financial report 2006 - umc.com · (system-on-chip) technologies ... equity method. (c) cash...

Financial Report

77

Financial Report 2006

78 ReviewofFinancialPosition,OperatingResults,RiskManagement andEvaluation

86 SpecialDisclosures94 DisclosureAccordingtoUSSecurityAuthoritiesRegulation

100FinancialReviewUnconsolidated

196 FinancialReviewConsolidated

United Microelectronics Corporation | Annual Report 2006

78

Review of Financial Position, Operating Results, Risk Management and Evaluation

79 AnalysisofFinancialPosition

80 AnalysisofOperatingResults

81 LiquidityAnalysis

81 MajorCapitalExpendituresand SourcesofFunding

82 AnalysisforInvestment

83 RiskManagementandEvaluation


79

Analysis of Financial PositionIn thousand NTD

Explanation for significant changes (over 20%) in financial position include:1. The increase in funds and investments is mainly due to an effect of the subsequent valuation in “Available-for-sale financial assets, noncurrent” originated from the imple-mentation of ROC SFAS No. 34, “Financial Instruments:

Recognition and Measurement”. 2. The decrease in additional paid-in capital mainly resulted from the adjustment of funds and investments disposal for 2006.3. The increase in retained earnings mainly resulted from the increase in net income over the previous year.

2006 2005 Difference % Change

Current assets 118,430,216 128,267,746 (9,837,530) (8)

Funds and investments 82,746,430 39,238,167 43,508,263 111

Property, plant and equipment 142,647,435 149,809,616 (7,162,181) (5)

Other assets 7,659,590 7,970,867 (311,277) (4)

Total assets 355,228,793 329,391,074 25,837,719 8

Current liabilities 30,060,546 28,303,962 1,756,584 6

Long-term interest-bearing liabilities 30,383,076 36,009,055 (5,625,979) (16)

Total liabilities 64,063,922 71,107,521 (7,043,599) (10)

Capital 191,323,332 197,983,633 (6,660,301) (3)

Additional paid-in capital 67,707,287 85,381,599 (17,674,312) (21)

Retained earnings 34,795,993 26,572,792 8,223,201 31

Total equity 291,164,871 258,283,553 32,881,318 13


80

Analysis of Operating ResultsIn thousand NTD

Explanation for significant changes (over 20%) in operat-ing results include :(a) Net operating revenues:The increase in net operating revenues primarily resulted from the recovery of the semiconductor industry, and subse-quently the increased number of orders received.(b) Gross profit analysis:The increase in gross profit for 2006 was due primarily to increases in sales quantity and the capacity utilization rate, and a decrease in the product unit cost. Reasons for differ-ence in gross profit are as follows:

(c) Non-operating income and expenses:Mainly resulted from an increase in gain on disposal of investments, and Investment gain accounted for under the equity method.(d) Cumulative effect of changes in accounting principles:Resulted from the implementation of ROC SFAS No. 34, “Financial Instruments: Recognition and Measurement” to account for the financial instruments effective January 1, 2006. (e) Income tax expense:The increase of income tax expense resulted from the in-crease in sales revenues and the net income for 2006, and the impact of The Income Basic Tax Act of the R.O.C.

Estimated Sales Quantities With the industry shifting towards the vertical disintegra-tion business model, UMC, with its position as an industry leader and pioneer in 300mm manufacturing and SoC (System-on-Chip) technologies, should be able to reach a revenue growth rate higher than that of the overall semi-conductor industry. Based on our capacity and customers’ demand forecast, the estimated sales quantity for 2007 is approximately 3.70 million 200mm wafer equivalents.

