Happy New Year to everyone. Welcome to TSMC's fourth 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 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 this event in English only. The format for today's event will be as follows.
First, TSMC's Senior Vice President and CFO, Ms. Lora Ho, will summarize our operations in the fourth quarter 2018, followed by the guidance for the first quarter of 2019. Afterwards, Ms. Ho and TSMC CEO, Dr. C.C. Wei, will jointly provide company's key messages. Then TSMC's Chairman, Dr. Mark Liu, will host a Q&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. 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. First of all, Happy New Year, everyone. Thank you for joining us today. My presentation will start with financial highlights, as usual, for the fourth quarter, and a recap of 2018 for the whole year. After that, I will provide the guidance for the first quarter. Fourth quarter revenue increased 11.3% sequentially to TWD 290 billion. As our business benefited from the strong demand for our 7 nm technology, covering both mobile and high performance computing applications. Gross margin increased 30 basis points sequentially to 47.7%, reflecting the absence of the virus incident that occurred in the third quarter, and an improvement in back-end profitability, higher capacity utilization, and a more favorable foreign exchange rate.
These factors helped offset the unfavorable technology mix. Total operating expenses increased by TWD 12.7 billion. Thanks to the operating leverage, only represented 10.6% of the revenue versus 10.8% in the prior quarter. Operating margin increased by 40 basis points sequentially to 37%. Overall, our fourth quarter EPS reached TWD 3.86, and ROE was 24.6%. Let's take a look at revenue by technology. 7 nm process technology continued to ramp strongly and accounted for 23% of wafer revenue in the fourth quarter. 10 nm was 6%, and a combined 16 nm-20 nm contribution accounted for 21%.
Advanced technologies, 28 nm and below, accounted for 67% of wafer revenue, up from 61% in the third quarter. On a four-year basis, 7 nm contribution reached 9% of wafer revenue in 2018. 10 nm was 11%, and a combined 6/20 nm 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 fourth quarter, communication increased 27%, while computer, consumer, and industrial standard decreased 2%, 35%, and 3%, respectively. On a four-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 fourth quarter with cash and marketable securities of TWD 695 billion, an increase of TWD 91 billion from the last quarter. On the liability side, current liabilities increased by TWD 19 billion. On financial ratios, accounts receivable turnover days was 41 days. Days of inventory decreased six days to 67 days due to stronger wafer shipment during the fourth quarter. Let me make a few comments on cash flow and CapEx. During the fourth quarter, we generated about TWD 189 billion cash from operations, and spent TWD 114 billion in capital expenditures.
As a result, we generated free cash flow of TWD 75 billion, and our overall cash balance increased TWD 89 billion to reach TWD 578 billion at the end of the fourth quarter. In the U.S. dollar terms, our fourth quarter capital expenditure reached $3.7 billion, and a total $10.5 billion for the full year CapEx. I would like to give you a recap of our performance in 2018. 2018 was another growth year for TSMC, as we continued 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 term, and 5.5% in TWD terms, to reach about TWD 1 trillion.
Main contributor was the strong demand for our 7 nm and 10 nm 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 percentage point to 37.2%, while we continue to increase investment in R&D for 7 nm and 5 nm 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 TWD 13.54. On cash flow, we generated TWD 574 billion in operating cash flow for the whole year, spent TWD 316 billion, or $10.5 billion in capital expenditure, leaving TWD 258 billion in free cash flow.
We also paid TWD 207 billion or TWD 8 per share in cash dividend, which is an increase of 14% from the 2017 level. I have finished my financial summary. Let's turn to the forecast first quarter guidance. Based on the current business outlook, we expect first quarter revenue to be between $7.3 billion and $7.4 billion, representing 22% sequential decline. Based on exchange rate assumption of $1 U.S. to TWD 30.6, our first quarter gross margin is expected to be between 43% and 45%, and operating margin is expected to be between 31% and 33%. This concludes my financial presentation. Let me follow by making a few comments about the near-term demand and inventory, CapEx and profitability.
