Welcome to TSMC's Q3 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 dialing lines are in listen only mode. As this conference is being viewed by investors around the world, we will conduct the event in English only.
The format for today's event will be as follows: First, TSMC's Senior Vice President and CFO, Ms. Laura Ho, will summarize our operations in the Q3 2018 followed by guidance for the Q4. Afterwards, Ms. Ho and TSMC's CEO, Doctor. C.
C. Wei will jointly provide company's key messages. Then we will open both the floor and the line for the Q and A. For those participants on the call, if you are 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 everybody 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. So please refer to the Safe Harbor notice that appears on our press release. And now, I would like to turn the microphone to TSMC's CFO, Ms. Laura Ho, for the summary of operations and current quarter guidance.
Good afternoon, everybody. Thank you for joining us today. My presentation will start with financial highlights for the 3rd quarter and followed by the guidance for the 4th quarter. 3rd quarter revenue in U. S.
Dollar reached $8,490,000,000 which increased 8.1% sequentially, reflecting customers' new product launches using our 7 nanometer and a more favorable foreign exchange rate. 3rd quarter revenue came in stronger than the revised guidance that considered the impact from the August 3 virus incident. As we were able to make up most of the delayed shipments. In NT dollars, revenue increased 11.6% sequentially. Compared with 2nd quarter, gross margin decreased 0.4 percentage point to 47.4% as the unfavorable technology mix was partially offset by the profitability improvement in the back end business, while the more favorable exchange rate offset the virus incident impact.
Total operating expenses increased by TWD 1,700,000,000. The increase was mainly for 5 nanometer and 7 nanometer plus development. Thanks to operating efficiency, total operating expenses represented 10.8% of revenue versus 11.3% in the 2nd quarter. So our operating margin improved 0.4 percentage points sequentially to 36.6%. On tax expenses, after a step up in tax rate to 17.5% in the 2nd quarter due to the accrual of retained earning tax.
Our effective tax rate fell back to 10% in the 3rd quarter. We expect the full year tax rate to be about 12%. Overall, our 2nd quarter EPS was $3.44 and ROE was 23.2%. Now let's take a look at wafer revenue contribution by application. During the 3rd quarter, communication and industrial standard increased 24% and 6%, respectively, while computer and consumer decreased by 35% and 1%, respectively.
Now let's take a look at revenue by technology. 7 nanometer process technology contributed 11% of total wafer revenue in the 3rd quarter. 10 nanometer accounted for 6%, while the combined revenue from the 16 20 nanometer accounted for 25%. Advanced technologies defined as 28 nanometer and more advanced technologies accounted for 61% of the total wafer revenue. Moving on to the balance sheet.
We ended the Q3 with cash and marketable securities of NT604 billion dollars a decrease of NT145 billion dollars from last quarter mainly as we paid out $207,000,000,000 of cash dividend, while we borrowed $43,000,000,000 short term loans for hedging purpose. Correspondingly, current liabilities decreased by NT141,000,000,000. On financial ratios, accounts receivable turnover days remain at 38 days. Days of inventory decreased one day to 73 days due to stronger wafer shipment during the quarter. Now let me make a few comments on cash flow in CapEx.
During the Q3, we generated about NT 94,000,000,000 cash from operations and spent JPY 70,000,000,000 in capital expenditures. As a result, we generated free cash flow of RMB 20.4 billion after we pay our cash dividend and borrow short term loans, cash balance decreased by about RMB 143,000,000,000 to RMB489,000,000,000 at the end of the quarter. In U. S. Dollar terms, the capital expenditure spend in the 1st three quarters of 2018 totaled US6.7 billion dollars I have finished my summary of financial.
Now let me provide you the 4th quarter guidance. Based on the current business outlook, we expect 4th quarter revenue to be between US9.35 billion dollars US9.45 billion dollars which is a 10.7% sequentially increase at the midpoint of the guidance. Based on exchange rate assumptions of US1 dollars to dollars. Our 4th quarter gross margin is expected to be between 47% 49%. Our 4th quarter gross margin our 4th quarter operating margin is expected to be between 36% 38%.
This concludes my financial presentation. Let me follow by making a few comments about the near trend demand, inventory, capacity and CapEx. Now on the near trend demand and inventory, we conclude our Q3 with revenue of TWD260,300,000,000 $49,000,000,000 which is above our revised guidance. According to the revised guidance, the computer virus incident on August 3 was estimated to have impacted our 3rd quarter revenue by about 2% and gross margin by about 1 percentage point, respectively. However, we were able to make up about 75% of the affected shipments in the 3rd quarter.
So overall, our 3rd quarter result was mainly driven by strong demand from product launches using our 7 nanometer technology. Moving into Q4, despite the current market uncertainties, our business will benefit from a continuous steep ramp of 7 nanometer for several high end smartphones as well as the demand for sixteentwelve nanometer for the launches of new generation GPU and AI. However, this growth will be partially offset by continued weakness in cryptocurrency mining demand and inventory management by our customers. Fabulous DOI exiting Q3 2018 was several days above seasonal level, slightly higher than what we expected 3 months ago. We forecast established DOI to continue to stay at this above seasonal level exiting 2018.
Now let me make some comment about capacity in CapEx. At TSMC, we view our capacity according to customers' demand. We are continuing to increase 7 nanometer capacity to meet the strong customer demand. We reiterate our 2018 CapEx to be between US10 $1,000,000,000 and US10.5 billion dollars In addition, as I have talked about before, although our leading edge's capital costs continue to increase due to increasing process complexity, we are able to offset its impact to our CapEx by productivity improvements and further optimization of our capacity planning. Going forward, we expect annual CapEx needed to support our 5% to 10% revenue CAGR in U.
S. Dollar terms. In the next few years, will continue to range between USD 10,000,000,000 $12,000,000,000 I conclude my remarks. Let me turn the microphone to C. C.
