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Au Optronics Corp (AUO) SEC Filing 20-F Annual report for the fiscal year ending Saturday, December 31, 2011

Au Optronics Corp

CIK: 1172494 Ticker: AUO
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 20-F

 

 

(Mark One)

 

     ¨ REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

 

     x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2011

OR

 

     ¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to            

OR

 

     ¨ SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Date of event requiring this shell company report            

Commission file number: 001-31335

 

LOGO

(Exact name of Registrant as specified in its charter)

 

 

 

AU OPTRONICS CORP.   TAIWAN, REPUBLIC OF CHINA
(Translation of Registrant’s name into English)   (Jurisdiction of incorporation or organization)

1 LI-HSIN ROAD 2

HSINCHU SCIENCE PARK

HSINCHU, TAIWAN

REPUBLIC OF CHINA

(Address of principal executive offices)

 

 

Andy Yang

1 Li-Hsin Road 2

Hsinchu Science Park

Hsinchu, Taiwan

Republic of China

Telephone No.: +886-3-500-8800

Facsimile No.: +886-3-564-3370

Email: IR@auo.com

(Name, Telephone, Email and/or Facsimile number and Address of Company Contact Person)

Securities registered or to be registered pursuant to Section 12(b) of the Act.

 

Title of each class

 

Name of each exchange on which registered

Common Shares of par value NT$10.00 each   The New York Stock Exchange, Inc.*

 

* Not for trading, but only in connection with the listing on the New York Stock Exchange, Inc. of American Depositary Shares representing such Common Shares

Securities registered or to be registered pursuant to Section 12(g) of the Act: None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None

 

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report. 8,827,045,535 Common Shares

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  x Yes  ¨ No

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.  ¨ Yes  x No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  x Yes  ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  ¨ Yes  ¨ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. Check one):

Large accelerated filer  x                Accelerated filer  ¨                Non-accelerated filer  ¨

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

U.S. GAAP  ¨    International Financial Reporting Standards as issued by the International Accounting Standards Board  ¨    Other  x

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.  ¨  Item 17  x  Item 18

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  ¨ Yes  x No

 

 

 


Table of Contents

TABLE OF CONTENTS

 

          Page  

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

     1   

CERTAIN CONVENTIONS

     2   

REFERENCES

     2   

PART I 

        6   

ITEM 1

   IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS      6   

ITEM 2

   OFFER STATISTICS AND EXPECTED TIMETABLE      6   

ITEM 3

   KEY INFORMATION      6   

3.A.  

   Selected Financial Data      6   

3.B.  

   Capitalization and Indebtedness      9   

3.C.  

   Reason for the Offer and Use of Proceeds      9   

3.D.  

   Risk Factors      9   

ITEM 4

   INFORMATION ON THE COMPANY      31   

4.A.  

   History and Development of the Company      31   

4.B.  

   Business Overview      32   

4.C.  

   Organizational Structure      43   

4.D.  

   Property, Plants and Equipment      47   

ITEM 4A.

   UNRESOLVED STAFF COMMENTS      50   

ITEM 5

   OPERATING AND FINANCIAL REVIEW AND PROSPECTS      50   

5.A.  

   Operating Results      50   

5.B.  

   Liquidity and Capital Resources      66   

5.C.  

   Research and Development      70   

5.D.  

   Trend Information      72   

5.E.  

   Off-Balance Sheet Arrangements      72   

5.F.  

   Tabular Disclosure of Contractual Obligations      72   

ITEM 6

   DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES      74   

6.A.  

   Directors and Senior Management      74   

6.B.  

   Compensation      77   

6.C.  

   Board Practices      78   

6.D.  

   Employees      78   

6.E.  

   Share Ownership      79   

ITEM 7

   MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS      80   

7.A.  

   Major Shareholders      80   

7.B.  

   Related Party Transactions      81   

7.C.  

   Interests of Experts and Counsel      82   

ITEM 8

   FINANCIAL INFORMATION      82   

8.A.  

   Consolidated Statements and Other Financial Information      82   

8.B.  

   Significant Changes      88   

ITEM 9

   THE OFFER AND LISTING      88   

9.A.  

   Offering and Listing Details      88   

9.B.  

   Plan of Distribution      88   

9.C.  

   Markets      88   

9.D.  

   Selling Shareholders      89   

9.E.  

   Dilution      89   

9.F.  

   Expenses of the Issue      89   

 

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          Page  

ITEM 10

   ADDITIONAL INFORMATION      89   

10.A.

   Share Capital      89   

10.B.

   Memorandum and Articles of Association      89   

10.C.

   Material Contracts      94   

10.D.

   Exchange Controls      94   

10.E.

   Taxation      95   

10.F.

   Dividends and Paying Agents      100   

10.G.

   Statement by Experts      100   

10.H.

   Documents on Display      100   

10.I.  

   Subsidiary Information      100   

ITEM 11

   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK      100   

ITEM 12

   DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES      105   

12.A.

   Debt Securities      105   

12.B.

   Warrants and Rights      105   

12.C.

   Other Securities      105   

12.D.

   American Depositary Shares      106   

PART II 

        107   

ITEM 13

   ITEM DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES      107   

ITEM 14

   MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS      107   

ITEM 15

   CONTROLS AND PROCEDURES      107   

ITEM 16A.

   AUDIT COMMITTEE FINANCIAL EXPERT      109   

ITEM 16B.

   CODE OF ETHICS      109   

ITEM 16C.

   PRINCIPAL ACCOUNTANT FEES AND SERVICES      110   

ITEM 16D.

   EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES.      110   

ITEM 16E.

   PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS.      110   

ITEM 16F.

   CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT      110   

ITEM 16G.

   CORPORATE GOVERNANCE      111   

ITEM 16H.

   MINE SAFETY DISCLOSURE      113   

PART III 

        114   

ITEM 17

   FINANCIAL STATEMENTS      114   

ITEM 18

   FINANCIAL STATEMENTS      114   

ITEM 19

   EXHIBITS      114   

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

     118   

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This annual report on Form 20-F contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 (the “Securities Act”), as amended, and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”), as amended. These forward-looking statements are based on our beliefs and assumptions and the information available to us from other sources we believe to be reliable as of the date these disclosures were prepared and we undertake no obligation to update these forward-looking statements. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this annual report. The words “anticipate,” “believe,” “expect,” “intend,” “seek,” “plan,” “estimate” and similar expressions, as they relate to us, are intended to identify a number of these forward-looking statements. Our actual results of operations, financial condition or business prospects may differ materially from those expressed or implied in these forward-looking statements for a variety of reasons, including, among other things and not limited to:

 

   

litigation and regulatory investigations against us;

 

   

the cyclical nature of our industry;

 

   

further declines in average selling prices;

 

   

our dependence on introducing new products on a timely basis;

 

   

our dependence on growth in the demand for our products;

 

   

our continued ability to achieve high capacity utilization rates;

 

   

our dependence on a small number of customers for a substantial portion of our net sales;

 

   

our ability to allocate capacity efficiently and in a timely manner;

 

   

our ability to obtain capital resources for our planned growth;

 

   

our ability to compete effectively;

 

   

our dependence on the outsourcing of manufacturing by brand companies to original equipment manufacturing service providers;

 

   

our ability to expand into new businesses, industries or internationally;

 

   

our dependence on key personnel;

 

   

our relationship with our affiliates;

 

   

our ability to acquire sufficient raw materials and key components and obtain equipment and services from our suppliers in suitable quantity and quality;

 

   

changes in technology and competing products;

 

   

possible disruptions in commercial activities caused by natural and human-induced disasters, including terrorist activity and armed conflict;

 

   

general political, economic, financial and regulatory conditions;

 

   

fluctuations in foreign currency exchange rates; and

 

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other factors in the “Risk Factors” section in this annual report. Please see “Item 3. Key Information—3.D. Risk Factors.”

CERTAIN CONVENTIONS

We publish our financial statements in New Taiwan dollars (“NT dollars”), the lawful currency of the Republic of China (“ROC”). This annual report contains translations of NT dollar amounts, Renminbi (“RMB”) amounts, Japanese Yen (“JPY” or “YEN”) amounts and Euro (“EUR”) amounts, into United States dollars (“U.S. dollars”), at specific rates solely for the convenience of the reader. For convenience only and unless otherwise noted, all translations between NT dollars and U.S. dollars, between RMB and U.S. dollars, between JPY and U.S. dollars and between EUR and U.S. dollars in this annual report were made at a rate of NT$30.27 to US$1.00, RMB6.29 to US$1.00, JPY76.98 to US$1.00, and EUR0.77 to US$1.00, respectively, the exchange rates set forth in the H.10 weekly statistical release of the Federal Reserve System of the United States (the “Federal Reserve Board”) on December 30, 2011. No representation is made that the NT dollar, RMB, JPY, EUR or U.S. dollar amounts referred to herein could have been or could be converted into U.S. dollars, RMB, JPY, EUR or NT dollars, as the case may be, at any particular rate or at all. On March 31, 2012, the exchange rates set forth in the H.10 weekly statistical release of the Federal Reserve Board were NT$29.50 to US$1.00, RMB6.30 to US$1.00, JPY82.41 to US$1.00, and EUR0.75 to US$1.00, respectively. Any discrepancies in any table between totals and sums of the amounts listed are due to rounding.

REFERENCES

Unless otherwise indicated, in this annual report:

 

  1. “Acer Display” refers to Acer Display Technology, Inc.;

 

  2. “ADSs” refers to our American Depository Shares;

 

  3. “ADTT” refers to Advanced Display Technologies of Texas, LLC;

 

  4. “AFPD” refers to AFPD Pte., Ltd.;

 

  5. “AMOLED” refers to active-matrix organic light emitting diode;

 

  6. “AMVA” refers to AUO Advanced Multi-domain Vertical Alignment;

 

  7. “Anvik” refers to Anvik Corporation;

 

  8. “Apeldyn” refers to Apeldyn Corporation;

 

  9. “AT&T” refers to AT&T Corporation and its affiliates;

 

  10. “BenQ” refers to BenQ Corporation;

 

  11. “BMC” refers to BenQ Material Corp.;

 

  12. “BTA” refers to the basic tax amount;

 

  13. “Cando” refers to Cando Corporation Ltd.;

 

  14. “CCFL” refers to cold cathode fluorescent lamps;

 

  15. “Changhong Electrics” refers to Changhong Electrics (Sichuan) Co., Ltd.;

 

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  16. “China” refers to the People’s Republic of China, excluding Taiwan and the special administrative regions of Hong Kong and Macau;

 

  17. “Code” refers to the Internal Revenue Code of 1986, as amended;

 

  18. “Convertible Securities” refers to bonds with warrants, preferred shares with warrants, convertible bonds, convertible preferred shares or certificates of warrants;

 

  19. “Delaware Court” refers to the United States District Court for the District of Delaware;

 

  20. “DG COMP” refers to the Commission of the European Communities Directorate-General for Competition;

 

  21. “DTC” refers to The Depository Trust Company;

 

  22. “Eidos” collectively refers to Eidos Display, LLC and Eidos III, LLC;

 

  23. “fabs” refers to fabrication plants;

 

  24. “FDTC” refers to Fujitsu Display Technologies Corporation (which was merged into Fujitsu Limited);

 

  25. “Federal Reserve Board” refers to the Federal Reserve System of the United States;

 

  26. “Forhouse” refers to Forhouse Corporation;

 

  27. “FSC” refers to the ROC Financial Supervisory Commission;

 

  28. “Hitachi” refers to Hitachi Displays Ltd.;

 

  29. “IBTA Statute” refers to the Statute of Income Basic Tax Amount;

 

  30. “ITC” refers to the United States International Trade Commission;

 

  31. “IEL” refers to inorganic electroluminescent;

 

  32. “Investment Regulations” refers to the ROC Regulations Governing Securities Investment by Overseas Chinese and Foreign Nationals;

 

  33. “KFTC” refers to the Korea Fair Trade Commission;

 

  34. “large-size panels” refers to panels ten inches and above in diagonal length;

 

  35. “LED” refers to light emitting diodes;

 

  36. “Lextar” refers to Lextar Electronics Corp.;

 

  37. “LG Display” or “LGD” refers to LG Display Co., Ltd.;

 

  38. “M. Setek” refers to M. Setek Co., Ltd.;

 

  39. “Mainland Investor Regulations” refers to Regulations Governing Securities Investment and Futures Trading in Taiwan by Mainland Area Investors;

 

  40. “MIP” refers to Memory in Pixel;

 

  41. “mm” refers to millimeters;

 

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  42. “MOEAIC” refers to Investment Commission of Ministry of Economic Affairs;

 

  43. “Motorola” refers to Motorola Inc.;

 

  44. “Nokia” refers to Nokia Corporation;

 

  45. “NYSE” refers to the New York Stock Exchange;

 

  46. “non-ROC resident” means you are not a resident of the ROC;

 

  47. “Northern California Court” refers to the United States District Court for the Northern District of California;

 

  48. “OLED” refers to an organic light emitting diode;

 

  49. “our” refers to AU Optronics Corp. and its consolidated subsidiaries, unless the context suggests otherwise;

 

  50. “our company” refers to AU Optronics Corp. and its consolidated subsidiaries, unless the context suggests otherwise;

 

  51. “PDP” refers to a plasma discharge panel;

 

  52. “PFIC” refers to a passive foreign investment company;

 

  53. “PRC” refers to the People’s Republic of China, excluding Taiwan and the special administrative regions of Hong Kong and Macau;

 

  54. “QDI” refers to Quanta Display Inc.;

 

  55. “QDIIs” refers to qualified domestic institutional investors;

 

  56. “QCSZ” refers to Qisda (Suzhou) Co., Ltd.;

 

  57. “Qisda” refers to Qisda Corporation;

 

  58. “Raydium” refers to Raydium Semiconductor Corporation;

 

  59. “ROC” refers to the island of Taiwan and the areas under the effective control of the Republic of China;

 

  60. “ROC GAAP” refers to the generally accepted accounting principles in the ROC;

 

  61. “ROC government” refers to the government of the Republic of China;

 

  62. “Samsung” refers to Samsung Electronics Co., Ltd.;

 

  63. “SEC” refers to The United States Securities and Exchange Commission;

 

  64. “SED” refers to surface-conduction electron-emitter;

 

  65. “Sharp” refers to Sharp Corporation;

 

  66. “Small- to medium-size panels” refer to panels which are under ten inches in diagonal length;

 

  67. “subsidiary” refers to companies owned directly or indirectly by AU Optronics Corp., unless the context suggests otherwise;

 

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  68. “SPTL” refers to SunPower Technology, Ltd., a subsidiary of SunPower Corporation;

 

  69. “Taiwan” refers to the island of Taiwan and the areas under the effective control of the Republic of China;

 

  70. “TCL Huizhou” refers to TCL King Electrical Appliance (Huizhou) Co., Ltd.;

 

  71. “Thomson” or “Thomson Licensing” collectively refer to Thomson Licensing SAS and Thomson Licensing LLC;

 

  72. “Toppan CFI” refers to Toppan CFI (Taiwan) Co., Ltd.;

 

  73. “TMD” refers to Toshiba Mobile Display;

 

  74. “us” refers to AU Optronics Corp. and its consolidated subsidiaries, unless the context suggests otherwise;

 

  75. “U.S. DOJ” refers to the United States Department of Justice;

 

  76. “UNIPAC” refers to Unipac Optoelectronics Corp.; and

 

  77. “we” refers to AU Optronics Corp. and its consolidated subsidiaries, unless the context suggests otherwise.

 

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PART I

 

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not applicable.

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

 

ITEM 3. KEY INFORMATION

3.A. Selected Financial Data

The selected consolidated statement of operations data for the years ended December 31, 2009, 2010, and 2011 and selected consolidated balance sheet data as of December 31, 2010 and 2011 set forth below have been derived from our audited consolidated financial statements included herein. The selected consolidated balance sheet data as of December 31, 2007, 2008 and 2009 and selected consolidated statement of operations data for the years ended December 31, 2007 and 2008 have been derived from our audited consolidated financial statements that have not been included herein. The selected financial data set forth below should be read in conjunction with “Item 5. Operating and Financial Review and Prospects” and our consolidated financial statements and the accompanying notes included elsewhere in this annual report.

Our consolidated financial statements are prepared and presented in accordance with generally accepted accounting principles in the ROC (“ROC GAAP”). For information relating to the nature and effect of significant differences between ROC GAAP and US GAAP as they relate to us, see note 27 to our consolidated financial statements. The table below sets forth certain financial data under ROC GAAP for the periods and as of the dates indicated.

 

     Year Ended and As of December 31,  
     2007     2008     2009     2010     2011  
     NT$     NT$     NT$     NT$     NT$     US$  
     (in millions, except percentages and per share and per ADS data)  

Consolidated Statements of Operations:

            

ROC GAAP

            

Net sales

     480,183.6        423,928.2        359,331.3        467,158.0        379,711.9        12,544.2   

Gross profit (loss)

     86,178.2        55,327.9        7,040.9        36,298.6        (28,187.3     (931.2

Operating expenses

     22,903.5        22,235.6        22,279.9        25,801.9        29,471.2        973.6   

Operating income (loss)

     63,274.8        33,092.3        (15,239.1     10,496.7        (57,658.5     (1,904.8

Earnings (loss) before income tax

     58,563.8        26,270.9        (27,267.4     8,596.0        (65,652.1     (2,168.9

Income tax (expense) benefit

     (2,087.9     (4,629.1     22.6        (1,187.9     4,205.1        138.9   

Net income (loss)

     56,475.9        21,641.8        (27,244.8     7,408.1        (61,447.0     (2,030.0

Weighted average shares outstanding—Basic

     8,695.1        8,760.3        8,796.7        8,827.0        8,827.0        8,827.0   

Weighted average shares outstanding—Diluted(1)

     9,115.8        9,111.1        8,796.7        8,990.5        8,827.0        8,827.0   

Earnings (loss) per share—Basic

     6.49        2.43        (3.04     0.76        (6.94     (0.23

Earnings (loss) per share—Diluted(1)

     6.16        2.34        (3.04     0.70        (6.94     (0.23

Earnings (loss) per ADS equivalent—Basic

     64.88        24.28        (30.43     7.58        (69.40     (2.29

Earnings (loss) per ADS equivalent—Diluted(1)

     61.64        23.39        (30.43     6.98        (69.40     (2.29

Consolidated Balance Sheets:

            

ROC GAAP

            

Current assets

     217,878.3        146,293.1        196,460.8        204,985.6        202,673.9        6,695.5   

Property, plant and equipment

     363,835.1        389,348.3        390,750.1        383,867.7        358,479.0        11,842.7   

 

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     Year Ended and As of December 31,  
     2007     2008     2009     2010     2011  
     NT$     NT$     NT$     NT$     NT$     US$  
     (in millions, except percentages and per share and per ADS data)  

Consolidated Balance Sheets:

            

ROC GAAP (continued)

            

Goodwill and intangible assets

     19,554.4        15,548.1        14,293.3        14,062.0        15,428.1        509.7   

Total assets

     617,459.2        566,935.6        622,612.8        629,315.8        612,778.1        20,243.7   

Current liabilities

     174,520.9        152,484.7        202,725.4        189,378.6        204,179.9        6,745.3   

Long-term liabilities

     142,097.2        115,170.9        144,829.2        157,287.0        186,158.7        6,149.9   

Total liabilities

     316,639.4        267,676.9        347,693.8        346,991.2        391,501.2        12,933.6   

Capital stock

     78,177.1        85,057.2        88,270.5        88,270.5        88,270.5        2,916.1   

Total stockholders’ equity

     300,819.9        299,258.7        274,919.0        282,324.6        221,276.9        7,310.1   

Other Financial Data:

            

ROC GAAP

            

Gross margin(2)

     17.9     13.1     2.0     7.8     (7.4 %)      (7.4 %) 

Operating margin(3)

     13.2     7.8     (4.2 )%      2.2     (15.2 %)      (15.2 %) 

Net margin(4)

     11.8     5.1     (7.6 )%      1.6     (16.2 %)      (16.2 %) 

Capital expenditures

     65,136.7        98,355.2        61,046.9        84,621.0        56,919.6        1,880.4   

Depreciation and amortization

     81,705.6        81,188.4        90.107.6        89,135.7        88,752.4        2,932.0   

Cash dividend paid

     1,514.8        19,670.6        2,551.7        —          3,530.8        116.6   

Cash flows from operating activities

     156,926.9        132,057.5        57,041.0        90,735.6        14,515.1        479.5   

Cash flows from investing activities

     (66,123.1     (101,257.4     (66,616.7     (87,218.3     (57,829.0     (1,910.4

Cash flows from financing activities

     (44,816.6     (37,435.6     11,925.3        878.2        45,835.9        1,514.2   

Segment Data:

            

ROC GAAP

            

Net sales

            

Display business

     480,183.6        423,928.2        357,033.5        456,725.6        366,482.6        12,107.1   

Solar business

     —          —          2,297.8        10,432.4        13,229.3        437.1   

Operating income (loss)

            

Display business

     63,274.8        33,092.3        (13,949.3     13,102.7        (54,433.2     (1,798.3

Solar business

     —          —          (1,289.8     (2,606.0     (3,225.3     (106.5

The table below sets forth certain financial data under US GAAP for the periods and as of the dates indicated.

 

     Year Ended and As of December 31,  
     2007     2008     2009     2010     2011  
     NT$     NT$     NT$     NT$     NT$     US$  

Consolidated Statements of Operations:

            

US GAAP

            

Net sales

     480,184.3        423,928.2        358,732.8        467,158.0        379,711.9        12,544.2   

Gross profit (loss)

     73,179.3        42,959.9        766.4        31,608.4        (34,317.7     (1,133.7

Operating expenses

     21,328.3        22,811.7        29,076.1        26,209.2        33,450.6        1,105.1   

Operating income (loss)

     51,851.0        20,148.1        (28,309.7     5,399.2        (67,768.3     (2,238.8

Earnings (loss) before income tax and non-controlling interests

     48,434.3        16,086.2        (29,662.3     5,468.4        (69,623.8     (2,300.1

Income tax (expense) benefit

     (3,053.1     (2,579.6     1,359.5        (745.0     (11,492.4     (379.7

Non-controlling interests in (loss) income

     25.7        416.9        367.5        479.0        (167.9     (5.5

Net income (loss) attributable to stockholders of AU Optronics Corp.

     45,355.5        13,089.7        (28,670.3     4,244.3        (80,948.2     (2,674.2

Weighted average shares outstanding—Basic

     8,409.6        8,606.7        8,785.2        8,827.0        8,827.0        8,827.0   

Weighted average shares outstanding—Diluted(1)

     8,818.3        8,817.6        8,785.2        8,827.0        8,827.0        8,827.0   

Earnings (loss) per share—Basic

     5.39        1.52        (3.26     0.48        (9.17     (0.30

Earnings (loss) per share—Diluted(1)

     5.17        1.49        (3.26     0.48        (9.17     (0.30

Earnings (loss) per ADS equivalent—Basic

     53.93        15.21        (32.63     4.81        (91.70     (3.03

Earnings (loss) per ADS equivalent — Diluted(1)

     51.67        14.89        (32.63     4.81        (91.70     (3.03

***

            

Consolidated Balance Sheets:

            

US GAAP

            

Current assets

     215,929.0        145,522.3        195,902.9        205,289.0        200,534.2        6,624.8   

Property, plant and equipment

     361,197.2        383,958.1        385,571.6        376,453.2        348,452.7        11,511.5   

Goodwill and intangible assets

     30,334.7        26,399.4        25,036.5        24,834.8        26,199.3        865.5   

 

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     Year Ended and As of December 31,  
     2007     2008     2009     2010     2011  
     NT$     NT$     NT$     NT$     NT$     US$  

Consolidated Balance Sheets:

            

US GAAP (continued)

            

Total assets

     623,655.0        568,985.6        626,141.8        631,122.3        595,060.7        19,658.4   

Current liabilities

     180,765.1        152,647.2        203,120.9        190,887.9        205,026.8        6,773.3   

Long-term liabilities

     142,182.1        115,209.3        145,004.4        156,860.7        187,559.2        6,196.2   

Total liabilities

     322,947.2        267,856.5        348,125.3        347,748.6        392,586.0        12,969.5   

Non-controlling interests in subsidiaries

     8,842.0        7,737.2        11,747.5        12,983.6        14,816.0        489.4   

Total equity attributable to stockholders of AU Optronics Corp

     291,865.8        293,391.9        266,269.0        270,390.1        187,658.7        6,199.5   

Other Financial Data:

            

US GAAP

            

Gross margin(2)

     15.2     10.1     0.2     6.8     (9.0 %)      (9.0 %) 

Operating margin(3)

     10.8     4.8     (7.9 )%      1.2     (17.8 %)      (17.8 %) 

Net margin(4)

     9.4     3.1     (8.0 )%      0.9     (21.3 %)      (21.3 %) 

Capital expenditures

     65,300.5        98,330.6        61,331.5        85,427.7        57,488.0        1,899.2   

Depreciation and amortization

     84,984.5        83,680.4        91,506.9        91,420.9        91,314.5        3,016.7   

Cash flows from operating activities

     156,942.2        132,044.2        58,566.1        90,852.2        14,429.3        476.7   

Cash flows from investing activities

     (66,313.7     (101,242.4     (68,550.3     (87,866.1     (58,072.7     (1,918.5

Cash flows from financing activities

     (44,816.6     (37,473.2     11,467.6        1,393.9        45,850.0        1,514.7   

 

(1) Diluted earnings per share in 2009 under both ROC GAAP and US GAAP were not calculated due to the anti-dilutive effect of stock options and convertible bonds. Diluted earnings per share in 2010 under US GAAP and 2011 under both ROC GAAP and US GAAP were not calculated due to the anti-dilutive effect of convertible bonds.
(2) Gross margin is calculated by dividing gross profit (loss) by net sales.
(3) Operating margin is calculated by dividing operating income (loss) by net sales.
(4) Net margin is calculated by dividing net income (loss) by net sales.

Exchange Rate

Fluctuations in the exchange rate between NT dollars and U.S. dollars will affect the U.S. dollar equivalent of the NT dollar price of our shares on the Taiwan Stock Exchange and, as a result, will likely affect the market price of the ADSs. These fluctuations will also affect the U.S. dollar conversion by the depositary of cash dividends paid in NT dollars on, and the NT dollar proceeds received by the depositary from any sale of, our shares represented by ADSs.

