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Executives

Elizabeth Sun – IR

Lora Ho – CFO

Rick Tsai – CEO

Analysts

Shailesh Jaitly - Nomura Securities

Timothy Arcuri - Citi

Pranab Kumar Sarmah - Daiwa Securities

Mehdi Hosseini - FBR

Randy Abrams - Credit Suisse

Daniel Heyler - Merrill Lynch

Mark FitzGerald - Banc of America Securities

Steven Pelayo - HSBC

William Dong - UBS

Matt Gable - Millennium Partners

Bhavin Shah - JP Morgan

Keril [Suiskin] – CA Asset Management

Mike McConnell - Pacific Crest Securities

Satya Kumar - Credit Suisse

Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC) Q3 2007 Earnings Call October 25, 2007 8:00 AM ET

Operator

Welcome to the TSMC’s third quarter 2007 results webcast conference call. Today’s event is chaired by Ms. Lora Ho, Chief Financial Officer and Vice President; and Dr. Rick Tsai, Chief Executive Officer and President. (Operator Instructions)

Please be advised that those participants who do not yet have a copy of the press release may download it from TSMC’s website at www.TSMC.com. Please also download the summary slides in relation to today’s quarterly review presentation.

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

Elizabeth Sun

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

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

The 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 20, 2007; TSMC’s registration statements on Form F-3 filed with the SEC on May 8, 2007; and such other documents that 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 would like to turn the conference call over to Ms. Lora Ho, our Chief Financial Officer and Vice President.

Lora Ho

Thank you, Elizabeth. Good morning and good evening to everyone. Welcome to our third quarter 2007 earnings conference call. First, I will go over the highlights from our third quarter results. I will then give you the outlook for the fourth quarter. Please refer to the quarterly financial summary slides on our website. All dollar figures are in NT dollars, unless otherwise stated.

First, the highlights of the quarter. TSMC delivered a strong quarter in Q3, in which we set a record in terms of revenue and wafer shipments. We expanded our gross margin and operating margin. In the meantime, we returned to $2.3 billion to our investors through cash dividends.

Now, let’s turn to income statement. During the third quarter, we saw stronger than expected demand across major market segments. As a result, we delivered revenue of NT$89 billion in the quarter, up 8% year over year and up 19% quarter over quarter.

Now, let’s take a closer look at our revenues. In terms of revenue by market segment, all three major segments delivered double-digit growth during the quarter, with the strongest growth coming from the computer segment, followed by consumer and communications. On a quarter-over-quarter basis, revenue from computer, consumer and communications grew by 29%, 15% and 12% respectively.

In terms of revenue by technology, we continue to ramp our 65-nanometer during the third quarter, as revenue from 65-nanometer more than doubled from the previous quarter to account for 7% of wafer sales. We expect percentage of revenue from 65-nanometer to further increase in the fourth quarter.

Total revenue for Advanced Technologies accounted for 56% of wafer sales, up 3 percentage points from the second quarter.

Gross margin was 45.8% for the quarter, up 2.8 percentage points quarter over quarter, mainly due to increased wafer shipments and higher level of capacity utilization, offset in part by a decline in fuel price.

Total operating expenses was higher than the previous quarter, largely due to higher legal fees and increased R&D spending on 55-nanometer and 65-nanometer related projects. Operating margin was 36.4% for the quarter.

Income from non-operating items and long-term investments totaled NT$1.9 billion, down NT$1.4 billion from Q2, mostly due to accrual of litigation losses related to the UniRAM case. Earnings per share were NT$1.15, down 7% year over year and up 19% quarter over quarter.

Moving on to the balance sheet and cash flow statements. We continue to have a strong balance sheet. We ended the quarter with NT$176 billion in cash and short-term investments, down from NT$233 billion in the last quarter, mostly due to an NT$82 billion payout of cash dividend and employee profit sharing, offset in part by NT$26 billion free cash flow generated during the quarter.

