Welcome to the Semiconductor Manufacturing International Corporation's 4th Quarter 2016 Webcast Conference Call. Today's conference call is hosted by Doctor. Thuy Chu, Chief Executive Officer Doctor. Yonggang Gao, Chief Financial Officer Mr. Garis Kung, Executive Vice President of Strategic Business Development, Finance and Company Secretary and Mr.
Anning Feng, Vice President of Investor Relations. Today's webcast call will be simultaneously streamed simultaneously streamed through the Ethernet SMIC's website. Please be advised that your dial ins are in listen only mode. However, at the conclusion of the management presentation, we'll be having a question and answer session,
at
which time you will see 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 1 hour after the event at www.s mics.com. Without further ado, I'd like to introduce to you Mr.
Anling Feng, Vice President of Investor Relations, for the cautionary statement.
Thank you, operator. Good morning and good evening. Welcome to SMIC's Q4 2016 earnings webcast conference call. For today's call, our CEO, Doctor. T.
Y. Chu, will first provide some 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.
Gareth 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. Before I turn the call over to Doctor.
T. Y. Chu, let me 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 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 20F filed on April 25, 2016. 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 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. Please also note that all 2016 full year figures are based on the submission of the unaudited quarterly results for the year of 2016.
I will now turn the call over to our CEO, Doctor. D. Y. Chu for the opening remarks. Y.
Chu:] Thank you, Erlin. Greetings to everyone. We wish every one of you an exciting, prosperous and healthy year of the roosters. We just finished another record year in 2016 with great performance and significant business growth. We recorded historical high revenue of $2,900,000,000 and annual revenue growth of 30% over 2015, outpacing the foundry industry average.
Operating profit reached an all time high of 3 $40,000,000 representing 12% operating margin. Net margin was a high of 11% and the net profit attributable to SMIC reached a record high of RMB376,000,000 dollars EBITDA surpassed $1,000,000,000 for the first time, dollars 1,100,000,000 to be precise, and we achieved an improved annual ROE of 9.6% from 7.6% in the previous year. In terms of significant accomplishments in the last year, we successfully acquired LFoundry in Italy, thus securing a significant foothold in the auto IC market. I'm also proud of the team's quick ramp up of Beijing JV fab as well as the Shenzhen fab, while maintaining high overall utilization of 97.5% in 2016. Over the past few years, we continue to improve productivity with an increase of 8.9% last year, 8.9% revenue per headcount in 2016.
In addition, SMIC engaged several dozen new customers and the number of new products to enter risk production increased 50% compared to 2015. In 2016, we also successfully completed 10:one consolidation of our ordinary shares, which we believe has attracted a broader range of investors. We had another solid quarter in Q4 to wrap up the strong 2016 year. We achieved our 8th consecutive quarters of record high revenue, RMB815,000,000 representing a growth of 33.5 percent year over year and 5.2% quarter over quarter. Our Q4 gross margin was 30.2% and annualized ROE maintained a double digit of 10.1%.
28 nano, 40 nano and 0.13 micron drove most of the growth in Q4 2016. 28 more than doubled sequentially, contributing 3.5% of our wafer revenue in Q4. 40 nano grew 92% year over year and 9.3% quarter over quarter and the 0.13 micron grew 100 and 3% year over year and 21% quarter over quarter. From an application perspective, specialty technology, including MMIC, nonvolatile memory and sensor together grew about 26% year over year and 7% quarter over quarter. We are also pleased to see that smart car business has taken off recently as our smart car related revenue tripled year over year and grew 48% quarter over quarter.
From a regional perspective, all regions experienced healthy growth when compared to Q4 twenty when comparing Q4 2016 to Q4 2015. China, 42% year over year North America, 36% year over year and Eurasia, 14% year over year. We have exited 2016 with strong momentum. And while in short term, we see the impact of seasonality as reflected in our 2017 Q1 guidance, our team has responded quickly to fill in the gaps, and we are targeting still 20% annual revenue growth in 2017. In this year, we continue to focus on careful expansion of our existing facilities in response to customers' executing our strategy of keeping a balanced focus on both growth and profitability.
In 2017, we target to maintain a mid to high 20s percent gross margin and an EBITDA margin of high-30s. With regard to key growth driver for 20 17, 28 nanometer will be one of the primary contributor to growth, and we target 28 wafer revenue contributing to reach high single digit contribution by the end of the year on a quarterly basis. We experienced great demand from 40 nano in 2016. And in 2017, we are able to begin to transition some of our 20 40 flexible capacity towards 28 nanometer. Other growth driver in 2017 include a more diverse variety of mature technologies.
