Happy New Year, everyone. Welcome to TSMC's 4th quarter 2016 earnings conference and conference call. This is Elizabeth Sung, 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 via the conference call, your dial in lines are in listen only mode.
As this conference is being viewed by investors around the world, we will conduct this event in English only. The format for today's event will be as follows: 1st, TS and T's Senior Vice President and CFO, Ms. Laura Ho, will summarize our operations in the Q4 of 2016, followed by our guidance for the Q1 of 2017. Afterwards, TSMC's Chairman, Doctor. Morris Chang, will provide our key messages and conduct the Q and A session where TSMC's 2 presidents and co CEOs, Doctor.
Mark Liu and Doctor. C. C. Wei, will be joining Chairman Chang and Ms. Hou in answering your questions.
For those participants on the call, if you do not yet have a copy of the press release, please 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. Please refer to the Safe Harbor notice that appears on our press release. And now, I would like to turn the podium to TSMC's CFO, Ms.
Laura Ho, for the summary of operations and current quarter guidance.
No?
Thank you for joining us today. My presentation will start with financial highlights for the Q4, the recap of our 2016 performance, followed by the guidance of the current quarter. 4th quarter revenue rose 0.7 percent sequentially to TWD262 billion, exceeding the high end of our guidance even in October, due to a stronger demand for TSMC's 16 nanometer technology and a more favorable foreign exchange rate than our original forecast. Gross margin increased by 1.6 percentage point quarter over quarter to 52.3%, mainly driven by continued cost improvement effort. Operating margin also increased by 1.1 percentage points sequentially to 41.9%, while R and D expense continued to grow, reflecting a higher level of 7 nanometer and 10 nanometer development activities.
Overall, our 4th quarter EPS reached $50.86 and ROE was 30% for the quarter. Now let's take a look at wafer revenue contribution by application. During the Q4, communication and computer increased 11% 7% from the prior quarter, respectively, while consumer and industrial standard decreased by 43% and 6%, respectively.
On a
full year basis, all four segments experienced year on year growth. Communication increased 16% Y o Y and represented 62% of our total wafer revenue. Computer increased 15%, consumer grew 32%, industrial standard rose 1%. Now let's take a look at the revenue by technology. Combined revenue from 16 and 20 nanometer reached 33% of wafer revenue in the 4th quarter, up from 31% in the 3rd quarter.
Our 28 nanometer contribution remains strong at 24% of revenue. Advanced technology in 28 nanometer and below accounted for 57% of total wafer revenue in the 4th quarter. On a full year basis, the combined 16 20 nanometer contribution increased by 8 percentage points and reached 28% of total wafer revenue in 2016. Advanced Technologies, 28 nanometer and below, accounted for 54% of total wafer revenue, up from 48% in 2015. Moving on to the balance sheet.
We ended the 4th quarter with cash and marketable securities of NT632 billion dollars an increase of NT115 billion dollars On the liability side, current liabilities increased by NT61 1,000,000,000 On financial ratios, accounts receivable turnover days increased 3 days to 45 days, while inventory while days of inventory decreased 3 days to 41 days, mainly driven by the reduction of working process. Now let me make a few comments on cash flow and CapEx. During the Q4, we generated about NT185 1,000,000,000 cash from operations and spent $113,000,000,000 in capital expenditures. As a result, we generated free cash flow of $20,73,000,000,000 and our overall cash balance increased $20.77,000,000,000 to reach $541,000,000,000 at the end of the quarter. In U.
S. Dollar terms, our 4th quarter capital expenditure reached $3,500,000,000 and the total year CapEx was $10,200,000,000 This is a bit higher than our prior guidance of slightly above $9,500,000,000 dollars mainly due to accelerated delivery of advanced technology tools. Now I would like to give you a recap of our performance in 2016. 2016 was a good year for TSMC as once again we set new records in terms of revenue and earnings. Our revenue grew 12.4% year over year to reached NT 948,000,000,000 or up 10.6 percent to US29.4 billion dollars a ton.
As we saw wafer shipments increased across nearly all technology nodes. Gross margin increased 1.4 percentage point to 50.1% in 2016, mainly due to continued cost reduction efforts and to a lesser extent, a more favorable foreign exchange rate. Our operating margin also increased 2 percentage points to reach 39.9%. Our effective tax rate was 13.5% in 2016, same as in 2015, And full year earnings per share was $12.89 an increase of 9% year over year. Excluding major one off items, namely share disposal gains and the closure of our solar operation in 2015 and a negative impact on the earthquake in 2016, our EPS would have grown 17.4 percent year over year in 2016.
On cash flow, we spent NT328 1,000,000,000 in capital expenditure. While we generated $540,000,000,000 in operating cash flow and $212,000,000,000 in free cash flow, We also paid NT156 1,000,000,000 in cash dividend, an increase of 33% from the 2015. From a semiconductor industry standpoint, we estimate that the semiconductor market is likely to have a remain flat year on year. While fabrics grew 5% and foundry rose 8%. The outperformance of foundry over the overall semiconductor industry was mainly driven by the strong demand from 4 gs plus smartphones in the China market, the replacement upgrade of gaming and emergence of artificial intelligence.
Compared to foundry's 8% growth, TSMC's 11% growth in U. S. Dollar underscore our further market segment share gain from 55% in 2015 to 56% in 2016, which is mainly propelled by our leadership in 16 nanometer and 20 nanometer. We estimated fabulous days of inventory ended 16 at slightly above seasonal level by about 2 days. I have finished my remarks on the financial summary.
