SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 20-F

o		REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934

þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2005

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

o		SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Taiwan Semiconductor Manufacturing Company Limited (Translation of Registrant’s Name Into English)		Republic of China (Jurisdiction of Incorporation or Organization)

No. 8, Li-Hsin Road 6
Hsinchu Science Park
Hsinchu, Taiwan
Republic of China
(Address of Principal Executive Offices)

Securities registered or to be registered pursuant to Section 12(b) of the Act:

Title of Each Class		Name of Each Exchange on Which Registered
Common Shares, par value NT$10.00 each		The New York Stock Exchange, Inc.*

Securities registered or to be registered pursuant to Section 12(g) of the Act:

None
(Title of Class)
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

None
(Title of Class)

     Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

     As of December 31, 2005, 24,730,024,647 Common Shares, par value NT$10 each were outstanding.

     Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o

     If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or (15)(d) of the Securities Exchange Act of 1934. Yes o No þ

     Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer þ                                        Accelerated Filer o                                         Non-Accelerated Filer o

     Indicate by check mark which financial statement item the registrant has elected to follow. Item 17o Item 18 þ

     If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

 

 

TABLE OF CONTENTS

Taiwan Semiconductor Manufacturing Company Limited

		Page
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION			1
GLOSSARY OF SELECTED TECHNICAL TERMS			2
PART I			5
Item 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS			5
Item 2. OFFER STATISTICS AND EXPECTED TIMETABLE			5
Item 3. KEY INFORMATION			5
Item 4. INFORMATION ON THE COMPANY			15
Item 4A. UNRESOLVED STAFF COMMENTS			25
Item 5. OPERATING AND FINANCIAL REVIEWS AND PROSPECTS			26
Item 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES			39
Item 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS			47
Item 8. FINANCIAL INFORMATION			50
Item 9. THE OFFER AND LISTING			51
Item 10. ADDITIONAL INFORMATION			52
Item 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			66
Item 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES			67
Item 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES			67
Item 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS			68
Item 15. CONTROLS AND PROCEDURES			68
Item 16A. AUDIT COMMITTEE FINANCIAL EXPERT			68
Item 16B. CODE OF ETHICS			68
Item 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES			68
Item 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES			69
Item 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS			69
Item 17. FINANCIAL STATEMENTS			69
Item 18. FINANCIAL STATEMENTS			69
Item 19. EXHIBITS			70
EX-8.1 LIST OF SUBSIDIARIES
EX-12.1 CERTIFICATION OF CEO UNDER RULE 13A-14(A)
EX-12.2 CERTIFICATION OF CFO UNDER RULE 13A-14(A)
EX-13.1 CERTIFICATION OF CEO UNDER RULE 13A-14(B)
EX-13.2 CERTIFICATION OF CFO UNDER RULE 13A-14(B)
EX-99.1 CONSENT OF DELOITTE & TOUCHE

“TSMC” and “tsmc” are our registered trademarks and NEXSYS, 1T RAM and Virtual fab are trademarks used by us.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

     This annual report includes statements that are, or may be deemed to be, “forward-looking statements” within the meaning of U.S. securities laws. The terms “anticipates,” “expects,” “may,” “will,” “should” and other similar expressions identify forward-looking statements. These statements appear in a number of places throughout this annual report and include statements regarding our intentions, beliefs or current expectations concerning, among other things, our results of operations, financial condition, liquidity, prospects, growth, strategies and the industries in which we operate.

     By their nature, forward-looking statements involve risks and uncertainties because they relate to events and depend on circumstances that may or may not occur in the future. Forward-looking statements are not guarantees of future performance and our actual results of operations, financial condition and liquidity, and the development of the industries in which we operate may differ materially from those made in or suggested by the forward-looking statements contained in this annual report. Important factors that could cause those differences include, but are not limited to:

	•		the volatility of the semiconductor and microelectronics industry;
	•		overcapacity in the semiconductor industry;
	•		the increased competition from other companies and our ability to retain and increase our market share;
	•		our ability to develop new technologies successfully and remain a technological leader;
	•		our ability to maintain control over expansion and facility modifications;
	•		our ability to generate growth or profitable growth;
	•		our ability to hire and maintain qualified personnel;
	•		our ability to acquire required equipment and supplies necessary to meet customer demand;
	•		our reliance on certain major customers;
	•		the political stability of our local region; and
	•		general local and global economic conditions.

     Forward-looking statements include, but are not limited to, statements regarding our strategy and future plans, future business condition and financial results, our capital expenditure plans, our capacity expansion plans, our expansion plans in mainland China, expectations as to the commencement of commercial production using 65-nanometer and more advanced technologies, technological upgrades, investment in research and development, future market demand, future regulatory or other developments in our industry. Please see “Item 3. Key Information — Risk Factors” for a further discussion of certain factors that may cause actual results to differs materially from those indicated by our forward-looking statements.

GLOSSARY OF SELECTED TECHNICAL TERMS

ASIC (Application Specific Integrated Circuit)		A custom-designed integrated circuit that performs specific functions that would otherwise require a number of off-the-shelf integrated circuits to perform. The use of an ASIC in place of a standard integrated circuit reduces product size and cost and also improves reliability.
BiCMOS		Integrated circuit fabrication technology that produces both bipolar transistors and CMOS transistors and combines them on one chip.
Cell		A primary unit that normally repeats many times in an integrated circuit. For example, a cell represents a bit in a memory integrated circuit.
CIS (CMOS Image Sensor)		A photodiode censoring circuit made by CMOS used in applications such as digital camera, surveillance and securing systems.
CMOS (Complementary Metal Oxide Silicon)		Currently the most common integrated circuit fabrication process technology, CMOS is one of the latest fabrication techniques to use metal oxide semiconductor transistors.
CVD (Chemical Vapor Deposition).		A process in which gaseous chemicals react on a heated surface to form solid crystalline materials.
Die		A piece of a semiconductor wafer containing the circuitry of a single chip.
DRAM (Dynamic Random Access Memory)		A volatile memory product that is used in electronic systems to store data and program instructions. It is the most common type of RAM and must be refreshed with electricity thousands of times per second or else it will fade away.
DSP (Digital Signal Processor)		A type of integrated circuit that processes and manipulates digital information after it has been converted from an analog source.
EPROM (Erasable Programmable Read-Only Memory)		A form of PROM that can be erased using ultraviolet light, so that it can be reprogrammed.
Fabless semiconductor company		A class of semiconductor company that designs, tests, markets and sells semiconductors, but subcontracts wafer manufacturing to silicon wafer manufacturers.
Flash memory		A type of non-volatile memory, similar to an EPROM in that it is erasable and reprogrammable. The difference is that it can be erased and electrically reprogrammed in the system into which the flash memory chip has been incorporated.
Integrated circuit		A combination of two or more transistors on a base material, usually silicon. All semiconductor chips, including memory chips and logic chips, are very

		complicated integrated circuits with up to millions of transistors.
Logic device		A device that contains digital integrated circuits that process, rather than store, information.
Mask		A piece of glass on which an integrated circuit’s circuitry is laid out. Integrated circuits may require as many as thirty different layers of design, each with its own mask. Also known as a reticle.
Memory		A group of integrated circuits that are used to store data or programs, such as ROM, Flash RAM, DRAM and SRAM.
Micron		1/25,000 of an inch. Circuitry on an integrated circuit typically follows lines that are less than one micron wide.
MOS		A device which consists of three layers (metal, oxide and semiconductors) and operates as a transistor.
Nonvolatile memory		Memory products which retain their data content without the need for a constant power supply.
Reticle		See “Mask” above.
RISC (Reduced Instruction Set Computing)		A type of processor architecture that processes programs more quickly than conventional microprocessors by using smaller, faster, less complex sets of instructions.
Scanner		A machine used in the photolithography process in making wafers. A scanner combines stepper technology with a photoscanning method to permit the exposure of a larger segment of the wafer than a stepper.
SRAM (Static Random Access Memory)		A type of volatile memory product that is used in electronic systems to store data and program instructions. Unlike the more common DRAM, it does not need to be refreshed.
Stepper		A machine used in the photolithography process in making wafers. A stepper aligns a small portion of the wafer with the mask upon which the circuitry design is laid out and then exposes that portion of the wafer to a laser beam, transferring the circuit design on to the wafer. The machine then “steps” to the next area, repeating the process until the entire wafer has been completed. Exposing only a small area of a wafer at a time allows the laser to focus more intensely, which improves the resolution of the circuitry design.
Transistor		An individual circuit that can amplify or switch electric current. Transistors are the building blocks of all integrated circuits.
Volatile memory		Memory products which lose their data content when the power supply is switched off.

Wafer		A thin, round, flat piece of material that is the base of most integrated circuits. Silicon is the most commonly used material.

PART I

   ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS

     Not applicable.

  ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

     Not applicable.

  ITEM 3. KEY INFORMATION

Selected Financial and Operating Data

     The selected income statement data, cash flow data and other financial data for the years ended December 31, 2003, 2004 and 2005, and the selected balance sheet data as of December 31, 2004 and 2005, set forth below, are derived from our audited consolidated financial statements included herein, and should be read in conjunction with, and are qualified in their entirety by reference to, these consolidated financial statements, including the notes thereto. The selected income statement data, cash flow data and other financial data for the years ended December 31, 2001 and 2002 and the selected balance sheet data as of December 31, 2001, 2002 and 2003, set forth below, are derived from our audited consolidated financial statements not included herein. The consolidated financial statements have been prepared and presented in accordance with accounting principles generally accepted (“GAAP” or “ROC GAAP”) in the Republic of China (“ROC” or “Taiwan”), which differ in some material respects from accounting principles generally accepted in the United States of America (“US GAAP”) as further explained under note 27 to our consolidated financial statements included herein.

		Year ended and as of December 31,
		2001				2002				2003				2004				2005				2005
		NT$				NT$				NT$				NT$				NT$				US$
		(in millions, except for percentages,
		earnings per share and per ADS, and operating data)
Income Statement Data:
ROC GAAP
Net sales			125,885				162,301				202,997				257,213				266,565				8,127
Cost of sales			(92,228	)			(109,988	)			(128,113	)			(141,394	)			(148,362	)			(4,523	)
Gross profit			33,657				52,313				74,884				115,819				118,203				3,604
Operating expenses			(20,879	)			(20,724	)			(23,583	)			(27,337	)			(27,234	)			(830	)
Income from operations			12,778				31,589				51,301				88,482				90,969				2,774
Non-operating income and gains(1)			6,476				2,350				5,669				6,016				7,068				215
Non-operating expenses and losses(1)			(8,467	)			(6,717	)			(5,791	)			(2,532	)			(3,773	)			(115	)
Income before income tax and minority interest			10,787				27,222				51,179				91,966				94,263				2,874
Income tax (expense) benefit			3,740				(5,637	)			(3,923	)			363				(630	)			(19	)
Income before minority interest			14,527				21,585				47,256				92,329				93,633				2,855
Minority interest in loss (income) of subsidiaries			(44	)			25				3				(13	)			(58	)			(2	)
Net income			14,483				21,610				47,259				92,316				93,575				2,853
Basic earnings per share(2)			0.58				0.87				1.90				3.73				3.79				0.11
Diluted earnings per share(2)			0.58				0.87				1.90				3.73				3.79				0.11
Basic earnings per ADS equivalent(2)			2.91				4.36				9.49				18.67				18.96				0.58
Diluted earnings per ADS equivalent(2)			2.91				4.36				9.49				18.67				18.95				0.58
Basic weighted average shares outstanding(2)			24,848				24,793				24,796				24,718				24,680				24,680

		Year ended and as of December 31,
		2001				2002				2003				2004				2005				2005
		NT$				NT$				NT$				NT$				NT$				US$
		(in millions, except for percentages,
		earnings per share and per ADS, and operating data)
Diluted weighted average shares outstanding(2)			24,848				24,793				24,806				24,724				24,693				24,693
US GAAP
Net sales			127,242				162,990				203,600				260,035				267,028				8,141
Cost of sales			(107,194	)			(115,374	)			(133,493	)			(154,785	)			(161,808	)			(4,933	)
Operating expenses			(41,712	)			(20,764	)			(25,744	)			(32,423	)			(32,605	)			(994	)
Income (loss) from operations			(21,664	)			26,852				44,363				72,827				72,615				2,214
Income (loss) before income tax and minority interest			(25,672	)			20,210				42,441				76,838				75,983				2,317
Income tax (expense) benefit			3,741				(5,638	)			(3,881	)			(508	)			(483	)			(15	)
Net income (loss)			(21,975	)			14,534				38,661				76,253				75,418				2,299
Cumulative preferred dividends			(455	)			(455	)			(184	)			—				—				—
Income (loss) attributable to common shareholders			(22,430	)			14,079				38,477				76,253				75,418				2,299
Basic earnings per share(3)			(0.95	)			0.59				1.59				3.14				3.07				0.09
Diluted earnings per share(3)			(0.95	)			0.59				1.59				3.14				3.07				0.09
Basic earnings per ADS equivalent(3)			(4.74	)			2.93				7.97				15.68				15.35				0.47
Diluted earnings per ADS equivalent(3)			(4.74	)			2.93				7.97				15.68				15.34				0.47
Basic weighted average shares outstanding(3)			23,671				23,991				24,135				24,311				24,571				24,571
Diluted weighted average shares outstanding(3)			23,671				23,991				24,145				24,318				24,584				24,584
Balance Sheet Data:
ROC GAAP
Working capital(4)			37,472				62,705				136,121				120,530				177,133				5,400
Long-term investments			11,599				10,635				10,748				38,102				42,428				1,294
Properties			251,288				246,498				211,854				258,911				244,823				7,464
Goodwill			11,438				10,159				8,721				7,116				6,011				183
Total assets			366,518				390,542				407,401				499,454				519,510				15,839
Long term bank borrowing(5)			22,399				11,051				8,800				1,915				663				20
Long-term bonds payable			24,000				35,000				30,000				19,500				19,500				595
Guaranty deposit-in and other liabilities(4)(6)			9,479				8,710				8,876				15,079				17,986				548
Total liabilities			89,208				94,594				78,098				100,413				73,271				2,234
Minority interest in subsidiaries			120				95				89				76				608				19
Capital stock			181,326				199,229				202,666				232,520				247,300				7,540
Cash dividend on common shares			—				—				—				12,160				46,504				1,418
Shareholders’ equity			277,310				295,948				329,303				399,041				446,239				13,605
US GAAP
Goodwill			47,464				47,476				47,287				46,757				46,993				1,433
Total assets			393,990				420,528				439,853				536,286				558,919				17,040
Total liabilities			91,419				96,747				81,977				108,416				80,962				2,468
Capital Stock			168,326				186,229				202,666				232,520				247,300				7,540
Mandatory redeemable preferred stock			13,000				13,000				—				—				—				—
Shareholders’ equity			289,450				310,623				357,173				427,125				477,297				14,552
Other Financial Data:
ROC GAAP
Gross margin			27	%			32	%			37	%			45	%			44	%			44	%
Operating margin			10	%			19	%			25	%			34	%			34	%			34	%
Net margin			12	%			13	%			23	%			36	%			35	%			35	%
Capital expenditures			70,201				55,236				37,871				81,095				79,879				2,435
Depreciation and amortization			55,323				65,001				69,161				69,819				75,649				2,306
Cash provided by operating activities			75,818				98,507				116,037				153,151				157,013				4,787
Cash used in investing activities(1)(7)			(77,232	)			(62,190	)			(53,702	)			(147,987	)			(77,440	)			(2,361	)

