Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Semiconductor Manufacturing International Corporation (NYSE:SMI)

Q2 FY08 Earnings Call

July 28, 2008, 8:30 PM ET

Executives

Theresa Teng - Head of Finance and IR

Morning Wu - Acting CFO, Chief Accounting Officer and Qualified Accountant

Richard Ru Gin Chang - Executive Director, Founder, President and CEO

Analysts

William Lu - Morgan Stanley

Randy Abrams - Credit Suisse

Shailesh Jaitly - Nomura, Singapore

Pranab Sarmah - Daiwa Institute of Research (Hong Kong) Ltd.

Steven Pelayo - HSBC

Daniel Heyler - Merrill Lynch

Donald Lu - Goldman Sachs Global Investment Research

Ming Kai Cheng - CLSA Asia-Pacific Markets

Operator

Welcome to the Semiconductor Manufacturing International Corporation's Second 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 Ms. 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 to you Ms. Theresa Teng, Head of Finance and Investor Relations for the cautionary statement. Please proceed.

Theresa Teng - Head of Finance and Investor Relations

Good morning, everyone. Welcome to the SMIC second 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 Commissions 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 will now turn the call over to Morning.

Morning Wu - Acting Chief Financial Officer, Chief Accounting Officer and Qualified Accountant

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 3.8% quarter-on-quarter to $330.7 million from first quarter '08 and increased by 24% year-on-year from second quarter '07.

Total revenue, however, declined to $342.9 million in second quarter '08, down 5.4% quarter-on-quarter from first quarter '08 and down 8.5% year-on-year from second quarter '07 due to reduced DRAM shipments following the decision in first quarter '08 to exit the commodity DRAM business.

DRAM as a proportion of total revenue sell to 3.6% in second quarter '08 from 12.1% in first quarter '08. Logic sales from 0.13 micron full-flow and the 90 nanometer technology nodes have increased by 14.5% in second quarter '08, quarter-on-quarter.

Gross margin was 6.1% in second quarter '08, as compared to negative 9% in first quarter '08. Simplified ASPs increased by 6.9% quarter-on-quarter to $853 per wafer from $798 in first quarter '08. The company recorded a net loss of $45.6 million in second quarter '08, primarily due to the fact that we are still transitioning from DRAM to large production in our Beijing facility. Fully diluted EPS was negative 0.1 to 2.27 per ADS in the second quarter of 2008. CapEx of $231 million was recorded for second quarter '08.

During the first quarter of 2008, the company reached an agreement with our customers to exit the commodity DRAM business. The company considers this as indicator of impairment in regard to the long lead assets of the company's Beijing facility. In accordance with FAS 144 after working with an external valuer the company has determined an impairment loss of 105.8 million therefore the Q1 net loss has been revised to $224.9 million.

Summarize of our income statement, balance sheet and cash flow statements are available in the appendix. Our guidance for the third quarter of 2008 is as follows. Revenue is expected to increase 5% to 8%. Operating expense as a percentage of revenue is expected to be in the high-teens. Capital expenditure will be approximately $230 million to $280 million. Depreciation and amortization is expected to be approximately $190 million to $210 million.

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

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

Thank you, Morning, and thank you all for joining us today.

I would like to comment on a few topics that many of you may have questions about. First, I would like to discuss the progress we have made so far, our key strategy initiatives, including the conversion from DRAM to Logic. Next, I want to discuss the market demand in the second and third quarters, which links closely to our operating performance. Finally, I would like to discuss other areas including our progress with Chinese fabless companies.

Overall as expected our revenue for the second quarter of 2008 declined slightly to $342.9 million. But, due to our gain in logic foundry services, we were able to significantly narrow our property loss to $45.6 million. The losses in the second quarter were primarily due to the affect that we are still transitioning from majority DRAM production to pure logic production in our Beijing facility.

The process of converting DRAM capacity into logic has been successful. Quite a number of new logic tape-outs with high yield are now in customer qualification, and a few have entered into production. Our total logic wafer shipments increased by 7.8% in the second quarter, and are expected to increase at least 30% in 2008, as compared to 2007. The ramp-up of our logic capacity remains critical to our strategy, as it will better position us to match the market demand for our services.

In the second quarter, we witnessed rather strong customer demand, despite the severe macroeconomic situation in the United States. The demand for our 8-inch fab service has been very strong consecutively every month for the second quarter. We foresee persistently increased the customer demand throughout the remainder of 2008, particularly in communications and consumer applications, such as digital TV, mobile TV, and wireless networking ICs, which comprise the major portion of our business. On a regional basis, revenue from North America remains solid, while revenue from the Asia Pacific region, including Mainland China and Taiwan, has in the highest growth.