Now let me turn on to the Q1 outlook. Moving on to the Q1 2017, we forecast the demand is weaker than the prior quarter due to mobile product seasonality and slightly above seasonal supply chain inventory at the end of 2016. Based on our current forecast and exchange rate assumption of US1 dollars to NT32 dollars We expect Q1 revenue to be between TWD 136 $1,000,000,000 and TWD239 billion, which represents an 8.9% to 10% sequential decline. Gross profit margin to be between 51.5% and 53.5 percent and operating margin to be between 40.5% 42.5%. This concludes my remarks.
Now I would like to turn the podium to Chairman for his comments. Ladies
and gentlemen, our first one wish you a very happy, carefree, healthy and profitable and hopeful New Year. And Laureang has just given her report on last quarter and also to give outlook for the Q1. I will just spend a few minutes to talk about 2017 the whole year. For 2017, we expect smartphone unit growth of 6% from 1.47000000000 units to 1.55000000000 units. Of the smartphone growth, we expect the high end smartphone will grow 3%, the mid end will grow 5% and the low end will grow 8%.
For 2017, we also expect that PC units will decline 5%, tablets will decline 7%.
DTE
units will decline 5%, and IoT units will grow 34%. Again, for 2017, we expect semiconductor market to grow 4%, foundry revenue to grow 7%. We expect PSMC revenue to grow 5% to 10% in U. S. Dollars.
ESMC revenue, we expect to grow 5% to 10% in U. S. Dollars. We believe that in the first half of twenty seventeen, our growth over the same period last year will be close to 10%. And in the second half of twenty seventeen, our growth over the same period last year will be close to 5%.
We expect to continue to increase our R and D investments, both in dollars and moderately in its percent of revenue. We also reaffirm our long term growth projection, which was made a couple of years ago. We think that in the 2015, 2015 to 2020 time period, DSMC revenue and operating profit will grow at a compound annual average rate of 5% to 10%, I'm sorry, 5% to 10%. And DSMC will maintain an ROE of above 20%. That concludes my outlook for 2017.
And I believe we are now open for questions.
So 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 questions. Questions will be taken both from the floor and from the line. And should you wish to raise your question in Chinese, I will translate it to English before our management answers your questions. Now we will start the Q and A session.
First, we will have Deutsche Bank, Michael Zhou.
Chairman, Co CEOs, CFO and Doctor. Siang. My first question is regarding the outlook in the first half. Given Q1's could be down 8% to 10%, so and your guidance for first half to be up 10% year on year. So does that imply you still expect you will see quarterly or we can say sequential growth for Q2 or Q3 going forward?
Right. Iko, you're asking what is going to be our Q2 and Q3 sequential growth, Q o Q?
Certainly not the next. What's the question?
Repeat the question.
You are asking us about the Q2 and Q3, quarter over quarter revenue growth outlook.
We expect it to be a very significant positive number.
Maybe the follow-up question for inventory. Given the Q1 outlook seems to be slightly below our estimate, so do you see the demand outlook for Q1 is weaker than you expected 3 months ago?
Did you hear the question, Laura?
Michael was asking, do we see the Q1 was weaker than we anticipated 3 months ago?
What can you did you answer that?
Yes. It was weaker than we had anticipated a couple of months ago.
But could you specify which segment? Or what kind of applications?
Basically, it's mobile product, as we have stated in the press release.
All right. Now the question will go to Credit Suisse, Randy Abrams.
Yes. Thank you. First question, I wanted to ask, your outlook is more in line with the industry, where you're guiding 5 to 10 versus foundry near similar levels. Could you talk about the factors to be more in line after gaining the last few years? And can you also address the China business?
We're seeing the China foundries grow faster, SMIC is growing 20%, 30%. How does TSMC combat or defend share more on the mature nodes where they're starting to grow faster?
Can you repeat the question?
Yes. All right. Randy, your first question is made with respect to TSMC's 2017 growth outlook, where Chairman has just mentioned that 5% to 10%, which is very much in line with the semiconductor industry. But With
the fab, I'm sorry, with the foundry industry, yes.
So you like to know the underlying reasons why we are only growing sort of in line with the foundry?
Why we are only in line with the foundry?
Then China, where the Chinese foundry appear to be growing faster than the foundry industry and what is going to be our strategy in defending our market share or growing, competing against them?
C. Wei:] Well, yes. I think that I really don't know how fast the Chinese foundry is not going to grow. But I do agree that their ambition is certainly to grow faster than the boundary average. Now as to why we are only why I projected just now that we are only going to grow the same rate as the foundry growth.
Well, first of all, we may well be conservative. It's a little too early to say because I said it's now in answer to this gentleman's question that actually, I said while I was giving the message that the second half the first half year over year will be 10% above 10% growth and the second half will be only 5%. And the second half is farther away, and that always makes it more difficult to predict and rather than on the high side, we will rather on the low side. So that's the first reason. And there is another reason.
That is this year, I think, 2017, will be pretty strong in terms of technology, it will be a pretty strong 16 or 14 FinFET year. And our market share in 2016, while it's quite high, it's not as high as I would like. It's actually it's in the close to 70% or 65% or 7%. Now that's not quite as high as our 28 nanometer, which even now at like almost 80%. And now 2017 is, I think, is a pretty will be we think will be a pretty strong year.
