Semiconductor Manufacturing International Corp. Q1 2008 Earnings Call Transcript

Semiconductor Manufacturing International Corp. (NYSE:SMI)

Q1 FY08 Earnings Call

April 29, 2008, 08:30 PM ET

Executives

Theresa Teng - Head of Finance and IR

Morning Wu - Acting CFO and Chief Accounting Officer

Richard Ru-Gin Chang - Founder, President and CEO

Analysts

Daniel Heyler - Merrill Lynch

Steven Pelayo - HSBC

Pranab Sarmah - Daiwa Institute of Research

Bill Lu - Morgan Stanley

Randy Abrams - Credit Suisse

William Tong - UBS

Eric Chen - BNP Paribas

Donald Lu - Goldman Sachs

Operator

Welcome to the Semiconductor Manufacturing International Corporation's First Quarter 2008 Webcast Conference Call. Today's conference call is chaired by Dr. Richard Chang, Chief Executive Officer and President; Ms. Morning Wu, Acting Chief Financial Officer, and Theresa Teng, Head of Finance and Investor Relations.

Today's webcast conference call will be simultaneously streamed through the Internet at SMIC's website, at www.smics.com. Please be advised that your dial-ins are in listen-only mode. However, at the conclusion of the management presentation, we will be having a question-and-answer session upon which you will receive further instructions as to how to participate.

The earnings press release is available for download at www.smics.com. Without further adieu, I would like to introduce you to Ms. Theresa Teng, Head of Finance and Investor Relations, for the cautionary statement.

Theresa Teng - Head of Finance and Investor Relations

Good morning everyone. Welcome to the SMIC first quarter 2008 earnings conference call. Joining me on the call today are Dr. Richard Chang, Chief Executive Officer and President and Ms. Morning Wu, Acting Chief Financial Officer. Our call will be approximately 60 minutes in length. The earnings press release and presentation are available for download at www.smics.com.

Please note the following Safe Harbor statement. SMIC 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 29, 2007.

For today's agenda, Morning will highlight our first quarter 2008 financial results and second quarter 2008 guidance with the summary of the cash flow statements and balance sheet in the appendix for your ease of reference. Following that Richard will provide an update on our business.

I would now turn the call over to Morning.

Morning Wu - Acting Chief Financial Officer and Chief Accounting Officer

Thank you, Theresa. I would like to highlight the following items which are all stated in U.S. dollars. Non-fee driven revenue increased by 5.5% quarter-on-quarter to $318.6 million from fourth quarter '07 and increased 25.6% year-on-year from first quarter '07. Total revenue, however, declined to $362.4 in first quarter '08 down 8.3% quarter-on-quarter from fourth quarter '07 and down 6.7% year-on-year from first quarter '07 due to lower DRAM shipment quantity.

DRAM as a proportion of total revenue fell to 12.1% in first quarter '08 from 23.6% in fourth quarter '07. Logic sales from 0.3 micron too grow [ph] and the 90 nanometer technology node has increased by 33.5% in first quarter '08 quarter-on-quarter.

Gross margin was negative 9% in first quarter '08 as compared to positive 8.9% in fourth quarter '07, primarily due to losses from the commodity DRAM business including $44.5 million additional loss provision taken against the remaining DRAM inventory. The company recorded a net loss of 119.1 million in first quarter '08. Including the reversal of 20.5 million before income tax benefits recorded in both quarter '07, as required under U.S. GAAP resulting in an adjusted net loss of 19 million in 2007. Fully diluted EPS was negative from 3205 per ADS [ph] in the first quarter of 2008. CapEx of 136 million was reported for first quarter '08, which is lower than our guidance due to slower equipment moving schedule.

Total plant CapEx for the year remained at approximately 700 million, and will be adjusted based on market conditions. During the first quarter of 2008 the company reached an agreement with our customers to exit the commodity DRAM [ph] business. The company consider this an indicator of impairment in regard to the long lead assets of the Company based impact [ph] in accordance with FAS 144. As of today the company has engaged an external valuer, and in the process of evaluating whether or not such asset has been impaired. Any impairment loss, if so determined, would result in an additional non-cash to the companies net income for the first quarter of 2008.

