Taiwan Semiconductor CEO Discusses Q3 2010 - Earnings Call Transcript

Oct.28.10 | About: Taiwan Semiconductor (TSM)

Taiwan Semiconductor Manufacturing Company Ltd., (NYSE:TSM)

Q3 2010 Earnings Call

October 28, 2010 08:00 am ET

Executives

Morris Chang – Chairman & Chief Executive Officer

Lora Ho – Senior Vice President, Chief Financial Officer & Spokesperson

Elizabeth Sun – Head of IR

Analysts

Medhi Hosseini -- Susquehanna International

Donald Liu -- Goldman Sachs

Randy Abrams – Credit Suisse

Steven Pelayo – HSBC

Steven Goldman

Bernard Sarvah – Daiwa

Gunther Hoeffbolder - UniCredit

Satya Kumar - Credit Suisse

Hussen Kharnaria - RBC Capital

Operator

Welcome to the TSMC third quarter 2010 results webcast conference call. This conference call is being webcast live via the TSMC website at www.tsmc.com and only in audio mode. (Operator instructions.) I would now like to turn the conference over to Dr. Elizabeth Sun, TSMC Head of Investor Relations.

Elizabeth Sun

Thank you. Good morning, good afternoon, and good evening everyone, welcome to TSMC’s third quarter 2010 conference call. Joining us on the call are Dr. Morris Chang, our Chairman and Chief Executive Officer, and Ms. Lora Ho, our Senior Vice President and Chief Financial Officer.

The format for today’s conference call will be as follows. First, Lora will summarize our operations in the third quarter and give you our guidance for the fourth quarter. Afterwards, TSMC’s Chairman, Dr. Chang will provide his general remarks on the business outlook and a couple of key messages. Then we will open the floor to questions.

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 results presentation.

I would like to remind all listeners that following discussions may contain forward-looking statements that are subject to significant risks and uncertainties, which could cause actual results to 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, 2010, 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.

Now, I’d like to turn the call over to Lora.

Lora Ho

Thank you, Elizabeth. Good morning and good evening to everyone, welcome to our third quarter conference call. To start with, I will walk you through the financial highlights in Q3, then I will give you the guidance for Q4. You may also refer to quarterly financial summary slides on our website, let me remind you that all dollar figures are in NT dollars unless otherwise stated.

TSMC’s net sales reached NT $412.3 billion, up 6.9% from Q2 and up 24.8% from the same period a year ago. Wafer shipments were 3.19 million 8 inch equivalent wafers, up 9% from the prior quarter and up 30.5% from the year ago quarter. Gross margin was 50%, representing half a percentage point increase from Q2, and a 2.3% increase from Q3 2009. Operating margin was 38.4%, down 2% points sequentially, but up 2.8% points compared with year ago quarter. EPS for Q3 reached NT$1.81, ROE was 36.5%.

Let’s now take a closer look at the income statement. Q3 gross margin was 50%, up by 0.5% points from 49.5 in Q2, mainly due to continued cost improvements. Operating expense increased NT$1.6 billion from Q2, primarily due to a higher level of development activities for our 28 nonometer and 20 nanometer technologies, and also a higher opening expense for our Fab 12, Phase V.

Non-operating income increased by NT$4.3 billion from Q2, mainly reflecting the receipts of SMIC shares from the litigation settlement. Net investment gain was NT$900 million, up NT$317 million from the prior quarter, mostly due to business improvements among certain invested companies. Net margin was 41.8%, up 3.4% points sequentially, and up 7.8% points year over year.

Now let’s take a look at our revenue by application. In Q3, demand from communications and industrial related applications continued to be strong, they grew 13% and 19% quarter over quarter, respectively. Consumer increased by 4% from last quarter, while computer declined 7% sequentially due to weaker than seasonal demand.

Overall revenue from communications, computer, consumer, and industrial applications accounted for 44%, 35%, 14% and 17% respectively, of all wafer sales in Q3. By geography, we continue to see strong adoptions in all leading edge technology. 40 nanometer and 65 nanometer continue to grow, and now represent 17% and 29% of total wafer sales, respectively. These two most leading edge technologies, combined, were 46% of all wafer sales.