		Year ended and as of December 31,
		2001				2002				2003				2004				2005				2005
		NT$				NT$				NT$				NT$				NT$				US$
		(in millions, except for percentages,
		earnings per share and per ADS, and operating data)
Cash provided by (used in) financing activities(1)(7)			897				(6,346	)			(27,073	)			(32,181	)			(57,969	)			(1,767	)
Net cash inflow (outflow)			(1,284	)			30,234				35,199				(28,687	)			22,181				676
Operating Data:
Wafer (200mm equivalent) shipment(8)			2,159				2,675				3,700				5,008				5,622				5,622
Average utilization rate(9)			51	%			73	%			89	%			100	%			92	%			92	%

Exchange Rates

     We publish our financial statements in New Taiwan dollars, the lawful currency of the ROC. In this annual report, “$”, “US$” and “U.S. dollars” mean United States dollars, the lawful currency of the United States, and “NT$” and “NT dollars” mean New Taiwan dollars. This annual report contains translations of certain NT dollar amounts into U.S. dollars at specified rates solely for the convenience of the reader. Unless otherwise noted, all translations from NT dollars to U.S. dollars and from U.S. dollars to NT dollars were made at the noon buying rate in The City of New York for cable transfers in NT dollars per U.S. dollar as certified for customs purposes by the Federal Reserve Bank of New York as of December 30, 2005, which was NT$32.80 to US$1.00 on that date. On April 17, 2006, the noon buying rate was NT$32.42 to US$1.00.

     The following table sets forth, for the periods indicated, information concerning the number of NT dollars for which one U.S. dollar could be exchanged based on the noon buying rate for cable transfers in NT dollars as certified for customs purposes by the Federal Reserve Bank of New York.

		NT dollars per U.S. dollar
		Average(1)				High				Low				Period-End
2001		NT$33.82				NT$35.13				NT$32.23				NT$35.00
2002			34.53				35.16				32.85				34.70
2003			34.41				34.98				33.72				33.99
2004			33.37				34.16				31.74				31.74
2005			32.16				33.77				30.65				32.80
October 2005			33.47				33.77				33.19				33.55
November 2005			33.58				33.71				33.39				33.51
December 2005			33.29				33.56				32.80				32.80
January 2006			32.01				32.59				31.83				31.97
February 2006			32.37				32.68				31.99				32.46
March 2006			32.49				32.67				32.28				32.46
April 2006 (through April 17, 2006)			32.45				32.71				32.30				32.46

     No representation is made that the NT dollar or U.S. dollar amounts referred to herein could have been or could be converted into U.S. dollars or NT dollars, as the case may be, at any particular rate or at all.

Capitalization and Indebtedness

     Not applicable.

Reasons for the Offer and Use of Proceeds

     Not applicable.

Risk Factors

     We wish to caution readers that the following important factors, and those important factors described in other reports submitted to, or filed with, the Securities and Exchange Commission, among other factors, could affect our actual results and could cause our actual results to differ materially from those expressed in any forward-looking statements made by us or on our behalf and that such factors may adversely affect our business and financial status and therefore the value of your investment:

Risks Relating to Our Business

Since we are dependent on the highly cyclical semiconductor and microelectronics industries, which have experienced significant and sometimes prolonged downturns, our revenues, earnings and margins may fluctuate significantly.

     Our semiconductor foundry business is affected by market conditions in the highly cyclical semiconductor and microelectronics industries. Most of our customers operate in these industries. Variations in order levels from our customers result in volatility in our revenues and earnings. From time to time, the semiconductor and microelectronics industries have experienced significant, and sometimes prolonged, downturns. Because our business is, and will continue to be, dependent on the requirements of semiconductor and microelectronics companies for our services, downturns in the general semiconductor and microelectronics industries lead to reduced demand for overall semiconductor foundry services worldwide, including our services. If we cannot take appropriate actions such as reducing our costs to sufficiently offset declines in demand, our revenues, margin and earnings will suffer during downturns.

Overcapacity in the semiconductor industry may reduce our revenues, earnings and margins.

     The prices we can charge our customers for our services are significantly dependent on the overall worldwide supply of integrated circuits and semiconductor products, which is outside of our control. In a period of aggressive pricing competition, industry-wide overcapacity or technology saturation, we may have to lower the prices we charge our customers for our services and/or we may have to operate at significantly less than full capacity. Such actions could reduce our margin and weaken our financial condition and results of operations. For example, due to the decreased annualized demand for semiconductors in 2001 and 2002, our average capacity utilization rate decreased to 51% during 2001, and 73% during 2002 as compared with 106% during 2000.

Decreases in demand and average selling prices for products that contain semiconductors may adversely affect demand for our products and may result in a decrease in our revenues and earnings.

     A vast majority of our sales revenue is derived from customers who use our products in personal computers, communications devices and consumer electronics. Any significant decrease in the demand for these products may decrease the demand for overall global semiconductor foundry services, including our products and may adversely affect our revenues. In addition, the historical and current trend of declining average selling prices of end use applications places pressure on the prices of the components that go into these end use applications. If the average selling prices of end use applications continue to decrease, the pricing pressure on components produced by us may lead to a reduction of our revenue.

If we are unable to compete effectively in the highly competitive foundry segment of the semiconductor industry, we may lose customers and our profit margin and earnings may decrease.

     The markets for our foundry services are highly competitive both in Taiwan and internationally. We compete with other dedicated foundry service providers, as well as integrated device manufacturers. Some of these companies may have access to more advanced technologies and greater financial and other resources than us. Our competition may, from time to time also decide to undertake aggressive pricing initiatives in one or more technology nodes. Competitive activities may cause us to lose customers or to decrease our average selling prices.

If we are unable to remain a technological leader in the semiconductor industry, we may become less competitive.

     The semiconductor industry and the technologies used in it are constantly changing. If we do not anticipate these changes in technologies and rapidly develop new and innovative technologies or our competitors unforeseeably gain sudden access to more advanced technologies, we may not be able to provide advanced foundry services on competitive terms. Although we have concentrated on maintaining a competitive edge in research and development, if we fail to achieve advances in technology or processes, or to obtain access to advanced technologies or processes developed by others, we may become less competitive.

If we are unable to manage our expansion and the modification of our production facilities effectively, our growth prospects may be limited.

     We have been ramping up production at Fab 12 and Fab 14, our 300mm wafer fabs in the Hsinchu Science Park and in the Southern Taiwan Science Park, respectively, since 2004. In 2005, the capacity of our 300mm wafer fabs increased from 30,000 wafer per month to 65,000 wafer per month at Fab 12 and Fab 14. We have also completed the building construction of our Fab 14 (Phase II) facility in the Southern Taiwan Science Park.

     Although we have studied the potential effects of vibration from the high speed railway planned to pass through the Southern Taiwan Science Park and believe that the vibrations will not affect our yield rates for production in the Southern Taiwan Science Park, we can give no assurances that our yields will not be negatively affected after the high-speed railway has commenced operation.

     Expansion and modification of our production facilities will increase our costs. We will need to purchase additional equipment, train personnel to operate the new equipment or hire additional personnel. In addition, we may incur other expenditures resulting from any negative effects of the high-speed railway on our expansions in the Southern Taiwan Science Park. If we do not increase our net sales accordingly in order to offset these higher costs, our financial performance may be adversely affected.

We may not be able to implement our planned growth or development if we are unable to accurately forecast and sufficiently meet our future capital requirements.

     Capital requirements are difficult to plan in the highly dynamic, cyclical and rapidly changing semiconductor industry. We will continue to need significant capital to fund our operations and growth. Although we currently have adequate financial resources and excellent relations with financial institutions who are willing to consider extending credit to us if needed on market terms, our continued ability to obtain sufficient external financing in the future is subject to a variety of uncertainties, including:

	•		our future financial condition, results of operations and cash flows;
	•		general market conditions for financing activities by semiconductor companies; and
	•		economic, political and other conditions in Taiwan and elsewhere.

     Sufficient external financing may not be available to us on a timely basis, on general market terms, or at all. As a result, we may be forced to curtail our expansion and modification plans or delay the deployment of new or expanded services until we obtain such financing.

We may not be able to implement our planned growth or maintain our leading position if we are unable to recruit and retain qualified management and skilled technical and service personnel.

     We depend on the continued services of our executive officers and skilled technical and other personnel. Our business could suffer if we lose for whatever reasons, the services of some of these personnel and we cannot adequately replace them. We may be required to increase the number of employees in connection with any business expansion, and since there is intense competition for the services of these personnel, we cannot ensure that we will be able to fulfill our personnel requirements in a timely manner.

We may be unable to obtain in a timely manner and at a reasonable cost the equipment necessary for us to remain competitive.

     Our operations and ongoing expansion plans depend on our ability to obtain a significant amount of equipment and related services from a limited number of suppliers, and in a market that is characterized, from time to time, by intense demand, limited supply and long delivery cycles. During such times, supplier-specific or industry-wide lead times for delivery can be as long as four to ten months or more. Supplier-specific or industry-wide shortages of equipment could result in an increase in equipment prices and longer delivery times. If we are unable to obtain equipment in a timely manner and at a reasonable cost, we may be unable to fulfill our customers’ orders, which could negatively impact our financial condition and results of operations.

Our revenue and profitability may decline if we are unable to obtain adequate supplies of raw materials in a timely manner and at reasonable prices.

     Our production operations require that we obtain adequate supplies of raw materials, such as silicon wafers, gases, chemicals, and photoresist, on a timely basis. Shortages in the supply of some materials experienced by specific vendors or by the semiconductor industry generally have in the past resulted in occasional industry-wide price adjustments and delivery delays. Also, since we procure some of our raw materials from sole-source suppliers, there is a risk that our need for such raw materials may not be timely met. Our revenue and earnings could decline if we are unable to obtain adequate supplies of the necessary raw materials in a timely manner or if there are significant increases in the costs of raw materials that we cannot pass on to our customers.

If the Ministry of Economic Affairs uses a substantial portion of our production capacity, we will not be able to service our other customers.

     According to our agreement with the Industrial Technology Research Institute of Taiwan, or ITRI, the Ministry of Economic Affairs of the ROC, or an entity designated by the Ministry of Economic Affairs, has an option to purchase up to 35% of certain of our capacity. Although the Ministry of Economic Affairs has never exercised this option, if this option is exercised to any significant degree during tight market conditions, we may not be able to provide services to all of our other customers unless we are able to increase our capacity accordingly or outsource such increased demand and in a timely manner.

Any inability to obtain, preserve and defend our technologies and intellectual property rights could harm our competitive position.

     Our ability to compete successfully and to achieve future growth will depend, in part, on our ability to protect our technologies, and to secure on commercially reasonable terms for certain technologies and licenses. In this regard, we are the beneficiary of government export licenses, technology licenses and a significant number of patent and other intellectual property license agreements that provide us with certain rights, technologies or patent and other intellectual property protection that may be material to our business.

     We cannot ensure that we will be able to develop independently, or secure from any third party, all of the technologies required for sustaining our business or upgrading our production capabilities.

     Litigation may also be necessary to enforce or defend our manufacturing processes, technologies and intellectual property rights. We have no means of knowing what patent applications have been filed by third parties in Taiwan, the United States or other jurisdictions until they are published or granted. Because of the complexity of the technologies used and the multitude of trade secrets, patents, and other intellectual property rights, it is often

difficult for companies to determine improper use of confidential technologies and/or infringement. Therefore, the semiconductor industry is characterized by frequent litigation regarding patent, trade secret and other intellectual property rights. We have received, from time-to-time, communications from third parties asserting that our technologies, manufacturing processes, the design of the integrated circuits made by us or the use by our customers of semiconductors made by us may infringe their patents or other intellectual property rights. And, because of the nature of the industry, we may continue to receive such communications in the future. In some instances, these disputes have resulted in litigation. In the event any third party were to assert infringement claims against us or our customers, we may have to consider alternatives including, but not limited to:

	•		negotiating cross-license agreements using the strength of our intellectual property portfolio to try to offset any financial costs;
	•		seeking to acquire licenses to the allegedly infringed intellectual property, which may not be available on commercially reasonable terms, if at all;
	•		discontinuing using certain process technologies, which could cause us to stop manufacturing certain semiconductor products or applying particular technologies if we were unable to design around the allegedly infringed intellectual property; or
	•		fighting the matter in court and paying substantial monetary judgments in the event we were to lose.

