Semiconductor Manufacturing International's CEO Discusses Q3 2013 Results - Earnings Call Transcript

Semiconductor Manufacturing International Corporation (NYSE:SMI)

Q3 2013 Earnings Conference Call

October 22, 2013 8:30 p.m. ET

Executives

En-Ling Feng – Senior Director of IR

T.Y. Chiu – Chief Executive Officer

Gareth Kung – Chief Financial Officer, SVP

Analysts

Bill Lu – Morgan Stanley

Daniel Heyler – Bank of America-Merrill Lynch

Szeho Ng – BNP Paribas

Steven Pelayo – HSBC

Eric Chen – Daiwa Securities

Donald Lu – Goldman Sachs

Gokul Hariharan – JPMorgan

Operator

Welcome to the Semiconductor Manufacturing International Corporation's third quarter 2013 webcast conference call. Today's conference call is chaired by Dr. T.Y. 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 a listen-only 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 third quarter 2013 earnings webcast conference call. For today's call, our CEO Dr. T.Y. Chiu will first provide some general remarks, then our CFO Gareth 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 presentations are available for you to download at www.smics.com, under Investor Relations, in the Events & Presentations section.

Before I turn the call over to Dr. T.Y. Chiu, let me remind you that the presentation we'll be making today including forward-looking statements. These statements and other comments are not guarantees of future performance, but rather are subject to risks and uncertainties. Our actual results may differ significantly from those projected or suggested in any forward-looking statements. For a more complete discussion of the risks and uncertainties that could impact our future operating results and the financial condition, please see our Form 20-F filed with the United States Securities and Exchange Commission on April 15, 2013.

Also during the call we will make reference to financial measures that do not conform to generally accepted accounting principles, GAAP. This information may be calculated differently than similar non-GAAP data presented by other companies. Please refer to the tables in our press release for reconciliation of GAAP to the non-GAAP numbers we will be discussing.

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

T.Y. Chiu

Thank you, En-Ling. Good morning and good evening to everyone. Thank you for joining us for our third quarter 2013 earnings webcast.

I would like to being today's call by highlighting our Q3 2013 achievements. SMIC has achieved another good quarter. Revenue excluding Wuhan wafer shipments was $503.7 million in the third quarter of 2013, representing a robust year-over-year growth of 21.7% and a sequential growth of 0.4%.

Total revenue including Wuhan wafer shipments declined 1.3% sequentially as we exited our relationship with Wuhan Xinxin. Inventory adjustments were offset by strong 40nm growth and robust [mass-making] revenue increase mainly from 40nm new tape-outs.

I'm happy to announce that 40nm revenue grew 50.3% sequentially to 15.7% of total wafer revenue. This growth was mainly driven by smartphone-related products. Meanwhile, 40nm new tape-outs grew significantly in the second half of this year, driven by both consumer and communications products like smartphone, set-top box, IPTV and tablets. As a result we are targeting strong growth for 40nm next year.

We also see revenue growth from China-based customers, again reaching an all-time high increase, 38.2% year over year and 1.6% sequentially to 42.1% of our revenue in third quarter '13. I'm also pleased that we made $42.5 million in profit attributable to SMIC, which is our -- which is our sixth consecutive quarters of positive net profit and more than three times the profit of 3Q last year.

Our return on equity was 8.5% using the trailing four quarters and surpassing our 5% near-term target. I'm happy to see the consistent progress of our financial performance and market share that confirms our strategy of sustainable profitability and growth is effective.

As the industry undergoes a general inventory correction, we are introducing new technology, new products, and are working to migrate some differentiated products to address the effect of the situation. For example, in Q3 we had 65nm tape-outs for products such as connectivity, SIM card, set-top box and NOR Flash. In Beijing we just successfully delivered our first new tape-out on 55nm for embedded non-volatile memory, embedded NVM, for SIM cards. Over the next few years we anticipate differentiated products such as CIS and the embedded eEEPROM to transition to more advanced notes.

During the quarter, demands for our differentiated application continued to be strong, especially in the area of power management, CIS and [EDPROM]. Revenue from our differentiated application, specifically PMIC, CIS and [EDPROM], grew over 50% year over year in third Q 2013 compared to third Q 2012.

In addition, we have recently announced that four of our China six bank card IC houses have chosen SMIC as their foundry partner during our -- using our embedded eEEPROM platform. Among the four bank card IC design houses, three of them have already been certified, and the fourth design house is targeted to be certified by the end of 2013. Based on the research of the China Semiconductor Industry Association, IC Design Branch, China's financial IC card demand is estimated to be 800 million units per year, with potential compounded annual growth rate of 20% over the next five years.

