Semiconductor Manufacturing Q4 2005 Earnings Conference Call Transcript (SMI)

Semiconductor Manufacturing (NYSE:SMI)

Q4 2005 Earning Conference Call

February 7th 2006, 7:00 PM.

Executive:

Jimmy Lai, Head of Investor Relation

Morning Wu, Acting Chief Financial Officer

Dr. Richard Chang, President & Chief Executive Officer

Analysts:

John Hailer, Merrill lynch

John Lau, Jefferies & Company

Donohue, Goldman Sachs

Andrew Lu, Citigroup

Mark Fitzgerald, Bank of America

Bill Lu, Piper Jaffray

Ivan Goh, DRKW

Eric Martin, BNP Paribas

Sunil Gupta, Morgan Stanley

Presentation:

Operator

Good day ladies and gentlemen and welcome to the Semiconductor Manufacturing International Corporation Fourth Quarter 2005 Webcast Conference Call. Today conference call is chaired by Dr. Richard Chang, Chief Executive Officer and President; Ms. Morning Wu, acting Chief Financial Officer; and Mr. Jimmy Lai, Head Of Investor Relation. Today’s webcast conference calls will be simultaneously streamed through the internet at SMIC’s website at www.smics.com. Please be advised that your dial in are in listen-only mode. However, at the conclusion of the management presentation, we will facilitate a Question and Answer sessions, upon which you will receive further instruction as to how to participate.

The earning press release is available for download at www.smics.com. Without further delay I would now like to introduce to you the head of SMIC’S Investor Relations, Jimmy Lai for the cautionary statements. Please proceed sir.

Jimmy Lai, Head of Investor Relation

Thank you, good morning from Shanghai everyone. On the call with me today are, Dr. Richard Chang, our President and CEO; and Ms. Morning Wu, our acting CFO. Before I going to this morning’s agenda, I would like to caution everybody again of our Safe Harbor policy. SMIC’s statements of its current expectations are forward-looking statements subject to significant risks and uncertainties. The actual results may differ materially from those contained in the forward-looking statements. Information as to those factors that could cause actual results to vary can be found in SMIC’s Form 20-F, filed with the United States Securities and Exchange Commission on June 28th, 2005 or SMIC’s filings with stock exchange of Hong Kong on April the 6th, 2005.

I would now turn the call over to Morning, who will highlight our fourth quarter 2005, financial results as-well-as guidance for the first quarter of 2006. Afterwards, Richard will provide an update on our business, Morning.

Morning Wu, Acting Chief Financial Officer

Thanks you, Lai. I hope you all have read the press release earlier and I would like to highlight the following items for the fourth quarter, which are all statements in US dollars. Sales increased 7% quarter-on-quarter to $333 million from $310 million mainly due to 6% high wafers shipments and 2% higher Blended ASP, or simplified ASP, total revenue divided by total wafer shipments is $885. This illustrates the full range full range of services that we provide to our customers. Cost of sales increased 2%, quarter-on-quarter to $290 million from $284 million.

Gross profit increased 70% to $43 million from $25 million, net loss increased to $15 million compared to a loss of $26 million in the fourth quarter, fully diluted loss per ADS was $0.04 compared with the loss of $0.07 in the third quarter. Because of that we had a very heavy depreciation burden, with cash generated growth operating activity of $174 million in the fourth quarter. On an annual basis, sales increased 20% to $1.2 billion in 2005 from $975 million in 2004. Cash flow from operations increased 25% to $648 million in 2005 from $590 million in 2004. EBITDA increased 27% to $729 million in 2005, from $572 million in 2004, and we achieved a static capacity of the 152,000 8-inch equivalent wafers per month. Based on total capital expenditures of 2005 of $904 million.

Moving on to the highlights of our guidance for the third quarter of 2006, we expect blended ASP to be flat over the fourth quarter, wafer shipments to increase by 2% to 4% over the fourth quarter. Utilization rate to be approximately 92% to 94%, gross margins to be at the same level as the fourth quarter. Operating expenses as a percentage of sales is expected to be in the 16% to 18% range. With the adoption of the FASB 123R, continuing to generate 2006. The non-cash stock-based compensation charge is expected to be approximately $7.2 million, compared to the $6.5 million in the fourth quarter. Interest percentage is expected to increase to approximately $14 million due to the increase in the interest rate. Depreciation and Amortization expected approximately $225 million, and the Capital Expenditure expected to be in the $250 million to $300 million range for the first quarter and $1.1 billion for 2006. I will now turn the call over to Richard to discuss all our current business trends.

