Taiwan Semiconductor Mfg. Co. Ltd. Q1 2006 Earnings Conference Call Transcript (TSM)

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Taiwan Semiconductor Mfg. Co. Ltd. (NYSE:TSM)

Q1 2006 Earnings Conference Call

April 27th 2006, 8:00 AM.

Executives:

Elizabeth Sun, Head of Investor Relations

Lora Ho, Vice President, Chief Financial Officer

Rick Tsai, President, Chief Executive Officer

Analysts:

Bhavin Shah, JP Morgan

Michael McConnell, Pacific Crest Securities

William Dong, UBS

Shailesh Jaitly, Nomura Securities

Mehdi Hosseini, FBR

Robert Maire, Needham & Company

Timothy Arcuri, CitiGroup

Pranab Sarmah, Daiwa Institute of Research

Ivan Goh, Dresdner Kleinwort Wasserstein

Daniel Heyler, Merrill Lynch

Doug Reid, Thomas Weisel Partners

Mark Fitzgerald, Banc of America Securities

Operator

Good day, ladies and gentlemen. Welcome to TSMC's First Quarter 2006 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 Webcast live via the TSMC website at www.tsmc.com and only in audio mode. Your dial in lines are also in listen only mode. At the conclusion of the management presentation, we will be opening the floor for questions at that time. Further instructions will be provided as to the procedure to follow if you would like to ask a question.

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 http://www.tsmc.com/. Please also download the summary slides in relation to today's quarterly review presentation. Once again, the URL is http://www.tsmc.com/.

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

Elizabeth Sun, Head of Investor Relations

Good morning and good evening to all participants. This is Elizabeth Sun, Head of Investor Relations for TSMC. Before we begin, I would like to state that management's comments about TSMC's current expectations made during this conference call are forward-looking statements, subject to significant risks and uncertainties, and that actual results may differ materially from those contained in the forward-looking statements.

Information as to those factors that could cause actual results to differ materially from TSMC's forward-looking statements may be found in TSMC's annual report on Form 20-F, filed with the United States Securities and Exchange Commission on April 20, 2006, and such other documents as TSMC may file with or submit to the SEC from time to time. Except as required by law, we undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

And now, I would like to turn the conference call over to Ms. Lora Ho, our Chief Financial Officer and Vice President.

Lora Ho, Vice President, Chief Financial Officer

Thank you, Elizabeth. Good morning and good evening to everyone. Welcome to TSMC's First Quarter 2006 Earnings Conference Call. Before I go over to first quarter results, I would like to announce a change to our financial reporting. In order to align TSMC with the international reporting standard, starting full-year 2006, TSMC will shift the basis for our financial reporting from unconsolidated basis to consolidated basis. This change is in line with our focus on providing investors with better transparency, in order to ensure a smooth transition to consolidated reporting and to help the investor to gain familiarity with the differences between consolidated and unconsolidated reporting. We will continue to report our operating results on unconsolidated basis for the first two quarters of 2006. Meanwhile, a reconciliation of material differences between the two will be provided in the management report. Starting from the third quarter of 2006, we will shift over to consolidated report only.

Now, I would like to walk you through our first quarter unconsolidated results, followed by a discussion of our first quarter consolidated results. I will then go over our second quarter 2006 guidance. I will keep my comments very brief and allow more questions in Q&A. We have prepared some slides on TSMC's website for your reference. As you listen to the conference call, the page will be flipped automatically as I go through them. All dollar figures are in NT dollars unless otherwise stated.

Let's first take a look at some highlights of our first quarter unconsolidated results. Due to stronger than expected demand from our customers in computer segment, our first quarter revenue exceeded our previous guidance to be slightly over NT$77 billion. Earnings per share for the quarter was NT$1.32, representing a 94% increase over the same period last year and a 4% decline for the last quarter.

We continued to generate strong cash flow from our operations, adding NT$44 billion to our cash and marketable securities during the quarter. Our return on equity reached 28% during the first quarter 2006.

Now, let's take a closer look at our income statement. Net sales increased by 39% over the same period last year and declined by 5% from last quarter. The quarter-over-quarter decline was mainly due to a 20% decrease in revenue from consumer applications, follow a 10% decline in communications, offset in part by an 8% increase in revenue from computer applications.

Gross margin declined by 1.7 percentage points to 47.4%. The 3.3% depreciation in U.S. dollars was an important factor. Operating margin was 39.9% for the quarter, which was above one percentage point higher than our guidance. Income from non-operating items, including investment income, was NT$3.8 billion for the quarter, including a one-time gain of NT$1.8 billion as a result of adopting statement of financial accounting standard number 4 -- number 34. Earnings per share was NT$1.32 for the first quarter. Our net margin for the quarter came into at 42.2%, directly better than the last quarter.

According to our new ROC accounting rules -- that is statement of financial accounting standard number 34 -- starting from this quarter, we will measure certain marketable securities at their fair value. As a result of such adoption, TSMC recognized a total gain of NT$1.6 billion. A large majority of the gain were unrealized gains from certain venture capital investments as of January 1, 2006. These gains need to be reported once and are non-recurring.

Now, let me go through our balance sheet for this quarter. We ended the quarter with NT$170 billion in cash and marketable securities, a NT$44 billion increase from the previous quarter. Our accounts receivable turnover days and inventory turnover days were both at 44 days for the quarter, which is two days higher than the respective level in the previous quarter, but still well within our normal range. Inventory turnover days increased slightly as we increased our ROE for inventories in light of supply tightness.