Now let’s turn to capacity and CapEx. Total installed capacity for the third quarter was about 2.2 million 8-inch equivalent wafers. We slightly reduced our fourth quarter capacity, bringing our total expected 2007 capacity to about 8.3 million 8-inch equivalent wafers, a 17% increase year over year. We spent $756 million in CapEx during this quarter. We now expect our full year 2007 CapEx to be around $2.6 billion, which include the $82 million purchase of 8-inch equipment from Atmel.

With that, let me give you the outlook for the fourth quarter of 2007. Based on our current business and foreign exchange rate expectations, we expect our consolidated revenue to come in between NT$92 billion to NT$94 billion.

In terms of margins, we expect our fourth quarter gross margin to be between 46% and 48%, and our operating profit margin to be between 37% to 39%.

That concludes my remarks today. Let me turn to our CEO, Dr. Tsai, for his remarks, followed by Q&A.

Rick Tsai

Thank you, Lora. Again, I would like to spend a few minutes on a few topics that many people have shown great interest in. The three topics I am going to talk about include:

  1. Business outlook.
  2. CapEx -- mainly CapEx for 2008.
  3. Pricing.

Let me start with the business outlook. As Lora just mentioned, the third quarter was a good quarter for TSMC. We have performed better than we expected. I think the same can be said for the whole semiconductor industry. All the PC shipments and handsets shipments I think exceeded expectations.

We are now looking at the year 2007 in better shape compared to three months earlier. Three months ago, we were forecasting a 3% to 4% growth for the semiconductor industry in 2007. Now we’re looking at 2007 at 4%, and maybe somewhat higher.

The foundry sector, however, still will under perform the semiconductor industry. We do not expect the foundry sector to grow much. Essentially, it will be a flat year for the foundry sector of the semiconductor industry.

Moving forward to 2008, what we are looking at right now is a better year from the semiconductor industry point of view. We expect right now for the 2008 to grow roughly between mid to high single-digits for the whole semiconductor industry, while the foundry sector should outperform the semiconductor industry.

I think in the year 2007, inventory correction in the early part of the year -- first quarter very strongly and also to a large degree in the second quarter -- impacted the foundry sector much more severely compared to the semiconductor industry. Hence, quite a bit of lower growth for the foundry compared to semiconductor.

However, we are seeing the inventory effect to be quite clear now. Third quarter inventory reports from most of the companies have shown continuing improvement and this will continue into fourth quarter. We expect fourth quarter days of inventory to continue going down compared to third quarter.

So with the inventory effect gone, we believe the foundry sector will resume its previous pattern which is the outperformance over the semiconductor industry. We certainly also expect TSMC to outperform the semiconductor industry.

Now let me talk about the CapEx. First let me comment on 2007. Again, as Lora just said, our CapEx in 2007 will be about $2.6 billion, which is a lot of money. With this $2.6 billion, we will have acquired large chunk of the capacity that we will need in 2008. For example, the 90-nanometer technology capacity we will be having, I believe, enough by the end of the fourth quarter this year and we probably will not need more 90-nanometer new capacity next year. However, we will continue purchasing equipment for 65-nanometer and 45-nanometer. The key point here is a large part of the capacity for 2008 will be covered already by the $2.6 billion CapEx spend in 2007.

In addition, we have worked very hard over the year on the productivity improvement of all the tools that we have purchased, especially the 12-inch tools. We have improved, certainly, the productivity to the extent that it also will help in lessening the need for the CapEx for year 2008.

Essentially what we have done is to improve our CapEx productivity in 2007, hence we will be able to lessen the need for CapEx in 2008. As a result, our current expectation for the CapEx in 2008 will be significantly lower than the CapEx in 2007. We believe this capital investment will allow us to support the business growth in 2008.

Now let me go to the pricing part. We have always aimed to reflect the total TSMC value proposition. The value proposition includes the value of our long-term investment in technology development, manufacturing capacity, design services, back end services, mask making services, et cetera, et cetera.