Dr. Richard Chang, President & Chief Executive Officer

Thank you, Morning. I am pleased to announce that our performance during the fourth quarter exceeded our expectations as we received strong orders from our broad custom basis across leading edge and mainstream technology nodes. As a result, revenues under the average selling price increased during the fourth quarter, further to my comments in the earnings release announcement, I would like to highlight our efforts to overcome our depreciation expenses, because we are a new foundry with only four years of commercial operations, and continue to extend our capacity to meet the increasing capacity demand of our customers. Our depreciation expense as a percentage of revenue driven back remains the highest in this foundry industry.

Despite this high depreciation expenses we believe that we will become profitable by improving our product mix, thereby, increasing our average selling price. We expect that we will begin commercial production of our first 90-nanometer production in March of this year. And we’ve achieved meaningful 90-nanometer revenues beginning in the second quarter of this year. We have also noticed this time of our fabless and IDM customers are migrating a significant portion of their product to the 0.13 micron and below technology nodes.

Revenues generated from the 0.13-micron and below technology node as a percentage of our logic revenue increased from 1.4% in 2004 to 11.3% in 2005. We expect that this upward trend will increased during 2006 to reach approximately 35% in the fourth quarter of 2006. Furthermore, our changing fab was quantified by additional customers during the fourth quarter, and achieved a utilization rate of over 80% at the end of the fourth quarter, as compared to the third quarter our changing fab decreased revenues from commodity DRAM product by over 50%, and increased the revenue from logic product by over 200%. We will continued to reduce, but maintain a minimum amount of our commodity DRAM production in order to maintain this technology. We expect to see improvement in our DRAM average selling price due to the improvement in our yield.

The increase in demand for additional DRAM capacity, and extension of partnership with our contract DRAM customers, who 90-nanometer and below process technologies. At the end of 2005, we had commenced commercial production for five of the top 10 fabless and IDM in the world. Overall in 2005, we engaged 93 new customers. Our Mainland China customers continue to represent an area of growth, as we engaged 55 new customers from mainland China, in 2005.

In December, more than 8% of our revenues were generated for Mainland Chinese Companies. Among the new products, we manufactured for these companies included the first 3G baseband chip on 0.13-micron processors, for the TD-SCDMA, WCDMA, and CDMA 2000 standards, a digital satellite receiver chip for set-top boxes, and also a HDTV video processor. We expect that the percentage of revenues from our Mainland China Customers were increased in 2006, as more of our new customers commenced commercial production.

Looking forward to 2006, we will continue to focus our effort on improving our process technology offering. We had identified key employee to lead our effort in the core development of our 55-nanometer process technology, with our customers and the partners. Our NAND Flash development team is working to commence production of our first NAND Flash product, which will be based on our logic process, during the fourth quarter of 2006. As a result of these increased efforts, we expect that our DRAM revenues as a percentage of our overall revenues will decrease to meet 20 in 2006.

I will now hand the call back to Jimmy, to moderate the Q&A portion of this call.

Jimmy Lai, Head of Investor Relation

Thank you, Richard. Operator, you can open the floor for Q&A now, I would like to caution everybody to please limit the questions to two per person so more people can get in, thank you. Operator?

Questions-and-Answer Session

Operator

Operator instructions And our first question comes John Hailer with Merrill lynch, please proceed.

Q - John Hailer

Hi, good morning this is John Hailer from Merrill lynch. Good morning Richard and Jimmy.

A - Richard Chang

Good morning, John.

Q - John Hailer

I wanted to ask you just quickly on, if you have forecast for your depreciation for 2006? This is my first question and then I will have a quick follow-up with the 90 –nanometer.

A - Richard Chang

Okay, our depreciation for 2006 is expected to be from $950 million to about $1 billion. And close to $1 billion.

