Annual Reports

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  • 20-F (May 3, 2011)
  • 20-F (May 11, 2010)

 
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AU OPTRONICS CORP 20-F 2005

Documents found in this filing:

  1. 20-F/A
  2. Ex-1.1
  3. Ex-32.1
  4. Graphic
  5. Graphic
  6. Graphic
Form 20-F/A
Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 


 

FORM 20-F/A

 


 

(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, 2004

 

OR

 

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

 

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)

 


 

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. 4,958,040,897 Common Shares

 

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 which financial statement item the registrant has elected to follow.    ¨  Item 17    x  Item 18



Table of Contents

EXPLANATORY NOTE

 

The annual report on Form 20-F of AU Optronics Corp. for the year ended December 31, 2004 was originally filed with the Securities and Exchange Commission on June 3, 2005. This amended filing is being made to update and restate the original filing and to include our Item 18 financials.

 

TABLE OF CONTENTS

 

     Page

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

   1

PART I

   2

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

   2

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

   2

ITEM 3. KEY INFORMATION

   2

3.A. Selected Financial Data

   2

3.B. Capitalization and Indebtedness

   5

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

   5

3.D. Risk Factors

   5

ITEM 4. INFORMATION ON THE COMPANY

   23

4.A. History and Development of the Company

   23

4.B. Business Overview

   23

4.C. Organizational Structure

   32

4.D. Property, Plants and Equipment

   32

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

   34

5.A. Operating Results

   34

5.B. Liquidity and Capital Resources

   46

5.C. Research and Development

   49

5.D. Trend Information

   50

5.E. Off-Balance Sheet and Other Arrangements

   50

5.F. Tabular Disclosure of Contractual Obligations

   50

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

   56

6.A. Directors and Senior Management

   56

6.B. Compensation of Directors, Supervisors and Executive Officers

   59

6.C. Board Practices

   60

6.D. Employees

   60

6.E. Share Ownership

   61

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

   62

7.A. Major Shareholders

   62

7.B. Related Party Transactions

   62

7.C. Interests of Experts and Counsel

   64

ITEM 8. FINANCIAL INFORMATION

   65

8.A. Consolidated Statements and Other Financial Information

   65

8.A.7. Litigation

   65

8.A.8. Dividends and Dividend Policy

   66

8.B. Significant Changes

   67

ITEM 9. THE OFFER AND LISTING

   68

9.A. Offering and Listing Details

   68

9.B. Plan of Distribution

   68

9.C. Markets

   68

9.D. Selling Shareholders

   69

 

i


Table of Contents
     Page

9.E. Dilution

   69

9.F. Expenses of the Issue

   69

ITEM 10. ADDITIONAL INFORMATION

   69

10.A. Share Capital

   69

10.B. Articles of Incorporation

   69

10.C. Material Contracts

   75

10.D. Exchange Controls

   75

10.E. Taxation

   75

10.F. Dividends and Paying Agents

   80

10.G. Statement by Experts

   80

10.H. Documents on Display

   80

10.I. Subsidiary Information

   80

ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

   80

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

   82

PART II

   82

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

   82

ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

   82

ITEM 15. CONTROLS AND PROCEDURES

   82

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT

   83

ITEM 16B. CODE OF ETHICS

   83

ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES

   83

ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES.

   84

ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS.

   84

PART III

   84

ITEM 17. FINANCIAL STATEMENTS

   84

ITEM 18. FINANCIAL STATEMENTS

   84

ITEM 19. EXHIBITS

   84

 

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Table of Contents

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, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Although these forward-looking statements, which may include statements regarding our future results of operations, financial condition, or business prospects, are based on our own information and information from other sources we believe to be reliable, 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,” “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, the cyclical nature of our industry, further declines in average selling prices, excess capacity in the TFT-LCD industry, our dependence on introducing new products on a timely basis, our dependence on growth in the demand for our products, our ability to compete effectively, changes in technology and competing products, our ability to successfully expand our capacity, our ability to acquire sufficient raw materials and key components, our dependence on key personnel, general political and economic conditions, including those related to the TFT-LCD industry, possible disruptions in commercial activities caused by natural and human-induced disasters, including terrorist activity and armed conflict, fluctuations in foreign currency exchange rates, and other factors. For a discussion of these risks and other factors, please see “Item 3. Key Information—Risk Factors.”

 

CERTAIN CONVENTIONS

 

We publish our financial statements in New Taiwan dollars, or NT dollars, the lawful currency of the Republic of China, or the ROC. This annual report contains translations of NT dollar amounts into United States dollars, or U.S. dollars, at specific rates solely for the convenience of the reader. For convenience only and unless otherwise noted, all translations from NT dollars to U.S. dollars and from U.S. dollars to NT dollars in this annual report were made at a rate of NT$31.74 to US$1.00, the noon buying rate in The City of New York for cable transfers in NT dollars per U.S. dollar as certified for customs purposes by the Federal Reserve Bank of New York on December 31, 2004. No representation is made that the NT dollar or U.S. dollar amounts referred to herein could have been or could be converted into U.S. dollars or NT dollars, as the case may be, at any particular rate or at all. On July 1, 2005, the noon buying rate was NT$31.64 to US$1.00. Any discrepancies in any table between totals and sums of the amounts listed are due to rounding.

 

All references in this annual report to “Taiwan” or the “ROC” are to the island of Taiwan and other areas under the effective control of the Republic of China, and all references to the “ROC government” are references to the government of the Republic of China. All references to the “our company,” “we,” “us” and “our” in the annual report are references to AU Optronics Corp. and its consolidated subsidiaries, unless the context suggests otherwise. All references in this annual report to the “PRC” or “China” are to the People’s Republic of China, excluding Taiwan and the special administrative regions of Hong Kong and Macau.

 

All references in this annual report to “large-size panels” refer to panels ten inches and above in diagonal length. All references to “small- to medium-size panels” refer to panels which are under ten inches in diagonal length.

 

1


Table of Contents

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 statement of operations data for the years ended December 31, 2002, 2003 and 2004 and selected balance sheet data as of December 31, 2003 and 2004 set forth below have been derived from our audited consolidated financial statements included herein. The selected balance sheet data as of December 31, 2000 and 2001 have been derived from our audited financial statements that have not been included herein. Our consolidated balance sheets as of December 31, 2002, 2003 and 2004 and related consolidated statements of operations, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2004 have been audited by KPMG Certified Public Accountants, or KPMG, independent registered public accounting firm, whose report thereon is included herein. The selected financial and operating data set forth below should be read in conjunction with “Item 5. Operating and Financial Review and Prospects” and the consolidated financial statements and the notes to those statements included herein.

 

Our consolidated financial statements are prepared and presented in accordance with generally accepted accounting principles in the ROC, or ROC GAAP. On September 1, 2001, we completed a merger with Unipac Optoelectronics Corporation, or Unipac, an affiliate of United Microelectronics Corporation, or UMC. Under ROC GAAP, the merger of Unipac has been accounted for under the pooling-of-interests method of accounting, whereby the historical financial statements of the previously separate companies for periods prior to the merger have been restated on a combined basis. As a result, unless otherwise indicated, our operational and financial data, under ROC GAAP, presented herein for periods or dates prior to September 1, 2001 represent the combined operational and financial data of our company and Unipac. In contrast, under generally accepted accounting principles in the United States, or U.S. GAAP, the merger of Unipac has been accounted for as the acquisition of Unipac by our company under the purchase method of accounting, whereby our cost of acquiring Unipac was measured by the market value of the shares we issued to Unipac shareholders in connection with the merger plus related acquisition costs. Such acquisition cost has been allocated to the assets of Unipac we acquired and the liabilities of Unipac we assumed, based on their fair value as of September 1, 2001. Our financial data, under U.S. GAAP, presented herein for periods or as of dates prior to September 1, 2001, do not include the financial data of Unipac.

 

For information relating to the nature and effect of significant differences between ROC GAAP and U.S. GAAP as they relate to us, see note 22 to our consolidated financial statements.

 

2


Table of Contents

The table below sets forth certain financial data under ROC GAAP for the periods and as of the dates indicated. As more fully discussed above in the second paragraph of this section, such data have been prepared under the pooling-of-interests method of accounting under ROC GAAP, whereby the financial data of both our company and Unipac for the periods and as of the dates prior to September 1, 2001, the date of the completion of our merger with Unipac, have been restated on a combined basis. The combined operational and financial data presented herein do not purport to be indicative of what our actual operational and financial results would have been if our merger with Unipac had actually taken place on January 1, 2000 or 2001, respectively, for the purpose of presenting our statements of operations, statements of changes in stockholders’ equity and statements of cash flows data for the years ended December 31, 2000 and 2001, respectively.

 

     Year Ended and As of December 31,

 
     2000

    2001

    2002

    2003

    2004

 
     NT$     NT$     NT$     NT$     NT$     US$  
     (in millions, except percentages and per common share and per ADS data)  

Statement of Operations Data:

                                    

ROC GAAP

                                    

Net sales

   25,583.2     37,588.6     75,689.2     104,860.6     168,111.6     5,296.5  

Cost of goods sold

   20,737.5     40,373.6     63,606.2     81,398.8     128,468.3     4,047.5  
    

 

 

 

 

 

Gross profit (loss)

   4,845.7     (2,785.0 )   12,083.0     23,461.8     39,643.3     1,249.0  

Operating expenses

   3,724.2     3,505.7     4,369.1     7,217.0     11,036.0     347.7  
    

 

 

 

 

 

Operating income (loss)

   1,121.5     (6,290.7 )   7,713.9     16,244.8     28,607.3     901.3  

Non-operating income

   1,640.2     704.0     541.8     530.8     501.0     15.8  

Non-operating expenses and losses

   825.3     1,157.8     2,232.9     1,202.4     1,084.1     34.2  
    

 

 

 

 

 

Income (loss) before income tax

   1,936.4     (6,744.5 )   6,022.8     15,573.2     28,024.2     882.9  

Income tax benefit (expense)

   926.3     34.3     (0.1 )   86.7     (61.3 )   (1.9 )
    

 

 

 

 

 

Net income (loss)

   2,862.7     (6,710.2 )   6,022.7     15,659.9     27,962.9     881.0  
    

 

 

 

 

 

Weighted average shares outstanding—Basic

   2,928.4     3,257.6     4,131.4     4,589.7     4,802.7        

Weighted average shares outstanding—Diluted

   2,928.4     3,257.6     4,420.8     4,644.2     4,802.7        

Earnings (loss) per share—Basic

   0.98     (2.06 )   1.46     3.41     5.82     0.18  

Earnings (loss) per share—Diluted

   0.98     (2.06 )   1.39     3.38     5.82     0.18  

Earnings (loss) per ADS equivalent—Basic

   9.78     (20.60 )   14.58     34.12     58.21     1.83  

Earnings (loss) per ADS equivalent—Diluted

   9.78     (20.60 )   13.91     33.77     58.21     1.83  

Balance Sheet Data:

                                    

ROC GAAP

                                    

Current assets

   19,221.0     30,515.7     49,830.0     50,682.3     59,747.3     1,882.4  

Long-term investments—equity method

   50.9     48.6     37.7     701.5     5,577.4     175.7  

Long-term investments—cost method

   —       —       46.6     185.3     373.3     11.7  

Property, plant and equipment

   60,695.4     65,669.6     71,045.3     100,552.5     159,743.1     5,032.9  

Intangible assets

   3,618.4     3,069.6     2,984.5     2,237.9     1,062.7     33.5  

Other assets

   3,821.2     4,096.9     5,227.3     3,711.3     4,190.6     132.0  

Total assets

   87,406.9     103,400.4     129,171.4     158,070.8     230,694.4     7,268.2  

Current liabilities

   14,707.5     19,495.4     25,204.3     39,789.6     53,600.8     1,688.7  

Long-term borrowings

   29,818.4     39,877.8     26,027.6     25,306.4     46,334.0     1,459.8  

Other liabilities

   115.8     79.9     111.4     320.3     194.0     6.1  

Total liabilities

   44,641.7     59,453.1     51,343.4     65,416.3     100,128.8     3,154.6  

Capital stock

   23,849.5     29,705.8     40,243.0     43,522.4     49,580.4     1,562.1  

Total stockholders’ equity

   42,765.2     43,947.3     77,828.0     92,654.5     130,565.6     4,113.6  

Other Financial Data:

                                    

ROC GAAP

                                    

Gross margin(2)

   18.9 %   (7.4 )%   16.0 %   22.4 %   23.6 %      

Operating margin(3)

   4.4 %   (16.7 )%   10.2 %   15.5 %   17.0 %      

Net margin(4)

   11.2 %   (17.9 )%   8.0 %   14.9 %   16.6 %      

Capital expenditures

   36,901.6     13,987.3     18,035.3     39,300.6     81,868.7     2,579.4  

Depreciation and amortization

   5,741.3     8,880.3     12,989.9     16,294.6     25,309.3     797.4  

Cash dividend paid

   —       —       —       2,006.9     5,208.3     164.1  

Cash flows from operating activities

   2,796.5     1,215.8     20,821.7     37,041.5     49,393.6     1,556.2  

Cash flows from investing activities

   (36,652.1 )   (15,299.5 )   (18,125.0 )   (40,339.4 )   (87,010.2 )   (2,741.3 )

Cash flows from financing activities

   27,471.8     16,779.5     16,754.3     (4,672.6 )   37,615.2     1,185.1  

 

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Table of Contents

The table below sets forth certain financial data under U.S. GAAP for the periods and as of the dates indicated. As more fully discussed above in the second paragraph of this section, such data reflects the application of the purchase method of accounting under U.S. GAAP, whereby only the financial data of our company are presented for the periods and as of the dates prior to September 1, 2001, the date of the completion of our merger with Unipac.

 

     Year Ended and As of December 31,

 
     2001

    2002

    2003

    2004

 
     NT$     NT$     NT$     NT$     US$  
     (in millions, except percentages and per common share and per ADS data)  

Statement of Operations Data:

                              

U.S. GAAP

                              

Net sales

   28,513.4     75,689.2     104,860.6     168,111.6     5,296.5  

Cost of goods sold

   31,491.1     66,197.1     84,940.9     135,256.0     4,261.4  
    

 

 

 

 

Gross profit (loss)

   (2,977.7 )   9,492.1     19,919.7     32,855.6     1,035.1  

Operating expenses

   1,670.5     3,678.7     6,581.8     12,686.8     399.7  
    

 

 

 

 

Operating income (loss)

   (4,648.2 )   5,813.4     13,337.9     20,168.8     635.4  

Non-operating income

   408.1     705.4     404.0     714.2     22.5  

Non-operating expenses and losses(1)

   1,100.5     1,367.9     1,256.6     2,307.1     72.6  
    

 

 

 

 

Income (loss) before income tax

   (5,340.6 )   5,150.9     12,485.3     18,575.9     585.3  

Income tax benefits (expenses)

   (0.3 )   (212.0 )   3,230.1     (463.4 )   (14.6 )
    

 

 

 

 

Net income (loss)

   (5,340.9 )   4,938.9     15,715.4     18,112.5     570.7  
    

 

 

 

 

Weighted average shares outstanding—Basic

   1,975.4     4,012.9     4,481.1     4,765.5        

Weighted average shares outstanding—Diluted

   1,975.4     4,294.0     4,534.6     4,765.5        

Earnings (loss) per share—Basic

   (2.70 )   1.23     3.51     3.80     0.12  

Earnings (loss) per share—Diluted

   (2.70 )   1.19     3.47     3.80     0.12  

Earnings (loss) per ADS equivalent—Basic

   (27.04 )   12.31     35.07     38.01     1.20  

Earnings (loss) per ADS equivalent—Diluted

   (27.04 )   11.94     34.74     38.01     1.20  

Balance Sheet Data:

                              

U.S. GAAP

                              

Current assets

   30,955.9     48,967.9     51,111.2     58,254.5     1,835.4  

Investments in equity-method investees

   117.2     26.8     533.2     5,719.1     180.2  

Investments in cost-method investees

   —       46.6     185.3     412.7     13.0  

Property, plant and equipment

   65,592.0     72,195.3     100,283.5     159,185.3     5,015.3  

Goodwill

   11,599.7     11,599.7     10,946.7     10,946.7     344.9  

Other intangible assets—net

   10,416.1     9,281.4     7,485.4     5,260.7     165.7  

Other assets

   1,333.3     1,413.7     3,360.4     5,335.0     168.1  

Total assets

   120,014.2     143,531.4     173,905.7     245,114.0     7,722.6  

Current liabilities

   19,676.4     25,789.5     41,275.4     55,444.9     1,746.8  

Long-term borrowings

   39,054.8     25,959.1     25,306.4     46,334.1     1,459.8  

Other liabilities

   1,144.7     1,190.6     345.0     649.4     20.5  

Total liabilities

   59,875.9     52,939.2     66,926.8     102,428.4     3,227.1  

Total stockholders’ equity

   60,138.3     90,592.2     106,978.9     142,685.6     4,495.5  

Other Financial Data:

                              

U.S. GAAP

                              

Gross margin(2)

   (10.4 )%   12.5 %   19.0 %   19.5 %      

Operating margin(3)

   (16.3 )%   7.7 %   12.7 %   12.0 %      

Net margin(4)

   (18.7 )%   6.5 %   15.0 %   10.8 %      

Capital expenditures

   8,311.5     18,035.3     39,300.6     82,011.1     2,583.8  

Depreciation and amortization

   6,649.6     14,614.0     17,369.8     26,358.0     830.4  

Cash flows from operating activities

   503.1     21,227.5     36,987.3     48,943.8     1,542.0  

Cash flows from investing activities

   (8,067.7 )   (18,549.9 )   (40,339.4 )   (88,001.0 )   (2,772.6 )

Cash flows from financing activities

   12,986.3     16,773.4     (4,618.4 )   38,066.2     1,199.3  

(1) Includes the cumulative effect of an accounting change of NT$0.6 million, net of tax in 2001.
(2) Gross margin is calculated by dividing gross profit 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.

 

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Table of Contents

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 based on the noon buying rate for cable transfers in NT dollars as certified for customs purposes by the Federal Reserve Bank of New York.

 

     NT dollars per U.S. dollar Noon Buying Rate

     Average

   High

   Low

   Period-End

     (of month end
rates for years)
              

2000

   NT$ 31.26    NT$ 33.25    NT$ 30.35    NT$ 33.17

2001

     33.82      35.13      32.23      35.00

2002

     34.54      35.16      32.85      34.70

2003

     34.40      34.98      33.72      33.99

2004

     33.27      34.16      31.74      31.74

2005: (through June 30)

     31.41      32.22      30.65      31.64

January

     31.85      32.22      31.65      31.71

February

     31.50      31.79      31.06      31.06

March

     31.11      31.73      30.65      31.46

April

     31.48      31.70      31.23      31.23

May

     31.27      31.47      30.98      31.13

June

     31.35      31.64      31.15      31.64

 

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

 

The industry in which we operate is cyclical. As a result, price fluctuations in response to supply and demand imbalances could harm our results of operations.

 

The thin film transistor liquid crystal display, or TFT-LCD, 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 sharp declines in average selling prices. For example, the significant increase in the average selling prices of large-size panels in the first half of 2002 was followed by a slowdown in demand growth in the second half of 2002, which in turn resulted in excess supply in the market and caused sharp declines in prices in that period.

 

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As a result, the average selling prices of our large-size panels decreased by 13.0% between the second quarter and the third quarter of 2002 and further decreased by 21.7% between the third quarter and the fourth quarter of 2002. There was a recovery in the average selling prices of large-size panels in 2003, with average selling prices of our large-size panels increasing by 17.3% between the first quarter of 2003 and the fourth quarter of 2003. Average selling prices of our large-size panels increased by 12.1% between the fourth quarter of 2003 and the second quarter of 2004 which was followed by a sharp decrease of 22.2% between the second quarter and the third quarter of 2004 and a further decrease of 17.1% between the third quarter and the fourth quarter of 2004. Average selling prices of our large-size panels decreased by 6.5% between the fourth quarter of 2004 and the first quarter of 2005. Capacity expansion currently being undertaken or anticipated in the TFT-LCD industry has led to excess capacity and could continue to lead to a future period or periods of general excess capacity in the industry. For example, it is expected that as additional capacity provided by fifth-, sixth- and future generation fabs becomes available, the TFT-LCD industry may face excess capacity. 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 be highly dependent upon our ability to maintain market share, increase unit sales of existing products, and introduce and sell new products that compensate for 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.

 

We experienced a net loss in 2001 and the first quarter of 2005. Although we were profitable in 2002, 2003 and 2004, if we are not profitable in 2005 or beyond, the value of the ADSs and our shares may be negatively affected.

 

We experienced a net loss in 2001 and the first quarter of 2005 due principally to a decline in the average selling prices of our products and lower utilization at our facilities caused by an oversupply of TFT-LCD panels in the market. The decline in average selling prices resulted in a decrease in our gross margins. We expect that average selling prices for many of our existing products will continue to decline over the long term. If we are not able to reduce our costs of manufacturing these panels to offset expected declines in average selling prices and maintain a high capacity utilization rate, our gross margin will continue to decline, which could seriously harm our business and reduce the value of our equity securities. Although we were profitable in 2002, 2003 and 2004, we cannot assure you that we will be profitable in 2005 or beyond.

 

Our future net sales, gross profit and operating income 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. The inability to develop or introduce new products in a timely manner may hurt our competitive position because customers may choose to source more advanced products from competitors.

 

    Our ability to develop or acquire and implement new manufacturing processes and product technologies. If we are unable to successfully implement new manufacturing processes and product technologies in a timely manner, our competitors may seize new opportunities in new markets.

 

    Our ability to control our fixed and variable costs and operating expenses. Increased fixed and variable costs and operating expenses may reduce our profitability and adversely affect our results of operations.

 

    Changes in our product mix or those of our customers. When our customers or we discontinue a product or experience production problems with new products, our results of operations may fluctuate.

 

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    Our ability to obtain raw materials and components at acceptable prices and in a timely manner. A shortage in raw materials and components could result in increased raw materials and components costs and put downward pressure on gross margins as well as cause delays to our production and delivery schedules, which may result in the loss of customers and revenues.

 

    Lower than expected growth in demand for TFT-LCD panels resulting in oversupply in the market. When oversupply conditions occur, we may reduce the price of our panels to maintain high capacity utilization rates or reduce the volume of our production.

 

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 negatively affected by:

 

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

 

    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 of orders from a key customer;

 

    changes in end users’ spending patterns;

 

    the rescheduling and cancellation of large orders;

 

    our customers’ adjustments in their inventory; 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 adversely affected if we cannot introduce new products on a timely basis 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 was initially introduced commercially in the early 1990s, this technology began to gain wide market acceptance only in the last few years, especially in the consumer electronics sector. 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 products 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 high-growth applications in computer products, consumer electronics, LCD television and other markets as demand increases. Because these products, such as mobile phones, portable game consoles, digital cameras and LCD television, are expected to be marketed to a diversified group of end-users with demands for different specifications, functions and prices, we have

 

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developed different marketing strategies to promote our panels for these products. We cannot assure you that our strategy 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.

 

Our net sales and results of operations may suffer if there is a downturn in the demand for, or a further decrease in the average selling prices of, panels for computer products.

 

A significant percentage of our net sales is derived from customers who use our TFT-LCD panels in computer products such as notebook computers and desktop monitors. Net sales of panels for computer products represented 88.3%, 85.2% and 78.1% of our net sales in 2002, 2003 and 2004, respectively. Demand for our panels for computer products is affected by numerous factors, including the general demand of the end-use markets and price attractiveness. For example, demand for desktop monitors is affected by the rate of substitution of TFT-LCD monitors for cathode ray tube, or CRT, monitors. We believe that a significant percentage of our net sales is, and will continue to be, derived from end users purchasing TFT-LCD monitors to replace their existing CRT monitors. The rate of substitution of TFT-LCD monitors for CRT monitors may be affected by a general slowdown in the global economy or a change in the average selling prices of such products which may also adversely affect the demand. In addition, since most brand companies sell their computer products bundled with TFT-LCD monitors, a change in the bundling policy of brand companies could also reduce the demand for our products. Demand for notebook computer displays may be affected by various factors, including a slowdown in information technology spending by corporations as well as a decrease in consumer spending as a result of a general slowdown in the global economy. Demand for notebook computers is also affected by price changes. A slowdown in the demand for notebook computers could adversely affect the number of panels sold and the average selling prices for our notebook computer panels.

 

If the demand for LCD television or consumer electronics products, or our market share in such end-use markets, does not grow as expected, our business prospects and results of operations may suffer.

