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Taiwan Semiconductor Manufacturing Co. Ltd. (NYSE:TSM)

Q3 FY08 Earnings Call

October 30, 2008, 8:00 AM ET

Executives

Dr. Elizabeth Sun - Head of IR

Lora Ho - VP and CFO

Dr. Rick Tsai - President and CEO

Analysts

Shailesh Jaitly - Nomura Securities

Dan Heyler - Merrill Lynch

Randy Abrams - Credit Suisse

Pranab Sarmah - Daiwa Securities

Bhavin Shah - JPMorgan

Bill Lu - Morgan Stanley

Steven Palao - HSBC

Mehdi Hosseini - Friedman, Billings, Ramsey Group, Inc.

Operator

Welcome to TSMC's Third Quarter 2008 Results Webcast Conference Call. Today's event is chaired by Ms. Lora Ho, Chief Financial Officer and Vice President and Dr. Rick Tsai, Chief Executive Officer and President.

This conference is being webcast live via the TSMC website, www.tsmc.com in only-audio mode. Your dial-in lines are also in listen-only mode. At the conclusion of management's presentation, we will be opening the floor for questions. At that time, further instructions will be provided as the procedure to follow if you would like to pose any questions.

Please be advised for those participants who do not yet have a copy of the press release, you may download it from TSMC's website at www.tsmc.com. Please also download the summary slides in relation to today's quarterly review presentation. Once again the URL is www.tsmc.com.

I would now like to turn the conference over to Dr. Elizabeth Sun, TSMC's Head of Investor Relations for the cautionary statement before the main presentation by Ms. Ho and Dr. Tsai.

Dr. Elizabeth Sun - Head of Investor Relations

Thank you, Clarissa. Good morning and good evening to all participants. This is Elizabeth Sun, Head of Investor Relations for TSMC.

Before we begin, I would like to state that management's comments about TSMC's current expectations made during this conference call are forward-looking statements subject to significant risks and uncertainties, and that actual results may differ materially from those contained in the forward-looking statements.

Information as to those factors that could cause actual results to differ materially from TSMC's forward-looking statements may be found in TSMC's annual report on Form 20-F filed with the United States Securities and Exchange Commission on April 15, 2008 and such other documents as TSMC may file with, or submit to the SEC from time to time. Except as required by law, we undertake no obligation to update any forward-looking statements, whether as a result of new information, future events, or otherwise.

And now, I would like to turn the conference call over to Ms. Lora Ho, our Chief Financial Officer and Vice President.

Lora Ho - Vice President and Chief Financial Officer

Thank you, Elizabeth. Good morning and good evening to everyone. Welcome to our third quarter 2008 earnings conference call. In summary, our third quarter business saw an improvement from the second quarter with demand growth across the board.

TSMC's registered nearly NT$93 billion revenue, which was the second highest quarterly revenue in our history. If compared on equal footing that is if we do not consider the expensing of employee profit sharing, net income and EPS would have been higher than those obtained in 4Q '07 which was the quarter with the highest revenue.

Output utilization was close to 100% in third quarter. Even with employee profit sharing expensing, we achieved more than 46% gross profit margin, a level higher than that of third quarter 2007, which has a similar utilization rate, more favorable exchange rate and without carrying the burden of employee profit sharing expense in that quarter. We have demonstrated once again our ability to consistently make money and improve profitability.

Now, I would start to go over the slides. Then I will give you the outlook for the fourth quarter '08. Please refer to the quarterly financial summary slides on our website. All dollar figures are in NT dollars unless otherwise stated.

Now let me give you some detail about third quarter results. Our third quarter business see an improvement from the previous quarter. We shipped NT$2.4 million eight-inch equivalent wafers, which was about 3.5% more compared to the previous quarter, NT dollars depreciated 2.4% on an average over the quarter in our reported revenue and margins benefit from it.

Our revenue was $93 billion and our gross and operating margins were 46.3% and 35.4% respectively. EPS was $1.18 for the quarter, a sequential increase of 7.5%. Free cash flow generated during the third quarter doubled to be $45.5 billion and return on equity was 27%.

Let's take a closer look at our income statements, for sequential and year-over-year comparison. Please let me remind you again that the accounting number reported for 2007 do not reflect the effects from the employee provisioning spending. This is a major difference from 2008.

That being said, our third quarter revenue increased 5.5% sequentially and 4.5% year-over-year. Compared with 2Q '08 gross margin rate increased 0.7 percentage points and operating margin rate increased 0.9 points, reflecting a favorable change of exchange rate.

Now operating income was $1.3 billion and we booked $185 million in long term investment gain. Net profit margin rate was 32.9%.

Now let's examine our revenue by applications. On a quarter-over-quarter basis, demand grew across the board, revenues from computer, communications and consumer applications increased 9%, 7% and 1% respectively. Overall revenue from computer, communications and consumer applications accounts for 33%, 41% and 20% of our wafer sales.

In terms of revenue by technology, we continue our strong ramp of 65-nanometer during the quarter. Revenue from 65-nanometer accounted for 25% of total wafer revenue. This is up 7 percentage points from last quarter. We expect 2008 to be a year for a strong 65-nanometer business ramp. Total revenue from advanced technologies accounted for 66% of wafer sales, up 3 percentage points from the second quarter.