The following table sets forth, for the periods indicated, information concerning the number of NT dollars for which one U.S. dollar could be exchanged. For periods prior to January 1, 2009, the exchange rates reflected the noon buying rate for cable transfers in NT dollars as certified for customs purposes by the Federal Reserve Bank of New York. For periods after January 1, 2009, the exchange rates reflect the exchange rates set forth in the H.10 statistical release of the Federal Reserve Board.

 

     Exchange Rate  
     Average      High      Low      Period-End  
     (or month-end
rates for years
                      

2007

     NT$32.85       NT$ 33.41       NT$ 32.26       NT$ 32.43   

2008

     31.52         33.55         29.99         32.76   

2009

     32.96         35.21         31.95         31.95   

2010

     31.49         32.43         29.14         29.14   

2011

     29.38         30.67         28.50         30.27   

October

     30.26         30.67         29.86         29.91   

November

     30.22         30.43         30.02         30.31   

December

     30.25         30.38         30.10         30.27   

2012 (through March 31, 2012)

     29.67         30.28         29.37         29.50   

January

     29.99         30.28         29.61         29.61   

February

     29.53         29.65         29.37         29.37   

March

     29.52         29.61         29.37         29.50   

 

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3.B. Capitalization and Indebtedness

Not applicable.

3.C. Reason for the Offer and Use of Proceeds

Not applicable.

3.D. Risk Factors

Risks Relating to Our Financial Condition, Business and Industry

If we are found to have violated antitrust and competition laws, or if our appeals regarding such violations are not successful, we may be subject to severe fines or penalties that would have a material adverse effect on our business and operations.

We are involved in a number of legal proceedings concerning matters arising from our business and operations. In particular, there have been numerous anti-trust proceedings and investigations, criminal, civil, and/or administrative concerning the alleged price fixing by manufacturers of TFT-LCD panels, including us. On March 14 (Taiwan time), 2012 we received the verdict for charges against us and certain of our executives made by the United States Department of Justice. See “Item 8. Financial Information—8.A.7. Litigation.” for a discussion of certain legal proceedings in which we are involved. If we are found to have violated any antitrust and/or competition law, we will likely have to pay a fine, penalty and/or damages. Certain of our current or former officers and/or employees have been, and may also be, indicted in certain jurisdictions for possible violations of antitrust and/or competition laws, and the individuals indicted may be held criminally liable and subject to imprisonment or fines or both. The ultimate outcome of the pending antitrust investigations cannot be predicted with certainty. Any penalties, fines, damages or settlements made in connection with these criminal, civil, and/or administrative investigations and/or lawsuits may have a material adverse effect on our business, results of operations and future prospects.

Our industry is cyclical, with recurring periods of capacity increases. As a result, price fluctuations in response to supply and demand imbalances could harm our results of operations.

The display panel industry in general is characterized by cyclical market conditions. The industry has been subject to significant and rapid downturns as a result of an imbalance between excess supply and a slowdown in demand, resulting in declines in average selling prices. For example, on a year-to-year basis, average selling prices of our large-size panels decreased by 24.4% in 2011 compared to 2010, decreased by 0.3% in 2010 compared to 2009, and decreased by 24.9% in 2009 compared to 2008. In addition, capacity expansion currently being undertaken or anticipated in the display panel industry may lead to excess capacity. It is anticipated that capacity expansion in the display panel industry due to scheduled ramp-up of new fabs, and any large increases in capacity that may create could further drive down the average selling prices of our panels, which would affect our results of operations. We cannot assure you that any continuing or further decrease in average selling prices or future downturns resulting from excess capacity or other factors affecting the industry will not be severe or that any such continuation, decrease or downturn would not seriously harm our business, financial condition and results of operations.

Our ability to maintain or increase our revenues will primarily depend upon our ability to maintain market share, increase unit sales of existing products, and introduce and sell new products that offset the anticipated fluctuation and long-term declines in the average selling prices of our existing products. We cannot assure you that we will be able to maintain or expand market share, increase unit sales, and introduce and sell new products, to the extent necessary to compensate for market oversupply.

 

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We may experience declines in the average selling prices of our display panels irrespective of cyclical fluctuations in the industry.

The average selling prices of our display panels have declined in general and are expected to continually decline with time irrespective of industry-wide cyclical fluctuations as a result of, among other factors, technology advancements and cost reductions. Although we may be able to take advantage of the higher selling prices typically associated with new products and technologies when they are first introduced into the market, such prices decline over time and in certain cases, very rapidly, as a result of market competition. If we are unable to anticipate effectively and counter the price erosion that accompanies our products, or if the average selling prices of our display panels decrease faster than the rate at which we are able to reduce our manufacturing costs, our profit margins will be affected adversely and our results of operations and financial condition may be affected materially and adversely.

Our results of operations have fluctuated in the past. If we are unable to achieve profitability in 2012 or beyond, the value of the ADSs and our shares may be adversely affected.

Our results of operations have fluctuated in the past. Primarily as a result of the global disruption in financial markets and adverse economic conditions and the decrease in average selling prices for our products, our net sales decreased by 15.2% to NT$359.3 billion in 2009 compared to 2008. We incurred a net loss of NT$27.2 billion in 2009. In 2010, our net sales increased by 30.0% to NT$467.2 billion and our net income increased to NT$7.4 billion compared to a net loss in 2009. In 2011, our net sales decreased by 18.7% to NT$379.7 billion (US$12.5 billion) and we incurred a net loss of NT$61.4 billion (US$2.0 billion). We cannot assure you that we will be profitable in 2012 or beyond. In addition, we expect that average selling prices for many of our existing products will continue to decline over the long term. If we are unable to reduce our costs of manufacturing of our products to offset expected declines in average selling prices and maintain a high capacity utilization rate, our gross margin will decline, which could seriously harm our business and reduce the value of our equity securities. If we are unable to achieve profitability in 2012 or beyond, the value of the ADSs and our shares may be adversely affected.

Our future net sales, gross profit, operating income and financing capabilities may vary significantly due to a combination of factors, including, but not limited to:

 

   

our ability to develop and introduce new products to meet customers’ needs in a timely manner;

 

   

our ability to develop or acquire and implement new manufacturing processes and product technologies;

 

   

our ability to control our fixed and variable costs and operating expenses;

 

   

our ability to expand capacity, our ability to manage our product mix;

 

   

our ability to obtain raw materials and components at acceptable prices and in a timely manner;

 

   

lower than expected growth in demand for display panels resulting in oversupply in the market;

 

   

our ability to obtain adequate external financing on satisfactory terms; and

 

   

fines and penalties payable relating to the alleged violation of antitrust and competition laws.

Our results of operations fluctuate from quarter to quarter, which makes it difficult to predict our future performance.

Our results of operations have varied significantly in the past and may fluctuate significantly from quarter to quarter in the future due to a number of factors, many of which are beyond our control. Our business and operations may be adversely affected by the following factors, among others:

 

   

the cyclical nature of both the industry, including fluctuations in average selling prices, and the markets served by our customers;

 

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the speed at which we and our competitors expand production capacity;

 

   

access to raw materials and components, equipment, electricity, water and other required utilities on a timely and economical basis;

 

   

technological changes;

 

   

the loss of a key customer or the postponement, rescheduling or cancellation of large orders from customers;

 

   

the outcome of ongoing and future litigation and government investigations;

 

   

changes in end-users’ spending patterns;

 

   

changes to our management team;

 

   

access to funding on satisfactory terms;

 

   

our customers’ adjustments in their inventory;

 

   

changes in general political, economic, financial and legal conditions; and

 

   

natural disasters, such as typhoons and earthquakes, and industrial accidents, such as fires and power failures, as well as geo-political instability as a result of terrorism or political or military conflicts.

Due to the factors noted above and other risks discussed in this section, many of which are beyond our control, you should not rely on quarter-to-quarter comparisons to predict our future performance. Unfavorable changes in any of the above factors may seriously harm our business, financial condition and results of operations. In addition, our results of operations may be below the expectations of public market analysts and investors in some future periods, which may result in a decline in the price of the ADSs or shares.

Our results of operations may be affected adversely if we cannot timely introduce new products or if our new products do not gain market acceptance.

Early product development by itself does not guarantee the success of a new product. Success also depends on other factors such as product acceptance by the market. For example, although TFT-LCD technology initially was introduced commercially in the early 1990s, its application to the consumer electronics sector began to gain wide market acceptance only in the last few years. New products are developed in anticipation of future demand. Our delay in the development of commercially successful products with anticipated technological advancement may adversely affect our business. We cannot assure you that the launch of any new product will be successful, or that we will be able to produce sufficient quantities of these products to meet market demand.

We plan to continue to expand our operations to meet the needs of applications in computer products, consumer electronics, LCD televisions and other markets as demand increases. Because these products, such as mobile phones, digital photo frames, digital still cameras, portable navigation display, portable DVD players and LCD televisions, are expected to be marketed to a diversified group of end-users with demands for different specifications, functions and prices, we have developed different marketing strategies to promote our panels for these products. We cannot assure you that our strategies to expand our market share for these panels will be successful. If we fail to successfully market panels for these products, our results of operations will be adversely affected.

 

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Our net sales and results of operations depend on continuing demand for televisions, notebook computers, desktop monitors and other products with display panels. Our sales may not grow at the rate we expect if there is a downturn in the demand for, or a further decrease in the average selling prices of, panels for these products.

Currently, our total sales are derived principally from customers using our products in televisions, notebook computers, desktop monitors, consumer electronics products and other products with display devices. In particular, a substantial percentage of our sales are derived from our panels and other related products for LCD televisions, which accounted for 48.2%, 50.8% and 43.5% of our net sales in 2009, 2010 and 2011, respectively. A substantial portion of our sales are also derived from our panels used in desktop monitors, which accounted for 19.0%, 16.7% and 15.4% of our net sales in 2009, 2010 and 2011, respectively, and our panels used in notebook computers accounted for 16.8%, 15.1% and 17.8% of our total net sales in 2009, 2010 and 2011, respectively. In addition, our panels used in consumer electronics products accounted for 13.1%, 12.1% and 16.5% of our net sales in 2009, 2010 and 2011. We will continue to be dependent on the growth of the television and personal computer industries for a substantial portion of our net sales, and any downturn in these industries would result in reduced demand for our products, reduced net sales, lower average selling prices and/or reduced margins and our business prospects and results of operations may be materially and adversely affected.

If we are unable to achieve high capacity utilization rates, our results of operations will be affected adversely.

High capacity utilization rates allow us to allocate fixed costs over a greater number of panels produced. Increases or decreases in capacity utilization rates can impact significantly our gross margins. Accordingly, our ability to maintain or improve our gross margins will continue to depend, in part, on achieving high capacity utilization rates. In turn, our ability to achieve high capacity utilization rates will depend on the ramp-up progress of our advanced production facilities and our ability to efficiently and effectively allocate production capacity among our product lines, as well as the demand for our products and our ability to offer products that meet our customers’ requirements at competitive prices.

Although we achieved high capacity utilization rates in certain quarters in 2009, 2010 and 2011, our results of operations in the past have been adversely affected by low capacity utilization rates. For example, in the first quarter of 2009, we had adjusted our utilization rates to as low as approximately 65%, resulting from a weaker demand caused by the financial crises in the markets in which we operate. We cannot assure you that we will be able to achieve high capacity utilization rates in 2012 or beyond. If we are unable to efficiently ramp-up our advanced production facilities or demand for our products does not meet our expectations, our capacity utilization rates will decrease, our gross margins will suffer and our results of operations will be materially and adversely affected.

We may experience losses on inventories.

Frequent new product introductions in the computer and consumer electronics industries can result in a decline in the average selling prices of our panels and the obsolescence of our existing display panel inventory. This can result in a decrease in the stated value of our display panel inventory, which we value at the lower of cost or net realizable value.

We manage our inventory based on our customers’ and our own forecasts. Although we regularly make adjustments based on market conditions, we typically deliver our goods to our customers one month after a firm order is placed. While we maintain open channels of communication with our major customers to avoid unexpected decreases in firm orders or subsequent changes to placed orders, and try to minimize our inventory levels, such actions by our customers may have a material adverse effect on our inventory management.

We depend on a small number of customers for a substantial portion of our net sales, and a loss of any one of these customers, or a significant decrease in orders from any of these customers, would result in the loss of a significant portion of our net sales.

We depend on a small number of customers for a substantial portion of our business. In 2009, 2010 ad 2011, our five largest customers accounted for 37.3%, 39.0% and 36.0%, respectively, of our net sales. In addition, certain customers individually accounted for more than 10% of our net sales in the last three years. For example, Samsung Electronics Co., Ltd. (“Samsung”) accounted for 16.9%, 15.3% and 12.9% of our net sales in 2009, 2010 and 2011, respectively.

 

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As some of our major customers are brand companies that also provide original equipment manufacturing services for other brand companies, such as Samsung, our panels shipped to these customers include both panels ordered for their own account, as well as panels ordered by or on behalf of their brand company customers.

In recent years, our largest customers have varied due to changes in our product mix. We expect that we will continue to depend on a relatively small number of customers for a significant portion of our net sales and may continue to experience fluctuations in the distribution of our sales among our largest customers as we periodically adjust our product mix. Our ability to maintain close and satisfactory relationships with our customers is important to the ongoing success and profitability of our business. If any of our significant customers reduces, delays or cancels its orders for any reason, or the financial condition of our key customers deteriorate, our business could be seriously harmed. Similarly, a failure to manufacture sufficient quantities of panels to meet the demands of these customers may cause us to lose customers, which may affect adversely the profitability of our business as a result.

Our customers generally do not place purchase orders far in advance, which makes it difficult for us to predict our future revenues and allocate capacity efficiently and in a timely manner.

Our customers generally provide rolling forecasts four to six months in advance of, and do not place firm purchase orders until one month before, the expected shipment date. In addition, due to the cyclical nature of the display panel industry, our customers’ purchase orders have varied significantly from period to period. As a result, we do not typically operate with any significant backlog. The lack of significant backlog makes it difficult for us to forecast our revenues in future periods. Moreover, we incur expenses and adjust inventory levels of raw materials and components based in part on customers’ forecast, and we may be unable to allocate production capacity in a timely manner to compensate for shortfalls in sales. We expect that, in the future, our sales in any quarter will continue to be dependent substantially upon purchase orders received in that quarter. The inability to adjust production costs, to obtain necessary raw materials and components or to allocate production capacity quickly to respond to the demand for our products may affect our ability to maximize results of operations, which may result in a negative impact on the value of your investment in the ADSs or our shares.

Our future competitiveness and growth prospects could be affected adversely if we are unable to expand successfully our fabs as planned.

As part of our business growth strategy, we have been undertaking and plan to undertake in the future a number of significant capital expenditure for our fabs. See “Item 4. Information on the Company-4.D. Property, Plants and Equipment-Expansion Projects.”

The successful expansion of our fabs and commencement of commercial production is dependent upon a number of other factors, including timely delivery of equipment and machinery and the hiring and training of new skilled personnel. Although we believe that we have the internal capabilities and know-how to expand our fabs and commence commercial production, no assurances can be given that we will be successful. We cannot assure you that we will be able to obtain from third parties, if necessary, the technology, intellectual property or know-how that may be required for the expansion of our fabs on acceptable terms. In addition, delays in the delivery of equipment and machinery as a result of increased demand for such equipment and machinery or the delivery of equipment and machinery that do not meet our specifications could delay the establishment or expansion of these fabs. Moreover, the expansion of our fabs may also be disrupted by governmental planning activities. If we face unforeseen disruptions in the installation, expansion and/or manufacturing processes with respect to our fabs, we may not be able to realize the potential gains from the manufacturing of panels and may face disruptions in capturing the growth opportunities.

 

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If capital resources required for our planned growth or development are not available, we may be unable to implement successfully our business strategy.

Historically, we have been able to finance our capital expenditures through cash flow from our operating activities and financing activities, including the issuance of equity securities, long-term borrowings and the issuance of convertible and other debt securities. Our ability to expand our production facilities and establish advanced technology fabs will continue to largely depend on our ability to obtain sufficient cash flow from operations as well as external funding. In addition, we expect to make capital expenditures in connection with the development of our business, including investments in 2012 in connection with technological upgrade and the enhancement of the value of capacity. These capital expenditures will be made well in advance of any additional sales to be generated from these expenditures. Our results of operations may be affected adversely if we do not have the capital resources to complete our planned growth or if our actual expenditures exceed planned expenditures for any number of reasons, including changes in:

 

   

our growth plan and strategy;

 

   

manufacturing process and product technologies;

 

   

market conditions;

 

   

prices of equipment;

 

   

costs of construction and installation;

 

   

market conditions for financing activities of display panel manufacturers;

 

   

interest rates and foreign exchange rates; and

 

   

social, economic, financial, political and other conditions in Taiwan and elsewhere.

If adequate funds are not available on satisfactory terms at appropriate times, we may have to curtail our planned growth, which could result in a loss of customers, adversely affect our ability to implement successfully our business strategy and limit the growth of our business.

We operate in a highly competitive environment and we may not be able to sustain our current market position if we fail to compete successfully.

The markets for our products are highly competitive. We experience pressure on our prices and profit margins, due largely to additional and growing industry capacity from competitors in Taiwan, Korea, Japan and the PRC. The ability to manufacture on a large scale with greater cost efficiencies is a competitive advantage in our industry. Some of our competitors have expanded through mergers and acquisitions. For example, in March 2010, Chimei Innolux Corp. was established as a result of the merger of three Taiwan-based LCD panel makers: Innolux Display Corp., Chi Mei Optoelectronics and TPO Display Corp. The merged entity has overtaken our position as Taiwan’s largest and the world’s third largest LCD panel maker in terms of revenue. Some of our competitors have greater access to capital and substantially greater production, research and development, intellectual property, marketing and other resources than we do. Some of our competitors have announced their plans to develop, and have already invested substantial resources in, eighth generation or AMOLED capacity. Our competitors may be able to introduce products manufactured using such capacity in advance of our schedule. In addition, some of our larger competitors have more extensive intellectual property portfolios than ours, which they may use to their advantage when negotiating cross-licensing agreements for technologies. As a result, these companies may be able to compete more aggressively over a longer period of time than we can.

 

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The principal elements of competition in the display industry include:

 

   

price;

 

   

product performance features and quality;

 

   

customer service, including product design support;

 

   

ability to reduce production cost;

 

   

ability to provide sufficient quantity of products to fulfill customers’ needs;

 

   

research and development, including the ability to develop in the new display technology, such as AMOLED;

 

   

time-to-market; and

 

   

access to capital.

Our ability to compete successfully in the display industry also depends on factors beyond our control, including industry and general political and economic conditions as well as currency fluctuations.

If brand companies do not continue to outsource the manufacturing of their products to original equipment manufacturing service providers with production operations in Taiwan, the PRC, Eastern Europe, Mexico and elsewhere, our sales and results of operations could be affected adversely.

In recent years, brand companies have increasingly outsourced the manufacturing of their products to original equipment manufacturing service providers in Taiwan, or such providers with part or all of their production operations in the PRC, Eastern Europe, Mexico and elsewhere. We believe that we have benefited from this outsourcing trend in large part due to our production locations in Taiwan, the PRC and Eastern Europe, which has allowed us to better coordinate our production and services with our customers’ requirements, especially in the areas of delivery time and product design support. We cannot assure you that this outsourcing trend will continue. If brand companies do not continue to outsource the manufacturing of their products to original equipment manufacturing service providers with their production operations in Taiwan, the PRC, Eastern Europe, Mexico and elsewhere, our sales and results of operations could be adversely affected.

If we are unable to manage our growth effectively, our business could be affected adversely.

We have experienced, and expect to continue to experience, growth in the scope and complexity of our operations and in the number of our employees. For example, we currently expect to make capital expenditures in connection with technological upgrade and the enhancement of value of capacity. This growth may strain our existing managerial, financial and other resources. In order to manage our growth, we must continue to implement additional operating and financial controls and hire and train additional personnel for these functions. We cannot assure you that we will be able to do so in the future, and our failure to do so could jeopardize our planned growth and seriously harm our operations.

We may encounter difficulties expanding into new businesses or industries, which may affect adversely our results of operations and financial condition.

We may encounter difficulties and face risks in connection with our expansion into new businesses or industries. For example, we entered the solar business at the end of 2008 and formed our Solar Photovoltaic Business Unit in October 2009. In connection with this expansion, we obtained a controlling interest in M. Setek Co., Ltd. (“M. Setek”), a major polysilicon and solar wafer manufacturer in Japan through equity investments in 2009. In May 2010, we formed a joint venture with, among others, SunPower Technology, Ltd. (“SPTL”), a subsidiary of SunPower Corporation, a leading manufacturer of residential and commercial solar systems in the United States, to construct and operate a solar cell manufacturing facility in Malaysia.

 

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We expect to continue to build our solar business in the future and we may need to devote significant additional resources. For example, pursuant to the terms of the joint venture agreement we entered into with SPTL in May 2010, we and SPTL, as of December 31, 2011, each already contributed US$108 million, respectively. Our cash contribution to the joint venture has been funded by our own capital or bank borrowing. Our long-term loans and facilities contain financial and other covenants, and our guidelines for capital lending contain lending restrictions, all of which may restrict our ability to provide debt financing to the joint venture or other activities in connection with our expansion into the solar business.

We cannot assure you that our expansion into the solar business will be successful as we have little experience in this industry. Solar industry demand continues to be largely driven by the availability and size of government and economic incentives related to the use of solar power. These government economic incentives have been reduced and could be further reduced or eliminated, in light of worldwide slow recovery of the economic downturn. In addition, the increasing competition and oversupply in the solar industry have resulted in substantial downward pressure on pricing, which could negatively impact our expansion efforts. Furthermore, we may not be able to generate sufficient profits to justify the costs of expanding into new businesses or industries. Technology innovation in the solar industry changes rapidly and constantly and we cannot predict which technology will be the mainstream in the future. As a result, we may invest in research and development of technology that may not succeed or may quickly become obsolete. If any new business in which we invest or which we intend to develop does not progress as planned, our results of operations and financial condition may be affected adversely.

We may undertake mergers, acquisitions or investments to expand our business that may pose risks to our business and dilute the ownership of our existing shareholders, and we may not realize the anticipated benefits of these mergers, acquisitions or investments.

As part of our growth and product diversification strategy, we may continue to evaluate opportunities to acquire or invest in other businesses, intellectual property or technologies and expand the breadth of markets we can address or enhance our technical capabilities. For example, we obtained a controlling interest in M. Setek through equity acquisition in 2009. See “Item 4.C. Organizational Structure” and Note 27 to our consolidated financial statements for further information.

Mergers, acquisitions or investments that we have entered in, and may enter into in the future entail a number of risks that could materially and adversely affect our business, operating and financial results, including, among others:

 

   

problems integrating the acquired operations, technologies or products into our existing business and products;

 

   

diversion of management’s time and attention from our core business;

 

   

conflicts with joint venture partners;

 

   

adverse effects on our existing business relationships with customers;

 

   

need for financial resources above our planned investment levels;

 

   

failures in recognizing anticipated synergies;

 

   

difficulties in retaining business relationships with suppliers and customers of the acquired company;

 

   

risks associated with entering markets in which we lack experience;

 

   

potential loss of key employees of the acquired company; and

 

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potential write-offs of acquired assets.

Our failure to address these risks successfully may have a material adverse effect on our financial condition and results of operations. Any such acquisition or investment will likely require a significant amount of capital investment, which would decrease the amount of cash available for working capital or capital expenditures. In addition, if we use our equity securities to pay for acquisitions, the value of your ADSs and the underlying ordinary shares may be diluted. If we borrow funds to finance acquisitions, such debt instruments may contain restrictive covenants that can, among other things, restrict us from distributing dividends.

Any impairment charges or changes in valuation allowance against deferred tax assets may have a material adverse effect on our net income.

Under ROC GAAP and US GAAP, we are required to evaluate our investments, long-lived assets and intangible assets for impairment whenever triggering events or changes in circumstances indicate that the asset may be impaired and carrying value may not be recoverable. If certain criteria are met, we are required to record an impairment charge. We are also required under ROC GAAP and US GAAP to evaluate goodwill for impairment at least on an annual basis or more frequently whenever triggering events or changes in circumstances indicate that goodwill may be impaired and the carrying value may not be recoverable. We currently are not able to estimate the extent or timing of any impairment charge for future years. Any impairment charge required may have a material adverse effect on our net income.

The determination of an impairment charge at any given time is based significantly on our expected results of operations over a number of years subsequent to that time. As a result, an impairment charge is more likely to occur during a period when our operating results are otherwise already depressed. The valuation of goodwill and other long-lived assets is subjective and requires us to make significant estimates about our future performance and cash flows, as well as other assumptions. These estimates can be affected by numerous factors, including changes in economic, industry or market conditions, changes in business operations, changes in competition or potential changes in our stock price and market capitalization. Moreover, the fair value measurement for goodwill uses significant unobservable inputs and reflects our own assumptions, such as revenue growth rate, appropriate discount rate and market trading multiple, etc. Changes in these estimates and assumptions, or changes in actual performance compared with estimates of our future performance, may affect the fair value of goodwill or other long-lived assets, which may result in an impairment charge. See “Item 5. Operating and Financial Review and Prospects —Critical Accounting Policies” for a discussion of how we assess if an impairment charge is required and, if so, how the amount is determined.

Under ROC GAAP, we can determine our valuation allowance for deferred tax assets only based on our projections of future operating profits. However, under US GAAP, cumulative losses in recent years is a significant piece of negative evidence which is difficult to overcome with projections of future operating profits for the purpose of determining the valuation allowance for deferred income tax assets. A valuation allowance is provided on deferred tax assets to the extent that it is not “more likely than not” that such deferred tax assets will be realized. As our industry is cyclical and our results of operations have fluctuated in the past, we cannot assure you that our projections of future operating profits for the purpose of determining the valuation allowance for deferred income tax assets will come out the same with the actual operating results in the future. If such valuation allowance against deferred tax assets is recognized, our results of operations and financial position may be affected materially and adversely.

The loss of any key management personnel or the undue distraction of any such personnel may disrupt our business.

Our success depends on the continued services of key senior management, including our Chairman, Vice-Chairman, Chief Executive Officer and President. We do not carry key person life insurance on any of our senior management personnel. If we lose the services of key senior management personnel, we may not be able to find suitable replacements or integrate replacement personnel in a timely manner or at all, which would seriously harm our business. In addition, our continuing growth will, to a large extent, depend on the attention of key management personnel to our daily affairs. If any of them is unable to devote enough time to our company, our operations may be affected adversely. In addition, several key senior management have been involved in certain legal proceedings. See “Item 8.A.7. Litigation.” If an adverse judgment is rendered against any of our senior management, and any of them may resign or is otherwise no longer able to serve in his capacity as a senior management of our company, our operations may be affected materially and adversely.

