Welcome to Semiconductor Manufacturing International Corporation's second quarter 2013 webcast conference call. Today's conference call is hosted by Dr. T.Y. Chiu, Chief Executive Officer, Mr. Gareth Kung, Chief Financial Officer, and Mr. En-Ling Feng, Senior Director, 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 a listen-only mode. However, at the conclusion of management's presentation, we will be having 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 also be available approximately one hour after the event. Without further ado, I would like to introduce you to Mr. En-Ling Feng, Senior Director, Investor Relations, for the cautionary statements.
Hello, everyone. Good morning and good evening. Welcome to SMIC's second quarter 2013 earnings conference call. For today's call, our CEO, Dr. T.Y. Chiu, will first provide some general remarks on our business. Our CFO, Gareth Kung, will present the Q2 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 presentation are available for you to download at www.smics.com under Investor Relations in the Events and Presentations 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 15, 2013. I will now turn the call over to our CEO, Dr. T.Y. Chiu, for the opening remarks.
Thank you, En-Ling. Greetings to everyone. Thank you for joining us for our second quarter 2013 earnings webcast. I would like to begin today's call by highlighting our Q2 2013 achievements. I am very pleased to report that SMIC has exceeded expectations and again achieved a record high revenue of $541.3 million in the second quarter of 2013, representing year-over-year growth of 28.3% and a sequential growth of 7.9%. This growth was primarily driven by demand for smartphone-related applications as handset makers prepare for new product launches. In addition, gross margin improved to 25% in the second quarter compared to 24.1% in second quarter 2012 and 19.6% in the first quarter of 2013. The enhanced gross margin was mainly due to higher utilization from both 8 in and 12 in. The utilization has increased to 98.5% compared to 95.2% in second quarter 2012 and 89% in first quarter 2013.
Both gross profit and profit from operations reached record high of $135.2 million and $79.1 million respectively. This is the fifth consecutive quarters of positive profit from operation, although when excluding other income from property and property disposal. Furthermore, profits attributable to SMIC was $75.4 million in second quarter compared to $7.1 million in second quarter last year and $14.6 million in first quarter 2013, a growth of 960% year-over-year and 85% quarter-over-quarter. In addition, I am glad to highlight that SMIC has surpassed a net income of $100 million for the first half of 2013. In detail, revenue growth was driven by the following factors. First, revenue from our China customers grew 14.3% sequentially and 60.6% year-over-year, contributing 40.9% of total revenue in the second quarter of 2013. This is an all-time high.
The demand from our China customers was driven primarily by low-end smartphone-related applications. Customers expressed strong demand for our 45/40 nm services, indicating a very strong new product tape out in the third quarter. As a result, our 40/45 nm revenue grew 71.9% sequentially, contributing 10% of total wafer revenue, compared to 6.4% in the first quarter of 2013. The key product for 40/45 nm nodes are again smartphone-related applications. We see continued momentum for 40/45 nm as planned new tape outs will increase significantly in Q3. Even with IC suppliers' inventory correction by smartphone manufacturers, we are targeting continued growth of this technology node for the rest of the year, reaching 15% of revenue in the second half of this year, either in Q3 or Q4. Besides advanced technology nodes in Q2, utilizations across all fabs are very high. In particular, 8
-in demand continued to be a key growth driver of our business.
Demand for our differentiated applications continues to be strong, especially in the area of power management, CIS, and embedded non-volatile. SMIC continued to hold a strong position in some differentiated technology by being the first source supplier for these products. Revenue from our differentiated technology, specifically PMIC, CIS, and embedded non-volatile, grew 83.6% year-over-year in second quarter 2013 compared to second quarter 2012. In order to further capture the market opportunities and to enhance our position in the differentiated technology, we are looking into various opportunities to expand our eight-in capacity. For the 12-in advanced technology development, we continue to work hard in R&D while carefully investing in advanced node capacity. Along the same line, our 28 nm for both polysilicon and the high-k metal gate development continue to be on target, and is on track to be process ready by the fourth quarter of 2013.