Now let's move to the balance sheet and cash flow statement. We ended the third quarter with $158 billion in cash and short-term investments, down from $224 billion in the last quarter. This is mainly due to the payment of cash dividend in the quarter. Average collection period for accounts receivables came up by one day to 43 days while days of inventory came down two days to 47 days. Our net debt fixed asset turnover was 1.4 times.

Total cash inflow generated from operating activities in the third quarter reached $56 billion. Capital expenditure was $10.4 billion, which was $12 billion less than the previous quarter. Free cash flow went up to $46 billion, mainly due to less capital expenditures and a tax payment in the quarter.

There was $77 billion paid for cash dividend, $24 billion spent for share buyback and $18 billion net investment in short-term investment. We ended the third quarter with NT$73 billion less in cash.

Now let's us turn to capacity and CapEx. Total installed capacity for the third quarter was about NT$2.4 million eight-inch equivalent wafers about 5% more compared with second quarter `08, we expect the fourth quarter capacity to be 2.5 million wafers, up 3% sequentially mainly due to the productivity improvement.

2008 capacity is expected to reach 9.4 million wafers, up 13% year-over-year, with 27% growth for 12-inch wafer capacity. We spent NT$332 million in CapEx during our third quarter. Till the third quarter of 2008, total CapEx reached NT$1.5 billion.

The total CapEx for 2008, the whole year, remained at NT$1.8 billion unchanged from our previous guidance.

With that let me give you the outlook for the fourth quarter of 2008. Based on current business expectations and forecast, exchange-rate of 32.73, we expect our consolidated revenue to come in between NT$69 million to NT$71 million. Insurance of margins, we expect our fourth quarter gross margin to be between 34% and 36%. Operating profit margin to be between 21% to 23%. This concludes my remarks today.

Now I would turn the call to Dr. Rick Tsai, our CEO for his remarks.

Dr. Rick Tsai - President and Chief Executive Officer

Good evening. I'd like to first comment on the business outlook, beginning with the year 2008. In this very severe business environment semiconductor industry certainly cannot be excluded from the impact.

We are now seeing the semiconductor industry revenue to decline by about 10% in the fourth quarter of 2008, so that's our result. The semiconductor industry in the whole year of 2008 will like to be flattish compared to 2007. So on a full year basis TSMC should still outperform the semiconductor industry and we will deliver positive growth in 2008.

Now let me turn to 2009. We now expect the semiconductor industry to decline by mid to high single-digit in 2009. I'd like to add, with very little visibility as of now; this projection of course is subject to most likely changes going forward. We have put in some conservative estimate of the system units shipment for 2009. However, we really cannot say we have a clear picture for that year.

And in this highly unsettling economy, also due to supply chains action in reducing inventories very aggressively, we believe the foundry structure will likely underperform the overall semiconductor industry in 2009.

Now with such severe challenges ahead of us, I'd like to comment on what TSMC is doing and will do. As you all know, we are in an unusually challenging environment. Global financial markets are in unprecedented turmoil and a global economic recession is looming.

We are preparing ourselves to weather the storm well and we are preparing ourselves to come out of this storm, strong and stronger. What we are going to do? We'll be in next six categories. First, we are reviewing our capital spending in 2009 very cautiously. We expect to cut down our capital investment next year significantly. We will invest however in 40-nanometer capacity and our R&D requirements.

Second, we will strengthen our cost reduction expense control effort as we have being doing for quite some time. We believe with the challenge ahead we will make further progress in that area.

Thirdly, in addition to the steady improvement of the cost and expense control we are also working on structure improvement in all manufacturing cost area.

Fourthly, even more importantly, we will continue to invest progressively in our future, both in technology and in our capabilities. We are not only going to invest in advanced technology area, we will also invest heavily in the mainstream technology capabilities. We expect to expand our market, our customer base and of course our revenues further with such efforts.

We are confident that TSMC will emerge as a stronger and better company when the market and the economy eventually recover.

Fifth, TSMC is committed to achieving our target structured probability. We will do so through improving our cost structure and by maintaining reasonable pricing.

Sixth, meanwhile we will continue our dividend policy of maximum cash returns. And we are committed to paying NT$3 dividend per share in 2009.

These are my remarks. Thank you. Elizabeth?

Dr. Elizabeth Sun - Head of Investor Relations

Operator, I think we can open the floor for questions now.

Question And Answer

Operator

At this time we will open the floor for questions. [Operator Instructions]. And your first question comes from the line of Shailesh Jaitly of Nomura Securities. Please proceed.

Shailesh Jaitly - Nomura Securities

Hi, thanks for taking my question. This is Shailesh Jaitly from Nomura. Firstly, question for Rick Tsai, can you just clarify you had talked about the very early expectations of 2009, semi growth number... semi decline numbers actually in revenue terms. In comprehending that estimate of mid to high single digit decline for semi industry, hat kind of unit growth, unit system growth are you looking at?