 

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If we are not able to attract and retain skilled technical personnel, including research and development and other personnel, our operations and planned growth would be affected adversely.

Our success depends on our ability to attract and retain skilled employees, particularly engineering and technical personnel in the research and development and manufacturing processing areas. We also have established a professional on-the-job training program for employees. Without a sufficient number of skilled employees, our operations and production quality could suffer. Competition for qualified technical personnel and operators in Taiwan is intense and the replacement of skilled employees is difficult. We may encounter this problem in the future, as we require increased numbers of skilled employees for our expansion. If we are unable to attract and retain our technical personnel and other employees, this may affect adversely our business and our operating efficiency may deteriorate.

Potential conflicts of interest with our affiliates may cause us to lose opportunities to expand and improve our operations.

We face potential conflicts of interest with our affiliates, such as Qisda Corporation (“Qisda”) and its subsidiaries, including BenQ Corporation. Qisda is our largest shareholder, owning directly and indirectly 7.52% of our outstanding shares as of February 14, 2012 and is also one of our major customers. Qisda and its subsidiaries accounted for 3.4%, 3.1% and 2.7% of our net sales in 2009, 2010 and 2011, respectively. Qisda and its subsidiaries’ substantial interest in our company may lead to conflicts of interest affecting our sales decisions or allocations. In addition, as of March 31, 2012, two of our eleven directors are representatives of Qisda. Mr. Kuen-Yao (K.Y.) Lee, our Chairman, is also the Chairman of Qisda. Mr. Hui Hsiung, our director, is also the President of Qisda. Mr. Kuen-Yao (K.Y.) Lee, our Chairman, also serves as Chairman of BenQ Corporation, a subsidiary of Qisda. See “Item 6. Directors, Senior Management and Employees—6.A. Directors and Senior Management.” As a result, conflicts of interest between their duties to Qisda and/or its subsidiaries and us may arise. We cannot assure you that when conflicts of interest arise with respect to representatives of Qisda and/or its subsidiaries, the conflicts of interest will be resolved in our favor. These conflicts may result in lost corporate opportunities, including opportunities that are never brought to our attention, or actions that may prevent us from taking advantage of opportunities to expand and improve our operations.

We need to comply with certain financial and other covenants under the terms of our debt instruments, the failure to comply with which would put us in default under those instruments.

Our long-term loans and facilities contain financial and other covenants and the failure to comply with the covenants could trigger a requirement for early payment. The financial covenants primarily include current ratios, indebtedness ratios, interest coverage ratios and minimum equity requirements. A default under one debt instrument may also trigger cross-defaults under our other debt instruments. In addition, such covenants restrict our ability to raise future debt financing. In 2009, our subsidiary M. Setek breached certain financial covenants under its loan agreements and on June 25, 2010, we repaid all outstanding amounts under the relevant loans. See “Item 5.B. Liquidity and Capital Resources.” If we breach our financial or other covenants, our financial condition will be adversely affected to the extent we are not able to cure such breaches or repay the relevant debt.

If we fail to maintain an effective system of internal controls, we may not be able to report accurately our financial results or prevent fraud.

The United States Securities and Exchange Commission (the “SEC”), as required by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring every public company to include a management report on such company’s internal controls over financial reporting in its annual report, which contains management’s assessment of the effectiveness of the company’s internal controls over financial reporting. In addition, an independent registered public accounting firm must report on the effectiveness of the company’s internal controls over financial reporting. Our management may conclude that our internal controls over our financial reporting are not effective. Moreover, even if our management concludes that our internal controls over financial reporting are effective, our independent registered public accounting firm may conclude that our internal controls over financial reporting are not effective. Furthermore, during the course of the evaluation, documentation and attestation, we may identify deficiencies that we may not be able to remedy in a timely manner. If we fail to achieve and maintain the adequacy of our internal controls, we may not be able to conclude that we have effective internal controls, on an ongoing basis, over financial reporting in accordance with the Sarbanes-Oxley Act of 2002. Moreover, effective internal controls are necessary for us to produce reliable financial reports and are important to help prevent fraud. As a result, our failure to achieve and maintain effective internal controls over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the trading price of our ADSs. Furthermore, we have incurred considerable costs and used significant management time and other resources in an effort to comply with Section 404 and other requirements of the Sarbanes-Oxley Act of 2002.

 

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Our planned international expansion poses additional risks and could fail, which could cost us valuable resources and adversely affect our results of operations.

To meet our clients’ requirements, we currently are expanding our operations internationally, which may lead to operations across many countries. For example, we have established LCD module-assembly operations in Europe and TV set assembly operations in China and Europe in order to provide more immediate services to our European and Chinese customers. We intend to run our operations in compliance with local regulations, such as tax, civil, environmental and other laws in conjunction with our business activities in each country where we may have presence or operations. However, there are inherent legal, financial and operational risks involved in having international operations and we cannot assure you that we will be able to develop successfully and expand our international operations or that we will be able to overcome the significant obstacles and risks of expanding our overseas operations.

Risks Relating to Manufacturing

Our manufacturing processes are highly complex, costly and potentially vulnerable to disruptions that can significantly increase our production costs and delay product shipments to our customers.

Our manufacturing processes are highly complex, require advanced and costly equipment and are modified periodically to improve manufacturing yields and production efficiency. We face the risk of production difficulties from time to time that could cause delivery delays and reduced production yields. These production difficulties include capacity constraints, construction delays, difficulties in upgrading or expanding existing facilities, difficulties in changing our manufacturing technology and delays in the delivery or relocation of specialized equipment. We may encounter these difficulties in connection with the adoption of new manufacturing process technologies. We cannot assure you that we will be able to develop and expand our fabs without equipment delays or difficulties, or that we will not encounter manufacturing difficulties in the future.

If we are unable to obtain raw materials and components in suitable quantity and quality from our suppliers, our production schedules would be delayed and we may lose substantial customers.

Raw materials and component costs represent a substantial portion of our cost of goods sold. We must obtain sufficient quantities of raw materials and components of the right quality at acceptable prices and in a timely manner. We source most of our raw materials and components, including critical materials like color filters, driver-integrated circuits, cold cathode fluorescent lamps (“CCFL”), polarizer, glass substrates, light emitting diodes (“LED”) and organic light emitting diodes (“OLED”) materials from a limited group of suppliers, both foreign and domestic. For example, in the second half of 2009, we experienced constraints in the supply of glass substrates due to an industry-wide decline in supply and demand outgrowing supply significantly. Our operations would be affected adversely if we could not obtain raw materials and components in sufficient quantity and quality at acceptable prices. We may also experience difficulties in sourcing adequate supplies for our operations if there is a ramp-up of production capacity by display panel manufacturers, including our company, without a corresponding increase in the supply of raw materials and components. The impact of any shortage in raw materials and components will be magnified as we establish new fabs and continue to increase our production capacity.

 

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We depend on supplies of certain principal raw materials and components mainly from suppliers in Taiwan, Japan and Korea. We cannot assure you that we will be able to obtain sufficient quantities of raw materials and components and other supplies of an acceptable quality in the future. Our inability to obtain raw materials and components of the right quality in a timely and cost-effective manner may cause us to delay our production and delivery schedules, which may result in the loss of our customers and revenues.

If we are unable to obtain equipment and services from our suppliers, we may be forced to delay our planned growth.

We have purchased, and expect to purchase, a substantial portion of our equipment from foreign suppliers for our new capacity and advanced technology tabs. These foreign suppliers also provide assembly, testing and/or maintenance services for our purchased equipment. From time to time, increased demand for new equipment may cause lead times to extend beyond those normally required by equipment vendors. For example, in the past, increased demand for equipment caused some equipment suppliers to satisfy only partially our equipment orders in the normal time frame. The unavailability of equipment, delays in the delivery of equipment or the delivery of equipment that does not meet our specifications could delay implementation of our planned growth and impair our ability to meet customer orders. Furthermore, if our equipment vendors are unable to provide assembly, testing and/or maintenance services in a timely manner for any reasons, our planned growth may be adversely affected. In addition, the availability or the timely supply of equipment and services from our suppliers and vendors also could be affected by factors such as natural disasters. We may have to use assembly, testing and/or maintenance service providers with which we have no established relationship, which could expose us to potentially unfavorable pricing, unsatisfactory quality or insufficient capacity allocation. As a result of these risks, we may be unable to implement our planned growth on schedule or in line with customer expectations and our business may be materially and adversely affected.

If we are unable to manufacture successfully our products within the acceptable range of quality, our results of operations could be affected adversely.

Display panel manufacturing processes are complex and involve a number of precise steps. Defective production can result from a number of factors, including but not limited to:

 

   

the level of contaminants in the manufacturing environment;

 

   

human error;

 

   

equipment malfunction;

 

   

use of substandard raw materials and components; and

 

   

inadequate sample testing.

From time to time, we have experienced, and may in the future experience, lower than anticipated production yields as a result of the above factors, particularly in connection with the expansion of our capacity or change in our manufacturing processes. We remediate our customers mainly through repairing or replacing the defective products or refunding the purchase price relating to defective products if they are within the warranty period. In addition, our production yield on new products will be lower than average as we develop the necessary expertise and experience to produce those products. If we fail to maintain high production yields and high-quality production standards, our reputation may suffer and our customers may cancel their orders or return our panels for rework, which could affect adversely our results of operations.

Climate change, other environmental concerns and green initiatives also present other commercial challenges, economic risks and physical risks that could harm our results of operations or affect the manner in which we conduct our business.

Increasing climate change and environmental concerns would affect the results of our operations if any of our customers would request us to exceed any standards set for environmentally compliant products and services. If we are unable to offer such products or offer products that are compliant but are not as reliable due to the lack of reasonably available alternative technologies, it may harm our results of operations.

 

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Furthermore, energy costs in general could increase significantly due to climate change regulations. Therefore, our energy costs may increase substantially if utility or power companies pass on their costs, fully or partially, such as those associated with carbon taxes, emission cap and carbon credit trading programs.

If we violate environmental regulations, we may be subject to fines or restrictions that could cause our operations to be delayed or interrupted and our business to suffer.

Our operations can expose us to the risk of environmental claims which could result in damages awarded or fines imposed against us. We must comply with regulations relating to storage, handling, generation, treatment, emission, release, discharge and disposal of certain materials and wastes resulting from our manufacturing processes. See “4.B. Business Overview—Environmental Matters.” In the past, we incurred small fines for failure to meet certain effluent standards and air pollution control regulations. Future changes to existing environmental regulations or unknown contamination of our sites, including contamination by prior owners and operators of our sites, may give rise to additional compliance costs or potential exposure to liability for environmental claims that may seriously affect our business, financial condition and results of operations.

If we violate labor regulations, we may be subject to fines or restrictions that could have an adverse effect on our business, financial condition and results of operations.

We must comply with the various labor regulations in the jurisdictions in which we operate. The cost of compliance with such regulations may increase as regulations change or new regulations are adopted. For instance, China has been experiencing rapid changes in its labor policies and it is uncertain how any such changes in China as well as other jurisdictions will impact our current employment policies and practices. Our employment policies and practices may violate current or future laws and we may be subject to related penalties, fines or legal fees. In addition, compliance with any new labor regulations may increase our operating expenses as we may incur substantial administrative and staffing cost.

Risks Relating to Our Technologies and Intellectual Property

If we cannot successfully introduce, develop or acquire advanced technologies, our profitability may suffer.

Technology and industry standards in the display panel industry evolve quickly, resulting in steep price declines in the advanced stages of a product’s life cycle. To remain competitive, we continually must develop or acquire advanced manufacturing process technologies and build advanced technology fabs to lower production costs and enable the timely release of new products. In addition, we expect to utilize other display technologies, such as AMVA, 3D and touch technologies, to develop new products. Our ability to manufacture products by utilizing more advanced manufacturing process technologies to increase production efficiency will be critical to our sustained competitiveness. As part of our business growth strategy, we have been undertaking and plan to undertake in the future a number of significant capital expenditure for advanced technology fabs and new capacity. See “ Item 4. Information on the Company—4.D. Property, Plants and Equipment—Expansion Projects.” However, we cannot assure you that we will be successful in completing our planned growth or in the development of other future technologies for our fabs, or that we will be able to complete them without material delays or at the expected costs. If we fail to do so, our results of operations and financial condition may be materially and adversely affected. We also cannot assure you that there will be no material delays in connection with our efforts to develop new technology and manufacture more technologically advanced products. If we fail to develop or make advancements in product technologies or manufacturing process technologies on a timely basis, we may become less competitive.

 

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Other flat panel display technologies or alternative display technologies could render our products uncompetitive.

We currently manufacture products primarily using TFT-LCD technology, which is currently one of the most commonly used flat panel display technologies. We may face competition from flat panel display manufacturers utilizing alternative flat panel technologies, including plasma discharge panel (“PDP”) and organic light emitting device (“OLED”) technologies. We also face competition in the large-size television market from alternative display technologies, particularly those utilizing projection technology, such as front digital mirror device projector, digital light processing projector, LCD projector and liquid crystal on silicon projector technologies. These alternative forms of display technology may be competitive in terms of performance-to-price ratio. If alternative display technologies gain a larger market share in the market for large-size televisions, our business prospects may be affected adversely.

Another commercially available flat panel technology is OLED. OLED technology is currently primarily used, and is beginning to compete with, TFT-LCD technology in small- to medium-size applications, such as mobile phones, digital still cameras, small-size televisions and tablets. Future development of OLED technology also may allow it to compete with TFT-LCD technology in larger applications such as monitors, notebooks and LCD television and render our products uncompetitive.

In addition, there are other alternative flat panel technologies currently either in the research and development stage or in the initial commercial promotion stage, such as inorganic electroluminescent (“IEL”) and surface-conduction electron-emitter (“SED”) display technologies. If the various alternative flat panel technologies currently commercially available, or in the research and development stage are developed to have better performance-to-price ratios, or they begin mass production, such technologies may compete with TFT-LCD technology and render our products uncompetitive.

Advancement and changes in alternative flat panel technologies are dependent on manufacturing economics and consumer demand. In 2008, we restarted our research and development efforts in OLED technology to ensure that we remain competitive with other manufacturers that utilize OLED technology. However, even though we seek to remain competitive through research and development of flat panel technologies, we may invest in research and development in certain technologies that do not come to fruition.

If we lose the support of our technology partners or the legal rights to use our licensed manufacturing process or product technologies, our business may suffer.

Enhancing our manufacturing process and product technologies is critical to our ability to provide high-quality products to our customers at competitive prices. We intend to continue to advance our manufacturing process and product technologies through internal research and development and licensing from other companies. We currently have certain licensing arrangements with Toshiba Mobile Display, Fujitsu Display Technologies Corp. (subsequently assumed by Fujitsu Limited), Semiconductor Energy Laboratory Co., Ltd., Hitachi Displays Ltd. (“Hitachi”), IPS Alpha Technology, Ltd., Sharp Corporation, LG Display, Samsung Electronics and other companies for product and manufacturing process technologies related to the production of certain products including certain display panels. If we are unable to renew our technology licensing arrangements with some or all of these companies on mutually beneficial economic terms, we may lose the legal right to use certain of the processes and designs which we may have employed to manufacture our products. Similarly, if we cannot license or otherwise acquire or develop new manufacturing process and product technologies that are critical to the development of our business or products, we may lose important customers because we are unable to continue providing our customers with products based on advanced manufacturing process and product technologies.

We have entered into patent and intellectual property license or cross license agreements, some of which require periodic royalty payments. In the future, we may need to obtain additional patent licenses or renew existing license agreements. We cannot assure you that these license agreements can be obtained or renewed on acceptable terms. If these license agreements are not obtained or renewed on acceptable terms, our business and future results of operations may be affected materially and adversely.

 

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Disputes over intellectual property rights could be costly and deprive us of the technology to stay competitive.

As technology is an integral part of our manufacturing process and product, we have, in the past, received communications alleging that our products or processes infringe product or manufacturing process technology rights held by others, and expect to continue to receive such communications. We currently are involved in intellectual property disputes with several companies. See “Item 8.A.7. Litigation.” There is no means of knowing all of the patent applications that have been filed in the United States or elsewhere and whether, if the applications are granted, such patents would have a material adverse effect on our business. If any third party were to make valid intellectual property infringement claims against our customers or us, we may be required to:

 

   

discontinue using disputed manufacturing process technologies;

 

   

pay substantial monetary damages;

 

   

seek to develop non-infringing technologies, which may not be feasible;

 

   

stop shipment to certain areas; or

 

   

seek to acquire licenses to the infringed technology, which may not be available on commercially reasonable terms, if at all.

If our products or manufacturing processes are found to infringe third-party rights, we may be subject to significant liabilities and be required to change our manufacturing processes or products. This could restrict us from making, using, selling or exporting some of our products, which in turn could affect materially and adversely our business and financial condition. In addition, any litigation, whether to enforce our patents or other intellectual property rights or to defend ourselves against claims that we have infringed the intellectual property rights of others, could affect materially and adversely our results of operations because of the management attention required and legal costs incurred.

Our ability to compete will be harmed if we are unable to protect adequately our intellectual property.

We believe that the protection of our intellectual property rights is, and will continue to be, important to the success of our business. We rely primarily on a combination of patent, trademark, trade secret and copyright law and contractual restrictions to protect our intellectual property. These afford only limited protection. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to obtain, copy or use information that we regard as proprietary, such as product design and manufacturing process expertise. Although we have patent applications pending, our pending patent applications and any future applications may not result in issued patents or may not be sufficiently broad to protect our proprietary technologies. Moreover, policing any unauthorized use of our products is difficult and costly, and we cannot be certain that the measures we have implemented will prevent misappropriation or unauthorized use of our technologies, particularly in foreign jurisdictions where the laws may not protect our proprietary rights as fully as the laws of the United States. Others independently may develop substantially equivalent intellectual property or otherwise gain access to our trade secrets or intellectual property. Our failure to protect effectively our intellectual property could harm our business.

Our rapid introduction of new technologies and products may increase the likelihood that third parties will assert claims that our products infringe upon their proprietary rights.

Although we take and will continue to take steps to endeavor that our new products do not infringe upon third-party rights, the rapid technological changes that characterize our industry require that we quickly implement new processes and components with respect to our products. Often with respect to recently developed processes and components, a degree of uncertainty exists as to who may rightfully claim ownership rights in such processes and components. Uncertainty of this type increases the risk that claims alleging that such components or processes infringe upon third-party rights may be brought against us. If our products or manufacturing processes are found to infringe upon third-party rights, we may be subject to significant liabilities and be required to change our manufacturing processes or be prohibited from manufacturing certain products, which could have a material adverse effect on our operations and financial condition.

 

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We rely upon trade secrets and other unpatented proprietary know-how to maintain our competitive position in the display panel industry and any loss of our rights to, or unauthorized disclosure of, our trade secrets or other unpatented proprietary know-how could affect adversely our business.

We rely upon trade secrets, unpatented proprietary know-how and information, as well as continuing technological innovation in our business. The information we rely upon includes price forecasts, core technology and key customer information. Our current standard employment agreement with our employees contains a confidentiality provision which generally provides that all inventions, ideas, discoveries, improvements and copyrightable material made or conceived by the individual arising out of the employment relationship and all confidential information developed or made known to the individual during the term of the relationship is our exclusive property. We cannot assure the enforceability of these types of agreements, or that they will not be breached. We also cannot be certain that we will have adequate remedies for any breach. The disclosure of our trade secrets or other know-how as a result of such a breach could affect adversely our business. Also, our competitors may come to know about or determine our trade secrets and other proprietary information through a variety of methods. Disputes may arise concerning the ownership of intellectual property or the applicability or enforceability of the relevant agreements and there can be no assurance that any such disputes would be resolved in our favor. Furthermore, others may acquire or independently develop similar technology, or if patents are not issued with respect to products arising from research, we may not be able to maintain information pertinent to such research as proprietary technology or trade secrets and that could have an adverse effect on our competitive position within the display panel industry.

Political, Geographical and Economic Risks

The slowdown in the global economy could continue to affect materially and adversely our business, results of operations and financial condition.

The slowdown in the global economy, particularly the sovereign debt crisis in Europe, that has been affecting global business, banking and financial sectors has also affected the market demand and has resulted in a negative impact on electronic products sales from which we generate our income. There continue to be a number of side effects from the slowdown on our business, including significant decreases in orders from our customers, insolvency of key suppliers resulting in raw material constraints and product delays, inability of customers to obtain credit to finance purchases of our products and/or customer insolvencies and counterparty failures negatively impacting our operations. Because of such factors, we believe the level of demand for our products and projections of future revenue and operating results will be difficult to predict. If the global economic downturn continues or if any similar economic downturn occurs in the future, our business, results of operations and financial condition may be affected materially and adversely.

Due to the location of our operations in Taiwan, the PRC, Japan, Singapore and Eastern Europe, we and many of our customers and suppliers are vulnerable to natural disasters and other events outside of our control, which may seriously disrupt our operations.

Most of our existing manufacturing operations, and the operations of many of our customers and suppliers, are located in Taiwan, the PRC, Japan, Singapore and Eastern Europe. Some locations are vulnerable to natural disasters, such as earthquakes and typhoons. For example, on March 11, 2011, a major earthquake, measuring over 9.0 on the Richter magnitude scale, occurred off the coast of Miyagi, Japan. The earthquake also created a large tsunami which caused extensive damage along Japan’s Pacific coast (including coast along Tokyo), where, in addition to the Sendai fab, M. Setek operates fabs in Soma. Production at these facilities was suspended, but resumed later in 2011 as the local infrastructure has recovered. As of December 31, 2011, expenses resulting from property damage losses and asset impairments have been recognized, and the amount did not have a material impact on our results of operations in 2011. The earthquakes in Japan in 2011 also have not caused any significant impact on obtaining raw materials and components from our suppliers. Taiwan is also a place that is vulnerable to natural disasters. In 2011, approximately 38.3% of our net sales were derived from Taiwan-based customers. We cannot assure you that the natural disasters will not happen and will not have adverse impact on our operations in the future.

 

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Any disruption of operations at our fabs or the facilities of our customers and suppliers for any reason, including earthquakes, typhoons or other natural disasters, work stoppages, power outages, water supply shortages and fire etc. could cause delays or disrupt in production and shipments of our products and raw materials. Any delays or disruptions could result in our customers seeking to source our products from other manufacturers. Shortages or suspension of power supplies have occurred occasionally, and have disrupted our operations. The occurrence of a power outage in the future could seriously hurt our business. In addition, our manufacturing processes require a substantial amount of water. Although currently approximately 82.9% of the water used in our production process is recycled, our production operations may be seriously disrupted by water shortages. For instance, the Hsinchu area, where several of our principal manufacturing sites are located, experienced a drought in 2002. In response to the drought in 2002, the ROC authorities implemented water-rationing measures and began sourcing water from alternative sources, and therefore we did not encounter any water shortage. However, we may encounter droughts in the Hsinchu, Taoyuan or Taichung areas in the future, where most of our current or future manufacturing sites are located. If another drought were to occur and we or the authorities were unable to source water from alternative sources in sufficient quantity, we may be required to shut down temporarily or substantially reduce the operations of these fabs, which would affect seriously our operations. In addition, even if we were able to source water from alternative sources, our reliance on supplemental water supplies would increase our operating costs. Furthermore, the disruption of operations at our customers’ facilities could lead to reduced demand for our products. The occurrence of any of these events in the future could affect adversely our business.

We have made investments in, and are exploring the possibility of expanding our businesses and operations to, or making additional investments in, the PRC, which may expose us to additional political, regulatory, economic and foreign investment risks.

We have expanded our module-assembly operations to the PRC and increased the registered capital of various PRC operating subsidiaries through cash injection. Depending on our business needs, we may further expand or adjust our business operations in the PRC in the future. Our businesses and operations and our future expansion or investment plans in the PRC are affected significantly by political and economic condition, regulatory control and general legal developments in the PRC and other foreign investment risks. The PRC economy differs from the economies of most developed countries in many respects, including the structure, level of government involvement, level of development, foreign exchange control and allocation of resources. The PRC economy has been transitioning from a planned economy to a more market-oriented economy and is growing rapidly. For the past two decades, the PRC government has implemented economic reform measures emphasizing utilization of market forces in the development of the PRC economy and also adjusted its macroeconomic control policies from time to time. These policies have led and may continue to lead to changes in market conditions. For example, as a result of the global financial crisis, the PRC government announced a RMB4 trillion economic stimulus package in 2009 which included some measures favorable to our business, such as subsidies for purchases of televisions in rural areas in China. Although we believe these reforms have had a positive effect on our overall operations in the PRC, we cannot predict whether changes in the PRC’s political, economic and social conditions, laws, regulations and policies will have any adverse effect on our current or future operations in the PRC. In addition, the interpretation of PRC laws and regulations involves uncertainties. We cannot assure you that changes in such laws and regulations, or in their interpretation and enforcement, will not have a material adverse effect on our businesses and operations in the PRC.

Rapid social, political and economic changes in China may increase our costs of operations and may negatively impact our profitability.

We have established subsidiaries in the PRC, primarily focusing on module-assembly operations and related supporting services. Labor costs in China have historically been available at relatively low cost. However, China has experienced rapid social, political and economic changes in recent years which have led to rising wages. In addition, there has been a growing shortage of blue-collar workers willing to work in China’s factories. As such, we cannot assure you that labor will continue to be available to us in China at a relatively low cost or that changes in labor or other laws will not be enacted which would have a material adverse effect on our current or any future manufacturing operations in China. Rising wages as well as a shortage of labor in China may increase our overall cost of production, cause delays in production and could have a material adverse effect on our results of operations.

 

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The current restrictions imposed by the ROC government on investments in certain related businesses may limit our ability to compete with other display panel manufacturers that are permitted to establish display panel production operations in the PRC.

Many of our customers and competitors have expanded their businesses and operations to the PRC. In order to take advantage of the fast growth of China’s market, the lower production costs in China and to establish a presence in this market, we began our investment in China with the establishment of a module-assembly facility in Suzhou, Jiangsu Province of the PRC, which began operations in July 2002. During the past few years, our investment and presence in the PRC gradually and significantly increased. As of March 31, 2012, we had 17 subsidiaries incorporated in the PRC, primarily focusing on module-assembly operations and related supporting services. For further information of our PRC investments, see “4.C. Organizational Structure.”

