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Executives

Dr. Elizabeth Sun - Head of IR

Ms. Lora Ho - VP, CFO

Dr. Rick Tsai - President & CEO

Analysts

Randy Abrams - Credit Suisse

Shailesh Jaitly - Nomura Securities International, Inc.

Mehdi Hosseini - Friedman, Billings, Ramsey Group, Inc.

Patrick J. Ho - Stifel Nicolaus

Steven Palao - HSBC

Bill Lu - Morgan Stanley

Bhavin Shah - J P Morgan

Dan Heyler - Merrill Lynch

Pranab Sarmah - Daiwa Securities

Timothy Arcuri - Citigroup

Taiwan Semiconductor Manufacturing Company Limited (TSM) Q2 FY08 Earnings Call July 31, 2008 8:00 AM ET

Operator

Welcome to TSMC's Second Quarter 2008 results webcast conference call. Today's event is chaired by Ms. Lora Ho, Chief Financial Officer and Vice President and Dr. Rick Tsai, Chief Executive Officer and President. This conference is being webcasted live via TSMC website, www.tsmc.com and only in audio mode. Your lines, your dial-in lines are also in listen-only mode. At the conclusion of management's presentation, we will be opening the floor for questions. At that time, further instructions will be given as to the procedure to follow if you would like to ask any questions. Please be advised for those participants who do not yet have a copy of the press release, you may download it from TSMC's website at www.tsmc.com. Please also download the summary slides in relation to today's quarterly review presentation. Once again, the URL is www.tsmc.com. I would now like to turn the conference over to Dr. Elizabeth Sun, TSMC's Head of Investor Relations for the company's cautionary statement before the presentation by Ms. Ho and Dr. Tsai.

Dr. Elizabeth Sun - Head of Investor Relations

Thank you, Lacy. Good morning and good evening to all participants. This is Elizabeth Sun, Head of Investor Relations for TSMC. Before we begin, I would like to state that the management's comments about TSMC's current expectations made during this conference call are forward-looking statements subject to significant risks and uncertainties and that actual results may differ materially from those contained in the forward-looking statements. Information as to those factors that could cause actual results to differ materially from TSMC's forward-looking statements may be found in TSMC's annual report on Form 20-F filed with the United States Securities and Exchange Commission on April 15, 2008 and such other documents as TSMC may file with, or submit to the SEC from time to time. Except required by law, we undertake no obligation to update any forward-looking statements, whether as a result of new information, future events, or otherwise. And now, I would like to turn the conference call over to Ms. Lora Ho, our Chief Financial Officer and Vice President.

Ms. Lora Ho - Vice President, Chief Financial Officer

Thank you, Elizabeth. Good morning and good evening to everyone. Welcome to our second quarter 2008 earnings conference call. Today, I will first go over the highlights from our second quarter 2008 results, then I will give you the outlook for the third quarter 2008. Please refer to the quarterly financial summary slides on our website. All dollar figures are in NT dollars unless otherwise stated. Now, I am on page three. Let me go over some highlights for the quarter. Our second quarter business received [ph] a solid improvement from the previous quarter. We shipped 2.3 million 8-inch equivalent wafers, which was about 6% more compared to the previous quarter. NT dollars appreciated 3.7%, on average over the quarter, it had a negative impact to our reported revenue and margin. In spite of that, we are still able to deliver the results that meet our guidance. Our revenue was NT$80.1 billion and our gross margin and operating margin were 45.6% and 34.5% respectively. EPS was NT$1.12 for the quarter, slightly up from first quarter. Free cash flow generated during the second quarter totaled NT$23 billion, down from last quarter by 46%, and return on equity was 24.2%. Let me... let's take a closer look at our income statement, both sequential and year-over-year comparison.