And so we're running into a little air pocket here. If you call this staying par with the rest of the foundry air pocket, if you call that an air pocket, well, we're running into a low air pocket. But then the next step after this, of course, is 10 and 7. We see clear sky. We see clear sky anyway.
So those two reasons. 1st, possible little conservatism and second, it is a little concerned that our 'sixteen is not does not have as high a market share as I like as I would like. And 2017 happens to be a year. It is very strong. We think it's very strong since the year.
Now having said all that, I will say that we certainly do not think we'll lose market share. So I said that foundry will grow at 7%, and we are going to grow at between 5% and 10%. I would just further clarify that statement by saying that we're going to grow we're not going to grow less than pound
2nd question, a quick follow-up if you plan to introduce a 12 nanometer to enhance your 16, if you have plans for that. And then the second question I had was on profitability. Margins are holding up quite well in the Q1, where normally utilization drop it should fall a few points. So if you could talk about
the
factors holding it up. And then as we move through the year, how the expectation from that level, actually we're ramping 10 nanometer, if you expect margin to improve from that level?
So Randy, your second question actually has 2 separate questions. So yes, first part of your second question is with respect to 12 nanometer. And second question of the second question is with respect to the margin profile over this year. First question is what? 12 nanometer.
Well, nanometer. I think that, C. C, will you answer the first question?
Well, let me answer the question. You're asking about the 12 nanometer on what?
Yes. If GFC has a strategy or plan to introduce an in between 12 nanometer to protect share on the sense that our customer is not going to 10 or 7?
Okay. In fact, we our strategy is continuously to improve every node in the performance such as 28 nanometer, and we are continually improving the 16 nanometer technology. And we have some very good progress. And you might call it a 12 nanometer because we're improving the density, logical density performance and the power consumption. Yes, we have that.
The second question is the profile Gross margin profile. I think it will be fairly constant. I think in the second half, 10 nanometer because the 10 nanometer will be ramping up very strongly in the second half, It will start to ramp in the Q1, but it will ramp very strongly in the second half. And the big volume for the year of 10 nanometer is going to be in the second half. And the 10 nanometer will drag down the corporate margin in the second half by about 2 points.
Now if you take that into consideration, then I would say that our structural profitability will be maintained. And by that, I mean something in the 50% range. But taking into consideration that in the second half, panorimeter will drag down the corporate margin, corporate average by about 2 points.
Okay. Next question will be coming from UBS,
Bill Lu.
Lu.
Thank you and Happy New Year. Doctor. Chen gave us the outlook for the various end markets in 2017. Can you talk about your outlook for the HPC market as well in 2017? Maybe units not the right way, but just in terms of the opportunity for TSMC.
So our outlook for high performance computing in 2017, what is going to be the growth outlook for HPC in this year?
C. Wei:]
Okay. The HPC high performance compute, let me define that first. It covers server, infrastructure networking, machine learning, gaming, AR and VR. We see some other AI product to surface, but we cannot estimate it. It is just too early to estimate it.
Of course, this year, you have seen the gaming ARVR product starting
to ramp.
And this is a very new growth area, and we see double digit growth in the beginning. By the way, we currently, we have a strong share in the network infrastructure and gaming already. And is those other areas that's coming to the play, the TSMC? So you can see this year, you see a before the threshold kind of growth and there's a double digit growth only, mostly in the product development space. If I can sneak in a question 1b, and if you look at the GPU, how do you categorize it?
Maybe this is for LoRa. Historically, it's really for PCs, but going forward, as you use it in autos and AI, are you going to put it in computers or industrials or how do you categorize that? GPU for graphics, we put it in the PC. GPU for the server accelerator, we put in the HPC, high performance computing. My second question is on capital spending.
2016 was a little bit higher than expected. What's the outlook for CapEx in 2017?
2017 CapEx will be about 10,000,000,000 dollars
Next question will be coming from Morgan Stanley's Charlie Chan.
Thanks for taking my question. My first question is regarding the advisory reports to the U. S. President that Friday, because in the reports, the U. S.
Seems want to ensure their semiconductor leadership, especially in the leading edge. So what would be TSMC's strategy to fit in this policy direction and ensure your own leadership?
You are referring to the advisory, the working I mean, actually, I think it's the working group. And that report was written to President Obama. And there'll be a new President in a few days.
And
whether any of that report will be adopted as policy by the new President is still unknown. But having said all that, I will say that Mr. Trump, President-elect Trump, has said many times that he wants to create jobs in the United States. And we highly applaud that. ESMC actually has created, we believe, hundreds of thousands of jobs in the United States in the last 20, 30 years of our existence.
We, for all practical purposes, we have created industry, the fabless industry in United States. And we have grown it. And the fabless industry, I believe, employs 100 of thousands of people in the United States. And we have done that by being here ourselves. So I think that we'll continue to create more jobs in the United States by helping the fabless industry in the United States and the IDMs, the users.
There are many IDMs in the United States that use us. And by using us, they have grown faster. And they create jobs too. So now I as to I mean, that's actually, of course, Mr. Trump's main policy to create jobs.
And of course, he has said a lot of things about other things, all right? And I don't want to comment on them right now. As far as that report is concerned, yes, in fact, I think the report was preceded by the Commerce Secretary in the United States. And I think that I agree with most of the things, but I agree with most of the things in the report. In fact, I agree with most of the things that Kenny said.
But just keep in mind that the report was written to President Obama. And actually, even if President Obama continues in office, I mean, the chance of us adopting the recommendations of a presidential passport are not very high. I mean, this we have history to guide us. In fact, I'll just tell you anecdote. In June of 6, I met even Bush, then President of the United States.