The revenue mix of 90 nanometers and 0.13 micron remains stable, at 14% and 12% of total wafer sales, respectively. The aggregate revenue strong point 0.13 micron and below accounted for 72% of total wafer sales.

Now, let’s move on to the balance sheet. We ended Q3 with NT$157 billion in cash and short term investments, representing a decrease of NT$39 billion from the prior quarter, primarily due to a cash dividend payment of NT$77 billion during this quarter. Total current liabilities decreased by NT$57 billion, primarily due to the payment of cash dividend, partially offset by an increase in short term loans. Accounts receivable days remain at 39 days. Inventory turnover days were 47 days. Net fixed assets turnover was 1.3 times.

On page nine, now let’s proceed to cash flow. Cash flow generated from operating activities totaled NT$64 billion, representing an increase of NT$15 billion from Q2, mainly due to the increase in net income and a decrease use in non cash net working capital. Capital expenditure was NT$42 billion in Q3, also just as I mentioned, we paid out NT$77 billion of cash dividends in the quarter.

Meanwhile, we increase another NT$19.8 billion in short term loans, to hedge a growing proportion of the company’s US Dollar position. In sum, the ending cash balance was NT$132 billion, down NT$40 billion sequentially. Free cash flow was NT$21.8 billion in this quarter.

Now let’s turn to capacity and capital expenditures. In Q3, due to (productive implement) at our Fab 14, we accelerated our schedule and upward revised our whole year capacity plan. Based on our current planning, 2010 overall capacity is expected to increase by 14% year over year, with 12 inch capacity up 37% year over year, compared with our last quarter announcement of 36%.

Total installed capacity was about 229.5 million wafers in Q3, representing a 7% increase from the prior quarter. In terms of capital expenditure, we spent US$1.32 billion in Q3, total capital expenditures for the past three quarters were US$4.4 billion. Total 2010 CAPEX will be $5.9 billion, as we guided last time we made our change.

Now let’s turn to the outlook for Q4 2010. Based on business expectations and exchange rate assumption of 30.60 NT to one US dollars, we expect our consolidated revenue in Q4 to come in between NT$107 and NT$109 billion. In terms of margins, we expect our Q4 gross margin to be between 48% and 50%. Operating margin to be between 35.5% and 37.5%.

This concludes my remarks today. Now I will turn the call over to Dr. Morris Chang, our Chairman and CEO, for his remarks.

Morris Chang

Hi everybody, this is Morris Chang. I will make a few comments first, on Q3, Q4,and the whole year this year. Q3 was a historical record in revenue dollars, in gross margin dollars, and in net income dollars. It was also a near historical record in gross margin percentage and operating income percentage. If Q4 were at the same exchange rate at Q3, then Q4 guidance would be revenue NT$111.6 billion to NT$113.7 billion which is higher than Q3 actual. Gross margin percentage would be 49.5% to 51.5%, which is also higher than the Q3 actual. Operating profit percentage would be 37.3% to 39.3% which would be flat from Q3. All those numbers I’ve given you, if the Q4 foreign exchange rate were the same as Q3.

So you can see that the business really is continuing at a brisk level in Q4. There is still considerable demand that we cannot schedule production for. Now, for the whole year, this year, in spite of the exchange rate variation in Q4, year 2010 will be a historical record for TSMC in every important operating measure. We also believe that we have increased our adjustable margin, and increased our share in that adjustable market. Our growth momentum has been fueled by the following factors.

One, we have increased 40-45 nanometer dollars more than five times in 2010 over 2009. 40-45 nanometers in Q4 accounts for 20% of our total revenue, with a gross margin at a level about corporate average.

Two, 44% growth in revenue dollars in 65 nanometer over 2009. Three, and this is perhaps new to a lot of people. We have had a 52% growth in specialty technology revenue over 2009. Specialty technologies include embedded flash, CMOS imager, and high voltage. All those in the mainstream technology loads.

