Thank you for standing by, and welcome to the Semiconductor Manufacturing International Corporation's third quarter 2014 webcast conference call. Today's conference call is chaired by Dr. TY Chiu, Chief Executive Officer, 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 listen-only mode. However, at the conclusion of the management presentation, we will be having a question and answer session, upon which you will receive further instructions as to how to participate. The earnings press release is available for download at www.smics.com. Webcast playback will also be available approximately one hour after the event at www.smics.com.
Without further ado, I would like to introduce to you Mr. En-Ling Feng, Senior Director of Investor Relations, for the cautionary statement. Thank you. Please go ahead.
Good morning and good evening. Welcome to SMIC's third quarter 2014 earnings webcast conference call. For today's call, our CEO, Dr. TY Chiu, will first provide some business remarks. Afterwards, 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 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 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 financial condition, please see our filings with the U.S. Securities and Exchange Commission and The Stock Exchange of Hong Kong Limited, including our annual report on Form 20-F filed with the United States Securities and Exchange Commission on April 14, 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 the tables in our press release for a reconciliation of GAAP to the non-GAAP numbers we will be discussing. Please note that all currency figures are in USD, unless otherwise stated. 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. SMIC had a good quarter in Q3. We achieved our 10th consecutive profitable quarter. When excluding Wuhan Xinxin, we reached another record high revenue and grew 2% quarter-over-quarter and 3.6% year-over-year. Profit for the quarter attributable to SMIC was $47.5 million. Though we are encountering weaker customer demand on 65 and 40 products and seasonality in the near term, we are working to develop more new products and technologies. We continue to be optimistic about our future as we prepare for new capacities and technology for various opportunities. 28 nm continue to be our top priority. We target 28nm production to begin in the first half of 2015 as we ramp up the production capacity in both Shanghai and Beijing.
We plan to install at least 16,000 per month 28 nm capacity by the end of 2015 to meet the demand for our customers. Demand for 8 in and differentiated products continued to be strong. PMIC, CIS, and EEPROM accounted for 1/3 of wafer revenue and 26% quarter-over-quarter, and 11% year-over-year in Q3 2014. As mentioned previously, other new differentiated technologies are also taking off. Fingerprint IC volume has been growing steadily with revenue and the shipment more than doubling quarter-over-quarter and tripling year-over-year. 55 nm embedded flash is also in volume ramp now. We have shipped thousands of 12 in wafers last quarter, and we will see further growth over the next quarters. Our BSI-CIS is in small volume production in the fourth quarter of this year, and is expected to enter volume ramp-up through 2015.
In the past, we had a significant presence in 90 nm and 65 nm NOR for mobile phone cold storage market. We have recently announced a major upgrade to 38 nm specialty NAND technology to address both communication and consumer segments, and we are in the early ramp-up phase. In terms of expansions, we plan to expand our Tianjin fab's production capacity to 42,000 8 in wafers per month, and Shenzhen is on track to reach 10,000 wafer per month installed capacity by year-end. We target to expand the Shenzhen fab capacity to 20,000 per month by the end of 2015. Meanwhile, Beijing joint venture project is estimated to have 1,000 12 in wafer already installed by this year-end. By the end of 2015, it will have 10,000 wafer per month capacity.
We target to reach 6,000 12 in wafer per month for 28 nm capacity by the end of 2014 in our Shanghai facility. We also continue to look for any suitable opportunity for 8 in merger and acquisition. The strong IC demand in China is continuing to drive our growth. Revenue from China has continued to be over 40% of our total revenue in the last past five quarters, and accounts for more than 42% of our total revenue in Q3 2014. China's government introduced guideline to promote the development of the IC industry, in which a market-based strategy to promote robust and healthy growth in the semiconductor industry and the IT industry has been formulated. This strategy will promote the whole semiconductor ecosystem, spanning from materials, chemicals, equipment, manufacturing, to fabless design houses. It will help to promote robust growth in semiconductor industry, not only here in China but worldwide.