Summarize [ph] of our income statement, balance sheet and cash flow statements are available in the appendix. Our guidance for the second quarter of 2008 is as follows; due to the top delivery of DRAM products total revenue expect to decrease 3% to 6% from first quarter '08 while non-DRAM revenue expect to grow 3% to 6% from first quarter '08. Operating expenses as a percentage of revenue expected to be around 20%, capital expenditure will be approximately $160 million to $200 million.

I will now turn the call over to Richard for the business update and review.

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

Thank you and good morning. There are a number of items that I'd like to touch upon many of which will have great impact on our business in 2008 and beyond. As part of our ongoing strategy to enhance our foundry services to our global customers we are focusing on several key elements. Continuing to develop leading edge technologies, advancing our high margin logic business, enhancing our turnkey services, capturing industry migration to China, expanding partnership with local service [ph] companies in China and terminating our business exposure to DRAM. We reported a quarterly loss of $119.1 million which includes an additional loss provision for DRAM inventories of about $44.5 million as well as the reversal $20.5 million deferred income tax benefit recorded in first quarter '07. During the quarter management reached an agreement with our customers to exit the commodity DRAM business. This reduction of DRAM production and conversion of DRAM capacity into logic which will continue throughout 2008, remains key our strategy. As a result SMIC made a concerted effort to reduce its DRAM foundry service by 53% from the previous quarter and 67.5% from the first quarter of 2007.

At the same time we increased logic shipment 6.2% quarter-on-quarter and our 90 nanometer logic shipment surged 136.8% over the fourth quarter and the DRAM as a portion of our total revenue fell to 12.1% compared to 23.6% in the first quarter of 2007. Our overall logic revenue gain 6.5% quarter-over-quarter and 25.6% year-over-year. By the end of this year we only plan to produce a small amount of specialty DRAM which should account for about 1% to 2% of our business.

The shift from DRAM contributed greatly to the quarterly loss, a temporary but a necessary consequence that we enable SMIC to focus on logic production which we believe will accelerate our path to profitability. I would like to take this opportunity to thank our DRAM partners for supporting us to stop our commodity DRAM services stopped in Q1 and after Q2 2008 were completely stopped any new loading.

Our Tianjin and Shanghai fabrication facility which has been manufacturing logic products for some time are profitable. We expect no difference from our Beijing fab once we complete its conversion to logic which is making strong progress. We are already seeing positive signs as our Beijing fab increased logic shipments by 145.2% quarter-on-quarter. With our current logic capacity fully utilized, we are working hard to increase our logic capacity. And in 2008 we expect shipment for 0.18 micron into product to increase at a triple digital growth rate into the 0.13 micron 8-inch and 90 nanometer 12-inch product shipments to grow by more than 50%.

We will continue to develop our technology in radio frequency mixed-signal, high-speed, low-leakage the sound [ph] chip and embedded logic product. We forecast persistently strong demand in advanced technology nodes through the reminder of 2008 and we witness tremendous market demand for the devices that consume logic IC such as mobile based band, multimedia processors, PDA, GPS, Flash controller IC, power management IC, MP3, MP4, digital TV video processors and a mobile TV and so forth.

As the world's largest market for integrated circuits, China has experienced exceptionally strong market growth since the beginning of the year. Our China revenue increased by 22.6% since the first starter of 2007 and we enjoy the additional 15 new domestic customers this quarter. We also reported a 17.1% quarter-on-quarter increase in new products take out [ph]. We have a number of Chinese fab customers, for whom we are manufacturing this 90 nanometer technology node, one of which has already attained end user qualification for its first 90 nanometer product and entered commercial production.

Our focus on China well remains strong as it matures, as the industry's driver and increasingly so its advanced technology nodes. Not only have we experienced considerable growth in our China sale, but we also enjoyed a significant boost in our North America sales, despite of the challenging economic situation in the U.S., our sales in North America grow by 10% quarter-over-quarter and increases as a portion of our total revenue to 53.6% in the first quarter of 2008 compared to 44.6% in the first quarter of 2007. We're also pleased with the progress we have made in regards to our 45 nanometer licensing agreement with IBM. Currently there are ten top tier fables and service and IDM companies expressing interest to work with us. As a result of our milestone agreements we've also increased our customer base for the 65 nanometer and a 90 nanometer logic node as customers are confident with SMIC's future technology roadmap.