I’d like to make a few comments on supply chain inventory and 2011 outlook. Supply chain inventory has increased in Q3, in both dollars and BOI, and at the end of Q3 is estimated to be close to the normal seasonal level. At the end of Q4, supply chain inventory is forecast to be at about the normal seasonal level. As for 2011, we are forecasting that the global semiconductor market will have a 5% growth, in 2011.

We are also forecasting that the total foundry growth, foundry revenue growth will be 14% in 2011, greater than the semiconductor market growth. As to TSMC, we believe that our momentum will continue into 2011, because we have the right technologies, we have available capacity, and we have good customer relationships. In summary, we expect to grow more strongly than the total foundry growth, which as I said, is 14%.

Now I would like to say a few words about our mission and strategy. Our mission is simply to be the technology and capacity provider of the global logic IP industry for years to come. We want to be the technology and capacity provider of the largest IP industry for years to come.

Our strategy; first we want to extend and strengthen our technology leadership. Our R&D expenses were $657 million in 2009, are estimated to be $945 million in 2010, and will increase to $1.1 billion in 2011. All those are in US dollars. On the CAPEX, is at $400 million this year, will increase to $700 million next year. Our R&D major projects will include 28 nanometer, 20 nanometer, 14 nanometer, and exploratory work on 10 nanometer and 7 nanometer. The major projects will also include specialty technologies, some of which I have already mentioned, and back end.

The second main element of our strategy is capacity. CAPEX will be $5.5 billion this year, as we guided a quarter ago, and CAPEX will be greater next year. We spend capital on the basis of forecast market demands from our customers, and expect the return on investment, not on speculation. Future generations will be increasingly more capital intensive.

28 nanometer capacity is already twice as expensive as 65 nanometer capacity. 28 is two times more expensive than 65. As to dividend, we already have one of the highest dividend yields in the technology sector. We will maintain NT$3.00 a share cash dividend payout in 2011. We will try to reward shareholders more in share price appreciation than in dividend payout.

Now we have already seen the first fruit of our strategy in the 2010 results. We will continue the strategy in 2011, and beyond.

Now I’d like to say a few words about new technology. First on 28 nanometer, the 28 nanometer development is going well. The Gate Last technology is proving out very well. Customer’s engagement is stronger than we had experienced in the 40-45 nanometer mode at the same stage. Customer engagement is stronger now with the 28 nanometer than 40-45 nanometer at the same stage.

Now, I’d like to show a slide, this slide is a scattergram of the tapeouts that we have scheduled, over the next some five quarters. They are all 28. Each star is one tapeout, and it means that it’s one design that’s based on our 28 nanometer technology that the customer has already scheduled a tapeout with us. So there are, all together, 71 tapeouts already scheduled, and we are quite sure that more will come as time progresses. So this is more tapeouts than we had with the 40-45 nanometers at the same stage of development.

Now, I also wanted to point out that as the 28 nanometer generation, customer designs are very difficult to port between foundries. They’re very difficult to move from one foundry to another. This is a new phenomena that did not exist even in the 45-40 generation.

Now I’d like to say a few words about specialty technologies. We have achieved a fair amount of success in opening up a new adjustable markets, which were not reached by the foundry segment before. Some examples are embedded flash, after many years of investments in developing this technology, we are now ramping up much faster than before. We expect our MCU, micro controller unit, business to grow 72% and our automotive business to grow 80% this year.

In the area of automotives, the requirements for quality and reliability are quite strict, for the under the hood applications. TSMC has gone from providing entertainment to under the hood for the automotive industry, and only a few companies are qualified to provide under the hood products for the automotive companies. Another example of specialized technology is CMOS, image sensors. TSMC proprietary backside illumination technology, also called BSI has the advantage of quality and form factor. It has been popular among smart phones, and compact digital still cameras.

TSMC is the first company to enter volume production in BSI. A few comments on back end technologies. We’re currently developing technologies in silicon interposer and 3dic. While we’re scaling CMOS from 40 nanometers to 28 nanometers and to 20 nanometers, etc., for improved speed, power, and density. We find even more opportunities to improve system performance on PC board levels, as an example, interconnect density on a PC keyboard is really more than 1000 times lower than that of silicon.

