Semiconductor Manufacturing International's CEO Discusses Q4 2012 Results - Earnings Call Transcript

Semiconductor Manufacturing International Corporation (NYSE:SMI)

Q4 2012 Earnings Call

February 6, 2013 7:30 PM ET

Executives

En Ling Feng – Senior Director, IR

TY Chiu – CEO

Gareth Kung – CFO

Analysts

Randy Abrams – Credit Suisse

Dan Heyler – Merrill Lynch

Steven Pelayo – HSBC

Sezho Ng – BNP

Rick Hsu – JP Morgan

Operator

Welcome to the Semiconductor Manufacturing International Corporation’s Fourth Quarter 2012 Webcast Conference Call. Today’s conference call is chaired by Dr. TY Chiu, Chief Executive Officer; Mr. Gareth Kung, Chief Financial Officer; and Mr. En Ling Feng, Senior Director of Investor Relations.

Today’s webcast conference call will be simultaneously streamed through the Internet at SMIC’s website. Please be advised that your dial-ins are in listen-mode. However, at the conclusion of the management presentation, we will be having a question-and-answer session upon which you will receive further instructions as to how to participate. The earnings press release is available for download at www.smics.com. Webcast playback will also be available approximately one hour after the event at www.smics.com.

Without further ado, I would like to introduce to you Mr. En Ling Feng, Senior Director of Investor Relations, for the cautionary statement.

En Ling Feng

Hello, everyone. Welcome to SMIC’s fourth quarter 2012 earnings conference call. For today’s call, our CEO, Dr. TY Chiu will first provide some general remarks. Then our CFO, Gareth Kung, will present the financial commentary. This will be followed by our Q&A session.

As usual, our call will be approximately 60 minutes in length. The earnings press release and quarterly financial presentation are available for you to download at www.smics.com under Investor Relations in the Events & Presentations section.

Please also be reminded of the Safe Harbor statement which provides as follows. SMIC’s statements of its current expectations are forward-looking statements subject to significant risks and uncertainties. The actual results may differ materially from those contained in such forward-looking statements. Information as to those factors that could cause actual results to vary can be found in SMIC’s Form 20-F filed with the United States Securities and Exchange Commission on April 27, 2012.

Please note that all currency figures are in U.S. dollars unless otherwise stated, and that all references to 2012 annual figures are on audit basis.

I will now turn the call over to our CEO, Dr. TY Chiu for the opening remarks.

TY Chiu

Thank you, En Ling. Good morning, and good evening to everyone. We wish you and your family a very happy Chinese New Year. Thank you for joining us for our fourth quarter and the full year 2012 earnings webcast. I am pleased to report that SMIC has outperformed the foundry market cycle again in Q4 of 2012.

We achieved record high revenue of up $485.9 million representing sequential growth of 5.4% and year-over-year growth of 67.8%. Furthermore, we delivered a net profit attributable to SMIC of $39.7 million in the fourth quarter. Revenue growth was mainly driven by increased demand for mobile product ICs such as baseband, Wi-Fi, NOR Flash, CIS, and the power management ICs.

Based on our unaudited financial statements for the full year of 2012, we also achieved record, high revenue of $1.7 billion, representing an increase of 29% year-over-year. This significant lease over the past 2012 year-over-year growth of world semiconductor sales up negative 2.9% and the pure play foundry growth rate of 15% according to iSuppli estimate. However, we deliver a positive income attributable to SMIC of $15.9 million in 2012, which is our highest in seven years.

In 2012 because of our improved operation, customer service, and quality, SMIC gained significant customer’s confidence, which contributed to the drive in high fab utilization. Apart from improved operation, revenue drivers in 2012 also include demand for mobile devices. Notably, our revenue from China group customers grew 34.1% in 2012 over 2011, while employing our full spectrum of technology from 0.35 micron to 40 nano.

Looking at our 2012 achievements, we are grateful to our hardworking and the dedicated employees as well as to the strong support and trust from our customers. Now to address our differentiation strategy, we have made profitable progress within our specialty processes in 2012. In Q3 our 0.13-micron low-power embedded EEPROM platform was made available but they enabled us to address China’s fast growing dual interface bank card market as well as the worldwide contact list Smart Card market.

