[Non-English content] In English, the earthquake that just took place at 1:10 this afternoon has no impact to TSMC's fabs or the backend packaging fab.
There's no impact.
[Non-English content] Welcome to TSMC's first quarter 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 dial-in lines are in listen 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 Senior Vice President and CFO, Ms. Lora Ho, will summarize our operations in the first quarter 2019, followed by the guidance of the second quarter. Afterwards, Ms. Ho and TSMC CEO, Dr. C.C. Wei will jointly provide company's key messages. We will open both the floor and the line for the Q&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 presentation. 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. Now I would like to turn the microphone to TSMC CFO, Ms. Lora Ho, for the summary of operations and current quarter guidance.
Thank you, Elizabeth. Good afternoon, everyone, and thank you for joining us today. My presentation will start with financial highlights for the first quarter, followed by the guidance of the second quarter. First quarter revenue decreased 24.5% 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 a photoresist defect material incident, gross margin decreased 6.4 percentage points sequentially to 41.3%. Total operating expenses decreased by about TWD 4.8 billion. They represented 11.9% of total net revenue in the first quarter. Operating margin decreased by 7.6 percentage points sequentially to 29.4%. Overall, our first quarter EPS was TWD 2.37. ROE for the first quarter was 14.4%. Let's take a look at revenue by technology. 7 nanometer technology accounted for 22% of wafer revenue in the first quarter, 10 nanometer was 4%, and 16 nanometer was 16%. Advanced technologies, which we now define as 16 nanometer and below, accounted for 42% of wafer revenue. Let's take a look at revenue contribution by application. During the first quarter, communication, computer, consumer and industrial standard decreased 27%, 31%, 10% and 16% respectively. 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. Let me explain how to read the table. The table shows between the four application and six platforms, how do they relate to each other. In general, within computer application, almost all revenue is from HPC. Within communication, about two-third is from smartphone.
HPC is about one-fifth, 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%. Let's take a look at revenue contribution by platform for the first quarter. Smartphone decreased 33% to account for 47% of our first quarter revenue. HPC decreased 26% to account for 29%, while IoT, automotive, digital consumer electronics, and others accounted for 5%-7% each. I would like to move on to the balance sheet. We ended the first quarter with cash and marketable securities of TWD 760 billion, an increase of TWD 65 billion from the last quarter. On the liability side, current liabilities increased by TWD 38 billion. On financial ratios, accounts receivable turnover days increased eight days to 49 days. Sales decreased 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. Let me take a few comments on cash flow and CapEx. During the first quarter, we generated about TWD 153 billion cash from operations and spent TWD 76 billion in capital expenditures. As a result, we generated free cash flow of TWD 77 billion, and our overall cash balance increased TWD 88 billion to reach TWD 646 billion at the end of the quarter. In US dollar terms, our first quarter capital expenditure was $2.46 billion. I have finished my financial summary. Let me provide the second quarter guidance. Based on the current business outlook, we expect second quarter revenue to be between $7.55 billion and $7.65 billion in US dollars, which is a 7.1% sequential increase at the midpoint.
Based on the exchange rate assumption of $1 to TWD 30.85, our second quarter gross margin is expected to be between 43% and 45% . Our second quarter operating margin is expected to be between 31% and 33% . In the second quarter, we will again need to accrue the 10% tax on the undistributed retained earnings. Our second quarter tax rate will be about 18%. The tax rate will fall back to 10% level in the third and fourth quarter, and the full year tax rate will be about 12%. This concludes my remark. Let me follow by making a few comments about the profitability, CapEx, and cash dividend. 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 first quarter due to high-end smartphone seasonality, which impacted our gross margin by close to four percentage points. The photoresist material incident impacted our gross margin by about 2.6 percentage points, as we indicated in our press release in February. I have just guided second quarter gross margin to improve by 2.7 percentage points sequentially at the midpoint. Most of the wafers scrapped in first quarter due to the photoresist incident will be made up in second quarter, gross margin can improve by about 1.5 percentage points in this quarter.