As the largest and the most advanced foundry in China, we are looking forward to accelerated industry growth, and we focus our direction and technology to capture market opportunity, serving the demand of China market. We believe the opportunities for continual growth will be plentiful. As announced previously, our bumping project joint venture with JCET has been established in Jiangyin. The company is currently in initial stage, and we target to finish clean room constructions and installation of 10,000 wafer per month, 12 in bumping capacity by the end of 2015. I am also happy to share that the issuance of $500 million bonds in October was successful and well-received in the market. These funds will be used in part to pay off higher interest rate loans, and the remainder will be saved for future capital expenses.
For the near term, we see market weaknesses in Q4 as some customers are witnessing inventory buildup and softness in smartphone segments. We are guiding Q4 revenue as a result of this overall market weakness. In conclusion, the third quarter was a quarter of modest growth. In the near term, there will be challenge from seasonality, inventory correction, and product transition. However, we continue to be optimistic about the future as we ramp up new 8 in capacity in Shenzhen and the 28 nm capacity in both Shanghai and Beijing. We continue to be optimistic in the China market, mobile product, smart consumer product, and IoT, and our strategy to capture growth opportunity in China. We stay committed to sustainable profitability and building value for all stakeholders. Thank you for your time. I will now hand the call to Yonggang for financial highlight and the Q4 guidance.
Okay. Thank you, TY. Greetings to all our listeners. I will now highlight our third quarter results and fourth quarter guidance. Our revenue was $521.6 million in 3Q 2014, an increase of 2% quarter-over-quarter. Meanwhile, our non-GAAP revenue, excluding wafer shipments from Wuhan Xinxin, was a record high of $521.6 million in 3Q 2014, an increase of 3.6% year-over-year compared to $503.7 million in 3Q 2013. Gross margin was 25.9% in 3Q 2014, compared to 28% in 2Q 2014, and 21% in 3Q 2013. Profit from a period attributable to SMIC was $47.5 million in 3Q 2014, compared to $56.8 million in 2Q 2014, and $42.5 million in 3Q 2013. Now, looking ahead into the fourth quarter of 2014. Our revenue is expected to decrease by 5%-9% quarter-over-quarter, and gross margin is expected to range from 19.5%-22.5%.
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 $99 million-$103 million. I will now hand the call over to Gareth for more detailed financial commentary.
Thank you, Gao. 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 $521.6 million in Q3 2014, mainly because of the increase in wafer shipments. Revenue decreased 2.4% year-on-year from $534.3 million in Q3 2013, mainly because there was no wafer shipments from Wuhan Xinxin since Q1 of 2014. Cost of sales increased to $386.7 million in Q3 2014, up 5% quarter-on-quarter from $368.3 million in the previous quarter. Gross margin decreased to 25.9%, down from 28% in the previous quarter, mainly due to a decrease in fab utilization. Operating expenses in Q3 2014 were $94.1 million, an increase of 10.9% quarter-on-quarter from $84.9 million in Q2 2014.
R&D expenses increased to $54.9 million in Q3 2014, from $45.1 million in Q2 2014, mainly due to, first, an increase in R&D activities in Q3 of 2014, and two, a decrease in the funding of R&D contracts from the government, which was $5.8 million in Q3 2014, compared to $7.6 million in the previous quarter. General and administrative expenses remain relatively flat, $34.7 million in Q3 2014, compared to $35.5 million in Q2 2014. Other operating income was $5.5 million in Q3 2014, compared to $4.8 million in the previous quarter. Mainly from the gain arising from a disposal of public living quarters in Beijing. Excluding the effect of employee bonus accrual, government funding, and gain from disposal of living quarters, non-GAAP OpEx was $98.3 million in Q3 2014 compared to $86.6 million in Q2 2014.
