Welcome to Semiconductor Manufacturing International Corporation second quarter 2018 webcast conference call. Today's conference call is hosted by Dr. Zhao Haijun, Co-Chief Executive Officer, Dr. Liang Mong Song, Co-Chief Executive Officer, Dr. Gao Yonggang, Chief Financial Officer, and Mr. Tim Ko, Director of Investor Relations. Today's webcast conference call will be simultaneously streamed through the internet at SMIC's website. Please be advised that your dial-ins are in listen-only mode. At the conclusion of the management's presentation, we will be having a question and answer session, at which time you will receive further instruction as to how to participate. The earnings press release is available for download at www.smics.com. Webcast playback will also be available approximately one hour after the event. Without further ado, I would like to introduce to you Mr. Tim Ko, Director of Investor Relations, for the cautionary statement.
Good morning and good evening. Welcome to SMIC's second quarter 2018 earnings webcast conference call. Our CFO, Dr. Gao, will highlight our financial performance and give guidance for the next quarter. Our Co-CEOs, Dr. Zhao and Dr. Liang, will provide some business commentary. This will be followed by our Q&A session. As usual, our call will be approximately 60 minutes in length. The earnings press release and financial presentation are available for you to download at www.smics.com under Investor Relations in the IR Calendar section. Let me also remind you that the presentation we will be making today includes forward-looking statements. These statements and other comments are not guarantees of future performance, but represent the company's estimates and are subject to risk and uncertainty. Our actual results may differ significantly from those projected or suggested in any forward-looking statements.
For a more complete discussion of the risks and uncertainties that could impact our future operating results and financial condition, please see our filings and submissions with the U.S. Securities and Exchange Commission and The Stock Exchange of Hong Kong Limited, including our annual report on Form 20-F filed with the U.S. Securities and Exchange Commission on April 27, 2018. During the call, we will make reference to financial measures that do not conform to generally accepted accounting principles. These measures may be calculated differently than similar non-GAAP data presented by other companies. Please refer to the tables in our press release for a reconciliation of GAAP to the non-GAAP numbers we will be discussing. Please note that all currency figures are in U.S. dollars, unless otherwise stated. I will now hand the call to our CFO, Dr. Gao, for financial highlights.
Thank you, Tim. Greetings to all our listeners. I will highlight our second quarter and the first half 2018 results, and then give third quarter 2018 guidance. In second quarter 2018, our revenue was $891 million, including the recognition of technology licensing revenue of $53 million, an increase of 7.2% quarter-over-quarter. Excluding the technology licensing revenue was $838 million, an increase of 15.8% quarter-over-quarter, mainly due to an increase in wafer shipments in the second quarter. Gross margin was 24.5%. Excluding the technology license revenue, gross margin improved 4.1 percentage points quarter-over-quarter to 19.7%, mainly due to the increased utilization and product mix change in the second quarter. Non-GAAP operating expenses were $270 million. Profits for the period attributable to SMIC was $52 million, while non-controlling interests were $20 million of credits to SMIC's attributable profits. Moving to the balance sheet.
At the end of second quarter, cash on hand, including financial assets, were $2.7 billion. Gross debt to equity was 45%, and net debt to equity was 10%. In terms of cash flow, we generated $111 million of cash from operating activities in the second quarter. If we look at our first half 2018 unaudited results, our revenue was $1.7 billion, gross profit was $438 million, and EBITDA was $637 million, all achieved record highs. Looking ahead into third quarter of 2018. Our revenue is guided to be down 4%-6% quarter-over-quarter, mainly due to technology license revenue recognized in the second quarter. If excluding the technology license revenue, our revenue is guided to be flat to up 2% quarter-over-quarter in the third quarter. Gross margin is expected to range from 19%-21%.
Non-GAAP operating expenses are expected to range from $232 million-$238 million. Non-controlling interests of our majority-owned subsidiaries are expected to range from positive $90 million to positive $21 million, which are losses before by non-controlling interests. We reiterate our planned 2018 CapEx for foundry operations of approximately $2.3 billion, of which approximately $1.3 billion are expected to be spent for the expansion of capacity, and approximately $0.4 billion for R&D equipment. The planned 2018 CapEx for non-foundry operations are approximately $137 million, mainly for the construction of employees living quarters. Our planned 2018 D&A is approximately $1.1 billion. If excluding the technology license revenue, our 2018 gross margin is expected to be in the high teens. I will now hand the call over to our Co-CEO, Haijun, for general remarks.