That’s why there’s really a lot of room for improvement at the PC board level, and that’s what we’re working on with our silicon interposer development and 3dic development. Now, a few comments on new businesses, which are LED and solar.

Our differentiation will be technology, that’s where we hope to differentiate ourselves in the LED and solar business. We have more than 250 employees in new businesses now, and they are still increasing. They are very busy developing LED and solar technologies. LED lab and Fab is almost completed, solar fab construction will be completed in mid-2011, mid next year. That’s the solar fab construction.

The new businesses will not contribute significant revenue in 2011 but will in 2012. Those are all the comments I have at this time.

Elizabeth Sun

This concludes our prepared statements. Operator, please open the floor to questions.

Question-and-Answer Session

Operator

(Operator Instructions.) Our first question comes from the line of Medhi Hosseini of Susquehanna International. Please proceed.

Medhi Hosseini -- Susquehanna International.

Thanks for taking my question, going back to the prospect of revenue growth for next year, if I just assume that the mix helping with the ASP improvement, therefore I would estimate that unit wafer shipment would be about 10 to 12%, and if the CAPEX is going to be higher than this year, wouldn’t that suggest that your capacity would actually grow at a faster rate than your shipment, for next year?

Morris Chang

No, not – the answer in no, because I do not think that it’s correct to assume that the average starting price would increase. You were assuming it would increase. So therefore, we still plan to have rather full loading of our capacity, as our capacity increases. We still plan to have rather full loading, and I will not specify how full is rather full, but it means pretty full loading, every quarter next year, even as our capacity increases.

Medhi Hosseini -- Susquehanna International

Okay, just two follow ups. How would the mix of CAPEX look like into next year? I’m not looking for a specific number, but as LED and solar starts to become material, how would the mix of CAPEX change, and then the second follow up question, as second tier memory manufacturers like power chip increase the mix of foundry services, what do you think the pricing pressure would be for the trailing edge?

Morris Chang

First question, the new businesses CAPEX, it would not be very significant next year. It will be perhaps single digit percent of our total CAPEX next year. And the second question, will the second tier foundries affect our trailing edge, our prices? Well, second tier foundries have been in existence all along. Not the same ones, but second tier foundries have been really present all along, and indeed, they have had an impact on our trailing edge prices. But I don’t see that the next year will be any different. I don’t see that next year we’ll see any greater impact from these second tier foundries.

Medhi Hosseini -- Susquehanna International

Thank you very much.

Operator:

Our next question comes from the line of Donald Liu of Goldman Sachs. Please proceed.

Donald Liu -- Goldman Sachs

Good evening, Chairman, Lora, and Elizabeth. My first question is on 28 nanometer high K, metal gate tapeout. Can you – I remember that TSMC was planning to make an announcement in September about starting the 28 nanometer high K metal gate service to customers. What is the progress there? Has the tapeout started yet for high K metal gate and what is the yield or anything you can share with us?

Lora Ho

Donald, our 28 nanometer tapeout progress well, our first devices use technology which is low power, we have completed process and we are seeing customer adopting it. And the rest of three technologies are on schedule.

Morris Chang

Well, actually the scattergram – I think I understand your question, Donald, when you were referring to September, I think on the scattergram I showed there are quite a few spots in Q4 this year, so yes, tapeouts have started, and in fact they are actively going on right now.

Donald Liu -- Goldman Sachs

Great, so the high K metal gate tapeout is just starting in Q4 this year?

Lora Ho

Yes.

Morris Chang

Yes.

Donald Liu -- Goldman Sachs

Okay, great. And when are we going to start to see 1% revenue from that technology?

Morris Chang

Second half of next year. 1 to 2% in second half of next year. 1 to 2% of our total revenue.

Donald Liu -- Goldman Sachs

1 to 2%, great. My second question is on the new business. I remember Chairman, I think maybe a year or two ago, commented that the new business would be $2 billion or more, by I think it’s 2012--

Morris Chang

No, I said no such thing, Donald.

