In English, the earthquake that just took place at 1:10 this afternoon has no impact to TSMC's fabs or the back end packaging fab. So there's no impact. Thank you. Welcome to TSMC's Q1 2019 Earnings Conference and Conference Call. This is Elizabeth Sun, TSMC's Senior Director of Corporate Communications and your host for today.
Today's event is webcast live through TSMC's website at www.tsmc.com. If you are joining us through the conference call, your dialing lines are in lesson only mode. As this conference is being viewed by investors around the world, we will conduct the event in English only. The format of today's event will be as follows: First, TSMC's Senior Vice President and CFO, Ms. Laura Ho, will summarize our operations in the Q1 2019, followed by the guidance of the Q2.
Afterwards, Ms. Ho and TSMC's CEO, Doctor. C. C. Wei, will jointly provide company's key messages.
Then we will open both the floor and the line for the Q and A. For those participants on the call, if you do not yet have a copy of the press release, you may download it now from our website at www. Tsmc.com. Please also download the summary slides in relation to today's conference presentations. As usual, I would like to remind everyone that today's discussions may contain forward looking statements that are subject to significant risks and uncertainties, which could cause actual results to differ materially from those contained in the forward looking statement.
So please refer to the Safe Harbor notice that appears on our press release. And now I would like to turn the microphone to TSMC's CFO, Ms. Laura Ho, for the summary of operations and current quarter guidance.
Thank you, Elizabeth. Good afternoon, everyone, and thank you for joining us today. The presentation will start with financial highlights for the Q1, followed by the guidance of the 2nd quarter. 1st quarter revenue decreased 24.5 percent quarter over quarter as our business was impacted by the overall global economic conditions, which dampened the end market demand. Also, customers' inventory corrections and high end smartphone seasonality and the photoresist defect material incident.
Due to lower level of capacity utilization and the negative impact from the photoresist defect material incident, gross margin decreased 6.4 percentage points sequentially to 41.3%. Total operating expenses decreased by about NT4.8 billion and represented 11.9% of total net revenue in the Q1. So operating margin decreased by 7.6 percentage points sequentially to 29.4%. Overall, our first quarter EPS was $2.37 and ROE for the Q1 was 14.4%. Now let's take a look at revenue by technology.
7 nanometer technology accounted for 22% of wafer revenue in the 1st quarter, 10 nanometer was 4% and 16 nanometer was 16%. Advanced technologies, which we now define as 60 nanometer and below, accounted for 42% of wafer revenue. Now let's take a look at revenue contribution by application. During the Q1, communication, computer, consumer and industrial standard decreased 27%, 31%, 10% and 16%, respectively. Now this is the last time we provide a revenue breakdown by application.
From this quarter on, we will report revenue breakdown by platform as we believe this change will better represent the company's results. Now let me explain how to read the tariff the table. The table shows the between the 4 application and the 6 platforms, how do they relate to each other. In general, within computer application, almost all revenue is from HPC. Within communication, about 2 third is from smartphone.
HPC is about 1 5th. And other platforms are single digit each. Consumer is mainly distributed between HPC and the digital consumer electronics, whereas industrial standard spread across all platforms with smartphone and HPC each representing about 30%. Now let's take a look at revenue contribution by platform for the Q1. Smartphone decreased 33% to accounted for 47% of our first quarter revenue.
HPC decreased 26% to accounted for 29%, while IoT, automotive, digital, consumer electronics and others accounted for 5% to 7% each. Now I would like to move on to the balance sheet. We ended the Q1 with cash and marketable securities of TWD 760,000,000,000 an increase of TWD 65,000,000,000 from the last quarter. On the liability side, current liabilities increased by NT38,000,000,000 On financial ratios, accounts receivable turnover days increased 8 days to 49 days, a sales decrease faster than average accounts receivable. Days of inventory increased 12 days to 79 days, reflecting 7 nanometer wafer pre build and an increase in raw wafers.
Now let me take a few comments on cash flow and CapEx. During the Q1, we generated about RMB153 billion cash from operations and spend yen 76,000,000,000 in capital expenditures. As a result, we generated free cash flow of JPY 77,000,000,000 and our overall cash balance increased JPY 88,000,000,000 to reach JPY 646,000,000,000 at the end of the quarter. In U. S.
Dollar terms, our first quarter capital expenditure was RMB 2,460,000,000. I have finished my financial summary. Now let me provide the 2nd quarter guidance. Based on the current business outlook, we expect 2nd quarter revenue to be between RMB 7,550,000,000 dollars and 7,650,000,000 in U. S.
Dollars, which is a 7.1% sequential increase at the midpoint. Based on exchange rate assumption of 1 dollars to NT30.85, Our first quarter gross margin is expected to be between 43% 45%. Our first quarter operating margin is expected to be between 31% 33%. Also, in the Q2, we will again need to accrue the 10% return, 10% tax on the undistributed retained earnings. As a result, our 2nd quarter tax rate will be about 18%.
The tax rate will then fall back to 10% level in the 3rd Q4. And the full year tax rate will be about 12%. This concludes my remarks. Let me follow by making a few comments about the profitability, CapEx and cash dividend. First, let me talk about the profitability in the first and second quarter.
