Ladies and gentlemen, thank you for standing by, and welcome to Semiconductor Manufacturing International Corporation's second quarter 2014 webcast conference call. Today's conference call is hosted by Dr. Tzu-Yin Chiu, Chief Executive Officer, and Dr. Yonggang Gao , Chief Financial Officer, Mr. Gareth Kung, Executive Vice President of Finance and Company Secretary, and Mr. En-Ling Feng, Vice President 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 a listen-only mode. However, at the conclusion of the management presentation, we will be having a question and answer session, at which time you will receive further instructions as to how to participate. The earning 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 to you Mr. En-Ling Feng, Vice President of Investor Relations, for a cautionary statement. Thank you. Please go ahead.
Good morning and good evening. Welcome to SMIC's second quarter 2014 earnings webcast conference call. For today's call, our CEO, Dr. Tzu-Yin Chiu, will first provide some business remarks. Afterwards, our CFO, Dr. Gao Yonggang, will highlight our financial performance and give next quarter's guidance. Our Executive VP of Finance and Company Secretary, Mr. Gareth Kung, will give the detailed financial commentary. This will then 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. Before I turn the call over to Dr. Tzu-Yin Chiu, let me remind you that the presentation we will be making today includes forward-looking statements.
These statements and other comments are not guarantees of future performance, but represent the company's estimates and are subject to risk and uncertainty. Our actual results may differ significantly from those projected or suggested in any forward-looking statements. For a more complete discussion of the 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 14th, 2014. 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 those tables in our press release for a reconciliation of GAAP to the non-GAAP numbers we will be discussing. Please note that all currency figures are in U.S. dollars, unless otherwise stated.
I will now turn the call over to Dr. Tzu-Yin Chiu, our CEO, for the business remarks.
Thank you, En-Ling. Greetings to you all, and thanks for joining us. We have some very good news to report in Q2. Excluding Wuhan contribution, SMIC achieved record high revenue in Q2, which is our ninth consecutive profitable quarter. We reached a growth margin of 28%, also our highest since 2005. Compared to Q1 2014, utilization was more than 10% up, while revenue increased 13.4% sequentially. Our Q2 growth margin increased 6.7 percentage points. Profit from operations nearly doubled, and the net profit tripled. We continue to emphasize the priority of sustained profitability and carefully planned growth. Overall, we are optimistic about 2015 as we prepare our capacity and the technology for many new and exciting opportunities. One of the growth drivers for 2015 will be 28 nanometer. We are happy to work with our longtime customers and partner as we ramp up this new technology.
We are on track to reach our target to have production ramp up in 2015. We are also working with other customers who are targeting to capture the LTE handset IP market in China, AP for tablet, and RF applications on 28 nanometer. The strong demand and interest for our 28 nanometer has compelled us to accelerate our expansion of 28 nanometer next year. We target to have more than 15,000 wafers per month capacity by the end of 2015. Our 40, 45, and 65 nanometer wafer revenue has rebounded in the second quarter to 13% and 26%, respectively, from products such as Wi-Fi, Bluetooth, smartphones, tablets, DTV, and others. We target 40 nanometer revenue contribution will reach mid-teens percentage at the end of this year.
Some of the revenue loss due to product transition from 45 to 28 has been made up by new influx of customers, as well as new products from old customers, and we continue to receive strong 40 nanometer NTOs. Our other growth driver for this year and more so in 2015 is our differentiated product offering. SMIC continues to experience high demand for 8 in products capacity for PMIC, CIS, embedded non-volatile, and the sensors. PMIC, CIS, and our NVM non-volatile technologies accounts for around one-third of our wafer revenues, and the growth is currently constrained by limited 8 in capacity. We believe this growth will resume as we are able to expand our capacity in Shenzhen. Our technology for bank card IC has been qualified and is in early production. The effort in 12 in specialty process development has recently yielded the industry's leading 55 nanometer embedded non-volatile solution.
Our customer has entered into high volume production based on this technology. This new 55 nanometer low power embedded flash platform has already been recognized by our customers for its excellent performance, and it includes a comprehensive IP library. We are therefore accelerating our effort to expedite on 28 nanometer, both poly-SiON and the high-k, as well as a number of new specialty technology into production phase. In response to overall strong capacity demand, we are squeezing more capacity out of our existing facilities and accelerating the ramp-up plan of our new facility. We have allocated funds to expand Tianjin from 39,000 wafers to 42,000 wafers per month. We still target Shenzhen fab to reach 10,000 wafer per month installed capacity by year end.
