Welcome to Semiconductor Manufacturing International Corporation second quarter 2017 webcast conference call. Today's conference call is hosted by Dr. Haijun Zhao, Chief Executive Officer, Dr. Yonggang Gao, Chief Financial Officer, and Mr. Anling Feng, Vice President of Investor Relations. Today's webcast conference call will be simultaneously streamed through the internet at SMIC's website. Please be advised that your dial-ins are in listen-only mode. However, at the conclusion of the management presentation, we will be having a question and answer session, at which time you will receive further instructions as to how to participate. The earnings press release is available for download at www.smics.com. Webcast playback will also be available approximately one hour after the event. Without further ado, I would like to introduce to you Mr. Anling Feng, Vice President of Investor Relations for the cautionary statement.
Good morning and good evening. Welcome to SMIC's second quarter 2017 earnings webcast conference call. For today's call, our CFO, Dr. Yonggang Gao, will comment on our financial performance first, and give guidance on the next quarter. And then our CEO, Dr. Haijun Zhao, will provide some business remarks. This will then be followed by our Q&A session. As usual, our call will be approximately 60 minutes in length. The earnings release and quarterly financial presentation are available for you to download at our website under Investor Relations in the Events and Presentation section. Let me also remind you that the presentation we'll 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 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 Hong Kong Stock Exchange Limited, including our annual report on Form 20-F filed with the U.S. Securities and Exchange Commission on April 27th, 2017. During the call, we will make reference to financial measures that do not conform to generally accepted accounting principles, GAAP. 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 turn the call over to our CFO, Dr. Yonggang Gao.
Okay. Thank you, Anling. Greetings to all our listeners. First, I will highlight our second quarter and first half 2017 results, and then give our third quarter 2017 guidance. In second quarter 2017, our revenue was $751 million, a decrease of 5.3% quarter over quarter, mainly due to the soft market. On a year-on-year basis, our revenue increased 8.8%. Gross margin was 25.8%, mainly due to low fab utilization, which was 85.7% in Q2 compared to 91.8% in Q1. Non-GAAP operating expenses were $187 million in Q2. Profit for the period attributable to SMIC was $36 million, while non-controlling interests were $3 million of credits to SMIC attributable profit. Moving to the balance sheet. At the end of second quarter of 2017, cash on hand, including other financial assets, were $1.4 billion. Gross debt to equity ratio was 48%, and net debt to equity ratio was 55%.
In terms of cash flow, we generated $245 million of cash from operating activities in the second quarter. If we look at our first half 2017 unaudited results, our revenue was $1.54 billion. Gross profit was $450 million, and EBITDA was $599 million, all achieved record highs. Looking ahead into the third quarter of 2017.
Our revenue is guided to be flat to up 3% quarter-over-quarter. Gross margin is expected to range from 22%-24%. non-GAAP operating expenses are expected to range from $179 million-$185 million. Non-controlling interests of our majority-owned subsidiaries are expected to range from $0-$3 million, which are losses borne by non-controlling interests. We reiterate our planned 2017 CapEx for foundry operations of approximately $2.3 billion. Our planned 2017 CapEx for non-foundry operations is approximately $70 million, mainly for the constructions of employee quarters. I will now hand the call over to our CEO, Haijun, for general remarks.
Thank you, Yonggang. Greetings to our listeners, and thank you for joining us. Today, I will highlight our second quarter and first half performance. I'll look at the second half, challenges, opportunities, technology development, and strategic directions as I see it. Our second quarter revenue grew 8.8% year-over-year and declined 5.3% quarter-over-quarter. Most of our year-over-year growth by application came from auto and industrial. Auto and industrial revenue grew almost sevenfold year-on-year and 16.2% quarter-on-quarter, mainly as a result of our acquisition of LFoundry and its improving utilizations. By device, most of our year-on-year revenue growth came from CMOS image sensors, NAND flash, application processors, and power ICs. From a technology node perspective, 28 nanometer grew twelvefold year-on-year and 24.8% quarter-on-quarter. 0.13 micron nearly doubled year-on-year and it grew 5% quarter-on-quarter.
The sequential decline in our revenue resulted primarily from our smartphone-related applications. This decline and muted growth guidance was the result of high inventory levels in the first half. Currently, customer inventory levels have come down. The buildup of inventory for China's smartphone supply chain is slower than the seasonal due to end-market uncertainty, resulting in a smaller than seasonal growth in Q3. Given this situation, we now target annual revenue growth of mid-to-high single digits in line with foundry industrial growth. We acknowledge the near-term challenges and take hold of upcoming opportunities. The challenge which we are facing this year includes node transition, pricing environment, customer inventory, market uncertainty, and new technology execution. In spite of the challenges we are facing, we are encouraged by our team's hard work and continued progress in capturing opportunities.