In terms of advanced capacity for future expansion, as announced in June, SMIC will jointly establish a fab in Beijing, focusing on 45 nm and finer technology, with planned manufacturing capacity of 35,000 wafers per month, ramped over the next three to five years. The equipment should be ready for moving around the first quarter of 2014. Meanwhile, we are also actively discussing with our customers in assessing their demand for advanced nodes. In addition, we are expanding our living quarters as part of our employee retention program. We believe that living quarters has been a very important component to SMIC's successful employee retention by providing our employees with comfortable, close-knit communities that is not only conveniently located near our factories and offices, but also family-oriented and near, location-wise, to our very, very competitive and top-notched schools.
Before I provide the outlook for 2013, I would like to share some overall market outlook, courtesy of Gartner. Worldwide semiconductor growth is estimated to be 6.8% in 2013 compared to 2012. For foundry revenue, it is expected to grow 13.3% this year compared to last year. Despite the inventory adjustments reported for the industry in the second half of the year, our goal is to significantly outgrow the semiconductor industry projection, and we will be well above the foundry average as well this year. Our original Q2 revenue guidance was sequential growth of 3%-5%. In fact, revenue growth reached 7.9% as customers pull in orders earlier, contributing to our stronger second quarter and a flattish third quarter. We currently guide Q3 to be flat sequentially, and we believe we will have a solid second half performance, of course, taking the Wuhan disengagement into account.
In conclusion, the second quarter of 2013, SMIC beat multiple records in terms of revenue and profitability. Despite the fact that the weather is sizzling in Shanghai, unfortunately, the market has fizzled a bit. Nevertheless, we are expecting a good second half when the contribution from this disengaged Wuhan is removed. The management is keenly focusing on continuous efficiency improvement, advanced technology introduction, mature technology enhancement, and improved profitability through our prescribed differentiation strategy and prudent investments for future growth. Before I close the session, I would like to thank our customers for their support and our employees for their hard work and dedication. Thank you for your time. I will now hand the call over to Gareth for overall business and financial commentary.
Thank you, T.Y., and thank you everyone for joining us today. I will now take a few moments to summarize our second quarter 2013 financial results and our third quarter guidance. You may also refer to our quarterly financial presentation on the website. Please note that all currency figures are in U.S. dollars unless otherwise stated. We are pleased to report another strong quarter. In the second quarter of 2013, we achieved our fifth consecutive quarter of record high revenue of $541.3 million, representing an increase of 28.3% year-over-year, an increase of 7.9% quarter-over-quarter. Revenue from China-based customers increased to 40.9% of overall revenue in the second quarter of 2013, an all-time high compared to 32.7% in the second quarter of 2012 and 30.6% in the first quarter of 2013.
Gross profit of $135.2 million in 2Q 2013 was a record high compared to $101.7 million in 2Q 2012 and $98.3 million in 1Q 2013. Gross margin improved to 25% in 2Q 2013 compared to 24.1% in 2Q 2012 and 19.6% in 1Q 2013. Profit attributable to SMIC was $75.4 million in 2Q 2013, more than 10 times the profit of $7.1 million in 2Q 2012, and 85.7% increase compared to the profit of $40.6 million in 1Q 2013. Now, looking into details of our income statement. Revenue growth in second quarter of 2013 exceeded our original guidance, mainly due to the increase of 40/45 nm and 0.18/0.15 micron wafer shipments. Wafer revenue from Wuhan Xinxin was $39.5 million in 2Q 2013 compared to $29.2 million in 1Q 2013. This portion of revenue will gradually be phased out starting third quarter 2013.
Cost of sales in 2Q 2013 was $406.1 million, comparable to $403.3 million in 1Q 2013, despite an increase in shipments. This is primarily due to the significantly high fab utilization, and as a result, depreciation expense was distributed to a larger amount of wafer produced and to inventory costs. Our 2Q 2013 gross margin was guided 20%-22% and resulted in 25%, compared to 19.6% in 1Q 2013, primarily due to significantly higher fab utilization in 2Q 2013. Operating expenses in 2Q 2013 were $56.1 million, which was offset by funding from R&D contract with the government of $3.8 million and other operating income of $33.1 million. OpEx increased compared to $47 million in 1Q 2013, which were offset by funding from R&D contract with the government of $10.9 million, an other operating income of $20.2 million.