And now, let's turn to cash flow. Operating cash flow generated during the quarter totaled about NT$48 billion, mainly from net income of NT$33 billion and depreciation of NT$16 billion. During the quarter, we spent about NT$11 billion on capital expenditures and we purchased about NT$13 billion in short term marketable securities. As a result, total cash increased by about NT$25 billion from the last quarter.

In the next two slides, I will go over our capacity and CapEx. Our installed capacity for the first quarter was NT$1.65 million, 8-inch equivalent wafers, about 1.3% higher than the previous quarter. Installed capacity for the remaining three quarters of 2006 is expected to increase by 3%, 4% and 6% quarter-over-quarter, respectively. Our total installed capacity for 2006 is expected to be slightly over 7 million equivalent wafers. This represents a year-over-year increase of approximately 18%.

Our CapEx for the first quarter was US$356 million. We maintain our CapEx guidance for the whole year at between 2.6 to US$2.8 billion.

Now, let me quickly go through the sales breakdown by technology application, customer and geography. For more detailed information, please refer to our management report. Our revenue from 90 nanometer continue to increase and accounts for 20% of our total wafer sales in the quarter, up from 17% in the previous quarter. Revenue from advanced technology represented 49% of total wafer sales during the quarter, which is flat from the previous quarter.

In terms of applications, due to expected losses analogy, percentage of revenue from consumer and communications both declined quarter-over-quarter. On the other hand, percentage of revenue from computer applications increased by 5 percentage points during the first quarter of 2006. In terms of sales by geography, there was no significant change in this quarter.

During the first quarter of 2006, revenue generated from our fabless customer increased to 74% of the total, while revenue from our IDM customers showed a 2 percentage point decline.

Now, before I go over to next quarter guidance, I would like to discuss briefly our consolidated results for the first quarter. First, I would like to give you an overview of our consolidated structure. Included in our consolidated results are the results from, number one, our original sales office, including our sales office in North America, Europe and Japan, number two, our manufacturing subsidiaries, including WaferTech and TSMC Shanghai, number three, our strategic alliance with Global Unichip, and lastly, TSMC's venture capital fund.

Now, let's take a look at the consolidated income statement for the first quarter. Our consolidated net sales were roughly NT$78 billion, about NT$560 million higher than unconsolidated basis. Our consolidated gross margin was about 1 percentage point higher than the unconsolidated gross margin, reflecting the true growth margin from the consolidated entities.

Consolidated operating expenses was also higher than unconsolidated operating expenses, mainly due to additional operating expense from our overseas sales office, WaferTech and certain venture capital funds. Consolidated investment income was NT$600 million for the quarter as compared to an investment income of NT$3 billion on the unconsolidated basis. This is because of upon consolidation, the financial results of our consolidating subsidiaries are no longer included in our investment income. Instead, they are included in as part of the categories of our income statement. In addition, certain one-time gains recognized under SFAX number 34 were included in a cumulative effect of changing accounting principle under the consolidated reporting.

Now, let's turn to consolidated balance sheet. Total consolidated assets were NT$555 billion, about NT$12 billion higher than the unconsolidated total assets. This was mainly due to cash, marketable securities and fixed assets from our consolidating entities. This was offset by a reduction in loan paying investments as a result of consolidation.

Total consolidated liabilities were also about NT$11 billion higher than the unconsolidated total liabilities, largely due to borrowings by TSMC Shanghai. Finally, the difference between consolidated and unconsolidated shareholder equity was due to minority interest.

Now, let's go through our consolidated cash flow statement. On a consolidated basis, cash generated from operating activities were NT$1 billion higher than that on unconsolidated basis, mainly due to higher consolidated depreciation and amortization. Net cash increase was about NT$24.9 billion on a consolidated basis, slightly higher than the NT$24.6 on unconsolidated basis. We ended the quarter with about NT$121 billion in consolidated cash position.

With that, I will turn to our guidance for the second quarter of 2006. Since, we will be shifting toward consolidated reporting, we will provide guidance on both consolidated and unconsolidated basis. Based on our current business and foreign exchange rate expectations, we expect unconsolidated revenue to be between 79 to NT$81 billion and consolidated revenue to be between 80 to NT$82 billion.

Our expectation for gross margin in the second quarter is between 47% and 49% on unconsolidated basis and between 48% to 50% on consolidated basis. The operating profit margin is expected to be between 40% to 42% on both consolidated and unconsolidated basis.

Finally, we also provide a recap of major TSMC events during the first quarter. I will leave them for your own reference. This ends my presentation today. Thank you very much. Operator, please open the floor for questions.

Question-and-Answer Session

Operator

Thank you. Operator Instructions And your first question comes from the line of Bhavin Shah from JP Morgan. Please proceed.

Q - Bhavin Shah

Yes. Thank you and congratulations on started reporting consolidated results. I just have a first quick question. If you have handy the consolidated depreciation that is included in COGS.

A - Lora Ho

I'm sorry Bhavin?

Q - Bhavin Shah

Yes. Hi, Lora.

A - Lora Ho

Bhavin, you're asking about consolidated depreciation in COGS. A simple way to look at that is the difference of margin between consolidated and unconsolidated is approximately 1 percentage point. On a consolidated basis the margin would be roughly 1% higher than unconsolidated.

Q - Bhavin Shah

Yeah. Lora, what I'm referring to is, for example, in the management report, table 3-1, if you could provide a similar table on a consolidated basis because as we shift our models to consolidated reporting, we'd like to receive this information. I guess most of this tables on a consolidated basis. If you don't have it handy, then maybe later on, I can follow-up.