Donald Liu -- Goldman Sachs

No? Oh, I’m sorry. Is that any quantitative goal we can factor in? In the next five years what kind of contribution the new business will be?

Morris Chang

Well, as I said in my prepared comments, new businesses will not contribute any significant revenue next year, but will in 2012. And by that I mean perhaps a few hundred million dollars in 2012.

Donald Liu -- Goldman Sachs

-few hundred million – great. Thank you. And my last question is about depreciation for next year. Given the CAPEX you are planning for this year, next year, how much would that increase by?

Morris Chang

I will let Lora answer that. Lora?

Lora Ho

Donald, we have not finalized our 2011 CAPEX plan, so I can just give you a range of our current estimations. The depreciation for 2011 may increase in the range of 25% or 30% over the range of 2010, however even with the increase in depreciation, we believe our structure profitability with the FGN, that Chairman was talking about –

Morris Chang

And the gross margins.

Lora Ho

Yes, standard gross margin will not deteriorate from this year.

Donald Liu -- Goldman Sachs

What is the, what gross margins will not change?

Lora Ho

Standard gross margins, that means the margin at 85% utilization.

Donald Liu -- Goldman Sachs

Will be 40%, or 45%?

Lora Ho

No, will be same as this year.

Donald Liu -- Goldman Sachs

Oh, I see, got it. So for next year if we have utilization at 85%, it would be similar to your last gross margins, if the utilization is at a similar level?

Lora Ho

Yes. The point is, it’s regard of the increasing in depreciation, we still can maintain similar level of standard gross margin of this year.

Donald Liu -- Goldman Sachs

Got it, great. Thank you very much.

Operator:

Our next question comes from Randy Abrams, of Credit Suisse. Please proceed.

Randy Abrams – Credit Suisse

Yes, hi. Good evening. I wanted to see if you could talk, you mentioned this afternoon about some of the specialty processes ramping up. I wonder if you’re considering, on some of your order 300 nanometer perhaps, on even the new megafabs, if analog is starting to make sense? We have TI starting to pitch 300 output (inaudible 0:38:34) I want to see if it’s starting to make sense for your business.

Morris Chang

Well, we have made a pretty careful analysis, and we believe that the cheapest way, the most economical way, I should say, to produce specialty technologies, which are all really in the mainstream nodes, the old technology nodes, 0.11 micron and 0.1190 and 0.25, 0.35, 0.5 microns, so all technology. The most economical way to produce these specialty technologies is still to use old 8 inch equipment, and not with 12 inch equipment. Even used 12 inch equipment, it would not be economical. So our plan is actually to expand our capacity facility in Shanghai, in China. Now we have an 8 inch fab in China right now, which is at capacity of roughly 49,000 wafers per month, right now. About 50,000 and we are planning to expand it, and that our is 8 inch. 49,000 right now, we’re planning to expand it to 110,000 8 inch, all 8 inch equipment, and I would say that the expansion would be to produce these specialty technologies. Rather than doing it on 12 inch plant.

Randy Abrams – Credit Suisse

Okay, but one more question. Is the timeline then, for that expansion, that’s for next year to get to 110,000. The second question I had was a followup to the 28 nanometer tapeout, and just your sense at this stage. Are most customers adopting the option to stay on the traditional (inaudible 0:41:16) gate, or are you seeing a number go to high K metal gate? At this stage is there a big difference in the yield ramp up for the 28 nanometer variations?

Morris Chang

Many customers are going to the high K metal gate. As for the timeline for the Shanghai fab expansion –

Lora Ho

Randy, we will expand in two year timeframe, not just one year.

Randy Abrams – Credit Suisse

Okay, thank you.

Operator:

Our next question comes from the line of Steven Pelayo, of HSBC. Please proceed.

Steven Pelayo -- HSBC

I was a little surprised with the depreciation growing 25 to 30% this year. I guess I had been modeling closer to 15%. Can you quantify how much depreciation on a quarterly basis will be in cost of goods sold in Q4, and Q1? I guess I’m concerned that we’ll see a big step up in Q1 depreciation in cost of goods sold, and then it may actually have an impact on margins if revenues are say, just flatish.