In the fourth quarter, we made a significant breakthrough in the development of Backside-illuminated CMOS image sensor technology. The first fab chip demonstrated good image quality, the complete BSI process technology is targeted to contribute revenue in 2014. This will serve the market for higher resolution of phone cameras and high performance video cameras. As we execute our differentiation strategy, we’ll continue to see the expansion of our addressable market size which gave us increasing confidence – now confidence in our strategic direction.

Moving to give some update on our 45/40 progress. Our 45/40 commenced their shipment in the fourth quarter and its revenue contribution more than tripled quarter-over-quarter to 2.6% of the total fourth quarter revenue. This increase was primarily due to the demand for mobile products from both international and domestic customers. In addition, we have an increasing number of 45/40 tapeout in the first quarter 2013. We are confident that our 45/40 capability will drive our revenue increase in 2013.

Now regarding the 28-nano, our 28-nano offering including both high-k/metal gate and poly/SiON processes is on track and is targeted to be ready by the fourth quarter of 2013.

Next, let me comment on the China market. The Chinese fabless ecosystem is broadening, as a growing number of mobile devices, both branded and non-branded are equipped towards baseband, RF, CIS, and in specialty memory designed by major Chinese fabless companies.

According to iSuppli, Chinese fables company overall revenue grew 15% in 2012. More than three times the global fables growth rate of 49%. By providing quality and innovative product, Chinese fabless companies are penetrating to supply chain Tier I name brand to non branded OEMs in all segments, from smartphones to feature phones to tablet.

As the leading and the most advanced foundry provider in China, we have upgraded our technology portfolio’s service and the quality to help all of our customers participating in this rapidly growing market. The latest survey published by the Ministry of Industry and the Information Technology, China software and Integrated Circuit Promotion Center, CSIP in November 2012, specifies that approximately 75% of Chinese fabless company choose SMIC as their preferred foundry partner, a noticeable and a significant improvement as compared to 59% in 2011.

I’m happy to see that our effort this year – this past year in augmenting our technology portfolio, improving quality, service and design support has made measurable positive impact in both China revenue as well as an independent customer survey.

Now, I want to address the mobile market. According to IC Insight, mobile phone accounted for 24% of IT industries’ revenue in 2012, and that share is forecasted to reach only nearly 32% in 2016. More interestingly, in terms of dollar content, mobile phone IT revenue is expected to exceed standard PC revenue for the first time in 2013. $71 million for mobile phone ITs versus $65 billion for IT used in the standard PC.

Furthermore according to our supply, China’s smartphone market is expected to double in terms of unit in the next four years from $186 million unit in 2012 to $377 million unit in 2016. Now given that roughly 60% of our labor revenue into fourth quarter of 2012 is from mobile devices including feature phones, smartphones, and tablet, we are confident that it might be – is well-positioned in these high-growth markets. Without diverse product offering for baseband, blue tooth, Wi-Fi, flash, CIS, RF, and application processors, we expect to continue to benefit from the rapid growth of the end market demand from communication and consumer product, especially within China.

To comment on Q1 2013, in contrast to our original expectations, Q4 demand had a late stage pickup. We expect Q1 to decline modestly, given the seasonality, our fab maintenance period and our stronger than expected Q4. However, we are again seeing strength in some segments in Q1; therefore our revenue forecast for Q1 remains cautious and ranges from up 1% to down 2%.

In conclusion, I am very pleased with SMIC’s achievement in 2012 and we are starting 2013 with both excitements and caution. The road ahead is fully of total challenges and a powerful competitors. So I believe we have the right strategy, the right focus and the right team. We will continue to focus on sustainable profitability, growth and the shareholder value. Again, I would like to now thank all of our employees for their dedication and hard work, our shareholders and customers and partners for their continue trust and the support.

And I will now also like to wish all of you and your loved ones health, happiness and fulfillment. Happy Chinese New Year.

I will now hand the call over to Gareth for overall business and the financial commentary.

Gareth Kung

Thank you, T. Y., and thank you everyone for joining us today.

I will now take a few moments to summarize our fourth quarter 2012 financial results, highlights of our 2012 full year and audit results and provide our first quarter 2013 guidance. You may also refer to our quarterly financial presentation on our website. All of our financial figures are prepared based on GAAP measures. Please note that all currency figures are in US$ unless otherwise stated.