     Any one or several of these and other developments could place substantial financial and administrative burdens on us and hinder our business. If we fail to obtain or maintain certain government, technology or intellectual property licenses and, if litigation relating to alleged intellectual property matters occurs, it could prevent us from manufacturing or selling particular products or applying particular technologies, which could reduce our opportunities to generate revenues. See “Item 8. Financial Information — Legal Proceedings” for a further discussion.

We are subject to the risk of loss due to explosion and fire because some of the materials we use in our manufacturing processes are highly combustible.

     We and many of our suppliers use highly combustible and toxic materials in manufacturing processes and are therefore subject to the risk of loss arising from explosion, fire, or environmental excursions which cannot be completely eliminated. Although we maintain many overlapping risk prevention and protection systems, as well as comprehensive fire and casualty insurance, including insurance for loss of property and loss of profit resulting from business interruption, our risk management and insurance coverage may not be sufficient to cover all of our potential losses. If any of our fabs were to be damaged or cease operations as a result of an explosion, fire, or environmental excursions, it could reduce our manufacturing capacity and may cause us to lose important customers, thereby having a potentially material adverse impact on our financial performance.

Any impairment charges may have a material adverse effect on our net income.

     Under ROC GAAP and US GAAP, we are required to evaluate our equipment and other long-lived assets for impairment whenever there is an indication of impairment. If certain criteria are met, we are required to record an impairment charge. We are also required under ROC GAAP and US GAAP to evaluate goodwill for impairment at least on an annual basis or whenever a triggering event or an indication of impairment occurs.

     We currently are not able to estimate the extent or timing of any impairment charge for future years. Any impairment charge required may have a material adverse effect on our net income.

     The determination of an impairment charge at any given time is based significantly on our expected results of operations over a number of years subsequent to that time. As a result, an impairment charge is more likely to occur during a period when our operating results are otherwise already depressed. See “Item 5. Operating and Financial Review and Prospects ¾ Critical Accounting Policies” for a discussion of our estimates made for determining an impairment charge.

Any significant decrease in sales to one or more of our major customers may decrease our net sales and net income.

     In 2004 and 2005, our ten largest customers have accounted for 49% and 52%, respectively, of our net sales. In particular, our largest customer in 2005 accounted for approximately 11% of our net sales in 2005. The fact that a relatively limited number of customers constitute a significant portion of our revenue may remain as a business characteristic inherent to our extensive presence in the dedicated foundry segment of the semiconductor market. Also, we are the sole foundry service provider for certain of our customers. We cannot assure you that there will be no loss or cancellation of business from any of our major customers, in the future due to reasons beyond our control. Loss or cancellation of business from our most significant customers, should there be any, could significantly reduce our net sales and net income.

Any failure to achieve and maintain effective internal controls could have a material adverse effect on our business, results of operations and the market price of our common shares and ADSs.

     Effective internal controls are necessary for us to provide reasonable assurance with respect to our financial reports and to effectively prevent fraud. If we cannot provide reasonable assurance with respect to our financial reports and effectively prevent fraud, our reputation and results of operations could be harmed.

     We are required to comply with various ROC and US laws and regulations on internal controls. For example, pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, beginning with our Annual Report on Form 20-F for the fiscal year ending December 31, 2006, we are required to furnish a report by management on our internal control over financial reporting, including management’s assessment of the effectiveness of our internal control over financial reporting. Moreover, ROC law requires us to establish internal control systems that would reasonably ensure the effectiveness and efficiency of operations, reliability of financial reporting, and compliance with applicable laws and regulations. We are also required under ROC law to file an internal control declaration within four months of the end of each fiscal year.

     Internal controls may not prevent or detect misstatements because of their inherent limitations, including the possibility of human error, the circumvention or overriding of controls, or fraud. Therefore, even effective internal controls can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements. In addition, projections of any evaluation of effectiveness of internal controls to future periods are subject to the risk that the internal controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. If we fail to maintain the adequacy of our internal controls, including any failure to implement required new or improved controls, or if we experience difficulties in their implementation, our business and operating results could be harmed, we could fail to meet our reporting obligations, and there could be a material adverse effect on the market price of our common shares and ADSs.

Risks Relating to the ROC

Relations between the Republic of China (“ROC”) and the People’s Republic of China (“PRC”) could negatively affect our business and financial status and therefore the market value of your investment.

     The ROC has a unique international political status. The PRC does not recognize the sovereignty of the ROC. Although the two sides have co-existed for the past 57 years and significant economic and cultural relations have been established during recent years between the ROC and the PRC, relations have often been strained. The government of the PRC has announced its intent to use military force to gain control over the ROC if the ROC declares itself independent. In particular, on March 14, 2005, the PRC adopted an anti-secession law which includes such a threat. However, in May 2005, the PRC announced a series of goodwill gestures towards the ROC, including the gift of two pandas, the lifting of a ban on its tourists visiting the ROC and easing restrictions on the import of various agricultural product. Past developments in relations between the ROC and the PRC have on occasion depressed the market prices of the securities of Taiwanese companies, including our own.

     The ROC government currently restricts transfer by Taiwanese companies of certain technologies to and certain types of investments by Taiwanese companies in Mainland China. The ROC government in April 2002, partially lifted the ban on investment by Taiwan semiconductor manufacturing companies in 200mm wafer fabs in

Mainland China. Even though we obtained approval to establish a 200mm wafer fab in Mainland China, significant restrictions remain.

     Our principal executive officers and our principal production facilities are located in the ROC and a substantial majority of our net revenues are derived from our operations in the ROC. Therefore, factors affecting military, political or economic conditions in the ROC could have a material adverse effect on our results of operations, as well as the market price and the liquidity of our ADSs and common shares.

Our production may be interrupted if we do not have access to sufficient amounts of fresh water or a sufficient supply of electricity.

     Our manufacturing processes use extensive amounts of fresh water and electricity. Due to the growth in semiconductor manufacturing capacity in Hsinchu Science Park and Southern Taiwan Science Park, the requirements for fresh water and power in these industrial parks have grown substantially. There is a risk that the overgrowth of Hsinchu Science Park and Southern Taiwan Science Park may cause such parks to suffer an under-capacity in adequate fresh water and electricity supply. We have sometimes suffered power outages caused by our major electricity supplier, the Taiwan Power Company, or other power consumers on the same power supply line, which have caused interruptions in our production schedule. For example, on April 10, 2004, a power outage caused by a circuit trip of a high voltage underground cable line of Taiwan Power Company, and on October 3, 2005, a serious power dip (an abrupt decrease of voltage in power supply) caused by a short-circuit fault of Taiwan Power Company’s Hsinchu Main Station, affected our fabs in Hsinchu Science Park. Similarly, our operation in mainland China may also suffer power outages due to reasons beyond our control. For example, our Fab 10 in Shanghai suffered a power outage for about one hour in May 2005 caused by lightning striking in the vicinity of Fab 10. Material power outages or water insufficiencies could disrupt the normal operation of our business and have an adverse effect on our financial condition and results of operations.

We are vulnerable to natural disasters which could severely disrupt the normal operation of our business and adversely affect our earnings.

     Most of our production facilities, as well as many of our suppliers and customers and upstream providers of complementary semiconductor manufacturing services, are located in Taiwan. Taiwan is susceptible to earthquakes, droughts, and typhoons. On September 21, 1999, Taiwan experienced a severe earthquake that caused significant property damage and loss of life, particularly in the central part of Taiwan. This earthquake caused damage to production facilities and adversely affected the operations of many companies in the semiconductor and other industries, including our own. Taiwan experiences droughts from time to time, and in 2002 and 2003, Taiwan experienced serious droughts. Although we maintain natural perils insurance up to policy limits, including insurance for loss of property and loss of profit resulting from business interruption, our insurance coverage may not be sufficient to cover all of our potential losses. A major earthquake or other natural disaster in Taiwan could severely disrupt the normal operation of our business and have a material adverse effect on our financial condition and results of operations.

Fluctuations in exchange rates could result in foreign exchange losses.

     Over half of our capital expenditures and manufacturing costs are denominated in currencies other than NT dollars, primarily U.S. dollars, Japanese yen and Euros. A larger portion of our sales are denominated in U.S. dollars and currencies other than NT dollars. Therefore, any significant fluctuation to our disadvantage in such exchange rate may have an adverse effect on our financial condition. In addition, fluctuations in the exchange rate between the U.S. dollar and the NT dollar may affect the U.S. dollar value of our common shares and the market price of the ADSs and of any cash dividends paid in NT dollars on our common shares represented by ADSs.

Any future outbreak of new or unusual diseases may materially affect global corporate operations and business, including our own.

     Any outbreak of a contagious disease may adversely affect the population on a pandemic regional or worldwide basis and therefore may potentially result in a quarantine of infected persons and also may affect the operations of the global business community, including one or more of our facilities. The global health authorities

cannot predict the impact any future outbreak could have on our financial condition and results of operations. In particular, we cannot assure you that our business or prospects would not be materially and adversely affected.

Risks Relating to ownership of ADSs

Your voting rights as a holder of ADSs will be limited.

     Holders of American Depositary Receipts (ADRs) evidencing ADSs may exercise voting rights with respect to the common shares represented by these ADSs only in accordance with the provisions of our ADS deposit agreement. The deposit agreement provides that, upon receipt of notice of any meeting of holders of our common shares, the depositary bank will, as soon as practicable thereafter, mail to the holders (i) the notice of the meeting sent by us, (ii) voting instruction forms and (iii) a statement as to the manner in which instructions may be given by the holders.

     ADS holders will not generally be able to exercise the voting rights attaching to the deposited securities on an individual basis. According to the ROC Company Law, the voting rights attaching to the deposited securities must be exercised as to all matters subject to a vote of shareholders collectively in the same manner, except in the case of an election of directors and supervisors. Election of directors and supervisors is by means of cumulative voting. See “Item 10. Additional Information — Voting of Deposited Securities” for a more detailed discussion of the manner in which a holder of ADSs can exercise its voting rights.

You may not be able to participate in rights offerings and may experience dilution of your holdings.

     We may, from time to time, distribute rights to our shareholders, including rights to acquire securities. Under our ADS deposit agreement, the depositary bank will not distribute rights to holders of ADSs unless the distribution and sale of rights and the securities to which these rights relate are either exempt from registration under the United States Securities Act of 1933, as amended, or the Securities Act, with respect to all holders of ADSs, or are registered under the provisions of the Securities Act. Although we may be eligible to take advantage of certain exemptions for rights offerings by certain foreign companies, we can give no assurance that we can establish an exemption from registration under the Securities Act, and we are under no obligation to file a registration statement with respect to any such rights or underlying securities or to endeavor to have such a registration statement declared effective. In addition, if the depositary bank is unable to obtain the requisite approval from the Central Bank of China for the conversion of the subscription payments into NT dollars or if the depositary determines that it is unlikely to obtain this approval, we may decide with the depositary bank not to make the rights available to holders of ADSs. See “Item 10. Additional Information — Foreign Investment in the ROC” and “Item 10. Additional Information — Exchange Controls in the ROC”. Accordingly, holders of ADSs may be unable to participate in our rights offerings and may experience dilution of their holdings as a result.

     If the depositary bank is unable to sell rights that are not exercised or not distributed or if the sale is not lawful or reasonably practicable, it will allow the rights to lapse, in which case you will receive no value for these rights.

The value of your investment may be reduced by possible future sales of common shares or ADSs by us or our shareholders.

     One or more of our existing shareholders may, from time to time, dispose of significant numbers of common shares or ADSs. In October 2003, one of our two largest shareholders, Philips, announced its intention to gradually and orderly reduce its equity interest in us and reiterated this intention in May 2005. In August and September 2005, Philips sold an additional 113,521,000 ADSs. Moreover, our other major shareholder, the Development Fund, has sold ADSs in several transactions since 1997, including 44,172,500 ADSs in August and September 2005.

     In addition, we have in place a conversion sale program that allows some of our shareholders to sell their common shares in ADS form to a specified financial intermediary during a 30-day period not more than once every three months. Since the establishment of the program in 1999, a total of 42,076,000 ADSs (without adjustments for subsequent stock dividends) were sold in several transactions under the program. We cannot predict the effect, if any, that future sales of ADSs or common shares, or the availability of ADSs or common shares for future sale, will

have on the market price of ADSs or common shares prevailing from time to time. Sales of substantial amounts of ADSs or common shares in the public market, or the perception that such sales may occur, could depress the prevailing market price of our ADSs or common shares and could reduce the premium, if any, that the price per ADS on the New York Stock Exchange represents over the corresponding aggregate price of the underlying five common shares on the Taiwan Stock Exchange.

The market value of our shares may fluctuate due to the volatility of, and government intervention in, the ROC securities market.

     Because the Taiwan Stock Exchange experiences from time to time substantial fluctuations in the prices and volumes of sales of listed securities, there are currently limits on the range of daily price movements on the Taiwan Stock Exchange. In response to past declines and volatility in the securities markets in Taiwan, and in line with similar activities by other countries in Asia, the government of the ROC formed the Stabilization Fund, which has purchased and may from time to time purchase shares of Taiwan companies to support these markets. In addition, other funds associated with the ROC government have in the past purchased, and may from time to time purchase, shares of Taiwan companies on the Taiwan Stock Exchange or other markets. In the future, market activity by government entities, or the perception that such activity is taking place, may take place or has ceased, may cause fluctuations in the market prices of our ADSs and common shares.