However, our recent pricing trend was not consistent with our value proposition and the statement I just made one minute ago. We must then aim to keep the pricing trend in line with our value proposition. This is our plan for 2008 pricing.

This is the end of my remarks. Thank you. We are happy to answer any questions that you have.

Elizabeth Sun

Before you raise your questions, let me remind you to please limit your questions to no more than two each time so that more people will have their chance to raise their questions. Thank you for your cooperation. Operator, you can open the floor now.

Question-and-Answer Session

Operator

Your first question comes from Shailesh Jaitly - Nomura Securities.

Shailesh Jaitly - Nomura Securities

Could you help clarify your comments in the prepared remarks about the inventory situation? You had mentioned that inventories continue to improve across the board. Do you see any pockets there? Do you still see excesses? Particularly if you can comment on the wireline communications segment, please.

Lora Ho

Could you please repeat your questions again? Sorry, we don’t have a very good sound system to completely hear your question.

Shailesh Jaitly - Nomura Securities

I just wanted to get a bit more color on the inventory situation across the board. I am wondering if there are any pockets of excesses, particularly if you can shed some more light on the wireline communication sector with respect to inventories?

Rick Tsai

We do not see that. However, I want to caution that I’m not sure we have that fine granularity. I had said in my remarks earlier that we are seeing the inventory level in general go down at a very healthy level. We certainly expect to see that continue into fourth quarter.

I might also add that from our output, or from our shipment schedule and our customers’ business expectation, we do not see a concern of inventory buildup.

Shailesh Jaitly - Nomura Securities

So more or less across the board, it has improved dramatically and you don’t see any excesses anywhere?

Rick Tsai

I think we have seen a continuous improvement over the last two to three quarters. So it’s a continuing process, I wouldn’t use the adjective dramatic as that would imply a sudden improvement. I think it is a continuing improvement, and also we see that going forward, also.

Shailesh Jaitly - Nomura Securities

I understand. Finally, if you could also comment on your strategy about the increase in stake at Vanguard, and whether you would be open to increase it beyond 50%?

Rick Tsai

Yes, we have increased our shareholding by 10 percentage points and reach about 37% of Vanguard’s shareholding. Our basic position with regard to Vanguard really has not changed. Vanguard has been and continues to be our strategic partner in the mature technology business. We have worked very closely with Vanguard, both from technology covering all the way from 0.5 micron to 0.18 micron.

Vanguard also can cover certain business that we have not been able to cover, also. I think definitely a win-win situation. The increase of the shareholding further solidifies the relationship. Of course, as of now, I cannot comment. I mean really, we do not have a firm plan as to what we will do in the future as far as the shareholding is concerned.

Operator

Your next question comes from Timothy Arcuri - Citi.

Timothy Arcuri - Citi

Rick, can you be a little more specific about what you think the ‘08 CapEx would be? When I look this year, you grew capacity 19% last year with similar CapEx. You grew capacity 24% the year before with similar CapEx. You grew capacity 17% this year with similar CapEx.

It would seem that is not unreasonable that CapEx might come down 50% or so next year. Is that a reasonable number?

Rick Tsai

Let me be straightforward. 50% is what you just said?

Timothy Arcuri - Citi

50%, yes.

Rick Tsai

I won’t say that’s unreasonable because I don’t want to create any confusion, but I will not comment further on any other numbers, all right? From anybody, not just you.

But you have calculated a lot of numbers that we have also, but to be very frank, we continue to work on the numbers and we really haven’t made the final decision yet but we’re fairly sure that the number will be significantly lower.

Timothy Arcuri - Citi

It sounds like you spend a lot on lithography this year and also last year. Is there some particular area of your capital spending where you think you’re getting a lot of efficiencies? Is it in litho, is that where you think you can scale back the most in ’08? Or is it something else?