Now turning to highlights of our fourth quarter 2012. We are pleased to report another strong quarter. Again, we achieved record revenue of $485.9 million representing an increase of 4.5% quarter-over-quarter, an increase of 67.8% year-over-year. Net cash flow from operations was $189.8 million compared to $119 million in the third quarter. Net income attributable to SMIC increased to $39.7 million compared to $12 million in third quarter. Diluted EPS was $0.06 per ATS.

Now looking into details of our financial. Now looking to details of our income statement, revenue growth in the fourth quarter of 2012 exceeded our original guidance mainly due to the change in the product mix in future achievements with high ASP. Wafer revenue from Wuhan Xinxin was $14.5 million in the fourth quarter, contributing 10% to our total revenue. Excluding the wafer revenue from Wuhan Xinxin for both quarters, our revenue increased 5.7% quarter-over-quarter.

Gross margin was guided 18% to 20% and resulted in 19.9% in the fourth quarter. As mentioned previously, it was mainly because the Shanghai 12-inch fab entered volume production in the fourth quarter. And as a result, all the production-related cost were removed from the R&D expense line and treated as manufacturing costs.

The inclusion of Shanghai 12-inch fab production-related cost led to a 4.4% decrease in gross margin in the fourth quarter. For this same reason, operating expenses in the fourth quarter were guided to be in the range of $70 million to $74 million compared to $106.5 million in the third quarter of 2012.

Operating expenses in the fourth quarter were $44 million, which was offset by R&D grants of $10.1 million and a gain from property disposal of $20.7 million.

The company disposal was from the sale of SMIC’s living quarter unit to employees. If excluding these items, the normalized operating expenses would be $74.8 million in the fourth quarter. We also achieved significant improvement in operating income, which increased from $20.4 million in the previous quarter to $52.7 million in the fourth quarter.

Income tax expense was $10.6 million in the fourth quarter compared to $1.1 million in the third quarter, mainly due to the land appreciation tax related to the sale of the SMIC living quarter units to employees.

Net income increased from $12.2 million in the third quarter to $39.9 million in the fourth quarter. Net income attributable to SMIC was $29.7 million in the fourth quarter of 2012.

Moving to the balance sheet. At the end of the fourth quarter of 2012, our debt-to-equity ratio was 48.3% compared to 47.6% in the third quarter. The ratio slightly increased, as our long-term debt increased by $127.6 million, while our short-term borrowing decreased by $92.5 million.

In terms of cash flow, we generated $189.8 million of operating cash compared to $119 million in the third quarter of 2012. Cash and cash equivalents, together with restricted cash at the end of the fourth quarter was $576.1 million, compared to $475.9 million in the previous quarter.

To examine our revenue by application, the communication segment was again of our biggest contributor to revenue this quarter. Revenue from this sector increased to $230.3 million, representing a sequential growth of 6.9%. The growth is mainly from increased in handset- related applications.

Revenue from the consumer segment increased 4.1% quarter-over-quarter, contributing to $207 million, mainly from gaming devices, set top box and smart cards. Geographically, revenue from each of our three regions grew. Revenue from North America grew 3.8% sequentially, contributing 54.4% of our total revenue. Revenue from China grew 3.9%, contributing 34.8% of total revenue. Eurasia grew 19.8% contributing 10.8% of total revenue as we round up orders from European customer.

In terms of technology, revenue from 65/55 nanometers increased 5.9% sequentially contributing 35.3% to our legal revenue for the fourth quarter. Meanwhile, revenue from 45/40 nanometers more than tripled sequentially contributing 2.6% of revenue in the fourth quarter of 2012.

In terms of our overall capacity, total monthly capacity at the end of fourth quarter increased from 212.8000 wafers to 219.3000 wafers at our Shanghai 12-inch fab successfully transitioned into a production fab.

The overall utilization was 90.5% in the fourth quarter compared to 92% in the third quarter. The utilization decrease is mainly due to the capacity of our Shanghai 12-inch fab. The reported CapEx in 2012 totaled $499.3 million. This was lower than our guidance due to the longer than expected lead time. Therefore, this previously planned CapEx will be reflected in 2013 CapEx guidance. Looking at 2012 unaudited results, we recorded record high annual revenue of $1.7 billion in 2012 compared to $1.3 billion in 2011, a increase of 29% year-over-year.