Thank you, Yonggang. Thank you all for joining us on today's call. SMIC is in a period of transition and preparation. We are making encouraging progress in advancing our technology, building up our technology platforms, and forging partnerships. At the same time, we are on track to grow high single digits annual revenue as demand and utilizations recovered in second quarter, and as we continue to enhance our technology platforms and push forward on R&D. In second quarter, our total revenue grew 7.2% quarter-over-quarter and 18.6% year-over-year. We met our Q2 gross margin guidance on the high end as utilization increased. When excluding the $52.8 million from the technology licensing, our revenue increased 15.8% Q-over-Q and 11.5% year-over-year. Revenue growth was mainly from the sequential increase of 28 nm, 55-nm, and 0.18-micron.
We benefited from the recovery of smartphones and tablet PC business. Newly growing home appliance business also added some incremental revenue. Our revenue from these three segments grew 27% sequentially and 32% year-over-year. Gross margin, excluding technology licensing revenue, was at 19.7%, an increase from 15.6% as we recovered from low seasonality and utilization. Through rigorous planning and efficient execution, we have made good progress on expanding and enhancing our mature nodes platforms. Our power management business platform is among the leading in the market share in the foundry industry. Power is one of the key revenue drivers for this year, and we see good momentum. Our revenue from power, CIS and non-volatile memory grew 5% sequentially and 34% year-over-year in the second quarter of 2018.
Our revenue in second quarter from the China region grew 53.2% year-over-year, and when excluding the technology license revenue, grew 14% sequentially and 38% year-over-year. As the preferred foundry partner in China, we are positioned to benefit from the growth opportunities of China IC market. China continues to represent the single largest market for consumer electronics, with a CAGR of 6% from 2016 to 2021. The home appliance are the largest sub-segments within consumer electronics, and it represent one of the largest IoT opportunities for us. We already seen increase in demand in home appliance and other consumer applications from our second quarter revenue, with a 12% sequential growth and 18% year-over-year growth when compared to second quarter last year. As we look into the second half of this year, our business has stabilized, and the margins are looking better than previously expected.
As mentioned last quarter, we target revenue growth in high single digits%, which is in line with the foundry industry growth rate. We also target a positive annual net profitability attributable to shareholders. We are pleased to adjust our previous growth margin target from teens% now to high teens% when excluding the technology license revenue. In closing, we are in a midst of transition. It will still take time to be fundamentally strong, but we are confident that we are well-positioned in China. We'll secure our position by working closely with our customers, setting up long-term relations, and aim to capture the market opportunities presented before us. Moreover, we will continue to expand and enhance both our mature and advanced technology platforms to provide our customers with comprehensive and competitive services in the mainstream foundry market.
I will now turn the call over to our Co-CEO, Meng-Song, for further comments.
Thank you, Haijun, and good morning, everyone. Thank you for joining us today. I would like to take this opportunity to share the latest progress on R&D and business development. Before that, I want to thank our hardworking employees that worked tirelessly in the past quarters. I have witnessed our engineers pulling consecutive late nights to help the company achieve its goals. A refined SMIC culture has begun to evolve. Because of our team's executions, we have seen increased customer engagement and tighter relations with partners. I'm happy to announce we have reached yet another important milestone in our R&D. In addition to our 28 nm Poly-SiON and HKC, our HKC+ technology development is now complete. Our 28 nm HKC continues to ramp up as its yield meets industry benchmark. As we complete our 28 nm HKC+ R&D, we target higher production by the end of this year.
We continue to enhance our 28 nm performance outlook and expand portfolios and derivatives to address applications such as application processes, radio frequency, high voltage controllers, and embedded memories used in consumer, Internet of Things, and auto-related products. We target to become more competitive by narrowing the gap with leading peers on these derivatives. We are pleased to say that we have achieved significant progress on our 14 nm FinFET development. The R&D of our first version of FinFET technology is now ready for business engagement. We are in the process of customer assessments, IP alignments, and reliability verification. We are on target to start risk production in the first half of next year. I'm confident to say that we are now at full speed to further expand our FinFET technology portfolios.
To conclude my remarks today, we continue to fulfill our customers' needs by providing more comprehensive and competitive technology platforms. We strive hard to accelerate, execute, and deliver for the sustainable profitability and growth of the company. As we are preparing for the future, we accelerate our technology and solidifying partnerships to secure our position as the preferred foundry partner in China. Thanks to all our listeners for your continued support, and look forward to giving you our future developments.