Rick Tsai

We have made progress in general, but litho is definitely one area that we have. We have put in a lot of effort during the last about 18 months, for the simple reason that it is the most expensive part of the investment. But in general, we look at the more bottleneck type of machine. Because there is a lot of work to do, we try to prioritize them to ensure we spend our resources most efficiently. But litho is definitely the number one priority.

Operator

Your next question comes from Pranab Kumar Sarmah - Daiwa Securities.

Pranab Kumar Sarmah - Daiwa Securities

Rick, you have mentioned about your CapEx productivity has been improving. Do you have any particular target to add 1,000 more 12-inch fab capacity in 2008, what type of CapEx you have to put in? Or if you can give us some number like whether that CapEx productivity will go up by 5% to 10%? Any sort of target you have.

Rick Tsai

I think you used 5% to 10% and that’s probably not a bad range. We certainly target improvement in productivity. As I said earlier, we do not try to improve productivity of every tool. What we are doing is to improve productivity with certain tools so we can increase overall output capability from the same set of tools. I think 5% to 10% is, well, a fairly good range to work with.

Pranab Kumar Sarmah - Daiwa Securities

Because of your significant CapEx plan in 2008, do you foresee any market share loss in the foundry industry in 2008, or you will be able to maintain your desired market share?

Rick Tsai

We did not say that we will not have capacity. We believe we will have enough capacity to serve the needs of the business requirements. We certainly will keep our market share. Just remember the revenue= price X quantity.

Operator

Your next question comes from Mehdi Hosseini - FBR.

Mehdi Hosseini - FBR

There is obviously a lot of confusion over your capacity requirements for next year, and it seems to me that we should expect a significant price increase next year given the significant decline in CapEx. Is that pricing premium driven by your expectation that you are able to continue to increase your market share or keep your lead at 65- and 45-nanometer processes?

Rick Tsai

I hope we have not created confusion that we will have low capacity next year. I think we tried to explain at the very beginning that with the capital investment we have spent this year, together with the productivity improvement of the critical tools that we believe with the significantly lower CapEx that we will still have enough capacity to support our business requirements next year.

Mehdi Hosseini - FBR

I’m just going back to your prepared remarks that semiconductor industry revenue could be up of 5% to 10% next year, and considering where your utilization rate is above 90%, the productivity improvement must be significant. That’s where we are trying to understand: how significant is this productivity improvement?

Rick Tsai

Well, we certainly aim to do better than 90%.

Lora Ho

I think there is one comment some analysts made this afternoon in our conference saying that even if TSMC were not to spend an extra penny on CapEx for next year, with whatever we have in the fourth quarter of this year, capacity, if you annualize that, it already represented a 9% year-on-year capacity increase even without a penny spent.

Mehdi Hosseini - FBR

Just for clarification, did you say this morning or during your local conference call that CapEx could be down by as much as 50%?

Rick Tsai

No, we did not say that.

Mehdi Hosseini - FBR

I just wanted to clarify. Where do you see 65-45 nanometer tape-outs? Given the kind of tape-out you see at these two technology nodes, is it below where 90-nanometer tape-outs were a couple of years of ago when 90-nanometer was first introduced?

Rick Tsai

I think 65-nanometer tape-out has been strong. I think our 65-nanometer business ramp has been certainly according to our schedule and somewhat better than that.  I forget the tape-out number, but the tape-out already in late October, we should have more than 100 product tape-outs for 65.

For 45-nanometer, I think it’s now a bit early to talk about the product tape-out; we do have one. However, I think it’s important to say compared to the same time of the 65-nanometer and 90-nanometer, we are engaging with I would say significantly more customers at the 45-nanometer technology.

Mehdi Hosseini - FBR

Sure. Is that one tape-out in the computing PC-related, or communication, wireless?

Rick Tsai

Wireless communication.

Operator

Your next question comes from Randy Abrams - Credit Suisse.