And at that time, the President Bush's task force advisory task force on Iraq. I just submitted a report. Basically, he recommended the U. S. Withdrawing from Iraq, and President Bush did not adopt the recommendation.
He actually adopted the contrary, which is to increase the troops. So I mean, that's just an example that quickly came to my mind when somebody talks about, Ah, the court has been written.
Thanks, Chairman. This is very insightful. So my next question is to Russ because it's a more maintenance financial question. So your Q1 gross margin guidance seems to be similar to your Q4. Your revenue scale is down like almost 5%.
So why the gross margin is improving in Q1? And can you give us some guidance about the depreciation as well?
We have pretty big volume of 16 nanometer. The profit is improving. And 28 nanometer still accounts for a big part of our revenue this year with very good profit. And we continue to do the cost reduction, so we can maintain a pretty good margin in spite of declining revenue in the Q1. That's the reason.
Your second question asked about depreciation for the whole year. Okay. With the US10 $1,000,000,000 CapEx in 2017, which will be slightly front end loaded, by the way. So the depreciation year over year, we expect to grow about high teens this year versus last year. In terms of Q1, since last year's CapEx was very much back end loaded, So we expect a more than 10% depreciation increase quarter over quarter in the Q1.
Okay. I think this is about time that we should take questions from the call. Operator, please proceed with the first caller on the line.
Certainly. The question comes from the line of Roland Xu of Citigroup. Please go ahead.
Hi, good afternoon. Can you hear me?
Yes, I can. You can.
Okay. Yes. Thanks for taking my question. First question, I just would like to ask about the recently there is a 12 inches wafer price high. So I would like to ask what's the impact to the overall gross margin?
And how long does you think this 12 inches wafer supply and demand imbalance will last? Thank you.
I think I will repeat Roland's question here. He's asking us about the recent raw wafer price increase. What's the impact of the raw wafer price increase on our gross margin? And how long do we expect the supply demand imbalance in the raw wafer supply to last?
The reason for the wafer price increase is because the imbalance of the price demand situations, so it's more demand and supply. And manufacturer was trying to reduce the loss or make more profit. So we anticipate some increase in raw wafer price. In terms of impact to TSMC, for this year, we expect impact will be about 0.2% of our gross margin. It's not very big, but it's not very small either.
In terms of when the situation sorry?
Yes, yes. Sorry.
Let me just answer very simply. I mean, we do buy a lot of things, And we have a lot of price every year. Every year, we have a lot of price increases. And we have also a lot of price reductions from our vendors. And what we do, and I think we do it well, is to try to improve in the past 5, 6, 7 years, improve our structural profitability to the present point.
And what we're going to do from now on is at least to maintain that level of structural profitability. And to manage that requires taking a lot of things into account, including price increase there, price reduction there, cost reduction here, cost reduction there, etcetera, etcetera.
Understood. Yes, I know there is a very limited impact to TSMC. Okay, thank you. My second question is your 8 inches revenue declined by double digit year on year last year despite overall revenue increased by 11% in U. S.
Dollars last year. So I would like to ask where did this 8 inches weakness come from? And how does it look for this year?
So Roland is asking last year 2016, our overall revenue go up by 11%, but our 8 inches wafer revenue declined double digit. What causes such weaknesses? Secondly, what do you think this year is going to happen, whether or not our 8 inches weakness will persist to this year?
Yes, thank you. Okay.
Last year, our 8 inches wafer business decreased close to double digit, mainly because of a lot of product moving into 12 inches wafer. One of the example is fingerprint sensor. We have customers are moving from 8 inches wafer to 12 inches wafer. And so this kind of a trend will continue. We expect this year was still decreased slightly.
But then we have also do a lot of activities to increase our applications in the 8 inches wafers technology. So the decreasing will be much more minimized as compared with last year.
Okay. So can we expect the utilization for 8 inches length will be much lower than previous this year?
Reuteration will be close the same or a little bit above as compared with last year.
Okay. Understood. Okay. Thank you.
All right. Let's have the next caller on the line, please.
Next question is from the line of Brett Simpson from RMB. Please go ahead.
Thanks very much. Doctor. Chang, you mentioned 10 nanometer and 7 nanometer was clear sky from a competitive perspective. Just interested, if you look at peak capacity for 7 nanometer in wafer terms, will this be a bigger node for TSMC than 28 nanometer? Thank you.
Brett, let me see if I get your question correct. You are asking us whether or not 10 nanometer and 7 nanometer will be bigger than 28 nanometer eventually. Is that your question?
In wafer terms, yes.
In wafer accounts? Yes. In business, in revenue as well as in wafer accounts? You are asking too much. You will only answer 1 of the 2, yes.
Only wafer counts.
Only wafer counts, okay.
Of 10, 7, is that right? 10/7. 10/7 wafer count will be slightly less than 28, slightly.
Okay. That's helpful. The revenue will
be much bigger. Revenue will be much bigger.
Thank you. And just a follow-up. With regards to HPC, we are seeing a lot of specialty memory, high bandwidth memory increasingly being packaged with your COOS. Does TSMC have any interest in developing stacked memories for HPC? Thank you.
Okay. Will TSMC be interested in developing specialty memory such as the high bandwidth memory ourselves to satisfy our business in CoWoS.
Well, we don't produce a special memory per se by TSMC, but we're working with the memory companies to provide the service under HBM.