Dr. Rick Tsai - President and Chief Executive Officer

Yes, I agree with that little early for projecting the 2009 semiconductor industry. We have come across many questions however from investors and the analysts. So, that's why we are deciding to share some of our views with you. And as I said earlier this is of course an early projection. I would definitely expect this projection to change as the year goes ahead.

So, the assumption I think mostly for the PC where we are putting negative growth unit, again, from a mid to high single-digit. We are also projecting handset to decline in the unit shipment also along with the consumer electronics, especially in the developed economies. I think the growth will continue... we believe the growth will continue in the developing countries however at a much lower rate compared to the last few years.

Shailesh Jaitly - Nomura Securities

I understand. And for you the PC, the computing segment was the highest growth driver. Looking at... and yesterday we heard from SPEL, they were guiding at 8% to 13% decline as they get into the fourth quarter. You have talked about the broader sense about 10%. Is the computing decline going to be more than the corporate average as you go into the fourth quarter or less than the corporate average?

Dr. Rick Tsai - President and Chief Executive Officer

For our equipment here, our fourth quarter computer related rate per shipment. We expect to see over 20% of the decline, which is very severe compared to a seasonal for instance a mid-teen percentage growth.

Shailesh Jaitly - Nomura Securities

I understand. Can I just ask one final question, please?

Dr. Rick Tsai - President and Chief Executive Officer

Please.

Shailesh Jaitly - Nomura Securities

Yes. The 65-nanometer has been a big growth area. Also if you could provide color as to which are the main applications driving that growth in the third quarter and what do you expect it to be going forward?

Dr. Rick Tsai - President and Chief Executive Officer

Computer applications, graphics, mobile phone applications, chipsets, set top boxes, some of the wireless connectivity and a DDV. These are all important applications, which have used our 65 and 55 nanometer technologies. We expect this to continue. Moreover, some of the products migrate into a 40-nanometer sometime early to mid next year.

Shailesh Jaitly - Nomura Securities

Thanks a lot. It's very helpful, Rick.

Dr. Rick Tsai - President and Chief Executive Officer

Thank you.

Operator

Your next question comes from the line of Dan Heyler of Merrill Lynch. Please proceed.

Dan Heyler - Merrill Lynch

Hi there. Just a quick question on the pricing side again. As you looked at the U.S. dollar revenue being up 3% in shipments in the third quarter being up 3.5% implying some ASP erosion, and then as I look at your 65 not only did it increase to about 25% of revenue from Q4, there was mix shipped there.

90 was only down a couple of percentage points Rick, so we are seeing your actual advanced technology of 90 and below go from 36% to 41% based on the numbers I have here. So it looks as though, there was a mix increase overall and I am wondering why the ASP isn't stronger?

Dr. Rick Tsai - President and Chief Executive Officer

We are... since 2008 we have firmed up our pricing since the beginning of the year. However we also said earlier in the year that quite a bit of the pricing was determined in 2008 back in 2007 as to third quarter of 2007. So we are still... we didn't say we have stopped the price decline in 2008. The price decline continued, however the rate at which have slowed down quite a bit. I believe our overall pricing in third quarter met our expectation as far as the 2008 total pricing trend is concerned.

Dan Heyler - Merrill Lynch

Okay. So the initiative was on 65 mainly and that should play out in '09 then?

Dr. Rick Tsai - President and Chief Executive Officer

Yes. In '09 for the advanced technology we have firmed up even further.

Dan Heyler - Merrill Lynch

Okay, great. And my second question was, I guess back to visiting the old inventory question, which has been one of much debate the last year or so what is normal inventories and what is high and what it low. Based on now, the information that's occurred here in the third quarter and you are seeing your customers now start to really want to ratchet down their inventories as you said.

In your mind how far do they need to go to be comfortable? Again just directly your customers, I know the end markets are very hard to call right now, but as the companies are getting nervous about end demand, how low and how long do they need to reduce in their mind?

Dan Heyler - Merrill Lynch

Well of course the customers do not tell us what their inventory target is. I think in many cases they are probably still struggling with it. However, we look at probably as you do too, the history during the last seven, eight years especially after the 2001 downturn. We are seeing data for the days of inventory to go down to say about mid 50s days. I think that one number we use as a reference. Again, I'd like to stress, but we do not have a firm idea as to what the customers are really driving on to.

Dan Heyler - Merrill Lynch

Right. And as I like that number, I'm wondering if the cycle times perhaps being longer a percentage of the overall mix whether or not that number would be higher at this point or lower. I don't if you guys have thought about that in a historical context or not?

Dr. Rick Tsai - President and Chief Executive Officer

I cannot say. I will say the generic cycle time at least from the wafer manufacturing point of view has come down. However, of course as people move to higher to more advanced technologies, a lot more steps also. Dan, I do not have a rigorous analysis from that point of view. But we do feel that you will take the system company and the semiconductor companies sometime into the first quarter of next year to have their inventory days down to the level we just discussed.

Operator

Your next question comes from the line of Randy Abrams of Credit Suisse. Please proceed.

Randy Abrams - Credit Suisse

Yes, hi good evening. I want to see on the gross margin, could you talk a little more about the magnitude of gross margin decline in fourth quarter, if some of that reduction due to lower wafer starts in fourth quarter had a first quarter shipment or was there also pricing or a mix change factoring into fourth quarter gross margins.

