Welcome to TSMC's Q2 2016 earnings conference and conference call. This is Elizabeth Sun, TSMC's Director of Corporate Communications and your host for today. Today's event is webcast live through TSMC's website atwww.tsmc.com. If you are joining us via conference call, your dialing lines are in listen only mode. As this conference is being viewed by investors around the world, we will conduct this event in English only.
The format for today's event will be as follows: 1st, TSMC's Senior Vice President and CFO, Ms. Laura Hou will summarize our operations in the Q2 of 2016 followed by our guidance for the Q3 of 2016. Afterwards, Ms. Hou and TSMC's 2 presidents and co CEOs, Doctor. Mark Liu and Doctor.
C. C. Wei will jointly provide our management's key messages. Then we will open both the floor and the line for the Q and A. For those participants on the call, if you do not yet have a copy of the press release, you may download it from TSMC's website at www.tsmc.com.
Please also download the summary slides in relation to today's earnings conference presentation. As usual, I would like to remind 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 statement. 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.
Thank you, Elizabeth. Good afternoon, everyone. Welcome to joining us today. My presentation will start with financial highlights for the Q2 and followed by the guidance for the Q3. We had a good second quarter.
Our second quarter revenue increased 9% sequentially to NT222 1,000,000,000, exceeding the high end of our guidance given in April, due to business upside resulting from the demand increases in mid and low end smartphones and the customer inventory restocking. Gross margin was also ahead of expectation and increased by 6.6 percentage point Q over Q to a record high of 51.5%, mainly driven by improvement in utilization rate and cost reduction efforts, partially offset by an unfavorable foreign exchange rate. Operating margin also increased by a similar magnitude to reach 41.2%. As we highlighted last quarter, we incurred a higher income tax in the Q2. The corporate tax rate rose to 23% as we accrue the 10% on distributed retained earnings.
And we estimate the 2016 full year tax rate to be about 14%. Overall, our 2nd quarter EPS reached $2.80 a 8.7% decline year over year, mainly due to a non recurring share disposal gain from ASML and Vanguard in the Q2 of last year. Excluding the one off items, 2nd quarter EPS actually grew 17% year over year. Now let's take a look at revenue contribution by application. During the Q2, communication was flat from the prior quarter, while computer, consumer and industrial and standard increased by 19%, 80% and 12%, respectively.
Now how about revenue by technology? Combined revenue from 16 nanometer and 20 nanometer continued to grow and represented 23% of revenue in the 2nd quarter same as the Q1. 28 nanometer contribution fell slightly to 28% versus 30% in the first quarter due to a higher revenue base in the second quarter, but absolute dollar revenue from 28 nanometer continued to increase q over q. Moving on to the balance sheet, we ended the 2nd quarter with cash and marketable securities of NPL668 billion, an increase of NPL19 billion. On the liability side, current liability increased NT163 billion dollars as we accrued about $156,000,000,000 for cash dividend, which will be paid out this month.
On financial ratios, accounts receivable turnover days increased 2 days to 43 days, while days of inventory remain at 54 days same as last quarter. Now let me make a few comments on cash flow and CapEx. During the Q2, we generated about RMB107 billion cash from operations and spent RMB74 billion in capital expenditure. As a result, we generated free cash flow of RMB33 1,000,000,000 this quarter and repaid $11,000,000,000 of corporate bonds. Our overall cash balance increased RMB24 1,000,000,000 to RMB622 billion at the end of the quarter.
In U. S. Dollar terms, the capital expenditure spend in the first half of twenty sixteen totaled US3.4 billion dollars The second half spending will be much more than the first half. I have finished my financial summary. Now let's turn to the 3rd quarter outlook.
We expect our business in the 3rd quarter will benefit from a customer's new product launch and continue inventory restocking. Based on our current business outlook and exchange rate assumptions of 1 to NT32.30, we expect 3rd quarter revenue to be between TWD254 1,000,000,000 and TWD 257 1,000,000,000, which represents 14.5 percent to 15.9% sequential growth. Gross profit margin to be between 50% 52% and operating margin to be between 39.5% 41.5%. This concludes my remarks.
Now we will begin the management comments and we will start with TSMC's CFO, Ms. Laura Ho.
I would like to make few comments on near term outlook, CapEx, profitability and the dividend. Let me start with near term outlook. Our second quarter result was helped by an increase in demand from China 4 gs plus smartphone ramping and continued 3 gs to 4 gs upgrade from emerging markets. Given a stronger than seasonal business for our fabulous customers in the Q2, we estimate our fabulous customers DOI exiting Q2 is above seasonal level. Looking ahead to Q3 'sixteen, we forecast continuing inventory build by the smartphone centric OEMs and fabless companies stimulated by subsidy provided to the telecommunication companies by the Chinese government.
We estimate fabless DOI will remain flat with the Q2, but will be above seasonal level by a few days exceeding Q3. Q4 is normally an inventory adjustment quarter, but the degree of adjustment will be depending on market dynamics and sentiment. For now, we expect the supply chain inventory to go back to the seasonal level exceeding Q4. For the whole year of 2016, TSMC maintains our target of between 5% and 10% growth in both revenue and operating profit, both in U. S.
Dollar and in anti dollars term. Now let me make a few comments on CapEx. Our 2016 CapEx forecast has risen from US9 dollars to US10 $1,000,000,000 to US9.5 dollars to US9.5 dollars to US10.5 billion dollars because expectation for 2017 mobile markets, mobile products revenue has risen as well. TSMC's CapEx to sales ratio, known as capital intensity, has came down significantly in the last 2 years, Compared with the high 40s level seen in 2011 to 2013, our capital intensity has dropped to about 31% last year. Going forward, we estimate our capital intensity will remain at mid-30s level for the next few years.
One major factor contributing to this moderate level of capital intensity is our effort made to minimize the conversion loss between 2 adjacent technology nodes. For example, between 20 nanometer and 16 nanometer, we closely manage 1 peak capacity, so we can minimize conversion loss. Now we also closely manage 10 nanometer and 7 nanometer as one peak capacity to minimize the conversion loss. In terms of profitability, in the past few years, despite the higher CapEx, which led to a substantial increase in depreciation expenses, we have been able to maintain and even improve our structural profitability. We expect to be able to maintain our gross margin at close to 50% level and operating margin at close to 39% level.