If excluding funding from R&D contract with the government and other operating income, which is mainly from asset disposal, the normalized OpEx would be $92.9 million in 2Q 2013 compared to $78.1 million in 1Q 2013, mainly resulting from higher employee staff approval. R&D expenses increased to $36.7 million in 2Q 2013 from $24.8 million in 1Q 2013, mainly due to, one, a $7.5 million decrease in funding from R&D contract with the government in 2Q, from $10.9 million in the previous quarter. Two, higher employee bonus accrued in 2Q 2013. General and administrative expenses increased to $42.6 million in 2Q 2013, up from $34.2 million in 1Q 2013. Also mainly due to higher employee bonus accrued in 2Q 2013.
Other operating income of $33.1 million in 2Q 2013 included, one, the gain arising from disposal of part of living quarters in Shanghai, and two, the gain arising from disposal of a company total ownership interest in SMIC Wuhan Development Corporation, which was mainly engaged in the construction, operation, and management of Wuhan living quarters and schools. Profit from operation in 2Q 2013 was a record high of $79.1 million, compared to $51.3 million in 1Q 2013. If excluding funding from R&D contracts with the government, other operating income, which is mainly from asset disposal and employees bonus accrual, the normalized profit from operation will also be a record high of $67.9 million in 2Q 2013, compared to $35.9 million in 1Q 2013, and $3.5 million in 2Q 2012.
Other expenses in 2Q 2013 was $3.3 million compared to $8.3 million in 1Q 2013, mainly due to a decrease in the finance costs and a payment of land idling tax charged by local governments in 1Q 2013. Income expenses were $0.5 million in 2Q 2013 compared to $2.5 million in 1Q 2013 due to a decrease in the number of living quarter units disposed in 2Q 2013 compared to the previous quarter, resulting in decreased income tax. Profit attributable to SMIC was $75.4 million in the second quarter of 2013 compared to $40.6 million in the previous quarter. Moving to the balance sheet. At the end of the second quarter of 2013, our cash and bank balances, together with restricted cash, was $477.4 million, compared to $478 million in the previous quarter. Trade and other receivables increased $117.1 million due to increased revenue.
Debt-to-equity ratio was 44.1% compared to 41.3% in the first quarter of 2013. The ratio increased as our long-term debt increased by $45.7 million and short-term borrowing increased by $57 million compared to the end of the first quarter 2013. In terms of cash flow, we generated $108.4 million of cash from operating activities, compared to $154.6 million in the first quarter of 2013. This decrease was mainly as a result of changes in working capital, as trade and other receivables increased. Cash used in investing activities increased by $159.9 million in the second quarter of 2013 compared to first quarter of 2013, due to higher cash CapEx payments. Cash flow from financing activities increased from an outflow of $137.5 million to an inflow of $104.2 million, as we increased our borrowings in certain quarters while we paid down debts in the first quarter.
Our cash and bank balances at the end of 2Q 2013 decreased by $30 million sequentially to $263 million. To examine our revenue by application, the communication segment was again our biggest contributor to revenue this quarter. Revenue from this segment increased to $246.8 million, representing a sequential growth of 4%. This growth is mainly from an increase in handset-related products. Revenue from the consumer segment grew 15% quarter-over-quarter, contributing $245.2 million, mainly from Bluetooth, gaming devices, and set-top box. Geographically, revenue from China grew 40.3%, an increase of $27.8 million, contributing 40.9% of total revenue. Revenue growth from China contributed the most to the total revenue increased in second quarter of 2013. Mainly, revenue growth from China contribute the most to the total revenue growth in the second quarter of 2013, mainly due to increased shipment from mobile-related applications.
Revenue from North America increased 1.4% sequentially, contributing 48.3% of total revenue. Rest of World Asia grew 16.5%, contributing 10.8% of total revenue, and increased also mainly from mobile-related shipments. In terms of technology, revenue from 40/ 45 nm increased 71.9% sequentially, contributing 10% of wafer revenue in the second quarter of 2013. Revenue from 55/65 nm and 90 nm increased 1.1%. Meanwhile, 0.13 -micron above line width grew 9.7%, with strength from power management, CMOS image sensor, and embedded EEPROM applications. In terms of overall capacity, total monthly capacity at the end of second quarter was 223,500 wafers compared to 219,600 wafers. The change was primarily due to increased 40/45 nm capacity in our Shanghai 12-in fab. The overall utilization was 98.5% in the second quarter of 2013 compared to 89% in the first quarter of 2013. The significant utilization increase was across all our fabs.