Lora Ho - Vice President and Chief Financial Officer

The first quarter gross margin decrease is mainly due to the lower utilization for both in our eight-inch line and also in our 12-inch line. That is the main reason.

Randy Abrams - Credit Suisse

Okay. Is there a bigger factor in terms of the fall in utilization between eight-inch and 12 inch?

Lora Ho - Vice President and Chief Financial Officer

Both capacity counts, both generally come down about their magnitude.

Randy Abrams - Credit Suisse

Okay. And then, one is if you can talk about the foundry company just in the prospect of you talked about microprocessors as an opportunity. Do you discount now your potential or do you lessen that investment to still target that customer from microprocessors? And then how do you view computing necessary ventures as far as the graphics business?

Dr. Rick Tsai - President and Chief Executive Officer

Randy, as far as the competitor is concerned, our attitude has always been we take them very seriously, every one of them. And we also compete very seriously with every one of them. Other than that, we do not really comment individual competitor.

As far as the AMD is concerned of course the microprocessors have always been manufactured in their internal VAP... expect for some country, I guess, a couple of years ago. I think from our point of view that does not have much impact on us.

AMD of course also through their ATI acquisition has long and strong relationship, foundry relationship with us. We did have communication before the announcement I think both company valued this relation very much and both company will continue to faster to foster this relation going forward.

Randy Abrams - Credit Suisse

Okay, thank you.

Dr. Rick Tsai - President and Chief Executive Officer

Thank you.

Operator

Your next question comes from the line of Todd Farm of Daiwa Securities. Please proceed.

Pranab Sarmah - Daiwa Securities

Hi. This is Pranab from Daiwa.

Dr. Rick Tsai - President and Chief Executive Officer

Hello.

Pranab Sarmah - Daiwa Securities

Hello, yes. Just making sure like they've picked up the right name. Anyway, I have two questions. The first one is on your CapEx point of view, you have indicated you might cut down CapEx about 20% for 2009. In that scenario what type of capacity additions you will have in 2009?

Lora Ho - Vice President and Chief Financial Officer

I think its 20% as I talk about this customer is to well thinking at this moment our 2009 is still highly uncertain. For that CapEx estimation for 2009, as you can think of you will be many for 12 inch especially for 40 and 45 nanometer ramp up.

Pranab Sarmah - Daiwa Securities

Okay. And if see like your macro outlook for 2009 basically talking about end demand or end product is negative growth, semi conductor foundry industry will be even growing at a slower rate and your capacity even if you don't add anything it will be up probably about 6% year-on-year, do you really need to spend that much of money next year?

Lora Ho - Vice President and Chief Financial Officer

The 40 and 45 nanometer in 2009 will be a big rent year. So that particular node, we are going to see demand increase versus this year. That's why we need to add capacity for.

Dr. Rick Tsai - President and Chief Executive Officer

We are also investing in the R&D tools for the 22 nanometer technology... although occupy CapEx.

Pranab Sarmah - Daiwa Securities

Okay. And my second question is basically can you give us a little bit of color on your view about the industry consolidation. Do you think that in this downturn and the foundry industry could go to any sort of consolidation and if it happens what will be TSMC's response on that?

Dr. Rick Tsai - President and Chief Executive Officer

We, Pranab, I think it is really improper for us to comment on this point. So I would politely decline to do that.

Operator

Your next question comes from Bhavin Shah of J P Morgan. Please proceed

Bhavin Shah - JPMorgan

Yes hi, Rick, Lora and Elizabeth. I have two questions. My first question is I just want to go back to 2000 to 2002 timeframe, interestingly your revenues sort of got back to 2000 levels by 2002, so just in the first year of recovery that was an amazing recovery on the revenue line. However, your profits did not for three reasons. One was depreciation was significantly higher, R&D was significantly higher and also the non-operating losses were significantly higher.

Now we all know that depreciation will be significantly what, most likely will decline in 2010, I would imagine given the way you are guiding for CapEx. But what do you think will happen to R&D expenses and non-operating losses, just so that--for some reason your revenues still bounce back in 2010, would the profits shift over accordingly, that is my first question?

Dr. Rick Tsai - President and Chief Executive Officer

Good, Bhavin. Let me comment on the R&D and we have lower non-operating. R&D, Bhavin, we will as I said strengthen our R&D investments. We have not really workout the numbers yet. But our intention is to increase the R&D investments. I'm not saying we will increase that by a large jump. However, we are looking into investing as I said not only in 22 nanometer 32 nanometer technology but also in many of the specialty technologies that will help us gain market in the mainstream technology vision scenario. So, I think from percentage point of view percentage of the revenue point of view is definitely going to be a higher say 6% going forward, for R&D.

Bhavin Shah - JPMorgan

For 2002 it was jumped from 4 to 7%. Currently you're running about 6%. So, how much of a jump could we assume say at a similar level in couple of year's time?

Dr. Rick Tsai - President and Chief Executive Officer

I would say again you probably can assume one point plus. That was our increase, assuming similar revenue or higher revenue. Even it's the lower revenue, percentage will be higher.

Operator

Your next question comes from the line of Bill Lu of Morgan Stanley. Please proceed.