Profit from operations in Q3 2014 was $40.8 million compared to $58.2 million in Q2 2014. Other income was $7.8 million in Q3 2014 compared to $1.1 million of other expenses in Q2 2014. The change was mainly due to, one, a government funding recognized as a reduction of interest expense in Q3 2014, and two, an appreciation of RMB against U.S. dollar in Q3 2014, partially offset by, three, lower revenue from our schools as a result of the summer vacation in Q3 2014. Moving to the balance sheet. At the end of the third quarter 2014, cash and cash equivalents decreased to $362.2 million in Q3 2014 from $573.3 million in the previous quarter, mainly because of a repayment of long-term borrowings. Our long-term borrowings decreased to $213.5 million, and short-term borrowing increased $11.7 million compared to the previous quarter.
At the end of the third quarter 2014, our total debt-to-equity ratio decreased to 32.2% compared to 39.7% in the previous quarter. In terms of cash flow, we generated $134.2 million cash from operating activities in the third quarter compared to $118.6 million in the second quarter, mainly because of the changes in working capital and others. Cash used in investing activities decreased to $144 million in the third quarter compared to $339.8 million in the second quarter because less financial asset investment made by SMIC in the third quarter. Cash flow from financing activities changed from an inflow of $357.2 million in the second quarter to an outflow of $202.3 million in the third quarter, mainly because of a repayment of long-term borrowings in the third quarter and the issuance of equity and convertible bonds in the second quarter.
To examine our revenue by application, the communications and consumer segments contributed 44.6% and 44.3% of our revenue respectively. Geographically, revenue from North America contributed 43.7% of total revenue. Revenue from China contributed 42.2% of total revenue. Eurasia contributed 14.1%. In terms of technology, revenue from 40/40 nm contributed 10.4%. The drop in revenue contribution from 45/40 nm was mainly due to a slower-than-expected ramp-up for our new products. Revenue from 65/55 nm and 90 nm decreased 5%. Meanwhile, on 13 um and above line width increased 9.4% quarter-over-quarter, mainly due to the strength of our differentiated products. In terms of overall capacity, total monthly capacity at the end of the third quarter was still 247,500 wafers. The overall utilization was 91.9% in the third quarter of 2014 compared to 94.6% in the second quarter of 2014.
At the end of the third quarter 2014, the planned 2014 capital expenditures for the foundry operations are down from approximately $1.1 billion to approximately $1 billion, of which about $430 million, instead of the previously estimated $571 million, is for Semiconductor Manufacturing North China (Beijing) Corporation. In short, SMNC, the company's majority-owned subsidiary in Beijing, which is 55% funded by the company and 45% funded by other shareholders of the entity. The decrease in capital expenditure is mainly because of some delay in the equipment move-in schedule for SMNC. The planned 2014 capital expenditure for non-foundry operations, mainly for the construction of living quarters, are down from approximately $110 million to approximately $50 million. The company plans 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 a Q&A session.
Thank you, Gareth. I would now like to open up the call for Q&A, as usual. Please be reminded to limit your question to two questions per person. Operator, please assist.
Thank you. Thank you, ladies and gentlemen. We now begin the question and answer session. 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 a request, please press the pound or hash key. Your first question comes from the line of Randy Abrams from Credit Suisse. Please ask your question.
Okay. Thanks a lot. Good morning. First question I wanted to ask on 28 nm, where you mentioned a start from second quarter. Could you go through your expectation, how you see 28 nm ramping through the year next year, for percent of revenue contribution as we go through 2015? At this stage, if you could give an update how the 28 nm process during early stage looks in terms of maturity and confidence, at least on the yield ramp and profitability for 28 nm as it ramps up. Thank you.
Yes. As you have heard, we continue to make progress in our 28 nm technology, so we continue to install our capacity in Shanghai as well as in Beijing. Indeed, we still have, and we maintain our expectation that 28 nm production will start the first half of next year. We expect that most of the capacity will be utilized during the second half or the fourth quarter of next year.
Okay. I guess if you get most of that capacity used, implying getting close to 15,000 wafer toward fourth quarter, how do you expect profitability? In another way, do you expect similar kind of high season margins, gross margins with 28 nm ramping? So next year, like similar levels, mid to high 20s gross margins, even with this filling up the 28 nm capacity?