Q - John Hailer

Okay, great, and then as you look at your capacity expansion plans, it looks though you have a pretty robust budget, is that – could you break that down for us in terms of your Fab 7 project? How much of that is memory and how much of that would be logic and if you have a little color on, how much you did spent to get your NAND business going out, that would be useful as well?

A - Jimmy Lai

Our capacity for Fab 7 changing fab is, we expect to reach 25,000 to 30,000 wafers per month at the end of this year.. And overall by the end of this year our logic capacity will be, hope to deliver over 70% and CM will be about well 25% to 28% in the range, capacity.

Q - John Hailer

Anything in NAND?

A -Richard Chang

NAND in this year, however, we will start, we are trying to start 2 Gigabit NAND Flash production, second half of this year. Capacity is not that peak yet, it goes to by the end of this year, the numbers would be close to 8,000 to 10,000 per month in the range.

Q - John Hailer

Right, just one quick clarification. The 90-nanometer that you referred contribution in the second quarter, is that logic or is that memory or is it a combination?

A -Richard Chang

90-nanometer, we’ve mentioned is logic.

Q - John Hailer

Okay, thank you.

A -Richard Chang

Thank you.

A -Richard Chang

Because our GOM we’ve already it started high level production. Its not included.

Operator

And your next question comes from John Lau with Jefferies & Company. Please proceed sir.

Q - John Lau

Great thank you very much, Richard and Jimmy. I had a question for you, in terms of housekeeping, the OpEx, the operational expense were going up pretty dramatically from Q4 into Q1, in Q4 it came out to 11.2% and you are now guiding for 16% to 18%. Even if you back out the stock option expense it is pretty hefty, can you go over some of the factors on that and what is the normalized rate for 2006? And I’ll have a follow-up Thank you.

A -Richard Chang

Our biggest increase is Research and Development, which increased 23%, because we spent a lot of effort in the manpower and also budget to develop 65-nanometer with more than one customer now, very interest in that project, so this is the main reason.

Q - John Lau

Will that be, you know if you were to take a look at the increases beyond the size have in excess of 30 plus billion dollars, do you believe that is the normalized rate for the rest of 2006?

A -Richard Chang

For the 2006, let me give you the number, yes. Normalized is, yes it will be the same rate.

Q - John Lau

Okay, and then finally I just had a follow-up. You did mention in your guidance, did you mention that revenue would be flat for March?

A -Richard Chang

Revenue? No.

A -Richard Chang

Revenue were - ASP was flat.

Q - John Lau

I understand, thank you for that clarification.

A -Richard Chang

Revenue, we are comparing is to increase.

Q - John Lau

Thank you.

A -Richard Chang

John, just to reemphasize what Richard said, ASP we guided for last, however, quantity we guided 2% to 4% increase.

Q - John Lau

Great, and I assume also that 16% to 18% CapEx guidance includes now the stock option expensing of $4.2 million?

A -Richard Chang

Correct.

Q - John Lau

Thank you.

Operator

And your next question comes from Donohue with Goldman Sachs. Please proceed.

Q - Thomas Lau

Hi, good morning this is Thomas Lau from Goldman. Just a couple of questions, first is a – I saw in your report that you now have Blended ASP and Simplified ASP, can you just explain what the difference between the two?

A -Richard Chang

Okay, this is a very interesting question, because when we started, we are underwriter, which is CSFB and Deutsche Bank. What is the destination of the ASP? And we found that each analyst, each banker gives a different definition. Later we found that, perhaps when we talk to our external auditor, we founded that the easiest way to represent ASP is the total revenue divided by the total wafers we deliver. This is the very simple and easy, no confusion way to present it. SMIC has - we have some burden on the ASPs, because we also grew that backend micro services department, which is only half of the process. The ASP usually is compare to the full flow it less, we decide. We also blended the whole thing in that hugely like our ASP compare to the full flow showing that a bit lower. For this portion we were to trying to talk to our external auditors and also the analysts to see which is the best way we should improve in presenting the ASP in order to compare our ASP apples-to-apples, oranges-to-oranges with other foundry in the industry.

Q - Thomas Lau

Okay, how if I understand correctly that portfolio Q1 guidance, first of all what should would be the Q1 ASP guidance on the simplified ASP base?