I will now hand the call back to Tim for the Q&A session of this call.
Thank you, Dr. Liang. Today's Q&A will be hosted by our Co-CEOs, Dr. Zhao and Dr. Liang, and our CFO, Dr. Gao. I would now like to open up the call for Q&A. As usual, please be reminded to limit your questions to two per person. Operator, please assist.
Thank you. Ladies and gentlemen, we will now begin the question and answer session. If you wish to ask a question, please press star one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press the pound or hash key. Please note that each questioner should limit up to two questions. Your first question comes from the line of Randy Abrams from Credit Suisse. Please ask your question.
Okay. Thank you. Good morning. First question, just a couple of parts to it. For the second half outlook. For third quarter, just the factors to guide flat to up 2% after the strong 16% rebound in second quarter, if there's applications or technology nodes that are relatively stronger in any areas that are weaker. The second part of that, in the full year, where you mentioned the $150 million license, as it would have some implications for the fourth quarter implied guidance? The final part of the question is just, factoring in the gross margin in OpEx, it looks like it would be loss-making, but I'm curious if you could talk about outlook for some of the other items like the grants, whether you can still maintain break even.
Hi, Randy. Nice to get questions. Basically, you have covered the overall business things for the second half and take into consideration of the first half, we come to the whole year forecast. Okay, the first one, you asked why the third quarter is flat after a very strong rebound in the second quarter. We should say it this way, SMIC is in a very good situation in utilization. Second quarter, we already found this kind of utilization, already made this type of utilization, quite difficult to make the third quarter even higher utilization unless we build out more capacities. Traditionally, if you look at the backtrack of many years, SMIC, the second quarter, always be the best season of the year, the third quarter more or less the similar sequential.
We should say we are in a very good situation, but quite difficult to adding more, because we are running a full capacity stage. As for the whole year, you mentioned that we forecast a high single digits. Yes, that's true. We might have a very strong pricing pressure for the mobile phone-related type of business. That is the overall in this market. So to make a full use of the capacity with a very high utilization and taking into the overall situation in the market on the average, this year we could not expect a very high growth in the revenue. Especially when we think about it, there are a lot of transitions. That means a 40-nm loadings transfer to 20-nm loadings. 55-nm loadings were converted to CIS memories, MCU, IP.
These kind of thing, they take time to make it and 100% converted. That's in conversion stage. That's why this year we do not target that high. Your last question is whether this company can make it realize the promise that it's a break-even profitable. Yes, that's our guidance to our shareholders, that we'll make the company profitable. We are already running now in August, and this year got four months left. The visibility to the end of this year, at least we see through the third quarter and the early fourth quarter, the situations there. We have the confidence that we can make the, just now you used the word break-even, and make the company profitable.
Okay. The second question I wanted to ask. For the blended pricing, it looks like it dipped in first half, and I think you did talk about more pricing, just ongoing pressure. Could you give a view, just pricing from here, now that you're operating pretty full on capacity, if you're seeing, I guess, on both areas, firming pricing on mature nodes, then from the 28-nm work you're doing, if any potential that can start to lift as you bring out more HKC or HKC+.
For the pricing things, everybody knows for 8-inch, the price stabilize, the demand is over the capacity. That is in a very solid situation. For the 12-inch, when everybody knows the overcapacity situation in 20-nm technology nodes, when customer want to move from 55-nm and 40-nm to 28-nm technology, on the average of the market pricing and gross margin is just getting lower.
That's the situation. As you might see, we are balancing both. On the one hand side, we need to support our customers' technology transfer from the legacy technology of 14 nm and the 55-nm to 28. In the meantime, we need to consolidate the other parts running to make sure that they cancel out each other so that we can guide the overall revenue, at the same time, maintain the profitability. 28-nm.
Okay.
Yes. We see the pressure from the market on pricing. Yes.
Okay. Finally, to clarify on the $150 million license, when you mention high single-digit growth, is that including the $150 million, or you'll grow high single even excluding that license fee?
Yes, including that.
Okay. All right. Thanks a lot.
Thanks, Randy.
Your next question comes from the line of Liping Wang from CICC. Please ask your question.
