Welcome to the Semiconductor Manufacturing International Corporation Third Quarter 2013 Webcast Conference Call. Today's conference call is chaired by Dr. TY 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 of 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.
Hello, everyone. Welcome to SMIC's third quarter 2013 earnings webcast conference call. For today's call, our CEO, Dr. TY Chiu, will first provide some general remarks. Then our CFO, Gareth, 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 presentation are available for you to download at www.smics.com under Investor Relations in the Events and Presentation section.
Before I turn the call over to Dr. TY Chiu, let me remind you that the presentation we will be making today, including forward-looking statements. These statements and other comments are not guarantees of future performance, but rather 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 risks and uncertainties that could impact our future operating results and the financial condition, please see our Form 20-F filed with the United States Securities and Exchange Commission on April 15, 2013.
Also, during the call, we will make reference to financial measures that do not conform to generally accepted accounting principles, GAAP. This information may be calculated differently than similar non-GAAP data presented by other companies. Please refer to the tables in our press release for a conciliation of GAAP to the non-GAAP numbers we will be discussing. I will now turn the call over to our CEO, Dr. TY Chiu, for the opening remarks.
Thank you, En-Ling. Good morning and good evening to everyone. Thank you for joining us for our third quarter 2013 earnings webcast. I would like to begin today's call by highlighting our Q3 2013 achievements. SMIC has achieved another good quarter. Revenue excluding Wuhan wafer shipments was $503.7 million in the third quarter of 2013, representing a robust year-over-year growth of 21.7% and a sequential growth of 0.4%. Total revenue, including Wuhan wafer shipments, declined 1.3% sequentially as we exited our relationship with Wuhan Xinxin. Inventory adjustments were offset by strong 40 nanometer growth and robust mask-making revenue increase, mainly from 40 nano new tape-outs.
I am happy to announce that 40 nano revenue grew 50.3% sequentially to 15.7% of total wafer revenue. This growth was mainly driven by smartphone-related products. Meanwhile, 40 nano new tape-outs grew significantly in the second half of this year, driven by both consumer and communications products like smartphone, set-top box, IPTV, and tablets. As a result, we are targeting strong growth for 40 nanometer next year. We also see revenue growth from China-based customers, again reaching an all-time high increase, 38.2% year-over-year and 1.6% sequentially to 42.1% of our revenue in third quarter 2013.
I am also pleased that we made $42.5 million in profit attributable to SMIC, which is our sixth consecutive quarters of positive net profit and more than three times the profit of 3Q last year. Our return on equity was 8.5% using the trailing four quarters and surpassing our 5% near-term target. I am happy to see the consistent progress of our financial performance and the market share. That confirms our strategy of sustainable profitability and growth is effective.
As the industry undergoes a general inventory correction, we are introducing new technology, new products, and are working to migrate some differentiated products to address the effect of the situation. For example, in Q3, we had 65 nanometer tape-outs for products such as connectivity, SIM cards, set-top box, and NOR flash. In Beijing, we just successfully delivered our first new tape-outs on 55 nanometer for embedded non-volatile memories, embedded NVM for SIM cards. Over the next few years, we anticipate differentiated products such as CIS and embedded EEPROM to transition to more advanced nodes. During the quarter, demands for our differentiated application continued to be strong, especially in the area of power management, CIS, and EEPROM. Revenue from our differentiated applications, specifically PMIC, CIS, and EEPROM, grew over 50% year-over-year in third Q 2013 compared to third Q 2012.
In addition, we have recently announced that four of our China six banks card IC houses have chosen SMIC as their foundry partner using our embedded EEPROM platform. Among the four bank card IC design houses, three of them have already been certified, and the fourth design house is targeted to be certified by the end of 2013. Based on the research of the China Semiconductor Industry Association IC design branch, China's financial IC card demand is estimated to be 800 million units per year, with a potential compounded annual growth rate of 20% over the next five years. A number of our customers are successfully entering the touch controller market based on the same embedded non-volatile solution and is starting to enter volume production.