Please let me remind you that the accounting number reported for 2007 do not reflect the effects on employee profit sharing expensing. This is the major difference from 2008. That being said, our second quarter revenue increased 0.8% sequentially and 17.6% year-over-year. Gross margin, gross margin rate compared with first quarter '08 increased 1.9 percentage points and operating margin rate increased 1.2 points mainly due to significant cost improvement and higher level of wafer movement, partially offset by the unfavorable exchange rate. Non-operating income was NT$1.7 billion and we booked NT$300 million long-term investment gain for the quarter. Net profit margin rate was 32.6%.

Now, let's examine our revenue by applications. On a quarter-over-quarter basis, revenue from consumer applications increased 24%, while revenue from communication and computer applications declined 2% and 8% respectively. Overall revenue from the computer, communication and consumer sector accounts for 31%, 41% and 21% of our wafer sales. In terms of revenue by technology, we continue our strong ramp of 65-nanometer during the quarter. Revenue from 65-nanometer accounted for 18% of our wafer sales, up 3 percentage points sequentially. We expect to see continued strength in the ramp up of our 65-nanometer business of the year. Total revenue from advanced technologies accounted for 63% of wafer sales, flat from the previous quarter.

On page eight, now let's move on to the balance sheet and the cash flow statement. We ended the quarter with NT$224 billion in cash and short-term investments, up from NT$210 billion in the last quarter. Average collection days of accounts receivable came down one day to 42 days. While days of inventory came up by one day to 47 days, our net [inaudible] asset turnover was 1.3 times.

Total cash inflow generated from operating cash activities in the second quarter reached NT$45 billion. Capital expenditure was NT$22.3 billion, which was NT$7 billion more than the first quarter. Free cash flow went down to NT$23 billion mainly due to a tax payment of NT$10 billion and more capital expenditure in the quarter. There were NT$6.6 billion spent for share buyback. Short-term investment increased by NT$25 billion. We ended the second quarter with NT$41 billion more cash.

Now let's turn to capacity and CapEx. Total installed capacity for the second quarter was about 2.3 million 8-inch equivalent wafers, about 6% more compared with first quarter. We expect the third quarter capacity to be 2.4 million wafers, up 5% sequentially. 2008 capacity is expected to reach 9.4 million wafers, up 13% year-over-year with 27% growth for 12-inch wafer capacity. We spent US $728 million in CapEx during the second quarter. Total CapEx for the first half of 2008 reached NT$1.2 billion. Our CapEx number for 2008 remain at about NT$1.8 billion, unchanged from previous guidance. With that, let me give you the outlook for the third quarter of 2008.

Based on current business expectations and a forecast exchange rate of 30.2, we expect our consolidated revenue to come in between NT$90 billion to NT$92 billion. In terms of margins, we expect our third quarter gross margin between 45% and 47%. Operating profit margins will be between 34% to 36%. This concludes my remarks today. Now, I will turn the call over to Dr. Rick Tsai, our CEO for his remarks.

Dr. Rick Tsai - President & Chief Executive Officer

Hello everyone. I have a few comments to make before we start our Q&A session. First I'd like to comment on the business outlook. Due to the slowing global economic outlook, we expect this year 2008, the growth in semiconductor industry to be about 4%, which is at the low end of our previous forecast. We previously forecasted 4% to 6% for the semiconductor industry. We believe foundry industries, steel will outperform the semiconductor industry by several points, we believe TSMC will outperform the foundry industry in 2008.

Next, as our guidance indicated, the third quarter revenue in US dollar terms is expected to grow at about 3% to 5% sequentially. This is well below our seasonal average of 10%in the past five years. And we also expect our business to turn weaker as we exit the third quarter. However, we expect the strong momentum in the demand for 55 nanometre technology to continue. Now, I also like to comment on the price adjustment and the customer reaction. Many of you have raised the question.

In the last two months, we have communicated with our customers that we will firm up our prices for the event process technologies, as of the first quarter 2009. The action is taken for the purpose as we communicated several times before already with you to... of protecting the structured profitability of TSMC and also to partially cover further unexpected increases in our manufacturing cost. For instance, the price increase from the utility, the cost decrease for the materials etcetera, etcetera. And for some pricing specifics, I would like to say that for any... for any one specific technology, our average 2009 price across a year will not be higher than that of the 2008 average. As to the customer, of course, different customers responded differently to our new prices. We have worked hard and diligently with them. I think, by now, most of them have decided to continue to work with us on a long-term win-win business relationship. Many of you also ask about the potential impact to our business. I believe the price action that we have proposed will not have much impact to our business in 2009.