A -Richard Chang

I think its quite either way to simplify or the conventional ASPs channel or domestic?

Q - Thomas Lau

So if you multiply the simplified ASP and your wafer shipped, we should get to your revenue?

A -Richard Chang

Yeah.

Q - Thomas Lau

Yeah, my second question is you commented that 0.13 revenue will go up to 35% by Q4 can you give us a kind of quantum where it will be in Q1 and Q2? And also what’s your orthodox for the 90-nanometer, 90-logic products as a percentage of revenue by mid-year?

A -Richard Chang

What we mentioned from 0.13 and more advance, including from 0.13 and the 90-nanometer logic should represent more than 35% of our revenue by the end of this year. I like to give you the general information that from January our strong one to our methodology, the increase somewhat I believe the percentage is, I will ask Jimmy to check the percentage for me. But starting from Q2, the 0.35um and the 90-nanometer logic were increased rapidly, for gentle – altogether for Q1 is our logic is to come almost the same as Q4 of last year, which is close to 13%. For Q2 the number or the increased to our plan is to be more than 20%, then Q3, already to be more than 30%, then Q4, to be more than 35%. Tom, did I answer your question.

Q - Thomas Lau

Yes, thank you. And my last question is, is there any plan for any financing to get loans or equity financing in this year?

A -Richard Chang

We plan to the refinance over Shanghai loan. In China its operation site has to get the loans individually for which in Shanghai our first loan we’ve already started to payback. So by the end of this Q1 the loan in Shanghai, the first loan will be much less, so we are trying to launch a new loan to payback this loan, Shanghai loan because that’s what gives us the flexibility, so this is the plan, and Morning Wu inform you about our other plans, for example we are plan to do another for the Tianjin place.

A - Morning Wu

We have to think in long-term loan to finish the loan this year. The market price is to go up, yeah we have to plan to some - this year.

Q - Thomas Lau

Your last sentence as I didn’t hear you clearly, you said that is…

A -Richard Chang

Stock market go up, in other words as this year we do not plan to do any of loans or anything. However, Morning just mentioned, if we really have the requirement, therefore, record capacity expansion. And also is the stock market is doing very well for our Company and we may consider to raise funds again for the future need, but, this is not…

Q - Thomas Lau

What is your capacity expansion plan for this year, is that going to be linear or is that going to be backend loaded?

A -Richard Chang

At this moment, our capacity as of today, because the older for Q1 is very strong, Q2 become stronger and on, so we -- our actually CapEx capacity increment is actually, its heavier in the first half of this year. Not backhand loaded to the far backend loaded. However, during the second half of this year, so far we could not see too much visibility, or six month later. However, if we see the demand as strong as the first half, well we may increase our CapEx this year. The CapEx is flexible based on the markets and also the customers demand.

Q - Thomas Lau

Okay great, thank you very much.

A -Richard Chang

Thank you.

Operator

And your next question comes from Andrew Lu with Citigroup. Please proceed.

Q - Andrew Lu

Yeah good morning, couple of questions, Richard mentioned if and only might come below, probably account for 35% by Q4, and 20% in Q2. Can you give a more color on 90-nanometer breakdown going forward for the next few quarters?

A -Richard Chang

Okay, actually the one I just mentioned is not for winding account once in that one and more advantage.

Q - Andrew Lu

Yeah

A – Richard Chang

So, throughout the entire year for I have the number for 90-nanometer, which is the DRAM flop logic towards the end of this year is about 25%, but we separate DRAM versus logic, I am checking that number for you, just one moment. For logic only will be about 16% to 17% in fourth quarter this year, this is our plan.

Q - Andrew Lu

Thank you. Second question is, you see the Asia revenue breakdown increased from 25.7% in Q3 to 28.2% in Q4, can you give us color for who is driving this increase, which area is driving the increase?

A -Richard Chang

By territory?

Q - Andrew Lu

Yeah by geographic?

A -Richard Chang

Geographic is you mean the Q4 versus the Q3?

A – Company Speaker

What Andrew like to know is the reason for the Asia…

A -Richard Chang

In Q4, right. Q4 is the driving the Asia areas, actually Asia is a combination of - which is the basically a combination of Taiwan and mainland China.