In February 2010, the Investment Commission of Ministry of Economic Affairs (“MOEAIC”) loosened certain restrictions, which has provided the possibility for TFT-LCD manufacturers in the ROC, including us, to expand into certain areas of the PRC. In March 2010, we applied to the MOEAIC to establish a 7.5-generation TFT-LCD front-end manufacturing fab in the PRC, and in December 2010, we received the approval from the MOEAIC for such application.

In March 2011, the MOEAIC further loosened the restrictions on the generation of TFT-LCD technology that can be transferred and manufactured by TFT-LCD plants in China. As a result, TFT-LCD manufacturers may now be granted approval to establish fabs in the PRC with the same generation of manufacturing technology as the fabs they establish in Taiwan. Moreover, the MOEAIC also allowed ROC TFT-LCD manufacturers to make equity investment or merge with companies in the PRC. Due to the further loosened restrictions, we revised our investment plan and submitted an application to the MOEAIC to make an equity investment to establish an 8.5-generation fab in Kunshan, PRC. In June 2011, we received the approval from the MOEAIC for such application.

We cannot assure you that our application for any future applications to the MOEAIC to make further investments in the PRC will be successful and timely obtained. We also do not know when and whether the remaining restrictions under ROC laws and regulations governing investment in the PRC will be amended or repealed and we cannot assure you that any such amendments to those regulations will permit us to invest in operations in the PRC. Restrictions under ROC laws on our ability to make investments in the PRC may materially and adversely affect our business prospects.

We may not be able to obtain or renew all licenses, approvals or permits necessary for our current and future operations.

Our current and future operations in the ROC, the PRC, Europe and other regions require a number of regulatory licenses, approvals and permits. We cannot assure you that we will be able to obtain licenses, approvals or permits necessary for our operations in the ROC, the PRC, Europe and other regions, or that upon the expiration of our existing licenses, approvals or permits, we will be able to successfully renew them. In addition, if the relevant authorities enact new regulations, we cannot assure you that we will be able to meet successfully such requirements. If we fail to obtain or renew the necessary regulatory licenses, approvals or permits, we may have to cease construction or operation of the relevant projects, be subject to fines, or face other penalties, which could have a material adverse effect on our business, financial condition and results of operations. Even if we already obtained the licenses, approvals and permits, there could be parties or interest groups with different views who may take actions against the renewal of such licenses, approvals and permits, which may have an adverse effect on our business operations.

Disruptions in Taiwan’s political environment could seriously harm our business and the market price of our shares and ADSs.

Most of our assets and operations are located in Taiwan and approximately 38.3% of our net sales were derived from customers in Taiwan in 2011. Accordingly, our business and financial condition may be affected by changes in local governmental policies and political and social instability.

 

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Taiwan has a unique international political status. The PRC government asserts sovereignty over mainland China and Taiwan and does not recognize the legitimacy of the government of the ROC. The PRC government has indicated that it may use military force to gain control over Taiwan if Taiwan declares independence or if Taiwan refuses to accept the PRC’s stated “One China” policy. In addition, on March 14, 2005, the National Peoples’ Congress of the PRC passed what is widely referred to as the “anti-secession” law, a law authorizing the PRC military to respond to efforts by Taiwan to seek formal independence. An increase in tensions between the ROC and the PRC and the possibility of instability and uncertainty could adversely affect the prices of our ADSs and our shares. It is unclear what effects any of the events described above may have on relations with the PRC. Relations between Taiwan and the PRC and other factors affecting Taiwan’s political environment could affect our business.

If economic conditions in Taiwan deteriorate, our current business and future growth could be affected materially and adversely.

In recent years, the currencies of many East Asian countries, including Taiwan, have experienced considerable volatility. In Taiwan, the Central Bank of the Republic of China has from time to time intervened in the foreign exchange market to minimize the fluctuation of the U.S. dollar/NT dollar exchange rate and to prevent significant decline in the value of the NT dollar. Our business, financial condition and results of operations may be affected by changes in ROC government policies, taxation, inflation, interest rates and general economic conditions in Taiwan, as well as the global economies. For example, the banking and financial sectors in Taiwan have been harmed seriously by the general economic downturn in Asia and Taiwan in recent years, which has resulted in a volatile property market, and an increase in the number of companies filing for corporate reorganization and bankruptcy protection. As a result, financial institutions are more cautious in providing credit to businesses in Taiwan. We cannot assure you that we will continue to have access to credit at commercially reasonable rates of interest or at all.

The market value of our ADSs may fluctuate due to the volatility of the ROC securities market.

The trading price of our ADSs may be affected by the trading price of our shares on the Taiwan Stock Exchange. The Taiwan Stock Exchange is smaller and more volatile than the securities markets in the United States and a number of stock exchanges in Europe. The Taiwan Stock Exchange has experienced substantial fluctuations in the prices and volumes of trading of securities, and there are currently limits on the range of daily price fluctuations on the Taiwan Stock Exchange. During the period from January 1, 2011 to December 31, 2011, the Taiwan Stock Exchange Index peaked at 9,145.35 on January 28, 2011, and reached a low of 6,633.33 on December 19, 2011. Over the same period, daily closing values of our shares ranged from NT$11.9 per share to NT$30.4 per share. On March 31, 2012, the Taiwan Stock Exchange Index closed at 7,933.00, and the closing value of our shares was NT$13.65 per share.

The Taiwan Stock Exchange is particularly volatile during times of political instability, including when relations between Taiwan and the PRC are strained. Several investment funds affiliated with the ROC government have also from time to time purchased securities from the Taiwan Stock Exchange to support the trading level of the Taiwan Stock Exchange. Moreover, the Taiwan Stock Exchange has experienced problems, including market manipulation, insider trading and settlement defaults. The recurrence of these or similar problems could have an adverse effect on the market price and liquidity of our shares and ADSs.

If the NT dollar or other currencies in which our sales, raw materials and components and capital expenditures are denominated fluctuate significantly against the U.S. dollar or the Japanese yen, our profitability may be affected seriously.

We have significant foreign currency exposure and are affected by fluctuations in exchange rates among the U.S. dollar, the Japanese yen, the NT dollar and other currencies. Our sales, raw materials and components and capital expenditures are denominated mainly in U.S. dollars, Japanese yen and NT dollars in varying amounts. For example, in 2011, approximately 90.4 % of our net sales were denominated in U.S. dollars. During the same period, approximately 11.3%, 26.0% and 57.6% of our raw materials and component costs were denominated in NT dollars, Japanese yen and U.S. dollars, respectively. In addition, in 2011, approximately 29.0%, 31.6% and 29.6% of our total capital expenditures (principally for the purchase of equipment) was denominated in NT dollars, Japanese yen, and U.S. dollars, respectively. From time to time, we enter into forward foreign currency contracts to hedge our foreign currency exposure, but we cannot assure you that we will fully minimize the risk against exchange rate fluctuations and the impact on our results of operations.

 

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Disruptions in the international trading environment and changing international trade regulation may seriously decrease our international sales.

A majority of our net sales is derived from sales to customers located outside of Taiwan. In 2009, 2010 and 2011, sales to our overseas customers accounted for 57.2%, 61.8% and 61.7%, respectively, of our net sales. In addition, a significant portion of our sales to customers in Taiwan is made to original equipment manufacturing service provider customers that use our display panels in the products that they manufacture on a contract basis for brand companies worldwide. We expect sales to customers outside of Taiwan to continue to represent a significant portion of our net sales. As a result, our business will continue to be vulnerable to disruptions in the international trading environment, including those caused by adverse changes in foreign government regulations, political unrest, international economic downturns, terrorist attacks and continued military involvement in Iraq and Afghanistan. These disruptions in the international trading environment may affect the demand for our products and change the terms upon which we sell our products overseas, which could seriously decrease our international sales.

In addition, our ability to compete effectively could be materially and adversely affected by a number of factors relating to international trade regulation. Higher tariffs, duties, or our failure to comply with trade regulations could restrict our ability to export products or compete effectively with our competitors, resulting in a decrease in our international sales.

We face risks related to health epidemics and outbreaks of contagious diseases, including H1N1 influenza, H5N1 influenza and Severe Acute Respiratory Syndrome, or SARS.

There have been reports of outbreaks of a highly pathogenic influenza caused by the H1N1 virus, as well as an influenza caused by the H5N1 virus, in certain regions of Asia and other parts of the world. An outbreak of such contagious diseases in the human population could result in a widespread health crisis that could adversely affect the economies and financial markets of many countries. Additionally, a recurrence of SARS, a highly contagious form of atypical pneumonia, similar to the occurrence in 2003 which affected the PRC, Hong Kong, Taiwan, Singapore, Vietnam and certain other countries, would also have similar adverse effects. Since most of our operations and customers and suppliers are based in Asia (mainly Taiwan), an outbreak of H1N1 influenza, H5N1 influenza, SARS or other contagious diseases in Asia or elsewhere, or the perception that such an outbreak could occur, and the measures taken by the governments of countries affected, including the ROC and the PRC, could adversely affect our business, financial condition or results of operations.

Risks Related to Our ADSs and Our Trading Market

The market value of our ADSs may fluctuate due to the volatility of the securities markets.

The securities markets in the United States and other countries have experienced significant price and volume fluctuations. Volatility in the price of our ADSs may be caused by factors beyond our control and may be unrelated to, or disproportionate to changes in, our results of operations. In the past, following periods of volatility in the market price of a public company’s securities, securities class action litigation has often been instituted against that company. Litigation of this kind could result in substantial costs and a diversion of our management’s attention and resources.

Restrictions on the ability to deposit shares into our ADS facility may adversely affect the liquidity and price of our ADSs.

The ability to deposit shares into our ADS facility is restricted by ROC law. A significant number of withdrawals of shares underlying our ADSs would reduce the liquidity of our ADSs by reducing the number of ADSs outstanding. As a result, the prevailing market price of our ADSs may differ from the prevailing market price of our shares on the Taiwan Stock Exchange. Under current ROC law, no person or entity, including you and us, may deposit its shares in our ADS facility without specific approval of the ROC Financial Supervisory Commission (the “FSC”), unless:

 

  (1) we pay stock dividends on our shares;

 

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  (2) we make a free distribution of shares;

 

  (3) ADS holders exercise preemptive rights in the event of capital increases for cash; or

 

  (4) investors purchase our shares, directly or through the depositary, on the Taiwan Stock Exchange, and deliver our shares to the custodian for deposit into our ADS facility, or our existing shareholders deliver our shares to the custodian for deposit into our ADS facility.

With respect to (4) above, the depositary may issue ADSs against the deposit of those shares only if the total number of ADSs outstanding following the deposit will not exceed the number of ADSs previously approved by the FSC, plus any ADSs issued pursuant to the events described in the subparagraph (1), (2) and (3) above. Issuance of additional ADSs under item (4) above will be permitted to the extent that previously issued ADSs have been cancelled.

In addition, in the case of a deposit of our shares requested under item (4) above, the depositary will refuse to accept deposit of our shares if such deposit is not permitted under any legal, regulatory or other restrictions notified by us to the depositary from time to time, which restrictions may specify blackout periods during which deposits may not be made, minimum and maximum amounts and frequencies of deposits.

ADS holders will not have the same rights as our shareholders, which may affect the value of the ADSs.

ADS holders’ rights as to the shares represented by such holders’ ADSs are governed by the deposit agreement. ADS holders will not be able to exercise voting rights on an individual basis. If holders representing at least 51% of our ADSs outstanding at the relevant record date instruct the depositary to vote in the same manner regarding a resolution, including the election of directors, the depositary will cause all shares represented by the ADSs to be voted in that manner. If, at the relevant record date, the depositary does not receive instructions representing at least 51% of ADSs outstanding to vote in the same manner for any resolution, including the election of directors, ADS holders will be deemed to have instructed the depositary or its nominee to authorize all the shares represented by the ADS holders’ ADSs to be voted at the discretion of our Chairman or his designee, which may not be in the ADS holders’ interest. Moreover, while shareholders who own 1% or more of our outstanding shares are entitled to submit one proposal to be considered at our annual general meetings, only holders representing at least 51% or more of our ADSs outstanding at the relevant record date are entitled to submit one proposal to be considered at our annual general meetings. Hence, only one proposal may be submitted on behalf of all ADS holders.

ADS holders’ rights to participate in our rights offerings are limited, which could cause dilution to the holdings of ADS holders.

We may from time to time distribute rights to our shareholders, including rights to acquire our securities. Under the deposit agreement, the depositary will not offer ADS holders those rights unless both the distribution of the rights and the underlying securities to all our ADS holders are either registered under the Securities Act or exempt from registration under the Securities Act. Although we may be eligible to take advantage of certain exemptions under the Securities Act available to certain foreign issuers for rights offerings, we can give no assurances that we will be able to establish an exemption from registration under the Securities Act, and we are under no obligation to file a registration statement for any of these rights. Accordingly, ADS holders may be unable to participate in our rights offerings and may experience dilution with respect to their holdings.

 

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Our equity holders may experience dilution if we issue stock bonuses and stock options to employees or sell additional equity or equity-linked securities.

Similar to other technology companies in Taiwan, from time to time we may issue bonuses to our employees in the form of shares. The issuance of these shares may have a dilutive effect on our ADSs. For example, in 2009, we issued 66.2 million shares to our employees for their services performed in 2008. These stock bonuses amounted to NT$2,009.8 million in 2009. We did not issue shares to our employees in 2010 or 2011. In addition, we assumed two employee stock option plans as a result of the QDI merger in 2006 pursuant to which our full-time employees of our consolidated domestic and foreign subsidiaries were eligible to receive stock option grants. These two employee stock option plans expired in 2008 and 2009, respectively. We did not grant any stock options to our employees in 2010 or 2011. If we issue stock bonuses or stock options to employees in the future, our equity holders may experience dilution.

In addition, the sale of additional equity or equity-linked securities may result in additional dilution to our shareholders. In October 2010, we issued US$800.0 million unsecured zero coupon convertible bonds due 2015 to purchase machinery and equipment overseas in line with the growth of our business. In September 2011, we early redeemed US$100 million of the outstanding bonds at a cost of US$78.7 million. Please refer to note 15 to our consolidated financial statements for more information. As of December 31, 2011, the balance of the outstanding convertible bonds was US$700 million. Moreover, on March 27, 2012, our board of directors resolved that it will be proposed at the shareholders’ meeting in June 2012 to authorize the board of directors, within the limit of 800 million common shares, to issue new common shares in private placement and/or to sponsor issuance of overseas depositary shares, depending on market conditions and our capital needs. The prior issuance of unsecured global convertible bonds as well as the proposed new issuance of common shares could each cause dilution to ADS holders.

Non-ROC holders of ADSs who withdraw our shares will be required to obtain a foreign investor investment identification and appoint a local custodian and agent and a tax guarantor in the ROC.

Under current ROC law, if you are a non-ROC person (other than a PRC person) and wish to withdraw and hold our shares from a depositary receipt facility, you will be required to obtain a foreign investor investment identification, or the Foreign Investor Investment I.D., issued in accordance with the ROC Regulations Governing Securities Investment by Overseas Chinese and Foreign Nationals (“the Investment Regulations”). You also will be required to appoint an eligible agent in the ROC to open a securities trading account and a Taiwan Depository & Clearing Corporation book-entry account and a bank account, to pay ROC taxes, remit funds, exercise shareholders’ rights and perform such other functions as you may designate upon such withdrawal. In addition, you will be required to appoint a custodian bank to hold the securities in safekeeping, make confirmation and settle trades and report all relevant information. Without obtaining such Foreign Investor Investment I.D. under the Investment Regulations and opening such accounts, the non-ROC withdrawing holder would be unable to hold or subsequently sell our shares withdrawn from the depositary receipt facility on the Taiwan Stock Exchange or otherwise. There can be no assurance that such withdrawing holder would be able to obtain the Foreign Investor Investment I.D. and open such accounts in a timely manner.

Non-ROC holders of ADSs (other than a PRC person) withdrawing our shares represented by ADSs also are required under current ROC law and regulations to appoint an agent in the ROC for filing tax returns and making tax payments. Such agent must meet certain qualifications set by the ROC Ministry of Finance and, upon appointment, becomes a guarantor of such withdrawing holder’s ROC tax obligations. Generally, the evidence of the appointment of such agent and the approval of such appointment by the ROC tax authorities may be required as conditions to such withdrawing holder’s repatriation of the profits. There can be no assurance that such withdrawing holder would be able to appoint and obtain approval for such agent in a timely manner.

Also, if any non-ROC person (other than a PRC person) receives more than 10% of our total issued and outstanding shares upon a single withdrawal, such non-ROC person must obtain prior approval from the MOEAIC. There can be no assurance that such withdrawing holder would be able to obtain such approval in a timely manner.

 

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Pursuant to the Regulations Governing Securities Investment and Futures Trading in Taiwan by Mainland Area Investors (“the Mainland Investors Regulations”), only qualified domestic institutional investors (“QDIIs”) approved by the China Securities Regulatory Commission and registered with the Taiwan Stock Exchange or Taiwan Futures Exchange are permitted to withdraw and hold our shares from a depositary receipt facility. In order to hold our shares, such QDIIs are required to appoint an agent and custodian as required by the Mainland Investors Regulations. If the aggregate amount of our shares held by any QDII or shares received by any QDII upon a single withdrawal exceeds 10% of our total issued and outstanding shares, such QDII must obtain the prior approval from the MOEAIC. We cannot assure you that such approval would be granted.

The protection of the interests of our public shareholders available under our articles of incorporation and the laws governing ROC corporations is different from that which applies to a U.S. corporation.

Our corporate affairs are governed by our articles of incorporation and by the laws governing ROC corporations. The rights and responsibilities of our shareholders and members of our board of directors under ROC law are different from those that apply to a U.S. corporation. Directors of ROC corporations are required to conduct business faithfully and act with the care of good administrators. However, the duty of care required of an ROC corporation’s directors may not be the same as the fiduciary duty of a director of a U.S. corporation. In addition, controlling shareholders of U.S. corporations owe fiduciary duties to minority shareholders, while controlling shareholders in ROC corporations do not. The ROC Company Law also requires that a shareholder continuously hold at least 3% of our issued and outstanding shares for at least a year in order to request that a member of our audit committee institute an action against a director on the company’s behalf. Therefore, our public shareholders may have more difficulty protecting their interests against actions of our management, members of our board of directors or controlling shareholders than they would as shareholders of a U.S. corporation.

Future sales or perceived sales of securities by us, our senior management, directors or major shareholders may hurt the price of our ADSs.

The market price of our ADSs could decline as a result of sales of ADSs or shares or the perception that these sales could occur. As of March 31, 2012, we had an aggregate of 8,827,045,535 shares issued and outstanding, most of which were freely tradable. If we, our senior management, directors or our shareholders, sell ADSs or shares, the market price for our shares or ADSs could decline. Future sales, or the perception of future sales, of ADSs or shares by us, our senior management, directors or major shareholders could cause the market price of our ADSs to decline.

You may not be able to enforce a judgment of a foreign court in the ROC.

We are a company limited by shares and incorporated under the ROC Company Law. All of our directors and executive officers, and some of the experts named herein, are residents of the ROC. As a result, it may be difficult for holders of our shares or ADSs to enforce against us or them judgments obtained outside the ROC, including those predicated upon the civil liability provisions of the federal securities laws of the United States. There is doubt as to the enforceability in the ROC, either in original actions or in actions for enforcement of judgments of United States courts, of civil liabilities predicated on the United States federal securities laws.

 

ITEM 4. INFORMATION ON THE COMPANY

4.A. History and Development of the Company

We were incorporated as Acer Display Technology, Inc. (“Acer Display”) under the laws of the ROC as a company limited by shares in 1996. The shares of Acer Display were listed on the Taiwan Stock Exchange on September 8, 2000.

On September 1, 2001, we completed a merger with Unipac Optoelectronics Corp. (“Unipac”) pursuant to a merger agreement dated April 9, 2001, as amended by a supplemental agreement dated May 15, 2001. We changed our name to AU Optronics Corp. on May 22, 2001. Prior to the merger, Acer Display was primarily involved in the design, development, production and marketing of large-size TFT-LCD panels, and Unipac was primarily involved in the design, production and marketing of both small-size and large-size TFT-LCD panels.

 

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On October 1, 2006, we completed our merger with Quanta Display Inc. (“QDI”), a company incorporated in Taiwan that manufactured and assembled TFT-LCD panels. Under the terms of the merger agreement dated April 7, 2006, we offered one share of our common stock for every 3.5 shares of outstanding QDI common stock issuing a total of 1,479,110,029 shares. As of the effective date of the merger, we became the surviving entity and assumed substantially all of the assets, liabilities and personnel of QDI. The merger received shareholder approval of our company and QDI on June 15, 2006, and FSC approval on August 15, 2006. The purpose of the merger was to increase our competitiveness and expand our market share.

At the end of 2008, we entered the solar business and formed our Solar Photovoltaic Business Unit in October 2009. In connection with this expansion, we obtained a controlling interest in M. Setek, a major polysilicon and solar wafer manufacturer in Japan, through equity investments in 2009. Also, in May 2010, we formed a joint venture with SPTL, a subsidiary of SunPower Corporation, a leading manufacturer of residential and commercial solar systems in the United States, to construct and operate a solar cell manufacturing facility in Malaysia.

Our principal executive offices are located at No. 1, Li-Hsin Road 2, Hsinchu Science Park, Hsinchu, Taiwan, ROC, and our telephone number is +886-3-500-8800. Our agent for service of process in the United States is Puglisi & Associates, 850 Library Avenue, Suite 204, Newark, Delaware 19711, and our agent’s telephone number is 302-738-6680.

Our ADSs have been listed on the New York Stock Exchange since May 29, 2002.

See “Item 5.B. Liquidity and Capital Resources—Capital Expenditures” for information concerning our principal capital expenditures.

4.B. Business Overview

Introduction

We operate in two businesses: display business and solar business.

Display business: we design, develop, manufacture, assemble and market flat panel displays and most of our products are TFT-LCD panels. TFT-LCD is currently the most widely used flat panel display technology. Our panels are primarily used in computer products (such as notebook computers and desktop monitors) and consumer electronics products (such as mobile phones, digital photo frames, digital still cameras, portable navigation display, and portable DVD players), LCD televisions, automobile and industrial displays, etc.

Solar business: we entered into the solar business at the end of 2008, and have established a vertically integrated solar value chain, including manufacturing and branding capabilities for our solar products. We manufacture upstream products such as polysilicon, ingots and wafers. We also formed a joint venture with SunPower to operate a solar cell manufacturing facility in Malaysia. In addition, we design, develop, and manufacture solar photovoltaic (PV) modules as well as produce solar PV systems and provide various value-added services for solar PV systems projects.

For the year ended December 31, 2011, net sales generated from our display business and solar business were NT$366.5 billion (US$12.1 billion) and NT$13.2 billion (US$0.4 billion), respectively, representing approximately 96.5% and 3.5% of our total net sales, respectively. For more information on the financial performance of our two operating segments, see “Item 5. Operating and Financial Review and Prospects” and Note 25 to our consolidated financial statements.

Display Business

We sell our panels primarily to companies that design and assemble products based on their customers’ specifications, commonly known as original equipment manufacturing service providers, or brand customers. These original equipment manufacturing service providers, most of whose production operations are located in Taiwan or the PRC, use our panels in the products that they manufacture on a contract basis for brand companies worldwide. Our operations in Taiwan and the PRC allow us to better coordinate our production and services with our customers’ requirements, especially in respect of delivery time and design support. We also sell our products to some brand companies on a direct shipment basis.

 

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We currently manufacture TFT-LCD panels at fabrication facilities commonly known as “fabs.” We were one of the first TFT-LCD manufacturers in Taiwan to commence commercial production at a fifth-generation fab, and we now operate four fifth-generation fabs. We believe we were the first TFT-LCD manufacturer in Taiwan to commence production at a sixth-generation and 7.5-generation fab. We also were the first TFT-LCD manufacturer in Taiwan to operate an 8.5-generation fab. New generations of TFT-LCD fabs are equipped to process increasingly larger sheets of substrates. For example, our 7.5-generation fabs are designed to process substrates with dimensions of up to 1,950 x 2,250 millimeters, and our 8.5-generation fabs are designed to process substrates with dimensions of up to 2,200 x 2,500 millimeters.

With production facilities utilizing 3.5-, fourth-, 4.5-, fifth-, sixth-, 7.5- and 8.5-generation technologies, we have the flexibility to produce a large number of panels of various sizes. We operate three fifth-generation fabs that commenced commercial production in March 2003, February 2004 and August 2005, respectively. We also acquired one fifth-generation fab through our merger with QDI in 2006. We operate one sixth-generation fab that commenced commercial production in March 2005 and acquired a second sixth-generation fab through our merger with QDI in 2006. We operate two 7.5-generation fabs that commenced commercial production in June 2006 and April 2009, respectively. We operate two 8.5-generation fabs that commenced commercial production in February 2009 and June 2011, respectively. We operate one 4.5-generation fab as a result of our acquisition of AFPD Pte., Ltd. Our existing principal operations are located at eight principal manufacturing sites in Taiwan, two module-assembly sites in Europe, three module-assembly sites in the PRC, and one module-assembly site in Singapore. See “Item 4. Information on the Company—4.D. Property, Plant and Equipment.”

Effective from September 2011, our display business has been divided into three business groups, namely Video Solutions, Mobile Solutions, and Touch Solutions. The Video Solutions Group covers applications such as LCD televisions and desktop monitors. The Mobile Solutions Group mainly covers applications such as smartphones, notebooks and audio video products. The Touch Solutions Group covers touch panel products. Integrated total solutions will be offered for clients and end customers to enjoy customized value-added services.

Principal Products

We design, develop, manufacture, assemble and market a wide range of display panels for the following principal product categories:

 

   

Computer products, which typically utilize display panels ranging from 7 inches to 27 inches, primarily for use in notebook computers and desktop monitors.

 

   

Consumer electronics products, which typically utilize display panels ranging from 1.5 inches to 10.4 inches or above for use in products such as mobile phones, digital photo frames, digital still cameras, portable navigation display, portable DVD players, digital camcorders, automobile display, amusement and printer displays, e-readers and portable gaming consoles.

 

   

LCD televisions, which typically utilize display panels ranging in size from 18.5 inches to 65 inches.

