Welcome to the Semiconductor Manufacturing International Corporation's second quarter 2012 webcast conference call. Today's conference call is chaired by Dr. T.Y. Chiu, Chief Executive Officer, Mr. Gareth Kung, Chief Financial Officer, and Mr. En-Ling Feng, Senior Director of Investor Relations. Today's webcast conference call will be simultaneously streamed through the internet at SMIC's website. Please be advised that your dial-ins are in listen-only mode. However, at the conclusion of the management presentation, we will be having a question-and-answer session, upon which you will receive further instructions as to how to participate. The earnings press release is available for download at www.smics.com. Webcast playback will also be available approximately one hour after the event at www.smics.com. Without further ado, I would like to introduce to you Mr. En-Ling Feng, Senior Director of Investor Relations, for the cautionary statement. Sir, please go ahead.
Hello, everyone. Welcome to SMIC's second quarter 2012 earnings conference call. For today's call, our CEO, T.Y. Chiu, will first provide some general remarks. Then our CFO, Gareth Kung, will present the financial commentary. This will 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 presentations are available for you to download at www.smics.com under Investor Relations in the Events and Presentation section. Please also be reminded of the safe harbor statement, which provides as follows. SMIC's statements of its current expectations are forward-looking statements subject to significant risks and uncertainties. The actual results may differ materially from those contained in such forward-looking statements.
Information as to those factors that could cause actual results to vary can be found in SMIC's Form 20-F filed with the United States Securities and Exchange Commission on April 27, 2012. I will now turn the call over to our CEO, T.Y. Chiu, for the opening remarks.
Thank you, En-Ling. Greetings to everyone. Thank you for joining us for our earnings webcast. I am very pleased to report a solid second quarter result with revenue of $421.8 million. This is a new sales record for SMIC, with a quarter-over-quarter increase of 26.8% and a growth of 19.7% over the same period last year. We have a positive operating profit and a net profit of $7.1 million. SMIC has benefited from strong customer demand across the board and in particular, an 87% quarter-over-quarter increase in our 65/55 nm revenue. Also, we are experiencing a strong demand increase for our specialty processes, including power management IC, EEPROM, and others. As a result, the overall revenue growth exceeded our original guidance. I would also like to point out that our significantly higher gross margin of 24.1% compared to 12% in the first quarter.
This is primarily due to increased utilization as well as enhanced efficiency in all of our fabs. We are pleased with our progress in improving efficiency. As such, we are making progress in lowering our break-even utilization. We are enjoying good overall fab utilization as a result of industry demand improvement and our own emphasis and effort. The second quarter overall utilization was 95% as compared to 74% in the first quarter. Our Shanghai 8-inch fab is heavily utilized, mainly driven by power management IC and other specialty ICs. We continue to allocate more capacity for this increasing power management IC demand. In the meantime, through efficiency improvement, we have been able to augment capacity by about 11,000 wafers per month, a 15% increase with virtually no CapEx.
Our Beijing 12-inch fab achieved a record high utilization and revenue level, of which the revenue in the second quarter grew 45% quarter-over-quarter. Beijing's growth driver were mainly smartphone, networking, tablet, and the connectivity applications. Also in the second quarter, we have aligned the equipment in our Beijing fab for greater flexibility in order to handle the strong 65 nm orders. We currently foresee that our Beijing fab's 65/ 55 nm shipment will continue to increase into the third quarter, primarily driven by demand from our mobile phone and other consumer customers. At our Tianjin fab, we transferred a significant amount of loading from our Shanghai 8-inch fab with excellent results. Tianjin fab has significantly increased loading in the second quarter, and we expect the Tianjin fab to continue to be heavily loaded in the third quarter.
Apart from macro reasons, the increase in demand and utilization is also driven by fundamental performance improvement, which include our customer service, product mix, yield improvement, cycle time, and defect density level. These enhancements effectively help us in gaining customer confidence and recognition. For example, with our precision execution on 65 nm products for one of the leading customers, we are now considered by them as a top-tier foundry based on our control of excursions, yield, and cycle time performance. This results in accomplishing a stronger partnership with these leading customers and more advanced technology business. Regarding the overall demand for our advanced technology, we are currently expecting that the number of new tape out for 65 nm and below will grow 30% from the second quarter into the third quarter.