Yes, Randy. As what TY mentioned, we are going to start ramping production for the 28 nm in the first half, and the revenue will grow in the second half. I think overall next year, it is still the early stage of the ramp for 28 nm productions. I think the gross margin will still be not at level that we target.
Okay. If I could ask on the 40 nm , where it is back to 10% of revenue, and now you are moving some capacity in Shanghai to 28 nm. Could you talk now for outlook on 40 nm, if that will come back or now with the capacity probably 10% of sales? You talked about product transition or a little bit of delay on new products. Maybe if you could talk about the outlook on 40 nm now, particularly as you try to bring up 28 nm.
At this moment, we are also qualifying 40 nm in Beijing to take advantage of the potential flexibility. We think that the 40 nm, we are seeing still a very strong, the number of tape out. Although it is slightly impacted by some of our customer's customers market fluctuation. We think that potentially there will be some recovery next quarter.
Yeah, just to add on to what TY say, as we speak, we are still receiving new tape outs from our key customers for the 40 nm. We do hope that the production will continue to get ramp up this year.
Okay. The last question, it's a quick follow-up on the new capacity that you'll qualify in Beijing. How much could you have for 40 nm? If you could give a view overall for 2015, a base case on CapEx, if you expect similar levels for next year, and how depreciation looks under that scenario.
Okay. Of course, most of our capacity in Beijing is also 40 nm capable, so we do have the flexibility to switch between the 20 nm and the 40 nm. We also have the flexibility, if the customer demand is strong, to increase the capacity if it is necessary.
Yeah, Randy, just to respond to your question on the CapEx for 2015. Obviously, we have not finalized the number right now because we are still working on our next year total budget for the company. As we reported earlier, our CapEx for 2014 for the founder operation is about $1 billion. Next year, our plan is continue to ramp up our capacity in our new fab in Beijing as well as our 8 in fab in Shenzhen. So right now, our initial look is that probably the CapEx will be slightly higher than the current year. In terms of your question on the depreciation, we think that with the ramp of the new fabs, I think the net depreciation will go up next year, maybe around $100 million.
Okay. Thanks a lot.
Thank you, Randy. The next question, please.
Thank you. The next question comes from the line of Steven Pelayo from HSBC. Please ask your questions.
Yeah. I am curious to hear, excuse me, some thoughts on your guidance. I think you just said that 40 nm, that you would see some recovery in the fourth quarter, so I guess you are going to have dollar growth there. Are you seeing growth in your specialty areas, like you had some pretty good strength in your 130 nm and above in the third quarter. Does that continue? I am just trying to figure out, when I look at your guidance for revenues, trying to do it from a bottom-up perspective. Forex is growing, is everything else down? Can you give us some color on that?
Yeah, Steve, I think, we have guided down our Q4 revenue. Basically, we see their overall weaknesses in terms of the product that we are targeting in Q4. We are overall optimistic if we go beyond the next quarter in the midterm because of a lot of new technologies that we are putting into production and also of some of the new technology coming into our fabs.
Okay. I can follow up on that later. Maybe we can talk a little bit about gross margins. Two sides I would like to explore. First one, just looking at the fourth quarter down about, I do not know, 400 or so basis points at the midpoint. Is that all just utilization, or is there some mix of pricing that is kind of evolved in there? Then secondarily on gross margins, my last question, I remember, I think it was a year ago, you guys were doing about $75 million a quarter, I think, in 40 nm node, and you had talked about that being at about breakeven gross margin. Is that still kind of the breakeven rate for it? Because I guess now you are doing roughly $50 million a quarter or so.
Right. Our gross margin changes, as you understand, is mainly driven by our utilization. Although there are some other factors, for example, some product mix change could also impact the gross margin. In terms of the breakeven utilization, we are still right now at about 80%, which has been quite consistent in the last few quarters.
40 nm breakeven, was that kind of the right number, $75 million a quarter?
