Happy New Year to everyone. Welcome to TSMC's 4th Quarter 2018 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 web through TSMC's website at www.tsmc.com. If you are joining us through the conference call, your dialing lines are in listen only mode.
As this conference is being viewed by investors around the world, we will conduct this event in English only. The format for today's event will be as follows: 1st, TSMC's Senior Vice President and CFO, Ms. Laura Ho, will summarize our operations in the Q4 2018 followed by the guidance for the Q1 of 2019. Afterwards, Ms. Hall and TSMC's CEO, Doctor.
C. C. Wei, will jointly provide company's key messages. Then TSMC's Chairman, Doctor. Mark Liu, will host a Q and A session where all three executives will entertain your questions.
For those participants on the call, if you do not yet have a copy of the press release, you may download it from TSMC's website at www.tsmc.com. Please also download the summary slides in relation to today's earnings 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 statements. Please refer to the Safe Harbor notice that appears in 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. First of all, Happy New Year, everyone. Thank you for joining us today. My presentation will start with financial highlights as usual for the Q4 and a recap of 2018 for the whole year. Then after that, I will provide guidance for the Q1.
4th quarter revenue increased 11.3% sequentially to TWD290,000,000,000 as our business benefited from the strong demand for our 7 nanometer technology covering both mobile and high performance computing Gross margin increased 30 basis points sequentially to 47.7%, reflecting the absence of the virus incident that occurred in the 3rd quarter and an improvement in back end profitability, higher capacity utilization and more favorable foreign exchange rate. These factors helped offset the unfavorable technology mix. Total operating expenses increased by TWD 12,700,000,000. Thanks to the operating leverage, only represented 10.6% of the revenue versus 10.8% in the prior quarter. And operating margin increased by 40 basis points sequentially to 37%.
Overall, our 4th quarter EPS reached $3.86 and ROE was 24.6%. Now let's take a look at revenue by technology. 7 nanometer process technology continue to ramp strongly and accounted for 23% of wafer revenue in the 4th quarter. 10 nanometer was 6% and the combined 16 20 nanometer contribution accounted for 21%. Advanced Technologies, 28 nanometer and below, accounted for 67% of wafer revenue, up from 61% in the 3rd quarter.
On a full year basis, 7 nanometer contribution reached 9% of wafer revenue in 2018, 10 nanometer was 11% and the combined sixtwenty nanometer contributions was 23% of wafer revenue. Advanced Technologies accounted for 63% of total wafer revenue, up from 58% in 2017. Now let's take a look at revenue contribution by application. During the 4th quarter, communication increased 27%, while computer, consumer and industrial standard decreased 2%, 35% and 3%, respectively.
On a
full year basis, computer, communication and industrial standard increased 61%, 1% and 3%, respectively, while consumer decreased 17%. Moving on to the balance sheet. We ended the 4th quarter with cash and marketable securities of TWD 695,000,000,000, an increase of NT 91,000,000,000 from the last quarter. On the liability side, current liabilities increased by NT19 1,000,000,000 On financial ratios, accounts receivable turnover days was 41 days. Days of inventory decreased 6 days to 67 days due to stronger wafer shipment during the Q4.
Now let me make a few comments on cash flow and CapEx. During the Q4, we generated about TWD189 billion cash from operations and spent RMB 114,000,000,000 in capital expenditures. As a result, we generated free cash flow of JPY 75,000,000,000 and our overall cash balance increased R89,000,000,000 to reach R578,000,000,000 at the end of the 4th quarter. In the U. S.
Dollar terms, our 4th quarter capital expenditure reached 3,700,000,000 dollars and a total US10.5 billion dollars for the full year CapEx. Now I would like to give you a recap of our performance in 2018. 2018 was another growth year for TSMC as we continue to set new records in both revenue and earnings. Despite the weakening macroeconomic outlook and demand headwinds in certain end applications. Our revenue grew 6.5% year over year in U.
S. Dollar turn and 5.5 percent in NT dollar turns to reach about NT1 1,000,000,000,000. Main contributor was the strong demand for our 7 and 10 nanometer wafers. Gross margin decreased 2.3 percentage points to 48.3%, reflecting a lower level of capacity utilization. The unfavorable technology mix and an unfavorable foreign exchange rate during the year.
Our operating margin decreased 2.2 percent to 37.2%, while we continue to increase investment in R and D for 7 nanometer and 5 nanometer technologies. Our effective tax rate was 11.7% in 2018, which was lower than 13.5% in 2017 due to lower retained earning tax. Full year earnings per share was $13.54 On cash flow, we generated TWD574,000,000,000 in operating cash flow for the whole year, spent TWD316 billion or $10,500,000,000 in capital expenditure, leaving $258,000,000,000 in free cash flow. We also paid TWD207 billion or $8 per share in cash dividend, which is an increase of 14% from the 2017 level. I have finished my financial summary.
Now let's turn to the forecast Q1 guidance. Based on the current business outlook, we expect 1st quarter revenue to be between US7.3 billion dollars and US7 point $4,000,000,000 representing 22% sequential decline. Based on exchange rate assumption of US1 dollars to NT30.6 dollars, our first quarter gross margin is expected to be between 43% 45%. And operating margin is expected to be between 31% 33%. This concludes my financial presentation.
Let me follow by making a few comments about the near term demand and inventory CapEx and profitability. Now on near trend demand and inventory, we conclude the 4th quarter with revenue of USD 287,800,000,000 dollars or US9.4 billion dollars in line with the guidance given 3 months ago. This result was mainly driven by the continued steep ramp of our industry leading 7 nanometer technology. Concluding 2018, semiconductor excluding memory growth was 8%, while foundry grew 6%. TSMC's revenue grew 6.5% year over year in U.