Meanwhile, Beijing JV's project logistics are taking a little bit more time than expected, so we have adjusted the estimated installed capacity in Beijing JV to about 1,000 wafer per month by the year end. To meet our customers' strong and urgent 28 nanometer need, we target to set up 6,000 per month 28 nanometer capacity by the end of 2014 in our Shanghai facility. To address the added capacity on both 8 in and converting 40 nanometer to 28 nanometer, we have increased our foundry CapEx by an additional $100 million. The strong IC demand in China is continuing to drive our growth. For the first time in SMIC's history, our China revenue has exceeded all other regions in the second quarter. Revenue from China now accounts for more than 44% of our total revenue.
Recently, China's central government introduced guideline to promote the development of the IC industry, in which the government expressed its intention to promote robust and healthy growth in the semiconductor and IT industry. As the largest semiconductor enterprise and the most advanced foundry in China, we are looking forward to a period of accelerated industry growth and to prepare to materialize all the opportunities that will be presented in China. We believe the opportunities for continued growth will be plentiful. In conclusion, the second quarter recovery ended with strong financials and profitability for SMIC. The growth in 2014 is constrained by our capacity. However, we are optimistic about 2015 as we prepare for the growth on 8 in and 28 nanometer. We continue to have confidence in our strategy to capture growth opportunity here in China, and we stay committed to sustainable profitability and building value for all stakeholders.
Thank you for your time. I will now hand the call over to Dr. Gao Yonggang for the financial highlights and the Q3 guidance.
Okay. Thank you, TY. Greetings to all our listeners. I will now highlight our second quarter results and the third quarter guidance. Our revenue was $511.3 million in 2Q 2014, an increase of 13.4% quarter-over-quarter. Meanwhile, our non-GAAP revenue, excluding wafer shipments from Wuhan Xinxin, was a record high of $511.3 million in 2Q 2014, an increase of 1.9% year-over-year compared to $501.8 million in 2Q 2013. Gross margin was 28% in 2Q 2014 compared to 21.3% in 1Q 2014. Profit for the period attributable to SMIC was $56.8 million in 2Q 2014, compared to $20.3 million in 1Q 2014. Our China region revenue grew to 44.4% of overall revenue, becoming the largest contributor to revenue regionally in 2Q 2014. Now, looking ahead into the third quarter of 2014.
Our revenue is expected to increase 1%-5% quarter-over-quarter, and gross margin is expected to range from 25%-26%, while non-GAAP operating expenses, excluding the effect of employee bonus accrual, government funding, and gain from the disposal of living quarters, are expected to range from $96 million-$101 million. I will now hand the call over to Gareth for more detailed financial commentary.
Thank you, Gao, and thank you everyone for joining us today. I will now comment on the details of our financial results. On the income statement, revenue increased to $511.3 million in Q2 2014, mainly because of the increase in wafer shipments. Revenue decreased 5.5% year-over-year from $541.3 million in Q2 2013, mainly because there were no wafer shipments from Wuhan Xinxin since first quarter of 2014. Cost of sales increased to $368.3 million in Q2 2014, up only 3.8% Q-on-Q from $355 million in Q1 2014. Gross margin increased to 28%, up from 21.3% in the previous quarter, mainly due to an increase in fab utilization. Operating expenses in Q2 2014 were $84.9 million, compared to $66.5 million in Q1 2014.
R&D expenses increased to $45.1 million in Q2 2014 from $36.7 million in Q1 2014, mainly due to, one, the decrease in funding of R&D contract with [inaudible] which was $7.6 million in Q2 2014 compared to $11.7 million in the previous quarter. Two, an increase in R&D activities in the current quarter. General and administrative expenses increased to $35.5 million in Q2 2014, up 53.2% Q-on-Q from $23.2 million in the previous quarter. Mainly because accrued employee bonus increased by $7.1 million. Two, government tax surcharges increased by $2.4 million in Q2 2014. Other operating income was $4.8 million in Q2 2014, an increase from $3 million in the previous quarter. Mainly because of the gain arising from the disposal of part of living quarters in Beijing.
