Welcome to the Semiconductor Manufacturing International Corporation first quarter 2015 webcast conference call. Today's conference call is hosted by Dr. T.Y. Chiu, Chief Executive Officer, Dr. Gao Yonggang, Chief Financial Officer, Mr. Gareth Kung, Executive Vice President of Strategy, Business Development, Finance, and Company Secretary, and Mr. Yi Lin Fang, Vice President of Investor Relations. Today's webcast conference call will be simultaneously streamed through the internet as SMIC website. Please be advised that your dial-ins are in listen-only mode. However, at the conclusion of the management presentation, we will have a question and answer session, at which time you will receive further instructions on how to participate. The earnings press release is available for download at www.smics.com. Webcast playback will be available approximately one hour after the event at www.smics.com.
Without further ado, I would like to introduce you to Mr. Yi Lin Fang, Vice President of Relations, for the cautionary statement.
Good morning and good evening. Welcome to SMIC's first quarter 2015 earnings webcast conference call. For today's call, our CEO, Dr. T.Y. Chiu, will first provide some general remarks. Afterwards, CFO, Gao Yonggang, will highlight our financial performance and give next quarter's guidance. Then our Executive VP of Strategic Business Development, Finance, and Company Secretary, Mr. Gareth Kung, will give the detailed financials commentary. This will then be followed by our Q&A session. As usual, our call will be approximately 60 minutes in length. The earnings press release and quarterly financial presentation are available for you to download at www.smics.com under Investor Relations in the Events and Presentation sections. Before I turn the call over to Dr. T.Y. Chiu, let me remind you that the presentation we'll be making today includes forward-looking statements.
These statements and other comments are not guarantees of future performance, but represent the company's estimates and are subject to risk and uncertainty. Our actual results may differ significantly from those projected or suggested in any forward-looking statements. For a more complete discussion of the risk and uncertainties and could impact our future operating results and financial condition, please see our filings with the U.S. Securities and Exchange Commission and the Hong Kong Stock Exchange Limited, including our annual report on Form 20-F filed with the U.S. Securities and Exchange Commission on April 28th, 2015. During the call, we will make reference to financial measures that do not conform to generally accepted accounting principles, GAAP. These measures may be calculated differently from similar non-GAAP data presented by other companies.
Please refer to the tables in our press release for a reconciliation of GAAP to the non-GAAP numbers we will be discussing. Please note that all currency figures are in US dollars, unless otherwise stated. I will now turn the call over to our CEO, Dr. T.Y. Chiu, for the opening remarks.
Thank you, Lin. Good morning and good evening. Thank you all for joining us. Utilization were high for our eight-inch fab last year when we ended in 2014 with 93% utilization in Q4. Most of our upside potential for the first half of 2015 was dependent on the rise of existing 12-inch utilization, namely 65 nanometer and 40 nanometer. In preparation last year, we successfully taped out new products over a broad range of applications for 65 and 40. We have growth in Q1, and we are guiding additional growth in Q2. Today, I'm happy to highlight our first quarter achievements and will follow with our recent technology progress, project status, company update, and outlook. In the first quarter, we utilized most of our existing assets on both eight-inch and 12-inch as a result of good market demand and diverse product mix exposure.
In the first quarter, our revenue increased 13% year-over-year and 4.9% quarter-over-quarter. Revenue hit $509.8 million, our highest Q1 revenue on record. Gross margin was 10-year high of 29.4%, and we achieved our 12th consecutive profitable quarter. Profit attributable to SMIC was $55.5 million. If the living quarters sales were excluded, we have achieved an all-time record high profit of $55.3 million. China region revenue grew to 47%. Revenue from 40 nanometer and 65 nanometer grew more than 25% quarter-over-quarter, and more than 58% year-over-year. To address our technology progress, we continue to work on 28 nano product qualification. We are pleased to report that we have already received an initial approval and will begin small volume risk production in Q2. We still target high-k metal gate to be two to three quarters after polysilicon process ramps successfully, and the 28RF later in 2016.
The specialty technology demand continued to be strong. PMIC, CIS, and EEPROM account around one-third of our revenue. Meanwhile, our newer applications will begin ramping throughout this year. Bank card IC are already shipping and undergoing high volume, large area system testing and are forecast to be more than triple this year. Our customers' eight megabit BSI CMOS image sensors started production in the first quarter and will begin shipping in the second quarter. Our new fabs are coming in line on schedule. To address eight-inch demand, we have started operation in Shenzhen and installed 10,000 wafer per month capacity at the end of 2014. Shenzhen will have revenue from metallization-related manufacturing in support of bottlenecked back-end of the existing eight-inch fabs. We will have shipments during the second quarter, and we plan to have full flow manufacturing revenue from Shenzhen in the third quarter.