C.
Wei:] Thank you, Laura. Good afternoon, ladies and gentlemen. Let me start with 20 eighteen's outlook. For the full year of 2018, we forecast the overall semiconductor market, excluding memory, will grow between 5% 7%, while foundry is expected to grow between 6% 7%. For TSMC, as Laura has just indicated, that our second half of twenty eighteen business will be strongly supported by the 7 nanometer ramp up, which is mainly driven by a few new smartphone launches.
However, our business is also negatively impacted by further weakening of cryptocurrency mining demand. As a result, we estimate our 2018 growth rate will be about 6.5% in U. S. Dollar term, which is close to the foundry industry's growth, but slightly below our 7% to 9% guidance given in the last conference. Now let me update you about the August 3 virus incident.
On August 3, TSMC experienced a computer virus outbreak, which affected a number of computer systems and fab tools. The infection was due to misoperation and insufficient of our controls. We have since corrected this problem to ensure such virus incident will not happen again in the future. Our remedial actions including the following: implementing an automatic system to guarantee full proof execution so that such misoperation will not happen again, enhanced firewall control for fab isolation and network control to each individual computer. More enhancement are ongoing to for further improve toward immunity against future infections.
TSMC sets top priority for such security enhancement. Now let me talk about the N7 and N7 plus and the EUV's progress. TSMC's N7 technology is now available for customers to unleash their innovations. This is the first time in the semiconductor industry, a most advanced logic technology is available for all product innovations at the same time. We continue to work with many customers on N7, N7 plus product design and expect to see more than 100 customer product tape hours by end of 2019.
We expect 7 nanometer to be a long node and will attract multiple waves of customer adoptions. N7 plus is in risk production now. Since N7 plus has 15% to 20% better density and more than 10% lower power consumption, We are working with many customers for their 2nd wave product design on N7 plus Although the number of tape outs today accounts for a small portion of the total 7 nanometer tape outs, we expect the activity to pick up at a rapid pace in 2020 and beyond. Because the Asian plus is using a few layers of EUV photolithography to have better cycle time and pattern control, we have made a steady progress on EUV technology development towards high volume production. Tour availability, UV power, productivity, defect reduction, mask improvement, material and process optimization are all on schedule.
A few customers has already made plans to adopt our N7 plus in their 2019 products. Let me move to N5 status. Our N5 technology development is on schedule. We have completed the design solution development and are ready for customers' design start. The N5 risk production schedule in first half twenty nineteen stays the same.
Compared to N7, TSMC's N5 delivered 1.8x to 1.86x logic area reduction and close to 15% to 18% speed gain on ARM A72 core. We expect to receive 1st customer product tape outs in spring of 2019, followed by production ramp in first half twenty twenty. Now let me talk about the N28, N22 and mature node strategy. Due to faster than expected technology migration from 28 nanometer to 16 nanometer and below, 28 nanometers of overcapacity becomes an industry wide phenomenon and is expected to last for a few years. TSMC's mature node strategy is to work closely with our customers to develop specialty technology solutions to meet customer's requirement.
For example, we continue to develop 22 nanometer for scaling benefit and better performance. We are also developing 22 nanometer for CMOS image sensor, MRAM and RN. For all mature nodes, TSMC will continue to develop a variety of spatial technologies such as power management IC, embedded flash, image sensor, MEMS to maintain our good capacity loading rate and to increase our technology value to customers. Now let me talk about advanced packaging update. TSMC has been developing advanced wafer level packaging technologies to integrate advanced SoCs, memories, integrate the passive device to enhance system performance.
We believe our advanced packaging solutions will contribute to our business growth. We are now expanding the application of both CoWoS and InFO, especially for high performance computing. Most of the core works products require integration of SoC with high bandwidth memory, HBM. In 3 d stack, we are making good progress in qualifying multiple HBM sources through close collaboration with customers and the DRAM suppliers. We are also working with a few leading customer on SOIC, which stands for system on integrated chips, where multiple heterogeneous chiplets will be integrated with close proximity to deliver better performance, and we target to start production in 2021 timeframe.
That's all my report and thank you for your attention.
Thank you. 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 an opportunity to ask their questions. Questions will be taken both from the floor and from the call. Should you wish to raise your questions in Chinese, I will translate it to English before our management answers your question.
So we can start. Deutsche Bank, Michael Zhou first.
Thanks. Two questions. One is, what is the outlook for 7 Dome sales portion in 2019? Can you give some color at this moment based on your current visibility or some take on numbers? [SPEAKER
UNIDENTIFIED COMPANY REPRESENTATIVE:] I hope your question is what is the outlook of 7 nanometer
in 2019?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] In 2019?
In terms of the sales portion or any indication.
I would like to answer the question, say it's a very strong demand in all the platforms, in all the market sector, which including the mobile phone, high performance computing that's included graphic, a lot of AI accelerator, FPGA, you name it, a lot of customers working with us as I just stated and we expect 100 or more than 100 tape outs, product tape outs in year 2019. So did I answer your question? [SPEAKER UNIDENTIFIED COMPANY
REPRESENTATIVE:] Is that fair to say the 7 nanometer sales portion will be more than 20% of total sales for the whole year next year?
Next, you?
Let me answer that. You have seen our report, the 3rd quarter 7 nanometer accounts for 11%. And Q4 will be more than 20%. So for whole year 2018, 7 nanometer will contribute close to 10% of total TSMC revenue. Go beyond 2018, we will have very, very strong ramp in 2019 as well.
We expect the revenue contribution will be much higher than 20%.