Wafer shipment increased 30.2% year-over-year from 1.7 million wafers in 2011 to $2.2 million wafers in 2012. Gross margin improved from 7.7% in 2011 to 20.5% in 2012. Operating margin improved 15.6% from minus 14.5% in 2012 to 2.1% – in 2011 to 2.1% in 2012. Net income attributable to SMIC was 59 – $15.9 million, a seven-year high. Looking ahead at the first quarter of 2013, the guidance up 1 to in revenue. Gross margin is expected to range 17.5% to 19.5%. Operating expenses has expected to range from $74 million to $77 million, excluding foreign exchange, R&D grants and asset disposal.

We estimate of 2013 CapEx for foundry operation to be approximately $600 million of which approximately $100 million as CapEx carry forward from 2012 due to postponed shipment. The majority of the 2013 CapEx is allocated for 12-inch foundry operations.

I will now hand the call back to En Ling for the Q&A session.

En Ling Feng

Thank you, Gareth. I will now like to open up the call for Q&A. As usual, please reminded to limit your questions to two per person. Operator, please assist.

Question-and-Answer Session

Operator

Ladies and gentlemen, we will now begin the question-and-answer session. (Operator Instructions) Your first question comes from the line of Randy Abrams from Credit Suisse. Please ask your question.

Randy Abrams – Credit Suisse

Okay. Yes. Thank you. My first question – just, I’m going into the growth. You’ve done much better faster than the industry in the last four to five quarters. Could you, as you look ahead to this year talk about if you expect to continue to outgrow the industry or maybe your view on the industry in your growth into this year, and if that’s still coming from like the mobile and then the China applications?

TY Chiu

Okay. Our visibility is clear on the first quarter. And so in the first quarter as we have forecasted is between growth of 1% to minus 2%. So the rest of the year, we think that in second half of the year, there will be a pretty general to the growth again, but we do not have that figure right at this moment, but we feel that indeed we will still outgrow the industry average.

Randy Abrams – Credit Suisse

Okay. Thank you. And I wanted asked on the CapEx with utilization on low 90s, how much capacity or maybe with our fabs, how much like the wafer capacity growth through the year. And any update on the Beijing fab, just your plans for timing to launch that and potential financing or if you get government support, maybe an update on the next fab expansion plans? Thank you.

TY Chiu

In terms of the capacity growth for 2013, the main growth will be in our 12-fab in Shanghai, which is mainly for the 44 to 45-nanometer production. At the end of Q4 2012, it was 6,000 per month. Our CapEx used to increase to above 12,000 per month by the end of 2013 and as for the other fabs there will be some marginal increase, for example, for our 8-inch fab in Shanghai, the growth of 90 to 94 wafers per month and then for the our 21-inch fab Beijing increased from 35,000 to 37,000 per month. I don’t think you also asked about the new project in Beijing, looking now the fab is still under construction and we don’t think it will be in production throughout 2013. Have it answer the question?

Randy Abrams – Credit Suisse

Okay. Yes, I mean I guess for the Beijing fab for financing, is that fully SMIC financed or will there be any major potential you could get some government support for that fab.

TY Chiu

It will be a joint venture fab with the investment entities belonging to the Beijing municipal governments. The agreement right now, we are still finalizing it and we cannot provide details at this point in time, but you are right, it would be probably fund the government entities in Beijing.

Randy Abrams – Credit Suisse

Okay. And if I could clarify, you get financing with that help on depreciation, you only depreciate the portion that – or would it, I mean, if you go into that detail if I could save on that?

TY Chiu

I am sorry. Can you repeat the question?

Randy Abrams – Credit Suisse

Yeah, if it’s, I guess, the joint venture – I guess some terms are so big finalized but this is that you don’t outlay the whole capital. So would save on depreciation and then whether there will be profit share I guess to the extent you have details at this stage.

TY Chiu

Yes, I think the plan is that the fab was owned by SMIC. So we will still consolidate the fab as our majority of owned subsidiary. So there will be all not that CapEx spend in the fab, will still be reflected in our financial statements. But as I mentioned, the funding will probably coming from the joint venture.

Randy Abrams – Credit Suisse

Okay. Thank you.

Operator

Thank you for your question. Your next question comes from the line of Dan Heyler from Merrill Lynch. Please ask your question.