A number of our customers are successfully entering the touch controller market based on the same embedded non-volatile solution, and is starting to enter volume production. According to IHS market research, the worldwide demand for touch controller IC in capacitive touch panels will reach about 2.7 billion units by 2017, nearly a 21% compounded annual growth rate from 2012.

In Q3, utilization in our 8-inch fab continues to be high. In order to further capture the market opportunities and to enhance our position in the differentiated technology, we continue to look into various opportunities to expand our 8-inch capacity.

Earlier this week we also issued a press release about the formation of our Center for Vision, Sensors and 3DIC. This consolidates and strengthens our existing R&D and manufacturing capability in sensor technology, [CSC] and other middle and wafer processing technologies for CIS, [man] sensors, 3D [stack] devices and [TFE-based] high-performance 2.5D and 3D system and package.

To update you, the schedule for our 28nm development remains on track and is targeted to be process ready by the fourth quarter of 2013.

To ensure long-term growth and profitability, SMIC is constantly working to improve efficiencies. Our standing and investment into advanced capacity is gradual and prudent. Our asset turnover ratio has improved over 60% in Q3 this year as compared to Q3 in 2011, while our estimated employee productivity in 2013 has improved about 40% compared to 2011, which is when this new management team came onboard.

The joint venture in Beijing was established in this quarter and that it is reflected in our consolidated financials. As we announced earlier this year, the fab would have the capacity, the capability to serve -- to serve 45nm and below customers with a planned manufacturing capacity of 35,000 wafers per month over the next three to five years.

Currently the fab construction should be completed around the next two months and the [team] will be ready for equipment moving in the first quarter of 2014. Our customers have expressed enthusiasm over this new advanced capacity.

Excluding Wuhan shipments, 4Q revenue will be somewhere between flat to modest 4.5% decline. While we faced a slower than expected market, we have confidence in our team to execute all the initiatives in bringing new products online and migrating technology to more advanced nodes.

We are also confident in the underlying demand for mobile-related products. According to Gartner semiconductor forecast database third quarter 2013 update, from 2012 to 2013, low-end and mid-end smartphone semiconductor revenue will grow at a compound annual growth rate of 24.2%, with low-end tablet growing at a compound annual growth rate of 38.3%.

So to conclude, we target another full year of record-high revenue and net profit in 2013, with sustainable profitability and growth as our priority. Looking into 2014, we aim to outgrow the industry average again. We have a number of exciting opportunities ahead of us. One, our 40nm ramp-up continues to be strong. Secondly, our 28 technology's coming online is on schedule with robust customer interest. Three, our embedded non-volatile is finding widespread customer acceptance as we enter the targeted markets.

Fourth, the derivative applications for our -- the same technology also being identified and tried out. Five, a number of other value-added differentiated technology will be rolling out in 2014. And lastly, our new capacity for high-end and mature technology is coming online as schedule. We believe it will be an exciting 2014.

Thank you for your time. I will now hand over the call to Gareth for overall business and 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 third quarter 2013 financial results and our fourth quarter 2013 guidance. You may also refer to our quarterly financial presentation on our website.

Please note that all currency figures are in US dollar unless otherwise stated.

Overall we had a good quarter for Q3 2013. We achieved revenue excluding Wuhan wafer shipments of $503.7 million, representing an increase of 21.7% year over year, an increase of 0.4% quarter over quarter. Revenue including Wuhan -- revenue including wafer shipments from Wuhan was $534.3 million in Q3 2013, representing increase of 15.8% year over year, and down 1.3% quarter over quarter.

Gross margin excluding wafer shipment from Wuhan was 22.1% in Q3 2013 compared to 30.4% in Q3 2012 and 26.7% in Q2 2013. Gross margin including wafer shipments from Wuhan was 21% in Q3 2013 compared to 27.5% in Q3 2012 and 25% in -- sorry, 27.5% in Q3 2012 and 25% in Q2 2013.

Q3 2013 is our sixth consecutive quarter of positive profits. Profit attributable to SMIC was $42.5 million compared to $12 million in Q3 2012 and $75.4 million in Q2 2013. Revenue from 40/45nm application increased to a record 15.7% of wafer revenue compared to 0.8% in 3Q 2012 and 10% in Q2 2013.

Cash and bank balances increased to $473.5 million from $231.8 million in Q3 2012 and $263 million in Q2 2013. Revenue from China-based customers increased to 42.1% of overall revenue in Q3 2013, an all-time high, compared to 35.3% in Q3 2012 and 40.9% in Q2 2013.

Now let's look at our income statement in detail.

Revenue decrease in the third quarter of 2013 was mainly due to a decrease of revenue generated by shipments from Wuhan Xinxin. Wafer revenue from Wuhan Xinxin was $30.6 million in Q3 2013 compared to $39.5 million in Q2 2013. We began phasing our wafer shipments from Wuhan Xinxin in Q3 2013.