A - Lora Ho

Bhavin, in page three of our management report, if you look at part three, profit expense analysis, you will find out the COGS and the depreciation. So, this is unconsolidated, of course.

Q - Bhavin Shah

Okay. I guess I can follow-up later on. I just wanted that table on a consolidated basis. The second question I had was graphics. Is it at all possible for you to provide some color of -- because I think you are now doing graphics for a variety of applications and apart from the video game, potentially the mobile graphics could become a significant driver. So, if possible, could you give some color on your outlook, some kind of a split of graphics into your different end markets?

A - Rick Tsai

Oh. So, you're asking about the business outlook for mobile graphics rather than just graphics?

Q - Bhavin Shah

Yeah, I'm just wondering if this would be -- mobile graphics would become an important contributor to your graphics revenue?

A - Rick Tsai

I see. Actually, Bhavin, in our different characterization, mobile graphics would be in the communications part of the segment. Then, from our view, it is the young and the growing segment. I don't have all the data at hand, but I think, revenue point of view, it has a higher growth rate. But, the absolute dollar term is still not too big. They do not need to use the most advanced technology compared to the PC graphics.

Q - Bhavin Shah

I see. Great. And one of your competitors talked about how customers physically booking orders in the third quarter already, which I guess is understandable, given the fact of capacity situation. So, I just wondering what you are seeing there, whether it's -- how do you view that? Is it a good thing, bad thing? How do you monitor any excessive ordering pattern from customers? Thank you.

A - Rick Tsai

Okay. Bhavin, I would answer the question more to response your -- for the double ordering part rather than to what other people are saying about the third quarter visibility. Our visibility has always been, as we have said many times before, roughly between 2 to 2.5 months from orders point of view. But, we are concerned with the dollar orders. There is always, just like you said, tight, "tight," capacity situation, there is a possibility for double order. We -- I feel that the, for the advanced technology product, double ordering phenomenon is probably not significant, if there is any, since we have been able to at least, shall we say, stretch ourselves to meet our customers' demand using our advanced technology. And also, for others, I think, as I said in the afternoon, some of our customers, I believe, are already paying a lot of attention and putting actions to correct the inventory situation. So, going forward, my view is the currently seemingly higher PC related inventory level will be under some control, but it will take some time. Other segments, so far, look reasonably good to us.

Q - Bhavin Shah

Okay, thank you. And, in fact, you also answered my next question, so thank you.

A - Lora Ho

Bhavin, before you go, back to your first question, you were asking for the consolidated depreciation and the consolidated cost of sales. In page 18 of our presentation, you can find the consolidated depreciation. It is NT$17.7 billion for the first quarter. And on the cost of sales, you can find one of the attachments in our management report. It has the full income statement of consolidating, including the COGS.
Q - Bhavin Shah

Great. A lot of that depreciation would be total depreciation, I would assume including groups COGS depreciation and other depreciation.

A - Lora Ho

Correct.

Q - Bhavin Shah

Yeah. So, I guess, what I was looking for was depreciation consolidated -- into that in the consolidated cost of goods sold.

A - Lora Ho

Oh, okay, okay. Well, we can give you later.

Q - Bhavin Shah

Okay, sounds good. Thank you.

Operator

And our next question comes from Michael McConnell from Pacific Crest Securities. Please proceed.

Q - Michael McConnell

Thank you. I wanted to ask first on Q2, if I look at your normal seasonality in Q2, it seems like guidance is a little bit light here. Is what's kind of adding to some of the cautiousness of Q2 guidance the PC inventory you alluded to? And specifically, within PCs, is this more on the graphics side, chipsets or both?

A - Rick Tsai

Yeah, I think the -- for the second quarter outlook, we do expect declines in the PC segment from our book -- from our business compared to that of the first quarter. Again, that -- other segments all have pretty good growth sequentially. That probably -- that explains almost our guidance for the second quarter. I don't -- I think we do not really comment in such detail as to between graphics and the chip set usually. But, I believe this -- the PC shipments in the first quarter did not do as well as some people expected, even for a normal seasonal pattern. So, probably more broader phenomenon rather than specific point.

Q - Michael McConnell

So, looking at the outlook for PCs in Q2, you believe this is more end market inventory driven. Your competitor yesterday had alluded to starting some new production for some new customers. So, you're looking at it more from an end market inventory standpoint than some shifting of production to your competitor?

A - Rick Tsai

Yeah, yeah, yes. I think the answer to that is yes. We are definitely looking from end market or a weaker end market in the first quarter. And, as you know, second quarter traditionally also is a weak quarter for the PC industry.

Q - Michael McConnell

Okay. And then, looking at the utilization rates in Q1 in your wafer shipments, I don't -- maybe I missed that. I didn't see it disclosed in the release. Could you talk about that a little bit in terms of what it was for both wafer shipments and utilization rate in Q1?

A - Lora Ho

We do not talk about utilization. But, if you look at our report and we show shipments -- 1.73 million pieces for first quarter. And you have our installed capacity, as well. So, you probably can figure out. Actually, our first quarter capacity is very write through.

Q - Michael McConnell

Okay. And the last question, just more to the model and then, I'll let some other people ask questions. Just, looking at the investment income for Q2, what should we model there? And what should we be thinking about for a tax rate for this year and potentially '07, as well?

A - Lora Ho

For investment income, that number usually is quite more. You cannot take the first quarter as a model because the first quarter, there's a one time gain of 1.8 billion. So, if you take that out and the second quarter number is pretty much unchanged from that number. Your second question about tax rate -- for your model purpose, I would suggest you use 13% as your model.