We are continuing our efforts in developing advanced technology nodes as more and more of our customers have migrated to finer line width technologies. Logic output for the 0.13 micron and 90 nanometer technology nodes is expected to increase around 10% in the third quarter. We have also commenced our internal 65 nanometer library and customized IPs bit cell development, and our 45 nanometer collaboration with IBM is proceeding smoothly in accordance to schedule.

We are pleased to see strong progress being made by our Chinese customers. As we continue to serve them with our 90 nanometer technology process, we have also engaged them at the 65 nanometer technology node. In other areas we also locate one customer announced that their new RFID product, which was manufactured in our factory received EPC Global official authentication this month. This is the first Chinese made RFID product to receive this international certification. Another customer for example, started mass production of their 2G and 3G CMMB mobile TV chip in the second quarter in our fab. The demand has been very strong extending to the rest of the year and beyond. Moving forward, we will continue to strengthen our local advantage in China by collaborating with these local fabless design houses.

We are also pleased with our profitable solar business and approved expansion plan. We will expand our solar capacity five to six times our current production output in the first half of 2009. As we continue to execute our growth plans, we believe we will continue to create value for our customers worldwide and further enhance shareholders' value for the coming years.

I will now hand the 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 questions per person. Operator?

Question And Answer

Operator

[Operator Instructions]. At this time you have a question from the line Bill Lu with Morgan Stanley. Please proceed.

William Lu - Morgan Stanley

Yes, hi, good morning. I guess just a quick question first. Can you give me some guidance on gross margins for the third quarter?

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

Morning, do we give that guidance?

Morning Wu - Acting Chief Financial Officer, Chief Accounting Officer and Qualified Accountant

No.

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

No,but we give you the growth, it's a... the total revenue will grow 5% to 8%

Morning Wu - Acting Chief Financial Officer, Chief Accounting Officer and Qualified Accountant

Yes.

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

In third quarter.

William Lu - Morgan Stanley

Okay, well maybe I can ask that, can you give us a different way, if you look at second quarter, some of the profitability was impacted by the conversion of DRAM into Logic production. Exactly how much of that impact? How much of that can we still expect in the third quarter?

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

Third quarter, what is the impact of the DRAM, there was a noise... but that's what I understand, please.

Morning Wu - Acting Chief Financial Officer, Chief Accounting Officer and Qualified Accountant

For the second quarter DRAM, the percentage of the total revenue.

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

His question is Mr. Lu would you please say your question again, because there was a noise here, we cannot hear you.

William Lu - Morgan Stanley

Sure, no problem, Richard I think you've got it, basically what I am asking is a positive realty in second quarter was impacted by the conversion of DRAM into Logics, so there is some you know, one-time affection there. How much of that do we still expect in the third quarter and beyond?

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

In the third quarter, we expect DRAM almost a very little DRAM. Morning, do you have the number? At the effect, the overall contribution from DRAM will be almost the same about 3% or 4% because we still have the inventory. We just want to get rid of the inventory. But, the manufacturing wise, we don't have further LCM loss. No more.

Morning Wu - Acting Chief Financial Officer, Chief Accounting Officer and Qualified Accountant

Yes. Also our gross margin will increase a little compared to the second quarter.

William Lu - Morgan Stanley

Yes that's great.

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

I just want to... she wants to tell you that the gross profit margin will be better in third quarter.

William Lu - Morgan Stanley

That's on the overall or just on the DRAM business?

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

DRAM business, we basically out of this. And we stopped manufacturing in Q2 completely, finished all the DRAM in pipeline. Now, only a few inventory customers take in the inventory quarter-by-quarter. In third quarter, they would take some and the fourth quarter, almost all gone.

William Lu - Morgan Stanley

Okay, I am sorry, but just maybe one last follow-up on the profitability question is, if you look at just your logic business, how much better is the margin there versus the quarter average?

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

I'm sorry; can you repeat it again your question?

William Lu - Morgan Stanley

Yes, my question is the overall gross margin is 6%, if you look at your digital logic portion of the, how much better is the gross margin there?

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

Logic is definitely much better than the DRAM, the DRAM business is right now is still very much negative products, logic is all was positive.

William Lu - Morgan Stanley

Okay, great. Thank you very much.

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

Thank you.

Operator

Your next question comes from the line of Qi Chen from Shore Capital Management [ph]. Please proceed.