Okay. "ready for business engagement." I translate by myself. Thank you for the management and congratulations for the good result and the technology improvement. I have two questions. The first question about the 14 nms. Can you help us to understand what does the ready for business engagement actually means from the technology perspective, and what's your plan to develop your 14-nm business? The second question is, what's your plan beyond the 14 nm? Thank you.
Thank you, Mr. Wang. That is a very good question, sir. It's also not easy to clarify. Let me try my best to answer your question, okay. The definition of the customer engagement, that means we've reached our process, as well as we deliver our version 1.0 PDK for customer to do the circuit evaluations. That is the, we call the business engagement start. Of course, we also qualify our process already. Your second part of the first question is our business plan, okay. Other than the high-speed AP, application process, I think mainstream mobile application are just migrating from 28 nm to 14 or more advanced nodes. We do see growing mobile and wireless connectivity with more 4G, LTE, and the future of 5G in China. Where we think our customer traditional have strong demands in their areas.
In addition to mobile application, we are also seeing demands from emerging applications such as AI, IoT, automotive, and industry sectors. We will plan to expand our 14-nm portfolios to cover those areas that I just described. Your second question actually is also very important. I've been thinking this for a long time, okay. After the 14-nm, there are many nodes, like 10-nm, 8-nm, 7-nm, 6-nm, 5-nm. Some people even have 4-nm. Indeed, it's a bit confusing for technology node naming and contents. We would base on SMIC customers' requirements as well as the internal capability to define our second generation of FinFET. Of course, we will also benchmark industry practice and market demands. The most important thing, I think we will assure both technology competitiveness.
That means PPAC, power, performance, area, cost, as well as the SMIC, the long-term business growth. That will determine and define our next generation to FinFET technology. I hope I answer most of your questions.
Yeah. Thank you very much. Thank you.
Your next question comes from the line of Charlie Chen from Morgan Stanley. Please ask your question.
Hi, Dr. Zhao, Dr. Liang, and Dr. Gao. My first question is more about near term. Can you comment a little bit on second half demand by end markets. Because recently we are seeing some noise about semiconductor demand, no matter from automotive vendor like Renesas, and also Microchip also reported a kind of bearish outlook. Can you give us some color about your second half PC sales?
Hi, Charlie, thank you for the questions. Actually, what we saw at this moment, the demands just stabilized. We did not see obvious downtrend. For SMIC, we are not that big size, you know that, Charlie. We diversified our mature technologies. Just now in my quarterly review, I already said that we expand our technology platform in mature nodes, such as analog power, BCD, high voltage driver, CMOS image, memory, MCU, IoT, these type of things. We are in the transition stage. When this kind of platform fully in position, we expect from IC point of view, we expect SMIC's demands will getting much higher than today, to fulfill our expansion plan. At this moment, my comments for the markets for the mature technology nodes is that it stabilize.
We know that for the 8-inch, the capacity is still in a very shortage to support the analog power and the power devices. For 12-inch, we really see the high-voltage and IoTs, CIS are in high demands. You are right, we see the stabilization or like the downtrends and the competitiveness of memory, standalone memory, especially for NAND flash. For SMIC, the exposure to this area is not that big. We also have the conversion, our NAND flash convertible to the technology nodes just now I mentioned.
Okay. Thanks. Next one is more about your medium, long-term plan. It's about your capital intensity. Now currently company is still investing. What will be the long-term capital intensity? If you want to benchmark in the foundry peer, TSMC is at 25%-30%. What does that mean to your mid- to long-term cash flow and fundraising plan? Actually, I'm curious. Since you are converting your 40 and 55-nm capacity to 28 nm, why do you still need to spend such high CapEx for this year?
Charlie, this year we said that we just now, and Dr. Gao already specified the total spending of $2.3 billion this year for CapEx. We split this kind of spending, a part of it, 0.4% for the new equipment for leading-edge technology R&D, and the remaining to build out the pilot lines for the FinFET manufacturing. We do not build out that much for 28 nm. Currently, we should say this, SMIC size is small. We account for 5% of the total foundry markets only. Our customer demands is way above this 5% capability. We do not build up a capacity for a potential market, but build up the capacity for the true customer demands. We reach a strategic alliance with our customers on both the leading edge and mature technology nodes.
We make the long-term, like 3 years of planning, and then we give the promise that we will build up the capacity accordingly. For this year, we have this kind of spending. For next year, the more or less visibility now is to see 3 years. We expect the similar type of spending on year-on-year. That's mainly to support our customers' demands. In the meantime, for a very stable healthy growth of SMIC in capacity.