Q - Michael McConnell

13% for '06 and '07?

A - Lora Ho

Huh?

Q - Michael McConnell

For 2006 and 2007, 13%?

A - Lora Ho

No, I'm talking about 2006.

Q - Michael McConnell

2006.

A - Lora Ho

Uh-huh.

Q - Michael McConnell

Okay. And then, one last one, just on the end markets for Q2, what are you seeing, what are you expecting strength in? Obviously, we've talked about PCs on the weaker side, but what are you expecting specific strength for Q2?

A - Rick Tsai

It looks right now, both communication, including wireless and wired, and the physical consumer look pretty good and some of the other ones by the industrial. They all look pretty good.

Q - Michael McConnell

Okay. Thank you.

A - Rick Tsai

Sure.

Operator

And our next question comes from the line of William Dong from UBS. Please proceed.

Q - William Dong

Hi, guys. Quick, two quick questions. I think that during the analysts meeting earlier today, I think, Rick, you mentioned sort of the plan for a new strategic initiative on 80 nanometer platform for digital consumers. Can you just elaborate a bit more on how this helps the customer then? Is it more on pricing or is it also on the technology side?

A - Rick Tsai

I'd say it's more on the -- well, what I should say, it should -- we hope that they will help our customer to design more products which has a better combination of performance, power management and the cost structure through the technology -- I mean, it is the 80 nanometer technology, a very competitive one. And through some of the design of the devices, they probably can get a better power, for instance. We have talked to several customers and their reaction have been very positive.

Q - William Dong

Okay, thanks. And separately, I think one more thing I wanted to ask was on the -- so, what is the product planning in terms for SOI or is that really too far away for the purpose of the customers that you serve at this point?

A - Rick Tsai

Yeah, I would say so. I would say, I don't know if too far away is a good word or not, but right now, SOI serves in a pretty limited field. Well, the CPU, but CPUs not more, but the number of customers is fairly limited. We have the technology and I think what we probably need to do is to develop the infrastructure. So, it's having technology -- just like what I said earlier in the afternoon about the platform. Having technology alone is not sufficient to really create a -- to become a product. So, we will continue to work on the design infrastructure.

Q - William Dong

So, would you say maybe it's 45 nanometer it becomes important or --?

A - Rick Tsai

I think it has the opportunity. It also has some, probably some other competitors from a technology point of view. But, there are other forms of transistors in the research area and -- or, actually more than research. But, I think I would in general, agree with what you just said. At 45 nanometer, the likelihood of SOI being utilized more is quite a bit higher, should be quite a bit higher.

Q - William Dong

Great. Thank you very much.

A - Rick Tsai

Sure.

Operator

And our next question comes from Shailesh Jaitly from Nomura Securities. Please proceed.

Q - Shailesh Jaitly

Yeah, thanks for taking my question. Firstly, if you could help explain as to how the ordering pattern has changed over the past month. Particularly, we are seeing some of the customers talking about hard inventory. In other words, if you were to give this guidance one month back, how that guidance would have looked like versus now?

A - Rick Tsai

For the second quarter?

Q - Shailesh Jaitly

Yeah.

A - Rick Tsai

I think if I looked one month back, it would be about -- I can actually take a look. It's quite similar from guidance point of view one month ago. I guess, this ordering pattern, we -- I would say that during the past couple of months has been steady. I mean, obviously, there's some fluctuation among some customers.

Q - Shailesh Jaitly

Okay. Then, looking at your 0.13 micron revenues, that has declined a bit faster than your overall company’s average about 14% if you could help break down this product decline, what proportion of that is volume related versus the ASP decline related? If you could help quantify that.

A - Lora Ho

The 0.13 micron revenue decline in first quarter, I think, for the main reason is that a lot of customers transitioned to 90 nanometer. So, if you combine the two, it's actually the same. It's 49% versus -- first quarter versus fourth quarter last year.

Q - Shailesh Jaitly

Yeah. Lora, so, does that mean that it is all volume related, that 14% decline as the customers have migrated to 90 nanometer?

A - Lora Ho

It's more volume related than price.

Q - Shailesh Jaitly

Okay. And the price declines on this note, is it pretty similar to what you are seeing across all process imaging or is it more pronounced?

A - Rick Tsai

I think it is more along the line with the other bigger geometry technology.

Q - Shailesh Jaitly

Okay. And Rick, you mentioned about the ongoing PC market inventory collection. In your opinion, how long do you think this correction would last? Do you think that it should be over by 2Q or could it get into 3Q, as well, given that seasonally, we are getting into the slow part of the PCs?

A - Rick Tsai

I -- probably a better question to ask of our customers. I really don't -- well, I can give you my personal opinion, really. It's probably second quarters. It's really my, kind of a gut feel type of an opinion.

Q - Shailesh Jaitly

Well, thanks. And one last question, if I could, about your 65 nanometer engagement, if you could give some color and as to when do you expect customers to get into the volume production and contribute, say becomes material part of your business, some time line to that?

A - Rick Tsai

I'd say we have a little less than two dozen of customers engaging with us, covering quite a few applications. But, a big large volume ones are still the base land, the graphics, the ones that you are familiar with. Well, some of the communication, other communication type, too. We do not expect really significant revenue from 65 nanometer this year, at least percentage wise. I think next year is probably the first year we will see some minimal numbers. But, we do not have a good estimate now.

Q - Shailesh Jaitly

Thank you for your input.

A - Rick Tsai

Thank you.