Our first quarter gross margin declined by 6.4 percentage points sequentially as our 7 nanometer saw a substantial cutback in utilization in Q1 due to high end smartphone seasonality, which impacted our gross margin by close to 4 percentage points. In addition, the photomaterial photoresist material incident impact our gross margin by about 2.6 percentage points as we indicated in our press release in February. I have just guided 2nd quarter gross margin to improve by 2.7 percentage points sequentially at the midpoint. Since most of the wafer scrapped in first quarter due to the photoresist incident will be made up in 2nd quarter, gross margin can improve by about 1 by about 1.5 percentage point in this quarter. In addition, the 7 nanometer dilution in 2nd quarter as compared to Q4 2018 will be close to 3 percentage point, which is about 1 percentage point improvement from the Q1 in terms of dilution.
And we also expect a slight improvement in other nodes utilization rate. Our gross margin in 1st and second quarter are primarily impacted by a lower capacity utilization rate. As our business and utilization rate improves in the second half of this year, we believe about 50% is still a target for our gross margin going forward. Now I will talk about the CapEx outlook. We reiterate our 2019 CapEx to be between USD 10,000,000,000 to USD 11,000,000,000 About 80% of the CapEx budget will be allocated for advanced process technologies, including 7 nanometer, 5 nanometer and 3 nanometer.
About 10% will be spent for advanced packaging and mask making. And about 10% will be spent for specialty technologies. As I have stated before, we see our CapEx forecast between USD 10,000,000,000 $12,000,000,000 to support our average growth rate of 5% to 10% per annum in the next few years. My last comment is about the cash dividend distribution. In the future, TSMC intend to return about 70% of free cash flow to shareholder every year by distributing quarterly dividends.
TSMC also remains committed to a sustainable cash dividends on both an annual and quarterly basis. In June, TSMC will hold the annual shareholder meeting to approve the Board's proposed anti dollar $8 cash dividend per share for the full year of 2018. And the shareholder meeting will also approve the revision of the articles of incorporation to adopt quarterly dividends. Subject to the approval by the Annual Shareholder Meeting, the board plans to approve NT dollar $2 cash dividend per share for the Q1 2019 and to be paid in the Q4 2019. Therefore, TSMC's shareholder will receive a total of NT $10 per share cash dividend in 2019.
That also means in 2020, shareholders will receive at least any dollar $10 per share cash dividend for the whole year. That concludes my remarks. Let me turn the podium
and inventory. We concluded our Q1 with revenue of TWD280,700,000,000 or US7.1 billion dollars in line with our revised guidance. Our business in the Q1 was impacted by 3 factors: 1st, the overall global economic condition, which dampened the end market demand second, customers are ongoing inventory adjustment and third, the high end mobile product seasonality. Meanwhile, the net effect from the photoresist defect material incident also impacted our Q1 revenue by about 3.5%. Moving into Q2 this year.
While the economic factor and mobile product seasonality still linger, we believe we may have passed the bottom of the cycle of our business as we are seeing customers' demand stabilizing. Based upon customer indications for their business and wafer loading in Q2, we also expect our customers' overall inventory to be substantially reduced and approach the seasonal level around the middle of this year. In the second half of this year, TSMC's business will be supported by this healthier inventory base as well as strong demand from our industry leading 7 nanometer technology, which support high end smartphone new product launches, initial 5 gs deployment and HPC related applications. For the whole year of 2019, we forecast the overall semiconductor market, excluding memory as well as foundry growth to both be flattish. For TSMC, we reiterate that we expect to grow slightly in 2019.
Now let me update the photoresist material instant. On February 15, in order to ensure quality of wafer delivery, TSMC announced it will scrap a large number of wafers as a result of a batch of bad photoresist material from a chemical supplier. This batch of photoresist contain a 4 ring polymer that created a desirable, undesirable effect and resulted in yield deviation on 12- and 16 nanometer wafers at FAB14B. We have since taken corrective action to enhance our defenses and minimize future risk. Our actions, including the following: improve TSM Seesong in house incoming material conforming test and controls upgrade control and methodology with all suppliers for incoming material quality certification establish robust in line and off line monitoring process to prevent defect escape.
Now I'll talk about our N5 status. Our N5 technology development is well on track. N5 has entered with production in Q1, and we expect customer tape outs starting this quarter and volume production ramp in first half of twenty twenty. With 1.8 large density and 15% speed gain on an ARM A72 core compared with 7 nanometer, we believe our N5 technology is the most competitive in the industry with the best density, performance, power and the best transistor technology. We expect most of our customers who are using 7 nanometer today will adopt 5 nanometer.
With N5, we are expanding our customer product portfolio and increasing our addressable market. Thus, we are confident that 5 nanometer will also be a large and long lasting node for TSMC. Now I will talk about the ramp up of N7 and N7 plus and introduction of N6. We are seeing strong tapeout activity at N7, which include HPC, IoT and automotive. Meanwhile, our N7 plus which adopts EUV for a few critical layers, has already started volume production now.
The yield rate is comparable to N7. We reaffirm N7 and N7 plus will contribute more than 25% of our wafer revenue in year 2019. As we continue to improve our 7 nanometer technology and by leveraging the EUV lending from N7 plus we now introduce N6 process. N6 has 3 major advantage. First, N6 have 100% compatible design rules with N7, which allows customer to directly migrate from N7 based design, which substantially shortened the time to market.
2nd, N6 can deliver 18% higher logical density as compared to N7 and provide customer with a highly competitive performance to cost advantage. 3rd, N6 will offer shortened cycle time and better defect density. Risk production of N6 is scheduled to begin in Q4 year 2020 with volume production starting before the end of 2020. Now let me talk about advanced packaging technology. TSMC's advanced packaging strategy focuses on providing advanced wafer level system integration technologies to meet customers' product needs.