Randy Abrams - Credit Suisse

I wanted to follow up on the 45-nanometer, maybe talk about some of the new applications you are seeing coming there. You are seeing more activity at 65 and 90, do you expect the ramp to be faster or a greater amount as we go to 45 then we saw at 65 and 90?

Rick Tsai

The application that we are seeing for the 45-nanometer now is broader than 65-nanometer, with more customers. I would say now it’s somewhat early to predict the ramp, but what I can say is if this situation continues, I would probably expect, yes, at least the same or better ramp.

Basically, if you look at our 45-nanometer offering and the schedule of availability, it represents a very good value for the customers.

Randy Abrams - Credit Suisse

I wanted to ask, given your comment about inventory days coming down in fourth quarter, what is your initial view of revenue trends into the first quarter ’08?

Also, with the macro uncertainty, have you seen any notable changes in the order book, whether it is cancellations or rush orders?

Rick Tsai

Of course we are not guiding first quarter now. We do not see now any abnormal patterns other than the usual seasonal patterns. The first quarter has some seasonal pattern now, I think it has continued for a few years.

Randy Abrams - Credit Suisse

Have you seen any real changes in the order trends in terms of just cancellations or rush orders in either direction, just given the macro uncertainty out there?

Rick Tsai

We’re not really seeing cancellations, no. We still see some requests for the pull in of the wafers. But I would not want to mislead you to think that we have a very strong situation;  it is normal and probably a little better than normal.

Operator

Your next question comes from Daniel Heyler - Merrill Lynch.

Daniel Heyler - Merrill Lynch

Good evening. I have a follow-up question, Rick, on 300-millimeter. What percentage of your current capacity is capable of 65-nanometer? It’s 7% of revenue, but I was wondering what percentage of your installed 300-millimeter, roughly, is 65-nanometer capable?

Lora Ho

Dan, we are increasing the capacity of 65-nanometer so we have seen the revenue continue to go up. Other than telling you what capacity allocates at 65, I can say that a big part of our capital expenditure for this year and going forward for next year will be needed to support 65-nanometer.

Daniel Heyler - Merrill Lynch

Is it fair to say that a big part of your productivity gain would be a lot of these fabs here that are running fairly full will be migrating forward from 90 to 65 so you have a huge die advantage, a die shrink capability there? Is that where you are seeing the biggest gain in productivity or are there other factors that I am missing?

Lora Ho

I think the productivity improvement is across the board, both for 8-inch and 12-inch. On 12-inch, it seems we are still adding capacity, so the productivity improvement has been more [phenomenal]. As an effect, getting to reach to economic scale the productivity improvement is quite significant, so that also covers the 65-nanometer and also 90-nanometer and 0.13 micron as well.

Daniel Heyler - Merrill Lynch

Will that be a greater productivity gain, say from 90 to 65, relative to 130 to 90? If so, why?

Lora Ho

You can say that again mostly came from the area that we are adding capacity, because it is a fill effect. So in a sense, you are right, since we are adding capacity with 65, it’s probably true.

Daniel Heyler - Merrill Lynch

As you look out to ‘09, I guess much of your capacity additions here in the second half of ‘07 are for your ‘08 growth. It seems as though the industry, clearly the growth rates as Rick talked about, are less volatile. Do you have an ability or increased ability to start to think about ‘09, or is that just crazy? Or do you think the industry will be in a 5 % to 15% growth range, even out to ‘09?

Rick Tsai

I think the direct answer should be no, we don’t really have that kind of ability, for sure. Even for next year is what we forecast based on certain of our mechanisms, processes that we have. If we have to look at ‘09, we will have to use the macro trend line for the semiconductor industry trend line growth.

Daniel Heyler - Merrill Lynch

Trend line, but then less likely to see massive inventory swings that you have seen in the past? Clearly there are less players, right? There are less producers. I am wondering if you’ve thought through what that means in terms of the volatility going forward and if that will be driving your returns further up?