Our Q3 2013 gross margin excluding wafer shipments from Wuhan was 18.5% to 21.5% and resulted in 22.1%. Our Q3 2013 gross margin including wafer shipment from Wuhan was guided 17.5% to 20.5% and resulted in 21%. The decrease in gross margin was primarily due to lower fab utilization and product mix change.

Operating expenses in Q3 2013 was $53.4 million compared to $56.1 million in Q2 2013. R&D expenses increased to $37.6 million in Q3 2013 from $36.7 million in Q2 2013, mainly due to a $6.8 million increase in R&D expenses from increased R&D activities, and partially offset by $9 million in funding of R&D contracts from the government in Q3 2013, compared to $3 million in Q2 2013.

General and administrative expenses was $24.7 million in Q3 2013, down from $42.6 million in Q2 2013, mainly due to a decrease of -- mainly due to a decrease of employees bonus accruals in Q3 2013.

Other operating income was $8.2 million, which mainly consists of the gain arising from the disposal of part of the living quarters in Shanghai. If excluding funding of R&D contracts from the government and other operating income which is mainly from asset disposal, so normalized OpEx would be $80.6 million in Q3 2013 compared to $92.2 million in Q2 2013, mainly resulting from lower employee bonus accrual.

Profit from operation in Q3 2013 was $40.5 million compared to $79.1 million in Q2 2013.

Moving to the balance sheet, at the end of the third quarter 2013, our cash and bank balances together with restricted cash was $669.3 million compared to $477.4 million in the previous quarter. The large increase is due to, first, the receipt of $108 million in cash as partial capital contribution for the JV company established in Beijing from general shareholders of the JV. And secondly, we drew down some bank borrowings in Q3 2013.

Meanwhile, our long-term borrowing increased $78.7 million and short-term borrowings decreased $38 million compared to Q2 2013. And our sector equity ratio decreased to 43.1% from 44.1% in the second quarter of 2013.

In terms of cash flow, we generated $269.6 million of cash from operating activities in the third quarter of 2013 compared to $108.4 million in the second quarter of 2013. This increase was mainly as a result of changes in working capital.

Cash used in investment activities decreased by $29.4 million in Q3 2013 compared to Q2 2013. Cash from financing activities increased from $104.2 million to $154 million as we received partial capital contribution for the joint venture company established in Beijing from the other shareholders of the joint venture.

To examine our revenue by applications, the communication segment was still our biggest contributor to revenue this quarter. Revenue from this quarter contributed 44.4%. Revenue from the consumer contributed 43.9%. Both communications and consumer sectors declined slightly as others had some modest growth, mainly from [Mac] revenues.

Geographically, revenue from China grew 1.5% sequentially, contributing 42.1% of total revenue. Revenue from North America decreased 6% sequentially, contributing 46% of total revenue. Eurasia grew 8.9%, contributing 11.9% to the revenue, and increased mainly from mobile-related shipments.

In terms of technology, revenue from 45/40nm increased 50.3% sequentially. Revenue from 65/55nm and 90nm decreased 13.9%. Meanwhile 0.13 micron (inaudible) decreased 7.2% quarter over quarter.

In terms of our overall capacity, total monthly capacity at the end of the third quarter was 231.8 thousand wafers compared to 223.5 thousand wafers. The change was primarily due to increased 40/45nm capacity in our Shanghai 12-inch fab. We still plan to expand our Shanghai 12-inch fab to 15 by end of the year.

The overall utilization was 88.2% in the third quarter of 2013 compared to 90.5% in the second quarter of 2012 -- 2013.

Looking ahead to the fourth quarter of 2013, excluding wafer shipment from Wuhan Xinxin, which are gradually phased out starting from the third quarter of 2013, revenue is expected to be down 4.5% to flat quarter over quarter. Including Wuhan, total revenue is expected to be down 9% to down 4.5% quarter over quarter.

Gross margin excluding wafer shipment from Wuhan Xinxin is expected to range from 19% to 22%. Including Wuhan, gross margin is expected to range from 18.5% to 21.5%. Operating expenses are expected to range from $80 million to $84 million excluding the effect of foreign exchange, funding of R&D contracts from the government, employee bonus accrual, and gain from disposal of living quarters.

We reiterate our 2013 capital expenditures estimated for foundry operations to be approximately $675 million. The 2013 planned capital expenditure does not count for additional expenditure for the joint venture company in Beijing which has been established on July 12, 2013. The joint venture company will principally engage in, among other things, the testing, development, design, manufacturing, packaging and sale of integrated circuits. As mentioned last quarter, in addition to the estimated CapEx for the foundry operations, we have budgeted CapEx of another $130 million in 2013 for construction of living quarters for employee, as part of employee retention program. We plan to either rent out or sell those living quarter units to the employees in the future.

I would now hand the call back to En-Ling for a Q&A session for this call.