My last comment is about dividend. We anticipate a steadily improving free cash flow in the next few years. Therefore, we expect our dividend to steadily increase in the next few years as
well. Thank
you. Let me turn the microphone to Mark for his comment.
Good afternoon, everyone. Thank you for joining us. I'd like to deliver you the message, firstly, on leading edge technology status that include 10 nanometer, 7 nanometer and 5 nanometer. 1st, on 10 nanometer. Our 10 nanometer has been transferred from R and D to production.
Our first 10 nanometer customer product has been produced with satisfactory functional yield. So far, 3 customer products have been taped out to us. More customer product tape outs are expected later this year. Those product tape outs will start a revenue stream starting Q1 2017, which will ramp steeply throughout 2017. On 7 nanometer, our 7 nanometer technology development is well on track.
Its 256 megabit SRAM yield improvement is ahead of our schedule. In addition, we believe our 7 nanometer PPA, that is power, performance and area density with its schedule is ahead of our competitors. This technology has been aggressively adopted not only by mobile customers, but also by high performance computing customers. They all have aggressive product tape out planned in first half 2017 with volume production planned in early 2018. On 5 nanometer, we have been executing our 5 nanometer development since the beginning of this year.
TSMC's 5 nanometer will achieve 1.9 times of logic density over our 7 nanometer. We plan to extensively use EUV lithography in 5 nanometer to improve density, simplify process complexity and reduced cost. The 5 nanometer risk production qualification in first half twenty nineteen remain unchanged. Secondly, EUV status. We plan to adopt EUV extensively in our 5 nanometer technology.
Today, EUV technology uses 7 nanometer as a development vehicle. We have good integration progress in EUV scanner, EUV mask and EUV photoresist. Same EU level has been repeatedly demonstrated using 2 EUV layers in 7 nanometer. Currently, we are running 4 state of the art EUV scanner for EUV infrastructure development and for N7 and N5 technology development. We will move in another 2 EUV high volume production tools that is NXE3400 in Q1 2017 next year.
Recently, we successfully implemented 125 watt EUV source in our EUV 3350 to improve productivity. In our in house mask shop, we have developing unique EUV mask technologies on mask blank, material, inspection and repair to seamlessly integrate our EUV Lithography Total Solution. With all the encouraging development and progresses made at EUV, we estimate that EUV will be cost effective tool for high volume manufacturing by 2020 in time for our 5 nanometer ramp. Should EUV become cost effective earlier, say, around 2019, we believe we can still benefit from the earlier available of EUV for our 7 nanometer high volume manufacturing. Thirdly, on growth drivers.
1st, smartphone as a growth driver. We expect smartphone related demand will support half of our growth in the next 5 years. It will come from unit growth as well as increasing silicon content. Despite a weak semiconductor industry growth this year, we estimate the smartphone unit growth rate will be about 6% and the silicon content growth rate per smartphone will increase by a double digit for high and mid end and about flattish for the low end. We estimate total semiconductor revenue excluding memory in smartphone, will increase about 7% this year.
Longer term, we believe the smartphone unit will continue to grow at a mid single digit rate, and the silicon content will continue to increase. This silicon content increase is driven by the increasing adoption of innovative smartphone features, such as dual camera, security sensing, augmented reality, virtual reality and migration of 4 gs, 4 gs plus and to 5 gs. Most of the high end smartphone features are also proliferating into lower end smartphones Because those innovative features usually require more advanced technologies, with our customers, we will gradually increase our market share in the smartphone market. As to high performance computing as a growth driver, as the digital trend develops in all industry worldwide today, silicon IC will need it to take up vast amount of computation load in the future. We estimate computing opportunities will support about one quarter of our growth in the next 5 years.
In TSMC, we work with IC innovators around the world. We see momentum building up in the computing space for our customers. In May this year, 7 companies announced that they are forming a interconnect consortium called CCIX to enable heterogeneous computing in data centers. In China, cloud leaders and technology company formed Green Computing Consortium aiming to develop energy efficient data centers. We also see increasing activities around machine learning, where system companies differentiate down to the silicon level.
TSMC as a foundry player focuses on enabling our customers' innovation through providing leading edge technology. Other innovations in computing area are augmented reality, virtual reality, gaming and ADAS or advanced driver assistance systems. TSMC has been developing suitable process technologies and design enablements for all those innovations. Above is my message. Thank you.
I turn the microphone to C. C.
C. C. Wei:] Thank you, Mark. Good afternoon, ladies and gentlemen. Let me start with our 16 nanometer status.
We continue to ramp 16 nanometer with defect density and cycle time better than ours plan. Major applications this year include mobile processor, cellular baseband, graphic and video game. We are happy to report that we have been recognized by a major customer for our contribution to the success of a deep learning chip using TSMC's 16 f f plus We expect our 16 nanometer business will continue to increase in the second half of this year with most of the products adopting our 16 FFC, which is a low power and low cost version of the 16 nanometer process. We expect to generate more than 20% wafer revenue from 16 nanometer in this year. Now 28 nanometer, our 28 nanometer has entered its 6th year of volume production.
TSMC's 28 HPC and HPC plus have been widely adopted by most of the mobile application processor suppliers for the faster growing mid- to low end smartphones and other applications such as the Wi Fi, digital TV, set top box, fast controller, etcetera. With our differentiated technology, stable yield, short cycle time and large capacity support, we expect stronger demand for our 28 nanometer Huarra Su this year. Now let me touch a little bit on our competitiveness for those technologies, which has been in volume production, namely 16 nanometer, 20 nanometer and so on. TSMC continues to improve our technologies and development and develop new variants even after these technologies have entered mass production stage. For example, to meet the changing market requirement, we introduced a low cost, low power version, 16 gigahertzc this year, after 16 nanometer started volume production last year.