On near-term demand and inventory, we conclude the fourth quarter with revenue of TWD 287.8 billion or $9.4 billion, in line with the guidance given three months ago. This result was mainly driven by the continued steep ramp of our industry leading 7 nm 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 nm technology. Moving into first quarter 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, stayed 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 comments about the CapEx. As I have stated before, we believe $10 billion-$12 billion capital budget will be sufficient to support our average growth of 5%-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 million to a level between $10 billion-$11 billion. That said, our commitment to support customers' product ramp remain unchanged. Out of this $10 billion-$11 billion CapEx for 2019, about 80% of the capital budget will be allocated for advanced process technologies, which includes 7 nm , 5 nm , and 3 nm. A little more than 10% will be spent for advanced packaging and mask making, and about 10% will be spent for specialty technologies. This is about CapEx. Let me follow on by make some comments about our profitability. Okay.
As I stated in our first quarter 2018 earnings call, I said TSMC's profitability is determined by the following six factors. Number one 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 growth margin. I have just guided first quarter growth margin to decline by 3.7% points sequentially at the midpoint of the guidance. This is primarily attributable to a lower utilization due to the overall weakening macroeconomic environment, and the mobile product seasonality, and the high level of inventory in the supply chain.
Due to the recent changes in high-end smartphone business condition, our 7 nm capacity will see a substantial cutback on utilization rate in first quarter and second quarter, which is expected to hit our growth margin by more than 4% 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 nm 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 growth margin in the second half of this year will be better than first half, and we believe our long-term growth margin target of about 50% is still a good target. Thank you for your listening. Let me turn the podium to C.C. for his remark.
Thank you, Lora. Good afternoon, ladies and gentlemen. 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 macroeconomic 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 nm , where we see strong interest from our customer in high performance computing, mobile, and automotive.
Even with a slow year like 2019, we firmly believe AI and 5G are the mega trends that will drive the future semiconductor growth. And we reaffirm our long-term growth projection of 5%-10% CAGR. I will talk about our 5 nm status. Our N5 technology development is well on track. Which customer tape out schedule for first half 2019 and volume production ramp in first half 2020. We are already in preparation for N5's ramp. All applications that are using 7 nm today will adopt 5 nm . 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. I will talk about the ramp-up of N7 and N7+ . Our 7 nm has been a very steep and successful ramp in second half 2018, we expect continued ramp through 2019. Our customer portfolio is growing stronger, while more applications such as HPC and automotive are coming to N7 as well. Customer tape-outs activity at N7 continue to be strong despite the cautious macro outlook. We are actually seeing increased silicon content for AI and 5G related product designs. We expect that 7 nm to contribute more than 25% of our wafer revenue in 2019.
Our N7+ yield rate is progressing well and comparable to N7. N7+ volume production is scheduled to begin in second quarter this year. As I have stated before, we are working with several customers on N7+ to support their second and third wave product designs, and we expect the N7+ contribution to the 7 nm family will grow increasingly larger over the next few years. Now I will talk about TSMC's mature node strategy and our new 8 in facility.
For mature nodes, our strategy is that we do not increase large capacity at mature nodes. 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 Fab 6 in Tainan is a part of this strategy. The extension is not an increase of wafer capacity per se, but the purpose is to increase the clean room 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 five year. As I just stated, we believe 5G and AI will be the mega trend underlying the ubiquitous computing, which will drive the semiconductor growth in the future. With the successful ramp of 7 nm , 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 five years. Thank you for your attention.
All right. This concludes our prepared statements. Before we begin the Q&A session, I would like to remind everybody to limit your questions to two at a time to allow all participants 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.
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. Now let's begin the Q&A. First question will 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? Also the assumptions for 5 nm in EUV to keep the CapEx intact?
Okay. Good afternoon. I want to say happy New Year again. Yeah, welcome to the investor conference. Your first question, I would like C.C. to answer.
You're asking about, which only grows slightly but CapEx did not decrease dramatically. Good question. We now become more conservative on CapEx. It's because we forecast a lower 5 nm of demand at the initial ramp. However, we still have to prepare enough capacity to support our customer. We believe that today we wrote down a few hundred million U.S. dollars is to reflect the reality of expecting the high-end smartphone a little bit slower growth.
This year is because of 7 nm capacity has been built. Actually, we forecast the number of the units of the smartphone, especially high-end smartphone, to be negative growth. Although we still want to say that for TSMC, the year-on-year from 2019 compares to 2018, the smartphone, the mobile business, will still grow slightly of this year regardless of the unit is dropping. Okay. As a result, we expect, as I just said, we expect the foundry business will be flat, TSMC still grows slightly.
