Welcome to TSMC's Q2 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 viewed by investors around the world, we will conduct this event in English only.
The format for today's event will be as follows: 1st, TSMC's Senior Vice President and CFO, Ms. Laura Ho, will summarize our operations in the Q2 2018 followed by our guidance for the Q3. Afterwards, Ms. Ho and TSMC's CEO, Doctor. C.
C. Wei will jointly provide the company's key messages. Then TSMC's Chairman, Doctor. Mark Liu will host the Q and A session where all three executives will entertain your questions. For those participants on the call, if you do not yet have a copy of today's press release, you may download it from TSMC's website at www.tsnc.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 statement 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 on our press release. And now, I would like to turn the microphone to TSMC's CFO, Ms. Laura Ho, for the summary of operations and current quarter guidance.
Thank you, Elizabeth. Good afternoon, everyone. Thank you for joining us today. I will first summarize our Q2 financial results and then provide the guidance for the 3rd quarter. Our 2nd quarter revenue in U.
S. Dollars was RMB 7,850,000,000, a decrease of 7.2% sequentially, but an increase of 11.2% year over year. In NT dollars, revenue declined 6% sequentially, mainly due to the impact from mobile product seasonality. Gross margin was 47.8% in the 2nd quarter, a decrease of 2.5 percentage point versus 1st quarter. About 2 percentage point of the decrease was attributable to the absence of the favorable inventory valuation that I had mentioned in April, while the remainder was attributable to a lower level of capacity utilization, partially offset by cost improvements and a slightly more favorable foreign exchange rate.
Operating expenses ratio was 11.3% as our revenue decreased more than our expense decrease. Operating margin decreased 2.8 percentage points Q over Q to reach 36.2% in the 2nd quarter. As I said during the last quarterly conference, the corporate tax rate would increase to 17.5% in the 2nd quarter as we accrued the 10% tax on undistributed retained earnings. The tax rate will fall back to 10% to 11% level in the second half and the full year tax rate will be about 12%. Overall, our 2nd quarter EPS was $2.79 and ROE was 18.7%.
Now let's take a look at wafer revenue contribution by application. During the 2nd quarter, communication and industrial standard decreased 14% and 1%, respectively, while computer and consumer increased by 34% 23%, respectively. Now let's take a look at revenue by technology. We began volume production of 7 nanometer process technology in the Q2. The revenue contribution was less than 1% in 2nd quarter and the wheel ramp to above 10% in the 3rd quarter.
10 nanometer contributed 13% of total wafer revenue during the Q2, while the combined revenue from 16 20 nanometer accounted for 25%, and 28 nanometer was 23%. Advanced Technologies defined as 28 nanometer and more accounted for 61% of total wafer revenue. Moving on to the balance sheet. We ended the 2nd quarter with cash and marketable securities of CLP 749,000,000,000 an increase of CLP 65,000,000,000 from the Q1. On the liability side, current liabilities increased by TWD 121,000,000,000 as we accrued about NT 208,000,000,000 for cash dividends, which will be paid out today.
On financial ratios, accounts receivable turnover days decreased 4 days to 38 days. Days of inventory increased 11 days to 74 days, primarily due to the ramp up of 7 nanometer, which has a longer cycle time and a slightly increase in raw wafers. Now let me make a few comments on cash flow and CapEx. During the Q2, we generated about RMB230 1,000,000,000 cash from operations and spent RMB 60,000,000,000 in capital expenditures. As a result, we generated free cash flow of TWD 70,000,000,000.
Overall, cash balance increased by $54,000,000,000 to $632,000,000,000 at the end of the second quarter. In the U. S. Dollar terms, the capital expenditure spend in the first half of the twenty eighteen totaled US4.5 billion dollars Now I have finished my financial summary of the Q2. Now let me provide you the 3rd quarter guidance.
Based on the current business outlook, we expect 3rd quarter revenue to be between US8.45 billion dollars US8.55 billion dollars which is an 8.2% sequential increase at the midpoint. Based on exchange rate assumption of TWD 1 to TWD 30.50, our 3rd quarter gross margin is expected to be between 40 8% 50%. And our 3rd quarter operating margin is expected to be between 36.5% 38.5%. This concludes my financial summary. Now let me make remarks on capital expenditure and profitability.
I will first talk about the capital expenditure. At our last investor conference in April, we stated our 2018 CapEx budget to be between $11,500,000,000 to $12,000,000,000 However, we now plan to trim our CapEx budget by about $1,500,000,000 and expect our 2018 CapEx to be between US10 $1,000,000,000 $10,500,000,000 The reduction of 2018 CapEx come from the following three factors. The first one, about US700 $1,000,000 came from delay of payment to 2019 due to leading edge towards relocation schedule adjustment. However, the planned capacity remain unchanged. 2nd, about USD 600,000,000 comes from efficiency gains that allow us to spend less on tours.
3rd, about $200,000,000 comes from the U. S. Dollar appreciation against euro and Japanese yen. My second remark is regarding profitability. Now I will talk about Q3 2018 gross margin and the overall outlook of our profitability.
Our 3rd quarter gross margin is expected to improve from 2nd quarter by more than 1 percentage point. The increase mainly comes from better utilization rate, more favorable foreign exchange rate and improved profitability of our back end business, offset however by the unfavorable technology mix, which includes the ramp of 7 nanometer that is expected to dilute our gross margin by more than 1 percentage point in the 3rd quarter and the lower contribution from 28 nanometer. The net gain in gross margin, therefore, is expected to be slightly more than 1 percentage point. That said, TSMC's financial objective remain unchanged. Our goal is to achieve revenue and net income compound annual growth rate in the next few years to be between 5% 10% in U.
S. Dollars gross margin to be about 50%, operating margin to be about 39% and ROE to be above 20%. This ends my remark. Now let me turn the microphone to C. C.
For his comment.