Bill Lu - Morgan Stanley

Yes, hi there. Good evening, and thanks for taking the call. I've got two questions. One was on the longer term, one on the shorter term. The first question is as we go into a 40 nanometers I think expectation we'll probably comment has been several IDM's are going to stop doing their old past development and else was completely... given that we are going to a downturn in '09, does that change at all with a little more capacity as IDM can you still be concerned about that or is that still pretty firm. That's the first question.

Dr. Rick Tsai - President and Chief Executive Officer

I think these two questions 40 nanometer and the downturn are not connected too much. I think most customers who are designing in 40 nanometer or 45 nanometer technologies of course are designing new products that they will want to come out in 2009 and 2010 timeframe. And these products usually represent the future revenues and profits. There are few a companies. If at that we'll stop or delay those projects.

As to IDM, again, just as you say, the IDM companies who are engaging with us on 40 or 45 nanometer technology, we expect them to continue moving forward from just because the point I just made.

Bill Lu - Morgan Stanley

But even with the outsourcing from the or additional outsourcing from IDM you will think that the foundries grow little bit less than the overall semis in '09?

Dr. Rick Tsai - President and Chief Executive Officer

For the capacity that they owned internally I think there will be impact for instance in some cases 90-nanometer or 21C micro.

Bill Lu - Morgan Stanley

I see

Dr. Rick Tsai - President and Chief Executive Officer

It's not assured.

Bill Lu - Morgan Stanley

Okay. I understand. Second question is for Lora, I have just been very bad at forecasting the margins. Hypothetically, if revenues were to decline by say another 10%, 15% from the fourth quarter levels, where do you think margins would go, gross margins?

Lora Ho - Vice President and Chief Financial Officer

This is a complex question actually depending on what drives the revenue it goes with down. If the revenue goes down because of utilization these have been a single factor and I can't give you easiest with some. Based on our present financial performance if utilization goes down by one percentage point the impact to our margin would be roughly from 4.3 to 4.4 percentage points. But it also depends on which technology drives down the margins. So that's the general rule of thumb.

Operator

Your next question comes from the line of Steven Palao of HSBC. Please proceed.

Steven Palao - HSBC

Yes, I'd like you to talk a little bit on the margin question. It seems like the magnitude of the gross margin pressure on the fourth quarter is a little more than just utilization rates would imply, especially, given Taiwan dollar depreciation on a quarter-over-quarter basis. Is there any thing more behind that or can we at least rule out the depreciation component impacting. What's you expectation for depreciation in cost of goods sold for the fourth quarter and then also for 2009?

Lora Ho - Vice President and Chief Financial Officer

Depreciation in fourth quarter will be slightly, only very slightly higher than third quarter. Actually the main reason drive the margin down in the fourth quarter is the very big reason is the utilization itself. As I mentioned earlier, the utilization for the fourth quarter is going to be low for both 12-inch and eight-inch. That's actually the main reason.

Steven Palao - HSBC

Okay. And then one more quick question for you. Do you think your... I'm impressed with your cash flow management this quarter, do you think you can keep your DSOs and inventory turns around the current level or what would be a good target for the fourth quarter. It seems to me if you keep them around the same level you are going to generate a significant amount of free cash flow next quarter on the low CapEx number again?

Lora Ho - Vice President and Chief Financial Officer

That's probably true and we do not see any abnormal accounts receivable, these inventory days and account receivable days so far. So these rather main assumptions and there will be the cash flow will still be quite positive in fourth quarter.

Steven Palao - HSBC

Okay. So DSOs can stay around 45 days or so you think next quarter?

Lora Ho - Vice President and Chief Financial Officer

Yes, right.

Steven Palao - HSBC

Perfect. Thank you.

Operator

Your next question comes from the line of Mehdi Hosseini of FBR. Please proceed.

Mehdi Hosseini - Friedman, Billings, Ramsey Group, Inc.

Yes, thank you. It is Mehdi Hosseini of FBR. Couple of questions. First, going back to your assessment of next year's spending decline 5% to 10%, is that based on top down analysis or your conversation with your customers and could you please repeat your commentary on the PC end market?

Dr. Rick Tsai - President and Chief Executive Officer

I think that it's a combination of the semiconductor companies outlook for the fourth quarter, I am sure as you also have seen, most of the companies guiding much lower than seasonal fourth quarter business. Then of course part of it.... we suspected that not all of the companies have announced their fourth quarter guidance, part of which is our own estimate.

Mehdi Hosseini - Friedman, Billings, Ramsey Group, Inc.

Okay. Consequent on the PC, I'm just curious as to you are highlighting PC end markets declining the more, if I heard correctly, is that right?

Dr. Rick Tsai - President and Chief Executive Officer

Yes. PC market declined. I'm sorry, can you--.

Mehdi Hosseini - Friedman, Billings, Ramsey Group, Inc.

In your prepared remarks you highlighted PC end markets declining the more. Is that accurate? Or did I hear you right?

Dr. Rick Tsai - President and Chief Executive Officer

Okay. For the fourth quarter?

Mehdi Hosseini - Friedman, Billings, Ramsey Group, Inc.

Yes.