Q - Andrew Lu

Thank you. Last question is can you give us some color in Q1, your revenue guidance assuming the Blended ASP flat, roughly about 3% up in Q1, most of foundry we would follow pretty much show us the seasonal decline, can you give us more color on Q1, what area, or what customer’s area Asian area drives the growth are showing above average growth and what area showing the low average growth, for example decline or flat?

A -Richard Chang

In our Company the communication continue to be very strong continue to grow.

Q - Andrew Lu

Wireless or wireline?

A - Richard Chang

Pardon? Oh. More in the wireless area and wireless line. And for consumer area it is likely less, and computing continues to be strong both for our case.

Q - Andrew Lu

Suppose, communication in the computer area, one shows, the higher gross compared to pretty good share revenue?

A - Richard Chang

Yes.

Q - Andrew Lu

Thank you.

A - Richard Chang

Thank you

Operator

And your next question comes from the line of Mark Fitzgerald with Bank of America, please proceed.

Q - Mark Fitzgerald

Just, if I look out at your depreciations schedule, when would you get an inflection point where depreciation would start coming down on a quarterly basis?

A - Richard Chang

This is a very good question, we liked. We also started sighted - It is actually starting second half this year, our Fab 1 and (indiscernible) family equipment will be fully depreciated. However in Fab 4 and in Tianjin, wish to expanding our capacity, so our depreciation over the year or two, 2006 will be higher than 2005. But starting in 2007, starting the second half of 2007, clearly we start to see depreciation start to go down. And depreciation may slightly go down or maintain the same level in first half of 2007 compared to that of 2006.

Q - Mark Fitzgerald

And a very soon kind of flattish CapEx into ’07?

A - Richard Chang

2007 as of, is not far away for us to predict but that based on our conservative forecast. We expect 2007 of CapEx to maintain the same level as of 2006.

Q - Mark Fitzgerald

Okay and then just a question on the NAND market, is the architecture that you presuming a multi-cell architecture?

A - Richard Chang

Yes. We are using the Tianjin Enron (phonetics) technology, Enron technology it can do multi-cell level, equally well, as a matter of fact our first multi-cell NAND, we plan to do is to come out of that, say maybe too sensitive very soon, maybe, let me make this clear to you, we are doing the R&D work for both single cell and multi-cell. And the deferred 2 Gigabyte NAND will be single cell. And all the products, very few of them have the multi-cell as of today.

Q - Mark Fitzgerald

Okay, thank you.

A - Richard Chang

Thank you

Operator

And your next question comes Alex Ross with Morning Star, please proceed.

Q - Alex Ross

Hi, my questions were answered, thank you.

Operator

And the next question comes from the line of Bill Lu with Piper Jaffray, please proceed Sir.

Q - Bill Lu

Yeah, hi, thanks for taking the call. Couple of clarifications. One is on your 1Q guidance of flat ASP, can you put that down, basically maybe give a logic?

A - Richard Chang

We, the basic is, from logic is, as it continues to increase. In our focus, we did not focus the increase of the IC of the DRAM. Actually DRAM price will go up, Q1 versus Q4 last year, Q1 this year will be higher. And because we are doing some of the config DRAM for customers. So, it takes a timeless thought to reflect ASP up, but we are working on this with our customers. We hope in Q1 we can see that ASP go up, you know, our forecast for seasonal, we did not forecast that.

Q - Bill Lu

Okay. I guess, my take again is, your guidance is pretty conservative because DRAM ASP likely could be up a little bit with flat and larger ASPs will be up a little bit too, is that the way to read that?

A - Richard Chang

Yes.

Q - Bill Lu

Okay great and then if you look at your 2006 capital spending, you said that it is going to be lower end, yet for the quarter it’s about 250 to 300 which looks like me like its about a quarter of the full year spending, can you just help me rationalize that?

A - Richard Chang

Okay. Jimmy you would like to answer that?

A - Jimmy Lai

Actually, to give you a little more quantitative, when Richard said, it is front end loaded, I think, we are probably looking at the first half being 60% to 65% on the total budget and the rest being spend in the second half of the year. So, it looks like 2Q was spending little more money than 1Q.