If excluding funding R&D contract from the government, gain arising from the disposal of living quarters and employee bonus accrual, the non-GAAP OpEx was $86.6 million in Q2 2014, compared to $79.4 million in the previous quarter. Profit from operation in Q2 2014 was $58.2 million, compared to $39.6 million in Q1 2014. Our expenses was $1.1 million in Q2 2014, compared to $5.2 million in Q1 2014. This change was mainly due to larger foreign exchange losses arising from the valuation of our RMB against US dollar in the first quarter of 2014. Moving to the balance sheet at the end of the second quarter of 2014, cash and cash equivalents increased to $573.3 million in Q2 2014 from $437.6 million from the previous quarter. Other financial assets increased to $358.4 million in Q2 2014 from $178.4 million in the previous quarter.
In both cases, the increase was due to the net proceeds received from the issuance of convertible bonds and new shares issued in the second quarter of 2014. Our long-term borrowings increased $81.6 million, and short-term borrowings increased $52.1 million compared to the previous quarter. At the end of the second quarter of 2014, our total debt-to-equity ratio increased to 39.7% compared to 3.5% in the previous quarter. In terms of cash flow, we generated $118.6 million cash from operating activities in the second quarter of 2014, compared to $169.4 million in the previous quarter, mainly because of the changes in the working capital and others in the second quarter of 2014. Cash used in investing activities increased to $339.8 million in the second quarter of 2014, compared to $24.9 million in Q1 of 2014, mainly because of additional investment in financial assets in the second quarter of 2014.
Cash flow from financing activities changed from an outflow of $168.4 million in Q1 2014 to an inflow of $357.2 million in Q2 2014, mainly because of the net proceeds received from the issuance of convertible bonds and new share issues in the second quarter of 2014. To examine our revenue by application, the consumer segment was still our single largest contributor to our revenue this quarter. Revenue from this sector contributed 48%. Revenue from the communication sectors contributed 41.4%. Geographically, China region revenue grew to 44.4% of the overall revenue, becoming the largest contributor to revenue regionally in Q2 of 2014. In terms of technology, our 45/40 nanometers and 65/55 nanometers revenue has rebounded in the second quarter to 13% and 26% respectively of wafer revenue.
In terms of our overall capacity, total monthly capacity at the end of the second quarter was 247,500 wafers, compared to 243,500 wafers in the first quarter. The change was due to the expansion of capacity in our Shanghai and Tianjin 8 in fab. The overall utilization was 94.6% in the second quarter of 2014, compared to 84.2% in the previous quarter. We raised our 2014 capital expenditures for foundry operation to approximately $1.1 billion. The increase is mainly for the product mix change, including the conversion of 40/45 nano to 28 nano in our Shanghai 12 in fab, and expansion of capacity in our Tianjin 8 in fab from 39,000 to 42,000. Around $570 million of the total estimated 2014 CapEx is expected to be used for our new Beijing majority-owned subsidiary, which is 55% funded by SMIC and 45% funded by the other shareholders of the subsidiary.
As previously announced, 2014 CapEx for the non-foundry operations is approximately $110 million, which is mainly for the construction of living quarters. We plan to rent out or sell these living quarter units to employees in the future. I will now hand the call back to En-Ling for the Q&A session.
Thank you, Gareth. I would now like to open up for the call for Q&A. As usual, please be reminded to limit your question to two per person. Operator, please assist. Thanks.
Ladies and gentlemen, welcome to the question and answer session. To queue for a question, please press star followed by one on your telephone keypad and wait for your name to be announced. Thank you. Your first question comes from the line of Randy Abrams from Credit Suisse. Please ask your question.
Hi. Good morning. My first question, just on the demand outlook for the guidance, the 1%-5%. You also talked about supply constraints. I just want to see if any part of that was due to the supply constraint on 8 in. For the demand side, if you could talk about with 1%-5%, it is a little bit below some of the historical years, if there is any area you are seeing particular weakness, and if you expect, at least at this early stage, for that to continue into fourth quarter for, say, a modest decline into fourth quarter as we head toward low season.
Well, first of all, happy birthday, Randy. We heard that this is your big date.
Thanks. I appreciate celebrating with you guys.
Okay. Yes, we have a very strong second quarter for the 8 in capacity. This particular strength in the 8 in demand will continue, and we are doing everything possible to address this customer demand through capacity expansion in the 8 in in Shenzhen, and as well as adding capacity to our present facilities as much as possible. As far as 12 in is concerned, there will be a strong demand when our 28 nanometer comes into production, and we are doing as quickly as possible to also meet our customers' capacity requirement. As far as Q3 is concerned, I think that there is still a growth, but indeed, we are noticing that there are some slacking off of the demand. That is indeed what we are seeing.