S. Dollars, mainly due to strong demand for our 7 nanometer technology. Moving into Q1 2019, our business will be dampened by the overall weakening of the macroeconomic outlook, mobile product seasonality and high level of inventory in the semiconductor supply chain. Due to the overall softening economic environment, semiconductor supply chain inventory exiting 2018 stay at a much higher level than seasonal. We expect the excess inventory in the semiconductor supply chain will take a couple of quarters to digest and the overall supply chain inventory will gradually approach to the seasonal level around the middle of this year.
Now let me make a comment about the CapEx. As I have stated before, we believe USD 10,000,000,000 to USD 12,000,000,000 capital budget will be sufficient to support our average growth of 5% to 10% per annum in the next few years. Given the macroeconomic outlook in 2019, we are tightening this year's capital spending by several $100,000,000 to a level between USD 10,000,000,000 to USD 11,000,000,000 in U. S. Dollars.
That said, our commitment to support customers' product ramp remain unchanged. Out of this RMB10 1,000,000,000 to RMB11 1,000,000,000 CapEx for 2019, about 80% of the capital budget will be allocated for advanced process technologies, which includes 7 nanometer, 5 nanometer and 3 nanometer. A little more than 10% will be spent for advanced packaging and mask making and about 10% will be spent for Specialty Technologies. So this is about CapEx. Let me follow on by make some comments about our profitability.
Okay. As I stated in our Q1 2018 earnings call, I said TSMC's profitability is determined by the following six factors: number 1 is leadership technology development and ramp up and pricing and cost reduction and capacity utilization and foreign exchange rate and last one is technology mix. All these factors except capacity utilization determine our standard gross margin. I have just guided 1st quarter gross margin to decline by 3.7 percentage points sequentially at the midpoint of the guidance. This is primarily attributable to a lower utilization due to the overall weakening macroeconomic environment and mobile product seasonality and high level of inventory in the supply chain.
Due to the recent changes in high end smartphone business condition, our 7 nanometer capacity will see a substantial cutback on utilization rate in 4th quarter in Q1 and Q2, which is expected to hit our gross margin by more than 4 percentage points in each quarter. Going forward, to better manage our leading edge utilization rate, we will be working closely with customers for more effective capacity planning. Looking at other profitability factors for 2019, our 7 nanometer ramp up remains very strong. We continue to provide value to customer and drive aggressive cost reduction. In the meantime, we are increasing our resource in Specialty Technologies development to backfill our mainstream technology capacity.
With all the above factors, we expect our gross margin in the second half of this year will be better than first half, and we believe our long term gross margin target of about 50% is still a good target.
Let me start with our 2019 full year outlook. We forecast a slowdown in global GDP growth from 3.2% in 2018 to 2.6% in 2019 due to the weakening vehicle economic conditions, leading to a low growth for the semiconductor industry. For the full year of 2019, we forecast the overall semiconductor market, excluding memory, will grow 1%, while foundry growth will be flat. For TSMC, we estimate our business will grow only slightly in 2019 given the slowing economic environment. Our 2019 business will be supported by the continuing demand for our 7 nanometer, where we see strong interest from our customer in high performance computing, mobile and automotive.
Even with a slow year like 20 19, we firmly believe AI and 5 gs are the megatrends that will drive the future semiconductor growth, and we reaffirm our long term growth projection of 5% to 10% CAGR. Now I will talk about our 5 nanometer status. Our N5 technology development is well on track, which customer take our schedule for first half twenty nineteen and volume production ramp in first half twenty twenty. We are already in preparation for N5s ramp. All applications that are using 7 nanometer today will adopt 5 nanometer.
In addition, we are expanding the customer product portfolio at N5 and see expanding addressable market opportunities. We expect more application in HPC to adopt N5. Thus, we are confident that N5 will also be a large and long lasting node for TSMC. Now I will talk about the ramp up of N7 and N7 plus Our 7 nanometer has been a very steep and successful ramp in second half twenty eighteen, and we expect continued ramp through 2019. Our customer portfolio is growing stronger, while more applications such as XPC and automotive are coming to N7 as well.
Customer tape outs activity at N7 continued to be strong despite the cautious macro outlook. We are actually seeing increased silicon content for AI and 5 gs related product designs. We expect the 7 nanometer to contribute more than 25% of our wafer revenue in 2019. Our N7 plus year rate is progressing well and comparable to N7. N7 plus volume production is scheduled to begin in Q2 this year.
As I have stated before, we are working with several customers on N7 plus to support their second and third wave product designs, and we expect the N7 plus contribution to the 7 nanometer family will grow increasingly larger over the next few years. Now I will talk about TSMC's mature node strategy and our new 8 inches facility. For mature nodes, our strategy is that we do not increase large capacity at mature nodes, but rather, we work with customer to develop specialty technologies that create differentiated and longer lasting value to customers. Our recent plan for an extension at 56 in Thailand is a part of this strategy. The extension is not an increase of wafer capacity per se, but the purpose is to increase the cleanroom space for more specialty tools.
With successful execution of our mature node strategy, we believe we will be able to continually deliver good profitability in the future. Finally, I will talk about our most important growth contributor in the next 5 years. As I just stated, we believe 5 gs and AI will be the bigger trend underlying the ubiquitous computing, which will drive the semiconductor growth in the future. With the successful ramp of 7 nanometer, we are able to expand our customer product portfolio and can add applications related to PC and tablets to the HPC platform. With this inclusion, we believe HPC will become the largest contributor to our business in terms of revenue growth in the next 5 years.
Thank you for your attention.
All right. This concludes our prepared statements. Before we begin the Q and A session, I would like to remind everybody to limit your questions to 2 at a time to allow all participants the opportunity to ask 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.
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. Now let's begin the Q and A. First question will go to be coming from Credit Suisse, Randy Abrams.
Yes. Thank you. Thanks for the details. The first question I had was on the guidance both for the sales and the CapEx. You're lowering sales outlook to just slight growth, but only making a small change to CapEx.