In thousand NTD

Reasons for Difference Gross Profit

Average selling price 299,724

Unit cost 7,937,397

Product mix -

Quantity 1,366,350

Others (85,546)

Difference 9,517,925

2006 2005 Difference % Change

Sales revenues 102,023,597 90,780,340 11,243,257 12

Sales returns and discounts (710,191) (1,840,345) 1,130,154 (61)

Net sales 101,313,406 88,939,995 12,373,411 14

Other operating revenues 2,785,205 1,835,444 949,761 52

Net operating revenues 104,098,611 90,775,439 13,323,172 15

Operating costs (83,419,400) (79,614,153) (3,805,247) 5

Gross profit 20,679,211 11,161,286 9,517,925 85

Realized (unrealized) intercompany profit 14,261 34,264 (20,003) (58)

Gross profit-net 20,693,472 11,195,550 9,497,922 85

Operating expenses (14,569,334) (13,864,269) (705,065) 5

Operating (loss) income 6,124,138 (2,668,719) 8,792,857 (329)

Non-operating income 33,871,592 13,871,542 20,000,050 144

Non-operating expenses (2,979,691) (4,175,293) 1,195,602 (29)

Income from continuing operations before income tax 37,016,039 7,027,530 29,988,509 427

Income tax expense (3,208,211) (838) (3,207,373) 382,741

Cumulative effect of changes in accounting principles (1,188,515) - (1,188,515) -

Net income 32,619,313 7,026,692 25,592,621 364


81

Project Actual or Expected Sources of Funding Completion Status

(up to 2006)

Total Amount

(up to 2006)

Capital Expenditures Plan

2006 2005

Production Equipment Cash flows generated from operations, bank loans and issuance of bonds

Completed 44,632,783 28,132,964 16,499,819

R&D Equipment Cash flows generated from operations, bank loans and issuance of bonds

Completed 5,158,223 3,071,455 2,086,768

Impact on the Company’s Financial Operations and Contingency Action Regarding Major Capital Expenditures

In thousand NTDExecution Status of Major Capital Expenditures and Sources of Funding

Cash Balance at Beginning of Year

Net Cash Provided by Operating Activities

Net Cash Used in Investing and

Financing Activities

Cash Balance at End of Year

Source of Funding in case of Cash Shortfall

Investing Plan Financing Plan

96,596,623 46,049,174 (59,250,995) 83,394,802 - -

Liquidity AnalysisIn thousand NTDAnalysis of Cash Flows for 2006

Cash Balance at Beginning of Year

Projected Cash Inflows from Operating

Activities

Projected Cash Outflows from

investing and financing activities

Projected Cash Balance at End of

Year

Source of Funding in case of Cash Shortfall

Investing Plan Financing Plan

83,394,802 44,222,821 (98,068,887) 29,548,736 - -

In thousand NTDProjected Cash Flows for 2007

(a) Cash inflows from operating activities are the result of net income reconciled to net cash with depreciation as the largest adjustment.(b) Cash outflows from investing activities are attributed to the increase of capital expenditures, while cash inflows from investing activities are attributed to proceeds from available-

for-sale financial assets and long-term investment under the equity method.(c) Cash outflows from financing activities resulted from the repayment of bonds payable, purchase of treasury stocks and payment of cash dividends.

Expected Benefit from Capital ExpendituresStarting from 2007, production capability for the Company’s 0.25-micron and below technologies will increase to 68% or

more as a percentage of total production capacity due to the above mentioned capital expenditures.

Note Net cash used in investing and financing activities includes factoring for currency exchange, which amounts to (85,133) thousand.