 

Although panels for use in LCD television and consumer electronics products accounted for a small percentage of our net sales in 2004, we believe that such end-use markets present opportunities for growth. As end users may find LCD television attractive because of their thin size as compared to traditional CRT televisions, we believe that a substantial portion of our sales growth will be derived from end users purchasing LCD televisions as additional televisions or to replace traditional CRT televisions. We have installed, and we expect to continue to install, production capacity in anticipation of increased demand for LCD television generated as a result of the growing market acceptance of LCD television. As a result, if end users purchase LCD televisions at a slower rate than we expect, we may not be able to maintain high utilization rates of the capacity installed or allocated to manufacture panels for LCD television. In addition, we may face greater than expected downward pricing pressures for our panels used for LCD television and other applications as a result of excess supply of such panels due to excess capacity or as a result of price competition by competitors seeking to stimulate demand in order to maintain or increase market share. We also manufacture panels for use in consumer electronics products. Demand for consumer electronics products that use TFT-LCD panels may be adversely affected by numerous factors, including a slowdown in general economic conditions and a change in price. If there is a slowdown in the demand for LCD television or consumer electronics products that use TFT-LCD panels, our business prospects and results of operations may suffer.

 

If we are unable to maintain high capacity utilization rates, our profitability will be adversely affected.

 

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 significantly impact our gross margins. Accordingly, our ability to maintain or improve our gross margins will continue to depend, in part, on maintaining high capacity utilization rates. In turn, our ability to maintain high capacity utilization 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 maintained high capacity utilization rates in 2003

 

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and 2004 and, in particular, have been successful to date in the ramp-up of our fifth-generation fabs, our results of operations in the past have been negatively affected by low capacity utilization. We cannot assure you that we will be able to maintain high capacity utilization rates through 2005 or beyond. If demand for our products does not meet our expectations, our capacity utilization will decrease and our gross margins will suffer.

 

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 are dependent on a small number of customers for a substantial portion of our business. In 2002, 2003 and 2004, our five largest customers accounted for 39.3%, 43.6% and 35.1%, respectively, of our net sales. In addition, certain customers individually accounted for more than 10% of our net sales in each of the last three years. BenQ Corporation, or BenQ, and its subsidiaries accounted for 20.8%, 20.9% and 19.9% of our net sales in 2002, 2003 and 2004, respectively. As some of our major customers are brand companies which also provide original equipment manufacturing services for other brand companies, such as BenQ, 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, 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 or market share and our business may suffer 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 TFT-LCD 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 substantially dependent 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 adversely affected if we are unable to complete the construction and installation of our 7.5-generation fab as scheduled or encounter unforeseen disruptions in manufacturing at our 7.5-generation fab.

 

In the third quarter of 2004, we commenced construction of our 7.5-generation fab that is designed to process substrates of 1,950 mm x 2,250 mm, which is the optimal size for the production of panels larger than 40-inches. Based on our current schedule, we plan to begin installation of machinery and equipment in the second quarter of 2006 and begin commercial production in the fourth quarter of 2006. The successful completion of our 7.5-generation fab is dependent upon a number of 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 construct, install and operate a 7.5-generation fab, no assurances can be

 

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given that we will be successful in establishing our 7.5-generation fab. 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 a 7.5-generation fab 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 of our 7.5-generation fab. In addition, the manufacturing processes for TFT-LCD panels are highly complex and potentially vulnerable to disruptions. In particular, the manufacturing processes for 7.5-generation fabs are currently untested. If we are unable to complete our 7.5-generation fab as scheduled, or face unforeseen disruptions in the manufacturing processes, we may not be able to realize the potential gains from the manufacturing of 7.5-generation fabs and may face disruptions in capturing the growth opportunities associated with the expected expansion of the market for LCD TV panels.

 

If capital resources required for our expansion plans 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 next generation fabs will continue to largely depend on our ability to obtain sufficient cash flow from operations as well as external funding. We expect to make substantial capital expenditures in connection with the expansion of our production capacity, including investments in 2005 in connection with the ramp-up of our sixth-generation fab, the establishment of a third fifth-generation fab, a 7.5-generation fab and our third in-house color filter production facility. These capital expenditures will be made well in advance of any additional sales to be generated from these expenditures. We may lose market share if we do not have the capital resources to complete our expansion plans or if our actual expenditures exceed planned expenditures for any number of reasons, including changes in:

 

    our growth plan;

 

    manufacturing process and product technologies;

 

    market conditions;

 

    prices of equipment; and

 

    interest rates and foreign exchange rates.

 

We cannot assure you that required additional financing will be available to us on satisfactory terms, if at all. If adequate funds are not available on satisfactory terms at appropriate times, we may have to curtail our expansion plans, 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 and Japan. The ability to manufacture on a large scale with greater cost efficiencies is a competitive advantage in our industry. 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, sixth- or higher generation 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 TFT-LCD 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;

 

    time-to-market; and

 

    access to capital.

 

Our ability to compete successfully in the TFT-LCD industry also depends on factors beyond our control, including industry and general economic conditions.

 

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

 

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. We believe that we have benefited from this outsourcing trend in large part due to our production locations in both Taiwan and the PRC, which has allowed us to coordinate better 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 or the PRC, our sales and results of operations could be adversely affected.

 

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

 

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 are currently devoting significant resources to the ramp-up of our sixth-generation fab, the establishment of a third fifth-generation fab, a 7.5-generation fab and our third in-house color filter production facility. 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 expansion plans and seriously harm our operations.

 

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

 

Our success depends largely upon the continued services of key senior management, including our Chairman, President and Chief Executive Officer. 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. For the foreseeable future, we expect that Mr. Kuen-Yao (K.Y.) Lee’s time will be divided between serving as Chairman and Chief Executive Officer of our company and Chairman and Chief Executive Officer of BenQ. If Mr. Kuen-Yao (K.Y.) Lee is not able to devote enough time to our company, our operations may be negatively affected.

 

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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 expansion plans would be adversely affected.

 

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. In 2004, we established a new flat panel display research and development center, the AUO Technology Center, in Hsinchu Science Park. The 684,000 square foot, nine-storey research center houses eight to 16 research labs, advanced training facilities and is expected to accommodate over 1,000 research engineers. We are also planning the establishment of a professional on-the-job training facility for employees, the AUO Learning Center. Without a sufficient number of skilled employees, our operations and production quality would 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 adversely affect our business, and our operating efficiency may deteriorate.

 

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

 

We face potential conflicts of interest with BenQ. BenQ is our largest shareholder, owning directly and indirectly 13.32% of our outstanding shares as of July 1, 2005, and is also one of our largest customers. BenQ and its subsidiaries accounted for 20.8%, 20.9% and 19.9% of our net sales in 2002, 2003 and 2004, respectively. BenQ’s substantial interest in our company may lead to conflicts of interest affecting our sales decisions or allocations. In addition, as of July 1, 2005, three of our nine directors and one of our three supervisors are representatives of BenQ, and Mr. Kuen-Yao (K.Y.) Lee, our Chairman and Chief Executive Officer, is also Chairman and Chief Executive Officer of BenQ. As a result, conflicts of interest between their duties to BenQ and us may arise.

 

We cannot assure you that when conflicts of interest arise with respect to representatives of BenQ, 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.

 

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

 

The United States Securities and Exchange Commission, or 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 attest to and report on management’s assessment of the effectiveness of the company’s internal controls over financial reporting. These requirements will first apply to our annual report on Form 20-F for the fiscal year ending December 31, 2006. 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 still be unable to attest to our management’s assessment or may issue a report that concludes 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 time to meet the deadline imposed by the Sarbanes-Oxley Act for compliance with the requirements of Section 404. 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. 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

 

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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 anticipate that we will incur considerable costs and use significant management time and other resources in an effort to comply with Section 404 and other requirements of the Sarbanes-Oxley Act.

 

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 periodically modified 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 many of these difficulties in connection with the planned establishment of our third fifth-generation fab and our 7.5-generation fab, and the ramp-up of production capacity for our sixth-generation fab. We may also encounter these difficulties in connection with the establishment of our third in-house color filter production facilities as well as the adoption of new manufacturing process technologies. We cannot assure you that we will be able to complete our third fifth-generation fab, our 7.5-generation fab, our third in-house color filter production facilities, and the ramp-up of our sixth-generation fab without material 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 high quality raw materials and components 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, or CCFL, and polarizer and glass substrates, from a limited group of suppliers, both foreign and domestic. In 2001, we experienced a shortage of glass substrates due to the closure of the production facility of one of our two major suppliers of glass substrates. In addition, there was a shortage in the supply of color filters and glass substrates beginning in the second half of 2003 which continued into 2004. In addition, based on announced plans for new TFT-LCD production capacity, there could also be a shortage in the supply of driver integrated circuits, polarizer and CCFL. Our operations would be adversely affected 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 TFT-LCD manufacturers, including our company, without a corresponding increase in the supply of raw materials and components. The impact of any material shortage in raw materials and components will be magnified as we establish new fabs and continue to increase our production capacity.

 

Although approximately 37.4% of our raw materials and components was sourced locally in Taiwan in 2004, we depend on supplies of certain principal raw materials and components from suppliers in Japan. 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 high-quality raw materials and components 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 from our suppliers, we may be forced to delay our expansion plans.

 

We have purchased, and expect to purchase, a substantial portion of our equipment from foreign suppliers, especially for our planned 7.5-generation fab. 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

 

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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 expansion plans and impair our ability to meet customer orders. If we are unable to implement our expansion plans on schedule or in line with customer expectations, our business may suffer.

 

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

 

TFT-LCD manufacturing processes are complex and involve a number of precise steps. Defective production can result from a number of factors, including:

 

    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. 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 will negatively affect our results of operations.

 

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. We incurred small fines in December 2002 and October 2003 for non-compliance with a waste storage-labeling requirement. In June 2004, we also incurred small fines for failure to update our air pollution emission permit.

 

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.

 

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 TFT-LCD industry evolve quickly, resulting in steep price declines in the advanced stages of a product’s life cycle. To remain competitive, we must continually develop or acquire advanced manufacturing process technologies and build next generation fabs to lower production costs and enable timely release of new products. In addition, we expect to utilize other display technologies, such as organic light-emitting diode, or OLED, and low temperature poly-silicon, or LTPS, 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. We plan to invest a substantial amount of capital to ramp-up our sixth-generation fab, establish a third fifth-generation fab and a 7.5-generation

 

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fab and have committed significant management resources to develop color filter production facilities. However, we cannot assure you that we will be successful in completing the development of the sixth-generation fab or 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.

 

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, or PDP, and OLED technologies. Currently, PDP technology is primarily used to produce panels larger than 30-inches for use in television, as compared to the TFT-LCD technology primarily used to produce panels less than 40-inches for use in monitors, notebooks and LCD television. However, as the demand for LCD televisions with panel sizes as large as that of televisions using PDP technology continues to grow, competition between these two technologies is likely in the large-size television market. 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 and digital still cameras. Future development of OLED technology may also 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 in the research and development stage, such as field emission display, or FED, inorganic electroluminescent, or IEL, and surface-conduction electron-emitter, or 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 price-to-performance ratios, such technologies may compete with TFT-LCD technology and render our products uncompetitive.

 

We also face competition 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 price to performance ratio. If alternative display technologies gain a larger market share in the market for large-size television, our business prospects may be adversely affected.

 

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 major licensing arrangements with Matsushita, Fujitsu Display Technologies Corporation, or FDTC, Semiconductor Energy Laboratory Co., Ltd., or SEL, Toppan Printing Co., Ltd., or Toppan, and other companies for product and manufacturing process technologies used to produce a substantial number of our TFT-LCD panels. These agreements are typically for terms of five to seven years. 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.

 

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We have entered into patent and intellectual property license agreements that 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 materially and adversely affected.

 

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 are currently involved in intellectual property disputes with several companies. See “Item 8. Financial Information—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; 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 could in turn materially and adversely affect 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 materially and adversely affect 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 adequately protect 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. As of December 31, 2004, we had 536 U.S. patent applications pending, 663 Taiwan patent applications pending and 1,099 patents pending in other jurisdictions. 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 may independently develop substantially equivalent intellectual property or otherwise gain access to our trade secrets or intellectual property. Our failure to effectively protect our intellectual property could harm our business.

 

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Political, Geographical and Economic Risks

 

Due to the location of our operations in Taiwan and the PRC, 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, which is vulnerable to natural disasters. In 2004, approximately 40.6% of our net sales was derived from Taiwan-based customers. In addition, we have expanded our module assembly operations to the PRC since July 2002. Our module-assembly operations in the PRC, and the operations of many of our customers and suppliers in that area, may also be vulnerable to natural disasters. As a result of this geographic concentration, disruption of operations at our fabs or the facilities of our customers and suppliers for any reason, including work stoppages, power outages, water supply shortages, fire, typhoons, earthquakes or other natural disasters, could cause delays in production and shipments of our products. Any delays or disruptions could result in our customers seeking to source TFT-LCD panels from other manufacturers. For instance, our operations stopped completely for five days in September 1999, largely because of a power outage caused by a severe earthquake. After the stoppage, it took us several days to ramp-up to full operations. Shortages or suspension of power supplies have occasionally occurred, and have disrupted our operations. The occurrence of a power outage in the future could seriously hurt our business.

 

Our manufacturing processes require a substantial amount of water. Although currently more than 75% 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 one of our principal manufacturing sites is 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 seriously affect 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 adversely affect 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. 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 subject, to a significant degree, to the 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. 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. Although we believe these reforms will have 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. For example, the PRC government has indicated publicly that it may change its monetary policy to tighten the extension of credit and discourage investments, particularly in certain industries such as real estate and construction. This change in policy may adversely affect our 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.

 

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Although we have been advised that we have all the relevant government approvals required in connection with our PRC operations, additional approvals from the PRC central government may be required.

 

We operate module assembly facilities in the Suzhou Industrial Park located in Suzhou, PRC, through our subsidiary, AU Optronics (Suzhou) Corp., Ltd. The Suzhou Industrial Park is a special economic zone established by the PRC central government with others and is under the regulation of the Suzhou Industrial Park Administrative Committee, or SIPAC. Under PRC laws and regulations, foreign investment projects require the approval of the relevant governmental authorities in the province or special economic zone in which the project is located and, in some circumstances, the approval of the relevant authorities of the PRC central government. In connection with the initial establishment and subsequent capital increases of our PRC subsidiary, we received approvals from SIPAC, which were filed by SIPAC with the State Planning Commission, the National Development and Reform Commission and the Ministry of Commerce of the central government of the PRC. We have been advised by SIPAC that such approvals and filings complete the approval process, which is consistent with the approval processes generally applicable to companies under the regulation of SIPAC, and that all necessary PRC governmental approvals in connection with the initial establishment and subsequent capital increases of our PRC subsidiary have been obtained.

 

The interpretation of PRC laws and regulations involves uncertainties, however, and there can be no assurance that all relevant authorities of the PRC central government will agree with SIPAC’s position, and it has come to our attention that additional approval from the PRC central government may be required for the initial establishment and subsequent capital increases of our PRC subsidiary. If required, we intend to obtain any such additional approval in consultation with SIPAC. In that event, we cannot assure you as to when the PRC central government will grant such approval, if at all. Because the PRC central government has significant discretion in dealing with our situation, we cannot assure you that the PRC central government will not take action that is material and adverse to our PRC operations.

 

The current restrictions imposed by the ROC government on investments in certain related businesses may limit our ability to compete with other TFT-LCD manufacturers that are permitted to establish TFT-LCD 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 lower production costs in China and to establish a presence in the China market, we established module-assembly facilities in Suzhou, Jiangsu Province of the PRC. We commenced operations at such facilities in July 2002. Module-assembly involves connecting components to the cell panel. We may further explore the possibility of investing in other businesses or operations in the PRC as and when we are legally permitted to do so. Currently, ROC laws and regulations permit investment in module-assembly operations in the PRC but do not permit investments in array and cell operations. We do not know when or if such ROC laws and regulations governing investment in the PRC will be amended, and we cannot assure you that any such amendments to those regulations will permit us to invest in operations involving array and cell processes in the PRC.

 

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 40% of our net sales is derived from customers in Taiwan. Accordingly, our business and financial condition may be affected by changes in local governmental policies and political and social instability.

 

Taiwan has a unique international political status. The government of the PRC asserts sovereignty over mainland China and Taiwan, and does not recognize the legitimacy of the government of the ROC. The government of the PRC has indicated that it may use military force to gain control over Taiwan if Taiwan declares independence or a foreign power interferes in Taiwan’s internal affairs. In particular, the increasing influence of the Democratic Progressive Party, which has in the past formally advocated Taiwan’s independence from the PRC, including the reelection of Mr. Chen Shui-bian, a member of that party, as President of the ROC in March 2004, may increase political tensions and instability between the PRC and the ROC. In addition, on

 

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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 would be materially and adversely affected.

 

In recent years, the currencies of many East Asian countries, including Taiwan, have experienced considerable volatility and depreciation. The Central Bank of China, which is the central bank of the ROC, 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. NT dollars have depreciated against U.S. dollars from US$1.00 = NT$27.52 on January 2, 1997 to US$1.00 = NT$31.64 on July 1, 2005, based on the noon buying rates published by the Federal Reserve Bank of New York.

 

Our business, financial condition and results of operations may be affected by changes in ROC government policies, taxation, inflation and interest rates in Taiwan, as well as general economic conditions in Taiwan. In addition, the banking and financial sectors in Taiwan have been seriously harmed by the general economic downturn in Asia and Taiwan in recent years, which has caused a depressed 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. The Taiwan Stock Exchange has experienced substantial fluctuations in the prices and volumes of trading of securities. In the past decade, the Taiwan Stock Exchange Index peaked at 12,495.34 in February 1990 and subsequently fell to a low of 2,560.47 in October 1990. On March 13, 2000, the Taiwan Stock Exchange Index experienced a 617-point drop, which represented the single largest decrease in the Taiwan Stock Exchange Index in its history. The Taiwan Stock Exchange Index experienced a 17.1% increase in 2001, a 19.8% decrease in 2002 and a 32.3% increase in 2003. During the period from January 1, 2004 to December 31, 2004, the Taiwan Stock Exchange Index peaked at 7,034.10 on March 4, 2004, and reached a low of 5,325.68 on July 20, 2004. Over the same period, daily closing values of our shares ranged from NT$33.2 per share to NT$78.5 per share. On July 1, 2005, the Taiwan Stock Exchange Index closed at 6,272.14, and the closing value of our shares was NT$54.5 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 seriously affected.

 

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 in U.S. dollars, Japanese yen and NT dollars in varying amounts. For example, in 2004, approximately 96.8% of our net sales was denominated in U.S. dollars. During the same

 

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period, approximately 29.4%, 30.3% and 40.1% of our cost of goods sold (principally raw materials and component costs) was denominated in NT dollars, Japanese yen and U.S. dollars, respectively. In addition, in 2004, approximately 30.9%, 53.1% and 13.4% 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.

 

Disruptions in the international trading environment may seriously decrease our international sales.

 

A substantial portion of our net sales is derived from sales to customers located outside of Taiwan. In 2002, 2003 and 2004, sales to our overseas customers accounted for 47.3%, 57.5% and 59.4%, respectively, of our net sales. In addition, the majority 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.

 

A reoccurrence of Severe Acute Respiratory Syndrome, or SARS, or an outbreak of avian flu or other contagious diseases, may have an adverse effect on the economies and financial markets of certain Asian countries and may adversely affect our results of operations.

 

In the first half of 2003, China, Hong Kong, Taiwan, Singapore, Vietnam and certain other countries experienced an outbreak of SARS, a highly contagious form of atypical pneumonia. To date, the SARS outbreak that occurred in the first half of 2003 has had no significant impact on our production operations and those of our suppliers or customers. Additionally, the World Health Organization has warned that a potentially lethal strain of the avian flu could spread from Southeast Asia to other areas, including Taiwan and other countries where our operations are located. We cannot assure you that future outbreaks of SARS, avian flu or other contagious diseases will not occur and that any future outbreaks, or the measures taken by the ROC, PRC or other countries’ governments against such potential outbreaks, will not seriously interrupt our production operations or those of our suppliers and customers. The perception that an outbreak of SARS, avian flu or other contagious disease may have an adverse effect on the economic conditions of certain countries in Asia.

 

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

 

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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 and Supervisory Commission, unless:

 

(1) we pay stock dividends on our shares;

 

(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 ROC Financial and Supervisory Commission, 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 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 voting rights as our shareholders, which may affect the value of the ADSs.

 

ADS holders’ voting 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 and supervisors, 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 and supervisors, 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.

 

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.

 

Our issuance of stock bonuses to employees may have a dilutive effect on our ADSs.

 

Similar to other technology companies in Taiwan, from time to time we may issue bonuses to our employees in the form of shares, valued at par, under the ROC Company Law and our articles of incorporation. Since these shares are issued at par value, the issuance of these shares may have a dilutive effect on ADSs.

 

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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 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, or the Investment Regulations. You will also be required to appoint an eligible agent in the ROC to open a securities trading account and a Taiwan Securities Central Depository Co., Ltd. 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 will be able to obtain the Foreign Investor Investment I.D. and open such accounts in a timely manner.

 

Non-ROC holders of ADSs withdrawing our shares represented by ADSs are also 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, 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 will be able to appoint and obtain approval for such agent in a timely manner.

 

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 supervisor 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 executive officers, directors, supervisors 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 July 1, 2005, we had an aggregate of 4,958,040,897 shares issued and outstanding which were freely tradable, except for 12,000,000 shares of our treasury shares. If we, our executive officers, directors, supervisors 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 executive officers, directors, supervisors or existing 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, supervisors and executive officers, and some of the experts named herein, are residents of Taiwan. As a result, it

 

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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., or 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 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.

 

Our principal executive offices are located at No. 1, Li-Hsin Road 2, Hsinchu Science Park, Hsinchu, Taiwan, ROC and our telephone number is 886-3-500-8899. 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.

 

4.B. Business Overview

 

Introduction

 

We design, develop, manufacture, assemble and market flat panel displays and substantially all of our products are TFT-LCD panels. TFT-LCD is currently the most widely used flat panel display technology. Our panels are used in computer products, such as notebook computers and desktop monitors, consumer electronics products, such as digital cameras, digital camcorder, car television, car navigation systems and portable DVD players, as well as for LCD television.

 

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. These original equipment manufacturing service providers, most of whose production operations are located in Taiwan and 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 the areas of delivery time and design support. Some of our major original equipment manufacturing service provider customers include BenQ, Lite-On Technology and Top Victory Electronics. BenQ is a shareholder of our company, and held directly and indirectly 13.32% of our outstanding shares as of July 1, 2005. We also sell our products to some brand companies on a direct shipment basis.

 

We currently manufacture TFT-LCD at production 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 two fifth-generation fabs. We believe we were the first TFT-LCD manufacturer in Taiwan to commence production at a sixth-generation fab. New generations of TFT-LCD fabs are equipped to process increasingly larger sheets of glass, or substrates. For example, our sixth-generation fab is capable of processing substrates with dimensions of up to 1,500 x 1,850 millimeters, our fifth-generation fabs are capable of processing substrates with dimensions of up to 1,100 x 1,250 millimeters and 1,100 x 1,300 millimeters, respectively, and our fourth-generation fab is capable of processing substrates with dimensions of up to 680 x 880 millimeters.

 

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We commenced commercial production of small- to medium-size panels in 1994 and large-size panels in 1999. We have significantly expanded our capacity since 1999. With production facilities utilizing 3.5-, fourth-, fifth- and sixth-generation technologies, we have the flexibility to produce a large number of panels of various sizes. We operate two fifth-generation fabs that commenced commercial production in March 2003 and February 2004, respectively and we are in the process of establishing a third fifth-generation fab which we expect to commence commercial production in the fourth quarter of 2005. Our sixth-generation fab commenced commercial production in March 2005. Our existing operations are located at three principal manufacturing sites in Taiwan and one module-assembly site in Suzhou, PRC.

 

Principal Products

 

We manufacture a wide range of TFT-LCD panels for the following principal product categories:

 

    Computer products, which typically utilize display panels ranging from 8.4 inches to larger than 20 inches, primarily for use in notebook computers and desktop monitors.

 

    Consumer electronics products, which typically utilize display panels ranging from 1.5 inches to 10.2 inches or above for use in products such as digital cameras, digital camcorders, mobile phones, car television monitors, car navigation systems, portable television, multiple function machines, printer displays, portable game consoles and portable DVD players.

 

    LCD television, which typically utilizes display panels with panel size of 14 inches to 46 inches. We commenced the production of display panels for LCD television in the fourth quarter of 2002.

 

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 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.

