently has achieved initial success in development cooperation with its customers on a couple of the new products.

However, in the third quarter, the company's new technology platform and new product, especially for small and midsize products, we're still in production ramp-up period. Therefore, the contribution from these new products to the company's profitability was softer than our expectations.

Second, our solar business is still facing an industry downturn. Going forward, the company will proactively adjust its operations scale and cut operating costs, as well as expenses, aiming to effectively reduce the operating losses in the solar business.

Looking forward, as the TV market is expected to recover gradually, the company will continue to focus on technology upgrading and manufacturing process enhancements. We will also continue to strengthen the customer in product portfolios of small and midsized panels, hoping to promptly improve its production efficiency and operational performance.

This ends our presentation. We shall use the remaining time to take your questions. Before we open the phone for questions, I would like to remind you to limit your questions to 3 per call so that we can give equal opportunity to all participants. Thank you.

And now, operator, please open the floor for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Brian White.

Brian John White - Topeka Capital Markets Inc., Research Division

I'm wondering if you could talk a little bit about the trends you expect after the December quarter in terms of shipments for televisions and then IT?

Pearl Lin

Brian, as I mentioned, for the fourth quarter, we expect the larger-size shipment to come down around mid-single-digits. And within the larger-size panel, I think the -- we feel the TV panel market right now is going to recover, so the TV is still trending better compared to the IT panel. And on the other hand, hetero [ph] IT panels right now are moving to the third quarter and Q4. So relatively, the TV trend will be stronger compared to the IT panel.

Brian John White - Topeka Capital Markets Inc., Research Division

Okay. And how should we think about capacity expansion next year for the industry? And how should we think about volume growth in 2013 for the industry?

Pearl Lin

We feel that the market supply demand has a chance to get more and more balance next year. Right now based on the current market information, we estimate the worldwide capacity may have a chance to increase around 4%, y-on-y, but the demand will continue to grow maybe around 8% to 10%. That's the current expectation right now.

Brian John White - Topeka Capital Markets Inc., Research Division

Okay. And finally, I didn't hear, but what are you thinking about costs down in the December quarter?

Andy Yang

Brian, this is Andy, we -- in our conversation, we just guide a cost down from material side, about 2% in fourth quarter.

Operator

Your next question comes from the line of Jeff Su.

Pearl Lin

Jeff?

[Technical Difficulty]

Jeffrey Su - Macquarie Research

Sorry, I just have a few questions. First, I wanted to understand, I mean, we can see that the third quarter margin just saw a minor improvement here. Solar, I guess, is still one very big issue. But could you maybe help us understand a bit more where you are in the TV side? Of course, we can see that the demand from TV generally seems to be okay, Golden Week in China was okay. But in terms of the product mix and the margin of the TV business, where do we stand right now, and also going into the fourth quarter? That's the first question.

Andy Yang

Jeff, this is Andy. Normally, we don't guide it or disclose margin information for each product segment. But the thing I could say to you is that the quarter-on-quarter is peaking. TV business has been reporting a quite impressive improvement in terms of EBITDA margin. And the EBITDA margin for TV actually was well above the company's average in Q3.

Jeffrey Su - Macquarie Research

Okay. And so this trend is something we can expect, at least going forward in the next one quarter or so, to continue on the gradual improvement trend? For the TV side?

Andy Yang

As far as we understand from the supply/demand situation now, it's likely the TV segment would -- might be able to remain in a recovery trend.

Jeffrey Su - Macquarie Research

Okay. My second question is then on the solar side of the business. Clearly, I think you've broken it out, looking at third quarter, although a small percentage of revenue is almost 1/3 plus contributor to the operating loss. So I just want to make it clear, I can see from some of your statements that the strategy going forward for the solar business would be to kind of rationalize or kind of minimize the exposure here.

Andy Yang

I think because the serious downturn in the solar industry we are facing now, actually we may not see a recovery in the short period of time. So that we may take some downsize action about this business, and hopefully, they could cut some operating costs and expense. And in turn, hopefully, the operating loss from this business could shrink a little bit in the coming quarters.