82

Investment Policy, Causes of Profit /Loss and Future Investment Plans

The Company held a meeting of its Board of Directors on January 27, 2006, and passed a resolution to sell 63.48% of the equity of its subsidiary, Hsun Chieh Investment Co., Ltd. (Hsun Chieh), to Hsieh Yong Capital Co., Ltd. (Hsieh Yong). Before this transaction, the Company held a 99.97% stake in Hsun Chieh. After completing the sale of a 63.48% stake to Hsieh Yong, the Company holds a 36.49% stake in Hsun Chieh and retains one of the three seats on the Company’s Board of Directors. After the transaction, Hsun Chieh Investments Co., Ltd. was no longer a subsidiary of the Company and thus any share of the Company held by Hsun Chieh Investments Co., Ltd. shall be reclassified from treasury stocks to long-term investments in the Company’s books, of which NTD 10,881 million was recorded in effect

under long-term investments and stockholders’ equity, respectively. Both the Company and Hsieh Yong set the terms of the sale, in consideration of the future prospects of the industry, and the technical and management capabilities of Hsun Chieh’s invested companies. The companies that make up Hsun Chieh’s investment portfolio come from a wide range of sectors within the electronics supply chain. Over 97% of the value of Hsun Chieh’s investment portfolio is in publicly listed companies. The value of Hsun Chieh was determined based on the closing stock price of its portfolio companies at the end of trading on January 25, 2006 and was reviewed by securities and accounting specialists, confirming the reason-ableness of this transaction.


83

Impact on Corporate Profitability from Fluctuating Inter-est Rates, Exchange Rates, and InflationThe impact on the Company from fluctuating interest rates, exchange rates, and inflation has been minimal due to ef-fective monitoring and control. The Company will continue to watch market movement with regard to interest and exchange rates to avoid losses.

Profit or Loss from Activities in High Risk and Highly Leveraged Investments, Loans Provided to Others, En-dorsements and Guarantees, and DerivativesStarting from November 2005, the Company provided guarantees of NTD 7.5 billion to its subsidiary, UMCJ. The guarantees had expired on October 31, 2006. The Company has not engaged in any transaction of high risk and highly leveraged investments. Any deriva-tives transaction is to elevate the Company’s operating performance and reduce operating and financial risks.

Upcoming R&D Plans and Their StatusUMC is determined to maintain its position as a semicon-ductor industry leader by addressing the challenges of semi-conductor scaling and continuing the advancement of tran-sistor technology. The accomplishments being unveiled at 65-nanometer and 45-nanometer development demonstrate UMC’s capabilities and confidence in the development and delivery of advanced process technologies for 45-nanometer and beyond. With the upcoming completion of UMC’s new R&D center and new wafer plant for nanometer technologies in Tainan, Taiwan, the development momentum moving to 45-nanometer, 40-nanometer (shrunk version of 45-nanometer) and 32-nanometer is accelerating, with extraor-dinary achievements expected in the coming year. 65-nanometer product ramp is on track for several customers for 2007 and 55-nanometer technology qualifi-cation is expected to be completed during the second half of 2007. The development pace for 45-nanometer technol-ogy is accelerating as well. Continued enhancements to process margin and volume production windows will be the Company’s current focus for UMC’s 45-nanometer Low Leakage process. Further mobility enhancement for the high performance chip segment is an on-going challenge that has been determined to be resolved in 2007. The 45-nanometer release schedule has been aligned with UMC’s strategic customers’ product roadmap for 2008. The definition of 32-nanometer technology and device specification discus-sion have been initiated with UMC’s leading customers. The Company is also co-working with a leading technology company at Advanced Technology Development Facility (ATDF) to develop leading-edge transistor structures incor-porating new materials (high-k dielectrics and metal gate electrode, Silicon-on-insulator (SOI) and non-classical CMOS schemes (multiple-gate field emission transistor) for future generation devices on new technology. UMC will continue to strengthen its silicon validated intellectual property portfolio, with a particular emphasis

on increasing 65-nanometer and 90-nanometer IP. For 65-nanometer design support, the foundation will be built upon DFM compliance libraries, memory compilers and reference design flows. State-of-the-art analog mixed-signal IP will further complement customers’ SoC design needs, espe-cially those supporting industry standards (such as PCI-E, SATA, HDMI, etc.), advanced video, audio and consumer applications. UMC will leverage its success in delivering 90-nanometer libraries and analog mixed-signal devices to de-velop 65-nanometer solutions while expanding its partner-ship base with the world’s IP community to offer the most comprehensive design support resources for SoC designs. As the SoC Solution Foundry, UMC continues to develop innovative yet practical technology solutions to help SoC designers maximize the competitiveness of their products. UMC’s continuous advancements in leading-edge and emerging technology areas are criti-cal for customers’ product success. UMC will complete its specialized R&D center and continue to build its methodology designed to accelerate leading-edge nano-electronic technology to the marketplace.