Dan Heyler – Merrill Lynch

Yeah, thanks. Good morning, guys. I want to focus a little bit on the derivative technologies where you’ve been doing very well. Are there other opportunities that you see in these areas. You highlighted a number of things that you’re focusing on, but I wondered is there any opportunity to expand your presence more in some of the high voltage areas such as all old city drivers, and if you wanted to do that, would you be able to acquire used technology or are there fabs in China to grow that business? Just your thoughts on the derivative technology growth. Thank you.

TY Chiu

Okay. Hi, Dan. Thank you for asking this question. Yes, we see a lot of other opportunities and some of them we are already working on that. But at this point of time that we are not giving out plenty of details because we have find out that last time we review our technology, our competitor start to canvassing out customers. So in the future that we will announce that technology once it’s completely done and tape on and product come into the market.

Dan Heyler – Merrill Lynch

Yeah, thanks. Sorry for asking the question. I hope it doesn’t create any problems, sorry, in the future. And...

TY Chiu

No.

Dan Heyler – Merrill Lynch

Yeah, go ahead.

TY Chiu

Let me say that we continue to export our specialty technology since there are plenty of opportunity in slightly larger market in China.

Dan Heyler – Merrill Lynch

That makes sense. Thanks. Maybe I ask this way, are there – to grow your – chip business, your fabs are pretty fully utilized. So given vision that you would perhaps need capacity there and would you prefer to acquire to those fresh fabs?. Thanks.

TY Chiu

Yes, we continue to explore all possibilities and there are opportunities for us to improve our own efficiencies like we have done in the past year, and we are also definitely looking at potential used fab or used equipments.

Dan Heyler – Merrill Lynch

Used equipment, right. Thank you. And then another question was on the 40-nanometer you had mentioned that this is an important growth driver this year. I wondered if you could elaborate a bit. I that from – are you targeting existing customers that say are migrating forward or other have you been able to expand your addressable market?

TY Chiu

Yes, we have been able to attract new customers that to use this technology as well as some of our older traditional customers.

Dan Heyler – Merrill Lynch

And again, I guess I’m wondering if this is going to be primarily driven by the mobile market or would you be able to expand into other end markets. Some more details on 40-nanometer would be great, because that’s an important growth driver for you this year. Thanks.

TY Chiu

Our specialty, we are specializing in the low powered aspect of the 40/45 nano, and therefore the most natural product category indeed is for mobile devices.

Dan Heyler – Merrill Lynch

Okay, excellent. And finally on CapEx and capacity, would you tell us your CapEx budget for the year and how that’s going to play out on a quarterly basis?

TY Chiu

Yeah. This would be prettily – pretty evenly spread throughout the year.

Dan Heyler – Merrill Lynch

All right. And so the full – just refresh us on the full number for this year and -?

Gareth Kung

Yeah. We are targeting CapEx for this year for bulk operation to be about $600 million.

Dan Heyler – Merrill Lynch

Okay. How much that’s going to be 8-inch versus everything else, or everything else just the flip between the 8-inch and 12-inch would be great. Thanks.

Gareth Kung

Yeah. I think, yeah, absolutely the majority of that will be spent on the 12-inch operation.

Dan Heyler – Merrill Lynch

Okay. And can you tell us about the R&D line, you are working on 28-nanometer which I presume is pretty expensive. What you need to do in R&D this year and what are you budgeting for government grants there? Thanks.

Gareth Kung

Okay. The R&D, this year our R&D budget will increase and indeed there are two areas increase, number one is the advanced technology areas of both the 20-nanometer as well as the 20-nanometer. But we are also ramping up our R&D in the matured technology area. So we will see a visible to increase in R&D, Sandy.

Dan Heyler – Merrill Lynch

Can you give us a ballpark in terms of.

Gareth Kung

Yeah. If you look at our Q4 financials, the normalize R&D expense is above 7%. So if you will be seeing some curve up throughout 2013, maybe by about 1 to 2 percentage points throughout 2013. And then you also asked about R&D grant. This year we received about totaling – 2012, we received about $30 million R&D grant, so for next year may – cost enough, but the nature is a little unpredictable, so we cannot see for sure, but maybe still in the range of $20 million to $25 million for whole year.