Operator

Our next question comes from Mehdi Hosseini from FBR. Please proceed.

Q - Mehdi Hosseini

Thank you for taking my question. As a follow-up to the previous commentary, as you expect 65 nanometer to become more meaningful in the first half of '07, at what point in the second half of this year are you going to start planning for the required capacity? And then, the second question -- you are increasing your available capacity by 18%, but just based on the Q1 wafer shipment, it seems like wafer shipment could grow by well above 18%. So, I'm just trying to understand how you're able to meet customer demand with this kind of a moderate capacity increase.

A - Rick Tsai

Our capacity -- let me see. I tried to remember your second question and I forgot about the first one.

A - Lora Ho

65 nanometer meaningful revenue --

A - Rick Tsai

Oh, okay. The capacity for 65 nanometer. We're starting the 65 nanometer production capacity. We, of course, have a prototype capacity already. Production capacity, some time in the early third quarter, fab 12. I expect -- well, fab 14, we are also building at least a small line to qualify the technology as soon as possible.

Q - Mehdi Hosseini

Right, but, how would that increase or the pace of capacity increase for 65 nanometer change in the second half, given the kind of meaningful revenue contribution that you would be expecting by the first half of 2007?

A - Rick Tsai

Well, I think the -- it also depends on the definition of the meaningful. We -- I do expect to run some volume of 65 nanometer by second half, maybe later part of the second half -- a couple of thousand, a couple of two thousand wafer, for instance. That takes -- to install 65 nanometer capacity takes quite a bit of investment and some time. So, we want to prepare ourselves.

Q - Mehdi Hosseini

And would it be fair to conclude that that required investment for additional capacity is not in the calendar '06 CapEx budget?

A - Rick Tsai

No. I think the answer is no. I mean, some of the 65 nanometer CapEx is in the--.

A - Lora Ho

2006.

A - Rick Tsai

2006 budget. But, you also have to realize, quite a bit of those equipment can also be used for 90 nanometer. We're not going to let them just sit there, other than some, maybe some very specialized equipment. Your second question?.

Q - Mehdi Hosseini

The second question had to do with your available capacity growth 18% for 2006. But, if I just look at Q1 shipment and increase that moderately throughout the year, your wafer shipment could be well above 18% growth. So, how should I think about the Q-over-Q wafer shipment while your capacity is truly utilized?

A - Lora Ho

Let me explain this. The quarter capacity you are seeing right now does not include outsourcing capacity, which will contribute to our extra shipments. So, it includes -- actually the increase year-over-year is bigger than 18%.

Q - Mehdi Hosseini

Would that be well above 20%?

A - Lora Ho

I would say so, yes.

Q - Mehdi Hosseini

Thank you.

Operator

And our next question comes from Robert Maire from Needham. Please proceed.

Q - Robert Maire

Yeah. Two questions. One is in terms of inventory. Can you give us whatever insight you have as to what inventory exists in the channel, whether a dye bank or finished goods and what applications may have more or less inventory to give us some sense of, you know, how things are going in particular applications? And second question is in terms of utilization, if you could give us some granularity by geometry as to what your utilization rates look like and what your expectation utilization going over the next quarter or two would look like?

A - Rick Tsai

From an inventory point of view, I think, as we can read from the financial reports from many companies by now, it looks to us that the PC related inventory level is higher than the normal seasonal pattern. Almost all inventory level in all companies goes up in first quarter sequentially.

Q - Robert Maire

Yeah. I'm looking for what has gone up more than the normal seasonal average.

A - Rick Tsai

Yeah, PC.

Q - Robert Maire

Yeah. And that's both on the graphic and the chip set side or more on the chip set side?

A - Rick Tsai

I don't think I can comment on that specific in this case. On the other hand, other segments look pretty reasonable, pretty reasonable. Let me see. What's your other question?

Q - Robert Maire

The other question was utilization by geometry, you know, where the current utilization is at on a geometry basis and where you see that going over the next couple quarters.

A - Lora Ho

I'm sorry. I probably cannot talk about utilization by geometry. But, I can tell you, overall utilization is pretty full. As you know that we are building advanced technology capacity to meet customer demand. So, you can imagine, if the demand is there, we will continue to build capacity. And we think that it is going to be quite high. And we have been saying that we cannot -- we do not have enough capacity and we are looking for every possibility to get more capacity to the customers that are quite full. And the other logistic analogy I would say, it's not 100% full, but it's very high, very high.

Q - Robert Maire

Okay. So, that's somewhere in the 90s across the board. Is that an accurate statement?

A - Lora Ho

Above.

Q - Robert Maire

Above 90% across the board. And I would assume that the smaller geometry's utilization is close to 100 or if not at 100?

A - Lora Ho

Yes.

Q - Robert Maire

Okay. Thank you.

Operator

Our next question comes from Timothy Arcuri from Citigroup. Please proceed.

Q - Timothy Arcuri

Hi, a couple things. If I talk to some of your suppliers of equipment, it sounds like you're accelerating orders fairly dramatically in the June quarter. And if I look at your capacity add, you're going to add now about 6% sequential capacity now in the fourth quarter of this year, which is probably the tools being ordered in the June quarter. And if I go back and I compare that since 2000, you've only ever added 6% sequentially in the fourth quarter one time and that was in 2002 when you added 9%. So, I wonder if that's a sustainable amount of capacity to be adding in what's typically kind of a seasonally soft quarter, the fourth quarter. And I wonder if that kind of rate of capacity add might be, you know, a little closer to peak. Thanks.