Impact on the Company’s Financial Operations and Con-tingency Action Regarding Recent Changes in Domestic and International Policies and RegulationsThe Company strictly follows governing policies and regula-tions. All of the related departments constantly monitor any changes in related policies and regulations, and adjust inter-nal operating procedures and business activities accordingly so that business operations continue smoothly. As to the revisions of ROC “Business Entity Accounting Law” announced on May 24, 2006, Financial Supervisory Commission, Executive Yuan (FSC) proposed a policy of “identification of employee dividend and bonus payouts as expenses” (the “Policy”) to be enforced from January 1, 2008. The Company’s financial/business impact from this new Policy and action measures for resolution will be:(1) Impact: the Company will follow the Policy and related

accounting principles and regulations in financial re-porting.

(2) Action Measures: related regulations and principles of the Policy have not been proposed by FSC; as such the Company will monitor them and consult with its ac-counting service firm for an implementation plan for the Policy.

Impact on the Company’s Financial Operations and Con-tingency Action Regarding Recent Changes in TechnologyThe Company has been sharply focused on the development of advanced technology. In 2006, the Company’s R&D ex-penses were approximately NTD 9.2 billion. The Company has taken the lead position in the foundry industry in both volume production of 90-nanometer and the development of 65-nanometer technologies. The Company has migrated 90-nanometer chips to mainstream volume production; 90-nanometer and below chips represented 21% of total revenue

Risk Management and Evaluation


84

in the 4th quarter, 2006; 65-nanometer chips represented 1% of total revenue in 2006. The Company’s current financial situation is sound and cash on hand is sufficient for future technology development.

Impact on the Company’s Risk Management and Con-tingency Action Regarding Recent Changes in Corporate ImageTo ensure the long-term success of the Company and to fur-ther the corporate goal of building long-term partnerships with our customers and our community, the Company holds Shareholder Meetings and Investor Conferences regularly to maintain a high-level of financial transparency. The Company consistently meets its obligations as an exemplary corporate citizen by participating in a wide range of public activities that benefit the community and society as a whole. In addition, the Company has established a comprehensive and robust set of response procedures aimed at addressing the needs of a highly diverse range of emergency conditions, reducing management uncertainty to the lowest achievable level.

Risk from the Company Encountering an Economic Down-turn during Expansion by Acquisition or MergerThrough future acquisitions, UMC is expected to integrate resources, lower operating costs, widen its business scope, raise profitability and add to its overall international com-petitiveness, which will help the Company to contend in a capital and technology intensive industry that is constantly changing. The cyclical fluctuation in the semiconductor indus-try is volatile and uncertain. Once a company encounters an economic downturn during expansion by acquisition or merger, there would exist the possibility of an excess capacity situation. The risk might temporarily damage the Company’s profitability but such a situation would also help to eliminate companies with poor operations and restruc-ture the industry composition. The other possible risk would be that the acquired company would encounter difficulties when integrating with the acquiring company. Factors such as unsuccessful production integration or issues brought by differences in corporate culture would partly offset the contribution from the acquired company. To avoid the negative effects from improper acquisition, for future operations, the Company will conduct thorough evaluations to prevent unfavorable acquisition conditions caused by improper information disclosure. Following any acquisition, the Company’s corporate culture will be introduced to its new employees to create a unified team that will work hard towards the common goal of increasing the Company’s competitiveness.