 

The following table sets forth our production volume by product category for the periods indicated:

 

     Year Ended December 31,

     2002

   2003

   2004

     (panels in thousands)

Panels for Computer Products

              

Panels for notebook computers

   3,133.7    3,494.2    4,923.0

Panels for desktop monitors

   5,186.3    8,085.5    12,150.8
    
  
  

Total panels for computer products

   8,320.0    11,579.7    17,073.8
    
  
  

Panels for Consumer Electronics Products

   9,092.1    21,454.3    33,697.7
    
  
  

Panels for LCD Television

   1.6    249.9    1,369.4
    
  
  

Total

   17,413.7    33,283.9    52,140.9
    
  
  

 

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

 

     Year Ended December 31,

     2002

   2003

   2004

     NT$    NT$    NT$    US$
     (in millions)

Panels for Computer Products

                   

Panels for notebook computers

   22,386.5    22,009.4    32,268.5    1,016.7

Panels for desktop monitors

   44,434.7    67,349.2    98,999.8    3,119.1
    
  
  
  

Total panels for computer products

   66,821.2    89,358.6    131,268.3    4,135.8
    
  
  
  

Panels for Consumer Electronics Products

   6,731.5    11,970.9    21,043.8    663.0
    
  
  
  

Panels for LCD Television

   31.2    2,800.3    14,585.7    459.5
    
  
  
  

Other(1)

   2,105.3    730.8    1,213.8    38.2
    
  
  
  

Total

   75,689.2    104,860.6    168,111.6    5,296.5
    
  
  
  

(1) Includes revenues generated from sales of raw materials and components and other TFT-LCD panel products, and from service charges.

 

Computer Products

 

Panels for Notebook Computers. In 2002, 2003 and 2004 sales of panels for notebook computers accounted for 29.6%, 21.0% and 19.2%, respectively, of our net sales. The decline in notebook computer panels sales as a percentage of our total net sales resulted primarily from the increase in sales of our other products, which grew at a faster rate than sales of notebook computer panels.

 

The most commonly produced sizes for panels for notebook computers have changed in recent years, partly as a result of migration in TFT-LCD production technology. The most commonly produced panel sizes for notebook computers were from 12.1 inches to 14.1 inches in 2000 and 2001 and 14.1 and 15.4 inches in 2002, 2003 and 2004. As fifth-generation production capacity increases, we expect that 15.4-inch panels will continue to be one of the most commonly produced sizes for notebook computers, with demand for 17-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.

 

In 2004, unit sales of our panels for notebook computers were approximately 4.9 million, of which a substantial majority was accounted for by 14.1 inch to 15.4 inch panels. In 2004, our net sales accounted for by panels for notebook computers was approximately NT$32.3 billion.

 

Panels for Desktop Monitors. We commenced commercial production of desktop monitor panels in the first quarter of 2000. In 2002, 2003 and 2004 sales of panels for desktop monitors accounted for 58.7%, 64.2% and 58.9%, respectively, of our net sales. We expect that our sales of desktop monitor panels will continue to grow in 2005, primarily as a result of our capacity expansion and demand growth due to the continued trend toward the bundling of TFT-LCD monitors with new computers and the substitution effect of purchasers replacing CRT monitors with TFT-LCD monitors.

 

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. 17-inch panels were most commonly produced for desktop monitors in 2004. In 2004, unit sales of our panels for desktop monitors was approximately 12.2 million, of which a significant portion was accounted for by 17- and 19-inch panels. In 2004, our net sales accounted for by panels for desktop monitors was approximately NT$99.0 billion, of which a significant majority was accounted for by 17- and 19-inch panels. We expect 17-inch panels will continue to be one of the most commonly produced desktop monitor sizes, with increasing demand for 19-inch panels in 2005.

 

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Consumer Electronics Products

 

Our panels for consumer electronics products, including digital cameras, camcorders, car television, car navigation systems, portable DVD players, multiple function machines, printer displays, portable game consoles and portable televisions, consist of display panels ranging from 1.5 to 10.2 inches or above. Our sales of panels for consumer electronics products as a percentage of our total net sales has varied from 8.9% in 2002 to 11.4% in 2003 to 12.5% in 2004. 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 of our customers and the customized nature of consumer electronics panels. Unit sales of our panels for consumer electronics products increased 57.1% to 33,697.7 thousand panels in 2004 from 21,454.3 thousand panels in 2003 primarily as a result of the growing market acceptance of the use of TFT-LCD panels in consumer electronics products and increase demand for products such as portable DVD players and other handheld devices.

 

LCD Television

 

Our panels for LCD television consist of panels with a panel size of 14 inches or above. We commenced commercial production of panels for LCD television in the fourth quarter of 2002. Our current portfolio of LCD television panels consists of 14- to 46-inch panels. Our sales of LCD television panels, as a percentage of our net sales, increased from 2.7% in 2003 to 8.7% in 2004. In 2004, the most commonly produced size of LCD television panels were those below 20-inches. We believe that our sales of LCD television panels will continue to grow in 2005, primarily as a result of the commencement of production at our sixth-generation fab and expected demand growth for LCD television, while we expect average selling prices of panels for LCD television to continue to decline. We also believe that beginning in 2005 there has been a trend towards greater customer demand for larger LCD television panels (above 30-inches). Units sales of our LCD television panels increased to 1,369.4 thousand panels in 2004 from 249.9 panels in 2003 primarily as a result of growing market demand and the replacement of CRT televisions with LCD televisions by consumers.

 

Customers, Sales and Marketing

 

We sell our panels primarily to original equipment manufacturing service providers such as BenQ, Lite-On Technology and Top Victory Electronics. BenQ is a shareholder of our company, and held directly and indirectly 13.32% of our outstanding shares as of July 1, 2005. We also own a 5.47% equity interest in BenQ as of December 31, 2004. 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. We also sell our panels to some brand companies on a direct shipment basis.

 

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,

 
     2002

    2003

    2004

 

Region


   Net Sales

   %

    Net Sales

   %

    Net Sales

   %

 
     (in NT$ millions, except percentages)  

Taiwan

   39,902    52.7 %   44,558    42.5 %   68,275    40.6 %

Japan

   3,396    4.5     3,602    3.4     7,365    4.4  

Asia(1)

   28,057    37.1     51,928    49.5     84,214    50.1  

Europe

   1,693    2.0     1,422    1.4     4,710    2.8  

United States

   1,479    2.2     1,233    1.2     1,702    1.0  

Others

   1,162    1.5     2,118    2.0     1,846    1.1  
    
  

 
  

 
  

Total

   75,689    100.0 %   104,861    100.0 %   168,112    100.0 %
    
  

 
  

 
  


(1) Excludes Japan and Taiwan.

 

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Our sales in Taiwan, as set forth in the table above, represent a significant portion of our net sales for the past three years. The majority 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. As many of these service providers relocate an increasing portion of their production capacity from Taiwan elsewhere, or expand their operations elsewhere, typically to the PRC, due to cost and other considerations, orders placed in Taiwan by such customers have accounted for a decreasing portion of our net sales in recent years.

 

We sell our panels for notebook computers primarily to 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. Our original equipment manufacturing service provider customers include Compal, Quanta Computer and Wistron Infocomm. We market our panels to, and negotiate prices with, both our original equipment manufacturing service provider customers and their 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 primarily to original equipment manufacturing service providers such as BenQ, Lite-On Technology and Top Victory Electronics.

 

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

 

A significant portion of our net sales is attributable to a small number of our customers. In 2002, 2003 and 2004, our five largest customers accounted for 39.3%, 43.6% and 35.1%, 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. BenQ and its subsidiaries accounted for 20.8%, 20.9% and 19.9% of our net sales in 2002, 2003 and 2004, respectively. Since BenQ also provides original equipment manufacturing services for its brand company customers, panels shipped to BenQ include both panels ordered for its own account as well as panels ordered by or on behalf of its brand company customers.

 

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.

 

Our customers typically provide monthly non-binding rolling forecasts of their requirements for the coming four 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, 2004, our reserve for warranties totaled NT$297.1 million (US$9.4 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 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 suppliers. Our credit policy for sales to related parties and other customers typically requires payment within 30 to 45 days. The average number of collection days extended for sales to our customers for the years ended December 31, 2002, 2003 and 2004, was 46 days, 47 days and 29 days, respectively. We have not experienced any material problems relating to customer payments.

 

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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 October 2003. We also established a color filter production facility at our sixth-generation fab in March 2005.

 

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 Matsushita and 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, PRC in July 2002, as part of our efforts to reduce labor costs and the majority of the module-assembly work is conducted in Suzhou.

 

Raw Materials and Components and Suppliers

 

Our manufacturing operations require adequate supplies of high-quality raw materials and components 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 monthly. We source most of our raw materials and components, including critical materials such as glass substrates, color filters, CCFL, 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.

 

In 2001, we experienced a shortage of glass substrates due to the closure of the production facility of one of our two major suppliers of glass substrates. There was a shortage in the supply of color filters and glass substrates beginning in the second half of 2003 which continued into 2004. In addition, based on announced plans for new TFT-LCD production capacity, there could also be a shortage in the supply of driver integrated circuits. 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 TFT-LCD 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 effect our gross margins.

 

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Set forth below are our major suppliers of key raw materials and components:

 

Glass Substrates


 

Liquid Crystals


 

Color Filters


 

Polarizer


 

Backlight Units


 

Driver Integrated

Circuits


Asahi Glass

  Merck   Allied Material Technology   Nitto Denko   Coretronic   NEC

Corning Taiwan

  Nichimen Corp.   Cando Corporation(1)   Optimax   Forhouse   Novatek

Nippon Electric Glass

  Plan-Net Corp.   Dai Nippon Printing       Helix   Panasonic

NH Technoglass

      Toppan Sintek       Radiant   Toshiba

(1) Cando Corporation has been our equity method investee since November 2003. See “Item 7.B. Related Party Transactions.”

 

We use a large amount of water and electricity in our manufacturing process. We obtain water from government-owned entities and recycle more than 70% 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. In September 1999, a power outage caused by a large earthquake resulted in a suspension of production at our fabs for five days. Except for this power outage, 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 tailored to our specific requirements for our manufacturing processes. The principal types of equipment we use to manufacture TFT-LCD panels include chemical vapor deposition equipment, steppers, developers and coaters.

 

We made significant purchases of equipment in 2004, and we expect to make significant purchases in 2005, to implement our capacity expansion and technology advancement plans. See “Item 5. Operating and Financial Review and Prospects—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 TFT-LCD industry is highly competitive. Most of our competitors operate fabs in Korea, Taiwan, Japan and the PRC. We believe there are no TFT-LCD fabs in the United States or Europe. Our principal competitors are:

 

    LG.Philips LCD and Samsung Electronics, in Korea;

 

    Chi Mei Optoelectronics, Chunghwa Picture Tubes, Hannstar Display, Quanta Display, Innolux Display and Toppoly Optoelectronics, in Taiwan;

 

    Hitachi, Tottori Sanyo, Sharp and Toshiba Matsushita Display Technology, in Japan; and

 

    SVA-NEC and BOE-OT, in the PRC.

 

The principal elements of competition for customers in the TFT-LCD market include:

 

    price, based in large part on the ability to ramp-up lower cost, “next generation” production facilities before competitors;

 

    product features and quality;

 

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    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; and

 

    access to capital.

 

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 involves 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.

 

We also perform quality control procedures for 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.

 

Our quality control programs have received accredited International Organization of Standards ISO 9001 certifications, as well as qualifications from our customers. In addition, most of our facilities have been certified as meeting the International Organization of Standards ISO-14001 environmental protection standards, with certification for our recently completed fifth-generation fab pending. 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.

 

Intellectual Property

 

We currently hold a total of 950 patents, including 616 in Taiwan and 177 in the United States. These include patents for TFT-LCD manufacturing processes and products. These patents will expire at various dates from 2007 through 2024. We also have a total of 663 pending patent applications in Taiwan, 536 in the United States and 1,099 in other jurisdictions, including the PRC, Japan and Korea as of December 31, 2004. In addition, we have registered “AU Optronics” as a trademark and service mark in the ROC and PRC, and we are in the process of registering our logo as a trademark and service mark in the ROC and PRC.

 

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

 

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We have licenses to use certain technology and processes from certain companies. In 2002, 2003 and 2004, our running royalty expenses to the companies from which we license intellectual property were NT$229.4 million, NT$405.4 million and NT$1,017.8 million, respectively, which accounted for 0.3%, 0.4% and 0.6%, respectively of our net sales. We expect that our royalty expenses relating to intellectual property licenses will increase in the future due to increases in unit sales as well as our license agreement with SEL entered into as a part of a settlement and mutual release agreement with SEL on September 3, 2003.

 

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—Financial Information—Litigation.”

 

Insurance

 

We 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 property insurance covers replacement costs for our assets. As of December 31, 2004, our insurance also included protection from covered losses, including property damage up to maximum coverage of NT$21.2 billion for all of our inventories and NT$228.8 billion for our equipment and facilities. In addition, as of December 31, 2004, we had insurance coverage for business interruptions in the aggregate amount of NT$5.3 billion. See “Item 3. Key Information—Risk Factors—Political Geographical and Economic Risks—Due to the location of our operations in Taiwan and the PRC, 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.”

 

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 waste products, including wastewater, liquid waste products and hazardous gases, which are strictly monitored by local environmental protection bureaus. To meet ROC environmental standards, we employ various types of pollution control equipment for the treatment of hazardous 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.

 

We incurred small fines in December 2002 and October 2003 for non-compliance with a waste storage-labeling requirement. In June 2004, we also incurred small fines for failure to update our air pollution emission permit. Following each of the infractions described above, we have taken the necessary steps to obtain the appropriate permit and believe that we are in compliance with the existing environmental laws and regulations in Taiwan.

 

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4.C. Organizational Structure

 

The following chart sets forth our corporate structure and ownership interest in each of our principal operating subsidiaries and affiliates as of December 31, 2004.

 

LOGO

 

The following table sets forth summary information for our subsidiaries as of December 31, 2004.

 

Subsidiary


  

Main Activities


   Jurisdiction of
Incorporation


   Total Paid-in
Capital


   Percentage of
Our Ownership
Interest


 
              

NT$

(in millions)

      

AU Optronics (L) Corp.

   Holding company    Malaysia    5,802.9    100 %

AU Optronics Corporation America

   Sales services in the United States    United States    31.7    100 %(1)

AU Optronics (Suzhou) Corp.

   Assembly of TFT-LCD modules in the PRC    PRC    5,395.8    100 %(1)

AU Optronics Corporation Japan

   Sales services in Japan    Japan    25.4    100 %(1)

Konly Venture Corp.

   Venture capital investment    ROC    900.0    100 %

AU Optronics Europe B.V.

   Sales services in Europe    Netherlands    1.9    100 %(1)

AU Optronics Korea Ltd.

   Sales services in South Korea    South Korea    4.9    100 %(1)

(1) Indirectly, through our 100% ownership of AU Optronics (L) Corp.

 

4.D. Property, Plants and Equipment

 

We have three principal manufacturing sites in Taiwan and one module-assembly site in Suzhou, PRC. With current production facilities utilizing 3.5-generation, fourth-generation, fifth-generation and sixth-generation technologies, we have the flexibility to produce a large number of panels of various sizes.

 

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Table of Contents

Principal Facilities

 

The following table sets forth certain information relating to principal facilities as of March 31, 2005. The land in the Hsinchu Science Park on which our facilities are located is leased from the ROC government.

 

Location


  

Building
Size

(in square
meters)


   Input Substrate Size (in
millimeters) / Installed
Capacity (substrates
processed per month)


   Commencement of
Commercial
Production


  

Primary Use


  

Owned or Leased


No. 5, Li-Hsin Rd.
6, Hsinchu
Science Park,
Hsinchu,
Taiwan, ROC

   69,647    610x720/45,000    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,
Taiwan, ROC

   163,564    610x720/30,000    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,
Taiwan, ROC

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

•      Building is owned

•      Land is leased (expires in January 2017)

No. 1, Xinhe Rd.,
Aspire Park 325
Lungtan,
Taoyuan
Taiwan, ROC

   248,231    680x880/60,000(1)
1,100x1,250/50,000(2)
1,100x1,300/70,000(3)
   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(5)

No. 1 JhongKe Rd.
Central Taiwan
Science Park
Taichung 407,
Taiwan, ROC

   N/A    1,500x1,850/60,000(4)    March 2005    Manufacturing of
TFT-LCD panels; module and component assembly; manufacturing of color filters
  

•      Building is owned

•      Land is leased (expires in December 2022)

No. 398, Suhong
Zhong Road
Suzhou
Industrial Park,
Suzhou, PRC

   226,549    N/A    July 2002    Module and component assembly   

•      Building is owned

•      Land is leased (expires in 2051)


(1) Our fourth-generation fab.
(2) Our first fifth-generation fab, which commenced commercial production in March 2003.
(3) Our second fifth-generation fab, which commenced commercial production in February 2004.
(4) Our sixth-generation fab, which commenced commercial production in March 2005.
(5) We purchased this land in January 2005.

 

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Expansion Projects

 

Set forth below is a description of our principal expansion projects which we expect to finance with cash on hand, long-term debt and cash flow from operations.

 

Fifth-Generation Fabs. We commenced commercial production at our second fifth-generation fab which is capable of processing substrates with dimensions of 1,100 x 1,300 millimeters, in February 2004. As of December 31, 2004, our second fifth-generation fab had an estimated input capacity of approximately 70,000 substrates per month. We plan to establish a third fifth-generation fab capable of processing substrates with dimensions of 1,100 x 1,300 millimeters which we expect to commence commercial production in the fourth quarter of 2005. We also plan to establish a third color filter production facility in order to meet a portion of our color filter requirements at our two fifth-generation fabs as well as our other existing fabs. Our third fifth-generation fab will be housed in the same facility as our 7.5-generation fab. We expect to spend approximately NT$10 billion to NT$11 billion to construct this facility and spend an additional NT$30 billion to NT$35 billion for the installation of machinery and equipment at our third fifth-generation fab. As of December 31, 2004, we had spent a total of NT$5.0 billion for construction and the purchase of machinery and equipment at our third fifth-generation fab.

 

Sixth-Generation Fab. To meet the growth in the large-size TFT-LCD market, we established a new fab in Taichung Science Park utilizing sixth-generation manufacturing technology. Our sixth-generation fab is capable of processing substrates with dimensions of 1,500 x 1,850 millimeters. Our sixth-generation substrate size is designed to produce large-size panels with high efficiency and with capabilities of cutting, for example, eight 32-inch panels, six 37-inch panels or four 40-inch panels in wide format. Our sixth-generation fab commenced commercial production in March 2005 and as of March 31, 2005 had an estimated input capacity of approximately 5,000 substrates per month. We expect that the estimated input capacity for our sixth-generation fab to increase to 60,000 substrates per month by the end of 2005. We also plan to establish color filter production and module-assembly facilities at our sixth-generation fab. As of December 31, 2004, we had incurred a total of NT$40.7 billion in connection with our new sixth-generation fab, together with the new color filter production and module-assembly facilities within such fab. We expect to spend an additional amount of approximately NT$40.0 billion to NT$45.0 billion to complete our sixth-generation fab.

 

7.5-Generation Fab. We intend to establish a 7.5-generation fab in order to target the HDTV market and produce LCD TVs that are larger than 40-inches. We expect that our 7.5-generation fab will be capable of processing substrates with dimensions of 1,950 x 2,250 millimeters. Our 7.5-generation substrate size is designed to produce large-size panels with high efficiency and with capabilities of cutting, for example, eight 42-inch panels, six 47-inch panels or three 56-inch panels in wide format. We currently plan for equipment move-in to be scheduled for the second quarter of 2006 and expect to commence commercial production in the fourth quarter of 2006. We expect to spend approximately NT$35 billion to NT$38 billion for the installation of machinery and equipment at our 7.5-generation fab. As of December 31, 2004, we had not purchased any machinery or equipment for our 7.5-generation fab.

 

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

5.A. Operating Results

 

Overview

 

The TFT-LCD 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 sharp declines in average selling prices. For example, the significant increase in the average selling prices of large-size panels in the first half of 2002 was followed by a slowdown in demand growth in the second half of 2002, which in turn resulted in excess supply in the market and caused sharp declines in prices in that period. As a result, the average selling prices of our large-size panels decreased by 13.0% between the second quarter and the third quarter of 2002 and further decreased by 21.7% between the

 

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third quarter and the fourth quarter of 2002. Average selling prices of our large-size panels recovered in 2003 with prices increasing by 17.3% between the first quarter of 2003, and the fourth quarter of 2003. Average selling prices of our large size panels fluctuated throughout 2004, increasing by 12.1% between the fourth quarter of 2003 and the second quarter of 2004 and decreasing by 22.2% between the second quarter and the third quarter of 2004 and further decreasing 17.1% between the third quarter and the fourth quarter of 2004.

 

Our revenues depend substantially on the average selling prices of our panels and are affected by fluctuations in those prices. The average selling prices of our large-size panels increased by 15.6% between 2001 and 2002 and decreased by 3.1% between 2002 and 2003 and increased by 0.9% between 2003 and 2004. The change in the average selling prices of our panels and decreases in variable costs, depreciation and amortization expenses and other fixed costs associated with the expansion of our production capacity on a per panel basis contributed to the increase in our gross margins from 16.0% in 2002 to 22.4% in 2003 and 23.6% in 2004. The strong demand for TFT-LCD panels in 2003 resulted in a recovery in average selling prices in 2003. Strong demand continued in the first half of 2004, keeping average selling prices high; however this was offset by an oversupply of and reduced demand for TFT-LCD panels in the second half of 2004, which resulted in average selling prices remaining relatively stable for the full year of 2004 compared to the full year of 2003. To meet demand, many TFT-LCD manufacturers, including our company, may expand their 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 our panels in the future. In addition, we expect that, as is typical in the TFT-LCD industry, the average selling prices for our existing product lines will gradually decline as the cost of manufacturing TFT-LCD panels declines and as the product becomes more commodity-like.

 

Production Capacity

 

We measure the capacity of a fab in terms of the number of substrates and the glass area of substrates that can be produced. As of December 31, 2004, we had an annual capacity to produce approximately 311.7 million square meters of glass area of TFT-LCD panels.

 

Fab Construction and Ramp-Up Process

 

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 three 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, and lower raw materials 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.

 

Product Mix

 

Our product mix affects our sales and profitability, as the prices and costs of different size panels may vary significantly. The larger panel sizes command higher prices, but also have higher manufacturing costs. In 2004,

 

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an increase in demand for consumer electronic products using larger TFT-LCD panels such as portable DVD players caused a shift in product mix to more medium sized panels being produced. The continued trend toward notebook computers with larger screens and the continuing demand for TFT-LCD panels for desktop monitors as a result of the replacement of CRT monitors for TFT-LCD monitors led us to shift our product mix to include primarily 14.1-inch and 15.4-inch panels for notebook computers and 15-, 17- and 19-inch panels for desktop monitors. Moreover, a strong demand for LCD television contributed to increased production of LCD television panels. Our fifth-generation fabs have enabled us to produce 15-, 17- and 19-inch or larger panels more efficiently. Our sixth-generation fab will also enable us to produce larger LCD television panels. 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

 

Preparation of our consolidated financial statements requires us to make estimates and judgments that affect the amounts of our assets, liabilities, revenues and expenses. We continually evaluate these estimates, including those related to allowances for doubtful accounts, inventories, useful lives of properties, goodwill, income tax valuation allowances, pension plans and the fair value of financial instruments. We base our estimates on historical experience and other assumptions, which we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions and conditions. We have identified below the accounting policies that are critical to our consolidated 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. Such provisions are deducted from sales in the year the products are sold. 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:

 

     2002

    2003

    2004

 
     NT$     NT$     NT$     US$  

Balance at beginning of year

   68,650     91,906     45,756     1,441  

Provision charged (reversal credited) to revenue

   91,906     (23,464 )   696,328     21,939  

Write-off

   (68,650 )   (22,686 )   (43,578 )   (1,373 )
    

 

 

 

Balance at end of year

   91,906     45,756     698,506     22,007  
    

 

 

 

 

As of December 31, 2002, 2003 and 2004, the allowance for sales discounts and returns was NT$92 million, NT$46 million and NT$699 million (US$22.0 million), respectively. In 2003, we reversed certain allowances established in prior periods due to lower than expected sales discounts and returns. For the years ended December 31, 2002, 2003, and 2004, we did not have to record any additional provisions subsequent to the year ended because actual returns and pricing discounts were lower than the estimated amounts.

 

Recoverability of Long-Lived Assets

 

Under U.S. GAAP, we review our long-lived assets and certain identifiable intangible assets, including purchased intangible assets for impairment whenever we feel that events or changes in circumstances indicate that the carrying amounts of these assets may not be recoverable. Furthermore, under ROC and U.S. GAAP, we review our assets held for sale for impairment whenever we feel that the fair value of these assets may be lower than the carrying amount. Judgments about the fair value of assets held for sale are generally based upon market assumptions about value of similar assets, and are supported by third party appraisals.