Lora Ho

Dan, can you repeat your questions? We don’t quite understand your point.

Operator

Your next question comes from Mark FitzGerald - Banc of America Securities.

Mark FitzGerald - Banc of America Securities

I was looking at the mix of IDM and fabless business and over the last year that has declined for the fables. I was curious if that trend would continue going forward?

Is there any correlation between the pricing problems and that trend?

Rick Tsai

I think you probably see a change, I think, in the first quarter of this year or fourth quarter of last year, I forgot. But mainly that change came mostly because of the acquisition of ATI by AMD, so there is a specific reason. Otherwise the ratio between IDM and the fabless has been fairly consistent over the year.

Mark FitzGerald - Banc of America Securities

Is pricing to those two segments similar? Do you do better in the fabless than you do in the IDM?

Rick Tsai

I think the pricing is very much customer-specific. I wouldn’t really comment, that’s such a big group.

Mark FitzGerald - Banc of America Securities

Is there any evidence that your fabless companies have slowed their traditional technology shifts here as the cost of designing chips has gone up? That they are staying at a technology node longer?

Rick Tsai

I think this point have been raised by many people over a fairly long period of time. I think the dynamic we are seeing is you probably can say that they are going to 90-nanometer but it seems to us that as time went on people learned and as I said just now, 45-nanometer engagement has been strong; has been stronger than actually 55-nanometer. My thinking is at the end of the day, economics rule.

Operator

Your next question comes from Steven Pelayo - HSBC.

Steven Pelayo - HSBC

Your lower CapEx next year is going to do wonders for your free cash flow. I’m curious if this is just, do you think, a one-time step down? I am not going to try to pin you down on an absolute dollar number, but over the last three years you have spent about 25% of revenues on CapEx. If CapEx is down about 20% next year and you grow about 15%, that ratio is going to go down to about 18%. Do you think that’s a new run rate for the next three-year average on CapEx as a percentage of sales?

Rick Tsai

I want to answer your question very carefully. (1) This is not a one-off phenomena. (2) However, we also do not have -- at least now -- a set ratio which we will use for the coming few years.

We still look at CapEx based on the business outlook as well as the strategic thinking. You also need to realize the annual CapEx has this artificial annual thing. When we need to build, for instance, a shell for a new fab, that will definitely add a significant CapEx, which will not turn into production for a longer period of time compared to CapEx for the incremental tools, for instance, for next year.

I cannot really promise you a set ratio, but this is definitely also not a one-off phenomena, either.

Steven Pelayo - HSBC

Maybe if you could comment, just in general, about your pricing strategies here. How much of it is really making your customers understand the value proposition that you afford versus really the fact that capacity is just going to be growing at a much slower rate and your utilization rate is going to be running at a higher level and so customers just need to understand that it is going to be a little bit tighter? Are you focusing on it from the value proposition side, or just the utilization rate is running higher?

Rick Tsai

It seems that if you raise the question with the customers -- I think the reality is both. I mean for any customer, they will look at many factors. Especially large customers, a long-term customer who has worked with us, they have many factors they look at when they decide to work with TSMC long term, which includes the technological capability, long-term capacity, support, assurance of supply, ability to ramp, a good reasonable die cost, all of those things. Of course price is always a function of supply and demand, which, by the way, TSMC is only a part of.

Operator

Your next question comes from William Dong - UBS.

William Dong - UBS

I wanted to follow up on the split between 8-inch and 12-inch. How would you characterize the difference in demand growth going forward between 8-inch and 12-inch? Obviously, Advanced Technology is always the main demand driver but how would 8-inch fit into this? Does that also account for the limited growth going forward?

Rick Tsai

I would say Advanced Technology is certainly the growth driver compared to a mature technology. However the mature technology, we do have 5 million?

Lora Ho

Yes, 5 million capacity.

Rick Tsai

5 million plus 8-inch capacity, which certainly represents a very significant amount of our business. We continue to try to upgrade our business in that area, too.

