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, 2006

OR

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 SECURITEIS EXCHANGE ACT OF 1934

(Exact Name of Registrant as Specified in Its Charter)

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, 2006, 25,829,687,846 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 17 o 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
PART I			2
Item 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS			2
Item 2. OFFER STATISTICS AND EXPECTED TIMETABLE			2
Item 3. KEY INFORMATION			2
Item 4. INFORMATION ON THE COMPANY			12
Item 4A. UNRESOLVED STAFF COMMENTS			21
Item 5. OPERATING AND FINANCIAL REVIEWS AND PROSPECTS			21
Item 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES			36
Item 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS			44
Item 8. FINANCIAL INFORMATION			47
Item 9. THE OFFER AND LISTING			49
Item 10. ADDITIONAL INFORMATION			50
Item 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			63
Item 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES			65
Item 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES			65
Item 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS			65
Item 15. CONTROLS AND PROCEDURES			65
Item 16A. AUDIT COMMITTEE FINANCIAL EXPERT			67
Item 16B. CODE OF ETHICS			67
Item 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES			67
Item 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES			68
Item 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS			68
Item 17. FINANCIAL STATEMENTS			68
Item 18. FINANCIAL STATEMENTS			68
Item 19. EXHIBITS			69
EX-1.1 ARTICLES OF INCORPORATION
EX-8.1 MANUFACTURING SUBSIDIARIES OF REGISTRANT
EX-12.1 CEO CERTIFICATION
EX-12.2 CFO CERTIFICATION
EX-13.1 CEO CERTIFICATION PURSUANT TO 18 USC & 1350
EX-13.2 CFO CERTIFICATION PURSUANT TO 18 USC & 1350
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 differ materially from those indicated by our forward-looking statements.

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, 2004, 2005 and 2006, and the selected balance sheet data as of December 31, 2005 and 2006, 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, 2002 and 2003 and the selected balance sheet data as of December 31, 2002, 2003 and 2004, 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 “R.O.C. GAAP”) in the Republic of China (“R.O.C.” or “Taiwan”), which differ in some material respects from accounting principles generally accepted in the United States of America (“U.S. GAAP”) as further explained under note 30 to our consolidated financial statements included herein.

		Year ended and as of December 31,
		2002				2003				2004				2005				2006				2006
		NT$				NT$				NT$				NT$				NT$				US$
		(in millions, except for percentages,
		earnings per share and per ADS, and operating data)
Income Statement Data:
R.O.C. GAAP
Net sales			162,301				202,997				257,213				266,565				317,407				9,739
Cost of sales			(109,988	)			(128,113	)			(141,394	)			(148,362	)			(161,597	)			(4,958	)
Gross profit			52,313				74,884				115,819				118,203				155,810				4,781
Operating expenses			(20,724	)			(23,583	)			(27,337	)			(27,234	)			(28,545	)			(876	)
Income from operations			31,589				51,301				88,482				90,969				127,265				3,905
Non-operating income and gains(1)			2,350				5,669				8,581				9,399				9,705				298
Non-operating expenses and losses(1)			(6,717	)			(5,791	)			(5,097	)			(6,105	)			(3,608	)			(111	)
Income before income tax and minority interest			27,222				51,179				91,966				94,263				133,362				4,092
Income tax benefit (expense)			(5,637	)			(3,923	)			363				(630	)			(7,774	)			(238	)
Income before cumulative effect of changes in accounting principles			21,585				47,256				92,329				93,633				125,588				3,854
Cumulative effect of changes in accounting principles			—				—				—				—				1,607				49
Income before minority interest			21,585				47,256				92,329				93,633				127,195				3,903
Minority interest in loss (income) of subsidiaries			25				3				(13	)			(58	)			(185	)			(6	)
Net income attributable to shareholders of the parent			21,610				47,259				92,316				93,575				127,010				3,897
Basic earnings per share(2)			0.82				1.82				3.58				3.63				4.93				0.15
Diluted earnings per share(2)			0.82				1.82				3.58				3.63				4.92				0.15
Basic earnings per ADS equivalent(2)			4.09				9.09				17.89				18.16				24.63				0.76

		Year ended and as of December 31,
		2002				2003				2004				2005				2006				2006
		NT$				NT$				NT$				NT$				NT$				US$
		(in millions, except for percentages,
		earnings per share and per ADS, and operating data)
Diluted earnings per ADS equivalent(2)			4.09				9.09				17.88				18.15				24.60				0.75
Basic weighted average shares outstanding(2)			25,880				25,883				25,804				25,763				25,789				25,789
Diluted weighted average shares outstanding(2)			25,880				25,893				25,810				25,776				25,813				25,813
U.S. GAAP
Net sales			162,990				203,600				260,035				267,028				317,979				9,757
Cost of sales			(115,374	)			(133,493	)			(154,785	)			(161,808	)			(179,175	)			(5,498	)
Operating expenses(3)			(21,154	)			(27,369	)			(32,191	)			(32,764	)			(37,050	)			(1,137	)
Income from operations			26,462				42,738				73,059				72,456				101,754				3,122
Income before income tax and minority interest			20,210				42,441				76,838				75,983				106,647				3,272
Income tax expense			(5,638	)			(3,881	)			(508	)			(483	)			(10,954	)			(336	)
Cumulative effect of changes in accounting principles			—				—				—				—				38				1
Net income			14,534				38,661				76,253				75,418				95,711				2,937
Cumulative preferred dividends			(455	)			(184	)			—				—				—				—
Income attributable to common shareholders			14,079				38,477				76,253				75,418				95,711				2,937
Basic earnings per share(4)			0.57				1.55				3.04				2.98				3.73				0.11
Diluted earnings per share(4)			0.57				1.55				3.04				2.98				3.73				0.11
Basic earnings per ADS equivalent(4)			2.85				7.74				15.22				14.90				18.67				0.57
Diluted earnings per ADS equivalent(4)			2.85				7.74				15.22				14.89				18.66				0.57
Basic weighted average shares outstanding(4)			24,691				24,847				25,044				25,308				25,629				25,629
Diluted weighted average shares outstanding(4)			24,691				24,857				25,050				25,320				25,650				25,650
Balance Sheet Data:
R.O.C. GAAP
Working capital(1) (5)			62,705				136,121				120,574				177,179				213,457				6,550
Long-term investments(1)			10,635				10,748				38,058				42,383				53,895				1,654
Properties			246,498				211,854				258,911				244,823				254,094				7,797
Goodwill			10,159				8,721				7,116				6,011				5,985				184
Total assets			390,542				407,401				499,454				519,510				587,485				18,027
Long term bank borrowing			11,051				8,800				1,915				663				654				20
Long-term bonds payable			35,000				30,000				19,500				19,500				12,500				384
Guaranty deposit-in and other liabilities(5)(6)			8,710				8,876				15,079				17,986				18,333				563
Total liabilities			94,594				78,098				100,413				73,271				78,347				2,404
Capital stock			199,229				202,666				232,520				247,300				258,297				7,926
Cash dividend on common shares			—				—				12,160				46,504				61,825				1,897
Shareholders’ equity attributable to shareholders of the parent			295,853				329,214				398,965				445,631				507,981				15,587
Minority interest in subsidiaries			95				89				76				608				1,157				36
U.S. GAAP
Goodwill			47,476				47,287				46,757				46,993				46,940				1,440
Total assets			420,528				439,853				536,286				558,919				626,108				19,212
Total liabilities			96,747				81,977				108,416				80,962				92,549				2,840
Capital Stock			186,229				202,666				232,520				247,300				258,297				7,926
Mandatory redeemable preferred stock			13,000				—				—				—				—				—
Shareholders’ equity attributable to common shareholders of the parent			310,623				357,173				427,125				477,297				532,403				16,336
Minority interest in subsidiaries			158				703				745				660				1,156				36

		Year ended and as of December 31,
		2002				2003				2004				2005				2006				2006
		NT$				NT$				NT$				NT$				NT$				US$
		(in millions, except for percentages,
		earnings per share and per ADS, and operating data)
Other Financial Data:
R.O.C. GAAP
Gross margin			32	%			37	%			45	%			44	%			49	%			49	%
Operating margin			19	%			25	%			34	%			34	%			40	%			40	%
Net margin			13	%			23	%			36	%			35	%			40	%			40	%
Capital expenditures			55,236				37,871				81,095				79,879				78,737				2,416
Depreciation and amortization			65,001				69,161				69,819				75,649				73,715				2,262
Cash provided by operating activities(1)			98,507				116,037				153,523				157,225				204,997				6,290
Cash used in investing activities(1)(7)			(62,190	)			(53,702	)			(148,359	)			(77,652	)			(119,724	)			(3,674	)
Cash used in financing activities(7)			(6,346	)			(27,073	)			(32,181	)			(57,969	)			(63,783	)			(1,957	)
Net cash inflow (outflow)			30,234				35,199				(28,687	)			22,181				21,353				655
Operating Data:
Wafer (200mm equivalent) shipment(8)			2,675				3,700				5,008				5,622				7,215				7,215
Billing Utilization Rate(9)			69	%			92	%			105	%			94	%			102	%			102	%

Exchange Rates

          We publish our financial statements in New Taiwan dollars, the lawful currency of the R.O.C. 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 29, 2006, which was NT$32.59 to US$1.00 on that date. On April 16, 2007, the noon buying rate was NT$33.15 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
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
2006			32.51				33.31				31.28				32.59
October 2006			33.19				33.31				32.05				33.26
November 2006			32.81				33.16				32.35				32.35
December 2006			32.51				32.74				32.27				32.59
January 2007			32.77				32.99				32.38				32.95
February 2007			32.97				33.08				32.86				32.98
March 2007			33.01				33.13				32.84				33.01
April 2007 (through April 16, 2007)			33.10				33.15				33.05				33.15

          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 periods of downturns and overcapacity, our revenues, earnings and margins may fluctuate significantly.