A - Rick Tsai

Right now, we don't believe so. Right now, we don't believe so. Some of -- but, of course, there -- if the guys you cover can ship their product sooner, that would be fine. Then, the first quarter number will be a little lower.

Q - Timothy Arcuri

Right. Okay. Well, yeah, they can probably get you tools relatively quickly, so. Okay, that's the first question. Then, the second question is at what point, to your point about lead times and about the suppliers being able to ship tools relatively quickly, what point in the year do you have to start working off of 2007 CapEx? So, in other words, can you still order equipment in the September quarter and have it installed this calendar year?

A - Lora Ho

It depends on the equipment lead-time. The problem with equipment is it takes a longer lead time. So, you should talk about September quarter fulfill this year's demand, that would be difficult because it's only a few months.

A - Rick Tsai

Yeah, you need to get the equipment installed and be qualified.

A - Lora Ho

Right.

A - Rick Tsai

So, it's obviously difficult.

Q - Timothy Arcuri

Okay. Let me just ask one more, just so that I can understand this. So, if I take your fourth quarter sequential capacity addition of 6%, which is what you're actually guiding to, if I annualize that, I get 24%, which is the same amount of capacity year-over-year you added in '05 and more than you added in '04 or '03 or even '02, for that matter. So, it would seem that on an annualized basis, that the fourth quarter's capacity add would be fairly aggressive relative to maybe some of the inventory levels that we're seeing out there. Would you agree with that?

A - Lora Ho

You're saying you'll annualize our fourth quarter and you figure out 24% increase year over year. I have to remind you that in the capacity forecast we give you, does not include the outsource capacity. We are adding a new source, which is PSV Company, as one of our outsource companies, which was not exist in the past few years.

Q - Timothy Arcuri

Understood, yeah. I was just taking the 6% of your own capacity that you're guiding to in the fourth quarter and 6% Q4 divided by Q3 and just annualizing that and getting 24% year-over-year, which is more than you've added in really any year in the last five years annualized. So, that's where I was going. Thanks.

Operator

And our next question comes from Pranab Sarmah from Daiwa Institute of Research. Please proceed.

Q - Pranab Sarmah

Hi, good afternoon, this is Pranab. I have a couple of questions. I just read the last quarter, you mentioned like your systems customers are doing very well. Could you just elaborate, like how the system customers are going to perform in the second quarter and -- yeah, this is my first question.

A - Lora Ho

Pranab, you're talking about what customer?

Q - Pranab Sarmah

Systems. Like, it was put under fabless category now.

A - Lora Ho

Oh, I see, I see. We do not comment individual customers.

Q - Pranab Sarmah

Okay. In systems customers, I guess you have more than one customer.

A - Lora Ho

I cannot tell you that.

Q - Pranab Sarmah

Okay. Then on technology front, could you give us the development of 45 nanometer and what time frame you can expect some results from your R&D side on 45 nanometer?

A - Rick Tsai

Well, 45 nanometer actually, that would be -- actually, we're going to have our -- are we going to -- we're going to have our Technology Symposium next month. Are we going to talk about 45? Suffice to say that the 45 nanometer we have a big team working and we are accelerating the development phase. It is technically challenging technology, but we're determined that we will be one of the very early ones to deliver the technology. And we do have customers working very closely with us. We do expect something to happen next year.

Q - Pranab Sarmah

Okay. So, we'll wait for the announcement on this next month probably technology conference. And could you give us some idea about new fab construction and when you think that you'll be able to bring in equipment on the fab 15?

A - Rick Tsai

Oh, sure. What we will -- fab14 is down in China and right now, the Phase I is pretty much full. We are right now ramping the Phase II, which is basically an extension of Phase I. We will be starting the construction for Phase III in second half this year. That's our current plan for this year.

Q - Pranab Sarmah

Equipment movement will be probably end of 2007 in that case on the Phase III?

A - Rick Tsai

That's probably -- let me think. Yeah, that's probably about right.

Q - Pranab Sarmah

Okay. Thank you very much.

Operator

Our next question comes from Ivan Goh from Dresdner. Please proceed.

Q - Ivan Goh

Hi, good evening. I'd just like to ask something about the mechanics of capacity addition. In the afternoon, you said that you believe that -- you forecast that the semi industry growth will be 8% to 11% in 2006. If I look at your capacity growth this year, it's 18%. And I think you also mentioned as a preliminary forecast for 2007 is for industry to grow about, in the high single digit percentage. So, if we assume that that forecast firm up, I mean, what kind of capacity growth are you likely to plan for 2007?

A - Lora Ho

It's probably too early to talk about the capacity in 2007.

Q - Ivan Goh

Is there any relationship between how the semi industry, between semi industry growth and your capacity growth?

A - Rick Tsai

If you’re asking whether we are making the capacity sufficient based on the semiconductor growth projection --.

Q - Ivan Goh

Exactly.

A - Rick Tsai

I think that would at best, a second order consideration.

A - Lora Ho

Semiconductor growth -- foundry usually grow bigger than semiconductor growth. So, when we plan capacity, we are planning on our foundry capacity growth, which is normally bigger.

Q - Ivan Goh

Okay. And I want to ask also a question on the fab 14. As you said earlier that you have started to construct Phase III. And I presume, by next year you would -- if invested, you will start increasing in the second half of 2007. How much would the shell and the facilitization of that Phase III cost and how would that be split between 2006 and 2007?

A - Lora Ho

Ivan, very difficult to answer. I can tell you that the shell, percentage of the shell is 12 inch versus 8 inch. You can imagine as the equipment gets more expensive, the percentage of shell will be less. For 12 inch, it will be less than 8 inch. I probably cannot give you a good number about how does that split between 2006 and 2007.