This year, our team continued to ramp up 28 nanometer, which will be one of our primary growth drivers. In addition, we are happy to see fingerprint sensors picking up strongly in the second half. We also see a continued growth in flash memory, and collaborate closely with our clients to capture opportunities in the near handset models, IoT, auto, and the industrial control segments. Our technology development, I'm glad to see our team reach several milestone achievements on 28 nanometer. As mentioned previously, our 28 nanometer has three platforms, Polysilicon, HKN, and HKC. The first platform, 28 Polysilicon, is our major growth driver for this year, serving communications-related applications. We maintain our belief that Polysilicon will continue to have demands in the long term. The second platform, 28 nanometer HKN, has already been in small volume production since last year.
This platform is suitable for and is serving communication applications. The third platform, 28 HKC, successfully entered risk production as scheduled this quarter. This platform is being used for communications and consumer applications. In addition, we plan to have HKC+ ready in next year. 28 nanometer overall contributed 6.6% of our wafer revenue in second quarter and is expected to reach high single digits contribution by Q4 this year. 14 nanometer development is also underway at our advanced technology development joint venture, where SRAM yield has been demonstrated. I would like to now reiterate SMIC's strategy. SMIC continues to be an independent and international business. Our sustainable profitability strategy remains to fully utilize our existing assets, efficient technology, and advanced technology to serve the migration of our customers' products.
Since assuming my role as CEO, I have been taking time to refine our strategy actions and review various projects, their market potentials, and return on investment. In the past quarter, I have worked with my team to refocus resources on area of greater foreseeable markets and profit opportunities. To expand upon SMIC's strategy, I have identified three areas of focus and action. First, we must work to expand our cooperation with existing customers. We aim to tighten relationships, increase service, enhance quality and technology, and to broaden customers' portfolio to build customer trust and increase our shares with existing customers. Second, we aim for excellence in mature technology. SMIC already has a great position as a leader in mature nodes.
We work to drive greater increments to our existing base, generic logic technology, to become the most competitive in the industry for mature nodes by pushing better quality, deliver cycle time, performance, and IP support. Third, we aim to build up investment into specialty platforms in which we already hold good market shares, such as CIS, special MCU, flash memory, and others. We strive to improve our specialty technology for our customers so that they can gain a competitive edge and win shares in their respective markets. SMIC is in a state of growth, and by pursuing these three directions, we can more clearly consolidate, solidify our positions in the foundry market as the preferred foundry partner in Mainland China. SMIC continues to expand capacity in mature nodes and new nodes with the needs of our customers. This year, our CapEx remains unchanged.
The incremental increase in capacity in 2017 compared to 2016 year-end for our 8-inch fabs includes Shanghai adding 9,800, Tianjin adding 3,600, Shenzhen adding 2,000. For our 12-inch fabs, Beijing B1 adding 8,600, Beijing Joint Venture add on 10,000, and Shenzhen adding a mini line of 3,000. To conclude, although the near-term outlook is not as seasonally expected, we work diligently to maintain our position as the foundry of choice in China. Through deepening cooperation with our customers, enhancing product quality, service, and offerings, SMIC is in a great position to benefit from the broad-based growth in semiconductor markets. Together with SMIC team, we will work harder to contribute to long-term sustainable value and growth for you, our shareholders. Thanks for your support.
I will now hand the call back to Anling for the Q&A session of this call.
Thank you, Haijun. I would now like to open up the call for Q&A. As usual, please be reminded to limit your questions to two questions per person. Operator, please assist.
Thank you. Ladies and gentlemen, 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. Your first question comes from the line of Randy Abrams of Credit Suisse. You may ask your question.
Okay. Yes. Thank you. Good morning. I wanted to ask the first question. If you could talk a bit more about what is driving the slower pickup in the third quarter. You mentioned smartphone, I'm just curious if it's just relating to the smartphone weakness. If you could talk looking past that you were targeting to backfill applications, if you could give an initial view for the fourth quarter, considering the lower base product delay and strategy for backfill, maybe potential for things to start to pick up in the fourth quarter.
Hi, Randy. Thank you for the question. Your question mentioned the points I made that we see the recovery in the loadings and utilizations in the coming quarters. Yes, we do see on the recovery trends from the smartphone markets. For SMIC, on our side, we do not see the margin from any smartphone, but the connected part on like auto CIS, [CMGR], and NOR flash, and these kinds of products. We do see the recovery of the loadings from our customers. One of the big areas we see the downturn previously is the fingerprint applications and set-up box, these kinds of jobs. Now we see the recovery of these kinds of applications. For the coming quarters, we already gave the guidance, I really can say this way that the smartphone-related market areas, especially for the customers of SMIC, looks better.