          The semiconductor market and microelectronics industries have historically been cyclical and subject to significant and often rapid increases and decreases in product demand. Our semiconductor foundry business is affected by market conditions in such 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 periods of downturns and overcapacity. Because our business is, and will continue to be, dependent on the requirements of semiconductor and microelectronics companies for our services, periods of downturns and overcapacity 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 and periods of overcapacity.

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 2006, with the commencement of commercial production at Fab 14 (Phase II) and as a result of our ramping up efforts, the capacity of our 300mm wafer fabs increased from 68,000 wafer per month to 93,700 wafer per month at Fab 12 and Fab 14.

          Although we have studied the potential effects of vibration from the high speed railway passing through the Southern Taiwan Science Park and believe that the vibrations are not affecting our yield rates for production in the Southern Taiwan Science Park, we can give no assurances that our yields will not be negatively affected by the continued operation of the high-speed railway.

          Expansion and modification of our production facilities will, among other factors, increase our costs. For example, 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 flow;
	•		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 and contributions of our executive officers and skilled technical and other personnel. Our business could suffer if we lose, for whatever reasons, the services and contributions 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 recruitment 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 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 R.O.C., 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 the continued strength of our intellectual property portfolio. There can be no assurance that, as our business or business models

expand into new areas, we will be able to independently develop the technology, trade secrets, software or know-how necessary to conduct our business or that we can do so without infringing the intellectual property rights of others. We may have to rely increasingly on licensed technology from others. To the extent that we rely on licenses from others, there can be no assurance that we will be able to obtain all of the licenses we desire in the future on terms we consider reasonable or at all. The lack of necessary licenses could expose us to claims for damages and/or injunctions from third parties, as well as claims for indemnification by our customers in instances where we have contractually agreed to indemnify our customers against damages resulting from infringement claims. 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. While we actively enforce and protect our intellectual property rights, there can be no assurance that our efforts will be adequate to prevent the misappropriation or improper use of the protected technology, trade secret, software or know-how.

     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 R.O.C. GAAP and U.S. 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 R.O.C. GAAP and U.S. 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.

The loss of or significant curtailment of purchases by any of our largest customers could adversely affect our results of operations.

     While we generate revenue from hundreds of customers worldwide, our ten largest customers accounted for 52% and 53% of our net sales in 2005 and 2006, respectively, and our largest two customers accounted for approximately 10% and 8% of our net sales in 2006. The loss of, or significant curtailment of purchases by, one or more of our top customers, including curtailments due to a change in the design or manufacturing sourcing policies or practices of these customers, or the timing of customer or distributor inventory adjustments, may adversely affect our results of operations and financial condition.

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 R.O.C. and U.S. laws and regulations on internal controls. For example, pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, beginning with this Annual Report on Form 20-F for the fiscal year ended 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, R.O.C. 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 R.O.C. 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.

Our global manufacturing, design and sales activities subject us to risks associated with legal, political, economic or other conditions or developments in various jurisdictions, including in particular the Republic of China (“R.O.C.”), which could negatively affect our business and financial status and therefore the market value of your investment.

     Our principal executive officers and our principal production facilities are located in the R.O.C. and a substantial majority of our net revenues are derived from our operations in the R.O.C. In addition, we have operations worldwide and a significant percentage of our revenue come from sales to locations outside the R.O.C. Operating in the R.O.C. and overseas exposes us to changes in policies and laws, as well as the general political and economic conditions, security risks, health conditions and possible disruptions in transportation networks, in the various countries in which we operate, which could result in an adverse effect on our business operations in such countries and our results of operations as well as the market price and the liquidity of our ADSs and common shares.

     For example, past developments in relations between the R.O.C. and the People’s Republic of China (“PRC”) have on occasion depressed the market prices of the securities of Taiwanese companies, including our own. Although the R.O.C. and PRC have co-existed for the past 58 years and significant economic and cultural relations have been established, relations have often been strained and the government of the PRC has announced its intent to use military force to gain control over the R.O.C. if the R.O.C. declares itself independent. In addition, the R.O.C. government currently restricts transfer by Taiwanese companies of certain technologies to and certain types of investments by Taiwanese companies in Mainland China. While the R.O.C. government in April 2002 partially lifted the ban on investment by Taiwan semiconductor manufacturing companies in 200mm wafer fabs in Mainland China and the R.O.C. government has been gradually liberalizing other restrictions, allowing us, for example, to transfer 0.18 micron process technologies to our fab in Mainland China, significant restrictions remain.

Our results of operations could be materially adversely affected by natural disasters or interruptions in the supply of utilities ( such as water or electricity) in the locations in which we, our customers or suppliers operate.

     We have manufacturing and other operations in locations subject to natural disasters such as severe weather and earthquakes as well as interruptions or shortages in the supply of utilities (such as water and electricity) that could disrupt operations. In addition, our suppliers and customers also have operations in such locations. For example, 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, which is susceptible to earthquakes, typhoons, and has experienced droughts from time to time. In addition, 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. A natural disaster or interruptions in the supply of utilities that results in a prolonged disruption to our operations, or the operations of our customers or suppliers, may adversely affect our results of operations and financial condition.

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 in 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.

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 R.O.C. 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 the Republic of China (Taiwan) 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 R.O.C.” and “Item 10. Additional Information — Exchange Controls in the R.O.C.”. 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. The National Development Fund, one of our two largest shareholders, has sold ADSs in several transactions since 1997, including 44,172,500 ADSs in August and September 2005. In May 2005, Philips reiterated its intention, first announced in October 2003, to gradually and orderly reduce its equity interest in us, and sold in August and September 2005 an additional 113,521,000 ADSs. Further, on March 9, 2007, we and Philips jointly announced a multi-phased plan to facilitate an orderly exit by Philips from its current shareholding in us. Specifically, the announced plan contemplates that Philips will divest its current shareholding in us through one or more block trades on the Taiwan Stock Exchange, a public offering of our common shares in the form of ADSs, and through participation in share buy-backs conducted by us in the period beginning in 2007 and ending in 2010. The plan’s initial step occurred on March 12, 2007, when Philips sold approximately US$1.75 billion worth of our common shares over the Taiwan Stock Exchange through block trades to a few institutional investors in Taiwan. As a result of such disposition, Philips owned 12.8% of our outstanding equity securities as of March 12, 2007. Further, the plan’s contemplated second step is a sale in 2007, subject to TSMC’s board approval, receipt of all regulatory approvals and market conditions, by Philips in a public offering registered with the U.S. Securities and Exchange Commission of up to approximately US$2.50 billion worth of our common shares in the form of ADSs. It is the intention of TSMC and Philips that no further ADS offerings will be conducted in respect of Philips’ shareholding in TSMC. In addition, under the plan’s third step, we currently contemplate to conduct in 2007, subject to the approval by our board of directors, a tender offer to repurchase, and subsequently cancel, up to approximately US$1.50 billion worth of our common shares and we currently understand that Philips intends to participate and sell its shares to us in such share repurchase. Lastly, the plan’s fourth step calls for us to conduct, subject to us maintaining our current annual cash dividend per share, additional share repurchase and cancellation programs between 2008 and 2010, in which Philips has informed us that it intends to tender its remaining common shares held in us at such time. In addition, the announced plan contemplates that Philips may also consider to sell its remaining common shares held in us to specified long-term investors mutually agreeable to Philips and us. While we hope to continue to work with Philips to implement the above plan to facilitate the contemplated disposals by Philips of its equity interests in us in a way that minimizes, to the extent possible, any adverse impact on us and the market price of our ADSs and common shares, there is no written agreement between us and Philips in respect of the above plan and no assurances can be given as to the timing and potential impact of the implementation of such plan or any other method of disposal by Philips.

     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 four 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 R.O.C. 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 R.O.C. 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 R.O.C. 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 believe 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 R.O.C. government, Philips and other private investors and were incorporated in the R.O.C. 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 U.S.-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, 2007, we owned an approximately 99.996% equity interest in WaferTech.

     Operations 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 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. On March 20, 2007, the R.O.C. Ministry of Economic Affairs approved our transfer of 0.18 micron process technologies to Mainland China for production. As of February 28, 2007, 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. The SSMC fab commenced production in December 2000. In connection with the sale by Philips in September 2006 of a 80.1% equity interest in its subsidiary Philips Semiconductors International B.V. (“Philips Semiconductors”) to a consortium of private equity investors, we, Philips and Philips Semiconductor, which was subsequently renamed NXP B.V. (“NXP”) entered on September 25, 2006 into an assumption and assignment agreement. Pursuant to such agreement, Philips assigned to NXP all of its rights, and NXP assumed all of Philips’ obligations, under specified agreements, including, among other things, the shareholders agreement relating to SSMC. In November 2006, TSMC and NXP exercised their option rights under the shareholders agreement to purchase all of the SSMC shares owned by EDB Investment Pte. Ltd. As a result, TSMC owned 38.8%, and NXP owned 61.2% of SSMC as of February 28, 2007. While we, together with NXP, have the right to purchase up to 100% of SSMC’s annual capacity, we and NXP 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 SSMC’s annual installed capacity.