Could you talk about the assumptions you're making for further market share gains or demand recovery and also the assumptions for 5 nanometer and EUV to keep the CapEx intact?
Okay. Good afternoon. I want to say Happy New Year again. Yes, welcome to the investor conference. Your first question, I would like to see see to answer.
[SPEAKER UNIDENTIFIED COMPANY
REPRESENTATIVE:] You're asking about which only grew slightly, but CapEx did not decrease dramatically. Good question. We now become more conservative on CapEx is because we forecast slower lower 5 nanometers of demand at the initial ramp. However, we still have to prepare enough capacity to support our customer, and we believe that today, we wrote down a few $100,000,000 is to reflect the reality of expecting the high end smartphone little bit slower growth. But this year, this year is because of 7 nanometers capacity has been fueled and the demand actually we forecast the number of the units of the smartphone, especially high smartphone to be negative growth.
Although we are I still want to say that for TSMC, the year on year from 2019 compared to 2018, the smartphone, the mobile business, we still grow slightly this year regardless of the unit is dropping. And as a result, we expect as I just said, we expect foundry business will be flat, but TSMT still grows slightly.
One follow-up to that and then I'll ask a second question. For that capital spending change you mentioned on EUV, could you talk now about kind of magnitude and steepness, like what type of ramp we should expect next year for that node? And on the CapEx, are you making any consideration with the slower environment to reuse more equipment? So that's a follow-up to the first question.
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Yes. We do expect that we in the 5 nanometer, we'll use some of the 7 nanometers equipment. To answer your question more correctly actually is that why Song Yi show up a little bit a few $100,000,000 because of EUV tour. Actually, we already buy a lot, all right. And we expect that one continue to grow also.
So the ramp up of the 5 nanometer now definitely was slower than we expected, but we still think it's a long lasting node because of all our customers who are using 7 nanometers a day are engaged with TSMC today in their product design. So and in addition to that, we also increased our product portfolio, our customers' product portfolio and that will be add something to HPC application. So looks not very promising this year, but we still have the confidence that 5% to 10% CAGR will be sustained.
I'll change on the second question, but I'll follow-up one more. For the 5 nanometer, if you could just talk a little bit more what's driving some of the change in consideration, if it's anything about the EUV readiness versus cost structure, mature 7 versus 5. Maybe you can go into if now you expect a bigger 7 initially and what the factor for that is? [SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:]
Let's talk about EU visa readiness. We are progressing very well. So that's why I say the 7 plus which using the EUV was started will start production in Q2 this year. And our 5 nanometers technology development, a lot of based on the EUV's progress and 5 nanometers technology development is on track. So that's one thing.
And why we wrote down that our CapEx because of we expect the high end smartphones growth will not be as strong as we used to project before. Okay, we lowered it down a little bit, but still, we still think that high end smartphone will grow because of 5 gs and AI's application.
I guess the question was more EUV for it to be slower than original. Maybe what drove the change to the EUV or to the 5 nanometer?
I did not say the EUV will be slower. 5 nanometer? 5 nanometer, no, it continue.
The CapEx this year, majority of it is spent on 5 and some even 3 nanometer. EUV's productivity continue to improve and that modulate the CapEx we need to invest. So from the number, we are very confident that our 5 nanometer will ramp according to our previous plan. However, we do put a more conservative tighten up our CapEx under those confidence to improve the productivity and make sure the lead time is tightened up enough to minimize the CapEx.
The lower 5 nanometer initial ramp, so could you talk about that? Like what's the rationale for that lower initial 5 nanometer ramp?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Well, I just said we expect a higher growth, but right now we are more conservative on the high end smartphones growth. C. Wei:] Yes.
Thank you.
Next question will be coming from Citigroup's Roland Xu.
Thank you. Happy New Year. First question is, C. C, you said for the mobile business this year, you still expect some growth. But under your overall year, the whole year, revenue growth just slightly.
So how about the growth for your the other platform product, IoT, HPC and automotive?
Okay. Roland, you asked a good question. Smartphone grew slightly, IoT grow double digit, automotive will be flat. HPC, if we're excluding the quicker currency mining, HPC also grew slightly, but cryptocurrency is a big drop from 2018 to 2019. So if we put a cryptocurrency together in the HPC, it's a big drop.
It's almost double digit.
Okay. May we have more color C. Wei:] Okay. May we have more color for the breakdown for this whole platform, the revenue breakdown in last year in 2018?
This one maybe, Laura, you can directly answer it from the number.
For 2018, smartphone roughly accounts for 45% of our wafer revenue. HPC, about 30% 32% IoT, single digit, around 6% Automotive, 5% Digital Electronics, 6% and there's other 5%.
Okay. May I know how big of the contribution for cryptocurrency last year?
A lot.
We don't want to specify too much on this segment, particularly this belongs to one of the big customers. So C.
Wei:] Okay.
Thank you. And the other question is, Laurent said for 7 nanometer utilization will be dropped a lot in first half. But the whole year, the 7 nanometer revenue contribution coming by CC will be about 25 So that means yes, above 25%. That means the second half, the 7 nanometer contribution will be very strong. So may we have more color?
What kind of application is driving such strong 7 nanometer demand?
C. Wei:]
Okay. A lot of it is because of seasonality of the high end smartphone. So in the second half, we expect to ramp up the high end smartphone again. The first half is a little bit kind of cyclical in the high end smartphone.
To be honest, this high end smartphone drop in the Q1 is came a little bit sudden. So the inventory in the supply chain is quite a lot. So that may push the first half drop. But second half, we expect the new product launch will carry on another wave of ramp.
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] So Roland, I'll give you more color. How about that? In the second half, we already say that we have more customers of product portfolio. So that will expand into the high performance computing. Some of the product will enter into production slightly from Q4 and extend it to the next year.
Thank you. For the 7 nanometer follow-up, I think 7 plus will be also included in the whole 7 nanometer. And 7 plus, the total revenue will be still somewhere around TWD 1,000,000,000.