ITEM 4. INFORMATION ON THE COMPANY

Our History and Structure

     We are currently the world’s largest dedicated IC foundry in the semiconductor industry. We were founded in 1987 as a joint venture among the ROC government, Philips and other private investors and were incorporated in the ROC on February 21, 1987. Our common shares have been listed on the Taiwan Stock Exchange since September 5, 1994, and our ADSs have been listed on the New York Stock Exchange since October 8, 1997.

     WaferTech in the United States. In 1996, we entered into a joint venture called WaferTech with several US-based investors to construct and operate a US$1.2 billion foundry in the United States. Initial trial production at WaferTech commenced in July 1998 and commercial production commenced in October 1998. In December 1998, we increased the percentage of our ownership interest in WaferTech to 68%. By the end of the first quarter of 2001, we had increased the percentage of our ownership interest in WaferTech to approximately 99% by purchasing all of the remaining interest of all of the other joint venture partners. As of February 28, 2006, we owned an approximately 99.996% equity interest in WaferTech.

     Operations in Mainland China. In February 2003, we received Phase I approval from the ROC government to expend US$898 million (including US$371 million as a direct equity investment in TSMC Shanghai) to establish TSMC Shanghai and to construct a 200mm wafer fab in Mainland China. In August 2003, we established TSMC Shanghai, a wholly-owned subsidiary primarily engaged in the manufacturing and selling of integrated circuits. We applied for further, “Phase II”, approval (relating to the relocation of manufacturing equipment from Taiwan to Mainland China) with the ROC Ministry of Economic Affairs in March 2004, and received the Phase II approval on May 11, 2004. We have achieved commercial production with 0.35 micron and 0.25 micron process technologies in Fab 10, our 200mm wafer fab in Songjiang, where we commenced production in late 2004. As of February 28, 2006, we owned a 100% equity interest in TSMC Shanghai.

     Systems on Silicon Manufacturing Company Pte. Ltd. (“SSMC”). In March 1999, we entered into an agreement with Philips and EDB Investment Pte. Ltd. to found a joint venture, SSMC, to build a fab in Singapore. As of February 28, 2006, we owned 32%, Philips owned 50.5% and EDB Investment Pte. Ltd. owned 17.5% of SSMC. The fab commenced production in December 2000. While we, together with Philips, have the right to purchase up to 100% of its annual capacity, we and Philips are required to purchase, in the aggregate, at least 70% of SSMC’s full capacity; we, alone, are required to purchase up to 28% of the annual installed capacity.

Our Principal Office

     Our principal executive office is currently located at No. 8, Li-Hsin Road 6, Hsinchu Science Park, Taiwan, Republic of China. Our telephone number at that office is (886-3) 563-6688. Our web site is www.tsmc.com. Information contained on our website does not constitute part of this annual report.

Business Overview of the Company

     As a foundry, we manufacture semiconductors using our advanced manufacturing processes for our customers based on their own or third parties’ proprietary integrated circuit designs. We offer a comprehensive range of leading edge wafer fabrication processes, including processes to manufacture CMOS logic, mixed-signal, radio frequency and embedded memory and BiCMOS mixed-signal and other semiconductors. IC Insights (The McClean Report 2006 Edition) estimates that our revenue market share among dedicated foundries worldwide was 46% in 2004 and 49% in 2005. We also offer design, mask making, probing, testing and assembly services.

     We believe that our large capacity, particularly for advanced technologies, is a major competitive advantage. Please see “¾ Manufacturing Capacity and Technology” and “¾ Capacity Expansion and Technology Upgrade Plans” for a further discussion of our capacity.

     We count among our customers many of the world’s leading semiconductor companies, ranging from fabless semiconductor companies and systems companies such as Altera Corporation, ATI Technology Inc., Broadcom Corporation, Marvell Semiconductor Inc., nVidia Corporation, Qualcomm and VIA Technology, Inc., to integrated device manufacturing companies such as Analog Devices, Inc., Freescale Semiconductor Inc. and Philips. Fabless semiconductor companies/systems companies and integrated device manufacturers accounted for approximately 70.4% and 29.6%, respectively, of our net sales in 2005.

Our Facilities

     After combining the operations at two of our 200mm fabs in 2001 and the decommissioning of one of our 150mm wafer fabs (Fab 1) in March 2002, we currently operate one 150mm wafer fab, seven 200mm wafer fabs and two 300 mm wafer fabs, including Fab 14, where we commenced production in the fourth quarter of 2004. Our corporate headquarters and six of our fabs are located in the Hsinchu Science Park, two fabs are located in the Southern Taiwan Science Park, one fab is located in the United States, and one fab is located in Shanghai. Our corporate headquarters and our six fabs in Hsinchu occupy approximately 275,078 square meters of land. We lease all of this land from the Hsinchu Science Park Administration in Hsinchu under agreements that will be up for renewal between March 2008 and December 2020. We have leased from the Southern Taiwan Science Park Development Office 395,000 square meters of land for our fabs in the Southern Taiwan Science Park under agreements that will be up for renewal between November 2018 and December 2025. WaferTech owns 1,052,181 square meters of land in the State of Washington in the United States, where the WaferTech fab and related offices are located. TSMC Shanghai owns 420,000 square meters of land in Shanghai, where Fab 10 and related offices are located.

     Other than certain equipment under leases located at testing areas, we own all of the buildings and equipment for our fabs. We are expanding our 300mm fabrication capacity through Fab 12 (Phase II and III) in the Hsinchu Science Park and Fab 14 in the Southern Taiwan Science Park. Total monthly capacity for 300mm fabs was increased from 30,000 wafers to 65,000 wafers in 2005. We will continuously evaluate our 300mm capacity in light of prevailing market conditions.

     We believe that our quality and reliability policy and practice has ensured a high standard of manufacturing quality and reliability. We have been informed by customers that wafers produced by us consistently met or exceeded the quality and reliability requirements in the field.

Manufacturing Capacity and Technology

     We manufacture semiconductors on silicon wafers based on proprietary circuitry designs provided by our customers or third party designers. Two key factors that characterize a foundry’s manufacturing capabilities are output capacity and fabrication process technologies. Since our establishment, we have possessed the largest

capacity among the world’s dedicated foundries. We also believe that we are the technology leader among the dedicated foundries in terms of our net sales of advanced semiconductors with a resolution of 0.13 micron and below, and are one of the leaders in the semiconductor industry generally. We were the first semiconductor foundry with proven low-k technology in commercial production, in both the 0.13 micron process technology and the 90-nanometer Nexsys^SM technology. The 90-nanometer Nexsys^SM technology was the first process technology based entirely on low-k dielectrics. In 2005, TSMC followed with full commercial production of 80-nanometer Nexsys^SM process technology. Moreover, in 2005, we completed a number of customer prototypes through Cybershuttle^SM service with our advanced 65-nanometer Nexsys^SM technology entering early production phase. TSMC’s 65-nanometer Nexsys^SM technology is the third-generation TSMC process to employ low-k dielectrics.

     The following table lists our fabs and those of our affiliates, together with the year of commencement of commercial production, technology and capacity during the last five years:

						Current most
						advanced technology				Monthly capacity(3)(4)
		Year of				for volume
Fab(1)		commencement				production(2)				2001				2002				2003				2004				2005
1(5)			1987				—				11,378				—				—				—				—
2			1990				0.45				45,225				43,540				42,977				47,584				47,584
3(6)			1995				0.18				82,700				71,000				71,600				83,300				83,300
5			1997				0.15				40,000				34,920				37,800				42,500				42,500
6			2000				0.13				41,000				48,700				63,500				73,000				73,000
7			1995				0.35				46,500				22,500				11,800				13,400				13,400
8			1998				0.15				54,700				52,600				63,500				76,500				76,500
10			2004				0.25				—				—				—				500				15,600
12			2001				0.09				3,375				11,475				31,797				60,300				106,875
14			2004				0.09				—				—				—				6,750				46,125
WaferTech			1998				0.15				28,000				30,000				30,000				32,500				33,500
SSMC(7)			2000				0.18				5,166				8,000				9,600				13,400				16,700
Total											358,044				322,735				362,574				449,734				555,084

     As of December 31, 2005, our monthly capacity (in 200mm equivalent wafers) was 555,084 wafers, compared to 449,734 wafers at the end of 2004. This increase was primarily due to the expansion of our 0.13 micron and 90-nanometer advanced technologies.

Capacity Expansion and Technology Upgrade Plans

     We intend to maintain our strategy of expanding manufacturing capacity and improving manufacturing process technologies to meet both the fabrication and the technological needs of our customers. Based upon estimates of market demands, we currently expect to continue ramping up of Fab 12 and Fab 14 and capacity increases at Fab 10. The current capacity increase plan is based on our long term market demand forecast conducted periodically and may change significantly at any time.

     Our capital expenditures in 2003, 2004 and 2005 were NT$37,871 million, NT$81,095 million and NT$79,879 million (US$2,435 million) on a consolidated basis, respectively. We currently expect our capital expenditures to be approximately US$2,600 million to US$2,800 million in 2006. During 2006, we anticipate capital expenditures to focus primarily on the following:

	•		ramping up production at Fab 12 (Phases II and III) and Fab 14 (Phase I) and commencing production at Fab 14 (Phase II);
	•		capacity expansion for mask operation;
	•		development of process technologies such as sub-45 and 65nm nodes; and
	•		other research and development projects.

     These investment plans are still preliminary and our expected capital expenditures may change based upon market conditions.

     Capacity Utilization Rates. One of the key factors influencing our profit margins is our capacity utilization. Because a high percentage of our cost of sales is of a fixed nature, operations at or near full capacity can have a significant positive effect on profitability. Starting from the first quarter of 2003, we revised our capacity utilization rate calculation to exclude engineering wafers and Vanguard capacity to reflect our own production capacity and our contractually committed capacity. The average utilization rate for each quarter of 2005 was 78%, 85%, 96% and 104%, respectively and 92% for the entire year, compared to a utilization rate of 100% in 2004.

     Other factors affecting utilization rates are the percentage yield of commercially useful wafers during the fabrication process, the complexity of the wafer produced and the actual product mix. We determine the capacity of a fab based on the capacity ratings given by manufacturers of the equipment used in the fab, adjusted for, among other factors:

	•		actual output during uninterrupted trial runs;
	•		expected down time due to setup for production runs; and
	•		expected product mix.

     Except for regularly scheduled maintenance shutdown, all of our fabs currently operate 24 hours per day, seven days per week. Employees work shifts of 12 hours each day on a two days on, two days off basis, except during periods of annual maintenance.

     Commitments by Customers. Because of the fast-changing technology and functionality in semiconductor design, foundry customers generally do not place purchase orders far in advance to manufacture a particular type of product. However, we engage in discussions with customers regarding their expected manufacturing requirements in advance of the placement of purchase orders.

     Several of our customers have entered into arrangements with us to ensure that they have access to specified capacity at our fabs. These arrangements are primarily in the form of deposit agreements. In a deposit agreement, the customer makes an advance cash deposit for an option on a specified capacity at our fabs. Deposits are generally refunded as shipments are made. As of December 31, 2005, our customers had on deposit an aggregate of approximately US$88 million to reserve future capacity for the years 2006 through 2007.

Markets and Customers

     The primary customers of our foundry services are fabless semiconductor companies/systems companies and integrated device manufacturers. The following table presents the breakdown of net sales by types of customers during the last three years:

		Year ended December 31,
		2003								2004								2005
Customer Type		Net Sales				Percentage				Net Sales				Percentage				Net Sales				Percentage
		(in millions, except percentages)
Fabless semiconductor companies/systems companies		NT$145,752					71.8	%		NT$176,705					68.7	%		NT$187,662					70.4	%
Integrated device manufacturers			57,245				28.2				80,508				31.3				78,903				29.6
Total		NT$202,997					100.0	%		NT$257,213					100.0	%		NT$266,565					100.0	%

     We categorize our net sales based on the country in which the customer is headquartered, which may be different from the net sales for the countries to which we actually sell or ship our products. Under this approach, the following table presents a regional geographic breakdown of our net sales during the last three years:

		Year ended December 31,
		2003								2004								2005
Region		Net Sales				Percentage				Net Sales				Percentage				Net Sales				Percentage
										(in millions, except percentages)
North America		NT$154,075					75.9	%		NT$191,624					74.5	%		NT$205,255					77.0	%
Asia			39,381				19.4				47,584				18.5				40,785				15.3
Europe			9,541				4.7				18,005				7.0				20,525				7.7
Total		NT$202,997					100.0	%		NT$257,213					100.0	%		NT$266,565					100.0	%

     A significant portion of our net sales are attributable to a relatively small number of our customers. In 2004 and 2005, our ten largest customers accounted for approximately 49% and 52% of our net sales, respectively.

     Over the years, we have attempted to strategically manage our exposure to commodity memory semiconductor manufacturing services. This policy has successfully shielded us from significant adverse effects resulting from the previous precipitous price drops in the commodity memory semiconductor market.

     We have five marketing and customer support regions. The office in Hsinchu serves Asian (excluding Japanese and Chinese) customers. Wholly-owned subsidiaries in the United States, Japan, Shanghai and the Netherlands serve North American, Japanese, Mainland Chinese and European customers, respectively. Foundry service sales are technologically intensive and involve frequent and intensive contacts with customers. We believe that the most effective means of marketing our foundry services is by developing direct relationships with our customers. We do not use agents or distributors. Our customer service managers work closely with the sales force by providing integrated services and detailed technical advice and specifications to customers.

The Semiconductor Fabrication Process

     The semiconductor fabrication process can be categorized into a series of stages. The following are the main stages involved in semiconductor production:

	•		Circuit Design: The layout of the circuit components and interconnections is generally produced at computer-aided design terminals. A complex circuit may be designed in as many as thirty layers of patterns or more.
	•		Mask Making: Each layer of the pattern of the circuit is duplicated on a photographic negative, known as a mask (also referred to as a reticle), by an electron beam generator.
	•		Wafer Fabrication: This is the process by which raw silicon wafers are modified to form junctions, transistors or interconnects. In this process, the raw wafers are oxidized to form silicon dioxide, which is used as an insulator between the conductors and as an insulating layer for a controlling gate. Through the introduction of various impurities, the characteristics of conduction in the silicon are eventually changed to form a junction or transistor. During the wafer fabrication process, conductor, semiconductor or resistor materials are applied to the wafer in multiple layers in different patterns specified in the masks.