Our Principal Office

     Our principal executive office is located at No. 8, Li-Hsin Road 6, Hsinchu Science Park, Hsinchu, 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, embedded memory, BiCMOS mixed-signal and other semiconductors. IC Insights (The McClean Report 2007 Edition) estimates that our revenue market share among dedicated foundries worldwide was 50% in 2005 and 49% in 2006. 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, Broadcom Corporation, Marvell Semiconductor Inc., nVidia Corporation, Qualcomm and VIA Technology, Inc., to integrated device manufacturing companies such as Advanced Micro Devices, Analog Devices, Inc., Freescale Semiconductor Inc., Philips and NXP. Fabless semiconductor companies/systems companies and integrated device manufacturers accounted for approximately 72% and 28%, respectively, of our net sales in 2006.

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 2021. 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 68,000 wafers to 93,700 wafers in 2006. 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. TSMC’s 65-nanometer Nexsys^SM technology is the third-generation TSMC process to employ low-k dielectrics. In 2006, we fully qualified our 65-nanometer process technology and commenced full commercial production.

     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
		Year of				for volume				Monthly capacity(3)(4)
Fab(1)		commencement				production(2)				2002				2003				2004				2005				2006
1(5)			1987				—				—				—				—				—				—
2			1990				0.45				43,540				42,977				47,584				47,584				50,506
3(6)			1995				0.18				71,000				71,600				83,300				83,300				89,900
5			1997				0.15				34,920				37,800				42,500				42,500				51,500
6			2000				0.13				48,700				63,500				73,000				73,000				83,400
7(8)			1995				0.35				22,500				11,800				13,400				13,400				—
8			1998				0.15				52,600				63,500				76,500				76,500				83,500
10			2004				0.25				—				—				500				15,600				32,000
12			2001				0.065				11,475				31,797				60,300				106,875				131,175
14			2004				0.065				—				—				6,750				46,125				79,650
WaferTech			1998				0.15				30,000				30,000				32,500				33,500				35,500
SSMC(7)			2000				0.18				8,000				9,600				13,400				16,700				17,700
Total											322,735				362,574				449,734				555,084				654,831

     As of December 31, 2006, our monthly capacity (in 200mm equivalent wafers) was 654,831wafers, compared to 555,084 wafers at the end of 2005. This increase was primarily due to the expansion of our 0.15/0.18 micron, 90-nanometer and 65-nanometer advanced technologies.

     Our semiconductor manufacturing facilities require substantial investment to construct and are largely fixed-cost assets once they are in operation. Because we own most of our manufacturing capacity, a significant portion of our operating costs is fixed. In general, these costs do not decline when customer demand or our capacity utilization rates drop, and thus declines in customer demand, among other factors, may significantly decrease our margins. Conversely, as product demand rises and factory utilization increases, the fixed costs are spread over increased output, which can improve our margins.

     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.

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 2004, 2005 and 2006 were NT$81,095 million, NT$79,879 million and NT$78,737million (US$2,416 million), respectively. We currently expect our capital expenditures to be approximately US$2,600 million to US$2,800 million in 2007. In 2007, we anticipate capital expenditures to focus primarily on the following:

	•		ramping up production at Fab 12 (Phases II and III), Fab 14 (Phase II) and Fab 10;
	•		capacity expansion for mask operations;
	•		development of process technologies which include 32- and 45-nanometer nodes; and
	•		other research and development projects.

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

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,
		2004								2005								2006
Customer Type		Net Sales				Percentage				Net Sales				Percentage				Net Sales				Percentage
		(in millions, except percentages)
Fabless semiconductor companies/systems companies		NT$176,705					68.7	%		NT$187,662					70.4	%		NT$229,168					72.2	%
Integrated device manufacturers			80,508				31.3	%			78,903				29.6	%			88,239				27.8	%
Total		NT$257,213					100.0	%		NT$266,565					100.0	%		NT$317,407					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,
		2004								2005								2006
Region		Net Sales				Percentage				Net Sales				Percentage				Net Sales				Percentage
		(in millions, except percentages)
North America		NT$191,624					74.5	%		NT$205,255					77.0	%		NT$247,895					78.1	%
Asia			47,584				18.5	%			40,785				15.3	%			43,167				13.6	%
Europe			18,005				7.0	%			20,525				7.7	%			26,345				8.3	%
Total		NT$257,213					100.0	%		NT$266,565					100.0	%		NT$317,407					100.0	%

     A significant portion of our net sales are attributable to a relatively small number of our customers. In 2005 and 2006, our ten largest customers accounted for approximately 52% and 53% of our net sales, respectively, and the two largest customers accounted for 9% and 11% in 2005 and 10% and 8% in 2006.

     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 customer support and/or marketing regions. The office in Hsinchu serves Asian (excluding Japanese and Mainland Chinese) customers. Wholly-owned subsidiaries in the United States, Japan, Shanghai, the Netherlands and South Korea serve North American, Japanese, Mainland Chinese, European and South Korean

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.

     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, 2006, our customers had on deposit an aggregate of approximately US$116 million to reserve future capacity for the years 2007 through 2008.

The Semiconductor Fabrication Process

     The semiconductor manufacturing process begins with a thin silicon wafer on which an array of semiconductor devices is fabricated. The wafer is then tested, cut into chips, and assembled into packages that are then individually retested. Our focus is on wafer fabrication although we also provide all other services either directly or through outsourcing arrangements.

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.

     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. 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/RF 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/RF Semiconductors. Analog/digital semiconductors combine analog and digital devices on a single semiconductor to process both analog and digital data. We make mixed-signal/RF 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/RF semiconductors. The primary uses of mixed-signal/RF 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/RF 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 0.11 and 0.13 micron, respectively.

     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 500V, which are suitable for various panel-size display driver and power IC applications. Applicable voltage range covers up to 40V with Bi CMOS-DMOS structure and extends up to 500V with drain extended HV CMOS structure.

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

		Year ended December 31,
		2004								2005								2006
Semiconductor Type		Net Sales				Percentage				Net Sales				Percentage				Net Sales				Percentage
		(in millions, except percentages)
CMOS
Logic		NT$174,905					68.0	%		NT$199,657					74.9	%		NT$240,278					75.7	%
Memory			22,120				8.6	%			2,133				0.8	%			3,174				1.0	%
Mixed-Signal(1)			50,414				19.6	%			63,442				23.8	%			71,734				22.6	%
BiCMOS(2)			1,029				0.4	%			1,066				0.4	%			1,904				0.6	%
Others			8,745				3.4	%			267				0.1	%			317				0.1	%
Total		NT$257,213					100.0	%		NT$266,565					100.0	%		NT$317,407					100.0	%

      Design and Technology Platforms.

     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 introduction of new technologies to meet customers’ demands and 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$12,516 million, NT$14,017 million and NT$16,076 million (US$493 million) in 2004, 2005 and 2006, respectively, on research and development, which represented 4.9%, 5.3% and 5.1%, respectively, of our net sales for these periods. We plan to continue to invest significant amounts on research and development in 2007, 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, 80-nanometer and 65-nanometer Nexsys^SM technology for volume 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 13.2% of our net sales in 2005 and 12.6% of our net sales in 2006. The three largest components of raw material costs — wafers, gas and chemicals — accounted for 42.2%, 9.4% and 20.5%, respectively, of our raw material costs in 2005 and 42.9%, 9.1% and 19.7%, respectively, of our raw material costs in 2006. 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% and 89.6% of our total wafer needs in 2005 and 2006, respectively. We have in the

past obtained, and believe we will continue to be able to obtain, a sufficient supply of 150mm, 200mm and 300mm 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 2004 and 2005. In 2006, wafer prices increased by approximately 8% and we expect wafer prices to continue to increase in 2007. 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 R.O.C. Environmental Protection Administration, U.S. Environmental Protection Agency or State Environmental Protection Administration of mainland China, and local environmental protection authorities, including the Science 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 U.S. 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 comply with Taiwan regulatory requirements. We received ISO14001 certification in August 1996 and continue to implement improvement programs in connection with this certification. All our manufacturing sites in Taiwan were ISO14001 certified in 2005. Fab 10, our manufacturing site in mainland China, received ISO 14001 certification in 2005. WaferTech obtained ISO 14001 certification in 2001. In 2006, we received the “National Award for Outstanding Achievements in Industrial Waste Disposal and Resources and Recycling”, and “Annual Enterprise Environmental Protection Award” from the Environmental Protection Administration, Executive Yuan, R.O.C., the “Water Conservation Outstanding Performance Award” from the Water Resource Agency, and “National Sustainable Development Award” from National Council for Sustainable Development, Executive Yuan. Moreover, WaferTech has been a member of U.S. EPA’s Performance Track Program since 2004. In 2006, WaferTech applied for and passed the QC080000 IECQ HSPM certification of a Hazardous Substance Process Management site.

          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 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. 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.