And does TSMC expect yes, would TSMC be interested in developing its own memories for HPC long term?
No. Okay. Thanks very much.
All right. Let's come back to the floor. Next question will be coming from Goldman Sachs, Donald
Lu. Hi, Tianhe. Very nice to see you and Chairman. One question is on the demand outlook for next year. Seems like everything except the smartphone is declining and the smartphone is increasing only 6%.
How do you get to a 4% semi growth? Is the smartphone content going to increase?
Next, how do I get the
Right. Chairman said semiconductor growth is 4%.
So I don't know if
you're saying that smartphone is 6%.
Yes. And also smartphone mix is going to the low end as well. So
That's a tough question, Donald. I'm trying to think I mean, these numbers are all compiled by our own forecaster. And again, he tells me what other forecasters are saying. And it seems that all of them are saying about 4%, 3%, 4%, or even more, 5%. Now you're asking, well, where does it come from?
Mark said, Silicon content. Answer the question loudly, please.
You're right. The existing content of smartphone will increase from 16% to 17%.
So even the mix is going more to
the low end? Even mix. We see the silicon content of all tiers increase and low end increases more, but overall, the sit in content will increase high single digit next year.
I see. Great. Yes, we are making our forecast based on your forecast. So it's good to know. My second question is more on the AI.
Although I like the Mark commented, it's early stage, but it's pretty hot. So how should we look at the opportunity for TSMC for AI? I mean, there is a big on the server side on building the model. There's also on the premise on the handset or PC. Which market will be bigger?
And how should we predict it in the future for TSMC? Is there any thoughts on
that? We do see a lot of opportunity in we have 4 growth platforms. The first one is mobile, smartphones. The second one is high speed computing. Third one is IoT.
The 4th one is automotive. And we do see a lot of opportunities for artificial intelligence in all those 3 platforms. Now perhaps, Mark, would you care about would you care to say some more about the high performance in building and perhaps C. C. Will say something more about IoT and automotive.
Yes.
I think AI is a coming killer application for the industry and people are excited. One of the reason is the there is a tremendous progress in the algorithms that makes the machine into much more than traditional programming programmable machine. This is the machine can think and do things. So for the application side, it's immense as many of you must have read on this growing opportunities. All the cloud provider are in this field.
Now in AI for us, I think it's also an important opportunity for us. Let me just talk about the computing side of AI. AI needs deep learning and collecting a lot of data, therefore, it requires very massive computation. And in the past years, our technology development is collecting our pace and we now can provide the world's most competitive technology for those artificial intelligence computing purposes. That's number 1.
So the people who can get into this field is across the industry using our technology. Secondly is this AI is efficient new. So, all the algorithms, all the architecture, they are all new. So the computing
so the
So
basically the playing field is leveled. It's not as before where the high components computing, it has to be a certain architecture to get into this field. This is a leveling playing field. So many players are into this field. That is where the massive innovation can come.
So we are very excited. And also because of this, we see application will include many segments. So we developed this advanced packaging And that is an area that requires the AI application. And that area is also we spent several years getting to this and now already come to the fruit that be it info or the COOS and there will be multiple generations of that advanced packaging. So on the technology side, we are prepared to embrace this, many people call it explosive growth.
Leave some time for CC2,
right? C.
Wei:] Yes. But there's no I think there's a lot of close opportunities for IoT and automotive too. Oh, well. In connection with AI.
In connection with the AI, I think we need to have a lot of sensor connectivity, you know that, right, to constitute a big all the data format and connect with that AI so they can do a lot of applications. So we do believe that in the future, IoT, which is a lot of sensor connectivity, brought them together and combined with the high performance computing and then form the fundamental basis of the AI. And we do expect the IoT business to grow very fast because of the in the future, you will see a lot of applications, even the autonomous driving. You need to look at all the background or the environment surrounding a car. And also the car has to communicate with the cars together, so everything.
We project the future in that the whole world, you will see a lot of connectivity, a lot of sensors. And that's where we constitute our IoT business.
Okay. The next question will be coming from Daiwa's Rick
Xu. Hi, happy New Year, Doctor. Chen and all. I guess my first question goes back to the your Q2 and Q3 business outlook. I think despite the kind of weak Q1 revenue, Mr.
Chairman was talking about your 2nd quarter revenue and Q3 revenue will grow significantly. And you also mentioned about your 10 nanometer ramp up will be also meaningful in these 2 quarters. What's the main demand driver behind that gross momentum? In different applications, would that be just coming from mobile or across the board or mobile, professional gaming and etcetera?
Just repeat the question now.
Yes. Rick, your question is what's the growth driver for our Q2 and Q3 business? Is it only from mobile or from other areas?
Well, actually, the simplest answer to your question is the growth driver is always customers' demand. And at our elaborate, I think we are more we do have more concentrated customers today than we did several years ago. So those particular customers' demand fluctuation impacts our seasonal I mean, our quarterly fluctuations. It's a great deal, great deal. And so seasonality, to us, doesn't mean very much anymore.
Every year's seasonality is different from the next year's or last year's. Last year, we had a pretty low first quarter and a pretty strong second quarter. And then 3rd and 4th quarters were even stronger now, I think, right? And this year, at least at this point, we see a somewhat different pattern. So yes, it was it's customary.
And of course, technology plays a part, and it will be the
ramp up.
Thank you so much. That's clear. The second question probably goes to Laura or maybe to Mr. Chairman as well. Can you give us more insight for color about your cash dividend this year and kind of ballpark number?