According to IHS market research, the worldwide demand for touch controller IC in capacitive touch panels will reach about 2.7 billion units by 2017, nearly a 21% compounded annual growth rate from 2012. In Q3, utilization in our 8-inch fab continued to be high. In order to further capture the market opportunities and to enhance our position in the differentiated technology, we continue to look into various opportunities to expand our 8-inch capacity. Earlier this week, we also issued a press release about the formation of our center for vision sensor and the 3D IC. This consolidate and strengthen our existing R&D and manufacturing capability in sensor technology, TSV, and other middle-end wafer processing technologies for CIS, MEMS sensors, 3D stack devices, and TSV-based high-performance 2.5D and 3D system in package.
To update you, the schedule for our 28 nanometer development remains on track and is targeted to be process-ready by the fourth quarter of 2013. To ensure long-term growth and profitability, SMIC is constantly working to improve efficiencies. Our spending and investment into advanced capacity is gradual and prudent. Our asset turnover ratio has improved over 60% in Q3 this year as compared to Q3 in 2011. Our estimated employee productivity in 2013 has improved about 40% compared to 2011, which is when this new management team came on board. The joint venture in Beijing was established in this quarter, and it is reflected in our consolidated financials. As we announced earlier this year, the fab would have the capability to serve 45 nano and below customers with a planned manufacturing capacity of 35,000 wafers per month over the next three to five years.
Currently, the fab construction should be completed around the next two months, and the clean room will be ready for equipment move-in in the first quarter of 2014. Our customers have expressed enthusiasm over this new advanced capacity. Excluding Wuhan shipments, Q4 revenue will be somewhere between flat to modest 4.5% decline. While we faced a slower-than-expected market, we have confidence in our team to execute all the initiatives in bringing new products online and migrating technology to more advanced nodes. We are also confident in the underlying demand for mobile-related products. According to Gartner's Semiconductor Forecast Database, third quarter 2013 update, from 2012- 2013, low-end and mid-end smartphone semiconductor revenue will grow at a compound annual growth rate of 24.2%, with low-end tablet growing at a compound annual growth rate of 38.3%.
To conclude, we target another full year of record high revenue and net profit in 2013, with sustainable profitability and growth as our priority. Looking into 2014, we aim to outgrow the industry average again. We have a number of exciting opportunity ahead of us. One, our 40 nano ramp-up continued to be strong. Secondly, our 28 technology is coming online as on schedule with robust customer interest. Three, our embedded non-volatile is finding widespread customer acceptance as we enter the targeted market. Fourth, the derivative applications for the same technology are also being identified and tried out. Five, a number of other value-added differentiated technology will be rolling out in 2014. Lastly, our new capacity for high-end and mature technology is coming online as scheduled. We believe it will be an exciting 2014.
Thank you for your time. I will now hand over the call to Gareth for overall business and financial commentary.
Thank you, TY, and thank you everyone for joining us today. I will now take a few moments to summarize our third quarter 2013 financial results and our fourth quarter 2013 guidance. You may also refer to our quarterly financial presentation on our website. Please note that all currency figures are in US dollar unless otherwise stated.
Overall, we had a good quarter for Q3 2013. We achieved revenue excluding Wuhan, with shipments of $503.7 million, representing an increase of 21.7% year-over-year, an increase of 0.4% quarter-over-quarter. Revenue including wafer shipments from Wuhan was $534.3 million in Q3 2013, representing increase of 15.8% year-over-year and down 1.3% quarter-over-quarter. Gross margin excluding wafer shipment from Wuhan was 22.1% in Q3 2013 compared to 30.4% in Q3 2012 and 26.7% in Q2 2013. Gross margin including wafer shipments from Wuhan was 21% in Q3 2013 compared to 27.5% in Q3 2012 and 25%. Sorry, 27.5% in Q3 2012 and 25% in Q2 2013. Q3 2013 is our sixth consecutive quarter of positive profit. Profit attributable to SMIC was $42.5 million, compared to $12 million in Q3 2012 and $75.4 million in Q2 2013.
Revenue from 40, 45 nanometers applications increased to a record 15.7% of wafer revenue, compared to 0.8% in 3Q 2012 and 10% in Q2 2013. Cash and bank balances increased to $473.5 million from $231.8 million in Q3 2012 and $263 million in Q2 2013. Revenue from China-based customers increased to 42.1% of overall revenue in Q3 2013, an all-time high, compared to 35.3% in Q3 2012 and 40.9% in Q2 2013.