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 natural 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 all our fabs. Equipment and inventories in transit are also insured.

ITEM 4A. UNRESOLVED STAFF COMMENTS

None.

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 20 years since our inception. As the leader of the foundry segment of the semiconductor industry, our net sales and net income increased from NT$162,301 million and NT$21,610 million in 2002 to NT$317,407 million (US$9,739 million) and NT$127,010 million (US$3,897 million) in 2006, respectively. In 2002, the semiconductor industry reported little revenue growth as growth in volume was significantly offset by erosion in average selling prices. 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$257,213 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. Our net sales and net income in 2005 continued to grow, but at a lower rate, to NT$266,565 million and NT$93,575 million, respectively, mainly due to an increase in customer demand, partially offset by a decrease in the average selling price of our wafers, and a stronger NT dollar against U.S. dollar. In 2006, our net sales and net income increased to NT$317,407 million (US$9,739 million) and NT$127,010 million (US$3,897 million), respectively, primarily due to a further strengthening of the semiconductor industry and customer demand, partially offset by continued decline in average selling price primarily resulting from pricing pressures in our customers’ end markets and an increase in competition.

          The principal source of our revenue is wafer fabrication, which accounted for approximately 90% of our net sales in 2006. 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.

          Substantial Fixed Costs for Production Capacity. Our semiconductor manufacturing facilities require substantial investment to construct and are largely fixed-cost assets once they are in operation. Because we own most of our manufacturing capacity, a significant portion of our operating costs are fixed. In general, these costs do not decline when customer demand or our capacity utilization rates drop, and thus declines in customer demand, among other factors, may significantly decrease our margins. Conversely, as product demand rises and factory utilization increases, the fixed costs are spread over increased output, which can improve our margins. We have expanded our aggregate capacity from 322,735 wafers per month as of year-end 2002 to 654,831 wafers per month as of year-end 2006. Our annual sales volume grew from approximately 2,675,000 200mm equivalent wafers in 2002 to approximately 7,215,000 200mm equivalent wafers in 2006. In 2006, our operations ran on average at full capacity. However, after reaching a peak in the second quarter of 2006, our capacity utilization rate started to decline and decreased further in the last quarter of 2006 to a level significantly below full capacity due to a decrease in orders resulting from our customers’ inventory correction, which started in the third quarter of 2006 and is currently expected to continue through the first quarter of 2007, and the demand weakness in the consumer, consumption and computer sectors. We currently expect our capacity utilization rate during the first quarter of 2007 to further decline from the fourth quarter of 2006 and to continue to adversely affect our gross margin during such period. We do, however, currently expect overall customer demand to begin to recover by the end of the first quarter of 2007.

          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,
		2004				2005				2006
		Percentage of total wafer				Percentage of total wafer				Percentage of total wafer
Resolution		revenue(1)				revenue(1)				revenue(1)
£0.09 micron			0	%			9	%			23	%
0.13 micron			28	%			36	%			26	%
0.15 micron			13	%			9	%			10	%
0.18 micron			27	%			24	%			22	%
0.25 micron			15	%			10	%			8	%
0.35 micron			10	%			6	%			6	%
³0.5 micron			7	%			6	%			5	%
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, 2004, 2005 and 2006, the amount set aside for sales returns and allowances recorded in the accompanying consolidated statements of income was NT$4,650 million, NT$5,806 million and NT$5,382 million (US$165 million), respectively, representing 1.8%, 2.1% and 1.7% of our gross sales for the years ended December 31, 2004, 2005 and 2006. In 2004 and 2005, no additional provisions were recorded subsequent to the year-end. Subsequent to December 31, 2006, we also did not have to record any additional provisions for 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, 2004, 2005 and 2006, the allowance set aside for doubtful receivables was NT$983 million, NT$981 million and NT$750 million (US$23 million), respectively, representing 3.1%, 2.2% and 2.1% of our gross notes and accounts receivables as of those dates. For the years ended December 31, 2004 and 2005, we did not have to record any additional allowances subsequent to year-end. Subsequent to December 31, 2006, we also did not have to record any additional allowances for 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 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, 2004, 2005 and 2006, we recorded inventory valuation allowances in the aggregate amount of NT$1,578 million, NT$1,686 million and NT$1,005 million (US$31 million), respectively. Our inventory valuation allowances were primarily for estimated scraps and defects. For the years ended December 31, 2004 and 2005, we did not have to record any additional allowances subsequent to year-end. Subsequent to December 31, 2006, we also did not have to record any additional allowances for 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, alternative minimum tax, 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, 2006, 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, 2004, 2005 and 2006, the ending balance for valuation allowances under R.O.C. GAAP were NT$14,611 million, NT$11,191 million and NT$8,127 million (US$249 million), respectively, representing 58.0%, 44.5% and 37.0% 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 events 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 R.O.C. 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 R.O.C. 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, R.O.C. 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 U.S. GAAP continued to be depreciated for R.O.C. GAAP purposes. In 2000, WaferTech recorded approximately US$ 330 million as impairment under U.S. GAAP. No additional impairment was recorded since then, as the value determined based on discounted cash flow or comparable market prices is higher than the carrying value of the long-lived assets.

          As of December 31, 2005 and 2006, net long-lived assets and intangible assets amounted to NT$251,830 and NT$260,031 million (US$7,979 million), respectively, under R.O.C. GAAP.

          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 U.S. GAAP, and effective on January 1, 2005 under R.O.C. 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 R.O.C. 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 cash generating units, assigning assets and liabilities to the relevant cash generating units, assigning goodwill to the relevant cash generating units, and determining the fair value of the relevant cash generating units. Under R.O.C. GAAP, we have identified that we have four cash generating units. The fair value of the four cash generating units is compared to the associated carrying value including goodwill. On the other hand, under U.S. GAAP, 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.

          Under R.O.C. GAAP, goodwill recorded from the acquisition of TSMC-Acer and WaferTech is evaluated for impairment under two cash generating units on an annual basis. Based on our most recent evaluation, the fair value calculated by using projected cash flow in five years was higher than the associated carrying value. As a result, we did not record any impairment charge under R.O.C. GAAP. Under U.S. GAAP, goodwill recorded from the acquisition of TSMC-Acer and WaferTech is 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 also did not record any impairment charge, under U.S. GAAP.

          As of December 31, 2005 and 2006, goodwill amounted to NT$ 6,011 million and NT$ 5,985 million (US$184 million), respectively, under R.O.C. GAAP.

          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$351 million, NT$129 million and NT$280 million (US$9 million) in 2004, 2005 and 2006, 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,
		2004				2005				2006
Net sales			100.0	%			100.0	%			100.0	%
Cost of sales			(55.0	)%			(55.7	)%			(50.9	)%
Gross profit			45.0	%			44.3	%			49.1	%
Operating expenses
General and administrative			(4.4	)%			(3.4	)%			(2.7	)%
Sales and marketing			(1.3	)%			(1.6	)%			(1.2	)%
Research and development			(4.9	)%			(5.3	)%			(5.1	)%
Total operating expenses			(10.6	)%			(10.3	)%			(9.0	)%
Income from operations			34.4	%			34.0	%			40.1	%
Non-operating income and gains			3.4	%			3.5	%			3.0	%
Non-operating expenses and losses			(2.0	)%			(2.2	)%			(1.1	)%
Income before income tax and minority interest			35.8	%			35.3	%			42.0	%
Income tax benefit (expense)			0.1	%			(0.2	)%			(2.4	)%
Income before cumulative effect of changes in accounting principles			35.9	%			35.1	%			39.6	%
Cumulative effect of changes in accounting principles			¾				¾				0.5	%
Income before minority interest			35.9	%			35.1	%			40.1	%
Minority interest in loss (income) of subsidiaries			0.0	%			0.0	%			(0.1	)%
Net income			35.9	%			35.1	%			40.0	%

Year to Year Comparisons

Net Sales and Gross Margin

		For the Year Ended December 31,
										%
										Change												% Change
		2004				2005				from 2004				2006								from 2005
		NT$				NT$								NT$				US$
		(in millions)												(in millions)
Net sales			257,213				266,565				3.6	%			317,407				9,739				19.1	%
Cost of sales			(141,394	)			(148,362	)			4.9	%			(161,597	)			(4,958	)			8.9	%
Gross profit			115,819				118,203				2.1	%			155,810				4,781				31.8	%
Gross margin percentage			45.0	%			44.3	%			—				49.1	%			49.1	%			—

Net Sales

          Our net sales in 2006 increased by 19.1% from 2005. The increase in our net sales in 2006 was largely attributable to a continued increase in customer demand, which resulted in a 28.3% increase in wafer shipment in 2006, from 5,622 thousand 200mm equivalent wafers in 2005 to 7,215 thousand 200mm equivalent wafers in 2006. The

increase in sales volume was partially offset by a 7.4% decrease in the average selling price of our wafers in U.S. dollar terms in 2006. The decrease in the average selling price of our wafers in U.S. dollar terms was primarily the result of a decline in pricing for the same product or technology resulting primarily from pricing pressures in customers’ end market and an increase in competition, partially offset by a more favorable product mix as we saw a continued shift toward higher priced products using more advanced technologies. Our net sales in 2006 were also positively impacted by the fact that the average exchange rate for the NT dollar against the U.S. dollar depreciated by 1.1% in 2006 compared to 2005, as a significant portion of our sales are denominated in U.S. dollars. Our publicly disclosed sales guidance for the first quarter of 2007 was between NT$62,000 million and NT$64,000 million, representing a decrease of 17.3% to 14.6% from our net sales in the last quarter of 2006. This decrease in our net sales is expected primarily as a result of a decrease in orders resulting from our customers’ inventory correction, which started in the third quarter of 2006 and is currently expected to continue through the first quarter of 2007, and the demand weakness in the consumer, consumption and computer sectors.