Okay. If I could ask, just to follow up on the first one, if any of this is relating to the 28, just a slow migration, if any bit has been a transition issue, just from 40, where you've had a strong position in broadening customer base and 28 just starting to ramp. Is any of this relating to transition or, say, competitors already on 28? If that's the case, is there potential you get some of that business back once your 28 High-K ramps up?
Previously, we already said the revenue change are really related to the markets. One of the factors is the soft term of the markets. Another thing that we also say that we did see the product transition from 40 nanometer to 28 nanometer, and that's true. We do see the recovery of these kinds of applications also back to 40 nanometer. In the meantime, for 28 nanometer, we also got a pickup loading. We already showed up the number and forecast. We have the high single digits of revenue from our 28 nanometer in the fourth quarter .
Okay. The second question I wanted to ask, if you could go through gross margin, where it's coming down a couple points on flat to up sales. Could you go through the factor, how much is mix of 28 versus the depreciation coming up? Maybe in outlook, where you see margin range, if these lower 20s may be the right range with depreciation rising, or if you fill up this capacity, we can get back up toward high 20s.
Yeah, Randy. We do not really break down to different technology nodes on the gross margins. We give the guidance on the 22%-24% in our forecast for this quarter. We already announced that. For the gross margin drop from the first quarter to second quarter, we already mentioned the reasons. The first reasons from the softer markets of smartphone, that impact our fab utilizations. The biggest factor impact the gross margin is the fab utilization. Another thing we really saw, that last year, the fab capacity was very tight. About this year, we see the relaxation of the fab and capacity across the markets. That led to the pricing competition. We are using the market price, but overall market price can become more competitive. That also affects the gross margin.
Just now you mentioned that the for new technologies , for SMIC, we have been through so many years in the mature nodes and in new technology nodes. We have our successful way of doing things to controlling the cost so that we believe we will make another successful story on the new technology on 28 nanometer .
Okay. Thank you.
Thanks, Randy.
Your next question comes from the line of Steven Pelayo, HSBC. Please go ahead.
Yeah. First, if I can follow up on Randy's questions. On 28 nanometer, I'm curious, can you talk, you mentioned that the majority of this year is more polysilicon, but I'm wondering if you could just talk a little bit about number of customers, tapeouts, how you see the High-K version ramping up. Will that be a meaningful percentage by the fourth quarter, or just give us a little bit more color on 28 nanometer besides just percentage of revenues.
We can't disclose the names of the customers, but we do have more than two customers on the 28 nanometer polysilicon. Currently, we have enough products, new products, to keep the loadings going. For 28 nanometer, yes, you are right. For the second quarter, the majority of revenue come from 28 nanometer polysilicon, and second quarter, we increased 26% compared with the first quarter. The total contribution already account for 6.6% of the revenue. We target the total loadings and the percentage of 28 nanometer in our total revenue. We continue increase to high single digits in the next two quarters. We do have the HKC right into production. We will see the contribution to our revenue in the second half year.
Okay. Second question for me is going to be a little bit on cash flow. Yes, you guys have fairly good cash flow from operations, but your CapEx is still 2 to 3 times bigger than your operating cash flow. Looks like a negative $500 million to $700 million per quarter burn on the decrease in cash each quarter. You have about $1.4 billion in total cash on hand. Do we really only have 2 to 3 quarters here? Are we going to have to do another financing event there? What are you thinking on cash flow over the next 2 to 4 quarters?
For SMIC, actually, we have very conservative policy in controlling these cash flow things. Currently, we do have sufficient cash in our hands from our operation revenues. In the meantime, we also have sufficient guarantees of these financial tools. You see the job of this kind of cash flow mainly because for the investments, it's never really run through month by month. You already agree with the guide here, and we just guide out these kind of investments at a specific time point. Overall, we are very conservative on the cash, and we do not see issues at this moment.
Steven, I'd like to also remind that we do have a joint venture, which will also contribute the cash into this CapEx. Also, you probably noticed we also exercise some of the leasing program and to fund this installation of equipment . Overall, we see we should be fine with our cash position.
Okay. Are you expecting capital contributions from the JV partner in the second half of the year? How much will that be?
Our largest joint venture is the joint venture in Beijing together with the investors, SMIC account for 51% of the share in the company and controlling. For the CapEx, we have the investment in Beijing, and that one, 50% come from our partners in the joint venture.
I'm sorry, last time I was trying to understand, will there be a capital injection from the JV partners in the second half of the year?
Yes. Because this year's CapEx mainly for the fab expansion in 12-inch, and the largest 12-inch expansion actually happens in Beijing joint venture. That cash injection is 50% of the CapEx spending we announced.