Lora Ho

Steven, the increase of depreciation for next year, I think it will moderately increase quarter by quarter. I have seen around 10% increase in Q1 versus Q4 this year.

Steven Pelayo – HSBC

Okay, excellent. and then a question for Chairman. A year ago, maybe it was a year and a half ago, you really talked about wanting to implement a new strategy at TSMC where you partner with the customers and you prove to them that you always have capacity available. You then prevent spillover going over to second tier foundries out there. You then admitted that the other cycle just came back too quickly, and you couldn’t really adopt that strategy. It sounds like you’re trying to install capacity almost at that level to remain fully loaded. So has the strategy changed? Do you, ideally, want to run TSMC as 90% utilization so there is always upside available for customers, or do you now think we’re targeting 100% to balance – as close to 100% as possible?

Morris Chang

You are exactly right. We did adopt, we did start to adopt the strategy that I described a year ago, except we had to catch up. We were more than 100% loaded and then we have been 100% loaded this year. And next year, we will still be 100% loaded, but you know, we don’t really want to spend $10 billion of capital all in one year. So yes, we are still on that strategy that I expressed a year ago, and I think there will be a time, maybe in 2012, when we will have ready to – reserve capacity. But I think that even though we are 100% loaded now, and plan to be 100% loaded next year, I think that our pace of adding capacity has been faster than our second tier competitors, and therefore, I think that even though we don’t have any reserve capacity, we will not have any reserve capacity in the near future, I think that certainly less will spill out to the second tier foundries than they did.

Steven Pelayo – HSBC

And just to follow up on that, a couple of years from today when you have caught up and built the reserve capacity, do you think the company will still be able to do 50%+ gross margins, if we’re building in that buffer?

Morris Chang

Well, I cannot be 50% gross margin, I think that greater than 20% ROE is unalterable benchmark.

Steven Pelayo – HSBC

Okay, thank you.

Operator:

Our next question comes from the line of Steven Goldman of (inaudible 0:46:07) Please proceed.

Steven Goldman

Thanks for taking my question, it’s actually on your results. I was listening to the call this morning, and you said you’re expecting going forward, obviously foundry growth of around 14%, though it seems to be a bit higher than that. You also said having targeted 20%+ROE from now on, for the next five years, you’re really looking at a 10% profit before tax rate, annually. Now, if we’ve got 15% + shipment growth, I assume you mean shipment, and 10% TDT, then am I right in assuming that margins are relatively stable going forward, you’re looking at maybe 5, 6, 7% blended ASP drop per year? Is that a sensible way of thinking about it?

Morris Chang

You may be right, but I don’t think about these things this way, and also I don’t think about, I look at the average price. I look at the price by node very, very carefully, future price development by node, by node or technology. 65, 40, and 28 and all those, and also the more (inaudible 0:47:57) by node, and I want an assurance that every node will have a return on assets which then translates to return on equity. When you add up all these return on equity, you get greater than 20%. And 20%, as I said, is an unalterable minimum, and actually that hasn’t changed since day one of our company. But we always manage to deliver more than that, most of the years we managed to deliver more than that. So when I say that 20% is an unalterable goal, I don’t mean that we’re going to retreat into that level, you know, but it’s always nice to set a minimum benchmark, and then set other criteria and the other criteria, the new criteria that we have set now, is the earnings per year growth. Earnings per share, profit before taxes, but per year growth. That, as you said, is 10%. So what I’m saying is I think we’ll achieve 10% in the next five years, 10% per year, profit before tax and I think that – I also maintain the 20% minimum ROE, but certainly my expectation is that we will probably exceed that.

Steven Goldman

Okay, thanks. Also, you talked about how 28 nanometer porting technology between different foundries is tougher than previous generations. Are you able to talk a little bit more on that? Is that getting too technical?