A large part of the expected growth was driven by our consistent track record in delivering quality products for our customers, and thus they are expanding their product portfolios to be sourced from SMIC. Over the last three quarters, we have successfully regained the confidence of our customers, ensured good loading for our mature fabs, ramped up our Beijing operation to meet strong demand, and managed a demand surge in our fab in Wuhan. I must thank our excellent team for executing with precision and with much improved efficiency. Regarding our differentiation strategy, we are enjoying the return of our investment in specialty technology, as evidenced from the increasing demand in PMIC and embedded non-volatile technologies. A number of other technologies are being actively pursued, and we will increase our resources and investments. We are making good progress, and for confidentiality reasons, we will report at the appropriate time.
Now, let me make some comments regarding the China market. Our China revenue continued to grow along with China's semiconductor market. In the second quarter of 2012, our China revenue grew 28% quarter-to-quarter, equivalent to about 33% of our total revenue in the second quarter of 2012. The overall demand in China is still relatively strong, primarily driven by feature phones, smartphones, tablets, and the set-top box. We are now seeing more positive signals, such as Chinese customers entering top-tier cell phone supply chain and migrating into more advanced technology area. In addition to the advanced nodes, some of our specialty processes are widely adopted by Chinese customers, which include smart card, smart meter for power grid, and a CIS, et cetera. We would expect China's semiconductor market to continue its momentum in the future.
On the advanced technology front, we continue to attract interest from a large number of customers, and the feedback on our technology readiness has been very positive. However, end customers' market position has slowed the pace of the loading. We remain cautiously optimistic that good volume will come during the second half of the year. Our 32/28 nm development is on schedule as planned. Our plan is to provide both high-k metal gate and the polysilicon process, and we target to have the process ready in late 2013. Meanwhile, we have also established a pathfinding team on the 20 nm process and target to have the technology ready in the middle of 2015. Our strategy right now is to push for these programs and simultaneously speed up its development.
With a steady R&D investment in our 28 nm, 20 nm, and enthusiastic response to our advanced production nodes, we are preparing for the future capacity need for our partners. On May 15, we have announced that we have entered into a cooperation framework with the Beijing Municipal Government in forming a joint venture to build a new advanced fab in Beijing with up to 20 nm capability. With this JV arrangement, the funding needed for the future expansion will be significantly reduced while SMIC will still be able to support the strong demand forecasted. The capacity expansion will be initiated after 2014 and will be paced with clear customer demand and the technology readiness. At the conclusion of the second quarter, we are pleased by our progress today in 2012, and we will continue our strategic execution in capturing growth opportunities via technology advancement and value-added differentiation.
We are currently expect the overall macro growth momentum approaching the end of 2012 to be slower than the first half. Although the macro environment is uncertain, we believe our position has been much improved, and we aim to see further improvement in the future. I thank you for your continuous support and look forward to updating you again in the near future. Before I finish, let me welcome our new CFO, Gareth Kung, who has rejoined the company a month ago and will be a great contributor of expertise and professionalism as we continue pursuing the growth opportunity that lie ahead for SMIC. I would also like to express thanks to our former CFO, Gary Tseng, for his hard work and dedication. I will now hand over the call over to our CFO, Gareth, for overall business and financial commentary.
Thank you, T.Y., and th ank you, everyone, for joining us today. I am really excited to be a part of SMIC again. I look forward to meeting many of you in the future. I will now take a few moments to summarize our second quarter 2012 financial results and provide our third quarter 2012 guidance. You may also refer to our quarterly financial presentation on our website. Please note that all currency figures are in U.S. dollars unless otherwise stated. In the second quarter, SMIC had upbeat performance as we successfully delivered a record high quarterly revenue and achieved a turnaround both operationally and financially. Specifically, for the second quarter of 2012, total revenue increased 26.8% quarter-over-quarter to $421.8 million due to robust demand across the board, especially for our 55 nm nodes and our special processes for power management ICs.