En-Ling Feng

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

Question-and-Answer Session

Operator

Certainly. (Operator Instructions).

Our first question comes from the line of Bill Lu from Morgan Stanley. Please ask your question.

Bill Lu – Morgan Stanley

Yeah, hi. My first question is on 2014. Dr. Chiu talked about seeing several drivers and your competitor TSMC talked about double the growth for 2014. I'm wondering if you can help us quantify what type of top-line growth we could expect for 2014 and also, let's say by end of the year 2014, what will be the revenue contribution from 40nm?

T.Y. Chiu

Okay. We are looking at 2014 with quite excitement because there are a number of new technologies coming out. Actually we believe that our growth will be above industry average, and you can actually check out the -- what the industry average number is, actually the, you know, foundry industry average is actually above the double-digit.

So, secondly, as the 20nm -- no, 40nm growth, the contribution will still increase and, yeah, we, at this moment, not here to be very specific on the proportion of the revenue.

Gareth Kung

Yeah. Bill, I think just to add on to what T.Y. said, I think we are seeing robust growth in the 40nm because we see very strong tape-out activities for our 40nm both in the Q3 and the Q4. And in terms of the growth for 2014, I think we are very optimistic for two reasons. First of all, we think that the underlying growth for the mid and low-end smartphone and tablet continue to be strong. And secondly, we are seeing a lot of progress in terms of our differentiated strategy. And both will drive our revenue this year.

Bill Lu – Morgan Stanley

So just to be clear, you're saying the foundry sector should grow by double digit next year and SMIC above that, correct?

Gareth Kung

We -- Bill, I think, well, I'm sure you have seen, you know, some of the analyst forecast for the growth for this year, and we are [having] a growth above the industry, yes.

Bill Lu – Morgan Stanley

Okay. My second question is on gross margin. If you look at the fourth quarter, I think there are quite a few moving parts, right? You've got utilization rates, you've got your improvements for 40nm, you've got capacity and depreciation going up, and mix is shifting as well. Can you quantify what are some of the, you know, what are the key drivers for gross margin in the fourth quarter?

Gareth Kung

Well, obviously utilization, you know, will be major determinant for the gross margin. Actually I think we want to correct that for our -- we expect flat overall depreciation to the company quarter on quarter in Q4. So I just want to correct that point.

Bill Lu – Morgan Stanley

Thank you.

Gareth Kung

Well, in terms of the, you know, the long-term gross margin, we continue to see opportunity for us to improve on our gross margin, mainly because, you know, we continue to optimize our product mix, and this way our differentiation strategy is going to play a major part. And secondly, we are still -- well, we are making progress in terms of improving our, you know, service quality of customers, and that will help us keep our loading high.

Bill Lu – Morgan Stanley

Well, can you qualitatively talk about where 40nm gross margin is relative to the corporate average?

Gareth Kung

I think at this point in time, I would say that it's still below the corporate average. But I will emphasize that, you know, the 40nm business is definitely accretive to our net earnings. Because, as you understand, a lot of the costs now in our 12-inch fab in Shanghai is fixed cost.

Bill Lu – Morgan Stanley

And do you have a timeline for when that reaches corporate average?

Gareth Kung

I think it's a little bit hard for us to [pinpoint on] timeline at this point in time.

Bill Lu – Morgan Stanley

Okay, great. Thank you very much.

Operator

Your next question comes from the line of Daniel Heyler from Merrill Lynch. Please ask your question.

Daniel Heyler – Bank of America-Merrill Lynch

Thank you. Good morning gentlemen. My first question of the two would be on the capacity expansion plans. You have -- you're building out both 300mm and you continue to think about adding more 8-inch next year. Could you give us just roughly how much you plan to expand capacity just in terms of wafers for 12-inch and 8-inch?

Gareth Kung

For 12-inch, we are targeting to reach, you know, 15K capacity by end of this year for the 40/45nm capacity. But as you look at this year, I mean actually the actual shipment is much lower than that 15K because, you know, really in the course of ramp-up. For next year, the capacity will be available for full year. So, you know, that would be an increase in the overall capacity for 12-inch. And they were also trying to put in, at this point in time, a [mini] line in our [B2 new fab]. So I think the plan is first of all to move into 40nm production.

And then for 8-inch, we are incrementally increasing our capacity for our Beijing fab in Shanghai as well as in Tianjin. At the same time, we are planning to ramp up our 12-inch fab, our Shenzhen project, in the near future.

Daniel Heyler – Bank of America-Merrill Lynch

Yeah, that's what I was wondering, is when -- okay, so it sounds like your cost to securing some used equipment to the Shenzhen fab, and how much, again, how much 8-inch capacity do you think you can expand next year based on all these moving parts, Shenzhen and Tianjin and Shanghai? You know, are you adding, you know, can you add 50,000 wafers next year?