Okay. Thanks for taking my question. Very solid execution for last quarter.
Yeah. Thanks.
Your next question comes from the line of Rick Hsu from Daiwa Securities. Please ask your question.
Yeah. Hi, good morning. This is Rick. Thank you for taking my questions. My first question is a bit housekeeping. In second quarter, how much the subsidies from the government did you guys receive in second quarter?
Hi, Rick.
Yes.
I relay this question to our CFO, Dr. Gao, to give you the answer. Okay?
Sure.
我还是讲中文吧。我们今年以来R&D的开支的确是比以往年度有了比较大的增长。那么在二季度，我们R&D的费用占销售收入的比重已经超过了20%。We are seeing the R&D expenses has increased since the beginning of this year.
If you look at our second quarter R&D expenses to sales ratio is around 20%. [Foreign language] The R&D funding that we have received in the second quarter is around $19 million. For the full year, we are expecting to have roughly $100 million for the R&D funding.
Right. Great. Yeah. That's very helpful. Thank you. My second question is regarding your 28 nm development. I'm a bit curious, could you give us more guidance about your 28 nm revenue contribution in Q3 and also the trend toward second half of next year? I know you did a pretty good job in second quarter. I think it rose to almost like a high single digits. Will you expect this rising trend to continue in Q3 and Q4?
Hi, Rick. You know, we are running our 28 nm loading to customer demands. As you say, and Justin also mentioned the same, 28 nm unit worldwide over capacity, and the pricing game is very high. We do not really push very hard for the ramp up of 28 to the maximum capacity stage. We just balance, just now we say that we like to achieve a balance in loading both 28 and the other technology node and the special case, so that we can meet our guidance of the gross margin. For 28 nm revenue for this year, we will maintain as mid-single digits percentage.
All right. Great. Thank you so much. Just one quick follow-up. When you start to commercialize your HKC+, I assume starting to commercialize in the first half next year, can I assume your 28 nm revenue contribution will accelerate in 2019 to double digits?
At this moment, our planning is to maintain the gross margin for the overall. We do not have the aggressive plan to push very hard to the high volume of 28 high-k metal gate C+, even though we have the demands there, we need to balancing both.
Okay. Great. Thank you so much. Yeah, those are all the questions.
Okay. Thank you. Great. Yes.
Your next question comes from the line of Bill Lu from UBS. Please ask your question.
Yeah. Hi. My first question is on technology. It was in the news that the SMIC order a EUV tool and it will be delivered in 2019. I wonder if you could talk a little bit more about your strategy in terms of using that EUV tool. What is the timing for production? What node will it be? Thank you.
Okay. That's a very good question as well. We don't comment on the procurements of any specific equipment. What I can say is we don't have problems of purchasing equipment from our vendors. We will carefully make the equipment procurement plan based on our needs. That is the things I can tell you. You ask a specific question about which node to use the EUV. I think that depends on each company's strategy. As I mentioned earlier, the PPAC, the last one, C, the cost is very critical, of course, the area. The EUV will help area shrinkage as well as cost reduction, if the EUV technology matures. That part I believe most company understand this. For SMIC, which node will use the EUV?
That is still under debate, because of the area reduction and cost benefit, at this moment, still not very clear. What I can say is probably, if we think our 14 is N node, our N+ node will be our next one. EUV will use probably at the N+2 node. The N+2 node, which is five or six or seven. Really not decided yet. That's all I can tell you at this moment.
Great. That's very helpful. My second question is on your growth outlook. This year, the revenue growth is a little bit below your long-term guidance. I'm wondering if we can talk a little bit more about 2019. Do you think there's the possibility that you get back on the trend line? Secondly, you've talked about some of the conversions and capacity being an issue. How do we think about the capacity next year, and what nodes can we deprioritize next year? Thank you.
SMIC has announced a couple of constructions of new wafer fab shells. We have Tianjin, we have Beijing, and Shenzhen, and Shanghai. Shanghai 1 specialize in the FinFET. Next year, we will see a low volume ramp up. That's the FinFET portion. For Tianjin, some legacy fab will ramp up 8-inch. At this moment, normally limited by the supply of the machines, and the delivery of the machines these days become a very long lead time. Basically, what we want to go for a very conservative and solid growth in the mature node. So far, we already have very big customer base demands for 8-inch. 8-inch is in a short supply. Just now I mentioned that even though we want to expand, the supply of 8-inch, both the brand new and the secondhand, are very long lead time.