Wafer revenue from our managed fab, Wuhan Xinxin, was $41.6 million in the second quarter, contributing $9.9 million of our total revenue. Excluding wafer revenue from the managed fab for both quarters, our revenue increased 22.5% quarter-over-quarter. Second quarter gross margin was 24.1% compared to the previous quarter, 12%. Major drivers for second quarter gross margin achievement. The improvement of 12.1 percentage points quarter-over-quarter was a result of increased utilization and shipments, as well as our continued improvements in manufacturing efficiency, particularly increases in equipment daily moves and reduction in wastage and manufacturing overheads. In terms of operating expenses, the overall OpEx was $88 million, factoring in government grants of $16 million. Therefore, the normalized OpEx for the same quarter was $104 million, compared to $93.9 million in the first quarter.
This increase was mainly due to an increase in R&D expenses for advanced technology development and mid-year bonuses. The R&D cost of 45/40 nm will come down after third quarter when we move into volume production towards the fourth quarter of this year. In the second quarter, our operating income improved from a loss of $50.3 million in the first quarter to an income of $13.7 million, which reflected an overall improvement in our operational efficiency. The gain attributable to holders of ordinary shares was $7.1 million in the second quarter of 2012. The fully diluted EPS was $0.01 per ADS. Moving to balance sheet. At the end of second quarter of 2012, our debt-to-equity ratio was 50%. It went up slightly as we drew down part of our syndicated loans during the quarter.
In terms of equity, our share count increased from 27.5 billion to 32 billion shares as a convertible preferred share issued to CIC and Datang in June last year had recently been fully converted into ordinary shares, as they carry an expiration period of one year. We are also pleased to note that in July, our CEO, T.Y., had personally purchased 3.5 million shares in the secondary market as well. In terms of cash flow, we generated $109.4 million of operating cash compared to $35.8 million in the first quarter of 2012, due to increased revenue and VAT refunds. Overall cash and cash equivalents at end of second quarter were $290.7 million compared to $300.6 million in the previous quarter. To look at our revenue by application.
Consumer application were the largest contributor to revenue growth, having increased to $201.6 million in the second quarter, which represent a sequential growth of 50.9%. Meanwhile, communication grew 7.8% sequentially to $103.2 million. Geographically, revenue from the U.S. and China grew 29.2% and 27.7% respectively. In terms of technology, 90 nm and below increased 69.6%, contributing 41.7% of our wafer revenue in the second quarter. With regard to capacity, our Shanghai 8-inch fab increased from 79,200 8-inch wafers per month to 84,600 WSPM by end of second quarter. Mainly due to our continuous capacity realignment and more allocation for niche technology such as PMIC and EEPROM. Fab will reach 90,000 8-inch wafers per month.
At the Beijing fab, our overall capacity increased from 30,000 12-inch wafers per month in the first quarter, to 34,000 in the second quarter, due to fab equipment realignment and critical capacity addition for our 65 nm capacity. By end of second quarter, we had capacity of 17,500 12-inch wafers per month for 65 nm, which we plan to ramp up to 24,000 towards the end of 2012, due to tremendous demand on our 65 nm node. The critical capacity expansion in Shanghai and Beijing fabs has been mainly achieved by equipment efficiency improvements and realignment with minimal CapEx requirements. In the second quarter, there was no change to our Tianjin fab capacity. The overall utilization significantly improved from 74.1% in the first quarter to 95.2% in the second quarter. We are pleased to see that all our fabs were highly utilized across the board in the same quarter.
Looking ahead at the third quarter 2012, we are guiding our revenue to increase 4%-6% because of continued increase in demand from customers across the board. Gross margin is expected to range from 22%-24%. We expect our operating expenses to range from $93 million-$96 million, excluding foreign exchange effect and government grants. Last but not least, for the CapEx of 2012, we have revised upwards to between $550 million-$600 million, depending on the equipment move-in schedule. The additional CapEx would mainly be spent on the collaboration project with IBM on the 24-nm technology development, 65 nm CapEx expansion, and 8-inch specialty processes, the bottlenecked tools, mask shop technology upgrade, R&D equipments, and also construction of our living quarters. The additional CapEx will be mainly funded by own cash generation and loans.
