Welcome to Semiconductor Manufacturing International Corporation's First Quarter 20 17 Webcast Conference Call. Today's conference call is hosted by Doctor. T. Y. Qiu, Vice Chairman Doctor.
Haijun Zhao, Chief Executive Officer Doctor. Yonggang Gao, Chief Financial Officer Mr. Gareth Kong, Executive Vice President of Strategic Business Development and Finance and Company Secretary and Mr. Ng Ling Feng, Vice President Investor Relations. Today's webcast conference call will be simultaneously streamed through this Internet at SMIC's website.
Please be advised that your dial in 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.smic.com, but cast playback will also be available approximately 1 hour after the event. Without further ado, I would like to introduce to you Mr. Erng Lin Feng, Vice President of Investor Relations for the cautionary statement.
Thank you.
Good morning and good evening. Welcome to SMIC's Q1 2017 earnings webcast conference call. For today's call, our Vice Chairman, Doctor. T. Y.
Chu will make a few comments first. Then our CEO, Doctor. Haijun Zhao will provide some business remarks. Afterwards, our CFO, Doctor. Gao Yonggang will highlight our financial performance and give guidance on the next quarter.
Then our Executive VP of Strategic Business Development, Finance and Company Secretary, Mr. Garrett Gong, will give the detailed financial commentary. This will then be followed by our Q and A session. As usual, our call will be approximately 60 minutes in length. The earnings press release and the quarterly financial presentation are available for you to download at our website under Investor Relations in the Events and Presentations 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 are subject to risks and uncertainty. Our actual results may differ significantly from those projected or suggested in any forward looking statements. For a more complete discussion of our 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 reports on Form 20F filed with the U. S. Securities and Exchange Commission on April 27, 2017. During the call, we will make reference to financial measures that do not conform to Generally Accepted Accounting Principle, 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 reconciliation of CAAP 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 Vice Chairman, Doctor.
T. Y. Qiu for some opening comments.
Thank you, Erlin. Greetings to everyone. As most of you are aware, SMIC yesterday announced that I have stepped down as CEO. Doctor. Haijun Zao, as nominated by me, was appointed by the Board as the new CEO to take the company forward.
This is a tough personal decision for me, but my family commitments have called for me to devote more time to them. Although I no longer serve in an executive capacity with SMIC, I continue to serve on the Board as Vice Chairman and a Non Executive Director, and I will continue to contribute to SMIC's future growth and success. It was an honor to lead the SMIC team in transforming the company these last 6 years. Challenges were many, but as a team, we have overcome those challenges. We improved our product portfolio, tightened factory operations, raised the fab utilization, strengthening our financial position and earning the respect from our stakeholders.
SMIC is now well positioned as a leading player in the global foundry market. I'm extremely proud of our team's achievement and as well as thankful to their dedication. Now as we move on to our next chapter of growth, the opportunities and challenges in front of us are still many, but both the Board and I are highly confident that under Haijun's leadership, the SMIC team can continue to deliver outstanding results for the benefit of all stakeholders. Since joining SMIC 7 years ago, Hygiene has been an invaluable leader and is critical part of the team, which brought about the transformation in these past few years. Hai Jin joined SMIC in October 2010 and has moved quickly through the company's rank.
In April 2013, he become the Executive VP and Chief Operating Officer. And in July 2013, he also assumed the role of General Manager of SMNC, our joint venture in Beijing, which has been the most significant investment made by SMIC in recent years. I believe in hygiene and his energetic leadership that he will continue to lead the company as a global professionally managed and independent company. In the meantime, I'll stay full time to support hygiene and ensure smooth and seamless transition. Over the last 6 years, we have strived to improve our management system and have come to cultivate very strong teamwork.
Now we benefit from outstanding management team with a diverse range of experienced leaders and thousands of dedicated employees. This is a perfect time to make the handover and transition. I will now hand the call over to Haijun for Q1 results and business remarks.
Thank you, T. Y. Greetings to all listeners and thank you for joining us. I'm greatly honored to have this opportunity to lead SMIC team at this exciting moment in our history. I would like to thank KY for his guidance and mentorship.
I look forward to continuing working with SMIC team as we continue to enhance our competitive position in the foundry markets. As a global and independent foundry player, we are committed to delivering results benefiting our shareholders, customer and employees. Now to address SMIC's business, I will highlight our quarterly performance, the challenges we are facing, how we are tackling these challenges, our long term opportunities, the preparation for continued long term sustainable growth. In the face of seasoning weakness and our customers' transitions, Our team delivered a good quarter with decent year on year growth, improved operation income and a record high EBITDA in Q1 2017. Revenue grew 25% year on year, representing a sequential decline of 2.7%.
Gross margin was 27.8% compared with 24.2% in Q1 last year and 30.2% Q4 last year. Operating profit grew 17% year on year and 57.9% quarter over quarter. Consolidated net profit was $34,200,000 an increase of 24.1 percent year on year and 10.6% quarter over quarter. Net profit attributable to SMIC was at $39,800,000 compared to $31,400,000 in Q1 last year and $104,000,000 in Q4 last year. EBITDA was a record high of $312,400,000 an increase of 42.8% year on year and 13.9% quarter on quarter and representing an EBITDA margin of 39.4%.