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Thank you, Laura. Good afternoon, ladies and gentlemen. Let me start with our near term demand outlook. We conclude our 2nd quarter with revenue of NT233.3 billion or US7.85 billion dollars in line with our guidance given 3 months ago. This result reflected mainly a strong demand from high performance computing, including cryptocurrency mining, but was offset by seasonal decline in high end smartphones.
Moving into Q3 2018, our business is expected to benefit from new product launches using TSMC's industry leading 7 nanometer technology. While cryptocurrency mining demand were declining due to weakening cryptocurrency prices. That being said, we do see slight improvement in smartphone demand in second half of this year as compared to our forecast 3 months ago. GPU demand for AI and the gaming continue to increase. For the full year of 2018, we forecast the overall semiconductor market, excluding memory, will grow by 5%, while foundry is expect to grow by about 7%.
We forecast TSMC's 2018 revenue in U. S. Dollar will grow by a high single digit rate rather than the previously stated about 10% due to general weakness in cryptocurrency mining demand. Now let me move to our long term business growth driver. As we stated 3 months ago that we are optimistic about the development of the industry's megatrend, particularly AI and 5 gs communication.
Recently, we have observed more promising development. For example, we see AI continues to faster proliferate from data center to edge server and to end client devices. As for 5 gs, major operator in several countries has rolled out the development schedule where multiple ODMs and IC vendors have planned their 5 gs products, which are set to ramp in the coming 2 years. Despite the slowing unit growth in smartphones in the near term, we expect the development of 5 gs will fuel the next wave of smartphone growth both in units and in silicon contents. In HPC, we expect the increasing workload in data center and complexity of AI will boost the demand for AI accelerator, GPU and CPU in server.
We also expect the introduction of next generation video gaming while at growth of HPC. We believe all our 4 growth platforms, smartphone, HPC, IoT and Automotive are well positioned to benefit from the longer term makeup trend of AI and 5 gs. With our leading and comprehensive technology offering, our vast capacity and our policy of not competing with customers, we will be able to support our customers to expand their markets and therefore fuel our future growth. Let me talk about N7 ramp up status. PSMC's 7 nanometer technology is leading in the industry.
It has the best performance, power and area density and its schedule is ahead of competition. For the tape outs that we have completed for customers, all have very good yield and performance. We forecast a total of more than 50 customer product take outs by end of this year from a wide range of applications covering mobile, server CPU, network processor, gaming, GPU, FPGA, cryptocurrency, automotive and AI. Our 7 nanometer is already involved in production and accounted for less than 1 percentage of our total wafer revenue in 2nd quarter. Is expected to jump to more than 10% of our wafer revenue in 3rd quarter and is estimated to contribute more than 20% revenue for us in Q4 in this year.
Now let me talk about N7 plus and EUV. Our 7 nanometer plus or N7 plus can leverage the success of our N7 and enjoy 15% to 20% better gate density and more than 10% power reduction. With a few EUV layers replacing certain emerging discovery process, we are able to have fewer masking layers, shorter cycle time and less process complexity. Therefore, we expect to achieve better yield as compared to our N7. Furthermore, as we have fine tuned all the advanced equipment to their optimum condition during the ramp up of both our 10 nanometer and 7 nanometer technologies.
We believe we can leverage our production lending to 7 plus and enjoy the industry's best defect density among our peers comparable technologies. The silicon result from our N7 plus today are very encouraging. The lead N7 plus product has tape out early this month, and we expect to receive a few more tape outs by end of this year. Volume production will start Q2 next year, that is Q2 twenty nineteen, which will be the world's 1st EUV foundry production by that time. We have made ready multiple EUV scanners to support not only the N7 plus development but also N5 development.
Our silicon data have proved all the benefits we expect from process simplification with EUV. In addition, we have also started our N3 technology development using EUV. Now let me talk about the EUV status. Good progress continue to be made in the EUV infrastructure in the last few months. They include photoresist, mask defect and yield, helical defects and transmission.
Besides the silicon development, EUV technology continues to mature toward high volume production. We have achieved 250 watts source upgrade in April, and the tools are running smoothly with minimal degradation and high level of uptime. In summary, we started EUV development work early, and we have secured the largest number of EUV tours among our peers to be ready for 2019 volume production for N7 plus and 2020 volume production for N5. Let me talk about N5. Our 5 nanometer technology, N5, is progressing well.
The 2 56 megabits SRAM yearly is 1 quarter ahead of schedule and the device performance is well on track. TSMC's N5 will begin with production in first half twenty nineteen. We believe it will be the most advanced technology in the foundry industry by that time. We are actively engaging with several lead customers, and we are running their test shift now. We expect to receive 1st customer product tape outs in first half twenty nineteen.
Volume production is expected to start in first half twenty twenty. I'm talking about now with our specialty technology. We work closely with our customer to accelerate our specialty technology roadmap By leveraging our logic capability, we develop specialty technology features such as MEMS, CMOS image sensor, high voltage power management IC, emerging and big data memories and analog to more advanced node including 55, 40 nanometer and 28, 22 nanometer. These efforts bring scaling benefit to our customers. Our 22 ERP process is qualified and on track for risk production in August, that is next month.
About 40 customer product paper outs using our N22 are planned in the next few quarters, covering a broad spectrum of applications from digital TV, consumer electronics to IoT and RF connectivity. N22 have 15% performance gain, 25% power reduction and 5% to 10% die area shrink when compared with N28. With these improvements, we expect our N22 will extend our leadership at 28 nanometer node and enjoy a long and successful economical life. Since we have already built a broad technology capacity at 12 inches for various specialty technologies, we are migrating some of our customers' products from 8 inches to 12 inches with seamless transition where our customer can enjoy flexible capacity support and further scaling benefit. And that's all.
Thank you for your attention.
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. For those of you on the call, if you like to ask a question, please press the star then one on your telephone keypad now.