By the end of this year, we plan to install an additional 10,000 wafer per month of capacity in Shenzhen. We are also incrementally increasing our eight-inch capacity in Shanghai and Tianjin. Our Beijing B2 is qualifying both 40 and the 28 technology and is entering initial production at this moment. Our 12-inch fab in Shanghai has 14,000 per month capacity, mainly for 40, 45, and R&D, of which the 6K is capable of 28 nano production. In early March, we welcome our new Chairman to SMIC, Dr. Zhou Zixue, whose extensive experience in electronic information industry in China provide us with great insight. We would also like to thank our previous Chairman, now an advisor as well as Honorary Chairman, Mr. Zhang Wenyi, for his exceptional contribution and continued dedication to this company. Our steadfast commitment to be an independent and international company remains strong.
The primary goal is to maintain sustainable profitability, and this goal has not been changed. Our aim to grow the company and to service our global customers is our primary goal in mind. To execute our goal, our strategy remains the same in threefolds: maintain full utilization; differentiate and diversify our technology portfolio to provide value for our customer and to address broad market need and profitable area of growth; and lastly, to expedite advanced technology in preparation for the migration of the application we serve. We increase our capacity carefully according to the need of our customers and our own capability. We always carefully consider partnership which will benefit SMIC in the long run and which contribute to our goal of growth and sustainable profitability. In August last year, we formed a bumping joint venture with JCET.
This project is on schedule with equipment currently being moved in and production targeted to begin in the second half of this year. This JV has already begun to generate revenue from wafer probe testing. Last year, many are asking about the Chinese government, how the Chinese government would support the IC industry after the formation of the IC investment fund. In mid-February, we announced that China Integrated Circuit Industry Investment Fund was to invest approximately $400 million in SMIC. We believe this demonstrates the fund's confidence in SMIC's strategy, track record, and execution, and to further support our long-term goal of gaining the stronger foothold in China and the global IC market. As the largest and most advanced foundry in China, we are looking forward to benefit from the overall growing IC ecosystem in China.
In conclusion, we are witnessing a relatively strong first half with very high utilization and a broad range of application. Growth in the first half is being driven from a diversified base of 65 and 40 products. We are cautiously optimistic about the second half during the industry's Oh, no, sorry. We are cautious about the second half giving the industry's inventory situation. However, we remain optimistic about our long-term future as we work on our 28 nano and the new eight-inch capacity in Shenzhen. We stay committed to maintain sustainable profitability and building value for all stakeholders. Thank you for your time. I will now hand the call to Yonggang for the financial highlight and 2015 Q2 guidance.
Okay. Thank you, T.Y. Greetings to all our listeners. First, I will now highlight our fourth quarter 2015 results and our second-quarter guidance. Our revenue was $509.8 million in 1Q15, an increase of 4.9% quarter-over-quarter, an increase of 13% year-over-year. Gross margin was 29.4% in 1Q15, our highest since 1Q04, compared to 22.5% in 4Q14, and 21.3% in 1Q14. Profits for the period attributable to SMIC was $55.5 million in 1Q15, compared to $28.4 million in 4Q14 and $20.3 million in 1Q14. If excluding gain from disposal of living quarters, our profits for the period attributable to SMIC was $55.3 million in 1Q15, a record high. China region revenue grew to a record high of 47 points of overall revenue in 1Q15. Looking ahead into second quarter of 2015. Our revenue is expected to increase by 2%-5% quarter-over-quarter.
Gross margin is expected to range from 27%-29%. The non-GAAP operating expenses, excluding the effect of employee bonus accrual, government funding, and gain from the disposal of living quarters, are expected to range from $120 million-$125 million. Non-controlling interest of our majority-owned subsidiaries to range from positive $5 million to positive $7 million, which are losses to be borne by non-controlling interests. The planned 2015 capital expenditures for foundry operations are adjusted to approximately $1.5 billion, while the planned 2015 capital expenditures for non-foundry operations are adjusted to approximately $150 million. I will now hand the call over to Gareth for more detailed financial commentary.
Thank you, Yonggang , and thank you, everyone, for joining us today. I will now comment on the details of our last quarter financial results. On the income statement, revenue increased to $509.8 million in Q1 2015, up 4.9% Q on Q from $485.9 million in Q4 of 2014, mainly because of an increase in wafer shipment for 65 nanometers and 40 nanometers. Cost of sales decreased to $359.9 million in Q1 2015. Down 4.4% Q1Q from $376.6 million in the previous quarter. Mainly due to the decrease of depreciation as some equipment have been fully depreciated. Gross margin increased to 29.4% in Q1 2015, up from 22.5% in the previous quarter. The change was mainly due to, A, an increase in fab utilization, and B, a decrease of depreciation within the cost of sales.