	•		Wafer Probing: After a visual inspection, individual semiconductors, called “dies”, on a wafer are tested, or “probed”, electrically. Dies that fail this test are “marked” to be discarded.
	•		Assembly: Each wafer is cut into individual dies and defective dies are discarded. Good dies are connected to a conductive lead frame or organic substrate-based package and the bonded semiconductors, if lead frame based, are then encapsulated using a plastic molding compound or a ceramic casing.
	•		Testing: Packaged semiconductors are fully tested by the use of specialized testing equipment.

Our Foundry Services

     Range of Services. Because of our ability to provide a full array of services, we are able to accommodate customers with a variety of input and output needs. The flexibility in input stages allows us to cater to a variety of customers with different in-house capabilities and thus to service a wider class of customers as compared to a foundry that cannot offer design or mask making services, for example.

     The following diagram illustrates the services we provided in 2005, either directly or through outsourcing, to our customers:

     Fabrication Processes. We manufacture semiconductors using the complementary metal oxide silicon, CMOS and BiCMOS processes. The CMOS process is currently the dominant semiconductor manufacturing process. In the past, a competing manufacturing process called the “bipolar” process was also prevalent. The BiCMOS process combines the high speed of the bipolar circuitry and the low power consumption and high density of the CMOS circuitry. We use the CMOS process to manufacture logic semiconductors, memory semiconductors including SRAM, flash memory, mixed-signal semiconductors, which combine analog and digital circuitry in a single semiconductor, and embedded memory semiconductors, which combine logic and memory in a single semiconductor. The BiCMOS process is used to make high-end mixed-signal and other types of semiconductors.

     Types of Semiconductors We Manufacture. We manufacture different types of semiconductors with different specific functions by changing the number of and the combinations of conducting, insulating and

semiconducting layers and by defining different patterns in which such layers are applied on the wafer. At any given point in time, there are over a hundred different products in various stages of fabrication at our foundries. We believe that the keys to maintaining high production quality and utilization rates are our effective management and control of the manufacturing process technologies that come from our extensive experience as the longest existing dedicated foundry and our dedication to quality control and process improvements.

     The following is a general description of the key types of semiconductors that we manufacture:

     Logic Semiconductors. Logic semiconductors process digital data to control the operation of electronic systems. The largest segment of the logic market, standard logic devices, includes microprocessors, microcontrollers, DSPs, graphic chips and chip sets.

     Mixed-Signal Semiconductors. Analog/digital semiconductors combine analog and digital devices on a single semiconductor to process both analog signals and digital data. We make mixed-signal semiconductors using both the CMOS and BiCMOS processes. We offer CMOS mixed-signal process down to the 90-nanometer Nexsys^SM technology and 0.35 micron BiCMOS process and 0.35 micron and 0.18 micron silicon germanium process for manufacturing mixed-signal semiconductors. The primary uses of mixed-signal semiconductors are in hard disk drives, wireless communications equipment and network communications equipment, with those made with the BiCMOS process occupying the higher end of the mixed-signal market.

     Memory Semiconductors. Memory semiconductors, which are used in electronic systems to store data and program instructions, are generally classified as either volatile memory (which lose their data content when power supplies are switched off) or nonvolatile memory (which retain their data content without the need for a constant power supply). Examples of volatile memory include SRAM and DRAM and examples of nonvolatile memory include electrically EPROM and flash memory. We currently offer CMOS process for the manufacture of SRAM in resolutions down to 65-nanometer in both high speed and low power designs, and for the manufacture of flash memory and embedded flash in resolutions down to 0.18 micron.

     CMOS Image Sensor Semiconductors. Image sensors are primarily used in cameras, surveillance and security systems, and increasingly in vehicles. We are currently the leading foundry for the production of CMOS image sensors, characterized by technology features including low dark current, high sensitivity, smaller pixel size and high dynamic range achieved through integration with mixed mode processes.

     High Voltage Semiconductors. We offer a range of high-voltage processes, ranging from 5V to 80V, which are suitable for various panel-size display driver and power IC applications. Applicable voltage range covers up to 20V with double-diffused-drain MOS structures and extends up to 80V with lateral-diffused MOS structures.

     The table below presents a breakdown of our net sales during the last three years by each semiconductor type:

		Year ended December 31,
		2003								2004								2005
Semiconductor Type		Net Sales				Percentage				Net Sales				Percentage				Net Sales				Percentage
										(in millions, except percentages)
CMOS
Logic		NT$157,526					77.6	%		NT$174,905					68.0	%		NT$199,657					74.9	%
Memory			3,045				1.5				22,120				8.6				2,133				0.8
Mixed-Signal(1)			40,599				20.0				50,414				19.6				63,442				23.8
BiCMOS(2)			406				0.2				1,029				0.4				1,066				0.4
Others			1,421				0.7				8,745				3.4				267				0.1
Total		NT$202,997					100.0	%		NT$257,213					100.0	%		NT$266,565					100.0	%

     Design Services.

     We offer a wide range of design services, from providing fundamental technology files, libraries and other intellectual property to customization and chip implementation services.

     To facilitate our customers’ semiconductor designs, we provide a set of technology files for the process technologies we offer. The technology files include the necessary information to support design activities in physical layout, verification and circuit simulation.

     To accelerate the time-to-market for our customers, we provide a set of foundation library and selected silicon intellectual property to help designers expedite their design process. Our library and intellectual property portfolio includes standard logic cells, input/output interface cells, and memory/analog blocks. Each library and silicon intellectual property portfolio is designed to maximize performance while minimizing area and power consumption. We also enter into arrangements with third-party providers to provide to our customers a broader range of library and silicon intellectual property offerings.

     With advanced process technologies entering the nano-meter range, designers require more guidance to deal with the increasing complexities of managing performance and power consumption. Also, due to limited design and process margin on nano-meter technologies, fabless designers are required to work closely with a foundry to ensure that their designs are suitable for commercial manufacturing and can quickly be transferred to manufacturing. For these purposes, we have provided DFM, or design for manufacturing services. In addition, we created DFM models for advanced design flows that we co-developed with major design automation companies. We also apply these advanced design flows in our chip implementation services.

     Multiproject Wafers Program. To help our customers reduce costs, we offer a dedicated multiproject wafer processing service that allows us to provide multiple customers with wafers produced with the same mask. This program eliminates costly and time-consuming repetitive mask and wafer runs and reduces mask development costs by a very significant factor, resulting in accelerated time-to-market for our customers. We have extended this program to all customers and library and IP partners using our 65nm process technology. This extension offers a routinely scheduled multiproject wafer run to customers on a shared-cost basis for prototyping and verification.

     We developed our multiproject wafer program in response to the current system-on-chip development methodologies, which often require the independent development, prototyping and validation of several cores before they can be integrated onto a single device. By sharing resources with our customers to the extent permissible, the system-on-chip supplier can enjoy reduced prototyping costs and greater confidence that the design will be successful.

Customer Service

     We believe that our focus on customer service has been an important factor in attracting leading semiconductor companies as customers. The key elements of our customer service are our:

	•		firmly established customer-oriented culture, which emphasizes close interaction with our customers on a multifaceted basis, from senior management, sales and marketing, customer service staff to product and line engineers in the fabs and research and development staff;
	•		ability to deliver ordered wafers of consistent quality, on time and in the desired quantities;
	•		responsiveness to customer’s requirements in terms of engineering change orders and special wafer handling;
	•		flexibility in manufacturing processes, order size requirements and design changes, attributable in part to our technical capability and ability to plan and manage effectively many production runs;

	•		ability to reduce customer costs through the sharing, to the extent permissible, of ever increasing silicon verification costs through our multi-project wafer service, which combines multiple designs on a single mask set;
	•		eFoundry service which features real-time on-line information exchange throughout product design, engineering and logistic phases, including WIP (work in progress) performance reports for both in-house and subcontracted activities, for the processes of handling, assembly and final testing, before the products are shipped to our customers; and
	•		Virtual fab™, which is a customer service program designed to make our manufacturing services as transparent and easy to deal with for our customers as their own in-house fabs, with well coordinated resource management. The Virtual fab™ provides customers with the benefits of in-house fabs, including confidentiality of proprietary information, quality of service and products, on-time delivery and flexibility in scheduling and capacity.

Research and Development

     The semiconductor industry is characterized by rapid changes in technology, frequently resulting in the obsolescence of recently introduced technology and products. We believe that, in order to stay technologically ahead of our competitors and maintain our market position in the foundry segment of the semiconductor industry, we need to maintain our position as a technology leader not only in the foundry segment but in the semiconductor industry in general. We spent NT$12,713 million, NT$12,516 million and NT$14,017 million (US$427 million) in 2003, 2004 and 2005, respectively, on research and development, which represented 6.3%, 4.9% and 5.3%, respectively, of our net sales for these periods. We plan to continue to invest significant amounts on research and development in 2006, with the goal of maintaining a leading position in the development of advanced process technologies. Our research and development efforts have recently allowed us to provide our customers access to certain advanced process technologies, such as 90-nanometer and 80-nanometer Nexsys^SM technology for volume production, and 65-nanometer Nexsys^SM technology for engineering prototypes and early production, prior to the implementation of those advanced process technologies by many integrated device manufacturers and our competitors.

     Our research and development efforts are divided into centralized research and development activities and research and development activities undertaken by each of our fabs. Our centralized research and development activities are principally directed toward developing most advanced and new generation manufacturing technologies. The research and development activities undertaken in each fab focus on upgrading the manufacturing process technologies.

     We use internally developed process technologies and process technologies licensed from our customers and third parties. In continuing to advance our process technologies, we intend to rely primarily on our internal engineering capability and know-how and our research and development efforts, including collaboration with our customers and equipment vendors.

     We also continuously create in-house inventions and know-how. Since our inception, every year we apply for and are issued a substantial number of United States and other patents, most of which are semiconductor-related.

Equipment

     The quality and technology of the equipment used in the semiconductor manufacturing process are important in that they effectively define the limits of our process technology. Advances in process technology cannot be brought about without commensurate advances in equipment technology. The principal pieces of equipment used by us to manufacture semiconductors are scanners, steppers, cleaners and track equipment, inspection equipment, etchers, furnaces, wet stations, strippers, implanters, sputterers, CVD equipment, testers and probers. Other than certain equipment under leases located at testing areas, we own all of the equipment used at our fabs.

     In implementing our capacity expansion and technology advancement plans, we expect to make significant purchases of equipment required for semiconductor manufacturing. Some of the equipment is available from a

limited number of vendors and/or is manufactured in relatively limited quantities, and certain equipment has only recently been developed. We believe that our relationships with our equipment suppliers are good and that we have enjoyed the advantages of being a major purchaser of semiconductor fabrication equipment. We work closely with manufacturers to provide equipment customized to our needs for certain advanced technologies.

Raw Materials

     Our manufacturing processes use many raw materials, primarily silicon wafers, chemicals, gases and various types of precious and other metals.

     Raw materials costs constituted 12.0% of our net sales in 2004 and 13.2% of our net sales in 2005. The three largest components of raw material costs — wafers, gas and chemicals — accounted for 42.9%, 11.1% and 18.0%, respectively, of our raw material costs in 2004 and 42.2%, 9.4% and 20.5%, respectively, of our raw material costs in 2005. Most of our raw materials generally are available from several suppliers. Our raw material procurement policy is to select only those vendors who have demonstrated quality control and reliability on delivery time and to maintain multiple sources for each raw material so that a quality or delivery problem with any one vendor will not adversely affect our operations. The quality and delivery performance of each vendor is evaluated monthly or quarterly and quantity allocations are adjusted for subsequent periods based on the evaluation.

     The most important raw material used in our production is silicon wafers, which is the basic raw material from which integrated circuits are made. The principal suppliers for our wafers are Shin-Etsu Handotai and SUMCO CORPORATION of Japan, Siltronic AG of Germany, and MEMC Electronic Materials, Inc. of the United States. Together they supplied approximately 82% of our total wafer needs in both 2004 and 2005, respectively. We have in the past obtained, and believe we will continue to be able to obtain, a sufficient supply of 150mm, 200mm and 300 mm wafers. However, surge demand for some specialty products that require use of specialty wafers may sometimes cause a sudden shortage of the supply of specialty wafers. After a moderate increase of wafer prices in 2000, the price of wafers decreased slightly during 2003, 2004 and 2005. In order to secure a reliable and flexible supply of high quality wafers, we entered into long-term agreements and intend to develop strategic relationships with major wafer vendors to cover our anticipated wafer needs for the next three to five years.

Competition

     We compete internationally and domestically with dedicated foundry service providers, as well as with integrated device manufacturers that devote a portion of their manufacturing capacity to foundry operations. We compete primarily on the basis of process technology, quality and service. The level of competition differs according to the process technology involved. For example, in more mature technologies, the competition tends to be more intense. Some companies compete with us in selected geographic regions or application end markets. In recent years, substantial investments have been made by others to establish new dedicated foundry companies in mainland China and elsewhere.

Environmental Regulation

     The semiconductor production process generates gaseous chemical wastes, liquid wastes, waste water and other industrial wastes in various stages of the manufacturing process. We have installed various types of pollution control equipment for the treatment of gaseous chemical wastes and liquid wastes and equipment for the recycling of treated water in our fabs. Our operations at our fabs are subject to regulation and periodic monitoring by the ROC Environmental Protection Administration, US Environmental Protection Agency or State Environmental Protection Administration of mainland China, and local environmental protection authorities, including the Science Industrial Park Administration, the Washington State Department of Ecology or the Shanghai Environmental Protection Bureau.