The 7-nanometer dilution in second quarter as compared to fourth quarter 2018 will be close to three percentage points, which is about one percentage point improvement from the first quarter in terms of dilution. We also expect a slight improvement in other nodes' utilization rate. Our gross margin in first 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. I will talk about the CapEx outlook. We reiterate our 2019 CapEx to be between $10 billion and $11 billion. 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.
About 10% will be spent for specialty technologies. As I have stated before, we see our CapEx forecast between $10 billion-$12 billion U.S. dollars to support our average growth rate of 5%-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 NTD 8 cash dividend per share for the full year of 2018. 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 NTD 2 cash dividend per share for the first quarter 2019, to be paid in the fourth quarter 2019. Therefore, TSMC's shareholder will receive a total of NTD 10 per share cash dividend in 2019. That also means in 2020, shareholders will receive at least NTD 10 per share cash dividend for the whole year. That concludes my remark. Let me turn the podium to CC.
Thank you, Lora. Good afternoon, ladies and gentlemen. Let me start with our near-term demand and inventory. We concluded our first quarter with revenue of NTD 218.7 billion, or U.S. $7.1 billion, in line with our revised guidance. Our business in the first quarter was impacted by three factors. First, the overall global economic condition, which dampened the yield market demand. Second, customers' ongoing inventory adjustment. Third, the high-end mobile product seasonality. Meanwhile, the net effect from the photoresist defect material incident also impact our first quarter revenue by about 3.5%. Moving into second quarter 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 second quarter, 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 5G 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 incident.
On February 15th, 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 foreign polymer that created an undesirable effect and resulted in yield degradation on 12 nanometer and 16-nanometer wafers at Fab 14B. We have since taken corrective action to enhance our defenses and minimize future risk. Our actions, including the following, improve TSMC's own in-house incoming material conforming tests and controls, upgrade control and methodology with all suppliers for incoming material quality certification, establish robust in-line and offline 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 risk production in first quarter, we expect customer tape out starting this quarter and volume production ramp in first half of 2020. With 1.8x logical 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 extending 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+ and introduction of N6. We are seeing strong tape out activity at N7, which include HPC, IoT, and automotive.
Meanwhile, our N7+, 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+ will contribute more than 25% of our wafer revenue in 2019. As we continue to improve our 7-nanometer technology and by leveraging the EUV learning from N7+, we now introduce N6 process. N6 has three major advantage. First, N6 have 100% compatible design rules with N7, which allows customer to directly migrate from N7 base design with substantially shortened time to market. Second, N6 can deliver 18% higher logical density as compared to N7 and provide customer with a highly competitive performance to cost advantage. Third, N6 will offer shortened cycle time and better defect density.
Risk production of N6 is scheduled to begin in first quarter 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 CoWoS 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 fourth generation InFO solutions provide the finer interconnect line width and spacing to enable both mobile and HPC products. CoWoS continue to see good growth momentum in demand from HPC and AI applications as we continue to expand beyond the reticle size.
We are also working with a few leading customer on SoIC, which is an industry-leading 3D IC packaging solution. We target to start production in 2021 timeframe. 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 five years. CPU, AI accelerator, and networking will be the main growth area for our HPC platform.
With the successful ramp of N7 +, 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 5G 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&A session, I would like to remind everybody to limit your questions to two 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. 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 were received. If at any time you would like to remove yourself from the queue, please press the pound or the hash key. First question will be coming from Citigroup's Roland Shu.
Good afternoon, C.C. and Lora and everybody. First question, C.C. said you maintain your view for the whole year revenue to grow slightly. That means according to your first quarter revenue, second quarter guidance, means that second half is going to grow very fast. Can you just let us know what kind of applications are driving so strong second half to TSMC this year? Thank you.
The strong demand I just mentioned from 7-nanometer actually including the mobile platform, HPC platform and IoT, with a little bit flatness of automotive. That's all that what we rely on. Actually, we would say that seasonality of the mobile phone, the new product launch that make the major contribution.