We also lowered the operating voltage of our 16 nanometer process to 0.5 volt to meet the requirement for IoT applications. Similarly, at 28 nanometer node, we introduced 28 HPC and 28 HPC Plus for the low power solutions who are keeping the speed at almost the same level. For 40 nanometer, TSMC also introduced 40 low power for low power application. For 50 1 nanometer and older node, we apply similar approaches as well. Since we are able to start rolling production ahead of our competition, TSMC has enjoyed a substantial advantage in learning curve.
We are able to accumulate enough experience faster than our foundry peers, and therefore, we can better improve our cost and device performance for each technology node. Because of the learning curve advantage, we believe we are highly competitive in both performance and cost. Now let me talk about our another growth driver, which is IoT in addition to mobile and high speed computation market, which Mark just explained. Driven by innovative business model, we expect the diversified and fragmented IoT applications will become one of the most important growth driver for future semiconductor business. IoT applications require not only the collection of huge amount of data but also the ability to analyze the data and utilize the data to improve our daily lives, such as security and health.
In the near term, we can see smart band and smart watch for hairs care and smart meter for efficient energy and code 7. Longer term, we expect ADAS and autonomous driving be widely adopted. Smart home, smart city, robot drone are also progressing alone. We believe TSMC's specialty technology development in CMOS image sensor, MEMS, RF, power management IC and emerging memory are well positioned to capture the IoT opportunities. Now let me talk about our advanced back end technology.
First, on InFO, we are evolving production now. Our focus today is to continue yield improvement and cost reduction. We expect InFO will contribute more than $100,000,000 revenue in 4Q this year with moderate gross margin. At the same time, we are also developing the next generation InFO technology for products planned for next year and beyond. Now on core WOS, we have seen strong momentum from high memory bandwidth and high performance driven applications such as networking, deep learning and artificial intelligence.
While our cohorts is still in small volume production for those very high speed applications, we see the potential of demand increase as well. We expect to support our customer to grow their business in the high speed computing space with our cohorts as part of our advanced technology offer. Thank you for your attention.
All right. This concludes our prepared statements. Before we begin the Q and A session, I would like to remind everybody to limit your questions to 2 at a time to allow all participants an opportunity to ask questions. Questions will be taken both from the floor and from the call. Should you wish to raise your questions in Chinese, All right.
Now let's begin the Q and A session. I think we will have the pessimistic analyst from JPMorgan to ask the first question, Gokul.
Thank you very much. First of all, on smartphones and growth coming from smartphones being half of growth, and compute also contributing to quarter of the growth. Could you talk about what is the growth picture for the whole company? Are we going to maintain the 5% to 10% growth that we are predicting for this year into the next 5 years? Or how should we think about the growth pattern?
And I have a follow-up on the compute side as well.
Okay. Thank you. You talked about the growth model, right? Okay. We do have a growth forecast within the company, but let me share you with the
big picture.
In our model, we semiconductor has been stay on 0% growth for the past 2 years. For the next 5 years, we estimate about between still about 2% of Tubular Plan Plus to 3%. And the fabless company, because of the business model advantages and the leading edge technology advantages, they will grow about 5% per year in the next 5 years. And TSMC with this not only the fabless company, but also the system company and IDM outsourcing. We estimate we'll grow.
Our current estimate will be about between 5% to 10%, depending on the macroeconomics and semiconductor events. This model is assuming that there is no killer application happen in the next 5 years, okay? And as to the background of this non growth model, we have we are focusing on 4 areas as I presented to you earlier. First is the smartphone, mobile devices, mostly smartphones. And that will drive about the growth 50% of that growth in the next 5 years.
And the high performance computing, that will include the learning, artificial intelligence, the machine learning, AI, gaming, that will grow that would drive about 20 about a quarter of our driving growth in the next 5 years. And autonomous car and IoT and the rest will take up another quarter of the drive growth for the next 5 years. So this is largely our growth model.
So just on the smartphone bit, are we I think we've seen smartphone estimates getting coming down for the last 6 quarters. Are we expecting that smartphone units stay at this 5% to 6% kind of growth rate? Or could adding in most tech markets, once the saturation hits, we get down to probably GDP growth rate, which is like 2% or something like that. Are we anticipating that? And is the future growth in smartphones primarily coming from content growth, which is still pretty decent?
Indeed, the smartphone has been slowing down in the past 6 quarters, particularly for the high end. And actually but at the same time, the mid end sitting and content is increasing very fast and the unit number of the low end also increasing very fast. As far as the high end, we don't believe the trend for the last year drop will continue, okay? Innovation will surface to drive the momentum of the unit growth. So in total, we still estimate the growth rate will be about 5% in unit growth.
Silicon content, I mentioned, is also about equally important. So that's the general model we have.
Just a question on the compute side. Could you talk a little bit about the takeoff of the revenues given that you're expecting tape outs in first half next year? Typically, the end market that you serve in compute, especially the data center compute, takes a bit longer for qualification if you look at server market, for example. Are we anticipating revenues coming in with 7 nanometer in 2018 itself for compute? Or could you talk about your revenue model for the compute part of the site?
The question is regarding the high performance computing, how would that appears to be? At this point, the we think, first of all, the many of the low end servers has some of our smaller customer has penetrated already, okay? But for the ballpark, the main portion of the server, I think it will wait for the 7 nanometer to get some share by our customers. But in the next at least in the next so 7 nanometer will happen in 2018 and afterwards. So you'll start from 'nineteen and beyond.
So it will for the data center, I think it will be a more hockey stick beyond probably really bigger portion beyond 2020. So in the next 5 years, mostly are the computing of the cloud edge devices, of course, including the networking, storage and other cloud edge devices I just mentioned. Okay. Thank you.
Next, we will have Credit Suisse, Randy Abrams to raise the question.
Yes. Thank you. I wanted to ask the first one, actually another one on the growth drivers, just to get a feel for the base. The computing should we think of computing now just that computer end market that's 8% of revenue? Is that when you're thinking about computing, driving a quarter of the growth, it's only 8% of revenue now.
Like, are we thinking the same definition? And within computing, how much are you banking on ARM and IBM based servers versus some of the other things like the deep learning or if it's like the ARVR graphics that you're banking on for most of that growth?