In the first half of twenty seventeen, we are confronting the challenges of customer undergoing changes in the market positioning, seasonal inventory adjustment and overall muted handset market in China. As such, we have guided Q2 to decline 3% to 6% quarter on quarter, which however represents an increase of 17.5% to 21.3% year on year. We have actively pursued new incremental revenue from a variety of customers and markets to mitigate the impact of such headwinds. In the Q1 of 2017 from a technology node perspective, 28 nanometer and 55 nanometer wafer revenue sequentially grow 39% and 9.1% respectively. By application, smartphone weakness was countered by growth in feature phones, tablets and other consumer applications.
We continue to ramp up 28 nanometer, 55 nanometer and additional products on 8 inches wafers. From a device perspective, we are pursuing growth in area where we are seeing meaningful demand such as NOR flash, RF connectivity, power IC and others. We acknowledge this year is challenging, but remain confident in SMIC's long term potential and opportunities. We believe we are in a great position both strategically and financially to weather this cyclical downturn and benefits from some exciting future trends. We strongly believe SMIC is in a great position to benefit from an array of long term trends.
And today, I'd like to highlight the market opportunities in automotive and the Internet of Things. Our foundry serves as a platform for SMIC providing a most significant presence in the auto and industrial sector and has opened opportunities for collaboration in the future both in Europe and in China. Since the acquisition of AirFoundry, SMIC has become the market leader in auto related CIF. In addition, situated in China, the largest market for auto, IC design companies have the incentive to explore ways to break into the supply chain and SMIC may benefit from this in the long term. IoT is another exciting area.
As an example, one of our domestic customers recently reported 1,000,000,000 shipments of IoT related chips for which SMIC is their primary supplier. Some IoT chips manufactured by SMIC are being utilized in everyday items such as shared bicycles. They are reportedly millions of shared bikes in China and they are growing exponentially and are breaking into international markets. Shared bikes are just one example of IoT chips applied in China and we believe this is only the beginning. We are excited to be part of this trend.
In the last 2 years, utilization was running close to 100%, which advantage like make a juggling production and R and D requirements a challenge. We are currently taking advantage of the low fab utilizations to accelerate the R and D program for both advanced and mature nodes. The turnaround time for R and D project has accelerated R and D related wafer moves more than tripled in Q1 this year compared to Q1 last year. We believe these activities are vital to the company's long term sustainable probability and growth. Our 28 nanometer is ramping up and reached 5% of the wafer revenue in Q1, representing a growth of 39% Q1Q.
We continue to work with our customers on 28 nanometer new tape outs for a diverse set of applications. Going forward, we believe we will see an increasing variety of applications requiring this long base. The R and D activities on 14 nanometer are also well underway and on track. On larger notes, we continue our efforts in diversification and differentiation of technology. In addition to new technologies, we are working hard on the next generation for a range of existing technologies such as PMIC, CMOS image sensors and non volatile memory.
We are also well positioned financially. We have more than $2,100,000,000 cash on hand when including financial assets as of the end of Q1. In addition to stronger liquidity, we completed the conversion of our convertible bonds in March this year. We believe that the company has adequate funding to finance our near term capacity expansion. To conclude my remarks, SMIC is well positioned to meet the challenges of this year.
We are optimistic about the long term prospects and continue to work hard in preparing the right technologies and strategic path to grow the company profitably. Thank you to our loyal customers, supporting investors, hard working employees and other dedicated stakeholders. I now hand the call over to Yun Gang for the financial highlights and the next quarter guidance.
Thank you, Haijun. Greetings to all our listeners. First, I will highlight our Q1 2017 results and then we'll give our Q2 2017 guidance. Now I will highlight our Q4 2017 results. Our revenue was 793,000,000 dollars Gross profit was $221,000,000 Gross margin was 27.8 percent.
Profit for the period attributable to SMIC was 70,000,000 dollars Now looking ahead into the Q2 of 2017, our revenue is expected to decline by 3% to 6% quarter over quarter. Gross margin is expected to range from 25% to 27%. Non GAAP operating expenses are expected to range from 178,000,000 to $184,000,000 Non controlling interest of our majority owned subsidiaries are expected to range from positive $6,000,000 to positive 8,000,000 dollars which are losses be borne by non controlling interest. I will now hand the call over to Gareth for more detailed financial commentary.
Thank you, Gaozong, and thank you everyone for joining us today. I will now comment on the details of our last quarter financial results. On the income statement, revenue decreased by 2.7 percent Q on Q to US793 1,000,000 mainly due to decreased shipments and change in the product mix. On a year on year basis, our revenue in Q1 2017 still increased 25%. Gross profit was US221,000,000 Gross margin was 27.8 percent at the high end of our guidance range.
Operating expenses decreased to $143,000,000 in Q1 2017. R and D expenses decreased by 10,500,000 dollars Q on Q to $108,000,000 The change was mainly due to high level of R and D activities in Q4 2016. Funding of R and D contracts from the government was $14,000,000 in Q1 2017. G and A expenses decreased by $22,000,000 to $39,000,000 in Q1 2017. The change was mainly due to a decrease of accrued and employee bonus.
Effect of employee bonus accrual, government funding and gain from disposal of living quarters, Non GAAP operating expenses were $165,000,000 in Q1 2017. Profit from operations was $77,000,000 Operating margin was 9,800,000 dollars Profit for the period attributable to SMIC was $70,000,000 while non controlling interests were $6,000,000 of credit to SMIC's attributable profit. If excluding the impact of the finance cost, depreciation and amortization and income tax benefits and expenses, our EBITDA was a record high of $312,000,000 and EBITDA margin was 39.4% in Q1 2017. Moving to the balance sheet at the end of the Q1 2017, cash and cash equivalents plus other financial assets were $2,100,000,000 Our net debt decreased to $663,000,000 at the end of Q1 2017 because of the conversion of CPL 4,000,000,000 into common equities during the quarter. At the end of Q1 2017, our gross debt to equity decreased to 47%.