Yes. One follow-up to that, 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? On the CapEx, are you making any consideration with the slower environment to reuse more equipment? That's the follow-up to the first question.
We do expect that we, in the 5 nm, will use some of the 7 nm equipment. To answer your question more correctly, actually, why it is only drop a little bit, a few $100 million because of EUV tool. Actually, we already buy a lot. All right? We expect that one continue to grow also. The ramp-up of the 5 nm now definitely was slower than we expected, but we still think it is a long-lasting node because of all our customer who are using 7 nm today are engaged with TSMC today in their product design. In addition to that, we also increased our product portfolio, our customer's product portfolio, and that will be add something to HPC application. Looks not very promising this year, but we still have a confidence that 5%-10% of CAGR will be sustained.
Maybe I will change on the second question, but I will follow up one more. For the 5 nm, if you could just talk a little bit more what is driving some of the change in consideration. If it is anything about the EUV readiness versus cost structure, mature 7 nm versus 5 nm. Maybe if you can go into if now you expect a bigger 7 nm initially, and if, what the factor for that is.
Let us talk about EUV's readiness. We are progressing very well. That is why I say the N7+, which using the EUV, will start the production in second quarter this year. Our 5 nm technology development, a lot of based on the EUV's progress. 5 nm technology development is on track. That is one thing. Why we wrote down that our CapEx, because 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 the high-end smartphone will grow. It is because of 5G 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 nm?
I did not say the EUV will be slower.
5 nm.
5 nm, no. It continue.
The CapEx this year, majority of is spent on 5 nm and some even 3 nm . EUV's productivity continue to improve, and that modulate the CapEx we need to invest. From the number, we are very confident that our 5 nm 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 tighten up enough to minimize the CapEx.
The lower 5 nm initial ramp, though, could you talk about that? Like, what's the rationale for that lower initial 5 nm ramp? Okay.
Well, I just said we expect a higher growth. Right now we are more conservative on the high-end smartphones growth.
The nanometers.
Yeah. Thank you.
Next question will be coming from Citigroup's Roland Shu.
Thank you. Happy New Year. The first question is, C.C., you said for the mobile business this year, you still expect some growth. Under your overall year, the whole year, revenue grows just slightly. How about the growth for the other platform product, IoT, HPC, and the automotive?
Okay. Roland, you ask a good question. Smartphone grow slightly. IoT grow double digit. Automotive will be flat. HPC, if we excluding the cryptocurrency mining, HPC also grow slightly. Cryptocurrency is a big drop from 2018- 2019. If we put a cryptocurrency together in the HPC, it's a big drop. It's almost double digit.
Okay. Thank you. May we have more color for the breakdown for this whole platform, the revenue breakdown in last year, in 2018?
This one, maybe Lora, 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%. There's other 5%. Okay.
Okay. Thank you. May I know how big the contribution for cryptocurrency last year?
A lot.
We don't want to specify too much on the segments. Particularly, it belongs to one of the big customers.
Okay. Thank you. The other question is, Lora said for 7 nm utilization will be dropped a lot in first half. The whole year, the 7 nm revenue contribution, coming by C.C., will be about 25%. That means that above 25%. That means the second half, the 7 nm contribution will be very strong. May we have a more color? What kind of application is driving such strong 7 nm demand in the second half?
Okay. A lot of it because of seasonality of the high-end smartphone. 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 first quarter came a little bit sudden. The inventory in the supply chain is quite a lot. That may push the first half drop. Second half, we expect the new product launch will carry on another wave of ramp.
Roland, I give you a more color. How about that? In the second half, we already say that we have more customers of product portfolio. That will expand into the high-performance computing. Some of the product will enter into production slightly from fourth quarter and extend it to the next year.
Thank you. For the 7 nm follow-up, I think N7+ will be also included in the whole 7 nm. N 7+ , the total revenue will be still somewhere around TWD 1 billion. Right?
That's correct.
Okay. Thank you.
N7+ is not a major node, rather it is a technology good for second wave and third wave customers. It is come up slower when the first wave product or first wave customer ready to convert to the lower cost, to another improved version. It doesn't conflict with our 5 nm. 5 nm is another major node.
Thank you very much.
Next question will be coming from Goldman Sachs, Bruce Lu.