Unidentified Analyst

Well, thank you so much. Good morning. I'm just wondering could you talk about as profitability of the overall business. I think in the second quarter or recent second quarter you're talking about and that was this year you want to be profitable or at least a breakeven? So what's your opinion right now? When do you expect operating profits and when do you expect that profit going forward?

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

Thank you. At our first quarter earnings release, we announced that our first quarter, because we are exiting... we were exiting the DRAM business, so we took some loss for Q1 and Q2 will be better. But, still affected by the DRAM... the DRAM for the remaining, it takes a little quite to stop the total thing [ph].

To third quarter, we will be much better in overall profitability. We may be still little under but a little under, not much, that will be much improved compared to Q2 and Q4 now based on what... the information we have and also the orders in hand we have, we are doing all the best and try to be profitable again starting in Q4 this year. So to answer you, this is our plan and we really want to achieve the goal.

Unidentified Analyst

And just quick follow-up... is it on the operating level or is it on the net profit level? When you're talking about profitable?

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

Net profit level.

Unidentified Analyst

Okay, thank you.

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

Thank you. Again this is our plan and our goal. We really work hard towards that.

Operator

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

Randy Abrams - Credit Suisse

Yes, hi, good morning. Could you talk about how pricing for Logic is looking as you negotiate later this year and into 2009? And then on the other side, are you seeing any inflationary cost pressures that you're dealing with?

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

Usually we see that as a general trend, the Advance know, the ASPs better, much better, but however, of for the same technology node as a tendency that ASP erosion, but this time we noted that for many of the customers that they are willing to hold the ASP or sometime they even want to increase ASP a little bit because we provide special services to them. So ASP will be holding for the mature technology. For the advanced technology, we see that ASP is also holding relatively well compared to before.

Randy Abrams - Credit Suisse

Okay. And I wanted to ask about two other areas. Your business with Taiwan companies, maybe talk about the applications or customers you are starting to see traction with? And the other question is on system revenue it looks like it bumped from 14% to 20% of sales. I wanted to see what's driving that and expectations for growth out of that category?

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

Okay, we'd like to talk about the Greater China as a whole because this area, both Mainland China and Taiwan, is still very strong in the semiconductor business, but based on our only information. And second quarter if I remember correctly, Mainland China plus Taiwan crossed except Japan in Asia-Pacific area, the total revenue is almost 34.7% closed to a 35% now. So going very strong, last time recently, because recently the relationship across the Taiwan straight getting much better and smoother. So, that's to keep many Taiwan customers strong confidence to win the market in Mainland China and they also want be partner with us. So that we can support them to win the market in China that we see this growth will affect. In first quarter we see the growth has almost 70%, second quarter remains too strong and we see that for the rest of the year the growth in Taiwan still strong. In Mainland China because the local economies do not bad at all. And we see some weak area, but we also see some strong area, so overall still growing nicely, so the growth in Mainland, China the overall revenue we expect this year from China will grow compared to last year almost 80% total revenue.

Randy Abrams - Credit Suisse

Okay, and the system revenue going at 20% of sales?

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

Let me address this to some companies wrapping up, we just out sell to Taiwan mainly through our distributors in Taiwan. So under our regional system, we classify that as a system company, which is why you see that the proportion from system company has gone up which is mentioned by our... the sales to Taiwan has exceeded our expectations.

Randy Abrams - Credit Suisse

Okay, you mentioned that --

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

Again, we expect that the working relationship across the Strait, Taiwan Strait, continues to improve and we will be benefited greatly by this good relationship. Really, we see a lot of Taiwan fabless companies start to work with us so that we can support them to win the market in Mainland China? Thank you.

Randy Abrams - Credit Suisse

Thank you. You talked a bit about the 65-nanometers some of the logic library developments. Could you maybe talk about the ramp on 65, how quickly you see that progressing and when you see it show up as a line item in terms of percent of revenue?

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

Okay, 65 nanometer we're working with those COT customers since two years ago and took us to acquire to get the COT customers ready for competition now quite a few product over 65 nanometers in the process of being qualified. We expect in fourth quarter maybe four or five product will be qualified, ready for mass production, by the end of this year pure logic 65 nanometer we will see some revenue not much, but for the 65 nanometer like a NOR flash, we also expect, we're doing the qualification for some customers. We expect that 65 nanometer NOR Flash will be qualified also in fourth quarter product. That part, we will see some revenue because we can ramp up much faster for the situation. We're going to see quite a few products. We're into mass production, fourth part of this year but the real volume will ramp up very quickly in the first half 2009.