We design, develop and manufacture our panels to address specific needs of the end-products in which they are used, such as thinness, light weight, resolution, color quality, brightness, low power consumption, touch panel features, fast response time, slim form and wide viewing angles. For example, it is important for notebook computer displays to be lightweight and thin and to have low power consumption, while desktop monitors require high brightness and wider viewing angles.

 

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The following table sets forth the shipment of our products by category for the periods indicated:

 

     Year Ended December 31,  
     2009      2010      2011  
     (Panels in thousands)  

Panels for Computer Products

        

Panels for notebook computers

     35,225.9         44,825.9         49,246.9   
  

 

 

    

 

 

    

 

 

 

Panels for desktop monitors

     27,000.7         31,525.0         28,160.3   
  

 

 

    

 

 

    

 

 

 

Total panels for computer products

     62,226.6         76,350.9         77,407.2   
  

 

 

    

 

 

    

 

 

 

Panels for Consumer Electronics Products

     232,524.0         225,787.1         192,600.3   
  

 

 

    

 

 

    

 

 

 

Panels for LCD Televisions

     23,527.8         32,293.8         31,954.6   
  

 

 

    

 

 

    

 

 

 

Total

     318,278.4         334,431.8         301,962.1   
  

 

 

    

 

 

    

 

 

 

The following table sets forth our net sales by product category for the periods indicated:

 

     Year Ended December 31,  
     2009     2010      2011  
     NT$     NT$      NT$      US$  
     (in millions)  

Panels for Computer Products

          

Panels for notebook computers

     60,432.0        70,390.3         67,530.0         2,230.9   
  

 

 

   

 

 

    

 

 

    

 

 

 

Panels for desktop monitors

     68,431.1        77,942.3         58,406.8         1,929.5   
  

 

 

   

 

 

    

 

 

    

 

 

 

Total panels for computer products

     128,863.1        148,332.6         125,936.8         4,160.4   
  

 

 

   

 

 

    

 

 

    

 

 

 

Panels for Consumer Electronics Products

     46,939.7        56,401.7         62,832.2         2,075.7   
  

 

 

   

 

 

    

 

 

    

 

 

 

Panels for LCD Televisions(2)

     173,144.7        237,262.6         165,275.4         5,460.1   
  

 

 

   

 

 

    

 

 

    

 

 

 

Others(1)

     10,383.8        25,161.1         25,667.5         848.0   
  

 

 

   

 

 

    

 

 

    

 

 

 

Total

     359,331.3 (3)      467,158.0         379,711.9         12,544.2   
  

 

 

   

 

 

    

 

 

    

 

 

 

 

(1) Includes sales generated from panels for solar modules, from sales of raw materials, components, single crystal silicon wafers and ingots and from service charges.
(2) Includes sales from panels, TV sets and other related products for LCD televisions.
(3) The amount is under ROC GAAP. Under US GAAP, the total amount of net sales was NT$358,732.8 million. The difference was due to a difference in accounting treatment for acquisition date of our equity investment in M. Setek under ROC GAAP versus US GAAP. See note 27 to our consolidated financial statements for information relating to the nature and effect of significant differences between ROC GAAP and US GAAP as they relate to us.

Computer Products

Panels for Notebook Computers. In 2009, 2010 and 2011, sales of panels for notebook computers accounted for 16.8%, 15.1% and 17.8%, respectively, of our net sales. In 2011, unit sales of our panels for notebook computers were approximately 49.2 million compared to 44.8 million in 2010, and net sales of panels for notebook computers were approximately NT$67.5 billion (US$2.2 billion) compared to NT$70.4 billion in 2010. The increase in unit sales and decrease in net sales in 2011 from 2010, was primarily as a result of declined panel average selling price due to severe competition in the market.

The most commonly produced panel sizes for notebook computers have changed in recent years, partly as a result of migration in TFT-LCD production technology. Our product mix for notebook computers primarily includes 10.1- to 17.3- inch panels. The most commonly produced panel sizes for notebook computers have been 10.1, 14.0 and 15.6 inches. Currently, 14.0-inch and 15.6-inch panels with an aspect ratio of 16:9 are the most commonly produced sizes for notebook computers, with demand for 17.3-inch panels increasing as well. We typically seek to increase our production of notebook panels of a certain size, one to two quarters ahead of expected product migration towards that panel size.

Panels for Desktop Monitors. In 2009, 2010 and 2011, sales of panels for desktop monitors accounted for 19.0%, 16.7%, and 15.4%, respectively, of our net sales. In 2011, unit sales of our panels for desktop monitors were approximately 28.2 million, compared to 31.5 million in 2010, and net sales of panels for desktop monitors were approximately NT$58.4 billion (US$1.9 billion), compared to NT$77.9 billion in 2010. The decrease in unit sales and net sales in 2011 from 2010, was primarily as a result of a slowdown in consumer IT spending due to the worsening global economy.

 

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The most commonly produced size of desktop monitors changes as the generation of TFT-LCD manufacturing technology evolves, with manufacturers moving production to panel sizes that make the most efficient use of glass substrates processed by their fabs. In 2011, 18.5-, 21.5-, and 24-inch panels were most commonly produced for desktop monitors.

Consumer Electronics Products

Our panels for consumer electronics products are used in products such as mobile phones, digital photo frames, digital still cameras, portable navigation display, portable DVD players, digital camcorders, automobile display, amusement and printer displays. In 2009, 2010 and 2011, sales of panels for consumer electronics accounted for 13.1%, 12.1% and 16.5%, respectively, of our net sales. The markets for our panels for consumer electronics products are typically more stable and less cyclical than the markets for our computer products because of the high level of our involvement in the design process and the customized nature of consumer electronics panels. In 2011, unit sales of our panels for consumer electronics products were approximately 192.6 million, compared to 225.8 million in 2010, and our net sales of consumer electronics products were approximately NT$62.8 billion (US$2.1 billion), compared to NT$56.4 billion in 2010. The decrease in unit sales from 2010 was primarily due to the shift of our focus towards higher end feature products, such as smart phones, which generated higher profit margin and in return, our net sales of consumer electronics products increased.

LCD Televisions

We commenced commercial production of panels for LCD televisions in 2002. Our current portfolio of LCD TV panels consists of 18.5-inch to 65-inch panels. In 2011, approximately 79.8% LCD TV panels we produced were 30 inches and above. In 2009, 2010 and 2011, sales of LCD TV panels accounted for 48.2%, 50.8%, and 43.5% respectively, of our net sales. In 2011, unit sales of our LCD TV panels were approximately 32.0 million, compared to 32.3 million in 2010, and our net sales of LCD TV panels were approximately NT$165.3 billion (US$5.5 billion) compared to NT$237.3 billion in 2010. The decrease in unit sales and net sales from 2010 was primarily due to lower average selling price as a result of the worsening global economy.

Customers, Sales and Marketing

We sell our panels to original equipment manufacturing service providers and brand companies. These original equipment manufacturing service providers, most of whose production operations are located in Taiwan and the PRC, use our panels in the products they manufacture on a contract basis for brand companies. In addition, we seek to strengthen our strategic relationship with Qisda, a TFT-LCD system integrator and a shareholder of our company, to better service the needs of brand customers and to provide them with superior solutions in capturing emerging trends of TFT-LCD applications in consumer markets. By enhancing our strategic relationship with Qisda, we hope to improve our competitiveness vis-à-vis other TFT-LCD manufacturers and to secure potential business opportunities at an early stage. As of December 31, 2011, our equity interest in Qisda remained unchanged at 9.54%.

 

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The following table sets forth the geographic breakdown of our net sales by the location of our customers placing orders for the periods indicated:

 

     Year Ended December 31,  
     2009     2010     2011  

Region

   Net sales      %     Net sales      %     Net sales      %  
     (in NT$ millions, except percentages)  

Taiwan

     153,643.4         42.8     178,396.6         38.2     145,497.8         38.3

PRC

     98,430.5         27.4     147,491.9         31.6     107,117.7         28.2

Korea

     26,032.8         7.3     45,300.1         9.7     30,797.3         8.1

Asia(1)

     41,023.9         11.4     62,334.4         13.3     60,155.2         15.9

Europe

     19,221.8         5.3     16,199.1         3.5     13,580.0         3.6

United States

     18,702.2         5.2     11,698.9         2.5     13,956.2         3.7

Others

     2,276.7         0.6     5,737.0         1.2     8,607.7         2.2 %
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

     359,331.3         100.0     467,158.0         100.0     379,711.9         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Excludes Taiwan, the PRC and Korea.

Our sales in Taiwan, the PRC and Asia, as set forth in the table above, represent a significant portion of our net sales for the past three years. A significant portion of these sales were made to original equipment manufacturing service providers who use our panels in the products they manufacture on a contract basis for brand companies worldwide.

Export sales constitute a significant portion of our total sales volume. In 2009, 2010, and 2011 our total amount of export sales were NT$205,687.9 million, NT$288,761.4 million, and NT$234,214.1 million (US$7,737.5 million), respectively, which constituted 57.2%, 61.8% and 61.7%, respectively, of the total amount of our sales volume.

We sell our panels for notebook computers to brand companies and original equipment manufacturing service providers with production operations in Taiwan and the PRC that design and manufacture notebook computers based on the specifications of their brand company customers. We market our panels to, and negotiate prices with, both our original equipment manufacturing service provider customers and brand customers, as display panels often constitute a significant part of the end product.

We sell our panels for desktop monitors through sales channels similar to those for notebook computers. We supply desktop monitor panels to brand companies and original equipment manufacturing service providers.

We sell most of our panels for digital still cameras and camcorders to brand companies based in Japan, Europe and the United States. We sell our panels for automobile display primarily to component manufacturers for automotive audio and video products based in the United States, Japan, the PRC and Europe. We sell our panels for portable DVD players primarily to original equipment manufacturing service providers and component manufacturers, most of whom are located in Taiwan, the PRC and other Asian countries.

We sell a significant portion of our panels for mobile device products to mobile phone brand companies and original equipment manufacturing service providers in the United States, Europe, Japan, Korea and the PRC.

As the end-use market continues to grow for LCD television products, we expect to sell a significant amount of LCD television products primarily to brand companies based in Japan, Korea, United States and the PRC. Orders placed by such brand customers have accounted for a significant portion of our net sales in recent years. In addition, average price per panel for LCD television products is higher than notebook and desktop monitors.

A significant portion of our net sales is attributable to a small number of our customers. In 2009, 2010 and 2011, our five largest customers accounted for 37.3%, 39.0% and 36.0%, respectively, of our net sales. In addition, some customers individually accounted for more than 10% of our net sales for each of the last three years. For example, Samsung accounted for 16.9%, 15.3% and 12.9% of our net sales in 2009, 2010 and 2011, respectively.

We focus our sales activities on a number of large customers with whom we seek to build close relationships. We appoint a sales manager to serve as the main contact person with each of our major customers. Each product category has its own sales and marketing division, and is further subdivided into smaller teams dedicated to each of our major customers. Each dedicated customer team is headed by an account manager who is primarily responsible for our relationship with that specific customer.

 

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Our customers typically provide monthly non-binding rolling forecasts of their requirements for the coming four to six months, and typically place purchase orders one month before the expected shipment date. We generally provide a limited warranty to our customers, including the provision of replacement parts and after-sale service for our products. In connection with these warranty policies, based on our historical experience, we typically set aside an amount as a reserve to cover these warranty obligations. As of December 31, 2011, our reserve for warranties totaled NT$2,685.3 million (US$88.7 million). In addition, we are required under several of our sales contracts to provide replacement parts for our products, at agreed prices, for a specified period of time.

We price our products in accordance with prevailing market conditions, giving consideration to factors such as the complexity of the product, the order size, the strength and history of our relationship with the customer and our capacity utilization. Purchase prices and payment terms for sales to related parties are not significantly different from those for other customers. Our credit policy for sales to related parties and other customers typically requires payment within 30 to 60 days. The average number of collection days extended for sales to our customers for the years ended December 31, 2009, 2010 and 2011 was 44 days, 48 days, and 54 days, respectively. In general, we extend longer credit terms to our large customers compared to our smaller customers. We believe the terms for those customers and products are comparable to the terms offered by our industry peer competitors. We have not experienced any material problems relating to customer payments.

Our business is subject to seasonal fluctuations common in the display panel industry, which in turn is affected by the seasonality of demand for consumer- and other end-products produced by our customers. We typically record lower sales of our products in the first calendar quarter (primarily reflecting the smaller number of work days in the quarter) and higher sales in the third and fourth calendar quarters (primarily due to the expected rise in consumer demand as the holiday season approaches). In the case of IT panels for computer products, sales may decrease slightly from the third to the fourth calendar quarter as most back-to-school purchases of computers are made by September. The seasonality of our sales also may be affected by factors such as economic downturn, inventory management by us, our customers and others.

The TFT-LCD Manufacturing Process

The basic structure of a TFT-LCD panel may be thought of as two glass substrates sandwiching a layer of liquid crystal. The front glass substrate is fitted with a color filter, while the back glass substrate has transistors fabricated on it. A light source called a backlight unit is located at the back of the panel.

The manufacturing process consists of hundreds of steps, but may be divided into three primary steps. The first step is the array process, which involves fabricating transistors on the back substrate using film deposition, lithography and etching. The array process is similar to the semiconductor manufacturing process, except that transistors are fabricated on a glass substrate instead of a silicon wafer. The second step is the cell process, which joins the back array substrate and the front color filter substrate. The space between the two substrates is filled with liquid crystal. The third step is the module-assembly process, which involves connecting additional components, such as driver-integrated circuits and backlight units, to the TFT-LCD panel. We established a color filter production facility at one of our fifth-generation fabs with technical assistance from Toppan, one of our color filter suppliers, in order to meet a portion of our color filter requirements. We commenced commercial production of color filters at this facility in 2003. We also established a color filter production facility at one of our sixth-generation fabs in 2005. In addition, we acquired a color filter production facility along with a sixth-generation fab and one module-assembly facility in 2006 as a result of our merger with QDI. Also in 2006, we established a color filter production facility at our first 7.5-generation fab. Additionally, in 2009 we established a color filter production facility at our second 7.5-generation fab and our first 8.5-generation fab. We also acquired a 4.5-generation fab in 2010 as a commercial result with TMD in Singapore. In order to meet customer requirements, we further established a color filter production facility at our second 8.5-generation fab in 2011.

 

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The array and cell processes are capital-intensive and require highly automated production equipment. TFT-LCD manufacturers typically design their own fabs and purchase production equipment from various suppliers, most of which are based in Japan. Each TFT-LCD manufacturer combines various equipment according to its manufacturing process technologies to form a TFT-LCD fab. In addition to developing our own manufacturing process technologies, we also license such technologies from other companies, such as Fujitsu Display Technologies Corporation (which was merged into Fujitsu Limited) (“FDTC”). We have automated our array and cell processes, with the exception of some steps in the cell process, such as panel inspection, panel baking and injection of liquid crystal. In contrast to the array and cell processes, the module-assembly process is highly labor-intensive, as it involves manual labor to assemble the pieces. We started to move a substantial portion of our module-assembly process to Suzhou, Jiangsu Province, the PRC in 2002, as part of our efforts to reduce labor costs and the majority of the module-assembly work is conducted in Suzhou. In 2006, we acquired a module-assembly facility in Songjiang, Shanghai, the PRC as a result of our merger with QDI. We commenced commercial production at our module-assembly facility in Xiamen, Fujian Province, the PRC in 2007. We also commenced commercial production at our new module and TV set assembly facility in the Czech Republic in 2008. In addition, we commenced commercial production at a module-assembly facility in Trencin Slovak Republic in 2010. In March 2010, our board of directors and that of TPV Technology Limited approved to establish a joint venture involved in TFT-LCD module production in Gorzow, Poland. In April 2010, our board of directors and that of TCL King Electrical Appliance (Huizhou) Co., Ltd. approved to establish a joint venture involved in TFT-LCD TV panel module production in Huizhou city, Guangdong Province, the PRC. In April 2010, our board of directors and that of Haier Group approved to establish a joint venture involved in TFT-LCD TV panel module production in Qingdao city, Shandong Province, the PRC.

Raw Materials and Components and Suppliers

Our manufacturing operations require adequate supplies of raw materials and components of the right quality on a timely basis. We purchase our raw materials and components based on forecasts from our customers, as well as our own assessments of our customers’ needs. We generally prepare forecasts one to four months in advance, depending on the raw materials and components, and update this forecast weekly or monthly. We source most of our raw materials and components, including critical materials such as glass substrates, color filters, CCFL, LED, polarizer and driver-integrated circuits, from a limited group of suppliers. In order to reduce our raw materials and component costs and our dependence on any one supplier, we generally purchase our raw materials and components from multiple sources. We typically do not enter into contracts with our suppliers. However, during periods of supply shortages, we typically enter into supply contracts with suppliers to ensure a stable supply of necessary raw materials and components.

We experienced a shortage of glass substrates in both the second half of 2007 and 2009. We have also experienced shortages of other raw materials in the past from time to time. Our operations would be adversely affected if we could not obtain raw materials and components in sufficient quantity and quality. We may also experience difficulties in sourcing adequate supplies for our operations if there is a ramp-up of production capacity by display panel manufacturers, including our company, without a corresponding increase in the supply of raw materials and components.

Raw materials and components constitute a substantial portion of our cost of goods sold. An increase in the cost of our raw materials may adversely affect our gross margins.

Set forth below are our major suppliers of key raw materials and components in alphabetical order by category:

 

Glass Substrates

 

Liquid Crystals

 

Color Filters

 

Polarizer

 

Backlight Units

 

Driver-integrated

Circuits

Asahi Glass   Chisso Corporation   Cando Corporation   BenQ Material Corporation(2)   Coretronic   Renesas Electronics Corporation
Corning Taiwan   DIC Corporation   Dai Nippon Printing   Nitto Denko   BriView Corp.(3)   Novatek
Nippon Electric Glass   Merck   Toray Industries, Inc.   Sumika Technology Co., Ltd.   Forhouse(4)   Orise
    Toppan CFI(1)     Radiant Opto-Electronics   Raydium Semiconductor(5)

 

(1) Toppan CFI (Taiwan) Co., Ltd. (“Toppan CFI”) has been our consolidated subsidiary since 2007.
(2) BenQ Material Corporation is a subsidiary of one of our major shareholders, Qisda. See “Item 7.B. Related Party Transactions.”
(3) BriView Corp., previously named Darwin Precisions Corp., is our consolidated subsidiary.
(4) Forhouse is our investee. See “Item 7.B. Related Party Transactions.”
(5) Radium Semiconductor is our investee. See “Item 7.B. Related Party Transactions.”

 

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We use a large amount of water and electricity in our manufacturing process. We obtain water from government-owned entities and recycle approximately 82.9% of the water that we use in production. We use electricity supplied by Taiwan Power Corporation. We maintain back-up generators that provide electricity in case of power interruptions, which we have experienced from time to time. Except for power outages, power interruptions in general have not materially affected our production processes.

Equipment and Suppliers

We depend on a number of equipment manufacturers that make and sell the equipment that we use in our manufacturing processes. Our manufacturing processes depend on the quality and technological capacity of our equipment. We purchase equipment that is customized to our specific requirements for our manufacturing processes. The principal types of equipment we use to manufacture display panels include chemical vapor deposition equipment, sputters, steppers, developers and coaters.

In 2011, we decreased our equipment purchases from 2010 as a result of on-going macroeconomic concerns. Despite lower capital expenditures, we expect to maintain investments in advanced technology and higher-value products. See “Item 5.B. Liquidity and Capital Resources.” We purchase equipment from a small number of qualified vendors to assure consistent quality and performance. We typically order equipment four to six months or longer in advance of our planned installation.

Competition

The display business is highly competitive. Most of our competitors operate fabs in Korea, Taiwan, Japan and the PRC. Our principal competitors are:

 

   

LG Display Co., Ltd. (“LG Display”) and Samsung in Korea;

 

   

Chimei Innolux Corp., Chunghwa Picture Tubes, Ltd., Hannstar Display Corporation, Wintek Corporation, Giantplus Technology Co., Ltd. and E-Ink Holdings Inc. in Taiwan;

 

   

Sharp, Toshiba, IPS Alpha Technology, Ltd., Hitachi and Japan Display Inc. in Japan; and

 

   

BOE Technology Group Co., Ltd., InfoVision Optoelectronics (Kunshan) Co., Ltd., Century Corporation Co., Ltd. China, Shanghai Tianma Micro Electronics Co., Ltd., Shenzhen Tianma Micro Electronics Co., Ltd., Shenzhen China Star Optoelectronics Technology Co., Ltd. and Nanjing CEC-PANDA LCD Technology Co., Ltd. in the PRC.

The principal elements of competition for customers in the display market include:

 

   

price, based in large part on the ability to ramp-up lower cost, advanced technology production facilities before competitors;

 

   

product features and quality;

 

   

customer service, including product design support;

 

   

ability to keep production costs low by maintaining high yield and operating at full capacity;

 

   

ability to provide sufficient quantity of products to meet customer demand;

 

   

quality of the research and development team;

 

   

time-to-market;

 

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superior logistics; and

 

   

access to capital.

Solar Business

We entered the solar business at the end of 2008 and formed our Solar Photovoltaic Business Unit in October 2009. We have established a vertically integrated solar value chain, including manufacturing and branding capabilities for our solar products.

We manufacture upstream and midstream products such as polysilicon, ingots, wafers and solar cells. Through our acquisition of M. Setek in 2009, we began to operate four fabs in Japan that manufacture polysilicon, ingots, and wafers. Through our subsidiary AUO Crystal Corp., we operate a solar wafer fab and a multi-crystalline ingot growth and squaring fab in Taiwan. In April 2011, also through AUO Crystal Corp., we began construction of a mono-crystalline ingot and wafer fab in Taiwan and we expect mass production to begin in the second quarter of 2012. In May 2010, we formed a joint venture with SunPower Corporation, a leading manufacturer of residential and commercial solar systems in the United States, to construct and operate a solar cell manufacturing facility in Malaysia.

We also design, develop, and manufacture solar PV modules, as well as produce solar PV systems and provide various value-added services for solar PV systems projects. To date, we operate three downstream solar module fabs in the PRC, Czech Republic and Taiwan. A solar PV module is an assembly of PV cells that are electrically interconnected, laminated and framed in a durable and weatherproof package. Currently, our solar PV modules are manufactured with multi-crystalline PV cells and mono-crystalline PV cells. Our PV modules are made with a highly strengthened frame design that enhances their ability to withstand strong wind and vibrations. A solar PV system consists of one or more solar PV modules that are physically mounted and electrically interconnected with system components such as inverters, mounting structures, wiring systems and other devices to produce and store electricity.

We sell our solar PV modules primarily to overseas customers, which include installers, solar PV system integrators, property developers and other value-added resellers, who incorporate our PV modules into large on-grid integrated PV systems with inverters, mounting structures and wiring systems. Starting from February 2012, we began to use “BenQSolar” as our new brand name to market our solar PV products and services, which are sold in various markets worldwide, such as Europe, the United States, Asia and Africa. Also with our efforts to provide value-added services for solar PV systems projects, we have successfully completed and secured solar projects with our global partners in Europe, the United States, Africa and elsewhere.

We expect to continue to build our solar business over the next few years. In 2011, revenues generated from our solar business amounted of NT$13,229.3 million (US$437.1 million) representing 3.5% of our total net sales for 2011.

Quality Control

We have implemented quality inspection and testing procedures at all of our fabs and module-assembly facilities. Our quality control procedures include statistical process controls, which involve sampling measurements to monitor and control the production processes. We perform outgoing quality control based on sampling plans, ongoing reliability tests covering a wide range of application conditions, in-process quality control to prevent potential quality deviations, and other programs designed for process measurement and improvement, reduction of manufacturing costs, maintenance of on-time delivery, increasing in-process production yields and improving field reliability of our products. If a problem is detected, we take steps to contain the problem, conduct defect analyses to identify the cause of the problem and take appropriate corrective and preventive actions.

We visually inspect and test all completed panels to ensure that production standards are met. To ensure the effective and consistent application of our quality control procedures, we provide quality control training to all of our production line employees according to a certification system depending on the particular levels of skills and knowledge required.

 

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We also perform quality control procedures for the raw materials and components used in our products. These procedures include testing samples for large batches, obtaining vendor testing reports and testing to ensure compatibility with other raw materials and components, as well as vendor qualification and vendor ratings. We also implement procedures that manage the flow of any changes in the design, parts, or processes during mass production, in order to avoid problems in product quality and reliability caused by engineering changes, and thus to maintain product and system integrity.

Our quality management system has received accredited International Organization of Standards ISO 9001 and QC080000 certifications, as well as qualifications from our customers. We also received the ISO/TS16949 certifications for most of our facilities that design and manufacture the panel displays. In addition, all of our facilities have been certified as meeting the International Organization of Standards ISO 14001 environmental protection standards and OHSAS 18001 occupational health and safety standard and certain of our facilities have completed ISO 50001 certification for energy management. The International Organization of Standards certification process involves subjecting our manufacturing processes and quality management systems to periodic reviews and observations. International Organization of Standards certification is required by certain European countries in connection with sales of industrial products in those countries. We believe that certification also provides independent verification to our customers regarding the quality control employed in our manufacturing and assembly processes.

Insurance

We mostly maintain insurance policies on our production facilities, buildings, machinery and inventories covering property damage and damage due to fire, earthquakes, floods, and other natural and accidental perils. Our insurance policies cover factory maintenance and replacement costs for our sixth generation fabs and above, while for our fifth generation fabs and below, our insurance policies cover the amount equal to the book value of assets. As of December 31, 2011, our insurance also included protection from covered losses, including property damage up to maximum coverage of NT$59.8 billion (US$2.0 billion) for all of our inventories and NT$700.6 billion (US$23.1 billion) for our equipment and facilities. In addition, as of December 31, 2011, we had insurance coverage for business interruptions in the aggregate amount of NT$28.4 billion (US$0.9 billion).

In general, we also maintain insurance policies, including director and officer liability insurance, employee group health insurance, travel and life insurance, employer liability insurance, general liability insurance, and policies that provide coverage for risks during the shipment of goods and equipment, as well as during equipment installation at our fabs.

Environmental Matters

Our manufacturing processes involve the use of hazardous materials and generate a significant amount of pollution, including wastewater, solid/liquid waste and air pollution, which are strictly monitored by local environmental protection bureaus. We must comply with regulations relating to storage, handling, generation, treatment, emission, release, discharge and disposal of certain materials and wastes resulting from our manufacturing processes. To meet ROC environmental standards, we employ various types of pollution control equipment for the treatment of exhaust gases, liquid waste, solid waste and the treatment of wastewater and chemicals in our fabs. We control exhaust gas and wastewater on-site. The treatment of solid and liquid wastes is subcontracted to third parties off-site in accordance with pollution control requirements.