Now, let's look at our income statement in detail. Revenue decrease in the third quarter of 2013 was mainly due to a decrease of revenue generated by shipments from Wuhan Xinxin. Wafer revenue from Wuhan Xinxin was $30.6 million in Q3 2013 compared to $39.5 million in Q2 2013. We began phasing out wafer shipments from Wuhan Xinxin in Q3 2013. Our Q3 2013 gross margin, excluding wafer shipment from Wuhan, was guided 18.5%-21.5% and resulted in 22.1%. Our Q3 2013 gross margin, including wafer shipment from Wuhan, was guided 17.5%-20.5% and resulted in 21%. The decrease in gross margin was primarily due to lower fab utilization and product mix change.
Operating expenses in Q3 2013 was $63.4 million, compared to $56.1 million in Q2 2013. R&D expenses increased to $37.6 million in Q3 2013 from $36.7 million in Q2 2013, mainly due to a $6.8 million increase in R&D expenses from increased R&D activities, and partially offset by $9 million in funding of R&D contracts from the government in Q3 2013, compared to $3 million in Q2 2013. General and administrative expenses was $24.7 million in Q3 2013, down from $42.6 million in Q2 2013, mainly due to a decrease of employees' bonus accrued in Q3 2013.
Other operating income was $8.2 million, which mainly consists of the gain arising from the disposal of PowerVision quarters in Shanghai. If excluding funding of R&D contracts from the government and other operating income, which is mainly from asset disposal, the normalized OpEx would be $80.6 million in Q3 2013 compared to $92.2 million in Q2 2013, mainly resulting from lower employee bonus accrual. Profit from operation in Q3 2013 was $48.5 million, compared to $79.1 million in Q2 2013.
Moving to the balance sheet. At the end of the third quarter 2013, our cash and bank balances together with restricted cash was $669.3 million, compared to $477.4 million in the previous quarter. The large increase is due to, first, the receipt of $108 million in cash as partial capital contribution for the JV company established in Beijing from the other shareholders of the JV. Secondly, we drew down some bank borrowings in Q3 2013. Meanwhile, our long-term borrowing increased $78.7 million and short-term borrowing decreased $38 million compared to Q2 2013. Our debt-to-equity ratio decreased to 43.1% from 44.1% in the second quarter of 2013.
In terms of cash flow, we generated $269.6 million of cash from operating activities in the third quarter of 2013 compared to $108.4 million in the second quarter of 2013. This increase was mainly as a result of changes in working capital. Cash used in investment activities decreased by $29.4 million in Q3 2013 compared to Q2 2013. Cash from financing activities increased from $104.2 million to $154 million as we received partial capital contribution for the joint venture company established in Beijing from the other shareholders of the joint venture.
To examine our revenue by applications, the communication segment was still our biggest contributor to revenue this quarter. Revenue from this quarter contributed 44.4%. Revenue from the consumer contributed 43.9%. Both communications and consumer sectors declined slightly as others had some moderate growth, mainly from mask revenue. Geographically, revenue from China grew 1.5% sequentially, contributing 42.1% of total revenue. Revenue from North America decreased 6% sequentially, contributing 46% of total revenue. Eurasia grew 8.9%, contributing 11.9% of total revenue, and increased mainly from mobile-related shipments.
In terms of technology, revenue from 45, 40 nanometers increased 50.3% sequentially. Revenue from 65, 55 nanometers and 90 nanometers decreased 13.9%. Meanwhile, 0.13-micron and above line width decreased 7.2% quarter-over-quarter. In terms of our overall capacity, total monthly capacity at the end of the third quarter was 231,800 wafers, compared to 223,500 wafers. The change was primarily due to increased 45 capacity in our Shanghai 12-inch fab. We still plan to expand our Shanghai 12-inch fab to 15K by end of the year. The overall utilization was 88.2% in the third quarter of 2013, compared to 98.5% in the second quarter of 2013.