Our net debt to equity decreased to 11%. In terms of cash flow, we generated $147,000,000 of cash from operating activities. Cash used in investing activities was $849,000,000 Cash from financing activities was $126,000,000 To examine our revenue by application, Communication, Consumer and Computing segments contributed 46%, 37% and 6% of our revenue respectively. From Q1 onwards, we split we also highlight our AutoIndustrial segment to increase to improve our transparency. The AutoIndustrial segment contributed 6.6% of revenue in Q1 2017.
Geographically, revenue from China, North America and Eurasia contributed 47%, 30% and 15% of revenue respectively. In terms of technology, revenue from 20% contributed 5%, revenue from 40 45 nanometers contributed 20 percent and revenue from 50 fivesixty 5 nanometers and 90 meters contributed 22% and 1.3% respectively. Meanwhile, 0.1 micron above line width contributed 51.7% of wafer revenue. In terms of our overall capacity, total monthly capacity at the end of first quarter increased to 422,008 inches equivalent wafers per month. The increase was primarily due to the capacity expansion in our Beijing 300 millimeter fab and our majority owned Beijing 300 millimeter fab.
We reiterate our planned 2017 CapEx for foundry to be approximately $2,300,000 of which about $900,000,000 is expected to be spent for the expansion of our joint venture fab in Beijing. The planned 2017 CapEx for non foundry operations are approximately $70,000,000 mainly for the construction of employee living quarters. Our planned 2017 depreciation and amortization is approximately RMB1 1,000,000,000 slightly down from a previous forecast of RMB1.1 billion due to some delay in the moving schedule for some equipments.
Thank you, Gareth. We would now like to open up for the call for Q and A. As usual, please be reminded to limit your questions to 2 per person. Operator, please assist.
Thank you. Ladies and gentlemen, we will now begin the question and answer Our first question comes from the line of Randy Abrams from Credit Suisse.
Thank you. First, I want to congratulate Doctor. Chu on the work you've done and best of luck and also look forward to working with Doctor. Zhao. I wanted to ask the first question on the growth outlook.
I think you've targeted over long term 20% year over year growth. Maybe in light of the headwinds from mobile and inventory, your updated view for this year? And if you could give an initial view on second half, just your outlook if you see visibility that mobile maybe starts to reaccelerate. And then also from the other areas, what you're seeing from consumer, both from existing and also new applications to drive some additional growth in second half?
Thanks, Randy.
In terms of the growth outlook for this year, we have recognized actually this year turned out to be more challenging than what we expect. And it was seems that actually achieving the 20% growth target to be extremely challenging, okay. But obviously, we are still trying our best. But I think right now, we still think that likely the growth will be in the double digit, but we cannot give a precise number at this point in time because of the lack of visibility in the second half of twenty seventeen.
Okay. And if you could talk then about, for second half, I guess, just your initial view on the communications business, if you still expect, say, the slower trend to persist? And then maybe for the other part of the business, what your where you kind of see the growth coming from in consumer like newer existing applications?
Yes. I think it's I mean, it's quite relevant in the market that I think the Android supply chain turn out to be quite weak this year. And right now, we don't have much visibility in terms of this business in the second half. But we do see pockets of growth in our business. For example, we are engaging new customers in the LED driver area.
We're also having new customers in the image processors area. And we do see very steady growth in our business for our smart cards, our NOR Flash business, our PCD business as well as in our auto CIS business.
Okay, great. The second question I wanted to ask, it's probably 2 part, but it's the 28 nanometer. If you could give an updated outlook for ramp up, it's making some more progress 5%. So progression in second half, both percent of revenue and broadening out of customers second half into next year? And the second part is more based on that, depreciation is a bit lower.
So I'm curious if any potential CapEx, I guess this year is fixed, but if you think maybe CapEx could you could slow the expansion down a bit and so maybe a bit of a change in terms of the CapEx if we're looking out in the next year?
Yes. I would like Haijun to address the question on 28 nanometers and I'll comment on the CapEx.
Hi, Randy here. Hi, Jun. And thank you for the question. For 28 nanometer SMIC has been running and trying the production since the early of last year. And just now from the reports, you saw that we have 5% of the revenue from 28 nanometer.
The true production running in the fab is much more than that. You know that the revenue formed in the Q1 mainly come from the very jammed production of last year. And we expect to see the increasing amounts of this percentage in the next quarter. And for the 20 nanometer technology part of it, we already have 1 fully matured product platform running in full production almost use up most of the capacity at this moment for 20 nanometer. And the CapEx we are spending at this moment mainly to pull in the equipment to build up the additional capacity for another more advanced version of technologies.
And for that technology currently we have very key customers and running their pilot line products and the results already demonstrate that we can run out of the production in the second half of this year. And so at this moment, we are very happy to say that we see the promising results of technology development after the we'll allocate so much capacity and efforts to expedite the moves of R and D wafers and we really benefit the results in the second half year.
Okay. And one quick, if there was a fab that you delayed the equipment move in, like maybe one fab that's ramping up less, I guess with the lower depreciation, was there one area you slowed down?