Now let's begin the Q and A session. First question will be coming from Credit Suisse, Randy Abrams.
Yes, hi. Thank you. The first question I had on the 28 nanometer, you talked last quarter about it being a bit underutilized. Could you talk about now your confidence to back fill that node? And last quarter, you mentioned a big mask investment.
How much of that is tied to some of these backfill activities versus the mass squatter investment for some of the advanced applications?
So you have two questions. The first one is 28 nanometer loading and
Yes, the 28 loading, your confidence to get that loaded, the type of application.
Okay.
2nd part of that is the mask investment. How much of that is tied to these backfill applications versus advanced capacity?
All right. In my statement, I say that we improved 28 nanometer to 22 and now a lot of 28 nanometers tape out has been changed to 22 nanometer. And we start to running ramping up 22 nanometer next month. It will take probably a few quarters, so that 22 nanometers of volume will be high. So I expect that after few quarters, the 28 nanometer node, the confidence to fully utilize is high.
Now you're talking about the way
you [SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:]
Can I add this one? Yes. Regarding your question, by the way, thank you and good afternoon, everyone, to join this conference also the online participants, particularly on this hot summer afternoon. On 28 nanometer, this is the 8th year of our 28 production. And in everybody, the competition is coming gradually and with some expectation, they build capacities.
But the 28 nanometer has a lot of nuance in it. You have high performance, there are different grade of speed. Now, C. C. Is talking about additional sub node 22 nanometer.
I think the under loading will be a temporary and we intend to backfill this capacity based on our technology differentiation. [SPEAKER UNIDENTIFIED COMPANY
REPRESENTATIVE:] So Randy, your second question is we invest on mask as a capacity.
Very high CapEx last quarter for mask. Just what was the purpose or what applications you were tied to this high capacity relative to history that you've called out the mask CapEx?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Still, actually, we invest mask capacity because of a leading edge node. Most of it is because of leading edge node because it's very complicated in making the mask in many layers. Related to 28 is part of it, part of it because of we still have a very high activity in 28 nanometer node. Actually, it's still that's the number 1, number 2 tape outs account for TSMC's total tape outs.
Okay. So it sounds like it's both 28 plus for the 7 nanometer for the mask?
And the 60.
And 60, okay.
The second question I have on cryptocurrency, in the past, it was on a lagging note like 28 in 2016, the second half, but how do you view in the second half, but how do you view devoting new capacity as crypto to get the best performance and power want to move to 7. So how are you how do you see that market and also devoting capacity if it becomes more of a first wave application?
Well,
cryptocurrency all related to the hash rate. So naturally, they will move to very high end leading edge technologies to improve the performance and lower down the power consumption. Whether that IRR be that at the same time as a high loading when we move into the leading edge. That I probably we cannot say that. It's volatile in the business unit and it's continued to depend on the cryptocurrencies pricing.
So we don't plan our capacity because of that.
Thank you.
Next question will be coming from UBS, Bill Lu.
Hi there. Thank you very much for taking my question. Laura talked about slightly lower CapEx and $600,000,000 of that is from the efficiency gains. Can you talk a little bit more about that? Is that mostly from 7 nanometers?
Or where is the gains coming from?
Okay. The $600,000,000 efficiency gains actually covers various area. Number 1 is process simplifications. If you have a simpler process, you don't need to buy that much tools, number 1. And we also share tools between R and D and operations.
If we can find more opportunity to share, we don't have to buy that much tool, okay. The third one is relating to the back end equipment. We do see with the effort from TSMC and customer jointly, we do see a test time reductions. So those are the few areas that we classify as efficiency gain. Of course, we are always doing that, and we just have results coming right now.
Laurent, I can add more color to that. What we call the efficiency is that, let me tell you, we plan customers' product out. So you need some kind of processing cycle time, you need to buy the tool, tool has a leading time. So now we improve our process cycle time quite a lot. So now you don't have to buy the tour so early, 1.
The tool is equipment vendor work with us, so they also shorten their leading time. So we don't need to buy so early and that's what we call part of the reason of the quality efficiency improvement. It's continued to improve. That's progressing every day, every month.
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Yes.
I guess I'm just wondering how much of it is one time and how much of it can translate into lower CapEx going forward?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] It will be continuous effort because of it's our job to shorten the cycle time. Usually, if we ramp up a new technology, the cycle time is a little bit longer. Now we are getting better, getting very aggressive and very competitive cycle time, and so that's why we can cut it.
Sorry, one last follow-up on that. So I don't know the exact number, but I think the company has said CapEx next several years, if I'm not mistaken, dollars 10,000,000,000 to $11,000,000,000 So do you want to comment on that, whether there's any new thinking or changes?
Of course, number is a kind of rolling forecast. As far as we can see, it's still within that range. And the CapEx intensity, as I said earlier, is somehow between 25% to 30%. We're still with our view.
My second question is on the 7 nanometers. It sounds like it's progressing quite well and maybe slightly ahead of plan in terms of yield improvement and such. Can you just talk about the yield and the improvements that you're making there versus the previous couple of nodes, maybe 10 and 16?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] The year progressing very well, performance is good as compared with previous node, comparable probably a little bit better, but I cannot give you exact number.
Basically, 7 nanometer, we just have a better architecture and make the EU improvement easier.
Would that imply that you get to corporate average gross margin a little bit earlier as well?
I think the rule of thumb, I said about 8 quarter from mass production to quarterly average is about the same. We have seen that for every node, it's have that kind of pattern. There's no exception this time.
Next question will be coming from Deutsche Bank, Michael
Zhou. The first question actually is for 'twenty eight follow-up. You mentioned after few quarters, your UTR for 'twenty overall should improve. So is that under the assumption of the same capacity this year? And do you think the next year total 28, 22 nanometer cells will be up year on year?
That's my first question.