This year, we expect revenue growth from growth will be from various geographic regions, in particular, strength from North America based customers. We continue to benefit from our strong position in China, not only the growing domestic fabless industry, but also from international customers with a desire to capture more content share in China. In 20 17, we expect to increase absolute dollar of R and D spending to low to 10 low to mid teens of revenue, the highest as a percentage of revenue among all major pure play foundries. We continue to follow our technology strategy of diversification and paste advancement, which feed us continuous growth opportunities. Our R and D spending covers both advanced and specialty technology, allowing our customers a platform for a longer term collaborative roadmap.
We are preparing the baseline for diversified technology and we are investing much of our R and D this year on 14 nano FinFET, which is in early stage with the process flow and features defined. SMIC is among the world's top 5 patent filers for FinFET both domestically and globally. Meanwhile, given 20 sixteen's high utilization of 97.5 percent to address the need of more capacity, plant consolidated foundry CapEx of 2016 is $2,300,000,000 of which about $850,000,000 is for the Beijing joint venture fab, which will be 49% funded by our joint venture partners. We plan to add an estimated 11% total installed capacities to close out 2017 with 450,000 wafers per month compared to 406,000 at the end of 2016. In terms of overall annual effective capacity, the planned capacity growth is approximately 25% in 2017 versus 2016.
All capacity additions this year will be to our currently running fabs, in addition to the Shenzhen 12 inches fab, which will install a midline by the year end. With more than $2,100,000,000 cash on hand as of December 2016 and increasing cash generation from operations, we are in excellent position to fund our 2017 CapEx plan. We will continue to expand carefully as we gauge our demand and the overall market. I would like to take the time now to welcome our newest Board members. We welcome Doctor.
Jiangshan Yi, renowned foundry industry R and D veteran Doctor. Tong Guo Hua, a distinguished businessman, entrepreneur, Chairman and President of Datang and Doctor. Jason Kong, influential professor and researcher of advanced computing at UCLA. We are very honored to have such prestigious and seasoned experts joining our Board to contribute their valued insight to our company's vision and the directions. To conclude my remark, SMIC has delivered excellent performance in 2016 and continue to strive to grow profitably and add value, we reiterate our target of 20% compound annual growth from 2016 to 2019.
We have an advantageous position here in China, and we continue to work hard to seize opportunities for the benefit of our stakeholders. In this time of growth, our team strives to perform above par, executing our strategy of differentiation and diversification, serving our customers with excellence and building value through balancing growth and profitability. We thank you for your continued support and for your time. I will now hand the call over to Yonggang for the financial highlights and 2017 Q1 guidance.
Okay. Thank you, Kewei. Greetings to all our listeners. First, I will highlight our 2016 full year unaudited results, which are based on the submission of our unaudited quarterly results for the year of 2016 and our 4th quarter 2016 results and then we give our Q1 of 2017 guidance. Revenue in 2016 was $2,900,000,000 a record high compared to $2,200,000,000 in 2015.
Gross margin in 2016 was 29.2% compared to 30.5% in 2015. Profit for the period attributable to SMIC of 2016 was $377,000,000 a record high compared to 2 $53,000,000 in 20 15. Net profit margin was 12.9%, a record high, compared to 11.3% in 2015. ROE reached record high of 9.6% in 2016, compared to 7.6% in 2015. EBITDA reached record high of $1,100,000,000 in 2016 compared to $800,000,000 in 2015.
Now I will highlight our Q4 2016 results. Our revenue was a record high of $850,000,000 Gross profit was a record high of $246,000,000 dollars Gross margin was 30.2%. Profit for the period attributable to SMIC was $104,000,000 Now, looking ahead into the Q1 of 2017. Our revenue is expected to decline by 2% to 4% quarter over quarter. Gross margin is expected to range from 25% to 28%.
Non GAAP operating expenses are expected to range from $158,000,000 to 164,000,000 Non controlling interest of our majority owned subsidiaries are expected to range from positive $6,000,000 to positive $8,000,000 which are losses borne by non controlling interest. The planned 2017 CapEx for foundry operations are approximately $2,300,000,000 dollars while the planned 2017 CapEx for non foundry operations are approximately $70,000,000 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 increased by 5.2% Q on Q to 815,000,000 mainly because of an increase in wafer shipments in 4Q 2016 excluding LFoundry and also the revenue contributed from LFoundry. LFoundry only contributed for 2 months in Q3 2016, whereas it contributed to the full quarter in Q4 2016. Gross margin was 30.2 percent above the guided range, mainly due to product mix change.