In addition, we've garnered the interest of customers in China in working with SMIC's 45 nanometer technology solution. We plan to process qualification in 2009. I also updates, I also have updates on two SMIC's business ventures. First, TSES [ph] SMIC's joint venture with Tohan [ph] to produce color image sensors became profitable in March and we expect it to remain so. I am also pleased to announce that our solar business SMIC Tech [ph] continues to be successful

The dedicated R&D work of SMIC's engineers allow us to achieve earnings conversion efficiency that are among the best in the industry. Over the coming quarters, we'll continue to improve up on the quality and efficiency of SMIC Tech product and devote efforts to take the unit to even greater height. Our commitment to enhancing shareholders value in our company remains absolute to that end we will continue to execute our plan which we believe will accelerate growth, serve our customers and boost our bottom-line. We are very confident in our strategy and optimistic about upcoming years.

I will now hand this call back to Theresa who will moderate the Q&A session of this call. Theresa?

Theresa Teng - Head of Finance and Investor Relations

Thank you, Richard. I will now like to open up the call for Q&A. Please limit your question. Operator?

Question And Answer

Operator

: [Operator Instructions]. Your first question comes from the line of Dan Heyler with Merrill Lynch. Please proceed.

Daniel Heyler - Merrill Lynch

Good morning, Richard.

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

Good morning, Dan.

Daniel Heyler - Merrill Lynch

I had a question on the profitability roadmap and revenue contribution from the other core businesses. So it seems though you have a lot of investment that are taking place here, and the joint venture strategy and exiting the DRAM strategy as well. When would you think you would be at a net breakeven level across the businesses and in a sustainable profitability structure?

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

Dan, thank you for the good question. We stopped the DRAM business on March 31st and immediately started the conversion of all the DRAM equipment into logics. So far based on our information about 75% of the incoming can be directly used for logic production. 25% of DRAM equipment needs modification. This takes some time, we estimate it may take us two quarters to completely convert all the DRAM commodity into logic production.

For Q2, Q3 still will be a little bit tougher for us. But from our own estimate starting in Q4 this year we should be able to be profitable. As I just reported our Shanghai fab has been profitable since 2004. Shanghai basically are all making a larger logic, more among DRAM. Now we also only do a very small amount of specialty DRAM in Shanghai. That makes us very profitable. Zhangjiang also stopped the DRAM and this year Zhangjiang is 100% logic and we observed the Zhangjiang fab also become profitable. That's why I reported to you that we will be no different, that once Beijing is converted into logic it will be profitable also. That will be completed, the conversion will be completed in Q4. So starting Q4 I expect the entire company will be profitable and from that end now, we believe there will be... going to be profitable.

Daniel Heyler - Merrill Lynch

Great, thank you and one quick follow-up on the Beijing fab. Maybe you could walk us through the products and the technology and this you will be converting to and whether or not that planning for the IBM technology will also be deployed at the Beijing fab?

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

Yes, currently Beijing... the logic part we are manufacturing 90 nanometer, they are the main product. We also logic... we are serving customer with 0.13 micron logic and we are also in the process of being qualified in the second product for the 65 nanometer. We already passed the preliminary cost by our customers and in Q2 we are entering the final computation stage. We will start in the second half of this year, where we will also start 65 nanometer logic manufacturing. 45 nanometer IBM turnout... our plan is to... we are doing the installation testing configuration process together with IBM. IBM did a wonderful job to transfer this technology to us. We expect starting 2009, 45 nanometer until mass production as well.

Daniel Heyler - Merrill Lynch

Thank you Richard.

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

Thank you Dan.

Operator

Your next question comes the line of Steven Pelayo with HSBC. Please proceed.

Steven Pelayo - HSBC

Yes, I am wondering if you can comment a bit on 90 nanometer ASPs, your shipments were up a 136%, your revenue was up about a 100% or so, is this 90 nanometer ASP pressure? And the my second question is also on ASPs, could you just help us understand the relative premium I guess, 90 nanometer DRAM wafer versus 90 nanometer logic or is the 90 nanometer DRAM wafer comparable on pricing to 130 nanometer logic. I am trying to understand how the ASPs are going to move as you move out the DRAM.