Currently, we have offered info and co works for several generation and recently introduced SOIC. We believe heterogeneous integration on the packaging level has become a clear trend for many applications. All our advanced packaging platforms enable efficient system level integration and will continue to do so. Our 4th generation InFO solution provide a final interconnected line with anticipation to enable both mobile and HPC products. CoreWatts continue to see good growth momentum in demand from HPC and AI applications as we continue to expand beyond the radical size.
We are also working with a few leading customer on SORIC, which is an industry leading 3 d IC packaging solution. We target to start production in 2021 time frame. The traction of our advanced packaging solution has been strong in mobile and HPC segment. And we have seen inquiry from automotive segment as well. We therefore believe our advanced packaging solutions will contribute to our business growth for years to come.
Finally, I will talk about HPC as our most important growth driver in the next 5 years. CPU, AI accelerated and networking will be the main growth area for our HPC platform. With the successful ramp of N7, N7 plus and the upcoming N6 and N5, we are able to expand our customer product portfolio and increase our addressable market to support applications such as data center, PC and tablets. Meanwhile, we also see networking growing, thanks to 5 gs infrastructure deployment over the next few years. We are truly excited about our growth opportunities in HPC.
Thank you for your attention.
All right. This concludes our prepared statements. Before we begin in Q and A session, I would like to remind everybody to limit your questions to 2 at a time to allow all participants a opportunity to ask their questions. Questions will be taken both from the floor and from the call. Should you wish to raise your questions in Chinese, I will translate it to English before our management answers your question.
First question will be coming from Citigroup's Roland Xu.
Good afternoon, Sisi and Laura and Elizabeth. First question, Sisi said you maintain your view for the whole year revenue to grow slightly. So that means according to your Q1 revenue, Q2 guidance means second half is going to grow very fast. So can you just let us know what kind of applications are driving so strong second half to TSMC this year?
C. Wei:] The strong demand I just mentioned from 7 nanometer actually including the mobile platform, HPC platform and IoT with a little bit flattish of automotive, but that's all that what we rely on. Actually, we will say that seasonality of the mobile phone, the new product launch that make the major contribution.
Yes. And I just do this calculation. I think for second half, your revenue actually is going to grow year by year. I think maybe mid single digit year on year. So I think except for this seasonality, do you gain share?
Or do you have more new applications in second half? C.
Wei:] We actually gained some shares because of 7 nanometer. And for the new product portfolio, that will be probably you will see the effect in 2020, not March this year.
Okay. Thank you. Yes. And also for the second half gross margin, lower sales with this higher utilization and also with less dilution from 7 nanometers. So you said your long term gross margin will be target will be 50%.
So is this means that for second half or just for the long term? Both. Okay. My second question is, C. C, last quarter, you said now we are at the market with the widest addressable market driven by HPC and CPU.
And C. C. Also said HPC is going to be our most important growth driver. So can you quantify how big foundry addressable market will be driven by HPC and CPU, respectively?
I don't think I have enough data to tell you that how much we can quantify the percentage. But I believe the HPC platform will grow double digit, excluding the cryptocurrency, of course.
How about the CPU?
Too specific.
Okay. And I think lastly
Roland, you have more than 2.
This is a follow-up on the second question. So do you have any competition on this CPU foundry outsourcing? Thank you.
Again, I don't want to be too more specific on the CPU area, all right?
Next, the question will be coming from JPMorgan's Gokul.
Thank you for taking
my question. So my first question is on 5 nanometer. Think in the last conference call, C. C, you mentioned that TSMC will be initially building a few percentage points or some lower capacity on 5 nanometer in 2020 compared to 7 nanometer. Now that you have more visibility into your customers' plans, could you let us know what does that mean?
Is it 30% lower, 10% lower? What does it mean? And why is that? Is it because customer is a little bit hesitant to go to 5 nanometer and has other options? Or you just believe that, like you previously mentioned, the only reason is that high end smartphone demand expectation, you are taking a more cautious view on that?
That's my first question.
Actually, I'd like to go through. I like your last sentence. You said that's more cautiously. Let me repeat again that we say N5's initial ramp, it might be slower than the N7. First, we learned the lesson from the N7's wafer loading.
Look at this year, so Q1 and Q2 right now, it's actually very low. So learn the lesson. So we are working with the customer to be more cautiously and effectively manage the capacity ramping. So that's what I said that it will be a little bit slow. But that being said, the N5's business, I want to reassure everybody that N5's business will grow bigger than N7 because of our expanding the product portfolio.
And you know what I mean. In the HPC, we have very good opportunities. And on the smartphone, we are gaining the market share. So I would believe that N5 initial ramp probably a little bit more cautiously slower than the N7, but it will pick up quickly. Okay.
Got
it. My second question is on the technology leadership. I think TSMC clearly now seems to be ahead of even IDMs in terms of technology leadership. How should we think about how that translates in a financial basis? What we have seen in semiconductor industry in the last several years is when one player becomes the dominant player, typically margins go up.
How should we think about this? What is TSMC's philosophy in terms of utilizing this technology leadership? Are we looking for higher than market revenue growth? Or we should expect structurally higher margins in the future years now that we are kind of getting through the smartphone saturation period and getting into HPC?
As you pointed out, we have technology leadership and suppose and we are working on that also. Actually, we want to grow the market share. We want to do bigger business with a higher profitability. I don't have enough data in my hand to give you all the analysis in the future years, but we are working on it. And that's the goal we are working on actually, higher profitability and get market share.