Operating expenses in Q1 2015 were $104.4 million, a decrease of 3% Q1Q from $107.7 million in Q4 2014. R&D expenses was $53.5 million in Q1 2015 as compared to $53.1 million in Q4 2014. Excluding the funding of R&D contract from the government, R&D expenses increased by $6.7 million Q1Q to $50.8 million in Q1 2015. Funding of R&D contract from the government was $5.3 million in Q1 2015 compared to $12.4 million in Q4 2014. General administrative expenses decreased to $42.5 million in Q1 2015, down 7.7% Q1Q from $46 million in Q4 2014, mainly because of decrease in share-based compensation expenses, tax-related expenses, legal, audit, and consulting expenses in Q1 2015. Excluding the effect of employee bonus accrual, government funding of R&D contracts, and gain from disposal of living quarters, non-GAAP operating expenses was $99.7 million in Q1 2015 compared to $113.2 million in Q4 2014.
Profit from operation in Q1 2015 was $45.5 million compared to $1.6 million in Q4 2014. Other income was $6.1 million in Q1 2015 compared to $10.3 million in Q4 2014. Interest income was $1.4 million in Q1 2015 compared to $6.4 million in the previous quarter. The change was due to lower bank deposit balances during the period as a result of the repayment of bank borrowings. Income tax expense was $54,000 in Q1 2015 compared to $10.4 million in the previous quarter. The change was mainly due to the land value-added tax incurred in Q4 of 2014. Non-controlling interests were $3.9 million credit to SMIC's attributable profit in Q1 2015 compared to $26.9 million in the previous quarter. The change was mainly because part of the group's R&D expenses were recharged to Semiconductor Manufacturing North China Beijing Corporation in Q4 of 2014. Moving to the balance sheet.
At the end of the first quarter of 2015, cash and cash equivalent decreased to $402.4 million in Q1 2015 from $603 million in Q4 2014. Other financial assets, which mainly comprise of short-term investment, decreased to $586 million in Q1 2015 from $644.1 million in Q4 2014, mainly because of the repayment of bank borrowings during Q1 of 2015. Including other financial assets, we had approximately $1 billion cash on hand in Q1 2015 compared to approximately $1.2 billion in Q4 of 2014. Our long-term borrowings decreased to $217.1 million and short-term borrowings increased $30.7 million compared to the previous quarter. At the end of Q1 2015, our total debt-to-equity ratio was 32.9% compared to 39% in the previous quarter. Our net debt-to-equity ratio was 3.5% compared to 1.3% in the previous quarter.
In terms of the cash flow, we generated $134.3 million cash from operating activities in Q1 of 2015 compared to $195.2 million in Q4 of 2014, mainly because of changes in working capital and others. Cash used in investing activities decreased to $140.9 million in Q1 2015 compared to $644.8 million in Q4 2014, mainly because of less financial asset investment made by SMIC in Q1 2015. Cash flow from financing activities changed from an inflow of $690.2 million in Q4 2014 to an outflow of $185.8 million in Q1 2015, mainly because of the issuance of corporate bonds and capital contribution from non-controlling interest in Q4 of 2014, and the repayment of bank borrowings during Q1 of 2015. The funds from the private placement to the China Integrated Circuit Industry Investment Fund is expected to come in during the second quarter of 2015.
To examine our revenue by application, consumers and communication segments contributed 46.3% and 44.2% of our revenue, respectively. Geographically, revenue from China contributed 47% of total revenue. Revenue from North America contributed 41.1% of total revenue. Revenue from Eurasia contributed 11.9%. In terms of technology, revenue from 45/40 nanometers contributed 16%. Revenue from 65/55 nanometers and 90 nanometers contributed 26.1% and 4.6%, respectively. Meanwhile, 0.13 micron and above line width contributed 53.3% of total revenue. In terms of our overall capacity, total monthly capacity at the end of the first quarter was 251,500 eight-inch equivalent wafers, compared to 247,500 wafers in the previous quarter. The change was mainly due to the expansion of capacity in our Tianjin eight-inch fab. The overall utilization was 99.7% in the first quarter of 2015 compared to 93% in the fourth quarter of 2014.
The planned 2015 capital expenditure for foundry operations are adjusted to approximately $1.5 billion, which are mainly for, first, capacity expansion in SMNC's 12-inch fab, which is around $800 million, of which only $450 million is to be funded by SMIC. Two, capacity expansion in our new 8-inch fab in Shenzhen. Three, investment in the R&D tools, our mask shop tools, as well as in our intellectual property areas. The planned 2015 capital expenditure for non-foundry operations, mainly for the construction of living quarters, are adjusted to approximately $150 million. The group plans to rent out or sell these living quarters to employees in the future. I will now hand the call back to Aning for the Q&A session.
