Welcome to TSMC's second quarter 2013 earnings conference and conference call. This is Elizabeth Sun, TSMC's Director of Corporate Communications, and your host for today. The event is webcast live via tsmc.com. If you are joining us through the conference call, your dialing lines are in listen-only mode. As this conference is being viewed by investors around the world, we will conduct this event in English only. The format for today's event will be as follows. First, TSMC's Senior Vice President and Chief Financial Officer, Ms. Lora Ho, will summarize our operations in the second quarter, followed by our guidance for the current quarter. Afterwards, TSMC's Chairman and Chief Executive Officer, Dr. Morris Chang, will provide his key messages. We will open the floor to questions.
For those participants on the call, if you do not yet have a copy of the press release, you may download it from TSMC's website at tsmc.com. Please also download the summary slides in relation to today's earnings conference presentation. Before we begin, I would like to remind everybody that today's discussion may contain forward-looking statements, and they are subject to significant risks and uncertainties, which could cause actual results to differ materially from those contained in the forward-looking statements. Please refer to the safe harbor notice that appears on our press release. Now I would like to turn the podium to TSMC CFO, Ms. Lora Ho.
Thank you, Elizabeth. Good afternoon, everyone. Thank you for joining us today. I will start my presentation with financial highlights for the second quarter, and I will follow that by providing the guidance for the third quarter. I'm very pleased to announce another record quarter for TSMC in both revenue and net income in the second quarter of this year. The record results once again demonstrate that our investment in R&D and advanced capacities has started to pay off. Looking at the numbers, our revenue increased 17.4% to NTD 156 billion, mainly due to strong demand for 28 nanometer technology, while customers' need in building inventory for the launch of mobile product in the second half also helped. On the margin side, second quarter growth margin was 49%, up 3.2 percentage points from the first quarter, thanks to higher utilization rate, cost improvements, and more favorable exchange rate.
Total operating expenses increased 14.8% to NTD 18.8 billion, mainly due to higher R&D and opening expense. Despite that, second quarter operating margin expanded 3.5 percentage points to 37% on larger revenue base and higher growth margin. Non-operating item was again of NTD 2.4 billion in the second quarter, up from NTD 1.3 billion in the previous quarter. The increase is mainly due to the legal settlement income, dividends from invested companies, and one-time gain from a deconsolidation revaluation of assets. None of these are recurring, but together contributed about NTD 0.04 of EPS to the second quarter. Overall, we made NTD 2 EPS in the second quarter, and the single quarter ROE was 27.4%. Let's have a look at the revenue by application. Mobile computing devices continue to drive our business growth in the second quarter.
The revenue contribution from the communication segment further increased from 55% in the first quarter to 57% of total wafer revenue in the second quarter. On a quarter-over-quarter basis, revenue increased across the board of all major segments. Communication again showed the strongest growth of 22%, followed by computers 18%, industrials 11%, and consumer 9%. In terms of revenue by technology, as 28-nanometer continued to ramp successfully, the revenue contribution has significantly increased to 29% in the second quarter from the 24% in the first quarter. Riding on the success of 28-nanometer, revenue from advanced technologies defined as 40 nanometer and below now already represents 50% of our total wafer revenue. Moving to balance sheet. Our cash and marketable securities increased TWD 38 billion to TWD 228 billion at the end of the second quarter, mainly due to proceeds from issuance of US dollar corporate bonds.
Correspondingly, our long-term interest-bearing debt increased TWD 43 billion to TWD 171 billion. Current liability increased by TWD 85 billion, mainly because we accrued the cash dividend of TWD 78 billion, which will be paid by the end of July. Looking at the financial ratio. Our accounts receivable turnover days remained flat at 43 days. Days of inventory decreased by 4 days to 47 days, mainly due to shipment out of finished goods and the lower working process inventory days. On the cash flow side, in the second quarter, we generated TWD 75 billion from operations, invested TWD 78 billion in capital expenditure, and raised TWD 45 billion through corporate bonds. In US dollar term, we spent $2.6 billion in capital expenditure in the second quarter.
Together with the $2.7 billion spent in the first quarter, we have already spent about 55% of our guided full-year CapEx, which is $9.5 billion-$10 billion. Overall, our cash balance increased TWD 40 billion to TWD 226 billion. Free cash flow ended slightly negative at TWD 3 billion. Lastly, I would like to talk about our capacity plan. Our total capacity increased 3% to around 4 million 8-inch equivalent wafers in the second quarter, and will increase by another 6.5% to 4.3 million wafers in the third quarter. For the full year, our 12-inch capacity is expected to increase 17% year-over-year, and our total annual capacity will increase 11% to 16.4 million 8-inch equivalent wafers. I have finished my financial summary. Before we talk about third quarter outlook, I would like to brief you one change that impacts our consolidated revenue.
We used to consolidate Xintec, one of our invested company, because TSMC's board representation in Xintec was greater than half. Recently, Xintec expanded its board structure by adding two independent directors in June. As a result, TSMC's board representation is now less than half. Therefore, we will no longer consolidate Xintec starting June 30 this year. The deconsolidation impact would be close to 1% reduction of our total revenue in the third quarter. Taking this into consideration, our third quarter guidance will be as follows. Based on current business expectation and a forecast exchange rate of 29.83, we expect our revenue to be between TWD 161 billion and TWD 164 billion. In terms of margins, we expect the third quarter growth margin to be between 47% and 49%, and operating margin to be between 35% and 37%. This concludes my remarks.