Looking ahead at the third quarter of 2013, excluding wafer shipment from Wuhan Xinxin, which is expected to gradually phase out starting in the third quarter of 2013, revenue is expected to be down 1% to up 2% quarter-over-quarter. Including Wuhan, total revenue is expected to be down 3% to flat quarter-over-quarter. Gross margin, excluding wafer shipment from Wuhan, is expected to range from 18.5%- 21.5%. Including Wuhan, gross margin is expected to range from 17.5%- 20.5%. Operating expenses are expected to range from $81 million- $85 million, excluding the effect of foreign change, funding from R&D contract with government, and gain from disposal of living quarters. We reiterate our 2013 CapEx guidance estimate for foundry operation to be approximately $675 million.
In addition, the company had budgeted CapEx of another $130 million in 2013 for construction of living quarters for employees, a key component of our long-term employee retention program. The company planned to either rent out or sell those units to employees in the future. I now hand the call back to En-Ling for a Q&A session for this call.
Thank you, Gareth. I would now like to open up the call for Q&A as usual. To be reminded, please limit your questions to two per person. Thank you, and operator, please assist.
Ladies and gentlemen, to ask a question, please press star one on your telephone keypad and wait for your name to be announced. That's star one to queue to ask a question. The first question comes from the line of Randy Abrams calling from Credit Suisse. Please ask your question.
Yes. Hi, good morning. Thank you. My first question on the third quarter for the latest guidance, if you could talk about what areas are continuing to grow and the areas you're seeing some slowdown in. Maybe implications into fourth quarter, if there's anything that could offset some of the trends we're seeing from other foundries that are guiding a bigger decline into fourth quarter.
Okay. We are guiding a flattish for the following reason. First of all, that we are still aiming to have a further increase in the 40/45 nm revenue. Secondly, we are still seeing some strength in some of the differentiated technology that we are actually emphasizing. So in area for the power management, CIS, and embedded non-volatile, we are still seeing some of the growth.
Yeah, Randy, just want to add more color to the Q3. I think we are seeing continued growth in our China revenue in Q3, but I think there will be a slight decline in our North American revenue. In terms of technology node, I think we are seeing strong growth in the 40/45 nm in the third quarter.
Okay. I guess for the second question, if you could talk about how CapEx will phase in for Beijing, the $3.6 billion overall, I guess your annual spending commitment that you expect from that, and then how much CapEx for the rest of the business, like outside of Beijing, you will need to spend as we look going forward. If you could do a quick comment on the first question, the fourth quarter, what your expectation relative to the foundry group, if some of these things like the specialty or 40 nm could offset the trends that we are seeing in broader foundry group.
Yeah. We do not give a very clear guidance on the fourth quarter number. But if you ask for the general sentiment, for us, if we look at the core revenue, that is without Wuhan, it is staying relatively flat. We are getting a strong new tape out in the 40 nm technology node, and we believe that will translate into additional revenue in that technology node. As to the CapEx for the B2, we have reported that B2 will ramp over three to five years, depending on the customer demand. So if you take an average of four years, you know that on the average, what is the CapEx, okay?
Randy, just want to mention that for new project in Beijing is a joint venture with the investment company and the Beijing government. We are contributing only 55% of the investment, and our joint venture partner will contribute about the other 45%. The total investment for that project is $3.6 billion. As what T.Y. mentioned, we could ramp that over three to five years. I think the CapEx will still be very manageable from our point of view.
Okay. So your expectation that the rough run rate per CapEx. Oh, go ahead.
As far as-
Is the rough run rate for CapEx?
-as far as the question of whether there will be significant CapEx outside of Beijing, that is our primary investments for the next four to five years. Certainly, we might have smaller investments to upgrade our 8-in fabs and our present Fab 8 in Shanghai. But the major investments will be in Beijing.
Okay. Thanks a lot.
The next question comes from the line of Daniel Heyler calling from Bank of America Merrill Lynch. Please ask your question.