Thank you, Gareth. Let's open up for the Q&A. As usual, please be reminded to limit your questions to two per person. Operator, please assist.
Ladies and gentlemen, if you wish to ask a question, you'll need to press star one on your telephone and wait for your name to be announced. Once again, that is star one on your telephone and wait for your name to be announced. If you wish to cancel your request, you'll need to press the pound or hash key. Your first question comes from the line of Randy Abrams from Credit Suisse. Please ask your question.
Yes. Thank you. The first question I wanted to ask a little more on the outlook where I think you mentioned cautious for second half. If you could talk about what that is implying for the growth outlook, maybe versus historical or seasonality. If you could also put in context your CapEx, you increased a bit, where that increase is tied to, if it's more confidence on 8-inch or if it's tied to more 40 or actually more progress on the 28.
Okay. I think we are aware of the various results from various sectors of the industry. However, we are also a bit optimistic because our 65 and 40 have seen a lot of
Strong demand, and we have diversified the applications in these technology sectors. In some of these new applications, which is quite independent of the handset area, and we maintain our optimistic projection.
Randy, I just want to add to what T.Y. said. Yes, we do recognize that there could be some inventory adjustments, especially relating to the handset side. Many of our new applications in the 40, 45 nodes are actually more geared for the consumer applications. Also, we have a number of new technologies to be ramped up this year, including our bank card ICs for our 8-inch applications, as well as our BSI applications. Hopefully with this more diverse customer base as well as on the application side, we are able to cushion this weak market in the second half.
Okay. If I could ask on the outlook, the 40 and 55, which ramp, do you expect that to continue to ramp into your new capacity? Say when you do the Beijing JV, do you have the flexibility to do 40? If you could talk about the margin implications, the 40 has more mature yield, but it's lower wafer price than 28. How the margin outlook, as you ramp up the Beijing fab, what we should expect the profitability of 40 versus 28, and then overall profitability as you ramp up the new fab.
Okay. Definitely our new B2 fab will have the capacity that can address both our 28 as well as the 40 demand. I think the margin will be high when the utilization is high. We are happy to see this strong demand both in 40 as well. In that sense, that we are able to maintain a high utilization in the new fab that's coming up.
Hey, Randy. I think as we're going to ramp up two new fabs in the second half, which is the new Beijing fab, as well as Shenzhen fab, you expect there'll be some pressure on the margin. However, if we can maintain a relatively high loading, existing fabs, as mentioned by T.Y., because of the broad range of application that we are running in those fabs, we are hopeful that that could help to cushion some of this impact.
Okay. If I could ask a quick follow-up. The 6K for Shanghai, I think, is what you have available for 28. You're starting risk production. Do you expect by end of year that 6K at least would be doing the 28, or it's still subject to yield ramp at this stage?
We have the flexibility to move the 28, both in Beijing as well as staying in Shanghai. It will be a very dynamic planning process where we can optimize for the best of the profitability.
On the 28th, as T.Y. mentioned, we are going to start the small volume risk production in Q2. I think it's a bit too early for us to say in terms of revenue contribution of 28 by the end of the year. I think we're going to report to the investor as we make more progress.
Okay. Great. Thanks a lot.
Thank you.
Your next question comes from the line of Sujit D'Silva from Topeka. Please ask your question.
Hi, guys. How should I think about the opportunity in 28 nano compared to 40? Should I think about it in terms of number of tape outs or customers you have lined up, versus maybe 40 or 65 a year ago? How can I think about the opportunity there?
Okay. We have about five new products coming in for both polysilicon as well as high-k metal gate. This is a very, I think, robust interest when comparing to the 40 nano at the same stage. We remain very optimistic in terms of our 28 technology.
That's very helpful. How should I think about your capacity, your eight-inch capacity? Is it constrained now? How does the new investment, the $400 million you got investment, how does that perhaps help you increase the capacity, or is that not the strategy there?
As we speak, in the process of ramping up our new fab in Shenzhen, and we are targeting to have about 20K available by end of 2015, and we'll continue to ramp up the fab in Shenzhen next year. We expect there'll be continued shortage in the eight-inch capacity. We've been actively looking at opportunities to expand the fab mature node capacity.
Okay. Congratulations on the results.
Thank you. Let me just add that, as a matter of fact, that our Shenzhen, we were lucky last year that we have some of the tools that can meet the capacity beyond the 20,000. If there is even stronger demand in the mature nodes, we will be able to accelerate our capacity expansion. So that flexibility remains there in Shenzhen.