 

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Under ROC GAAP we measure recoverability of our assets to be held and used by comparing the carrying amount of an asset to the fair value of the asset. Under U.S. GAAP, we measure recoverability of our long-lived assets to be held and used by comparing the carrying amount of an asset to its future undiscounted net cash flows. If we consider our assets to be impaired, the impairment we would recognize is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets. No impairment indicators were noted during 2004. Furthermore, we had assets held for sale in 2003 and 2004. As of December 31, 2003 and 2004, we recorded a provision for impairment of assets held for sale of NT$75 million and NT$136 million (US$4.3 million), respectively. The impairment of assets held for sale was classified in non-operating expenses and losses in the statements of operations.

 

Allowance for Uncollectible Accounts Receivable

 

We evaluate our outstanding accounts receivables on a monthly basis for collectibility 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 loss experience. There have been no changes in this policy for the last three years.

 

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

 

     2002

    2003

   2004

     NT$     NT$    NT$    US$

Balance at beginning of year

   30,112     39,387    81,085    2,555

Provision charged to expense

   137,948     41,698    9,221    290

Write-off

   (128,673 )        
    

 
  
  

Balance at end of year

   39,387     81,085    90,306    2,845
    

 
  
  

 

As of December 31, 2002, 2003 and 2004, the allowance we established for doubtful accounts was NT$39 million, NT$81 million and NT$90 million (US$2.8 million), respectively. For the years ended December 31, 2002, 2003, and 2004, we have not made any significant changes to estimates used to determine allowances for doubtful accounts.

 

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, which may be affected by the number of months inventory items remain unsold and their prevailing market prices. Additionally, our analysis of the amount we expect to ultimately realize are partially based 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, 2002, 2003 and 2004, the provision for inventory obsolescence and devaluation was NT$394 million, NT$607 million and NT$1,031 million (US$32.5 million), respectively, which were classified in cost of goods sold in the statements of operations. For the years ended December 31, 2002, 2003 and 2004, we have not made any significant changes to estimates used to determine the provisions for excess and obsolete inventory.

 

Recoverability of Long-Term Investments

 

Long-term equity investments in which we are not able to exercise significant influence over the investee’s operations and financial policies (generally those in which we own less than 20% of the investee’s voting shares) are accounted for using the lower of cost or the quoted market value if the investee is a listed company, otherwise such investments are accounted for using the cost method. If there is evidence indicating that a decline in the

 

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value of an investment is other than temporary, then the carrying amount of the investment is reduced to reflect its estimated net realizable value. Net realizable value is determined based on its quoted market value, if listed, or its fair value based on the present value of its estimated future cash flows. For the years ended December 31, 2002, 2003 and 2004, we have not recognized any significant impairment losses on long-term 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) 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 share of the excess of fair value over the carrying value of assets on the investee’s books. Such difference is reflected as a component of the investment balance and is adjusted to reflect changes in the basis of the related asset. Unallocated amounts are recorded as investor level goodwill, and are not subject to amortization, but rather are assessed for impairment as part of the carrying amount of the investment. For example, amounts allocated to property, plant and equipment are depreciated in a manner similar to the related assets through a charge to net investment gain recognized by equity method investments. 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 operations.

 

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.

 

In 2004, we purchased 126,600,000 shares of BenQ representing a 5.47% equity interest in BenQ. As we and BenQ share a common chairman and chief executive officer, a second officer board member, and have other commercial relationships, we are deemed to have the ability to exercise significant influence over BenQ. As such, we account for our investment in BenQ under the equity method of accounting.

 

Income Taxes

 

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, 2004, the ending balance for our valuation allowances on deferred tax assets was NT$8,805.0 million under ROC GAAP. If our current estimate of future profit had been higher, we would have decreased our valuation allowances accordingly. In contrast, if our current estimate of future profit had been lower, we would have increased our valuation allowances. However, due to the complexity of calculating our valuation allowances, we are unable to provide with reasonable accuracy the amount of changes to our valuation allowances that would have resulted based upon specific percentage changes to one or more individual factors such as our expected future revenue or profits.

 

Under U.S. GAAP, cumulative losses in recent years are a significant piece of negative evidence which is difficult to support a conclusion that expected taxable income from future operations (excluding reversal of existing temporary differences) justifies recognition of deferred tax assets. We suffered losses in 2001 and also

 

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had a net loss in the fourth quarter of 2002. As a result, we did not use the projection of future taxable income in determining our valuation allowance for periods through December 31, 2002. As we continue to generate taxable income from 2003 onwards, more positive evidence is available. We are using the available future taxable income projections in the near term in determining the extent of our valuation allowance.

 

Results of Operations

 

The following table sets forth certain of our results of operations data as a percentage of our net sales for the periods indicated:

 

     Year Ended December 31,

 
     2002

    2003

    2004

 
     %     %     %  

Net sales

   100.0     100.0     100.0  

Cost of goods sold

   84.0     77.6     76.4  
    

 

 

Gross profit

   16.0     22.4     23.6  
    

 

 

Operating expenses

   5.8     6.9     6.6  

Selling

   0.7     1.4     1.5  

General and administrative

   2.1     2.3     2.1  

Research and development

   3.0     3.2     3.0  
    

 

 

Operating income

   10.2     15.5     17.0  
    

 

 

Net non-operating income (loss)

   (2.2 )   (0.6 )   (0.4 )
    

 

 

Income before income tax

   8.0     14.9     16.6  

Income tax benefit (expenses)

   (0.0 )   0.0     0.0  
    

 

 

Net income

   8.0     14.9     16.6  
    

 

 

 

For the Years Ended December 31, 2004 and 2003

 

Net Sales

 

Net sales increased 60.3% to NT$168,111.6 million (US$5,296.5 million) in 2004 from NT$104,860.6 million in 2003 due to a 60.5% increase in net sales of large-size panels and a 62.0% increase in net sales of small- and medium-size panels. Net sales of large-size panels increased 60.5% to NT$148,130.6 million (US$4,667.0 million) in 2004 from NT$92,274.0 million in 2003. This increase was primarily due to an increase in unit sales. Large-size panels sold increased 59.0% to 18,851.4 thousand panels in 2004 from 11,852.7 thousand panels in 2003. The average selling price per panel of our large-size panels remained relatively stable, increasing 0.9% to NT$7,858 (US$247.6) in 2004 from NT$7,785 in 2003, primarily as a result of an increase in average selling prices in the first half of 2004 caused by strong consumer demand which was partially offset by a decrease in average selling prices in the second half of 2004 resulting from an oversupply of panels in the TFT-LCD industry. The increase in unit sales of large-size panels was due to our expanded production capacity and stimulated demand as a result of decreasing average selling prices in the second half of 2004. The increased demand was primarily due to consumers continuing to replace their CRT monitors with TFT-LCD monitors, increased bundling of TFT-LCD monitors and PCs by brand companies and increased demand for both notebook computers and LCD television.

 

Net sales of small- to medium-size panels increased 62.0% to NT$19,208.0 million (US$605.2 million) in 2004 from NT$11,855.8 million in 2003. The increase in net sales of small- to medium-size panels was primarily due to an increase in unit sales. Unit sales of our small- to medium-size panels increased 55.3% to 33,289.5 thousand panels in 2004 from 21,431.2 thousand panels in 2003. The average selling price per panel of our small- to medium-size panels increased 4.3% to NT$577 (US$18.2) in 2004 from NT$553 in 2003, primarily as a result

 

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of a shift in product mix to more medium-size panels being produced due to increasing demand for consumer electronic products using medium-sized TFT-LCD panels such as portable DVD players. The increase in unit sales of small- to medium-size panels was primarily due to new products which use small- to medium-size panels being introduced in the market, resulting in new customers, and the growing acceptance and use of TFT-LCD panels for consumer electronics products.

 

Cost of Goods Sold

 

Cost of goods sold increased 57.8% to NT$128,468.3 million (US$4,047.5 million) in 2004 from NT$81,398.9 million in 2003. This increase was primarily as a result of an increase in our requirements for raw materials and components and an increase in depreciation and amortization expenses. Raw materials and component costs increased 60.3% in 2004 as compared to 2003, primarily as a result of an increase in unit sales of our panels. While we expected the average market prices of raw materials and components to decline in 2004 compared to 2003, despite the fluctuation of market prices for glass substrates, color filters and driver integrated circuits throughout 2004, the average market prices of raw materials and components remained relatively stable in 2004 compared to 2003. Overhead expenses, including depreciation and amortization expenses, increased 56.4% in 2004 compared to 2003, primarily due to increased production costs and capacity at our fabs and increased depreciation expenses associated with our in-house color filter production facility and our second fifth-generation fab, both of which commenced commercial production in 2004. Direct labor costs increased 27.6% in 2004 compared to 2003, primarily as a result of an increased number of employees due to our increased production capacity, the ramp-up of our second fifth-generation fab, the construction of our sixth-generation fab and the expansion of our module-assembly facilities in Suzhou, PRC.

 

As a percentage of net sales, cost of goods sold decreased slightly to 76.4% in 2004 from 77.6% in 2003. This decrease was primarily as a result of a decrease in our cost of goods sold per panel for large-size panels and an increase in our net sales. The decrease in our cost of goods sold per panel for large-size panels was primarily as a result of lower fixed costs per panel for large-size panels. Fixed costs per panel (which include depreciation and amortization expenses, direct labor costs and utility and other overhead expenses) for large-size panels decreased due to improved production efficiency through yield rate improvement at our fifth-generation fabs, which was partially offset by a lower utilization rate in the second half of 2004.

 

Gross Profit

 

Gross profit increased 69.0% to NT$39,643.3 million (US$1,249.0 million) in 2004 from NT$23,461.8 million in 2003. Gross margin, which is gross profit divided by net sales, was 23.6% in 2004 as compared to 22.4% in 2003. The improvement in gross margin was primarily as a result of an increase in net sales.

 

Under U.S. GAAP, gross profit increased 64.9% to NT$32,855.6 million (US$1,035.1 million) in 2004 from NT$19,919.7 million in 2003. Gross margin, which is gross profit divided by net sales, was 19.5% in 2004 as compared to19.0% in 2003. The improvement in gross margin was primarily as a result of an increase in net sales, which resulted in lower per unit costs from lower absorption of fixed costs.

 

Operating Expenses

 

Operating expenses increased 52.9% to NT$11,036.0 million (US$347.7 million) in 2004 from NT$7,217.0 million in 2003. As a percentage of net sales, operating expenses decreased to 6.6% in 2004 from 6.9% in 2003. The increase in operating expenses was primarily as a result of an increase in unit sales of our panels in 2004. Selling expenses increased 75.4% to NT$2,447.1 million (US$77.1 million) in 2004 from NT$1,395.0 million in 2003, primarily due to increases in selling commissions, transportation costs and marketing expenses as a result of increased sales. Selling expenses as a percentage of net sales increased to 1.5% in 2004 from 1.4% in 2003. General and administrative expenses increased 46.9% to NT$3,577.3 million (US$112.7 million) in 2004 from NT$2,435.6 million in 2003, primarily as a result of the ramp-up costs at our fifth-generation fabs prior to

 

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commercial production at such facilities and the establishment of our sixth-generation fab. General and administrative expenses as a percentage of net sales decreased slightly to 2.1% in 2004 from 2.3% in 2003. Research and development expenses increased 48.0% to NT$5,011.6 million (US$157.9 million) in 2004 from NT$3,386.4 million in 2003, primarily due to the additional expenses associated with the installation of equipment at our new research and development facility, the AUO Technology Center, and royalties and license fees related to the transfer of new technologies. Research and development expenses as a percentage of net sales decreased to 3.0% in 2004 from 3.2% in 2003.

 

Under U.S. GAAP, operating expenses increased 92.8% to NT$12,686.8 million (US$399.7 million) in 2004 from NT$6,581.8 million in 2003. As a percentage of net sales, operating expenses increased to 7.5% in 2004 from 6.3% in 2003. The increase in operating expenses was primarily due to expansion, increase of sales related expenses as a result of an increase in unit sales of our panels and an increase of employee compensation expense. Selling expenses increased 62.5% to NT$2,093.2 million (US$65.9 million) in 2004 from NT$1,288.3 million in 2003, primarily due to increases in selling commissions, transportation costs and marketing expenses as a result of increased sales, the increase of employee compensation costs. Selling expenses as a percentage of net sales was about the same in 2004 and in 2003. General and administrative expenses increased 121.5% to NT$6,232.8 million (US$196.4 million) in 2004 from NT$2,813.9 million in 2003, primarily as a result of the ramp-up costs at our fifth-generation fabs prior to commercial production at such facilities and the establishment of our sixth-generation fab, and a result of the increase of compensation costs. General and administrative expenses as a percentage of net sales increased to 3.7% in 2004 from 2.7% in 2003. Research and development expenses increased 75.9% to NT$4,360.8 million (US$137.4 million) in 2004 from NT$2,479.6 million in 2003, primarily due to the additional expenses associated with the installation of equipment at our new research and development facility, the AUO Technology Center, and a result of the increase of compensation costs. Research and development expenses as a percentage of net sales increased to 2.6% in 2004 from 2.4% in 2003.

 

Operating Income and Operating Margin

 

As a result of the foregoing, operating income increased 76.1% to NT$28,607.3 million (US$901.3 million) in 2004 from NT$16,244.8 million in 2003, and operating margin increased to 17.0% in 2004 from 15.5% in 2003.

 

Under U.S. GAAP, as a result of the foregoing, operating income increased 51.2% to NT$20,168.8 million (US$635.4 million) in 2004 from NT$13,337.9 million in 2003, and operating margin decreased to 12.0% in 2004 from 12.7% in 2003.

 

Net Non-Operating Expenses and Losses

 

We had net non-operating expenses and losses of NT$583.1 million (US$18.4 million) in 2004 compared to net non-operating expenses and losses of NT$671.5 million in 2003. We had lower net non-operating expenses and losses in 2004 as compared to 2003 primarily as a result of investment gain on equity method investments and a decrease in net interest expense. We had a gain on equity method investments of NT$34.3 million (US$1.1 million) compared to a loss of NT$14.4 million in 2003. We had a net interest expense of NT$621.4 million (US$19.6 million) in 2004 compared to a net interest expense of NT$658.1 million in 2003, principally as a result of a reduction in the amount of average outstanding debt and lower interest rates.

 

Under U.S. GAAP, we had net non-operating expenses and losses of NT$1,592.9 million (US$50.1 million) in 2004 compared to net non-operating expenses and losses of NT$852.6 million in 2003. We had higher net non-operating expenses and losses in 2004 as compared to 2003 primarily as a result of an impair loss on securities available-for-sale which was partially offset by an investment gain on equity method investments. We recognized other-than-temporary impairment losses on securities available-for-sale of NT$922.9 million (US$29.1 million) in 2004 compared to none in 2003. We had a gain on equity method investments of NT$279.7 million (US$8.8 million) in 2004 compared to a loss of NT$177.8 million in 2003.

 

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Income Tax Expense

 

We recorded an income tax expense of NT$61.3 million (US$1.9 million) in 2004 compared to an income tax benefit of NT$86.7 million in 2003. We recorded an income tax expense in 2004 primarily due to income tax being assessed against us as a result of an increase in net income. While we used a portion of our outstanding tax credits to offset the income tax amount owed, the amount of tax credits that may be applied in any year is limited to 50% of the income tax payable for that year. We recorded an income tax benefit in 2003 due primarily to the fact that we generated more investment tax credits, combined with the recognition of additional net deferred income tax assets generated in 2003 due to our assessment that we would be able to realize certain of our deferred tax assets based on future profitability.

 

Under U.S. GAAP, we recorded an income tax expense of NT$463.4 million (US$14.6 million) in 2004 compared to an income tax benefit of NT$3,230.1 million in 2003. We did not use the projection of future taxable income in determining the deferred tax asset valuation allowance for periods through December 31, 2002. However, as we continue to generate taxable income from 2003 onwards, more positive evidence is available. We are using the available future taxable income projections in determining the size of the valuation allowance. As a result, we released a portion of the deferred tax asset valuation allowance in 2003 and the income tax benefit increased in 2003 by NT$1,869 million (US$58.9 million).

 

Net Income

 

As a result of the foregoing, net income increased 78.6% to NT$27,962.9 million (US$881.0 million) in 2004 from NT$15,659.9 million in 2003.

 

Under U.S. GAAP, as a result of the foregoing, net income increased 15.3% to NT$18,112.5 million (US$570.7 million) in 2004 from NT$15,715.4 million in 2003.

 

For the Years Ended December 31, 2003 and 2002

 

Net Sales

 

Net sales increased 38.5% to NT$104,860.6 million in 2003 from NT$75,689.2 million in 2002 due to a 38.0% increase in net sales of large-size panels and a 76.1% increase in net sales of small- and medium-size panels. Net sales of large-size panels increased 38.0% to NT$92,274.0 million in 2003 from NT$66,852.5 million in 2002. The increase in net sales of large-size panels was primarily due to an increase in unit sales, offset by a decrease in average selling prices. Large-size panels sold increased 42.4% to 11,852.7 thousand panels in 2003 from 8,321.6 thousand panels in 2002. The average selling price per panel of our large-size panels decreased 3.1% to NT$7,785 in 2003 from NT$8,034 in 2002, primarily as a result of decreases in average selling prices resulting from an oversupply of panels in the TFT-LCD industry during the second half of 2002. The increase in unit sales of large-size panels was due to our expanded production capacity and stimulated demand as a result of decreasing average selling prices. The increased demand was reflected in the increased rate of replacement of TFT-LCD for CRT monitors, increased bundling of TFT-LCD monitors and PCs by brand companies and increased demand for notebook computers.

 

Net sales of small- to medium-size panels increased 76.1% to NT$11,855.8 million in 2003 from NT$6,731.4 million in 2002. The increase in net sales of small- to medium-size panels was primarily due to an increase in unit sales, offset by a decrease in average selling prices. Unit sales of our small- to medium-size panels increased 135.7% to 21,431.2 thousand panels in 2003 from 9,092.1 thousand panels in 2002. The average selling price per panel of our small- to medium-size panels decreased 25.3% to NT$553 in 2003 from NT$740 in 2002, primarily as a result of intense competition and shift in product mix. The increase in unit sales of small- to medium-size panels was due to increased demand as a result of wider industry acceptance of the use of TFT-LCD panels for consumer electronics products.

 

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Cost of Goods Sold

 

Cost of goods sold increased 28.0% to NT$81,398.9 million in 2003 from NT$63,606.2 million in 2002. This increase was primarily as a result of an increase in our requirements for raw materials and components and an increase in depreciation and amortization expenses. Raw materials and component costs increased 22.4% in 2003 as compared to 2002, primarily as a result of an increase in unit sales of our panels, partially offset by decreases in average market prices of raw materials and components. Overhead expenses, including depreciation and amortization expenses, increased by 40.3% in 2003 compared to 2002, primarily due to increased production costs and the purchase of additional equipment and machinery for our fabs. Direct labor costs increased by 29.5% in 2003 compared to 2002, primarily as a result of an increased number of employees due to our increased production capacity and the ramp-up of our fifth-generation fabs and our module-assembly facilities in Suzhou, PRC.

 

As a percentage of net sales, cost of goods sold decreased to 77.6% in 2003 from 84.0% in 2002. This decrease was primarily as a result of a decrease in our cost of goods sold per panel for large-size panels and an increase in our net sales. The decrease in our cost of goods sold per panel for large-size panels was primarily as a result of decreases in raw materials and component costs and lower fixed costs per panel for large-size panels. The decrease in raw materials and component costs per panel for large-size panels was primarily due to decreases in the average market prices of raw materials and components and the introduction of new product designs with lower component costs. Fixed costs per panel (which include depreciation and amortization expenses, direct labor costs and utility and other overhead expenses) for large-size panels decreased due to improved production efficiency through yield rate improvement and advanced new generation technologies and economies of scale realized at our fabs.

 

Gross Profit

 

Gross profit increased 94.2% to NT$23,461.8 million in 2003 from NT$12,083.0 million in 2002. Gross margin, which is net sales less cost of goods sold, was 22.4% in 2003 as compared to 16.0% in 2002. The improvement in gross margin was primarily as a result of an increase in net sales due to an increase in unit sales and a substantial reduction in cost of goods sold per panel for most of our panels sold.

 

Operating Expenses

 

Operating expenses increased 65.2% to NT$7,217.0 million in 2003 from NT$4,369.1 million in 2002. As a percentage of net sales, operating expenses increased to 6.9% in 2003 from 5.8% in 2002. The increase in operating expenses was primarily as a result of an increase in unit sales of our panels in 2003. Selling expenses increased 168.3% to NT$1,395.0 million in 2003 from NT$520.0 million in 2002, primarily due to increases in selling commissions, transportation costs and marketing expenses as a result of increased sales. Selling expenses as a percentage of net sales increased to 1.3% in 2003 from 0.7% in 2002. Administrative expenses increased 50.7% to NT$2,435.6 million in 2003 from NT$1,616.0 million in 2002, primarily as a result of the ramp-up costs at our fifth-generation fabs prior to commercial production at such facilities. General and administrative expenses as a percentage of net sales increased slightly to 2.3% in 2003 from 2.1% in 2002. Research and development expenses increased 51.6% to NT$3,386.4 million in 2003 from NT$2,233.1 million in 2002, primarily due to the additional expenses for the development of advanced process and product technologies. Research and development expenses as a percentage of net sales increased to 3.2% in 2003 from 3.0% in 2002.

 

Operating Income and Operating Margin

 

As a result of the foregoing, operating income increased 110.6% to NT$16,244.8 million in 2003 from NT$7,713.9 million in 2002, and operating margin increased to 15.5% in 2003 from 10.2% in 2002.

 

Net Non-Operating Expenses and Losses

 

We had net non-operating expenses and losses of NT$671.5 million in 2003 compared to net non-operating expenses and losses of NT$1,691.1 million in 2002. We had lower net non-operating expenses and losses in 2003

 

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as compared to 2002 primarily as a result of realized and unrealized gains in short-term investments and a decrease in net interest expense. We had a gain on market price recovery of short-term investments of NT$126.9 million in 2003, as compared to a short-term investment permanent impairment loss of NT$650.6 million in 2002, primarily as a result of an improvement in the market prices of our short-term investments due to the recovery of market conditions on the Taiwan Stock Exchange. The short-term investment permanent impairment loss in 2002 was due primarily to the write-off of our short-term investment in PixTech in the amount of NT$523.7 million. We had a net interest expense of NT$658.1 million in 2003 compared to a net interest expense of NT$951.1 million in 2002, principally as a result of lower levels of debt and lower interest rates.

 

Income Tax Benefit

 

We recorded an income tax benefit of NT$86.7 million in 2003 compared to an income tax expense of NT$0.1 million in 2002. We recorded an income tax benefit in 2003 due primarily to the fact that we generated more investment tax credits, combined with the recognition of additional net deferred income tax assets generated in 2003 due to our assessment that we would be able to realize certain of our deferred tax assets based on future profitability.

 

Net Income

 

As a result of the foregoing, net income increased 160.0% to NT$15,659.9 million in 2003 from NT$6,022.7 million in 2002.

 

Inflation

 

We do not believe that inflation in Taiwan has had a material impact on our results of operations.

 

Taxation

 

The corporate income tax rate in Taiwan applicable to us is 25%. Prior to January 20, 2001, the corporate income tax rate in Taiwan applicable to us was 20% for our products produced in the Hsinchu Science Park and 25% for our products produced elsewhere in Taiwan. However, we did not generate any income in any year except 2000, 2002, 2003 and 2004. In 2000, although we generated income before tax, we applied certain loss carryforwards that we accumulated from previous years to offset the tax liability to which we could otherwise have been subject. In 2003, we recorded an income tax benefit due primarily to the fact that we generated more investment tax credits and recognized additional net deferred income tax assets. As a result, we did not incur any income tax expense during any of our fiscal years, except 2002 and 2004.

 

Recognition of Deferred Tax Assets

 

Our valuation allowance provided on deferred tax assets is calculated differently under ROC GAAP than under U.S. GAAP. This difference has a significant impact on us because we have a significant amount of deferred tax assets as a result of the various tax credits available to us under ROC governmental tax incentive programs and net operating loss carryforwards. Please see note 22 to our consolidated financial statements included elsewhere in this annual report for further discussion and quantification of these differences. The net deferred income tax assets we are able to recognize under ROC GAAP as of December 31, 2004 amounted to NT$2,970.4 million (US$93.6 million). This recognition of net deferred tax assets under ROC GAAP resulted primarily from the ability to consider our projection of income before tax for future years. If we do not achieve the projection of income before tax for future years, the amount of the deferred tax assets recognized may be significantly reduced.