Next year, we do not see a very big jump in this kind of capacity. For 12-inch, just now we mentioned that for 20 nm, we will maintain the similar capacity because the oversupply stage for 20 nm overbuild capacity type in the markets. What we expand for 12-inch next year, mainly on the area, we have very strong customer demand and market demands. We mentioned a couple of segmentations just now. For this kind of area, next year, we will see a ramp up, and we're mainly buying the machines to cover the missing part. That means a lot of capacity converted from the original logic production line. We need other unique tools to cover that so that we can run analog power, CIS, MCU, and the standalone memory, high voltage driver type.
We will see the mature nodes next year, like 55-nm, 65 nm, 14 nm will do the transition, and that capacity will see increase mainly to cover, make full use of the existing logic in addition to meet customer's requests in the market.
Yeah. Thank you. I'm wondering if you could just clarify-
In general, we do not see a very big jump in the capacity building.
Okay. Do you think you could clarify a little bit more on the mature 12-inch, how much capacity might increase next year?
We do not have a solid number because that need board directors approval. Our 12-inch wafer fab currently, we only have two. In Shanghai, we have one R&D fab, and that's up to 15,000 wafer per month. We are already running full capacity. Additional capacity mainly for R&D. For Beijing, we have the mature fab. The capacity is 50,000 wafer per month and currently running full capacity. For the second phase of Beijing, that's the joint venture. We already fulfill the first half, and the only missing part in SMIC inside the fab shell, inside the fab, only have the Beijing phase 2. That can be fill up next year.
Thank you. Sorry, can I ask one last follow-up on that topic? If I also think about the company getting back on a higher growth trajectory, should I be looking at really a bigger increase in 8-inch at some point in the future as well as 14 nm ramping up? Are those the key growth drivers maybe 2019 and beyond? What should I be thinking about?
SMIC, currently, we can say that we more or less build up the things, balanced type of capacity, match our technology and strengths. For the mature technology nodes, we do have more customer than our capacity. We need to build up the fab and also take a very long time to get a machine. We cannot expect the mature technology nodes to get a very high percentage of growth next year. For the leading edge, just now I already say that for 28 nm overall, I mean, in the world, technology node, the capacity is seriously overbuilt. When we move to the FinFET, we just build out a capacity from our customers' request. We will slowly build out a customer base. In that sense, we do not really build up at a very high pace on this kind of capacity.
We should say overall, SMIC will go for a very solid and healthy growth rate in the capacity buildup, and depends on customers' requests and our competitiveness in market.
Got it. Thank you very much.
Your next question comes from the line of Zhe Ni from China Renaissance. Please ask your question.
Oh, hi. Good morning, gentlemen. Two questions from my side. The first one regarding 28 nano. What will be the long-term strategy going forward? Should we expect more derivative solution coming out, like the 22 nano or 22 nano FD-SOI? The second question would be on 14 nm. What are the products that you guys are targeting initially, and when we should expect the revenue coming out from 14 nano? Thank you.
Okay. Mr. Ni, let me try to answer the first question, and for the second part of the second question, about the revenue of the 14 nm, I will leave to Dr. Zhao to answer that. Let me try to answer 28-nm technology. We think 28 nm will be a long node, okay? Particularly for the high-k metal gate. We are working closely with our customer to roll out multiple enhancement of the 28-nm high-k metal gate. As Dr. Zhao mentioned, in fact, for SMIC, the technology, 28-nm high-k metal gate technology is not a bottleneck in terms of the process variant. The more important is because the 28 has been such a long node, the worldwide capacity is overbuilt. We still think there are other derivatives for the future business opportunity.
Such as like AP and consumer RF for the high-voltage driver embedded in our wafer memory, and as well as the auto-grade products. We think there are still good business opportunity over there. By doing that, we think we could utilize our capacity and also narrow the gap with the leading peers on those derivatives and become more competitive. You ask about the 22 nm. 22 nm, we also have the 22 nm in our technology portfolio. At this moment, our 22-nm development is nearly complete. Our schedule and customer engagement were based on the customer actual needs and the market demands, as well as SMIC overall 28-nm ramp-up plans. That is my question about 28, 22 nm. Your second question, your first half of this
The second part.
Okay. I will give the call back to Dr. Zhao to answer your second question-
Sure
about his revenue contribution about on the 14.