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Michael, let me tell you that TSMC continue to improve the productivity. So actually, even we don't spend the CapEx, the capacity continue to increase. So that every year, when we're talking about our business versus the utilization, actually, the capacity continue to increase. And your question is the revenue?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Yes. Would 28, 22 Nomi together be up year on year in 20 19? And do you maintain a I shouldn't say maintain a same, given the underutilized 28 nanometer, would you to convert some 28 nanometer capacity to advanced node going forward or you will just maintain the same capacity? [SPEAKER
UNIDENTIFIED COMPANY REPRESENTATIVE:]
Well, converting the capacity is the last resort, okay? We want to fill the capacity based on technology. This is a constant effort. And 22 nanometer is one example. There are other specialty technologies on the pipeline to offer.
And that is our first resource, hopefully to get it filled it up as much as we can. If by then, then we'll have other capacity adjustment But at this time, it's not on our plan.
So did you expect revenue? [SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] I would expect in 2019 probably drop a little bit because we are ramping up and after that we'll start to increase.
Yes
Yes. Okay, sure. Thank you so much. 2nd question regarding your 7 nanometer progress. You mentioned you will do server CPU, if I'm here to write.
So would that be on base or x86 or you cannot give color for that? [SPEAKER
UNIDENTIFIED COMPANY REPRESENTATIVE:] It's too specific, so it's a CPU. Thank you.
Next question will be coming from Citigroup's Roland Xu.
Good afternoon. Thanks for taking my question. You talked about the 7 nanometer will be more than 10% of the total revenue in 3Q versus less than 1% in 2nd quarter. So the increase for 7 nanometer is more than 10%. But the 3Q overall revenue guidance for us is less than 10% means that the overall revenue from 10 nanometer and above are declining.
So can you give us more color for this technology node, which node is strong, which node is weak in 3Q? Thank you.
Which node is strong, which node is weak?
Yes, because on the overall 10 nanometer 16, 20, 28 and above, the overall revenue in 3Q will be declined sequentially. So I would like to know for which node specifically is strong and which node is weak in 3Q?
I cannot comment on that, right?
But we know 20 nanometer actually will be still decline. Is that right?
Right.
So means 16, I will be still fully loaded.
I don't want to
ask 1 by 1, starting from 0.159 program or something
like that.
[SPEAKER UNIDENTIFIED COMPANY
REPRESENTATIVE:] That's good enough. Actually, you know that our 7 nanometer is very strong, 7 and 10 very strong, 16 nanometer is fully loaded, okay. So that's good enough information for you to estimate. [SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:]
Okay. And follow-up question for this 7 nanometer ramp up because now we think 7 nanometer will be a major node like 16 and the 28 nanometer. So question is for next year for 7 nanometer revenue ramp up, will it be similar as 16 nanometer in 20 16 or 20 nanometer in 2030, which is the 2nd year for you ramp up this?
Stronger than any node we have in history.
Okay. So that means for next year for maybe in the single quarter, I think like for 7 nanometer reach 30% of the total revenue will be a reachable target?
I don't want to go to quarter. I would say, we just said 7 nanometer will account for 10% 3rd quarter, more than 20% in 4th quarter. For next year, 7 nanometer will account for more than 20% for the whole year. That's all I can say.
Okay. Thank you. Second question is for June monthly sales, unusually declined by double digit percentage point year on year and the quarter on quarter. It was less because the customer did not take the wafer shipment in their quarter end? Or was that purely because of the demand weakness?
Don't look at the monthly revenue because look at the quarterly revenue, which we have just provided guidance.
But I still have to ask, how about the 3Q, the monthly sales linearity in 3Q?
The monthly linearity is not really in our control. The customers shipping, they have their schedules sometimes within a couple of days range, they want to adjust their inventory and there are many factors. So it's not to our target to be target each month to have a financial goal, rather it will be a quarterly goal.
Okay. Thank you.
Next question will be coming from CL Securities, Sebastian Ho.
Thank you. My first question is on N5. Regarding the Taipao, you earlier mentioned that you expect to receive the first Taipao in Q1 or early next year. So how much of how many tebao do you expect to receive by the end of next year before the mass production begin in first half
20? Actually, we don't know it this time. 5 nanometer is a node, of course, is in the development. Right now, we know that we have customer test chips put it in our test vehicles, several of them and those are the subfunctional block of their products. So at this time, they most of them haven't commit the PayPal date.
So we really cannot summarize the number in particular time, but the engagement activity is very active.
So how do you compare the engagement activity or customer interest to N7 at the same stage?
[SPEAKER UNIDENTIFIED
COMPANY REPRESENTATIVE:] Okay.
At this time, probably less than N7 in the beginning because this is a big investment for our customers and they would I think they are planning in later time when N7 gets to ramp up in Fluidity. Then how do
you see the ROI on N5 versus N7? If less interest right now and how do you and the investment probably larger for you and how in terms of the payback ROI, how do you compare N5 and N7 at this moment?
It will be very similar.
Okay. My second question is on the advanced packaging that noticed the I think TSMC has continued to roll out new or launch new packaging offerings almost every year. So can you give us more some update on that and what kind of how many product offering you have on this? And do you see this becoming I mean, tiers and become even more serious in packaging rather than just in the past to facilitate the big
fact to add some color to it, in the future, we see the high performance computing is very important and TSMC runs packaging here of the customer to improve the system performance. And so now more and more activities to engage with the customer for their high end computing devices.
Okay. So can we assume that a big portion of the new tape out you're receiving on 16, 12, 7 and potentially 5 nanometers will adopt your packaging solution, whatever is info, is variance or COOS?
Sebastian, the advanced packaging is a major thrust of our technology development. The reason is the Moore's law over the years is indeed slowing down. That means that we have to create more value to our customer on their product to allow the technology migration continue. And advanced packaging is you can almost say it's a parallel thrust together with Moore's Law to develop our customers' product. And advanced packaging development encompass our customers' architecture development and algorithm development.