Happy New Year. Happy to be back. I want to ask about smartphone semiconductor adjustment market. TSMC used to provide that some semiconductor growth for high-end smartphone, mid-end smartphone, and low-end smartphone in the past. Can we ask what kind of semiconductor growth in the coming one or two years for different segment of smartphone? Also, what kind of semiconductor growth for smartphone moving from 4G- 5G, especially for the addressable market for TSMC?
If you want to specify what is the 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 too. That's one. Such as AI. We expect in the future, AR/VR will be inside. The second thing is 5G initial, that increase a lot on the frequency band, that will add the silicon content inside. I give you a kind of feeling that the smartphone unit will drop a few percentage, but TSMC still grow the smartphones as a business. That means is a lot of increase in that revenue is because of silicon content in terms of the smartphone business.
Moving to 5G, as you mentioned that there are a lot of RF content, those kind of silicon content increase. Do we see that having any impact to our business?
You have a good question. Yes, moving to 5G, the RF become more complicated, you have to add more chips or add more larger area in the RF chip. We expect the silicon content per se, that will increase, that the silicon content in the smartphone will increase. That's true.
Can we somehow quantify it a little bit?
Not very-
Let me put some color. This is based on, of course, the forecast number, so may not be accurate, but we have a picture about the silicon content supporting C.C. Wei's description. On a 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. That's the picture. Most of our business in the smartphone belongs to the high end, we are going to enjoy the silicon content bait with the equipment of our technology, leading-edge technology.
Okay. My second question will be that, management just mentioned that the 5% revenue growth CAGR within 10. I think management first mentioned that in 2017, and with slower growth in 2019. If you do that after maths, you're going to expect more than double-digit growth for the coming two years.
You can calculate it.
Do I read it correctly?
I want to reaffirm that the 5%-10% CAGR will extend. We have confidence on that. You calculate it.
The five-year timeframe is 2017-2021, right?
Yes.
Thank you.
Next question will be coming from CL Securities' Sebastian Hou.
Thank you. My first question is, I'd like to get TSMC's brains on the overall semi cycle inventory. Remember, three months ago, I think the company talked about that you're not too worried about the inventory situation compared to the full quarter 2017. Today, you just talked about that there's a lot of excessive inventory out there. I'm just wondering what has happened the past three months. Is it more due to demand slowed down a lot, or still more due to there is some hidden inventory, now they emerge?
I would say it's more due to the sudden drop in the demand rather than there is some hidden inventory that we did not see.
Okay. Can you elaborate more on which end application has seen the most significant decline in demand?
High-end smartphone is one thing, and then other things. The drop a lot is actually you can imagine that cryptocurrencies mining, that dropped quite a lot. 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. In terms of the inventory digestion, I think Lora talked about that the inventory will go back to more seasonal average level by middle of this year. Usually, the down cycle, we usually see the supply chain will tend to overcut inventory to below normal. Is the mid this year, is that means that the below normal level came before or after that?
We expect to be a reasonable level that it can sustain your business. We expect that this kind of a demand will recover gradually from first quarter, second quarter, and then moving into the second half of this year. That's what we expect 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 we compare this down cycle to the past. 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 this year, compared to the UTR we see in 2015, 2012, or say, post-financial crisis, is it likely to be the lowest point that we've seen since then?
This, as Lora just presented, the utilization impact this quarter is really mostly come from 7 nm . Although other nodes utilization is lower, but if you compare with the last downturn, if you take 2009, for example, it's not that low. Our 7 nm really is the major underutilized. We think it's temporary.
Thank you. Is it fair for us to assume that this UTR certainly not as low as the 2009 yet, but it is already lower than what we're seeing in 2011, 2012, that cycle, and also 2015 cycle?
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. Dr. Wei, I think, made a comment that, in the future, we will work with customers to plan for capacity differently. I wonder if you could talk a little bit more about that as far as what can be done. 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?
In fact, this is kind of the way we deal with our customer. It will be a better planning process. TSMC as well as TSMC's customer, I believe that we are learning a lot during this cycle. We will be more prudent or have found a way that TSMC and the customer can work together for the better planning of the capacity in the future. To summarize in one wording, we will be more conservative, we will not lose our support to our customer.
A wider product portfolio is another factor you mentioned.