That's correct.
Okay. Thank you.
7 plus is not a major node, but rather it is a technology good for 2nd wave and third wave customers. So it is come up slower when the 1st wave product or 1st wave customer ready to convert to the lower to another improved version. So it doesn't conflict with our 5. 5 is another major node.
Next question will be coming from Goldman Sachs, Bruce Lu.
Happy New Year. Happy to be back. So I want to ask about like smartphone, semi content adjustment market. TSMC manager used to provide like some semi content growth for high end smartphone, mid end smartphone and low end smartphone in the past. Can we ask like what kind of semiconductor growth in the coming 1 or 2 years for like different segments of smartphone?
And also what kind of semiconductor growth for smartphone moving from 4 gs to 5 gs, especially for the addressable market for TSMC? [SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] If
you want to specify what is semiconductors content into the high end smartphone actually, You want to nail down a specific number just like before? I don't think we can do it today because of there's a lot of application new application that add in 2, that's 1, such as AI and Samsung. We expect in the future ARVR will be inside. The second thing is 5 gs itself that increase a lot on the frequency band, and so that will add the silicon content inside. I give you a kind of a feeling that the smartphone unit will drop a few percentage, but TSMC still grow the smartphones business.
So that means there's a lot of increase in that revenue is because of silicon content in terms of the smartphone business.
But moving to 5 gs, as you mentioned that there are a lot of RF content, those kind of same content increase. Do we see that having any impact to our business?
C. Wei:] You have a good question. Yes, moving to 5 gs, then the RF become more complicated, and so you have to add more chips or add more larger area in the RF chip. And so we expect silicon content per se that will increase and so that the silicon in the content in the smartphone will increase. That's true.
But can we somehow quantify it?
Not really.
Let me put some color. I mean, this is based on, of course, forecast number. So nothing may not be accurate, but we have a picture about the non silicon content supporting C. C. Wei's description.
On the high end smartphone, we see the silicon content increase. Actually, it's increased every year very fast. On the mid end, it will increase slightly. On the low end, it's less predictable, but we take the model currently is decreased slightly. So that's the picture.
And most of our business in the smartphone is belongs to the high end. So we're going to enjoy the silicon content with the equipment of our technology, leading edge technology.
Okay. My second question will be that management just mentioned that 5% revenue growth CAGR will maintain. I think management first mentioned that in 2017. And with like slower growth in 2019, if you do that after math, you're going to expect that more than double digit growth for the coming 2 years?
You can calculate it. Do I read it correctly? I want to reaffirm that the 5% to 10% CAGR was sustained. That's we have confidence on that, And you calculate it.
Okay. So the 5 year timeframe is 2017 to 2021, right?
Yes.
All right. Next question will be coming from CL Securities, Sebastian Ho.
Thank you. My first question is, I'd like to get TSMC's brands on the overall semi cycle inventory. Remember, 3 months ago, I think the company talked about that you're not too worried about the inventory situation compared to the 4Q 2017. But today, you're talking about you just talked about that there's a lot of excessive inventory out there. So I'm just wondering what has happened in the past 3 months?
Is it more due to demand slowdown a lot or still more due to there is some hidden inventory now they emerge?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] I would say it's more due to the sudden drop in the demand rather than there is some hidden inventory
the which application which end application has seen the most significant decline in demand?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] High end smartphone is one thing and then other things that drop a lot is actually you can imagine that cryptocurrencies mining that drop quite a lot. And then related to that one is might be some of the high performance computing that you can see from other applications that related to the cryptocurrency mining.
Okay, got it. Thank you. And in terms of the inventory digestion, I think Laura talked about that the inventory will go back to more seasonal average level by mid of this year. So usually the down cycle, we would like to see the we usually see the supply chain will tend to over cut inventory to below normal. So is the mid this year, is that means that we already or is the below normal level came before or after that?
We expect to be a reasonable level that it can sustain your business and we expect that this kind of demand will recover gradually from Q1, Q2 and then moving into the second half of this year. So that's why we expect at the mid in the middle of this year, all the inventory will go back to the reasonable or seasonal level. Whether it will be much lower or something like that, we did not expect that yet.
Okay. Just one last question from me is if you compare this down cycle to the past, current I know that TSMC has not offered utilization rate details for many years already, but just to give us a rough idea, at the current utilization rate you are seeing now in first half of this year compared to the UTR we've seen in 2015, 2012 or say post the financial crisis, is it likely to be the lowest point that we've seen since then?
This as Laura just presented, the utilization impact this quarter is really mostly come from 7 nanometer. Although other nodes, utilization is lower, but if you compare with last downturn, if you take 2,009, for example, it's not that low. So our 7 nanometer E really is the major underutilized, we think is temporary.
Thank you. So can we assume is it fair for us to assume that the UTR is certainly not as low as the 2,009 yet, but it is already lower than what we've seen in 2011, 'twelve, that cycle and also 2015 cycle?
C. Wei:] You are right. You are
right. Okay. Thank you.
Next question will be coming from UBS, Bill Lu.
Hi, thank you very much and Happy New Year. First question is, we've seen a pretty sharp drop off in demand and Doctor. Wei, I think, made a comment that in the future, we will work with customers to plan for capacity differently.
Wonder if you could talk
a little bit more about that as far as what can be done? Is it more is it better planning? Is it diversification? Is it different payment terms? Can you just talk a little bit about what are some of the things?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Well, in fact, this is kind of
the way we deal with our customer. So it will be a better planning process. TSMC as well as TSMC is a customer. I believe that we are learning a lot during this cycle and then we'll be more prudent or have found a way that TSMC and customer can work together for the better planning of the capacity in the future. Without to summarize in one word, we want to be more conservative, but then we will not lose our support to our customer.
Wider product portfolio is another factor you mentioned.