I'm sorry. How much were you expecting?
We didn't say.
We did not disclose the detail of individual fabs.
Last quick question, just more longer-term question I wanted. There's a lot of Chinese capacity that's coming online, right? Hua Li, PowerChip, UMC, TSMC, GlobalFoundries, they're all building in China. As you think about two years from today, maybe, and all those fabs are up and running, how are you thinking about the competitive landscape in China? You guys have had sole running there for a while. What are you thinking a couple of years from now?
Hi, Steven. You are very familiar with the current situation in China. The strategy for SMIC is to focus on our own further development. Just now, I mentioned the strategy, three parts for SMIC. The first part that will strengthen our relations and build our strategic partnership with our existing customers and expand the portfolio for corporations. The second is that we'll strengthen and enhance our mature nodes and become the best quality, best delivery time of foundry. For so many years, we already have very solid base in the mature technology nodes and quality and the technology strengths and the relationship with our customers. The third, that we do have the specialty technologies like CMOS image and flash memory.
At this moment, just like you mentioned, that we really seriously study the situation and the challenges to SMIC, we are very confident that we can maintain SMIC's position in China and continue our success story.
Okay. I'm just going to sneak one last quick one in here for me. Depreciation, what are you targeting for the full year? I noticed that depreciation in the cost of goods sold in the second quarter actually decreased. How are you thinking about the depreciation within the cost of goods sold? What's embedded in your third quarter guidance there? Full year depreciation and amortization, then third quarter depreciation in cost of goods sold. Last question from me. Thanks, guys.
Yes. Actually, Steven, we already announced previously that for the whole year, the depreciation will be within $1 billion. We really see a quarter slight up, but whole year overall, still within the guidance, $1 billion.
Thank you.
Thanks, Steven.
The next question comes from the line of Rex Wu. You may ask your question.
Thank you, management. Can you comment a little bit on your Taiwan peers, like UMC, start to focusing more on the mature nodes. Can you talk about more SMIC's competitive advantage in these mature nodes? Thank you.
Hi, Rex. Thank you for the question. Just now we already mentioned the strategies, taking into consideration of the challenges we have from Mainland China, new wafer fabs, and the competitors overseas. Actually, for so many years, overseas situation more or less is the same. There won't be a change. The competition has been there for many years, and not from today. We'll focus on SMIC's strategy, just to strengthen our strengths in the mature nodes and in the relations with our customer, and in the qualities and time delivery to market. For this mature nodes, we do not comment on a specific competitor, but the things I like to say, the competition has been there for many years. We do now see, doesn't matter, they have the facility in China or overseas, the competition is no big change.
We have been facing with this kind of competition in the past four, five years. We really say that in our mature nodes, just now I mentioned that, for the communication sectors, fingerprints, CMOS images, flash memories, and the general logic are a final of this kind of MCU. We have been very successfully have our market share, and we have our product base and our customer base. We will continue our strategy on this part.
Oh, okay. Thank you. My second question is, can you update on your NOR flash, like an outlook for the next year?
Okay. That's a very good question. Actually, I like to mention that. As you know, SMIC from the start up was a memory company. Of course, at that moment was doing the DRAM technology. After SMIC completely withdrew from the DRAM foundry business, we focus on logic. Actually, we kept one of the area is the flash memory technology for special customers or specialty applications. For so many years, SMIC has been very strong in this area. That's one of our strongholds for this specialty flash memory and for the NOR flash and even the standalone NAND flash. You know, this year, from the end of last year, we saw very strong recovery and very strong demands for specialty memories.
SMIC benefits from the preparation of so many years of flash memory technology, also from the building up accumulation with the customer base and the market shares for our customers' market shares of the flash memory. We saw very, very strong demands for the NOR flash area. The only thing is that, is the time. SMIC, even though we like to cater to our customers' strong request, it take time to build out the capacity. The flash area, especially the NOR flash area, for our customer, they already qualify this kind of thing into the automotive and the server. This is a very stable area for long-term demands. We already convert part of our capacity to support this demand. That's one of the area for our revenue growth and the fab utilization in the coming quarter and next year.
Okay.
We can also comment that the profitability of such a special memory is quite good than before, much better than before.
Okay. Thank you.
Okay.
Your next question comes from the line of Charlie Chan of Morgan Stanley. Please ask your question.
Hi, Haijun. Hi, management . Thanks for taking my question. My first question is regarding the raw wafer supply. Can you give us some comments on the supply situation and whether that constrains your business development in those flash memory or other fab filler business that you mentioned last time? Thanks.