Jeffrey Su - Macquarie Research

Okay. And then my last question is, I mean, obviously, this year has been kind of a year of transition and a slow recovery in the core businesses as well, and you've done a lot of investments in various new technologies and stuff. If you look to 2013, where do you feel more excited or where do you feel your growth, key growth drivers or areas of focus will come from? Will it be more on the large-sized panel still? Is it on the medium or on the small -- just if you can share for us just some general thoughts on 2013, and what areas of opportunity or what areas do you think AUO is potentially could see some harvest then next year.

Andy Yang

Okay. Let me try to answer your question by separating our display business into 3 major product segments. I think the first one, TV, actually as I just said earlier, it's going on a stable recovery trend, which we may be able to see some improving margin in it continuously in the future. And for the medium-sized business, especially for the tablet, I think next year, the order [ph] market intelligence see a quite robust growth in the coming years, and in which, I believe, AUO could start to take a very strong growth trend in terms of market share because our breakthrough in the new technology playphone, which we call AHVA. So I think next year, our -- the growth, sales growth momentum and also the profitability, hopefully we could see some very good improvement. That's for our tablet. And then for the small-sized business such as smartphone, I think we are seeing -- we are getting somewhere to reach -- to enrich our customer portfolio, especially in China. And then that might help AUO to stabilize our loading in those low temporary capacity. And further, I think the strong growth momentum in smartphone in China, I think we will -- I guess we should be able to tap some certain market share in smartphone in China, because next year China will represent the most important growth momentum for smartphone. So to sum up these all 3 major segments together, I think for TV, that the margin has been actually good enough but we still see some improvement next year. And for our medium and small business, I think AUO -- the room for improvement is still very substantial for AUO, and we are confident that we should be able to materialize this growth momentum next year, hopefully.

Jeffrey Su - Macquarie Research

Okay. Just -- sorry, a quick follow-up, the AHVA technology you mentioned in tablets, that is the IPS-like? Or sorry...

Andy Yang

I think I won't comment if it's IPS-like or not, but I would say that technology playphone is now well recognized by the key customer in the world.

Operator

Your next question comes from the line of Andrew Abrams.

Andrew Abrams - Avian Securities, LLC, Research Division

[Audio Gap]

relatively close to breakeven gross margin. And I understood that you've got cost down in your favor, and you've got a bigger emphasis on TV and in ASP climbing, would you expect that to be enough to move you into positive gross margin territory in the next quarter or so? Or is solar and maybe some of the smaller products going to continue to keep that in the negative territory?

Pearl Lin

Andrew, actually, we're missing the first part of your question. Can you please, repeat again?

Andrew Abrams - Avian Securities, LLC, Research Division

Yes, I was asking if you thought that gross margins over the next maybe 2 or 3 quarters would turn positive. You were fairly close in this quarter. And with maybe some positive momentum in TV, both on the unit side and on ASPs, and maybe less of an effect, negative effect from solar, would that -- would you see that pushing gross margins into the positive zone in the next 2 or 3 quarters?

Andy Yang

Andrew, we still don't comment on the margin trend in the future for the company as a whole. So we may be unable to comment whether this gross margin could turn positive and the timing -- yes, sorry.

Andrew Abrams - Avian Securities, LLC, Research Division

But could you...

Andy Yang

Sorry, Andrew, sorry for the interruption. For your information, in Q3, actually for the TFT LCD business, our core business, actually the gross margin has been positive.

Andrew Abrams - Avian Securities, LLC, Research Division

Got it, that's very helpful. That's what it seemed like. It was just hard to segregate out the others. Could you talk a little bit about your tablet business? I know there's a lot of new product involved, and you're still kind of in the development stage or the early manufacturing stage. Can you kind of give us an understanding of where you are and where you expect to be in fourth quarter in that kind of tablet range?

T. K. Wu

Andrew, here is T.K. Actually we start our tablet development from the beginning of this year. And I think we can see a very strong momentum starting from the Q3, and we expect such kind of momentum will be sustained in the next couple -- we'll wait then to the next year.

Andrew Abrams - Avian Securities, LLC, Research Division

Okay. And lastly, can you talk just a little bit about OLED? You didn't mention anything about it this call. Last call, you mentioned that you should have product out or at least at customer sampling before the end of this year. Is that still in the same time frame?

T. K. Wu

Yes. So actually, we start to ship in general [ph] sample for designing purpose for more than one customers from this product. And actually, AMOLED is a totally a different platform for -- in terms of display technologies. So actually, the design and procedure is more difficult and complicated than we expected. But anyway, but we can see a positive progress on this portion.