Okay. For the second question, if I could ask on the Beijing JV, where now some of the 28 nanometer will ramp in Shanghai first. Could you give a new update for Beijing JV, how you plan to ramp that up through 2015, and then an update for progression of 28 nanometer as we move through next year? Like how you expect it to ramp toward 5% and 10% of sales, and how profitability looks if next year with the 28 nanometer ramp, if you could achieve similar gross margins to what you just achieved in the recent quarter, if that's a similar type of attainable goal.
For the Beijing fab, as mentioned by TY, we are looking at about 1,000 capacity by end of the year, and we will continue to ramp up the fab throughout 2015 to meet the customer demand. Likely to be probably close to more than 10,000 per month by end of 2015. In terms of the profitability, I think it's a bit too early to comment on it at this point in time. But as you can understand, this is a new nook for us and it's still a new fab. I think realistically, initially, the gross margin would be relatively weak. But as we going to increase in the production in scale, that should increase in terms of our profitability.
Okay. And maybe if you could take it, just factoring 28 starts at low margin. For overall corporate, with what you're doing on 8 in and you're continuing, I guess, mentioned 40 nanometer tape-outs, are you expecting a similar type of gross margin level? Or you've actually shown improvement the last few years. How should we, at least early stage, expect gross margin into next year? And I guess if there's any impact of depreciation, if that would increase next year with the recent investments.
Yeah. Randy, obviously, we always target to achieve better gross margin, okay. But I think at this point in time, it's too early for us to comment on the gross margin for next year. It all depends on the market situation and also the fab utilization. I think we will update the market as we progresses.
Okay. Can you give an early view on depreciation if there's a big increase, at least on the base CapEx you're assuming, if there's any real headwind from depreciation next year?
Yeah. Honestly, the depreciation for 2015 will also depend on the CapEx for 2015, which obviously we have not finalized the plan yet. I will just give you an early indication. If, let us say, assuming our CapEx for 2015 is around the same ballpark number as the current year, we are probably looking at an uptick in the depreciation in the range of $70 million-$100 million. Yeah.
$70 million to Okay. All right. Thanks a lot. Okay, thanks for the wishes.
Thank you. Next question comes from the line of Daniel Heyler from Bank of America. Ask your question, please.
Thanks. Good morning, gentlemen. I had a question on just the last comments that you had made, TY, because you guys had raised your second quarter margin guidance on the rising loading and utilization in June. You recently mentioned that there is some slacking in demand. Could you elaborate what areas you are seeing and what nodes are you seeing that in?
Okay. We are still seeing the Q3 revenues go up, of course. But there are some slowing down in terms of our 12 in 65/55 node. This is because one of our significant customers has shifted from 65/55 to 40, and we already captured their 40s product. However, we are looking forward to a ramp-up of our new technology in 65/55. For example, our embedded non-volatile technology is coming online and is ramping, and it just takes a little bit of time to accumulate enough product and also different applications to fill back this slight decrease in the loading.
Okay, great. Just a quick follow-up on that. So what is the linearity in orders been like? I know that things got very busy and very heated into the second quarter. Are you sensing the same kind of extended lead times, or are things slacking off a bit generally across the board?
I think the lead time in the 8 in loading is still very extended. Indeed, in the 12 in loading, we are seeing a reduction of the lead time.
Okay. My second question relates to the growth prospects for next year. I am just wondering how much capacity growth we would expect on a $1 billion in CapEx, which you spent this year. What kind of capacity growth do you think you can achieve overall? Because I know you are adjusting existing fabs, you are improving your throughput, you are adding new capacity, you are migrating technology. So there is a lot of moving parts. I just wondered if you could give us a sense of the total wafer capacity growth roughly you would expect next year, say, under a $ 1.1 billion or $ 1.2 billion kind of number.
The major growth in the capacity next year, as we can see right now, of course, it's possible to change based on market condition, will be the growth in our new fab in Beijing in terms of capacity to grow to at least about 10,000 by end of 2015. Then we also see growth in our Shenzhen fab capacity. By the end of 2014, we are talking about 10,000 installed capacity. By end of 2015, we should look at about 20,000 per month.
No other increases elsewhere in your facility. It would just be those two fabs.
Well, there could still be some marginal increase in our 8 in capacity, but I think the increase will be quite limited.