Looking ahead to the fourth quarter of 2013, excluding wafer shipment from Wuhan Xinxin, which had gradually phased out starting from the third quarter of 2013, revenue is expected to be down 4.5% to flat quarter-over-quarter. Including Wuhan, total revenue is expected to be down 9% to down 4.5% quarter-over-quarter. Gross margin, excluding wafer shipment from Wuhan Xinxin, is expected to range from 19%-22%. Including Wuhan, gross margin is expected to range from 18.5%-21.5%. Operating expenses are expected to range from $80 million-$84 million, excluding the effect of foreign change, funding of R&D contract from the government, employee bonus accrual, and gain from disposal of living quarters.
We reiterate our 2013 capital expenditures estimate for foundry operations to be approximately $675 million. The 2013 planned capital expenditure does not account for additional expenditure for the joint venture company in Beijing, which has been established on July 12, 2013. The joint venture company will principally engage in, among other things, the testing, development, design, manufacturing, packaging, and sale of integrated circuits. As mentioned last quarter, in addition to the estimated CapEx for the foundry operations, we have budgeted CapEx of another $130 million in 2013 for construction of living quarters for employees as part of employee retention program. We plan to either rent out or sell those living quarter units to the employees in the future.
I will 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, please be reminded to limit your questions to two per person. Operator, please assist.
Certainly. Ladies and gentlemen, if you wish to ask a question, please press star one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press the pound or hash key. Your first question comes from the line of Bill Lu from Morgan Stanley. Please ask your question.
Yeah. Hi. My first question is on 2014. Dr. Chiu talked about seeing several drivers, and your competitor, TSMC, talked about double-digit growth for 2014. I am wondering if you can help us quantify what type of top-line growth we could expect for 2014, and also, let us say, by end of the year 2014, what will be the revenue contribution from 40 nanometers?
Okay. We are looking at 2014 with quite excitement because there are a number of new technology coming out. Actually, we believe that our growth will be above our industry average, and you can actually check out what the industry average number is. Actually, in our foundry industry average is actually above the double digit. Secondly, if you add the 40 nano growth, the contribution will still increase. We, at this moment, not here to be very specific on the proportion of the revenue.
Yeah. Bill, I think just to add on to what TY said, I think we are seeing robust growth in our 40 nanometers because we see very strong tape-out activities for our 40 nanometers both in the Q3 and in Q4. In terms of the growth for 2014, I think we are very optimistic for two reasons. First of all, we think that the underlying growth for the mid and low-end smartphone and tablets continue to be strong. Secondly, we are seeing a lot of progress in terms of our differentiation strategies, and both will drive our revenue next year.
Just to be clear, you're saying the foundry sector should grow by double digits next year, SMIC above that, correct?
Bill, I'm sure you have seen some of the analyst forecast for the growth for this year, and we are talking the growth above the industry, yes.
Okay. My second question is on gross margins. If you look at the fourth quarter, I think there are quite a few moving parts, right? You've got utilization rates, you've got yield improvements, 440, you've got capacity and depreciation going up, and mix shift is shifting as well. Can you quantify what are the key drivers for gross margins in the fourth quarter?
Well, obviously, utilization will be a major determinant for the gross margin. Actually, I think we want to correct that. We expect flat overall depreciation to the company quarter-on-quarter in Q4. So I just want to correct that point.
Thank you.
Well, in terms of the long-term gross margin, we continue to see opportunities for us to improve on the gross margin, mainly because we continue to optimize our product mix. That's where our differentiation strategy, we're going to play a major part. Secondly, we have been making a lot of progress in terms of improving our service quality to our customers, and that will help to keep our loading high.
Well, can you qualitatively talk about where 40 nanometers gross margin is relative to the corporate average?
I think at this point in time, I would say that it's still below the corporate average. But I would emphasize that the 40 nano business is definitely accretive to our net earnings, because as you understand, a lot of the cost in our Shanghai in Shanghai is fixed cost.
Do you have a timeline for when that reaches corporate average?
I think it's a little bit hard for us to pin down a timeline at this point in time.
Okay, great. Thank you very much.
Your next question comes from the line of Daniel Heyler from Merrill Lynch. Please ask your question.