Q - Bill Lu

Okay, great, thanks very much.

A - Richard Chang

Right, by the way, we also mentioned at it. Our focus is a conservative one, even if the market is contend to be strong and our demand of our services continue to be strong then we may adjust our CapEx in order to increase our capacity to serve customers better, for your information.

Operator

And your next question comes from John Hailer with Merrill Lynch, please proceed.

Q – John Hailer

Hi, just a quick follow-up. If you guys could give us a little more color on your end product, I appreciate your application break out. But could you highlight, for instance, your major products for instance, LCD driver business, how that’s tracking for the fourth quarter into the first quarter? And a little more detail on the communications sector would be great, for instance, how much is the handset related wireless and how much is, how these new products since you are launching on 3G?

A - Richard Chang

We - The LCD driver Q4 versus Q3, we it should be less and in Q1, LCD drivers, is not that strong. Also, unless we grouped LCD drivers a part of the consumer product but before RF is very strong. Let me, give you a little more detail. Q2 very strong, cable modem strong, caller-id strong, cordless phones a little bit less, DSL increase, Ethernet, reduce a little bit and mobile handsets Q4 over Q3, still stronger, Router, very strong, Switch, strong and telephones and wireless telephones becomes less, wireless LAN, a little less, total communication, much stronger. Did I answer your question?

Q – John Hailer

Yeah. That’s great, that’s very helpful and finally your top 5 customers, what percentage of your total revenue did they represent on excluding DRAM?

A - Richard Chang

Yeah, I like to say that, the top 10 customers, we use a, calculate always for top 10? Top10, It’s any where between 65% to 70%, in the range.

Q – John Hailer

That’s great, thanks a lot Richard.

A - Richard Chang

Thank you.

Operator

And your next question comes from the line of Sunil Gupta with Morgan Stanley, please proceed.

Q - Sunil Gupta

Hi Good Morning.

A - Richard Chang

Good Morning.

Q - Sunil Gupta

Richard, I had, some follow-up questions on your earlier comments about 90 nanometer and also 65 nanometer development. Could you help and defend for 90 nanometer, you mentioned, you will have some commercial productions in March of ’06. How many customers are you likely to have in Q2 of ’06 and what sort of end applications are these targeted?

A - Richard Chang

Okay, we usually group NAND DRAM.

Q - Sunil Gupta

Okay.

A - Richard Chang

90 nanometer NAND DRAM product in Q2. We expect to have, of about 3 may be 4 customers in Q4.

Q - Sunil Gupta

And what are these 2 groups?

A - Richard Chang

Ah. beg pardon?

Q - Sunil Gupta

You said, you put them into two groups or two product categories, is it?

A - Richard Chang

Yes, one group is DRAM, we did not include in DRAM though, and a NAND DRAM product, as a NAND DRAM and SMIC, the Flash, our Flash, 90 mm Flash, use a 100% logic process, well, we group this as a NANA DRAM group.

Q - Sunil Gupta

Okay so, for 90 nanometer logic, how many customers would you have in second quarter. And what end applications are these likely to cater to?

A - Richard Chang

One is in the, I think, they use this for computers and not for Telecom.

Q - Sunil Gupta

Okay, great and on 65 nanometer, could you just help us lay out and understand it, might be a bit tentative at this stage. What are the key milestones over the next 18 odd months or a mid, or whatever timeframe you want to use?

A - Richard Chang

Our 65 nanometer, we always, we started this 65 nanometer last year, in April, we started it on April and we work with two partners. And the first partner product, our claim is to, the engineering sample by the end of this year, which is very aggressive. We really do our best, try to meet this schedule and second partner, we expect about 6 months later.

Q - Sunil Gupta

Okay, these are both non Flash logic?

A - Richard Chang

Both are to a logic, I mean, NAND Flash logic, yeah.

Q - Sunil Gupta

Great and my final follow-up question is that, you also mentioned earlier that to expect the business to breakeven sometimes soon, what kind of utilization rate, do you think, the business would require to breakeven and what would be your best estimate in terms of likely breakeven timing?