Yeah, thanks. Thanks, guys. Just two questions, one relating to the mature technology, one to the advanced technology. I was wondering, on the mature technology front, you've done very well with your derivative technology strategy, congratulations, and have been growing the business. Capacity seems pretty full at this point, and as you've said, you're keeping your fabs full, it looks like, for most of the year. As you look to 2014 to try to grow that business, you are trying to find capacity, but it looks as though a lot of others are also trying to seek 8-in capacity. How viable is it that you can secure 8-in capacity at an attractive price? Maybe give us some color on your strategy there to build out your 8-in derivative technologies.
Okay. I think that we have a number of opportunities, and we have a fab that is already built, but not outfitted with equipment, that is in Shenzhen. That is one fab that we can quickly bring into production, certainly. We have already secured a number of tools to initiate that work, but we are also exploring other opportunities, so we will react as those opportunities emerge.
Dan, another thing is actually, I think there is still room for us to incrementally increase our capacity in our Shanghai 8-in fab and also in the Tianjin fab. I think we are still growing the business.
Yes, exactly.
Could you give us a sense of the magnitude there, in both the internal expansion for 2014? Are we talking maybe we can squeeze out another 10% type of number? Are you planning to get mature equipment, used equipment, or at this point, do you have to find new sources of equipment?
I think for all these buildup, we are actively looking at used equipments, and there is an active 8-in used equipment market out there. We believe that there are actually a number of 8-in fabs that will be coming into the market soon.
Okay, great. On your advanced technology strategy, the handset market appears to be pretty strong. Moving, though, into the mid to low-end cell phone market, we have noticed a rapid conversion to 28 nm from 40 nm. I am wondering how you can sustain growth in 40 nm next year, what some of the applications for 40 nm would be.
Actually, there are migrations, products migrating from 40 nm to 28 nm, but there are also quite a few products migrating into the 40 nm technology node. Actually, we are still seeing a very strong new product tape out in the 40 nm. This is an area that we feel that it is not extreme worried at this moment. In addition, we have the plan for our Shanghai fab, a significant portion, up to 40% of our equipment are 28 nm compatible. As the product moves to 28 nm, a lot of our capacity will be, again, fully utilized.
Okay. Quick follow-up. As you are migrating people from 65 nm to 40 nm, that is keeping your 40 nm going. Maybe explain how you are going to backfill your 65 nm and 90 nm, what some of the applications will be at 65 nm, because you are migrating business forward, so you still have other fabs to fill.
Right. There will be product going from the older 0.13 micron going into the 65 nm and 55 nm as well. As you can see that some of our mature technology fab, actually, the utilization is fairly high. If you do the proper planning in the migration, I think it is possible to maintain a fairly good utilization across the board.
Oh, I see.
I think otherwise, we would see a very dramatic drop-off in the 8-in capacity utilization.
Okay. It sounds like derivative technology will be filling those fabs, the 65 nm, 55 nm and 90 nm fabs.
Yes.
Thank you.
Next question comes from the line of Cezo, calling from BNP. Please ask your question.
Oh, hi. Good morning, gentlemen. Two questions from my side. First one for 28 nm. When should we expect the node to be revenue generating?
Excuse me. Could you?
For 28 nm, when should we expect it to be generating revenue?
Revenue generating. We expect to start to have revenue generation from the, maybe, end of third quarter, the beginning of fourth quarter 2014.
Okay. I believe that would be for Poly-SiON version first, right?
Yes, it is first Poly-SiON.
When should we expect the high-k metal gate business to come in then?
Maybe second half of 2015.
Okay. All right. Second question for the managed fab, Wuhan Xinxin. When should we expect that part of business to be fully ramped down? Yeah, because it has been maintaining at a pretty high level, is even going into Q2. Yeah.
Yeah. Starting Q3, you will see the revenue start to ramp down, and I think it will come down to a very low level, in Q4.
Okay. All right. Okay. Thank you very much.
This question comes from the line of Steven Pelayo, calling from HSBC. Please ask your question.
Yeah, guys. Congratulations on the good quarter in the second quarter. The gross margins were far above expectations for me. However, when we do look in the third quarter, a flattish guidance, all in including Wuhan, maybe flat to down, sorry. The gross margins may be at the midpoint, down about 600 basis points, I guess, if I'm assuming that right. I understand, utilization rates, I think are relatively staying fully loaded. I understand there's some depreciation spreading going on, but still 600 basis point decline seems very severe. Is there something else going in the third quarter gross margins there?