In that, I'm talking about to go into the 3 d IC and that is the purpose to add to this the Moore's Laws development to maximize our customers' product, okay? So this is not a typical packaging business. It is a major technology development for TSMC. Although today, it is indeed more expensive, some of the market sector cannot afford it. So today, we see the affordable segment will be the high performance computing, particularly in the server and also the high speed networking area.
Of course, the current biggest customer is in the mobile and I believe the mobile sector will gradually come in when they see the value. So it is not a typical Moore's Law pace, rather it is an additional development effort to augment it to the Moore's Law. That's my response in the total picture.
So this part of the things are now like before the info launch and now you have more offerings. So presumably, you can assume you can generate more packaging revenue going forward and that is incremental compared to the past. So can we assume that your packaging revenue may potentially or I know you reported non wafer revenue part of the business and on MOPS and that is about over 10% last year. And can we assume that those part of the business can reach like grow faster than your wafer revenue going forward?
Of course, of course, we want to we expect that. It's again, it is in this semiconductor packaging in the past hasn't been playing the role of increased system performance. And this is new and we indeed first see in our biggest customers verification products, but there are new customers are interested in that, including some of them are mobile, some of them are high performance computing, but cost is always a factor in determining when do they move in to this technology and that varies segment by segment.
Next question will be coming from JPMorgan's Gokul.
Thank you. My first question is on N7 plus and N PHY. So given N PHY is pretty high layer count for EUV, in your early engagement with customers, are you seeing customers trialing N7 plus at least for some small volume products and then going to N PHY? Or are you seeing more customers directly going to N PHY? And could you also give a view on how big N7 plus is likely to be?
Is it going to be a small volume node while N7 is still going to be majority of the 7 nanometer family? That's my first question.
Gokul, there is no correlation that with the customer need to go to N7 plus then go to N5. Customer choose working with TSMC for their product development. So they choose that the best technology at a time that fits their product well. So no correlation. But you are talking about the way that they need to go through this, no.
So you feel that customers are already comfortable with the EUV throughput at that level of layer count to directly
go to the right? [SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] They are because of we communicate with them our progress and our status. And actually, we believe we have a very good progress and still feel comfortable with.
Okay. Just one clarification on the smartphone commentary in terms of slightly better demand that you're seeing in smartphones compared to the last 3 months. Could you classify it, is it more coming in the mid to low end or is it really at the high end? And second question is, is it because TSMC is gaining more share compared to what you expected to or your share gains are coming faster? Or is it a view on the overall smartphone market itself?
Well, most of these are high end smartphone, all right. And the mid low end, the industry wide is weak, although it's gradually coming back, but its pace of coming back is slower than expected.
Next question will be coming from Goldman Sachs, Donald Lu.
Yes, good afternoon. I have two questions. First question is about China. Here, I have 2 specific questions. One is that earlier this year, when the ZTE saga starts to play out, MediaTek initially said it cannot shift to ZTE.
But my understanding is TSMC has never turned down the TE's wafer out. So I'm wondering what's going on here. Is there a law or a rule or something going forward going to dictate how you can serve Chinese customer because Chinese customer now accounts almost a quarter of your revenue. 2nd on China is UMC is going to lift its China entity in China and arguably can get a lot of capital for R and D and growth. Will TSMC one day consider that?
And I'm sure it will be very well welcomed. Yes, I have another question, but I will wait. First on ZTE,
yes, when U. S. Government put a ban on the shipment to ZTE, indeed, most company, ZTE supplier stopped the shipment. However, TSMZ is not a direct supplier to ZTE. It's not a direct supplier to ZTE.
So indeed, some of the they do have a subsidiary of ZTE and but according to their rule, you need to have a certain percentage of value added from the U. S. And so for that particular subsidiary, the value added is mostly from China and from TSMC. So that also is beyond the restriction scope.
Sorry, can you explain a little more here? I understand ZTE also makes chips and that's manufactured at the TSMC, so that's not correct?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] No, no. ZTE do not make chips and send order to TSMC. They do have a subsidiary and a small dealer house and very small volume have some business with us. However, we talked to Taiwan government and outside counsel, the value added doesn't occur at U. S.
So it was not in the restriction scope.
And hypothetically, if high silicon have a problem similar to the TE, would that be a problem?
I don't want to answer the hypothetical question, okay.
Understood. Thank
you. You have another question?
Yes. It's on the potential Asia listing of your great Okay. This goes to Laura.
Laura told me we are not short of capital.
Company go for IPO, main purpose to source the funding and we have enough funding to support our growth. There is no plan for us to do that.
I have second question is on 7 nanometer. The first is about China. 7 nanometer, I have a question. What was TSMC's market share at 16 nanometer and at 7 nanometer foundry market? And also how compared to TAN, how much is 7 nanometer TAN versus 16 10 nanometer TAM in terms of market size?
Our 7 nanometers market share and 16 FinFET, okay, 16 FinFET market share is very high and 7 nanometer is even higher.
How much, higher 10 percent?
I cannot be so specific, right? High is the high.
It's the 10 of 7 nanometer.
10 of 7 nanometer is bigger.
Bigger than 16? Yes. Why is that? Because historically, that seems to be decreasing by 7 meters.
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Well, there are some reason that we are talking about the AI, we are talking about 5 gs, high performance computing all add together.
So Talk about dollar of 10, right?
Thank you.
Let's actually go to the line for the first caller on the line. Operator, please.
Apologies about the background noise. In the Q4 conference call, you disclosed last year 7% of revenues came from back end services. Now you're talking about also improved profitability in that area. Can you help us understand your outlook for total back end services contribution this year and how significant the profitability improvement is?
Back end contribution this year and profitability.
The back end contributions to total revenue is increasing. It's slightly higher than last year with the more advanced packaging coming on the line. So I think back end EVO adds up is slightly more than 10% of our revenue versus about 10% last year.