Hi, Charlie. Raw wafer supply has been a very big topic these days in the market. So far, we do not see a very big concern on this area. One of the reasons that SMIC has been in the foundry market for so many years, and we already qualified all the major suppliers, we got a mix. Just to pre-empt these kind of sudden situations, this is one of the factors. The second factor is that, SMIC, since two years back, we already forecast a very strong growth in our revenue. Beforehand, we already start to have this kind of forecast with our supplier side. We still on trend for revenue growth and wafer demand , so we do not suffer from this kind of sudden change type of things, mainly because of the planning, where we have the forecast for additional requests on the wafer quantities.
Just now I mentioned that for the NOR flash, for the NAND flash, for this kind of memory, special things, it has been in our forecast. This is one of the reasons. Another reason is that, actually, for the raw material supply these days, mainly limited by the overall quantity inside of these special requirements. It doesn't matter what kind of wafer specialty, and on the requirement, on the specifications. The true bottleneck actually is the silicon ingot. It's the silicon slice or silicon wafers, instead of the later part, process treatment side. Like somebody like, let's be thicker epi , let's be thinner, and different concentration of the dopants in the wafer. We should say, SMIC is still on the trend of forecast that each year, how much percentage of the revenue growth, how much more wafer we need to produce.
This kind of a cooperation and a contract already settled down with our suppliers. They want to change with the product mix change inside SMIC. The situation is very good so far. Yes.
Okay, thanks. My next question is regarding your fab utilization and your CapEx plan. I think at the beginning, the company revised down the full-year revenue growth guidance, while you maintain your full-year CapEx guidance at $2.3 billion. Fab utilization rate, I think in 2Q is high eighties, right? I am not sure how to reconcile this low utilization versus your strategy that you want to utilize the current assets instead of spending CapEx when your fab still has space. Can you sort of reconcile this long-term strategy versus this year's challenge?
Sure. I get your point, Charlie. For the long term, we already announced before, communicate with our investors, that long term, we target 20% CAGR growth. That portion, no change. We still maintain that for the long term, we have this 20% across years growth. In order to make this kind of targets really safe, we need to have the growth. This is the first thing that really for the CapEx spending, for the capacity expanding, for the technology development will continue. The second thing, we do have the flexibility, really take into the market change, dynamic change. We have the criteria for the tools and procurements and the capacity release. For that portion, we are very cautious. So far we're still able to handle that.
Come back to the second quarter, soft market, utilization drop , you mentioned the high 80s. We do see the recovery from the market and the situation for the fourth quarter next year looks better than before. At this moment, we do not have the strong motivation to slow down or to stop. I would just now mention that we do have the criteria. We do not suddenly buy all the machine there, just prepare for next year. We do have the trigger points. By what kind of utilization to trigger and how much capacity we need to acquire in the next quarter, in next six months. We have very accurate adjustments on this part.
Okay, understood. Just a very quick clarification on your second half fingerprint business recovery, right? You said the coming in new customer or the existing big customer, their demand comes back. Can you clarify a little bit?
First things first, we do have new customer coming, this account for part of the things. For the existing customer, for the fingerprint applications, the same as their imager applications, we also see the recovery. Yes.
Okay. It's perfect. Thank you.
Thanks, Charlie.
Your next question is from Roland Shu of Citigroup . You may ask your question.
Hi. Thank you for taking my question. First question, for your strategy, now you are going to work on your existing customer and mature technology and also improve the specialty platforms. It looks like your CapEx spending next year or going forward probably won't be as big as this year. Is this right?
Hi, Roland. We have to say no comments for next year. Just now we mentioned that for the long term, we are targeting at 20% growth CAGR. Definitely we need to prepare the things for this kind of targets.
Yeah. Agree. For this 20% growth CAGR, you need to expand the capacity. For your strategy, actually, you are trying to focus on more mature technology and the specialty platform. For the leading-edge technology, probably the intensity, will it be as big as this year or previously?
We are expanding like previous years. We are expanding on both the mature and the leading edge. We are working with our customers. We build out a capacity on the basis of the customer demands. Definitely we have the plans with our customer on what kind of technology platform, what kind of capacity, what kind of a timeline. Mainly the targeted marketing area, customer name, and the product name, and the timelines. With this kind of a realistic base to expand the capacity. It turns out to be, there's a mix of different products, even in the same fab. For example, even in the 12-inch fab, we do now have the same fab setting as the other peers.
Let me dedicate one fab just to one technology now. For our side, we have to make some mature nodes and the leading edge in the same fab. When we're talking about mature, they including the 12-inch, about established type of platform to get expanding, expansion. Just now I mentioned that for the NAND flash, these kind of things. Currently, for the CapEx, we have more than two-thirds of equipment CapEx spending in Beijing B1 and B2 joint venture . Also Shenzhen 12-inch wafer fab. We already mentioned that for the Beijing B1, the 12-inch wafer fab in Shenzhen, that's mainly on the mature nodes. Beijing B2, that's the brand-new fab.