Great. Thank you. Second question is for Laura. Can you talk about the depreciation for this year? And I'm asking that because I feel like TSMC over the last year, year and a half has bought quite a few EUV tools, and I believe you don't depreciate until these tools are in production, right?
And so if you look at the CapEx trend versus the depreciation trend, is there a different linearity because all of a sudden, the tools you bought, I don't know, 10, 15 tools need to be depreciated?
You're right. We start depreciating the tour when it gets into the productions. The depreciation pattern versus the CapEx changes is not linear, also because the where the CapEx is front end loaded, back end loaded that also will impact the whole year depreciation. But I can tell you based on the JPY 10,000,000,000 to JPY 11,000,000,000 CapEx for this year, we expect the depreciation will increase by mid single digit, which is versus last year was double digit. So you see, it's all about RMB 10,000,000,000 to RMB 11,000,000,000, but the depreciation change can be quite different.
Yes.
Sorry, I need to work through the math a little bit, but what is it assuming for I guess 7 plus because I just want to figure out next couple of years as EUV ramps up, are we going to see it pick up or how does that work?
I don't recall, I remember there is a sudden increase, and it's more modest increase year over year.
Thank you.
All right. I think it's about time that we should go to the line for the questions from analysts waiting in the line. So operator, could you please have the first caller on the line?
Yes. The first question is from the line of Brett Pippen of RK Research. Please go ahead.
Yes. Thanks very much. I just had a question on inventory levels. Can you help maybe frame where the industry inventory levels are at the moment, maybe in weeks or days or inventory days versus a quarter ago? And what would you say is normal inventory levels in weeks a day, just so we can look at we can frame exactly how elevated the inventory levels are at the moment?
Brad, I think you probably talked too close to the microphone, so I'm not hearing you quite well. But I think you are asking the inventory level, the excess inventory that we see it now versus we saw 3 months ago? And you would like to have a little bit color on that difference. Is that your question?
Yes. Thank you for a little bit. And also just to understand what normal inventory levels are, can you review?
3 months ago, we estimate the inventory exiting 2018 is several days above seasonal. Now we look at it more like 10 days above seasonal.
Okay. Thank you. Thanks very much. And you said March on seasonality was also going to be a weak event in Q1. What do you suggest in the communication division will do in Q1 versus Q4 of revenues?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:]
Well, I think the main reason is because of high end smartphones' seasonality. So that's and typically, Q1 is low season for the high end smartphone, but this kind of high inventory is because of a sudden drop from the 4Q last year and extended to the Q1 this year. And that's why the inventory started to increase so much. Did that answer your question?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Can you
maybe quantify thank you. Can you perhaps quantify how big a drop in Q1 your communication revenue will be because of the smartphone seasonality?
Okay. Laura, would you answer this?
So you're asking the by segment, how do we see the changes in Q1? Communication in Q1 will drop the most, followed by the computer. Consumer actually will grow slightly and industrial standard will grow very significant. So I think the decline in Street sector are all double digit decline in the Q1.
Okay. And one last question on 7 nanometer. What percent of sales in Q1 do you expect to come from 7 nanometer? And you're suggesting a very strong 7 nanometer ramp in second half when industry gets back to normal inventory levels. Is there a risk that demand for 7 nanometer exceeds supply?
And to what extent can you get customers to pull in orders at 7 nanometer and start ramping earlier in Q2 this year?
We're trying to understand your question. So you're asking us about 7 nanometer since we said that there's going to be a strong cutback on 7 nanometer. Are you asking what percentage of 7 nanometer is part of our Q1 revenue? And then what will be the level in the second half for 7 nanometer?
Let me answer let me try to clarify the ramping of 7 nanometer this year. We already ramped the 7 nanometer last year, and that's our 1st generation 7 nanometer. Coming to the Q1, the 7 nanometer composition is about 21% of our corporate revenue already. Now this year, we are preparing to ramp the 2nd generation 7 nanometer. We don't have a specific name, different customer have the different flavors, But overall, it's their 2nd generation product to be launched this year.
So all the 7 nanometer numbers for the 2nd generation will be drastically increased during this ramp in the second half of this year.
I'm sorry, just to clarify, can you indicate what 7 nanometer as a percent of sales might be in Q1? And does this mark the trough for 7 nanometer in 2019?
Question is, what's the percentage of 7 nanometer in our revenue in Q1? And whether or not that percentage is the trough, is the lowest for this year?
Laura, can
you answer that?
Okay. Mark just mentioned the 7 nanometer accounts for 21% of our first quarter revenue. We see that percentage of total revenue will continue to grow. So I would say that percentage wise, Q1 will be the 12.
Okay. Thank you very much.
So operator, let's go to the next caller on the line. Thank you.
Certainly. Next question is from the line of Maggie Kochanaini from SIG.
Yes. Thank you for taking my question. I have one follow-up regarding your high performance compute expectation for 2019. I believe cryptocurrency accounted for only a few percentage of overall revenues in the first half of twenty eighteen. So why is it still an overhang on your HPC revenue mix?
I believe you said including crypto, it will be HPC will be down double digit. And I'm just trying to better understand how it has changed from 2018 to 2019? And I have a follow-up.
So Mehdi, I think you are asking us about HPC this year. If crypto accounted for a few points of our business in 2018 and how much crypto will be accounting for our business since 2019?
Yes. Okay. This year, we don't forecast we become conservative in forecasting this volatile business. So the cryptocurrencies are mining this year is much, much less than last year. And to what percentage, I don't think it's I can release it right now.
This is a conservative estimation of crypto fees.
The truth about is if you have had a new HPC customer program, how come those rents are not enabling you to ramp HPC in 2019 better than just a few ID up?
So, Mehdi's comment is that if we have this expanding customer portfolio in HPC, why is it that HPC, excluding crypto mining, can only grow slightly this year?