Can you repeat question? Yes.
So the question, the starting point is computing are you when you're referring to computing driving a quarter of the growth, is it 8% of revenue now? We should think of your computing end market category. And for the growth, are you factoring most of that growth from the ARM IBM based servers? Or is most of it more from the VR, AR, AI type stuff?
Okay. When I talk about computing, it doesn't include a lot of PC or tablets or current computing. I'm more category the high performance computing part, of course, data center, networking storage, but mostly is in the next 3 years, I think it will be mostly the machine learning, AI, augmented reality, gaming, those are those computing devices, okay? Data center will not I don't think it will come out a big volume until 2018.
Okay. The second question, I had a 2 part question on the gross margin. For 3rd quarter, if you could go into the factors, sales are up 15%, but the gross margin is kind of flattish. If you could talk about the factors, say, from info or ramp of 16 nanometer, what's driving kind of the factor you're not seeing the leverage from Q2 to Q3 in gross margin with the higher sales? And then the second part is, as you ramp 10 nanometer next year, this year you had the benefit of 16 being a more mature process, borrowing from 'twenty.
So would there be any margin impact on the 1st year of the 10 nanometer ramp in 2017?
Shao Yuan, you referred to the margin for the Q3. As we are continue ramping 16 nanometer, so 6 nanometer will account for bigger part of our revenue in the Q3 versus the Q2. This year is only the 2nd year of the 16 ramp, so it still has some dilution to corporate average gross margin. So this is a negative for the Q3.
So most of it's just 16 in info?
Info is very small quantity, and the quantity comes on the line in the 4th quarter. C. C. Was mentioning the 4th quarter will be bigger than US100 $1,000,000 with modest margin. So it will have some dilution as well, but very small.
Okay. And the second part was if any startup impact on 10 nanometer next year. Since this year, 'sixteen was 2nd year and also helped by the 'twenty learning, so if 10 might have an impact?
Yes. The answer is yes. And we will start to mass produce 10 nanometer from the Q1 next year. So for the whole year, 10 nanometers margin will be below corporate average. So it will be a dilution factor for the next year, whole year.
Okay. Thank you.
Next question will be coming from Citigroup's Roland Chu.
I think your first question is for the high performance computing. On-site for the ARM based CPU for server, 1 being have a significant market share on tier 2020. That time, they expect about 25% of the share. So that means for this ARM based CPU in this high performance computing, probably won't be very limited from now on to maybe 2018. And so let me for the application point, process point of Yatin Nanyue, that actually will be using our 16 nanometer and even 10 nanometer because our 7 nanometer, I think the 1 mass production from 2018.
So my question is, is there any performance gap on this 16 nanometer 10 nanometer in terms of this ARM based CPU performance? So that's why for people cannot use adapt ARM based CPU on the server or even on this high performance computing quickly?
On the ARM based server or anyway, the CPU chip was server indeed, the to the main bulk of the CPU, it will take we will have to work with our customer on 7 nanometer and is ongoing actively. Before that, I think there are customer working on 16 and even 28 to enter low end server already also. But for the other high performance computing application, really, the entry technology is spread quite wide. Just take the ADAS, for example, 28 nanometer is prevailing entry for the ADAS technology in many of the high end cars already. For machine learning, 16 nanometer, what do you see mostly already high volume is on 16 nanometer and entry to developed market already.
The gaming is already also entry in the 16 nanometer soon. It is it's just started in the 16 nanometer already. So for other high performance computing, the application will happen much earlier already on 28 and 16 and 10 also. So that is different than the data center.
Okay. So for this high performance computing will account for 1 quarter of the next 5 years' growth. So how big it will be from this high performance CPU for server or for this data center?
Well, that depends on how much growth we have, right? Right now, I think it's currently our because of the forecast has a big range between 5% to 10%. So it is very difficult to pin down the specific number, but it's about 1 quarter of the growth portion.
On the AMD's CPU in notebook or PC, I think last quarter, Mark, you said you expect it will happen from maybe tablet first. So are you still seeing the same trend? And how big it will contribute to our revenue for the next 5 years? Yes. I look at the transcript.
Okay. Yes. Yes. Tablet of course.
The tablet has been application processor has been widely used in tablet already, right? It's only the tablet growth rate is not growing. The unit number is not growing. So you can calculate how much the revenue is already. So it's not a big number.
Okay. My second question is, look at your second quarter result, your 65 nanometer revenue actually have been increased a lot. So I think that actually has been 65 nanometer revenue have been declined for continues for quarters. And I think there will be a Q1 in the past maybe 1 or 2 years, we see the growth. So can you elaborate now why?
How is the growth driver for this 65 nanometer increase in 2nd quarter?
You are asking about 65 nanometer. Why is increase? Yes. It's because of some major customer, they have increased their demand in automotive area. I cannot say more than that.
Will this be continued into second half or into next year?
I hope so because automotive business is a very steady business and is increasing in the number of units, and we enter into mass production since the beginning of this year. And that's why you see a certain increase.
Okay. Next question will be coming from Morgan Stanley, Charles Charlie Chan.
Chen. So first question is regarding your smartphone content per box. Last year, you gave us some data points. I think this is super helpful. So if you can quantify the absolute dollar of the content in high end, mid end, low end, I think that will be very helpful.
So last year, mentioned that high end content is around $18 to $19 mid end, 6 to 6.4 dollars low in is around 3.4 dollars So what did you see today?
I probably cannot provide specific dollar, but what I can say is the high end content will continue to increase even into the next year. The mid end and low end is kind of flattish.
Okay.
And my next question is on CapEx spending. So you mentioned that the increased CapEx for this year is actually for next year demand. So is that more for 28 nanometer, 16 or 10 nanometer spending?
It's mainly for a 10 nanometer and 7 nanometer combined. We see a stronger demand than we earlier expect, and we require to build more capacity next year.
Okay. Thanks. Just a very quick clarification about management's comments. So firstly is on the cash dividend increase. You mentioned that you will increase steady in coming years.
How about next year? Is it a done deal?
I will not tell you how much. It's steadily increasing. You will know by then.