Dr. Rick Tsai - President and Chief Executive Officer

Yes, for our way for demand the PC market declined significantly over 20% and especially if you compare that rate, the decline rate with the normal seasonal PC growth rate which usually would be in the teen, low teens. This trend is really very significant in light of fourth quarter case.

Mehdi Hosseini - Friedman, Billings, Ramsey Group, Inc.

Okay. And this is my second question has to do with your 45 nanometer capacity I think we are all trying to further understand the required CapEx for mix with in these kind of environment, semi conductor industry, revenue declining 5% to 10%. Is there any way you can provide us the color as to what makes a 45 nanometer, could be. Is that a single digit as a percentage of revenue or double-digit?

Lora Ho - Vice President and Chief Financial Officer

It's probably too early and we do believe the 45 nanometers is going to ramp significantly in 2009. I cannot quantify that degree. I think it will be a representing a very significant portion of our revenue.

Mehdi Hosseini - Friedman, Billings, Ramsey Group, Inc.

Okay, thank you.

Operator

Your next question comes from the line of Bhavin Shah of JP Morgan. Please proceed.

Bhavin Shah - JPMorgan

Thank you. Finally, can we continue with the previous question I appreciate?

Lora Ho - Vice President and Chief Financial Officer

This is Bhavin?

Bhavin Shah - JPMorgan

Yes.

Lora Ho - Vice President and Chief Financial Officer

Okay, I think you previous question referred to non-op items, we want to compare 2001 last cycle with this cycle?

Bhavin Shah - JPMorgan

Yes.

Lora Ho - Vice President and Chief Financial Officer

That was your question?

Bhavin Shah - JPMorgan

I think --.

Lora Ho - Vice President and Chief Financial Officer

Okay, I'm sorry.

Bhavin Shah - JPMorgan

No, I was just saying that in 2001, 2002 timeframe the investment losses were pretty meaningful and that prevented the earning recovery of the same magnitude as the revenue recovery, and that was one of the factors from did not being probably all the same?

Lora Ho - Vice President and Chief Financial Officer

Okay, I think if you compare 2001 cycle and how what's categorized with our investments losses and. And that time was the WaferTech, SSMC and Vanguard. But nowadays I can tell you WaferTech and SSMC are doing much better in 2001 and same for Vanguard because they have successfully turned into a foundry business which is elastically cold. So, I would say in general the cycle, the magnitude of the changes in investments losses will be smaller than last cycle.

Bhavin Shah - JPMorgan

Okay... okay, thank you Lora. Second question I had was on I think Rick mentioned you estimate customer inventory days to be a lot in mid 50s. Was it at the end of '08 or sort of some point in '09? And actually related to that is, if you look at the guidance from some of the handset companies, they are still talking about some sort of growth in Q4, sequential growth. Maybe say 10% or something whereas you are seeing a pretty steep decline in Q4. So, there is a big delta here between what those companies are thinking about end markets versus what you are seeing? So, I was just wondering how will sort of you see that.

Dr. Rick Tsai - President and Chief Executive Officer

Bhavin, it's really difficult to project. I do not believe the semiconductor companies can slash their days of inventories down to the 50s or whether it's mid or high 50s in 2008. I do not believe that will be the case. Fourth quarter, I know what you are talking about. But I think that for next year, we are... I believe you are also projecting a fairly significant slowdown in that handset shipment in 2009 also.

Bhavin Shah - JPMorgan

Yes, I guess my question was about Q4. Your handset company, you are still thinking about some sort of growth sequentially, and you have already seen sort of steep decline. Is it that how do you see that, its bit of a contradiction I would say. And in fact that if the end market is still growing in Q4, which again we can debate whether it's not growing enough. How can you see such a steep decline then? Only way it can be explained is if, customers are going to see very, very sharp decline in inventory levels?

Dr. Rick Tsai - President and Chief Executive Officer

Actually, we did notice that the appointments with Nokia or Samsung, still projecting some growth in fourth quarter. On the other hand if you looked at Nokia's inventory number I believe their third quarter and inventory days is higher, not only higher but quite a bit higher than their inventory days at the end of the second quarter. So they do have build up for the inventory and they need to consume.

Bhavin Shah - JPMorgan

Right. So that's mid-50s comment you made with that sort of sometime in 2009 is that?

Dr. Rick Tsai - President and Chief Executive Officer

Yes. First quarter 2009, we hope the inventory level and the days will come down to a low enough level.

Bhavin Shah - JPMorgan

Thank you.

Dr. Rick Tsai - President and Chief Executive Officer

Yes.

Operator

Your next question comes from the line of Dan Heyler of Merrill Lynch, please proceed.

Dan Heyler - Merrill Lynch

Thanks, I just had a follow up question on your comments regarding 200 millimeter, expenditures Rick did, made a comment and your initial loss, Damien said that you would be looking at investments there and expanding, I think early in the year, you guys had commented that you are less bullish on eight-inches, I'm just wondering and what's changed there and what areas you plan to invest and to expand that business?

Dr. Rick Tsai - President and Chief Executive Officer

Dan, what I said was, we will invest from R&D point of view in the mainstream technology basis. These are for instance analog technology, mixed signal manned et cetera, et cetera. However I did not say that we will invest in mainstream technology capacity and we do not plan to either. I hope I'm communicating clearly.