Let me turn the podium to our Chairman and CEO, Dr. Morris Chang.
Good afternoon, ladies and gentlemen. On the screen, you see an outline of what I'm going to say in my message today. First, second quarter and third quarter. Second quarter was a record quarter for TSMC, both in revenue and in earnings per share. The strength was mainly driven by the strong growth in mobile related applications, and TSMC's strong position in the 28-nanometer technology. We are rather pleased about the results of the second quarter. Third quarter guidance has already been given by our CFO, and there will be growth in the third quarter, and we are rather pleased about the expected performance of our third quarter as well. Next, let me talk about industry outlook, the forecast, and supply chain inventory. For full year 2013, we are forecasting a global GDP of 2.6%, which is unchanged from our forecast three months ago.
For semiconductors, however, we are lowering our earlier forecast of 4% growth to 3% in 2013 for semiconductor growth. For fabless, we continue to forecast 9% growth. This is unchanged from our last forecast. For foundry, we are forecasting now 11% growth. This is the foundry industry. We are forecasting 11% growth, which is up from 10%. For TSMC, we again forecast a revenue growth which is much higher than the foundry industry growth, and that's unchanged. Now let's look at the supply chain inventory. Two things have happened in the last three months, or two things have actually become more obvious in the last three months. First, the IC vendors' inventory preparation for product launch by several major handset makers. The IC vendors preparing for product launch by several major handset makers has caused the supply chain inventory days to increase.
Second, the lower than expected sales of PCs and several smartphone models have again caused the supply chain inventory to become higher. Now, in April, we had forecast the fabless supply chain inventory to be 73 days. I'm sorry, to be 70 days. In April, we had forecast the fabless supply chain inventory to be 70 days at the end of the second quarter. Now we are forecasting, we are saying that it will be, or it was 73 days at the end of the second quarter. Now, three months ago, we were forecasting the fabless supply chain inventory to be 68 days at the end of third quarter. Now we are forecasting it to be 71 days at the end of the third quarter.
About the fourth quarter, three months ago, we were forecasting the inventory, again for the fabless, to reach 66, and now we're still forecasting 66. Our inventory days forecast for the fabless supply chain has increased for the second and third quarter, but remains unchanged in the fourth quarter. This is an early indication that fourth quarter may be a down quarter, because we expect the supply chain will take serious action to manage their inventory in the second half. The overall inventory, however, will approach the seasonal level by fourth quarter. I'm talking about the 66 days that we are forecasting. That's very close to the seasonal level. A few words on our structural profitability. Since 2009, I picked 2009 because that was the year when I resumed my CEO responsibilities.
Since 2009, our structural profitability at constant exchange rate has improved by 7.7 points, 770 basis points. On the other hand, the 2009 exchange rate was 32.87, and the year-to-date 2013 exchange rate is 29.66, a change of 9.8%, almost 10%. We have said several times that each point of change in exchange rate causes 0.4% change in our margin. The almost 10% change in exchange rate has caused a 4% change unfavorable in margin. Therefore, at prevailing exchange rates, our structural profitability has improved by only 3.8%. Still, I think it's very encouraging, and there are signs that the exchange rate may stabilize, or perhaps NTD may even depreciate a little bit. If that happens, it would of course help our progress in structural profitability even more.
At any rate, the message in the last section is that in the last four years, our structural profitability has improved by 3.8 points at prevailing exchange rates. Next, I want to talk about high-end, mid-end, and low-end mobile product growth and TSMC's position. Mobile products have been important in driving the demand in recent years and will continue to enjoy robust growth in this year as well as in coming years. High-end year-on-year growth this year was 18%, or is 18%, we estimate, from 361 million last year to 428 million this year. Mid-end grows from 167 million units to 227 million units, a 36% growth. Low-end grows from 202 million to 341 million, 69% growth. This year, we'll see high-end units to grow 18%, mid-end 36%, low-end 69%, for a total smartphone year-to-year growth of 36%.
We are uniquely, as a foundry, we're uniquely positioned because our comprehensive technology portfolio, we have solutions to address each tier, high, low, middle, each tier of the smartphone market. Of course, we benefit from the overall strength of the smartphone demand. We, in particular, I want to point out, I think everyone knows that our 28-nanometer technology has allowed us to be very well positioned in the high end and part of the mid end. I want to particularly point out that we are very well positioned in the low end. Because of the comprehensive technology portfolio, we can do silicon area shrink and layer reductions help our customers to streamline features and to integrate functionalities for their overall lower cost designs. China, of course, is a fast-growing area for mid to low-end smartphones.
We're seeing our Chinese customers taking a more important role in providing chip solutions to the market. Many of them have accelerated their cadence in adopting advanced technology. As a result, our business from Chinese customers has doubled in the first half this year from a year ago. For the whole year, our China region is expected to account for 6% of our total business this year. Next, a few words on 28-nanometer. Our 28-nanometer is on track to triple in wafer sales this year. Our 28-nanometer High-K Metal Gate is ramping fast and will exceed the oxynitride solution starting this quarter. For the oxynitride solution, in which we do have competitors, we believe that we have a substantial lead in yield. For the High-K Metal Gate solution, we do not have any serious competitors yet. We believe we have a substantial lead in performance.