Andrew Abrams - Avian Securities, LLC, Research Division

And would you expect to have -- to see retail product in first quarter of next year? I know it's really not only in your control, but what would be your time frame for when your product actually shows in the marketplace?

T. K. Wu

Yes, you're right. It's not on our control because we have to collaborate with the smartphone maker. It really depends on their progress also.

Operator

Your next question comes from the line of Jerry Tsai.

Pearl Lin

Jerry?

[Technical Difficulty]

Jerry Tsai - HSBC, Research Division

You mentioned that your TV EBITDA margin was well above the company average in the third quarter. Can you tell us how is that in the second quarter? I mean, the second quarter TV EBITDA margin compared to the average, company average, in the second quarter?

Andy Yang

Jerry, I think for Q2, actually, I don't have that kind of comparison handy. But I definitely could say that third quarter EBITDA margin of TV is much better than second quarter.

Jerry Tsai - HSBC, Research Division

Okay, great. And my second question is that during the fourth quarter, do you expect a pretty stable monthly sales pattern? Or do you expect a peak in certain months then followed by a big decline in the next month?

Andy Yang

If you are talking about a monthly trend in the fourth quarter, I guess there's still some factors that are quite dynamic. I think first of all is the selling price trend, and also the second one would be the product portfolio or our shipment. And the third one would be the -- I'm thinking that might be the most important one, is the yield rate on those new products. So it's quite difficult for us to comment on that monthly trend at this moment.

Jerry Tsai - HSBC, Research Division

Okay. For the last question, I'd like to know, can you tell us the percentage of revenue coming from this ultra large-sized TV? Basically, I guess you can define it as anything bigger than 50-inch or 55 inches?

Michael K. C. Tsai

Jerry, this is Michael. Our current -- our average TV size is increasing in this year. So above 40-inch, we call it a 40-inch above, is around 40% in this quarter.

Jerry Tsai - HSBC, Research Division

And can you tell or give us some idea of where you are in, let's say, 2 quarters? Just for comparison, one is, I'd like to see if the business percentage around this is going up.

Michael K. C. Tsai

So third quarter is around 37%. Q4, we may increase to 41%. That is for our largest size of over 40-inch.

Operator

Your next question comes from the line of Harsh Agarwal.

Harsh Agarwal - JP Morgan Chase & Co, Research Division

I had -- [indiscernible] one was your guidance for CapEx for the year is TWD 42 billion. You've already spent about TWD 36 billion in the first 9 months, which means your fourth quarter CapEx should be only about TWD 6 billion. Just to make sure you don't expect to overshoot that number because TWD 6 billion for the fourth quarter seems quite low, given what you spent in the first 9 months of the year.

Andy Yang

Harsh, in terms of the CapEx amount, actually it's the cash flow that would pay for the equipment and other fixed assets. So TWD 6 billion in fourth quarter is actually the amount we forecast we need to pay in the coming quarter.

Harsh Agarwal - JP Morgan Chase & Co, Research Division

Okay. So TWD 6 billion for the fourth quarter is the right number then in terms of cash flows?

Andy Yang

It might vary a little bit, but I guess may not be far from this number.

Harsh Agarwal - JP Morgan Chase & Co, Research Division

Okay, got it. The second question I had was, can you give us a sense of your cash balance. I mean, you're sitting on a fair bit of cash. I mean, do you think that this is a normal level? Or do you think this cash level -- or your sort of minimum required cash balance is a lot lower and we can expect the cash to be deployed over the course of coming months and quarters?

Andy Yang

We never disclosed the so-called minimum cash requirement on our balance sheet before. So I guess the cash flow at this moment is still sufficient enough to cover all our coming debt obligations.

Harsh Agarwal - JP Morgan Chase & Co, Research Division

I'm sure the cash balance is more than sufficient. I'm just wondering if you think this is a normalized kind of a cash balance you're happy with, or you think the cash balance is on the higher side?

Andy Yang

Well, it depends. Actually, it depends on in the coming period of time, how much we need to pay for the CapEx, how much we need to pay for the debt, how much we need to pay for everything. So I guess it may be different from time to time.