Thank you. Good morning, gentlemen. My first question of the two would be on the capacity expansion plans. You are building out both 300 millimeter and you continue to think about adding more 8-inch next year. Could you give us just roughly how much you plan to expand capacity, just in terms of wafers for 12-inch and 8-inch?
For the 12-inch, we are targeting to reach 15K capacity by end of this year for the 40, 45 nano capacity. As you look at this year, actually, the actual shipment is much lower than that, 15K, because we are in the process of ramp up. For next year, the capacity will be available for the full year, so that will be an increase in the overall capacity for 12-inch. We are also planning to put in, at this point in time, a mini line in our B2 new fab. I think the plan is, first of all, to move into 40 nanometers production. For 8-inch, we are incrementally increasing our capacity for our 8-inch fab in Shanghai, as well as in Tianjin. At the same time, we are planning to start our Shenzhen project in the near future.
Yeah, that's what I was wondering is when. Okay, so it sounds like you're close to securing some used equipment for the Shenzhen fab. How much 8-inch capacity do you think you can expand next year based on all these moving parts, Shenzhen and Tianjin and Shanghai? Can you add 50,000 wafers next year?
For the Shanghai, we can expand capacity from currently 19,000 wafers per month to about 100K per month. Our Tianjin right now, the plan is to expand it to about 40K or slightly more than that in Tianjin. For Shenzhen right now, we are still in the planning stage, and we can provide you with more color in the next quarter.
Did you say Shanghai from 19 to 100K is your plan?
Yeah, from 90 to 100K. Yes.
Okay, for next year.
Yeah.
Great, thanks. Finally, just a little bit on the financial side. I appreciate that. I have noticed your year-over-year cost of goods sold depreciation, your margins are down year-on-year from 27. You have got a huge increase in depreciation as a result of that. So basically, a 37% increase in year-on-year depreciation. Conversely, though, you have been able to offset that. It looks like the OpEx is, in fact, down 40% year-on-year, and that is due to the big drop in R&D. How have you been able to drop the R&D so much, given you have so many new projects on derivative technologies, 20 nanometer and tape-outs? Could you give us some color on the magnitude of the R&D credits you are getting?
Yeah. I just want to clarify, we have not decreased in our R&D spending. I think if you look at 2013- 2012 number, the reason you saw a drop is because in 2012, our 12-inch fab in Shanghai was still in sort of an R&D fab. So all the expenses got into the R&D line. But as we started volume production for that fab in the last quarter of 2012, all the expenses go into the cost of goods sold line, which is why you see a decrease in R&D spending. But in effect, we have not reduced our R&D spending. In fact, if I look at our R&D spending in the course of 2013, if we exclude the R&D grant, our R&D spending increased from about 6.5% to about 8.3% in the third quarter. So actually, we are putting more effort and emphasis in the R&D.
Yeah. Could you give us what the grants are the last few quarters? Because your R&D has been a very mild increase despite many projects, if you just look at the past several quarters. So what was the R&D amount credit that you received this quarter and last quarter? The dollar amount.
This quarter, I think we have received about $9 million, compared to about $3 million in the last quarter.
Okay, great. Just for 2014, any view of where you think that will go up because of these projects that are related to national projects and other things going on? Could we expect this to continue to run about $9 million per quarter?
I think we've been guiding the market that for this year, we're going to receive about $25 million- $30 million. I think that is our expectation, yeah.
Okay, for next year.
This year, we do not know yet, but we will talk about. I think for modeling purpose, you can make the assumption, but we can provide more color in the next quarter, yeah.
Okay, excellent. Thank you, gentlemen.
Your next question comes from Szeho Ng from BNP Paribas. Please ask your question.
Hi, good morning, gentlemen. Just want to note what percentage of the revenue right now is coming from the differentiate applications, and how do you expect to grow that part of business going into 2014 and 2015?
Differentiate.
Could you repeat the question again?
What percentage of the revenue is coming from the specialty process, the differentiate applications?
Let me double-check the number. I am sorry, I do not have the number on here right now. We will get back to you later on.
Oh, okay. All right. The big picture, I think all the foundry players are talking about getting into the specialty process market. Just want to know how are you going to differentiate from the competition.