Our operations can expose us to the risk of environmental claims which could result in damages awarded or fines imposed against us. We have taken the necessary steps to ensure the proper operation of our facilities to meet the necessary standards and strengthened the monitoring mechanisms against further violations, as well as obtained the appropriate permits, and believe that we are in compliance with the existing environmental laws and regulations in all material aspects in the ROC.

 

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Intellectual Property

Overview

As of March 31, 2012, we held a total of 9,206 patents, including 3,461 in the PRC, 3,019 in Taiwan and 2,148 in the United States, as well as 578 in other jurisdictions, including Japan, Korea, the United Kingdom, France, Germany, Hong Kong, Singapore, Canada and India. These include patents for TFT-LCD manufacturing processes and products. These patents will expire at various dates from 2012 through 2031. We also have a total of over 5,000 pending patent applications in various jurisdictions, including Taiwan, the United States, the PRC, Japan, Italy, India, United Kingdom, France, Germany and Korea as of March 31, 2012. In addition, we have registered “AU Optronics” as trademarks in some countries and jurisdictions where we operate, including ROC, United States, European Union and Korea and registered our corporate logo, “AUO” as trademarks in the ROC, PRC, United States, European Union, Japan and Korea.

We require all of our employees to sign an employment agreement which prohibits the unauthorized disclosure of any of our trade secrets, confidential information and proprietary technologies subject to the terms and conditions of the employment agreement, and we also require our technical personnel to assign to us any inventions related to our business that they develop during the course of their employment.

We have licenses to use certain technology and processes from certain companies. Our royalty expenses relating to intellectual property licenses may increase in the future due to increases in unit sales as well as the potential need to enter into additional license agreements or to renew existing license agreements on different terms.

We intend to continue to file patent applications, where appropriate, to protect our proprietary technologies. We may find it necessary to enforce our patents or other intellectual property rights or defend ourselves against claimed infringement of the rights of others through litigation, which could result in substantial cost and diversion of our resources. We may suffer legal liabilities and financial and reputational damages if we are found to infringe product or process technology rights held by others. We are currently involved in litigation regarding alleged patent infringement. See “Item 8.A.7. Litigation.”

License Agreements

We have entered into patent and intellectual property license and cross license agreements, some of which require periodic royalty payments. In the future, we may need to obtain additional patent licenses or renew existing license agreements.

We have a license agreement with FDTC (subsequently assumed by Fujitsu Limited), effective as of March 31, 2003, which provides for the non-transferable and non-exclusive license under certain patents to manufacture certain TFT-LCD panels at our facilities.

In connection with the settlement of a lawsuit with Sharp Corporation (“Sharp”), we entered into a cross-license agreement with Sharp, effective as of January 1, 2011, under which each party granted to the other non-transferable and non-exclusive licenses under certain patents to manufacture certain TFT-LCD panels and modules.

In connection with the settlement of a lawsuit with LG Display Co., Ltd., (“LGD”) we entered into a cross-license agreement with LGD, effective as of August 8, 2011, under which each party granted to the other non-transferable and non-exclusive licenses under certain patents to manufacture certain TFT-LCD panels and modules.

In connection with the settlement of a lawsuit with Samsung Electronics Co., Ltd. (“Samsung”), we entered into a cross-license agreement with Samsung, effective as of January 1, 2012, under which each party granted to the other non-transferable and non-exclusive licenses under certain patents to manufacture certain TFT-LCD panels and modules.

 

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We have a cross-license agreement with Hitachi and IPS Alpha Technology, Ltd., effective as of July 1, 2009, under which each party granted to the other non-transferrable and non-exclusive licenses under certain patents to manufacture certain TFT-LCD and OLED panels and modules.

We have a license agreement with Semiconductor Energy Laboratory Co., Ltd., effective as of January 1, 2009, which provides for the non-transferable and non-exclusive license under certain patents to manufacture certain LCD and OLED products.

We have a cross-license agreement with Toshiba Mobile Display, effective as of April 26, 2010, under which each party granted to the other non-transferrable and non-exclusive licenses under certain patents to manufacture certain TFT-LCD and OLED panels and modules.

In addition to the above, we have also entered into license or cross license agreements with other third parties in the course of our business operations in connection with certain patents which such third parties own or control.

4.C. Organizational Structure

The following chart sets forth our corporate structure and ownership interest in each of our principal operating subsidiaries as of March 31, 2012.

 

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The following table sets forth summary information for our subsidiaries as of March 31, 2012.

 

Subsidiary

  

Main Activities

  

Jurisdiction of
Incorporation

  

Total Paid-in
Capital

   Percentage of
Our Ownership
Interest
               (in millions)     

AU Optronics (L) Corp.

  

Holding and trading company

   Malaysia    US$1,343.2        100 %

AU Optronics Corporation America

  

Sales support in the United States

   United States    US$1.0        100 %(1)

AU Optronics Corporation Japan

  

Sales and sales support in Japan

   Japan    JPY40.0        100 %(1)

AU Optronics Europe B.V.

  

Sales support in Europe

   Netherlands    EUR0.05        100 %(1)

AU Optronics Korea Ltd.

  

Sales support in South Korea

   South Korea    KRW173.1        100 %(1)

AU Optronics Singapore Pte. Ltd.

  

Holding and sales support in South Asia

   Singapore    SGD183.4        100 %(1)

AU Optronics (Shanghai) Co., Ltd.

  

Sales support in the PRC

   PRC    RMB21.8        100 %(1)

AU Optronics (Xiamen) Corp.

  

Assembly of TFT-LCD modules in the PRC

   PRC    RMB1,678.2        100 %(1)

AU Optronics (Suzhou) Corp., Ltd.

  

Assembly of TFT-LCD modules in the PRC

   PRC    RMB1,967.3        100 %(1)

AU Optronics (Czech) s.r.o.

  

Manufacturing and repair center in Czech Republic and assembly of TFT-LCD modules and solar PV modules

   Czech Republic    CZK300.0        100 %(1)

AU Optronics Manufacturing (Shanghai) Corp.

  

Assembly of TFT-LCD modules in the PRC

   PRC    RMB867.0        100 %(1)

AU Optronics (Slovakia) s.r.o.

  

Assembly of Optoelectronics LCD products in Slovakia and manufacturing and sale of related parts

   Slovakia    EUR40.0        100 %(1)

AUO Energy (Suzhou) Corp.

  

Design and installation of solar modules

   PRC    RMB8.2        100 %(8)

AUO Energy (Tianjin) Corp.

  

Design and installation of solar modules

   PRC    RMB111.7        100 %(8)

AUO Green Energy America Corp.

  

Holding company and sales support in America

   United States    US$9.5        100 %(8)

AUO Green Energy Europe B.V.

  

Holding company and sales support in Europe

   Netherlands    EUR0.043        100 %(8)

BriView (Xiamen) Corp.

  

Manufacturing and sale of liquid crystal products and related parts

   PRC    RMB332.2        100 %(5)

Darwin Precisions (L) Corp.

  

Holding and trading company

   Malaysia    US$85.0        100 %(2)

Darwin Precisions (Hong Kong) Limited

  

Holding company

   Hong Kong    US$62.0        100 %(3)

Darwin Precisions (Suzhou) Corp.

  

Manufacturing, assembly and sale of backlight modules and related components in the PRC

   PRC    RMB127.5        100 %(4)

Darwin Precisions (Xiamen) Corp.

  

Manufacturing, assembly and sale of backlight modules and related components in the PRC

   PRC    RMB506.0        100 %(4)

 

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Subsidiary

  

Main Activities

  

Jurisdiction of
Incorporation

  

Total Paid-in
Capital

   Percentage of
Our Ownership
Interest
               (in millions)     

Darwin Precisions (Chengdu) Corp.

  

Manufacturing, assembly and sale of backlight modules and related components in the PRC

   PRC    RMB53.9        100 %(4)

Darwin Precisions (Qingdao) Corp.

  

Manufacturing, assembly and sale of backlight modules and related components in the PRC

   PRC    RMB34.1        100 %(4)

Darwin Precisions (Dongguan) Corp.

  

Manufacturing, assembly and sale of backlight modules and related components in the PRC

   PRC    RMB54.2        100 %(4)

BVCH Optronics (Sichuan) Corp.

  

Assembly and sale of TFT-LCD modules in the PRC

   PRC    RMB100.0        51.0 %(1)

Huizhou Bri-King Optronics Co., Ltd.

  

Assembly and sale of TFT-LCD modules in the PRC

   PRC    RMB81.3        51.0 %(1)

BriView (Kunshan) Co., Ltd.

  

Manufacturing and sale of liquid crystal products and related parts

   PRC    RMB34.1        100 %(5)

BriView (Hefei) Co., Ltd.

  

Manufacturing and sale of liquid crystal products and related parts

   PRC    RMB196.6        100 %(5)

Konly Venture Corp.

  

Venture capital investment

   ROC    NT$2,700.0        100 %

Ronly Venture Corp.

  

Venture capital investment

   ROC    NT$2,500.0        100 %

BriView Corp. (formerly Darwin Precisions Corp.)

  

Manufacturing and sale of backlight modules

   ROC    NT$5,460.7        68.86 %(6)

Toppan CFI (Taiwan) Co., Ltd.

  

Manufacturing and sale of color filters

   ROC    NT$15,363.0        49 %(7)

BriView (L) Corp.

  

Holding and trading company

   Malaysia    US$81.2        100 %(13)

AUO Crystal Corp.

  

Design and installation of solar modules

   ROC    NT$7,750.0        86.40 %(12)

AUO Crystal (Malaysia) Sdn. Bhd.

  

Manufacturing and sale of single crystal silicon wafers

   Malaysia    US$15.0        100 %(10)

M. Setek Co., Ltd.

  

Manufacturing of single crystal silicon wafers and ingots and sales of solar modules

   Japan    JPY35,183.2        93.49 %(10)

Darshin Microelectronics Inc.

  

IC design and sales

   ROC    NT$80.0        66.68 %(9)

AFPD Pte., Ltd.

  

Manufacturing LCD panels based on low temperature polysilicon technology

   Singapore    US$458.9        100 %(1)

AU Optronics (Kunshan) Co., Ltd.

  

Manufacturing, assembly and sale of TFT-LCD modules products in the PRC

   PRC    RMB1,341.9        49 %(14)

AUO Green Energy Germany GmbH

  

Sales support in Europe

   Germany    EUR0.025        100 %(11)

Sungen Power Corporation

  

Power generation

   ROC    NT$74.0        100 %

 

(1) Indirectly, through our 100% ownership of AU Optronics (L) Corp.
(2) Indirectly, through our 68.86% ownership of BriView Corp.
(3) Indirectly, through our 100% ownership of Darwin Precisions (L) Corp.

 

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(4) Indirectly, through our 100% ownership of Darwin Precisions (Hong Kong) Limited.
(5) Indirectly, through our 100% ownership of BriView (L) Corp.
(6) 50.98% held directly by us, 10.88% held indirectly by Konly Venture Corp. and 7.01% held indirectly by Ronly Venture Corp., respectively.
(7) We consolidated Toppan CFI (Taiwan) Co., Ltd. in accordance with ROC SFAS No. 7 and FASB ASC Subtopic 810-10 starting from fiscal year 2007. See note 27 to our consolidated financial statements.
(8) Indirectly, through our 100% ownership of AU Optronics (Singapore) Pte. Ltd.
(9) Indirectly, through our 100% ownership of Konly Venture Corp.
(10) Indirectly, through our 86.40% ownership of AUO Crystal Corp., respectively.
(11) Indirectly, through our 100% ownership of AUO Green Energy Europe B.V.
(12) 70.81% held directly by us and 15.59% held indirectly through Konly Venture Corp., respectively.
(13) 55.65% held indirectly through AU Optronics (L) Corp. and 44.35% held indirectly through BriView Corp., respectively.
(14) Indirectly, through our 100% ownership of AU Optronics (L) Corp., we consolidated AU Optronics (Kunshan) Co., Ltd. due to our capability of exercising control over the operating, financial and personnel policies of AU Optronics (Kunshan) Co., Ltd.

The following is a summary of our newly established subsidiaries, restructuring and other major organizational activities in 2011 and the first quarter of 2012:

 

   

BriView Electronics Corp. and BriView Corp. In September, 2011, BriView Electronics Corp. was merged with and into Darwin Precisions Corp., with Darwin Precisions Corp. as the surviving entity. Darwin Precisions Corp. was then renamed as BriView Corp.

 

   

M. Setek Co., Ltd. In October 2011, AU Optronics (L) Corp. transferred all of its ownership interests in common and preferred shares of M. Setek Co., Ltd. to AUO Crystal Corp. due to group restructuring.

 

   

AU Optronics (Kunshan) Co., Ltd. In October 2011, AU Optronics (L) Corp. joint ventured with Kunshan Economic and Technical Development Zone Assets Operation Co., Ltd. to invest in AU Optronics (Kunshan) Co., Ltd. with AU Optronics (L) Corp. owning 49% of the shareholding. We plan to establish an 8.5 generation fab in Kunshan, China to produce large-size panels, if market demand allows.

 

   

AUO Green Energy Germany GmbH In October 2011, we established a wholly owned subsidiary, AUO Green Energy Germany GmbH, which is mainly engaged in the sales support of solar PV modules in Germany.

 

   

Sungen Power Corporation Sungen Power Corporation was founded in the Taichung Science Park of the Republic of China in January 2011 and we initially owned 50% of the shareholding. On March 27, 2012, we acquired additional 50% of the shareholding; as a result, Sungen Power Corporation was included in our consolidated financial statements since that date. Sungen Power Corporation is mainly engaged in power generation. As of March 31, 2012, the operating activities of Sungen Power Corporation have not started up.

4.D. Property, Plants and Equipment

As of March 31, 2012, we have eight principal manufacturing sites in Taiwan, three module-assembly sites in the PRC, three manufacturing sites in Japan, two module-assembly sites in Europe and one module-assembly site in Singapore.

Principal Facilities

The following table sets forth certain information relating to our principal facilities as of March 31, 2012. The land in the Hsinchu Science Park, Lungke Science Park and Central Taiwan Science Park on which our facilities are located is leased from the ROC government. The land in the Songjiang Export Processing Zone, Torch Hi-tech Industrial Development Zone and Suzhou Industrial Park, on which our facilities are located, is leased from the PRC government.

 

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Location

   Building Size   Input Substrate Size/
Installed Capacity
   Commencement of
Commercial
Production
  

Primary Use

  

Owned or Leased

     (in square
meters)
  (in millimeters)/
(substrates processed
per month) ****
              

No. 5, Li-Hsin Rd.

6, Hsinchu

Science Park,

Hsinchu 30078,

Taiwan, ROC

   69,647   610x720/40,000(1)    December 1999    Manufacturing of TFT-LCD panels   

•    Building is owned

•    Land is leased (expires in December 2020)

No. 1, Li-Hsin Rd.

2, Hsinchu

Science Park,

Hsinchu 30078,

Taiwan, ROC

   162,895   610x720/LTPS
40,000
(1)
   November 2000    Manufacturing of TFT-LCD panels; business operations; research and development; sales and marketing   

•    Building is owned

•    Land is leased (expires in December 2020)

No. 23, Li-Hsin Rd.

Hsinchu

Science Park,

Hsinchu 30078,

Taiwan, ROC

   105,127   600x720/60,000(1)    July 1999    Manufacturing of TFT-LCD panels   

•    Building is owned

•    Land is leased (expires in January 2017)

No. 189, Hwaya Rd. 2,

Kueishan Hwaya
Science Park,
Kueishan 33383,

Taoyuan, ROC*

   162,826   620x750/a-Si 30,000(1)

1,100x1,300/70,000(4)

   October 2003

December 2001

   Manufacturing of TFT-LCD panels   

•    Building is owned

•    Land is owned

No. 1, Xinhe Rd.

Aspire Park

Lungtan 32543,

Taoyuan

Taiwan, ROC

   535,528   680x880/60,000(2)

1,100x1,250/50,000(4)

1,100x1,300/70,000(4)

   February 2001

March 2003

February 2004

   Manufacturing of TFT-LCD panels; module and component assembly; manufacturing of color filters   

•    Building is owned

•    Land is owned

No. 228, Lungke St., Lungke
Science Park,

Lungtan, 32542,

Taoyuan,

Taiwan, ROC*

   867,955   1,500x1,850/120,000(5)    August 2005    Manufacturing of TFT-LCD panels; manufacturing of color filters   

•    Building is owned

•    Land is leased (expires in December 2027)

No. 1 JhongKe Rd.

Central Taiwan

Science Park

Taichung 40763,

Taiwan, ROC

   1,430,750   1,500x1,850/120,000(5)

1,100x1,300/120,000(4)

1,950x2,250/75,000(6)

1,950x2,250/60,000 (6)

2,200x2,500/40,000(7)

   March 2005

August 2005

June 2006

April 2009

February 2009

   Manufacturing of TFT-LCD panels; module and component assembly; manufacturing of color filters   

•    Building is owned

•    Land is leased (expires in December 2022)

No. 1, Machang Rd.

Central Taiwan

Science Park,

Houli Dist

Taichung City

42147, Taiwan,

R.O.C.

   587,810   2200x2500/20,000(7)    June 2011    Manufacturing of TFT-LCD panels; module and component assembly; manufacturing of color filters   

•    Building is owned

•    Land is leased (expires in December 2025)

 

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Location

   Building Size   Input Substrate Size/
Installed Capacity
   Commencement of
Commercial
Production
  

Primary Use

  

Owned or Leased

     (in square
meters)
  (in millimeters)/
(substrates processed
per month) ****
              
10 Tampines
Industrial Avenue 3
Singapore 528798***
   182,943   730x920/LTPS
45,000
(3)
   August 2002    Manufacturing of TFT-LCD panels   

•    Building is owned

•    Land is leased (expires in June 2059)

No. 398,
Suhong Zhong Road

Suzhou

Industrial Park,

Suzhou, the PRC

   413,035   N/A    July 2002    TFT-LCD module and component assembly   

•    Building is owned

•    Land is leased (expires in 2051)

No. 3, Lane 58, San-Zhuang Rd., Songjiang Export Processing Zone,
Shanghai, the PRC*
   83,508   N/A    October 2004    TFT-LCD module and component assembly   

•    Building is owned

•    Land is leased (expires in 2052)

No. 1689, North of XiangAn Rd.,
XiangAn Branch,
Torch Hi-tech Industrial Development Zone,
Xiamen, the PRC
   289,744   N/A    September 2007    TFT-LCD module and component assembly   

•    Building is owned

•    Land is leased (expires in 2056)

Turanka 858/98a, Slatina,

627 00 Brno,

Czech Republic

   9,312   N/A    August 2010    Solar module assembly   

•    Building is leased (expires in December 2016)

•    Land is leased (expires in December 2016)

Turanka 856/98d,
Slatina, 627 00 Brno,

Czech Republic

   10,432   N/A    January 2012    Solar module assembly   

•    Building is leased (expires in December 2016)

•    Land is leased (expires in December 2016)

Brnianska 1, 91105 Trencin, Slovak Republic    124,819   N/A    April 2010   

TFT-LCD module and TV set assembly

and related component

  

•    Building is owned

•    Land is owned

Kochi Site 1: 378,
Myoken-cho,

Susaki-shi, Kochi-ken, Japan**

   36,586.92
(including
Kochi
Site 1 and
Kochi
Site 2)
  Ingot

300 ton per
month

   Kochi Site 1:
April 2004

Kochi Site 2:
January 2009

   Production of ingot   

•    Building is owned

•    Land is owned

Kochi Site 2: 1117-1, Otani, Susaki-shi, Kochi-ken, Japan**              

 

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Location

   Building Size   Input Substrate Size/
Installed Capacity
   Commencement
of Commercial
Production
  

Primary Use

  

Owned or Leased

     (in square
meters)
  (in millimeters)/
(substrates processed
per month) ****
              

Soma

2-2-21, Koyo, Soma-shi, Fukushima-ken, Japan**

   47,596.14

(including
Soma Site
1 and
Soma Site
2)

  Polysilicon

530 ton
per month

   Soma
Site 1:
October
2007

Soma
Site 2:

February
2011

  

Production of

polysilicon

  

•    Building is owned

•    Land is owned

 

* Facilities acquired through our merger with QDI.
** Facilities acquired through our acquisition of M. Setek.
*** Facilities acquired through our acquisition of AFPD Pte., Ltd.
**** Not applicable to polysilicon, silicon wafer, ingot, solar cell and solar module products.
(1) 3.5-generation fab.
(2) fourth-generation fab.
(3) 4.5-generation fab.
(4) fifth-generation fab.
(5) sixth-generation fab.
(6) 7.5-generation fab.
(7) 8.5-generation fab.

Expansion Projects

Set forth below is a description of our principal expansion projects that we expect to finance with cash on hand, cash flow from operations and financing activities, including the issuance of equity securities, long-term borrowings, and the issuance of convertible and other debt securities.

8.5-Generation Fab in Kunshan of China. We plan to establish an 8.5-generation fab in Kunshan, China to produce large-size panels if market demand allows. This 8.5-generation fab is capable of processing substrates with dimensions of 2,200 x 2,500 millimeters with high efficiency and with capabilities of cutting, for example, eighteen 32-inch panels, eight 47-inch panels, or six 55-inch panels. The equipment move-in and ramp-up schedule will be subject to market demand.

4.5-Generation Fab. We acquired the 4.5-generation LTPS (Low Temperature Polysilicon) fab through our acquisition of AFPD Pte., Ltd. in July 2010. The fab was mainly used to produce panels for notebooks, but since the third quarter of 2011, the small and medium panel for smart phones went into mass production and became the main output. We intend to build capacity for producing Organic Light Emitting Diode (OLED) display and touch sensor in this fab if market demand arises. The fab is capable of processing substrates with dimensions of 730x920 millimeters.

We estimate our capital expenditures to be around NT$40.0 billion for 2012, primarily for technological upgrade and the enhancement of value of capacity. The capital expenditures are still preliminary and may change in accordance with actual market conditions.

 

ITEM 4A. UNRESOLVED STAFF COMMENTS

None.

 

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

5.A. Operating Results

Our operating results are affected by a number of factors, principally by general market conditions, operating efficiency and product mix.

 

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General Market Conditions

The display panel industry in general has been characterized by cyclical market conditions. The industry has been subject to significant and rapid downturns as a result of imbalances between excess supply and slowdowns in demand, resulting in declines in average selling prices. For example, on a year-to-year basis, average selling prices of our large-size panels decreased by 24.4% in 2011 compared to 2010, decreased by 0.3% in 2010 compared to 2009, and decreased by 24.9% in 2009 compared to 2008. We expect average selling prices of panels will fluctuate from time to time due to the change of general market conditions.

Our revenues primarily depend on the average selling prices and shipment volume of our panels and are affected by fluctuations in those prices and volumes. The prices and shipment volume of our panels are affected by numerous factors, such as raw material costs, yield rates, supply and demand, competition, our pricing strategies and transportation costs. We had a negative gross margin of 7.4% in 2011 compared to a gross margin of 7.8% in 2010, primarily due to the decline in average selling prices and the lower capacity utilization rate caused by the global economic downturn. Our gross margin increased from 2.0% in 2009 to 7.8% in 2010 primarily due to the rise of average selling prices in the first half of 2010.

To meet a potential future increase in demand, many display panel manufacturers, including our company, may expand capacity. If such expansion in capacity is not matched by a comparable increase in demand, it could lead to overcapacity and declines in the average selling prices of panels in the future. In addition, we expect that, as is typical in the display panel industry, the average selling prices for our existing product lines will gradually decrease as the cost of manufacturing display panels declines. However, the impact of such decreases may be offset through the development of new products.

Operating Efficiency

Our results of operations have been affected by our operating efficiency. Our operating efficiency is impacted by production yield, cycle time, capacity utilization, production capacity, and other factors.

Our manufacturing processes are highly complex and require advanced and costly equipment. In order to maintain our competitiveness and to meet customer demand, we must routinely upgrade or expand our equipment. Upgrades and implementing new equipment to improve production yields and production efficiency takes time and training and may require adjustments to the manufacturing process. In addition, certain of our customers have different specification requirements than other customers. Specification requests may also require adjustments to or the use of different manufacturing processes which may accelerate or delay production. The turnaround time for production and our capacity utilization is also impacted by the availability of raw materials and components as well as the level of demand for our products.

We measure the capacity of a fab in terms of the number of substrates and the glass area of substrates that can be produced. For 2011, we had an annual capacity to produce approximately 25.4 million square meters of glass area of TFT-LCD panels. Our production capacity has been affected by the process of construction and the schedule of commencement of operation of our fabs. Once the design of a new fab is completed, it typically takes six to eight quarters before the fab commences commercial production, during which time we construct the building, install the machinery and equipment and conduct trial production at the fab. An additional two to four quarters are required for the fab to be in a position to produce at the installed capacity and with high production yield, where production yield is the number of good panels produced expressed as a percentage of the total number of panels produced. This process is commonly referred to as “ramp-up.” At the beginning of the ramp-up process, fixed costs, such as depreciation and amortization, other overhead expenses, labor, general and administrative and other expenses, are relatively high on a per panel basis, primarily as a result of the low output. Variable costs, particularly raw materials and component costs, are also relatively high on a per panel basis since production yield is typically low in the early stages of the ramp-up of a fab, resulting in greater waste of raw materials and components. In general, upon the completion of the ramp-up process, a fab is capable of producing at its installed capacity, leading to lower fixed costs per panel as a result of higher output, as well as lower raw material and component costs per panel as a result of higher production yield. We typically construct our new fabs in phases in order to allocate our aggregate capital expenditure across a greater period of time. As a result, the installed capacity in the early phases of production at a new fab is typically lower than the maximum capacity that can be installed at a fab.