We would like to assure The Street that our investment priority right now is to focus on technology development rather than capacity building. However, we are revising CapEx at this time solely because we have seen clear positive dynamics from our relations with our customers and solid operational improvement in the past quarters. Thus, we are confident that reasonable capital investment will enable us to better capture growth opportunities and maximize shareholders' returns. I will now hand the call back to En-Ling for a Q&A session.
Thank you, Gareth. I would now like to open up the call for Q&A. As usual, please be reminded to limit your questions to two per person. Operator, please assist. Thank you.
Thank you very much, sir. Ladies and gentlemen, we will now begin the question-and-answer session. If you wish to ask a question, please press star followed by one on your telephone keypad and wait for your name to be announced. The first question comes from the line of Dan Heyler from Bank of America. Please ask your question.
Hello, Dan.
Mr. Heyler, your line is open. We are not getting any response from Mr. Heyler. We will move on to the next person. The next in queue is Steven Pelayo from HSBC. Please ask your question.
Great. Thank you. Let's see. First questions are really going to be just more financial. I do not know, maybe more to Gareth, but I am trying to understand your gross margin improvements quarter-on-quarter. You are talking about better utilization rates and better efficiencies and leveraging capacity and realigning it better. But realistically, gross margins are up about 1,200 basis points quarter-on-quarter. About 1,000 basis points of that was because depreciation costs within cost of goods sold was down 14% quarter-on-quarter. That does not really sound like increased efficiency. Can you explain a little bit more, what is going on within cost of goods sold relative to depreciation? Also maybe talk a little bit about more some of those efficiencies and some of the non-depreciation of cost of goods sold and how you are seeing gains there?
Yes.
Steve.
Hi, Steve. Yes.
It is okay.
Regarding the depreciation in cost of goods sold, you see that actually there is some reduction there. But actually that is mainly because our fab is right now fully loaded. Therefore actually, more of the depreciation have been captured in the progress inventory that is expected to be shipped out in Q3. That explains why there is a decline in the depreciation in the cost of goods sold. In terms of the overall improvement in gross margin, as you rightly point out, there are really two major reasons for that. One is because of the high utilization. That bring down the average manufacturing cost per wafer. The other thing is, the team in the last few quarter have made a lot of efforts and progress in terms of improving the productivity in the fab, by getting rid of some wastage, improving the different moves, improving the cycle time.
That all helps to contribute to this big improvement in gross margin.
Maybe I can follow up later. I guess I'm still confused how shipments can increase 25% quarter-on-quarter and depreciation can go down to 14%. I understand that you have a lot of WIP in the fab and that's going to be pushed to 3Q, but still, that significant a number to have that big of a decline seems a bit of a surprise. We'll follow up with that later on. I guess the next question is relative to your other income line. Obviously, up quite a bit, I think about 30% or so quarter-on-quarter. I think you're dealing with higher interest costs from more debt. Could you give us some guidance for that going forward?
In terms of the interest expense, we see it, actually, it may go up marginally in Q3 because we're going to draw down some additional loans, but it will not be a big increase.
Okay, I'll just sneak in one final one. I'm surprised that your comm business was only up by, I think, about 8% quarter-on-quarter, kind of underperforming the corporate average. I think you have some large customers there with Broadcom and Qualcomm. Could you talk a little bit about what's going on with why comm was relatively underperformer, and I think consumer was the one that was a big outperformer, if I remember correctly. What are the shifts that are going on there?
Yeah. Let me say that it depends a little bit of our categorization of the products. In our categorization of product, we depend a lot of that on the customer's feedback. That could be some Wi-Fi product, some customers decide to put it in a consumer because it goes into PC. Some others put it into communication because they put it in the handphone. Okay, that's one factor.