Yeah. I just do this calculation. I think for second half, your revenue actually is going to grow year-over-year. I think maybe mid-single digit year-over-year. I think except for this seasonality, do you gain share or do you have more new applications in second half?
We actually gain some shares because of 7-nanometer. For the new product portfolio, that will be probably you are see the effect in 2020, not much in this year.
Okay, thank you. Yeah, also for the second half gross margin, Lora said with this higher utilization and also with less dilution from 7-nanometer. You said your long-term gross margin target will be 50%. Is this means that for second half or just for the long term?
Both.
Okay, thank you. 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 the CPU. C.C. also said that HPC is going to be our most important growth driver. Can you quantify how big a foundry addressable market will be driven by HPC and the CPU respectively?
I don't think I have enough data to tell you that how much we can quantify the percentage. I believe the HPC platform will grow double digit, excluding the cryptocurrency, of course.
How about the CPU?
Too specific.
Okay, thank you.
Roland, you have more than two.
This is a follow-up on the second question. Yeah. Do you have any competition on this CPU foundry also? Thank you.
Again, I don't want to be too more specific on the CPU area. All right. Roland.
The question will be coming from J.P. Morgan's Gokul.
Thank you for taking my question. My first question is on 5-nanometer. I 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. 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 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're taking a more cautious view on that? That's my first question.
Actually, I like, Gokul, I like your last sentence. You say 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's first quarter and second quarter right now, it's actually very low. We learn the lesson. We are working with the customer to be more cautiously and effectively managing the capacity ramping. That's what I say that it will be a little bit slow. 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. You know what I mean. In the HPC, we have very good opportunities, and on the smartphone, we are gaining the market share.
I would believe that N5 initial ramp, probably a little bit more cautiously slower than the N7, 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? 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, we are working on it also. Actually, we want to grow the market share. We want to do a 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, we are working on it. That, the goal we are working on, actually, higher profitability and gain market share.
Just one sub-question there. I think if we observe the last couple of years, foundry industry has not outgrown semis ex-memory, TSMC also has not grown much faster than the foundry industry, which was not the case in the past, right? In the past, foundry was growing much faster than semis, TSMC was growing much faster than foundries. When do we expect that gap to open up between TSMC's growth and foundry growth and potentially foundry growth and semis 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 extend it to the next few years, we will start to widen the gap. Is that answer your question?
Okay. That's specific enough. Thank you.
Next question will be coming from UBS, Bill Lu.
Hi. Thank you very much for taking my question. In the last couple of months, I've had a chance to visit a few fabless 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. On the flip side, I hear maybe a bit more concerns about cost per transistor for five 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 ourself. We're still seeing the cost per transistor is 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 learn some kind of experience so that we can introduce N6. Is EUV's productivity is very good already? Not yet. We expect it to continue to improve every year, just as we did for the immersion photolithography. We expect in the future that EUV will offer a better tool in terms of cost, in terms of technologies moving forward, but not today yet. There's still a lot of process complexity. We using the EUV to replace some of the very critical layers, and the cost probably are equal today.
In the future, we hope it will improve. Once it improve, the cost per transistor will decrease faster.
Is there a timing for that?
No, as fast as possible.
Sorry, second question is just a clarification. I think previously Dr. Wei said that the HPC ex crypto growth double digits. Is that for this year, or is that longer term?
For this year, it's close. For longer term, that's what I mean. For longer term.
Yeah, 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. HPC is close to double digit.
Yeah
without crypto, mid-single digit, including crypto.
Oh, no. HPC without the cryptocurrency, it will be somewhere mid-single digit. With the cryptocurrency, it's dropped down.
Okay. Got it.
Yeah.
Thank you.
Next question will be coming from Morgan Stanley's Charlie Chan.
Thanks. First of all, just want to follow up that HPC segments, because just compared the notes, last quarter, we said HPC excluding crypto, up slightly, including crypto, down more than 10%. It seems like the number seems to be a little better. You said the right comments about HPC market doing better than expected.