All right. Good question. As because of our customer, we're expanding our customer portfolio and product portfolio, but their ramp was starting from probably in the second half this year with a small volume and then going to the mass production next year. That's why this year, we saw just a slightly increase on the HPC business, excluding the cryptocurrency.
Okay. Very clear. Thank you. And my second follow-up has to do with the 5 nanometer ramp. And I'm trying to better understand your visibility and take out engagement.
Should we expect a 5 nanometer ramp in 2020 to look more like 7? Or is that going to be steeper? Any color will be appreciated. [SPEAKER UNIDENTIFIED COMPANY
REPRESENTATIVE:] What I'll be coming on that. 5 nanometers ramping 2020, I would expect that product portfolio is expanding more as compared with the 7 nanometer in 2018. How much of steeper of that one, it will be similar or probably we are a little bit conservative. But today, we saw the better product portfolio, better customer portfolio, but a steeper ramp probably very similar.
Sure. Should we assume that 5 will become bigger than 7 in 2021? Is that when the true benefits of 5 and the customer diversification is going to materialize? [SPEAKER UNIDENTIFIED COMPANY
REPRESENTATIVE:] From today's situation and customer we engaged with, yes, 2021 5 nanometer was bigger than the 7 nanometers same period of time.
Okay. Thank you very much.
All right. Let's come back to the floor. Next question will be coming from Morgan Stanley's Charlie Chan.
Thank you. So my first question is about smartphone semi demand for this year because the management attribute the weakness in 1Q to the seasonality, but do you see any structural issues, for example, the lengthier replenishment cycle, lack of collapse, that's issue of the smartphone semi demand. And also, I can not really get the math, right, because high end smartphone, they can't even it's a higher content, it should contribute to more of your revenue. But you're assuming this segment will decline and units will decline, right? So why can you get a number that the full year mobile revenue can still grow a site fee?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Good question. Actually, high end smartphone this year, at least for the first half, it still have some kind of inventory issue. But in the second half, we expect a new model coming out. It's ramping up starting from the Q2 and all the way to the end of this year with a new model coming out. However, the total units as we expected or we forecasted, that will be dropped slightly.
The content will increase more than the unit drop in the percentage wise. So TSMC still grow slightly on the mobile business. That's why. And your question is? So I just
want to get a confidence why you think second half debt recovery could happen, right? Because it's possible that new product disappoints again, right? Okay. So yes, if I can give more color, do you think it's kind of a specific brand issue or is that kind of across different brands, have they kind of a high end smartphone demand issue?
All right. Second half,
it's a
good question also. Second half, why we still expect a recovery because we have a better customer portfolio, that's what I can say.
Okay, this is fair enough. So I will assume some market share again there. And also, I want to follow-up the previous question regarding HPC, right? So because compared to your previous targets to grow 20% year on year, every year for HPC, I feel like except for crypto, there is also some demand issue, right? For example, I'm not sure what do you see the demand in the AI, cloud and also telecommunication, right?
Because there got to be some demand issue to get only kind of slightly growth for HPC versus your targets of 20%. Can you comment on the demand? [SPEAKER
UNIDENTIFIED COMPANY
REPRESENTATIVE:] Let me comment on that. We used to be very optimistic. We're still very optimistic because of AI and 5 gs, But AI and 5 gs, AI is picking up. 5 gs was started from this second half, start to install some of the base station, the infrastructure was start to build up. So we did not expect the 5 gs smartphone would be a big number this year.
It will be a big number next year. And all the smartphone, we expect that the AI will be included inside with some kind of a content that we did not get the full picture yet, but we know it's increasing. And you are talking about HPC, we used to say that 20% CAGR, did we say that?
At least last year and the year before.
No, The last year compared with the year before because there is one uncertain another one uncertain one surprise that's called cryptocurrency mining. It started to increase dramatically and TSMC because of a technology offering. So we have to say that we are the we get the most of the benefit of the cryptocurrencies mining business. Now it's so volatile, it dropped. However, without the cryptocurrency, we still see strong momentum on the high performance computing.
1, because of we have very competitive or actually, we are I want to say the industry leading technology that which fit the requirement of HPC business. 2nd, again, I would like to say we have a stronger customer portfolio.
Let's look beyond 2019, right? So for 2 or 3 very high growth profile segment, HPC, IoT and also and also I'm also very surprised you are coming your companies are only flat year on year, right? So for coming maybe 2 or 3 years, what do you think should be the right CAGR for HPC, IoT and auto? Thanks.
I think the strongest growth is high performance computing. But the 2nd strong growth in terms of the dollar increase is still smartphone. So that's just a dollar increase.
But auto, you've got those kind of EV, I'm not sure you classify the autonomous driving, right? But auto, I think it used to be a kind of a segment, the company gives better strong growth, right? What this year if we don't see it?
Yes. In auto, if you look at the past 2 years, very strong growth, 20 some percent. But as you know, since last year, suddenly the automotive markets almost stopped growing. Many of our customers say the same thing very consistently and some of them has to attribute to the steel and aluminum tariffs and that is a I think is the structure of the automotive. In terms of the long term, we still see the innovation of the automotive will come out of this.
So yes, I guess one question from lots of investors. Yes, so it's about dividend payout, it's patient, right, because Cummins was to steadily grow every year, right? But it happens over the past 2 years, EPS growth of around 3% every year. And this year, I'm not sure, right, a bit flat, right? So does the company think this year you want to increase dividend dollars again?
Despite of short term market weakness, like we look at free cash flow that we can generate, it remains to be very strong. So we plan to further increase dividend in 2019. And we will get a board approval in February. So we will make announcement after that.
All right. Next question will be coming from JPMorgan Skokul.
Yes. Thanks for
My first question, could you talk a little bit about any recalibration in the China expansion given what we have seen with cryptocurrency and some of the China demand as well? Could you talk about the plans on China expansion? I think last time you mentioned maybe go up to 20 ks in Phase 1 and then potentially expand beyond that. Is there any time line difference on the Nanjing fab?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] The plan did not change because this is a short term kind of market softness. No, it did not change our strategy. The plan continues.