          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 shipments in 2005, from 5,008 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 U.S. dollar terms in 2005. The decrease in the average selling price of our wafers in U.S. 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 toward higher priced products using more advanced technologies. Our sales in 2005 were also negatively impacted by a stronger NT dollar against U.S. dollar, which appreciated against the U.S. dollar by 4%, as a significant portion of our sales are denominated in U.S. 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.

          Gross Margin

          Our gross margin fluctuates, depending on the level of capacity utilization, wafer shipments and product mix, among other factors. Our gross margin increased to 49.1% of net sales in 2006 from 44.3% of net sales in 2005. The higher margin in 2006 was primarily driven by higher capacity utilization, resulting primarily from higher market demands in 2006, which contributed 3.8 percentage points to the 4.8 percentage points increase in the gross margin. In addition, higher wafer shipments, the improvement in overall product mix, favorable cost reduction, which contributed 7.2 percentage points to the increase in the gross margin, and a weaker average exchange rate of the NT dollar against the U.S. dollar, which contributed 0.9 percentage points to the increase in the gross margin, more than offset the unfavorable impact on gross margin of price declines, which negatively impacted the gross margin by 7.1 percentage points. Depreciation and amortization expenses related to cost of sales decreased marginally from NT$69,902 million in 2005 to NT$69,123 million (US$2,121 million) in 2006. The decrease in depreciation and amortization expenses in 2006 reflects the benefits received from the reduced depreciation of facilities and equipment in 200mm fabs, and lower amortization of deferred charges, partially offset by the increase in depreciation from our advanced technology fabs. We anticipate our depreciation and amortization expenses related to cost of sales to increase in 2007, 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 addition, while our operations ran on average at full capacity in 2006, after reaching a peak in the second quarter of 2006, our capacity utilization rate started to decline and decreased further in the last quarter of 2006 to a level significantly below full capacity due to a decrease in orders resulting from our customers’ inventory correction, which started in the third quarter of 2006 and is currently expected to continue through the first quarter of 2007, and the demand weakness in the consumer, consumption and computer sectors. We currently expect our capacity utilization rate during the first quarter of 2007 to further decline from the fourth quarter of 2006 and to continue to adversely affect our gross margin during such period. We do, however, currently expect overall customer demand to begin to recover by the end of the first quarter of 2007.

          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 contributed 3.6 percentage points to the overall 0.7 percentage point decrease in the gross margin. In addition, price declines, which contributed 3.4 percentage points to the decrease in gross margin, and a strengthening of the NT dollar against the U.S. dollar, which contributed 1.8% to the decrease in gross margin, together with the lower capacity utilization more than offset higher wafer shipments, the improvement in overall product mix, and favorable cost reduction, which positively contributed 7.7 percentage points to the gross

margin. Depreciation and amortization expenses related to cost of sales increased from NT$64,201 million in 2004 to NT$69,902 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).

     Operating Expenses

		For the Year Ended December 31
										% Change												% Change
		2004				2005				from 2004				2006								from 2005
		NT$				NT$								NT$				US$
		(in millions)												(in millions)
Research and development			12,516				14,017				12.0	%			16,076				493				14.7	%
General and administrative			11,454				9,085				(20.7	)%			8,717				268				(4.1	)%
Sales and marketing			3,367				4,132				22.7	%			3,752				115				(9.2	)%
Total operating expenses			27,337				27,234				(0.4	)%			28,545				876				4.8	%
Percentage of net sales			10.6	%			10.3	%			—				9.0	%			9.0	%		—
Income from operations			88,482				90,969				2.81	%			127,265				3,905				39.9	%
Operating Margin			34.4	%			34.0	%			—				40.1	%			40.1	%		—

     Operating expenses increased by NT$1,311 million in 2006, or 4.8%, from 2005, after a decrease in operating expenses of NT$103 million in 2005, or 0.4%, from 2004.

     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$2,059 million in 2006, or 14.7%, from 2005. Research and development expenses were higher in 2006 than in 2005 primarily due to the increase in expenses relating to an increase in development activities in 45/65 nanometer technologies in 2006 as compared to 2005 which more than offset the decrease in research and development expenses relating to less advanced technologies. We plan to continue to invest significant amounts in research and development expenses in 2007.

     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.

     General and Administrative, Sales and Marketing Expenses

     General and administrative, sales and marketing expenses decreased by NT$748 million in 2006, or 5.7%, from 2005, due to a decrease of general and administrative expenses by NT$368 million, or 4.1%, and a decrease in sales and marketing expenses by NT$380 million, or 9.2%. The decrease in general and administrative expenses was primarily due to a change in accounting principle pursuant to which, effective January 1, 2006, goodwill is no longer amortizable under R.O.C. GAAP, partially offset by an increase in Fab 14 (phase II) opening expenses. With the commencement of its commercial operation in 2006, expenses associated with the start-up of Fab 14 (Phase II) will cease to be accounted for as general and administrative expenses going forward. The decrease in sales and marketing expenses was primarily due to a decrease in stock compensation and bonus expenses in 2006. The operating margin in 2006 was 40.1%, higher than 34.0% in 2005.

     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) which 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.

     Non-Operating Income and Expenses

		For the Year Ended December 31
		2004(1)				2005(1)				% Change from 2004				2006								% Change from 2005
		NT$				NT$								NT$				US$
		(in millions)												(in millions)
Non-operating income and gains			8,581				9,399				9.5	%			9,705				298				3.3	%
Non-operating expenses and losses			(5,097	)			(6,105	)			19.8	%			(3,608	)			(111	)			(40.9	)%
Net non-operating income (expenses)			3,484				3,294				(5.4	)%			6,097				187				85.1	%

     Net non-operating income increased by NT$2,803 million in 2006, or 85.1%, from NT$3,294 million in 2005 primarily due to a NT$2,804 million decrease in loss on settlement and disposal of financial instruments, a NT$1,736 million increase in interest income, a NT$914 million increase in investment income recognized under the equity method, and a NT$523 million decrease in interest expense, partially offset by a change from NT$2,610 million net foreign exchange gain in 2005 to a net foreign exchange loss of NT$401 million in 2006 and a NT$476 million increase in net valuation loss on financial instruments. The decrease in loss on settlement and disposal of financial instruments was mainly due to a change from a settlement loss on hedging instruments in 2005 to a settlement gain on hedging instruments in 2006 as a result of a depreciation of the NT dollar against the U.S. dollar in 2005 compared to a very moderate appreciation of the NT dollar against the U.S. dollar in 2006, partially offset by higher hedging costs due to a greater differential between U.S. dollar prevailing interest rates and NT dollar prevailing interest rates in connection with our foreign currency swap transactions in 2006. The increase in interest income was primarily the result of higher interest rates on interest bearing treasury assets and a higher level of cash holding. The increase in investment income recognized under the equity method was primarily due to better operating performance of equity method investees. The decrease in interest expense primarily resulted from a NT$10,500 million repayment of bonds in 2005. The change from NT$2,610 million net foreign exchange gain in 2005 to a net foreign exchange loss of NT$401 million in 2006 was primarily due to a depreciation of the NT dollar against the U.S. dollar in 2005 compared to a very moderate appreciation of the NT dollar against the U.S. dollar on spot rate basis in 2006. The increase in net valuation loss on financial instruments was primarily due to an increased decline in the market value of marketable financial instruments.

     Net non-operating income decreased by NT$190 million in 2005, or by 5.4%, from NT$3,484 million in 2004 primarily due to a change from a NT$3,480 million gain on settlement and disposal of financial instruments in 2004 to a loss of NT$3,603 million in 2005, a NT$661 million decrease in net investment income recognized under the equity method and a NT$262 million increase in net valuation loss on financial instruments, partially offset by a change from NT$3,036 million net foreign exchange loss in 2004 to net foreign exchange gain of NT$2,610 million in 2005, a NT$1,023 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 received in 2005. The change from a gain on settlement and disposal of financial instruments in 2004 to a loss in 2005 was mainly due to a change from a settlement gain on hedging instruments in 2004 to a settlement loss in 2005 as a result of an appreciation of the NT dollar against the U.S. dollar in 2004 compared to a depreciation of the NT dollar against the U.S. dollar in 2005, and higher hedging costs due to a greater differential between U.S. dollar prevailing interest rates and NT dollar prevailing interest rates in connection with our foreign currency swap transactions in 2005. The decrease in net investment income recognized under the equity method was primarily the result of less favorable operating results of equity method investees. The increase in net valuation loss on financial instruments was primarily the result of an increased decline in the market value of marketable financial instruments. The change from a NT$3,036 million net foreign exchange loss in 2004 to a net foreign exchange gain of NT$2,610 million in 2005 was primarily due to an appreciation of the NT dollar against the U.S. dollar in 2004 compared to a depreciation of the NT dollar against the U.S. dollar in 2005. The increase in interest income was primarily the result of higher interest rates on interest bearing treasury assets and higher levels of cash holdings.