Okay. Thank you. And one more question for you, Laura. I remember last year, you also had 10 nanometer going to greater than 20 percent of revenues in the Q4. This year, you have 7 nanometer going to greater than 20% of revenues in the 4th quarter.
The guidance that you just gave for the Q3 suggested 100 basis points of headwind from the initial ramp of 7 nanometer. I'm curious, as 7 nanometer goes to more than 20% of revenues in the Q4, is does the volume start to offset and you won't get as much of a headwind? Or the fact that it's such a large percentage of mix, will 7 nanometer still be a significant headwind to the potential margin progression going into the Q4?
So Stephen's question is, if we ramp 7 nanometer to more than 20% revenue in the 4th quarter, what will be the margin headwind brought by this ramp?
In the 1st year of production, usually, the margin for 7 nanometer is lower than corporate average. So we do see with the 3rd quarter guidance I just gave you, which include 10% contribution from 7 nanometer, this is going to dilute corporate margin by 1 percentage point, slightly more than 1 percentage point. And going forward to the Q4, where 7 nanometer will account for more than 20% of total wafer revenue, We expect the dilution will be about 2.5 percentage point to corporate gross margin.
Okay, great. Thank you. And if I could just sneak one last one. And I'm surprised we haven't talked much about feedback from your customers on potential trade war impacts. Does TSMC have a viewpoint?
And what are you hearing from your customers on potential impacts for the rest of this year?
On the U. S.-China trade tension, and they issued tariffs on the 3 waves. First wave is on the $34,000,000,000 products, second wave is on 2016,000,000 and third wave is on the 200. And only the first wave has been executed today. And in that, we see very minimal impact for our business and our customer.
Those are the mostly related to the IC related to the semiconductor is only discrete devices in the first wave. On the 2nd wave, although it's still in the common stage, but we do a thorough check on that effects, It does include integrated circuits. However, we look at it still a very minimal impact effect in our business so far. So even though the SIA in the U. S.
Is still protesting about including the IC into the second phase. But what I'm talking about even though they put it into effect, it's still a very minimal effect.
Great. Go ahead.
Thank you.
Next question will be coming back to the floor. Sorry, let's come back to the floor first. It will be from Morgan Stanley's Charlie Chan.
Thanks for taking my question. So my question is actually follow-up to previous questions. First of all, is the smartphone semi better in Q3. Is that do you see an upward revision of smartphone semiconductor or you mean is better than 2nd quarter? Can you comment on that?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] Of
course, it's better than second quarter because 3 months ago, we are a little bit more conservative and but recently, the development in smartphone units actually recovered. So it's better than what we forecasted 3 months ago. But it's not a big deviation from that our forecast at the beginning of this year.
Okay. And I guess another question that you also care about is your revenue exposure to the Quito Semiconductor. And so what so after 2 quarters, what is the exposure in first half? And what do you think the percentage of crypto semi would be in second half? [SPEAKER UNIDENTIFIED
COMPANY REPRESENTATIVE:] We already mentioned that because of our cryptocurrency surprising, so we forecast a softer demand from the cryptocurrency mining in the second half. So as what is the ratio between the first half and the second half? I can also specific, but with one of the reason is very uncertain, right? It's volatile. But our own forecast, we'd already done.
Okay.
Yes. I think the full picture is we currently, we at our best effort to forecast weaker cryptocurrency. However, it's largely compensated by the increased strength of the smartphone. So that's why the total number forecast is not that different. However, cryptocurrency is still have some uncertainty, right?
That's why we adjusted the 10% number, but still we're going to fight for that to reach close to
that. Thanks. So my next question is regarding your AI semiconductor. It has been a very strongly growing sector over the past 2 years, right? And it's going to be another key growth driver for coming years.
So can you give us some numbers? For example, the AI Semiconductor premium contribution this year, last year and the growth rate trajectory in the coming year, especially next year, I'm going to see AI semiconductor to double and I want to define this AI semiconductor a little bit. So this should exclude the AI features including the smartphone chipset. I'm referring to those discrete chips, no matter it's for cloud AI or the HAI?
Today is embedded into the existing product. For example, you look at the smartphone in these days, the application processor embedded a lot of AI functionality inside, so you can have a lot of new features, right? Look at the face recognition, the voice recognition and then etcetera, etcetera. So if you want to specifically identify what is increase of last year, what increase of this year is pretty hard for us to do. But we can see the activity going up because of you look at networking processor keep coming, application processor for the all the smartphone keep increasing functionality, so you can estimate what kind of a die size they increase, so the silicon content.
By doing that, you probably can figure out what is the contribution and why TSMC making it so big deal because we saw the trend from AI and 5 gs all combined together. That will be a megatrend. [SPEAKER UNIDENTIFIED COMPANY
REPRESENTATIVE:] Let me add some for the future communication purposes. AI is in every growth segment we have, okay? In the smartphone, in the automotive, in IoT, AI increased the silicon content. For the high performance computing, indeed, there are a lot of discrete AI chips. So just if we those discrete AI chips that include XPU, accelerator GPUs and network processors and some of them even games in that those are discrete CPU.
So as we speak today, indeed high performance computing growth
is
very
is pretty fast. Last year was 40%. This year is 25%, around that, because the reason is slowing down because cryptocurrency is included in the high performance computing. So Boeing up is still the highest growth sectors today we have, but future is very difficult to predict. Like next year, we're just trying to help our customer to expand their market as quickly as possible.
I think we still need to go back to the line for the next caller. Operator, please? Yes. Next question is from Agency Partners, Douglas Smith. Your line is now open.
Hi, thank you. A couple of quarters ago, Morris Chang said that there were no plans to expand manufacturing capacity in the U. S. Because of current events, has that been resolved? And the second question is, what steps is TSMC taking to protect its intellectual property, given there's been a lot of allegations of IP theft recently?