If you recall, ours is a gate-last version, our competitors are mainly in the gate-first version. In High-K Metal Gate, we have a lead in power. Our power is lower. In performance, our performance is better. Should the competitors who are in gate-first now switch to gate-last, they will be considerably behind us in yield learning, in yields. Our continued lead in yield and performance will keep our 28-nanometer market segment share strong for both this year and in future years. A few comments on 2016, I want to say a few words on our Grand Alliance, also I want to show you a few photographs of our new GigaFab, which is dedicated to 20-nanometer and 16-nanometer. 20-nanometer SoC and 16-nanometer FinFET are both progressing well. On 20-nanometer, we see little competition.
The risk production has started in the first quarter, volume production will start in early 2014, next year. I will show you the photograph of our brand-new fab. The equipment are already being installed. Equipment are streaming in and are being installed, are going to be tried out, volume production will start in early 2014. On 16 FinFET, it will start volume production about one year after 20 SoC. In other words, early in 2015. Our R&D progress on 16 FinFET is very good. Yield improvement is better than planned and is better than 20-nanometer a year ago. We have been working with several major customers, many product tape-outs are planned for next year. The joint work is essential before tape-outs, of course, that joint work has been progressing for some time.
Grand Alliance, by that we mean our alliance with customers, with the electronic design, EDA companies such as Arm and Imagination Technologies, companies like Cadence, Mentor Graphics, as well as our own platform, the Open Innovation Platform. It's an alliance with customers, with the EDA companies, with the IP providers and, of course, with our key vendors, critical vendors. The reason I want to point that out is that for TSMC, we have entered a new era of competition. We pointed that out almost every time we get together in this meeting, we've been pointing it out for the last one or two years now. In this new era of competition, the competition is not foundry to foundry. It is not foundry to IDM. It is Grand Alliance to IDM. Have I made it clear? That's the reason I'm pointing it out.
We feel on the 20, as I already said, that we see little competition. On the 16, if we put it on a foundry to foundry or foundry to IDM basis, we are competitive. If you put it on a Grand Alliance to IDM basis, we are more than competitive. I want to show you a few photographs of our new GigaFab, which as I said, is dedicated to 2016. Is there no pointer? There's no pointer. Well, that's too bad. I don't think there will be any problem with this photograph or with the next two, because you see the big building almost in the middle of the photograph, and that's our P5, phase 5 of Fab 14. It's located in Tainan, and it's the first one. It's just one-third of the GigaFab. One third.
I will show you the other two-thirds in the next two photographs. This third of this 16/20, 16-nanometer, 20-nanometer GigaFab will start production, I said earlier, in early 2014, and this picture says February 2014. This particular phase 5 has a total floor space of 184 sq m. Next, please. Well, can you switch it back, please? This is finished. The building is finished. As I said, equipment are streaming in, being installed, being tested out to get ready for the volume ramp-up in early 2014. Next photograph is the second one-third of our 20-nanometer, 16-nanometer GigaFab. This one is only half finished because volume production will start only in May of next year. It's about the same size. The total floor space is 180,000 sq m, about the same as the last one. Next, please.
This is the last one-third of this new GigaFab. You can see that you don't see very much yet, but you'll see what's going on. It's very busy now. I think the foundation, so on, has been laid, et cetera. It will start volume production in April of 2015. Its total floor space is about the same as each of the other two. Altogether, these 3 phases of this GigaFab is about 550,000 sq m. Just in comparison, our 28 facility, which is in Taichung, is about 400,000 sq m. This one's 550. It's dedicated for 2016, the 28 is about 400. All right, let's show the next photograph. Without a pointer, this is going to be more difficult. This is our Tainan campus or complex. Well. In the upper part, you see the older fabs.
Well, old, most of them are less than 10 years old. They are old compared to the new place that I just pointed out to you. Right below them, you see the new fabs. There's one other side, it's our back end. That's where our 3D IC is going to be. That's where our CoWoS is also. Now actually, yeah. Thank you very much. I think this will help. Well, I'm not going to point out the old fabs. This is phase 5. That's the first of the new phases, phase 5. This is phase 6. This is phase 7. I do want to point out one very important aspect of this super fab. Even though you see three separate buildings, they will all be connected. All these three will be connected by clean room links.
All right, so much for the photographs. If you were on EUV last time, I think I pointed out that we just had a breakthrough last time on EUV, or I should say ASML had a breakthrough on EUV. Progress has continued. Cymer and ASML have demonstrated an EUV power output of 40 watts on their factory floor. The next step for ASML is to achieve 80 watts of source power. While there's still some distance to reach the source power of 250 watts, 40 already achieved. Next milestone, 80, and then the economically desirable threshold is 250 watts. 250 watts will give us a throughput of 125 wafers per hour, which is the economic threshold. While there's still some distance to get there, we are collaborating with ASML very closely to ensure that EUV can become production ready by 10 nanometer, at least for the critical layers.
Next, specialty technologies. When we say specialty technologies, we include high voltage for power management ICs, mixed-signal for audio codec, embedded flash for MCU, MEMS for motion sensors, CMOS image sensors for digital cameras. In addition to those that we have been working on for a long time, the following specialty technologies are expected to grow significantly next year. Image signal processors stacked with CIS. That is, processors stacked with the sensors. Mixed-signal for fingerprinting sensors. High voltage for small panel drivers. Embedded flash for near-field communication, smart cards, and touch screen controllers. What differentiates TSMC in the specialty technology foundry arena, besides the fact that we have the largest capacity and the broadest scope, is our superior ability to integrate specialty devices.