In conclusion, I think I believe that through our capability and intelligence, TSMC will continue to earn our position as the largest total value provider to our customers. We have that confidence and we will make that happen. Thank you.

Question and Answer

Operator

At this time, we will open the floor to questions. [Operator Instructions]. And our first question will come from the line of Randy Abrams with Credit Suisse. Please proceed.

Randy Abrams - Credit Suisse

Yes. Hi, good evening. I wanted to ask a follow-up on the pricing comments where you mentioned 2009 won't be up versus 2008, could you talk about... is the pricing outcome what you are expecting coming into discussions with customers and now what were the implications, should we expect slower price erosion on a node-for-node basis and potentially up for blended ASPs?

Dr. Rick Tsai - President & Chief Executive Officer

Yes, Randy, I think you're right. I mean, I believe you're right. For any specific technologies, we have the pricing, as I just said, not higher than the average of the 2008, which of course have slowed down the decline of the 2009 prices. And, of course, as the mix continued to migrate, I think the blended pricing can go either way, yes.

Randy Abrams - Credit Suisse

Okay. And on the cost pressure, will you talk about some inflationary pressures, maybe discuss the magnitude of some of the big variables we've heard like energy costs, raw materials? And then for operating expenses, do you see any inflationary pressures, how should we expect Opex to trend the next few quarters?

Ms. Lora Ho - Vice President, Chief Financial Officer

On the cost front, the inflation, cost... mainly own utility cost and also some other costs associated with the utility cost increase. There were many forecasts on the cost of sales area, not too much on the operating expenses. In terms of the magnitude, we believe the impact will be... will not be very significant, we would think about the low single digits in our range and we're trying to do everything we can to manage our costs. So, we are trying to reduce the impact to our bottom line.

Randy Abrams - Credit Suisse

Okay. And one final question for 45 and...

Operator

As a reminder, please limit your questions to two questions at a time. Our next question will come from the line of Shailesh Jaitly with Nomura Securities. Please proceed.

Shailesh Jaitly - Nomura Securities International, Inc.

Yes. Hi. Thanks for taking my question. Firstly, for 0.11 and 0.13 micron, there was quite a pronounced decline. So, if you could detail right as to what product segments is it coming from, is it more fabulous or ideal centric?

Dr. Rick Tsai - President & Chief Executive Officer

I don't think .. I don't believe we have those numbers at hand, most of the probably decrease is a migration into 90 nanometer and 65 nanometer. Lora, do you have that?

Ms. Lora Ho - Vice President, Chief Financial Officer

It's... we do not see the it as coming from fabless and IBN [ph] and because our fabless percentage in IBN is to maintain the same as first quarter. So, I would say it's not coming from a specific area.

Shailesh Jaitly - Nomura Securities International, Inc.

And the price actions, you said were instituted primarily for the advanced nodes. So would you characterize that this 0.11 and 0.3 micron also was under price negotiation or no?

Dr. Rick Tsai - President & Chief Executive Officer

Yes. The price action, we just mentioned covered both 0.11 micron and 0.13 micron..

Shailesh Jaitly - Nomura Securities International, Inc.

Okay. And is there any perceptible market share shifts in that segment?

Dr. Rick Tsai - President & Chief Executive Officer

No. We don't believe so, not because of the pricing action, no. I think it is the more mix shift from node to node.

Operator

As a reminder, ladies and gentlemen, please limit your questions to two questions. Please rejoin the queue for any follow-up that you may have. Our next question will come from the line of Mehdi Hosseini with FBR. Please proceed.

Mehdi Hosseini - Friedman, Billings, Ramsey Group, Inc.