Great. Thank you. Second question is for Lora. Can you talk about the depreciation for this year? I'm asking that because, I feel like TSMC over the last 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? 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 depreciated the tool when it gets into the production. The depreciation pattern versus the CapEx changes is not linear. Because whether the CapEx is front-end loaded, back-end loaded, also will impact the whole year depreciation. I can tell you based on the TWD 10 billion-TWD 11 billion CapEx for this year, we expect the depreciation will increase by mid-single-digit, which versus last year was double-digit. Yeah. You see it's all about TWD 10 billion-TWD 11 billion, but the depreciation change can be quite different.
Yeah, sorry. I need to work through the math a little bit. What is that assuming for, I guess N7+? I just want to figure out next couple of years as EUV ramps up, are we going to see a pickup or how does that work?
I don't recall. I remember there was a sudden increase. It's a more modest increase year-over-year, I think.
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. Operator, could you please have the first caller on the line?
Yes. The first question is from the line of Brett Simpson of Arete Research. Please go ahead.
Yeah, 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 inventory days versus a quarter ago? What would you say is normal inventory levels in weeks or days, just so we can frame exactly how elevated the inventory levels are at the moment. Thank you.
Can you repeat the question?
Brett, I think you probably talked too close to the microphone, so I'm not hearing you quite well. I think you are asking, the inventory level, the excess inventory that we see it now versus we saw three months ago, and you would like to have a little bit color on that difference. Is that your question?
Yes. Thank you, Elizabeth. Also just to understand what normal inventory levels are in your view?
What's the normal level?
Three months ago, we estimated 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. You said smartphone seasonality was also going to be a weak event in Q1. What are you suggesting the communication division will do in Q1 versus Q4 revenues? Thank you.
Well, I think, the main reason is because of high-end smartphones seasonality. Typically, Q1 is a 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 first quarter this year. That's why the inventory suddenly increased so much. Did that answer your question?
Yes, thank you. Can you perhaps quantify how big a drop in Q1 your communication revenue will be because of the smartphone seasonality?
Okay. Lora, would you answer this?
You're asking by segment, how do we see the changes in first quarter? Communication in first quarter will drop the most, followed by the computer. Consumer actually will grow slightly, and industrial standard will grow very significant. I think, the declining three sector are all double-digit decline in the first quarter.
Okay. Thank you. One last question on 7 nm. What percentage of sales in Q1 do you expect to come from 7 nm? You're suggesting a very strong 7 nm ramp in second half when the industry gets back to normal inventory levels. Is there a risk that demand for 7 nm exceeds supply? To what extent can you get customers to pull in orders at 7 nm and start ramping earlier in, say, Q2 this year?
You're going to repeat the question?
We're trying to understand your question. You're asking us about 7 nm, since we said that there's going to be a strong cutback on 7 nm. Are you asking what perecentage of 7 nm is part of our Q1 revenue, and then what will be the level in the second half for 7 nm?
Let me answer.
Yes. Okay.
Let me try to clarify the ramping of 7 nm this year. We already ramped the 7 nm last year, that's our first generation 7 nm . Coming to the first quarter, the 7 nm composition is about 21% of our corporate revenue already. Now, this year, we are preparing to ramp the second generation 7 nm . We don't have a specific name. Different customer have the different flavors. Overall, it's their second-generation product to be launched this year. All the 7 nm numbers for the second 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 nm as a percentage of sales might be in Q1? Does this mark the trough for 7 nm in 2019?
Question?
Question is, what's the percentage of 7 nm in our revenue in Q1? Whether or not that percentage is the trough, is the lowest for this year.
Lora, can you answer that?
Okay. Mark just mentioned the 7 nm accounts for 21% of our first quarter revenue. We see that percentage of total revenue will continue to grow. I would say that percentage-wise, first quarter will be the trough.
Okay. Thank you very much.
Operator, let's go to the next caller on the line. Thank you.
Certainly. Next question from the line of Mehdi Hosseini 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 2018. Why is it still an overhang on your HPC revenue mix? I believe you said, including crypto, HPC will be down double digit. I'm just trying to better understand 2018- 2019. I have a follow-up.
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 in 2019.
Yes.
Okay. This year, we become conservative in forecasting this volatile business. The cryptocurrencies mining this year is much, much less than last year. To what percentage, I don't think I can release it right now.
Sure.
It is a conservative.
I think what.
Yeah.
This is a conservative estimation on the cryptocurrency.
What I'm confused about is, if you have had a new HPC customer program, how come those ramps are not enabling you to ramp HPC in 2019, other than just slightly up?