Very good. Thanks.
Your next question comes from the line of Steve Pelayo from HSBC. Please ask your question.
Yeah. A quick follow-up on the 200 millimeter. Excuse me. I guess when I look at 0.15 micron and above, that looks like maybe it was down more than 10% or so. 200 millimeter, you're adding capacity, yet your utilization rates were probably down as well. Could you talk a little bit about 200-millimeter utilization rates and, is this creating any excess capacity and potential pricing pressure on the 200 millimeter, which has really been kind of fully loaded for, I don't know, many quarters?
Steve, actually, you see the contribution is down because proportionally we are increasing more in our 65 and 40 nanometers. Actually, the shipment of eight inches is not down quarter-on-quarter. Secondly, yes, as we mentioned earlier, some of our communication customers are impacted and somewhat impacted our eight-inch as well. At the same time, as we mentioned earlier, that we have some new technology being introduced this year, including the bank card. We do see a quite important ramp-up for the bank card this year, as well as the introduction of our new BSI technologies. That could help our eight-inch capacity. All the more, given the eight-inch capacity is sort of limited in supply globally. We are still quite positive about our mature node business.
I guess what I'm getting at there is in your annual report, you disclose your largest customer, I think about 25% of revenue, and I think that customer's a pretty large 200-millimeter buyer for power management ICs. When I look at 0.15 and 0.18 micron revenues down 8% quarter-on-quarter. When I look at kind of the insourcing, Samsung kind of internalizing things like power management ICs. I'm just curious, do you see any risk there at 200 millimeter? Or it sounds like, given the fact that you're increasing capacity and see opportunities with bank cards that no, in fact, you're going to be no problem keeping 200 millimeter full, including the new capacity being added.
Hello, Steve. This is T.Y. It's a good question, indeed, as you say, that there are some decrease from our certain customers, we have fairly diverse new applications coming up. In this year, the eight-inch utilization is still very high. There is no decrease in utilization. There is somewhat of a difference because, in the past, our power management IC is a turnkey IC, we also are responsible for the back end. That contribution and the revenue on per wafer count is higher than like a BSI or other wafer mode, business mode. However, the utilization will remain very high in the eight-inch demand. We have a very high confidence that our Shenzhen fab will be fully utilized.
Okay.
Steve, actually, I think, I would say that from measurement point of view, we had anticipated that there could be an issue where we have too high loading from a single customer. In the last 2 years, we've been very active in terms of trying to diversify in terms of our customer base, as in terms of our application. I think, we are seeing some benefit from it right now.
Great. If I could just sneak in 2 quick more. With the capacity plans that you have and the 28-nanometer ramp plan and Beijing 2 ramp plan, could you just talk a little bit about the impacts to your depreciation costs in the second half of the year and really outlook in 2016 as well? Depreciation is one, and then the final question for me is, talk just to me a little bit about the system companies business. I guess I wasn't aware this has gone up from 11% to 16% of revenues. It really drove the bulk of the growth, I guess you could say, quarter-on-quarter. Any more clarity you can provide us on system companies there and depreciation? That's my last question. Thank you.
Steve, in terms of depreciation, as you can see from our disclosure, the depreciation expenses have come down in Q1, it will remain relatively flat in Q2. As we start to ramp up our 2 new fabs in the second half, it's going to step up. I think our guidance for the whole year depreciation remain the same, which is about 3% higher year-on-year. In terms of your question about system company. Yes, we do have exposure to pretty good system companies, and that again, shows that actually we are widening our customer base.
Yeah, Steve, let me also add that it's also unique. In China now, there are quite a number of system companies that are trying to also be involved in specializing their product and getting into the IC design, so that their product can be more unique. These system companies have been approaching SMIC, not only for our production capability but also design service, as well as our ecosystem, where we have design service companies such as Brite.
Okay. did you answer on 2016 depreciation thoughts, given the capacity increase?
Steve, I think we are still in the first half of 2015. I think it's a bit too early for us to comment on the depreciation for 2016. We will talk more about it in the second half.
Okay.
Your next question comes from the line of Leping Huang from Nomura. Please ask your question.
Thank you for taking my questions. I have two questions. First is, we see a lot of news report about China want to enter the DRAM business. what is SMIC's view on the DRAM business? Is interesting? if it happen, what will be the role of SMIC in this DRAM? Whether this will be partnered with China National IC Fund? These are the first question.
Okay. Hello, Leping.
Yeah.
We also hear about a lot of these report in the press. SMIC has always maintained a certain capability in memory business. We have had a NOR business all the way from 13, 90 nanometer, 65 nanometer, and we had last year announced our 38 nanometer NAND technology. However, we do not have DRAM capability. At this point of time, we have no firm plan to get into very high volume memories of production. If there are very good opportunity out there which we need to be convinced, at this moment, we do not have the plan.