Dan Heyler – Merrill Lynch

Okay. Did you say the full year 2012 number, just to be cleared, that was $33.0 million?

Gareth Kung

Yeah. The whole year 2012 R&D grant was about $30 million.

Dan Heyler – Merrill Lynch

Right.

Gareth Kung

So what can save for 2015, maybe in the range of $20 million to $25 million.

Dan Heyler – Merrill Lynch

What’s just – sorry, but what’s the feeling? Why would that be down given you are doing a lot more projects and mobile being one of them, this year feeling there. Why would you want – why you think that number would be down?

Gareth Kung

Well, I think we’re just being conservative. Just the nature of it is a little unpredictable.

Dan Heyler – Merrill Lynch

Okay. Great.

Gareth Kung

We have our two projects to be approved by the government, so we are not sure about the timing of the approval.

Dan Heyler – Merrill Lynch

Excellent. Okay, that will be helpful if we get quarterly updates on that one. Appreciate that. Thank you.

TY Chiu

Yeah. Thank you.

Operator

Thank you for your question. Your next question comes from the line of Steven Pelayo from HSBC. Please ask your question.

Steven Pelayo – HSBC

Great. Thank you. First on industry perspective, Dr. Morris Chang made some comments about industry growth being about 7% this year. You quote a lot of the third party researchers, you can seize the foundry market of roughly $40 billion or so. Even if we say that’s 10% growth, that’s only an incremental $4 billion. When I contrast that with Morris’s comment that his 28-nanometer revenue is going to triple quarter-over-quarter, that’s about an incremental $4 billion of him alone. So these suggesting all of the growth is just going to come from 28-nanometer. So I’m curious if you can talk a little bit about your expectations for industry growth for above 28-nanometer, 40-nanometer and above and what you think that mean, especially when you see as SMIC is really not going to have 20-nanometer this year, QSMC look like they didn’t have much either. So just thoughts on growth above 28-nanometer this year?

TY Chiu

Okay. Okay, definitely, first of all, we respect QSMC’s comment. What we see is that China I see is growing rapidly and we don’t think of it is in the 28-nanometer. So indeed that particular growth still contains a large component of more mature technology for the 65 and from 18. And at this moment, I do not have a figure for the growth in revenue outside of the 28-nano in China, but we think that it still is significant.

Steven Pelayo – HSBC

Okay. And I was surprised, I think in the last quarter you guys were speaking about targets of greater than 10% of revenue by the fourth quarter this year from 40 nanometer, 45 nanometer, I think at the Analyst Day you even mentioned it could reach the teens. You didn’t mention this on this call, so has there been any change in your targets for 40 nanometer and 45 nanometer as a percentage of mix at the end of this year?

TY Chiu

Steve, obviously no, our visibility is for the coming quarter. So we are not in a position to provide guidance for the whole year, but I think our outlook is – have not changed.

Steven Pelayo – HSBC

Okay. And then just one more quick one here. I was pretty excited at the analyst meeting, your discussion of your niche strategy, power management MEMS, CMOS image sensors, you talked about integrated passes, you just mentioned about your back side elimination being right for 2014. So can you just help me understand how big quantified, percentage of revenue would you consider this niche strategy was to your revenues in 2012 and what do you think this will be to 2013 or is there really more, it’s still going to take a little bit longer, it’s more 2014 when you have to invite backside elimination really contributing more?

TY Chiu

Okay. Indeed I think the CIS already is a significant portion of our revenue. The CIS, so after – at last year, it is near to between 5% to 7.5% of our revenue coming from the CIS, okay. And BSI, we expect that definitely will enlarge our access to this market. We believe that by fairly 2014, we should have a reasonable amount of our CIS that comes with BSI technology. Does that answer your question?

Steven Pelayo – HSBC

Yeah, I guess for one segment. Then if we had in all those things, you guys talked about your niche strategy for things like the EPROMs and going after some MEMS and even talked about microcontrollers and integrated passes. I mean I understand CIS is 5% to 7% revenue, but if lumped in all of those segments, are those 10% to 15% of revenues today and do you think that they can be, I don’t know, double or something year-on-year. Can you just give me some general idea what the total niche strategy for SMIC represents today in revenue, what it could a year from today let’s say?