Operating expenses increased to $197,000,000 in Q4 twenty sixteen. R and D expenses increased by $36,000,000 Q on Q to $118,000,000 The change was mainly due to high level of R and D activities. Funding of R and D contracts from the government was RMB 23,000,000 in Q4 2016. G and A expenses increased by $25,000,000 to $61,000,000 in Q4 2016. The increase was mainly due to accrued employee bonus.
Excluding the effect of employee accrued bonus, government funding and gain from disposal of living quarters, non GAAP operating expenses were RMB 193,000,000 in Q4 2016. Profit from operations was RMB 49,000,000. Profit for the period attributable to SMIC was RMB 104,000,000 while the non controlling interests were RMB46 1,000,000 of credit to SMIC attributable profit. The change in non controlling interest was mainly due to the recognition in Q4 2016
of the
contribution to SMIC Group's advanced technology R and D expenses incurred in 2015 by the company's majority owned subsidiary in Beijing. If excluding the impact of the finance cost, depreciation and our amortization and income tax benefits and expenses, our EBITDA margin was 34% in Q4 2016. Moving to the balance sheet. At the end of the Q4 2016, cash and cash equivalents increased to $2,200,000,000 if including other financial assets. At the end of Q4 2016, our gross debt to equity ratio was 56%.
Our net debt to equity ratio was at a healthy level of 16%. In terms of cash flow, we generated $406,000,000 of cash from operations for the quarter. On a full year basis, we generated RMB977,000,000 cash from operations in 2016 compared to RMB669,000,000 in 2015. Cash used in investing activities was RMB 128,000,000 Cash from financing activities was $231,000,000 To extend our revenue by applications, the Communication and Consumer segments contributed 44% 37% of our revenue, respectively, for the quarter. On a full year basis, the Communications and Consumer segments contributed 48% 30% of our revenue, respectively, in 2016.
Geographically, revenue from China, North America and Eurasia contributed 48%, 33% 19% of total revenue, respectively, for the quarter. On a full year basis, revenue from China contributed 50% of total revenue. North America contributed 29% of total revenue, and EuroAsia contributed 21%. In terms of technologies, revenue from 20 nanometer contributed 3.5%. Revenue from 4045 nanometer contributed 23.6 percent.
Revenue from 50 55 nanometers and 90 nanometers contributed 19.8% and 1.6 percent respectively. Meanwhile, 11.11 micron above line width contributed 51.5 percent of wafer revenue for the quarter. On a full year basis, revenue from 45 nanometers and below contributed 24%. In terms of our overall capacity, total monthly capacity at the end of the 4th quarter increased to 406,008 inches equivalent wafers. The increase was mainly because of the capacity expansion in our Beijing 300 millimeter fab as well as our majority owned fab in Beijing during the quarter.
The planned 2017 capital expenditure for foundry operation were up the planned 2017 CapEx for foundry operations is approximately RMB 2,300,000,000 of which about RMB 900,000,000 will be spent for the expansion of our capacity in our majority owned Beijing 300 millimeter fab. The planned 2017 CapEx for non foundry operations are around $70,000,000 mainly for the construction of employees' living quarters. Our planned 2017 depreciation and amortization is around RMB1.1 billion, an increase of about RMB380 1,000,000 year over year. I will now turn the call to Ernie for the Q and A session.
Thank you, Gareth. I would now like to open up 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'll now begin our question and answer session. Your first question comes from the line of Randy Abrams of Credit Suisse. Please ask a question.
Okay. Yes. Thank you. Good morning. My first question, I wanted to ask just on the change in guidance from the original expectation to grow in Q1.
Could you talk about how broad based the slowdown you saw in Q1 or whether it was isolated to a few applications? And then, maybe talk about the rebound if you see it more a matter of new products being qualified, where it's the same applications coming back? And if you could characterize just whether any business was lost to other foundries given you were tight for several quarters last year?
Okay. Thank you, Randy. Yes, we have seen business loss in a few area. Our customers seems to gone through some of the marketing difficulties, but we think that is on a few particular area. So we are winning additional opportunity to backfill these capacities that is coming up.