Okay. At this moment, we are working closely with our customers on the new product design, and it take time to guide the products in. Based on the current schedule, we expect the revenue of 14 nms start to guide in in the later part of next year.
I think that's probably the good answer because, as we said, our 14-nm ramp-up will start first half next year with a small volume, of course, right? To project those revenue contribution is a little bit difficult to see at this moment.
Yeah. Zhe, a little bit more comments on the 28-nm technology, or another so-called 22 nm, is this way. It is very important technology nodes. SMIC has put in a lot of resources. We compare it to the long nodes of 350 nm and a 0.18-micron technology. You know that 0.18-micron technology aluminum today is still the very big part of every foundry. Very, very strong. These days are still the capacity in shortage. 0.18-micron technology has been there for almost 20 years. It is long nodes. Another 350 nm currently is also in a shortage in capacity, because it's another long node. It's just before the transition to the immersion scanner. We really believe at 28 and 22, we consider that as a same node, will be a long node, maybe in the next 20 years, continue to be there.
It takes time to absorb the current overview capacity. For SMIC to stay with a very healthy momentum, is that we do not overview additional things. We need to deepen our technology understanding, and platforms diversify, guiding customer base. For the future, we still have very big hope there. At this moment, we will also do, just now we say that mid-single digits type of % revenue on this technology nodes, but just maintain a very healthy stage on this technology volume.
Yeah. Sounds great. Last question from my side. Do you expect 14 nano to be a bigger node than 28 nano from SMIC's perspective?
Zhe, could you say your question again?
Yeah. Do you expect 14 nm revenue potential will be a lot bigger than 28 nm for SMIC's case?
Let me try to answer part of that. I do believe, 14 nm and 28 nm, in terms of technology, they are very different ingredient in there. 28 high-k metal gate is the last planar, high performance, low power planar technology, 28 or 22. For the FinFET, that's a different thing. FinFET will have a technology shrinkage plus higher performance, as well as lower power. To compare the 28 and 14 lifetime, I believe, we think 14 FinFET should have a longer lifetime than 28. Of course, that depends on the application as well. Depends on those mainstream, the mobile migration. Right now, mainstream mobile applications start from the 14 nm migrate to 28. If they migrate to 14 faster or the cost is more justified, then we believe the migration speed will be faster.
Okay.
To maintain the 14 nm PPAC advantage as well as the low cost is very important for SMIC and as well as for the industry technology migration. That's my comments.
Okay.
Your next question comes from the line of Gokul Hariharan from J.P. Morgan. Please ask your question.
Yeah. Hi. Thanks for taking my questions. First of all, I just had a quick question on R&D spending. It has gone up quite a bit, as the focus on leading edge has come back in the last couple of years. What do you think is the optimal level, to support your ambitions, especially on 14 nm and beyond? Now that we are tuning down the expansion in terms of capacity on 28 to adjust to market reality, will we also think about adjusting R&D expense to kind of adjust to slower industry revenue growth, or that is still going to continue regardless? That's my first question.
You like
Hey, Gokul, could you specify your question again about the R&D part?
Yeah. I was asking, R&D has stepped up quite a bit in the last couple of years. Are we expecting this to continue to move up in the next couple of years as we get closer to 14 nm? Second part of that is, if the newer nodes are slower in terms of ramp up, would we adjust down R&D spending just like we are adjusting down the capacity spend, or R&D spending is going to move up regardless of the ramp-up of the new process nodes?
Okay. Let me try to address this one, okay? The R&D spending definitely is not uncontrolled, okay? R&D spending were based on our revenue and as well as our gross margin consideration. At this moment, the reason our R&D spending is higher because we try to speed up our first generation's FinFET technology. Beyond that, actually, the second generation, third generation FinFET, it doesn't use the whole new equipment. There's a lot of commonality equipment could be used
R&D spending will increase slightly, but not as rapidly as you can see recently. That's my comment.
Okay, that's very helpful. My second question is on all the trade wars and tariff. I think there's been a lot of discussion about that. Could you talk about what has been your feedback, talking to both your customers, both the non-China customers as well as China customers, as well as maybe with your equipment and material vendors also, many of them are from the U.S. as well. Could you talk about what has been your feedback over the last three, four months while this has been in a very high degree of focus?