Second question, C. C, you mentioned 28 nanometer oversupply in the industry could be normal situation over the next few years. So will management consider converting some 28 nanometer to advanced node? I know you mentioned some specialty, especially PMIC in 20 8, CS in 20 8, so which should be a good volume product, but would you consider to conversion capacity to advanced snow? [SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:]
Good question, Michael. Actually, we are moving from 28 nanometer to 22 nanometer, which is a smaller geometry and more advanced. I think your question is that are we consider moving into 2016 convert some of them? We keep the flexibility to moving the wafer around so they can support each other. We already did that.
So there are a lot of commonality in the tools. So some of that capacity or part of the capacity can support other technology node. So it means if
for instance, if your 16, 12 nanometer domain is beyond your estimate, so you can use some 28 nanometer to do some 16 nanometer in the future? [SPEAKER UNIDENTIFIED
COMPANY REPRESENTATIVE:] We have some tools that have commodity. Say for example, implanter, right, and clean up and a lot of things. But let me stress again, I say the overcapacity for few years. However, we are developing 22 nanometer, we are developing a lot of specialties and for TSMC, this only probably a couple of years. We are going to fully utilize 28 nanometer again.
Then is that fair to say your 28, 22 UTR over the next few years, you are confident you can maintain maybe above 85% or above 90%? C. Wei:]
I'm not going to answer this question, but after a couple of years, it will be the high utilization rate again.
Next question will be coming from Credit Suisse, Randy Abrams.
Okay. Yes, thank you. I wanted to ask a question about sales and also gross margins. The sales in 4th quarter is actually fairly good factoring in the business environment. Could you talk maybe the forward view?
You mentioned also fabless days of inventory may exit the year a few days high. So with the implications for first half, especially relative to the last two years, we saw declines in 1st and second quarter. So if you have a view kind of the rate or magnitude of decline relative to what you think normal seasonal is for 1st and second quarter?
Are we going to forecast the second next year's Q1 and Q2?
Initial view based on inventory and demand.
We have very strong demand in 7 nanometer. Let me just continue to say that. For the last quarter of this
year, our you're talking about the profit margin, right? Yes. The second question on margin I wanted to ask, it's about a point or 2 below the traditional, say, 49 to 50 target. Laura cited product mix. Next year, 7 will be more mature.
Do you think you have the catalyst to get back to that 49, 50 or other factors like 28 8 oversupply? [SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:]
Well, let me answer the your 4th quarter's profit margin is a bit lower than we used to have, that's between 49, 50, that's because of product mix Laura just mentioned. Product mix, one of the major reason is the 7 nanometers ramp up much faster than we thought and the demand is very strong and so that lower down our margin a couple of points. I'll let the CFO to explain the number.
C. C. Mentioned about 7 nanometer being particularly strong compared with our other leading edge technology in the past. It does dilute our corporate margin level starting from the Q3 this year. Going to the Q4, as I mentioned, the revenue contribution will be 20% more than 20% of our 4th quarter revenue and margin for 7 nanometer at the beginning stage still below corporate average.
So the dilution in the Q4 will be more severe than the Q3. Our estimation is between 2 to 3 percentage point for 4th quarter gross margin. Now going into 2019, CEREM will continue to be very strong. So we believe the margin dilution will be eased off when we reach to the second half of twenty nineteen.
Maybe just to follow-up on that first one about sales. You mentioned 7 is very strong, but I guess do you have a view the rest of the business may be doing some further inventory adjustments in Q1?
There are several days above seasonal this quarter and going into 2019, I think, limited will be gradually digested when we move into the second half of twenty nineteen.
The second question I wanted to ask was about the 7 plus versus 5 nanometer. You mentioned 2020 would see the very strong ramp up of tape out in activity and volume on 7 plus Is it your view I think last conference, Mark said 5 was a little bit more conservative at this stage. So how is your view now for interest activity and expectation for a steep ramp up of 5 into 2020?
We still expect a very fast ramp on fly. The reason is simple, because of a lot of product developed in the AI area. You need speed, you need lower power and you also need small footprint. So from this from today, we can see when we work with our customer, the ramp will be steep again.
Okay. Do you think mobile will also contribute in that steep ramp?
Still come from the mobile phone first and followed by other applications.
Okay, great. Thank you.
Next question will be coming from Citigroup's Rui Lin
Good afternoon. I would like to follow-up for this 4Q gross margin guidance. If I compare with 4Q last year, actually, we have a similar percentage contribution from this leading edge. Last year, 4Q panometer was about 25% of the total revenue. And in 4Q this year, actually, we have a favorable exchange rate compared to 4Q last year.
And also, we have this improved back end profitability. So how come we still have a lower gross margin compared to 4Q last year?
There is about 2 percentage point difference this 4Q versus last 4Q. There's one reason is product mix issue. I'm particularly talking about 28 nanometer. You know our 28 nanometer is very profitable and the contribution to corporate revenue has declining from last year to this year. So these are two reasons, product mix because 28 declining and also because the utilization of 28 is not full.
That's one reason that there's a new phenomenon.
Okay. So how about the standard gross margin? Does it change?
Structural property is still intact. No change.
Okay. And also last quarter, you talked about for longer term, our financial objective for gross margin is 50%. So is this 50% a fixed number or this 50% is average for the upcoming few years?
50% is our goal. We aim to achieve that. If we can have higher utilization, I am quite confident we can achieve
that. Okay. So this year, I think the property, we were not able to achieve this 50% because of utilization.
Not this year and also because the 7 nanometer ramp is more severe than previous node. So 1st year dilution is slightly bigger.
Okay. My second question is AMD starts with 7 nanometer CPU from server. And also, ARM recently also talked, they have this new brand server product. So is server CPU going forward to be a very significant part of our business going forward? Thank you.
C. Wei:] It will be an important part. Significant?
Maybe. C. Wei:] So your 4th growth platforms, smartphone, HPC, IoT and Automotive, and so this server CPU will be in HPC side?