First question is, do we have mentioned that we have no plan to expand manufacturing capacity in the United States. Have we changed our mind?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:] No. We did not work it's working. No, we did not change our plan. Only when it's necessary, we will do it. But so far, we did not see the need to put to establish a new fab in the U.
S. Lisa?
The second question is how do we protect our intellectual property against theft?
Yes, this is the actually, this is the core of China U. S. Trade tension and we take it very seriously too. And theft can we call espionage, can come from everywhere, not just from one country or they are sometimes indirect come to the getting our proprietary information. I can only say that we are fiercely protecting our IP and information, because those are IP information is origin developed in TSMC over the past more than 30 years and that is ours.
No other states can take it and putting the effort to espionage. That is the main focus among all these tension.
Now we come back to the floor. The next question will be coming from UBS, Bao Lu.
Hi, thanks very much. So there's been quite a few questions today on Events Packaging and how that's sort of helping with Moore's Law slowing down. If you look at these HPC applications, the move to parallel compute, the requirement to access high bandwidth memory, that I think is a big part of the packaging trend. I just feel like packaging is going up in value, but so is memory, right? Is there a case to be made for TSMC doing more there either in terms of partnerships or in terms of own efforts or just comment on that space?
You're right. We don't produce memory, neither DRAM or flash, but we work very closely with 3 memory houses, including Samsung and Hynix and Micron. And all the engineering work together very closely. And at this point, the engineering work is further intensified. And so we this is our strategy is that we still wanted the memory supply can come from multiple sources for our customer, so that they can most freely develop their product.
And yes, there are among the 3, some of the memory company work closer with us, but all 3 are working quite close with us to help our customers' product to get to their market.
Second question is on your ASP. If you look at the next last several years, CapEx going up and now the CapEx intensity is coming down a little bit. And yet, you've got you can have big market share at 7 nanometers and the big market that is upcoming. What is the thinking here? Should we think that with lower cost that you're going to pass it on to the customers given that you are going to get to your ROE goals?
Or how do we think about that?
Phil, I thought you were asking about ASP and then you are also asking about how we deliver value to our customers?
Sorry, I guess my question is, if you think about ASP, with your last several notes, ASP has been going up, right? But now that your cost structure is coming down, does that mean we should expect flatter ASP going forward?
Do we share our cost reduction benefit with our customers more than before, which is reflected in the price. That's what
we're thinking.
I just realized last several note that the leading edge actually has been shrinking, right? And so now you've got a big market, your cost is coming down. If you're not going to raise price, you could potentially benefit more because the size of the market might grow. Just how do you think about that problem, I guess? [SPEAKER UNIDENTIFIED
COMPANY REPRESENTATIVE:] I still don't understand that you are talking about that it's getting more mature, so then the cost is down and so that we have to roll down our price.
[SPEAKER UNIDENTIFIED
COMPANY REPRESENTATIVE:] I'm sorry. I'm not being very clear. Just comment on ASP next couple of years, I guess. [SPEAKER
UNIDENTIFIED COMPANY REPRESENTATIVE:] We sell the value. We don't sell by the cost. That's rule. And we work with our customer to make sure that their product can be sellable, feasible in the market. So that's all the rule of thumb that we consider.
Okay. Thank you.
Next question will be coming from Credit Suisse, Randy Abrams.
Yes, hi. Thank you. First question I want to ask on the 4 growth platforms. If you could give an update, mobile, I think, in the past early in the year was flat or that was the expectation and then I think came down. So if you could give your view now that mobile platform expectation year over year And then for the other 3, an updated snapshot, like how large HPC, IoT and Auto are for TSMC now?
[SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:]
Okay, let me answer that. As I just mentioned, I think that because of the introduction of the AI and 5 gs, so even we start to forecast that the mobile smartphone, the contribution to our growth will continue. And but there's one surprisingly that good result from the HPC. So HPC HPC is a contribution now, it will be comparable to the mobile phone and then followed by IoT and Automotive. So that now is a 2 big contributor.
We used to say mobile is 50%, now it's a little bit less than 50%, and then HPC will be closing to the mobile contribution now in the course per se.
Okay. But I guess could you I think HPC has been running or growing from 20% to 25% or just kind of the range now for HPC? And then I think the last metric auto was about $1,400,000,000 I'm not sure if you've given the IoT, but if you have kind of a rough just so we have a rough picture since that's the way we're looking at the business now.
Well, it's you're asking a question through the lens of the future. Look at it, high performance computing today is 25%. We expect that percentage will increase slightly and mobile, the percentage will decrease slightly. And IoT and Automotive, those are roughly about 6% or 7% of our business, but that growth rate is pretty fast. We are talking about 20 more than 20% growth year after year.
So that is our current picture of the growth and that is also why we see these as 4 growth drivers for TSMC.
Okay. And the 6% to 7%, is that combined or each one?
Each one.
Okay. The second question I have on gross margin, following up to Steve's question, there's about 1.5% headwind in Q4 from 7 nanometer, but you're also guiding growth again in Q4 based on the full year guidance. So do you expect you can offset the depreciation sorry, the 7 nanometer headwind with growth to keep margins at near similar levels?
Actually, the headwind for 7 nanometer in Q4 is 2.5%, not 1.5 percentage point, just volume is pretty big.
2.5% over the 3rd quarter, okay.
Over 1.3%, yes, you're right, 1.5% more than Q3. Well, there are many factors and 1.5000000000, it's not that big. There are things can be done if we improve the product mix, if the utilization gets better and we have better cost efficiency and you can gather. So I'm not projecting that, but that's all the effort we've been exercising in the company.
Thank you.
Next question will be from CL Securities, Sebastian Ho.
Thank you. My first follow-up is to clarify what Mark just said on the HPC revenue growth. Was it 40% last year, 25% this year?
Yes.
Okay. Including the crypto.