Harsh Agarwal - JP Morgan Chase & Co, Research Division

Okay. The last question I had was on your convertible bonds. You bought back some of your convertible bonds a while back. I'm just wondering if you have any plans to come back to the market to buy back more CBs?

Andy Yang

We evaluate from time to time. But so far, we have yet come to any conclusion about it.

Operator

Your next question comes from the line of Chris Lin.

Chris Lin - Daiwa Securities Capital Markets Co. Ltd., Research Division

Just a question on the solar business. Could you please help us remember how much of the total investment was in M.Setek? And if we were to write down the whole thing, how would the amount turn out to be?

Andy Yang

The total fixed asset on M.Setek's balance sheet, if what I remember is correct, would be around JPY 60 billion. And for the question you asked about -- JPY 60 billion, 6-0. Net fixed assets. I think for the asset impairment tax, actually we would do it at the end of this year. So far we have no any clue about the -- what would be the result for the asset impairment tax. It really depends on the market price for the poly -- solar sales, I'm sorry, poly, wafer and solar module at the end of this year.

Chris Lin - Daiwa Securities Capital Markets Co. Ltd., Research Division

Okay. So is it possible to just cut off the entire business? Or are we still keeping this business for -- make [ph] to your long-term kind of outlook and hope that this sector will turn around?

Andy Yang

If you are talking about whether there would be any strategic move about our solar business, I think the answer would be yes. If that -- the strategic collaboration with others may treat that best interest of our company and our shareholders, we would take the action when it comes.

Operator

Your next question comes from the line of Jamie Yeh.

Jamie Yeh - Barclays Capital, Research Division

I have some different [ph] questions to ask. One is you expected the fourth quarter blended ASP is to -- up 5% Q-o-Q. And what do you expect this about apples-to-apples, I mean like-to-like panel price increase for fourth quarter, and even for the 2 early next year. And then the rest will be coming from the blended -- I mean, the size migration.

Andy Yang

Jamie, we don't guide on the apples-to-apples basis. We only guide on the blended ASP. Sorry about that.

Jamie Yeh - Barclays Capital, Research Division

Sure, that's okay. And the other second question is that -- in terms of the OpEx, can you give us a breakdown on the R&D expenses and also the rest of SG&A?

Andy Yang

Sorry, actually I don't have that information handy. Would you please call our IR later? We may be able to get that information tomorrow. Sorry about that.

Jamie Yeh - Barclays Capital, Research Division

Sure, that's okay. Okay, and then finally, to follow-up with the solar questions, in terms of the scale down, or I mean at least [ph] to see to narrow the cost, when would we expect it to see, the contribution onto the financial statement, like fourth quarter this year? Or we need to wait until maybe sometime next year?

Andy Yang

I think there are some factors before we could answer this question. I think the first factor will be how much will be the one-off expense if we are going in from the downsizing. I think that's the first factor. The other factor was still depends on the pricing trend for solar polysilicon and solar wafer and solar modules. Because AUO, we have a quite vertically integrated valuation in the solar business. So I think for the pricing trend in solar business in different segments still will have the determining factors to how much we could endure in the loss for our solar business in the fourth quarter.

Operator

[Operator Instructions] Your next question comes from the line of Harsh Agarwal.

Harsh Agarwal - JP Morgan Chase & Co, Research Division

Sorry, I just had one more quick question for you. Generally, how do you guys think about your leverage? Are you sort of okay with where the leverage stands right now? Or I mean, do you have any concrete plans to delever the company for the coming year?

Andy Yang

Harsh, we'll review the leverage from time to time, and it depends on the financing resource available for us. So far, I think the leverage is still okay, and I will graciously [ph] review that from time to time, and --- yes.

Harsh Agarwal - JP Morgan Chase & Co, Research Division

Okay. And is there any way of knowing by any chance how much of the debt is sitting in the solar business?

Andy Yang

Actually, I don't have that number handy. Would you please send email to our IR account so we could get it back to you later?

Operator

And there are no further questions at this time. I would now hand the call back over to Ms. Pearl Lin.

Pearl Lin

If there are no more questions, we are going to end the conference call. For those who still have questions, please do write to us to ir@auo.com.

Operator, please close the conference call. Thank you.

Operator

You're welcome. Ladies and gentlemen, this does conclude today's conference call. You may now disconnect.

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