Okay, thanks. For your mature nodes, are you considering to use a 12-inch mature node to do the production for applications such like driver IC or MCU or even for this power management IC?
Actually, SMIC already qualified this kind of technology in 12-inch, currently for the three products you mentioned that we are running both 8-inch fab and the 12-inch fab. Some are even exactly the same platform, same technology nodes, we are running both 8-inch and 12-inch. It depends on the fab spaces and the flexibility of the machines when we add on the mature nodes capacity. For example, if we add on the mature nodes, in 12-inch, we can cover all the way from 55 to 0.18-micron. We may choose to add on the machines to 12-inch wafer fabs. Especially in SMIC, we also consider, the fab spaces, which fab spaces we add on machines, and they can contribute to the revenue quickly. That's true.
Okay.
Your point is that we also do the things, expand the capacity in 12-inch. Yes.
Okay. Thank you. Yeah, my second question is, I see the revenue on your 0.11-micron, 0.13 micron and the 55, 65 nanometer nodes increased. The revenue contribution from 0.15, 0.18-micron have been decreased a lot in the past quarters. What kind of the end applications change for each node?
That's mainly from the soft markets of smartphones and-
They change the product mix. When we have the product mix, usually they also impact the fab utilizations. For some customers, for some applications, they need many layers of front-end implantation, this kind of thing for another product. When you switch to, you need to add on a lot of metal layer . That's a product mix, make the utilization change. Our side, for our foundry fabs, we really see very strong demands for the automotive products, and that give us a very big increase. In the-
Yeah,-
For the second quarter, for the fingerprint product, we see a serious drop. That one product getting higher, another product getting lower, that's the product mix change.
I can assume these auto parts actually are probably increased, at least contribute this 0.11-micron, 0.13 micron.
Yes.
NOR flash probably contribute at least 55, 65 nanometer. Am I right?
You can say that. 0.18-micron
How about the decrease from 0.15, 0.18-micron? That is mainly from the fingerprint sensor decrease.
I guess you are right.
Okay, how about for 3Q? For third quarter, how does these, each end application work in 3Q?
We could not comment too much on this part, but just now we already mentioned that we already saw the recovery of the mobile phone area, especially for the fingerprint, these kind of products, and also the flash memory products. Yes.
Okay. Thank you. Yeah.
Thanks, Roland Shu.
The next question is from Rick Hsu of Daiwa Securities. You may ask your question.
Yeah. Hi. Good morning, guys, and thank you for taking my questions. I just have two questions here. The first one is regarding your second quarter OpEx. The number looks pretty high compared with the first quarter. Did you guys not receive any government subsidies, or can you elaborate that part?
Hi, Rick. First thing first, yeah, that's right. For the second quarter, you see the OpEx percentage higher than the first quarter. For the overall, we maintain the same level, around the same level for next quarter. Because the OpEx, we invest in the R&D and the Shenzhen 12-inch wafer fab mini line setting up.
Oh, okay.
The second question that I mentioned that, whether or not we receive the government funding and grant, we do have that in our financial table. You can see that we have $16 million grant for R&D contract from the government side. Yes.
Okay. I just want to clarify that in second quarter, you did not receive the funding from government? Is that am I right?
No. We received, just now I mentioned the number, $16 million grant from the government on the R&D contract. Yes.
$15 million.
16.
16.
Yeah. $16.
Okay. You also provided guidance, a quarter earlier that, in total you expect to receive $75 million-$80 million, from government for the whole year. The number is still true?
Yes, still true. We still maintain that we'll receive that much, yeah.
Okay. Thank you so much. Second question is, I know you talk about your full year revenue growth expectation, and you also talk about your Q4 this year's revenue will likely be better than before. Could you elaborate more about your Q4 visibility? I know it's a little too early, but I want to see how your Q4 look like in terms of visibility. Would that be counterseasonal?
I cannot give too much comments on the fourth quarter. At this moment, we really saw the PO momentum picking up. Just now we say that the situation looks better than previous expectation.
Okay. All right. Thank you so much. That's all I have.
Thanks.
Your next question is from Chris Yim of BOCOM International. Please ask your question.
Hi, good morning and thanks for taking my question. My first question is on what you mentioned earlier regarding to ASP pressure. Can you give us a little bit more color on where you are seeing the ASP pressure and how much it is impacting your gross margin? That is my first question. Thank you.