That's right.
Okay. Thank you. Can you just reiterate growth breakdown for this 4th platform next year? Thank you.
Okay. Let me give you some color on it. In the next few years, if we look ahead, actually, the smartphone going to be in our daily life even more and more. So we have 4 growth engines. 1 is a mobile phone, actually it's a high end smartphone.
2nd one is high performance computing, automotive IoT. The mobile phone probably for TSMC UI have in 5 years at CAGR, if I look at it right from today, it will be mid single digit growth. And all other 3 platforms have a very comfortably double digit growth in the 5 years time frame. And so that's does that answer your question? Yes.
Thank you. You're welcome.
Next question will be coming from UBS, Bill Lu.
Hi, there. Thank you very much. First question is on China. So a lot of concerns about the trade tension, about the economy slowing down, etcetera. Can you talk a little bit about what feedback you might be getting from the Chinese customers, both short term and long term?
And short term meaning whether you're seeing any increasing levels of conservatism on ordering on demand. Longer term, is there any change in the strategies of these Chinese customers in terms of perhaps less reliance on the U. S, etcetera? Thank you.
To answer your question, for the short term, we did not see any impact if there's any at all. So our China customer, no, they did not change their behavior. So we continue to work with the customer to produce their product. For the long term, long term due to the trade tension, your question is a difficult question. Let me answer the question by another way.
TSMC has been proud to be everybody's boundary. So if there is a trade tension, if there is and if it continues, I think that TSMC the impact to TSMC will be less or minimized because if we still need the semiconductor device and TSMC is everybody's foundry, right? So whether produce here, produce there, it's all TSMC's customer.
Great. Thank you. I know 2018 is not over yet, but if you think about the next couple of years, I know TSMC has talked about a long term growth rate of 5% to 10%. Now I feel like more recently, you've talked a lot more about the progress on 7 nanometers. We all know about Intel's struggles with their process technology and it's public information they've announced it, right?
So and then you've got some good design wins.
Can you
talk about your long term outlook 2019 given these drivers? You just said out of the 3 out of the 4 new drivers will be above 10%. So we looking at something more towards the high end of that? Or how do you think about that? [SPEAKER UNIDENTIFIED
COMPANY REPRESENTATIVE:] We continue to say 5% to 10% growth rate. Probably, I would like to following your question, I would like to say probably tends to be the higher side of that 5% to 10%. Does that answer your question?
Yes. Thank you very much.
Next question will be coming from Daiwa's Rick
Thank you. Xiaohou Hao. My first question is, I know, Stacy was talking about your more than 100 tape outs for N7 and N7 plus Can you give us a little bit more idea about the breakdown? I would like to know how many tape out for N plus and also what kind of application for that?
Okay. N plus is a tape out product tape outs, I'm talking about product tape outs, it's still a small percentage of the total N7 nanometers node as I just mentioned. But then after 2019, I expect 2020 when the current customer, they start to design on their 2nd wave products, then it will be more of them on 7 and 7 plus. So I don't have a specific number for you on 2020.
Okay. Thank you. My second question is, you also mentioned that your N7 will likely be another long note. So presumably, probably something like N28, in terms of success. So my question is, in terms of capacity build, I know you don't talk about the capacity number, but in terms of capacity build, would you benchmark your N28 in terms of capacity number?
We build our capacity according to the customer demand and I can assure you that. Compute with 28 nanometer, I cannot make any comment right now.
Well, thank you so much.
Okay. Next question will be coming from Morgan Stanley's Charlie Chan.
Thank you. So my first question is regarding the semiconductor inventory. So in which segment do you see more inventory? Because we are hearing lots of noise about automotive, industrial segment weakness and some cloud CapEx costs, right? So can you give us some color about where do you see the inventory and also your 8 inches fab utilization rate?
Thanks.
Well, I don't think we want to specify which product sector that have high inventory, but let me assure you that this year's at the end of this year, the inventory level actually as compared with the last year's same time is much smaller. So even we have some kind of inventory adjustment, I don't think the impact to the next year's quarter or next year's first half will be as severe as we saw this year, right? So that's all I can say because it's a very dynamic. Laura, you want to tell
us something?
I can add some color to your questions. When I look at the 4th quarter, we have just guided a 10.7% growth quarter over quarter. But looking at the segment, 4th quarter communication will grow very strong. Computers, small growth, lower than the corporate growth, so that area is relatively weak. Consumers is weaker, it's negative growth and industrial is a small decline.
So maybe this can give you some color about which segment has more inventory?
Yes, thanks. Yes, so maybe this is also related to Bill's previous question, right? So when you analyze this inventory, customers demand, do you think there is any impact from any make for a factor including the China U. S. Trade tension or is it just no more semiconductor cycle?
I would say it's just a no more inventory cycle.
Okay, thanks. And next question is also related to 7 nanometer plus, right? So you mentioned only 2 tape outs, but sometimes that one tap out can be very significant to revenue, right? So can you give us some comments regarding the 7 nanometer plus revenue contribution next year?
No, I don't want to specifically say which one.
All right. Thank you.
I think at this point, we would like to turn the question into the callers
on the
line. So operator, could you please put the first caller on the line first? The first question is from the line of
Mr.
Vazavi, can you remind
me? Yes. In protecting my question, I want to go back to your view on 2,000. It's interesting here because we have a migration from 4 to 5 to 5 to our competition, which could adversely impact the ramp. But you also have AI, the IT ramping.
How should we think about the mix changing and with new applications and continued share pay would enable you to actually offset any adverse impact as we might for the 5 gs.
Mehdi, in fact, we can only hear your voice in a discontinued manner. So could you please repeat your question again, maybe keep your voice a little bit away from the microphone?