We are still keeping the CapEx guidance for this year to be RMB2.3 billion. But I think there are some changes in the timing for some moving of some equipment. So they have slightly impacted our depreciation schedule, yes.
Okay, great. Thanks a lot.
Thank you. Your next question comes from the line of Stephen Pellego from HSBC. Please ask your question.
Yes. I was reviewing the annual report for last year that came out a few weeks ago and it showed 2 of your top customers represented roughly 2 thirds of the incremental dollar growth. And I think if you excluded the LFoundry acquisition, maybe more than 75% of the incremental dollar growth last year. So it was a very concentrated growth year. I guess as you look out to 2017, what's your outlook for kind of these top customers?
And do you see a much more expanding breadth that's going to allow to drive this double digit growth you're looking at this year?
Hi, Steve.
Actually, if you track our performance in the last few years, our top five customer consistently contribute about 55%, 60% of revenue. But of course, among the top 5, there's some changes in the ranking for different customers, okay. So what I'm trying to say is that our major customer all have been having engagement with us for a long, long time, okay. But their own performance will vary from year to year, okay. So I don't think our customer concentration is a big issue.
I mean, if you look at our performance historically, although individual customer performance may vary, but overall, I think our overall customer concentration remain more or less the same.
Okay. Then maybe just a longer term question, maybe for Doctor. Zhao. Are things changing, I guess, with the management change in terms of strategy longer term? Are you looking to maybe accelerate maybe some development and moves to 14 nanometer and beyond as well?
I'm curious just kind of the longer term strategy, does it change with management shifts as well?
Thanks, Steve, and thank you for the question. Basically, we should say this way, just now Doctor. Qiu addressed the transitions. And I have been one of the key members of this team under the leadership of Doctor. Chu and I really believe that the strategy in the past 6 years we formed and we already verified proof that and the strategy works very well for SMIC And I will continue to focus on the careful expansion of the existing facilities and everything.
More or less that we will stick to the successful strategy. I want to make drastic change. And with the new challenges like a 14 nanometer and moving to even smaller dimensions, that's the area we like to enhance. And from the introduction by Doctor. Qiu, we also mentioned that SMIC will go for smooth transition and in the meantime we'll go for very steady technology.
We already in practice in the past few years. So we'll stick to the existing strategy, we'll not make a change at least we do not make a drastic change in the near term. And in the meantime, we have to cope with the new challenges both inland and on the technology front end. So we have to make sure that we have stronger technology competition and we have a larger scale of capacity to serve our customers. And that's the balance and we already tried this balance very well in the past many years and we'll continue that.
Okay. Maybe I could just follow-up then relative to Randy's question and that question. Do you have some targets for 28 nanometer? How much do you think it contributes in the Q4 this year? And then maybe as you look to maybe end of next year, what does 28 nanometer or even 14 nanometer start to contribute?
I think our target is still the same. We're still looking at high single digit contribution by Q4 this year.
And do you have 14 nanometer revenue next year or is that more 2019?
Right now for 40 nanometers, we are looking to start risk production in 2019 timeframe.
Okay. Thank you very much, guys.
Thank you, Steve.
Thank you. Your next question comes from the line of Gokul Hariharan from JPMorgan. Please ask your question.
Hi, morning. Couple of questions that I had. And first of all, congrats, Doctor. Chew and welcome, Chao. I want to ask, when you reiterate your long term growth outlook of 20%, could you now attach some kind of a profitability metric also to that?
Are we expecting the EBITDA margins also to stay in this high 30s kind of levels when you kind of go towards that kind of 20% growth target? And how do we manage that growth between your very successful investments that we have seen in the older nodes versus your recently ramped up efforts in terms of going a little bit more faster towards the advanced nodes?
Yes. With the challenges that we faced this year in terms of growth, right now, we're looking at our gross margin guidance for the average for the whole year. We will target about mid-20s. In terms of our EBITDA margin, we still target a high 30 EBITDA margin because at the same time, we are also managing this downturn with very strict tight control over our cost. So actually, we also reviewing all the expenses in the both in the fab and also in the back office to make sure that our cost structure is in line with the new growth
scenario.
Okay. And on the near term stuff, could you talk a little bit about I think we've talked previously about 8 inches potentially having a pretty long backlog of customers. How does that backlog look like right now given that the end demand environment seems to change quite a bit? And could you also talk about what is your outlook in terms of re qualifying some of these fabs for new customers to accommodate that backlog? And when do we kind of expect to get back to near full utilizations on 8 inches
Yes. Obviously, the overall business environment is sort of more challenging now. So that also impact our 8 inches business as well. The backlog is obviously not as long as last year, but we are still qualifying a lot of new products in our 8 inches business, and we are hopeful that some of this new product will start ramping in the second half. At the same time, as you know, through LFoundry, we have entered into the auto sales business and that business is growing very
strong. Okay.
Understood. Just one last question. Just to give get some more granularity on your 28 comments, is there any change in terms of the 28 capacity addition plans through the end of the year? And could you also talk a little bit about how many 28 nanometer tape outs that you are that you currently have on hand?
Yes, thank you. For 20 nanometer capacity expansion and more or less we stick to the original forecast and we do see the demand is still very strong for this long technology nodes so called and we do have both the overseas and domestic customers and are working on this technology nodes with S5C, we see mainly 2 parts. One part comes from the 14 nanometer and the transition for the existing product transit to 28 nanometer, so the capacity for 28 nanometer and keep getting higher. And the second thing is that we do see the new applications for 28 nanometer and they use this technology from other parts. For example RF, SoC and this kind of showing up for 20 nanometer capacity.