And actually, it is a good opportunity for other customers. During last year, we had very, very constrained supply for them, and now they can freely grow with SMIC. So we think that eventually, we'll be able to backfill completely this downward train. So I think I would actually,
I think the slight correction in Q1 is really in line with what we see in the industry. I won't say anything specific about SMIC in this regard.
Okay, great. I wanted to ask a follow-up question on the margins. Could you go through the factors, the gross margin dipping to 25% to 28% maybe how much is the depreciation coming in or ramping through the year? And if you could also talk the impact of now moving some business from 40 to 28, if there's any headwind at this stage ramping up 28 relative to the mature 40 nanometer. And I guess that margin 25 to 28, if you think that should be reasonable range through the full year or any headwind from those factors depreciation or 28 nanometer?
Yes. Well, first of all, regarding the dip in the Q1 gross margin, I think there are 2 impacts here. First of all, you're right upon now, the depreciation is effective because we're going to see about $30,000,000 increase in the depreciation in Q1 compared to Q4. And secondly, as mentioned by T. Y, we're going to see some slight correction in business in Q1.
So you can see our utilization is going to drop below about 90% in Q1. So that has some impact on the gross margin for sure.
Okay.
And I guess,
to follow-up, can you maybe give a look as we go through the year if you improve utilization, but then factoring depreciation in 'twenty eight, if there's a rough feel for maybe a medium term or through the year, how gross margins may trend?
Yes. As I said, let me just clarify. I think we are looking at a utilization of high 80s, close to 90% in Q1. For the gross margin for the rest of the year, as mentioned earlier, we're going to experience, I would say, an increase in depreciation in 2017 over 2016 to a tune of about RMB380 1,000,000 and that is in line with the expansion in our fab capacity. We're going to ramp up our fab in Beijing and Shenzhen.
So obviously, that will have an impact on our gross margin. But we are still guiding I would say we are still targeting a mid- to high-twenty gross margin. But as I said, at this point in time, we don't have a clear picture about 2017, but this is our initial feelings.
Okay. And is $28,000,000 still dilutive like as you shift from $40,000,000 to $28,000,000 or yields are far enough along that it's less headwind now?
Our yield has actually been along our expectations, and I think that and it's still doing steady improvements. So I think that it should not be a significant drag to our margin. I think it's just simply the increase in depreciations.
Okay,
great. Thanks a lot. Thank you.
Your next question comes from the line of Stephen Polayo of HSBC. Please ask your question.
Yes. A few questions. First of all, I guess, 2017 growth, you're talking about 20% year on year growth with North America outperforming. So it's roughly 1 third of revenue is growing faster. I guess, does that mean China underperforms?
Do you think Eurasia actually can decline? Or when you think about the other regions for 2017, maybe a little bit of color there? And then also, could you comment a little bit on 20 17 from a node perspective? With 28 nanometer ramping too, I think you said high single digits by the end of the year, Does that mean 40 nanometer still grows this year? Help us understand kind of the node outlook for 2017 as well, geographically and by nodes.
Hey, Steve. We commented North America is going to grow quite well in 2017. They are for two reasons. First of all, 28 nanometer will be a major growth driver in 2017. And as you know, we have a major U.
S. Customers for the 29 nanometer. And secondly, we are for LFoundry, we only consolidated the company for about 5 months in 2016. And for 2017, there will be a full year consultation. And their customer base are mostly in the North America.
So that also contributed to the growth in the U. S. Customers, okay. In terms of the node perspective, I think the major growth, as we can see it right now, of course, this is really there's not enough visibility to say precisely at this point in time. It will be mainly from 20 nanometers, 65 nanometers and 55 nanometers as well as the growth, as I mentioned, the contribution from LFoundry.
And so 40 nanometer node, do you think it actually declined year on year?
No. We are seeing the major growth. We still think that the 40 nanometers would remain to be a major node for us. Okay.
And then we struggle to kind of forecast your model here with your operating expense volatility with R and D credits and some of the other things that go on property sales and other benefits that you can get through there. And then now bonus accruals as well. So could you talk just a little bit more? I know you like to guide excluding those things, but could you talk a bit about including those things? What kind of expectations you have for those in the Q1 as well as 2017?
What we've guided in Q1 in terms of the OpEx, We don't think there's any extraordinary items in Q1 that you should be concerned about. In terms of the full year OpEx guidance, in terms of the normalized OpEx, we're still looking at the high teens number relative to the revenue. The main increase will be in the R and D area as mentioned by TY. We will continue to invest heavily in R and D, but we will continue to maintain very disciplined spending in terms of G and A expenses and sales expenses.