A - Richard Chang

Yes, good question. Actually we can reach breakeven point at the utilization rate as low as 80%, if we have the right product mixture. This is a more part of mixture related than utilization rate. Previously, our utilization rate was high, but we had commitment to continue to run, these SDRAM, to our customers, took us six months to gradually pay out, this agreement of our customers, so was about 2, 3 quarters ago, you see that our utilization is almost maintained at same. Because we feel it is pretty high because we want to continue around and feel as event, we are reducing the event. So, in the near future, if we are continue to reduce, for example as Geff just mentioned, our period of events should be completely fade out price due to easier. Then, we continue to increase our performance back end (phonetics) and 90 nanometer logic. So, that’s where, help us to reach breakeven point sooner. But utilization rate is not already compete, to be comfortable to say, for a reasonable part of mixture, currently the utilization is even 90%, we can reach breakeven point. In the future, if we continue to improve our partnership to migrate more and more into the Advance logic with front end (phonetics) and 90 nanometer, I know, utilization could be even lower, with which we reach breakeven point with profitability.

Q - Sunil Gupta

Okay, great, and thank you Richard

A - Richard Chang

Thank you.

Operator

And your next question comes from Ivan Goh with DRKW, please proceed

Q- Ivan Goh

Hi, good morning Richard and Jimmy. I have a few questions first the for the NAND flash business that you are embarking this year, will they be SMIC branded or you at all or are you just going with one or two customers that you sort of imply.

A - Richard R. Chang

As of this moment we still work with our customers. But from which we developed the technology we own the right to use the technology to serve additional customers. So for your information we maintain ourselves as the dual foundry.

Q- Ivan Goh

Also out of the year, how many customers that you have in NAND Flash.

A - Richard R. Chang

As of today we expect by the end of this year maybe three.

Q- Ivan Goh

And would the three be sort of like your existing customers or would they be new customers.

A - Richard R. Chang

They are existing customers so far. We may based on the market situation and our own capacity we may start to serve more customers in NAND area.

Q- Ivan Goh

And would this customers be like your current DRAM or Logic customers.

A - Richard R. Chang

Let me see. So far they all new customers, DRAM customer we do not serve them on the NAND yet.

Q- Ivan Goh

And my last question if you strip off your non-commodities DRAM, you said you will all fade off by the 2nd quarter. So the consecutive DRAM business was drop to 25you’re your total revenue. Is that correct?

A - Richard R. Chang

That’s the one not only context but also including some special niche markets there.

Q- Ivan Goh

Because I understand that your productions for Elpidio was about in second quarter so I am just wondering your commodity DRAM business will fade away but you will have one additional customer ramping up so I was wonder if how would that kind of, unless your commodity DRAM today is quite substantial, how would you get down to 25% by the end of the year.

A - Richard R. Chang

We are, we already mentioned that, we also probably announced at that our DRAM customers are basically are two one is Infineon another is Elpidio. And we also have a few other customers they run the niche market DRAM. Even for the niche market event we grouped together into this DRAM business.

Q- Ivan Goh

Okay.

A - Richard R. Chang

A few kind of DRAM for other fabulous DRAM companies, the top ones, we are also struggling.

Q- Ivan Goh

So like say in your Q4 revenues 31% was ERAM, it would be helpful if you can strip out, you can break it down between commodity and contracted ERAM. Will that be possible?

A - Richard R. Chang

All right, I don’t have the number on hand, Jimmy do have an estimate. Again this is pure estimate.

Q- Ivan Goh

Sure I appreciate very much.

A - Jimmy Lai

I think if you the DRAM so called the what Richard’s referring to your legacy commodity DRAM, actually in the fourth quarter is obviously little less than 15% or the total DRAM. And it would continue to go down from that point on.

Q- Ivan Goh

Okay thank you very much, very helpful.

A - Richard R. Chang

All right thank you.

Operator

And your next question come from Eric Martin with BNP Paribas, please proceed.

Q - Eric Martin

Hi Richard, and a couple of questions. The first just following the question you mentioned a breakeven point of utilization there and then you put it this way, in two years and what kind of utilization rate you are using as will the reach the breakeven point.