     We have adopted pollution control measures which are expected to result in the effective maintenance of environmental protection standards consistent with the practice of the semiconductor industry in Taiwan, the US and mainland China. We conduct an annual environmental audit to ensure that we are in compliance in all material respects with, and we believe that we are in compliance in all material respects with, applicable environmental laws and regulations. Furthermore, our waste reduction steps fully meet Taiwan regulatory requirements. We received ISO14001 certification in August 1996 and continue to implement improvement programs in connection with this

certification. In January 2000, we received OHSAS18001 certification for our occupational health safety management system. All our manufacturing sites in Taiwan were ISO14001 and OHSAS18001 certified in 2005. Fab 10, our manufacturing site in mainland China, has received ISO 14001 and OHSAS18001 certification in 2005. WaferTech obtained ISO 14001 certification in 2001. While WaferTech has not obtained OHSAS18001 certification, it has applied for the Washington State Voluntary Protection Program in 2005 and is expected to be audited for its membership in June 2006. Membership in the Washington State Voluntary Protection Program represents the official recognition of the State of Washington for outstanding efforts in achieving exemplary occupational safety and health. In 2005, we received the “National Award for Outstanding Achievements in Industrial Waste Disposal and Resources and Recycling” from the ROC EPA and the “Water Conservation Outstanding Performance Award” from the Water Resource Agency. Moreover, WaferTech has been a member of U.S. EPA’s Performance Track Program since 2004. For its past safety performance, WaferTech has received four “Meritorious Achievement” awards from the State of Washington Department of Labor and Industry.

     In 2001, we have expressed our voluntary commitment to reducing perfluorinated compounds (PFCs) emissions to 10% below the average emission value of 1997 and 1999 by 2010, based on the standard set forth in a Memorandum of Understanding by the Taiwan Semiconductor Industrial Association. In our effort to achieve such commitment, the evaluation and implementation of projects including process optimization, chemical replacement and abatement systems have been commenced by us.

Electricity and Water

     We use substantial amounts of electricity supplied by Taiwan Power Company in our manufacturing process. Businesses in the Hsinchu Science Park and Southern Taiwan Science Park, such as ours, enjoy preferential electricity supply. We have sometimes suffered power outages caused by our major electricity supplier, the Taiwan Power Company, which lead to interruptions in our production schedule. For example, on April 10, 2004, a power outage caused by a circuit trip of a high voltage underground cable line of Taiwan Power Company, causing an approximately 0.6 day loss of wafer movement at Fab 8 and Fab 12, and on October 3, 2005, a serious power dip (an abrupt decrease of voltage in power supply) caused by a short-circuit fault of Taiwan Power Company’s Hsinchu Main Station, affected our fabs in Hsinchu Science Park. Similarly, our operation in mainland China may also suffer power outages which could disrupt our operation. For example, our Fab 10 in Shanghai suffered a power outage for about one hour in May 2005 caused by lightning striking in the vicinity of Fab 10.

     The semiconductor manufacturing processes also use extensive amounts of fresh water. Due to the growth of the semiconductor manufacturers in the Hsinchu Science Park and Southern Taiwan Science Park, and the droughts that Taiwan experiences from time to time, there is concern regarding future availability of sufficient fresh water and the potential impact insufficient water supplies may have on our semiconductor production. A recently completed pipeline connecting reservoirs in Tainan with the river in Kaoshiung area has provided additional water supplies to the Southern Taiwan Science Park. Under the government’s current water management policies, we currently expect to have sufficient water supplies for our production. Moreover, a large dam in the Hsinchu area is expected to be in service in late 2006, and should gradually increase the fresh water available in the Hsinchu Science Park until late 2007. We have not experienced any water shortages at Fab 10, our manufacturing site in mainland China, and WaferTech.

Risk Management

     We have emergency plans for the response to natural disaster and other disruptive events that could disrupt the operation of our business, and these emergency plans are developed to prevent or minimize loss of personnel and damage to our facilities, equipment and machinery caused by nature disaster and other disruptive events. We also maintain insurance with respect to our facilities, equipment and inventories. The insurance for the fabs and their equipment covers, subject to some limitations, various risks including fire, typhoon, earthquake and some other risks generally up to the respective policy limits for their replacement values and lost profits due to business interruption. In addition, we have insurance policies covering losses in respect of the construction and erection of Fab 10, Fab 12 and Fab 14. Equipment and inventories in transit are also insured.

ITEM 4A. UNRESOLVED STAFF COMMENTS

     Not applicable.

ITEM 5. OPERATING AND FINANCIAL REVIEWS AND PROSPECTS

Overview

     We manufacture a variety of semiconductors based on designs provided by our customers. We also provide various design services. Our business model is now commonly called a “dedicated semiconductor foundry”. The foundry segment of the semiconductor industry as a whole experienced rapid growth over the last 19 years since our inception. As the leader of the foundry segment of the semiconductor industry, our net sales and net income increased from NT$125,885 million and NT$14,483 million in 2001 to NT$266,565 million (US$8,127 million) and NT$93,575 million (US$2,853 million) in 2005, respectively, despite one major industry downturn over that same period. In 2001, the semiconductor industry experienced a significant downturn due to a slowdown in the global economy, overcapacity in the semiconductor industry and a worldwide semiconductor inventory adjustment that led to decreases in our net sales and net income in 2001. In 2002, the semiconductor industry reported little revenue growth as growth in volume was significantly offset by erosion in average selling prices. Our net sales and net income increased from NT$125,885 million and NT$14,483 million in 2001 to NT$162,301 million and NT$21,610 million in 2002. The recovery of the semiconductor industry combined with a more favorable product mix resulted in an increase of our net sales and net income from NT$162,301 million and NT$21,610 million in 2002 to NT$202,997 million and NT$47,259 million in 2003. Our net sales and net income in 2004 further increased to NT$257,123 million and NT$92,316 million, respectively, primarily as a result of the continued growth of the semiconductor industry combined with a more favorable product mix. The market demand in the semiconductor industry remained strong in 2005 but there was continued price pressure. Our net sales and net income in 2005 were NT$266,565 million (US$8,127 million) and NT$93,575 million (US$2,853 million), respectively.

     The principal source of our revenue is wafer fabrication, which accounted for approximately 90% of our net sales in 2005. The rest of our net sales is derived from design, mask making, probing, and testing and assembly services. Factors that significantly impact our revenue include:

	•		the worldwide demand for semiconductor products;
	•		the worldwide semiconductor production capacity as well as our production capacity;
	•		capacity utilization;
	•		technology migration;
	•		pricing; and
	•		fluctuation in foreign currency exchange rate.

     Production Capacity and Capacity Utilization. One of the key factors influencing our revenue and profit margin is our capacity utilization. Because a high percentage of our cost of sales is of a fixed nature, operations at or near full capacity can have a significant positive effect on profitability. We have expanded our aggregate capacity from approximately 358,044 wafers per month as of year-end 2001 to approximately 555,084 wafers per month as of year-end 2005. Our annual sales volume grew from 2,159,000 200mm equivalent wafers in 2001 to approximately 5,622,000 200mm equivalent wafers in 2005. Our average utilization rate for each quarter of 2005 was 78%, 85%, 96% and 104%, respectively. Our annual utilization rate for 2005 decreased by 8% to 92%, compared to 100% for 2004, primarily due to lower market demands in the first half of 2005 and increased capacity. Starting from the first quarter of 2003, we revised our capacity utilization rate calculation to exclude engineering wafers and Vanguard capacity to reflect our own production capacity and our contractually committed capacity.

     Technology Migration. Since our establishment, we have regularly developed and made available to our customers manufacturing capabilities for wafers with increasingly higher circuit resolutions. Wafers designed with higher circuit resolutions can either yield a greater number of dies per wafer or allow these dies to be able to integrate more functionality and run faster in application. As a consequence, higher circuit resolution wafers generally sell for a higher price than those with lower resolutions. In addition, we began in November 2001 offering

our customers production of 300mm wafers which can produce a greater number of dies than 200mm wafers. Advanced technology wafers have accounted for an increasingly larger portion of our sales since their introduction as the demand for advanced technology wafers has increased. Because of their higher selling price, advanced technology wafers account for a larger pro rata portion of our sales revenue as compared to their pro rata share of unit sales volume. The higher selling prices of semiconductors with higher circuit resolutions usually offset the higher production costs associated with these semiconductors once an appropriate economy of scale is reached. Although mainly dictated by supply and demand, prices for wafers of a given level of technology typically decline over the technology’s life cycle. Therefore, we must continue to offer additional services and to develop and successfully implement increasingly sophisticated technological capabilities to maintain our competitive strength.

     The table below presents a percentage breakdown of wafer sales by circuit resolution during the last three years:

		Year ended December 31,
		2003				2004				2005
		Percentage of total wafer				Percentage of total wafer				Percentage of total wafer
Resolution		revenue(1)				revenue(1)				revenue(1)
£0.13 micron			17	%			28	%			45	%
0.15 micron			20				13				9
0.18 micron			26				27				24
0.25 micron			20				15				10
0.35 micron			9				10				6
>0.5 micron			8				7				6
Total			100	%			100	%			100	%

     Pricing. We usually establish pricing levels for a specific period with our customers, subject to adjustment during the course of that period to take into account market developments and other factors. We believe that our large capacity, flexible manufacturing capabilities, focus on customer service and ability to deliver high yields in a predictable and timely manner have contributed to our ability to obtain premium pricing for our wafer production. Our historical pricing policy is to pass through to our customers a portion of cost savings realized as our production processes migrate to more advanced technologies and our manufacturing operations achieve higher yields and greater economy of scale.

Critical Accounting Policies

     Summarized below are our accounting policies that we believe are both important to the portrayal of our financial results and involve the need for management to make estimates about the effect of matters that are uncertain in nature. Actual results may differ from these estimates, judgments and assumptions. Certain accounting policies are particularly critical because of their significance to our reported financial results and the possibility that future events may differ significantly from the conditions and assumptions underlying the estimates used and judgments made by our management in preparing our financial statements. The following discussion should be read in conjunction with the consolidated financial statements and related notes, which are included in this annual report.

     Revenue recognition. We recognize revenue when evidence of an arrangement exists, the shipment is made, price is fixed or determinable, and the collectibility is reasonably assured. Revenue from the design and manufacturing of photo masks, which are used as manufacturing tools in the fabrication process, is recognized when the photo masks are accepted by our customers. We record a provision for estimated future returns and other allowances in the same period the related revenue is recorded. Provision for estimated sales returns and other allowances is generally made and adjusted at a specific percentage based on historical experience, our management’s judgment, and any known factors that would significantly affect the allowance, and our management periodically reviews the adequacy of the percentage used. However, because of the inherent nature of estimates, actual returns and allowances could be different from our estimates. If the actual returns are greater than our estimated amount, we could be required to record an additional provision, which would have a negative impact on our recorded revenue and gross margin.

     As of December 31, 2003, 2004 and 2005, the amount set aside for sales returns and allowances recorded in the accompanying statements of income was NT$4,252 million, NT$4,650 million and NT$5,806 million (US$177 million), respectively, representing 2.1%, 1.8% and 2.2% of our net sales for the years ended December 31, 2003, 2004 and 2005. In 2002, 2003 and 2004, no additional provisions were recorded subsequent to the year-end because actual returns and allowances did not exceed the estimated amounts. For the year ended December 31, 2005, we also did not have to record any additional provisions as of February 28, 2006.

     Allowances for doubtful accounts. We record provisions for doubtful accounts based on a percentage of accounts receivables due from our customers. We determine this percentage by examining our historical collection experience and current trends in the credit quality of our customers as well as our internal credit policies. If the financial condition of our customers, or economic conditions in general, were to deteriorate, additional allowances may be required in the future and such additional allowances would increase our operating expenses and therefore reduce our operating income and net income.

     As of December 31, 2003, 2004 and 2005, the allowance set aside for doubtful receivables was NT$1,020 million, NT$983 million and NT$981 million (US$30 million), respectively, representing 3.6%, 3.1% and 2.3% of our gross accounts receivables as of those dates. For the years ended December 31, 2003 and 2004, we did not have to record any additional allowances subsequent to year-end. For the year ended December 31, 2005, we also did not have to record any additional allowances as of February 28, 2006.

     Inventory valuation. Inventories are stated at the lower of cost or market value. Market value represents the net realizable value for finished goods and work-in-progress, and replacement costs for raw materials, supplies and spare parts. Due to rapid technology changes, we also evaluate our ending inventory and reduce the carrying value of inventory for estimated obsolescence and unmarketable inventory by an amount that is the difference between the cost of the inventory and the lower of the estimated market value. The estimated market value of the inventory is mainly determined based on assumptions of future demand within a specific time horizon, which is generally 180 days or less. If actual demand and market conditions are less favorable than those projected by management, additional write-downs may be required. If actual demand and market conditions are more favorable than anticipated, inventory previously written down may be sold at a higher price, resulting in lower cost of sales and higher income from operations than expected in that period.

     As of December 31, 2003, 2004 and 2005, we recorded inventory valuation allowances in the aggregate amount of NT$1,364 million, NT$1,578 million and NT$1,686 million (US$51 million), respectively. Our inventory valuation allowances were primarily for estimated scraps and defects. For the years ended December 31, 2003 and 2004, we did not have to record any additional allowances subsequent to year-end. For the year ended December 31, 2005, we also did not have to record any additional allowances as of February 28, 2006.