This is the struggle though, because I think R and D in 20 This is a struggle though, because I think R and D
in 20 16 was about 13%. I think of revenue, if
I exclude the R and D credits, maybe around 11% including. So I guess on a comparable basis, you talked about that I think going to the low teens, if I remember correctly, is R and D. Is that including or excluding R and D credits? Do you expect R and D subsidies to increase in 2017? And what kind of number should we think about?
Yes. We expect right now, we are guiding the R and D spending probably in the low teens to mid teens level, and that is excluding R and D funding. In terms of the R and D funding for 2016, for the whole year is about RMB 52,000,000. We expect this number would go up in 2017, maybe close to $65,000,000 to $70,000,000 But this number as we mentioned earlier that there's some uncertainties depending on the completion of these R and D projects as well as the funding availability from the government.
Okay. And then the last line item that I also struggle on is the non controlling interest line. I guess I'm trying to understand as this fab ramps up, does it ramp up initially where you have more losses and then there's a greater add back or does that number then decrease over time? When you think about that line through 2017 or maybe just on a full year basis, how do you think that will track this year or contribute this year?
Well, first of all, the Q4 number, in terms of the contribution from the non controlling interest was high because of this sharing of R and D expenses with our majority owned subsidiary in Beijing. And that part contributed about $29,000,000 for the quarter, okay. So actually, if you remove that number, actually the number is quite consistent quarter on quarters. Right now, we are still looking at similar number in 2017, yes.
I'm sorry, similar kind of every quarter, this kind of $7,000,000 to $8,000,000 I think is what you guided to the
quarter. Yes,
just just right. Okay. Excellent. All right. I'll get back in the queue.
Thank you.
Thank you. Your next question comes from the line of Roland Xu of Citigroup. Please ask your question.
Yes. Thanks for taking my question. First question is, can you repeat the overall capacity increase number this year?
Just give me a second. The increase in the capacity for 2017 We are looking at an annualized capacity increase of about 25%. And then on EM basis, the increase is about 11%.
So year end means year end compared with year end in last year?
Yes, that's right. We're talking about year end over year end about 11% increase and on an annualized capacity basis, it's about 25% increase.
May I add How about
12 inches and 8 inches increase?
I hope it's combined,
yes. Yes, but how about
the increase on the 12 inches Do you have the factor?
Obviously, the increase in 12 inches is more than 8 inches I think the major expansion in the capacity will still be in our 28 nano capacity. And also, there will be quite a bit of increase in our 65, 55 nano capacity, yes.
Okay. Yes. Okay. Thank you. And also,
just to add that the 25% annualized effective capacity increase, also a lot of it is because full year's foundry's capacity will come in, yes.
Okay. Thank you. Yes. And also for your utilization in Q1, talk about cost to 90%. So how about the 12 inches and the 8 inches utilization specifically?
Well, we don't break out the utilization for each fabs, but I would say it's quite even, yes.
Okay. So both 12 inches and 8 inches are close to 90%?
I would say 8 inches is still better than 12 inches
Okay. Yes. Thank you. And for the whole year, the Q1 revenue will be correct a little bit and the whole year revenue target still grew by 20%. So what's the quarterly revenue linearity in this year?
Will it be increased gradually or will it be more back end loaded?
I think it's too early for us to comment on that. I think the 20% growth is our target, okay. But at this point in time, I think we don't have much visibility beyond the Q1. So we update the we'll update the market as we see more visibility.
Okay. Thanks. And I think last question is for your others revenue by application increased a lot in 4Q last year. So what contributed into this category? And what is just a one off or will it be recurrent in this year?
Thank you.
Yes. That category actually we have put in the revenue from LFoundry. As you know, LFoundry's customers are mostly in the auto industrial sectors.
Okay. So then we expect it will be increased meaningfully this year because we have the full year consolidation number from Kaifeng GDC, right?
Yes, that's correct, yes.
Okay. Thank you.
Thank you. Your next question comes from the line of Liping Huang of CICC. Please ask your question.
Okay. Thank you for taking my question. So the first question is about your 20 nanometer migration strategy. I remember that your previously was mainly think like the competition in 20 8 was too intense and the profitability you would prefer to focus on the 40, 45 nanometer process, which is much better in terms of profitability. So what has changed that you this time you start to migrate into 10 nanometer?
It's more a customer driven or it's more that you have excess capacity which to migrate or which application you will first migrate? Thank you.