Dan Heyler - Merrill Lynch

Yes. What I was wondering though is since those products are produced on the eight-inch elsewhere as competitors and eight-inch is in abundance, what kind of margins would you expect on in terms of getting into the eight-inch business, both mixed signal analog and however supply that is just you think that the margins in that business will be good or not?

Dr. Rick Tsai - President and Chief Executive Officer

Well, there is margin pressure, but pricing pressure I would say. But the technology is so it's not trivial at all. Actually many of those technologies now are in the hands of the IDM Company. And as far as I can tell, these technologies are not available from the company although they've taken these. That represents opportunity, we understand the pricing requirements. We are also working on our cost. So, we will compose technology and account so that we can get more business in that area. We are talking about the standard logic type of business here.

Dan Heyler - Merrill Lynch

Okay. And when you say some contribution and that for these investment for next year. So, is this a bank for 2010 or you thinking more second half of '09?

Dr. Rick Tsai - President and Chief Executive Officer

I think 2010 is probably more likely. However, we are already. I think we will be getting some business starting 2009. But unfortunately would be 2009 being such a challenging year. It would be difficult to can it out.

Dan Heyler - Merrill Lynch

Okay. Thank you.

Dr. Rick Tsai - President and Chief Executive Officer

Sure.

Operator

Your next question comes from the line of Steven Palao of HSBC. Please proceed.

Steven Palao - HSBC

Rick, I am curious with such a strong pullback in the fourth quarter, what are you thinking about first quarter revenue, does it need to be down significantly more than seasonally, what's the probability we could be setting up for another 20% plus decline in the first quarter?

Dr. Rick Tsai - President and Chief Executive Officer

Steve, right now, we do not comment on the first quarter, especially at TSMC numbers, however we have shared our view on 2009, overall with you at the stage and we have discussion earlier on with Bhavin and other people on the inventory situation. I think I also said in the afternoon as the inventory carrying is now conducted by aggressively by both semiconductor company and system companies and this inventory pairing will take some time and I believe that will go into the first quarter of 2009.

Steven Palao - HSBC

Okay. And then two final quick question. I didn't get an answer on my earlier question. On your expectations for 2009 depreciation and then the last question is expectations for continued stock repurchases is here but similar amounts like you did in third quarter or what are your thoughts going forward?

Lora Ho - Vice President and Chief Financial Officer

Okay. Depreciation in 2009 although we have not finalized the CapEx although we did indicate it would drop around 20% from this year. With that in mind I think the depreciation for 2009 will be increased only very slightly versus 2008.

Steven Palao - HSBC

Okay. It still increases, okay.

Lora Ho - Vice President and Chief Financial Officer

Yes, but a very small increase, I would say 2% to 3% at most, okay. And was share buyback your second question?

Steven Palao - HSBC

Correct.

Lora Ho - Vice President and Chief Financial Officer

And actually we learned from the market and we feel also to returning cash for shareholder has two ways. The number one pay our cash dividend, number two doing buyback. We have done buyback and with a very good reason, major reason to help bidders to sell down this year. So they don't affect the shipments too much, as to absorb the feel overhand that was the main purpose for the cost buyback. With the currency situations and we want to back to where we originally belief which is cash dividend most important issue by then. So we'll preserve that we can only move for the cash dividend that's our number one priority.

Steven Palao - HSBC

Okay, fair enough. Thank you.

Operator

Your next question comes from the line of Pranab Sarmah of Daiwa Securities. Please proceed.

Pranab Sarmah - Daiwa Securities

Lora, regarding on your payback point, I guess you are also limited by the retained earning. Are you guys going to have lobby with that Taiwan government to change some of the rules so that you can give all the excess cash back to the shareholder?

Lora Ho - Vice President and Chief Financial Officer

Pranab, I'm glad you mentioned that again. It's every quarter you talk to me like this. Actually it is true, the paying back cash for shareholder will be constraint be the capability of how much we are trying earning we generated. We have been communicating with the government official hopefully laptop that but so for we had not been able to change their decision. I think our information 2009 we are committed to pay $3, no problem. And 2010 depending on 2009's possibilities and we have time to open that. The regulations in environment may also change but we don't know we have no guarantee for that. But you have to trust me. We will continue work on that.

Pranab Sarmah - Daiwa Securities

Okay. And next one, could you make a little bit of comment about the customer rate cut order rate cut. I think that was very severe sometime on the mid of second quarter. Are you seeing that similar rate of order cut? Or you are seeing a little bit of stability at this point?

Dr. Rick Tsai - President and Chief Executive Officer

Pranab, I think, the orders are still... I should say that's not stabilized. People are still carrying their inventories. I think not until we and customers semiconductor companies have a more clear view as to the holiday season go through. Now we will have a more stable environment.

Pranab Sarmah - Daiwa Securities

I think on the inventory side you have just mentioned a very nice point like system and semiconductor guys are now pairing together to cut inventory. Do you foresee that trend will continue forward like systems semiconductor even the semiconductor foundries like you're you... to pair together to cut down the inventory on the whole supply chain at some point?