A - Richard R. Chang

In two years I expect that in the range of about, let me see the number, about 88% to about 90% we can reach the breakeven point.

Q - Eric Martin

Okay next based on what kind of assumption and you did mention earlier the year revenue contribution from the logic well increased pretty significant, so I would like to know what kind of assumption you had with this number in two years?

A - Richard R. Chang

Okay in two years we will try to maintain commodity DRAM to be in the range of 20% to 25%. And the others are non DRAM. And with this kind of product mixture we should be able to reach breakeven point to between 88% or 90%.

Q - Eric Martin

Okay and also you mentioned about a depreciation probably I am not very to each other. The depreciation quite here is-?

A - Richard R. Chang

From 2006 and 2007 our depreciation gradually going down, but after 2008 when most of the equipments has been fully depreciated most of the 8-inch, then our breakeven point should be even lower.

Q - Eric Martin

Will that start in the year 2010?

A - Richard R. Chang

Starting from 2008?

Q - Eric Martin

Okay I see thank you. And my other question is the regarding to the China IC design house and what kind of product you think that will be booming in China and what kind of sector and in two years what kind of revenue contribution you think, you will get upon this China design costs. Thank you.

A - Richard Chang

Okay in China to be very specific basically telecom products, consumer product will be booming in China more than the computer related products. More specifically the 3G kits will beginning in the next starting very strong within two years and SDTV will be another one and also like centralized setup box, this kind of related to also very strong in China.

Q - Eric Martin

Okay. If I am right so that means 3G like a CDMA and that the 3G controller and the setup box like in market data were booming two years you think.

A - Richard R. Chang

In the telecom and the consumer area and also and the MP3 related, and CDMA, Do you remember the digital camera still remain to be strong in China.

Q - Eric Martin

Okay. I got it and my last question is you mentioned about your CapEx with a pretty margin in the first half of this year and on the front end the equivalent, so my question is how down would have right now and do you think there is any shortage on the equivalent for the 90 nanometer in the first of this year.

A - Richard R. Chang

We did not see the shortage of equipment, part of the reason maybe we communicate personally with our common vendors, so they knew which was made trying to order so when we ready to issue the PO we still can get a very good delivery time.

Q - Eric Martin

Okay so the lead times are going to be stay.

A - Richard R. Chang

I think we need a operator I think we only have time for one more caller.

Q - Eric Martin

Okay thank you very much.

A - Richard R. Chang

Thanks a lot.

Operator

And your final question comes from (indiscernible) Mincaw please proceed.

Q

Hello good morning. My question is about, earlier you had mentioned about the gross profit margin were roughly the same as the first quarter, what would you forecast 2006 whole year the gross forward margin.

A - Richard R. Chang

You know it difficult you hear you.

A - Richard R. Chang

The question is of gross margin forecast for whole 2006, it just two far forward-looking statement, so far we probably can see a better picture in the first quarter, past that really not advisable to comment on that.

Q

And just any chance that you can get breakeven in this 2006?

A - Richard R. Chang

I am sorry, can you repeat that question.

Q

Will you see any chance that SMI get breakeven in this year?

A - Jimmy Lai

I think we had a better chance, much better chance in the second half as we saw in 3Q however, in the meantime we were working as hard as we can to move that limit earlier to be confirmative, we like to answer you this, if you view the whole year, the full year would be profitable and as of when we can reach breakeven point as Jimmy defined, 3Q is a very highly competent, move one quarter earlier we are working on that.

Q

You mean profitable, that means you have given a year ago.

A - Jimmy Lai

Yes from a net income level.

Q

Thank you.

A - Jimmy Lai

Thank you

Operator

Yeah, there are no further question I turn the call back over to management.

Dr. Richard Chang, President & Chief Executive Officer

Ladies and gentlemen we thank you again for attending our quarterly earnings release conference and as usual I very like to invite you to continue to communicate with us closely and also and whenever you are China visit us either in Shangai, Beijing, Shenzhen, or Chandou, and we also like to listen to your advise which are very helpful to us continue to do better job and improved. We thank you again and may god bless you all Bye bye.

Operator

Thank you ladies and gentlemen for participating in today’s conference that concludes presentations, you may all now disconnect, have a great day.

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