Okay. I think last year, basically, we had a very, very tight capacity year and a lot of our 4 d customers or 4 d products are single sourced in SMIC. And any so any discontinuity in the Visa product supply will really impact a significantly larger economic range. And so that is the reason that we had actually even at the beginning of the year, I think of 'twenty eight, the market was softer than we had thought. That's why our capacity has shifted towards meeting the 40 nano demand.
It wasn't a straight economic margin considerations. This year, we have always intend, even as of last year, to quickly ramp up our advanced capacity so that we can meet both the 40 nano as well as the 28 nano demand. So at the second half of last year, we have increased our capacity sufficiently to at this point of time to meet both the 40 as well as 28 nanometer customer demand. So that's the reason this year we can see a significantly faster 28 nano ramp up.
Okay. The second question is that we see October I think October last year you announced that you will build a new factory in Ningbo. So can you elaborate what's the plan in Ningbo? Also, these days, we see that the local government do provide a lot of favorable financial condition to attract the foundry to the local city like recently Chengdu has cooperated with the GlobalFoundry. So do you also consider to expand your geographical expansion in China?
Or Or I remember you previously mainly focused on Shanghai, Beijing because of your constraint on R and D result?
Certainly, SMIC is exploring all potential opportunities. But I think as consistent with our previous announcements, our main focus will still be in the our present production site, that is Shanghai, Beijing, Tianjin and Shenzhen as well as expanding some of our capacity in Italy. So that doesn't certainly doesn't preclude us to consider other opportunities. But I think at this moment, I think that we are still putting in capacities in our present production site, and that is our main focus.
So the Ningbo will not be a factory or it will be what Ningbo will be?
Ningbo, right now, we have we are exploring design service centers. We are exploring and converting some of the specialty technology into production, and there are a number of conditions that needs to be, how do I say, proven and verified, such as a working specialty technologies and a very strong customer base before we start any fab constructions.
Thank you.
Thank you. Your next question comes from the line of Sebastian Hou of CLSA. Please ask your question.
Hi, good morning guys. Thanks for taking my questions. The first question is on 28 nanometers. I wonder what's your strategy on 28 for this year? Is more poly or Hikmetogay by the end of the year given your high single digit revenue guidance?
And another follow-up on that is the your strategy is more your existing customers migration need or are you going to gain some new applications for new customers?
Okay. Our 28 certainly is focused not only on a single customer, that we have a number of customers, both globally as well as domestically. So indeed, certainly, we are going to first meet our customer demand that is put in front of us right away. And but in the same time, we're going to there are a number of customers still interested in the polycyon. Of course, we are also getting NTOs or product tape out in our high case technology.
So this is also a significant focus for SMIC this year.
Okay. So in terms of your revenue guidance for 28, about high single count for high single digit by the end of this year, Can we assume that most of that or nearly all of that will be polycyon?
I think there will be a significant portion will be polysilon, but we do we are targeting some high case revenue.
Okay. And in terms of your position, what do you compare yourself in terms of performance, pricing versus the other foundries who are offering 20 nanometers for years?
Competitive.
Competitive performance and pricing or performance or pricing? Both? Both. Okay. My second okay, thank you.
Thank you, Tior. My second question is on your Q1 guidance. You guided to decline by 2% to 4%. And I think, Tiwa, you already mentioned about is one or some specific customer and some specific area see weakness. Can we and also to comment about that you think that you can backfill the capacity pretty soon.
So how soon is that? Can we expect that you can backfill that within 1 to 2 quarters, given that right now major 8 inches foundry is only in tightness right now?
Yes. I think it's been mentioned that, for example, we have
customers
in the fingerprint sensor areas that have been some correction in business. But we're also seeing other new customers coming in for the applications and which is going to ramp up this year. At the same time, for example, we are seeing very good orders from our PMIC as well as from our smart car business to fill the gap. So we are pretty, I would say, cautiously optimistic in terms of our growth this year.
Okay. So you mentioned about the yes, sorry, please go ahead.
So I think that indeed, I think that we will be able to at least we target to backfill within a few quarters' time.
A few quarters, which means not 1 quarter?
A few quarters, I mean, 1 or a few quarters, Right,
right. So what I'm trying to get a sense is that is because you need to backfill that, so your 8 inches capacity came back to 100%. So when do you expect your 8 inches capacity utilization rate to return to your 100% level or close to 100% level?