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

Good. 90 nanometer ASP is logic that is holding very well because not to many foundries provide this kind of services. Only a few of the top line. So the competition is less and customer demand is high. So basically it is holding very well.

As on 90 nanometer DRAM versus 90 nanometer logic is a big, big difference. 90 nanometer DRAM is a big loss and 90 nanometer ASP is positive. So, again a big difference. Sorry, I cannot tell you the exact number but you can do the calculation assuming that 90 number DRAM, the ASP is say $1 per chip and for the 90 nanometer ASP logic usually maybe anywhere between $5 to about $10 trench.

Steven Pelayo - HSBC

Okay, when I look at the current quarter you just had memory down about 50% quarter-over-quarter, 90 nanometer doubled quarter-over-quarter, logic up 6%, but I think the blended average fees are relatively flattish, so it seems kind of odd that such a mix improvement didn't result in a significant ASP improvement?

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

It is because the DRAM prices have dropped, continuously dropped from Q4 last year and in Q1. And, logic price is holding, so you will see that as part of volume, our volume is 90 nanometer increase. So when you do a calculation, you can find out. Also I just mentioned to you that the ASP DRAM versus logic you can calculate it, it's a big difference.

Steven Pelayo - HSBC

Okay, and now that you will be exiting the DRAM business you should have a lot more stability in ASPs, do you think that we can start taking gross margin guidance as well?

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

We noticed that in this industry, the top foundry people did not give ASP guidance any more, but they will report, we always report the ASP quarter-on-quarter to everybody. I don't think it is fair to our customers not to provide the ASP guidance, as you can...

Steven Pelayo - HSBC

I am sorry, but actually looking for just gross margin guidance overall for estimated fees for the second quarter and beyond as you are getting a lot of DRAM and some of the volatility of your margins should decrease?

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

Your overall margin will increase.

Steven Pelayo - HSBC

Okay, thank you.

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

Thank you.

Operator

Your next question comes from the line Pranab Sarmah, Daiwa Securities. Please proceed.

Pranab Sarmah - Daiwa Institute of Research

Yes thank you for the questions. I sort have couple of questions, first one, could you let me know... are you holding any more DRAM inventory on your inventory at this point and if so is there any more rate of risk on this DRAM inventory?

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

In Q1 we basically rolled off all the inventory and starting Q2 we did not start any new commodity DRAM at all. So we do not expect any further inventory write off because already written off at this time. Okay.

Pranab Sarmah - Daiwa Institute of Research

Okay, on the solar business could you elaborate a bit what type of capacity you have at currently and what type of profitability level you are going through and obviously wafer start is always there in their business whether you are able to increase your production ramp out there?

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

Yes, the solar is very insisting. As matter of fact it has been focusing on technology development and not really focusing on to increase the volume yet. And we us the Simons [ph] Technology to improve the solar cell efficiency. We have reached wonderful performance. Our customers however, said our conversion efficiency is among the best in the industry. However, we are very consciously working with our partners from whom we purchase the raw material from, purchased the poly silicon material. And currently this operation is still in very small quantities. Even in this small quantity we become profitable because efficiency is very high. I believe we will continue to acquire more feedstock, then we will expand the volume. By the way, the first gentlemen asked me a question about we get into new business. Actually it is not new business, that is similar division, siemens image sensor, color filter and micro lenses business.

We already started a little over two years ago but it took us about together with the token... little over two years would make this business profitable, so that we start to harvest what we plan two to three years ago. Solar energy is the same thing. We started this project almost two years ago and starting last year we are basically profitable and this year we are meant to be profitable. We are planning with our partner as soon as we can to receive more of the feedstock that we are going to expand the business. Market is not a problem at all, profitability is not a problem, its the challenges in raw material which are the things we try to work on now. As I mentioned to you previously we focus on technology development and the efficiency... energy converting efficiency is excellent. It was our focus. And we will do a wonderful job so maybe later part this year we will report to you more about the solar energy project and that business.

Pranab Sarmah - Daiwa Institute of Research

Okay, since your share price is significantly below book value does it validate any of the loan covenants you have reached your bankers?

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

So far no. We still have lot of cash on hand. So there is no... we do not see you not see this kind of problems. Yes, I really feel that our start is a personal finish really way under valued.

Pranab Sarmah - Daiwa Institute of Research

Okay, thank you.