     Valuation allowance for deferred tax assets. When we have net operating loss carry forwards, investment tax credits or temporary differences in the amount of tax recorded for tax purposes and accounting purposes, we may be able to reduce the amount of tax that we would otherwise be required to pay in future periods. We recognize all existing future tax benefits arising from these tax attributes as deferred tax assets and then establish a valuation allowance equal to the extent, if any, that it is more likely than not that deferred tax assets will not be realized. We record an income tax benefit or expense when there is a net change in our total deferred tax assets and liabilities in a period. The ultimate realization of the deferred tax assets depends upon the generation of future taxable income during the periods in which the net operating losses and temporary differences become deductible or the investment tax credits may be utilized. Specifically, our valuation allowances are impacted by our expected future revenue growth and profitability, tax holidays, and the amount of tax credits that can be utilized within the statutory period. In determining the amount of valuation allowance for deferred tax assets as of December 31, 2005, we considered past performance, the general outlook of the semiconductor industry, future taxable income and prudent and feasible tax planning strategies.

     Because the determination of the amount of valuation allowance is based, in part, on our forecast of future profitability, it is inherently uncertain and subjective. Changes in market conditions and our assumptions may cause the actual future profitability to differ materially from our current expectation, which may require us to increase or decrease the amount of valuation allowance that we have recorded. Because our expectation for future profitability is generally less during periods of reduced revenue, we will be more likely to provide significant valuation allowances with respect to deferred tax assets during those periods of already reduced income.

     As of December 31, 2003, 2004 and 2005, the ending balance for valuation allowances under ROC GAAP were NT$15,957 million, NT$14,611 million and NT$11,191 million (US$341 million), respectively, representing 62.7%, 58.0% and 44.5% of net deferred tax assets as of those dates.

     Valuation of long-lived assets and intangible assets. We assess the impairment of long-lived assets and intangible assets whenever triggering or changes in circumstances indicate that the asset may be impaired and carrying value may not be recoverable. Our long-lived assets subject to this evaluation include property, plant and equipment and amortizable intangible assets. Factors we consider important which could trigger an impairment review include, but are not limited to, the following:

	•		significant under performance relative to historical or projected future operating results;
	•		significant changes in the manner of our use of the acquired assets or our overall business strategy; and
	•		significant unfavorable industry or economic trends.

     When we determine that the carrying value of intangible assets and other long-lived assets may not be recoverable based upon the existence of one or more of the above indicators of impairment, we measure any impairment for long-lived assets based on a projected future cash flow. If the long-lived or intangible assets that are determined to be impaired are to be held and used, we recognize an impairment loss through a charge to our operating results to the extent the present value of discounted cash flows attributable to the assets are less than their carrying value. We also perform periodic review to identify the assets that are no longer used and are not expected to be used in future periods. An impairment charge is recorded to the extent, if any, that the carrying amount of the idle assets exceeds their fair value. Under ROC GAAP, if the recoverable amount increases in a future period, the amount previously recognized as impairment will be reversed and recognized as a gain. However, the adjusted amount may not exceed the carrying amount that would have been determined, net of depreciation, as if no impairment loss had been recognized.

     The process of evaluating the potential impairment of long-lived assets requires significant judgment. We are required to review for impairment groups of assets related to the lowest level of identifiable independent cash flows. Due to our asset usage model and the interchangeable nature of our semiconductor manufacturing capacity, we must make subjective judgments in determining the independent cash flows that can be related to specific asset groups. In addition, because we must make subjective judgments regarding the remaining useful lives of assets and the expected future revenue and expenses associated with the assets, changes in these estimates based on changed economic conditions or business strategies could result in material impairment charges in future periods. Our projection for future cash flow is generally less during periods of reduced earnings. As a result, an impairment charge is more likely to occur during a period when our operating results are already otherwise depressed.

     Under ROC GAAP, for purposes of evaluating the recoverability of long-lived assets, assets purchased for use in the business but subsequently determined to have no future economic benefits are written down to their fair value and recorded as either idle assets or assets held for disposition. However, prior to 2005 ROC GAAP did not provide guidelines for impairment of assets that could still be used in the business. Therefore prior to 2005, long-lived assets that could still be used in the business and were impaired under US GAAP continued to be depreciated for ROC GAAP purposes. In 2000, WaferTech recorded approximately US$ 330 million as impairment under US GAAP. No additional impairment was recorded since then, as the amount of impairment determined based on discounted cash flow or comparable market prices higher than the carrying value of the long-lived assets.

     Net long-lived assets and intangible assets amounted to NT$251,830 million (US$7,678 million) under ROC GAAP as of December 31, 2005.

     Goodwill. Goodwill is recorded when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. Under US GAAP, and effective on January 1, 2005 under ROC GAAP, we assess the impairment of goodwill on an annual basis, or more frequently whenever triggering events or changes in circumstances indicate that goodwill may be impaired and carrying value may not be recoverable. Moreover, effective on January 1, 2006, goodwill is no longer amortizable under ROC GAAP. Factors we consider important which could trigger an impairment review include, without limitation, the following:

	•		significant decline in our stock price for a sustained period; and
	•		significant decline in our market capitalization relative to net book value.

     Application of the goodwill impairment test is also highly subjective and requires significant judgment, including the identification of reporting units, assigning assets and liabilities to the relevant reporting unit, assigning goodwill to the relevant reporting unit, and determining the fair value of the relevant reporting unit. We have identified that we have only one reporting unit. The fair value of the reporting unit is compared to the associated carrying value including goodwill.

     Goodwill recorded from the acquisition of TSMC-Acer and WaferTech are evaluated for impairment under one reporting unit on an annual basis. Based on our most recent evaluation, the fair value calculated by using the market capitalization method was higher than the associated carrying value. As a result, we did not record any impairment charge.

     Goodwill amounted to NT$ 6,011million (US$183 million) under ROC GAAP as of December 31, 2005.

     Accounting for investments in private and publicly-traded securities. We hold equity interests in companies, some of which are publicly traded and have highly volatile share prices. We review all of our investments for impairment quarterly and record an impairment charge when we believe an investment has experienced an other-than-temporary decline in value. Determining whether an other-than-temporary decline in value of the investment has occurred is highly subjective. Such evaluation is dependent on the specific facts and circumstances. Factors we consider include, but are not limited to, the following: the market value of the security in relation to its cost basis, the duration of the decline in value, the financial condition of the investees, and our intent and ability to retain the investment for a sufficient period of time to allow for recovery in the market value of the investment. Impairment reviews with respect to private equity investments also require significant judgments. Factors indicative of an other-than-temporary decline in value include recurring operating losses, credit defaults and subsequent rounds of financings at valuation below the cost basis of the investment.

     We have experienced significant declines in the value of certain privately held investments and recorded impairment loss of NT$653 million, NT$351 million and NT$129 million (US$4 million) in 2003, 2004 and 2005, respectively. While we have recognized all declines that are currently believed to be other-than-temporary as a charge to income, adverse changes in market conditions or poor operating results of underlying investments could result in further losses in future periods.

Results of Operations

     The following table sets forth, for the periods indicated, certain financial data from our consolidated statements of income, expressed in each case as a percentage of net sales:

		For the year ended December 31,
		2003				2004				2005
Net sales			100.0	%			100.0	%			100	%
Cost of sales			(63.1	)			(55.0	)			(55.7	)
Gross profit			36.9				45.0				44.3
Operating expenses
General and administrative			(4.0	)			(4.4	)			(3.4	)
Sales and marketing			(1.3	)			(1.3	)			(1.6	)
Research and development			(6.3	)			(4.9	)			(5.3	)
Total operating expenses			(11.6	)			(10.6	)			(10.3	)
Income from operations			25.3				34.4				34.0
Non-operating income and gains			2.8				2.4				2.7
Non-operating expenses and losses			(2.9	)			(1.0	)			(1.4	)
Income before income tax and minority interest			25.2				35.8				35.3
Income tax (expense) benefit			(1.9	)			0.1				(0.2	)
Income before minority interest			23.3				35.9				35.1
Minority interest in loss (income) of subsidiaries			0.0				0.0				0.0
Net income			23.3	%			35.9	%			35.1	%

Year to Year Comparisons

     Net Sales and Gross Margin

		For the Year Ended December 31,
										%												%
										Change												Change
		2003				2004				from 2003				2005								from 2004
		NT$				NT$								NT$				US$
		(in millions)												(in millions)
Net sales			202,997				257,213				26.7	%			266,565				8,127				3.6	%
Cost of sales			(128,113	)			(141,394	)			10.4	%			(148,362	)			(4,523	)			4.9	%
Gross profit			74,884				115,819				54.7	%			118,203				3,604				2.1	%
Gross margin percentage			36.9	%			45.0	%			—				44.3	%			44.3	%			—

     Net Sales

     Our net sales in 2005 increased by 3.6% from 2004. The increase in our net sales in 2005 was largely attributable to an increase in customer demand, which resulted in a 12.3% increase in wafer shipment in 2005, from 5,007 thousand 200mm equivalent wafers in 2004 to 5,622 thousand 200mm equivalent wafers in 2005. The increase in sales volume was partially offset by a 4% decrease in the average selling price of our wafers in US dollar terms in 2005. The decrease in the average selling price of our wafers in US dollar terms was primarily the result of a decline in pricing for the same product or technology, partially offset by a more favorable product mix as we saw a shift in product mix toward higher priced products using more advanced technologies. Our sales in 2005 were also negatively impacted by a stronger NT dollar against US dollar, 4%, as the majority of our sales are denominated in US dollars. Our notes and accounts receivable were NT$43,082 million as of December 31, 2005, an increase of 38% from NT$31,214 million as of December 31, 2004 reflecting a significant increase in net sales in the last two months of 2005 as compared to the same period in 2004.

     Our net sales in 2004 increased by 26.7% from 2003. The significant increase in our net sales in 2004 was largely attributable to an increase in customer demand, which resulted in a 35.3% increase in wafer shipment in 2004, from 3,700 thousand 200mm equivalent wafers in 2003 to 5,007 thousand 200mm equivalent wafers in 2004. The increase in sales volume was partially offset by a 3% decrease in the average selling price of our wafers in US dollar terms in 2004 compared to 2003. The decrease in the average selling price of our wafers in US dollar terms was primarily the result of a decline in pricing for the same product or technology, partially offset by a more favorable product mix as we saw a shift in product mix toward higher priced products using more advanced technologies. Our sales in both 2004 and 2003 were negatively impacted by a stronger NT dollar against US dollar as the majority of our sales are denominated in US dollars.

     Gross Margin

     Our gross margin fluctuates, depending on the level of capacity utilization, wafer shipments and product mix, among other factors. Our gross margin declined to 44.3% of net sales in 2005 from 45.0% of net sales in 2004. The lower margin in 2005 was primarily driven by lower capacity utilization, resulting primarily from lower market demands in the first half of 2005 and increased capacity, which reduced the gross margin in 2005 by 3.6%. Capacity utilization rate decreased from 100% in 2004 to 92% in 2005. Higher wafer shipment, the improvement in overall product mix, and favorable cost reduction by 7.7% were offset by the unfavorable impact on gross margin of price declines by 3.4%, stronger NT dollar against US dollar by 1.8%, higher fixed manufacturing costs, and to a lesser extent increased material and labor costs typically required during early stages for the manufacturing of advanced semiconductors. Depreciation and amortization expenses related to cost of sales increased from NT$64,201 million

in 2004 to NT$70,847 million (US$2,160 million) in 2005. The increase in depreciation and amortization expenses in 2005 reflects our capital investment in order to ramp up Fab 12 (Phase II) and Fab 14 (Phase I). We anticipate our depreciation and amortization expenses related to cost of sales for 2006 to remain at the same level as 2005 as a result of the benefits received from the reduced depreciation of facilities and equipment in 200mm fabs, the effect of which we expect will offset the depreciation and amortization for ongoing additional capital expenditures.

     Our gross margin improved to 45.0% of net sales in 2004 from 36.9% of net sales in 2003. The improved margin was primarily driven by higher capacity utilization, as we saw our capacity utilization increase from 89% in 2003 to 100% in 2004. Higher wafer shipment and the improvement in overall product mix during 2004 also offset the unfavorable impact on gross margin of price declines and higher fixed manufacturing costs, and to a lesser extent increased technology, material and labor costs typically required during early stages for the manufacturing of advanced semiconductors. Depreciation and amortization expenses related to cost of sales increased from NT$63,374 million in 2003 to NT$64,201 million in 2004. The increase in depreciation and amortization expenses in 2004 primarily reflects our capital investment in order to ramp up Fab 12 (Phase I) and Fab 14 (Phase I).

     Operating Expenses

		For the Year Ended December 31
										% Change												% Change
		2003				2004				from 2003				2005								from 2004
		NT$				NT$								NT$				US$
		(in millions)												(in millions)
Research and development			12,713				12,516				(1.5	)%			14,017				427				12.0	%
General and administrative			8,200				11,454				39.7	%			9,085				277				(20.7	)%
Sales and marketing			2,670				3,367				26.1	%			4,132				126				22.7	%
Total operating expenses			23,583				27,337				15.9	%			27,234				830				(0.4	)%
Percentage of net sales			11.6	%			10.6	%			—				10.3	%			10.3	%			—
Income from operations			51,301				88,482				72.5	%			90,969				2,773				2.81	%
Operating Margin			25.3	%			34.4	%			—				34.0	%			34.0	%			—

     Operating expenses decreased by NT$103 million in 2005, or 0.4%, from 2004, after an increase in operating expenses of NT$3,754 million in 2004, or 15.9%, from 2003.

     Research and Development Expenses

     We remain committed to being the leader in developing advanced process technology. We believe that continued investments in process technologies are essential for us to remain competitive in the markets we serve. Research and development expenditures increased by NT$1,501 million in 2005, or 12.0%, from 2004. Research and development expenses were higher in 2005 than in 2004 primarily due to the increase in expenses relating to development activities in 65, and 80/90 nanometer technologies in 2005 as compared to 2004. We plan to continue to invest significant amounts in research and development expenses in 2006.