Okay, excellent. Thank you.
Thank you. Your next question comes from the line of Steven Pelayo from HSBC. Go ahead, please.
Yeah. First question is, I guess on margins. Obviously, you are guiding down sequentially here in the third quarter. I am trying to understand what is the normalized level of gross margins. Obviously, you had a very strong Q2 number. Help me understand what is pulling down the third quarter gross margins and should I be thinking the 28% level is achievable on a long-term basis, or should I be thinking now down more than 300 basis points, I think at the midpoint of guidance, as being more of the normalized run rate?
Well, Steve, as you can understand, the biggest driver for gross margin is the fab utilization. The big increase in the Q2 gross margin actually is all attributable to the 10% increase in the fab utilization in Q2 compared to Q1. Likewise, we are guiding down our gross margin Q3 marginally. Because as TY mentioned, we are seeing some softening in the demand that could impact our fab utilization in Q3.
Okay. Remind me what the utilization rates were in kind of 200 millimeter versus 300 millimeter in the second quarter versus your expectations in the third quarter.
We're still looking at a very full loading in our 8 in fab, in Q3. But we are seeing a lower utilization for our 12 in fab, especially for the 65 nanometer nodes.
Okay. Last question I just want to ask is relative to margins a bit more. 45 nanometers got to, I think, about mid-teens percent of revenue in the second half last year. And I think you mentioned at the time that was about breakeven on the gross margin level. It's currently getting back to that kind of level. So could you just remind me, is 45 nanometer profitable at the gross margin level on an absolute dollar basis? And it sounds like you're going to be transitioning some of this 45 nanometer to 28. So cumulatively, I'm just wondering if the 45 nanometer node's never really going to get above 20% of total revenues, and if it's never really going to contribute a significant amount of earnings. So could you help me understand the margins on kind of 45 nanometer and the planned contributions going forward?
Yeah. Right now, we are still having low gross margin for our 45 node at this point in time. But as we are seeing a high utilization, we're targeting a high utilization in second half, so hopefully that will bring up our gross margin for that node. Yes, we are actually building more flexibility in the fab by converting part of the capacity to 28 nano. But that is basically to just create more flexibility for the fab. We are not giving up on the 40 nano revenue.
Okay, and then last questions from me is just on share count going forward. So you did an equity offering. You have a couple of convertibles, I think, in the last couple of quarters as well. What should we be thinking about your share count in the third quarter as well as if those are conversely converted as well?
Steve, we can email you the share count exact information after the call.
Yeah.
Maybe
Okay
Let me give a little bit more color. In the past, we have done a couple of tranches of convertibles, and one tranche of equity. Much of this cash is used to pay down our higher interest domestic loans, so that we can reduce some of our interest payments. So, this is in the past that we are trying to restructure our debt mixture so that you can see that we are lowering our debt-to-equity ratio and also getting an overall lower interest rate.
Okay. I am sorry if I could just sneak one more in. Do you see anything on the R&D funding, property sales, one-time benefits or charges in the third quarter?
Yes. In terms of the R&D funding from the government, so far in 2014, we have recorded about $90 million. Based on our most recent outlook, we should be looking at about close to about $40 million. I think that you can use it for your modeling purpose. In terms of the gain from the disposal of living quarters, I think there is still some marginal amount to be booked in the second half, but it will not be material.
Okay, thank you very much.
Thank you. Next question comes from the line of Ken Hui from Jefferies. Go ahead, please.
Thank you for taking my question. First question on your 28 nanometer capacity in Shanghai. Is it going to be temporary, or is it going to be permanent there? If it is going to be permanent, how are you going to ensure proper synergy with your Beijing fab going forward?
This capacity will be permanently a part of Shanghai's Fab 8. Because our R&D, physically, is located in Fab 8, the ramp-up is the smoothest if we initially ramp Fab 8. We will take a copy-exact approach, to transfer this technology to Beijing. We expect that transfer to be relatively smooth as well.
Okay. My second question is, you mentioned that the 3Q weakness is mainly on 65 nanometer. Can you give us more color regarding your current capacity for 65?
Could you repeat again?
Can you give us some details on your current capacity on 65 nanometer?
Right now, the 65 nanometer capacity is all resident in our 12 in fab in Beijing. It is around 24,000 per month. But actually, as what I mentioned, even though some of the product migrated into 40 nanometer, we are actually, at this point in time, qualifying some new product to backfill the fab. So hopefully, we are going to see some improvement in the utilization down the road.