Okay. This part, I would like to say that in a number of the areas that we are playing into our strength. For example, in the embedded non-volatile for smart card applications, SMIC has some very strong partners that had experience since the China ID Card . These companies had worked through that project, and over the last three or four years, had expanded into other areas, such as Social Security card, SIM card. They had become the overwhelmingly dominant supplier to the China SIM card market. Actually, these partners have been working with us for a long time. They know the application in China very well, and we believe that they will be able to work with us very closely to address this market since it is a very local market. This is an example in the smart cards.
In other areas, such as the CIS, we believe that and we are a lready are seeing a very strong growth in the customers that we have, that they are becoming the dominant players in some of these mid to low-end CIS. As they expand into the high-end market, I think they will be doing very well. I think for us, our strategy is to pick the right customers and work with them and serve them as they need.
Szeho, just want to get back to you on your earlier question about for our three differentiation of technology, CIS, PMIC, and EEPROM. I think, for Q3, it generate about 30% of revenue.
Okay. All right. Thank you. My next question is on 28 nano. When should we expect 28 nano to be revenue generating?
Okay. The 28 nano, we are freezing our process this quarter for our commercial IP suppliers to try out as well as some of our close-up customers and partners to try out. We believe that we are aiming to generate some revenue by the end of 2014.
Okay. All right. Last question, on the CapEx side, you budget $130 million for the employees quarter. How much have you spent so far?
I think we have probably spent three quarters of that until now. Yeah.
Okay. All right. The balance will be spent by the end of the year, right?
Yes. Yeah.
Okay. All right. Thank you very much, and good quarter.
Your next question comes from the line of Steven Pelayo from HSBC. Please ask your question.
Thank you very much. I would like to explore a little bit more on the margins here. You were answering Bill's question. You did not know for sure when 40 nanometer would hit corporate average, but you also talked about capacity in Shanghai getting to 15K by the end of the year, then having a full year effect of having 15K in Shanghai next year. Is a fully utilized 15K enough to be doing above 20% gross margins in 40 nanometer? Can I ask the question that way?
Let me answer that, Steve. We are also building up our B2, and B2 will be running 40 nano as well, besides the Shanghai. It is a moving scenario, and it is very difficult to be hammering down the exact gross margins at the exact timeframe.
Okay. Then maybe I will just ask the margins on the other side. You mentioned the press release that your differentiated strategies grew 50% year-on-year. You just said they were 20% of revenues. Where are that 20% of revenues relative to your corporate average margins?
Oh, just I mentioned the differentiate process, but comprise only three component, the CIS, PMIC, and EEPROM, made up 30%, not 20% of revenue.
Okay. Sorry. Where are the margins on that 30% of revenues relative to your corporate average?
I would say it is better.
What about the magnitude of better? How much is it?
Quite a fair bit better. Yeah.
Okay. Quite a fair bit. Thanks for the detail. The last couple quick questions here. You guys really talked about mask revenues really helping you. I am curious, how much is this other revenue segment for you? How big is mask and other for you guys?
Our mask revenue is ranging about USD 20 million-USD 25 million per quarter. Yeah.
Per quarter. Okay. I am sorry, I got to ask you to quantify a little bit more because I think everybody has different industry growth forecasts for next year. You did hint to maybe double-digit industry growth forecasts. What industry growth forecasts are you guys assuming that you are going to outperform next year?
Which one is that? I think that's the [audio distortion]. Got it. Steve, we will check out exactly which one it is, okay? Hold on. We will come back to you later.
Okay. I will get back in line. Thanks, guys.
Your next question comes from the line of Eric Chen from Daiwa Securities. Please ask your question.
Yes. My first question I would like to make clear in terms of the CapEx and the capacity, the expansion, for this year and for next year. For the whole year, the CapEx still maintain at $675 million. Is that right?
That's correct, yes.
Okay. How about the capacity expansion? How many percent year-on-year growth?
You mean the capacity growth?
I mean the capacity, let's say the 8-inch equivalent, the capacity. For the whole years versus the last year, how many percent year-on-year growth?
I'm sorry, I don't have the number offhand right now, but we'll try to get back to you later on.