So my comments that for 20 nanometer capacity expansion will more or less stick to the original forecast. We still have a strong expectation on this technology nodes for growth.
Do you have any details on the number of tape outs that you have? Or is it too few to kind of disclose at this point?
I'm afraid I can't disclose.
We don't usually disclose such detailed information.
Thank you. Thank you.
Yes. Thanks, Gogu.
Thank you. Your next question comes from the line of Charlie Chan from Morgan Stanley. Please ask your
question. Hi, good morning. So first of all, I want to thank the contribution from Doctor. Chu over the past 6 years, and we look forward to the new leadership from Doctor. Zhao, and we hope all the transition will be very smooth.
So my first question is regarding your A business because you mentioned that this year demand is a little bit weak. So my question is that whether you consider to fill up the ANS fab with some commodity products, for example, the NOR flash, because as you can see, the NOR flash market price continue to go up. So this is my first question.
First of all, our NOR flash run on the 12 inches fab, it's not on the 8 inches fabs, okay. But you made a good point that we are also increasing our wafer start on some of what we call the filler products like the NOR flash and the NAND flash to keep our fab at a relatively reasonable utilization. But we do have on the each side, we do have some new product mix ups, as I said, and that we hope to start ramping in the second half. I mean we have new products in the BCD area. We have new products in the LED drivers area.
These are all exciting large volume business. So we're hopeful that we can transition this downturn quite successfully.
Okay. Thanks. So just quick follow-up on this one. For the driver IC offering, when do you think there will be some small production?
I think, actually, we should start shipping in Q3, my understanding, yes.
Okay. Thanks. And my second question is regarding your depreciation guidance because you mentioned that some change of tool moving schedule and some impact to the depreciation. So can you give us some numbers? And also, I noticed that actually your gross margin holds up quite well in 1Q.
And even for 2Q, the revenue scale is smaller. Gross margin still maintained okay. So why you think the full year gross margin guidance will be only 25 percent?
Yes. As mentioned in my script, we have lowered the full year depreciation to about CNY1 1,000,000,000. So I think that is our current estimate for the depreciation. In terms of the gross margin, as I mentioned, we are also looking at our cost structure very carefully, both inside the fab and also outside the fab, means our OpEx. So basically, we are trying to control our cost in line with this new growth scenario in our business.
So we do intend to maintain our profitability disregarding the slower growth.
Okay. Understood. Thank you very much.
Thank you, Charlie.
Thank you. Your next question comes from the line of Rick Xu from Daiwa Securities. Please ask your question.
Yes. Hi, good morning, guys. I think one quick follow-up to Peter's question about the 28 nanometer. I think Haijun mentioned about a new product ramp up in commercialization sometime in second half this year for new customer. Can I know more about this?
What kind of application products this ramp up is going to be about?
Okay.
Hi, Rick. Hi. I kind of mentioned the specific type of products applications, but mainly I have to tell you that on the new technology platform for this 29 nanometer technologies and currently we're working on 3 fronts, the wireless terminal phase, wireless and consumer. And the first ramp up we currently we are working on the ramp up will be consumer products relatively on medium size of volume type of consumer products. But in the meantime, we do working on a fixed wireless and we have multiple KPOP at this moment to ramp up the consumer products and the face of wireless.
That's the early way we classify the applications to wireless terminal fixed wireless and consumer. We have both the consumer and fixed wireless, yes.
Yes. Let me just make sure to get this right. So you mentioned about 3 product platform for 28 nanometer. One's wireless. The second one is consumer.
What's the ramp up it's going to have? And what's the third one?
Consumer. The wireless terminal on fixed wireless and consumer, more or less the way we classify this way. That's the things I can share with you.
Okay. Brilliant. Thank you so much. One more question is in the fingerprint space, the fingerprint foundry space. Can you talk about your diversification?
Are you diversifying into new customers in this platform? And if so, when are we going to see the real benefit from this diversification?
Yes. We are diversified. We have new customer engagement in the fingerprint areas, and we plan to start to ramp up in the second half.
Ramp up in second half. Okay. Thank you so much.
Thank
you, Rick.
Thank you. Your next question comes from the line Ken Hui from Huatai. Please ask your question.
Thank you for taking my questions. So in terms of the full year outlook, you talked about the revenue, you talked about the gross margin. Can you also give us some guidance in terms of the expenses because it seems like in the first half, it is actually growing faster than the revenue? That's my first question. Thank you.
Yes, that's right. If we look at our normalized CapEx, normalized OpEx, Q1 is about 21%. So we try to target to keep control of this normalized OpEx in the low 20s for the rest of this year.
So can I get more details regarding the reason for the increase in OpEx? Is it because of the 28 nanometer new tab outs or the 14 nanometer or even the new 8 inches product that you need to develop in order to fill the fabs?
Yes. In general, we are still increasing our R and D spending. Obviously, we are working on many version of 28 right now. At the same time, 49 node R and D is well on the way. And as a matter of fact, given the fact that right now, our fab actually the loading has come down.
And we also take advantage of this opportunity to accelerate the R and D activities so that we'll be better positioned for growth in the near term. Okay.
Then my second question is actually related to the loading. I think you report about 92% utilization in the Q1. Can you give us some color regarding the utilization specifically for 12 inches and 8 inches which part is doing relatively better?
We don't actually, we don't break down utilization by fab or by 12 inches or 8 inches But overall, we are looking at probably mid- to high-80s utilization in Q2.