Randy Abrams - Credit Suisse

Okay. Thank you.

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

Thank you.

Operator

Your next question comes from the line of Shailesh Jaitly with Nomura, Singapore. Please proceed.

Shailesh Jaitly - Nomura, Singapore

Yes hi, good morning, Richard. With some of your competitors I have talked about cost pressures that they are facing because of which they have to raise the pricing at the customers. Firstly, what your views are and whether you plan to do the same, given that cost pressures probably should be industry wide?

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

We continue to strengthen our service to the customers. So in return, many of the customers are willing to give us better ASP. So this is a win-win situation. So, at this moment, we continue to migrate into the advanced technology node and also increase a lot additional services to customers. For example, we team up with them to win the market together. And this kind of services, the customer's willing to give us better ASP. So we will see continued, we will see the trend to continue. As you can see the Simplified ASP in Q2 compared to Q1, increased a lot. Too recently, the DRAM price was very bad. So we reduced DRAM that helped our ASP. Second factor is because we increased our services and also migrated more into the advanced technology that helps our ASP as well. Actually we are very happy with the growth that will grow 6.9% from Q2 compared to Q1.

Shailesh Jaitly - Nomura, Singapore

Could you talk about some cost pressures? What kind of cost increases have you seen and which areas?

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

We are making every hour... manufacturing decision our locating remain in China. However, the cumin and the manufacturing material are all imported. So we see that the valuation of the U.S dollar that does not affect that part of our costs. Those costs that we see some pressure in Mainland China is from basically from the labor costs and utility costs basically, and however utility cost and labor cost all together It's about a less than 20% or about 18% or something around. So, if we see 10% increase of the, the effect is the overall cost is about 1.8% increase. So it's not that's the view at this moment. After all, we have to continue to provide betters services such as our customers were willing to support us with better ASPs, higher ASPs

Shailesh Jaitly - Nomura, Singapore

Understand. Would it be possible to share the utilizations of your 8-inch facilities versus that of 12-inch?

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

Okay, 8-inch facility, utilization is very, very high, and almost fully loaded. So we would like to say almost maybe 98% loaded or 8-inch fab, a 12-inch fab the logic portion is utilization is very high, maybe above 90% but for the DRAM starting in May last year DRAM portion was almost zero, so we're converting the DRAM the 12 inch DRAM facility into logic and so far just reported this process has been successful and we're running about 12 or 13 different kind of logic using the DRAM facility. And so far all these logic product with high yield. However, the logic product takes longer time to be qualified so most of those are still in the process of being qualified. And two customers with very... the limited data, a very good data they are willing to take there to run pilot production, a small quantity of mass production. We now begin that now. We expect in Q3 quite a few product will be qualified then we will, start in Q3 we will see the utilization rate of our 12-inch fab will increase.

Shailesh Jaitly - Nomura, Singapore

Which area these two customers are in?

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

Those are consumer products first and they want to very quick turnaround time and also they are... their complication time is run deliberately short, so the first 12 or 13 product all our consumer related and following that we start to work on the telecom related product now.

Shailesh Jaitly - Nomura, Singapore

Okay, and finally, if you could basically talk about your LCD driver business, what proportion of the total it is and pricing environment there?

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

LCD driver?

Shailesh Jaitly - Nomura, Singapore

Yes, please.

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

Our LCD driver I did not have the breakdown but compared to other foundry our LCD driver is a very low, because we really like to use the logic facility to support on higher margin logic product. But, later when our Chengdu Fab is ready then we will use that fab to support more LCD radio [ph] customers.

Shailesh Jaitly - Nomura, Singapore

Thank you.

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

Thank you.

Operator

Your next question comes from the line of Pranab Sarmah with Daiwa. Please proceed.

Pranab Sarmah - Daiwa Institute of Research (Hong Kong) Ltd.

Hi, good morning, Richard. This is Pranab from Daiwa. First a little bit of housekeeping questions. Could you let us know without Beijing fab contribution we're you profitable on the second quarter?

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

Yes. Shanghai has been profitable since 2004.

Pranab Sarmah - Daiwa Institute of Research (Hong Kong) Ltd.

What about Shenzhen?

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

Shenzhen also profitable this year. You can see very clearly, Shanghai has been mainly running the logic products. So we're doing pretty well. Shenzhen starting last year we already completely stopped DRAM and migrated 100% to logic. So starting this year, Shenzhen will become profitable.

Pranab Sarmah - Daiwa Institute of Research (Hong Kong) Ltd.