Well, as you understand, the 12 in fab in Beijing, the scale is relatively small. I am sorry, the 12 in fab in Shanghai is relatively small. So I think, we do have to maintain a pretty good utilization to achieve a good gross margin for us.
All right. Well, maybe let me ask my last question the other way. Talk about utilization rates maybe by fab, or I know you will probably talk about 200 mm versus 300 mm, but maybe it would be interesting to talk about Shanghai versus Beijing as well. That is my last question.
Yeah. We still maintain very high utilization for the 8 in fabs, which is mainly driven by the strength of our differentiated technologies. In terms of the 12 in fabs, we are seeing a lower utilization, because of the overall market weaknesses. Yes.
Okay. We will talk later. Thank you.
Okay. Thank you, Steve. Next question, please.
Thank you. Your next question comes from the line of Szeh o Ng from BNP Paribas. Please ask your questions.
Oh, hi. Good morning, gentlemen. Two questions. Number one, what percentage of your CapEx year to date was put in for Beijing B2?
Yes. If you look at our earning release, we did mention that out of the $1 billion CapEx, about $430 million is spent on the new fab in Beijing.
Yeah. What percentage have you spent so far for that $430 million budget?
We do expect that will be spent by end of this year.
I mean, in the first three quarters of the year, how much have you spent for Beijing?
About half has been spent, and the other half would come in in Q4.
Okay. All right. Thank you. Second question for the Shenzhen fab. Have you fully secured the 20,000 capacity already?
Yes. We have actually fully secured that 20,000 capacity equipment.
Okay, great. Last one, maybe. For the gross margin guidance for Q4, it seems that you are guiding for a bigger range this time compared with what you did in the past. Any special reason for that?
Yeah. Because the gross margin, apart from impact by the revenue for that quarter, is also impacted by the fab utilization. Which, as you understand, given the cycle time of factory, will be based on some future demands in Q1. So for that portion, actually, the visibility is quite limited at this point in time. So we want to be more conservative in the way we guide.
All right. Okay. Thank you very much.
Thank you, Szeho. Okay, next question, please.
Thank you. Your next question comes from the line of Le ping Huang from [Nomura]. Please ask your question.
Thank you for taking my question. So, two questions. First is, can you further explain which product or which segment of the customer are facing the inventory correction issues, since I see your communication this quarter are still up 9.9%, but your Chinese customer down. Is China smartphone issues, or is other segment maybe misintegrated one? Thank you.
I think if I want to address, for example, as mentioned that we do have some weaknesses in terms of our [chuck range] utilization. We are facing some product transitioning issue because some of the product that could be running in our [chuck range] fab have migrate to a higher node. We were in the process of qualifying new products. In terms of end market weaknesses, for example, we used to run a lot of baseband for the 90 nm for those 3G phones. That obviously is facing some problems because the market is moving to 4G in China. We also have some customers who were supplying to a particular handphone companies. They are also facing some problems. I think that have been the issue that we face in the near term.
Okay. Yeah. Thank you. The second question, can you comment, since the Tsinghua Unigroup Spreadtrum are the one of your major customers, do you think that the Intel's investment on Spreadtrum will have any impact or whether they will move out of your-- What will be the long-term impact on your relation with Spreadtrum? Thank you.
Actually, we are very glad to see that some of the Chinese fabless companies are able to attract significant investments from some of these global companies. This shows that they have good capability, and we think that actually, that will promote these companies' growth, and that in turn will benefit SMIC as well.
Thank you.
Thank you, Le ping. Next question, please.
Thank you. Your next question comes from the line of Daniel Herbert from Merrill Lynch. Please ask your questions.
Thanks. TY, I had a question on the competitive environment going into 2015. As I look at what's been going on at the other foundries, they're also having trouble filling their 40 nm, 45 nm, and 65 nm capacity as the two companies are moving to 28 nm. So that's creating some excess there. On top of that, 28 nm is certainly much more competitive with two major new players coming in, and clearly available capacity available at the number one player coming on as they move on to 20 nm and 16 nm. So it just seems in this mid-technology area, especially in 12 in, it just looks like there's going to be a lot of capacity. On the other hand, you continue to talk about how, over a long time, how great demand is on 8 in, and indeed across the industry, 8 in is where it's rather tight, and there's lots of demand there.