Yes, thank you. It's Mehdi Hosseini, FBR. During your prepared remarks, you talked about Q3 ending on the weak side, if you could elaborate on it and where is that weakness coming from? Is there any specific area or is it across the board? And then also, if you could elaborate on utilization rate cost different technology nodes? Thank you.

Dr. Rick Tsai - President & Chief Executive Officer

When we said it would turn weaker in asset [ph] in Q3, we mean basically the impact will be significant in the month of September. I think we're seeing the impact across the board as demand induced phenomena. I think the macro business environment is the main cause for that.

Ms. Lora Ho - Vice President, Chief Financial Officer

Regarding the utilization by node, in general our advanced technology utilization is still very, very high and our [inaudible] utilization is high but not as before not as high as advanced technology.

Operator

And our next question will come from the line of Patrick Ho with Stifel Nicolaus. Please proceed.

Patrick J. Ho - Stifel Nicolaus

Thank you very much. Can you give us an update in your progress on the microprocessor front and how you plan to add capacity, would it be for the 4X technology node or beyond that? Thank you.

Dr. Rick Tsai - President & Chief Executive Officer

Okay... I think the...the status of the microprocessor area has not changed greatly as we reported in last quarter's conference call. Basically, it is moving as we expected. The product will top with the 40 nanometer technology, we're work... also working with the customers on the 32 nanometers technology node. Again, this is a fairly new application for TSMC. We have invested significantly in this area and we expect this to bear fruit probably more toward late 2009.

Operator

And our next question will come from the line of Steven Palao. Please proceed.

Steven Palao - HSBC

In your earlier meetings, you spoke a lot about how this is more demand-driven, you didn't think your customers had much excess inventory. So in past cycles when we did have excess inventory, that would usually lead to one or two quarters of 10% sequential decline, so my question is really, do you think we don't have to use history as a guide here and do you think your fourth quarter or first quarter don't need to see those similar kind of magnitudes of decline?

Dr. Rick Tsai - President & Chief Executive Officer

It is quite difficult for us to predict the decline in the upcoming quarters. The visibility for the fourth quarter right now is low. It is correct again to say that is... that the inventory level with our customers base remains, I think, at a reasonable level. The customers... if you look at the numbers, the days of inventory numbers for our customer base at the end of the second quarter, you will see the number has actually come down a little bit compared to the... at the end of first quarter.

Customers have certainly paid a lot of attention to their inventory and they have managed their inventory in a very timely manner and certainly it's showing up in our third quarter guidance numbers. For that we feel relatively comfortable with the inventory situation. So... but, that's not what I can say about that demand picture because it's quite unpredictable. As you know, the situation in the US has been weak for a period of time. And for China market, this year so far it has been rather mute [ph], I would say. But, if the demand picture turns somewhat better than we expect it and the situation can also turn better more quickly than before.

Steven Palao - HSBC

Okay. My second question is your capital spending came up a lot in the second quarter, it looks like you spent about two-thirds of your budget in the first half of the year. Yet, your guidance for the third quarter on gross margin really implies that maybe there's not a big increase in depreciation there. You guys are putting up some very impressive gross margins at these levels. Can you talk about your depreciation both overall, as well as the portion in cost of goods sold for the remainder of 2008. And then, also your competitor yesterday talked about their depreciation declining 10% next year. What is your early thoughts on depreciation impacts to margin next year?

Ms. Lora Ho - Vice President, Chief Financial Officer

Steven, on depreciation, I don't have the number in front of me regarding which... how much in your third quarter and fourth quarter, but I can tell you this year's depreciation over last year is about 2% increase. And you were also concerned about 2009 depreciation, we'll have to depend on our CapEx, which we are still working on. Okay. Okay, let me finish the 2009 part. We believe even there is increase in depreciation it will be a very small increase for 2009. And I just come back to you on the third quarter depreciation. I got a number in front of me. On a consolidation basis, our third quarter depreciation will be around 4% higher than second quarter.

Operator

And our next question will come from the line of Bill Lu with Morgan Stanley. Please proceed.