Okay. So if we look at the full year guidance for this year, it's high single digit rate and if we take cryptocurrency out of it this year and last year, apple to apple comparison without cryptocurrency, what's the growth rate of TSMC what's the growth guidance for TSMC for this year? Still in the range of 5% to 10%?
We don't have the number readily, but I think for this numerical answer, maybe Elizabeth can relate to you after the meeting.
Okay, right. And going forward, the I think you maintained the CAGR compound annual growth rate of 5% to 10% and that's including crypto or without crypto?
That's including the crypto. But as we look at today, the cryptos will be not in a factor if you talk about 5 year horizon. But things can change, but this at this time, we don't count on the crypto.
So which means the non crypto part of the high purpose computing segment, you're becoming more confident. Can we say that? Yes. Okay. 2nd follow-up is on the mature nodes.
If I calculate your 0.11 micron process nodes above, assuming that's 8 inches fab, but I know you some of that you used 12 inches fab to manufacture those nodes, but presumably 0.11 micron above nodes in the first half this year, the first half of last year, the YOY is down by 8%, 9% U. S. Dollars terms. So there's been a lot of industry saying about the 8 inches foundry is very tight, demand very strong, price high, etcetera, but we don't see that reflected on TSMC in the first half this year. So what can you tell us what's going on?
It's actually you're talking about our 0.11 micron and above revenue decreasing. Actually, we are fully loaded in that 8 inches wafer fab. So that's why I mentioned in my statement that we are transferring some 8 inches wafers product into 12 inches wafers so that we can have more capacity to serve the customer. As for the revenue, I did not have an executive number in my hand. We are the weibo price is dropping.
We did not I did not have a good number in my hand. [SPEAKER UNIDENTIFIED COMPANY
REPRESENTATIVE:] Well,
it looks like it's 8 inches is 0.15 and below. And you're talking about it's 0.11 and below. I think that's the differences. So there are some under utilization in that part from the point.
Okay. But you're seeing the wafer pricing is declining, is due to the product mix or like to like comparison? Because we heard like some other your peers are raising price since the beginning of this year and maybe another wave of the price hike in second half? [SPEAKER UNIDENTIFIED COMPANY REPRESENTATIVE:]
I don't comment my competitors' behavior, but for TSMC, we actually we work with our customer and once we settle down the wafer pricing, we have a commitment. We don't easily change that. Even we observe the raw wafer pricing increase, we stick on our commitment to our customer.
Okay. Thank you.
Next question will be coming from Deutsche Bank's Michael Zhou.
Zhou.
Thanks for follow-up. The first question, you mentioned the high end smartphone unit is stronger than you expected than 3 months ago. Can I say that?
Yes, you can say that.
Okay. Is that broad based or customer specific? It's broad based. Okay. Second question is more housekeeping.
What is the outlook for the other segment, consumer, industrial because you mentioned crypto and smartphone?
So you're asking the 3rd quarter segment? Okay. In 3rd quarter, we see communication improved, computer declined the most, Consumer slightly declined. Industrial above flat.
Next question will be from Citigroup's Roland Xu.
Just one question. You have a sufficient capital to fund your growth and also you are generating more free cash flow. So are you considering to do the share buyback? Or by what kind of like criteria you are considering to do share buyback?
Currently, it is not in our plan. Actually, we have done a very thorough study of how do we return cash to shareholder. I think the general feedback is our shareholder prefers cash dividend than buyback.
Now we need to go to the line. Operator, please have the next caller on the line. Yes. Our first question comes from the line of Mehdi Hosseini. Your line is open.
Yes. Thanks for squeezing me in. A couple of follow ups. I noticed your wafer shipment in the March June quarter has been rather flattish, but revenues down by high single digit both in March June quarter. Should we expect wafer shipment in the second half to be flattish?
Or how should we think about the trend in the second half? And again, the trend between the wafer shipment and the revenues, Q3 and Q4? And I have a follow-up.
Wafer shipment in second half will be increasing, will be higher than the first half, so was the revenue. Did I answer your question?
Does that mean would your inventories remain the same?
You mean our own inventory?
Yes. Because your days of inventory has been going up over the past 6 months.
Yes. Inventory mainly for TSMC's work in process. And we had 73 days inventory at the end of Q2. With the ramping of 7 nanometer, we expect the inventory will go up a few days in 3rd quarter, but will come down as we ship more 7 nanometer by end of Q4. So our inventory are mainly work in process.
Okay. And then I have
a question regarding the longer term trend, specifically on artificial intelligence. Can you provide some qualitative assessment how you see the mix between GPU and ASIC evolving for the AI application?
All right. Mehdi, your question is with respect to future artificial intelligence related ICs. You want us to give you some sort of qualitative descriptions about the breakdown between GPU and ASIC?
Yes, yes. And my the purpose of asking this question is, I'm just trying to get a sense of how the market trends are evolving and also how I should think about the difference in the die size. I'm under assumption that GPUs generally are bigger dies compared to ASIC. And how should I think about this looking forward?
Well, we can only say that AI will be implemented in the GPU, CPU area. Coming on customers at that size, no, we cannot comment on that, but it's increasing, we can say. And AI is going to be used in a lot of functionalities anyway.
Sure. Let me restate the question. Would the wafer capacity requirement for AI be different between GPU and ASIC?
The wafer requirement or
Wafer capacity requirement, does that make a difference for you?
Well, let me give you probably not exactly what you want. The biggest portion of high performance computing in today in TSMC is XPU, followed by GPU, okay, in the high performance computing purpose.
All right. Now with this very bright long term outlook of artificial intelligence, bigger die size, a lot of wafers, we will conclude our today's conference. So please be advised that the replay of the conference will be accessible within 3 hours from now. Transcript will be available 24 hours from now, both of which will be available through our website. Thank you for joining us today.
We hope you will join us again next quarter. Goodbye and have a good day.