 

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Product Mix

Our product mix affects our sales and profitability, as the prices and costs of different size panels may vary significantly. The larger size panels command higher prices, but also have higher manufacturing costs. In 2011, an increase in demand for consumer electronics products using larger panels such as digital still camera, smart phone and automobile displays caused a shift in product mix to more medium-sized panels being produced. Net sales of panels for computer products & TV panels represented 84.0%, 82.5% and 76.7% of our net sales in 2009, 2010 and 2011, respectively. This declining trend primarily was due to the increase in sales of panels for consumer electronics products, which represented 13.1%, 12.1% and 16.5% of our net sales in 2009, 2010 and 2011, respectively. Moreover, a strong demand for smart phones contributed to increased net sales of panels for consumer electronics products. We periodically review and adjust our product mix based on the demand for, and profitability of, the different panel sizes that we manufacture.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations contained elsewhere in this annual report are based on our audited consolidated financial statements which have been prepared in accordance with ROC GAAP. Our reported financial condition and results of operations are sensitive to accounting methods, assumptions and estimates that underlie the preparation of our financial statements. We base our assumptions and estimates on historical experience and on various other assumptions that we believe to be reasonable and which form the basis for making judgments about matters that are not readily apparent from other sources. On an ongoing basis, our management evaluates its estimates. Actual results may differ from those estimates as facts, circumstances and conditions change.

The selection of critical accounting policies, the judgments and other uncertainties affecting application of those policies and the sensitivity of reported results to changes in conditions and assumptions are factors to be considered when reviewing our financial statements. Our principal accounting policies are set forth in detail in Note 3 to our consolidated financial statements included elsewhere herein. We believe the following critical accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements.

Revenue Recognition

Revenue is recognized when title to the products and risk of ownership are transferred to the customers, which occurs principally at the time of shipment. We continuously evaluate whether our products meet our inspection standards and can reliably estimate sales returns expected to result from customer inspections. Allowance and related provisions for sales returns are estimated based on historical experience, our management’s judgment, and any known factors that would significantly affect such allowance. Such provisions are deducted from sales in the same period the related revenue is recorded. There have been no changes in this policy for the last three years.

The movements of the allowance for sales returns and discounts are as follows:

 

     2009     2010     2011  
     NT$     NT$     NT$     US$  
     (in thousands)  

Balance at beginning of year

     1,145,135        118,329        782,007        25,834   

Provision charged to revenue

     623,728        2,015,341        2,474,726        81,755   

Utilized

     (1,650,534     (1,351,663     (2,805,707     (92,689
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of year

     118,329        782,007        451,026        14,900   
  

 

 

   

 

 

   

 

 

   

 

 

 

The provision made in 2011 decreased as compared with 2010 primarily due to the decreases in sales in 2011. The provision made in 2010 increased as compared with 2009 primarily due to the increases in sales in 2010.

 

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Long-Lived Assets, Excluding Goodwill

Under ROC and US GAAP, we review our long-lived assets, including purchased intangible assets for impairment whenever events or changes in circumstances indicate that the assets may be impaired and the carrying amounts of these assets may not be recoverable. Our long-lived assets subject to this evaluation include property, plant and equipment and amortizable intangible assets.

Under ROC GAAP, we measure recoverability of our long-lived assets by comparing the carrying amount of an asset to the future net discounted cash flows to be generated by the asset. If the sum of the discounted cash flows is less than the carrying value, an impairment charge is recognized for the amount that the carrying value of the assets exceeds its fair value. When circumstances subsequent to the loss recognition indicate that the earlier carrying amount of the asset is recoverable, the amount of loss may be reversed to the extent that the resulting carrying value should not exceed the carrying value had no impairment loss been recognized in prior years. Under US GAAP, we assess recoverability of our long-lived assets to be held and used by comparing the carrying amount of an asset to its future net undiscounted cash flows. If we consider our assets to be impaired, the impairment we would recognize is the excess of the carrying amount over its estimated fair value derived from discounted cash flow analysis. Such impairment cannot be reversed.

The process of evaluating the potential impairment of long-lived assets requires significant judgment. Our cash flow assumptions are based on historical and forecasted revenue, operating costs, and other relevant factors. Due to the cyclical nature of our industry and changes in our business strategy, market requirements, or the needs of our customers, if our estimates of future operating results change, or if there are changes to other assumptions, the estimate of the fair value of long-lived assets could change significantly. Such change could result in impairment charges in future periods, which could have a significant impact on our consolidated financial statements. Under ROC GAAP, we recognized impairment losses on long-lived assets of nil in both 2009 and 2010 and NT$16.0 million (US$0.5 million) in 2011, classified under non-operating expenses and losses. Under US GAAP, the impairment losses on long-lived assets were not materially different from the amounts recognized under ROC GAAP. We classify impairment losses on long-lived assets and assets held for sale within operating expenses under US GAAP.

Business Combinations and Goodwill

When we acquire businesses, under ROC GAAP, we allocate the purchase price to tangible assets and liabilities and identifiable intangible assets acquired. Any residual purchase price is recorded as goodwill. Under US GAAP, pursuant to FASB ASC Topic 805, “Business Combinations – a replacement of Statement 141,” the identifiable assets, liabilities, non-controlling interests, and goodwill acquired in a business combination are required to be recognized and measured at “full fair value.” The sum of the fair value of identifiable net assets acquired less the fair value of the non-controlling interests, if any, exceeding the sum of the fair value of the consideration transferred and the fair value of the equity interests held before the business combination is recorded as goodwill. The allocation of the purchase price requires management to make significant estimates in determining the fair values of assets acquired and liabilities assumed, especially with respect to intangible assets. These estimates are based on historical experience and information obtained from the management of the acquired companies. These estimates can include, but are not limited to, the cash flows that an asset is expected to generate in the future, the appropriate weighted-average cost of capital, and the cost savings expected to be derived from acquiring an asset. These estimates are inherently uncertain and unpredictable. In addition, unanticipated events and circumstances may occur which may affect the accuracy or validity of such estimates.

Goodwill is not amortized but is tested for impairment at least annually or more frequently if events or circumstances indicate it might be impaired. Prior to 2010, we determined that we have one cash-generating unit, taken the enterprise as a whole, for purposes of testing goodwill for impairment. As a result of the acquisition of M. Setek in late 2009, we have two cash-generating units, which are the display business unit and the solar business unit, for the purposes of testing goodwill for impairment in 2010 and 2011. The recoverable amount of the cash-generating unit calculated using a cash flow projection of eight years was compared to the carrying value of the cash-generating unit. If the recoverable amount of the cash-generating unit is lower than the carrying amount of the cash-generating unit, an impairment loss is recognized. We test goodwill for impairment annually on June 30 and when a triggering event occurs between annual impairment tests.

 

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Under US GAAP, we also determined that we have two reporting units for purposes of testing goodwill for impairment in 2010 and 2011. We entered the solar business with the acquisition of M. Setek in October, 2009. The acquisition resulted in the recognition of a gain on bargain purchase under US GAAP and no additional goodwill was recognized. Therefore, there is no need to test the solar reporting unit for goodwill impairment because there is no goodwill allocated to it. Under US GAAP, the goodwill impairment test is a two-step test. We estimated the fair value of the display and solar business reporting units by using the discounted cash flow approach, which we believed we have made reasonable estimates and assumptions in determining the fair value. In addition, for the purpose of analyzing the reasonableness of the fair value determined by the discounted cash flow approach, we also compared the aggregate sum of the fair value measurements of our display and solar reporting units to our market capitalization at June 30, 2011 based on the quoted market price of our shares, adjusted it by an appropriate control premium. To determine an appropriate control premium, references were made to recent and comparable merger and acquisition transactions in the high-tech electronics industry. If the fair value of the reporting unit is less than its carrying value, an indication of goodwill impairment exists for the reporting unit. An impairment loss will be recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation, in accordance with FASB ASC Topic 805.

Under ROC GAAP, based on management’s assessment, the estimated fair values of the display and solar cash generating units significantly exceeded their respective carrying amounts at June 30, 2011. Also, under US GAAP, the estimated fair value of the display reporting unit significantly exceeded its carrying amount at June 30, 2011. Therefore, management concluded that goodwill was not impaired.

During the second half of 2011, the quoted market price of our capital shares had sustained a further decline resulting in our market capitalization becoming substantially lower at December 31, 2011. Consequently, management determined the need for an additional test for goodwill impairment at December 31, 2011. As a result of that additional assessment, under ROC GAAP, the estimated fair values of the display and solar cash generating units continued to significantly exceed their respective carrying amounts at December 31, 2011. Also, on a US GAAP basis, the estimated fair value of the display reporting unit significantly exceeded its carrying amount at December 31, 2011. Therefore, management concluded that goodwill was not impaired and, accordingly, no impairment charge was recorded at December 31, 2011.

The Company performed an analysis at June 30, 2010 to evaluate the potential impairment of our goodwill on both ROC GAAP and US GAAP basis. The valuation methodology of performing the goodwill impairment test was the same with that utilizing at June 30, 2011. Based on management’s assessments, the estimated fair values of the display and solar cash generating units significantly exceeded their respective carrying amounts at June 30, 2010 under ROC GAAP. Also, the estimated fair value of the display reporting unit exceeded its carrying amount at June 30, 2010 under US GAAP basis. Therefore, management concluded that goodwill was not impaired. In addition, no triggering events occurred between annual impairment test dates.

In 2009, we determined that we only have one cash-generating unit and one reporting unit under ROC GAAP and US GAAP, respectively, for purposes of testing goodwill for impairment, which is the enterprise as a whole. On June 30, 2009, we compared the carrying amount of total stockholders’ equity consolidated on a US GAAP basis to market value based on the quoted market price of our shares on the date of assessment to determine if goodwill is potentially impaired. We did the test again for goodwill impairment on December 31, 2009. Based on the assessments mentioned above, we concluded that goodwill was not impaired under both ROC GAAP and US GAAP.

Allowance for Doubtful Accounts Receivable

We evaluate our outstanding accounts receivables on a monthly basis for collectability purposes. Our evaluation includes an analysis of the number of days outstanding for each outstanding accounts receivable account. When appropriate, we provide a provision that is based on the number of days for which the account has been outstanding. The provision provided on each aged account is based on our average historical collection experience and current trends in the credit quality of our customers. We also carry accounts receivable insurance for potential defaults. There have been no changes in this policy for the last three years.

 

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The movements of the allowance for uncollectible accounts are as follows:

 

     2009     2010     2011  
     NT$     NT$     NT$     US$  
     (in thousands)  

Balance at beginning of year

     99,333        95,998        86,195        2,847   

Provision charged to expense (reversed to income)

     (3,335     20,534        (4,270     (141

Write-off

     —          (30,337     —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of year

     95,998        86,195        81,925        2,706   
  

 

 

   

 

 

   

 

 

   

 

 

 

The allowance we established for uncollectible accounts in 2010 decreased by 10.2% as compared to 2009 primarily due to the write-off of uncollectible account according to our accounting policy. The allowance we established for uncollectible accounts in 2011 decreased as compared to 2010 primarily due to the collection of several payments of overdue accounts receivable that were previously assessed unlikely to be paid along with continuous improvement on management of accounts receivable.

Realization of Inventory

Provisions for inventory obsolescence and devaluation are recorded when we determine that the amounts that will ultimately be realized are less than their cost basis or when we determine that inventories cannot be liquidated without price concessions, which may be affected by the number of months inventory items remain unsold and their prevailing market prices. Additionally, our analyses of the amount we expect to ultimately realize are based partially upon forecasts of demand for our products and any change to these forecasts. There have been no changes in this policy for the last three years.

As of December 31, 2009, 2010 and 2011, the provision for inventory obsolescence and devaluation was NT$4,359.3 million, NT$6,046.6 million, and NT$8,584.5 million (US$283.6 million), respectively, which were classified in cost of goods sold in the consolidated statements of operations. The provision made in 2009 decreased significantly primarily due to an increase in the average selling price in the fourth quarter of 2009. The provision made in 2010 increased significantly due to substantial decrease in average selling prices in the fourth quarter of 2010. The provision made in 2011 increased significantly due to substantial decrease in average selling prices in 2011 compared to 2010. For the years ended December 31, 2009, 2010 and 2011, there have been no significant recoveries in excess of adjusted carrying amounts of inventory that were previously written-down.

Equity-Method Investments

When we have the ability to exercise significant influence over the operating and financial policies of investees (generally those in which we own between 20% and 50% of the investee’s voting shares and/or have significant board and management representation) those investments are accounted for using the equity method. The difference between the acquisition cost and the carrying amount of net equity of the investee as of the acquisition date is allocated based upon the pro rata excess of fair value over the carrying value of non-current assets. Any unallocated difference is treated as investor-level goodwill. Prior to January 1, 2006, under ROC GAAP, the amount of unallocated difference is amortized over five years. Commencing January 1, 2006, as required by the amended ROC SFAS No. 5 “Long-term Investments under Equity Method,” it is no longer amortized and the carrying value of the total investment is assessed for impairment. Under US GAAP, such difference is not amortized, but the carrying value of the total investment is assessed for impairment. The allocation of excess basis in equity-method investments requires the use of judgments regarding, among other matters, the fair value and estimated useful lives of long lived assets. Changes in those judgments would affect the amount and timing of amounts charged to our statement of income.

In 2011, the Company’s investment in Qisda experienced significant declines in market value. Considering primarily the length of time and the extent to which the market value (based on quoted share price) was less than the carrying amount of the investment, management concluded that this impairment was other-than-temporary at December 31, 2011, for US GAAP purposes. As a result, the Company recognized an impairment loss of NT$1,801.9 million (US$59.5 million) related to its investment in Qisda for the year ended December 31, 2011. No impairment loss was recognized for ROC GAAP purposes for the investment in Qisda because management believes that the recovery of the carrying amount is supported by the expected discounted cash flows from the investment.

 

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Certain investments in which we hold less than a 20% voting interest, but are nonetheless able to exercise significant influence over the operating and financial policies of investees through board representation or other means are also accounted for using the equity method. Significant judgment is required to assess whether we have significant influence. Factors that we consider in making such judgment include, among other matters, participation in policymaking processes, material intercompany transactions, interchange of managerial personnel, or technological dependency.

Income Taxes Uncertainties and Realization of Deferred Tax Assets

We are subject to the continuous examination of our income tax returns by the ROC tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes.

As of December 31, 2011, our valuation allowances on deferred tax assets was NT$25,480.7 million (US$841.8 million) under ROC GAAP, which primarily due to investment tax credits that we believe are unlikely to be realized in the future. During 2010 and 2011, investment tax credits that expired unused amounted to NT$6,889.4 million and NT$2,305.8 million (US$76.2 million), respectively. Such investment tax credits were previously fully provided in the valuation allowance. Therefore, the write-offs of these deferred tax assets and related valuation allowances had no impact on our income tax expense in 2010 and 2011. In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible and net operating loss and investment tax credits utilized. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Under ROC GAAP, based upon projections for future taxable income over the periods in which the deferred tax assets are deductible, we believe it is more likely than not that we will realize the benefits of these deductible differences, net operating loss and investment tax credits, net of the existing valuation allowance as of December 31, 2011. However, under US GAAP, cumulative losses in recent years is a significant piece of negative evidence which is difficult to overcome with projections of future operating profits for the purpose of determining the valuation allowance for deferred income tax assets. A valuation allowance is provided on deferred tax assets to the extent that it is not “more likely than not” that such deferred tax assets will be realized. As a result, under US GAAP, our valuation allowances on deferred tax assets was NT$42,133.1 million (US$1,391.9 million) as of December 31, 2011.

We used estimated future taxable income for the next five years to determine the realizability of our deferred tax assets and the resulting requirement for valuation allowance. We believe that, as of December 31, 2011, the estimated future taxable income beyond the five-year period cannot be objectively and reliably determined given the cyclical nature of the display panel industry. In addition, the five-year period is considered to be consistent with the statutory period that the tax credit and loss carryforwards can be utilized under ROC Tax Law. Effective January 21, 2009, the statutory period during which loss carryforwards can be utilized has been extended to 10 years.

The amount of the deferred tax asset considered realizable could be reduced in the near term if estimates of future taxable income during the carryforwards or reversal periods are reduced.

Legal Contingencies

From time to time, we are involved in disputes that arise in the ordinary course of business, and we do not expect this to change in the future. We are currently involved in legal proceedings discussed in “Item 8.A.7. Litigation.”

When the likelihood of an unfavorable outcome from our legal proceedings is probable and our management can reasonably estimate such loss, we make appropriate provisions in our consolidated statement of operations. These estimates have been based on our assessment of the facts and circumstances at each balance sheet date and are subject to change based upon new information and intervening events.

 

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Convertible bonds

In October 2010, we issued US$800.0 million unsecured zero coupon convertible bonds, which were recorded in their entirety as a liability at fair value at the date of issuance under US GAAP. The difference between fair value and redemption value at the date of issuance is recorded as a discount, and amortized over the redemption period using the effective interest rate method. In September 2011, we early redeemed US$100 million of the bonds at a cost of US$78.7 million.

Under US GAAP, we concluded that the conversion features for the new overseas convertible bonds qualified as embedded derivative instruments under FASB ASC Topic 815, as these bonds are denominated in a currency that is different from our functional currency, and therefore was required to be bifurcated from the debt hosts. We further concluded that the call options embedded in the convertible bonds did not meet the definition of embedded derivative instrument under FASB ASC Topic 815, as they were considered to be clearly and closely related to the debt hosts. As a result, under US GAAP, the new overseas convertible bonds were recorded at the fair value at the date of issuance without taking into account the embedded conversion options.

The reconciliation of net income determined in accordance with ROC GAAP and US GAAP for the year ended December 31, 2011 included the impact of changes in fair value of the embedded derivative instrument liability of NT$780.6 million (US$25.8 million), which is recognized only for US GAAP purposes.

Deconsolidation of a subsidiary

Under ROC GAAP, upon the sale of equity-method investment, the difference between the selling price and carrying amount of the investment at the date of sale is recognized as an investment gain or loss. Under US GAAP, pursuant to FASB ASC Subtopic 810-10, “Consolidation—Overall,” changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary is accounted for as equity transactions in the consolidated financial statements. However, if a change in ownership of a consolidated subsidiary results in a loss of control, that subsidiary is then deconsolidated and any retained ownership interest is re-measured at fair value, and any gain or loss is included in the consolidated statement of operations.

On June 30, 2010, due to a change in the composition of the board of directors of Lextar Electronics Corp. (“Lextar”), we no longer had a controlling financial interest in Lextar. As a result, we deconsolidated Lextar on June 30, 2010 and accounted for this investment under the equity method of accounting. Consequently, pursuant to FASB ASC Subtopic 810-10, we recognized a non-cash gain of NT$362.8 million, representing the difference between the fair value of the investment on June 30, 2010 and its carrying value in our US GAAP consolidated statements of operations for 2010. Under ROC GAAP, we also accounted for the investment in Lextar under the equity method of accounting upon loss of control, however no gain or loss is recognized upon deconsolidation and the carrying value of the investment in Lextar was based on our proportion interest of the net book value of Lextar on the date of deconsolidation.

Results of Operations

The following table sets forth certain of our results of operations information under ROC GAAP, in both real numbers and as a percentage of our net sales for the periods indicated:

 

     Year Ended December 31,  
     2009     2010     2011  
     NT$     %     NT$     %     NT$     %  
     (in millions, except percentages)  

Net sales

     359,331.3        100.0        467,158.0        100.0        379,711.9        100.0   

Cost of goods sold

     352,290.5        98.0        430,859.4        92.2        407,899.2        107.4   
    

 

 

     

 

 

     

 

 

 

Gross profit (loss)

     7,040.9        2.0        36,298.6        7.8        (28,187.3     (7.4
    

 

 

     

 

 

     

 

 

 

Operating expenses

     22,279.9        6.2        25,801.9        5.6        29,471.2        7.8   

Selling

     8,000.0        2.2        8,641.5        1.9        9,636.6        2.5   

General and administrative

     8,094.4        2.3        10,736.9        2.3        11,208.8        3.0   

Research and development

     6,185.5        1.7        6,423.6        1.4        8,625.8        2.3   
    

 

 

     

 

 

     

 

 

 

Operating income (loss)

     (15,239.1     (4.2     10,496.7        2.2        (57,658.5     (15.2
    

 

 

     

 

 

     

 

 

 

Net non-operating expenses and losses

     (12,028.4     (3.4     (1,900.7     (0.4     (7,993.6     (2.1
    

 

 

     

 

 

     

 

 

 

Earnings (loss) before income tax

     (27,267.4     (7.6     8,596.0        1.8        (65,652.1     (17.3

Income tax (expense) benefit

     22.6        —          (1,187.9     (0.2     4,205.1        1.1   
    

 

 

     

 

 

     

 

 

 

Net income (loss)

     (27,244.8     (7.6     7,408.1        1.6        (61,447.0     (16.2
    

 

 

     

 

 

     

 

 

 

 

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In 2011, a weaker demand in the TFT-LCD industry resulting from the slowdown of the global economy contributed to a decrease in our unit sales. As a result, we were unable to achieve higher profitability in 2011. Our gross, operating and net margins have decreased from 2010 to 2011, primarily as a result of the global economic downturn which caused a significant decrease in end-demand and a continuing decline in average selling price of panels.

For the Years Ended December 31, 2011 and 2010

Net sales

Net sales decreased 18.7% to NT$379,711.9 million (US$12,544.2 million) in 2011 from NT$467,158.0 million in 2010 primarily due to a 23.7% decrease in net sales of large size panels, which was partially offset by a 14.6% increase in net sales of small- to medium-size panels.

Net sales of large-size panels decreased 23.7% to NT$303,411.3 million (US$10,023.5 million) in 2011 from NT$397,798.2 million in 2010. This decrease was primarily due to a decrease in average selling price. The average selling price per panel of our large-size panels decreased by 24.4%, which were at NT$2,649.7 (US$87.5) in 2011 and NT$3,503.4 in 2010, respectively. Large-size panels sold slightly increased 0.8% to 114.5 million panels in 2011 from 113.5 million panels in 2010.

Net sales of small- to medium-size panels increased 14.6% to NT$50,633.1 million (US$1,672.7 million) in 2011 from NT$44,198.7 million in 2010. The increase in net sales of small- to medium-size panels was primarily due to an increase in average selling price, which was partially offset by a decrease in unit sales. The average selling price per panel of our small- to medium-size panels increased 35.0% to NT$270.1 (US$8.9) in 2011 from NT$200.1 in 2010, and unit sales of our small- to medium-size panels decreased 15.1% to 187.5 million panels in 2011 from 220.9 million panels in 2010, both primarily as a result of the change in our product mix.

Cost of Goods Sold

Cost of goods sold decreased 5.3% to NT$407,899.2 million (US$13,475.4 million) in 2011 from NT$430,859.4 million in 2010. This decrease was primarily due to a decrease in cost of raw material and component costs, as well as a reduction in units of products sold.

Raw material and component costs decreased 10.9% in 2011 as compared to 2010, primarily as a result of a decrease in average purchasing price especially in large-size panels. Overhead expenses, including depreciation and amortization expenses, increased 6.4% in 2011 as compared to 2010, primarily due to an increase in electricity expenses and repair and maintenance expense, which were partially offset by less depreciation expenses and employee profit sharing expenses and bonuses. Direct labor costs decreased 6.9% in 2011 as compared to 2010, primarily as a result of a decrease in employee profit sharing expenses and bonuses.

Gross Profit (Loss)

Gross loss was NT$28,187.3 million (US$931.2 million) in 2011 compared to gross profit of NT$36,298.6 million in 2010. Gross margin, which is gross profit (loss) divided by net sales, mainly fluctuates, among other factors, with our capacity utilization rate, market price change of our products and our product mix. We had a negative gross margin of 7.4% in 2011 compared to a gross margin of 7.8% in 2010, primarily due to the decline in average selling price and the lower capacity utilization rate caused by the global economic downturn; moreover, the scale of decrease in average selling prices was greater than the scale of decrease in cost of goods sold. As a result of a downward trend in average selling prices, net inventory devaluation write-down included in cost of goods sold increased to NT$2,735.7 million (US$90.4 million) in 2011 from NT$1,886.5 million in 2010.

 

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Operating Expenses

Operating expenses increased 14.2% to NT$29,471.2 million (US$973.6 million) in 2011 from NT$25,801.9 million in 2010. As a percentage of net sales, operating expenses increased to 7.8% in 2011 from 5.6% in 2010 which was primarily due to our decreased sales. The increase in operating expenses was primarily due to an increase in research and development expenses. Research and development expenses increased 34.3% to NT$8,625.8 million (US$285.0 million) in 2011 from NT$6,423.6 million in 2010 primarily due to devoting to research and development on future advanced technologies and high value-added products to remain competitive in the markets we serve. Research and development expenses as a percentage of net sales increased to 2.3% in 2011 from 1.4% in 2010. Selling expenses increased 11.5% to NT$9,636.6 million (US$318.4 million) in 2011 from NT$8,641.5 million in 2010, primarily due to an increase in product promotion fees, which were partially offset by a decrease in freight expense and warranty expense. Selling expenses as a percentage of net sales increased to 2.5% in 2011 from 1.9% in 2010. General and administrative expenses increased 4.4% to NT$11,208.8 million (US$370.3 million) in 2011 from NT$10,736.9 million in 2010, primarily due to an increase in professional service expenses which were partially offset by a decrease in employee profit sharing expenses and bonuses. General and administrative expenses as a percentage of net sales increased to 3.0% in 2011 from 2.3% in 2010.

Operating Income (Loss) and Operating Margin

As a result of the foregoing, we had operating loss of NT$57,658.5 million (US$1,904.8 million) in 2011 compared to an operating income of NT$10,496.7 million in 2010. We had a negative operating margin of 15.2% in 2011 compared to an operating margin of 2.2% in 2010.

Under US GAAP, we had operating loss of NT$67,768.3 million (US$2,238.8 million) in 2011 compared to operating income of NT$5,399.2 million in 2010. We had a negative operating margin of 17.8% in 2011 compared to an operating margin of 1.2% in 2010.

Under ROC GAAP, the provision for the potential litigation losses and others is usually recognized in the consolidated statement of operations as a non-operating expense. However, under US GAAP, the provision for the potential litigation losses and others is recognized in the condensed consolidated statement of operations as an operating expense.