Okay. Sorry about that. I'm just trying to better understand how you're thinking about 2019. It seems like there are many new projects that are ramping given the number of takeouts at 7 nanometer. And we also know that in the smartphone market, we're in transition from 4 to 5 gs.
In that context, should we expect new products, especially for AI and IoT, is strong enough to offset any adverse impact from migration from 4 to 5 gs?
So you want to repeat the question?
All right. Let me try. I think, Mehdi's question is that he is very positive about the outlook for us in 2019 because we have so many new product launches from our customers using 7 nanometer and smartphone is entering into a 5 gs era. And so he thinks that we may get a lot of new products in AI and IoT, which would be able to off offset the migration from 4 gs to 5 gs?
From 4 gs to 5 gs, well, that's the question. So looks like the question says indicate that 4 gs to 5 gs Jaguar have a dip. Actually, it's not. 5 gs in 2019, we expect start to grow another significant number. So most of the phone, the smartphone, I mean, it will be in 4 gs still in 2019.
However, you mentioned about the AI and other products segment. Yes, that will start to grow in 2019, and we expect a lot of new product other than the smartphone will contribute that 20 19 7 nanometers business.
So could new products actually be big enough to help you with a 5% to 10% revenue growth? And I'm asking you this because this year, we have had adverse impacts from customer inventory and cryptocurrency that impacted your overall growth target for 2018. But in 2019, would new products offset any weakness that is associated with the mature products?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:]
Well, in 2019, as I just mentioned, the inventory correction will be much less effect as compared with the 2018 beginning of 2018. So definitely, our growth rate in the 5% to 10% will be much likely and in the high side, That's what I say. Not only because of the That
sounds like, but
Okay. So maybe accept our very positive outlook for 2019. Good. And so operator, could you please go to the next caller on the line? Thank you.
Thank you. The next question is from the line of Kokun Hadi Han from JPMorgan. Your line is now
open. Yes, hi. Thanks for taking my question. My first question is on the China demand and capacity build out. Could you talk a little bit about the progress of the build out for N16 in Nanjing?
What is the schedule for Phase 2? And has there any change in plan post the weakness that we have seen in cryptocurrency demand for some of the Chinese customers? That's my first question.
So Gokul's first question is he asked us to update our Nanjing fabs progress and he asked if we have any changes in plans to this ramp up in Nanjing fab because of the weakness in cryptocurrency mining?
Nanjing Chairman want to answer that? [SPEAKER UNIDENTIFIED COMPANY
REPRESENTATIVE:] We had 10,000 wafer per month installed capacity currently and we're planning to increase capacity to 20,000 wafer per month next year. And we are developing customer as well as some derivative technology related to the 16 nanometer. So we are progress as we plan.
Okay. Thank you. So my second question is on N7 and N7 plus Now TSMC appears to be in the best position to comment about the benefits of EUC given that you have N7 and N7 plus 1 in production, 1 in this production. Could you talk a little bit about the kind of improvements that we are seeing either from an in grade perspective or reduction in mask layers, etcetera, and the impact in terms of overall cycle time for the fab comparing N7 and N7 plus?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Okay. Actually, the question is about EUV and how much of the benefit we can get from the EUV, right? Usually, if we are not using the EUV, sometimes for the very critical dimension on the N7, you have to or N7 plus you have to using the 4 layer of the lithography to have a to pattern 1 of the critical dimension. Using the UV, you just use 1 layer, so that you reduce the cycle time by 4 times of photolithography, 4 times of edge. Now you become 1 discography, 1 edge.
In total, how many layers we reduce? That is depends on the customer's requirement. But usually, I just give you a hint already, right? 4 layer can become 1 and we are replacing some of the 3 layers to become 1 and we have a few layers of that. So that give you a hint.
Cycle time reduction, definitely because of you do 4x and do 1x, that's a big advantage. Productivity wise, today, EUV is progress very well up to our expectation. And in fact, TSMC has turned on the 2 50 watt power and we believe we are the only one company continuously run the 2 50 watts EUV power so far today.
Okay. That's very helpful. Thanks.
Now we can come back to the floor. Next question will be coming from CL Securities, Sebastian
Ho. Thank you. My first question is on the trailing age profitability and outlook. So a couple of your peers in the past 12 well, past 2 years have decided to not to stop going advance. So now their strategy is to focus on the node they are already they already have.
And China is also ramping up some trailing edge technology capacity. So it seems like more focused on there. And understand that TSMC actually generate lots of profit cash flow from China Technology. So how do you see this dynamic going forward? There potential for you to for this to negative impact your trailing edge profitability?
This first question.
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Okay. Actually, I don't want to comment on my competitors' strategy, but let me again stress our mature notice strategy. We continue to develop some of the specialty technology to meet the customer's requirement, right? I just stated in that. And there's a lot of specialty technology we are doing.
I give you some example already power managed by CMO CM centimeters centimeters centimeters centimeters centimeters centimeters, everything. So that will help us to compete with our competitor. Actually, this kind of specialty technology particularly we have to work with the customer. And so that's why I say working with the customer to meet their requirement and that in turn to give TSMC's business. And that's a way that we migrate logic technology, pure logic technology to the more advanced node, but for the existing capacity, we develop into the specialty technology.
And so our strategy is still meet customers' requirement, but we don't increase the existing logic capacity.
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Right. But I thought TSMC has been doing this for a long time. So you'll keep doing this, but the real change is not what you're doing, but the real change is what your competitors, the dynamic, the more competition threat from the [SPEAKER UNIDENTIFIED
COMPANY REPRESENTATIVE:] We already have a lot of competition. But before they announce that, we still think they are the competitor, no doubt about it. Not because of the drop out some of the technology, no, they don't want to do. No, we are not going to change our strategy because of that.
Fair. Thank you. Second question is still on the node profitability. So I remember the rule of thumb for TSMC, no probability is that N minus 2 now usually have the very good or probably the highest probability of for TSMC. So now we're already ramping up 7.