 

Tax Exemptions

 

Based on our status as a company engaged in the TFT-LCD business in Taiwan, all income attributable to the use of equipment that we purchase, in part or in whole, with proceeds we raise through share offerings, may

 

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be exempted from corporate income tax in Taiwan if our shareholders determine to allow us, instead of the shareholders themselves, to use these tax exemptions. In addition, income attributable to the use of equipment that we purchase, in whole or in part, with retained earnings that we capitalize, may be exempted from corporate income tax in Taiwan. These exemptions typically apply for four or five consecutive years, commencing in a year to be designated by us within two years following the commencement of commercial production using such equipment. We set forth below certain information with respect to our tax exemptions:

 

    Share offerings in 1999 by Unipac for the purchase of equipment used at two of our 3.5-generation fabs, and share offering in 1999 by Acer Display for the purchase of equipment used at our fourth-generation fab.

 

    The tax exemption period relating to our first 3.5-generation fab commenced in 2002 and will expire in 2005.

 

    The tax exemption period relating to the equipment purchased for our second 3.5-generation fab is four years and will expire in 2008.

 

    The tax exemption period relating to our fourth-generation fab will commence in 2005 and expire in 2009.

 

    Share offering in 1996 by Acer Display for the purchase of equipment used at our 3.5-generation fab.

 

    The tax exemption period will commence in 2003 and will expire in 2007.

 

    Share offerings in 2001 for the purchase of equipment used at our fourth-generation fab.

 

    The tax exemption period will commence in 2005 and will expire in 2009.

 

    Capitalization of retained earnings in 2001 for the purchase of equipment used at our previous early generation fab and 3.5-generation fab.

 

    The tax exemption period is five years for our previous early generation fab and our 3.5-generation fab.

 

    We have not received all required government approvals and have not yet designated the year from which we will use this tax exemption.

 

    Capitalization of retained earnings in 2003 for the purchase of equipment used at our fifth-generation fab.

 

    The tax exemption period is five years.

 

    We have not yet received all required government approvals and have not designated the year from which we will use this tax exemption.

 

    Issuance of ADS in 2002 for the purchase of equipment used at our fifth-generation fab.

 

    The tax exemption period is five years.

 

    We have not received all required government approvals and have not yet designated the year from which we will use this tax exemption.

 

    Capitalisation of retained earnings in 2004 for the purchase of equipment used at our sixth-generation fab.

 

    The tax exemption period is five years.

 

    We have not received all required government approvals and have not yet designated the year from which we will use this tax exemption.

 

    Issuance of ADS in 2004 for the purchase of equipment used at our fifth-generation fab.

 

    The tax exemption period is five years.

 

    We have not received all required government approvals and have not yet designated the year from which we will use this tax exemption.

 

If we make a qualified rights offering, our shareholders will be entitled, pursuant to a majority vote at a shareholders’ meeting held within two years after the rights offering, to elect to receive a tax credit for individual

 

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shareholders of up to 10% (which percentage is decreased by 1% every two years from 2000) or for corporate shareholders of up to 20% of their subscription amount against taxes payable within five years after expiration of the first three years of investment, during which period such shareholders are required to hold onto their investment in order to utilize the tax credit. For individual holders, except for the last year of that period, the tax credit deductible shall not exceed 50% of the total income tax payable by such shareholder in a particular year. Even if the shareholders elect to receive the shareholders’ tax credit, it is unlikely that ADS holders would be able to benefit from such tax credits. The ROC statute governing this tax credit does not expressly prohibit holders of ADSs from benefiting from such tax credit. However, in practice, even if an ADS holder may have other ROC sources of income against which to use the tax credit, ADS holders would not be able to prove that they meet the holding requirement necessary to claim the tax credit.

 

Loss Carryforwards

 

As of December 31, 2004, we have loss carryforwards of NT$2,393.7 million (US$75.4 million) available.

 

Tax Credits

 

We also benefit from certain tax credits under ROC law that may be applied toward reducing our tax liabilities. Prior to April 2002, we received tax credits at a rate of 10% of the purchase price in connection with our purchase of imported equipment and at a rate of 20% of the purchase price in connection with our purchase of locally manufactured equipment. As a result of the ROC becoming a member of the World Trade Organization, the ROC Ministry of Economic Affairs amended the tax credit rules in April 2002 to adopt a tax credit at a rate of 13% to be applied to the purchase of equipment, regardless of the location of production of the equipment. This rate was subsequently reduced to 11% in July 2004. We also receive tax credits at a rate of 10% for the purchase of production technology and at a rate of 13% for the purchase of pollution control equipment. As of December 31, 2004, we had accumulated NT$10,541.5 million (US$332.1 million) of these tax credits. These tax credits are expected to expire four years after the end of the year in which we received the equipment. As of December 31, 2004, NT$1,712.1 million (US$53.9 million), NT$2,285.7 million (US$72.0 million), NT$1,952.1 million (US$61.5 million) and NT$4,591.6 million (US$144.7 million) of these tax credits are expected to expire in 2005, 2006, 2007 and 2008, respectively.

 

We also benefit from other tax credits of up to 30% of certain research and development and employee training expenses. If the amount of these expenses that we incur in any year exceeds the average of such expenses for the proceeding two years, an additional 50% of the excess amount may be included in the applicable tax credit for such year. As of December 31, 2004, we had accumulated NT$910.4 million (US$28.7 million) of these tax credits. These tax credits are expected to expire four years after the year expenses are incurred. As of December 31, 2004, NT$65.4 million (US$2.1 million), NT$189.9 million (US$6.0 million), NT$252.6 million (US$8.0 million) and NT$402.5 million (US$12.6 million) of these tax credits are expected to expire in 2005, 2006, 2007 and 2008, respectively.

 

Tax on Retained Earnings

 

In 1997, the ROC Income Tax Law was amended to integrate the corporate income tax and shareholder dividend tax. Under the 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. See “Item 10. Additional Information—Taxation—ROC Tax Considerations—Retained Earnings Tax.” As a result, if we do not distribute as dividends in any year all of our annual retained earnings generated in the preceding year, our applicable corporate income tax rate may exceed 25% for such year.

 

5.B. Liquidity and Capital Resources

 

We need cash primarily for 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 expand our

 

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capacity has been largely dependent 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 expansion plans, including plans for newer generation 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. 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. Other than as described below in “—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, 2004, our primary source of liquidity was NT$17,797.7 million (US$560.7 million) of cash and cash equivalents and NT$1,586.5 million (US$50.0 million) of short-term investments. As of December 31, 2004, we had total short-term credit lines of NT$17,015.1 million (US$536.1 million), of which we had borrowed NT$6,183.0 million (US$194.8 million) as of December 31, 2004. 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. We are subject to restrictions on the sale, lease, transfer or other disposal of our assets under some of our short-term loan facilities. 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, 2004, we had outstanding long-term borrowings of NT$47,418.5 million (US$1,494.0 million). The interest rates in respect of these long-term borrowings are variable, and as of December 31, 2004 ranged between 1.8% and 5.0% per year.

 

In November 2001, we issued an aggregate principal amount of NT$10,000.0 million of convertible bonds due November 2008. The convertible bonds have been fully converted into our shares as of October 2003. The convertible bonds had a stated interest rate of 2.0% and an effective interest rate of 4.50%. The initial conversion price was NT$15.80 per share, subject to adjustment. The conversion price was adjusted to NT$14.9 per share based on the resolution of our board of directors’ meeting on June 16, 2003, to reflect the stock dividend distributed in 2003. As of December 31, 2002 and 2003, the total principal amount of convertible bonds which had been converted into our shares totaled NT$8,748.7 million and NT$10,000 million, respectively, which amounted to NT$5,537.1 million and NT$6,376.0 million, respectively, for our shares and a premium of NT$3,315.3 million and NT$3,795.0 million, respectively, recorded as capital surplus.

 

In November 2003, we entered into a NT$35.0 billion seven-year syndicated credit facility, for which International Commercial Bank of China acted as the agent bank, for the purpose of funding the construction and purchase of machinery and equipment at our fabs. 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, 2004, NT$9.0 billion has been drawn down under this credit facility. We issued NT$6.0 billion secured corporate bonds under this credit facility in April 2004.

 

In June 2004, we entered into a NT$55 billion and US$150 million 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 fabs. 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, 2004, NT$3 billion has been drawn down under this credit facility. We issued NT$6.0 billion secured corporate bonds under this credit facility in June 2005.

 

In June 2004, we issued an aggregate of 30,000,000 ADSs representing 300,000,000 shares of our common stock. The net proceeds from the offering were approximately NT$15,967.2 million (US$503.1 million). We

 

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used the net proceeds for the construction of and purchase of equipment and machinery for our production facilities, including the ramping up of our fifth-generation fabs and the construction of our sixth-generation fab.

 

Our long-term loans and facilities contain various financial and other covenants that could trigger a requirement for early payment. Among other things, these covenants require the maintenance of certain financial ratios, such as liquidity ratio, indebtedness ratio, interest coverage ratio and other technical requirements. In general, covenants in the agreements governing our existing debt, and debt we may incur in the future, may materially restrict our operations, including our ability to incur debt, pay dividends, make certain investments and payments and encumber or dispose of assets. A default under one debt instrument may also trigger cross-defaults under our other debt instruments. An event of default under any debt instrument, if not cured or waived, could have a material adverse effect on our liquidity, as well as our financial condition and operations.

 

The carrying amount of our assets pledged as collateral to secure our obligations under our long-term borrowings and bonds, including building, machinery and equipment, amounted to NT$89,345.0 million (US$2,814.9 million) as of December 31, 2004.

 

Net cash provided by operating activities amounted to NT$20,821.7 million in 2002, NT$37,041.5 million in 2003 and NT$49,393.6 million (US$1,556.2 million) in 2004. Our depreciation and amortization was NT$12,989.9 million in 2002, NT$16,294.6 million in 2003 and NT$25,309.3 million (US$797.4 million) in 2004. Our notes and accounts payable increased NT$1,322.0 million in 2002, NT$11,413.0 million in 2003 and NT$5,026.6 million (US$158.4 million) in 2004. Increases in depreciation and amortization were primarily due to increased capital investment for the expansion of our production capacity. Our depreciation and amortization and increases in our notes and accounts payable were partially offset by increases in notes and accounts receivable of NT$1,171.5 million in 2002, NT$6,894.2 million in 2003 and NT$4,541.4 million (US$143.1 million) in 2004 and increases in inventories of NT$1,770.7 million in 2003 and NT$6,517.3 million (US$205.3 million) in 2004.

 

Net cash used for investing activities was NT$18,125.0 million in 2002, NT$40,339.4 million in 2003 and NT$87,010.2 million (US$2,741.3 million) in 2004. Net cash used for investing activities primarily reflected capital expenditures for property, plant and equipment of NT$18,035.3 million in 2002, NT$39,300.6 million in 2003 and NT$81,868.7 million (US$2,579.4 million) in 2004. These capital expenditures were primarily funded with net cash provided by operating activities and financing activities, primarily from long-term bank borrowings and the issuance of shares.

 

Net cash provided by financing activities was NT$16,754.3 million in 2002, reflecting primarily our share issuance totaling NT$19,170.3 million, partially offset by our repayment of long-term loans and bonds of NT$5,104.1 million. Net cash used by financing activities was NT$4,672.6 million in 2003, reflecting primarily our repayments of long-term loans and bonds of NT$10,792.1 million, partially offset by borrowings of NT$8,740.4 million under long-term loans. Net cash provided by financing activities was NT$37,615.2 million (US$1,185.1 million), in 2004, reflecting primarily our issuance of shares in connection with our ADS follow-on offering totaling NT$15,967.2 million (US$503.1 million) and long-term loans and bonds of NT$28,315.8 million (US$892.1 million) partially offset by our repayment of long-term loans and bonds of NT$6,892.1 million (US$217.1 million) and a cash dividend distribution of NT$5,208.3 million (US$164.1 million).

 

We have made, and expect to continue to make, substantial capital expenditures in connection with the expansion of our production capacity. Substantially all of our investments in capital expenditures are located in Taiwan and the PRC. The table below sets forth our principal capital expenditures, paid or committed, for the periods indicated.

 

     2002

   2003

   2004

     NT$    NT$    NT$    US$
     (in millions)

Equipment purchases

   16,715.1    40,424.1    80,814.5    2,546.1

Land and building purchases

   1,874.5    3,990.0    2,233.3    70.4

 

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We are sometimes required to prepay our purchases of land and equipment. Prepayments for purchases of land are the result of a standard processing procedure by the ROC government related to the transfer of legal title. As of December 31, 2002, 2003 and 2004, our prepayments for purchases of land amounted to NT$30 million, NT$28 million and NT$0 million, respectively. Prepayments for purchases of equipment result from contractual agreements involving down payments to suppliers when the equipment is ordered by us. As of December 31, 2002, 2003 and 2004, prepayments for purchases of equipment amounted to NT$10,055 million, NT$11,753 million and NT$38,037.4 million (US$1,198.4 million), respectively.

 

For the year ended December 31, 2004, our capital expenditures amounted to NT$83,047.8 million (US$2,616.5 million), primarily for purchase of equipment to build our sixth-generation fab, including the color filter production facilities to be located at our sixth-generation fab, and the expansion of our existing fabs and our module-assembly operations.

 

We estimate our capital expenditures to be approximately NT$70.0 billion to NT$80.0 billion for 2005, primarily for the purchase of equipment to complete our third fifth-generation fab, including a second color filter production facility, the ramp-up of our sixth-generation fab and the establishment of our planned 7.5-generation fab. As of July 1, 2005, we have made commitments to purchase approximately NT$51.7 billion of equipment and machinery. We may adjust the amount of our capital expenditures upward or downward based on cash flow from operations, the progress of our expansion plans, and market conditions.

 

We believe that our existing cash, cash equivalents, short-term investments, expected cash flow from operations and borrowings under our existing and future credit facilities will be sufficient to meet our capital expenditure, working capital, cash obligations under our existing debt and lease arrangements and other requirements for at least the next 12 months. We frequently need to invest in new capacity to improve our economies of scale and reduce our production costs, which may require us to raise additional capital. We cannot assure you that we will be able to raise additional capital should it become necessary on terms acceptable to us or at all. The sale of additional equity or equity-linked securities may result in additional dilution to our shareholders.

 

5.C. Research and Development

 

We incurred research and development costs of NT$2,233.1 million, NT$3,386.4 million and NT$5,011.5 million (US$157.9 million) in 2002, 2003 and 2004, respectively, which represented 3.0%, 3.2% and 3.0%, respectively, of our net sales.

 

Our research and development activities are principally directed toward advancing our technologies in key components, manufacturing processes and product development, with the objective of improving the features of our products to bring added value to our customers in addition to design products that meet their specific requirements. We have a product development team dedicated to each of our primary product categories, including notebook computers, desktop monitors, LCD TVs, consumer electronics and general industrial applications. Each of these teams focuses on development of our existing products for its respective markets. To support our fabs, we maintain a centralized research and development team that works to improve our manufacturing processes, as well as a team of technical support personnel that focuses on computer integrated manufacturing. We also have two research and development teams that are dedicated to the development of LTPS and OLED, respectively. In addition, we have two research and development teams to explore new design platforms for next-generation displays. Finally, we have one research and development team that focuses on manufacturing yield and key component vendors. Monetary incentives are provided to our employees if research projects result in successful patents. As of December 31, 2004, we employed approximately 717 research and development engineers in our company.

 

We plan to continue to increase our spending on research and development with the goal of improving our TFT-LCD manufacturing process and developing new TFT-LCD products such as high-resolution 17-inch or

 

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larger panels for desktop monitors and 26-inch or above panels for television. We are also developing alternative technologies such as LTPS and OLED display. In particular, we are developing color active-matrix OLED technology for small- to medium-size panels, which we expect to be utilized in products such as mobile phones and digital still cameras.

 

We completed the establishment of a dedicated flat panel research and development center, the AUO Technology Center, in the third quarter of 2004. The research activities at the AUO Technology Center have initially been divided into several general areas, including advanced technology development in new liquid crystal materials, new system electronics, new backlight unit technologies, image and color processing, OLED, LTPS and plasma display. In addition to new product development and module processing, the AUO Technology Center also focuses on improving our current TFT-LCD panel product and manufacturing process technologies. As of December 31, 2004, we had invested a total of NT$879.0 million (US$27.7 million) in the AUO Technology Center.

 

5.D. Trend Information

 

For trend information, see “Item 5. Operating and Financial Review and Prospects—Operating Results.”

 

5.E. Off-Balance Sheet Arrangements

 

We have, from time to time, entered into non-derivative financial instruments, including letters of credit to finance or secure our purchase payment obligations. As of December 31, 2004, we had off-balance sheet outstanding letters of credit of US$9.7 million and JP¥3,144.1 million. In addition, we have entered into interest rate swap transactions to hedge our interest rate exposure arising out of our long-term borrowing facilities. As of December 31, 2004, we had interest rate swaps contracts with a total notional amount of NT$24.5 billion and with the maturity dates ranging from January 2008 to July 2009. We also entered into foreign currency forward contracts to economically hedge our existing assets and liabilities denominated in foreign currencies and identifiable foreign currency purchase commitments. As of December 31, 2004, we had outstanding foreign currency forward contracts of US$518.5 million and NT$6,872 million with settlement dates ranged from January to March 2005.

 

5.F. Tabular Disclosure of Contractual Obligations

 

The following tables set forth our contractual obligations and commitments with definitive payment terms which will require significant cash outlays in the future as of December 31, 2004.

 

     Payments due by Period

     Total

   Less than
1 year


   1-3 years

   3-5 years

  

More than 5

years


     NT$    NT$    NT$    NT$    NT$
     (in millions)

Contractual Obligations

                        

Long-term debt obligations(1)

   53,418.5    7,084.4    23,464.2    16,904.1    5,965.8

Operating lease obligations(2)

   1,433.0    95.4    190.7    190.7    956.2

Purchase obligations(3)

   71,283.2    59,283.2    12,000.0    —      —  
    
  
  
  
  

Total

   126,134.7    66,463.0    35,654.9    17,094.8    6,922.0
    
  
  
  
  

(1) Includes principal payment obligations only, as our interest obligations relating to the majority of our long-term debt are floating rate obligations.
(2) Represents our obligations to make lease payments to use the land on which our fabs and module-assembly facilities are located.

 

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(3) Include purchase orders for the machinery and equipment at our fabs. We have already begun to place orders related to the installation of machinery and equipment at our new sixth-generation and our third fifth-generation fabs, together with the color filter production facilities housed at such fabs. As of December 31, 2004, we had made commitments of approximately NT$31.3 billion (US$1.0 billion), primarily relating to the sixth-generation fab and color filter production, and approximately NT$23.5 billion (US$0.7 billion), relating to the third fifth-generation fab, which commitments may be cancelled subject to the payment of certain penalties.

 

In addition to the contractual obligations set forth above, we also have continuing obligations to make cash royalty payments under our technology license agreements, the amounts of which are determined based on net sales of our panels.

 

We have not entered into any financial guarantees or similar commitments to guarantee the payment obligations of non-affiliated third parties. In addition, we do not have any written options on non-financial assets. Our long-term loan and lease agreements include provisions that require early payment under certain conditions. The terms of our credit facilities for long-term borrowings also contain financial covenants, including current and debt-equity ratios and other technical requirements. Our debt under these facilities may be accelerated if there is a default, including defaults triggered by failure to comply with these financial covenants and other technical requirements. As of December 31, 2004, we were in compliance with all financial covenants and other technical requirements under our credit facilities.

 

U.S. GAAP Reconciliation

 

The following table sets forth a comparison of our net income and shareholders’ equity in accordance with ROC GAAP and U.S. GAAP for the periods indicated.

 

     For the Year Ended December 31,

 
     2002

    2003

    2004

 
     NT$     NT$     NT$     US$  
     (in millions, except per share data)  

Net income in accordance with

                        

ROC GAAP

   6,022.7     15,659.9     27,962.9     881.0  

U.S. GAAP

   4,938.9     15,715.4     18,112.5     570.7  

Shareholders’ equity in accordance with

                        

ROC GAAP

   77,828.0     92,654.5     130,565.6     4,113.6  

U.S. GAAP

   90,592.2     106,978.9     142,685.6     4,495.5  

Cash flows from operating activities in accordance with

                        

ROC GAAP

   20,821.7     37,041.5     49,393.6     1,556.2  

U.S. GAAP

   21,227.5     36,987.3     48,943.8     1,542.0  

Cash flows from investing activities in accordance with

                        

ROC GAAP

   (18,125.0 )   (40,339.4 )   (87,010.2 )   (2,741.3 )

U.S. GAAP

   (18,549.9 )   (40,339.4 )   (88,001.0 )   (2,772.6 )

Cash flows from financing activities in accordance with

                        

ROC GAAP

   16,754.3     (4,672.6 )   37,615.2     1,185.1  

U.S. GAAP

   16,773.4     (4,618.4 )   38,066.2     1,199.3  

 

Below is a discussion of certain material differences between ROC GAAP and U.S. GAAP. See note 22 to our consolidated financial statements for a complete discussion of significant differences between ROC GAAP and U.S. GAAP.

 

Business Combination

 

We completed our merger with Unipac on September 1, 2001 through the issuance of 1,512,281,607 of our shares in exchange for all of the outstanding shares of Unipac. Under ROC GAAP, the merger was accounted for using the pooling-of-interests method and, accordingly, all of our consolidated financial statements for prior periods included in this prospectus have been restated to include the results of operations, financial position and

 

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cash flows of Unipac. Further, according to the ROC Company Law, the excess of Unipac’s net assets over the par value of our shares issued for completion of the merger has been appropriated from unappropriated earnings and recorded as capital surplus. Under U.S. GAAP, the merger has been accounted for as the acquisition of Unipac, using the purchase method of accounting. Under purchase accounting, the aggregate purchase price of NT$39,636.9 million was calculated based on the market value of our shares issued and this amount was allocated to the assets acquired and liabilities assumed based on their respective fair values. The market value of our shares was based on the average market price of our shares over the five-day period before and after the terms of the acquisition were agreed upon and announced. Our management is responsible for the determination of the fair value of the assets acquired, including identifiable intangible assets, and liabilities assumed of Unipac. In determining such fair values, management considered a number of factors, including valuation reports by third parties. Based on the results of these valuations and our best estimates of fair value, we allocated the purchase price to the assets acquired and the liabilities assumed in accordance with U.S. GAAP. The difference between the purchase price and the fair value of the net assets that we acquired, including identifiable intangible assets, has been recorded as goodwill. The financial results of Unipac prior to the acquisition date of September 1, 2001 have been excluded from our U.S. GAAP results of operations.

 

We recorded NT$8,730.4 million of acquired intangible assets as part of the purchase price for Unipac, of which NT$53.5 million was assigned to in-process research and development assets that were then written off at the date of acquisition in accordance with Financial Accounting Standards Board, or FASB, Interpretation No. 4, “Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method.” Those write-offs were included in research and development expenses in 2001. The remaining NT$8,676.9 million of acquired intangible assets have a weighted average useful life of approximately 88 months and no estimated residual value. These intangible assets include large-size TFT-LCD product and manufacturing process technologies of NT$3,123.6 million and small- to medium-size TFT-LCD panel product and manufacturing process technologies of NT$5,553.3 million. The key technology for small and medium-size TFT-LCD production includes the technologies independently developed by Unipac and 13 related patents. The key technology for large-size TFT-LCD production includes the technologies jointly developed by Unipac and Matsushita, product technologies developed by Unipac and three related patents.

 

We also recorded NT$11,599.7 million in goodwill. In accordance with U.S. GAAP Statement of Financial Accounting Standards, or SFAS, No. 141, “Business Combinations,” goodwill arising from a purchase accounting business combination consummated after June 30, 2001 is not amortized but is tested for impairment. Effective January 1, 2002, for U.S. GAAP purposes, we adopted SFAS No. 142, “Goodwill and Other Intangible Assets.” As a result, we test goodwill for impairment on at least an annual basis at the reporting unit level.

 

Beneficial Conversion Feature of Convertible Bonds

 

When we issued our convertible bonds in November 2001, ROC GAAP did not require us to recognize or account for any beneficial conversion feature embedded in the bonds. However, under U.S. GAAP, the beneficial conversion feature should be recognized and measured by allocating a portion of the proceeds equal to the intrinsic value of that feature to capital surplus. The amount of the beneficial conversion feature was calculated at the commitment date as the difference between the conversion price and the fair value of our shares, multiplied by the number of shares into which the bonds are convertible. As a result of our allocating a portion of the proceeds equal to the intrinsic value of the beneficial conversion feature to capital surplus for U.S. GAAP purposes, a discount on the bonds was recognized. The discount resulting from this allocation will be recognized as interest expense over the life of the bonds.