Gareth Kung

For the Shanghai, we're going to expand, you know, we can expand capacity from currently 90,000 wafers per month to about 100K per month. And then our Tianjin, right now the plan is to expand it to about 40K or three more than that in [Xinxin]. And for Shenzhen, right now we're still in the planning stage and we can provide you with more color in the next quarter.

Daniel Heyler – Bank of America-Merrill Lynch

You said Shanghai from 19 to 100K is your plan?

Gareth Kung

Yeah, from 90 to 100K, yes.

Daniel Heyler – Bank of America-Merrill Lynch

Okay, for next year.

Gareth Kung

Yeah.

Daniel Heyler – Bank of America-Merrill Lynch

Great. Thanks.

And then finally, on -- just a little bit on the financial side, appreciate that. I've noticed the, you know, your year-over-year cost of goods sold depreciation, you know, your margins are down from 27. You've got a huge increase in depreciation, you know, as a result of that, so basically a 37% increase in year-on-year depreciation. Conversely though, you've been able to offset that. It looks like, you know, your OpEx is in fact down, you know, 40% year on year, and that's, you know, due to the big drop in R&D. How have you been able to drop R&D so much given you have some of your new projects on derivative technologies, 20nm and tape-outs? Could you let us, you know, give us some color on the magnitude of the R&D credits you're getting?

Gareth Kung

Yeah. Actually we have not been -- I think -- just to clarify, we have not decreased R&D spending. I think if you look at 2013 to 2012 number, the reason you saw a drop is because in terms of '12, our 12-inch fab in Shanghai was still in a [sort of R&D fab], so all the expenses got into the R&D line. But as we started production for that fab in the last quarter of 2012, all the expenses go into the cost of goods sold line, which is why you see a decrease in R&D spending. But in fact we have not reduced our R&D spending.

In fact if I look at our R&D spending in the course of 2013, our R&D spend, if we exclude the R&D grant, our R&D spending increased from about 6.5% to about 8.3% in the third quarter. So actually we are putting more effort and emphasis in our R&D.

Daniel Heyler – Bank of America-Merrill Lynch

Yeah. But could you give us what the grants are the last few quarters? Because your R&D has been very, you know, very mild increase despite many projects, if you just look at the past several quarters. So what was the R&D amount credit that you received this quarter and last quarter, the dollar amount?

Gareth Kung

This quarter I think we have received about $9 million compared to about $3 million in the last quarter.

Daniel Heyler – Bank of America-Merrill Lynch

Okay, great. And then just for 2014, [any of you aware], you think that will go up because of these projects that are related to national projects and other things going on? Could we expect this to be, you know, continue to run about $9 million per quarter?

Gareth Kung

I think we've been -- I think we've been guiding the market that for this year we're going to receive about $25 million to $30 million, and I think that is our expectation, yeah.

Daniel Heyler – Bank of America-Merrill Lynch

Okay. For next year also?

Gareth Kung

This year we don't know yet, but (inaudible). I think for your modeling purpose, no, you can't make the assumption. But we can provide more color, you know, in the next year quarter, yeah.

Daniel Heyler – Bank of America-Merrill Lynch

Excellent. Thank you gentlemen.

Operator

Your next question comes from Szeho Ng from BNP Paribas. Please ask your questions.

Szeho Ng – BNP Paribas

Hi. Good morning gentlemen. Just want to know what percentage of the revenue right now is coming from the differentiated applications and how do you expect to grow that part of the business going into the 2014 and '15?

T.Y. Chiu

Could you repeat the question again?

Szeho Ng – BNP Paribas

Yeah. What percentage of the revenue is coming from the specialty projects, the differentiated applications?

Gareth Kung

Let me double-check the number. Sorry, I don't have the number on-hand right now, we'll get back to you later on.

Szeho Ng – BNP Paribas

Okay, all right. Anyway, the big picture, I think all the foundry players are talking about getting into the specialty projects market. So, just want to know how are you going to differentiate from the competition? Yes.

T.Y. Chiu

Okay. This part, I would like to say that in a number of the areas that we are playing into our strength. For example, in the embedded non-volatile for smart card applications, SMIC has some very strong partners that had experienced since the China IC card. And these companies had worked through that project and over the last three or four years had expanded into other areas such as certain security card, SIM card. They had become the dominant, overwhelmingly dominant supplier to the China SIM card market.

Actually these partners have been working with us for a long time. They know the application in China very well. And we believe that they will be able to work with us very closely to address this market since it is a very local market. This is an example in the smart cards.

In other areas such as the CIS, and we believe that -- and we already are seeing a very, very strong growth in the customer that we have, that they are becoming the dominant players in some of these mid to low-end CIS. And as they expand into the high-end market, I think they will be doing very well.