Now I think this year, we have forecasted 20 we have targeted 20% growth. And so to achieve 20% growth, you can project that it still needs to be fairly high utilization.
Okay. Thank you.
Thank you. Your next question comes from the line of Charlie Chan of Morgan Stanley. Please ask your question.
Thanks for taking my question and happy Chinese New Year. So first question is regarding your gross margin guidance because it seems like your depreciation increased a lot. So just putting into perspective, the depreciation was around 20% of last year's revenue, And this year, it will increase to 30% of this year's revenue. So it is like 10 percentage points increase. And you mentioned that EBITDA margin will maintain at the highest 30 percentage, but your gross margin guidance implies only 5% for this decline.
I'm not sure what was the gap here.
Are
you going to reduce your OpEx significantly? Or is there any big chance for cost reduction in your variable costs?
Charlie, I think my calculation is somewhat different from yours. Because we are guiding a RMB380 1,000,000 increase in the in the depreciation. That will going to have an impact on the gross margin for sure. And then at the same time, we also said that we couldn't intend to maintain the OpEx of high teens. So I think with that, I think we're still quite confident about achieving or at least it is our target to achieve mid to high teens gross margin, yes.
Okay. Maybe I misunderstood. So what was the RMB1.1 billion depreciation guidance for?
That is including both
the total depreciation, the majority amount goes to the cost of goods sold, but part of it is also relating to the R and D spending as well. Got
it. I'm sorry. Okay. And next question is regarding your free cash flow because you made around RMB1 1,000,000,000 EBITDA negative, which is a good number. But it seems like your CapEx was above RMB2 1,000,000,000 this year, continue to be above RMB2 1,000,000,000.
So it seems like there is ongoing cash outflow. So how are we going to fund for those cash flow?
Yes. You're right. I mean, SMIC is still not in a free cash flow positive situation yet. But what we are seeing right now is that we are continuing our CapEx this year. At the same time, we are increasing our EBITDA total EBITDA generations.
So that should help to reduce the gap. At the same time, as mentioned by TY, we have more than TWD 2,000,000,000 cash holding on hand. So we should be able to fund the CapEx without too much of a problem.
Okay. Got it. And lastly, 28 nanometer. So when do you think revenue would significant ramp up this year? I think your guidance implies revenue is going to double, right?
So you said 2Q, 3Q are very back loaded?
Right now, we are targeting to increase gradually over each quarter, but maybe we're going to see a more big increase in the second half.
Okay. Yes. So I think another topic, I'm not sure if management team has discussed about that regarding U. S. Protection Nissan on the semiconductor industry.
So and it seems like you own some customers from North America and Qualcomm, they also work with you on some leading edge R and D like 14 nanometer. So do you think there's going to be any impact to SMS in the long term? And do you expect any friction between China and U. S. In terms of semiconductor cooperation?
I think that indeed, we are cautiously optimistic in terms of the market growth and overall market trend. This is, of course, disregarding the potential trade wars that may really come around. But we think that and hope that the semiconductor company semiconductor industry is a very, very global industry. I think the market here in China is a great opportunity for everyone outside of China as well as in China. I think that anyone that really have a careful study, we'll find that China market and arrangement at this point of time is good for everyone.
And so we hope that there will be a good environment for business for foundry, for fabless as well as for all other customers in China.
Okay, understood. Thank you very much.
Thank you. Your next question comes from the line of Gokul Hariharan of JPMorgan. Please ask your question.
Yes. Hi. Thanks for taking my call. Just wanted to ask first on the R and D spending increase with emphasis on 14 nanometer. Is there any change in direction in terms of 14 nanometer development and trying to bring it on production earlier than expected?
I think previously, I think it was kind of more like a 2020 kind of target. And the second question is, with that increase in R and D spending, how does it affect the operating leverage expectations in terms of operating margins as we target the 20% growth CAGR over the next few years?
Okay. Indeed, our 14 nanometers, we are providing a faster turnaround time, a better R and D support to our team. And definitely, if possible, we will try to bring it up in production earlier that it would be great if we can bring it before 2020. But I think that in general, SMIC's strategy is to continuously have a strong support to our R and D efforts, both in advanced technology as well as in our specialty mature technology as well.
Right now, as mentioned earlier, we are targeting low teens to mid teens R and D spending. And in terms of the OpEx spending, in terms of normalized OpEx, we'll be in the high teens level. So I think in terms of the impact on the operating margin, I think the major impact will be coming from the gross margin, I think.