 

The carrying amount of the convertible bonds was NT$1,206.0 million as of December 31, 2002 and NT$0 as of December 31, 2003 and 2004, and the related unamortized discount from the beneficial conversion feature was NT$80.9 million as of December 31, 2002 and NT$0 as of December 31, 2003 and 2004. The effective interest rate of the bonds was approximately 6%.

 

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Compensation Costs

 

Our articles of incorporation require a cash remuneration payment of up to 1% of our annual distributable earnings to our directors and supervisors. Under ROC GAAP, these payments are charged directly to retained earnings for the period during which our shareholders approve these payments. Under U.S. GAAP, these cash payments have been recorded as compensation expense in the period when the related services are rendered.

 

Certain of our employees are entitled to bonuses in accordance with our articles of incorporation, which specify a bonus amount ranging from 5% to 10% of our annual distributable earnings. Employee bonuses may be paid in cash, shares, or a combination of both. Under ROC GAAP, these bonuses are appropriated from retained earnings in the period our shareholders’ approval is obtained. If these employee bonuses are settled through the issuance of our shares, the amount charged against retained earnings is based on the par value of our shares issued.

 

Under U.S. GAAP, the employee bonus expense is charged to income in the year during which services are provided. Shares we issue as part of these bonuses are recorded at fair value. Since the amount and form of the bonuses are not finally determinable until our shareholders’ meeting in the following year, the total amount of these bonuses is initially accrued based on the minimum cash value to be paid. Any difference between the amount initially accrued and the fair value of these bonuses settled by the issuance of our shares is recognized in the year of approval by our shareholders.

 

Derivative Financial Instruments

 

We sell our products to customers worldwide and source a significant portion of our raw materials and components from suppliers outside Taiwan. This exposes us to changes in foreign currency exchange rates. We also have exposure to changes in interest rates that affect our cash flows on long-term borrowings. We use financial instruments, including derivatives such as foreign currency forward contracts and interest rate swaps, to reduce our foreign currency and interest rate exposure.

 

For ROC GAAP purposes, we record our interest rate swaps as hedge transactions by recording the net receivable or payable each month related to these interest rate swap contracts, offsetting or adding to our interest expense of the related debt. For foreign currency forward contracts, we record unrealized gains or losses measured using the change in the spot rate of the contracts in our consolidated statements of operations if the contracts are used to hedge existing foreign currency denominated receivables and payables, or we defer recognition of unrealized gains or losses for those contracts hedging anticipated transactions that will be denominated in a foreign currency. The discount or premium on a forward contract is amortized into earnings over the life of the contract.

 

For U.S. GAAP purposes, we adopted SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended, as of January 1, 2001. In accordance with the related transition provisions of SFAS No. 133, we recorded an after-tax charge to earnings of NT$0.6 million, representing the cumulative effect of the adoption related to the foreign currency forward contracts for the year ended December 31, 2001. The after-tax earnings charge to the statements of operations had no material effect on our U.S. GAAP earnings per share for the year ended December 31, 2001.

 

After our adoption of SFAS No. 133, as amended, none of our existing derivatives met the U.S. GAAP hedge accounting criteria. As a result, all derivative contracts are recognized as either assets or liabilities and are measured at fair value at each balance sheet date. Changes in fair values of derivative instruments arising subsequent to the transition date amounted to a charge of NT$22.2 million and NT$(249.6) million in 2003 and 2004, respectively, and are included in other non-operating income for U.S. GAAP purposes. In addition, we reclassified NT$9.4 million and NT$2.8 million, net of tax, of the deferred losses from accumulated other comprehensive income into earnings from the interest rate swap contracts during 2003 and 2004, respectively. Changes in the fair value of these derivatives in subsequent periods could result in increased volatility of our results of operations under U.S. GAAP.

 

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Income Taxes

 

Under ROC GAAP, a valuation allowance is provided on deferred tax assets when they are not certain to be realized based on the available projection of future taxable income. However, the criteria by which the need for a valuation allowance is determined is less stringent than under U.S. GAAP. Under U.S. GAAP, cumulative losses in recent years are significant piece of negative evidence, which is difficult to overcome using projections of future taxable income for the purpose of determining the valuation allowance. We suffered losses in 2001 and also had a net loss in the fourth quarter of 2002. As a result, we did not use the projection of future taxable income in determining our net deferred tax asset valuation allowance for the periods through December 31, 2002. However, we started to generate profits in 2003, and expect to continue to generate profit going forward. Therefore, more positive evidence is available that the use of available future taxable income projections in determining the size of the valuation allowance is appropriate. As a result, we reversed a valuation allowance of NT$1,869.1 million in 2003.

 

Under a revised ROC tax rule effective on January 1, 1998, an additional 10% corporate income tax will be assessed on taxable income but only to the extent such taxable income is not distributed before the end of the following year. As a result, from January 1, 1998 to January 20, 2001, our undistributed income is subject to a corporate tax rate of 28% and distributed income is taxed at 20%. Commencing from January 20, 2001, the undistributed and distributed income is subject to a corporate tax rate of 32.5% and 25%, respectively. Under ROC GAAP, the 10% tax on undistributed earnings is recognized as an expense on the date that shareholders approve the amount of the earnings distribution. Under U.S. GAAP, we measure our tax expense, including the tax effects of temporary differences, using the undistributed rate.

 

Depreciation of Property, Plant and Equipment

 

Under ROC GAAP, we depreciate buildings over estimated lives of 20 or 50 years based on guidance from the ROC Internal Revenue Code. Under U.S. GAAP, buildings are depreciated over an estimated useful life of 20 years.

 

Marketable Securities and Equity-Method Investments

 

Under ROC GAAP, marketable equity securities are carried at the lower of aggregate cost or market price. Under U.S. GAAP securities that have readily determinable fair values are to be classified as either trading, available-for-sale or held-to-maturity securities. Equity securities that are bought and traded for short-term profits are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings. Equity securities not classified as trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of other comprehensive income. Debt securities that we have the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost. We had no trading or held-to-maturity portfolios as of December 31, 2004. At December 31, 2004, the unrealized loss of one of our available-for-sale securities, which has been in a continuous unrealized loss position for more than twelve months, amounted to NT$922.9 million. We have determined that the impairment is other than temporary, and as a result, the unrealized loss of NT$922.9 million has been written off to current operations.

 

In March 2003, we purchased a 20% ownership in FDTC, recording the investment at NT$436.3 million, and equity method goodwill of NT$240.2 million. The equity method goodwill will not be amortized in accordance with SFAS No. 142, but will be tested for impairment annually or more frequently if events or circumstances indicate it might be impaired. Under ROC GAAP, the income and goodwill of FDTC is recognized using the equity method and recorded in the following year. The equity method goodwill will be amortized over five years using the straight-line method, and the amortization is recorded as investment loss. In August 2004, we sold half of our ownership in FDTC and beginning in September 2004, we recognized income and goodwill of FDTC using the cost method. We sold our remaining 10% ownership in May 2005.

 

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As permitted under ROC GAAP, we recognize our equity in the income (loss) of Patentop in the following year on a one-year lag basis. Under U.S. GAAP, we recognize our equity in the income (loss) of Patentop in the current year with no lag.

 

Recent U.S. GAAP Accounting Pronouncements

 

In November 2004, the FASB issued SFAS No. 151, “Inventory Cost.” SFAS No. 151 amends the guidance contained in the Accounting Research Bulletin (ARB) No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage). This statement is effective for fiscal periods beginning after June 15, 2005. The initial adoption of SFAS No. 151 is not expected to have a material impact on our results of operations or financial position.

 

In December 2004, the FASB issued SFAS No. 123 (Revised 2004), “Share Based Payment.” This statement establishes standards for the accounting of transactions in which an entity exchanges its equity instruments for goods or services. This statement is effective for fiscal periods beginning after June 15, 2005. On April 14, 2005, the SEC adopted a new rule permitting registrants to elect to adopt the revised standard beginning of the first annual period that begins after June 15, 2005. We have elected to defer the required adoption until the beginning of the first quarter of 2006. SFAS No. 123R allows for either prospective recognition of compensation expense or retrospective recognition. We are currently evaluating these transition methods. The initial adoption of SFAS 123R is not expected to have a material impact on our results of operations.

 

Recent ROC GAAP Accounting Pronouncements

 

Under ROC GAAP currently in effect, we categorize securities we own as either short-term investments or long-term investments. Short-term investments are recorded at cost when acquired and stated at the lower of aggregate cost or market value, or LCM. Long-term investments are stated at cost when acquired. Long-term investments in listed equity securities are evaluated under the LCM method or equity method, depending on the percentage of our shareholdings. Long-term investments in non-listed equity securities are evaluated under the cost method or equity method, depending on the percentage of our shareholdings. On December 25, 2003, the Financial Accounting Standards Committee, or FASC, issued ROC Statement of Financial Accounting Standards, or ROC SFAS, No. 34, “Accounting for Financial Instruments”, which will take effect beginning 2006. Investments in debt and equity securities will be classified into three categories: trading securities, available-for-sale securities and held-to-maturity securities. Changes in the values of securities in the trading portfolio will be recognized in the income statement immediately; changes in the values of available-for-sale category will be reported as a separate component of shareholders’ equity; held-to-maturity securities will be recorded under the amortized cost method.

 

Under ROC GAAP currently in effect, derivatives are treated as off-balance sheet items; however, ROC SFAS 34 will require all derivatives to be recorded on the balance sheet at fair value and establish “hedge accounting” for three different types of hedges: fair-value hedge, cash-flow hedge and foreign-currency hedge. Under hedge accounting, the effective portion of gains or losses from the hedging instrument and the hedged item will be recognized in earnings immediately. Changes in the fair value of derivatives that do not meet the criteria of one of these three categories of hedges are recorded directly in earnings. We do not expect the adoption of ROC SFAS No. 34 to have a material effect on our results of operations or financial condition.

 

On July 1, 2004, FASC issued ROC SFAS No. 35, “Accounting for Impairment Loss”. ROC SFAS No.35 applies to our financial statements for financial periods beginning January 1, 2005. We must recognize impairment loss in respect of our fixed assets, intangible assets, long-term investments under the equity method,

 

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idle assets and goodwill if their realized value is below their book value. Reversals of impairment losses (except for impairments of goodwill) are permissible under limited circumstances only. Before ROC SFAS No. 35 came into effect, ROC GAAP did not contain any definitive guidance on the method of recognizing impairment loss. We do not expect the adoption of ROC SFAS No. 35 to have a material effect on our results of operations or financial condition.

 

On December 9, 2004, FASC issued the ROC SFAS No.7 (Revised 2004) “Consolidated Financial Statements”, which requires us, beginning January 1, 2005, to consolidate in our consolidated financial statements the results of operations of all entities in which we have control over the financial and operating policies, irrespective of whether or not we have a majority shareholding in such entities. We do not expect the adoption of ROC SFAS No. 7 (Revised 2004) to have a material effect on our results of operations or financial condition.

 

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

 

6.A. Directors and Senior Management

 

Members of our board of directors are elected by our shareholders. Our board of directors is composed of nine directors. The chairman of the board of directors is elected by the directors. The chairman of the board of directors presides at all meetings of the board of directors and also has the authority to act as our representative. The term of office for directors is three years.

 

We also have three supervisors. In accordance with the ROC Company Law, supervisors are elected by our shareholders and cannot concurrently serve as our directors, executive officers or other staff members. The term of office for supervisors is three years. The supervisors’ duties and powers include, but are not limited to, investigation of our financial condition, inspection of corporate records, verification of statements by the board of directors, giving reports at shareholders’ meetings, representation of us in negotiations with our directors and giving notification, when appropriate, to the board of directors to cease acting in contravention of applicable law or regulations or our articles of incorporation or beyond our scope of business.

 

Pursuant to the ROC Company Law, a person may serve as our director or supervisor in his or her personal capacity or as the representative of another legal entity. A director or supervisor who serves as the representative of a legal entity may be removed or replaced at any time at the discretion of that legal entity, and the replacement director or supervisor may serve the remainder of the term of office of the replaced director or supervisor. Of our nine current directors, three are representatives of BenQ and one is a representative of Darly 2 Venture Ltd. Of our three supervisors, one is a representative of BenQ and one is a representative of China Development Industrial Bank, or CDIB.

 

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The following table sets forth information regarding all of our directors and supervisors as of July 1, 2005. The business address of all of our directors and supervisors is the company’s principal executive office.

 

Name


   Age

   Position

   Term
Expires


   Years
with
Us


  

Principal Business Activities

Performed Outside Our Company


Kuen-Yao (K.Y.) Lee

   53    Chairman    2007    9    Chairman and Chief Executive Officer of BenQ; Director of Darfon Electronics Corp.; Director of Daxon Technology Inc.

Hsuan Bin (H.B.) Chen

   54    Director    2007    8    Chairman of Wellypower Optronics Corporation

Hsi-Hua Sheaffer Lee(1)

   50    Director    2007    9    President and Chief Operating Officer of BenQ; Chairman of Darfon Electronics Corp.; Director of Gallant Precision Machining Co. Ltd.

Po-Yen Lu(1)

   54    Director    2007    8    Director of Cando Corporation

Hui Hsiung(1)

   52    Director    2007    9     

Chin-Bing Peng(2)

   52    Director    2007    1    President of iD SoftCapital Inc.

Cheng-Chu Fan

   53    Director    2007    1    Senior Advisor, WK Technology Fund

Vivien Huey-Juan Hsieh

   42    Director    2007    1    Chairman, Chin Sing Sing Steel Company; Advisor, China Development Asset Management Corporation

T.J. Huang

   59    Director    2007    1    Chairman, Systex Corporation; Chairman, Sysware Corporation; President, Asia Vest Partners TCW/YFT (Taiwan) Ltd.

Chieh-Chien Chao

   61    Supervisor    2007    1    Director, Professional Training Center, MOEA

Ko-Yung (Eric) Yu(1)

   49    Supervisor    2007    9    Chief Financial Officer of BenQ; Chairman of Daxon Technology Inc.; Supervisor of Darfon Electronics Corp.

Shin Chen(3)

   57    Supervisor    2007    *    Senior Executive Vice President, CDIB

(1) Representing BenQ.
(2) Representing Darly 2 Venture Ltd.
(3) Representing CDIB.
* Joined our company as supervisor after CDIB reappointed its representative on October 20, 2004.

 

Kuen-Yao (K.Y.) Lee has been the Chairman of our company since 1996 and a director of our company since 1996. Mr. Lee received his Bachelor’s degree in Electrical Engineering from the National Taiwan University in Taiwan in 1974 and his Master’s of Business Administration from the International Institute for Management Development in Switzerland in 1990.

 

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Hsuan Bin (H.B.) Chen has been a director of our company since 1998. In addition, Mr. Chen has been our President and Chief Operating Officer since 1997. Mr. Chen received his Bachelor’s degree in Communications Engineering from the National Chiao Tung University in Taiwan in 1975. Mr. Chen worked for Acer Technologies Sdn. Bhd. in Malaysia from 1992 to 1997 before he joined Acer Display in 1997.

 

Hsi-Hua Sheaffer Lee has been a director of our company since 1996. Mr. Lee has also been the President of BenQ since September 2003. He received a Bachelor’s degree in Electrical Engineering from the National Cheng Kung University in Taiwan in 1978.

 

Po-Yen Lu has been a director of our company since 2001. Mr. Lu has also been our Executive Vice President in charge of all our operating units since 1997. He received a Bachelor’s degree in Chemical Engineering from the National Taiwan University in Taiwan in 1974 and a Ph.D. degree in Chemical Engineering from University of Illinois in Urbana-Champaign in 1982. Before he joined our company in 1997, Mr. Lu worked for Gould Labs from 1978 to 1980, Bell Labs as Technical Manager from 1982 to 1995, and Electronics Research & Service Organization, Industrial Technology Research Institute as a Deputy Director of Display Research and Development from 1995 to 1997.

 

Hui Hsiung has been a director of our company since early 2002. Mr. Hsiung joined our company in 1996 as Director of the Research and Development Department, and from 1997 to 1999 served in positions in the company’s Marketing & Sales Division. Mr. Hsiung was a director of Acer Display from April 1999 to August 2001. Since June 2002, Mr. Hsiung has also served as our Executive Vice President in charge of all our business units of our company since 1996. He received a Bachelor’s degree in Physics from the National Taiwan University in Taiwan in 1975 and a Ph.D. degree in Physics from the University of California, Berkeley in 1985.

 

Chin-Bing Peng has been our director since April 2004. He is also the President of iD SoftCapital Inc. Mr. Peng received a Master’s of Business Administration degree from National Chengchi University in Taiwan in 1980.

 

Cheng-Chu Fan has been a director of our company since April 2004. He is also the senior advisor to WK Technology Fund and Chairman of Gatax Technology Co., Ltd. Mr. Fan was a president of Microsoft, Taiwan from 1992 to 2001 and the president of WK Technology Fund from 2001 to 2003. Mr. Fan received a Bachelor’s degree in electrical engineering from National Taiwan University in 1974.

 

Vivien Huey-Juan Hsieh has been a director of our company since April 2004. Ms. Hsieh is also the advisor of China Development Asset Management Company and Chairman of Chin Sing Sing Steel Company. Ms. Hsieh received a Ph.D. in Finance from the Graduate School of Business Administration, University of Houston, University Park, in Texas.

 

T.J. Huang has been a director of our company since April 2004. He is also the Chairman of Systex Corporation since 1977, the Chairman of Sysware Corporation since 1997 and the president of AsiaVest Partners, TCW/YFY (Taiwan) Ltd. since 1995. He was formerly Chief Financial Officer and Managing Director of YFY Paper Mfg. Co., Ltd. Mr. Huang received a Ph.D. in Computer Science from the University of Wisconsin at Madison in 1973.

 

Chieh-Chien Chao has been a supervisor of our company since April 2004. He is also the Director of Professional Training Center of MOEA. Mr. Chao was the Chairman of Chiao Tung Bank from 1994 to 2000, the Chairman of The Farmers Bank of China from 2000 to 2003 and the Chairman of Small and Medium Business Credit Guarantee Fund from 2003 to 2004. Mr. Chao received a Ph.D. in economics from National Taiwan University in 1974.

 

Ko-Yung (Eric)Yu has been a supervisor of our company since 1996. Mr. Yu was the Controller of Acer Peripherals, Inc. from 1996 to 1999. Thereafter, Mr. Yu was the Chief Financial Officer of Acer

 

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Communications and Multimedia Inc. from November 1999 to December 2001, and has served as a Vice President and the Chief Financial Officer of BenQ since January 2002. He received a Bachelor’s degree in Accounting from Fu Jen Catholic University in Taiwan in 1980 and a Master’s of Business Administration degree from the Strathclyde Graduate Business School in United Kingdom in 1995.

 

Shin Chen has been a supervisor of our company since October 2004. He is also a Senior Executive Vice President at China Development Industrial Bank. Mr. Chen was Chief Executive Officer of Chinatrust Venture Capital Corp. from 2001 to 2004 and Chief Executive Officer of Central Investment Holdings Company from 1996 to 2000. Mr. Chen received a Ph.D. in Business Administration from Nova University in Fort Lauderdale, Florida in 1986 and a Master’s of Business Administration from California State University at Long Beach in 1976.

 

Executive Officers

 

The following table sets forth information regarding all of our executive officers as of July 1, 2005.

 

Name


   Age

  

Position


   Years with Us

Kuen-Yao (K.Y.) Lee

   53    Chairman and Chief Executive Officer    9

Hsuan Bin (H.B.) Chen

   54    President and Chief Operating Officer    8

Po-Yen Lu

   54    Executive Vice President    8

Hui Hsiung

   52    Executive Vice President    9

Max Cheng

   43    Chief Financial Officer; Chief Accounting Officer; and Controller    7

 

Kuen-Yao (K.Y.) Lee. See “—Directors and Supervisors.”

 

Hsuan Bin (H.B.) Chen. See “—Directors and Supervisors.”

 

Po-Yen Lu. See “—Directors and Supervisors.”

 

Hui Hsiung. See “—Directors and Supervisors.”

 

Max Cheng has been our Chief Financial Officer, Chief Accounting Officer and Controller since 1998. He graduated from Fu Jen Catholic University in Taiwan with a Bachelor’s degree in Business Administration in 1985 and from Northern Illinois University with a Master’s degree in Accounting in 1990. Before he joined our company in 1998, Mr. Cheng served as the Controller of Acer Technologies Sdn. Bhd. from 1995 to 1998.

 

6.B. Compensation of Directors, Supervisors and Executive Officers

 

According to our articles of incorporation, we may distribute up to 1% of our annual distributable earnings in cash to our directors and supervisors as compensation after the payment of all income taxes, the deduction of any past losses, and the allocation of 10% of our annual earnings as legal reserves. In the event that a director or supervisor serves as a representative of a legal entity, such compensation is paid to the legal entity. See “Item 10. Additional Information—Articles of Incorporation—Dividends and Distributions.” We did not pay compensation to our directors and supervisors for their services rendered in 2001 due to our net loss in that year. The aggregate compensation paid in 2004 to our directors and supervisors for their services was approximately NT$70.5 million (US$2.2 million). We pay our executive officers monthly salaries, in addition to employee bonuses. The aggregate compensation paid in 2004 to our executive officers for their services was approximately NT$80.4 million (US$2.5 million).

 

We have a defined benefit pension plan covering our regular employees. Retirement benefits are based on length of service and average salaries or wages in the last six months before retirement. We make monthly contributions, at 2.0% of salaries and wages, to a pension fund that is deposited in the name of, and administered

 

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by, the employees’ pension plan committee. Our accrued pension cost for the year ended December 31, 2004 was NT$139.4 million (US$4.4 million). See note 12 of notes to consolidated financial statements.

 

6.C. Board Practices

 

General

 

For a discussion of the term of office of the board of directors, see “—Directors and Senior Management.” No benefits are payable to members of the board or the executive officers upon termination of their relationship with us.

 

Audit Committee

 

Our board of directors established an audit committee in August 2002. The audit committee has responsibility for, among other things, oversight of the services provided to us by any accounting firm. The audit committee is appointed by the board of directors and currently consists of Cheng-Chu Fan, Vivien Huey-Juan Hsieh and T.J. Huang. Each audit committee member is an independent director who is financially literate with accounting or related financial management expertise. The audit committee meets as often as it deems necessary to carry out its responsibilities.

 

6.D. Employees

 

Employees

 

The following table provides a breakdown of our employees by function as of December 31, 2002, 2003 and 2004.

 

     As of December 31,

Function


   2002

   2003

   2004

Production

   7,181    10,359    14,142

Technical(1)

   1,967    2,642    3,278

Sales and marketing

   108    509    375

Management and administration

   863    1,073    2,112
    
  
  

Total

   10,119    14,583    19,907
    
  
  

(1) Includes research and development personnel.

 

The following table provides a breakdown of our employees by geographic location as of December 31, 2002, 2003 and 2004.

 

     As of December 31,

Location


   2002

   2003

   2004

Taiwan(1)

   7,635    8,272    10,544

Suzhou, Jiangsu Province, PRC(2)

   2,474    6,286    9,329

Others

   10    25    34
    
  
  

Total

   10,119    14,583    19,907
    
  
  

(1) Employed by AU Optronics Corp.
(2) Employed by AU Optronics (Suzhou) Corp.

 

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Employee salaries are reviewed and adjusted annually, while performance evaluations are conducted semi-annually. Salaries are adjusted based on inflation and individual performance. As an incentive, discretionary cash bonuses may be paid based on the performance of individuals. In addition, ROC law generally requires that our employees in Taiwan be given preemptive rights to subscribe for between 10% and 15% of any of our share offerings.

 

Our employees in Taiwan participate in our profit distributions under our articles of incorporation. Employees in Taiwan are entitled to receive bonus shares, cash or a combination of bonus shares and cash, based on a percentage of our annual distributable earnings. The amount allocated in shares is, subject to the resolution of our shareholders’ meeting, determined by valuing the shares at their par value, or NT$10.00 per share, and paid to our employees in Taiwan based on individual performance and job seniority. We did not allocate any such amount for employees in Taiwan in 2002 for work performed in 2001 due to our net loss in 2001. We paid NT$433.6 million in bonus shares to our employees in 2003 for work performed in 2002. We paid NT$887.9 million in bonus shares and NT$380.5 million (US$12.0 million) in cash bonuses to our employees in 2004 with respect to 2003.

 

The Hsinchu Science Park Administration offers a variety of employee-related services, including medical examinations, health insurance, career planning advice and other services for our employees in Taiwan. In addition to the services provided by the Hsinchu Science Park Administration, we have established a welfare committee, a pension fund committee, and other employee committees and a variety of employee benefit programs.

 

We do not have an employee option plan as of December 31, 2004. We do not have any collective bargaining arrangement with our employees. We consider our relations with our employees to be good.

 

6.E. Share Ownership

 

The table below sets forth the share ownership, as of July 1, 2005, of the legal entities represented by our directors and supervisors and executive officers.