It will be consolidated into SMIC's listed co , or it will be a separate? Since DRAM is basic-- I just worry about whether this will have negative impact on the SMIC's profitability.
Excuse me. We have not said there will be any consolidation into SMIC. At this moment, we have no firm plans on the separate memory business.
Leping, I think in the foreseeable future, our main focus will still be in our core foundry business.
Okay. The second question is, we see quite a lot of local news about the Zhongxin Juyuan and the venture capital arm of your business doing the-- For example, recently just acquire PA company. Can you slightly describe how big of the venture capital business in your, and what's the relation with your core business? Yeah, thank you.
We have a venture funds, which is about $100 million, that we have been managed by independent team and investing in different projects. They are quite separate from our core business.
I think this is very similar to other investment funds set up by major foundries. I think that hopefully, we will see that in the long term that these investments will bring more synergy in the whole IC ecosystem and bring SMIC additional revenue in the future.
Thank you.
Your next question comes from the line of Sze Ho Ng from BNP. Please ask your question.
Hi, good morning, gentlemen. Just want to know for Q4, should we still expect a very lumpy minority interest credit, or you have already tried to give out the impact for other quarter this year?
Yes. In terms of the non-controlling interest, it was pretty high in Q4 because we have a one-time recharge of our R&D expenses to our majority-owned subsidiary in Beijing for the use of our technology. Okay. For this quarter it is lower, and we have given a guidance for Q2. I think that is the main reason for fluctuation is because of the one-time charge in Q4.
We should still expect another lumpy credit in Q4 this year.
We have this arrangement that given our new Beijing fab, which is majority owned by SMIC, we're going to allocate part of this R&D cost to them. There could be another charge at the end of this year. This amount is not finalized yet.
Okay. All right. Second question for OpEx. Actually, the Q1, the number came in significantly lower than your guidance. Is there a chance that you may have, again, over-estimated the OpEx of Q2?
I'm sorry, I don't quite get your question. Can you repeat your question again?
Oh, okay. Sure. Yeah. Q1, the OpEx actually came in a lot lower than guidance. I'm just trying to see if there's a chance that you may have also over-estimated the OpEx of Q2 in your guidance.
Yes. No, we did our estimate the best we could, it is always our philosophy to be a little bit more conservative in our guidance. Yeah, I think the Q2 expenses should be in line with what we guided. Yeah.
Okay. All right. Okay, thank you very much. Anyway, good quarter. Yeah. Thanks.
Your next question comes to the line of Rick Shu from Daiwa Securities. Please ask your question.
Yeah. Hi, good morning. Just a few questions from me. Okay, regarding your Shenzhen fab, I think this fab has already started up and running. Why are you guys not including in your capacity, the total capacity calculation here?
Yeah, the reason is that, we are still not in the full flow manufacturing mode right now. Basically, it's more like a risk production mode. Yeah.
When do you expect to include this fab into your calculation?
We expect in Q3, the Shenzhen fab will commence commercial productions, for full flow. That is when we're going to reclassify the fab as a production fab.
I see. Okay. Fair enough. Could you remind me, because I think I missed this part. Talking about your CapEx breakdown this year. Can you run through that again?
Sure. The CapEx this year is $1.5 billion, which is for the foundry operation, of which about $800 million is for our new fab in Beijing. As you know, for that fab, we have 55% ownership, and the other 45% is held by other shareholders. The amount that we are going to fund out of this $800 million is about $450 million. The balance of the CapEx is mainly for our new Shenzhen fab, as well as the investment we are making in the R&D areas, in the mask shops, as well in IP areas. Then for the non-foundry operation, our CapEx is about $150 million this year. That would be mainly goes towards building of the living quarters for our employees.
Okay. Thank you. That's very clear. One last question is, I know you don't have a clear visibility for your full year depreciation, but could you give us some idea about your second quarter depreciation guidance?
Actually, I did mention about for Q2, the depreciation will be flat compared to Q1. As we're going to start the ramp up of the two new fabs in second half 2015, the depreciation is going to step up. On a year-over-year basis, the depreciation in 2015 will be 3% higher than 2014.
All right, great. Thank you so much. Congratulations for the results.
Thank you.
Your next question comes from the line of Daniel Haley from Bank of America Merrill Lynch. Please ask your question.
Yeah, thanks for taking my questions. I wanted to focus on cash flow questions here. I wanted a clarification, sorry, on the CapEx. You mentioned $1.5 billion CapEx, $800 million for the new fab. You then said you're only paying $450. That means $1 billion is going to be spent on everything else, including eight-inch. Could you explain what you mean by that? What is your cash CapEx?