Actually, this year, the capacity got a relaxation than last year, and the overall market become very competitive, not just to SMIC. Everybody feel the pressure. We recognize the pricing competition, and we are picking up the market price. The trend, we should say, your understanding of the market situation, that is the normalized pricing game for SMIC. I can say that. For SMIC, we have been so for so many years, and we are mainly running on the mature nodes. We are later on the leading edge, and we have our way of handling the cost control. We will continue the way of doing this. You know previously when we have the 75 nanometer, 40 nanometer, we might have with a similar competition on the pricing side. The market, not every year they have the very tight situation like last year.
For so many [relapse] years, we run through with a similar strategy. We just focus on our internal management and cost reduction, and finally, we will work through the competition in the pricing.
My follow-up is on your revised annual revenue guidance. Given that you are guiding a little bit lower for 2017, do you still maintain the gross margin target for mid-twenties this year?
Yes. We'll maintain that. Yes, mid-20 for the overall gross margin for this year.
Thank you. My second question has to do with your 28 nanometer technology. I was wondering if you can tell us more detail on the HKC and HKC+. Would you be able to tell us the demand you're seeing in HKC? For HKC+, you mentioned being ready in 2018. Is that more like risk production, mass production? Compare to HKC, in terms of performance and power consumption and maybe die size, how much is HKC+ better compared to HKC?
Hi, Chris. For 28 nanometer High-K, technology nodes wise we already say that we'll make the production and on HKC in the second quarter and second half year, We will deliver the technology at the end of this year so that we can ramp up the High-K capacity next year. Currently, we are very carefully ramp up the High-K capacity. Performance point of view, SMIC is foundry compatible. We deliver the compatible performance to the similar technology nodes in this foundry industry. That's the standard-setting performance. For HKC+, for SMIC, we give the competitive edge. That means the customer running the product needed this high performance and more or less different foundries have to agree that different foundries and give a little bit different number. Our number, when we really look at our HKC, that's the most competitive in the foundry area.
In the performance, the die size reduction performance and the standby current dynamic power. We just match the most competitive.
Thank you. That's all I have.
Okay, thanks. Great.
Your next question comes from the line of Sebastian Hou of CLSA. Please ask your question.
Hi. Yes. Thanks for taking my questions. My first question, that is on your LFoundry contribution. If I look at your application breakdown, can I assume that most of your automotive industrial revenue is coming from LFoundry?
The first question is, yes. As you might see.
Okay
that in China side, we also get other products. Like MCU, NAND flash also rank in the auto area.
Okay. Yeah, I understand. If you look at LFoundry, the revenue run rate that in the past few years before you acquired, it's probably around $200 million or $200 million-$250 million revenue per year. Since you just started to book the revenue from that since August last year, if I remember correctly, that's five months in last year. If we do the math, this year, you have full year. Last year, you only had five months. Basically, that can help you to grow about 5% incremental revenue. Your full-year revenue guidance is mid to high single digit, which means that most of your growth this year is driven by LFoundry acquisition. Your organic growth probably will be 0% or just a very small growth. Am I right?
Yes. More or less, your numbers has been there. We also get growth from the joint ventures from Beijing fab this year. They also ramp up to very high capacity. For the mature fab, you know that. Last year, we already announced that ASP is running more than 100% utilization. Naturally, we want to expect the growth from there.
Okay, thank you. My second part of the question is on the NOR flash that you mentioned. You mentioned the profitability is better than before. I wonder how much better wafer price do you get, say, per 10% increase in NOR flash chipset price hike, since you're a foundry, but not IDM, you probably need to share the price increase with your fabless customers. What was the profit sharing, and how much better is that in terms of the profitability? Is it above or similar to your corporate average margin?
Sebastian, usually we do not disclose such detailed information, the sensitive information. We should say that its profit margin mainly comes from definitely the market getting better, customer can afford higher price. In the meantime, we also simplify the process flow and so that the cost is lower than before.
Okay. I understand. I understand it's confidential. Just wonder, just like a ballpark number in terms of the profitability, is it right now standing above your corporate average or similar?
Okay, similar.
Similar. Okay, got it. Also, just to follow on the NOR flash, that you say that these are going to be, I think you mentioned a couple of times in your prepared remarks and the Q&A session, that this has been the driver for your public growth driver for your second quarter revenue, also you're very positive in second half this year into next year. If I understand correctly, I think most of your NOR flash is manufactured on 55 or 65 nanometer, but that node's revenue only increased by 2% sequentially. It seems not very significant. I wonder how and when do you see the more significant revenue ramp or contribution to you? Which quarter? Second half this year or next year? Also, I think NOR flash is, every die size is pretty small, so it doesn't consume a lot of wafers.
How will this put into the numbers to contribute to your growth for next year, given it doesn't consume a lot of wafer?