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

Thank you.

Operator

Your next question comes from the line Bill Lu with Morgan Stanley. Please proceed.

Bill Lu - Morgan Stanley

Yeah, hi. Good morning, you know, I am hoping we can go back to the profitability question because if you look at 1Q even if you back out write-offs from DRAM margin and profitability were still lower than it was in previous quarters at similar revenue levels, you basically had to say that profit margins was better than the quarter average and I was just wondering if you can help me reconcile that?

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

The profitable margin, I would like to ask Morning to answer this question.

Morning Wu - Acting Chief Financial Officer and Chief Accounting Officer

I think when you take though I think... which number did you take out, I think you only take 4 million right. Is it correct?

Bill Lu - Morgan Stanley

Yes.

Morning Wu - Acting Chief Financial Officer and Chief Accounting Officer

That is only the LCM for the remaining inventory and we have also the realized amounts from DRAM shipments. So we did not disclose this number but actually, if you spec out DRAM we lead to losses, actually the gross margin is much higher.

Bill Lu - Morgan Stanley

Okay. So anyways you can help me a little bit more on just the difference in margins to enlarging a DRAM right now?

Morning Wu - Acting Chief Financial Officer and Chief Accounting Officer

As what Dr. Chang mentioned earlier, the logic prices have been holding very well in the last few quarters. And DRAM prices had declined substantially. So you can see there is a big difference in terms of gross margin. And obviously logic is positive for us and DRAM is very negative for us.

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

In very simple way you can calculate that. The ASP per wafer, logic compelled to DRAM, logic is many times higher, many times not only percentage wise.

Bill Lu - Morgan Stanley

Okay, great. Thank you. My second question is, you are converting a lot of your dual capacity or I guess all of it to logic and that is going to take some time. Can you just help me with your overall capacity for next couple of quarters just because I thought I am going to figure it out without any guidance?

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

Okay. The first quarter our wafer capacity is about... for logic is about 167,000 per month. But our conversion is ongoing by the end of this year first quarter this is including all of that. We expect will be increased, should I say... we are going to increase a lot. But in other words the DRAM capacity, if we don't have to buy any new equipment, direct conversant we can do almost 50% of the DRAM capacity without any modification to convert to logic. You can easily calculate how much capacity you will be able to gain. However, if we do some bottleneck management, especially in the second, which is the metal interconnection portion, we can reach much higher, maybe conversion better than 70% maybe 75%. We are working on this now.

Bill Lu - Morgan Stanley

That's helpful

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

Thank you.

Bill Lu - Morgan Stanley

Thanks.

Morning Wu - Acting Chief Financial Officer and Chief Accounting Officer

Thank you.

Operator

Your next question comes the line of Randy Abrams with Credit Suisse. Please proceed.

Randy Abrams - Credit Suisse

Yes, good morning. I wanted to see if you can provide an update on the Chengdu and Wuhan and then also the Shenzhen fab brands, and I think last quarter you mentioned by year end about 210,000 wafer capacity and then 267,000 including the managed fabs, just want to see where is the conversion now, if you can give an update on those year end capacity numbers.

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

Thank you, good question also. Our Chengdu fab already started production, power production two quarters before, and now the capacity is close to 8,000 wafers per month. We manage this fab. Also the equipment Chengdu government purchased from Japan are right in Q1. It takes maybe three months to install testing and the configuration. So basically starting in second half this year Chengdu's capacity were increased. The total is about... maybe increased to 25,000 by the end of this year. 25,000 wafers per month. Wuhan project is a good news as Wuhan already started production since a weak ago and started with Flash. And there are quite a few different kind of Flash products, already planned or already loaded in Wuhan fab.

So, Wuhan fab is going to ramp up according to the qualification process. Because the 12 inch fab takes much longer time to be qualified we expect that the by the end of this year Wuhan's income will not be significant. But starting 2009 their contribution will be fairly significant because eventually with the current plan Wuhan can reach capacity at more than 15,000 wafers per month, by some time between 2009. It depends on how fast that we can qualify the product and we can approve the equipment.