Bill Lu - Morgan Stanley

Yes. Hi, there. Good evening. My first question is, I'm hoping you can just talk a little bit about what you're seeing competitively because if I look at the results so far in 2Q, it looks like the gap [ph] of possibility is getting bigger and bigger between you and your competitors. And yet, if I look at the growth especially the trading edge, it also looks like some of your competitors have grown faster at 0.13 and above. Is it your view that your competitors are kind of fighting irrationally and what are you seeing out there?

Dr. Rick Tsai - President & Chief Executive Officer

Let me think. The mainstream technology actually in the second quarter capacity was fully loaded or close to very fully loaded. We have not increased our mainstream technology capacity much this year. Our pricing, our firming up pricing action also applies to mainstream technology. We have… but on the other hand I think the competitors where mainstream technology covers a wider spectrum more than the usual ones we discuss, so it is the more difficult to predict, the pricing situation in the mainstream technology arena compared to the advanced technology area.

Steven Palao - HSBC

I guess my question is, you talked about structural possibility, when you look at your competitors, do you feel like they are kind of thinking about this the same way or are they still acting the same way they have acted in previous years?

Dr. Rick Tsai - President & Chief Executive Officer

It is very difficult for us to know right now to be very frank, mainly because as I said the mainstream technology player, we can count more than 10 of them for instance, not all of them think the same way especially with respect to a structured possibility we think. It is more unpredictable compared to advanced technology.

Operator

And our next question will come from the line of Bhavin Shah with J P Morgan, please proceed.

Bhavin Shah - J P Morgan

Yes. Just a clarification on the outlook for the industry in terms of growth exceeding by several percentage points. I would assume that semiconductor industry growth is made out in U.S dollars, but when you mentioned that comment on the foundry and your outperformance, is that in U.S dollars or Taiwan dollars?

Dr. Rick Tsai - President & Chief Executive Officer

Bhavin, U.S dollars... U.S dollars. When we talk about growth rate and we use U.S dollars as the... as the basis.

Bhavin Shah - J P Morgan

Okay. I know I asked this question because if I translate several points into sort of a single digit number, it would imply a very low growth in Taiwan dollars for TSMC and it would imply a big... big drop in revenues in Q4. So that's why I asked that question.

Dr. Rick Tsai - President & Chief Executive Officer

Well, we'll see whether it's a fairly low number or not. Later.

Ms. Lora Ho - Vice President, Chief Financial Officer

Bhavin, we don't know what the exchange rate going to be.

Bhavin Shah - J P Morgan

Well, I think this is just on a year-on-year basis, even if you assume flat exchange rate from here on, there is 5 to 6 percentage point impact on your growth. The differential basically between U.S dollar and Taiwan dollar and in the year in which growth rates are generally low anyway, that makes a big difference on how to interpret your comment, that's why I asked.

Ms. Lora Ho - Vice President, Chief Financial Officer

Yes, exactly. For example, in 2008, we are experiencing a quite significant NT dollar appreciation, so the growth rate between local currency and U.S dollar will be big.

Operator

And our next question will come from the line of Dan Heyler with Merrill Lynch. Please proceed.

Dan Heyler - Merrill Lynch

Hi, I had a question on the technology mix. You've talked about 65 nanometer ramping aggressively and that's on track and leaving the year I believe the fourth quarter is over at 20%, given visibility in the business is fairly limited, what's driving your confidence that 65 will continue to ramp to year-end?

Dr. Rick Tsai - President & Chief Executive Officer

We believe the major run there for the 65 nanometer, 55 nanometer, the migration from 90 nanometer, 80 nanometer is moving very smoothly and very rapidly, especially in the graphics area followed very closely by the handset, wireless area. Now we have other products in... actually [inaudible] being either prototype or close to coming to production. So the momentum you can see, as I said earlier in the afternoon, we can see a strong and healthy backlog of the 65-nanometer [inaudible] to production. So we're fairly confident about that.