Risk of Excess Capacity from Fluctuating Economic Condi-tionsThe Company increases its production capabilities through fab expansion in order to accommodate more customer orders, thus providing the means to increase revenue, profits and market share. When production capacity reaches economies of scale, manufacturing costs can be dramatically reduced. However, the significant potential for fluctuations in the semiconductor industry economic cycle creates finan-cial risk, as any excess capacity still must be accounted for under depreciation of plants and equipment during demand softening caused by economic conditions. This risk would be considered a burden to the Company. The Company’s capacity expansion is under deliberate capital expenditure plans, which focus on satisfying cus-tomers’ needs while optimizing capital utilization. Disci-plined capital expenditure can help to develop a healthy industry environment.

Risk and Countermeasures of the Company Encounter-ing Material Shortage from Suppliers Failing to Provide Materials due to Circumstances Created by Natural or Unnatural Factors The Risk of Material Shortage: Material shortage may result from suppliers encountering situations such as insufficient capacity, industrial accidents in factories or natural disasters.Solution for Material Shortage:UMC currently uses consignment contracts to offset its risk.

Risk of Profit Loss if Sales are Concentrated on a Single or a Few Customers, and a Major Customer Reduces its OrdersUMC has established long-term and steady partnerships with numerous world-class customers. The combined strengths of both UMC and these customers will ensure the long-term steady growth of the Company. The ten larg-est customers of UMC accounted for 63% of sales in 2006. UMC mitigates its risk through dispersed sales to lower the potentially significant impact that a single or a few custom-ers may cause.

Risk of Change of Control and Stock Price Fluctuation from Large Scale Transfer of SharesIf Company’s directors, supervisors or major shareholders holding more than 10% of issued and outstanding shares transfer a significant portion of their shareholdings in the Company, then a change of control may occur. Furthermore, such transfer may give rise to investor concerns on the op-eration of the Company and may cause the market price of Company shares to f luctuate. The share withholding status of the Company’s direc-tors, supervisors and managers have been reported based on official regulations and laws. Meanwhile, there has been no significant share transfer activity.

Risk Management and Evaluation (cont.)


85

Risk of the Company Losing One or More Key Personnel without Adequate Replacement Due to Any Change of Company ControlUMC’s future success depends to a large extent on the con-tinued service of the Company’s Chairman and key execu-tive officers. If the Chairman or key executive officers leave their positions as a result of a change in Company control, and qualified replacement personnel cannot be found and integrated in a short period of time, operations may be adversely affected. The Company’s management focuses its operations with the intent to maximize value for its shareholders, thus gain-ing their trust and recognition. If there were a replacement of management, the succeeding personnel would have to recognize corporate culture, be qualified to assume profes-sional duties, and be able to execute the Company’s policy.

Litigation and Non-litigated IncidentsOn February 15, 2005, Taiwan’s Hsinchu District Court Prosecutor’s Office conducted a search at UMC offices, assertively investigating whether there was any evidence of violation of Taiwan Securities and Exchange Act. UMC’s former Chairman, Mr. Robert H.C. Tsao, and former Vice Chairman, Mr. John Hsuan, had received summons as the defendants. On the afternoon of January 9, 2006, Taiwan’s Hsinchu District Court Prosecutor’s Office announced that UMC’s former Chairman, Mr. Robert H.C. Tsao, and for-mer Vice Chairman, Mr. John Hsuan, had been prosecuted due to their violations of Article 71 of Business Entity Ac-counting Act and Article 342 paragraph 1 of Criminal Law. In actuality, Mr. Robert H.C. Tsao and Mr. John Hsuan had both resigned from their director positions from the Board of Directors on the morning of the same day. This case is waiting for Taiwan Hsinchu District Court’s trial. On July 12, 2005, one of UMC’s Taiwan shareholders, Mr. T.Y. Huang brought a civil litigation action against UMC and the other Taiwan listed companies and claimed that all of the resolutions in this aforesaid companies’ 2005 annual shareholders meetings were null and void. This case had been overruled by Taiwan Hsinchu District Court on March 7, 2006. Mr. T.Y. Huang appealed. On September 12, 2006, Taiwan High Court ruled in favor of UMC. Mr. T.Y. Huang did not appeal to Taiwan Supreme Court within the statu-tory time limit; this case is closed. On February 13, 2006, Taiwan Hsinchu District Court delivered a notice to UMC and informed UMC that Taiwan Power Company (“TPC”) had filed a civil litigation case against UMC and other Taiwan companies. TPC claimed: (1) UMC and the other Taiwan companies should collectively pay NTD 13,348,056 with interest to TPC for electrical fees, and (2) UMC should pay NTD 21,210,000 to TPC for the electrical line’s fees. Up until this Annual Report’s editing deadline, UMC had provided the defense documents. This case is under Taiwan Hsinchu District Court’s trial.