So I think for us, our strategy is to pick the right customers and work with them, and serve them as they need.

Gareth Kung

Yeah. Szeho, just want to get back to you on your earlier question about, you know, for our three differentiation technology, CIS, PMIC and eEEPROM. I think for Q3 it generated about 30% of revenue.

Szeho Ng – BNP Paribas

Okay, all right. Thank you. And my next question is 28nm. When should we expect 28nm to be revenue generating?

T.Y. Chiu

Okay. The 28nm, we are [freezing] our process this quarter and for our commercial [IP] suppliers and to try -- as well as some of our close-out customers and partners to try out. And we believe that we are aiming to generate some revenue, you know, at the -- by the end of 2014.

Szeho Ng – BNP Paribas

Okay, all right. And last question, on the CapEx side, you budget $130 million for the employee quarter. How much have you spent so far?

Gareth Kung

I think we have probably spent three-quarter of that until now, yes.

Szeho Ng – BNP Paribas

Okay, all right. And then the balance will be spent at the end of the year, right?

Gareth Kung

Yes.

Szeho Ng – BNP Paribas

Okay. All right. Thank you very much. Good quarter.

Operator

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

Steven Pelayo – HSBC

Thank you very much. I'd like to explore a little bit more on the margins here. You were answering Bill's question, you didn't know for sure when 40nm would hit corporate average, but you also talked about capacity and Shanghai, you know, getting to 15K by the end of the year, and then having a full-year effect of having 15K in Shanghai next year. Is the full utilized 15K enough to be doing, you know, above 20% gross margins in 40nm? Can I ask the question that way?

T.Y. Chiu

Let me answer that, Steve. You know, the -- it is -- we are also building up our B2, and B2 will be running 40nm as well besides the Shanghai. So it is a moving scenario and so it is very difficult to be hammering down the exact gross margin, the exact timeframe.

Steven Pelayo – HSBC

Okay. And then maybe I'll just the margins on the other side. You just mentioned, well, you mentioned in the press release, that your differentiated strategies grew 50% year on year, you just said they were 20% of revenues. Where are those, that 20% of revenues relative to your corporate average margins?

Gareth Kung

Just I'll mention the differentiated process comprised of three components, the CIS, PMIC and eEEPROM, made up 30%, not 20% of revenue.

Steven Pelayo – HSBC

All right. Sorry. And so where are the margins on that 30% of revenues relative to your corporate average?

Gareth Kung

I would say it's better.

Steven Pelayo – HSBC

What about the magnitude of better?

Gareth Kung

Quite a fair bit better, yes.

Steven Pelayo – HSBC

Okay, quite a fair bit. Thanks for the detail.

The last couple of quick questions here. You guys really talked about mass revenue is really helping you. So I'm curious, how much is this other revenue segment for you -- how big is mass and other for you guys?

Gareth Kung

Our mass revenue is ranging about $20 million, $25 million per quarter.

Steven Pelayo – HSBC

Per quarter. Okay. Okay. And then I'm sorry, I got to ask you to quantify a little bit more, because I think everybody has different industry growth forecasts for next year. You did hint to maybe double-digit industry growth forecast. What industry growth forecasts are you guys assuming that you're going to outperform next year?

T.Y. Chiu

Steve, we will check out exactly which one is it, okay? So we'll contact you later.

Steven Pelayo – HSBC

Okay. I'll get back in line. Thanks guys.

Operator

Your next question comes from the line of Eric Chen from Daiwa Securities. Please ask your question.

Eric Chen – Daiwa Securities

Yes. My first question, I would like to make clear in terms of the CapEx and capacity [expansion] for this year and for next year. So for the whole year the CapEx is still maintained at $675 million, is that right?

Gareth Kung

That's correct, yes.

Eric Chen – Daiwa Securities

Okay. How about the capacity expansion, how many percent year on year growth?

Gareth Kung

You mean the CapEx growth?

Eric Chen – Daiwa Securities

I mean the capacity, like the 8-inch equivalent capacity for the whole year versus last year, how many percent year on year growth?

Gareth Kung

I'm sorry, I don't have the number on-hand right now, but we'll try to get back to you later on.

Eric Chen – Daiwa Securities

Okay, please. Probably roughly idea is also quite helpful.

And how about for next year? I remember probably the earlier conference you mentioned that CapEx for next year probably will grow and probably quite significant. So can we assume like a $1 billion level, does that make sense for you for the CapEx next year? And -- yeah. And once we -- looking at the 28nm process, we probably need a much higher CapEx for next year, right? Does that make sense for you?

Gareth Kung

To be honest, I think right now at this point, we're still working on our next year budget, and that includes the CapEx spending next year. But just want to emphasize that I think the management team is -- believe in a very disciplined approach to CapEx. And I think the priority for us is, first of all, to make the maximum use of our existing capacity in two sense. And then we only add our CapEx incrementally based on clear visibility on customer demand and also our process readiness.