Flash, CIS, RF, high voltage, power MOSFET, integrate those specialty devices into our strong CMOS baseline while maintaining our CMOS IP compatibility. Those are all the comments I've prepared. I believe we are now open for Q&A.
Right.
Q&A?
Yes. This concludes our prepared statement. Before we begin the Q&A session, I would like to remind everybody to limit your questions to two at a time, to allow all participants an opportunity to ask questions. Questions will be taken both from the floor as well as from the call. Should you wish to raise your question in Chinese, I will translate it into English before our CEO or CFO answers your question. For those of you on the call, if you would like to ask a question, please press the star, then one on your telephone keypad now. Questions will be taken in the order in which they are received. If at any time you would like to remove yourself from the question queue, please press the pound or the hash key. Let's begin the Q&A session.
First question comes from the floor, that would be Credit Suisse, Randy Abrams.
Thank you. The first question on the margins, short term, then medium term. For third quarter guidance, just want to see why you're guiding a decline for margins on a small increase in sales. Into 2014, as you ramp 20-nanometer with a steep ramp, do you see any margin impact in the early stage of 20-nanometer?
Hey, Randy, you're asking about the third quarter guidance on the margins?
Yes.
We are adding capacity in the third quarter. I was talking about another 6.5% leading-edge technology. Third quarter, as Chairman just mentioned, we are going through the inventory correction period. We expect the third quarter utilization will be lower than second quarter. That's the main reason that the revenue improves, the margin doesn't improve. You also asked how going into 2014, when we ramp 20-nanometer, how would that affect our margin? Every new technology, when it comes to mass production, in the early beginning, it always starts with a lower margin. When the quantity starts to go up, maybe after seven or eight quarters, the margin will be getting closer to corporate average. We expect that will happen for 20-nanometer as well.
Can I have one follow-up on that question?
Okay.
Do you expect, even with 20 ramping up, structural profitability will continue to see at least maintain, or how do you see structural profitability and depreciation in 2014?
We are confident we can maintain the structural profitability.
Okay. The second question, and it probably relates to some of the pictures of the big fabs that are getting built. Want to ask if you've any concern you spend the CapEx and some of these large customers switch foundries, so that they switch foundries every node, and so you put a lot of investment. Just curious the assurance that if you bring in some of these projects, you can maintain that business for several nodes.
Switch foundries meaning switch to?
Let's see. Just if you put in This fab capacity targeting some large customers, just to be sure, if you can maintain that customer relationship for several nodes.
Well, you realize that we don't always put in the amount of capacity that the customer requests. We do make our own estimates and so on. We have not and will not always follow the customer's estimates for their capacity. I don't know whether that answers your question or not. I mean, your question as I understood it was that you put in the capacity, the customer switches foundries, et cetera.
Yes.
My answer is that, well, we try to anticipate what foundries they would switch.
Okay.
You still look a little puzzled.
Okay. Yeah.
Yeah.
Maybe to rephrase it, because some of these customers are getting quite large in amount of capacity they demand. For a product generation, you build capacity for that customer, but because it's a huge volume, at the next node it switches.
They switch what?
Switch their business to another foundry.
Oh. That does not happen. That does not happen. No. Your experience must be with the commodity products. Well, I'm sorry to say that, because obviously, your experience is not only with commodity product. I can assure you that I kept emphasizing all through the last 10, 15 years that our strength was in three directions: technology, manufacturing, and customer relationships.
When you say that the customer works with us, suddenly a company works with us, and we build the capacity, suddenly after the capacity is built, he switches a foundry. That does not happen.
Okay. Thank you.
For his sake as well as for ours.
Okay. Good. Next question would be coming from the floor again from Deutsche Bank, Michael chou.
Thank you. Chairman, you gave the guidance before regarding 20 nanometer sales portion in Q2 with a low single digit. Do you have any revision for that, or you maintain the same guidance?
Q2 for?
Q2 next year.
Q2 next year. How much 20-nanometer will account for our revenue?
Well, Q2 next year, I don't know. For a whole year next year, I expect it will be in the high single-digit % of our total revenue.
Thank you.
I think that's correct, isn't it? Yeah. For the whole year next year, I think 20-nanometer will be in the high single-digit % of our total revenue.
Thank you. My second question is, what is the outlook by segments in Q3 this year?
The what?
Segment. Segment outlook. I think Lora can maybe take that.
In third quarter, computer will decline the most, followed by a communication with modest decline. We expect consumer industrial for TSMC will go up in third quarter.
Thank you.
Next question will still be coming from the floor, and it will be from J.P. Morgan, JJ Park.
Okay. First of all, congratulations for another good quarter. It's very impressive.
Thank you.
The first question is, what's your view on the longer life cycle for the 20 nano, given increasing pattern intensity moving down to 20 nano, and then FinFET? I believe the 20 nano life cycle could be longer than the previous technology.
Your question is whether or not 20-nanometer will have a shorter life cycle as compared to prior nodes.
I think yes, probably. I said I'll give you that. It's for both 20 and 16. Yes, 20 I think will have probably, I'm not sure yet, a shorter life than 28. Then, we convert it quickly, convert the capacity to 16. I think 20 and 16 together will have a longer life than 28. Actually everything has a long life in TSMC anyway. We're still making 1 micron? 1 micron still, yeah?