So the N minus 2 for you is 16. Understand that the 28 used to be very profitable as Laura just said. So I'm just wondering if based on this assuming 2016 2020 we compare 201628, assuming they are both depreciated at the same utilization rate, will 2016 be more profitable than 28 or similar?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Well, this is very specific. You asked the profitability. Laura, are we going to answer that one?
I probably cannot quantify that, but we don't know whether you said N minus 2 is the most profitable node, it's correct. But eventually, I think as we continue to improve productivity and we keep very competitive specialty technology for the mature node, our margin will be all very good.
Okay. Let me ask from another perspective is that the some of this capacity on 2016 or 2020 was installed in 2014, 2015, so which means that they will become fully depreciated very soon, so which means that these will become a margin probability tailwind for TSMC starting from next year that partially offset some of the 28 headwinds. And is that the right way to look at it?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] We certainly expect that, all right. You are talking about the fully depreciated tool to generate more profit. Yes, you can calculate. We have 5 years of depreciation period. [SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Right.
Which means that by the same time next year, regardless of the utilization rate or whatever pricing, 16 will likely to be more profitable than 28? [SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:]
Actually, TSMC's 28 nanometer is very profitable and that is what should I say? You say 16 is better than 28? And I hope so, but I cannot tell you the true number.
Okay. Thank you.
I think our profitability is not depending on which node is better than which other node. We want all the nodes to be very profitable. Thank you. Okay. Next question will be coming from Morgan Stanley's Charlie Chan.
Thanks for taking my follow-up questions. So after the recent industry consolidation, does that change anything like your buckling power and also you're thinking about the cash return? So what does that change you're thinking about, for example, the payout ratio going forward, the industry consolidation?
Industry consolidation?
Yes. I mean, in global foundry exceed 7 nanometer and Intel seems to be struggling with their leading edge. So I would assume competition in the leading edge is getting less, right? So in that case, maybe your bargaining power can increase and also you have more cash made free up to return to the shareholder? [SPEAKER
UNIDENTIFIED COMPANY REPRESENTATIVE:] I don't want to say that because of my competitor well, in fact, the interior is my customer. So we respect their performance, of course. But TSMC's strategy actually is working with customer. And whether that I have a competition or I don't have a competition, that's independent of that. And so we think we offer very good technology value to our customer.
Customer are happy, so we are working together and growing the business together. I'm not going to tell you that's my pricing strategy, That's not in discussion.
Okay. So your current payout ratio is around 60%, right? So in what kind of a second sense in the long term would you consider to revise up your payout ratio to maybe 70% or even above?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Actually, we have been paying around 70% in the past few years. And I have said many times and with 5% to 10% growth and we are confident we can continue to generate increasing free cash flow. That will be the source for the increasing of cash dividend. Yes, so we're still with that kind of commitment.
Thank you. And the next follow-up is regarding that EUV question, right? I know it could be too direct to ask about revenue contribution from 7 nanometer plus, but from another angle, what keep your customer hesitating to that 7 nanometer plus, right? Because you mentioned a few tape outs, Is there any concern about your rate sorry, the throughput of EUV or capacity of EUV? What will keep customer hesitating about UV adoption next year?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Let me give you some explanation because of TSMC's 7 nanometer is very successful. So customer using the design on 7 nanometer first. But 7 plus has some certainly have some advantages, right? We're using the EUV, you have a shorter cycle time and I just say that it's kind of better pattern control, so that means your critical dimension has been tightly controlled that help that performance also. So we expect the customer moving their 2nd wave product, a lot of them will go to 7 plus.
And have there any concern about the EU visa maturity that actually that's what you are asking? C.
Wei:] Yes. So everything sounds very decent, right? So what was the issue, price or any issue? [SPEAKER UNIDENTIFIED COMPANY
REPRESENTATIVE:] What's the issue? Okay. EUV progress steadily to our expectation, but as compared with DUV photolithography, the maturity is not comparable, not yet, not yet. EUV still climbing up and we hope that the productivity can be better and better, but today, not yet. You just look at how many WV we have and how many EUV we have, you know what I'm talking about.
I mean, that's in the industry, just say in the industry.
Lastly, if I may, right? I think AI semi has been a very topical growth driver, right? So I think recently, it is getting more clear that some ASIC claims their performance can be 8x better than GPU, those are general purpose, right? So with now a lot of new ASIC coming to align, do you think that's going to impact your overall AI Semiconductor revenue? Or put it in another perspective, you expect any reacceleration or slowdown of your AI semiconductor business in the coming year?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] I think the AIs application will be everywhere actually from the server edge server or to the end device that's just like a smartphone in everybody. So this kind of development is to our advantage because TSMC certainly have a technology leadership and all the AI will be effective. You need a very advanced technology for the high performance computing. So I don't see the effect that you're talking about this application is better than that, so that will affect the growth or something. No, it will be continuous to grow and I expect this grow much faster than I predicted here.
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Okay. Thank you.
Next will be coming from Deutsche Bank as a follow-up question.
Thanks for taking my follow-up questions. Regarding the 7 nanometer cable next year, so C. C, can you give some color regarding the portion of 7 nanometer versus 7 nanometer plus UV? So will customer shift to 7,000,000 plus UV aggressively in the second half of next year in the 2020?
Your question is You mentioned
more than 100 table numbers, right, for next year by the end of next year. So will the majority of that be 7 nanometer or 7 nanometer plus EUV?
Next year, it's still 7 nanometer. Because of 7 plus, we're working with the customer and some of the customer moving a little bit faster, some of them and for those customers already in the 7 nanometer, they are planning on the 2nd wave product in the 7 plus. Okay. So next year, I can say most of them are still in 7, but then activity will start to rapidly growth in second half and then 2020 that will be even grow faster.