Lora Ho - Vice President and Chief Financial Officer

Pranab, can you repeat your question again?

Pranab Sarmah - Daiwa Securities

Now, actually now what is happening on the industries, semiconductor makers as well as system makers are pairing together to bring down the whole channel inventory. And going forward, do you see a possibility along with them like the foundry makers or other semiconductor makers, they also pair up like three levels of pair up to bring down the system in channel inventory even at the low level than where we are now?

Dr. Rick Tsai - President and Chief Executive Officer

Pranab, I believe the way this is going, the inventory will go down to quite low level sometime in the first quarter of next year. We're of course part of that.

Pranab Sarmah - Daiwa Securities

Okay. Thank you very much.

Dr. Rick Tsai - President and Chief Executive Officer

Thank you.

Operator

Your next question comes from the line of Randy Abrams of Credit Suisse. Please proceed.

Randy Abrams - Credit Suisse

Yes, I want to ask one more clarification question on the dividend. If you're earnings would have fall say below than $3 in 2009. Could you pay out more than 90% of prior year earnings and say CapEx the way you will reserve it would you be prepared to do that to protect that dividend even in the following year?

Lora Ho - Vice President and Chief Financial Officer

Yes, Randy the answer to your question is yes. If the retained earnings are to decide how much dividend you can pay out and we can use the prior year retained earnings too. So, we may at some year we said 80% is the minimum. In some year we certainly can go above that.

Randy Abrams - Credit Suisse

Okay. And you previously have talked about a minimum one quarter cash and CapEx that you want to keep. With the tightening credit environment in downturn, do you take that up in terms of a minimum cash that you want to maintain as a target level?

Lora Ho - Vice President and Chief Financial Officer

You are asking the level of the cash around the business, will that go up?

Randy Abrams - Credit Suisse

Yes, yes.

Lora Ho - Vice President and Chief Financial Officer

Will business go in the downturn?

Randy Abrams - Credit Suisse

Yes, exactly.

Lora Ho - Vice President and Chief Financial Officer

I think answer should be opposite. When business become smaller of the level, provident cash would be smaller.

Randy Abrams - Credit Suisse

Okay. So it's still about a quarter of cash and CapEx?

Lora Ho - Vice President and Chief Financial Officer

Right.

Randy Abrams - Credit Suisse

Okay. And then one last question on just if you could talk a little bit more about the foundry versus the backend. We have SPEL and Amcor, regarding a little bit more moderate decline. Maybe if you could talk about some of the difference that you are seeing foundry wise versus backend or if you think its just a timing issue or a wafer bank issue?

Dr. Rick Tsai - President and Chief Executive Officer

Randy, I don't really have much insight. The one that I can think of would be the cycle time difference to DTime. I think the DTime for the backend is substantially shorter. And so, when... one thing I can observe but I'm not sure I have better insight for you.

Pranab Sarmah - Daiwa Securities

Okay, thank you.

Lora Ho - Vice President and Chief Financial Officer

Operator, in the interest of time we will allow one last caller.

Operator

Our final question will come from the line of Bhavin Shah of JP Morgan. Please proceed.

Bhavin Shah - JPMorgan

Yes, I guess in terms of CapEx at the end of... one of my question was on the crisis actually. You haven't yet laid out the guidance for pricing strategy, and one of the... there are multiple reasons why you had a particular price strategy in mind. And one of them was the cost pressures that you are facing in light of inflationary environment. Now, clearly we are in a very different environment as far inflation goes. So, the cost pressures must have reversed for you. So how does that factor into your pricing strategy?

Dr. Rick Tsai - President and Chief Executive Officer

Bhavin, as I said earlier. We're committed to achieving our target structure probability. And this probability comprised of both pricing and cost. We also stated several times before that we always aim to have pricing decline rate, somewhat lower than the cost decline rate. So these are the two factors we are looking into and we make trade off, we balance. So if we have an improved cost structure, we will adjust ourselves from a business point of view. So, that's how we look at it.

Bhavin Shah - JPMorgan

Okay. Is it fair to say that the cost pressures... you are going to see some benefits from the cost side and from the input cost on material and so on?

Dr. Rick Tsai - President and Chief Executive Officer

I'd say it varies Bhavin. It's not as straightforward. I wish they were but, for instance, in Taiwan utility, costs going up and it doesn't seem to come down even with the severe down of the oil price. But the utility is run by the state. There is not much we can do. But on the other hand, there is some other input prices as you said coming down because of the loosing up of the market. So we... again for us it's the no matter what we will work in anyway we can to lower our cost. So that we can have much strong competitive edge, also so that we can make our reach reasonable returns of the investment.

Bhavin Shah - JPMorgan

Okay. Thank you.

Dr. Rick Tsai - President and Chief Executive Officer

Thank you, Bhavin.

Dr. Elizabeth Sun - Head of Investor Relations

Well, this concludes our question-and-answer session. Operator, please proceed.

Operator

Before we conclude TSMC's third quarter 2008 results webcast conference call today, please be advised that the replay of the conference call will only be accessible through TSMC's website at www.tsmc.com. Thank you all. You may now disconnect. Good day. .

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