1.5.
1.5? I guess we're not making 1 micron anymore, 0.5 micron. When you say short life or long life, if you refer to a specific customer's usage, yeah, maybe. We have second wave, third wave, and we have the specialty technology users who are something outside the second wave and third wave. We have second wave, third wave logic users, then outside the second, third wave, we have the specialty technology, who in time sequence are usually in the second, third or fourth or fifth wave. Yeah.
Okay. My second question is, you mentioned about the competitive advantages at the gate-last. As far as I know, your competitor is going to use the gate-last from the 20-nanometer. Based on your experience, how difficult and how much time they require to commercialize gate-last at the 20-nanometer from the gate-first?
Your question is with regard to whether or not there will be competitors switching to gate-last at 28-nanometer?
At 20-nanometer.
In 20 nanometer-
Yes
switching at 20 nanometer to gate-last. How much time and how difficult it will be for such a competitor to switch?
I don't know. It depends on his capability, I think. I don't know. I think it takes a long time, that's for sure. A year, maybe even longer. Do I see anybody switching, any competitors? I don't even know the answer to that. I do know that we don't see any serious competition at the 20 nanometer node.
Okay. Thank you very much.
Yeah. Mm-hmm.
Okay, I think it is about time that we should take a next question from the call. Operator, please proceed with the next caller on the line. Your first question from the call comes from Steven Pelayo from HSBC. Please ask the question.
Great. Thank you for taking my question. I'm curious about, you mentioned third quarter utilization rates declining slightly. You mentioned the possibility of fourth quarter revenues also being down. You also talked about capacity being up a lot in the third quarter. I guess I would like to hear you comment on utilization rates by node, and in particular, are you keeping the leading-edge nodes full? If not, the negative leverage effect to margins if the leading edge is not fully utilized.
Well, first, to answer your question generally, actually about a year ago, I predicted almost the same phenomenon for the fourth quarter last year and the first quarter this year. About a year ago, in fact, it was a year ago, when I said that the fourth quarter might be down and the first quarter might also be down. Fourth quarter last year, first quarter this year might also be. By the second quarter, we will see a strong rebound. Said that in July of 2012. Now this year, July 2013, and I see almost the same thing, except I think there is a bit of difference. The fourth quarter down could be a little more severe than the fourth quarter down last year. However, the first quarter down will not be as severe as the first quarter down this year.
Am I making myself clear? I think that last year, incidentally, our fourth quarter was down by about 7%, I just said now that Well, anyway it could be a little more severe than that. The first quarter, however, could be reasonably flat from the fourth quarter. However, next year, second quarter rebound, is going to be, I believe, a very strong one, just as this year's second quarter rebound was. That's answering the question generally, I think that our third quarter, by the way, you said fourth quarter will also be down. Our third quarter is up. It's not the quarter, okay?
You asked whether the margin, you said Yeah.
I was just asking relative to the
Okay
utilization rate by node, if the leading edge isn't as fully utilized, doesn't it have a more profound impact to your margins?
20-nanometer is still fully loaded in the third quarter. How well it'll be loaded in the fourth quarter is, at this point, unknown. I think that it may be less than 100% loaded in the fourth quarter. The other nodes, 45 and 65, et cetera, well, some of them are still fully loaded in the third quarter, but may not be fully loaded in the fourth quarter. We're really not giving fourth quarter guidance right now, so I want to limit that.
Okay, just one final question. This is really just a clarification. I think last quarter you spoke about 20-nanometer in its first year being bigger than what 28-nanometer was. This quarter, you're now saying 20-nanometer is going to be high single-digit % of revenue. I guess it depends what we think the total revenue number is going to be. I'm just curious, is there a change there on what you think the total TWD contribution can be next year for 20-nanometer at TSMC?
Well, actually, the first year of 28-nanometer was 2011.
Oh, I'm sorry. Yep, repeat.
The first year of 28-nanometer was 2011, and I'm quite sure that, in 2011, 28-nanometer did not reach 8% of our total revenue.
Okay, understood. Thank you.
Next question, I think we'll still keep it on the call. Operator, please proceed to the next caller. Your next question from the phone comes from Mehdi Hosseini from SIG. Please ask the question.
Yes, thanks for taking my question. Dr. Chang, early on in your prepared remarks, you talked about the growth rate for high-end smartphone peaking and the low to mid-range is growing at a faster rate. Also, you talked about the very expansive and very expensive 20/16 nanometer factories under construction. Do you think that profitability for the new smartphones, given the fact that they're going to be selling at a lower price, could help build enough demand to fill these GigaFabs?
Mehdi, I think I am able to capture the first part of your question, but the second part after you said that we're building GigaFabs for 20 and 16, can you repeat that part again?
Sure. Let me repeat the entire question. I'm just trying to better understand what Dr. Chang thinks about the trend in the smartphone and the trend towards the low end. Will there be enough profitability for the fabless companies to migrate to 20 and 16 nanometer nodes?
Your question is, based upon the trend, the smartphone trend is towards faster growth on the lower end, whether or not there's still the need to fab ramp the leading-edge nodes such as 20 and 16. Is that your question?
Yes. Thank you.
He confirmed that that was his question, would you repeat the question for me?