What was the question?
He wants to know additional color on this year's dividends per share. Laura?
Okay. I have a short answer. We will increase cash dividends in 2017. Magnitude, prefer to wait for the Board meeting, February. You're going to know by then.
Thank you so much.
You won't have long to wait. February or something, right? I don't remember the exact date of the board meeting.
14th, mid February.
8th 9th. Well, I think yes. Of course, the final decision is made by the Annual Shareholders' Meeting, and that's in June. The Board's recommendation on the dividend will be announced to the public after the Board meeting.
Thank you.
All right. Next question will be coming from HSBC, Stephen Pelleo.
Great. Thank you. The segments that you report to us, communications, consumer, computing and other are helpful, but now 2 thirds of your business is coming from computing. So we can't really divine a lot from that. We're all excited about automotive and AI and high performance computing, IoT.
If we were to use those of the segments, what percentage of revenues does TSMC get from each of those categorizations today?
Last year, roughly with mobile, it's about 55%, 56%. And high performance computing, we for the definition I just said, it's about 15% roughly. And PC is not a growing sector, but it's about 10%. And IoT and Automotive, both of them are less than 10%.
Okay.
Maybe a question for Laura. I'm very impressed with your gross margins in the Q1 potentially going up even on down maybe 10% in revenues. Could you talk a little bit about the nodes and the utilization rates maybe in the Q1? Is 16 nanometer falling off significantly? Yet you're making up the margin elsewhere.
Help us understand maybe what's driving the margins in the Q1 if we looked at each of the individual nodes and how they're going to perform?
16 nanometer is not falling off. I just said I wish our market share were higher. Okay. It's not falling off.
16 nanometer will be blacked up sequentially?
I'm sorry. Other than it seem now falling off. Damian, you have a question?
Stephen, actually you are asking a product mix things, right? Yes. There's more than product mix. Actually, it's improving profitability in each technology node, particularly 16 nanometer and we have very significant amount of revenue coming from 16 nanometer in Q1. And the 28 nanometer continue to be a very strong node.
Those two nodes actually supported our Q1 margin pretty well in spite of lesser revenue growth or decline revenue growth. That was the main reason. And the past, as I said earlier, continued cost improvement efforts in the operations side, that also helps.
Just a follow-up there. If you look at your full year gross margins, 2016, about 50% or so, you're suggesting maybe even as much as 53% or higher in the Q1. Are TSMC's structural gross margins higher this year that we can maybe look for a couple of 100 basis points growth for full year 2017 gross margins?
What was the question? All
right. Stephen, if I understand your logic, his question is given 50% gross margin for TSMC for the full year and 10 nanometer will take 2 points away from our margins in the second half, then that means first half, our gross margin will be very good to get the 50% average. And so
Well, look, let's not take all the numbers I say literally. I mean, when I said, I mean, we do have a narrow range. It's not the range is not 0. When I say that we want to keep our structural profitability at about close to 50%. I mean, at least give me 1 or 2 points leeway, okay?
It's not exactly just a year. Give me 1 or 2 points leeway. So it's like 49, 50. Yes. So we really can't even forecast the next quarter's gross margin that closely.
We always have a range of what, 2 or 3 points.
I mean 2 or 3 points. That would be that precise.
But I think Stephen's main question is, do we increase our structural profitability this year? Well,
I think that most of that most of the improvement has already happened. It has already happened. If you look back 6 or 7 years, we have improved it by several 100 basis points. And that was not easy at all. That was not easy.
And I think that, I would say, most of the improvement has already occurred. And so from this point on, our priority is to maintain itself.
If I could just speak one more quick one in. What do you think 10 nanometer to be more than 10% of revenues for which quarter this year?
Which quarter 10 nanometer will exceed 10%?
We answer questions like that.
Sometimes in the second half of this year, yes.
Well, if we answer questions like that, I think it should be more, all right? I mean, you don't have to answer it, no.
The big volume comes on the second half. So for whole year, it will be more than 10%.
His question is when does it exceed the 10%, I think?
3rd quarter. Really?
Okay. Next question will be coming from Credit Leonese, Sebastian Ho.
Thank you, Doctor. Song. Chairman and the 2 CEOs. C.
Wei:] He means volume. He doesn't mean gross margin. Revenue. Revenue. Yes.
Okay, good. Just want to be sure that Laura understood the question.
Yes. Thank you. So my first question is on the assumption of the growth rate that Chairman already mentioned about smartphone unit growth this year, you expect 6% and Mark mentioned about the silicon What did
you say? I'm sorry. What did he say?
The growth rate, smartphone, Chairman mentioned units. Oh, smartphone, okay.
6% and silicon content grew by high single digit per mark, which means we're growing about 13%, 14%. And given that mobile account for 55% to 60% of the total revenue this year, which means smartphone alone or mobile device alone can contribute 7% to 8% of the growth this year, plus the growth in hyperphones computing and double digit growth and also IoT growth of 34% of the whole market, which means it seems like easily to reach the high end of the growth even close to 10% for this year. I'm not sure if my assumption is right or too bullish.
Assumption is right. Calculation may not be.
Yes, I think that most of the growth
this year will be coming from smartphones,
80% of that. And that's because IoT and automotive are small. They do have
looking to 20% to 30% growth for those growth areas, but attributed to the whole company is still very small. So as opposed to the rest of it. So I think I don't calculate
it up to that number.
I think it's still in line with about 7 between 5 to 10, probably in the middle. That's my calculation.