I see. And then the 4th question is, so if you are loading up your 8 inches with new products in the second half, should we assume the wafer prices to be impacted as well in the second half?
First of all, let me correct myself. We also have new product in our 12 inches fab as well, okay. I think Haijun mentioned that we have new tip ups in our trunnate. At the same time, we also have some new products on a mature 12 inches as well. For example, we have new customers in the smart card areas and also we have new customers in the image processors area.
And obviously, we're also increasing our loading for some of the fat filler product, okay. I'm sorry, what's the second question? On ASP, yes. ASP, I think, is a function of the industry conditions. I mean when there's overall the industry loading is down, obviously, there are more pressure from our customer on ASP.
And I think we are not insulated from this trend,
yes.
Okay. Thank you very much.
Thank you, Ken.
Thank you. Your next question comes from the line of Besson Ho from CLSA. Please ask your question.
Hi, thanks for taking my question. So I want to ask about your 40 nanometers revenue. So that has been the major driver for the past few quarters, but noticed a drop in this quarter. When we compare that to TSMC and UMC major foundry, they relatively show still stable 40 nanometers revenue stream, even if the despite the weak seasonality in Q1. So I wonder is there anything change on your 14 nanometer's like customer commitment?
And how do you see this 14 nanometer's outlook for this year and next year?
I think our 40 nanorevenues is basically impacted by what
we're seeing in
the China smartphone supply chain. I think the reason is quite well known in the market. And obviously, some of our 14 hour customers' product are also transitioning to the 20 nanometer.
Okay. All right. But if we look at your communication revenues, it seems not as weak as you indicated in terms of the mobile weakness. If you compare that to TSMC, UMC, there's a clear drop in their communication applications. But look at yours, application breakdown is pretty stable and more of the drivers seems to come from like other applications.
So what's the mix? And how do you really categorize these products into this application?
Yes, because I think our communications is also we the weakness in our 40% is all offset by the growth of 28%, okay? So you don't really see the drop in the communication segment. Yes.
Okay. Last two, the follow-up on the NOR Flash. You mentioned about your I think this is the first time in the past 2 years you mentioned about I think you're excited about NOR flash. So I just wonder whether this is just this market right now is good. So and your utilization rate is low.
So you're desperate for the new business. So you're getting you see this as good opportunities that you're getting to there. So what's the long term strategy of your I mean the product commitment? And who's your customer here and how do you see the Norflash business to grow for the second half of this year into next year?
Okay. I think this is not a hot strategy. It's not that because things are bad, so we start to do NOR, okay. I think this is a well planned strategy that we have we know that the industry will go through cycles. So under Doctor.
Chew's leadership, we have replanned for some of what we call filler products that include the NOR flash and some of the NAS flash products, okay. So as we enter into a downturn in industry, I think we are able to have some product we can actually fill the fabs to maintain a stability in the loading for the fab. So I think this is a well planned and well executed strategy.
Okay.
Thank you. Let me add a little bit. This strategy was also employed in the previous when we had some, see, with some weaknesses inventory adjustment in the market. This exact strategy was used to really ensure good continuous business and good loading in the fab.
Okay, understood. Thank you.
Thank you, Sebastian.
Thank you. Your next question comes from the line of Stephen Chen from Kinkeng Maybank. Please ask your question.
Hi, good morning and thank you for taking my questions. Most of the questions are already answered, but I just have one follow-up regarding the operating expense. You just previously indicated the normalized OpEx ratio target for this year is low 20s. But may I follow-up with more details about what is your expectation of the R and D subsidy? And also, if possible, can you provide an expectation on this for both Q2 and the full year?
And also for the full year NCI, can you also advise us if you have any preliminary expectation at the current time? Thank you.
Yes. In terms of the Cameron funding for R and D contracts, right now we are targeting about $75,000,000 to $18,000,000 for this year. And in terms of the I think the NCI, we are looking at it will continue to be a credit to our income statement in the next three quarters.
Understood. So just to clarify, so when you indicate about low-20s operating expense ratio for this year target, that's already after consider the government R and D funding. Is this the case?
No. Our normalized OpEx exclude the R and D funding, yes.
Okay. Got it. Thank you.
Thank you. Your next question comes from the line of Bill Lu from UBS. Please ask your question.
Yes. Hi. Good morning. First of all, I also want to congratulate Doctor. Qiu for a job well done over the last 6 years.
I think you can all see the changes the company has made in terms of technology, financials, etcetera. So thank you very much. And also want to congratulate Doctor. Zhao, looking forward to working more with you in the future. One is on 28 nanometers.
Can you tell us can you give us an update on when you are going to ramp haikimatogate?
Okay. Hi, Bill. You mentioned a specific name, so for the 28 nanometer Heiko Metal Gate. And actually for this technology we have been running, this high key micro gate 20 nanometer actually has developed into general three versions and we have been running the 1st high performance Metal Gecko HPM type of standard platform since last year in the low volume mainly for the learning curve. Another thing is last year and you know the SMIC fabs for the 12 inches has been fully jammed and so we do not have that much free capacity to give to this new learning.
And this year and we continue the ramp up of this 20 nanometer first version, but we also start to de verifications and test runs of the second version and in the Q3 of this year we'll run into the production. Currently we're running on a pilot line case and with a very small volume for the second version. And to answer your questions the 28 nanometer high gate, metal gate and we also have to increase the capacity and volume from the Q3 this year. And for the running, we have been running the small volume since last year.