Shenzhen fab, we already started company establishment, registration, and many details. Design is already done and to be approved by government, then we can start. Our plan is to start ground breaking in June this year. And it takes 15 months up to 18 months to get it start to work on the pilot production. So we expect that second half of 2009 Shenzhen fab will start to contribute. By the way Shenzhen fab is very unique because it is located in South part of China where many semiconductors uses the... fab is located. And many customers already booked 100% of the capacity. We told them that it will be 15 to 18 months later. They already want to book the capacity for the fab. So, Shenzhen's location is very, very interesting.

Chengdu also because they are located in West China so the demand also is very strong. Wuhan again, most of the customers are from overseas. A part of Chengdu and [indiscernible] most of the customers are from Mainland China, Chengdu for specialty products.

Randy Abrams - Credit Suisse

Thank you.

Operator

[Operator Instructions]. The next question comes as a follow up from Dan Heyler with Merrill Lynch. Please proceed.

Daniel Heyler - Merrill Lynch

Hi, thanks for that. I just had one question on the IBM agreement. I know that it is obviously a confidential agreement on the process technology, but are you, Richard is there any special treatment that SMIC is being treated given your profitability level is pretty low and there are typically licensing fees associated fairly significant ones, for acquiring the IBM technology. Is this contingent on you successfully ramping and getting partners or do you basically have to pay an upfront fee, irregardless of your ramp schedule?

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

We cannot disclose the details but there is a common rule, the technology transfer fee we paid to our partner consists of two parts one is upfront fee. Usually it is the fee to cover the technology transfer, detailed meetings, the... wafers, test wafers, testing programs, many and also the unsight technical support from IBM people... from our technology partners. Another portion is associated with the royalty. It means after we start production to serve customers then we start pay that portion. So this is always like that. However I really feel that the deal we work with IBM is very beneficial for both companies and also benefit a lot of potential customers of ours, of IBM's and SMIC.

Daniel Heyler - Merrill Lynch

Okay, thanks and then a follow up for that would be on the timing of the technology transfer, I believe you are not participating in the joint development, I am wondering, that there maybe a lag in the deployment of 45 relative to say the ones that are in the joint development consortium?

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

We... because we entered the 45 a little late, compared to other IBM partners. But we are catching up very fast. So I do not know the other company's production schedule. Maybe we are not far away from, because we expect to start production in 2009 and I believe the other company maybe also close to this schedule.

Daniel Heyler - Merrill Lynch

Okay. Thanks Richard.

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

Thank you Dan.

Operator

Your next question comes the line of William Tong from UBS. Please proceed

William Tong - UBS

Hi, good morning, quick question. I know that previously there was talk about a strategic investment coming in and I was just wondering could you talk a bit more about the rationale for trying to introduce a strategic investor and also potential timeline?

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

We have been approached by many potential strategic partners since about a year ago. They have different proposals and everyone of them, I am not sure financial investors, they also bring additional values to us. We have been carefully evaluating... usually those are events exclusive, mutually exclusive. We, except one, and the other maybe not easy for us to work with other as it is kind of strategic investor and partner. So we have been very carefully doing our homework and of course they will work with potential partners to find out which one really create maximized value for both companies. But it takes time and however, we are at the final stage to make the final decision soon and again we will make the announcement to the world once it is firm and finalized. William, does it answer your question.

William Tong - UBS

Yes, it does. Second question I had was a stringent fab, I think one of them would be a 12 inch fab as you mentioned before. Just wondering as we exited the DRAM business initially what will then be the target product for some of these 12 inch capacities?

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

The Shenzhen fab will build the 8 inch fab first. But, however, when we do the construction we will build the 8 inch share and the 12 inch fab share together. We are so close to each other we just decided the location is close to each other. So we decided [ph] simultaneously product to install equipment we already purchased the equipment, the 8 inch equipment for Shenzhen. Actually the line up to 20,000 wafer permits is already secured. So once the building is ready, facility is ready, the equipment can move in very quickly, 8 inch first. 8 inch, definitely there are basically the logic and also some... we also focus, we are going to support a lot of men type of customers from logic and the...

William Tong - UBS

Okay. Thank you.

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

Thank you.

Operator

Your next question comes from the line of Eric Chen with BNP. Please proceed.

Eric Chen - BNP Paribas

Yes, your second quarter CapEx income and so what's the reason behind for tax increasing in second quarter was useful and also for the year 2008 the depreciation expense didn't have any idea and could you give us some highlights? Thank you

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

Our CapEx for Q2 mainly up for the IBM 45 nanometer equipment.