Dan Heyler - Merrill Lynch

Okay, great. And on a follow-up on that, then I guess there is a migration taking place, what would be the margin implication of products migrating forward from say 90 to 65, given the... is there a efficiency gain there inside TSMC that implies that you have some margin upside from the migration or is it...is that passed on, are those gains passed on to your customers?

Dr. Rick Tsai - President & Chief Executive Officer

Okay, from margin point of view, our structure improvement, structure profitability improvements average, as you know, apply to both 90 nanometer and 65 nanometer. The objective is to have the margin at similar level, well either a technology and at... also at a better level compared to before.

Operator

And our next question will come from the line of Matt Gabel with Scotlandfield Group [ph]. Please proceed.

Unidentified Analyst

Hi, I missed the part about what is normal Q3 seasonality for you on a sequential basis?

Dr. Rick Tsai - President & Chief Executive Officer

It should be about 10%, during the last five years.

Unidentified Analyst

Okay, thank you very much.

Dr. Rick Tsai - President & Chief Executive Officer

Sure.

Operator

And our next question will come from the line of Shailesh Jaitly with Nomura Securities. Please proceed.

Shailesh Jaitly - Nomura Securities

Hi, thanks. If you could just clarify the reasons for that margin expansion, which is there in your statements, higher level of wafer movements, how exactly does it work?

Ms. Lora Ho - Vice President, Chief Financial Officer

Okay. I can explain a little bit better about high-level wafer movement. We're talking about on the same state of equipment, same number of equipment, without additional equipments, we can produce more wafer, either coming out from our output or they move faster, those stay in a [inaudible]. So by doing that, actually we are talking about... that we have higher productivity. So then their margin will be better considering our cost structure is heavily fixed cost in nature.

Shailesh Jaitly - Nomura Securities

So it's just improvement in productivity?

Ms. Lora Ho - Vice President, Chief Financial Officer

Yes.

Shailesh Jaitly - Nomura Securities

I understand. And Rick, you normally provide some more color in terms of the products outlook right. I do understand the computer has been weak, continues to be weak but if you could also provide some more color, right, as to which products are doing all right as we go into 3Q and where you see more pronounced weakness?

Dr. Rick Tsai - President & Chief Executive Officer

For third quarter computer has a slight growth in third quarter compared to the second quarter. [inaudible] slight areas, I think it looks strong at least for the third quarter. Other area is fairly average, I would say.

Operator

And our next question will come from the line of Pranab Sarmah with Daiwa Securities. Please proceed.

Pranab Sarmah - Daiwa Securities

Thank you. I have again questions about the third quarter margins, I know the cost of margins improvement is mainly, partly also due to the improvement in the utilization rate in the 8 inch fab?

Ms. Lora Ho - Vice President, Chief Financial Officer

Can't hear you clearly, can you speak clearly again?

Pranab Sarmah - Daiwa Securities

The third quarter margin improvement guidance, is it also partly due to the improvement in utilization rate for 8 inch fab?

Ms. Lora Ho - Vice President, Chief Financial Officer

Utilization in general is, is good in third quarter [inaudible] 14 inch and 8 inch.

Pranab Sarmah - Daiwa Securities

I'm just trying to figure out like if due to some reason 8 inch utilization rate drops at some point, do you think that your margin will be adjusted to affect it. Just to give a color basically whether your 8 inch margins, 8 inch fab margins are still better than the 12 inch fab margins?

Ms. Lora Ho - Vice President, Chief Financial Officer

It's generally right, our 8 inch product margin is generally better than 12 inch for a very simple reason, most of our 8 inch has been fully depreciated.

Operator

And our next question will come from the line of Timothy Arcuri with Citi. Please proceed.

Timothy Arcuri - Citigroup

Hi guys, not sure if you actually commented on this because I actually joined late but can you give some indication and it might be a little early but can you give us some indication of what you are thinking in terms of kind of the trajectory of spending as you exit the year and you kind of move into next year. I would think that your Capex will be up next year, at least a little bit but I'm just kind of wondering what you are thinking at this early stage? Thanks.