Okay. So when you mentioned the 3 new products in the second half of this year, those are in fact, HiKi Metal Gate?
On a note, 3 products, 3 platforms, Hai Ke Metal Gate, yes. Actually, the Hai Ke Metal Gate has been divided at a different stage into 3 or more than 3 platforms. So they can't interchangeable in a certain sense. So what I mean is we have been running in a small volume for the 1st technology platform since last year. And this year, we're running both that platform and the new platform.
So how should we think about margins as you ramp up these new platforms? Because I think ASP should be better for haiky metal gate. At the same time, there might be some yield improvement initially that a bit of a learning curve. So how do we think about margins in the second
half for twenty eighteen?
Yes. I think as you rightly put out, I think the margins aside tied to yield as well as the volume, okay. So we don't disclose the margin by technology note, but we in general, as we increase the volume and production scale, the margins improve.
Okay. Second follow-up is on what I guess we're calling fab fillers in terms of NAND and NOR Flash. Can you give me an idea of how much of total revenues this could be, let's say, by the second half of the year?
Actually, obviously, I do have this number on hand, but we will try to feedback to you later on. But we are actually increasing the capacity for our NOR flash and also some of our NAND products right now, yes.
Okay, great. Thank you very much.
Thank you, Bill.
Thank you. The next question comes from the line of Michael Cho from Deutsche Bank. Please ask your question.
Hi. Good morning. I have several follow-up questions. Regarding your high k middle gate, you mentioned Q3 see brand of this at revenue contribution in Q3 or Q4 this year? This is my first question.
Hi, Michael. And Jocelyn mentioned that 20 nanometer Heiko Metal Gate, we have a small volume since last year and we'll run out the second version in the Q3 this year. And because Justin will mention that we have another version of high volume mature keep running already committed the capacity to one of the long term customer there and we're in the run up in the meantime pulling the machines for 20 nanometer high ks. So the high ks for this year I do not expect a very high volume, but they will continue to increase.
So you mean maybe you have very limited revenue contribution in the second of this year, am I right?
Yes, limited by the existing capacity for the Hikmetogane loop. And high metal gate does share most of the common tools with another mature high volume production. But for the high mechanical loop, we are putting the machines in.
Okay. Could you give some updates for your 28 nanometer capacity this year? Is the majority of the 20 nanometer should be polysilicon this year? Could we assume that it could be nearly 100% of your capacity will be for Polycom this year? Or you will have maybe 5% capacity from Hikmoking this year?
I do not have that number exactly on hand because the sharing of the metal gate capacity we also use it for the new platform development for the R and D purpose and I do not know that exactly on the assuring of how much give to the R and D, how much give to the new products ramp up? Yes, I think as what Haijun said, we are trying to pull in the capacity for high key right now. But some of
the I think some of the move in schedule is not confirmed. So we cannot have the precise number at this stage. But as you know, originally, most of the capacities will be were polysilicon. And right now, we are increasing the capacity on high ks, yes.
Yes.
Thank you so much.
Thank you, Michael.
The other thing is, Ming Chu mentioned before you were used on 28 nanometer to do some 40 nanometer. Is that still the planning for this year?
As I said, our 40 nanometers of course, we are still running 40 nanometers right now, but we do we are seeing increasingly some of these product will be transitioned to 28.
Okay. Thank you so much.
Thank you, Michael.
Your next question comes from the line of Donna Lu from Goldman Sachs.
First, thank you, TY for successfully turning around SMIC and also congrats to Doctor. Zhao for becoming the CEO of SMIC in a new era. I think this new era actually there's both good and bad. The more challenging part is UMC will start 28 production in Xiamen this year and TSMC will start 16 nanometer in Nanjing. So my question is how what is the Board and you, Doctor.
Zoc, will do differently next year? And how would you compete with those guys? And also, I mean, comparing your comments 6 months ago and today, clearly, the demand is a lot worse, which is actually very natural for SMIC, you have very high customer concentration and for 20 8 and 40. And going forward, if you want to grow fast, your ROE will suffer. Would you or Board have a bottom line for ROE in the next few years?
Thank you.
Hi, Donald. And just now I already mentioned that like Doctor. Chu addresses at the beginning that we won't change strategy drastically. We will continue our strategy go for very careful expansion of our capacity and but we do and have the more freedom this year and from now on we'll continue to do this that we will allocate more capacity to get a faster move for our TD activities. By doing so, I can
expect that our R and
D progress will be better than before. And just now from so many questions and answers that and we will go for 20 nanometer high and middle gate ramp up this quarter this year and we are putting machines to expand capacity for that. So we really want to see a successful smooth running up of 28 nanometer high megahertz. And in the meantime for the future technology development since our strategy has been there that and we will allocate more capacity and get a faster move for 14 nanometer, we can also see a solid growth on 14 nanometer development.
I think in terms of the competition, as we said time and time again, we welcome competition into China. I mean, if you look at our 8 inches business, I mean, UMC and TSMC have built 8 inches fab in China, almost the same time as we ramped the fab SMIC ramped up the 8 inches fab in China. But history have proven to us that SMIC can compete very effectively. And we do believe that the China market is still growing nicely and big enough to accommodate all this competition. So we are still very confident that we will be able to compete very effectively with our competitors.
Okay, great. Can you give us guidance for free operating cash flow this year and CapEx. And also recently, I think, SMIC increased the number of shares, which will give you more flexibility to raise money. Is that something SMIC expect to do in the next 12 months?
