LPL

Business Context and Reporting Period

Company: LG.Philips LCD Co., Ltd. (LPL)

Filing Type: Form 20-F (Annual Report)

Reporting Period: Fiscal year ended December 31, 2006

Business Overview: LPL is the world's largest merchant supplier of large-size TFT-LCD panels, primarily for televisions, notebook computers, and desktop monitors. The company operates seven fabrication facilities (P1–P7) in Korea and assembly facilities in Korea, China, and Poland. The industry is characterized by high capital intensity, rapid technological change, and significant cyclicality in pricing.

Key Financial Metrics (Year Ended Dec 31, 2006)

Margins (2006): Gross Margin: (2.7)% | Operating Margin: (8.3)% | Net Margin: (6.5)%

Material Changes vs. Prior Period

• Profitability Reversal: The company recorded a net loss of (Won)693 billion in 2006, a significant deterioration from a net income of (Won)542 billion in 2005. This was driven by a gross loss of (Won)286 billion, compared to a gross profit of (Won)1,006 billion in 2005.
• Revenue Growth: Sales increased 5.4% to (Won)10,624 billion, primarily due to a 105% increase in unit sales of television panels (driven by large-size HD panels), which offset declines in desktop monitor sales.
• Price Erosion: Average selling prices (ASP) declined across all major categories: Televisions (-14.1%), Notebook Computers (-32.3%), and Desktop Monitors (-27.5%). Cost of sales increased 20.3%, exceeding revenue growth due to higher raw material costs and depreciation from new facilities (P7).
• Inventory Build-up: Inventories increased 52.5% to (Won)1,052 billion, partly due to a strategic shift from air to sea freight to reduce costs, resulting in higher goods in transit.
• Debt Levels: Long-term debt increased to (Won)3,856 billion (including current portion) from (Won)3,293 billion in 2005 to fund capacity expansion.

Guidance, Outlook, Risks, and Unusual Items

Outlook and Capital Requirements

Management expects capital expenditures on a delivery basis to be approximately (Won)1.0 trillion in 2007, with cash outflows estimated at (Won)1.7 trillion. Funds will support the expansion of P7, construction of P8, and new module plants in Guangzhou and Wroclaw. The company anticipates continued industry capacity expansion, which may exert downward pressure on panel prices.

Material Risks and Contingencies

• Antitrust Investigations: In December 2006, the company received notice of investigations by the Korean Fair Trade Commission, Japanese Fair Trade Commission, and the U.S. Department of Justice regarding possible anti-competitive activities in the TFT-LCD industry. Subsequent class-action lawsuits have been filed in the U.S. alleging violations of antitrust and securities laws. The company states it is too early to estimate potential losses.
• Patent Litigation: The company is engaged in multiple patent infringement lawsuits globally. In 2006, it was awarded approximately US$106 million in damages in two separate jury trials against competitors (Chunghwa Picture Tubes and others), but faces counter-claims and other pending litigation.
• Customer Concentration: The top ten end-brand customers accounted for 71.3% of sales in 2006. The two principal shareholders, LG Electronics and Philips Electronics, are major customers, accounting for 16.3% and 12.5% of sales, respectively.
• Exchange Rate Risk: Sales are primarily denominated in U.S. dollars, while costs are mixed (Won, Yen, USD). Appreciation of the Korean Won generally has a negative impact on results, though the company utilizes hedging strategies.

Key Facts for Investor Verification

• Antitrust Exposure: Verify the status and potential financial impact of the ongoing antitrust investigations by the DOJ and other global regulators, as well as related class-action litigation.
• Margin Sustainability: Assess the company's ability to reduce manufacturing costs faster than the rate of price erosion in the highly competitive TFT-LCD market, given the negative gross margin in 2006.
• Capital Allocation: Monitor the progress and cost overruns of the P8 fabrication facility and new module plants in China and Poland, which require significant ongoing capital expenditure.
• Inventory Valuation: Review the adequacy of inventory reserves given the 52% increase in inventory levels and the rapid decline in average selling prices.
• Shareholder Dynamics: Note that Philips Electronics has announced intent to sell a portion of its ownership (32.9%), which could impact corporate governance and tax exemptions tied to foreign direct investment.