Ms. Lora Ho - Vice President, Chief Financial Officer

Our 2009 CapEx is still being worked out and we don't have the number in front of me but if we talk about a longer range, we believe in the longer-range our capital expenditure versus our revenue will be lower than in the past five years. I mean capital intensity will be low in the future.

Timothy Arcuri - Citigroup

Okay. So you think that even though you are aggressively pushing to 65 and soon 45, so, you don't think capital intensity at those nodes is actually higher so that actually capital intensity will go up, rather do you think that it will go down?

Ms. Lora Ho - Vice President, Chief Financial Officer

Yes, for a longer period of time that's what we mean but there is another factor is actually with the scale we have today and the productivity effort we've been putting on the fab and we can gain productivity even without adding any capacity over here.

Operator

And our next question will come from the line of Bill Lu with Morgan Stanley as a follow up.

Bill Lu - Morgan Stanley

Yes, hi. Just a quick question. I think this was [inaudible] but I don't think I heard the answer. OpEx in 2Q was up about 8% quarter-on-quarter. Can you just help me with how I should model that going forward?

Ms. Lora Ho - Vice President, Chief Financial Officer

Operating expense, you're talking about?

Bill Lu - Morgan Stanley

Yes.

Ms. Lora Ho - Vice President, Chief Financial Officer

If you look at percentage of revenue, it was 10% in first quarter, about 11% in second quarter. So, I was saying that the numbers won't change much as we have seen in our past history.

Bill Lu - Morgan Stanley

Okay. Great, thank you.

Operator

And our next question will come from the line of Steven Palao with HSBC. Please proceed.

Steven Palao - HSBC

Yes. Actually to follow on the operating expense question. I'm curious about how.. how much you can flex those in the event that your revenues did decline 5% to 10% in both the fourth and the first quarter? How much of that operating expense is just kind of fixed and how much of that can you actually scale down as well?

Ms. Lora Ho - Vice President, Chief Financial Officer

I would say the scalability is not big, because we've been running very stable operating expense, but you know, we want to invest more in R&D. So we will not reduce R&D expense to a big degree. Of course, when you talk about quarter-over-quarter, there have always had some small changes but I don't expect the number is going to be big.

Steven Palao - HSBC

Okay. Well, just looking back here in the past and on your SG&A lines, they were 20% lower I guess you could say when you were at a revenue level of around NT$80 billion or so. I am just curious if revenues did get back to their... you think your OpEx could get back to that level as well?

Ms. Lora Ho - Vice President, Chief Financial Officer

There was a new factor, I have to tell you that because this year we thought we'd spend employee profit sharing. Some of the expense goes to operating expense as well. If the profit goes down, driven by revenue goes down, the operating expense will be smaller based on [inaudible]. So that's the new factor, which we don't have in last year.

Operator

[Operator Instructions]. And our next question is a follow-up question from the line of Dan Heyler with Merrill Lynch. Please proceed.

Dan Heyler - Merrill Lynch

Hi, guys. I have a follow-up on CapEx, it was only about NT$600 million or so [inaudible] versus first half of NT$1.2 billion, and I'm wondering what the capacity growth will look like in the first and second quarter, will those still be capacity growth or will it be mostly flat, or potentially down I guess if you are upgrading... upgrading [inaudible]?

Ms. Lora Ho - Vice President, Chief Financial Officer

I think what we said the second quarter capacity grow 6% and...

Dan Heyler - Merrill Lynch

[inaudible] next year, Lora.

Ms. Lora Ho - Vice President, Chief Financial Officer

Next year? We have not decided yet.

Dr. Rick Tsai - President & Chief Executive Officer

But Dan, you know that we are going to start ramping the 45 nanometer capacity next year, first quarter and second quarter.

Dan Heyler - Merrill Lynch

Okay. So the NT$600 million that you are spending in the second half is equipment that would start production and being turned on in the first quarter?