Eric Chen – Daiwa Securities

Okay. So that mean the other depreciation expense level and in terms of the absolute amount probably not grow too much, right? So like say 10% year on year growth, does that make sense for you?

Gareth Kung

Sorry, 10% year on year growth on?

Eric Chen – Daiwa Securities

For the depreciation expense level for next year. I mean you're just trying to highlight the CapEx, you try to be more disciplined.

Gareth Kung

Yeah.

Eric Chen – Daiwa Securities

So I'm wondering, is it fair for the analysts to assume your depreciation expense level growth for next year probably around the 10% level year on year growth?

Gareth Kung

I don't have the precise number because we're really right now in the middle of, you know, working on our budget next year. But I think we can -- we will provide more color on that when it comes to the next earnings call.

Eric Chen – Daiwa Securities

Okay. How about depreciation expense level compared to last year in terms of the year on year growth --

Gareth Kung

I think it's pretty flat actually.

Eric Chen – Daiwa Securities

Okay. So -- I got it. Okay.

And also the second question regarding to the special application, the process, the business you highlight, that will be one of the two drivers, and from your channel count. So I would like to know what kind of process is also the -- and the 40/45nm process mostly or the couple of different process we talked about?

T.Y. Chiu

Could you repeat that question again?

Eric Chen – Daiwa Securities

I mean for your CMOS sensor and eEEPROM and the [PMIC] what kind of process you are using now and --

T.Y. Chiu

Okay.

Eric Chen – Daiwa Securities

-- migration for next year.

T.Y. Chiu

Okay. For the embedded non-volatile we have offering at 0.18, 0.13 and our newest technology is at 55nm. And that is for the embedded non-volatile.

For the CIS, actually we are actually at, you know, 0.13 and working on the 12-inch 65nm, okay?

PMIC, our PMIC, right now our production is 0.18 and actually we have program at both 0.13 as well as 65nm.

Eric Chen – Daiwa Securities

Okay. For your CIS clients, the 65nm process you talked about, that's for the domestic client or for the US client, foreigner client?

T.Y. Chiu

We are actually having a lot of new clients working with us, so both domestic and overseas clients.

Eric Chen – Daiwa Securities

Uh-huh. I see. But in terms of the growth, it's mainly from the foreigner client, right? Is that right?

T.Y. Chiu

In terms of the -- this year's growth? Are you talking about this year's growth?

Eric Chen – Daiwa Securities

I'm talking about the next year growth.

T.Y. Chiu

I think that it could be both. It could be both, yeah.

Eric Chen – Daiwa Securities

Okay, I see.

T.Y. Chiu

May I get back to you, Steve? And the number that we have referring to, the foundry, overall foundry growth is based on the iSupply number.

Operator

Your next question comes from the line of Donald Lu from Goldman Sachs. Please ask your question.

Donald Lu – Goldman Sachs

Hi. Dr. Chiu, I have two questions. First is the Chinese government has recently announced a very ambitious plan to stimulate the semiconductor industry. And then we have had two high-profile privatization proposals for Spreadtrum and RDA. I just want to ask, as far as SMIC is concerned, what do you see as a potential change next year from the government's perspective in terms of R&D support or maybe other matters such as maybe Asia listing for SMI shares.

T.Y. Chiu

SMIC is already listed in Hong Kong, so we already -- so as far as the privatization of the Spreadtrum and RDA, I believe that they -- actually to us, we believe that the business will be actually positive because they will be able to extract more -- higher value. And once getting the higher financial resources, they will be able to do a lot of activities such as potentially, I'm not saying that they will definitely do that, they will be able to acquire a lot more companies and expand their market share aggressively. So we see that as a very positive move for SMIC.

Gareth Kung

Donald, I think just to get back to you, I think we expect the government, you know, the PRC government giving the emphasis on the semiconductor industry will have -- come out with even more supportive policy going forward.

On the question about, you know, Asia listing or whatever, I think, you know, SMIC is open to look at all the different possibilities to enhance shareholders value.

Donald Lu – Goldman Sachs

And just follow up on this, would that -- would there be more measures in terms of rebate for using domestic foundry and packaging service for Chinese fabless companies?

T.Y. Chiu

I don't think at this moment -- right now this design house has R&D, some of this, R&D contracts, but I don't see that there is an obvious rebate, at least we are not getting that, any obvious rebate.