But will you start from next year? Will you start from next year?
Yes. We mean we have been increasing dividend quite a bit. And we mean it. When we say steady increase, we mean every year we'll consider to increase
dividend. Thanks. And Mark mentioned that you will
Well, Charlie, this is already going beyond 2 questions.
Sorry about that. Sorry.
Okay. The next question will be coming from Goldman Sachs, Donald
Lu. My first question is on EUV. I think TSMC and Mark just commented that TSMC plans to insert EUV at 7 nanometer if it is mature enough before 2020 before 5 nanometer. My question is if another foundry, let's say, start 7 nanometer with EUV versus TSM C insert EUV at 7 nanometer? What's the implications on performance and product?
For example, will TSMC's customers have to redesign the 7 nanometer when you insert EUV in the 2nd year of the technology ramp? So that's my first question. The second question is on demand. I think what is the smartphone as a percent of revenues in the Q3? Will this be, let's say, 60% revenue or less?
And also, when you're saying in the next few years, smartphone would be half of the growth? Would you imply smartphone and non smartphone will grow at about the same pace?
Okay. On the first question on EUV, our 7 nanometer will be qualified Q1 next year, so it's only 3 quarters from now. Definitely, EUV will not be ready. And our customer product tape out will happen in first half next year. Definitely, we cannot put our customer at risk using EUV.
So this is because we are very aggressive in delivering 7 nanometer, and indeed, adoption is very wide range. Our plans to aggressively using EUV will be in 5 nanometer, where the 5 nanometer will start will finish core in the first half of twenty nineteen. And so we already starting 5 nanometer development. And EUV at this time, we cannot use that as a volume for R and D because doing R and D, a lot of activity, a lot of activity going on. So we choose that.
We aggressively get into 7 nanometer without EUV, and we extensively target EUV on 5 nanometer. Yes, indeed, some of our customer one of our customer plant EUV plant EUV on their 7 nanometer. But that is only very, very the schedule wise is very similar to our maybe a little bit ahead about 5 nanometer, a few quarters. But our 5 nanometer is 2 steps down. The density is very aggressive using EUV and learning after 7 nanometer will be very safe on the 5 nanometer.
Had the UV available before 2020, we consider using our 7 nanometer technology as a base to adopt EUV for the probably the 2nd wave products. But as far as but we want to minimize these design changes so that all the customer coming to our 7 nanometer will be easily adopt the what we can reap from the EUV on 7 nanometer. So that is our plan. I think we develop our technology at the best timing for our customers' products. So that is our current plan.
Second question is on smartphone as a percent of revenue in the 3rd quarter after Apple ramp. And also, would you imply smartphone, non smartphone will grow at the same time?
I don't know about the 3rd quarter, but generally, we current smartphone is about 55% of the corporate revenue, wafer revenue, okay? And yes, if the growth in the next 5 years, smartphone related will be half of that.
Related to this, what about earnings volatility? Because for 'sixteen or especially 10 nanometer, your largest customer will be essentially dominating this the leading the leading edge capacity with very limited number of customers?
I think, 1st of all, we are everyone's foundry. Our customer covers all areas of the application. We do have big customers. That is not new. I think your question is the volatility of the big customers.
Yes.
For 10 nanometer, let's say, your largest customer take 80% of the capacity. And if he has 2 seasonal or inventory issues, then you I feel it.
Well, that's why we design our 7 nanometer equipment wise is 95% convertible. So ballpark is can consider investment wise, 10% and 7% are can be converted easily. So that's how we minimize the volatility of the 10 nanometer.
Next question will come from Deutsche Bank's Michael
Zhou. One question. Do you expect ASP increase for this year? ASP increased for this year.
ASP. You're asking ASP? Yes. ASP increased
for this year, for whole year.
You're talking about a blended ASP?
Blended ASP.
Yes. We expect blended ASP will go up this year.
Would that be low single digit or?
I prefer not to quantify that.
2nd question, Sisi, you mentioned the 2nd generation of InFO for next year product. Will that be for 7 nanometer product or 10 nanometer? Starting with 10. Starting with 10, right? So it will start to have revenue contribution next year, second stage.
It should have. The first half or second half? 2nd half.
2nd half, probably more probably. Thank you.
All right. I think we will start questions that has been queuing in the line for quite some time. Operator, could you please have the first caller on the line?
Sure. Our first question is from the line of Brett Simpson, RBC Research. Please ask your question. Thanks very much. With regards to inflow and CO OP, as I see it, you're moving from 7 wafers to 7 turnkey chips only to die, which is a big change in your business model.
If you look at over the next few years, when you ramp 7 nanometer, what portion of your leading edge sales might be adopting this new turnkey model? And when it comes to DRAM memory and package, does TSMC take responsibility for sourcing and holding inventory for memory? Or do you expect your customers to fix this? Thank you.
Okay. Let me repeat Brett's question. He's asking how much of our 7 nanometer business will also be using either info or COOS that TSMC is providing a turnkey solution. What's the proportion of our 7 nanometer business that will be of this type of business model. And then the second part is about memory in the packaging solution.
If memory has any problem, whether it will be TSMC or the customer who is responsible for that problem.
Well, let me answer the 7 nanometer. Is that how much of the percentage will use core words and the info together or is it just core words?
Just TunKey solution.
TunKey solution, probably quite a big portion because of we offer InFO for very cost effective packaging service and that will help to improve the total packaging efficiency in terms of chip area or in terms of segments. For cobalt, you are here up to 7 nanometers are high computation space to competing a very high performance area. That will be a smaller percentage, but we see the potential. That's what I just mentioned in my presentation. So put all together, I would expect quite a significant amount of 7 nanometers product will be using either COOS or InFO.
That's one thing. Talking about the memory stacking together with 7 nanometers chips, we certainly, we offer the 10 key solution, And but we are very flexible in working with the customer that all the possible combination are all possible.
Does that mean that you would purchase the memory and book the memory sale within the overall package? Or would you leave your customers to purchase the memory and take inventory risk?