I'm wondering why SMIC is not spending much more focus on 8 in and on your derivatives. This middle area looks as though it's going to be really competitive.
Actually, we see similar issues, and that is why we have been actually spending a lot of effort to develop specialized technology. We have been putting a lot of effort to build up our 8 in capacities, both in Shenzhen as well as incrementally in some of our Tianjin and Shanghai fabs. The specialty technology we have built in 8 in eventually can also be transferred and scaled in our 12 in fab. We think that it is a good strategy to first bring this new technology into production in the 8 in facility, and then, when the time is right, port it to the 12 in as well. As far as the 12 in, we are also working on some of the unique technology that we think actually has given us the leadership in the whole foundry.
For example, our embedded non-volatile, we believe that the 55 nm embedded non-volatile is the leading technology in the industry, and we see very high interest level from a lot of different customers. In addition, I think that the 38 nm NAND targeted at mobile cold storage will also receive a lot of the volume as we start to ramp.
Dan, just want to add on to what TY said. We do have a solid strategy in place to fill our 65 nm/55 nm node in Beijing. For example, we have qualified a lot of new products in the Beijing fab, including in the area MCUs, NFCs, and we have removed some of our 8 in product into our 12 in fab. For example, in the area of CIS, our fingerprint, and also in some of the controller IC and in the embedded non-volatile areas. You also mentioned about the 40 nm node. Actually, I think, in terms of our planning, we have already foreseen that 40 nm could be a transitional node in the future. When we actually build the 40 nm capacity, we will build the flexibility to convert some of this capacity into 28 nm.
We do think that we have a solid strategy in place to address the product transitioning issues.
Okay, thanks. It seems like those products are also being supplied by others too, in terms of being pretty competitive in pricing. I appreciate the answer on the strategy side. I guess my second question is relating to coming back to the 28 nm. You are ramping it at two different fabs. Your Beijing fab, I think you said, would be 10,000 wafers per month by the end of next year. That looks as though it is pretty subscale. How much total capacity do you need for that to not be a drag on your corporate margin? Do you need to get that to 20,000 wafers per month and till it for your margin to be back to the corporate average? Give us a sense of the timeline when Beijing will not be a drag on your overall margin.
Yeah. As we mentioned earlier, our Beijing fab eventually go up to about 35,000 wafers per month, and then we also have 6,000 capacity in our Shanghai 12-in fab. Overall, we could have about 41,000 capacity for our 28 nm productions. We believe that is an economic scale production for us.
So 35,000 is where you think you get back to the corporate average. Again, lots of competition, I know it is hard to say. There is going to be aggressive pricing in 28 nm, so I know it is hard for you to predict pricing. Just in your current thinking, is it 20,000 that we see hitting the corporate average or 35,000? We need to get a sense of when this is going to be not dragging your margin down.
Yeah, I think it is a little bit difficult for us to comment on it because that also depends on the mix between polysilicon, High-K, and RF. I will just hold this comment for now, I think.
Okay. Thanks for that. I will get back in the queue.
Thank you, Dan.
Okay. Thank you, Dan. Next question, please.
Thank you. Our next question comes from the line of Ken Hui from Jefferies. Ask your question.
Thank you for taking my questions. My first question is regarding your Shenzhen fab. Going into next year, how fast can you fill the fab? Will there be positive or negative margin headwind for you in the first half or second half next year? That is my first question.
Okay. At this moment, we target to have the Shenzhen fab go into production on the second half of next year. At this moment, there are very robust demand, and we basically have more than our capacity can support in terms of the customer demand. Okay. Next year, the capacity is still relatively small. It will take us some time to ramp it to a scale where it is a corporate margin. We hope that we can ramp up as fast as possible to reach that aim.