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. A good question. As because of our customer, we expanding our customer portfolio and product portfolio. 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. My second follow-up has to do with the 5 nm ramp. I'm trying to better understand your visibility and tape out engagement. Should we expect a 5 nm ramp in 2020 to look more like a 7 nm, or is that going to be steeper? Any color will be appreciated.
Let me come in on that. 5 nm ramp in 2020, I would expect that product portfolio is expanding more as compare with the 7 nm in 2018. How much of a steeper of that one, it will be similar, or probably we are a little bit conservative. Today, we saw the better product portfolio, better customer portfolio, but steeper ramp, probably very similar.
Sure. Should we assume that five will become bigger than seven in 2021? Is that when the true benefits of five and the customer diversification is going to materialize?
From today's situation and the customer we engaged with, yes. 2021 5 nm were bigger than the 7 nm , 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. My first question is about smartphone semi demand for this year. Because demand trend attribute the weakness in one Q2 seasonality. Do you see any structural issues, for example, the lengthier return cycle, lack of clear access issue of the smartphone semi demand? I cannot really get the math, right? Because high-end smartphone, even if it's a higher content, it should contribute to more of your revenue. You are assuming this segment will decline and units will decline, right? Why can you get a number that a full year mobile revenue can still grow slightly?
Good question. Actually, high-end smartphone, this year, at least for the first half, it still have some kind of inventory issue. In the second half, we expect a new model coming out. It's ramping up, starting from the second quarter 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. TSMC still grow slightly on the mobile business. That's why. Your question is?
Yeah. I just want to get a confidence why you think second half that recovery could happen, right? Because it's possible that a new product disappoints again, right?
Okay.
If I can get more color, do you think it's kind of a specific brand issue, or is that kind of across different brands, have that 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 all I can say.
Okay. That's fair enough. I would assume some market share gain there. I want to follow up the previous question regarding HPC, right? 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 you see the demand in the AI, cloud, and also telecommunication, right? There got to be some demand issue to get only a kind of slight growth for HPC versus your targets of 20%. Can you comment on the demand?
Okay. Let me comment on that. We used to be very optimistic. We're still very optimistic because of AI and 5G. AI and 5G, AI is picking up. 5G was started from this second half, start to install some of the base station. The infrastructure was start to build up. We did not expect the 5G smartphone will be a big number this year. It will be a big number next year. 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. We know it's increasing. You are talking about HPC, we used to say that 20% CAGR. Did we say that?
At least last year and the year before.
The last year compared with the year before, because there's one surprise that's called cryptocurrency mining. It suddenly increased dramatically. TSMC, because of a technology offering. We have to say that we get the most of the benefit of the cryptocurrencies, the mining business. Now it's so volatile, it dropped. Without the cryptocurrency, we still see strong momentum on the HPC. One, because of we have very competitive, or actually, I want to say the industry-leading technology that which fit the requirement of HPC business. Second, again, I would like to say we have a stronger customer portfolio.
Let's look beyond 2019, right?
Yeah.
For two or three very high growth profile segment, HPC, IoT, and also another one I'm also very surprised your company is only flat year-over-year, right? For coming maybe two or three 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. The second strongest, in terms of the dollar increase, is still smartphone.
Yeah.
In terms of dollar increase.
Auto, you've got those kind of EV I'm not sure how you classify the autonomous driving, right? Auto, I think it used to be a kind of a segment the company expected strong growth, right? Why this year we don't see that?
Yes. Auto, if you look at the past two years, a very strong growth, 20-some percent. As you know, since last year, suddenly the automotive market is 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, 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. Yeah.
Yeah, I guess one question from lots of investors.
The question.
Yeah. It's about dividend payout expectation, right? Comments was to steadily grow every year, right? It happens over the past few years, EPS growth was around 3% every year, this year, I'm not sure, right? It could be flat. Does the company think that this year you want to increase the dividend dollars again? Thanks.
Despite a short-term market weakness, if we look at free cash flow that we can generate, it remain to be very strong. We plan to further increase dividend in 2019. We will get a board approval in February, we will make announcement after that.
All right. Next question will be coming from JP Morgan's Gokul.
Yeah. Thanks for taking my question. Happy New Year. 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 20,000 in phase I and then potentially expand beyond that. Is there any timeline difference on the Nanjing fab?
The plan did not change because this is a short-term different 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 two, given the?