The gross margin in Q3, we're getting lower, mainly because of the lower utilization of our fabs. We're looking at the utilization in the mid-80s in Q3, which is about more than 10 basis points decrease in utilization.
I guess I'm trying to understand then the linearity and the shape here. You guys are talking about second half opportunities and what the fourth quarter may be outperforming what we're seeing from everybody else. Do you expect then, I don't know, did you have kind of a big drop in utilization rates that are now going to then ramp back up again and keep the fourth quarter relatively flattish? Or, I guess I'm trying to understand how do you keep flat revenues and utilization rates are falling 10 points in the third quarter, as we go into the fourth quarter.
I think as what T.Y. said, I think we're seeing a lot of new tape outs in Q3, and we are hoping that they will translate into our revenues one quarter from now. So we are seeing, right now based on our current visibility, excluding Wuhan, it's more like a flattish quarter in Q4. I will caution that is really based on very limited visibility at this point in time, and as we moving more into Q4 revenue.
Okay. Gareth, if I could just ask two housekeeping questions real quick. I'm a little confused with the second quarter report since you have property sales and R&D tax rates than I was thinking as well. Can you help us understand maybe just what ongoing, excluding all those kind of items, net profit and EPS was? I'm trying to get a better understanding of what the ongoing EPS would've been, if I was able to exclude all those and get more of a normalized tax rate there.
I'm sorry, I don't quite get your question.
Well, I want to think about SMIC's second quarter results on an ongoing basis, excluding R&D credits, excluding property sales, asset disposals, exit Wuhan, and any other tax changes that impact because of those one-time gains. If I was thinking about your second quarter results on a continuing basis or an ongoing basis, what was the impact to the bottom line in EPS or net profit? Can you help me do that math?
Oh, I think, I mentioned that, in the second quarter, if we exclude, we have what we call a normalized operating income. I think we are talking at the. We mentioned that, if we exclude, funding for R&D contract with government, and other operating income, which is mainly from asset disposal and employee bonus. The normalized profit from operation would be about $68 million in second quarter 2013, compared to $36 million in first quarter 2013, and $3.5 million in second quarter 2012. Actually, we can refer to the PPT. Page six of the PPT will show the trend for last eight quarters.
Great. I appreciate that. The last one I could just sneak in on housekeeping is customer concentration. I am curious, how many customers are above 10% of revenues? Also even specific in the 40% of revenues that are coming from China, are any of those above 10% of total revenues as well? Can you talk a little bit about customer concentration, and that is the last question for me. Thank you.
Yeah. In terms of customer concentration, I think it is pretty stable over the period, and right now our top five customer contribute about 50%-60% of our revenue.
How many customers are above 10% of revenue, and are any of those China fabless?
No, not yet above 10%, but a number of them are exceeding 5%.
Okay. Otherwise, I think you guys just have two customers that are above 10%, is that correct?
Yes. Two customers are above 10%.
Excellent. Thank you, guys.
Thank you.
This question comes from the line of Bill Lu calling from Morgan Stanley. Please ask your question.
Good morning. This is Juno calling in for Bill. I have two questions. I want to follow up. One is about our guidance about the UT rate in the third quarter. We still seem very strong 40 nm demand into the third quarter. I want to understand why the utilization rate will go to mid-80s. Which now has lower utilization rate in the third quarter?
I think, in terms of Q3 utilization, we are seeing high utilization for our 8-in fab compared to our 12-in fabs.
Okay. I got it. One quick follow-up is, in our 40 nm, is that our China customer base is higher than average in the 40 nm?
Okay. For the last two quarters, the China contribution to the 40 nm revenue is very significant. But we are seeing quite a strong ramp-up and new tape out from the global customer base in this quarter, third quarter.
So far in the third quarter.
Yeah. Third quarter. Part of it, I think is because people are seeing that SMIC is shipping a significant amount of 40 nm wafers. And so are coming in and actually are convinced that we have a good technology and a stable process.