In terms of the operating cash flow, we are still targeting high-30s EBITDA margin this year. So we will still be generating a lot of cash from operations, which ties to the question that we don't have any plan for any equity or equity linked financing because we are actually very well funded. We have GBP 2,100,000,000 cash on hand and our net debt to EBITDA net debt to equity is only in 11%. So I think that again, pilot upon that SMIC have always been very prepared in terms of withstanding business cycles. I mean, we have been in the business long enough to know that the business is always in cycles, and we always run our business in such a way that at some point in time, industry will go through cycles.
And SMIC will able to go through the cycle smoothly.
Great. Thank you.
Thank you, Donald.
Thank you. Your next question comes from the line of Lebing Huang from CICC. Please ask your question.
Thank you for taking my question. I have two questions. One is also linked to the competition landscape. So you delivered very good growth profile in the last 2 years. And we see a lot of fangshui are built in China supported by either the local government or in the mature edge and also UMC and KFC also come to China.
So how you look the competition landscape in China's supply demand or whether the foundry market in China? And do you think that the when you develop the business of Cao Xue in next 2 years, how we should, as investors, look at your growth profile in terms of and the profitability? Maybe a very general question, yes.
Hi, Leping.
Basically, we will do this way. We believe that the new technology development and the competition will come from the market side. That means SMIC will focus on their market driven type of technologies. In the meantime, we also set up the baseline just now Gary answered your last question that and actually it doesn't make a very, very big difference to set up the wafer fab locations in China and overseas because SMIC is an international company. We've always been working with international customer and domestic customers.
So probably the competition if there's any has been there and we'll continue our customer oriented type of strategy to develop the diversified and the differentiation type of technologies to run our wafer fab and go for very careful expansion of our capacities. And this is mainly for the capacity and the technology part. We do not see very big difference in the scenario after the new foundries are set up in the mainland China. And but we do improve our side that like probably we have very high utilization and we do have insufficient allocation to the technology development wafer moves, but we already modified it so that we can deliver the things on time and faster. And for the probability and type of things, we'll continue the successful strategy for the past 6 years and we will maintain a very careful and solid move for the CapEx spending for the ramp up speed and for the customer diversification.
Thank you. And the follow-up, I think you so for similar as other question before, so people as our investor, we are still a little bit concerned about your progress in containers. So do you think that your 10 nanometer product offering, do you have any timetable what your product offering will be competitive enough with the other fabs in the market? So for example, do you have any timetable for the for example, the HiQi Metal K or the Metal Gate or the other product line?
We should say that for 20 nanometer, just now I mentioned that after a couple of years already developed into different platforms and we already have one platform running full capacity, full production, very high volume and that's fully ready to take in all the customers. And for the high end metal gate part, we also have the one platform already started the production last year and we are start to ramming starting to ramp up the 2nd platform this quarter this year. And we should say that we are still market driven type and we know our existing customer and the potential customers' needs and timetable. We just make sure that we allocate more capacity and supporting to R and D timetable to meet our customers' requirements. And for 20 nanometer it's a long node.
Everybody mentioned it stays where we believe so and it's also a mature node. Currently, we are putting the capacity to make sure that we meet customers' requests on these nodes.
Thank
you. Yes. Thank you, Leping.
Thank you. Your last question comes from the line of Maurice Chao from Ping Point Asset Management. Please ask your question.
Hi, good morning and congratulations to Doctor. Xiao for the new growth. So my question is really about your utilization and EBITDA margin relationship. So I noticed in Q1, obviously, wafer capacity increased by a few percentage to 421,000, but your utilization came down from 96.5 to 91 point 8%. So when I calculate the wafer shipment in the quarter, it was actually down 1.2%.
Sorry, it was actually yes, it was down 1.2% based on the capacity utilization. And yet somehow your EBITDA margin went up by almost 6 points. Can you help us to understand a little bit more of a dynamic of why is that your utilization is down, your wafer shipments down and somehow your EBITDA margin way up?
Yes, just because our OpEx had come down a lot in Q1. Because EBITDA margin take into account of not just the gross margin, but also the OpEx spending.
So is it so let's say if you're able to maintain your OpEx at a relatively lower level, I mean, does that imply, let's say, second half, when your utilization, when your shipment of wafer go up, you will see a pretty dramatic bounce back on EBITDA margin?
No, no. Because as I said, we intend to control our OpEx at the low 20s level, which I've said already. And it's also tied into our right now we are imposing very, very strict control on our spending to make sure that we have a cost structure that will be in line with the changes in the growth scenario.
Okay. So in other words, you sort of artificially depressed the OpEx in near term, but it would normalize in the latter part of this year. And therefore, even when your utilization go back up, you don't see the very dramatic go back in EBITDA margin. That's fine. But how should we think about based on your current forecast for the second half, how should we think about a range of EBITDA margin in the second half of this year?
As I mentioned, we're still targeting EBITDA margin to be high 30s, yes.
High 30s just in the second half or for the full year?
For the full year, yes.
For the full year. Okay. Okay. That's great. Thank you so much.
Thank you.
Thank you. I would now like to hand the call back to CEO, Doctor. Chao for closing remarks.
In closing, I'd like to thank everyone for participating in today's telephone conference call And again thank all of our shareholders, customers and employees and suppliers for their trust and support. Thank you.
This is the end of SMIC's Q1 earnings conference call. We thank you for joining us today.