 

Name


   Number of
Shares Owned


   Percentage of
Shares Owned


 

Kuen-Yao (K.Y.) Lee, Chairman and Chief Executive Officer

   6,870,376    *  

Hsuan Bin (H.B.) Chen, Director, President and Chief Operating Officer

   4,471,623    *  

Hsi-Hua Sheaffer Lee, Director(1)

   657,370,440    13.26 %

Po-Yen Lu, Director and Executive Vice President(1)

   657,370,440    13.26 %

Hui Hsiung, Director and Executive Vice President(1)

   657,370,440    13.26 %

Chin-Bing Peng, Director(2)

   1,399,036    *  

Cheng-Chu Fan, Director

   —      —    

Vivien Huey-Juan Hsieh, Director

   —      —    

T.J. Huang, Director

   —      —    

Chieh-Chien Chao, Supervisor

   —      —    

Ko-Yung (Eric) Yu, Supervisor(1)

   657,370,440    13.26 %

Shin Chen, Supervisor(3)

   40,868,112    *  

Max Cheng, Chief Financial Officer, Chief Accounting Officer and Controller

        *  

(1) Represents shares held by BenQ.
(2) Represents shares held by Darly 2 Venture Ltd.
(3) Represents shares held by CDIB.
* Less than 1%.

 

None of our directors, supervisors or executive officers has voting rights different from those of other shareholders.

 

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ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

 

7.A. Major Shareholders

 

BenQ is our major shareholder. As of July 1, 2005, BenQ beneficially owned 13.32% of our outstanding shares. Three of our directors and one of our supervisors are representatives of BenQ.

 

UMC was one of our major shareholders, holding 11.31% and 9.74% of our outstanding shares as of December 31, 2002 and December 31, 2003, respectively. As of April 15, 2005, UMC owns 1.44% of our outstanding shares. Prior to our shareholders’ meeting on April 29, 2004, three of our directors and one of our supervisors were representatives of UMC. UMC is no longer represented on our current board of directors and supervisors.

 

There have been no changes in our major shareholders or significant changes in the amount of shares BenQ holds since July 1, 2005.

 

The following table sets forth information known to us with respect to the beneficial ownership of our shares as of July 1, 2005, the most recent practicable date, by (1) each shareholder known by us to beneficially own more than 5% of our shares and (2) all directors and supervisors as a group.

 

Name of Beneficial Owner


   Number of Shares
Beneficially Owned


   Percentage of Shares
Beneficially Owned


    Percentage of Shares
Beneficially Owned
(Fully Diluted)


 

BenQ(1)
157, Shan-Ying Road,
Gueishan, Taoyuan 333,
Taiwan, ROC

   660,449,476    13.32 %   13.32 %

All directors and supervisors as a group(2)

   710,979,587    14.34 %   14.34 %

(1) Formerly Acer Communications and Multimedia Inc.
(2) Calculated as the sum of: (a) with respect to directors and supervisors who are serving in their personal capacity, the number of shares held by such director or supervisor and (b) with respect to directors and supervisors who are serving in the capacity as legal representatives, the number of shares owned by such institutional or corporate shareholder for which such director or supervisor is a legal representative.

 

None of our major shareholders has voting rights different from those of our other shareholders. To the best of our knowledge, we are not directly or indirectly controlled by another corporation, any foreign government, or any other natural or legal person, severally or jointly.

 

We are not aware of any arrangement that may at a subsequent date result in a change of control of our company.

 

As of December 31, 2004, approximately 4,958.0 million of our shares were outstanding. We believe that, of such shares, approximately 934.4 million shares in the form of ADSs were held by approximately 40,584 holders in the United States as of April 18, 2005.

 

7.B. Related Party Transactions

 

We have not extended any loans or credit to any of our directors, supervisors or executive officers, and we have not provided guarantees for borrowings by any of these persons. We have not entered into any fee-paying contract with any of these persons for such person to provide services not within such person’s capacity as a director, supervisor or executive officer of the company.

 

We have, from time to time, purchased raw materials and components and sold our panels to our affiliated companies. We believe that these transactions with related parties have been conducted on arms’-length terms, or on terms more favorable to us than arms’-length terms. Given the nature of our business, it is not practical for us to review

 

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many of these related party transactions on a day-to-day basis. However, at the meeting of our board of directors on April 11, 2002, we adopted an amended related party transactions policy which requires, among other things:

 

    pre-approval by a majority vote of disinterested directors of each sale to, or purchase of raw materials and components from, a related party that is in the ordinary course of our business, which transaction involves a transaction amount in excess of 5% of our net sales or raw materials and component purchases, as the case may be, for the previous three months on an unconsolidated basis, provided that any series of similar transactions with the same related party that collectively exceeds 40% of our net sales or raw materials and component purchases, as the case may be, for the previous three months on an unconsolidated basis shall also require pre-approval;

 

    periodic review by our board of directors of other related party transactions in the ordinary course of business;

 

    pre-approval by a majority vote of disinterested directors of related party transactions not in the ordinary course of business and not otherwise specified in our related party transaction policy; and

 

    recusal of any interested director from consideration of matters involving the company he or she represents or with respect to which the director might have a conflict of interest.

 

BenQ and Related Companies

 

BenQ

 

BenQ is our major shareholder, owning directly and indirectly a 13.32% equity interest in our company as of July 1, 2005. In addition, three of our nine directors and one of our three supervisors are legal representatives of BenQ. In 2004, we purchased 5.47% of BenQ’s outstanding shares in order to establish a long-term strategic relationship with BenQ.

 

We sell panels for desktop monitors and LCD television to BenQ. We generated net sales to BenQ in the amount of NT$5,823.4 million in 2002, and NT$1,534.7 million in 2003 and NT$2,310.9 million (US$72.8 million) in 2004, and our receivables from these sales were NT$558.7 million as of December 31, 2003 and NT$475.8 million (US$15.0 million) as of December 31, 2004.

 

We also purchase printed circuit boards from BenQ. We also purchased TFT-LCD monitors, projectors, mobile phones and notebook computers from BenQ for use in our business. Our purchases from BenQ amounted to NT$1,177.0 million in 2002, NT$218.4 million in 2003. We did not make any purchases from BenQ in 2004.

 

BenQ (IT) Co., Ltd. Suzhou (“BQS”)

 

BQS, an affiliate of our company, was 100% indirectly owned by BenQ as of March 31, 2005. We sell desktop monitor display panels to BQS. We generated net sales to BQS in the amount of NT$9,922.9 million in 2002, NT$18,781.4 million in 2003 and NT$30,030.2 (US$946.1 million) in 2004, and our receivables from these sales was NT$3,083.7 million as of December 31, 2002, NT$3,598.5 million as of December 31, 2003 and NT$4,007.5 million (US$126.3 million) as of December 31, 2004.

 

BenQ Mexicana S.A. De C.V. (“BQX”)

 

BQX, an affiliate of our company, was 84.5% owned by BenQ as of March 31, 2005. We sell panels for desktop monitors to BQX. We generated net sales to BQX in the amount of NT$721.6 million in 2002, NT$1,569.5 million in 2003 and NT$850.7 million (US$26.8 million) in 2004, and our receivables from these sales was NT$157.9 million as of December 31, 2002 and NT$178.2 million as of December 31, 2003 and NT$85.1 million (US$2.7 million) as of December 31, 2004.

 

Acer Inc.

 

Acer Inc. is our affiliate, owning a 9.52% equity interest in BenQ as of March 31, 2005. We sell notebook computer display panels to Acer Inc. We generated net sales to Acer Inc. in the amount of NT$853.7 million in

 

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2002, NT$3,894.7 million in 2003 and NT$6,733.6 million (US$212.1 million) in 2004. Our receivables from these sales were NT$219.0 million as of December 31, 2002, NT$801.0 million as of December 31, 2003 and NT$521.8 million (US$16.4 million) as of December 31, 2004.

 

Wistron Corp.

 

Wistron Corp., an affiliate of our company, was 33.51% owned by Acer Inc. as of March 31, 2005. We sell notebook computer display panels to Wistron. We generated net sales to Wistron in the amount of NT$1,017.7 million in 2002, NT$736.3 million in 2003 and NT$931.7 million (US$29.4 million) in 2004.

 

Wistron Infocomm (Philippines) Corp.

 

Wistron Infocomm (Philippines) Corp., an affiliate of our company, was 100.0% owned by Wistron Corp. as of March 31, 2005. We sell notebook computer display panels to Wistron Infocomm (Philippines) Corp. We generated net sales to Wistron Infocomm (Philippines) Corp. in the amount of NT$2,104.3 million in 2002, NT$641.7 million in 2003 and NT$906.9 million (US$28.6 million) in 2004, and our receivables from these sales were NT$35.6 million, NT$177.8 million and NT$53.8 million (US$1.7 million) as of December 31, 2002, 2003 and 2004, respectively.

 

Min Tour Inc.

 

Min Tour Inc., an affiliate of our company, was 100.0% indirectly owned by Acer Inc. as of September 30, 2003. In 2000, we entered into lease agreements with Min Tour for land, buildings, dormitories and equipment. We paid Min Tour related rent and administration fees in the amount of NT$62.7 million in 2001, NT$67.2 million in 2002 and NT$89.3 million in 2003. In September 2003, Min Tour was acquired by Acer Building Maintenance Management Corp., a wholly owned subsidiary of Acer Inc., and the obligations of Min Tour Inc. under these agreements were assumed by Acer Building Maintenance Management Corp. after the acquisition. We paid Acer Building Maintenance Management Corp. related rent and administration fees in the amount of NT$89.5 million in 2004. As security for our obligations under the lease agreement, we made refundable deposits, the outstanding balance of which amounted to NT$867.0 million as of December 31, 2004.

 

Cando Corporation

 

We owned 21.47% of Cando Corporation as of March 31, 2005. We purchased color filters from Cando Corporation in the amount of NT$1,494.4 million in 2003 and NT$2,551.1 million (US$80.4 million) in 2004.

 

Other Related Company

 

Fujitsu Display Technologies Corporation (“FDTC”)

 

FDTC was 10% owned by our company as of March 31, 2005. We purchased a 20% ownership interest in FDTC in March 2003 and sold a 10% ownership interest in August 2004. We sold our remaining 10% ownership in FDTC in May 2005. We purchased liquid crystals, backlight units, driver integrated circuits and polarizers from FDTC in the amount of NT$310.7 million in 2003 and NT$316.1 million (US$10.0 million) in 2004. We sold display panels for notebook and desktop computers to FDTC in the amount of NT$769.5 million in 2003 and NT$2,538.8 million (US$80.0 million) in 2004.

 

We entered into a Joint Research and Development and Cost Sharing Agreement with FDTC in March 2003 for joint research and development of TFT-LCD technologies. This agreement was terminated in July 2004. We paid NT$244.6 million and NT$182.3 million (US$5.7 million) as cost shared for research and development project under this agreement in 2003 and 2004, respectively.

 

7.C. Interests of Experts and Counsel

 

Not applicable.

 

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ITEM 8. FINANCIAL INFORMATION

 

8.A. Consolidated Statements and Other Financial Information

 

8.A.1. See Item 18 for our audited consolidated financial statements.

 

8.A.2. See Item 18 for our audited consolidated financial statements, which cover the last three financial years.

 

8.A.3. See page F-2 for the audit report of our accountants, entitled “Report of Independent Registered Public Accounting Firm.”

 

8.A.4. Not applicable.

 

8.A.5. Not applicable.

 

8.A.6. See note 21 to our consolidated financial statements included in Item 18 of this annual report for the amount of our export sales.

 

8.A.7. Litigation

 

On September 17, 2003, Sharp Corporation filed a suit in the United States District Court of Northern District of California against us and eight other co-defendants, including BenQ, alleging infringement of certain of Sharp Corporation’s patents in the United States relating to the manufacturing of TFT-LCD panels. The suit is seeking, among other things, (1) a judgment that the defendants, including us, have directly infringed, contributorily infringed and/or actively induced the infringement of Sharp Corporation’s patents; (2) a preliminary and permanent injunction on the infringement of the patents through manufacture, use, import, offer for sale and/or sale of the infringing products and systems; (3) compensatory damages for the infringed patents, which in any event should not be less than the amount of reasonable royalty had such technology been licensed from Sharp Corporation, together with prejudgment interest, costs and disbursements as determined by the court; and (4) punitive damages of up to three times the amount found or assessed for infringement of patents due to the willful and deliberate nature of the infringement. On July 6, 2005, we entered into a patent cross license agreement with Sharp Corporation relating to the patents that are subject to the foregoing litigation. The parties agree that Sharp Corporation will dismiss this lawsuit against us.

 

On April 13, 2004, Commissariat A L’Energie Atomique, a French government agency, filed a lawsuit against us, our U.S. subsidiary and sixteen other defendants in the United States Federal District Court for the District of Delaware. The suit alleges infringement of certain patents. The parties are currently in discovery. At this stage of the proceedings it is not possible to predict the outcome or likely outcome of the litigation, or the final costs of resolving the suit.

 

On January 19, 2005, Guardian Industries Corp. filed a suit in the United States District Court for the District of Delaware against us and twenty other co-defendants, including BenQ, alleging infringement of certain of Guardian Industries Corp.’s patents in the United States relating to the manufacturing of TFT-LCD panels. The suit is seeking, among other things, (1) a judgment that the defendants, including us, have directly infringed, contributorily infringed and/or actively induced the infringement of Guardian Industries Corp.’s patents; (2) a permanent injunction on further infringement of the patents; (3) compensatory damages for the infringed patents, which in any event should not be less than the amount of reasonable royalty had such technology been licensed from Guardian Industries Corp., together with prejudgment interest as determined by the court; (4) punitive damages of up to three times the amount found or assessed for infringement of patents due to the willful infringement; and (5) Guardian Industries Corp.’s reasonable attorney’s fees, expenses and costs incurred in the action. On June 1, 2005, we entered into a license agreement with Guardian Industries Corp. for its patents relating to the technology that is the subject of the foregoing litigation. As a result, on June 23, 2005, the suit by Guardian Industries Corp. against us and BenQ was dismissed.

 

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On February 15, 2005, Sharp Corporation filed a suit in the United States District Court of Central District of California against us and nine other co-defendants, including BenQ, alleging infringement of certain of Sharp Corporation’s patents in the United States relating to the manufacturing of TFT-LCD panels. The suit is seeking, among other things, (1) a judgment that the defendants, including us, have directly infringed, contributorily infringed and/or actively induced the infringement of Sharp Corporation’s patents; (2) a preliminary and permanent injunction on the infringement of the patents through manufacture, use, import, offer for sale and/or sale of the infringing products and systems; (3) compensatory damages for the infringed patents, which in any event should not be less than the amount of reasonable royalty had such technology been licensed from Sharp Corporation, together with prejudgment interest, costs and disbursements as determined by the court; and (4) punitive damages of up to three times the amount found or assessed for infringement of patents due to the willful and deliberate nature of the infringement. On July 6, 2005, we entered into a patent cross license agreement with Sharp Corporation relating to the patents that are subject to the foregoing litigation. The parties agree that Sharp Corporation will dismiss this lawsuit against us.

 

On February 24, 2005, Thomson Licensing S.A. and Thomson Licensing Inc. filed an action with the United States International Trade Commission against us and BenQ, alleging infringement of certain U.S. patents through the importation and sale in the U.S. of certain color TV receivers, color display monitors and components thereof (“accused products”). The action seeks, among other things, (1) the commencement of an investigation by the International Trade Commission to remedy the unlawful importation in the U.S., the sale for importation into the U.S. and/or the sale within the U.S. after importation by BenQ of the accused products; (2) the issuance of a permanent exclusion order excluding from entry into the U.S. all accused products manufactured by or for BenQ, that infringe one or more of the patents; and (3) a cease and desist order directing BenQ to immediately cease the importation into the U.S., sale for importation in the U.S. and sale in the U.S. after importation of the accused products and to immediately cease the demonstration, sale, use and movement or shipment of U.S. inventory of the accused products. On March 9, 2005, Thomson Licensing S.A. also filed a suit in the United States District Court for the Northern District of California against us and BenQ, alleging infringement of the same patents that are the subject of the action filed with the International Trade Commission. The lawsuit filed in California has been automatically stayed pending the outcome of the action filed with the International Trade Commission. As of the date of this report it is not possible to predict the outcome or likely outcome of the litigation, or the total costs of resolving the litigation.

 

Our customers may from time to time be subject to lawsuits related to products that contain TFT-LCD panels manufactured by us. Two such lawsuits initiated by Sharp against BenQ and TECO Electric and Machinery Co. are currently pending in Japan. On July 6, 2005, we entered into a patent cross license agreement with Sharp Corporation. The parties agree that Sharp Corporation will dismiss the lawsuit against BenQ pending in Japan.

 

8.A.8. Dividends and Dividend Policy

 

The following table sets forth as a percentage the stock dividends per share paid during 2001 on the shares outstanding on the relevant record date for each of Acer Display and Unipac. Other than in 2001, neither company had previously paid any stock dividends. In addition, neither company had previously paid any cash dividends.

 

Dividend Paid in 2001


   Stock
Dividend Per
Share(1)


   Dividend Payment Date

   Total Number of
Shares Issued as
Stock Dividend(2)


   Aggregate Stock
Dividend Amount


   Outstanding
Shares as of
August 31, 2001(4)


                    NT$(3)    US$     
               (in thousands)    (in thousands)     

Acer Display Technology, Inc.

   1.60    September 3, 2001    208,300    2,083,000    59,514    1,458,300,000

Unipac Optoelectronics Corporation

   1.42    July 9, 2001    227,120    2,271,200    64,891    1,757,120,000

(1) Stock dividends are declared in NT dollars per share. A shareholder receives as a stock dividend the number of shares equal to the NT dollar amount per share of the dividend declared, multiplied by the number of shares owned by the shareholder, and divided by the par value of NT$10.00 per share. Fractional shares are not issued, but are paid in cash.

 

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(2) Total number of shares issued as stock dividends includes shares issued from retained earnings and from capital reserves.
(3) The NT dollar amount of stock dividends paid is calculated based upon the par value of NT$10.00 per share.
(4) The merger of Acer Display and Unipac was completed on September 1, 2001.

 

No cash or stock dividends were distributed for the year 2001 due to our net loss in that year. We distributed cash dividends of NT$0.5 per share on August 11, 2003 and stock dividends of NT$0.5 per share for the year 2002 on July 31, 2003. We distributed a cash dividend of NT$1.2 per share on July 23, 2004 and a stock dividend of NT$0.5 per share on July 12, 2004 for the year 2003.

 

Our articles of incorporation provide that the cash portion of any dividend shall generally not be less than 10% of the annual dividend. However, the ratio for cash dividends may be adjusted in accordance with actual earnings and operation conditions. The form, frequency and amount of future dividends will depend upon our earnings, cash flow, financial condition, reinvestment opportunities and other factors.

 

We are generally not permitted under the ROC Company Law to distribute dividends or to make any other distributions to shareholders for any fiscal year in which we have no earnings. Our articles of incorporation provide that we shall allocate 10% of our annual earnings as a legal reserve in each fiscal year after:

 

    payment of all income taxes; and

 

    deduction of any past losses.

 

Earnings distributions are made in the following manner:

 

    5% to 10% of the remainder is distributable as a bonus for employees;

 

    no more than 1% of the remainder is distributable as remuneration to directors and supervisors; and

 

    all or a portion of the balance is distributable as dividend and bonus to our shareholders.

 

In addition to permitting dividends to be paid out of accumulated earnings after deducting losses, we are permitted under the ROC Company Law to make distributions to our shareholders of additional shares by capitalizing reserves, including the legal reserve. However, the capitalized portion payable out of our legal reserve is limited to 50% of the total accumulated legal reserve, and only if and to the extent the accumulated legal reserve exceeds 50% of our paid-in capital. See “Item 10. Additional Information—Articles of Incorporation—Dividends and Distributions.” For information as to ROC taxes on dividends and distributions, see “Item 10. Taxation—ROC Tax Considerations—Dividends.”

 

The holders of ADSs will be entitled to receive dividends to the same extent as the holders of our shares, subject to the terms of the deposit agreement.

 

Any cash dividends will be paid to the depositary in NT dollars and, after deduction of any applicable ROC taxes and fees and expenses of the depositary and custodian, except as otherwise provided in the deposit agreement, will be converted by the depositary into U.S. dollars and paid to the holders of ADSs. Whenever the depositary receives any free distribution of shares, including stock dividends, on any ADSs that the holders of ADSs hold, the depositary may, and will if we so instruct, deliver to the holders of ADSs additional ADSs which represent the number of shares received in the free distribution, after deduction of applicable taxes and the fees and expenses of the depositary and the custodian. If additional ADSs are not so delivered, each ADS that the holders of ADSs hold shall represent its proportionate interest in the additional shares distributed.

 

8.B. Significant Changes

 

We have not experienced any significant changes since the date of the annual financial statements.

 

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ITEM 9. THE OFFER AND LISTING

 

9.A. Offering and Listing Details

 

Our shares have been listed on the Taiwan Stock Exchange since September 8, 2000 under the number “2409.” The ADSs have been listed on the New York Stock Exchange under the symbol “AUO” since May 23, 2002. The table below sets forth, for the periods indicated, the high and low closing prices and the average daily volume of trading activity on the Taiwan Stock Exchange for the shares and the high and low closing prices and the average daily volume of trading activity on the New York Stock Exchange for the shares represented by ADSs.

 

    Taiwan Stock Exchange

  New York Stock Exchange(1)

    Closing Price per
Share


  Average Daily
Trading
Volume


  Closing Price per
ADS


  Average Daily
Trading
Volume


        High    

      Low    

        High    

      Low    

 
    (NT$)   (NT$)   (in thousands of
shares)
  (US$)   (US$)   (in thousand of
ADSs)

2000:

  57.26   15.84   1,506.54            

Third Quarter (from September 8)

  57.26   40.20   467.03            

Fourth Quarter

  38.58   15.84   1,754.04            

2001:

  35.62   11.38   36,889.47            

2002:

  58.57   15.24   93,256.21   12.33   4.30   733.59

2003:

  49.90   16.86   95,656.02   14.80   4.81   438.40

First Quarter

  23.90   18.29   66,511.04   7.03   5.33   147.22

Second Quarter

  24.48   16.86   71,756.44   7.08   4.81   187.35

Third Quarter

  48.20   24.38   165,645.71   14.58   7.00   604.15

Fourth Quarter

  49.90   38.60   73,940.05   14.80   11.21   797.31

2004:

  78.50   41.40   97,560.92   27.93   12.47   3,274.97

First Quarter

  63.50   41.40   86,004.93   21.05   12.47   2,860.20

Second Quarter

  78.50   48.90   107,158.69   27.93   15.24   4,152.33

Third Quarter

  50.50   37.50   87,191.13   15.77   11.08   3,062.58

Fourth Quarter

  46.20   33.20   69,850.15   14.38   9.77   2,360.43

2005 (through June 30):

  55.70   41.50   58,771.47   18.14   12.73   1,848.57

First Quarter

  49.90   41.50   58,172.41   16.48   12.73   2,056.82

January

  45.60   41.50   68,588.05   15.47   12.73   2,271.09

February

  49.90   47.70   64,845.83   16.48   15.15   2,135.78

March

  49.75   42.00   46,086.39   16.20   13.44   1,793.84

Second Quarter (through June 30)

  55.70   45.45   59,284.95   18.14   14.57   1,650.07

April

  50.70   45.45   72,214.85   16.22   14.57   2,026.00

May

  53.90   49.60   62,026.48   17.74   16.10   1,478.11

June

  55.70   50.70   44,913.57   18.14   16.81   1,455.38

(1) Each ADS represents the right to receive 10 common shares.

 

9.B. Plan of Distribution

 

Not applicable.

 

9.C. Markets

 

The principal trading markets for our shares are the Taiwan Stock Exchange and the New York Stock Exchange, on which our shares trade in the form of ADSs.

 

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9.D. Selling Shareholders

 

Not applicable.

 

9.E. Dilution

 

Not applicable.

 

9.F. Expenses of the Issue

 

Not applicable.

 

ITEM 10. ADDITIONAL INFORMATION

 

10.A. Share Capital

 

Not applicable.

 

10.B. Articles of Incorporation

 

The following statements summarize the material elements of our capital structure and the more important rights and privileges of our shareholders conferred by ROC law and our Articles of Incorporation.

 

Objects and Purpose

 

The scope of our business as set forth in Article 2 of our articles of incorporation includes the research, development, production, manufacture and sale of the following products: plasma display and related systems, liquid crystal display and related systems, OLED and related systems, amorphous silicon photo sensor device parts and components, thin film photo diode sensor device parts and components, thin film transistor photo sensor device parts and components, touch imaging sensors, full color active-matrix flat panel displays, field emission displays, single crystal liquid crystal displays, original equipment manufacturing for amorphous silicon thin film transistor process and flat panel display modules, original design manufacturing and original equipment manufacturing business for flat panel display modules and the simultaneous operation of a trade business relating to our business.