Q - Ivan Goh

Okay. Thank you very much.

Operator

We have a follow-up question from Bhavin Shah from JP Morgan. Please proceed.

Q - Bhavin Shah

Yes, a couple of questions. Will you be adding any new Top 10 Travelers customer over the next 6 to 12 months and if so, what kind of products? Then I have another question.

A - Lora Ho

Bhavin, we cannot hear you clearly. Can you repeat your question?

Q - Bhavin Shah

Yeah, sorry. Would you be adding any new Top 10 Travelers customer over the next 6 to 12 months and if so, for what kind of product?

A - Rick Tsai

Bhavin, I -- well, I think it would be inappropriate to answer the question directly in that you know there are very few Top 10 Travelers companies which are not our customers. So, it is just not our policy to comment from that point of view. Please excuse us.

Q - Bhavin Shah

It’s alright, that’s okay. I just gave it a try. And on the flash, could you comment on any plans beyond Spansion and also specifically for Spansion, how big it could be and whether or not it could be complimentary to your logic business in terms of helping you with any fall in utilization of the logic business. Thank you.

A - Rick Tsai

Okay. We are working on flash. We -- I think we are in the process of remedying the NOR or flash production, although I would say the overall revenue and the quantity is still not very significant compared to our overall total revenue. We do -- however, we do -- we also are working on other form of, other forms of non-volatile memory. We view it always as a long term or mid to long-term growth area. And we are putting, I think, I would say significant resources together with our customers, our partners, to develop those technologies and the -- they will provide I think revenues, growth possibility and in some cases, I think they can help us fuel the fire, also.

Q - Bhavin Shah

Great. Thank you.

Operator

Our next question comes from Dan Heyler from Merrill Lynch. Please proceed.

Q - Daniel Heyler

Hi, Rick. I had a follow-up question on 45 nanometer. Over the years, TSMC has been able to open doors to new applications and new products at each technology. Does this 45 nanometer provide any opportunities or any platforms that you necessarily haven't addressed yet?

A - Rick Tsai

Dan, I'm not sure I -- we understand your question.

Q - Daniel Heyler

For example, CPUs, for instance, or -- and there is possibility of a product or anything else?

A - Rick Tsai

Oh, I see. I would say, yeah, other than the, our -- what we have been working very successfully on during the year and still across a few years and now. We certainly are considering other platforms which can use our event technology and the -- those will take some pretty major effort.

Q - Daniel Heyler

Got you. Thanks. And it sounded as if they, when you talked about the very tight situation on 200 millimeter, you're both increasing your outsourcing from the 5% level in addition to adding internal capacity. But, your overall capacity growth still is very mild. So, what I'm wondering is, are those internal additions more technology upgrades - that is, maybe taking 0.25 and migrating to 0.15 or what -- maybe you could explain what's going on, on the 200 millimeter internal movements.

A - Lora Ho

On the capacity number, you have seen, on internal capacity growth, if you look at a breakdown by fab, you can find out if majority, these 300 millimeters on the 12 range expansion. Other than that, looking from a chart, I can see on those range we're adding incremental capacity on each fab.

Q - Daniel Heyler

I'm wondering--.

A - Rick Tsai

Awesome but Dan, let me -- pardon.

Q - Daniel Heyler

I'm here, yeah.

A - Rick Tsai

Well, I just want to add that the -- we're not upgrading quarter micron to 0.18 since we have also a pretty strong demand for quarter micron. So, we are adding extra capacity for 0.18. But, it also takes time to get these collating and in store and qualified. So, that's why I think you're seeing somewhat moderate increase this year for internal. How it's working - we are doing that, but what we are seeing right now is probably what we're going to do for a while.

Q - Daniel Heyler

Great. And then, last question on the outsourcing number - do you have kind of a normalized -- there's a cycle percentage outsourcing that you are going to work with, work around that or does once maybe demand slows, would you tend to pull that number down to zero again?

A - Rick Tsai

I think right now the outsource capacity, if you look at the size of the outsource capacity, which is relatively small, I think in the foundry, I think we're working a combination of the outsourcing from us to our -- to other companies. But some of them will stay there for long-term. Some of them, more depending on the customers' preference, they may have more than one source. I think from TSMC's point of view, once we qualify those sources, we like to keep a longer term relationship because we believe over the long period of time, we will be able to utilize much of growth volume, if not all for the time.

Q - Daniel Heyler

That's very helpful. Thank you.

A - Rick Tsai

Okay.

Operator

Our next question comes from Doug Reid from Thomas Weisel Partners. Please proceed.

Q - Doug Reid

Thanks. I was wondering, within the 24 customer engagements you now have at 65 nanometer, could you indicate how many were secured during Q1? And also, were any of those customers not previously a TSMC customer of 0.13 micron or 90 nanometer?

A - Rick Tsai

I can only -- I mean, I don't have the full list at hand. I can only say that I believe most of the customers are what we've been working with for some time. There might be a couple or three that are fairly new. What was your first question?

Q - Doug Reid

Well, I was wondering how many of those 24 engagements were secured during the first quarter.

A - Rick Tsai

Oh. It was -- I really don't have that data at hand.

Q - Doug Reid

Okay. Thanks.

Operator

Our next question comes from Mark Fitzgerald from Banc of America. Please proceed.

Q - Mark Fitzgerald

I was wondering how important these companies were during R&D, outsource R&D design in the states like East Silicon are in terms of your current wafer starts and how important they are from a growth point of view for the company?