Is there any timing differential in terms of when you get into Phase 2 given the 2? [SPEAKER UNIDENTIFIED
COMPANY REPRESENTATIVE:] All you are dependent on the business situation, definitely. But 20,000 wafer per month is a plan continue to be executed.
Okay. Next question I had was on N PHY. So just building on some of the other questions as well. So it is for many customers, it's going to be the 1st node with significant EUV insertion. So could you help us understand what is the feedback you're getting from customers?
Are customers planning to stay on at N7 longer, given N7 has been a successfully proven node and as you mentioned, a lot more customers are coming through there. Or do we expect to see the same number of tape outs, like 50 tape outs that you had by end of 2017? Are we going to be at similar kind of levels as we get into end of this year? Could you give us some idea about how that progress from a breadth of customer base is progressing in N5?
Okay. On the NFI progress, I just reported that our progress is on track and we work with the customers. And you say that whether the customer are worried or you have concern on the UVs readiness or the stability or those kind of things. No, they are happy with us. We work with supplier, we work with customer on both sides and our progress so far, so good.
Now whether that they want to move into N5 or stay in the 7, all I say is all the customers who are working with us on N7 are engaging with us on N5. The product, when they want to introduce into the market, that were customers' judgment because N5 did offer very good performance per se as compared with N7. So some of the high speed computing, some of the high end smartphone, they still need to go into N5. So you would expect those customer will adopted N5 immediately that one is available, okay. So number of the tape outs, I cannot tell you right now, but I already told you that all the customers are engaging with us.
Okay. Thank you.
Next question will be coming from Credit Suisse, Randy Abrams.
Hi, thank you. I wanted to ask a follow-up on your guidance for 2019. Last year, you gave a guidance at the beginning of the year for first half year over year growth and also second half year over year. So if you could give a view or maybe split how you see first half versus second half?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:]
Can you give the number?
2nd half definitely is better than first half, okay.
[SPEAKER UNIDENTIFIED
COMPANY REPRESENTATIVE:]
That's good, Much better.
Q1 of 2019 is quite weak and we think it's going to take another quarter to recover. So from what I have seen now, for this year, if you compare year over year, our first half may not be higher, maybe worse than last year, okay. But second half definitely will be better.
Okay. A follow-up on the application and inventory issue. Could you talk how broad because you did flag smartphone as inventory, but could you flag how broad you think that inventory issue is across applications? And the guidance by product had industrial up significantly, consumer up slightly. If you could talk a bit about that factoring in the inventory comments, what's driving those increases?
You mean supply chain's inventory?
Yes, just because you mentioned it's a broad inventory or you have an inventory issue, how you see it across the other applications and then what's driving that segment?
Exiting 2018, I think the inventory increase is broad range, yes, because of the macroeconomic and uncertainty on this trade tension, pretty much put people really on hold or very careful. So it seems to be across the board.
And then I guess the rationale then for industrial up significantly and consumer up slightly?
Well, I think that the industrial
Randy, your question is industrial segment is down in Q1?
No, I
think you said industrial slightly.
The other sector all down.
Okay. Thank you. And if I could squeeze one more in the back end, it's still another significant CapEx. Could you talk maybe a snapshot what you expect for the back end business this year and what you're seeing for info and COAS expansion this year?
The back end business is this year, you're up double digit, still a very good business because we offer the solution to the customers so that they can get a higher performance and that better cost structure that they cannot find other place?
The back end last year is about RMB 2,500,000,000. And going forward, currently we see the double digit growth at least year over year. To clarify, back end business still is initial stage because as you remember, initially, our back end was adopted by the smartphone. But now more and more, we see the high performance computing customer in the 5 nanometer, almost all of them adopt wants to adopt what do we call advanced packaging. So we see the advanced packaging business is coming to support our high performance computing products across the leading edge customers.
Just to make the record, from now on, we call we don't call back end, we call advanced packaging because we realize that packaging is very different than the back end or OSAT business we used to know.
Follow-up question from CL Securities, Sebastian Ho.
Thank you. First follow-up is, can you provide us some update on the tick down numbers that you have received on 5 nanometers now or your expectation by the end of this year? [SPEAKER UNIDENTIFIED
COMPANY REPRESENTATIVE:] Well, I
just say that I cannot give you the number today, but I repeat it again. All the 7 nanometers, the customer are working with us right now on their design.
And the 7 nanometer tape out number is still on track to exceed 100 by the end
of this year? It's still.
Or it could be earlier?
Well, it depends on how quickly that our customer can adapt our N7, N7 plus but it's still the numbers still meet our expectation on the HPC probably even more higher.
Yes. And given the current macro uncertainty, have you noticed any of your customers which are doing the tape out on 7 right now become more hesitant or cautious in terms of the production schedule?
No. They are being very aggressive because of 7 nanometer is a very good performance, so that can help them to gain the market to their product going to the market. So it's not slowing down. It's actually accelerating a little bit.
Okay. So I think last year and this year, I think probably only not a big portion of these 7 nanometer type of customers are reaching already reached production. Is that a fair assumption? Yes. Just one of the big customers, but account for big wafer volume, but the tape on number is small.
And which means do you expect more of this smaller volume type of the customers, but they together account for the big numbers of the tape out will reach production in 2020?
Well, I just mentioned, yes, some of the second wave or third waves of product design get into the 7 plus will start to ramp probably second half or the Q4 of this year. Mass production will be expected in 2020.
Okay. So it sounds like you don't notice or feel any bubbling in terms of the tape out booming?
No, we did not see that.
Okay, that's great. My next question is sorry, I only have one question. Thank you.
Okay. All
right. Follow-up questions from Citi's Roland Xu.