On February 15, 2006, Taiwan Ministry of Economic Affairs, Executive Yuan (MOEA) fined UMC NTD 5 million for UMC’s alleged violation of Governing Relations between Peoples of the Taiwan Area and the Mainland Area Act (Article 35, failure to gain government’s approval for con-ducting investment in China Mainland). UMC had filed an administrative appeal against MOEA on March 16, 2006. On October 19, 2006, Executive Yuan denied the administrative appeal filed by UMC. Up until this Annual Report’s editing deadline, UMC had filed an administrative litigation case against MOEA on December 8, 2006. UMC’s Singapore Branch (as UMCi Ltd., prior to the conversion of that business to UMC Singapore Branch) as plaintiffs issued a Writ of Summons against Tokio Marine & Fire Insurance Company (Singapore) Pte. Ltd. as defendants on June 6, 2005 under a marine cargo insurance policy for the replacement cost of a 300mm Endura System damaged in transit. UMC’s Singapore Branch believes a chamber of that equipment was damaged in shipment, incurring a cost of approximately USD 1.2 million to replace the damaged chamber. UMC’s Singapore Branch filed suit to recover under the insurance policy on the grounds that the equip-ment was damaged in shipment as a result of rough han-dling or conditions. Tokio Marine has denied the incident was a covered event under the policy. Discovery has been completed and the parties are preparing their affidavits of evidence-in-chief for exchange. Based on results to date, UMC feels its Singapore Branch has a meritorious case. Trial is expected for the first half of 2007. Although it is too early to determine the possible outcome, the maximum exposure to UMC’s Singapore Branch would be the loss of its claim for reimbursement plus no more than a few hundred thousand dollars more in assessments, fees and costs. Mr. C.F. Shih, a workman of a subcontractor hired by Yih-Shin Construction Co., Ltd. (“Yih-Shin”), one of compa-nies engaged by UMC for Fab 12A dormitory construction, was severely injured during construction. Mr. C.F. Shih’s wife filed a request to Taiwan Tainan Prosecutors’ Office to file charges against UMC and other related parties for personal injury. Taiwan Tainan Prosecutor’s Office denied this request. On March 30, 2006, Mr. C.F. Shih also filed a civil litigation case against Yih-Shin, UMC and other related parties. Mr. C.F. Shih claimed that Yih-Shin, UMC and other related parties should collectively pay NTD 20,967,400. Mr. C.F. Shih’s mother and wife each requested for com-pensatory damages in the amount of NTD 300,000 and Mr. C.F. Shih’s three children each requested for compensatory damages in the amount of NTD 100,000. Mr. Shih and his families also claimed that an annual interest rate of 5% to be accrued for the claimed damages. This case is waiting for Taiwan Tainan District Court’s trial.

Other Important RisksNone.

Risk Management and Evaluation (cont.)

None.

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financial report 2006 - umc.com · (system-on-chip) technologies ... equity method. (c) cash...

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