William Dong - UBS

Going forward, would you grow your 8-inch capacity at the same rate as 12-inch, or a little bit slower?

Rick Tsai

I would say slower.

William Dong - UBS

In the terms of the economies of scale in the Shanghai fab, is that fab right now running at a lower margin than overall business, or do we hope that the economies of scale there improves so that it can reach the parent level?

Rick Tsai

You are right. I think right now the scale is not sufficient to render that as efficient and as profitable compared to our other 8-inch fabs in Taiwan. We are further expanding the capacity there with, for instance, the tools we just announced to purchase recently. I think that will certainly help that fab to be as competitive going forward.

Operator

Your next question comes from Matt Gable - Millennium Partners.

Matt Gable - Millennium Partners

Do you have any color at all from customers about the general end demand trends in Q1?

Rick Tsai

Other than -- I think maybe I am repeating myself -- nothing other than a normal first quarter seasonal pattern.

Operator

Your next question comes from Bhavin Shah - JP Morgan.

Bhavin Shah - JP Morgan

What is embedded in the outlook for CapEx for next year? Can you say how much is the CapEx for 200-millimeter? Or put it another way; how much additional 200-millimeter capacity do you think you might need to add, if at all? Just a ballpark would be helpful.

Rick Tsai

I think there will be, at most, some incremental investment for 8-inch next year.

Bhavin Shah - JP Morgan

Depreciation has started to rise slightly at a faster rate in 2007, but perhaps that pattern will change again in 2008. Any guidance on what percentage of increase in depreciation we should assume for 2008?

Lora Ho

Bhavin, since we have not finalized the 2008 CapEx, we just say it will be significantly less.  I would expect the depreciation increase will be less than 10%, as we compare this year versus last year. The degree of increase will be smaller.

Operator

Your next question comes from Keril Suiskin – CA Asset Management.

Keril Suiskin – CA Asset Management

Another question on CapEx; actually a clarification on the one you already answered. The question was what particular areas of equipment you would consider priority, or what areas you would consider cutting? You mentioned litho, so I am not quite sure I understand whether you mentioned it as your number one priority for new spend or whether you are saying that you have already spent enough to have capacity for another 18 months?

Rick Tsai

I think you probably have misunderstood. We were discussing productivity improvement of certain tools. I was asked whether we have worked on the lithography tools. My answer was positive, mainly because lithography tools are the most expensive ones, and usually the bottleneck.

Keril Suiskin – CA Asset Management

So if you were going to cut CapEx significantly in 2008, what areas would you consider strategically important in terms of equipment?

Rick Tsai

Let me first say, I do not know. I do not have a list of equipment that we need to purchase. But on the other hand, we have a certain target for the 65-nanometer, 45-nanometer capacity, and we have a group of tools, and we will buy the balance of the tools. But I just don’t have the list myself.

Keril Suiskin – CA Asset Management

Could you possibly comment on the segment strength in Q4 and perhaps beyond that? So you were saying I think in Q4 the growth will be driven by PCs. Could you may be expand a little bit, and comment on first half ‘08?

Lora Ho

For fourth quarter, we think the computer-related applications will grow the strongest, followed by communication-related applications, while consumer applications will decline, this follows their seasonal pattern.

Keril Suiskin – CA Asset Management

What about first half ‘08?

Rick Tsai

We have not separated them in such fine detail. I think we would expect next year for PC unit growth to stay roughly the same as this year. Handsets will continue to grow, but not as strong as this year.

Operator

Your next question comes from Mike McConnell - Pacific Crest Securities.

Mike McConnell - Pacific Crest Securities

Not to beat a dead horse here, but on the significant CapEx provision next year, is this more driven by the productivity gains you have outlined, or is this a function or a strategy to essentially stabilize pricing, considering the comments that pricing is more supply/demand driven?