Well, let me see if I can if I hear you correctly. You are asking whether or not we are paying for the memory and then charge the customer as part of the revenue that we obtained from info or it is separated?
C. Wei:] Exactly, yes. Okay.
Okay. We don't buy the memory per se. We work with a memory supplier so that their spec in terms of mechanical stress, in terms of a lot of things, the phthalates or those kind of thing, we work with them, but we don't buy memory and resell to the customer. However, we are responsible to stacking them together and as a whole packaging to our customer.
And maybe just one final question. When you look at TSMC 7 nanometer for high performance compute, can you give us your perspective? I mean, how would you typically compare this to Intel's 10 nanometer, which will be in production relatively similar timescales? Yes. Thank you.
Can you repeat the question?
Yes. How do we compare our 7 nanometer's performance and whatever the characteristics versus Intel's 10 nanometer, which, Brett believes that time frame wise, we are about to offer in these two technologies about the same time?
Well, you have to ask our customers. I cannot speak for them. They have they definitely have their plan, and we deliver our technology. And of course, as you know, the they deliver their architecture differentiation. So really, the end product performance depends on multiple factors.
So I cannot speak for my customers at this point on this.
Okay. Let's move to the next caller on the line. Operator, please.
Sure. Our next question comes from the line of Steven Pellego from HSBC. Please ask your question. Yes. First question is on 20 nanometer.
It's still your largest segment, but it did decline last year, yet the total company still managed to grow about 10% or more in 2015. What do you think for 28 nanometer this year? What type of growth, I assume you think it's going to grow this year. Are you expecting?
Stephen, we really cannot hear you that well. Can you sort of move a little bit away from the microphone? And you're asking about revenue contribution from different geometries? Yes, please.
No, I was asking specific to 28 nanometer node. It's still your largest node, and yet it declined last year. And Bill, I was asking for this year, do you expect it to grow and by how much?
Okay. Whether or not we will grow 20 nanometer and by how much in this year?
Correct.
Well, Stephen, in fact, we deliberately combine 16 nanometer with 20 nanometer and we report that as one node. So we do not separate that, sorry.
I was talking about specifically 28 nanometer. 28 nanometer.
That's 28 nanometer.
I expect that to grow.
Sorry, 28 nanometer. 28 nanometer, do we grow 28 nanometer and by how much this
year?
While LoRa is checking with the number, all I can say is our revenue this year, slightly lower than last year, slightly, but percentage wise because our revenue increased. So the percentage of the 28 nanometers of revenue.
CC, actually, according to our forecast, 28 nanometer dollar wise will be higher this year than last year.
Higher? Okay. Good. As I said, stronger demand in the second half.
So I confirm that.
I apologize.
Okay. That's fine. The reason why I'm asking the question is really to talk a little bit about above 28% here. Competitors like us might see are growing very fast this year and their capacity constraints. They don't really have any 28 nanometer really to speak of.
So what's going on with the above 28 nanometer node? So above 28 nanometer, it seems like maybe TSMC's share. Is that right? Is that just China's influences? How would you respond to that question?
All right. His question is for bigger nodes, bigger than 28 nanometer, how does TSMC what's our strategy compared to other foundries who are growing shares in those bigger nodes?
Okay. For the order generations, our strategy is simple. We don't particularly to increase the capacity. We instead, we develop some derivative technologies such as in the CMOS image sensor, embedded flash, power management IC. So to keep that whole capacity fully loaded, that's our strategy right now.
We don't substantially increase the capacity as other foundry peers do it.
And maintain good profitability.
Okay. That's great.
Thank you. Okay. That's fair enough.
My last question, if I could just sneak in here, is about the cash dividend. You guys are raising your dividend. Nick, you're generating more free cash flow every year. So you're growing your cash balance. I'm curious when does this become too much, when does it start to impact your goal of sustaining kind of greater than 20% ROE?
Is there an optimal cash level and an optimal capital structure that we could talk about instead of focusing on the dividend payout ratio?
So Stephen's question is we have been growing free cash flow every year and our cash balance continues to go up. What would be a capital structure of TSMC or payout ratio?
Stephen, we don't use payout ratio. Our dividend policy has rooted as a sustainability, and we have started to pay dividend since 2008, since 2004 actually and there is a very long period of time, we paid $3 every year for a consecutive 8 years and then we significantly increased the dividend to $4.50 a year ago and then to $6 today. So if I look at from today's forecast and we have confidence we can continue to grow our free cash flow every year. That is why I say, the dividend policy will kind of change from sustainable to sustainable and increasing. So that's the thinking that we have in mind.
And is the current $668,000,000,000 in cash, is that an excess amount that you need? Or what is an optimal cash level to run your business? That's my last question.
The optimal cash position depends on what you do with your cash, okay? I think for now, our cash is mainly to support our organic growth. We may have some M and A, but we don't know at this moment. So we will try to be a little bit conservative in keeping enough cash to do the both, one way to support a sustainable increase in dividend. On the other hand, to have some buffer if there is M and A case.
All right. Operator, let's move on to the next caller on the line, please.
Our next question comes from the line Mehdi Sultani from SDG. Please ask the question. Thank you. I have two questions, one on CapEx. I know a couple of years ago when first started investing 20 nanometer, there was a surge in CapEx as you were preparing 'twenty.
And now it seems like 10% and 7% are pretty much comparable to 'twenty and 'sixteen. And back then, a couple of years ago, after significant spending in 'twenty, then there was a period where your CapEx came in flat or even last year, it declined. Should we assume the same kind of a CapEx spending looking forward, especially since 10/7 are comparable to 2016?
You repeat the question?
Right. Madhik's question is when last time he saw TSMC having a surge in CapEx, that was the time when we built 20 nanometer, when we ramp 20 nanometer. He is asking whether same type of CapEx pattern will be repeated in the future when we ramp, say for example, 10 nanometer?
We don't believe so because as Mark was mentioning, there's a very high percentage of conversion rate. So when we roll to the next generation of technology, a big part of it will be converted from the previous generation. So you will not see a step up type of things that we have experienced in the past. It will be gradually increasing.
Right. A step up is happening in 2016. So in 2017, your CapEx may not increase actually may be flat or down as the conversion starts to take place. Is that correct?