Morris Chang

Well, it doesn’t have to be very technical, all I mean is – first of all, each technology is sort of sufficiently different so that our paying customer desires one technology, he will really have to endure a pretty extensive redesign, if he wants to use another company’s technology. This, of course, in the past I think this was somewhat so. In 40-45 I think it was pretty hard for the customers to second source, let’s say, from another company. It is already in the 40-45 generation; but in the 28 generation, I think it’s almost an order of magnitude harder than the 40-45 generation.

Steven Goldman

Right, okay. Thank you very much.

Morris Chang

Yes, thank you.

Operator:

Our next question comes from the line of Bernard Sarvah of Daiwa. Please proceed.

Bernard Sarvah -- Daiwa

Hi, good afternoon everyone. Can you give a little bit of color, the automotive type of product, how much percentage of your revenue it is contributing now?

Lora Ho

Contributing from what?

Bernard Sarvah -- Daiwa

Automotive applications. How much percent of the revenue is coming from automobile related product?

Lora Ho

For now it is single digit, but it will continue to grow in the next few years.

Bernard Sarvah -- Daiwa

Could you expect to reach about 3 to 5% revenue somewhere middle of next year?

Lora Ho

It’s already 3%, so it’s going to be bigger than that next year.

Bernard Sarvah -- Daiwa

Okay, that’s great. Thank you. And next one is we have seen a lot of smart phone related products are coming up, and for second tier chip makers, there might be some sort of memory (inaudible 0:52:53) capabilities. How are you going to address that issue? Hello?

Morris Chang

We’re still here, we’re just formulating – I wanted your question to be repeated, because I didn’t understand it, or hear it, I should say. There’s some noise on the line. Actually, our approach to this memory versus cpu arrangement is the silicon interposer and the 3dic. That’s our approach, so that’s one of the new technologies, both of those in the backend category, and we are working on that.

Bernard Sarvah -- Daiwa

Will that include some third party out there, or you will be doing everything by yourself?

Lora Ho

Technology is going to be developed by ourself.

Bernard Sarvah -- Daiwa

Okay, got it. Okay, thank you very much.

Morris Chang

Thank you.

Operator:

Our next question comes from the line of Gunther Hoeffbolder of UniCredit. Please proceed.

Gunther Hoeffbolder – UniCredit

Hi, thanks for taking my question. I had one related to your new business areas, to LEDs. They’re right now, you know, memory players, like Samsung already in the market, and of course those are the established players. Do you have a different approach here for some regarding manufacturing or the product to be successful in the LED market here?

Morris Chang

Well, as I said, we are still in the process. Our differentiation will be technology, in both LED and solar. So we’re still at this point visibly trying to develop a technology, and you know very well that for solar there are different approaches, and we have actually chosen what we want to do, and we are developing that. That’s a long term thing, and it’s a fixed thing. For LED there are various technologies, not just in the emitter, but also in the various types of packaging etc., and so we’re developing those. Also epitaxy and so on, so we have a long way to go, but the goal or strategy, I should say, is to have a stronger technology which means higher performance, perhaps, or lower cost, or both. That’s what we are shooting for and there’s – we don’t have a final product yet, therefore we are not going to have any significant revenue even next year, but our plan is to have a significant revenue in 2012.

Gunther Hoeffbolder – UniCredit

I remember, I think your press release regarding LED earlier this year, you were talking about maybe adding a second fab or a second module here already for LEDs. Is there already a position being made here, in this regard?

Lora Ho

I do not believe that we have a press release about second module. We did have a press release of the first module, which is near complete, as Chairman has said.

Gunther Hoeffbolder – UniCredit

Okay. Thank you very much.

Operator:

Our next question comes from the line of Satya Kumar with Credit Suisse. Please proceed.

Satya Kumar -- Credit Suisse

Yes, hi. Thanks. I was wondering if you could quantify your spending, not the dollar level, but the percentage of spending by technology mode for this year and next year, and if you could also provide that for 200 nanometer and 300 nanometer? Thanks.