Okay, please. Probably roughly idea is also quite helpful. How about for next year? I remember probably the earlier conference that you mentioned, the CapEx for next year probably will grow, and probably quite significant. Can we assume that like a $1 billion level, does that make sense for you for the CapEx next year? Once we're looking at the 28 nanometer process, we probably need much higher CapEx for next year, right? Does that make sense for you?
To be honest, I think right now, at this point in time, we are still working on our next year's budget, and that includes the CapEx spending next year. Just want to emphasize that I think the management team believes in a very disciplined approach to CapEx. I think the priority for us is, first of all, to make the maximum use of our existing capacity in two senses. Then, we only add our CapEx incrementally based on clear visibility on customer demand and also our process readiness.
Okay. That means all the depreciation expenses, in terms of the absolute amount, probably not grow too much, right? Let's say the 10% year-on-year growth, does that make sense for you?
Sorry, 10% year-on-year growth on?
For the depreciation expenses for next year. You just tried to highlight the CapEx, you try to be more disciplined.
Yeah.
I'm wondering, does that fail for the analysts to assume your depreciation expenses, the growth for next year, probably around the 10% level year-on-year growth?
I don't have a precise number because we are really, right now, in the middle of working on our budget next year. But I think we will provide more color on that when it comes to the next earning call. Yeah.
Okay. How about our depreciation expenses compared to last year in terms of the year-on-year growth this year?
I think it's pretty flat, actually.
Okay. So, mm-hmm. I got it. Okay, and also the second question regarding the special, the application, the process, the business you highlight, that will be the one of the two drivers from your China client. So I would like to know what kind of process. It's also at the 40, 45 nano process mostly, or a couple of different processes we talk about.
Could you repeat that question again?
For your CMOS sensor and the EEPROM, and the power management, what kind of process are you using now and aiming the geometry migration for next year?
Okay. For the embedded non-volatile, we have offerings at 0.18-micron, 0.13-micron, and our newest technology is at 55 nanometer. That is for the embedded non-volatile. For the CIS, we are actually at 0.13-micron and working on the 12-inch 65 nanometer. Okay. Our PMIC, right now, our production is 0.18-micron, and actually we have programmed at both 0.13-micron as well as 65 nanometer.
Okay, for your CIS client, the 65-nanometer process you talk about, that is for the domestic client or for the U.S. client, foreign client?
We are actually having a lot of new clients working with us, so both domestic and overseas clients, customers.
Okay. I see. But in terms of the growth, it's mainly from the foreign client, right? Can I assume that?
In terms of this year's growth? Are you talking about this year's growth?
I talk about the next year's growth.
I think that it could be both. Yeah.
Okay, I see. Okay, thank you.
May I get back to you, Steve, and the number that we are referring to, the overall foundry growth is based on the iSuppli number.
Your next question comes from the line of Donald Lu from Goldman Sachs. Please ask your question.
Hi, Dr. Chiu, I have two questions. First is, the Chinese government has recently announced a very ambitious plan to stimulate the semiconductor industry. We have had two high-profile privatization proposals for Spreadtrum and RDA. I just want to ask as far as SMIC is concerned, what do you see as a potential change next year from the government perspective in terms of R&D support or maybe other measures such as maybe A-share listing for SMIC shares?
SMIC is already listed in Hong Kong. As far as the privatization of the Spreadtrum and RDA, I believe that, to us, the business will be positive because they will be able to extract more higher value. Once getting the higher financial resources, they will be able to do a lot of activities, such as, potentially, I'm not saying that they will definitely do that. They will be able to acquire a lot more companies and expand their market share aggressively. We see that as a very positive move for SMIC.
Donald, I think we just want to get back to you. I think we expect the PRC government, given the emphasis on the semiconductor industry, will have come up with even more supportive policy going forward. On your question about A-share listing or whatever, I think SMIC is open to look at all the different possibility to enhance shareholders' value.
Mm-hmm. Just follow up on this, will there be more measures in terms of rebate for using domestic foundry and packaging service for Chinese fabless companies?
I don't think at this moment. Right now, these design halls have some R&D, some of these R&D contracts. But I don't see that there is an obvious rebate. At least we are not getting any obvious rebate.