Whether 2017 CapEx will be flat or down compared to this year because of conversion?
It will not. It will not. As I just said earlier, I think you will not see a step up kind of things. But we will look at the business every year and depending on how much leading edge capacity we want to build in that year also depending on the profile of the ramping that also another factor that will affect our CapEx. It's probably better to follow my earlier guidance that the we believe in next 5 years, our CapEx intensity will be in the range of mid-30s.
Okay. Now
And I have a follow-up question regarding the near term trend. You said that the customer data inventory is going to increase in Q3 and you're not sure about the sell through. Is it going to take quite a couple of more months to better determine if customers are overburdening? Or do we have to wait till like January, February time frame? How do you assess this?
Because your commentary is a little bit confusing, especially regarding these inventory.
All right. Mehdi's question is how do we know whether or not the inventory that we are seeing today will be too much? Do we have to wait until next January or February to know? Or do we have a method to assess?
C. Wei:]
Well, indeed, we cannot see crystal clear about sell through. What we have tell you about the unit growth is really the sell in sell in to the phone service providers. So sell through, indeed, there are uncertainties, but we see the growth of we assume the growth of 6% increase. And the model we the inventory level we cited is assuming the sell through is also a 6% increase. If this differs, then the inventory level will also differ accordingly.
Thank you.
All right. Thank you, Mehdi. Now let's come back to the floor. And the next question will be from Credit Lyonnais, Sebastian Ho.
Thanks for taking my questions. So my first question is to follow-up on the back end, the Vans back end technology. So, CEC guided this year, 4th quarter revenue of info will be above at least $100,000,000 So can you give us some guidance for the next Q4 next year and also the Q4 2018 when info and co was combined?
The Q4 this year is high volume ramping. Following next year, it's supposed to continue this kind of production, I believe. So next year, the whole year will be much better than just this quarter times 4. You are talking about in 2018, CoWoS and InFO together or 2017? 2018.
2018. I would believe CoWoS has a high potential, but it's still a small volume as compared with the InFO. InFO is much more high volume production. So most of the revenue will come from InFO. Okay.
So based on your Q4 2016 guidance, it will probably account for 1% to 2% of your 4Q revenue for info. So is there any in terms of revenue contribution percentage for 2018 in terms of info and COOS combined? Would it be higher this 1% to 2% run rate?
I would hope so, but I don't know that 2018 is a revenue yet.
Okay. And my second question is on the 7 nanometer and 10 nanometers. So 6 months ago, I remember I asked the questions and Mark and C. C. Answered me that the 10 nanometers revenue contribution in 4Q next year will be higher than the revenue contribution of 20 nanometers back in Q4 2014.
So I wonder does that still hold?
Elizabeth, can you repeat the question? I don't quite get it.
Sebastian's question is compared to 2014 Q4 revenue from 20 nanometer with 2017 4th quarter revenue from 10 nanometer, which one will be bigger?
Amy, right now, we the dollar wise, we think is bigger, okay? But the percentage wise is next year's business. So those numbers are too early to predict at this point, yes. But it's 10 nanometer is very is pretty, very strong, and we cannot give you a specific number for that. It will be around similar level, I think.
I think 4Q 2014, our 20 nanometer was 21%.
Yes.
But 2014 compared to 2017 will be a smaller year overall wise.
Okay. Understand. And given that you have more tables on the and design tables on the 7 nanometers compared to 10 nanometers. So we can assume that by Q4 2018, the 7 nanometer revenue contribution or in dollar amounts should be a lot higher than 10 nanometer contribution Q4 2017.
This is 2018 and we are middle of 2016, Sebastian. Whatever the guidance we can give you may not be reliable.
But you guys have a very long visibility.
Not that long. Not 2.5 years.
I think we're going through ramp, 10 nanometer going through ramp next year. And 7 nanometer will 7 nanometer and 10 nanometer will continue the ramp in 2018. Okay. Thank you. Okay.
Next question will be a follow-up from Morgan Stanley's Charlie Chan.
Thanks for taking my question again. So I just want to clarify Mark's comments on smartphone market share. So you mentioned that you believe you can continue to gain market share in the smartphone semiconductors, but now you essentially have a very high market share now except for those in house production from Samsung. So where is the upside for this market share in smartphone?
Well, we and our customer work together to increase their shares. And we will yes, currently, our smart share smartphone with our customer market share is already very high. And but we will gradually increase we think we will gradually increase further, okay? And many of the our customer today in mid end were also attempting to get into the high end. And particularly, the silicon content of high end and mid end also increasing, which favors leading edge technology, what we provide.
So those are the reason those are the advantages that we have with our customer to be able to get increase the market share we have. Okay.
That's very clear. So gain market share along with your customers. Okay. So I just want to follow Donald's question on this short term volatility, right, because you risk CapEx for next year 10 nanometer demand, but I think the fact is that you disclosed in your 20F, right, Apple and Qualcomm, each accounts for 15% of your 2015 revenue. And we all know that Qualcomm may walk away to Samsung temporarily.
And for Apple, you also mentioned that you cannot predict the sales of, let's say, iPhone 7. So how can you be the confidence to spend the CapEx for 2017, 10 nanometer demand?
We cannot give you a specific number, it doesn't mean we are not confident. I think, of course, we want to support our customer for any growth opportunities this can achieve. At the same time, we manage carefully about our capacity build up. So this is a very complicated discussion and with our customers. So at this point, I think we will those capacity we built will be needed by our customers.
Is
there any early indicator you will win, keep very high market share as a 10 nanometer project for the customer?
Yes, we have been working with customer for a long time for 10 nanometer and we believe our market share will be more than 70% next year.
Okay. Thanks.
Okay. Follow-up questions from Citigroup's Roland Xu.
Xu. Thanks. I just want to take your assumption for 16 nanometer gross margin to be about 1 percentage point dilution of the corporate average in 2nd quarter and 3Q. So I just did a calculation. It seems in 3Q, actually, we don't have any benefit from the higher utilization on gross margin point of view.