Dr. Rick Tsai - President & Chief Executive Officer

Some of that. Yes, some of it will go to 40... 45 nanometer. Of course, much of it will also happen in the first half of next year. By the way, I do have one thing to correct from my earlier comment on the third quarter business in the computer area, I said the hard disk drive business will grow, I was incorrect. Actually hard disk drive business for us will decline. The graphics and the PC chip set will in fact grow. I apologize for that.

Dan Heyler - Merrill Lynch

Okay, thanks. And I get to ask my second question? It was relating to...yes it was relating to the... follow on the 40 to 45 question, Rick and in the past, you guys have been pretty... pretty capable at adding a small amount of production initially so, what I'm wondering is under what circumstances would you make a bigger investment in the full production line on your 40 to 45 because currently you are producing that I guess in your existing facility so before you move to your next full production line, would you move to... move it to 10K scale and would you want to roll that out to kind of a full 20...20K scale quickly?

Dr. Rick Tsai - President & Chief Executive Officer

This is of course again a strong function of the customer demand. As I said in the afternoon earlier, that we're seeing a strong demand for our 40-nanometre process. We are building capacity with close cooperation with our customers, whether and when the10K per month capacity will be installed remains to be seen. And also we haven't made the final decision on that yet. One thing we are sure though is the... we will be putting the equipment for 45-nanometer production by the end of the year.. this year. We are rushing the building of our next wafer fab in Hsinchu, we definitely plan to also start production of 45... 48-nanometer in the new fab, also in the first half of next year.

Operator

And our next question will come from the line of Randy Abrams with Credit Suisse. Please proceed.

Randy Abrams - Credit Suisse

Yes, I wanted to ask a question on the buyback earlier in the quarter, talk about the rationale for pulling back on that amount and do you still plan additional buybacks next year or do you want to move back to dividend payouts?

Ms. Lora Ho - Vice President, Chief Financial Officer

On the buyback, I think this year's buyback as you know is part of the program helping Phillips to exceed their holding in TSMC. So, the program started in the middle of May and ended end of June. During that period, our share price actually outperformed the major index. I would say, our share price holding very well. So, we did not buy to the full amount as we had planned, so we only buy around less than 50%. In the future, I think regarding our capital management our preferred means is returning cash to shareholder in cash dividend. Of course we also consider buyback to...in addition to offset Phillips' slowdown also [inaudible] partially to remove some of the dilution from employee profit sharing or stock dividend when the share price is low.

Randy Abrams - Credit Suisse

Okay, thank you. And on graphics, a customer of yours discussed a [inaudible] of graphics this past quarter from overheating. Could you discuss if there is any issues or areas you need to step in to help share the damage or were you uninvolved in that issue?

Dr. Rick Tsai - President & Chief Executive Officer

We are not responsible for that and... but we cannot really comment on our customers' issues.

Operator

And our next question will come from the line of Dan Malkoon [ph] with More Capital [ph]. Please proceed.

Unidentified Analyst

Hi. Just a quick question on the 3Q guidance again, if you could clarify, I know you went through computer and hard drive, but could you just... normal seasonality is up 10% sequentially, you guys are guiding for less than that. Can you just walk through the puts and takes of what's better or what's worse versus normal seasonality on a segment basis? Thanks.

Dr. Rick Tsai - President & Chief Executive Officer

Hello? It is difficult for us to walk through all segments in comparison to the seasonality, however, what I can say is for the communications, the wireless in general will grow although the handset is not as strong. Wireline actually will be growing fairly well. For the computer area, graphics and the chip set will grow, but hard drive and LCD monitor will not. In the consumer area, the game player and the set-top box will grow, but DVD will not grow. Seasonality-wise, it's very difficult for us to compare.

Operator

[Operator Instructions].

Dr. Elizabeth Sun - Head of Investor Relations

Operator, if there is no more question, I think we can end our conference call as of now. Thank you.

Operator

Before we conclude TMC's 2008 second quarter results webcast conference call today, please be advised the replay for the conference call will only been accessible through TSMC's website at www.tsmc.com. Thank you all.

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Source: Taiwan Semiconductor Manufacturing Co. Ltd. Q2 2008 Earnings Call
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