TY Chiu

Okay. At this moment, I think our some of our specialty technology end up differently, greater than 15% of our revenue already. And we figured, we target to grow these specialty technology to at least by a factor of 2 in the upcoming few years.

Steven Pelayo – HSBC

Okay, few years. Okay, great. I’ll get back in the queue. Thanks.

Operator

Thank you for your question. Your next question comes from the line of Sezho Ng from BNP. Please ask your question.

Sezho Ng – BNP

Hi. Good morning, gentlemen. I just want to know what would be the default lateral capacity scale you are targeting for 40-nano?

TY Chiu

Our capacity for 40-nano by end of 2016 should reach about 12 Kh per month.

Sezho Ng – BNP

And what capacity levels you achieved across market breakeven for 40-nano?

TY Chiu

We think that by the end of 2013, we should be able to breakeven.

Sezho Ng – BNP

Breakeven. Okay. And one more question. And when would you achieve 40-nano gross margin compared to corporate average? Or at what capacity level you are that confident?

TY Chiu

Yeah. Well, we think that as we continue to ramp up the 40-nano production, the gross margin for that business should improve. I think by May of this year, it will be below our corporate average.

Sezho Ng – BNP

Okay. And last question. What percentage of the 40-nano equipment can be extended 20-nano production, maybe kind of percentage of deployment cost, yeah?

TY Chiu

If I hear your question correctly, you’re talking about how much of your 40-nano capacity is also 28-nano compatible? Is that correct?

Sezho Ng – BNP

Yeah, yeah.

TY Chiu

Yeah. What can you see is that for the 16 vessels for this year from the 6K to 12K that portion will be 100% 28-nano compatible.

Sezho Ng – BNP

Okay. Great. Thank you very much. Good quarter. Yeah.

Operator

Thank you for your question. Your next question comes from the line of (inaudible) International. Please ask your question.

Unidentified Analyst

Okay. Thank you for taking my question TY and Gareth. Congratulations on the strong results. So my first question is on the business outlook of the first quarter 2013. I see the guidance is from 1%, close to 92%. For the – seems more positive in the first quarter in this year and actually I notice from the previous guidance we have seen some decline first quarter, but now we see the upside as 11%. I can see that this is more positive tone from the management, do you see any upside on this guidance? So who would be the major driver for the first quarter?

TY Chiu

I think we have to stick to our guidance, which is plus 1% to 2%, which is based on current visibility. I think the strength for Q1 will still be in the mobile computing and for 40-nanometer production.

Unidentified Analyst

Okay. My second question is on the capacity. As you say there is a 12-inch where 40-nanometer will be perhaps higher by the end of 2013. And my analysis shows that the capacity in 2013 may go low teens year-on-year basis, is that a good assumption?

TY Chiu

Yes, I think that’s a good assumption. As I mentioned earlier, the main growth in the capacity for the 40 nanometer capacity, but there will be also marginal increase in the capacity for our 8-inch fab in Shanghai and our 12-inch fab in Beijing.

Unidentified Analyst

Okay. Thank you.

Operator

Thank you for your question. Your next question is a follow-up question from the line of Steven Pelayo from HSBC. Please ask your question.

Steven Pelayo – HSBC

Yeah. Just a quick one. I understand the gross margins are down in the fourth quarter because of the Shanghai impact, but you mentioned the Shanghai impact was about 400 basis points, I think you said 440 here in the presentation. Total gross margins were down, what is it, close to 800 or so. So I am curious the other portion excluding the Shanghai impact, where do you think that gross margin decline came from?

TY Chiu

Yeah. You’re right. I think excluding the Shanghai 12-inch fab impact, I think the gross margin is down by about 3.2%. I think there is a combination of reasons. Now if we look at our utilization quarter-on-quarter down about 2% and the effect contribute partly to the decrease in the gross margin. And also at the end of this year we also made some inventory provision for some ageing inventory, that also contribute to the decrease in the gross margin.

Steven Pelayo – HSBC

Okay. Thank you for that. One quick one more for you, Gareth, and then enough QA. The tax rate going forward, so obviously with the property sale you have some issues in the fourth quarter, but help me understand tax rate as we go through 2013.

TY Chiu

Oh, I think if we exclude the tax related to the property disposal, I think we should not be paying any taxes.

Steven Pelayo – HSBC

And that continue for the full year 2013, you have enough loss carry forward?