Thank you. The next

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

Pranab, sorry.

Pranab Sarmah - Daiwa Institute of Research (Hong Kong) Ltd.

Yes go ahead please, Richard.

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

We probably expect that when Beijing, if we can successfully convert DRAM, in all into logic, Beijing will be profitable as well. And then again, people always ask us why we did not stop DRAM earlier? Last time I explained this to you is because we were subject to export license from Western countries and previously we can not obtain the export license for advance... logic technology until December last year, we were granted with the export license, even including IBM's 45 nanometer logic. So feel comfortable with that that we can stop DRAM and primitively as DRAM is the driver but now we don't need DRAM as the second hand driver anymore and also I talked to all customers, they all agreed that we can stop DRAM. But we started to convert DRAM early this year and we expect it may take up total maybe three to four quarters to complete converting DRAM into logic. As far as gross profit is our goal, try to make Beijing profitable as well. When the deal is comfortable then the entire company, got you, it is profitable.

Pranab Sarmah - Daiwa Institute of Research (Hong Kong) Ltd.

Okay, got it. And second one is do you have any other impairment charges to be booked everything is book already?

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

Everything is owing the first quarter.

Pranab Sarmah - Daiwa Institute of Research (Hong Kong) Ltd.

Only is booked on the first quarter, so no more we expect on this year, right?

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

Yes.

Pranab Sarmah - Daiwa Institute of Research (Hong Kong) Ltd.

Okay, thank you. And if I see your logic only ASP was sequentially down on the second quarter despite your product mix has gone up a bit, what is a reason behind that?

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

Okay, the logic along in the... because we still try to migrate from that [ph] into the more advance one. And second quarter is the transition period and third quarter you will see that we are going to be manufacturing less, so the mature technology nodes we are going to be manufacturing more. So, the second quarter was the transition quarter.

Pranab Sarmah - Daiwa Institute of Research (Hong Kong) Ltd.

Okay. And Richard, just to breakeven on the net level by fourth quarter, whenever it is, what will be the quarterly revenue you will be having? It used to be more than $400 million per quarter to breakeven the bottom line or any definitive targets?

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

Overall revenue will be... maybe give you a rough range. Overall revenue will be more than, definitely will be more than $400 million. But exactly, we don't have a number. I'm sorry, no fourth quarter... it should be... and this moment it's difficult for me to give you the answer. It is a little bit too sensitive, but, I originally expect maybe $400 million to actually less than $500 million we should be able to reach that goal okay.

Pranab Sarmah - Daiwa Institute of Research (Hong Kong) Ltd.

Okay, got it. Thank you very much.

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

Thank you.

Pranab Sarmah - Daiwa Institute of Research (Hong Kong) Ltd.

Okay, got it. Thank you very much.

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

Thank you.

Operator

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

Steven Pelayo - HSBC

Good morning, Richard a question on the fourth quarter goal that try to get the breakeven here. So let us say it does end up being around $400 million in revenue there. It would seem your gross margin has to have an incredible jump if you have operating expenses in the high-teens or maybe they would be more in the mid teens by then, you have interest expenses that are 3% or 4% of revenues, you gross margins are going to have to be probably closer 20% or more to breakeven, is that your expectation you're exit the share with the 20%type gross margin?

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

Our... to reach breakeven and with our number shown there, if our gross profit margins close to 15% we should be able to achieve that, so please you can calculate it together with us again this is the number. So our goal to be better than that then we should be able to achieve, again this is our goal as we set the goal for the entire company to work towards and we work very hard try to achieve our goal again I cannot guarantee that we definitely going to achieve that part of we are doing still hard and higher community trends to achieve the goal.

Steven Pelayo - HSBC

Okay. So, I can see on an operating basis 15% gross margin, 15% spent in OpEx will get you operating break even. But then the cover some of them the interest expenses that you have in your other income line, your gross margin still has to be a little higher that that. So, to be profitable on the net line, I would think it has to be higher than 15%, but we will go ahead and see how that plays out. My last question is I'm curious about the capital structure. You have taken on a little bit more debt here. There is obviously a lot of speculation about potential new equity, what do you think the capital structure is going to look like exiting this year?

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

The capital situation, how about Gareth [ph], would you like to answer that?

Unidentified Company Representative

If you look at our Q2 balance sheet, there is some increase in our debt. At the same time our cash in our short term investment corresponding it is all have increased, so our net increase in debt, there was a slight increase in our debt overall. But this because if we drawdown some loans to fund our expansion for our Logic capacity. But as we move towards Q3 and Q4 we are going to be paying more debt based on our schedule of payments, so you will see that the amount may decrease further. I hope that I have addressed the question.