Okay. I got it. When we migrate to the 28 nm, the client 28 nm is existing client in the 40 nm , or we have a new customer in the 28 nm?
Oh. We do have a number of new customers using our 28 nm process. This is as well as certainly the existing customers that is in the 40 nm.
Okay, I got it. One final question is that I want to get more colors by the margin by each node, because TSMC comment about that actually they have a quite similar cost margin for each node, including the lagging node and the leading edge node. Is that the same case in our fab?
Right now, I think our 40 nm node, I think probably you want to find out in particular the 40 nm. Our 40 nm node has been ramping up last two quarters, and our margin is improving steadily and significantly. We are not able to release the exact number at this point of time.
Is that higher than the corporate average in the 40 nm, or is still below?
I think, let me explain in such a way. I think overall, I think our mature node gross margin will be higher than our new advanced node at this point in time.
Okay. I got it. That's all from me. Thank you so much.
Thank you.
Thank you.
Our next question comes from the line of Miles Li, calling from Nomura. Please ask your question.
Hi. Thank you for taking my question. Dr. Chiu just mentioned about the inventory. Can you help me understand more about it? Is the inventory issue coming more from the higher-end smartphone customers, or more from the low-end smartphone customers? From current situation, can we see when will the inventory be back to normal level? It will be in first quarter or the first quarter in next year? Thank you.
The inventory that we are seeing a number of our customers reporting an increase in inventory level. Some of them are reporting that the inventory, and telling us the inventory problems will be resolved within a quarter. But some of them, others, are thinking that they will digest their inventory in two quarters' time. We think that it will be somewhere in between the fourth and the first quarter where our broad-based customers will be able to resolve this issue.
Okay. Thank you. My second question is on the China market. Actually, there will be two things. One, we know the issue of the 4G license, I think, will be issued very soon. What will be the implication to SMIC? The second in the China market is the release of Xiaomi's Hongmi. I think that's a quite low-priced smartphone, priced at RMB 799. Also, the cheap iPhone were introduced. What will that impact on the low-end smartphone market? What's the implication to SMIC as well? Thank you.
Okay. Our customer base actually covers mostly low-end smartphone, and some of them are trying to get into high-end as well. But the robust growth in the low-end smartphone definitely will benefit our customers' base, and certainly, that will carry over to SMIC. As far as the 4G LTE license, we are excited that China will grant a few license this year. Definitely, that would also increase and stimulate additional market for smartphones, and we believe that we stand to benefit from all these growth.
Okay. Thank you.
Thank you.
The next question comes from the line of Roy Shen, calling from SWS Research. Please ask your question.
Thank you. Thank you for taking my questions, and congratulations on strong second quarter results. If you look at the future growth drivers and the niche market, my question is, do the management see the orders from smart card business, such as bank card and social security card orders surge in third quarter? What is the percentage of revenue contribution from the smart card business in second quarter? Thank you.
Okay. We do not give a specific breakdown on the specific market segments. But non-volatile business is a large business and a growing business for SMIC. As we have reported, half of the customers that have passed the bank card initial qualification, half of these qualified vendors are SMIC customers. We expect that a number of market that is emerging will actually benefit our customers, and SMIC will actively participate in those card segments. We are also actually working on new technology, and will be coming out with a more advanced technology sometime later next year. We are preparing our technology roadmap for this card segment continuously, and we believe that we have some of the best technology to be offered in the market.
Okay, thanks.
Thank you.
Thank you.
Comes from the line of Eric Chen calling from Daiwa. Please ask your question.
Hi, gentlemen. First, I would like to make the clarify. You talk about the demand quite strong, and for the power management, the CMOS image sensor, and the embedded EEPROM. How about for the smartphone and the tablet PC, the IC, and how's it going on the demand there?
Yeah, I think we continue to see very strong demand from the mobile-related application, which is why we are seeing very strong tape-out in the current quarter for the 40/45 nm node. As what we said earlier, we are hopeful that this new tape-out will translate into pretty strong revenue one or two quarters down the road.
Okay. My follow-up question is, I assume most of the business mainly came from China, the client. How about your revenue, the percentage from your China client, and your expectation at the year-end, and even like the next year, roughly idea?
Yeah. For Q3, we are seeing stronger growth in our China-based customers as compared to our North American customers. So we will see a slight increase in our China revenue contribution in the third quarter.