Yes. It doing better.
Okay.
Because of one of the factor or one of the component in the HPC is the networking. You know that the 5G's deployment, so that helped the course of the networking quickly.
Okay. Yeah, I think this is related to my second question, right? I think a lot of traders saying that some of the customers in smartphone and the base station segment is building up inventory, for whatever reason. Share gain or some strategic inventory. Management also said that you believe the inventory level will be back to normal. It's around a mid-year. My question is that do you worry about this kind of a overbuild inventory and how are we going to manage that kind of risk?
We don't specifically comment on one customer's particular business behavior. Let me share with you why we say that the inventory will be greatly reduced.
Be close to the seasonal level around the middle of this year. We actually look at our history and the second quarter, the customers' growth rate, we using that number and look at the customers' demand number to give to us in the second quarter. We do some calculation, and we come to a conclusion that they are digesting their inventory quickly. That's why we say that in the second quarter, they are not building the inventory. They actually are reducing the inventory quickly. That's why we come to the conclusion that in the second half, we were healthier inventory base.
Okay, thanks. Yeah. Maybe quick question to Lora on cash dividend. This year, I think the quarterly run rate is like TWD 2 per quarter. Right. The annual dividend payout is actually TWD 10 in total. Right. For next year, what would be the kind of minimum dividend payout? Should you use a TWD 2 run rate, so we get like an TWD 8 for the full year for 2020, you said the guidance?
This year actually is a transition year, we issue twice of cash dividend. The first were TWD 8 followed by the TWD 2 on quarterly basis. Starting from first quarter next year, we will only have a quarterly dividend.
Okay.
We want to have a sustainable on quarterly dividend and on annual both. We would like to see more stable dividend on quarterly basis as well.
Okay.
Since I said the dividend will be no less than TWD 10, and we want to be stable on quarterly basis.
You can assume or expect we will issue TWD 2.50 on quarterly basis at least. Okay.
Okay, thanks. Very clear.
Next question will be coming from Credit Suisse, Randy Abrams.
Okay. 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 four platforms, how they're sequentially improving from this low level? 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 second quarter on sequential basis by platform. Followed by the full year picture. Is that what you're asking, Randy Abrams? Okay. For second quarter, we are expecting smartphone to grow single digit, HPC grow double digit. IoT, automotive, and others will grow single digit. The digital consumer electronic will slightly decline.
Okay.
That's for second quarter. For the whole year, we expect smartphone will grow high single digits. HPC, excluding crypto, will grow high single digits as well. IoT will go double digits, automotive will decline single digits. Digital still camera and others will decline single digits. That's the overall picture for this year. Thank you.
Okay, great. Appreciate that. Then follow up on the migration for these derivative N7+ 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 seven for now. As the node matures, if you could talk about the pace, how you see customers, say, as a percent of the node, or how meaningful next one to two years for those derivative process.
As I said, we have a very high tape out activity for N7 for this year. Actually, a lot of customers from the four platforms. Mostly it's from the HPC area, they are all designing their product with a N7. A few of them adopt the N7+. That's why we introduce a N6 that can be 100% compatible to the N7. I'll give you a taste that probably starting 2020, most of the customers in the N7 will move to N6. From that day on, probably the 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, five, 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?
Oh. 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. You bet there are some of the tools from 28 nanometer can be used for seven or for five. Of course, it's less and less. Two, for the over capacity in the 28 nanometer because of some of the non-market-driven capacity increased, our strategy is to develop some of derivative technology like a 22 nanometer, so that we can ensure that we still have a very healthy loading in the future.
Thank you.
Next question will be coming from Daiwa's Rick Hsu.
Hi. Xiao, this is Rick from Daiwa. 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, actually the performance, they still have a big gap. N5 compared with the N7, actually the logic density increased by 80%, eight-zero. N6 compared with N7 is only 18. You can see there's a big difference in the logic density and transistor performance also. As a result, the total power consumption in a chip is lower in the N5. Also there's a lot of benefit if you move into N5. Nevertheless, N5 is one of the node, four node, and it will take 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. Some of the customer, they depend on their product's characteristic and their market.