Right. His question is, the trend in smartphone is shifting towards higher growth at low end, we are still building very fast, a leading-edge capacity at 20 and 16.
We're still building-
Leading-edge capacity at 20 and 16.
I think the question was whether the low end will migrate to 16. I think so, very definitely. It's only a question of time. I don't frankly know. 16, even the leading edge won't start using 16 until 2015. I think that the low-end manufacturers will probably be, I would say, at least two years behind, 2017. Is he worried about our capacity utilization for 16? I don't know what I can say to assure you again and again and again. This question came up almost for every generation. Again, I think, first, the premise. The premise is that we do not build capacity until we are quite confident of the demand. That's premise number one. We do not build capacity until we are quite confident of the demand.
We look at demand not by market segment, but by customer. We base the confidence on the work that we have already been doing with the customer. That's premise number one, that we don't build capacity until we are reasonably confident, highly confident of the demand. The second premise is that we do have waves, succeeding waves of customers. When the first wave migrates to an even more advanced node, we have second wave, third wave, and we have specialty technology customers taking over the capacity that the first wave, the succeeding waves ahead of them have left behind.
Maybe my follow-up would be, since you're very clear that you're not going to build capacity ahead of demand, would you comment or would you help us with any idea of how next year's CapEx could look like at this point in time?
Next year's CapEx. His question is next year's CapEx.
Next year's CapEx will be about the same as this year.
Got it. Thank you.
Okay. Let's come back to the floor. The next question will be coming from the floor and will be coming from Morgan Stanley's Bill Lu.
Thank you. Dr. Chang, you talked about building capacity based on customers. I went back and looked at your annual report. Top 10 was 51% of sales in 2007. Last year was 59%. Top 1 was 11% 2007, 17% 2012. Quite a big increase in customer concentration. I think probably you can expect that going forward, that gets bigger, right? With the big customer coming on board. Top 2 could be more than your revenues.
That makes it easier for us.
Right.
In terms of building capacity, in terms of estimating capacity, right?
Yeah. I guess I'm just wondering, if you have more customer-specific risk going forward, and how do you deal with that?
Well, there are always risks. You got risk crossing the street, but you take it, and I think that, frankly, the way I look at it, we want to make our relationship with our major customers such that the risk of their, Maybe Paul Yee said that. The way he put it, switching foundries. The way we work with customers, the major customers, makes the risks of their switching foundries almost as small as crossing the street.
I guess I'm not as much worried about them switching as much as one customer just doesn't do well with a poor product line or something like that.
As they what? They blow out?
I guess, I think customer risk could be one is switching, but two is just one particular chip doesn't do well.
Sure. Sure. That risk exists. As I said, remember what I said earlier, that we don't always build as much capacity as they would like us to build. Everybody, I think, tends to be a little optimistic about his own new products or whatever, new market and so on.
My second question is, you broke down smartphones by high-end, mid-end, low-end. I think it was last year, maybe the year before, you had given a content per smartphone type of number for TSMC. Can you give that maybe now versus then?
Do you remember the number?
I think it was TWD eight-point something.
Was it that much? No.
I think we said NT$ 7 for average.
Okay. Seven. Yeah.
What's the use of telling you this if you don't even remember what I told you last time?
Well, I.
Well, anyway, the reason I test you is because I wanted to tell a new number, but I just first wanted to test whether you remember the last one or not. In any case, for the high end and the middle end, the number has risen by about NT dollars 1. The smartphones have become smarter, partly because they carry more ICs made by us. That's why the content has, our value added in each high end and middle end has risen by about NT dollars 1. The low end, I haven't seen the number. Do we have low-end value? Yeah, you go ahead, Cathy.
On the average smartphone, we have NT dollars 7 per phone. From the low end, it's NT dollars 4, middle end, NT dollars 6, and high end, NT dollars 9.
The average hasn't changed from before.
$7.
Okay, great.
Well, average has, lower has increased. In the low end, you can't have TWD 8 or TWD 9 in the low end. The consumers don't want to pay that. They don't need all those features either.
All right. Next question still comes from the floor and will be from Goldman Sachs, Donald Lu.
Sorry. I got to be careful when asking questions, I don't get a question back. My first question is on second sourcing. I noticed a trend. Before 28 nanometers, there's always substantial amount of second sourcing going on. In 28 and 20, seems like very little. In your speech, quoting your words, you said, "For FinFET, we need substantial joint work between foundry and customer." Does that mean the second source kind of business model is not going to work very well in the future, in terms of foundry second sourcing?
It's very difficult. Foundry second source has always been a difficult thing. I think that whether it will work, yeah, I think it could work, but the second source usually will be considerably behind the first source.
Would this gap continue to increase with each node going forward?
I don't believe so. Certainly Let me put it this way. Where we are the first source, we are going to certainly do our best to prevent a second source. All right? Where we have the opportunity of become a second source, we will often refuse to be one.
Okay.
It's very different. I think it's difficult, and I do not think it's the way to go for either the customer or the supplier.
Just follow up on that question. If a customer for a particular product, is that still possible to source it at both TSMC and another foundry at the same time?
It's difficult for the same product. For the same technology, yeah, I can see that it's possible. It's not only possible, but that's not really second source-
Sure. Yeah
anymore. Yeah. That's two first sources in the same technology, yeah.
Okay. That's still possible.
Yeah.