Net Non-Operating Expenses and Losses

We had net non-operating expenses and losses of NT$7,993.6 million (US$264.1 million) in 2011 compared to non-operating expenses and losses of NT$1,900.7 million in 2010. We had higher net non-operating expenses and losses in 2011 compared to 2010 primarily due to (i) a decrease in net gains on valuation of financial instruments to NT$744.1 million (US$24.6 million) in 2011 from NT$3,986.1 million in 2010, resulting from our decreased financial instruments to hedge our position corresponding to our decreased sales in 2011; (ii) a net investment loss recognized by the equity method of NT$63.9 million (US$2.1 million) in 2011 compared to a net investment gain of NT$681.3 million in 2010, resulting from loss position of some of our investees; (iii) an increase in net interest expenses to NT$4,472.7 million (US$147.8 million) in 2011 from NT$3,946.3 million in 2010, primarily resulting from a full year of amortization expenses of convertible bonds being included in 2011 whereas 2010 only included amortization expenses from the date of issuance; (iv) a net foreign currency exchange loss of NT$94.7million (US$3.1 million) in 2011 compared to a foreign exchange currency loss of NT$3,581.1 million in 2010, primarily due to a decrease in net assets position corresponding to our decreased sales in 2011; (v) an increase in net gains on sale of investment securities to NT$3,080.7 million (US$101.8 million) in 2011 from NT$1,527.2 million in 2010; and (vi) an increase in provisions made for potential litigation losses and others to NT$8,966.3 million (US$296.2 million) in 2011 from NT$2,011.4 million in 2010.

 

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Under US GAAP, we had net non-operating expenses and losses of NT$1,855.5 million (US$61.3 million) in 2011 compared to net non-operating net income and gains of NT$69.2 million in 2010. We had net non-operating expenses and losses in 2011 compared to net non-operating income and gains in 2010, primarily as a result of an increase in asset impairment loss, a decrease in net gains on valuation of financial instruments, an increase in net interest expense and an increase in net investment loss, partially offset by a decrease in net foreign currency exchange loss and an increase in net gains on sale of investment securities. We had a loss on asset impairment of NT$2,263.0 million (US$74.8 million) in 2011 compared to nil in 2010. We had net gains on valuation of financial instruments of NT$1,667.5 million (US$55.1 million) in 2011 compared to NT$3,164.4 million in 2010. In 2011, we had a net interest expense of NT$4,609.9 million (US$152.3 million) compared to NT$3,801.7 million in 2010. We had a net investment loss of NT$26.0 million (US$0.9 million) in 2011 compared to net investment income of NT$668.5 million in 2010. In 2011, we had net foreign currency exchange loss of NT$100.0 million (US$3.3 million) in 2011 compared to NT$3,582.8 million in 2010. In 2011, we had net gains on sale of investment securities of NT$3,030.2 million (US$100.1 million) compared to NT$1,478.4 million in 2010.

Income Tax Benefit (Expense)

Under ROC GAAP, we recognized an income tax benefit of NT$4,205.1 million (US$138.9 million) in 2011 compared to an income tax expense of NT$1,187.9 million in 2010. The effective tax rate decreased to 6.4% in 2011 from 13.8% in 2010 under ROC GAAP. This change was primarily due to an increase in valuation allowance for deferred income tax assets.

Under US GAAP, we recognized an income tax expense of NT$11,492.4 million (US$379.7 million) in 2011 compared to income tax expense of NT$745.0 million in 2010. Under US GAAP, and in accordance with FASB ASC Topic 740, “Income Taxes,” if a valuation allowance is recognized at the acquisition date for deferred tax assets for an acquired entity’s deductible temporary differences or operating loss or tax credits, the tax benefit for those items that are first recognized subsequent to the acquisition (by elimination of the valuation allowance) are to be applied (a) first reduce to zero any goodwill related to the acquisition, (b) second to reduce to zero other noncurrent intangible assets related to the acquisition, and (c) third to reduce income tax expense. Additionally, cumulative losses in recent years is a significant piece of negative evidence which is difficult to overcome with projections of future operating profits for the purpose of determining the valuation allowance for deferred income tax assets. A valuation allowance is provided on deferred tax assets to the extent that it is not “more likely than not” that such deferred tax assets will be realized. Accordingly, a valuation allowance of NT$42,133.1 million (US$1,391.9 million) has been recognized for these deferred tax assets, and the effective tax rate increased to 16.5% from 13.6% in 2010 under US GAAP.

Net Income (Loss)

As a result of the foregoing, we incurred net loss of NT$61,447.0 million (US$2,030.0 million) or net loss per basic and diluted share of NT$6.94 (US$0.23) in 2011 as compared to net income of NT$7,408.1 million or NT$ 0.76 per basic share and NT$0.70 per diluted share in 2010.

Under US GAAP, we incurred net loss attributable to stockholders of AU Optronics Corp. of NT$80,948.2 million (US$2,674.2 million) or net loss per basic and diluted share of NT$9.17 (US$0.30) in 2011 as compared to net income attributable to stockholders of AU Optronics Corp. of NT$4,244.3 million or NT$0.48 per basic and diluted share in 2010. The per share effect from tax holidays for the years ended December 31, 2010 and 2011 were NT$0.05 and NT$0.02 (US$0.0007), respectively.

 

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For the Years Ended December 31, 2010 and 2009

Net sales

Net sales increased 30.0% to NT$467,158.0 million in 2010 from NT$359,331.3 million in 2009 primarily due to a 26.3% increase in net sales of large-size panels and a 29.4% increase in net sales of small-size panels.

Net sales of large-size panels increased 26.3% to NT$397,798.2 million in 2010 from NT$314,840.5 million in 2009. This increase was primarily due to an increase in the sales volume. Large-size panels sold increased 26.7% to 113.5 million panels in 2010 from 89.7 million panels in 2009. The increase in unit sales of large-size panels was primarily due to an increase in market demand. The average selling price per panel of our large-size panels remained stable, which were at NT$3,503.4 in 2010 and at NT$3,512.3 in 2009, respectively.

Net sales of small- to medium-size panels increased 29.4% to NT$44,198.7 million in 2010 from NT$34,168.5 million in 2009. The increase in net sales of small- to medium-size panels was primarily due to an increase in average selling price, which was partly offset by a slight decrease in unit sales. The average selling price per panel of our small- to medium-size panels increased 33.9% to NT$200.1 in 2010 from NT$149.4 in 2009, primarily as a result of the change in our product mix. Unit sales of our small- to medium-size panels decreased 3.4% to 220.9 million panels in 2010 from 228.6 million panels in 2009. The decrease in unit sales of small- to medium-size panels was also primarily due to the change in our product mix.

Cost of Goods Sold

Cost of goods sold increased 22.3% to NT$430,859.4 million in 2010 from NT$352,290.5 million in 2009. This increase was primarily due to an increase in the raw material and component costs and an increase in overhead expenses resulting from our increased sales.

Raw material and component costs increased 28.2% in 2010 as compared to 2009, primarily as a result of our increased unit sales. Overhead expenses, including depreciation and amortization expenses, increased 11.7% in 2010 as compared to 2009, primarily due to an increase in indirect materials and electricity expenses. Direct labor costs increased 18.4% in 2010 as compared to 2009, primarily as a result of an increase in employee bonus expenses.

Gross Profit

Gross profit increased to NT$36,298.6 million in 2010 from NT$7,040.9 million in 2009. Gross profit margin, which is gross profit divided by net sales, mainly fluctuates, among other factors, with our capacity utilization rate, market price change of our products, our product mix. Our gross profit margin increased to 7.8% in 2010 from 2.0% in 2009, primarily due to the rise of average selling prices in the first half of 2010 and our improved cost control and product mix, which was partially offset by appreciation of NT dollars against US dollars and the decline of average selling prices in the fourth quarter of 2010.

Operating Expenses

Operating expenses increased 15.8% to NT$25,801.9 million in 2010 from NT$22,279.9 million in 2009. As a percentage of net sales, operating expenses decreased to 5.6% in 2010 from 6.2% in 2009 which was primarily due to our increased sales. The increase in operating expenses was primarily due to an increase in general and administrative expenses. General and administrative expenses increased 32.6% to NT$10,736.9 million in 2010 from NT$8,094.4 million in 2009 primarily due to pre-operating expenses arising from our new plants in Japan, an increase in employee bonus and salaries, and management fees paid to the Science Based Industrial Park of the ROC, which were partially offset by less depreciation expenses and banking fees. General and administrative expenses as a percentage of net sales remained at 2.3% in 2010 and 2009. Selling expenses increased 8.0% to NT$8,641.5 million in 2010 from NT$8,000.0 million in 2009, primarily due to an increase in shipping expenses and warranty expenses, both resulting from an increase in sales and an increase in employee bonus expenses, which were partially offset by a decrease in royalty expenses. Selling expenses as a percentage of net sales decreased to 1.9% in 2010 from 2.2% in 2009. Research and development expenses increased 3.8% to NT$6,423.6 million in 2010 from NT$6,185.5 million in 2009, resulting from our increased research and development activities and an increase in employee bonus and indirect materials. Research and development expenses as a percentage of net sales decreased to 1.4% in 2010 from 1.7% in 2009.

 

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Operating Income (Loss) and Operating Margin

As a result of the foregoing, we had operating income of NT$10,496.7 million in 2010 compared to operating loss of NT$15,239.1 million in 2009. We had an operating margin of 2.2% in 2010 compared to a negative operating margin of 4.2% in 2009.

Under US GAAP, we had operating income of NT$5,399.2 million in 2010 compared to operating loss of NT$28,309.7 million in 2009. We had an operating margin of 1.2% in 2010 compared to a negative operating margin of 7.9% in 2009.

Under ROC GAAP, the provision for the potential litigation losses and others is usually recognized in the consolidated statement of operations as a non-operating expense. However, under US GAAP, the provision for the potential litigation losses and others is recognized in the condensed consolidated statement of operations as an operating expense.

Net Non-Operating Expenses and Losses

We had net non-operating expenses and losses of NT$1,900.7 million in 2010 compared to net non-operating expenses and losses of NT$12,028.4 million in 2009. We had lower net non-operating expenses and losses in 2010 compared to 2009 primarily due to (i) an increase in net gains on valuation of financial instruments to NT$3,986.1 million in 2010 from NT$813.2 million in 2009, resulting from our increased financial instruments to hedge our position corresponding to our increased sales in 2010; (ii) a net foreign currency exchange loss of NT$3,581.1 million in 2010 compared to a foreign currency exchange income of NT$236.9 million in 2009, primarily due to (1) the depreciation of US dollars against NT dollars in the second half of 2010, and (2) the appreciation of JPY against NT dollars in the second and third quarters of 2010; (iii) an increase in net gains on sale of investment securities to NT$1,527.2 million in 2010 from NT$384.2 million in 2009; (iv) an increase in net investment gains recognized by the equity method to NT$681.3 million in 2010 from NT$139.6 million in 2009, resulting from a gain on an investee company; (v) an increase in net interest expenses to NT$3,946.3 million in 2010 from NT$3,180.6 million in 2009, resulting from amortization expenses relating to the issuance of convertible bonds and a decrease in interest capitalization in 2010 compared to 2009 because more construction was completed in 2010; and (vi) a decrease in provisions made for potential litigation losses and others to NT$2,011.4 million in 2010 from NT$9,696.1 million in 2009, resulting from a decrease in the amount of provisions made in connection to antitrust matters in 2010 compared to 2009.

Under US GAAP, we had net non-operating income and gains of NT$69.2 million in 2010 compared to net non-operating expenses and losses of NT$1,352.7 million in 2009. We had net non-operating income and gains in 2010 compared to net non-operating expenses and losses in 2009, primarily as a result of an increase in net gains on valuation of financial instruments, an increase in net gains on sale of investment securities, an increase in net investment income and an increase in net other income, partially offset by an increase in net interest expense and an increase in net foreign currency exchange loss. We had net gains on valuation of financial instruments of NT$3,164.4 million in 2010 compared to net gains on valuation of financial instruments of NT$806.3 million in 2009. In 2010, we had net gains on sale of investment securities of NT$1,478.4 million compared to net gains on sale of investment securities of NT$549.2 million in 2009. We had a net investment income of NT$668.5 million in 2010 compared to a net investment income of NT$48.6 million in 2009. In 2010, we had a net other income of NT$2,071.3 million compared to a net other income of NT$1,637.0 million in 2009. In 2010, we had a net interest expense of NT$3,801.7 million compared to a net interest expense of NT$3,187.8 million in 2009. In 2010, we had net foreign currency exchange loss of NT$3,582.8 million compared to a net foreign currency exchange gain of NT$218.9 million in 2009.

 

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Income Tax Benefit (Expense)

Under ROC GAAP, we recognized an income tax expense of NT$1,187.9 million in 2010 compared to an income tax benefit of NT$22.6 million in 2009. An increase in income tax expenses primarily resulted from a substantial increase of taxable income of subsidiaries, taxes paid for dividends received from our subsidiaries located in China according to PRC’s tax regulations, a decrease of investment tax credit obtained and the effect of deferred assets caused from the change of the statutory tax rate in 2010. Therefore, the effective tax rate increased to 13.8% in 2010 from 0.1% in 2009 under ROC GAAP.

Effective from January 1, 2010, the statutory tax rate was reduced to 20% in accordance with the ROC Income Tax Act. In June 2010, the statutory rate was reduced from 20% to 17%, effective retroactively on January 1, 2010. The effective tax rate was lower than 17% primarily due to investment tax credits and tax exemptions. While we used a portion of available tax credits to offset our income tax payable, the amount of tax credits available to be applied in any year, except for the final year in which such tax credit expires, is limited to 50% of the income tax payable for that year. There is no limitation on the amount of tax credits available to be applied in the final year.

Under US GAAP, we recognized an income tax expense of NT$745.0 million in 2010 compared to an income tax benefit of NT$1,359.5 million in 2009. Under US GAAP, and in accordance with FASB ASC Topic 740, “Income Taxes,” if a valuation allowance is recognized at the acquisition date for deferred tax assets for an acquired entity’s deductible temporary differences or operating loss or tax credits, the tax benefit for those items that are first recognized subsequent to the acquisition (by elimination of the valuation allowance) are to be applied (a) first reduce to zero any goodwill related to the acquisition, (b) second to reduce to zero other noncurrent intangible assets related to the acquisition, and (c) third to reduce income tax expense. The effective tax rate increased to 13.6% in 2010 from 4.6% in 2009 under US GAAP, primarily due to the effect of the change of the statutory tax rate in 2010.

Net Income (Loss)

As a result of the foregoing, we incurred net income of NT$7,408.1 million or NT$ 0.76 per basic share and NT$0.70 per diluted share in 2010 as compared to net loss of NT$27,244.8 million or net loss per basic and diluted share of NT$3.04 in 2009.

Under US GAAP, we incurred net income attributable to stockholders of AU Optronics Corp. of NT$4,244.3 million or NT$0.48 per basic and diluted share in 2010 as compared to net loss attributable to stockholders of AU Optronics Corp. of NT$28,670.3 million or net loss per basic and diluted share of NT$3.26 in 2009. The per share effect from tax holidays for the years ended December 31, 2009 and 2010 were NT$0.09 and NT$0.05, respectively.

Segment Information

General

Our business reports in two operating segments: display business and solar business. Our management monitors and evaluates the performance of both operating segments based on the information of their sales and operating income (loss) measured under ROC GAAP. The following table sets forth our segments information for the years indicated under ROC GAAP.

 

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     For the year ended December 31,  
     2009     2010     2011  
     NT$     NT$     NT$     US$  
     (in millions)  

Net sales

        

Display business

     357,033.5        456,725.6        366,482.6        12,107.1   

Solar business

     2,297.8        10,432.4        13,229.3        437.1   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     359,331.3        467,158.0        379,711.9        12,544.2   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

        

Display business

     (13,949.3     13,102.7        (54,433.2     (1,798.3

Solar business

     (1,289.8     (2,606.0     (3,225.3     (106.5
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     (15,239.1     10,496.7        (57,658.5     (1,904.8
  

 

 

   

 

 

   

 

 

   

 

 

 

Display business

Net sales from our display business segment decrease 19.8% to NT$366,482.6 million (US $12,107.1 million) in 2011 from NT$456,725.6 million in 2010, primarily due to a 23.7% decrease in net sales of large-size panels, which was partially offset by a 14.6% increase in net sales of small- to medium-size panels. Operating expenses in our display business segment increased 18.2% to NT$28,657.5 million (US$946.7 million) in 2011 from NT$24,251.6 million in 2010, primarily due to an increase in research and development expenses. The increase in research and development expenses was primarily due to higher spending in developing future advanced technologies and high value-added products to remain competitive in the markets we serve. We had operating loss from our display business segment of NT$54,433.2 million (US$1,798.3 million) in 2011 compared to operating income of NT$13,102.7 million in 2010, primarily due to the decline in average selling prices and lower capacity utilization rate caused by the global economic downturn; moreover, the scale of the decrease in average selling prices was greater than the scale of the decrease in cost of goods sold. For information of the changes in sales by product category for our display business segment, see “4.B. Business Overview – Display Business.”

Net sales from our display business segment increased 27.9% to NT$456,725.6 million in 2010 from NT$357,033.5 million in 2009, primarily due to a 26.3% increase in net sales of large-size panels and a 29.4% increase in net sales of small-size panels. Operating expenses in our display business segment increased 10.6% to NT$24,251.6 million in 2010 from NT$21,933.1 million in 2009, primarily due to an increase in general and administrative expenses. The increase in general and administrative expenses was primarily due to an increase in employee bonus and salaries and the management fees paid to the Science Based Industrial Park of the ROC, which were partially offset by less depreciation expenses and banking fees. We had an operating income from our display business segment of NT$13,102.7 million in 2010 compared to a loss of NT$13,949.3 million in 2009.

Under US GAAP, operating loss from our display business segment was NT$64,543.0 million (US$2,132.2 million) in 2011 as compared to an operating income of NT$8,005.2 million in 2010 and an operating loss of NT$27,019.9 million in 2009. The primary differences in segment operating results under ROC GAAP versus US GAAP are depreciation of buildings, compensated absences expense, etc. and reclassification of provisions for potential litigation losses and others from non-operating expense to operating expense. See Note 27 to our consolidated financial statements for further discussion of these GAAP differences.

Solar business

Net sales from our solar business increased to NT$13,229.3 million (US$437.1 million) in 2011 from NT$10,432.4 million in 2010. Segment operating loss increased to NT$3,225.3 million (US$106.5 million) in 2011 from NT$2,606.0 million in 2010. The primary reason for the increase in solar segment sales was because AUO Crystal (Malaysia) Sdn. Bhd. and AUO Crystal Corp. have begun mass production since the second quarter and the third quarter in 2011, respectively. The main reason for the operating loss of solar business segment in 2011 was primarily due to a decline in average selling price of wafers and ingots; meanwhile, the operation of M. Setek was impacted by the major earthquake in Japan that caused a decrease in net sales during the suspension period of production. The operating results from our solar business segment under US GAAP was not materially different from the operating results under ROC GAAP.

 

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Net sales from our solar business increased to NT$10,432.4 million in 2010 from NT$2,297.8 million in 2009. Segment operating loss increased to NT$2,606.0 million in 2010 from NT$1,289.8 million in 2009. The primary reason of the increase in the reported segment sales and losses is because a full year of segment results was included for 2010 whereas 2009 only included the result of M. Setek from the date of consolidation. The main reason for the operating loss of solar business segment in 2010 was because the phase II of M. Setek Soma factory was under the start-up phase in 2010. See Note 27(a)(3) to our consolidated financial statements for information relating to the nature and effect of significant differences between ROC GAAP and US GAAP as they relate to us.

Inflation

Our most significant markets are Taiwan and the PRC. We do not believe that inflation in Taiwan or the PRC has had a material impact on our results of operations in 2011. However, we cannot provide assurance that in the event of significant variations in the nature, extent or scope of inflation within any of our key markets in the future would not have a material impact on our results of operations.

Taxation

In the past, we had been granted exemptions from income taxes in Taiwan for construction and capacity expansions of production facilities according to the Science Park Administration and the ROC Statute for Upgrading Industries. The exemption period may begin at any time within four to five years following the completion of a construction or expansion. The aggregate tax saving of such exemption were approximately nil, NT$303.7 million and nil in 2009, 2010 and 2011, respectively.

In addition, we have enjoyed other tax incentives generally available to technology companies in the ROC, including tax credits ranging from 30% to 50% for the research and development expenses and employee training expenses, and tax credits at 7% for the investment in automation equipment and technology and certain qualifying investments.

The ROC Statute for Upgrading Industries expired at the end of 2009 and we are no longer entitled to enjoy the tax benefits of investment tax credits and the five-year tax exemptions starting from January 1, 2010 in connection with our purchases of qualifying machinery and equipment and capital raising. However, we are still eligible for those unexpired tax credits and exemptions which were approved by the related authority before the expiration of the ROC Statute for Upgrading Industries.

The corporate income tax rate in Taiwan applicable to us was 25% for 2009, 17% for both 2010 and 2011. Effective from January 1, 2010, the statutory income tax rate has been reduced to 20% in accordance with the ROC Income Tax Act. In June 2010, the ROC government promulgated another amendment of the Income Tax Law to reduce the income tax rate from 20% to 17%, effective retroactively on January 1, 2010. Therefore, the statutory income tax rates applicable to AUO and its subsidiaries located in the ROC are both 17% in 2011 and 2010.

Pursuant to the Statute of Income Basic Tax Amount (the “IBTA Statute”) announced in late 2005, an alternative minimum tax system became effective on January 1, 2006 in the ROC. When a taxpayer’s income tax amount is less than the basic tax amount (“BTA”), a taxpayer is required to pay the regular income tax and the difference between the BTA and the regular income tax amount. For enterprises, BTA is determined using regular taxable income plus specific add-back items applied with a basic tax rate ranging from 10% to 12%. The add-back items include exempt capital gain from non-publicly traded security transactions and exempt income under tax holidays. Currently, the basic tax rate set by the tax authority is 10%. There are grandfathered treatments from the tax holidays approved by the tax authorities before IBTA Statute took effect. The IBTA Statute does not have a significant impact on our financial statements.

In 1997, the ROC Income Tax Law was amended to integrate the corporate income tax and shareholder dividend tax. Under such amendment, after-tax earnings generated from January 1, 1998 and not distributed to shareholders as dividends in the following year will be subject to a 10% retained earnings tax. According to the amendment to the ROC Income Tax Law, which came into effect on June 1, 2006, commencing from 2005, the undistributed retained earnings should be calculated in accordance with our earnings as determined under ROC GAAP and as reported in our audited consolidated financial statements rather than our tax returns submitted to the ROC taxation authority. See “Item 10.E. —Taxation—ROC Tax Considerations—Retained Earnings Tax.”

 

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5.B. Liquidity and Capital Resources

We need cash primarily for technology advancement, capacity expansion and working capital. Although we have historically been able to meet our working capital requirements through cash flow from operations, our ability to upgrade our technology and expand our capacity has largely depended upon, and to a certain extent will continue to depend upon, our financing capability through the issuance of equity securities, long-term borrowings and the issuance of convertible and other debt securities. If adequate funds are not available, whether on satisfactory terms or at all, we may be forced to curtail our growth plans including new capacity and advanced technology fabs. Our ability to meet our working capital needs from cash flow from operations will be affected by our business conditions which in turn may be affected by several factors. Many of these factors are outside of our control, such as economic downturns and declines in the average selling prices of our products caused by oversupply in the market. The average selling prices of our existing product lines are reasonably likely to be subject to further downward pressure in the future if oversupply occurs. To the extent that we do not generate sufficient cash flow from our operations to meet our cash requirements, we may need to rely on external borrowings and securities offerings. Our subsidiaries must follow local regulations in order to transfer funds to us. However, such regulations have not and are not expected to have an impact on our ability to meet our cash obligations. Other than as described below in “Item 5.E—Off-Balance Sheet Arrangements,” we have not historically relied, and we do not plan to rely in the foreseeable future, on off-balance sheet financing arrangements to finance our operations or expansion.

As of December 31, 2011, we had current assets of NT$202,673.9 million (US$6,695.5 million) and current liabilities of NT$204,179.9 million (US$6,745.3 million). We expect to meet our working capital requirements as they become due and comply with current ratio covenants in our long-term loans and facilities through cash flow from operations, supplemented as necessary by financing activities. In addition, we can drawdown on our existing long-term credit facilities.

As of December 31, 2011, we had cash and cash equivalents of NT$90,836.7 million (US$3,000.9 million). As of December 31, 2011, we had total short-term credit lines of NT$31,752.7 million (US$1,049.0 million), of which we had borrowed NT$7,850.8 million (US$259.4 million). All of our short-term facilities are revolving with a term of one year, which may be extended for terms of one year each with lender consent. Our repayment obligations under our short-term loans are unsecured. We believe that our existing credit lines under our short-term loans, together with cash generated from our operations, are sufficient to finance our current working capital needs.

As of December 31, 2011, we had outstanding long-term borrowings of NT$198,957.1 million (US$6,572.7 million). The interest rates in respect of most of these long-term borrowings are variable, and as of December 31, 2011 ranged between 0.645% and 7.935% per year.

Below is a summary of our major outstanding borrowings and loans as of December 31, 2011. Please also see note 16 to our consolidated financial statements for further information.

 

   

In July 2005, we entered into a NT$42.0 billion seven-year syndicated credit facility, for which the Bank of Taiwan acted as the agent bank, for the purpose of funding the construction and purchase of machinery and equipment at our first 7.5-generation fab. The syndication agreement for this facility contains covenants that require us to maintain certain financial ratios. Our obligations under this credit facility are secured by certain of our equipment and machinery. As of December 31, 2011, NT$8.2 billion (US$0.3 billion) was outstanding under this credit facility. We issued NT$5.0 billion secured corporate bonds under this credit facility in March 2006. These bonds matured in March, 2011.

 

   

In August 2006, we entered into a RMB2.8 billion and US$75.0 million seven-year unsecured syndicated credit facility, for which ABN AMRO Bank acted as the agent bank, for the purpose of funding the construction and purchase of machinery and equipment at our Suzhou and Xiamen module-assembly facilities. The syndication agreement for this facility contains covenants that require us to maintain certain financial ratios. As of December 31, 2011, NT$4.8 billion (US$0.2 billion) was outstanding under this credit facility.

 

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In September 2006, we entered into a NT$55.0 billion seven-year syndicated credit facility, for which Bank of Taiwan acted as the agent bank, for the purpose of funding the construction and purchase of machinery and equipment at our second 7.5-generation fab. The syndication agreement for this facility contains covenants that require us to maintain certain financial ratios. Our obligations under this credit facility are secured by certain of our equipment and machinery. As of December 31, 2011, NT$32.0 billion (US$1.1 billion) was outstanding under this credit facility. We issued NT$7.0 billion secured corporate bonds under this credit facility in August 2008. As of December 31, 2011, the balance of the outstanding secured corporate bonds was NT$3.5 billion (US$0.1 billion).

 

   

In October 2008, we entered into a NT$58.0 billion seven-year syndicated credit facility, for which the Ban