TY Chiu

Yeah.

Steven Pelayo – HSBC

Okay.

TY Chiu

Yes, yes.

Steven Pelayo – HSBC

Okay. And then final question. We talked a lot about China and China being 35% of revenues, but I also still get excited about a couple of big U.S. customers that you have. You also are talking about these new European customers that you have as well. When you look within those, I’m curious about your market share gain. How much of it is coming from deeper penetration within those existing customers versus actually gaining new customers? The reason why I asked is, I think it’s pretty well known that Qualcomm is a large customer for you primarily in a power management perspective, but I am interested in your opportunity or potential to penetrate other areas of such a large customer for things like apps processors, baseband and technically. So can you give us some thoughts on that?

TY Chiu

Okay, I think you are right. We are gaining both new customers as well as penetrating more deeply without traditional customers, existing customers. So a lot of our existing customers are indeed trying our 40, 45-nano technology and we hope our goal is that this year that we will see some of that significant ramp up with both new customers as well as existing customers. They already have – had a number of new tapeouts and so we are pretty excited about upcoming opportunities.

Steven Pelayo – HSBC

Can you just quantify – I mean last question, number of customers that are above 10% of revenue and maybe what the top three customers maybe represent total revenue. Help me understand the concentration of customers.

TY Chiu

In terms of the customer concentration, our top five customer make about 50% to 60% of our revenue and that would be quite consistent.

Steven Pelayo – HSBC

It would be consistent. Okay. Thanks, guys.

Operator

Thank you for your question. Your next question comes from the line of Rick Hsu from JP Morgan. Please ask your question.

Rick Hsu – JP Morgan

Yeah. Hi, Happy New Year to you guys. I think my first question is about your depreciation cost. Can you give us a little bit color how your depreciation cost will look like for this year, 2013?

TY Chiu

Yes. Based on our current CapEx plans, we think our depreciation year-on-year will stay flat.

Rick Hsu – JP Morgan

Okay. So basically flat year-on-year?

TY Chiu

That’s right. Yes.

Rick Hsu – JP Morgan

All right. Then regarding your US$600 million CapEx for this year, how are you going to finance? Are you going to define this all of them internally or are you going for any external financing?

TY Chiu

Yeah, I think, we will be able to financing through our operating cash flow, which should be quite sufficient. And in addition, we still have additional debt capacity we can draw of that.

Rick Hsu – JP Morgan

Okay. All right. Thank you so much.

Operator

Thank you for your question. Your next question is a follow-up question from the line of Randy Abrams from Credit Suisse. Please ask your question.

Randy Abrams – Credit Suisse

Yes. Thank you. I just want to ask one follow up on the gross margin. With the moving parts depreciation flat, but then 40 ramps up at lower below corporate average, for your margins, if you grow through the year toward the high 90s utilization, can you get margin expansion where you think near full utilization, margins are back low to mid 20s or given more 40s at, should we expect more stable margins around current levels. If you could give some feel for how margins could progress.

TY Chiu

Yeah, Randy. Honestly, no, our visibility is just for one quarter, we cannot provide guidance for our full year gross margin. But using your – assuming for high-level utilization, yes, we can see our gross margin to improve to what you said.

Randy Abrams – Credit Suisse

Okay. Now that’s helpful. Okay. And then on the pricing, in fourth quarter, I think you mentioned better mix products or better ASP products; how does the mix shift look. At least if you can guide for the first quarter, is that mix going to or would we expect I guess shipments relative to ASPs in the first quarter any change?

TY Chiu

We’ve seen that for Q1. You should see a steady higher mix for the 40, 45-nano shipment. So over I think the ASP should remain pretty flattish.

Randy Abrams – Credit Suisse

Okay. Thank you for that.

Operator

(Operator Instructions) Thank you for your questions. There are no further questions at this time. I would now like to hand the call back to CEO, Dr. Chiu for closing remarks.

TY Chiu

In closing, I would like to thank everyone who participated in today’s call. Again, thank all our shareholders, customers, employees, and suppliers for their trust and support. Have a happy Chinese New Year and a safe journey to those traveling for the holidays. Thank you very much.

Gareth Kung

Happy Chinese New Year.

Operator

Ladies and gentleman, this is the end of SMIC’s fourth quarter earnings conference call. We thank you for joining us today.

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