Steven Pelayo - HSBC

Okay. And then my last question is just going to be, when you think longer term here, historically you had spent about 50% of revenues in CapEx each year, do you think that as you become more a Logic player, you can kind of get that revenue, that capital intensity level down.

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

Yes, this is our plan. DRAM equipment lifecycle is shorter. They move from node to node so fast. And also from node to node usually quite a few major equipment has to change and for logic the same equipment can last multiple generation. So when we move to logic, we see this and we can spend a less capital to use the equipment with effective life time equipment much longer.

Steven Pelayo - HSBC

Can I assume then using less capital means the next year's CapEx can actually decline you think directionally?

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

We want to reduce the CapEx next year compared to this year.

Steven Pelayo - HSBC

Great, thank you Richard.

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

Thank you.

Operator

Your next question comes from the line of Dan Heyler with Merrill Lynch.. Please proceed.

Daniel Heyler - Merrill Lynch

Good morning. I had a couple of questions Richard this you could give us an update on your strategic partners you had previously talked about pursuing a potential strategic investor what your thinking is on now?

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

We still work closely with the potential partner and because there are many people working to be done so, it's still delayed a little bit not because of intention not because the strategic partnership in those situation details are still very positive it just need a time to complete all the approvals and the paper works like that.

Daniel Heyler - Merrill Lynch

Right, understand. Okay, and then as you've got a lot of moving parts in the business in your efforts to convert Beijing fab etcetera, I was wondering if you could revisit the capital spending number with me. And to give us not only the full year, but perhaps break that out as to what portion is specifically to upgrades and what portion is specifically related to additional wafer capacity? In other words the --

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

For R&D related maybe 15%. He will answer this. Gareth [ph] will answer this. He has all the detailed numbers.

Daniel Heyler - Merrill Lynch

Okay, sorry.

Unidentified Company Representative

For this year, 2008, the spending on the equipment just for R&D total on the equipment side is about $150 million. And the orders pretty much for expanding capacity all that converting the DRAM capacity into logic.

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

To modify some of the DRAM equipment, converting it to make it logic manufacture for equipment.

Daniel Heyler - Merrill Lynch

Okay, how much is that for the Beijing how much is 300 millimeter related spend?

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

The number do you have the number, for the Beijing where is the number? I would say for the 12-inch this year is around $100 million to 115 million, the rest would be for an inch.

Daniel Heyler - Merrill Lynch

Okay, great. And then on the 8-inch demand, Richard you mentioned that the demand is quite strong. What's your view on expanding 8-inch? Do you anticipate continued growth in your 8-inch business this year and next year? And if so, then are you pursuing new equipment, or is there available 8-inch equipment in the used market?

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

To give you one example, is our Shenzhen fab, which was the fab we purchased from Motorola and that fab, the last year capacity close to 20,000 instrument but this year we expanded to about 34,000 instruments by the end of this year, because the demand is very, very strong and that fab is almost fully loaded. But we basically we use the refurbished equipment for the expansion and for this year and next year because Shenzhen that fab Beijing facility maximize about 35k. So next year the expansion will be very little for Shenzhen, almost reach the maximum capacity and as for in future we will continue to expand Chengdu fab and the Shenzhen fab. Shenzhen fab is just now under construction, that equipment will be 100% refurbished. We're already locking equipment from a very good partner. Very, very good 8 inch equipment by the overall used equipment price. And Chengdu basically all used equipment as well.

Daniel Heyler - Merrill Lynch

I'm just wondering those fabs will be ramped this year or those move into next year?

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

Chengdu fab, we interrupted a little bit due to the earthquake. Fortunately no damage, no real damage, but it delayed our ramp up to a certain extent and we expect fourth quarter Chengdu fab well start to have some output this year. But that will ramp up very quickly next year. Shenzhen most actually, we will start some kind of production may be fourth quarter next year. Shenzhen will be really some contribution will come out in 2010. Fab is interesting is because very close to the customer. Well many customer already booked in capacity which is very good for us. Thank you

Daniel Heyler - Merrill Lynch

Okay, great. And then finally on OpEx. What portion of your OpEx is relating to the upgrade you talked about R&D I guess being part of that but in terms of the conversion of the Beijing fab, could you walk us through the second quarter and the next few quarters, what is the impact on operating expense line is for the conversion process?