They will define 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 a quick follow-up. Can you share the number of critical layer that you will be built by EUV for I know for 7 plus? 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 one. Okay, that give you a hint. N5 is a plus many.
Okay, thank you. That's very clear. My second question is, you look at your 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? Also, can you elaborate a little bit more what's the rationale behind that 79 days?
Yeah, I can. 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. It's not so tight. It's very empty in first half. We're trying to preview some of the inventory for our customer in the working process, so they will not be constrained by our second half capacity. By doing so, that our working process value will certainly go up, right? When we move into the second half, when we digest those inventory and the 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 high single digit this year. This is substantially stronger than the smartphone shipment growth. Manager also guided that previously that the next couple of years, the smartphone growth will be mid-single digit. It's also higher than the smartphone shipment growth in our view. Basically, 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. Can we somehow quantify that a little bit?
Quantify, I probably cannot. The answer to your question is both. We gain the market share and the content increase quite a lot.
Can we know that which one is stronger?
You got me. I want both of them to be as high as possible, I don't have a calculation, because of the market share gain, we have to very carefully to do the calculation. Also the content increase. Let me say that. Content increase in the 5G area or in the AI area, every customer is different. They put a different functionality inside. We don't have a very good detail or detail inside to give you an exact number to quantify what is the % per se.
I see. The reason why I try to dig down a bit further is that, if the content grows, which means that will be at expense of the smartphone cost structures. If you have higher content growth, which means that the semi-content in terms of cost structure is higher, which at the end of the day will dampen the smartphone shipment as a price elasticity. If we proceed a very, very strong content growth, which means that the cost structure for your customer will be much higher at the end of the day. There will be certain trade-off, at the end of the day.
There will be certain trade-off of the high-end smartphones pricing and their cost, of course. For TSMC, our job is to fully support customers need. Once they need this functionality, they need this kind of a speed, we support them. Whether that will increase their pricing or the smartphones end markets strategy, that's not in our concern. We support them all the way.
My second question is more for Lora. Can you somehow help us to quantify the margin impact in 2020 as we can expect very high, a very quick ramp-up for the 5-nanometer, which naturally in the first year, that will be the negative margin impact, and we will come into this third year of 7-nanometer, the margin negative impact should be less, but you have new margin negative impact on 5. 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, the first 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. If we look at the corporate margin, you have to take consideration of both. If we just talk about the leading-edge introductions, N5 will be like N7. You will have some dilution next year. We have indicated before, it takes seven or eight quarters to reach to corporate level. We believe N5 will follow the same pattern.
Can we assume that the first two quarters of N5 in the second half next year, when you ramp up the negative impact for the margin is likely like 2% or 3% like what we had in N7?
No, we need to look at what's the ramping speed as well. If you ramp faster, eventually you can get through the learning curve quicker. If you ramp slower, you take a long time. It's many factor will affect that.
I see, most of the investor concern is that with EUV potential higher CapEx, blah, blah. That might have higher negative impact in terms of the gross margin when we ramp up N5. 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.
Understand. Thank you.
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 [Inaudible] . Please go ahead.
Thanks very much. I have two questions for C.C. First, on FD-SOI. It seems to be getting more traction in 5G than we first thought, both on RFSOI and on the modem side for handsets. I'm just keen to understand if TSMC might consider supporting FD-SOI or RFSOI, and if not, how do you plan to defend against it?
Okay. The question is, FD-SOI has some good momentum in 5G area. Does TSMC consider to develop the FD-SOI? The answer is no. We actually also offer a very good technology, 22 nanometer technology, that today's performance is very comparable to FD-SOI, if not better. We talking to the customer right now, a lot of customers start to adopt the TSMC's approach. No, we are not going to develop FD-SOI technology.