So just one sub question there. I think if we observe the last couple of years, TSMC, foundry industry has not outgrown semis, ex memory, and TSMC also has not grown much faster than the foundry industry, which was not the case in the past. In the past, foundry was growing much faster than semis, and TSMC was growing much faster than semis than foundries. So when do we expect that gap to open up between TSMC's growth and foundry growth and potentially foundry growth and semi's growth itself?
You are asking more and more specific on the schedule. I would expect that starting from the second half of this year and extended to the next few years, we'll start to widen the gap. Is that your question? Okay.
That's specific enough.
Next question will be coming from UBS, Bill Lu.
So
in the last couple of months, I've had a chance to visit a few fabulous customers. And I feel like
the feedback that I'm getting
is that maybe previously there was more concerns about EUV feasibility. That is now mostly going away or maybe it's just less. But on the flip side, I hear maybe a bit more concerns about cost per transistor for 5 nanometers. I'm wondering if you agree with that and what can be done about that?
Well, that's a good question. We did some calculation by ourselves. We still seeing the cost per transistor still decreasing, but not as fast as it used to be. That's one thing. As you mentioned about the EUV, today, we put the EUV into mass production already, and we learned some kind of experience so that we can introduce NC6.
But is UV's productivity is very good already? Not yet. We expect it to continue to improve every year just as we did for the emerging photolithography. So we expect in the future that U. V.
Will offer a best tool in terms of cost, in terms of technologies moving forward, but not today yet. There's still a lot of process complexity. So we're using the EUV to replace some of the very critical layers, and the costs are probably equal today. And in the future, we hope it will improve. Once it improves, the cost per transistor will decrease faster.
Is there a timing for that?
No, but as fast as possible.
Sorry, second question is just a clarification. I think previously, Doctor. Wei said that HPC ex crypto grows double digits. Is that for this year? Or is that longer term?
C. Wei:] For this year, it's close. For longer term, that's what I mean for longer term.
Yes. I really appreciate the breakout by platform. Can you help me with this year's growth, maybe just for smartphone versus HPC?
Both are probably in the middle single digit, somewhere around that.
Okay. So HPC is close to double digit without crypto, mid single digit, including crypto?
No. HPC without the cryptocurrency, it will be somewhere mid single digit. With the critical cryptocurrency is dropping.
Okay. Got it. Thank you.
Next question will be coming from Morgan Stanley's Charlie Chan.
First of all, just want to follow-up that HPC segment because just to compare the notes, last quarter, we said HPC, excluding crypto, upsizing, right, including crypto, down more than 10%. So it seems like number seems to be a little better. You said the right comments about HPC market doing better than expected?
Yes, it's doing better because of one of the factor or one of the component in the HPC is networking. And you know that the 5 gs's deployment, so that help the growth of the networking quickly.
Okay. Yes. So I think this is related to my second question, right? I think a lot of traders saying that some big customers in smartphone and the base station segment is building up inventory for whatever reason, share gain or some strategic inventory. But management also said that you believe the inventory level will be back to normal, it's around
the mid year.
So my question is that do you worry about this kind of overbuilt inventory? And how are we going to manage that kind of risk?
C. Wei:] We don't specifically comment on one customer's particular business behavior. But let me share with you why we say that the inventory will be greatly reduced and be close to the seasonal level around the middle of this year. We actually, we look at our history and the Q2, the customers' growth rate and we're using that number and look at the customers' demand number to give to us in the Q2. And we do some calculation, then we come to a conclusion that they are digesting their inventory quickly.
And so that's why we say that in the Q2, they are not building the inventory. They actually, they are reducing the inventory quickly. And that's why we come to the conclusion that in the second half, we were here to share inventory base.
Okay. Yes. Maybe quick question to Laura on cash dividend. So this year, I think the quarterly run rate is like $2 per quarter, right? But annual dividend payout is actually $10 in total, right?
So for next year, what would be the kind of minimum dividend payout? Should we use $2 run rate or we get like $8 for the full year for 2020, is that the guidance?
This year actually is a transition year, so we issued twice of cash dividend. The first was $8 followed by the $2 on quarterly basis. Starting from Q1 next year, we will only have a quarterly dividend. And we want to have a sustainable on quarterly dividend and on annual both. So we would like to see more stable dividend on quarterly basis as well.
So since I said, the dividend will be no less than $10 and we want to be stable on quarterly basis. So you can assume or expect we will issue $2.50 on quarterly basis at least.
Okay. Thanks. Very clear.
All right. Next question will be coming from Credit Suisse, Randy Abrams.
Yes. Thank you. I want to ask a follow-up. It was good disclosure moving to the new platform segmentation. Could you talk about sequential pickup?
How you see the different 4 platforms? How they're sequentially improving from this low level? And then for full year, since we got the other pieces, also the IoT and Automotive, What your view is on the other segments for the full year?
I will first comment on the Q2 on sequential basis by platform and followed by the full year picture. Is that what you're asking, Randy? Okay. For Q2, we are expecting smartphone to grow single digit, HPC grow double digit and IoT, Automotive and others will grow single digit and digital consumer electronics will slightly decline. That's for Q2.
For the whole year, we expect smartphone will grow high single digit. HPC, excluding crypto, will grow high single digit as well. And IoT will go double digit, automotive will decline single digit, and digital steel camera and others will decline single digit. That's the overall picture for this year.
Okay, great. Appreciate that. And then follow-up on the migration for these derivatives 7 plus and 6 nanometer. It seems to date the adoption has been rather slow for this year. If you could talk maybe about factors why a lot of customers are staying on 7 for now?