Income Tax Benefit (Expense)

		For the Year Ended December 31
										% Change												% Change
		2004				2005				from 2004				2006								from 2005
		NT$				NT$								NT$				US$
		(in millions)												(in millions)
Income tax benefit (expense)			363				(630	)			—	(1)			(7,774	)			(238	)			1,132.8	%
Cumulative effect of changes in accounting principles			—				—				—	(1)			1,607				49				—	(1)
Net income			92,316				93,575				1.4	%			127,010				3,897				35.7	%
Net margin			35.9	%			35.1	%			—				40.0	%			40.0	%			—

     Income tax expense increased by NT$7,144 million in 2006, or 1,132.8%, from 2005. This significant increase was mainly due to the combined effects of a decrease in the tax credit rate applicable to machinery and equipment from 11% in 2005 to 7% in 2006, the expiration of the tax exemption period for some of our 200mm fabs in 2006, and an increase in taxable income. See “— Taxation” below for a further discussion. In 2007, due to the combined effects of an expected further increase in taxable income, an anticipated further decrease in tax credits and the expiration of the tax exemption period for additional of our 200mm fabs in 2007, we expect the amount of income tax expense for 2007 will be significantly higher than that in 2006.

     In 2005, we incurred income tax expenses of approximately NT$630 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 effective tax rate because some of our fabs have ceased to enjoy their tax exemption period.

     Cumulative Effect of Changes in Accounting Principles

     On January 1, 2006, we adopted the newly released R.O.C. SFAS No. 34, “Accounting for Financial Instruments” (SFAS No. 34). Upon adoption of SFAS No. 34, an adjustment of NT$1,607 million made to the carrying amounts of the financial instruments categorized as financial assets or liabilities at fair value through profit or loss was included in the cumulative effect of changes in accounting principles; and an adjustment of NT$307 million made to the carrying amounts of those categorized as available-for-sale financial assets was recognized in shareholders’ equity.

Liquidity and Capital Resources

     Our cash, cash equivalents and current investments in marketable financial instruments amounted to NT$195,079 million (US$5,986 million) as of December 31, 2006, up from NT$145,309 million as of December 31, 2005. Our current investments in marketable financial instruments primarily consist of agency bonds, corporate bonds, corporate issued asset-backed securities, open-end mutual funds, government bonds, structured time deposits, publicly-traded stocks and a variety of money market funds. Cash and cash equivalents increased by NT$21,353 million in 2006, or 22.1%, from 2005, following an increase of NT$22,181 million in 2005, or 29.9%, from 2004.

						For the year ended December 31,
		2004(1)				2005(1)				2006
		NT$				NT$				NT$				US$
		(in millions)								(in millions)
Net cash provided by operating activities			153,523				157,225				204,997				6,290
Net cash used in investing activities			(148,359	)			(77,652	)			(119,724	)			(3,674	)
Net cash used in financing activities			(32,181	)			(57,969	)			(63,783	)			(1,957	)
Net increase/(decrease) in cash			(28,687	)			22,181				21,353				655

     Operating Activities

     In 2006, we generated NT$204,997 million (US$6,290 million) net cash from operating activities, as compared to NT$157,225 million in 2005. The increase in net cash from operating activities was primarily the result of higher net income in 2006 of NT$127,010 million (US$3,897 million) compared to NT$93,575 in 2005, and a decrease in notes and accounts receivable of NT$6,447 (US$ 198 million) in 2006 compared to an increase of NT$10,601 million in 2005 and a decrease of deferred income taxes of NT$122 million in 2006 compared to an increase in deferred income taxes of NT$3,353 million in 2005, partially offset by lower depreciation and amortization in 2006 of NT$73,715 million (US$2,262 million) compared to NT$75,649 million in 2005.

     In 2005, we generated NT$157,225 million net cash from operating activities, as compared to NT$153,523 million in 2004. The increase in net cash from operating activities was primarily the result of higher net income in 2005 of NT$93,575 million compared to NT$92,316 in 2004, and higher depreciation and amortization in 2005 of NT$75,649 million compared to NT$69,819 million in 2004.

     In 2006, depreciation and amortization expenses were NT$73,715 million (US$2,262 million), as compared to NT$75,649 million in 2005. The decrease in depreciation and amortization expenses was primarily due to a decrease in amortization expense of goodwill, which more than offset the continued increased depreciation associated with ramping up Fab 12 (Phases II and III) and Fab 14 (Phase I). Effective January 1, 2006, pursuant to the newly revised R.O.C. SFAS No. 25, “Business Combinations — Accounting Treatment under Purchase Method” (SFAS No. 25), goodwill is no longer amortizable but is tested for impairment annually instead. We expect depreciation and amortization expenses to increase in 2007, as compared with that in 2006, 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 2005, depreciation and amortization expenses were NT$75,649 million, as compared to NT$69,819 million in 2004. The increase in depreciation and amortization expenses was primarily due to the continued increase in depreciation associated with ramping up Fab 12 (Phase II) and Fab 14 (Phase I).

     Investing Activities

     In 2006, net cash used in investing activities was NT$119,724 million (US$3,674 million), a significant increase from NT$77,652 million in 2005. The increase in net cash used in investing activities in 2006 was the result of more cash invested in financial assets, an increase in deferred charges and refundable deposits, and less cash received from disposal or redemption of investment in financial assets, partially offset by less spending on capital expenditures. Capital expenditures in 2006 were primarily related to:

	•		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 operations;
	•		developing process technologies such as sub-45 and 65nm nodes; and
	•		other research and development projects.

     Net cash used in investing activities amounted to NT$77,652 million in 2005, a significant decrease from NT$148,359 million in 2004. The primary cash usage for investing activities for 2004 and 2005 was for capital equipment purchases, which totaled NT$81,095 million and NT$79,879 million, respectively.

     We currently expect capital expenditures to be approximately US$2,600 million to US$2,800 million in 2007. We expect this amount to be spent primarily on process technologies such as 32 and 45nm nodes, ramping up Fab 12, Fab 14 and Fab 10, capacity expansion for mask operations, 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 2006, net cash used in financing activities was NT$63,783 million (US$ 1,957 million), as compared to NT$57,969 million in 2005. The net cash used in financing activities in 2006 primarily reflects payments of cash dividends on our common stock of NT$61,743 million (US$1,895 million), payments of employee bonus of NT$3,432 million (US$105 million), partially offset by an increase in guarantee deposits of NT$921 million (US$28 million) and proceeds from exercise of stock options of NT$575 million (US$18 million).

     In 2005, net cash used in financing activities was NT$57,969 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, payments of employee bonus of NT$3,086 million and repayments of long-term bank loans and corporate bonds in the amount of NT$1,337 million and NT$10,500 million, respectively. 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.

     As of December 31, 2006, we had no short-term debt, and the current portion of our long-term debt was NT$7,004 million (US$215 million) and our aggregate long-term debt was NT$13,154 million (US$404 million). NT$652 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 used. NT$652 million of the long-term bank loans had floating interest rates based on the London interbank offer rate, or LIBOR. NT$12,500 million of the long-term bonds had fixed interest rates ranging from 2.75% to 3.00%. As of December 31, 2006, we had an aggregate of approximately NT$27,280 million (US$837 million) in unused short-term credit lines and an aggregate of approximately NT$6,192 million (US$190 million) in unused long-term credit lines.

     Our loan agreements, and credit facilities 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, 2007, 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) outstanding as of December 31, 2006:

		Long-term debt
		NT$
		(in millions)
During 2007			7,004
During 2008			132
During 2009			8,261
During 2010			261
During 2011 and thereafter			4,500

     The following table sets forth information on our material contractually obligated payments for the periods indicated as of December 31, 2006:

										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)			20,158				7,004				8,393				261				4,500
Capital Lease Obligations(2)			613				—				—				—				613
Operating Leases(3)			4,090				946				1,119				518				1,507
Other Payments(4)			9,321				618				674				598				7,431
Capital Purchase or other Purchase Obligations(5)			30,548				27,786				1,597				675				490
Total Contractual Cash Obligations(6)			64,730				36,354				11,783				2,052				14,541

     During 2006, we entered into derivative financial instruments transactions to manage exposures related to foreign-currency denominated receivables or payables. As of December 31, 2006, our cash requirements in 2007 for outstanding forward exchange contracts and cross currency swaps contracts were approximately US$820 million, with our expected cash receipts of approximately NT$26,855 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$81,095 million, NT$79,879 million and NT$78,737 million (US$2,416 million) in 2004, 2005 and 2006, respectively. We currently expect that our plans for the development of process technologies such as 32 and 45nm nodes and ramping up production at Fab 12, Fab 14 and Fab 10, and other research and development projects will require capital expenditures in 2007 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 credit will provide sufficient resources to meet our planned capital requirements.