I see. Okay. Thank you. My second question is on the return on your 40 nanometer investment. I think both Bill and Steve has asked you about gross profit margins. One, you tool back to the corporate average. Let's say it go back to the corporate average. Let's say it's 20% or so. Given the potential scale you have, which is probably around 20K or 30K, the most, for 40 nm, what kind of return do you think you can get for this kind of investment in terms of either ROE or the payback period for investment? Because I'm afraid, after all, most of your investment are still in the 12-inch and leading-edge. Can you get enough return so that you can continue to improve your balance sheet?
Hi, Donald. I think that let's look at it in general, that SMIC ROE has improved steadily, and that contribution comes from both the mature as well as the advanced technology. A few quarters back, we have announced a target of ROE of 5%. I think when we look at the trailing four quarters, we have already surpassed that particular target, and we continue to improve upon it. There are a lot of factors as to how we optimize the margin for each technology node. But the important thing is the general, the overall return on equity. The scale at this moment, you may think, is small for the 40 nano, but 40 nano will also be run in B2. And we will shift the weight of the 40 nano to 28 nano, depending on the customer demand as we proceed.
But how about the 40 nanometer CapEx investment based on current pricing and
Actually, right now, even in the Shanghai fab, all our latest investments are the 28 capable. So even though we have invested, say, for the 40 nano capacity, the overwhelming amount of these equipments are able to switch to 28 production when the technology becomes available.
But just over the long term, do you think your 40 nanometer investment will generate, let's say, 5% return on the investment?
I believe so.
Well, certainly, I think we have set a very clear target for our ROE going forward. As a management team, we are very focused in terms of delivering the returns for our shareholders.
Great. Thank you.
Thank you.
Your next question comes from the line of Randy Abrams from Credit Suisse. Please ask your question. Randy Abrams, your line is now open.
Maybe-
As we are not getting a response.
Donald, let me follow through, and let me put it this way. In the past, I think we have always seemed to have to justify that SMIC is capable of being profitable and running at a sustainable profitability level, because there were a lot of questions as to SMIC's scale. There are impressions out there saying that the only determining factor in having a profitability is the scale. But I think scale is very important, but there are other factors where we can bring the cost down and bring the efficiency up and have a good profitability even at a lower scale as compared to other foundry. This is where we are trying to do, and this is where we have proven that we are able to do.
Your next question comes from the line of Randy Abrams from Credit Suisse. Please ask your question. Randy Abrams, your line is now open.
Okay.
Maybe we'll go to the next.
Maybe we'll go to the next one. When Randy comes up, we can go back to Randy.
Your next question comes from the line of Gokul Hariharan from JPMorgan. Please ask your question.
Yeah. Hi, good morning. A quick question on your Chinese customers. I think you mentioned that there is still some inventory correction going on in that supply chain. What is your read on when that inventory correction is likely to end? Is it going to end by 4Q as your competitors, like TSMC, were suggesting, or is it going to take until first quarter? I have one other question. Thanks.
Yeah. Obviously, I think we are entering in a stage of inventory correction at this point in time. I think our visibility right now is only for one quarter, and I think it would be difficult for us to comment too much on Q1. I would say, going beyond these two quarters, I think we are still very confident of growth. Again, back to what we talked about just now. I think we still believe in the strong underlying growth for the mid and low-end smartphone tablets. Secondly, we are making a lot of progress in terms of differentiate strategies, and that should pay off in 2014. Yeah.
Okay. My other question was, last time you suggested that there are a couple of one or two customers who are starting their 40 nanometer evaluation and could likely come in first quarter of next year. Is that still on track, and is that going to be enough for your first quarter to be an up quarter or a flat quarter and kind of buck the normal seasonal trend? Thanks.
We do see a very strong NTO activities for our 40 nanometers in Q3 and Q4, and we do target robust growth for 40 nano revenue next year.
Let me add that there are about three or four additional customers going into production as compared to this quarter and the last quarter.
Okay. Thank you.
As we are now going over time, I would now like to hand the call back to CEO, Dr. Chiu, 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. Thank you very much until next quarters. See you. Bye-bye.
This is the end of SMIC's third quarter earnings conference call. We thank you for joining us today.