The second question is that today, when you showed those pictures of fab, you stressed that all the GigaFabs can be connected. I noticed that compared TSMC with Samsung and Intel, TSMC definitely have huge fabs that are connected versus the other two are more scattered around the world, for various reasons. For TSMC, number one, that will give you more cost advantage. Is that still the case for FinFET, etc., going forward, even you have one large?
Cost advantage, yes. I believe there is some cost advantage in connecting all the fab into one GigaFab. I think the main advantage is probably in time to expand or time to market. That is, we qualify only once, because in one big GigaFab, we qualify only once. Whereas if they are disconnected, if they are separate fabs, then usually we have to qualify each fab. Yeah. On the same product, that is. Yeah. Well, on the same technology, let's say. Yeah.
Just follow up on that. Does that also mean TSMC will probably not build a 12-inch fab, let's say, in the U.S. or China? Is that strategy still true?
You are predicting things for me Donald. No, we always consider doing things, but I think every time in the past we just run up against this stock, which it's very costly to do it in a separate location, in another very different location. Well, we have expanded our China fab considerably in the last two years. It is not what you knew two years ago. It's twice as large as the size two years ago, yeah.
Is that profitable?
Oh, yeah. Why would we do it if it wasn't?
Okay. Next question also comes from the floor, and it will be from-
It is very profitable, actually. Yeah.
Hopefully, next question is also related to very profitable question from Barclays, Andrew Lu.
Dr. Chang and Lora, I have two questions. First one, I remember last year, almost at same time, I think it's year July 20-something, you mentioned that Q4 will be down. You say will be low part of the double digits, have a close to 10% decline. You end up with a rush order, and Q4 revenue decline only 7%. The same for Q1. Earlier, you guide a similar decline like Q4, end up with 1% decline. Based on your current visibility, earlier you mentioned will be similar or worse than last year. Are you saying worse than 7% decline or worse than your original guidance last year, when you give about 10%?
I meant worse than the actual 7%, yeah. Could be worse.
Could be double digit?
Well, actually, I kind of regret that I even went into this fourth quarter thing now. I don't expect it to be at the. I think it'll be a decline, but I normally don't even guide or forecast the quarter after this. When I see something unusual happening, I do try to tell you in advance. That was the case last time, and it's a year ago, and it's the same case this time. Same situation this time. I see a finite possibility of the fourth quarter being down from the third quarter. As to its magnitude, I really don't. Even when I said that maybe a little more serious than the minus 7% last year, I was taking a risk. That risk is greater than crossing the street, by the way.
Okay. My second question is regarding the FinFET competition. Based on our industry check, Intel will ramp up 14nm FinFET by second half next year. Probably will start to do the foundry for 2015. Samsung claim they are going to jump from 28 to 14nm FinFET similar next year, 2015. Our FinFET also will mass produce from early 2015. My question is, based on these industry competitors and also some of customers' comments, our 16 FinFET, the die size is larger than our competitor's 14nm FinFET, and performance a little bit worse than competitor 14nm FinFET. Do you have any words to defend this statement?
No, I'm telling you that our 16. Well, first of all, you have to remember, nothing is out yet. Everything is just talking, talking, okay? Yeah. I stand on what I said, I guess it was 30 minutes ago now. On foundry competition, I believe we are being competitive on the 16. On a Grand Alliance versus IBM competition, I believe we are more than competitive.
Okay. I believe that this is about time for us to take a question from the call. Operator, could you please proceed to the next caller? The next question from the phone comes from Brett Simpson from Arete Research. Please ask the question.
Thanks very much. Dr. Chen, you mentioned the competition are not ramping 28 High-K Metal Gate yet. You're not seeing any competitors there. Your loading will start to come down towards the end of this year and then rebound in second quarter. During this time, we're going to see TSMC adding new capacity. You're ramping your new GigaFabs. Also, this time, we're going to have GlobalFoundries planning to add a lot of 300-millimeter capacity as they eventually get into 28 nanometer High-K Metal Gate. My question: Are you concerned at all about overall foundry supply that's coming on stream over the next 12 months?
Brett, your question is with respect to the potential oversupply condition for 28 nanometer starting fourth quarter of this year. You are concerned whether or not TSMC as well as competitions are building, continue to build 28 nanometer capacity, it will create a glut. Is that your question?
Yeah, particularly GlobalFoundries, who seem to be adding a lot of 300-millimeter capacity, at some point, they will start to ramp up 28 nanometer High-K Metal Gate. I'm trying to understand whether Dr. Chiang sees any oversupply conditions over the next 12 months. Yeah.
28 nanometer oversupply for next year? I don't think it will happen. You want to know the reasons why it won't happen?
Yes, please.
Look, I already said it. I think we have a substantial lead on yield and on performance in 28-nanometer. While other competitors, or at least some of the other competitors, are talking about building capacity and even actually building capacity, I think that we will have a much higher utilization in our capacity than most competitors. Much higher. This has happened before. In fact, has been happening all along in the last 15 years or so. While we always build capacity when we knew who our customers would be, and we knew at least approximately what their demand would be, real demand. While we build our capacity on that kind of knowledge, our competitors often build capacity on speculation.