U.S. GAAP Reconciliation

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

		Year ended and as of December 31,
		2004				2005		2006						2006
		NT$				NT$					NT$			US$
		(in NT$ millions)
Net income in accordance with:
R.O.C. GAAP			92,316				93,575				127,010				3,897
U.S. GAAP			76,253				75,418				95,711				2,937
Shareholders’ equity attributable to the shareholders of the parent in accordance with:
R.O.C. GAAP			398,965				445,631				507,981				15,587
U.S. GAAP			427,125				477,297				532,403				16,336

     Note 30 to the consolidated financial statements provides a description of the principal differences between R.O.C. GAAP and U.S. GAAP as they relate to us, and a reconciliation to U.S. GAAP of certain items, including net income and shareholders’ equity. Differences between R.O.C. GAAP and U.S. GAAP that have a material effect on our net income as reported under R.O.C. GAAP include compensation expense pertaining to stock bonuses to employees, marketable securities, impairment charges for long-lived assets, amortization of goodwill, and 10% tax imposed on unappropriated earnings.

     In July 2006, we distributed an aggregate bonus of NT$6,864 million, or 8% of our 2005 distributable net income, to our employees, 50% of which was paid in cash and 50% of which was paid in the form of common shares. The number of common shares distributed as part of employee bonuses is obtained by dividing the total nominal NT dollar amount of the bonus to be paid in the form of common shares by the par value of the common shares, at NT$10 per share, rather than their market value, which has generally been substantially higher than the par value. Under R.O.C. GAAP, the distribution of employee bonus shares is treated as an allocation from retained earnings, and we are not required to, and do not, charge the value of the employee bonus shares against income. Under U.S. GAAP, however, we are required to charge the market value of the employee bonus shares as employee compensation expense, which reduces our net income and income per share calculated in accordance with U.S. GAAP. Since the amount and the form of the payment of the compensation is subject to shareholder approval and only determinable at the annual shareholders’ meeting, which is generally held after the issuance of our financial statements, under U.S. GAAP, the compensation expense is initially accrued at the nominal NT dollar amount of the aggregate bonus in the period to which it relates as if it were to be paid entirely in cash. The difference between the amount initially accrued and the market value of the common shares and cash issued as payment of all or any part of the bonus is recorded as employee compensation expense in the period in which shareholder approval is obtained, which normally occurs during the second fiscal quarter of the subsequent year. Therefore, net income and income per share amounts calculated in accordance with R.O.C. GAAP and U.S. GAAP differ accordingly. For a more detailed discussion, please refer to note 30.g. to the consolidated financial statements.

     Prior to 2006, under R.O.C. GAAP, investments in marketable securities were stated at the lower of aggregate cost or market value, with the market value determined using the average-closing price during the last month of the period. Investments in debt securities were carried at amortized cost. An allowance was recognized for any temporary decline in the market value of investments with readily ascertainable fair market value with the corresponding amount recorded as an unrealized loss presented as a separate item in shareholders’ equity. The carrying values of investments whose fair market values were not readily determinable were reduced to reflect an other-than-temporary decline in their values, with the related impairment loss charged to income. Under U.S. GAAP, debt and equity securities that have readily determinable fair market values are classified as either trading, available-for-sale or held-to-maturity securities. Trading securities are reported at fair value, with unrealized gains and losses included in the accompanying statements of income. Available-for-sale securities are also reported at fair value, with unrealized gains and losses reported as a separate component of shareholders’ equity. Additionally, under U.S. GAAP, fair market value of listed

stocks is determined using the closing price of the listed stock on the last trading day for the period. Beginning from 2006, we adopted the R.O.C. SFAS No. 34, “Financial Instruments: Recognition and Measurement”, and No. 36, “Financial Instruments: Disclosure and Presentation.” Under these new R.O.C. accounting pronouncements, financial instruments, which include debt and equity securities, are categorized as either “financial assets or liabilities at fair value through profit or loss”, “available-for-sale”, or “held-to-maturity” securities. “Financial assets or liabilities at fair value through profit or loss” are divided into two sub-categories, financial assets designated on initial recognition as one to be measured at fair value and those that are classified as held for trading, which are also measured at fair value with fair value changes recognized in profit and loss. Thus, the classifications and valuation methodology for debt and equity securities under these new R.O.C. accounting pronouncements are similar to those required by U.S. SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” As a result of adopting R.O.C. SFAS No. 34, a favorable impact of NT$1,607 million was recorded as cumulative effect of changes in accounting principles in 2006 under R.O.C. GAAP to adjust the carrying basis of trading securities, which were previously recorded at the lower of aggregate cost or market value, to fair market value, which is a one-time reconciling adjustment between R.O.C. and U.S. GAAP in 2006.

     For purposes of U.S. GAAP, we are required to periodically evaluate the recoverability of the carrying amount of our long-lived assets. Whenever events or changes in circumstances indicate that the carrying amounts of those assets may not be recoverable, we are required to compare undiscounted net cash flows estimated to be generated by those assets to the carrying value of those assets. To the extent that cash flows are less than the carrying value of the assets, we are required to record impairment losses for the difference between the carrying value and the fair value of the assets. Prior to 2005, under R.O.C. GAAP, we were not required to record impairment losses of assets that could still be used in the business but were required to evaluate the impairment losses of idle assets which were purchased for use in the business but subsequently determined to have no use. Beginning from 2005, under R.O.C. GAAP, when an indication of impairment is identified, any excess of the carrying amount of an asset over its recoverable amount is recognized as a loss. If the recoverable amount increases in a future period, the amount previously recognized as impairment would be reversed and recognized as a gain, to the extent of the carrying amount that would have been determined, net of depreciation, as if no impairment loss had been recognized. Please see note 30.c. to the consolidated financial statements for a more detailed discussion of the impairment of long-lived assets and U.S. SFAS No. 144.

     Under R.O.C. GAAP, prior to January 1, 2006, goodwill was amortized over ten years. Under U.S. GAAP, prior to January 1, 2002, goodwill was amortized over five or ten years. Effective January 1, 2002, we adopted U.S. SFAS No. 142, “Goodwill and Other Intangible Assets.” In accordance with U.S. SFAS No. 142, goodwill is no longer amortized, and instead is assessed for impairment on at least an annual basis. In connection with our acquisition of TSMC-Acer, goodwill from the 1999 acquisition of the initial 32% equity interest in TSMC-Acer was recognized for R.O.C. GAAP purposes since the goodwill was from an acquisition paid in cash. However, goodwill from the 2000 acquisition of the remaining 68% equity interest in TSMC-Acer was not recognized under R.O.C. GAAP. Rather it was netted against capital surplus since the goodwill was from a business combination in the form of a share exchange. Under U.S. GAAP, goodwill from both acquisitions was recognized. Effective January 1, 2006, under R.O.C. GAAP, goodwill is no longer amortized and is assessed for impairment on at least an annual basis.

     In R.O.C., a 10% tax is imposed on any unappropriated earnings. For R.O.C. GAAP purposes, we record the 10% tax on unappropriated earnings in the year of shareholders’ approval. Under U.S. GAAP, the 10% tax on unappropriated earnings should be accrued during the period the earnings arise and adjusted to the extent that distributions are approved by the shareholders in the following year. An expense is recognized in the year in which earnings are recorded under U.S. GAAP, which may be offset by available tax credits.

Taxation

     We are eligible for four-year and five-year tax holidays for income generated from construction and capacity expansions of production facilities according to the regulation for Science Park Administration and the Statute for Upgrading Industries of the R.O.C., respectively. The exemption period may begin at any time within four or five years, as applicable, following the completion of a construction or expansion. The aggregate tax benefits of such exemption periods in 2004, 2005 and 2006 were NT$14,713 million, NT$12,243 million and NT$12,281 million, respectively. We commenced the exemption period for part of Fab 8 in 2002 and part of Fab 2, and Fab 3, 4, 5 and 6 in 2003, and Fab 12 (Phase I) in 2004.

     Under regulations promulgated under the R.O.C. Statute for Upgrading Industries, we are entitled to a tax credit for specified percentages of purchases of equipment used in manufacturing processes. The rate of such tax credit was 11% and 7% of such investments in 2005 and 2006, respectively, and is expected to remain 7% of such investments in 2007.

     The R.O.C. government enacted the R.O.C. Alternative Minimum Tax Act (“AMT Act”) which became effective on January 1, 2006. The alternative minimum tax (“AMT”) imposed under the R.O.C. AMT Act is a supplemental tax which is payable if the income tax payable pursuant to the R.O.C. Income Tax Act is below the minimum amount prescribed under the R.O.C. AMT Act. The taxable income for calculating the AMT includes most income that is exempted from income tax under various legislations, such as tax holidays and investment tax credits. The AMT rate for business entities is 10%. However, the R.O.C. AMT Act grandfathered certain tax exemptions and tax credits granted prior to the enactment of the R.O.C. AMT. We currently expect the AMT to have a minimal effect on our income tax expense in 2007.

Off-Balance Sheet Arrangements

     There are no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

Inflation

     Our most significant export market is North America and we do not believe that inflation in the R.O.C. or North America has recently had a material impact on our results of operations.

Recent Accounting Pronouncements

     Please see notes 2 and 31.a. to the consolidated financial statements for a discussion of recent accounting pronouncements relating to R.O.C. GAAP and U.S. GAAP, respectively. We do not expect the recent accounting pronouncements relating to R.O.C. GAAP and some of the recent accounting pronouncements relating to U.S. GAAP to have any material effect on our consolidated financial statements, and we are still in the process of assessing the potential impact that the adoption of some of the accounting pronouncements relating to U.S. GAAP may have on our results of operations and financial position under U.S. GAAP. For further details, please refer to notes 2 and 31.a. to the consolidated financial statements.