Donald Lu – Goldman Sachs

Okay. Okay, thank you. My second question is on your -- the return on your 40nm investment. I think both Bill and Steve have asked you about gross profit margins, when it will be back to the corporate average. Let's say it goes back to the corporate average let's say it's 20% or so. If you -- I mean given like the potential scale you have, I mean which is probably around the 20K or 30K at most for 40nm, what kind of return do you think you can get for this kind of investment in terms of either ROE or the payback period for investment? Because I'm afraid, I mean after all, most of your investments are still in the 12-inch and the leading-edge. And can you get enough return so that you can continue to improve your balance?

T.Y. Chiu

Hi, Donald. I think that let's look at it in general, that SMIC ROE has improved steadily and the contribution comes from both the mature as well as advanced technology. We have, a few quarters back, we have announced a target of ROE of 5%. I think we have -- when we look at the trailing four quarters, we have already surpassed that particular target, and we'll continue to improve upon it. There are a lot of factors as to how we automize the margin for each technology node, but the important thing is the general, the overall return on equity.

So the scale, at this moment you may think it's small for the 40nm but, you know, 40nm will also be run in B2 and we will shift the weight of the 40nm to 28nm depending on the customer demand as we proceed.

Donald Lu – Goldman Sachs

But how about the 40nm CapEx investment?

T.Y. Chiu

Okay.

Donald Lu – Goldman Sachs

-- and --

T.Y. Chiu

Actually right now, even in the Shanghai fab, for our latest investment, are 28 capable. So even though that we have invested say for the 40nm capacity, you know, the overwhelming amount of these equipments are able to switch to 28nm production when the mature -- when the technology becomes available.

Donald Lu – Goldman Sachs

But can -- just over the long term, do you think your 40nm investment will generate let's say 5% return on the investment?

T.Y. Chiu

I believe so. I believe so.

Gareth Kung

Well, certainly I think we have set a very clear target for ROE going forward. And we are, as a management team, we are very focused in terms of delivering the returns for our shareholders.

Donald Lu – Goldman Sachs

Great. Thank you.

Gareth Kung

Thank you.

Operator

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

Randy Abrams, your line is now open.

As we are not getting a response --

T.Y. Chiu

Maybe Donald, let me follow through, let me put it this way. In the past I think we have always seemed to have to justify that SMIC is capable of being profitable and being -- running at a sustainable profitability level because there were a lot of questions as to the SMIC's scale and there are impressions out there saying that the only determinant factor in having a profitability is to scale.

But I think scale is very important, but there are other factors where we can bring the cost down and bring the efficiency up, and so -- and have a good profitability even at a lower scale as compared to other foundry. And this is where we are trying to do and this is where we have proven that we are able to do.

Operator

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

Randy Abrams, your line is now open.

En-Ling Feng

Maybe we go to the next.

T.Y. Chiu

Maybe we go to the next one. And when Randy comes up, we can go back to Randy.

Operator

Your next question comes from the line of Gokul Hariharan from JPMorgan. Please ask your question.

Gokul Hariharan – JPMorgan

Yeah, hi. Good morning. A quick question on your Chinese customers. I think you mentioned that there is still some inventory correction going on in that supply chain. What is your read on when that inventory correction is likely to end? Is it some time -- is it going to end by 4Q as your competitors like TSMC were suggesting, or it's going to take until fourth quarter? And I have one other question, thanks.

Gareth Kung

Yeah. Obviously I think we are entering in a stage of inventory correction at this point in time. I think our visibility right now is only for one quarter. And I think it will be difficult for us to comment too much on Q1.

But I would say beyond these two quarters, I think we are still very confident growth. Again back to what we, you know, talked about just now, I think we still believe in the strong underlying growth for the mid and lower end smartphone and tablets. And secondly, we are making progress in terms of differentiated strategies. And that should [pick up] in 2014, yeah.

Gokul Hariharan – JPMorgan

Okay. My other question was, last time you suggested that there are a couple of -- one or two customers who are starting their 40nm evaluation and could likely come in the fourth quarter of next year. Is that still on track? And is that going to be enough for your first quarter to be up quarter or a flat quarter and kind of buck the normal seasonal trend? Thanks.

Gareth Kung

We do see a very strong [NTO] activities for our 40nm in Q3 and Q4, and we do target robust growth for our 40nm revenue next year.

T.Y. Chiu

Let me add. There are about three or four additional customers going into production compared to this quarter and the last quarter.

Gokul Hariharan – JPMorgan

Okay. Thank you.

Operator

As we are now going over time, I would now like to hand the call back to your CEO, Dr. Chiu, for closing remarks.

T.Y. Chiu

In closing, I would like to thank everyone who participated in today's call, and again thank all our shareholders, customers, employees and suppliers for their trust and support. And thank you very much. Until next quarter. See you. Bye-bye.

Operator

This is the end of SMIC's third quarter earnings conference call. We thank you for joining us today.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Semiconductor Manufacturing International (SMI): Q3 EPS of $0.00. Non-GAAP Revenue of $503.7M (+21.7% Y/Y). (PR)