Hi, Gokul here. Here's Haijun. Yes. We saw the impacts, but very limited, because SMIC does not produce the end products, and our percentage in the overall IC world is also quite limited. At this moment, we just carefully observe the development of the situation internationally, but we strictly follow our commitment to our customers. SMIC in China actually is an international company. We are listed in Hong Kong ADR in U.S. We have maintaining a very good balance between the overseas customers and domestic customers in the past many years. We do not comment on specific equipments or materials. At this moment, we do not meet up any problems with these kind of things. We do not see in the short term such kind of problems. Just now I mentioned that we watch very carefully on the development of the situation.
Okay, that's very clear. Just one more clarification, if I may, on one of the earlier questions. You mentioned that the high single-digit growth for 2018 is including the tech licensing. Does it imply that, in Q4, we are kind of expecting a sequential decline in wafer revenues? Just wanted to understand what is the rationale behind that, given in the last few years Q4 has been largely flattish or even higher than Q3. Thanks.
At this moment, we do not have the full visibility on the fourth quarter. Tentatively, just now, you already calculate the guidance we give. You run up certain conclusions. We haven't reached that conclusion yet. On our side, we are still work with our customers. At this moment, we still see very good trends for customer loading. Again, the visibility is not that clear for the fourth quarter.
Okay. Thank you.
Sure.
Your next question comes from the line of Roland Xu from Citigroup. Please ask your question.
Hi. Good morning. Thanks for taking my questions. First question is, will second quarter product mix change positive or negative to your gross margin? If I look at your technology breakdown, you have about 5.4 percentage points revenue increase on 28 nm, and 40 and 65 nm together was similar as the first quarter, and 90 and above actually were lower than first quarter. Just wondering, for this kind of the product mix change, was it positive or negative to your gross margin in second quarter? Thanks.
Hi, Rex. Basically this way, almost every foundry companies have the similar situations there. Their eight-inch, the legacy node, are fully loaded and in shortage. More or less, we say the product mix in the eight-inch wafer fabs, there's a low impact, almost no impact to the gross margins. Heavily swap to meet up customers' requests. Their loadings there, their margins there. The product mix impact mainly come from 12-inch. Just now, I mentioned that 28 nm over-capacity situation is serious. When we convert from 40, 55-nm to 28 nm, because the serious depreciation of the capacity, the gross margin from 28 nm is very low. The product mix, when we have more 28 nm HKMG type of products running, and we have less 40 or 55-nm, then we see the gross margin getting lower.
That's why, from previous question, we keep answering that to maintain a balance between 28 nm revenue and the other revenue is very important. We have to balance that to maintain the guidance of gross margin.
Understood. 28 nm now your gross margin is still below corporate average. Is this right?
Yes.
My second question is, you're talking about your second generation of FinFET. Is this second generation FinFET going to be adopted on the 14 nm or adopt on your N+1 or N+2 technology? The second, a follow-up is, what's the difference between your first generation and second generation FinFET? Thank you.
To answer your question, the N plus one, our second generation to the FinFET, we define, again, is the power, performance, area, and cost. Power will be 40% reduction, and speed will be 30% enhanced. For the logic area, we'll have a 50% reduction. That is our technology definition.
Yeah. Is it going to be adopt on 14 nm or N+1 ?
Okay. The definition of the technology node, as I mentioned earlier, up to 14, they are from 10 to five nm definition. As I told you, we work based on our customers' demands and our company's cost structure, and define our second generation to FinFET technology.
Okay. Thank you.
Your last question comes from the line of Chen Wenzhang from Bohai Securities. Please ask your question. Chen Wenzhang, your line is open. You can now ask your question.
Thank you. Thank you for taking my question, congratulations for our great progress in R&D. My question is, 14 nm is relatively mature for our competitors. What is the relative competitiveness or advantage for our company in 14 nms? Thank you.
Okay. For the 14 nm technology definition, at the beginning, we benchmark our 28 nm second generation high-k metal gate. That means 28 HKC plus. Using 28 HKC plus as a reference, we define our 14 nm, which can provide 60% speed gains and 70% power reduction, as well as a 50% logic area reduction. Those are numbers and targets we already achieved and before the process frozen. That is the definition of our first generation FinFET.
Okay, thank you.
I would now like to hand the call back to IR Director, Tim Ko, for closing remarks.
In closing, we would like to thank you everyone who participated in today's call, and again, thank all of you for your trust and support to SMIC. Thank you very much.
This is the end of SMIC's second quarter earnings conference call. We thank you for joining us today.