Do you think you can reach to the corporate margin by end of next year for Shenzhen?
I think relative to other 8 in fabs that we are running, I think by end of next year, Shenzhen will still be low, the average for the 8 in fabs. As what TY said, actually, the demand is not an issue. There is more demand than we can handle for 8 in right now. I think we could have a very fast ramp-up for Shenzhen fab, and we do hope to bring it to our average corporate margin very soon. Yeah.
Okay. Then, my second question is that, are you able to comment on the news that you may invest in Dongbu HiTek in Korea?
I think TY already mentioned in the script that we do actively look for M&A opportunities, but we don't want to make any comment on specific news.
Okay. Thank you much.
Thank you, Ken. Next question, please.
Thank you. Your next question comes from the line of Eric Lin from CIMB. Please ask your questions.
Hi, Dr. Chiu. Just got a couple follow-up questions on the OpEx. The OpEx increased a lot in the third quarter. Can you give us more detail about the majority of the expense? Are they going to 40 nm new product development, or are they going to 28 nm process development?
Yes. Our OpEx have been increasing. If you look at in 2013, our OpEx, excluding the R&D funding, excluding some of the profit from the employee sales and employee bonus, it was about 15% in 2013. At the end of Q3 2014, it was about 19%. The main increase is really in the R&D area. We consider this as an investment for us as we have been spending R&D, for both our advanced node and also on our mature node new processes. We do think that with this investment, we are well-positioned for the future.
Yeah. I guess in the fourth quarter, the expense will still go up. Does that mean you will spend more money on the 28 nm process development, or still on 40 nm product development?
First of all, we think that our R&D spending will continue to be at a relatively high level. Secondly, our R&D for both the advanced nodes and also for the mature nodes. In terms of the question, the 40 nm, basically, we have completed the R&D, and we are in volume production. That would not be a focus for us.
I see. My last question is on the 28 nm and the 40 nm interchangeable issue. Let's say, if there are not enough orders for 28 nm in the coming few quarters, you may use some 40 nm product to fill in the capacity. In that sense, will that drag down the margin?
No. To answer the question, it's no. Because in the initial part of 2015, I think we're still in the process of ramping up the production for 28 nm. There'll be some excess capacity for us to address the need for the 40 nm. To answer your question, it's no. Yeah.
I think, let me add, definitely, it would be good to keep fab full as much as possible, any additional utilization will help us.
Got it . Thanks.
Thank you, Eric. Next question, please.
Thank you. Your next question comes from the line of Eric Chen from UBS. Please ask your question.
Hello?
Hello, Eric.
Okay, good morning. Two quick questions. The first regarding your new product. Would you give us the highlight? What kind of product are you going to do in the sensor? For the Beijing joint venture, you talk about the microcontroller, NFC, the fingerprint. What I would like to clarify to get the idea, the product for the Tianjin fab and new capacity, for the Shenzhen fab and new capacity, and for the Beijing joint venture, the new capacity, the major product. Thank you.
Okay, let me say that, for example, for the Tianjin, there is an increased demand for power management. We need to increase the delivery to the power management customers. Therefore, some of that capacity or the manufacturing needs to be moved to new fab. We have done that both to Beijing's 12 in and as well as Shenzhen. As far as the new Shenzhen fab, we have allocated a number of CIS, a number of additional power management technology, as well as some of the novel customers. We do see a very strong demand for Shenzhen.
Yeah, for the existing Beijing fab, as mentioned, we have qualified and we are in the process of qualifying a lot of new product there. That include MCU, NFC chips, CIS, fingerprint, controller IC, and some of the embedded flash. We do have a very broad and diverse portfolio for Beijing going forward.
Okay. Go ahead, I'm sorry.
For the Beijing joint venture, that fab will be, right now, our main target is for the 28 nm productions. As mentioned earlier, we do have three programs. One for polysilicon, we have a High-K, we also have RF.
Okay. Mm-hmm. For the geometry migration, like the 28 nm and the 14 nm, the FinFET . Are you going to deal with IBM continually, or you will switch to the Samsung, the recipe?