And as the node matures, if you could talk about the pace, how you see customer saves a percent of the node or how meaningful next 1 to 2 years for those derivative process?
As I said, we have very high tape out activity for N7 for this year. Actually, a lot of customer formed a 4 platform and mostly is from the HPC area, they are all designing their product with N7. A few of them adopt the N7 plus, but then that's why we introduced N6 that can be 100% compatible to the N7. So I'll give you a taste that probably starting year 2020, most of the customer in the N7 will move to N6. And from that day on, probably, N6 will pick up all the momentum and pick up all the volume production.
Okay. Great. If I can ask a follow-up, too. Given the strength on these derivatives, 6 nanometer, 5 nanometer and optimism, do you have any different view on 28 about if any of this equipment could be migrated to these advanced nodes? Or do you think it would be all new capacity?
From node to node, we have about 90% of the common tool or bigger than 90% of the percentage of the common tool being used for the next node. So you bet that some of the tools from 28 nanometer can be used for 7 or for 5, okay? But of course, it's less and less. But to for the overcapacity in the 28 nanometer because of some of the non market driven capacity increased, we our strategy is to develop some of the derivative technology, like a 22 nanometer and so that we can ensure that we still have a great HLC loading in the future.
Next question will be coming from Daiwa's Rick
Xu?
This is Rick from Daiwa. So I think the first question is about the follow-up on the N6. My question is, would you worry whether the N6 will cannibalize N5 development because this node looks pretty close?
The number N6 and N5 looks pretty close, but actually, the performance, they still have a big gap. N5 compared with N7, actually, the logic density increased by 80%, 80. N6 compared with N7 is only 18. So you can see there's a big difference in the logic density. And transistor performance also.
And so as a result, the total power consumption in the chip is lower in the N5. And also, that's just a lot of benefit if you move into N5. But nevertheless, N5 is one of the node, 4 node and it takes time for the customer to design their new product. The beauty of the N6 is they're already designing N7. They spend a very minimal effort they can move into the N6 and gain some benefit.
And so some of the customer, they depend on their product as characteristic and their market. They are defined which one go to N6, which one go to N5.
Can I have one quick follow-up to the first question before I ask the second one? Just quick follow-up. Can you share the number of critical layer that you will be billed by EUV
for and
I know for 7 plus you I think last year you mentioned just a few layers, critical layer from EUV. What about N6 and N5?
Okay. N6 is a few critical layer plus 1. Okay, that gives you a hint. N5 is a plus many, so.
Okay. That's very clear. And my second question is, you look at your end first quarter inventory days, 79. If I don't remember wrong, I think this is probably kind of all time high in history. Majority of this inventory were finished wafers or can you share some idea?
And also, can you elaborate a little bit more what's the rationale behind that 79 days? Yes.
Rick, the 79 is really high, But there's a good reason for that, because we anticipated 7 nanometer capacity will be very tight in the second half, but it's not so tight. It's very empty in first half. So we're trying to preview some of the inventory for our customer in the work in process. So they will not be constrained by our second half capacity. So by doing so, that work in process value will certainly go up, right?
So when we move into the second half, when we digest those inventory and demand start to pick up, our days of inventory will come down in the second half.
Thank you so much.
Next question will be coming from Bruce Lu, who is now with Goldman Sachs.
Hello, everyone. Thank you. My first question is still going back to the smartphone. Management mentioned that the smartphone growth is going to be about high single digit. This is substantially stronger than the smartphone shipment growth.
And manager also guided that previously that the next couple of years, the smartphone growth will be mid single digit. Again, it's also higher than the smartphone shipment growth in our in our view. So basically so where is the growth coming from? It's mainly driven by the content growth or share gain, either by your customer or yourself share gain. And can we somehow quantify that a little bit?
Quantify, I probably cannot. But the answer to your question is both. We gain the market share and the content increased quite a lot.
Can we know like which one is stronger?
You got me. I want both of them to be as high as possible, but I don't have a calculation because of the market share gain, they have to very carefully to do the calculation. And also, the content increase, let me say that content increase in the 5 gs area or in the AI area, every customer are different. So they put a different functionality inside. And we don't have a very good detail or detailed insight to give you an executive number to quantify what is the percentage per se.
I see. The reason why I try to dig it down a bit further is that if the content grows, which means that that would be at expense of the smartphone
cost structures.
So if you have higher content growth, which means that the semiconductor in terms of cost structure is higher, which at the end of the day will dampen the smartphone shipment as a price elasticity. So how do you if we foresee that very, very strong content growth, which means that the cost structure for your customer, customer will be much higher at the end of the day. So there will be certain trade off at the end of the day.
C. Wei:] There will be certain trade off of the high end smartphones of pricing and their cost, of course. But for TSMC, our job is to fully support customers' need. When they need this functionality, they need this kind of speed, we support them. Whether that will increase the pricing or the smartphone's end market's strategy, that's not in our concern.
We support them all the way.
Okay. My second question is more for Laura. So can you somehow help us to quantify the margin impact in 2020 as we can expect like very high, very
quick ramp up
for the 5 nanometer, which naturally in the 1st year, that will be the negative margin impact. And we will come into this 3rd year of 7 nanometer, so the margin negative impact should be less, but you have new margin negative impact on 5. So how do we can we get some color on it?
The margin impact actually has two front. Number 1, introduction of new technology, as you just mentioned. Usually, in the 1st year, there's a dilution to corporate gross margin. The other factor is the utilization on each technology node, particularly the advanced technology node. It's more sensitive to utilization.