You are depend on the business situation definitely. 20,000 wafer per month is a plan, continue to be executed.
Okay. Next question I had was on N5. Just building on some of the other questions as well. For many customers, it's going to be the first node with significant EUV insertion. 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? 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 N5 progress, I just have reported that our progress is on track, and we work with the customers. You say that whether the customer are worried or have concern on the EUV's readiness or the stability or those kind of thing. No, they are happy with us. We work with the supplier, we work with the customer on both side, and our progress so far so good. Whether that they want to move into N5 or stay in the N7, all I say is all the customer 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. N5 did offer very good performance, per se, as compared with the N7. Some of the high-speed computing, some of the high-end smartphone, they still need to go into N5. You would expect those customer will adopt the N5 immediately that when it is available. Okay. 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. If you could give a view or maybe split how you see first half for second half.
Lora , can you give the number?
Second half definitely is better than first half. Okay.
That's good. Much better.
First quarter of 2019 is quite weak, and we think it's going to take another quarter to recover. 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. Second half definitely will be better.
A follow-up on the application and inventory issue. You did flag smartphone as inventory, but could you flag how broad you think that inventory issue is? Is it across applications? 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 was driving those increases?
You mean supply chains inventory?
Yeah, just because you mentioned it's a broad inventory or you have an inventory issue, how you see it across the other applications.
Yeah.
What's driving those segments?
Exiting 2018, I think the inventory increase is broad range.
Okay.
Yeah. Because of the macroeconomic and uncertainty on those trade tension pretty much put people really on hold or very careful.
Yeah.
It seems to be across the board.
Okay. I guess the rationale then for industrial up significantly and consumer up slightly?
Well, I think with the industrial
Randy, your question is industrial segment is down in first quarter?
No, I think you said industrial was up significantly and consumer up slightly in first quarter.
Oh, no, I say industrial down significantly.
Down, okay.
Yeah. Only consumer up slightly.
Okay.
The other sector all down.
Okay. Thank you. 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 CoWoS expansion this year?
The back-end business is, this year it will grow double-digit. Still a very good business because of we offer the solution to the customer 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 TWD 2.5 billion. Going forward, currently we see the double-digit growth at least year-over-year. To clarify this, back end business still is initial stage because, as you remember, initially our back end was adopted by the smartphone. Now more and more, we see the high-performance computing customer in the 5 nm , almost all of them wants to adopt what 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 don't call back end, we call advanced packaging because we realize that that packaging is very different than the back end or OSAT, the business that we used to know. Yeah.
Thank you.
Follow the question from CL Securities, Sebastian Hou.
Thank you. First follow-up is, can you provide us some update on the tape-out numbers that you have received on 5 nm now? Your expectation by the end of this year?
Well, I just say that I cannot give you the number today, I repeat it again, all the 7 nm customer are working with us right now on their design.
Okay. The 7 nm tape-out numbers still on track to exceed 100 by the end of this year?
It's still.
It could be earlier?
Well, depends on how quickly that our customer can adopt our N7 and N7+. The numbers still meet our expectation, on the HPC, probably even more higher. Yeah.
Given the current macro uncertainty, have you noticed any of your customers, which are doing the tape-out on seven right now, become more hesitant or cautious in terms of the production schedule?
No. They are being very aggressive because of our 7 nm is a very good performance, that can help them to gain the market to their product going to the market. It's not slowing down, it's actually accelerating a little bit.
Okay. I think last year and this year, I think probably only not a big portion of these 7 nm tape-out for customers are already reached production. Is that a fair assumption?
Yes.
Just one of the big customers, but account for big wafer volume, but the tape-out number is small. Which means that do you expect the 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 N7/N7+ will start to ramp probably second half or the fourth quarter of this year. Mass production will be expected in 2020.
Okay. It sounds like you don't notice or feel any bubbling in terms of the tape-out booming.
No.
Okay.
We cannot 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 Shu.
Thank you. Last year, the raw wafer negative impact our gross margin. How about this year? Are we going to still see the same trend, or we are going to see it will be reversed, maybe you will benefit, for this raw wafer price in our margin? Thank you.
We have signed a long-term contract with our suppliers in 2017 and 2018, lock in the long-term supply and also lock in the price. We do not see any further price deterioration for us.
Okay. Yeah, given now the demand is declining, are we going to renegotiate this longer contract with these wafer suppliers?