     In March 2007, the R.O.C. Accounting Research and Development Foundation issued an interpretation which requires R.O.C. companies to recognize compensation expenses for bonuses paid to employees, directors and supervisors beginning January 1, 2008. Such bonuses are currently recorded as appropriation of earnings under R.O.C. GAAP. On March 30, 2007, the R.O.C. Financial Supervisory Commission also issued an interpretation which requires that bonuses granted to employees, directors and supervisors in the form of shares be valued at fair market value for purposes of compensation expenses. While definitive implementing accounting pronouncements have not yet been issued, we currently expect a significant increase in total compensation expenses upon adoption of the aforementioned interpretations on January 1, 2008. Please see note 2 to the consolidated financial statements.

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

Directors, Supervisors and Executive Officers

MANAGEMENT

     Members of our board of directors are elected by our shareholders. Following the resignation of Mr. Lobbezoo, the representative of Philips on our board of directors, on March 9, 2007, our board of directors is currently composed of eight directors. The chairman of the board of directors is elected by the directors. The chairman of the board of directors presides at all meetings of the board of directors, and also has the authority to act as our representative. The term of office for directors is three years.

     In order to strengthen corporate governance of companies in Taiwan, effective January 1, 2007, the newly amended R.O.C. Securities and Exchange Law authorizes the R.O.C. Financial Supervisory Commission, after considering the scale, shareholding structure and business nature of a public company, to require a public company to have at least two independent directors but no less than one fifth of the total number of directors. Under this authorization, the R.O.C. Financial Supervisory Commission promulgated guidelines requiring, among others, listed companies with a paid-in capital of NT$50 billion or more to have independent directors on the board. Of our current eight directors, four are independent directors.

     Also, pursuant to the newly amended R.O.C. Securities and Exchange Law, effective from January 1, 2007, a public company is required to either establish an audit committee or to have supervisors, provided that the R.O.C. Financial Supervisory Commission may, after considering the scale, shareholding structure and business nature of a public company, require the company to set up an audit committee to replace its supervisors. So far, the R.O.C. Financial Supervisory Commission has not yet mandated any public company to set up an audit committee to replace supervisors. A public company’s audit committee should be composed of all of its independent directors but not less than three, of which at least one member should have accounting or related financial management expertise, and the relevant provisions under the R.O.C. Securities and Exchange Law, the R.O.C. Company Law and other laws applicable to the supervisors are also applicable to the audit committee.

     Prior to January 1, 2007, we had two supervisors. In accordance with the R.O.C. Company Law, supervisors were elected by our shareholders and could not concurrently serve as our directors, executive officers or other staff members. The supervisors’ major duties and powers included, but were not limited to (i) investigation of our financial condition; (ii) inspection of corporate records; (iii) giving reports in connection with the company’s financial statements at shareholders’ meetings.

     However, according to our amended articles of incorporation, beginning from January 1, 2007, the duties and powers of our supervisors are being exercised by our Audit Committee, which is composed of all of our four independent directors. Accordingly, the tenure of James Ho and Michael Porter, our two supervisors, was terminated on December 31, 2006.

     Pursuant to the R.O.C. Company Law, a person may serve as our director in his personal capacity or as the representative of another legal entity. A director who serves as the representative of a legal entity may be removed or replaced at any time at the discretion of that legal entity, and the replacement director may serve the remainder of the term of office of the replaced director. Of our eight directors, one is a representative of the National Development Fund. Following the resignation of Mr. Lobbezoo on March 9, 2007, Philips no longer has any representative on our board of directors.

     The following table sets forth the name of each director and executive officer, their positions, the year in which their term expires and the number of years they have been with us as of February 28, 2007. The business address for each of our directors, supervisors and executive officers is No. 8, Li Hsin Road 6, Hsinchu Science Park, Hsinchu, Taiwan, Republic of China.

						Years
				Term		with our
Name		Position with our company		Expires		company
Morris Chang		Chairman		2009		20
F.C. Tseng		Vice Chairman		2009		20
J.C. Lobbezoo(1)		Director (Representative of Philips)		2007		13
Stan Shih		Director		2009		7
Chintay Shih		Director (Representative of the National
		Development Fund)		2009		10
Sir Peter Leahy Bonfield		Director		2009		5
Lester Carl Thurow		Director		2009		5
Carleton (Carly) S. Fiorina		Director		2009		1
Rick Tsai		Director, President and Chief Executive Officer		2009		17
Steve Tso		Senior Vice President and Chief Information
		Officer, Information Technology/Materials
		Management and Risk Management		—		10
Kenneth Kin		Senior Vice President of Worldwide Sales and Services		—		6
C.C. Wei		Senior Vice President of Operations I		—		9
Mark Liu		Senior Vice President of Operations II		—		13
Richard Thurston		Vice President and General Counsel		—		5
M.C. Tzeng		Vice President of Operations, Operations I		—		20
Lora Ho		Vice President, Chief Financial Officer and Spokesperson		—		8
P.H. Chang		Vice President of Corporate Human Resources		—		7

								Years
				Term				with our
Name		Position with our company		Expires				company
W.J. Lo		Vice President of Research & Development			—				3
Jason Chen		Vice President of Corporate Development			—				3
Fu-Chieh Hsu		Vice President of Design and Technology Platform			—				1
Jack Sun		Vice President of Research & Development			—				10

     Morris Chang has been the Chairman of our board of directors since our establishment and was our Chief Executive Officer until June 2005. From 1985 to 1994, he was President and then Chairman of the board of directors of ITRI. Prior to that, Mr. Chang was President and Chief Operating Officer of General Instrument Corporation; Corporate Group and Senior Vice-President for Texas Instruments. He holds a bachelor’s degree and a master’s degree in mechanical engineering from the Massachusetts Institute of Technology and a Ph.D. in electrical engineering from Stanford University and has been active in the semiconductor industry for 52 years.

     F.C. Tseng is a director. He has been our Vice Chairman since July 2005. He was Deputy Chief Executive Officer from August 2001 to June 2005. He is the Chairman of Global Unichip Corp. and also a director of Prosperity Venture Capital Corp., Digimax, Inc. and Allegro Manufacturing Pte. Ltd. He formerly served as the President of Vanguard from 1996 to 1998 and our President from May 1998 to August 2001. Prior to his presidency at Vanguard, Mr. Tseng served as our Senior Vice President of operations. Mr. Tseng holds a Ph.D. in electrical engineering from National Cheng-Kung University and has been active in the semiconductor industry for over 36 years.

     Stan Shih is an independent director. He is the Group Chairman of iD SoftCapital and a director of Acer, BenQ, Wistron and Nan Shan Life Insurance Company Ltd. He is also co-founder and Chairman Emeritus of the Acer Group. He had served as the Chairman and Chief Executive Officer of the Acer Group since 1976 to 2004. Mr. Shih holds a bachelor’s degree, a master’s degree and an honorary Ph.D. in electrical engineering from National Chiao Tung University. He also holds an honorary doctorate degree in technology from the Hong Kong Polytechnic University, an honorary fellowship from the University of Wales and an honorary doctoral degree in international law from the American Graduate School of International Management.

     Chintay Shih is a director. He is a professor and dean at the College of Technology Management of National Tsing Hua University. He is also a Managing Director and Special Advisor of ITRI and a director of the Industrial Technology Investment Corporation. Mr. Shih holds a Ph.D. in electrical engineering from Princeton University.

     Sir Peter Leahy Bonfield is an independent director. Sir Peter Bonfield was the Chief Executive Officer and Chairman of the Executive Committee of British Telecommunications from January 2, 1996 to January 31, 2002. He currently is the senior non-executive director of AstraZeneca Group Plc. and director of L. M. Ericsson, Mentor Graphics Corporation Inc. and Sony Corporation (Japan). He is also the Vice President of the British Quality Foundation and a member of the Citigroup International Advisory Board and the Sony Corporation Advisory Board. Furthermore, Sir Peter Bonfield is a non-executive member of Actis LLP Supervisory Board, as well as a non-executive director of Dubai International Capital. He is also the Chairman of Supervisory Board of NXP. B.V. He holds a bachelors degree in engineering from Longhborough University of Technology.

     Lester Carl Thurow is an independent director. Professor Thurow is the Jerome and Dorothy Lemelson Professor of Management and Economics at the Massachusetts Institute of Technology’s Sloan School of Management. He is also a director of Analog Devices, Inc. Professor Thurow served as dean of the Sloan School of Management from 1987 to 1993. Professor Thurow holds a Ph.D. in economics from Harvard University and an M.A. in philosophy, politics and economics from Oxford University where he was a Rhodes Scholar.

     Carleton (Carly) S. Fiorina is an independent director. She was the Chairman and Chief Executive Officer of Hewlett-Packard from July 1999 to February 2005. Prior to joining Hewlett-Packard, she spent nearly 20 years at AT&T and Lucent Technologies, where she held a number of senior leadership positions and directed Lucent’s initial public offering and subsequent spin-off from AT&T. She has previously served on the boards of Cisco Systems, Kellogg Company and Merck & Company. She currently serves on the boards of Cybertrust Inc. (specializing in cybersecurity), Revolution Healthcare Group and MIT Corporation Board of Trustees. She holds a bachelor degree in