A - Lora Ho

Mark, can you say -- can you repeat your question again, please?

Q - Mark Fitzgerald

Sure. The -- we've got a number of startups in the states here doing outsource R&D design, companies like East Silicon. And I'm curious how important they are as customers for TSMC at this point in terms of their starting the wafers there and how important a trend it is for you going forward from a customer point of view.

A - Rick Tsai

So, you're asking from a business model point of view?

Q - Mark Fitzgerald

Yeah, exactly. And how important it is -- I mean, how many wafer starts are -- I'm not looking for exact data, but are they important part of the mix at this point or growing part of the mix?

A - Rick Tsai

I think they're growing. I really cannot comment on the wafer starts. They are growing. I think from a business model point of view, they certainly provide an avenue for quite a few startup companies. They work closely and will with us. We -- I think this is -- to me, these, so far, is a good model. I think it's good for them and pretty good for us, too.

Q - Mark Fitzgerald

And has it done anything to lower the cost of design or the cost to start up or -- companies use employing?

A - Rick Tsai

You mean have we done anything?

Q - Mark Fitzgerald

Well, I mean, has the whole business model helped in terms of lowering the cost of -- design is ramping, is it an important, very high growth part of the expense of chip manufacturing at this point?

A - Rick Tsai

Oh, you mean for their model?

Q - Mark Fitzgerald

Yeah.

A - Rick Tsai

Again, I mean, I do not know every case that well. I think for many of the startup companies which have a very good system expertise, while lacking some of the implementation resources, this model seems to have a good match. Whether the cost is better or not, I do not know.

Q - Mark Fitzgerald

Okay. Thank you.

Operator

We have a follow-up question from Shailesh Jaitly from Nomura Securities. Please proceed.

Q - Shailesh Jaitly

Yeah, hi. Lora, if you could help explain the scalability of this outsourced capacity as to what proportion of your capacity would you say is coming from the outsourced segment and how scaleable is it in terms of going forward, what do we expect by the end of the year?

A - Lora Ho

The outsource capacity, currently roughly accounts for 5% of total capacity. And now, we have two outsource perhaps providers, namely Vanguard. They have been working with us for a long time. We are adding Power Chip this year and potentially coming on third quarter and fourth quarter. You're asking how scaleable--.

A - Rick Tsai

Those are mature.

A - Lora Ho

Those are all mature technologies, 0.18 micron and above. You're asking how scalable.

Q - Shailesh Jaitly

That's right.

A - Lora Ho

As Rick just mentioned, once we engage to outsource and we are considering to use them for a longer term. I think in terms of scalability, I'd say it's quite flexible, depending on our need.

Q - Shailesh Jaitly

And how big would the capacity, what you're adding from Power Chip?

A - Rick Tsai

I don't think we should disclose that. But, in the total capacity ratio gives, should give you a pretty good idea.

A - Lora Ho

It's a smaller par.

A - Rick Tsai

Between the two.

A - Lora Ho

Between the two.

Q - Shailesh Jaitly

Okay. And finally, this IDM revenue portion of the business, which declined at about 12% this quarter, if you could help explain it, to which segments that related to and is that coming back or fourth quarter had already seen the peak level of revenue from these segments?

A - Rick Tsai

I don't think we can really say which segment that will but suffice to say that we -- I think those business will be back even in the second quarter. Again, also, again looking at the just one quarter at a time may be too fine a granularity. But, I think I've said that many times before. You look at the history of the TSMC. The ratio between IDM and the fabless harbors the wrong range. It's not by design, but it just works out that way. And I don't see any reason for that to change dramatically in the future.

Q - Shailesh Jaitly

Okay, thank you.

A - Lora Ho

Operator, in the interest of time, we will just allow one more question. Thank you.

Operator

And our last question comes from Bhavin Shah from JP Morgan. Please proceed.

Q - Bhavin Shah

Yes, I believe a similar question might have been asked in the afternoon. When you look at your capacity increases in Q3 and Q4 and it's really below typical seasonality you might see in your business in those quarters. So, how should we interpret that? Is it probably a statement from you’re saying that first half, your first half business is above seasonality? So, that's -- in other words, customers are preparing for second half in advance? Or is -- should we interpret it in any particular way, the fact that you are adding pretty modest capacity and utilization is already I guess almost full?

A - Lora Ho

Bhavin, when you said it's below seasonality, I want to clarify one thing. The capacity we're adding on each quarter mainly advance geometry. So, if you look at 4%, 6%, this number is in percent revenue increase. This is one thing. Another one that I just explained earlier -- also in capacity, many joining in the third quarter and fourth quarter. So, exclude the number from what I've been showing you, the outsourcing contributes some of -- part of our capacity in the second half.

A - Rick Tsai

Bhavin, believe me - we're not planning on a lower second half. Maybe we should prepare our capacity communication a little better next time. I mean, there are so many questions on that and I think we need to improve that. But, it definitely does not mean that we're expecting a lower second half. So, second half here is second half, it's still a few months away. I cannot guarantee that either.

Q - Bhavin Shah

That is good. Thank you.

A - Rick Tsai

All right. Thank you.

Operator

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

Lora Ho, Vice President, Chief Financial Officer

Thank you very much and very happy that we can talk to you this quarter. So, we're looking forward to see you next quarter. Bye bye.

Operator

Before we conclude TSMC's first quarter result Webcast conference call, please be advised that the replay of the conference will only be accessible through TSMC's Website at http://www.tsmc.com/. Thank you all and have a great day.

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