 

Directors

 

Our board of directors is elected by our shareholders and is responsible for the management of our business. Our articles of incorporation provide that our board of directors is to have between seven to nine members. Currently, our board of directors is composed of nine directors. The chairman of our board is elected by the directors. The chairman presides at all meetings of our board of directors, and also has the authority to represent our company. The term of office for our directors is three years.

 

As required under our articles of incorporation, we currently have three supervisors. In accordance with the ROC Company Law, supervisors are elected by our shareholders and cannot concurrently serve as our directors, executive officers or other staff members. The term of office for supervisors is three years. The supervisors’ duties and powers include, but are not limited to, investigation of our financial condition, inspection of corporate records, verification of statements by the board of directors, giving reports at shareholders’ meetings, representation of us in negotiations with our directors and giving notification, when appropriate, to the board of directors to cease acting in contravention of applicable law or regulations or our articles of incorporation or beyond our scope of business.

 

The election of our directors and supervisors by our shareholders may be conducted by means of cumulative voting or other voting mechanics, if any, adopted in our articles of incorporation. Pursuant to the ROC Company

 

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Law, the election of our directors and supervisors is currently conducted by means of cumulative voting, as our articles of incorporation do not provide for another voting mechanism. The most recent election for all of the directors and supervisors was held on April 29, 2004.

 

Pursuant to the ROC Company Law, a person may serve as a director or supervisor in his or her personal capacity or as the representative of another legal entity. A legal entity that owns our shares may be elected as a director or supervisor, in which case a natural person must be designated to act as the legal entity’s representative. A legal entity that is our shareholder may designate its representative to be elected as our director or supervisor on its behalf. In the event several representatives are designated by the same legal entity, any or all of them may be elected. A natural person who serves as the representative of a legal entity as a director or supervisor may be removed or replaced at any time at the discretion of such legal entity, and the replacement director or supervisor may serve the remainder of the term of office of the replaced director or supervisor. Currently, four of our directors and two of our supervisors are representatives of other legal entities, as shown in “Item 6.—Directors, Senior Management and Employees—Directors and Senior Management—Executive Officers.”

 

Shares

 

As of July 1, 2005, our authorized share capital was NT$70 billion, divided into seven billion common shares, of which 100 million shares are reserved for the issuance of shares for employee stock options, and 4,958,040,897 shares were issued.

 

On June 2, 2004, we issued 305,803,656 shares of common stock for purposes of distributing stock dividends and employee bonuses. On June 23, 2004, we issued 300 million shares of our common stock in the form of 30 million ADSs. Each ADS represents the right to receive 10 shares of common stock. The public offer price per ADS was US$16.00. On June 14, 2005, our shareholders approved the issuance of 542,506,235 common shares for purposes of distributing stock dividends and employee stock bonuses. The stock issuance was authorized by the government authorities. The record date for this stock issuance is July 20, 2005.

 

All shares presently issued, including those underlying our ADSs, are fully paid and in registered form, and existing shareholders are not obligated to contribute additional capital.

 

New Shares and Preemptive Rights

 

The issuance of new shares requires the prior approval of our board of directors. If our issuance of any new shares will result in any change in our authorized share capital, we are required under ROC law to amend our articles of incorporation, which requires approval of our shareholders in a shareholders’ meeting. We must also obtain the approval of, or submit a registration to, the ROC Financial and Supervisory Commission and the Hsinchu Science Park Administration Bureau, as applicable. Generally, when a company issues capital stock for cash, 10% to 15% of the issue must be offered to its employees. In addition, if a public company intends to offer new shares for cash, at least 10% of the issue must also be offered to the public. This percentage can be increased by a resolution passed at a shareholders’ meeting, which will reduce the number of new shares in which existing shareholders may have preemptive rights. Unless the percentage of the shares offered to the public is increased by a resolution, existing shareholders of the company have a preemptive right to acquire the remaining 75% to 80% of the issue in proportion to their existing shareholdings.

 

Register of Shareholders and Record Date

 

Our share registrar, SinoPac Securities Corporation, maintains the register of our shareholders at its office in Taipei, Taiwan, and enters transfers of our shares in the register upon presentation of, among other documents,

 

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the certificates in respect of our shares transferred. The ROC Company Law permits us, by giving advance public notice, to set a record date and close the register of shareholders for a specified period in order to determine the shareholders or pledgees that are entitled to certain rights pertaining to our shares. Under the ROC Company Law, our register of shareholders should be closed for a period of sixty days before each ordinary meeting of shareholders, thirty days before each extraordinary meeting of shareholders and five days before each record date.

 

Transfer of Shares

 

Under the ROC Company Law, shares are transferred by endorsement and delivery of the related share certificates. In addition, transferees must have their names and addresses registered on our register in order to assert shareholders’ rights against us. Notwithstanding the foregoing, shareholders are required to file their specimen seals with our share registrar. The settlement of trading of our shares on the Taiwan Stock Exchange will be carried out on the book-entry system maintained by Taiwan Securities Central Depository Co., Ltd.

 

Shareholders’ Meetings

 

We are required to hold an annual ordinary shareholders’ meeting once every calendar year, generally within six months after the end of each fiscal year. Any shareholder who holds 1% or more of our issued and outstanding common shares may submit one written proposal for discussion at our annual ordinary shareholders meeting. Our directors may convene an extraordinary shareholders’ meeting whenever they think fit, and they must do so if requested in writing by shareholders holding not less than 3% of our paid-in share capital who have held their shares for more than a year. In addition, any of our supervisors may convene a shareholders’ meeting under certain circumstances. For a public company in Taiwan, such as our company, at least 15 days’ advance written notice must be given of every extraordinary shareholders’ meeting and at least 30 days’ advance written notice must be given of every annual ordinary shareholders’ meeting. Unless otherwise required by law or by our articles of incorporation, voting for an ordinary resolution requires an affirmative vote of a simple majority of those present and voting. A distribution of cash dividends would be an example of an act requiring an ordinary resolution. A special resolution may be adopted in a meeting of shareholders convened with a quorum of holders of at least two-thirds of our total outstanding shares at which the holders of at least a majority of our shares represented at the meeting vote in favor thereof. A special resolution is necessary for various matters under ROC law, including:

 

    any amendment to our articles of incorporation;

 

    our dissolution or amalgamation;

 

    a merger or spin-off;

 

    transfers of the whole or a substantial part of our business or properties;

 

    the acquisition of the entire business of another company which would have a significant impact on our operations;

 

    the distribution of any stock dividend; or

 

    the removal of directors or supervisors.

 

However, in the case of a public company such as our company, a special resolution may be adopted by holders of at least two-thirds of the shares represented at a meeting of shareholders at which holders of at least a majority of the total outstanding shares are present.

 

Voting Rights

 

According to the ROC Company Law, a holder of our shares has one vote for each share held at shareholders’ meetings. However, (i) treasury shares or (ii) our common shares held by an entity in which our company owns more than 50% of the voting shares or paid-in capital, or Controlled Entity, or by a third entity in

 

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which our company and a Controlled Entity jointly own, directly or indirectly, more than 50% of the voting shares or paid-in capital cannot be voted. There is cumulative voting for the election of directors and supervisors. In all other matters, shareholders must cast all their votes the same way on any resolution. Voting rights attached to our common shares may be exercised by personal attendance or proxy, or at our discretion, by written or electronic ballot.

 

If any shareholder is represented at an ordinary or extraordinary shareholders’ meeting by proxy, a valid proxy form must be delivered to us five days before the commencement of the ordinary or extraordinary shareholders’ meeting. Voting rights attached to our shares that are exercised by our shareholders’ proxy are subject to ROC proxy regulations. Any shareholder who has a personal interest in a matter to be discussed at our shareholders’ meeting, the outcome of which may impair our interests, is not permitted to vote or exercise voting rights nor vote or exercise voting rights on behalf of another shareholder on such matter.

 

Except for trust enterprises or share transfer agents approved by the ROC Financial and Supervisory Commission, where one person is appointed as proxy by two or more shareholders who together hold more than 3% of our shares, the votes of those shareholders in excess of 3% of our total issued shares will not be counted.

 

You will not be able to exercise voting rights on the shares underlying your ADSs on an individual basis.

 

Dividends and Distributions

 

We may distribute dividends in any year in which we have accumulated earnings. Before distributing a dividend to shareholders following the end of a fiscal year, we must recover any past losses, pay all outstanding taxes, and set aside in a legal reserve 10% of our annual earnings for that fiscal year until our legal reserve equals our paid-in capital.

 

At the shareholders’ annual ordinary meeting, our board of directors submits to the shareholders for approval proposals for the distribution of a dividend or the making of any other distribution to shareholders from our accumulated earnings or reserves for the preceding fiscal year. Dividends may be distributed either in cash, in the form of shares or a combination of cash and shares. Our articles of incorporation provide that the cash portion of any dividend shall generally not be less than 10% of the annual dividend. However, the ratio for cash dividends may be adjusted in accordance with actual earnings and operating conditions. Dividends are paid proportionately to shareholders as listed on the register of shareholders on the relevant record date.

 

Our articles of incorporation provide that we shall allocate 10% of our annual earnings as a legal reserve in each fiscal year after:

 

    payment of all income taxes; and

 

    deduction of any past losses.

 

Earnings distributions are made in the following manner:

 

    5% to 10% of the remainder is distributable as a bonus for employees;

 

    no more than 1% of the remainder is distributable as remuneration to directors and supervisors; and

 

    all or a portion of the balance is distributable as a dividend and bonus to our shareholders.

 

In addition to permitting dividends to be paid out of accumulated earnings after deducting losses, we are permitted under the ROC Company Law to make distributions to our shareholders of additional shares by capitalizing reserves, including the legal reserve. However, the capitalized portion payable out of our legal reserve is limited to 50% of the total accumulated legal reserve, and only if and to the extent the accumulated legal reserve exceeds 50% of our paid-in capital.

 

For information on the dividends paid by us in recent years, see “Item 8. Financial Information—Dividends and Dividend Policy.” For information as to ROC taxes on dividends and distributions, see “Item 10.—Additional Information—Taxation—ROC Tax Considerations—Dividends.”

 

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Acquisition of Shares by Our Company

 

With limited exceptions under the ROC Company Law, we are not permitted to acquire our shares.

 

In addition, pursuant to the Securities and Exchange Law, we may, by a board resolution adopted by majority consent at a meeting with two-thirds of our directors present, purchase our shares on the Taiwan Stock Exchange or by a tender offer, in accordance with the procedures prescribed by the ROC Financial and Supervisory Commission, for the following purposes:

 

    to transfer shares to our employees;

 

    to facilitate conversion arising from bonds with warrants, preferred shares with warrants, convertible bonds, convertible preferred shares or certificates of warrants issued by our company into shares; and

 

    if necessary, to maintain our credit and our shareholders’ equity; provided that the shares so purchased shall be cancelled thereafter.

 

We are not allowed to purchase more than 10% of our aggregate issued and outstanding shares. In addition, we may not spend more than the aggregate amount of our retained earnings, the premium from issuing stock and the realized portion of the capital reserve to purchase our shares.

 

We may not pledge or hypothecate any purchased shares. In addition, we may not exercise any shareholders’ rights attaching to such shares. In the event that we purchase our shares on the Taiwan Stock Exchange or through a tender offer, our affiliates, directors, supervisors, officers and their respective spouses and minor children and/or nominees are prohibited from selling any of our shares during the period in which we purchase our shares.

 

According to the ROC Company Law, as last amended and effective from June 24, 2005, an entity in which our company directly or indirectly owns more than 50% of the voting shares or paid-in capital, which is referred to as a controlled entity, may not purchase our shares. Also, if our company and a controlled entity jointly own, directly or indirectly, more than 50% of the voting shares or paid-in capital of another entity, which is referred to as a third entity, the third entity may not purchase shares in either our company or a controlled entity.

 

On October 14, 2002, our board of directors approved a buyback program for market repurchases of up to 10 million shares during the period between October 15, 2002 and December 14, 2002 at the target purchase price of between NT$15 and NT$20 per share, with a view to transferring these shares to our employees. We did not make any repurchases under this buyback program. On December 16, 2002, our board of directors approved another buyback program for market repurchases of up to 20 million shares during the period between December 17, 2002 and February 16, 2003 at the target price of between NT$17.5 and NT$23.5 per share for the same purpose. We repurchased an aggregate of 12 million shares at an average purchase price of NT$20.9 per share, or an aggregate purchase price of NT$250.8 million, under this buyback program.

 

Liquidation Rights

 

In the event of our liquidation, the assets remaining after payment of all debts, liquidation expenses, taxes and distributions to holders of preferred shares, if any, will be distributed pro rata to our shareholders in accordance with the ROC Company Law.

 

Rights to Bring Shareholder Suits

 

Under the ROC Company Law, a shareholder may bring suit against us in the following events:

 

    Within 30 days from the date on which a shareholders’ resolution is adopted, a shareholder may file a lawsuit to annul a shareholders’ resolution if the procedure for convening a shareholders’ meeting or the method of resolution violates any law or regulation or our articles of incorporation.

 

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    If the substance of a resolution adopted at a shareholders’ meeting contradicts any applicable law or regulation or our articles of incorporation, a shareholder may bring a suit to determine the validity of such resolution.

 

Shareholders may bring suit against our directors and supervisors under the following circumstances:

 

    Shareholders who have continuously held 3% or more of the total number of issued and outstanding shares for a period of one year or longer may request in writing that a supervisor institute an action against a director on our behalf. In case the supervisor fails to institute an action within 30 days after receiving such request, the shareholders may institute an action on our behalf. In the event that shareholders institute an action, a court may, upon motion of the defendant, order such shareholders to furnish appropriate security.

 

    In the event that any director, supervisor, officer or shareholder who holds more than 10% of our issued and outstanding shares and their respective spouse and minor children and/or nominees sells shares within six months after the acquisition of such shares, or repurchases the shares within six months after the sale, we may make a claim for recovery of any profits realized from the sale and purchase. If our board of directors or our supervisors fail to make a claim for recovery, any shareholder may request that our board of directors or our supervisors exercise the right of claim within 30 days. In the event our directors or our supervisors fail to exercise such right during such 30-day period, such requesting shareholder will have the right to make a claim for such recovery on our behalf. Our directors and supervisors will be jointly and severally liable for damages suffered by us as a result of their failure to exercise the right of claim.

 

Financial Statements

 

For a period of at least ten days before our annual shareholders’ meeting, we must make available our annual financial statements at our principal offices in Hsinchu, Taiwan and our share register in Taipei, for inspection by our shareholders.

 

Transfer Restrictions

 

Our directors, supervisors, officers and shareholders holding more than 10% of our issued and outstanding shares and their respective spouse and minor children and/or nominees, which we refer to as insiders, are required to report any changes in their shareholding to us on a monthly basis. No insider is permitted to sell shares on the Taiwan Stock Exchange for six months from the date on which the relevant person becomes an insider. In addition, the number of shares that insiders can sell or transfer on the Taiwan Stock Exchange on a daily basis is limited by ROC law. Furthermore, insiders may sell or transfer our shares on the Taiwan Stock Exchange only after reporting to the ROC Financial and Supervisory Commission at least three days before the transfer, provided that such reporting is not required if the number of shares transferred does not exceed 10,000.

 

Other Rights of Shareholders

 

Under the ROC Company Law, dissenting shareholders are entitled to appraisal rights in the event of a spin-off, a merger or various other major corporate actions. Dissenting shareholders may request us to redeem their shares at a fair price to be determined by mutual agreement. If no agreement can be reached, the valuation will be determined by court order. Dissenting shareholders may exercise their appraisal rights by notifying us before the related shareholders’ meeting or by raising and registering their dissent at the shareholders’ meeting.

 

Transfer Agent and Registrar

 

The transfer agent and registrar for our shares is SinoPac Securities Corporation, 3rd Floor, 53, Po Ai Road, Taipei, Taiwan; telephone number: 886-2-2381-6288. The transfer agent and registrar for our ADS is Citibank, N.A., 388 Greenwich Street, 14th Floor, New York, New York, 10013, USA; telephone number: 1-877-248-4237.

 

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10.C. Material Contracts

 

License from Matsushita. Unipac entered into a five-year Technology Assistance and Patent License Agreement with Matsushita effective as of October 30, 1998, which provides for the non-transferable and non-exclusive license and technical support to manufacture TFT-LCD panels between 13.3 inches and 19.0 inches at our previous second-generation fab and our 3.5-generation fab. The agreement provides for a fixed license fee, and, subject to a maximum payment requirement, ongoing royalty payments at a percentage of the sales of the panels we manufacture using the licensed technology. Currently, we pay royalties for production of 13.3-inch and 14.1-inch TFT-LCD panels manufactured at one of our 3.5-generation fabs. This agreement expired on October 31, 2003, and we are entitled to a grace period of three years during which we can continue using the license while proceeding with negotiation efforts for license renewal.

 

License from FDTC. We have a license agreement with FDTC, effective as of March 31, 2003, which provides for the non-transferable and non-exclusive license and technical support to manufacture all of our TFT-LCD panels at each of our facilities. The agreement provides for an initial license fee and fixed royalty payments to be paid for each of the first four consecutive 12-month periods following the effective date of the agreement.

 

Licenses from SEL. We entered into a license agreement with SEL effective as of September 1, 2003 in connection with our settlement and mutual release relating to a suit brought by SEL. The license agreement provides for the non-transferable and non-exclusive license to manufacture all of our amorphous silicon TFT-LCD panels and modules at each of our facilities using intellectual property owned by SEL. The agreement provides for a fixed license fee and ongoing royalty payments at a percentage of the sales of the panels we manufacture using the licensed technology.

 

10.D. Exchange Controls

 

We have extracted from publicly available documents the information presented in this section. Please note that citizens of the PRC and entities organized in the PRC are subject to special ROC laws, rules and regulations, which are not discussed in this section.

 

The ROC’s Foreign Exchange Control Statute and regulations provide that all foreign exchange transactions must be executed by banks designated to handle foreign exchange transactions by the Central Bank of China. Current regulations favor trade-related foreign exchange transactions. Consequently, foreign currency earned from exports of merchandise and services may now be retained and used freely by exporters. All foreign currency needed for the importation of merchandise and services may be purchased freely from the designated foreign exchange banks.

 

Aside from trade-related foreign exchange transactions, Taiwan companies and residents may remit to and from Taiwan foreign currencies of up to US$50 million and US$5 million, respectively, each calendar year. A requirement is also imposed on all private enterprises to report all medium- and long-term foreign debt with the Central Bank of China.

 

In addition, a foreign person without an alien resident card or an unrecognized foreign entity may remit to and from Taiwan foreign currencies of up to US$100,000 per remittance if required documentation is provided to ROC authorities. This limit applies only to remittances involving a conversion between NT dollars and U.S. dollars or other foreign currencies.

 

10.E. Taxation

 

ROC Tax Considerations

 

The following summarizes the principal ROC tax consequences of owning and disposing of ADSs and shares if you are not a resident of Taiwan. You will be considered a non-resident of Taiwan for the purposes of this section if:

 

    you are an individual and you are not physically present in Taiwan for 183 days or more during any calendar year; or

 

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    you are an entity and you are organized under the laws of a jurisdiction other than Taiwan and have no fixed place of business or other permanent establishment in Taiwan.

 

You should consult your own tax advisors concerning the tax consequences of owning ADSs or shares in Taiwan and any other relevant taxing jurisdiction to which you are subject.

 

Dividends

 

Dividends, whether in cash or shares, declared by us out of retained earnings and paid out to a holder that is not a Taiwan resident in respect of shares represented by ADSs or shares are subject to ROC withholding tax. The current rate of withholding for non-residents is 20% of the amount of the distribution, in the case of cash dividends, or of the par value of the shares distributed, in the case of stock dividends. As discussed below in “Retained Earnings Tax,” our after-tax earnings will be subject to an undistributed retained earnings tax. To the extent dividends are paid out of retained earnings that have been subject to the retained earnings tax, the amount of such tax will be used by us to offset the withholding tax liability on such dividend. Consequently, the effective rate of withholding on dividends paid out of retained earnings previously subject to the retained earnings tax will be less than 20%. There is no withholding tax with respect to stock dividends declared out of our capital reserves.

 

Capital Gains

 

Gains realized on ROC securities transactions inside or outside of Taiwan are currently exempt from ROC income tax. In addition, sales of ADSs by non-resident holders are not regarded as sales of ROC securities and, as a result, any gains on such transactions are currently not subject to ROC income tax.

 

Securities Transaction Tax

 

The ROC government imposes a securities transaction tax that will apply to sales of shares, but not to sales of ADSs. The transaction tax is payable by the seller for the sale of shares and is equal to 0.3% of the sales proceeds.

 

Estate and Gift Tax

 

ROC estate tax is payable on any property within the ROC of a deceased individual, and ROC gift tax is payable on any property within the ROC donated by any individual. Estate tax is currently payable at rates ranging from 2% of the first NT$600,000 to 50% of amounts over NT$100,000,000. Gift tax is payable at rates ranging from 4% of the first NT$600,000 to 50% of amounts over NT$45,000,000. Under ROC estate and gift tax laws, shares issued by ROC companies, such as our shares, are deemed located in the ROC regardless of the location of the holder. It is unclear whether or not ADSs will be deemed assets located in the ROC for the purpose of ROC gift and estate taxes.

 

Preemptive Rights

 

Distributions of statutory preemptive rights for shares in compliance with the ROC Company Law are not subject to ROC tax. Proceeds derived from sales of statutory preemptive rights evidenced by securities by a non-resident are exempt from income tax, but may be subject to an ROC securities transaction tax, discussed above. Proceeds derived from sales of statutory preemptive rights that are not evidenced by securities are subject to income tax at the rate of:

 

    25% of the gains realized by non-Taiwan entities; and

 

    35% of the gains realized by non-Taiwan individuals.

 

We have the sole discretion to determine whether statutory preemptive rights are evidenced by securities or not.

 

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Retained Earnings Tax

 

Under the ROC Income Tax Laws, we are subject to a 10% retained earnings tax on our after-tax earnings generated after January 1, 1998 that are not distributed in the following year. Any retained earnings tax so paid will further reduce the retained earnings available for future distribution. When we declare dividends out of those retained earnings, a maximum amount of up to 10% of the declared dividends will be credited against the 20% withholding tax imposed on the non-resident holders of our ADS or shares.

 

Tax Treaty

 

Taiwan does not have an income tax treaty with the United States. Taiwan has tax treaties for the avoidance of double taxation with Indonesia, Singapore, South Africa, Australia, Netherlands, Vietnam, New Zealand, Malaysia, Macedonia, Swaziland, Gambia, United Kingdom, Senegal and Sweden, which may limit the rate of ROC withholding tax on dividends paid with respect to shares. It is unclear whether, if you hold ADSs, you will be considered to hold shares for the purposes of these treaties. Accordingly, if you may otherwise be entitled to the benefits of an income tax treaty, you should consult your tax advisors concerning your eligibility for the benefits with respect to ADSs.

 

United States Federal Income Tax Considerations for United States Holders

 

The following is a discussion of the material U.S. federal income tax consequences of the purchase, ownership and disposition of our ADSs or shares to the U.S. Holders described in this annual report. The discussion set forth below applies only to beneficial owners of our ADSs or shares that are U.S. Holders, hold the ADSs or shares as capital assets and are non-residents of Taiwan as defined under “ROC Tax Considerations.” You are a “U.S. Holder” if, for United States federal income tax purposes, you are:

 

    a citizen or resident of the United States;

 

    a corporation, or other entity taxable as a corporation, created or organized in or under the laws of the United States or any political subdivision thereof; or

 

    an estate or trust the income of which is subject to U.S. federal income taxation regardless of its source.

 

This summary is based on the Internal Revenue Code of 1986, as amended, (the “Code”), administrative pronouncements, judicial decisions and final, temporary and proposed Treasury regulations, all as currently in effect. These laws are subject to change, possibly on a retroactive basis. In addition, this summary is based in part on representations by the depositary and assumes that each obligation under the deposit agreement and any related agreement will be performed in accordance with its terms. This summary does not contain a detailed description of all the U.S. federal income tax consequences to you in light of your particular circumstances and does not address the effects of any state, local or non-U.S. tax laws (or other U.S. federal tax consequences, such as U.S. federal estate or gift tax consequences). In addition, it does not describe the U.S. federal income tax consequences applicable to U.S. Holders subject to special treatment under the U.S. federal income tax laws, such as:

 

    dealers and traders in securities or foreign currencies;