Rick Tsai

Mike, just as I outlined in my opening statement, the combination of the $2.6 billion spend this year and the productivity improvement, we basically believe we should be able to invest less to get the capacity we need for next year. That’s really what we have been saying. Pricing, we must work out the value to ensure we get value of our services. Supply/demand, as I said also, we are just a part of the supply, so we are not able to really talk about that.

Mike McConnell - Pacific Crest Securities

if you look at your back end assembly and test, they have obviously dropped their capacity additions considerably to try to stabilize their pricing and tighten up supply. Do you feel that, given the pricing pressure maybe from an industry standpoint, that we have seen in the foundry industry that you and others may start to tighten up on capacity allocations to try to firm up pricing, drop depreciation, and then obviously get a higher return?

Rick Tsai

Mike, I really can only comment on what TSMC plans to do, which we have said many times. There’s absolutely no way that we can comment or know anything about our competitors.

Mike McConnell - Pacific Crest Securities

We have seen a slower cadence to which your customers are migrating to 65-nanometer today then 90-nanometer, for various reasons. What’s your confidence though, looking at 45-nanometer, that that cadence will accelerate and maybe we’ll start to see the adoptions reflect more of what we have seen at 90-nanometer? What’s the difference between 45- and 65-nanometer if I’m a customer trying to decide whether I migrate to it faster or slower?

Rick Tsai

First, we have seen a substantially a stronger engagement from a higher number of customers and if this situation continues, then I would say 45-nanometer will be a strong technology node.

Why? I think 45-nanometer, in our case, we accelerate the technology schedule, actually, for our GS processes. The 45-nanometer GS process basically is a 40-nanometer design node. We offer an extra 15%, maybe 20% area reduction. I would think that is very attractive to customers, and they will be available at the same time as the 45-nanometer was supposed to be available. Ditto, I think, for the low power part.

We also have learned over the years to, for instance, to get the IP environment consistent and in sync with the technology available at the time. Everything we have been doing to meet with the customers, to enhance their confidence, I think they have all worked out.

Mike McConnell - Pacific Crest Securities

If I look at 65-nanometer, the slower migration wasn’t really your fault. It’s just the fact that there is a higher rate of complexity of designs, more integration so customers are taking a longer time to tape-out because it takes them a longer time to come out with their design.

Do you feel at 45-nanometer that even though you have this going on, with these more complex designs from your customers, that you still could see maybe a migration to that node that’s going to be faster than what we saw at 65-nanometer?

Rick Tsai

Mike, I’m not sure I totally agree with what you just said. At 65-nanometer yes, it is a more difficult and more complex design. On the other hand, I must say I have been impressed with some customers’ ability to design and ramp and also to shrink. I mean, not everyone, but one thing is clear to me: it’s doable; quite doable. If you do your homework early, more completely, if you work with TSMC sooner, and you are utilizing our capability, it works. That’s why we are seeing also more and higher intensity in the collaboration level.

Operator

Your final question comes from Satya Kumar - Credit Suisse.

Satya Kumar - Credit Suisse

Could you provide some color on the pattern of spending for next year? I was looking at the last couple of years for TSMC and CapEx seems to be concentrated in Q2 and Q3. Is that a similar trend that we should expect for ‘08?

Lora Ho

We have not totally worked that out yet. I think for this year it is slightly back end loaded. I believe for 2008, since we have said it will be significantly less, I tend to think that it will be slightly front end loaded in that case.

Satya Kumar - Credit Suisse

Would it be 60/40, is that a good estimate?

Lora Ho

I don’t have a number right now. We are still working on the number.

Satya Kumar - Credit Suisse

Will it be higher than the second half of ‘07, Lora, or are you looking at maintaining the second half?

Lora Ho

I don’t have that at this moment. Maybe we can tell you more next quarter.

Operator

Ms. Ho, there are no more questions at this time.

Lora Ho

Thank you everybody for your participation. We are looking forward to talking to you next quarter.

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