We should say this way, this kind of memory demand has been there, to convert capacity or build up the bottleneck capacity takes time, the revenue contribution only show up in the Fourth quarter this year . The things that the final contribution to the company is mainly from the overall utilization increments. For the overall, we recover to a stage, we add up so much new capacity. Later stage, we'll see better utilization. For this kind of area, we have the NAND flash contribution because they fill up the capacity we build up.
Okay. Just clarify, sorry. You mentioned about that the revenue contribution just started in first quarter this year or when? Sorry, I didn't hear that clearly.
Fourth quarter this year.
Oh, 4Q this year. Okay.
Yes.
4Q this year. In the past, I understand that the NOR flash was probably similar to a filler for you, when the utilization rate is high or low, and like a filler. Are you now more serious than this compared to before?
Okay. The first thing, the first comment is, yes, probably the fab filler, but the total capacity is very minimum. Even though we treat it as a filler, but it did not really perform the functions that fill the fab. Now we mainly build out the bottleneck area. In the future, we still have the flexibility we can convert by 100% the capacity we use for NOR flash today.
Okay
We can treat it for the coming timeframe when the memory market is very hot, it is considered one of the strategic with our customer together. Once the market gets softer, we can convert back, yeah, all the capacity back to logic and other applications. The things that will follow our customers.
Okay, great. Thank you. Thanks a lot.
Yeah, Sebastian. Yeah, thank you.
We'll take our last question from the line of Gokul Hariharan of J.P. Morgan. Please go ahead.
Yeah, hi. Thanks for taking my question. First question is on your plans on 14 nanometer development and the R&D spending required for that over the next couple of years. Previously you'd mentioned 2019 is when you would see 14 nanometer coming into production. Is there any updates on that? I had a follow-up question as well.
Hi, Gokul. Yes. On the timelines for this technology delivery and production and the spending and maintain the same. Just as currently since our 20 nanometer program went smoothly, we have more resources to support this 14 nanometer FinFET development. Because 20 nanometer HKC+, HKC has been running the same R&D fab with a 14 nanometer. With one technology moved faster than scheduled, so we have more resources to support the 14 FinFET on development. So far, just now I mentioned that 14 nanometer FinFET, we got a very good progress in the SRAM yield and the process, and setting up. Yes.
Okay. Any color.
The timeline, other things still maintain the same. Yes.
Okay. Any color on how much of your R&D spend as we go into next year will be focused on 14? Because looks like, this year, a lot of it is still 28 related, right?
No specific type of comments on the 14 nanometer FinFET. At this moment, we still do not have the full visibility of next year's situation. SMIC's overall R&D spending has been within a certain %. We do not go for rush spending on one technology and the nodes. We really need to balance the overall planning for capacity, overall gross margin, and the customer requirements. Just now I mentioned that when we do the R&D, we mainly have four factors on the table. The number one is the market segmentation, the second customer's name, third is the product, and then timelines. We're taking all the factors into the consideration for the R&D speed and the spending.
Okay. Got it. My last question is on the leasing program for some of the capital expenditure. Looks like this year, you are taking advantage of more of the leasing facilities, especially in first half of the year. Could you talk a little bit about what is the strategy around that? How big a portion of the CapEx could be supported by the leasing program going forward? How does it impact the P&L, as we exercise more of those facilities?
Hi, Gokul. You know, the financial situation in China has been improved significantly in the past two years. We have all different choices, financial loans and leasings and other borrowings, many different ways. You used the terms that SMIC took advantage of the available financial tools. That's very right. We really have multiple leasing and companies working together with SMIC so that we can have very good preferred type of leasing and scheme for SMIC. That's a very good situation. Again, just now probably Frank already asked the question that for SMIC and for the cash flow, the cash balance, and overall CapEx spending, for the achieve the 20% growth of capacity on mature nodes and the leading edge, we really need to meet up all different requirements to reach a balancing point. Gross margins, R&D spendings, the capacity expansion, mature nodes, the leading edge.
We just take into the consideration the overall balancing point since we have different choices. For the leasing, this is the first time for SMIC to use this tool, probably they [open our guide is kind of tool]. I consider it's a very positive. How much we want to use it and mix together with the own cash, borrowings, other things. At this moment, we do not have the fixed number. We do not like to define ourselves how to go for that kind of percentage. It's really a balancing point for SMIC, and when we see the needs.
Okay, fair enough. Thanks.
Okay, thank you.
I would now like to hand the call back to CEO, Dr. Zhao, for closing remarks.
In closing, I'd like to thank everyone who participated in today's call, and again, thank all of the shareholders, customers, employees, and the suppliers for their trust and support. Thank you.
Thank you. This is the end of SMIC's first quarter earnings conference call. We thank you for joining us today. You may all disconnect.