Okay. But for the whole year, Taibao number, right, so can we say the 7,000,000 plus UV Taibao number increase quarter by quarter through end of next year, can we say that?
C. Wei:] What increase quarter by quarter? Yes, you can say that, but it's just still a smaller portion of the total 7 nanometers anode.
Okay. So based on the 7 nanometer plus UV Taibao by customer planning, right? So can you expect 2020, we will see very big volume 7 nanometer plus UV mesh production and the revenue contribution? Because you mentioned increase quarter by quarter, right? So you just try to find out if you will become very big revenue contributor and yes.
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] If I can forecast well, I mean, that's one step out, especially for some of the applications, takes about 1 year to full ramp up. So 7 plus will be increasing, but the revenue I would expect, I would expect 2020, 2021 start to see the big number.
Okay.
But not the 2019, not the first half of 2020.
Okay. How about second half next year? Do you think that will be [SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] You continue to nail down the number. Sorry.
Okay. Thank you. In 2019, less than RMB 1,000,000,000. That's RMB 1,000,000,000.
Thank you so much. Thank you. That's good.
All right. Hopefully, next question will be better. And it will be coming from UBS Bill Lu.
Hi, thanks again for taking my question. So it's a bit more of a long term question. Hoping to ask you about the R and D and maybe this is both for Doctor. Wei as well as Laura. If you look at Moore's Law, certainly not getting easier.
If you look at the number of players that can share the R and D burden, I think it's getting less. And number 3, TSMC is clearly ahead of the competitors now in terms of process development. So as you look out the next 2, 3 years, do you have to think about R and D increasing at a faster rate? Thank you.
C. Wei:] We do think the continue going on the smaller geometry takes a lot of effort to develop the technology. But I would like to use in TSMC's founder's wording to answer your question. So long as some people can develop it, TSMC will be there. That's our commitment to the customer, all right.
And in addition to smaller geometry, actually, TSMC also developed the wafer levers packaging, advanced packaging to help the customer improve their systems performance. And we think we have these 2 weapon in hand and so we are in a very good position to compete in that field.
I guess I'm not doubting TSMC's abilities to develop it, but I think TSMC has taken on more of the burden now. And you also have to add the cost for Advanced Packaging R and D as well, right? So I'm stressing about the cost. C.
Wei:] The cost, actually, I would like to say the value of our technology, all right, that's what we discussed with our customer. The cost, we continue to working on it and we hope TSMC has the capability and ability to draw down the cost as we already proving in the previous years.
But I think Bill's question is whether or not R and D as a percent of our revenue will increase in the future because of our taking up a bigger burden?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] We might, but I cannot tell you the executive number. So that's a cost. Yes. Thank you.
All right. Follow-up question from Citigroup's Roland Shu.
Just a follow-up question for the profitability, but I'm talking about the back end side because C. C, since last quarter, you kept talking about you have at least improving profitability on back end. And also in 2nd quarter in last quarter, you said the back end actually was able to partly offset the lower gross margin from this poor product mix. But consider your back yen is just a relative small part of your total revenue. So it has to be with a very good gross margin in order to possibly offset the unfavorable product mix.
So how does your back end gross margin compare to your corporate average right now? Thank you.
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Back end margin is indeed improving, but we don't compare back end margin with corporate average because back end the nature of back end is there's a very high asset turnover and lower margin compared with Weibo. So the overall investment return is pretty good. If you look at our IC, it's very good. So we don't compare bigger margin with corporate average. So if our back end revenue continue to increase, it may dilute a little bit of corporate margin, but the overall investment is pretty good.
And we have seen our advanced packaging, the we continue to invest in capital and we see more customer adoptions. So we are increasing the size and the business volume of the back end. And of course, we continue to improve the productivity. So back end is will be accretive to TSMC going forward.
Okay. So can we have the rough number of how much the revenue is coming from Beijing so far?
It's around the RMB 2,500,000,000 this year.
RMB 2,500,000,000, let's just include wafer bumping or this is purely from Info and the CoVAS?
Including all the back end, that including the way for bumping, testing, info, COVAS, everything.
Okay.
That's roughly a little bit more than 7% of this year's revenue.
Okay. But Laurent, you said if the banking revenue is is it a certain portion of the total revenue? Probably the corporate average gross margin will be diluted. So what is the ratio for the percentage of the backend?
No, the backend is only 7%. It's still low compared to our very big wafer size. But back end I think the back end probably is cyclical because it's very concentrated on several segment. Cyclicality is more of an issue. But in terms of financial return, we have that in our model.
So we're not worried about that. Of course, we continue to improve the probability. Okay. Thank you.
Follow-up question from Morgan Stanley is Charlie Chan.
Thanks for commentating another follow-up, right? So I think because the stock market weakness, so I need to a little bit microscope on your comments on near term. So C. C, you previously mentioned that 2019 inventory correction in 1Q wouldn't be as severe as the beginning of this year, right? So I don't know why now you have this kind of visibility.
Is that because of customers' order behavior? What have you seen for the coming 1Q that can make your inventory correction less severe than the beginning of this year? [SPEAKER UNIDENTIFIED
COMPANY REPRESENTATIVE:] You asked where I get those information to get the conclusion that next year's 1Q inventory correction will be less? [SPEAKER UNIDENTIFIED
COMPANY REPRESENTATIVE:]
Severe than this year. Less severe. That's interesting because of we work with customers, right? And Dora just mentioned about those market segment, communication, consumer and computer and we look at that, we work with the customer and we understand their business, not 100%, but we understand quite well. And so we can do this kind of forecast.
Okay. Thanks. Yes, so is that fair to link the industrial segment decline to their inch utilization rate. Can I assume that the 1 inch utilization is not that full as full as before? Is that a fair assumption?