Okay. I'm sorry. Let me clarify that.
What is your cash CapEx please?
This $1.5 billion include the $800 million CapEx for the new fab in Beijing. This $1.5 billion CapEx is a consolidated CapEx, okay? What we are saying is that, because the Beijing fab is only partly owned by SMIC, we are not going to contribute all the $800 million. We only contribute about $450 million out of this $800 million. If you work out these numbers, effectively for this year, the amount of CapEx out of this $1.5 billion CapEx, from SMIC, we need to fund about $1 billion.
Your cash CapEx will be $1 billion. Is that what you're saying?
We need to fund ourselves is about $1 billion.
What about the cash CapEx this year?
The cash CapEx will depend on all the payment terms and things like that. Yeah.
Okay. When I look at your cash and cash equivalents, they dropped from $600 million to $400 million quarter-on-quarter. Your cash flow from operations also declined from $195 to $135 per quarter. Could you walk us through how you're going to get to the $1 billion CapEx, to meet the funding of that? Looks like your cash balance is pretty low at $400 million. Your quarterly cash flow is around $130. How do we get to $1 billion this year to fund this? Thank you.
Yeah. Dan, what you saw on the balance sheet, the cash balances is only the cash and cash equivalent we have on hand. At the same time, we have about close to $590 million of short-term investment, which is actually cash as well. Altogether, we have about $1 billion cash that we can deploy right away. At the same time, as I mentioned, we have did a private placement to the National IC Fund that will be closed before end of June this year. We're going to bring in another $400 million. Okay. In addition, every year we generate about $700 million-$800 million cash from operations. I think we are in a very comfortable cash situation.
The $1 billion funding is going to come from the investment fund, $400 million. Should we assume that that's going to go directly?
No. The $400 million has not been reflected in our balance sheet yet. What we have right now on hand is about $1 billion cash that we can deploy. In addition, $400 million will come in before end of June. We still have cash generation from our operations.
Okay. That'll be probably deployed next year then, the $400 million then for next year CapEx. Is that right?
Well, the money will go into the pool, then we will deploy it as we need it.
Okay. Moving on to the income statement. You hit the upper end of your gross profit margin guidance is at 29%. You guided 27% to 29%. Then, the depreciation, though, exceeded your guidance. You said flat previously, and it was down 3%. I'm wondering why, given the depreciation dropped so much, what the dynamics there. Why aren't we seeing actually higher margins? Was that depreciation number a surprise to you? I'm just trying to understand why the margins are not going up more, given your revenue grew, right? You also had a drop. Your utilization went up quite a bit. Your depreciation fell 3%, but your GP margin was kind of up a tiny bit. Is it mix related, or why not more operating leverage there?
Okay. Dan, trying to respond to your question point by point. Our gross margin went up obviously for two reasons. One is because of the high utilization. I think there's a big jump of utilization there. Then, the second reason for the high gross margin is because I think our depreciation has dropped off about $10 million in Q1 compared to Q4. As I mentioned, this drop-off in depreciation because some of the equipment have been fully depreciated. Okay. Then we have guided in Q2, this depreciation will be flat compared to Q1. Okay? Then for the whole year, because of our two new fabs that are going into production in Q3 and Q4, you're going to see a step-up in the depreciation in Q3 and Q4. On a year-on-year basis, depreciation in 2015 will go up by 3% compared to 2014.
Yeah.
Okay. I hope this is clear to you. Okay.
Just trying to figure out the operating leverage, because as you look at the second quarter, you're guiding up again 2%-5%, but your GP margin is kind of below. You're saying 27%-29%, so implying potential downside to margin in the second quarter, yet depreciation is flat. I just want to understand the operating leverage there.
First of all, I think we have to consider some of the product mix change. At the same time, we try to be conservative in terms of our guidance.
On the operating expense side, finally, you had a big drop in G&A, and I'm wondering pretty much how sustainable that is. If you could guide us second quarter, your G&A and R&D expectations, please, for second quarter, that would be great.
In terms of our OpEx, actually, our OpEx have been increasing in the last few quarters. In terms of R&D, is already in the 10%-12% range, and we expect that to remain at a fairly high level throughout this year. In terms of G&A expenses, it have been higher because a lot of the startup costs for the two new fabs in Beijing and Shenzhen are still recorded as G&A expenses now because it's pre-production. As we move to production in second half of 2015, that portion of expenses will come down slightly. Overall, I think our total OpEx will still be in the around 20% range.