So if we look at the corporate margin, we have to take consideration of both. But if we just talk about the leading edge introductions, N5 will be like N7. You will have some dilution next year. And as we have indicated before, it takes 7 or 8 quarters to reach to corporate level. We believe N5 will follow the same pattern.
But can we assume that the first two quarters of N5 in the second half of next year when you ramp up the negative impact for the margin is likely like 2% or 3% like what we had in 7?
No, we need to look at what's the ramping speed as well because if you ramp faster, eventually you can get through the learning curve quicker. So if you run slower, you take a long time. So if manufacturer will affect that.
I see. Because most of the investor concern is like with EUV potential higher CapEx, blah, blah, blah. So that might have higher negative impact for in terms of gross margin when we ramp up 5%. So we just want to get some color to clear the concern.
I think the N5 impact will not have much difference than our previous leading nodes.
I think this is about time that we should go to the line for the questions. Operator, could you please have the next caller on the line?
Sure. Next question is from the line of Greg Simpson of Pareto Research. Please go ahead.
Yes. Thanks very much. I have two questions for Sisi. First on FDSOI. It seems to be getting more traction in 5 gs than we first thought, both on the RF SOI and on the modem side for handsets.
So I'm just keen to understand this TSMC might consider supporting FD SOI or RF SOI. And if not, how do you plan to defend against that?
Okay. The question is FDA SOI has some good momentum in 5 gs area. And does TSMC consider to develop the FD The answer is no. We actually we also offer a very good technology, 22 nanometers technology. That today's performance is very comparable to FD SOI, if not better.
And we talking to the customer right now, and a lot of customers start to adopt the TSMC's approach. So no, we are not going to develop FD SOI technology.
Okay. Thank you for that. And just a follow-up, C. C, can you give us your perspective on PSNC strategy for compound semiconductor materials like gallium nitride or silicon carbide? It seems to be still a very small market, but the potential long term seems to be quite significant.
So how does TSMC plan to deploy these in these areas? Thank you.
Okay. The question is just about 3 Y compound or the compound semiconductors. TSMC actually is developing the gallium nitride technology to support the power management IC or the high voltage, high current power management. And others like gallium arsenide to have high frequency or those kind of things, no, we are not doing it. We actually, we are doing the gallium nitride project to support our customers' need.
That today we are doing. Silicon carbide, no, we are not doing it also.
Operator, can you have the caller on the next caller on the line, please?
Sure. We have already Josey Hosseini of FIT. Please go ahead.
Yes. Thank you for taking my question. Two questions. First one, is your guide on the smartphone revenue growth of high single digit this year impacted by 1 of the leading semiconductor company entering the baseband business. And I'm just trying to understand how you're going to capitalize on that opportunity.
And I have a follow-up.
Mehdi's question is that whether or not this year, our high single digit growth in the smart phone platform is affected by one very large company's exit from the baseband market?
Well, again, we don't comment on specific customers' business situation. But I would say this year that we have a high single digit smartphones, of course. Is that because of, 1, we gain market share 2, again, that silicon content is higher. So that's why we say we have a high single digit
growth. Okay. Great. And then moving to 6 nanometer, I'm just trying to understand the applications that would utilize 6 nanometer. And if I read you correctly, 6 is going to be ramping later than 5.
And if you could elaborate on the current application that would use that, would we could it be in good understanding in that particular note?
Right. The question is about N6. Looks like N6 is behind the N5 in terms of schedule. So what is the application? Well, again, I want to reiterate that N6 is coming from the N7 plus experience learning.
And so the N6, if you there are a lot of customer already enter N7 and with a lot of tape out. So N6 provide them a very good path that they can easily port in their current product into N6. So again, gain the benefit of either the performance, the die area and also the shortened cycle time. N5 is a totally new node. So you enter into a very new area.
If you start to design the N5 today as compared with you want to enter the N6 with the N7 already in your pocket, I think the N6 will be much easier. Now I did not say the N5 is very difficult, but TSMC will help you to move into N5, of course. But you look at the effort that you build an ecosystem. Ecosystem is the one that's very important for all the product company want to design their new product. N7 ecosystem has been very complete.
We even offer to the automotive grade, okay? And not to mention about mobile, HPC, everything, the ecosystem already. And equally mature will be the N6 because it's 100% compatible. Of course, you still have to do some modification. If you want to shrink your die, you have to rerun your timing, close your, those kind of things.
But still much easier from N7 go to N6 rather than N7 go to N5. And that's the beauty of these two technology. Did I answer the question? C. Wei:] Thank you.
Yes, thank you.
Thank you. Follow-up question from Citi's Roland.
Thank you. Thanks for taking my question again. So it looks like 2020 will be a very busy year to you. You are ramping up N7 plus N6 and N5 together in the same year. So what kind of the revenue growth projection underlying these three key technology rents next year?
Roland, we don't forecast next year. Please attend the Q4 next year.
Okay. Then you have so many new technology ramp up next year. So how about 2021? So any new technology? What kind of new technology you are going to launch in 2021?
Please attend next year, sir.
Thank you. Okay. My next question is for Laurent. So I look at your 20 F, I think now your total accumulated legal capital reserve has exceeded paying capital in 2018. But still, Board Director Meeting in February had been approved to continue operating 10% of 2018 net income to legal reserve.
So why don't you just pay this 10% to investors in order to improve your
ROE? We are increasing the dividend, and it's all come from return and improve, not including the capital surplus, which we accrue every year. So we can choose not to, but we choose to because we want to be more conservative. And if we need it, we can issue dividend from now approved as well. So no impact to shareholders.