Thank you. Last year, the raw wafer negative impact of gross margin. How about this year? Are we going to still see the same trend? Or we are going to see if it will be reversed, maybe you will benefit for this raw wafer price margin?
C.
Wei:] We have signed a long term contract with our suppliers in 2017 2018. So locking the long term supply and also locking the price. So we do not see any further price deterioration for us.
Okay. Yes, but given now the demand is declining, and are we going to renegotiate this longer contract with these wafer suppliers? Yes. So this is for 2019 2020. This is for the going forward?
Going forward.
Going forward, we hope we achieve some
cost saving.
Okay. Thank you. Second question is that by when you will see your CPU revenue to reach 1% of your total revenue? And also by when you were seeing the CPU foundry outsourcing coming from multiple customers? Thank you.
That's a very specific 1%. But let's say that we start to working with the CPU customers and starting from 77 plus and all the way to 5, okay? And when time is up reported here, say that what is percentage that we got it from the CPU, okay?
I think you can calculate from our customers' financial.
Okay. So I think just to clarify, C. C. You said that you start to work with CPU customer or customers?
C. Wei:] Customers.
Okay. Thank you.
All right. Next question will be coming from UBS, Bill Lu.
Lu. Couple of questions on the trade tension and tariffs. One is that with tariffs becoming, I guess, more prevalent, does that change your outlook of where to place the fabs? And secondly, you've got more competition at the trading edge if you look at the Chinese fabs. Are you seeing an opportunity to take share with the trade tension?
You talk about fab location, right? It is as you know, we have when we build fab, we nowadays, we only build the leading edge fabs. That is we are doing 5 nanometer fabs preparation and we're building 3 nanometer. And the decision was made to build in Tainan, okay? And of course, with across the board support from the local and administration here.
Upon the trade tension, I think they appears that we will at this point, it seems that they are notched that, hey, is it good to build fab in Taiwan? But actually, we have almost none requests from our customer to change the plan we have. We but however, we do constantly assessing and deliberation about what's the pro and the cons of that plan and whether there are other options. But so far, we haven't changed our plan. The prime reason is this.
When we ramp the leading edge fabs, as you know, those are the really for the high performance computing or smartphone launch. The ramp is very tight. Time to market is critical. And to have a leading edge fab ramp, not only this fab has to be closely coupled with R and D fab, which is in Xinchu, the 2 teams almost work as one team. Also, this fab has to collaborate with other fabs in TSMC.
As our founder mentioned, there are thousands of engineer transport from to fab fab to cope with the sudden ramp of those resources needed. So those are the background of those leading edge fab. When we open book with our customers, this is a best sure way to ensure their product announcement and product launch and the request conversation will take them back. But we're constantly watching this bigger geopolitical change, of course, but at this present time, we do not have plan change that.
Thank you. The second part of your question is, are you seeing an opportunity to take share, for example, if U. S. Customers don't want to use Chinese fabs?
The question is
say again?
Is there an opportunity at the trailing edge, 20 nanometers, 8 inches to take market share?
On Chinese fab?
Well,
most of the U. S. Customer currently, the Chinese fab is still used by the local customers, let me put it this way. Intention of the other U. S.
Customer, we didn't encounter those comments.
All right. Follow-up questions coming from Morgan Stanley's, Charlie Chan. Thanks.
So I want to follow-up a little bit about trade attention issue because another topic is about Huawei's 5 gs and information security issue, right? So how does the company kind of evaluate this kind of business risk, meaning exposure to Huawei's supply chain? And have you got any concern from governments or U. S. Governments on this topic?
No. And we are everybody's country. And we did not see any kind of instruction or the information from the government.
So business as usual. Okay. Okay. And also another question is regarding your specialty semiconductor strategy. As you mentioned, you want to build up a new age fab in China.
I would guess it's for lots of niche demand. But how do you deal with this kind of outsourcing or partnership with your subsidiary Vanguard going forward in the 8 inches business?
Well, if you look at the market, 8 inches is a business actually, sometimes the capacity is in shortage. But regardless of Vanguard or not, TSMC did not increase the capacity. We increased the specialties capability and also that our service to the customer. So we build a new building to give more room to put specialty tool inside to support our customers.
Okay. And lastly, I guess this year could be tough, right? It could be the 1st downturn that 2 gentlemen become the new management, right? So is there any initiative that you want to take the company and get through this potential downturn? Any new initiatives in the company?
When you say this is a new management, we have been here for more than 20 years at least. The new measure, I mean, that's we follow a very good guidance from the previous Chairman. And so far, so good. The strategy continues. The management style continues.
So new management, hard to say.
Sorry for the other phrasing, sorry.
Let me comment. This is a we over the years, I mean, right now, probably is the the in terms of technology portfolio TSMC has built, both leading edge and specialty, I think this strongest position at present time, as you agree. And also about the customer engagement or customer portfolio, This time, it's about the widest customer portfolio we ever have. And CCE is talking about we're getting into high performance computing, even the CPUs, including data center CPU, accelerators and the client CPUs. It's probably the widest addressable market we ever have.
So we're going to continue with these three thrusts. We're going to invest further on the R and D, and we're going to continue to engage with our customers' design, closely closely build it as a team. Actually, we send people to our customers to build the design on 5 nanometer, some of them on 3 nanometer discussion. And also, we just want the high performance computing can adopt our technology development features more tightly. So we think this is a although that we're facing some headwinds on the macro economy And just and another certainty is not in our control is the trade dispute tension.
We just hope the 2 countries can come to a win win or at least not lose lose solution. I think we are on the road to climb our next peak, yes.
With TSMC's business under the steady, stable hands and the expanding addressable market, we will conclude today's conference. So please be advised that the replay of the conference will be accessible within 4 hours from now. The transcript will become available 24 hours from now, both of which will be available through our website at www.tsnc.com. Thank you for joining us today. We hope you will join us again next quarter.
Goodbye, and have a good day.
Thank you.
Thank you, everybody.