Okay. Yeah. Thank you for that. Just to follow up, C.C., can you give us your perspective on TSMC's 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. How does TSMC plan to deploy in these areas? Thank you.
Okay. The question is about the III-V 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. On others, like gallium arsenide, to favor high frequency or those kind of things, no, we are not doing it. Actually, we are doing the gallium nitride project to support our customers' need. That today, so we are doing. Silicon carbide, no, we are not doing it also.
Okay. Thanks very much.
Operator, can you have the next caller on the line, please? Sure. We have Mehdi Hosseini of SIG. Please, go ahead.
Yes. Thank you for taking my question. Two questions. First one, is your guide on smartphone revenue growth of high single digits this year impacted by one of the leading semiconductor company entering the baseband business? I'm just trying to better understand how you're going to capitalize on that opportunity. I have a follow-up.
Mehdi's question is that whether or not this year our high single digit growth in the smartphone 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. I would say this year that we have a high single digit smartphones, of course, is that because of, one, we gain market share. Two, again, that the silicon content is higher. That's why we say we have a high single digits growth.
Okay, great. Moving on to six nanometer, I'm just trying to better understand the applications that would utilize six nanometer. If I heard you correctly, six is going to be ramping later than five. If you could elaborate on the kind of applications that would use that would be great in better understanding that particular node.
All right. The question is about N6. Looks like N6 is behind the N5 in terms of schedule. What is the application? Well, again, I want to reiterate that N6 is coming from the N7+ experience learning. The N6, a lot of customer already enter N7, with a lot of tape out. N6 provide them a very good path that they can easily port in their current product into N6. Gain the benefit of either the performance, the die area, also the shortened cycle time. N5 is a totally new node, 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 a N7 already in your pocket, I think the N6 will be much easier.
Now, I did not say the N5 is very difficult, TSMC will help you to move into N5, of course. You look at the effort that you build an ecosystem is the one that's very important for all the product company want to design their new product. N7, the ecosystem has been very complete. We even offer to the automotive grade. Okay. Not to mention about the mobile HPC, everything. The ecosystem are ready. 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, closure, those kind of thing. Still, much easier from N7 go to N6 rather than N7 go to N5. That's the beauty of these two technology. Did I answer the question?
Thank you. Yes. Thank you.
Thank you. Follow-up question from Citi's Roland.
Thank you. Thanks for taking my question again. It looks like 2020 will be a very busy year to you. You are ramping up N7+, N6, and N5 together in the same year. What kind of the revenue growth projection are underlying these three key technology ramps next year?
Roland, we don't forecast next year. Please attend the fourth quarter next year, sir.
Okay. You have so many new technology ramp up next year. How about 2021? Any new technology, what kind of new technology you are going to launch in 2021?
Please attend next year, sir.
Thank you. My next question is for Lora. I look at your 20F. I think now your total accumulated legal capital reserve has exited paid-in capital in 2018. Board director meeting in February had been approved to continue appropriating 10% of 2018 net income to legal reserve. Why don't you just pay this 10% to investors in order to improve your ROE?
We are increasing the dividend, and it all come from retained earnings, including the capital surplus, which we accrue every year. We can choose not to, but we choose to because we want to be more conservative. If we need it, we can issue dividend from net approve as well. There's no impact to shareholders.
Understood. Means that for next year, going forward, you will still appropriate at least a 10% legal reserve every year.
Currently, that's what we're thinking. Yeah. We will decide each year. Okay. We have a very big retained earnings pool, you know that, okay.
Okay. Thank you.
Next question will be coming from CL Securities, Sebastian Hou.
Thank you. My first question is, can you give us the numbers about fabless DOI existing 1Q19, and what's your expectation by end of this quarter? How many days above?
Probably at the end of 1Q19, probably around 10 days, roughly. Okay. This is based on our own calculation, by the way. In the middle of this year, probably reduce 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. Just also one follow on that is the definition of your fabless, does that include some system company? No, just only the fabless, the pure semiconductor companies. Okay. I had an impression that earlier the company mentioned that the fabless days on inventory may continue to stay a few days above seasonal level throughout second half this year. Is that still the case based on the current outlook?