Unidentified Company Representative

Well actually the conversion expenses will capture under the gross margin line, this is a part of manufacturing expenses. So our OpEx are all strictly related to the R&D, G&A in telemarketing.

Daniel Heyler - Merrill Lynch

And is the R&D is that, I presume that's 45 and 65 development?

Morning Wu - Acting Chief Financial Officer, Chief Accounting Officer and Qualified Accountant

Yes.

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

Yes.

Daniel Heyler - Merrill Lynch

Okay, great. Thank you.

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

We also have a parallel effort to develop the 40 nanometer, which is a shrink of the 45, already ongoing. So we spend a lot of effort doing the R&D.

Unidentified Company Representative

Dan, I just want to add a comment about the conversion. The only item we charge under operating expenses is the impairment loss; which under accounting standards needs to come under operating line. The rest of the conversion expenses are all captured in the gross margin line.

Daniel Heyler - Merrill Lynch

Okay, great. One more housekeeping; did you guys provide what your interest expense for this year will be total?

Unidentified Company Representative

We did not provide the guidance, but it's pretty much steady quarter-to-quarter.

Daniel Heyler - Merrill Lynch

So pretty much flat in the second quarter?

Unidentified Company Representative

Yes.

Daniel Heyler - Merrill Lynch

Okay, thank you. That's all, I'll get back in line. Thank you.

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

Thank you, Daniel.

Unidentified Company Representative

Thank you.

Operator

Your next question comes from the line of Donald Lu with Goldman Sachs. Please proceed.

Donald Lu - Goldman Sachs Global Investment Research

Hey, good morning, everyone. My first question is Richard you commented that the pricing environment seems like it's improving incrementally but your logic ASP has declined significantly in Q2, would you expect your logic ASP to remain flattish in the second half on a quarter-by-quarter basis or maybe better yet if you can give us expected ASP trend for 8-inch and 12-inch logic product?

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

Gareth [ph], would you comment on what the Logic ASP decline in Q2, what's the percentage? I don't think it's not a really significant ASP trend. It's some percent. I just reported to you that we in Q2, we manufactured quite a number of the 0.03 micron and 0.02 micron because customers specially request. But after Q2 starting Q3 those low ASP mature the technology the product that will be reduced. So the ASP should be better and I will ask Gareth [ph]--

Unidentified Company Representative

Yes, I guess I am more interested in terms of ASP per as the same node, for example, that's 0.18 or 0.13, do you think the ASP at each particular node for a particular customer at a certain volume would remain flattish going forward or is that still trending down, like I think chartered case was still--

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

I can report to you that 0.25 micron, the Q3 ASP slightly better, and Q4 will be almost same as Q2. Again Q3 slightly better than Q2 and the Q4 was flattish.

Donald Lu - Goldman Sachs Global Investment Research

What's the last one... you're talking about, it's 0.18?

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

Yes.

Donald Lu - Goldman Sachs Global Investment Research

Okay.

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

0.25 I just mentioned, 0.25 Q3... 2.25 and 0.18 our Q3 ASP will be better than Q2, and Q4 will be the same as Q2.

Donald Lu - Goldman Sachs Global Investment Research

Great. Okay, thanks. Yes, my next question is more on the macro demand. I think, based on your comments, it seems like you are expecting your Logic wafer shipment and revenue to increase sequentially in Q4 after the increase in Q3. Do you... have you seen, are those like firm orders from customers that have paid for that kind of trend or is it just they are just current customer forecast? And also what is your Logic wafers order trend in the last few weeks with the incoming orders. Has that increased over the previous months or is that... has been relatively stable?

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

Relatively stable. We see some companies become little weaker, some companies capacity is strong this all... for example, even in the North America some companies are doing very well. They are considering increase to order and some customers they are little bit flattish or they are little bit weaker. So overall the order from North American, from our companies is still almost same for the rest of this year. The orders from Asia Pacific continue to be strong

Donald Lu - Goldman Sachs Global Investment Research

Right and for Q4 have customers placed to money in your cash box yet or are they just giving you a forecast?

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

For the delivery in October, already solid.

Donald Lu - Goldman Sachs Global Investment Research

I see.

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

Verystrong and the November and December is still some already place all in the forecast and that based on our confidence with those customers, we so far, our information is still showing into Q4 for SMICS is still very strong. We expect Q4 to be even better than even Q3, we still continue to have positive growth.

Donald Lu - Goldman Sachs Global Investment Research

Great. Thank you.

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

Thank you.

Operator

Your next question comes from the line of Ming Kai Cheng with CLSA. Please proceed.