Morris Chang

Well, let me just answer this. As far as this year is concerned, I think about 80-85% is on 65, and 40-45. Next year we’ll be adding 28, so next year whatever the amount will be, I think it will be 85% on 28, 45, and 65. Now you also have to take into account that the R&D capital, which is included in the total capital on this, it is $5.9 billion for this year, and that’s $400 million this year, and will be $700 million next year. So that’s additional percentage that included in the total, but the percentage that I just quoted to you were capacity percentages. That does not include the R&D capital. Did I make myself clear?

Satya Kumar -- Credit Suisse

Yes, I just wanted to – it sounds like you’re saying you’ll still spend excluding your R&D portion, 80-85% on the 28 and 65 nanometer next year, where it was 80-85% on 65 and 40 this year.

Morris Chang

I think that’s correct, yes.

Satya Kumar -- Credit Suisse

Okay, but you also mentioned that you’re planning to increase the China for 200 nanometer, that sounds like more trailing edge for next year. Is that not (inaudible) in the percentage?

Morris Chang

That’s in the other 15%.

Satya Kumar -- Credit Suisse

Okay, understood. Earlier on, I think you mentioned that the foundry industry will grow 14%, that’s faster than the 5% for the semiconductor industry. I understand that you are planning to grow faster with share gains. Can you quantify that increased growth for foundry, how is that splitting up between faster growth for your fab customers versus increased level of IDN outsourcing?

Morris Chang

Well, as far as our percentage revenue from each category is concerned, I think that the percentage hasn’t changed much over the years. We have always derived around 75% from fab customers. Now, the foundry industry has grown faster than the semiconductor industry, total, and actually in Asia between fabers and IDN has started to dry a few years ago. Most companies, most former IDN have declared themselves to be fablight, which means they are really not building any capacity for the advance technology, the leading edge technology any more. So you know, it’s all kind of blurry now, to talk about fabbers and IDN, but the key point, however, is that we are enlarging the (inaudible) market. The enlargement comes from the faster expansion of the foundries and also comes from the increased IDN outsourcing to us. So our growth comes both from us enlarging the serve or available market and from enlarging our share in that market. So larger share mean an ever expanding market. That’s what we’re talking about.

Satya Kumar -- Credit Suisse

Thank you.

Elizabeth Sun

Okay, operator, in the interest of time, we will only accommodate two more callers questions.

Operator

Our next question comes from the line of Medhi Hosseini, of Susquehanna International. Please proceed.

Medhe Hosseini – Susquehanna

Thanks, one final question. Going back to your customers inventory correction, and Q4 back to the normal levels, does that suggest that shut down days during the Christmas time and Chinese holiday period is going to be typical to a normal seasonal, or should we assume differently?

Lora Ho

You will pretty much on normal seasonal.

Medhe Hosseini – Susquehanna

So in other words, the impact to utilization rate should not be much?

Lora Ho

As Chairman said, we expect to be fully loaded in the upcoming quarters.

Medhe Hosseini – Susquehanna

Thank you.

Operator

Our next question comes from the line of Hussen Kharnaria (ph) of RBC Capital Markets. Please proceed.

Hussen Kharnaria -- RBC Capital

Thank you, I have a couple of questions regarding your strategy on the trailing edge. Number one, if you can provide some more color in terms of your analysis, considering that TI things that 300 nanometer is better for trailing edge, could the difference be because of the difference in the US versus China? And the second thing, I was under the impression that were building a 300 nanometer trailing edge fab 15 in Taiwan. Is that plan changed for expanding the China fabs?

Morris Chang

Let’s see. the question is – we’re not planning to use our new (inaudible) fab, which is the fab in Taichung, we’re not planning to use it for the trailing edge, especially technologies products, wafers. As I said earlier, we build a very careful analysis of this and we found the most economical way to produce special technologies, of course special technologies will eventually graduate to advanced technology too. But as of now, the most economical way to produce specialty technologies is still old used 8 inch equipment, which is available on the market and we have already got a fair amount of it, and we will continue to get more. We are planning to expand the Shanghai fab that I just mentioned with old equipment that we will be purchasing off site.

Hussen Kharnaria -- RBC Capital

Okay, Thank you very much.

Elizabeth Sun

This concludes our Q&A session. Thank you very much for your participation. We look forward to talking to you next quarter.

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