Okay. Understood. So means for next year, going forward, you will still probably at least 10% legal reserve?
Currently, that's how we're thinking. Yes, we will decide each year. We have a very big retaining pool. You know that, okay?
Okay. Thank you.
Next question will be coming from CL Securities, Sebastian
Ho. Thank you. My first question is, can you give us the numbers of our fabless DOI existing 1Q 'nineteen? And what's your expectation by end of this quarter? How many days above?
Probably at the end of 1Q twenty nineteen, probably around 10 days, roughly, okay? This is based on our own calculation, by the way. And in the middle of this year, probably reduced down to very low single digit. That's why we say it's close to the seasonal level.
I need to add a little clarification here. The so called fabless DOI is according to TSMC's own top 32 fabless customers DOI. It is not the entire fabless industry. Thank you.
Okay. Thank you. So for just also one follow-up on that is the definition of your fabless, does that include some system company? No, so just only the fabless, the pure semiconductor companies? Okay.
So I had an impression that earlier, the company mentioned that the days of fabless days of inventory may continue to stay a few days above seasonal level throughout second half this year. So is that still the case based on the current outlook?
Very close to seasonal. So we did not come in a few days above, no. Okay.
But close to seasonal buzz, maybe not like really at the seasonal level?
Well, I would like to say that probably below seasonal level, but we it's too early for us. We don't have enough data to do all the analysis and too early for us to forecast accurately, say, how many days or below or above, all right? But we make our own judgment from the wafer loading and their past histories data, so we make our own calculation. So we observe that their inventory is greatly reduced in the Q2. And we are confident actually that in the middle of this year, we'll be very close to the seasonal level.
Thank you. My second question is on the smartphone growth outlook for this year. Remember, last quarter, the company guided smartphone to grow slightly this year, and now it's like high single digit. So it seems like about like 5 percentage point higher based on our own calculation. And I think last time you mentioned about also market share again and content increase, this time also the same reason.
So I just wonder which of these two factors have surprised on the upside in the past 3 months?
Well, we gain market share. That's and actually, our customer gain market share, let me say that. And it's kind of a good news for TSMC, although we did not forecast that at the beginning of this year.
Great. That was actually my follow-up question. So in terms of the market share again and I was surprised on the upside in the past 3 months, how much of that is your own share gain in the AP or baseband or semiconductor chip? Or how much of that is your customers gain share so you benefit? Which one is more important?
How can we separate that one out because of all the high end smartphones, APs, all in TSMC. So you want me to separate out these customers again or TSMCs again, I cannot separate out. It's all in TSMC.
Right. But are you would you be worried about potential like maybe some of your high end smartphone customers gain share right now, but that might cannibalize some of the your other high end smartphone customers in second half this year?
Well, Solon was Solon or the high end smartphone continue to grow or so long TSMC has a very high market share, we just do our job to support them.
Okay. Doctor. Song, can I have just one more follow-up?
There's no objection, so you may continue.
So on the HPC side, also, it seems like the growth is better than last quarter guidance. Remember, it was slight growth without crypto. Now it's high single digits, also about like 5% point higher. I think the CCU earlier mentioned about is major due to the networking on the 5 gs deployment. So is it mainly driven by 1 or 2 customers or several customers across the board?
In the 5 gs area, there are many players and all of them are now very optimistic. And so the 5 gs deployment is faster than we initially planned, okay? That's a trend right now. And so we are forecasting a higher growth than 3 months ago. Okay.
So it's very widespread rather than 1 or 2 chips of customers?
JPMorgan's Gokul has a follow-up question.
Thanks for taking the follow-up question. My first question, I just want to clarify, I think last time you had mentioned N7 plus could be about $1,000,000,000 or slightly higher than that of revenue in 2019. Are we still seeing that? Or customers are still staying on N7 for this year?
We are ramping up N7 plus right now, but the revenue for this year is still a little bit less than RMB 1,000,000,000. And as I just mentioned, next year is that the one we try to look at it. I will believe most of the customer will adopt the N6 because that's much easier for them to move into. And the benefit almost the same as N7 plus So I would say N7 plus this year, a little bit below 1,000,000,000. Next year, probably won't grow, but N6 will start to pick up.
Okay. That's very clear. My second question, Doctor. Wei, could you explain a little bit more on what you encompass when you talk about heterogeneous integration? I think some of your customers have talked about packaging multiple process technologies in the same package.
I think some of the customers' forward running researchers even talked about multiple process in the same paper. Could you talk a little bit about what is TSMC's vision when we when it comes to heterogeneous integration maybe in the next couple of years since you're starting to showcase the technology and potentially go in production?
That is very complex question to be answered. Actually, we are working with the customer and the different customer has a different need. But the trend on the heterogeneous integration is what we believe that will be the few the future that a lot of customers will adopt. That's because of the benefit that when the circuit at some speed now is limited by the connection from the chip to chip, it's just a connection, chip to chip communication. So that has to be shortened.
And to gain the benefit of your single chip is high performance. So you want to put them together, you better to reserve your signals integrity. You better have a very minimal capacitance, minimal inductance and minimal loss in the resistance. So we that's what I say heterogeneous integration become important because we are using the InFO, we are using the cohorts to help our customer to integrate all of them together with the most efficient way to connect all the chip together and also extending if you need high bandwidth module, that will be one of the benefits that using TSMC is a cohort or InFO. And so if you ask me what is the application in the future, HPC will be the one that adopt this kind of process.