     Research and development expenditures decreased by NT$197 million in 2004, or 1.5%, from 2003. The decrease in research and development expenses in 2004 was primarily due to the decrease in expenses related to development activities in 0.11 micron and 90 nanometer technologies in 2004 in comparison to 2003 as these technologies had become more mature in 2004. The decrease in research and development expenses in 2004 was partially offset by an increase in research and development expenditures in connection with our development activities in 65 nanometer technologies.

     General and Administrative, Sales and Marketing Expenses

     General and administrative, sales and marketing expenses decreased by NT$1,604 million in 2005, or 10.8%, from 2004. The decrease was primarily due to the opening expenses incurred in 2004 for Fab 12 (Phase II) and Fab 14 (Phase I). As a result, the operating expenses associated with Fab 12 (Phase II) and Fab 14 (Phase I) ceased to be accounted for as general and administrative expenses in 2005. The operating margin in 2005 was 34.0%, slightly lower than 34.4% in 2004.

     General and administrative, sales and marketing expenses increased NT$3,951 million in 2004, or 36.3%, from 2003. This increase was primarily due to Fab 14 (Phase I) opening expenses and increased marketing expenses associated with increased business activities. The operating margin increased from 25.3% in 2003 to 34.4% in 2004.

     Non-Operating Income and Expenses

		For the Year Ended December 31
										% Change												% Change
		2003				2004				from 2003				2005								from 2004
		NT$				NT$								NT$				US$
		(in millions)												(in millions)
Non-operating income and gains			5,669				6,016				6.1	%			7,068				215				17.5	%
Non-operating expenses and losses			(5,791	)			(2,532	)			(56.3	)%			(3,773	)			(115	)			49.0	%
Net non-operating income (expenses)			(122	)			3,484				—	(1)			3,295				100				(5.4	)%

     Non-operating income and gains increased by NT$1,052 million in 2005, or 17.5%, from 2004. The increase was primarily due to a NT$1,286 million increase in interest income, settlement payments from Semiconductor Manufacturing International Corporation (“SMIC”) of NT$965 million, and subsidy income of approximately NT$322 million, partially offset by a NT$661 million decrease in net investment income recognized under equity method and a NT$915 million decrease in the net gain realized on sales of investments. The increase in interest income in 2005 was primarily the result of higher interest rate on interest bearing treasury assets and higher level of cash holding.

     Non-operating income and gains increased by NT$347 million in 2004, or 6.1%, from 2003. This increase was primarily attributable to a NT$2,094 million increase in net investment income recognized under equity method as a result of improved operating results of our unconsolidated affiliates, and a NT$896 million increase in interest income reflecting the addition of a significant amount of interest bearing instruments to our investment portfolio, partially offset by a NT$2,624 million decrease in the net gain realized on sales of investments.

     Non-operating expenses and losses increased by NT$1,241 million in 2005, or 49.0%, from 2004. This increase was primarily due to a NT$1,208 million increase in interest expense associated with our hedging activities. Even though our hedging activities were in line with past practice, interest expense resulting from such hedging activities increased in 2005 primarily due to a wider spread of applicable interest rates between US dollar and NT dollar.

     Non-operating expenses and losses decreased NT$3,259 million in 2004, or 56.3%, from 2003. This decrease was primarily attributable to a NT$1,506 million decrease in write-off of certain fixed and idle assets and related expenses, a NT$373 million decrease in foreign exchange loss as a result of the selection of appropriate hedging instruments with lower hedging cost, and a NT$437 million decrease in interest expense as a result of reduced borrowings.

     Income Tax Benefit (Expense)

		For the Year Ended December 31
										% Change												% Change
		2003				2004				from 2003				2005								from 2004
		NT$				NT$								NT$				US$
		(in millions)												(in millions)
Income tax benefit (expense)			(3,923	)			363				—	(1)			(631	)			(19	)			—	(1)
Net income			47,259				92,316				95.3	%			93,575				2,853				1.4	%
Net margin			23.3	%			35.9	%			—				35.1	%			35.1	%			—

     In 2005, we incurred income tax expenses of approximately NT$631 million, compared to an income tax benefit of NT$363 million in 2004. The increase in income tax expenses resulted from a higher taxable income and an increase in our effective tax rate because some of our fabs have ceased to enjoy their tax exemption period. See “— Taxation” below for a further discussion. In 2006, due to the combined effects of an expected increase in taxable income, an anticipated decrease in tax credits and the expiration of the tax exemption period for some of our 200mm fabs in 2006, we expect the amount of income tax expense for 2006 will be significantly higher than that in 2005.

Liquidity and Capital Resources

     Our cash, cash equivalents and short-term investments amounted to NT$143,883 million (US$4,387 million) as of December 31, 2005, up from NT$128,410 million as of December 31, 2004. Our short-term investments primarily consist of agency bonds, corporate bonds, corporate issued asset-backed securities, bond funds, government bonds and a variety of money market funds. Cash and cash equivalents increased by NT$22,181 million in 2005, or 29.9%, from 2004 as compared to a decrease of NT$28,687 million in 2004, or 27.9%, from 2003.

		For the year ended December 31,
		2003				2004				2005
		NT$				NT$				NT$				US$
		(in millions)								(in millions)
Net cash provided by operating activities			116,037				153,151				157,013				4,787
Net cash used in investing activities			(53,702	)			(147,987	)			(77,440	)			(2,361	)
Net cash used in financing activities			(27,073	)			(32,181	)			(57,969	)			(1,767	)
Net increase/(decrease) in cash			35,199				(28,687	)			22,181				676

     Operating Activities

     In 2005, we generated NT$157,013 million (US$4,787 million) net cash from operating activities, as compared to NT$153,151 million in 2004. The increase in net cash from operating activities was primarily the result of net income of NT$93,575 million (US$2,853 million) in 2005 and of NT$92,316 in 2004, and depreciation and amortization of NT$75,649 million (US$2,306 million) and of NT$69,819 million in 2005 and 2004, respectively.

     In 2004, we generated NT$153,151 million net cash from operating activities, as compared to NT$116,037 million in 2003. The increase in net cash from operating activities was primarily the result of net income of NT$92,316 million in 2004 and of NT$47,259 million in 2003, and depreciation and amortization of NT$69,819 million and NT$69,161 million in 2004 and 2003, respectively.

     In 2005, depreciation and amortization expenses were NT$75,649 million (US$2,306 million), as compared to NT$69,819 million in 2004. The increase in depreciation and amortization expenses was primarily due to continuously increased depreciation associated with ramping up Fab 12 (Phase II) and Fab 14 (Phase I). We expect depreciation and amortization expenses to remain at approximately the same level in 2006, as compared with that in 2005, as we continue to ramp up capacity at Fab 12 and Fab 14, which will be partially offset by the benefits received from the reduced depreciation of our 200mm fabs.

     In 2004, depreciation and amortization expenses were NT$69,819 million, compared to NT$69,161 million in 2003. The increase in depreciation and amortization expenses in 2004 compared to 2003 was primarily due to increased depreciation associated with ramping up Fab 12 (Phase I) and Fab 14 (Phase I).

     Investing Activities

     In 2005, net cash used in investing activities was NT$77,440 million (US$2,361million), a decrease from NT$147,987 million in 2004. The decrease in net cash used in investing activities in 2005 was the result of more cash received from disposal of short-term and long-term investment in financial instruments and less spending on capital expenditures. Capital expenditures in 2005 related primarily to:

	•		ramping up production at Fab 12 (Phase II) and Fab 14 (Phases I);
	•		capacity expansion for mask operations;
	•		developing process technologies such as sub-65 and 80/90nm nodes; and
	•		other research and development projects.

     Net cash used in investing activities amounted to NT$147,987 million in 2004, a significant increase from NT$53,702 million in 2003. The primary cash usage for investing activities for 2003 and 2004 was for capital equipment purchases, which totaled NT$37,871 million and NT$81,095 million, respectively.

     We currently expect capital expenditures to be approximately US$2,600 million to US$2,800 million in 2006. We expect this amount to be spent primarily on process technologies such as sub-45 and 65nm nodes, ramping up Fab 12 (Phases II and III) and Fab 14 (Phase I) and commencing production at Fab 14 (Phase II), capacity expansion for mask operation, and other research and development projects. See “Item 4. Information on the Company — Capacity Expansion and Technology Upgrade Plans” for a discussion of our capacity expansion and capital expenditures.

     Financing Activities

     In 2005, net cash used in financing activities was NT$57,969 million (US$ 1,767 million), as compared to NT$32,181 million in 2004. The net cash used in financing activities in 2005 primarily reflects payments of cash dividends on our common stock of NT$46,420 million (US$1,415 million), payments of employee bonus of NT$3,086 million (US$94 million) and repayments of long-term bank loans and corporate bonds in amounts of NT$1,337 million (US$41 million) and NT$10,500 million (US$320 million).

     In 2004, net cash used in financing activities was NT$32,181 million, as compared to NT$27,073 million in 2003. The net cash used in financing activities in 2004 primarily reflects payments of cash dividends on our common stock of NT$12,137 million, repurchase of shares of NT$7,060 million, and repayments of NT$6,656 million in long-term bank loans and NT$5,000 million in corporate bonds. The net cash used in financing activities in 2003 primarily reflects payments for the redemption of preferred stock of NT$13,000 million and repayments of long-term bank loans and corporate bonds in the amounts of NT$8,916 million and NT$4,000 million, respectively.

     As of December 31, 2005, we had aggregate short-term debt of NT$329 million (US$10 million), current portion of long-term debt of NT$5 million (US$168 thousand) and aggregate long-term debt of NT$20,163 million (US$615 million). NT$329 million (US$10 million) of the short-term debt and NT$657 million (US$20 million) of the long-term debt were denominated in U.S. dollars. To protect against reductions in value and the volatility of asset value caused by changes in foreign exchange rates, we utilize derivative financial instruments, including currency forward contracts and cross currency swaps, to hedge our currency exposure. See “Item 11. Quantitative and Qualitative Disclosure About Market Risk” for a discussion of the hedging instruments we use. All of the short-term and NT$657 million of the long-term bank loans had floating interest rates based on the London interbank offer rate, or LIBOR. NT$19,500 million of the long-term bonds had fixed interest rates ranging from 2.60% to 5.36%. As of December 31, 2005, we had an aggregate of approximately NT$24,000 million (US$732 million) in unused short-term credit lines and an aggregate of approximately NT6,232 million (US$190 million) in unused long-term credit lines.

     Our loan agreements, credit facilities and guaranty agreements for the obligations of our consolidated subsidiaries contain covenants which, if violated, could result in our obligations under these agreements becoming

due prior to the originally scheduled maturity dates. As of February 28, 2006, we were in compliance with our financial covenants.

     Cash Requirements

     The following table sets forth the maturity of our long-term debt (bank loans and bonds) and short-term debt (bank loans) outstanding as of December 31, 2005:

		Long-term debt				Short-term debt
		(in millions)
		NT$				NT$
During 2006			5				329
During 2007			7,004				—
During 2008			133				—
During 2009			8,263				—
During 2010 and thereafter			4,763				—

     The following table sets forth information on our material contractually obligated payments for the periods indicated as of December 31, 2005:

		Payments Due by Period
						Less than												More than
Contractual Obligations		Total				1 Year				1-3 Years				4-5 Years				5 Years
		(in NT$ millions)
Long-Term Debt(1)			20,168				5				15,400				263				4,500
Capital Lease Obligations(2)			598				—				—				—				598
Operating Leases(3)			2,802				371				1,034				440				957
Other Payments(4)			2,384				873				985				526				—
Capital Purchase or other Purchase Obligations(5)			10,957				10,902				55				—				—
Total Contractual Cash Obligations(6)			36,909				12,151				17,474				1,229				6,055

     During 2005, we entered into derivative financial instruments transactions to manage exposures related to foreign-currency denominated receivables or payables. As of December 31, 2005, our cash requirements in 2006 for outstanding forward exchange contracts and cross currency swaps contracts were approximately US$2,149 million, with our expected cash receipts of approximately NT$71,821 million. See “Item 11. Quantitative and Qualitative Disclosures about Market Risk” for more information regarding our derivative financial instruments transactions. See also note 2 to the consolidated financial statements for our accounting policy of derivative financial instruments and note 25 to the consolidated financial statements for additional details regarding our derivative financial instruments transactions.

     We do not generally provide letters of credit to, or guarantees for, or engage in any repurchase financing transactions with, any entity other than our consolidated subsidiaries.

     We require significant amounts of capital to build, expand, upgrade and maintain our production facilities and equipment. We made capital expenditures of NT$37,871 million, NT$81,095 million and NT$ 79,879 million (US$2,435 million) in 2003, 2004 and 2005, respectively. We currently expect that our plans for the development

of process technologies such as sub-45 and 65nm nodes and ramping up production at Fab 12 and 14 and other research and development projects will require capital expenditures in 2006 of approximately US$2,600 million to US$2,800 million.

     We expect to fund our expansion projects and other cash requirements primarily with internally generated funds. In the future, we may consider debt and equity financing, depending on market conditions, our financial performance and other relevant factors. In particular, an extended industry downturn could adversely affect our profitability and internal generation of cash, and thereby increase our reliance on external sources of funds. We believe that our working capital, cash flow from operations and unused lines of short-term credit will provide sufficient resources to meet our planned capital requirements.

US GAAP Reconciliation

     Our consolidated financial statements are prepared in accordance with ROC GAAP, which differs in certain material aspects from US GAAP. The following table sets forth a comparison of our net income and shareholders’ equity in accordance with ROC GAAP and US GAAP for the periods indicated:

		Year ended and as of December 31,
		2003				2004				2005				2005
		NT$				NT$				NT$				US$
						(in NT$ millions)
Net income in accordance with:
ROC GAAP			47,259				92,316				93,575				2,853
US GAAP			38,661				76,253				75,418				2,299
Shareholders’ equity in accordance with:
ROC GAAP			329,303				399,041				446,239				13,605
US GAAP			357,173				427,125				477,297				14,552