Okay. Got it. Can I also ask what is the status on LFoundry in terms of utilization as well as new customer qualifications? When do we expect some of the new customers to kind of start filling up the capacity?
Let me say that. We already see the outboundary utilization increase by about 10% to 15% after the conclusion of our merger. Certainly, right now, we are introducing additional customers to bring them into our foundry. So it would take a few quarters to bring in more than a few customers to fully fill the fab. But we think that this year, we should be able to maintain a reasonably high utilization and our market consistently.
And I think just to add on to what you guys said, we're also seeing a pretty strong recovery of orders from the auto customers. And I think the major reason for that, of course, is the end market for auto is doing well. And secondly, it's also the increasing confidence of their customers in terms of LFoundry's future, given the fact that they are combined with a much bigger group now as before.
Okay, great. Thanks.
Thank you. Your next question comes from the line of Michael Cao of Deutsche Bank. Please ask your question.
Hi, good morning. Thanks for taking my
One question is, as you know, the fingerprint sensor will shift to 12 inches in the future. So what's your planning for 12 inches fingerprint sensor product roadmap this year and the next year? Or do you expect your fingerprint sensor will be still from 8 inches process going forward?
Okay. At this moment, I think the request to shift from 8 inches to 12 inches are still limited. And our traditional customers as well as the new customers are still mainly focused in the 8 inches capacities. Certainly, I think that we are preparing additional 12 inches capacities for similar applications if there is such a need. This is already being set up and will come online in since then at the end of 2017.
Okay. So does that mean you will use a 65 nanometer to do single precision by the end of this year in terms of
fab? We will withhold a comment at this point of time. Right now, the we still have a lot of activities in our traditional technology arena for different applications.
Yes. I think we've seen most of our fingerprint customers are still focused on the 8 inches application at this point in time.
Okay. So do you expect that they will shift to 12 inches next year? Or you think most of the customers still stay 8 inches even next year?
I think for 2017, we don't see any migration at this point
time. Okay. In terms of year rate, do you think your 12 inches fingerprint sensor would be quite okay if you want to enter much production at some point, let's say, maybe 2018? It seems that 65 millimeter fingerprint sensor, you're right, is very challenging for some time in early stage. So what is your view?
As I said right now, because most of our customers still require only 8 inches production for this application. So we don't have any experience in the trucking yet.
Okay. My second question is, you guide for high single digit percentage of sales from 28 nanometer. But we remember that in the past, you've been quite aggressive in guiding 28 nanometer sales portion, but it seems that there's some change, so you cannot meet the guidance. But this time, what caused the difference? Or you think you have more customers than before or more product?
Or you do see some sort of complication? Because it seems like TSMC should finish 20 nanometer depreciation in the first half of this year. So in theory, 20 nanometer pricing competition should be very severe in the second of this year. And if you can see the UMC situation, there will be more questions in 20 nanometer Randak in terms of pricing and sales contribution. So what's your age going forward?
Because since the UMC will move 20 millimeter to the Xiamen fab, so they may have some benefit from the joint venture with the Xiamen government. So what's your view? What would you think about your 20 nanometer sales contribution in the long term?
Okay. I think, again, last year, indeed, we had we did not meet our 28 nano forecast. That was basically because we have extremely tight capacities and we had made a strategic decision to do the 40 first because the demand come in first and a lot of the product are single source. This year, we are able to ramp 28, at the same time maintaining good 40 output. The main reason is that we have expanded our capacity to a situation where we can take care of both our 40 as well as 28 customers.
So as far as the dilemma of coming in with a technology that is the slightly behind our competitors, that dilemma we have faced all throughout our last 16 years. And we have we were we came in with our 40 nano and I guess a lot of our peers would think that 40 nano for SMIC is probably a node that is not worth pursuing, but we had a very, very successful 2016 ramp up in the 40 nano. So we believe that as long as we can do in a good quality of 28, as long as there is customer demand, I think 'twenty eight ramp up is still a very important node for us.
Okay. One follow-up question.
Thank you. I think we run out of time here. And so Michael, I think we have to stop here.
Okay. Thank you.
Thank you. I would now like to hand the call back to CEO, Doctor. Qiu, for closing remarks.
In closing, I would like to thank everyone who participated in today's call and again thank all of our shareholders, customers, employees and the suppliers for their trust and support. We'll see you next time. Thank you.
Thank you. This is the end of SMIC's 4th quarter earnings conference call. We thank you for joining us today.