Would you expect improvement in 4Q already, or would it be too early to see that in 4Q?
Right now, I think it would take a while for us to qualify those products. As you understand, for this business, the visibility is quite limited to about three months. I think it is too early for us to comment.
Okay. Thank you.
Thank you. Next question comes from the line of Chris Yim from Mizuho Securities. Please ask your question.
Oh, hi. Good morning. Can you quickly comment on your customer inventory level at the current moment, especially in China? Do you expect the China strength to continue in the second half?
Chris, can you repeat your question, please?
Yes. Would you be able to quickly comment on your customer inventory level at the current moment, and especially your Chinese customer, whether you think the strength in China will continue in the second half?
Yeah, Chris, I think what we've seen in the second quarter is that, let's say, a rebuilding of a restocking among some of our customers in terms of inventory level. Right now, I think it's back to a more reasonable level. I think in Q3, we're going to see customer will be more cautious in terms of managing the inventory.
Okay. Thank you. You mentioned earlier that you are moving some of your specialty to 12 in. Is that an ongoing effort? Will we see more of your specialty products using 12 in wafers?
There is indeed some specialty technology development in 12 in. In areas where we think it is appropriate, we definitely will also develop a unique technological solution for our customers. I think that at this moment, our embedded non-volatile, for example, is ahead of the, or at least, leading in the industry. We are getting quite a bit of customer attractions in this area, and we have fairly high expectations that this particular technology can have numerous applications, both in the smart card as well as in the MCU area.
Thank you. That is all the questions I have.
Thank you. Your next question comes from the line of Gokul Hariharan from JP Morgan. Go ahead, please.
Yeah. Hi. Thanks for taking my question. My first question is on your 8 in capacity and the plan to expand capacity. Should we think the capacity expansion plan is limited primarily to filling up the Shenzhen fab over the next couple of years? Are you also going to be looking to buy some fully depreciated 8 in fabs at some point in time? Should we expect a more aggressive plan in terms of the 8 in capacity expansion given the capacity tightness? I have another question after that.
Okay. At this moment, our focus is into bringing up our Shenzhen fab. Of course, SMIC is always ready to scour the market for a good asset, and entering in other market segments which we do not have at the moment. That's part of the reason that we also, in the past, have done a number of these either convertible bond or equity so that we have enough financial resources when opportunity comes along.
Okay. You don't consider integrating a full fab from somewhere else a big challenge? That is not an issue to consider. That's not a big issue that would prevent you from going out and buying 8 in capacity?
SMIC is no stranger to merger and acquisition. For example, our Tianjin fab is a merger from a former Motorola fab.
Sure.
That had been executed in a very excellent way. Right now, I think our Tianjin fab is doing extremely well and very popular with our customers. We believe that although it's no small task to absorb a new entity, especially a large entity like a whole fab, SMIC is confident that we can undertake such efforts successfully.
Okay, great. My second question is on the non-GAAP OpEx guidance of around $96 million to $101 million in Q3. This is a pretty big jump from the Q2 levels. Is it primarily the R&D expense for 28 nanometer? How should we think about this going forward into Q4 and Q1 of next year as well? Is it going to stay at this elevated level, or we see some step down after that?
Yeah, I think the growth in the non-GAAP CapEx in Q3 is mainly for two reasons. One is because obviously, we are increasing our R&D spending, not just for 28 nanometer process, but also on many of the differentiated processes that we are going to launch in the next one or two years. Secondly, we also are incurring expenses right now to prepare for the ramp-up of the new Beijing fab and the Shenzhen fab. So, yes, you may see some elevated OpEx in the third and the fourth quarter.
Okay. On the Beijing fab, you mentioned there is a little bit of a delay. Could you elaborate a little bit on that? Is it something that is beyond a quarter, or is it just a small timing issue?
Let me answer that question. Basically, that is a small timing issue, and as you can see that we are actually trying to accelerate the pace so that we can catch up the delivery to our customers. By the end of the next year, we will have a 10,000 wafer per month installed capacity to meet our 28 nanometer demand.
Okay. Thank you.
Thank you. Your next question comes from the line of Lynn Cheng from Daiwa. Please ask your question.
Yes. Thanks for taking my question. My first question is about looking forward into 2015, how should we expect the combined revenue contribution from the advanced nodes includes 28 nanometer and 40 nanometer? Thanks.