Because you'll be adding a lot of people in the second half of the year. Maybe just in absolute numbers, $42 million G&A and $53 million. As we look at the second half, where should that number go? Can we run operating expenses at $104 million overall for the third and fourth quarter, or is that going to go up substantially? I assume you're hiring people and you're expanding operations. Maybe walk us through your operating expense for second half, the dynamics there, and quantitative guidance would be great.
Okay. In terms of non-GAAP OpEx, we are at about $100 million in Q1, and we should see a little bit higher in Q2 because of the higher R&D expenses and also higher spending on our new fab in Beijing and Shenzhen, because we are intensively building up the fab for production in second half of 2015. I think we have guided the OpEx for Q2 already, which is in about $100 million-$120 million range. In Q3 and Q4, because some of the G&A expenses, which is relating to the start cost for the new fabs, will move in the cost of sales. That number will come down again. That will be what we can share at this point in time.
You think you can sustain about $105 million operating expense on a quarterly run rate in the second half of the year. It should be pretty close to that, is what you're saying. Expenses go up, but then they shift the cost of goods sold in the second half of the year. Is that right?
That's correct, yes.
Okay. Thank you.
Yeah.
Your next question comes to the line of Ken Hui from Jefferies. Please ask your question.
Good morning. Thank you for taking my questions. My first question is regarding your 28 nanometer. How many customer would you expect to contribute to your revenue towards end of this year? Would it be just one single customer, or would it be possible to have some additional customers? That would be my first question. Thank you.
Hi, Ken. This is T.Y. Okay. We think that there is potentially one additional customers that can give us some small revenue by the end of the year. Indeed, there are opportunities that we are trying to address as much as possible.
Okay. Thank you. My second question is regarding your ramp of the new product at 65 nanometer and 40 nanometer. As the contribution is going to get higher, how we should think about your overall change in wafer ASP going forward?
We expect wafer ASP should remain relatively flat throughout this year.
The drivers behind that would be, because I thought the new products may have relatively better ASP, or is it because there are some other products which have lower ASP going up as well?
Yes. Actually, our mix, based on our visibility, the mix will be pretty stable in terms of our technology mix. There should not be material impact on our ASP.
Okay. Thank you very much.
Let me just add one complimentary comment. Yes, as we ramp up 45 and 40, there is also additional ramp up in terms of the Shenzhen capacity. The Shenzhen capacity, because it is a mature node, the ASP will tend to pull in the opposite direction.
Oh
balance each other. The overall ASP will remain more or less constant.
Right. Thank you.
Your next question comes to the line of Bill Lu from Morgan Stanley. Please ask your question.
Yeah, hi. Good morning. Thanks for taking my questions. If I look at CapEx and depreciation, you're raising CapEx a little bit from $1.4 billion-$1.5 billion, and yet your depreciation, you're guiding for up 3% year-on-year versus what you had said previously. Is this a timing issue? Are you changing how you depreciate, or can you talk a little bit more about that?
Hey, Bill, just want to clarify. Actually, we are saying year-on-year, the depreciation will go up 3%, not down 3%.
Yeah, up 3%. I think previously you said it'll be up $70 million.
Okay. I think there are some timing issues. The depreciation will depend on where we put the equipment and where we actually start commercial production. as Gareth mentioned, even though the depreciation is sort of lower in Q1 and Q2 because some of the existing two are fully depreciated, and we start the commercial production in Shenzhen and in our new Beijing fab in the second half, that is going to step up. Overall, year-over-year is going to go up by about 3%.
What is different now in terms of the ramp schedule? Is it more on the leading edge or is it the aging stuff?
Well, when we mentioned about the increase in $70 million last year, I think that's based on a relatively early estimate in terms of our pull-through in timetable and also in terms of when we're going to start production. Right now, I think we have a better visibility now. We can give a more accurate estimate.
Got it. Okay, thanks. The second question, I think Steven Pelayo asked this as well. You saw a big increase in the system house revenues. What application is that for? Is that the communications?
Actually, it is a very wide application. It covers both communication as well as consumer areas. I think that we are fortunate here in China, there will be more and more system house with a very wide applications coming in, seeking support from SMIC in terms of the design service as well as final production.
Okay, sorry. If I could sneak in one last question. I know you're not ready to talk about 28 contribution by the end of the year, but you also said that you've received a PO for 28 already. Can you talk about how big that PO is?
Sorry. At this moment, we are not going to talk about the size of the PO. We will report progress about 28 as we go along in following few quarters.
Okay, great. Thank you very much.
Thank you.
I would like to hand the call back to your CEO, Dr. Chiu, for closing remarks.
In closing, I would like to thank everybody who participated in today's call and, again, thank all of our shareholders, customers, employees, and suppliers for their trust and the support. Thank you very much, and see you next quarter.
This is the end of SMIC first quarter earnings conference call. We thank you for joining us today.