You might say, "Well, that's certainly not very advantageous to you either." No, it was not very advantageous to us, we still managed to hold our profitability. We still, over all these years, in almost all nodes, 0.13-micron, 90 nanometer, 60 nanometer, 65 nanometer, 45 nanometer, it has always happened. Our competitors build capacity on speculation. The result in every generation was that we still got our profitability. In fact, our structural profitability, as I pointed out, has improved. We also had very much higher utilization in our capacity at each node than our competitors. If you look at the history, you will find out. This is why our profits, I think even now, of course, GlobalFoundries is not a public company, and Samsung, Intel, I don't think exactly disclose their foundry revenue or income.
Back when we had foundry competitors that disclosed their revenue and earning, we had only 50% of the revenue of the total industry, we had 100% of the profit. See, that means the rest of the competitors, if they had negative profit, or if they had positive profit, it was canceled out by some other's negative profit. We had 50% of the revenue and 100% of the profit. I think that it will continue to be that way, frankly.
Can I-
Yeah.
Can I perhaps just ask a follow-on question, Dr. Chiang, about wafer ASPs? Your wafer pricing has been rising quite nicely over the last 12, 18 months as you've ramped 28-nanometer much faster than prior nodes. Can you talk a little bit about how you see wafer ASPs trending over the next few years as you start to ramp up 20-nanometer and 16 FinFET? Should we continue to see wafer ASPs rise at similar levels?
Yes. The blend of the average price will continue to rise.
Great. Thank you.
All right. Let's come back to the floor. The next question will come from Citigroup , Roland Shu.
Thanks. Chairman, I think the first question for me is for the 16-nanometer adoption. Will customers skipping 20-nanometer go to 16 directly, or customer will more likely sequentially migrate to 20-nanometer first and then to 16-nanometer? This is my first question.
Will they skip 20-nanometer? Is that the question? Yeah. I think some customers might. Some. I think a larger percentage of the customers will go to 20 first and then 16.
Okay. Follow-up question will be, for those 20-nanometer customers, will it be enough incentive for them to move from 20 to 16? Of course, we know there are a lot of improvements from 28 to 16. How about the comparison from 20 to 16? Will there offer more incentive for customers to migrate to?
You're talking about performance and the power and that sort of thing. I think they get a bit too detailed for me to talk to you here.
I think we have said our advantage of 16-nanometer over 20 is for speed, performance. It will be 20% faster at the same total power, and it will be 35% better efficiency power given the same speed.
Thank you. My second question is on the gross margin side. I think in 3Q, certainly we are going to have a more 28-nanometer wafer contribution. I think that certainly, for the first quarter, 24%, second quarter, 29%, then 3Q certainly will be up to about 30%. Also, we have more High-K Metal Gate. The 28 AP should be But still, we have a lower gross margin. Can Lora comment about maybe give some idea what the margin impact from this increasing 28-nanometer and also from this decreasing utilization in 3Q? Thank you.
28-nanometer continue to increase actually helps the overall margin. Given the third quarter, I was guiding a lower profitability, but not because of 28. 28 do very nicely, and it will be fully loaded. Its other nodes will be less utilized. To answer your question, basically, other nodes have lower utilization. Roland, are you done with all your questions?
Yes.
Great. All right. He's the first that only take one question. Next one comes from, I think you are Daiwa, right? Right. Daiwa, Eric Chen.
Hi, Dr. Chen and Lora. Very quickly, one question regarding to your China strategy. We talk about a lot of the high-end, the mid-range, and the low-end smartphone. From my understanding, your market share, and for the China kind, in the smartphone IC, lower than your market share for the global smartphone IC maker.
I don't know whether that's true or not.
My guess, let me say this way.
You're shaking your head to deny that it's true or what?
I don't think it is lower. Yeah.
Okay. Let's assume that's higher. My question is, China smartphone IC maker, they care about the wafer price.
Say what?
They care about the wafer price.
Price sensitive.
Huh?
Price sensitive.
Price sensitive.
Yeah.
They're probably bargaining the wafer price and even more severe. They are more sensitive. Any strategy you have for those, the China, either the PC IC maker or the smartphone IC maker, probably the one example is one guy just moved to GlobalFoundries. How you think this trend?
Anybody, somebody moves to a competitor, I feel very sad. This particular one, and the last time when I said I was very regretful when another one of our customers moved to Intel. This particular one, I think I know what you're talking about and who you're talking about. I will use a word that's considerably less than regret, okay? Yeah. We know that they are very price-conscious, and we try to work. Well, actually, I should say we try to work with our customers who have to work with their customers because their customers are the price-conscious ones. Yeah. As I reported in my message, we've been quite successful so far. Yeah.
Okay. Thank you.
Yeah.
My second question if the CapEx for next year is spread from this year, how many % CapEx growth and depreciation expense growth from this year?
I have no idea at this moment. Chairman just give you a ballpark of the total CapEx. We have not calculated based on that.
Well, I gave him actually a little more than ballpark. I gave him the size of the diamond anyway. Well, are you a baseball fan? You know what I'm talking about?
Yeah, I'm a baseball fan.
A ballpark is maybe 10 times the size of a diamond.
Okay. Actually, the follow-up question regarding to the CapEx. I just really want to know exactly why you're so confident for the demand. Yesterday, Intel announced they are going to cut their CapEx to Taiwan.
Why am I so confident of what demand?
The market demand and your CapEx.
I'm confident because I have usually been right.
Okay. Thank you, Mr. Chang.
Yeah.
All right. I think in the interest of time, and this is already a little over, it's about 100 minutes now, so I think we'll just end our investor conference for this quarter right now, and thank you for coming.