[SPEAKER CARLOS
ALBERTO PEREZ DE SOLAY:] You can repeat what I said to answer that question, all right? I mean, that's you're asking very specific that utilization and the customers' demand. Actually, let me say that we are very optimistic because of we work with the customer. As I said, we work with the customer, we understand their business. And going forward, we know that they are doing the inventory adjustment, but they also discuss about what they want in the 2019, which I'm not going to give you some forecast today, not yet.
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Okay.
Thanks. Sorry for those very detailed questions. Thank you.
Questions will be coming from Credit Liu, CL Securities, Sebastian Ho.
Thank you. Follow-up on the advanced packaging, I have the impression that of this year more than 50 7 nanometer tape out a huge part of that or a large portion of the customers will use our advanced packaging solution. So moving to next year, so our table number will be 100 or 100 more on 7. So it's still that kind of the percentage was still the same, which means that the advanced packaging customers on 7 nanometer will also double. [SPEAKER UNIDENTIFIED COMPANY
REPRESENTATIVE:] Maybe answer the question that advanced packaging that include the CoWoS and InFO. And the CoWoS is for very high speed performance, such as like a graphic chip, such as some of the networking processor. So those are using cobots. And for the infos that a lot of them are using for the mobile phone business. So that I can answer you, but I cannot give you say which one.
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] No, no, no, I'm not asking which one. I'm just asking still for the next year, 100 TEBAR, a large portion of this is in our
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Okay, okay.
Well, sorry that I misunderstood your question. So the next year, the info for the mobile phone application was some of them will move into the high performance computing also because that offer a little better cost structure. And the cohorts continue to be the high end high performance computing product. And we also introduced SOIC, as I just mentioned, that give a much better system performance. So we continue to progress our technology and that did that answer your question?
[SPEAKER
UNIDENTIFIED COMPANY REPRESENTATIVE:] Sort of. Well, anyway, my question is very simple, actually. Just want to simply just want to know that the your earlier comments on the large portion of the 7 nanometer customer tip-off will use our advanced packaging. And now our tip-off numbers like based on your comments seems like double from this year to next year. So this large portion still apply on the doubling 700 table next year.
Is that right?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Oh, I see. Develop one new back end process packaging process at actually will last for many years. So next year's 7 nanometer or 7 plus application for those products are still using the InFO and also using the cobots, yes. And whether it's double or not, I'm not ready to answer that question yet.
Okay. Thank you. That's clear. 2nd follow-up is, I remember last quarter when C. C.
You talked about the 28 nanometers outlook, you mentioned 2019 will come down and expect a recovery nice recovery in 2020 because of the 22 nanometers adoption. So today, you just mentioned that you expect the overcapacity will be the norm for several years. So what I interpret is that it sounds to me over the past 3 months you've become more cautious, conservative on 28 compared to 3 months ago, am I interpreting that right? [SPEAKER
UNIDENTIFIED COMPANY REPRESENTATIVE:] You may be right because of recently a lot of capacity has been build on 28 nanometer as compared with 3 months, 6 months ago, right? So that makes overcapacity a little bit more severe than previous predicted. However, I would like to stress again, I mean that the TSMC developed shrink of the geometry for customer to gain the benefit of performance and better density. We also develop specialties. So that's why I say that we have confidence a couple of years later that our 28 nanometer will enter into a new era with such a high inflation rate again.
Do you view those excessive 28 nanometer capacity or the more than expected newly add 28 nanometer capacity, is it a real threat to you or they're a known event? I mean, they're effective capacity or they're [SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:]
We always compete in the market whether there be a capacity, but of course, let me answer the question directly. Overcapacity is not good for any player in this field, definitely.
Okay. Thank you.
All right. I think given the consideration of time, we'll just have Randy Abrams to have the last question. Yes,
20 have you changed your view on the 16 migration? Because one factor, some foundries, if they stop at 28, can address the 16. So are you taking a more aggressive approach? So is part of your view on 28 of you getting more positive on 16 and you're trying to encourage more customers to migrate to that node where there's fewer players?
So your question is, are we going to
repeat this kind of a 28 migration?
We're just year migration?
We're just
In the
last few months, are you also seeing 1 more customer's demand to actually migrate to 2016? And is it also more your strategy with some competitors not moving on, you actually have less a bit less competition on and below?
Yes, we have less competition in 2016 and below, yes. But then, so long as you have one competitor that's good enough, right? I mean, you have to work really hard to compete.
Okay. But I guess on the customer side, are you starting to see more as part of your 28 coming down, you're actually seeing more customers with an urgency or desire to actually do that shrink. So you're seeing any change in that cadence of customers moving from 28 to 16?
To be more specific on your question, say that Just
to view, you're now you do feel like there's more capacity on 28. Yes. But flip side, are you seeing some of the demand you previously expected on 28 now shifting to 16 and 12?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Oh, okay. A lot of my competitor can do 28 nanometer, but not a lot of my competitor can do 16 or 14 nanometer, at least for today. And so far, we did not see the same phenomena as a 28 nanometer. Does that answer your question?
Okay. Just more about demand, do you see more customers now trying to make that shift to 16, the customer side?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] It will continue doing this way actually that customer migrate faster than we expected into 2016, right? And you expect that in the 2016 or 2014 will migrate faster than we expected into 10 or 7?
No, the question is now 'twenty eight, you're more worried about oversupply. Is part of that from you're seeing more customers migrate to 16?
[SPEAKER UNIDENTIFIED COMPANY
REPRESENTATIVE:] Yes. Okay. And they migrate into 10 and 7 also. So they are faster than we expected. Yes.
Yes. Thank you.
Okay. This will conclude our conference today. Please be advised that the replay of the conference will be accessible within 4 hours from now. Transcripts will be 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.