Eric Chen - BNP Paribas

Okay.

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

[Indiscernible] we purchased a lot of special equipment from the emerging type of scanner in Q2. That's how we find Q2 is increased. When we do the R&D and technology we would like to prove a hit to do this and our partner working very smoothly with us. So we find, we can do faster that's how we put our hit.

Eric Chen - BNP Paribas

Okay, how about a full year depreciation.

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

Full year CapEx is still the same, $700 million is our budget our plan, budget plan.

Eric Chen - BNP Paribas

Okay, that's about CapEx, how depreciation expense, do you have any idea?

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

At the closing of any... we are doing an analysis on any potential impairments in terms of operating facts that would have an impact on our going forward depreciation. At this point in time we cannot provide guidance.

Eric Chen - BNP Paribas

Okay, thank you anyways. The second question is regarding to the expansion, first I would like to know do you have any CapEx plan on the new equipment purchase and how do you deal with order of DRAM equipment going forward and for the expansion, the NAND Flash equipment supposed with you are putting in the fab A, if I am right, how about for the original name frame in the fab A in Shanghai fab, could you give us an idea, thank you?

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

Okay, very good question also. Because our NAND Flash is based on Tianjin Enron Technology. Tianjin technology and expansion basically used the sem technology or Enron technology. So for our NAND Flash equipment to support Tianjin and also the NAND Flash technology support expansion, equipments list is very same. So, we don't have to add any additional equipment to support expansion. So the CapEx is well under control.

Eric Chen - BNP Paribas

Okay. I see, but do you have to buy the additional equipment for NAND Flash, your main inventory?

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

Yes we do. Based on our agreement with suspension, whenever the older... PO transmission increases we will prepare additional and that additional CapEx is we think our budget of $700 million. The reason, because we already had the equipments, very good equipment volume and the leads from our Sichuan project. So to expand a capacity to such suspension is the very nature, very smooth.

Theresa Teng - Head of Finance and Investor Relations

Hello, operator?

Operator

The next question comes from Donald Lu with Goldman Sachs. Please proceed.

Donald Lu - Goldman Sachs

Hey, good morning Richard and Morning. My two questions first, your potential strategic investors you are considering including investment with goods rather than cash?

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

No. The potential investors, there are quite a few of them. Some propose to have cash plus different contribution to us. And some certain customers they... their investment will be their IT. Actually they did not charge off anyway. They will provide IT to us free as a partnership and also all cash. So there are many different possibilities. We are very carefully evaluating and going to finalize this very soon. Don, did I answer your question.

Operator

Ladies and gentlemen this concludes the question and answer session of today's call and now I would like to turn it back to Dr. Richard Chang for closing remarks.

Richard Ru-Gin Chang - Founder, President and Chief Executive Officer

Ladies and gentlemen SMIC previously... when we started in year 2000 in China because that time SMIC was still under the stringent export control from the country outside China. At that time with our permission to transfer to technology or even our permission to mass produce advanced technology were restricted to DRAM. So we started with DRAM as the technology driver and whatever we learned from the DRAM we applied to develop our logic technology. That has been serving SMIC's function and purpose and served our customers very nicely for a number of years. Until last year with the special support from many western countries that restriction was basically lifted. We have been granted the permission to directly transfer logic, advanced logic technology from many countries outside China and it happened DRAM partners also agreed with our request. They agreed that we can stop DRAM, so we thank all the partners and we put DRAM in the history. DRAM technology served SMIC nicely before we were granted with the permission to work on advanced logic technology.

So actually we were granted logic... advance logic export license fourth quarter 2007. But it took us a while, finally we are able to move full gear forward with logic only. So we well appreciate to all the friends from different countries, thank the government of different countries to continue to support us. Again I would like to take this opportunity to thank our DRAM partners. They have helped us in the past and we will... we hope them continue to do well and we will focus on logic formula and we really thank so many friends. God bless you. Bye, bye.

Theresa Teng - Head of Finance and Investor Relations

Thank you.

Operator

Ladies and gentlemen, thank you for participation in today's conference. That concludes the presentation. You may now disconnect. Have a good day.

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