Okay. Thank you. And my second question is on the President-elect Donald Trump in the United States that his policy is to create more job. And thank you, Chairman, for mentioning about how TSMC has helped create more jobs indirectly in the United States. But I'm wondering if you already got some pressure from your customers in the U.
S. That maybe when they do the calculation factoring the tax incentives that they think that maybe having manufacturing back in the U. S. Will be more can help them to improve their profit. I'm not sure.
So I'm just wondering whether you think about or ever consider building a fab in the U. S. And under what kind of the scenario and circumstances?
Sebastian, your question is whether or not we have pressure from U. S.-based customers wanting us to build an manufacturing site in the U. S. So that they can capture incentives?
Okay. My sorry, my second part of that question is that under what scenario and circumstances will TSMC consider building the fab in U. S?
Will we ever consider going there and build the fab?
I do not rule it out.
Okay. Thank you.
I do not rule out, but I see a lot of sacrifices that we and our customers will have to make if we do that.
Keep in mind
that we earned our business in the United States not by lower labor costs in Taiwan. In fact, on the whole, our labor costs in Taiwan, our labor costs in Taiwan are not lower than the United States. Now we earn our business by doing good. Just to give you an example, every year, we send thousands of engineers from one location to another. We have 3 locations in Taiwan, Baijung, Binzhou and Anand.
Now Baijung and Binzhou within daily commuting distance. Hainan, and you can even make a point, that Hainan and Cinzhu and Tainan and Taizong are within daily commuting systems also. Although, it's a little hard, but I know of people in New York, Manhattan, I know people that commute an hour and a half, 2 hours each way every day. If you're willing to do that, you can certainly commute between Tainan and Taizong and or Tainan and Hsinchu also. Now, I will even backing up a few steps.
You don't want to do that. It takes too long. It's still within weekly commuting distance, all right? So every year, we send literally over 1,000, 2,000 engineers from one location to another to be there for months. And that allows us to ramp up things quickly and to solve problems quickly also.
When one location, when one fab has got a problem, then another fab, engineers from another fab can go ahead and help them. And literally 1000, 1000 of engineer years do that every year. Now if we have a plant in the U. S, we won't be able to do that anymore. 2nd point, we have thousands of vendor people here in actually they are both in Xinjiang and in Xinjiang also, thousands of engineers from our partners located here.
Well, and these are things that not low labor costs. These are things that were the rules if we set up a plant in the U. S. And if we lose these things, our customers will lose, too. Yes, I don't rule out.
And actually, I've never ruled out. But year after year, time and again, we consider the subject. And we have not made the decision to go there, except, of course, we early in our life, we did set up WaveAttack Immuno. And it's still going. It has between 1500 employees, about 1500 employees.
It's still growing. But other than that, and that was set up in 1996. After that, we consider the question every so often, and we have not made the decision to set up a plant in the United States.
Okay. With that, we need to go back to the line. Operator, can you please have the next caller on the line?
Certainly. Next question is from the line of Mandy Hosseini from SIG. Please go ahead.
Yes. Thanks for taking my question. And Doctor. Cheng, good to hear you was on the call. I have a question on the 10 nanometer.
If your 16 nanometer market share is about 65%, What is your view on your market share when you migrate to 10 nanometer? And I have a follow-up.
Well, margins in Canada, I think they evolved about once it must have been a year ago because I was here last time a year ago. I vowed then that every new node from now on, we have a market share higher than our market share on 16.
Okay. So more than 65%. Is that your answer?
What?
Would that be above 65%?
Very definitely. Very definitely.
Okay. And then when we look into 7 nanometer and some of your competitors have a different definition of 7. Can you help us understand how your N7 competes and is positioned against your competitors?
So Nadir is saying that our 7 nanometer definition is different from other companies' 7 nanometer definition. So how do we compete at 7?
Our 7 nanometer definition is different from somebody else. Well, I'll let Mark answer.
Okay. I wouldn't want to comment on other people's 7 nanometer. Our 7 nanometer is under qualification now. And it will be qualified as according to plan on the end of Q1. And we have already more than 20 customers designing on this 7 nanometers.
And so and this year alone will be we estimate it will be 15, 20 kpals already. So this is our momentum built so far on 7 nanometer and no other competitor is getting to this stage of this leading edge technology. So we have we are to remember, I mentioned last time, we'll have 5 nanometer 2 years from now. And forget about the name, that will be a full node shrink and that will sit competing well with any technology come out at that time. Okay.
Let me add some 7 nanometer. We will maintain our 7 nanometer competitiveness just like we do on 28 and 16. And we will have a technology currently planned at 7 nanometer, but with the EUV insertion in the 2nd year of 2nd 7 nanometer, just 1 year approximately 1 year after. And that can greatly simplify the process and without increase the cost. And that is if customer can take advantage of minor design, it can further reduce their density increase their density, reduce their die cost.
And that is our plan to maintain the competitiveness of the 7 nanometer the year after. So we think 7 nanometer is a well adopted node by all the customers and we plan for the subsequent technology to shore up the demand continuously. And we hope to use this technology, I mean, the 2nd year technology to prepare for EUV production experience for the full fledged EUV technology on 5. So then our customer can have a very hopefully smooth getting to from our 7 nanometer to our 5 nanometer technology.
So that
is how we maintain our technology competitiveness.
May I ask a clarification question?
Sure.