Right now, I think it's a bit too early for us to commit precisely in terms of the revenue contribution from 20 nanometer and from 40 nanometer. We think that should increase from the current year, but I think it's too early for us to comment on the contribution at this point in time.
Okay. Could you give us some color about the customer tape-out progress of 28 nanometer process? Thank you.
Okay. Thank you, Lynn. We already have a number of customer tape-outs in the 28 nanometer. In addition, we have six or seven customers engaged with us in both poly-SiON as well as high-k technology. This will take a bit of time to fully qualify the product, but all of these activities are ongoing, and this is on track as well.
Okay, thanks. That's all.
Thank you. Your next question comes from the line of Leping Huang from Nomura. Thank you. Please go ahead.
Thank you for taking my question. I have two questions. The first question, back to the gross margin issues. Can you help me to understand your second quarter revenue is in line with original guidance, but your gross margin was up much higher than the original expectation, and your third quarter margin decline again. Why your revenues is still in line, but you say your utilization rate was higher than expected. Can you clarify this one issues? Thank you.
Yes. I think, obviously, there is some correlation between the revenue and the fab utilization. But as you understand, actually, the cycle time for a fab is about five to six weeks. There is some delay in terms of the revenue increase compared to the utilization. But just to comment on our gross margin fluctuation in Q2, as mentioned about our Q1 utilization compared to Q2 is about, our Q2 utilization compared to Q1 is about 10% higher, and that is the main reason for the significant higher gross margin in Q2. As mentioned earlier, we are looking at our utilization to come down in Q3, and that also explains what is driving down our Q3 gross margin.
Okay. The second question is about your cooperation with Qualcomm. When do you expect Qualcomm's LTE chipset revenue to contribute from? Can we expect revenue contribution from next year, or how big will this revenue contribution be? Also related to their CapEx, you raised your CapEx by 10% this time. Have you taken into account the additional CapEx for Qualcomm's 28 chipset? Thank you.
Okay. Our CapEx this year has included taking into account our customer demand. Secondly, as far as I cannot comment exactly what the customer's tape-out situation is. But we are working very closely with our long-term partner. Qualcomm has been working with us, both in mature node as well as all the advanced node. It is a very close partner as well as a very long-term customer. So whether we expect to have 28 nanometer revenue, yes, we definitely expect to have 28 nanometer revenue by 2015.
So we expect 20 nanometer revenue by 2015 from Qualcomm. Can we say that, or?
Yeah, I think, we are expecting 20 nanometer to contribute to our revenue in 2015. Yes.
Okay. Thank you.
Thank you. Your next question comes from the line of Sze Ho Ng from BNP. Please ask your question.
Hi, good morning, gentlemen. With regard to the embedded non-volatile memory, is it the technology you developed in-house, or you licensed from a third party? What sort of revenue outlook you can offer for eNVM?
Okay. The embedded non-volatile technology-wise, is developed in-house. This is a pFlash structure, which is bought up by ISSI. Therefore, we have been working very closely with ISSI. We are responsible for the technology development, and ISSI is responsible for the IP development. Of course, SMIC does have the IP design right.
Technology-wise, let me just say it again, technology-wise, it is developed only within SMIC.
But, how do I say? The device structure and some of the fundamental IPs are still owned by ISSI.
I can just add to what TY said. I think we do expect very broad applications for this technology, including things like touch application and MCU application.
I see. How about the revenue outlook for this technology?
We have restarted volume production for this technology, so we should expect some meaningful contribution from this technology for this year.
This year, right?
Yes.
Okay. All right. For the finance cost in Q2, it picked up quite a bit quarter-over-quarter. Is this just a one quarter issue, and we should expect it to come down in Q3?
The finance cost should be around the same in Q3, compared to Q2, yes.
Okay. Why is there the jump? Because I believe that you are doing quite a bit of refinancing at lower cost.
Actually, I think the reason for a lower finance cost in Q1 was due to some government funding we received with respect to our finance expenses.
Okay. So, on a steady basis, it should be around $8 million on a quarterly basis going forward.
Yeah, I think, the finance cost should stay relatively stable, if you look at our Q2 numbers.
I see. Okay. All right. Thank you very much.
Ladies and gentlemen, unfortunately, that's all the time we have for questions. I'll now hand back to our 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. See you next time.
Ladies and gentlemen, that does conclude our conference for today. Thank you for your attendance. You may all now disconnect.