That's the first one to go into. But of course, today, mobile smartphone already adopted the InFO technology as you knew already. And more and more of the high end smartphone and more and more of the HPC's customer will adopt TSMC's advanced packaging method, including heterogeneous integration.
So then we should expect that advanced packaging just keeps rising as a percentage of your revenue in a pretty steady manner for the next few years?
You're right.
Next question will be coming from Morgan Stanley's Charlie Chan.
So first of all, that revenue breakdown by application was very helpful. Just can you give us some clarification? For example, the consumer application on smartphone platform, can you give us some illustration for this kind of semiconductors? What is consumer application but applied in smartphone platform? Or you can just ignore those kind of minor contribution.
Probably,
I do you have any good answer to that one, the consumer inside a smartphone? If you are using a smartphone to do the gaming, can I say is the consumer function inside a smartphone?
Yes. I think your definition, for example, for GPU in gaming or for AI or for PC? I think that was clear, right? But now you provide a more breakdown. We appreciate it.
Just I want to make sure we don't get it
wrong. Video games is a consumer application now is in HPC. And set up box, digital TV, cordless phone, these are consumer applications now in the digital consumer electronics.
Okay. Okay. Yes. So also my next question is about your kind of supply chain management, right, related to your kind of high inventory level, right? So now how is the raw wafer inventory at foundry?
And do you plan to reduce some shipment from those raw wafer vendors? And also regarding that previous chemical issue, we do get any compensation from your chemical vendors?
I will answer the first part of the questions. Our DOI actually it does increase a few days of our own DOI because we have very low first and second quarter and we have a contract with those wafer companies. But moving to the second half as our demand pick up, those DOI on raw wafer will gradually digest
it
to
a normal level. This is the first part of your questions.
Yes. What
is the second question?
The chemical issue caused some damage, right? So we will get any reimbursements or compensation from your or TSMC will book it as kind of expense.
So what is our
chemical quality issue? The photoresist event? Yes.
And what we do?
Yes. In terms of financial.
Do we ask for financial compensation? Yes. I have no comment on that. Okay. No problem.
Okay. And also, C. C, regarding your comments about 5 nanometer will have a bigger larger scale than 7 nanometer because kind of wider applications. So my question is that besides exceeding 7 nanometer customers and applications, what would be the new customer for application for 5 nanometer?
We are actually, we are engaging with the new big customers and they are expanding their product portfolio into HPC area, and that's what we rely on. So that's why we say that 5 nanometer business probably even bigger than the 7 nanometer.
Yes. And lastly, I guess on M and A, right, because your subsidiary Vanguard acquired GlobalFoundries HVAC this early this year, right? So would you consider to do any M and A from those kind of overseas fab at some points?
We don't have plan right now. Of course, if there is a good opportunity or everything that meet our strategy, we will consider, but we don't have any plan of M and A right now.
Okay. Yes. And a follow-up question to Gokul's question regarding the profitability, right? So I guess last year, one big event, you said global foundry exceeded the leading edge, right? But if you look at first half gross margin, I think it was much below previous cycles' margin.
So do you think that your broadband power really improved after this industry consolidation? And how do you think about Samsung's EUV technology compared to your 5 or 6 nanometer?
You're talking about margin or profitability. Q1, 2nd quarters, most of the dip card is in the 7 nanometer loading. The loading is so low that affect our margin by 4 points in the 4th quarter, by 3 points in the second quarter.
So the
loading is actually the dominant one. It's not because of others. You're talking about the EUV status as compared with my competitor. All I can say is we are very confident that we can ramp up the EUV right now, and we believe our the maturity or the readiness of the EUV technology, TSMC definitely is better than others.
Follow-up question from Credit Suisse, Randy Abrams.
I just have 2 quick follow ups. One for Laura on the dividend. Since you're moving to quarterly and in Q1 approving for Q4 this year, next quarter would you declare for Q1 of 2020? And is it the view for 2020 you'll declare quarterly or we'll get a set amount for the full year next year?
After the shareholder meeting, we'll declare the $2 which is the Q1 dividend, will be paid in the Q4 this year. And so every quarter from then, we will declare cash dividend. It will be paid within 6 months. So Q1 next year, you will get a dividend from our board approval in Q3 this year. So that will continue going on.
Do I make myself clear?
Yes, that part is clear. And then so every quarter we'll declare, but is your goal Yes,
every quarter we will declare dividend.
Okay. And is your goal then for each year to still be stable or can it rise through the year?
That's right, stable.
Okay. And then one follow-up just to Charlie on the margins. Just relative to the revision you made, sales actually came in a little bit better, but the gross margin came in toward the lower end of the range. I guess, just relative if there were some factors that you saw in the last month that might have affected near term because it looks like by medium term you have margin getting back toward 50.
Actually, when we give the guidance on February, it's a range, right? So we are still within a range. So there are few factors that may have swing the gross margin. Photoresist is definitely 1. Actually, the actual number was slightly deviate from what we have said in February, but still within the range, okay?
Going forward, as I said in my remarks, we are thinking the 50% gross margin is still a good target for us. I really mean, if we can achieve better utilization, we can go back to 50%. But it will depend on each quarter's demand profile. I'm not ready to give you Q3 and Q4 separately, but what I can say is our gross margin will improve in Q3 and we will further improve in Q4.
Thank you.
Now with this very positive note on the margins and also as our CEO said, we have passed the bottom of the cycle for our business, and we're launching the industry's competitive leading edge technologies with volume production already taken place using EUV. I think let's end our conference today with such a high note. Thank you for coming to our event today, and we hope to see you next quarter. Thank you.