How about the revenue percentage? In the Q2, you already reached 40%. Can I assume like 45% at the year-end or like 50%-55% for the whole year next year, roughly?
Yeah, roughly, I would say, in the second half of the year, it will be around 40%-45%.
Okay. You talk about the CMOS image sensor business quite strong. We note OmniVision just invested the Wuhan fab. I am wondering, the business you talk about, the CMOS image sensor, is related to the Wuhan business or any business relationship going forward you will have with OmniVision?
Our CIS business is really on its own, without any relationship with the Wuhan fabs. We actually announced earlier that we have already introduced our BSI technology, and I think right now customer doing tape-out, and we are going to see some revenue towards the end of the year.
Okay. Can I assume that when you talk about the CMOS sensor business quite good, let's not talk about the Wuhan side?
It's not anything related to Wuhan.
Okay. Thank you. Very clear. My last question, regarding to your investment for the Beijing fab, I may lost, but from my understanding, you just mentioned about $3.6 billion for the five years investment. I would like to know any right issue plan or how you deal your cash flow, the side. Thank you.
Yeah. As I mentioned, this is a joint venture project that SMIC will own 55%, and our joint venture partner, which is the investment company in the Beijing government, will own 45%. We only contribute 55% investment, and it will spread over three to four years. I think the CapEx investment is very manageable from our operating cash flow. Yeah.
So $3.6 billion, that's the total amount you are going to do the investment, or you are going to do the investment is 55% of the $3.6 billion?
Yes. Our share of investment is 55% of the $3.6 billion.
Let me say that the cash flow required actually is even less than the 55% of that $3.6 billion because maybe one-third of it will come from the bank loans. So when you calculate that, let's say if you take four years as the total investment, on the average, it will be $900 million per year. And one-third will come from the bank, and so it will be $600 million per year from actually putting in the actual cash. And 55% of that $600 million will come from SMIC. Then if you go through that calculation, you can see that that cash flow will be no higher than our present cash flow required to do the investment.
So in other words, you don't have any plan for the right issue, right?
We don't comment on this as a practice. But as a listed company, we will always consider our future investment plan and also look at our funding needs. Yeah. But we don't have any immediate plan at this point in time.
I see. Thank you very much for your clear statement. Again, congratulations for your same quarter result. Thank you.
Thank you, Eric.
Next question comes from the line of Jeffrey Toder calling from CIMB. Please ask your question.
Hi, good morning. Two questions. One, just following up on what you were saying about the financing for B2. You are talking about one-third being covered by debt. Will that company hold the debt, or will SMIC take the debt out on their own books to finance their portion?
The joint venture company will borrow to fund part of the investment. But because the joint venture company is 55% owned by SMIC, that would be consolidated into our financial statement as well.
SMIC will carry 100% of the debt on the liability side of your balance sheet, and then that'll be removed later for the non-
That's correct.
-earning proportion. Is that correct?
Yes. That's on the basis that this joint venture company is a majority-owned subsidiary of SMIC, so they'll be consolidated into our balance sheet.
Okay, got it. Okay, and the other question, just going back to your comments on the utilization rate. Can you tell us how much capacity will be increasing in the third quarter?
Our major increase in capacity will still be in the 40/ 45 nm node capacity, and we are still targeting to raise it to about 15,000 wafers per month by end of the year.
Okay, but I mean, specifically, how much capacity increase do you expect in the third quarter, which is embedded in your 80% guidance?
As I said, the only increase in capacity in the third and fourth quarter will only be for our 12-in fab in Shanghai. Right now, the capacity for that fab is at about 8,000 wafers per month at the end of the second quarter. That should go to about 11,000- 12,000 by end of the third quarter. That is targeting to reach to about 15,000 by end of the year.
Okay, great. We'll run some numbers. Thank you very much.
Thank you.
I would now like to hand the call back to Dr. T.Y. Chiu, Chief Executive Officer, for closing remarks.
In closing, I would like to thank everyone who participated in today's call, and again, thank all of our shareholders, customers, employees, and suppliers for their trust and support. Have a good summer. See you next time.
Gentlemen, that concludes our conference call today. Thank you for your participation. You may all disconnect.