Very close to seasonal, we cannot comment a few days above, no.
Okay. Close to seasonal, but maybe not like really at the seasonal level.
Well, I would like to say that probably below seasonal level. 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. We make our own judgment from the wafer loading and their past histories data. We make our own calculation. We observe that their inventory greatly reduced in the second quarter. We are confident, actually, that in the middle of this year will 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. It seems like about like 5 percentage point higher based on our own calculation. I think last time mentioned about also market share again and content increase. This time also the same reason. I just wonder that which of these two factors have surprised on the upside in the past three months?
Well, we gain market share.
Okay.
Actually, our customer gain market share, let me say that.
Okay.
It's kind of a good news to TSMC, although we did not forecast that at the beginning of this year.
Great. Thanks. Actually, that was actually my follow-up question. In terms of market share gain, and what's the surprise on the upside in the past three months, how much of that is your own share gain in the AP or baseband or semiconductor chip? 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 are APs, all in TSMC. You want me separate out these, customers' gain or TSMC's gain, I cannot separate it out. It all in TSMC.
Right. Would you be worried about potential, 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, so long as all 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. Dr. Sun, can I have just one more follow-up?
Do you object? There's no objection, so you may continue.
Thank you. On the HPC side also, it seems like the growth is better than last quarter guidance. Remember, it was slight growth without crypto. Now is high single digits, also about a 5 percentage points higher. I think C.C. Wei earlier mentioned about is major due to the networking on the 5G deployment. Is it mainly driven by one or two, a few customers, or several customers across the board?
In the 5G area, there are many players, all of them are now very optimistic. The 5G deployment is faster than we initially planned. Okay? That's a trend right now. We are forecasting a higher growth than three months ago.
Okay. It's very widespread rather than one or two chips, customers. Thank you.
J.P. Morgan's Gokul has a follow-up question.
Thanks for taking the follow-up question. My first question, just want to clarify, I think last time you'd mentioned N7+ could be about TWD 1 billion 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+ right now. The revenue for this year is still a little bit less than TWD 1 billion. As I just mentioned, next year is that the one we try to look at it. I would believe most of the customer will adopt N6, because that's much easier for them to move into. The benefit almost the same as a N7+. I would say N7+ this year, a little bit below TWD 1 billion. Next year, probably won't grow, but N6 will start to pick up.
Okay. That's very clear. My second question, Dr. 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 waper. Could you talk a little bit about what is TSMC's vision 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?
Oh, that it very complex question that to be answered. Actually, we are working with the customer and the different customer has a different need. The trend on the heterogeneous integration is what we believe that what be the future that a lot of customer will adopt. That's because of the benefit that, you know, when the circuit at some speed now is limited by the connection. From the chip to chip is just a connection, chip to chip is the communication. That has to be shortened. To gain the benefit of your single chip is just a high performance. You want to put them together, you better to reserve your signal's integrity. You better have a very minimal capacitance, minimal inductance, minimal loss in the resistance.
That's what I say, heterogeneous integration become important because we are using the InFO, we are using the CoWoS to help our customer to integrate all them together with the most efficient way to connect all the chip together. Also extending if you need a high pin with module, that will be one of the benefits that using TSMC's CoWoS or InFO. If you ask me what is the application in the future, HPC will be the one that adopt this kind of approaches. That's the first one to go into. Of course, today, mobile smartphone already adopted the InFO technology, as you knew already. 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.
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 are right.
Next question will be coming from Morgan Stanley's Charlie Chan.
Thank you. 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 these kind of semiconductors? What is a consumer application but apply in a smartphone platform? You can just ignore, those are kind of minor contribution.
Probably. Do you have any good answer to that one? The consumer inside a smartphone?
I don't know.
You mean
Yeah
digital consumer inside smartphone?
Yeah.
Well, if you are using a smartphone to do the gaming, can I say it's a consumer function inside a smartphone?
