China's SMIC Reports Yet Another Loss

Red ink continues to flow from Semiconductor Manufacturing International Corp. (SMIC). China's largest chip maker reported another loss during the second quarter as its struggle with profitability dragged on.

SMIC reported a second-quarter loss of US$2.1 million on revenue of $374.8 million. Excluding subsidies from the Chinese government, SMIC's losses were greater still. Without this non-operating income, the company turned in a loss of $8.6 million.

By comparison, SMIC reported a profit of $1.4 million on revenue of $361.4 million during the same period last year. But the company's profit during that period came as the result of an $18.9 million tax credit. Without that one-time gain, the company had a loss of $17.3 million.

These are dark days for SMIC, once the darling of pundits who predicted the company would lead China to dominate the contract chip-making market. Instead the Shanghai company has struggled to turn a profit in recent years, even as rivals in Taiwan and Singapore showed better results.

Richard Chang, SMIC's founder and CEO, described the second quarter as a "most difficult quarter" during a conference call with analysts. Chang said the company will post better results during the third and fourth quarters. "Our goal is still to be profitable for the entire year," he said.

SMIC reported a $9 million profit during the first quarter, thanks to a $6 million tax credit and a one-time gain of $27.2 million from the sale of used chip-making equipment. These results underscore SMIC's recent reliance on one-time gains to turn a profit.

SMIC's gross margin-- which shows the basic profitability of the chips it makes-- underscores the company's profitability problem. SMIC's gross margin during the second quarter was 10.3 percent.

By comparison, Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC), the top contract chip maker, reported its gross margin during the same period was 43 percent. Singapore's Chartered Semiconductor Manufacturing Ltd.'s second-quarter gross margin was 24.2 percent.

More troubling for SMIC, the company's gross margin has declined over time, suggesting it's under pressure to cut its manufacturing prices. During the second quarter of 2006, the company's gross margin was 12 percent.

Part of SMIC's problem is DRAM, which commands a significantly lower price than other chips, such as processors and graphics chips. Compared to TSMC and Chartered, SMIC relies more heavily on DRAM for revenue, with these chips accounting for 28.9 percent of its revenue during the second quarter. The company was also hit by an inventory glut that has slowed demand for chips in recent quarters.