Ming Kai Cheng - CLSA Asia-Pacific Markets

Hi, Richard. Just a few questions here. First of all is it possible for you to discuss your solar capacity? You're talking about five to six times more than what you have at the moment? So exactly how much revenue are you making at the moment and perhaps capacity? And I have a few follow-up questions.

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

Our solar energy is very small. For the past two years we're basically running a parallel line using the recovered, recycled vapor generated by us and also by our friends from different fabs. They gave us recycled vapor we run it. It has been profitable. So, the number is very small. I can give you the numbers. It's only about 5 to 6 megawatt, it's small, but it has been profitable, very profitable since we started. But we have the plan to expand it to 33 megawatt, which is not still too big, not too big. The reason is, we want to do it very carefully. Our energy conversion rate has been very high. One of the reason may be because we use CMOS processing technology to do the solar energy. By nature it should be higher. So far we used the wafer, we purchased from Mainland China. The purity I think it may be 7N, around 7N. It's not too bad, but not that great. With this kind of wafer single crystalline wafer, our conversion rate reached average 16.5% peak the 18%. Now, the recent trend is even we can... energy conversion is better than 17.1%, I believe this energy conversion is a very, very high among all the solar energy manufacturers in the world. And with this technology, we developed, so we are very comfortable that we want to expand solar energy capacity. The limiting factor is the availability of the feedstock. And recently we just secured the capacity to support us to ramp up to 33 megawatt first quarter next year. So we expand phase on the availability of the feed stock and we expect with availability of the wafers solar cell wafers we will continue to expand this accordingly. Our goal is to expand really more than 100 megawatt in the near future. Again I just mentioned take otherwise no problem and that's conversion rate is very high and it is raw material.

Ming Kai Cheng - CLSA Asia-Pacific Markets

Right.

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

And we are securing the raw material step by step that we will continue to expand just because this business, it is very profitable with higher energy company generated, they're very profitable.

Ming Kai Cheng - CLSA Asia-Pacific Markets

Just onto my second question, you've mentioned that you have a bit of due inventory on your books still, is it possible for you to tell us how much you still have and how much of the third quarter sales will be DRAM?.

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

Do you have a few thousand wafers, not much left?

Ming Kai Cheng - CLSA Asia-Pacific Markets

Do you have the value of these inventory at the moment that's sitting on your books?

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

Very little now.

Unidentified Company Representative

We don't have to exact number of inventory, but as Richard mentioned I think our DRAM sell in Q3 which is going to clear our inventory above the Siemens in the current quarter in terms of percentage and revenue.

Ming Kai Cheng - CLSA Asia-Pacific Markets

And so the impairment charges that's in the first quarter, there is no write-down of inventory or anything else right. It's just the equipment changes and fab changes?

Unidentified Company Representative

No, Q1, in the original earning forecast we already write-down inventory. And right now we stated the first quarter results based on the impairment loss on equipment and facilities.

Ming Kai Cheng - CLSA Asia-Pacific Markets

So, in theory, when you sell your DRAM you should be profitable, right now?

Unidentified Company Representative

Basically we are breakeven.

Ming Kai Cheng - CLSA Asia-Pacific Markets

You're breakeven so, okay. And what's the third quarter DRAM sales contribution if you can tell us?

Unidentified Company Representative

Second quarter is 3.6%, our third quarter is very close to this number.

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

And then, Ming Kai, as yet this is slightly profitable. When we sell the DRAM in the third quarter. Okay.

Operator

Thank you. At this time I'd like to turn the conference back over to Dr. Richard Chang for closing remarks.

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

Okay. Ladies and gentlemen, we are, SMI has been undergoing tough time for the first two quarters. And we see that starting third quarter and on the situation is getting better and better for us. And so we can see that once our fabs are running Logic, we can be profitable. We have proven this both in Shanghai and in Shenzhen now. Beijing is now in the process of converting all the DRAM into Logic. We expect, when Beijing is fully converted Logic, based on our calculations Beijing will be profitable as well. And again we set our goal, aggressive goal, to try to achieve the goal in fourth quarter this year. And we expect next year be definitely much better and again whenever possible please come to China and visit us and it's very good for us to face to face discussion and also we would like to host you to our impact and you will see the process of our conversion. And again keep in touch and may god bless everybody. Bye-bye.

Operator

Thank you, for your participation in today's conference. This concludes the presentation. You may now disconnect, and have a great day.

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

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

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

Source: Semiconductor Manufacturing International Corp. Q2 2008 Earnings Call
This Transcript
All Transcripts