Yes.
This is for the 2019 and 2020, or 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 will see the CPU foundry outsourcing coming from multiple customers? Thank you.
That's a very specific 1%. Let's say that we start to working with the CPU customers and starting from 7 nm/N7+ and all the way to five. Okay? When time's up, report it here. Say that what is % that we got it from the CPU. Okay?
I think you can calculate from our customer's financial.
I think just to clarify, since you said that you start to work with CPU customer or customers.
Customers.
Okay, thank you.
All right, next question will be coming from UBS, Bill Lu.
Hi, thank you. Couple of questions on the trade tension and tariffs. One is that, with tariffs becoming, I guess, more prevalent, does that change your outlook on where to place the fabs? Secondly, you've got more competition at the trailing edge if you look at the Chinese fabs, are you seeing an opportunity to take share with the trade tension? Thanks.
Trade tension. Fab locations. You talk about fab location, right? As you know, when we build fab, nowadays, we only build leading-edge fabs. That is, we are doing 5 nm fabs preparation, and we're building 3 nm . The decision was made to build in Taiwan. Okay. Of course, with across the board support from the local and administration here. Upon the trade tension, I think it appears that at this point, it seems that they are nudged that, "Hey, is it good to build a fab in Taiwan?" Actually, we have almost none requests from our customer to change the plan we have. However, we do constantly assessing and deliberation about what's the pros and cons of that plan, and whether there are other options. 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 really for the high-performance computing or smartphone launch. The ramp is very tight. Time to market is critical. To have a leading-edge fab ramp, not only this fab has to be closely coupled with the R&D fab, which is in Hsinchu. The two 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 fab to fab to cope with the sudden ramp of those resources needed. 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. We're constantly watching this bigger geopolitical change, of course. At this present time, we do not have plan to change that.
Thank you. The second part of the 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 it again.
Is there an opportunity at the trailing edge, 28 nm, 8 in to take market share?
Oh, Chinese fab? If U.S. customers don't want to use the Chinese fabs. Well, 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. I want to follow up a little bit about trade tension issue because another topic is about Huawei's 5G and information security issue, right? How does a 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.
Okay.
We are everybody's. We did not see any kind of instruction or the information from the government. Business as usual.
Okay. Thanks. Another question is regarding your specialty semiconductor strategy. As you mentioned, you want to build up a new 8 in fab in Tainan. I would guess it's for lots of niche demand. How do you deal with this kind of outsourcing or partnership with your subsidiary, Vanguard, going forward in the 8 in business?
If you look at the market, 8 in business actually sometimes the capacity is in shortage. Regardless of Vanguard or not, TSMC did not increase the capacity. We increased the specialty capability and also our service to the customer. We build a new building to give more room to put the specialty tool inside to support our customers.
Okay. Lastly, I guess this year could be tough, right? It could be the first downturn that the two gentlemen become the new management. Is there any initiative that you want to take the company get through this potential downturn? Any new initiatives in the company?
Well, you say this is a new management. We have been here for more than 20 years at least. The new management, we follow a very good guidance from the previous chairman. So far so good. The strategy continues, the management style continues. New management, hard to say.
Sorry for the phrasing. Sorry.
Let me comment this. Over the years, right now, probably in terms of technology portfolio, TSMC has built both leading edge and specialty. I think this is the strongest position at the present time. I agree. Also about the customer engagement or customer portfolio. This time is about the widest customer portfolio we ever have. C.C. is talking about we're getting into high-performance computings, even the CPUs, including data center CPU, accelerators, and the client CPUs. It's probably the widest addressable market we ever have. We're going to continue these three thrusts.
We're going to invest further on the R&D, and we're going to continue to engage with our customers' design closely, build it as a team. Actually, we send people to our customers to build the design on 5 nm, some of them on 3 nm discussion. Also, we just want the high-performance computing can adopt our technology development features more tightly. We think although that we're facing some headwinds on the macroeconomic economy, and just on the another uncertainty is not in our control is the trade dispute tension. We just hope the two 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. Yeah.
Thanks.
With TSMC's business under the steady, stable hands and the expanding addressable market, we will conclude today's conference. Please be advised that the replay of the conference will be accessible within four hours from now. The transcript will become available 24 hours from now, both of which will be available through our website at www.tsmc.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 very much everybody.