SMIC decided that we will go from the 28 nm to FinFET directly. As far as at this moment, we are looking at various possibility to work with joint development collaborator. SMIC had gone through the 28 nm development successfully, and we are pretty confident that we can do the 14 nm FinFET relatively successfully as well. Any partner and joint development is also being considered.
Okay. So far you are quite open mind, and you have not made the call yet in term of the technology wise, right?
That's correct.
Okay. Thanks to your product for the new capacity. We notice the power management and the sensor probably were the two key product. Could you give us idea of what kind of application product? Then we talk about the sensor, probably for the smartphone, probably for the handset. The power management is probably for LED driver ICs, that kind of thing. Could you give us an idea in term of end product application, what kind of product we're talking about? Thank you.
I think that CIS, definitely most of the CIS is targeted towards mobile handset. We have seen a new product coming out, 8 MP BSI-CIS. Next year, we'll be capable of entering this high-end, 8 MP as well as 5 MP market. We hope that our customers will ramp these product with us successfully next year. The PMIC is a general application PMIC. Some of it is certainly for consumer, some of it is for the handset.
Okay, how about for power management? What kind of end product application are we talking about?
The power management, it would have both a consumer as well as communication applications.
Okay.
Thank you, Eric.
My last, the second question—
Eric, I think the time is up here. I think you already asked the three questions.
Okay.
Thank you, Eric.
Okay.
Seems like we are over the time. Let's have one more question to close this session.
Your last question comes from the line of Steven Pelayo from HSBC. Please ask your questions.
Great. Just a couple of follow-ups here. Looking to next year, it does look like we're going through a bit of an inventory purge. You talked about product transitions as well. What do you think this means for the first quarter outlook? Do you feel like we can have a better than seasonal trend, especially with China government support and 4G ramping and maybe 3G inventory being purged? What are your initial thoughts on the semi cycle and your opportunities as we go into the first quarter next year?
Yes, Steve. I think right now, given the limited visibility, I think we do not want to comment too much on Q1 at this point in time.
Thanks, Gareth.
Next year overall, obviously, we are still optimistic, given all the new technology that we have put in place and the fact that we are going to ramp up on our 28 nm productions. We are optimistic, yes.
Okay. Just two more.
Let me add—
Go ahead.
Let me add, Steve, that, yes, I think that you have seen that we have increased our R&D spending. This is definitely in preparation with some of the new technology we are bringing forth, both in the 8 in as well as 12 in. We are seeing, actually, in the recent quarters, all these new technology we have been working on being actually qualified and the product is being verified. Every one of these technologies are getting a very good response from the customer sets.
Yeah, Steve, also add that next year, we do think that there will be major ramp up for 4G phones in China. For that, obviously, it will require a lot of baseband and AP, which is manufactured using 28 nm process. There will also be demand for a lot of peripheral chips, things like PMIC, CIS, fingerprint, all these are being manufactured in our fabs.
Excellent, guys. Last question from me is, would you just remind me, the total R&D subsidies for this year? Does it change now that we have a more formalized maybe support coming from, or to the industry from the government for next year? Do you think it changes significantly in 2015? I think it was like $30 million-$40 million a year. Remind me. I forget the numbers.
Yeah. Just to refresh you. 2013, we recognized about $27 million R&D funding. Up to Q3 of this year, for the first three quarters, we recognized about $25 million. This year, for the whole year, we target to recognize about $40 million. I think it's on the uptrend right now. Yeah.
Do you think it significantly increases with the more formalized programs from the government for next year?
We hope so, but that will depend on the government policy and the government funding as well. Yeah.
All right, guys. Thanks a lot.
Thank you, Steve. This ends our session. Operator?
Thank you. I would now like to hand the call back to the 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 shareholder, customers, employees, and suppliers for their trust and support. Thank you.
Thank you. Ladies and gentlemen, this is the end of SMIC's third quarter earnings conference call. We thank you for joining us today. Goodbye.