Yeah, I think your definition, for example, for GPU in gaming or for AI or for PC, I think that was clear, right? Now you provide a more, a breakdown. We appreciate. Just I want to make sure we don't get it wrong.
Video games-
video games
is a consumer application now it's in HPC. set-top box, digital TV, cordless phone, these are consumer applications now in the digital consumer electronics.
Okay. Thanks. Yeah. Also my next question is about your kind of supply chain management related to your high inventory level. Now how is the raw wafer inventory at the foundry, do you plan to reduce some shipment from those raw wafer vendors? Also regarding that previous chemical issue, would you get any compensation from your chemical vendors?
I will answer the first part of the questions. Our DOI actually including a increase of raw wafer inventory. On quarter-to-quarter basis, 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. Moving into a 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.
Yep.
What is the second question?
Oh, the chemical issue caused some damage, right? Will you get any reimbursements or compensation from your TSMC will book it as a kind of expense?
what is our-
Chemical quality issue.
Oh, the photoresist event-
Yeah
What we do?
Yeah, in terms of financial.
Do we ask for financial compensation?
Yeah.
I have no comment on that one.
Okay. No problem. Okay. Also, C.C., regarding your comments about 5-nanometer will have a bigger, larger scale than 7-nanometer because of wider applications. My question is that, besides exceeding 7-nanometer customers and applications, what would be the new customer or application for 5-nanometer?
Actually, we are engaging with the new big customers. They are expanding their product portfolio into HPC area. That's what we rely on.
Okay.
Okay. That's why we say that the 5-nanometer business probably will be bigger than the 7-nanometer.
Yeah. Lastly, I guess on M&A, because your subsidiary, Vanguard, acquired GlobalFoundries' [ianudible] Fab this earliest year. Would you consider to do any M&A from those kind of overseas fab at some point?
We don't have plan right now. Of course, if there's a good opportunity or everything that meet our strategy, we will consider, but we don't have any plan of M&A right now.
Okay. Yeah. A follow-up question to Gokul's question regarding profitability. I guess last year, one big event is that GlobalFoundries exited leading edge. If you look at the first half gross margin, I think it was much below previous cycles margin. Do you think that your bargaining power really improved after this industry consolidation? How do you think about Samsung's EUV technology compared to your 5-nanometer or 6-nanometer? Thanks.
You are talking about the margin or profitability. Let me say that I think that the first quarter, second quarter, most of the difficulty is in the 7-nanometer loading. The loading is so low that affect our margin by four points in the first quarter, by three points in the second quarter. The loading is actually the dominant one, is not because of others. Now, you are talking about the EUV status as compared with my competitor. All I can say is that we are very confident that we can ramp up the EUV right now, and we believe the maturity or the readiness of the EUV technology, TSMC definitely is better than others.
Follow-up question from Credit Suisse, Randy Abrams.
Yes. Hi, I just have two quick follow-ups. One for Lora on the dividend. Since you're moving to quarterly and in first quarter approving for fourth quarter this year, next quarter, would you declare for first quarter of 2020? 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 TWD 2, which is the first-quarter dividend, will be paid in the fourth quarter this year. Every quarter from then, we will declare cash dividend, and will be paid within six months. First quarter next year, you will get a dividend from our board approval in third quarter this year, so that will continue going on. Did I make myself clear?
Yeah, that part's clear.
Yeah.
Every quarter we'll declare, but is your goal-
Yeah. Every quarter, we will declare a dividend.
Okay. Is your goal then for each year to still be stable, or can it rise through the year?
Yeah. That's right. Stable.
Stable. Okay, good. Okay. 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 months 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. We are still within a range. There are a few factors may have swing the gross margin. Photoresist is definitely one. Actually, the actual number will 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 would depending on each quarter's demand profile. I'm not ready to give you third quarter and fourth quarter separately, but what I can say is our gross margin will improve in third quarter, and we will further improve in fourth quarter. Okay.
Thank you.
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 taking 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.