I think if I heard you correctly, you will insert if I heard you correctly, you said you will insert EUV in the 2nd year of your 7 nanometer, which suggests to me that you may actually be able to commercialize and conclusion here?
Medi, I'm afraid that your voice was broken at some point in time. Can you please repeat? We heard you that you said that we will insert EUV in the 2nd year of 7 nanometer and then you had something that it was cut off. Can you repeat that part?
Sure.
Yes. Sorry about that. I just want to make sure I understand the EUV commentary correctly.
You said that you will
insert EUV in the 2nd year of 7 nanometer. That suggests to me that you may actually be able to insert EUV before competitors that have said insertion will happen at 5. Is that a right conclusion as we compare and try to better understand your competitiveness at 7 nanometer?
Yes. We will commercialize the 7 EUV in the 2nd year of our 7 nanometer production. I wouldn't comment of when will our competitor insert their EUV. That is I don't intend to do the comparison here.
Got it. Thanks so much for the details. I appreciate it.
Thank you. Now we come back to the floor. The next question will be going to Deutsche Bank's Michael Cho again.
Just two quick questions. One is what would be the tax rate in 2017?
Similar to 2016, 13%, 14% effective tax rate.
2nd question is, if we look at the first 3 years of 7 nanometer 10, would that be bigger than 28 nanometer for the 1st 3 years as well? Yes, total addressable market.
Total variable Total addressable market.
Addressable market. Yes, in terms of dollar, much bigger. Much bigger.
Okay. Then going to HSBC, Stephen Pelayo again.
Just two quick questions from me as well. With 2016 finished now, I believe, if I remember correctly from your 20th 2015, you had 2 customers that were 16% of revenues each. Curious, what was your customer concentration in 2016?
I think in general, our top five customer accounts about 50% of revenue and top 10 about 70%. This percentage hasn't changed much over years.
Any Any more details on the ones you disclosed that are over 10% of revenues? I can wait for the 20 F.
Please wait for 20
My second question was, you generated over $200,000,000,000 in free cash flow this year on 950 $1,000,000,000 in revenues, roughly 20%, 22% of revenue is free cash flow, quite nice. But if you're talking about high teens growth in depreciation this year, maybe 10% growth in your EBIT, you're probably going to add another $80,000,000,000 or so by my calculation to your free cash flow, which could get you over 30% of revenues. Is that a realistic target to think about this year? TSMC generates more than 30% of revenues in free cash flow.
I cannot be that precise, but I think our free cash flow will grow this year versus last year.
Now going to Credit Suisse, Randy Abrams.
Also two quick follow ups. The low that you're seeing in the business now, could you talk about how broad based that low is? If it's across application end markets or if it's select parts? The low you mentioned a low in the business that you're moving through. How broad is that lull across like application or your customer base?
The lower end of The lull.
No, you talked about like a slowdown. So for that slowdown, if you could talk by application, if it's across your business, broad based or if it's isolated to certain areas.
First half of this year, what's the weaker area of our demand, right? I think it's mobile.
What was the question?
The question is with respect to the first half of this year, what will be the area that the demand is relatively weaker?
And how What market sector or?
Market. Market.
Can you answer that question more?
What was the question? Sorry. Yes. The question is Tell me what was the question.
How broad based is the slowdown And which applications are you seeing the slowdown? In any area it's holding up stronger?
1st quarter? Or first quarter or first half?
I think, Mark, do you know the answer? Mark, do you know the answer?
Let me answer the question. The slowdown really come from the seasonality of our major customers in the mobile areas. And there will be minor inventory correction because as Laura mentioned, exiting last year is 2 days above inventory and exiting Q1 maybe slightly higher still. So we see some minor inventory correction going after, but we don't see a major slowdown at all.
And the second follow-up for the R and D expense. How I think you talked about increase. If you could talk about the range you see R and D moving in an increase or as percent of sales?
R and D as a percent of sales, right?
You're talking about rising.
Right. We said we are going to increase the R and D spending as well as the percentage. So what's the percentage?
It's approximately 8%. 8%. 8%.
Last year, it was 7.5%. This year, it will be slightly above 8%.
And when I said a moderate increase in its percent, I mean several tens basis points, all right, several tens basis points.
All right. Follow-up question from Goldman's Donald
I have a question. Inventory in Q4 has declined quite substantially. And will it increase substantially in Q1? And would that be potential boost to gross margins in Q1?
I don't believe so. Not in Q1.
Okay. Follow-up question from Credit Lyonnais, Sebastian Ho, and I think that should be our last question for this conference today.
Thank you for letting me ask. So my question is, is there any impacts you see there from the minimum wage hike and the EVE show regulation by the government, the government on the cost side.
Okay. What's the impact of the government's new policy on Yi Li Xiu and the minimum wage?
Yes. Our first estimate is that it will increase our cost about 30 basis points, 30 basis points. That's right, isn't it, Laura?
That's right. 0.3% of cost. Yes.
So it's on the cost of goods sold. And my second question is on the 2016 CapEx that turns out to be actually slightly higher than the last conference revision, about like $500,000,000 So I wonder whether that's just a cash pull in cash payment pull in or any other plan change of the capacity?
Just pulling in of payment. There's nothing changing capacity buildup.
Thank you.
Okay. I think we have concluded our Q and A session. Before we conclude today's conference, please be advised that the replay of the conference will be accessible within 3 hours from now. Transcript will become available 24 hours from now.
Again, wish you a very happy New Year.
Okay. Thank you for joining us today. We hope you will join us again next quarter. Goodbye, and have a good day.