So does that means in 3Q, the average is 16% revenue growth is mainly from the product mix
change.
The hotel is announcing a fire on the 29th floor. Are you sure? Yeah. Okay. It's not a real fire.
It's just a drill. It's a fire drill taking place at this time. So we will continue. Okay.
Yes. Yes. I think TSMC's practice is that when you have this long day, everybody needs to evacuate. So okay, I think my question just to repeat my question, I just take your assumption, 60 nanometer gross margin to be 1 percentage point dilution of the corporate average in 2nd quarter and 3Q. And my calculation shows in 3Q, even though we have about 16% revenue growth, however, we don't it seems we don't have any gross margin benefit on the higher utilization.
So is that means that this 16% revenue increase is mainly from the product mix change or in 3Q, we have higher depreciation to have a drag of the gross margin? Thank you.
So basically, Roland, your question is whether or not we will have a higher utilization rate or a lower utilization rate in the 3rd quarter compared to the 2nd quarter. And that's the reason for not giving you a 55% gross margin, right?
Yes. And if the depreciation is much higher than
the It's a combination of many factors. We do have higher depreciation. Just imagine, we have back end loaded CapEx. So it's naturally depreciation will go up from second half. That's one thing.
And also, we are ramping 60 nanometer, which we still have some dilutions. And we have a bandwidth utilization in Q3 as well. So if you took all those three factors together, that's the guidance that was provided grounded based on those.
Yes. So can we have a rough number for how high the depreciation in 3Q it will be?
I think it's $2,500,000,000 more.
Yes,
it's about 2,500,000,000 NT dollars quarterly depreciation.
So it's about 1 percentage point lower in gross margin?
Roughly. Yes.
Okay. And the whole year depreciation is still increased by mid- to high single digit. Is that the sense?
It's in the mid the range of mid teens, year over year. Mid teens. Mid teens. Mid teens, yes.
Less is very different from the number you talked
No, I was talking about the same thing. Yes, depreciation year over year will increase by meetings, yes. I didn't change that.
Okay. No, no, I think it's not.
Low single digit.
Mid to high single digit.
I'm sorry, I'm sorry. I was looking at wrong line.
Yes, mid single digit. Okay. Thank you for the clarification. And the last question for the DIY inventory. For us, you said in 3Q, we are still customers still restocking in 3Q and 4Q will be restocking and inventory days were back to seasonal label.
So does that means that from first half first quarter next year, are we going to see a normal seasonality normal quarter in Q1 or customer are going to restocking again from Q1 next year? Thank you.
I think there are still uncertainties depending on how the inventory situation in the Q4 and over sentiment in the Q4. So it's a little bit too early to say that.
Okay. Follow-up question from Credit Suisse, Randy Abrams.
Thank you. Just to follow-up on Roland's question, to pull it back to Q4, where you talked about the inventory and the high base. Is there a way to think about it relative to seasonal? Like what's the seasonal Q4 and then if you're thinking it's normal or below seasonal? Your question is 4th quarter, like what you'd expect normal seasonal.
You mentioned it's normally a correction quarter. So what's the normal magnitude? And then how you see at this stage, it could change, at this stage, how you see it relative to seasonal?
4th quarter is a seasonally will correct. It's will correct. And what we say from 3rd quarter, little bit higher than seasonal going to Q4 seasonal, including both factors, correcting the deviation of seasonal and also between Q3 and Q4, seasonal will be corrected. The days will decrease.
Okay. But do you think the decline because it was above seasonal in 3rd quarter and inventory above, we could see below seasonal 4th quarter? Do you expect you could see a below seasonal 4th quarter?
No, no. We see it's close to seasonal.
Okay. My follow-up question, IoT is one of your growth drivers. Your competitors like Samsung GlobalFoundries have been pitching FD SOI. Do you see any merits to that track? Or like how do you see customer interest in that relative to the strategy you're adopting?
And any need to consider that in the future?
Well, let me answer that question. For the FD SOI, the merit is kind of low power consumption, which I think TSMC has offer a complete set of technology road map for the low power applications like we started from 14 nanometers low power, then entering into 28 nanometer, now even 16 VFET, we offer down to 0.5 volt operation voltage. And according to our experience, we're talking or working with our customer, the roadmap has been very satisfactory to their product needs. So we expect we are very well positioned to capture that all the opportunities.
Let me add to that. I think FDO SOI may be useful for specific product, but our bulk CMOS, ultra low power has a much bigger ecosystem design ecosystem. And IoT is a very fragmented designs. And many, many customers are trying to enter that. So we think the ecosystem of the our bulk CMOS is much, much useful for our customer than the niche FD SOI application.
Okay. There's a question in the back. I think you are Merrill Lynch sales, right? No, you are not. UBS, sorry, the lady in the back is sales from UBS.
Thank you, Doctor. Sun. This is Julie from UBS. My question will be actually more simple than the analysts. I'm actually quite interested regarding to the market share comment that Mark has made.
I'm just wondering regarding to the market share gain, would that be coming in from, let's say, your existing clients making into higher end of smartphone tapping into area that never happened before. That's one thing. That's called market share gain, right? Secondly, is it existing client coming back to you? That's also a market share gain.
So which one would that be?
Both.
Yes.
So which one is happening faster?
It happened at the same time.
Okay. And would you be able to quantify the market share of TSMC in smartphone?
Currently, we are about 55%, and we expect to increase from that number further, up gradually.
Okay. And my second question is actually what's TSMC's view on ASML buying Hermes? Does that help you going forward in terms of tools procurement? Or could you comment on that?
HMI Hermes has this same defect inspection tool. It can detect very fine feature on wafers. And SML and HMI merger intent to be able to develop the lithography more precisely control according to the wafer images. So I can only speak from industry or technical perspective that definitely will help the capability of a lithography tools and therefore help the technology capability and help the technology development for their customers. That's my comments.
Well, all right. Last question coming from Credit Lyonnais, Sebastian Ho.
Thank you, Doctor. Tong. Just two quick follow ups. So first one is we noticed the consumer application in 2nd quarter increased significantly both from quarter on quarter and year on year perspective. Can you can Cece or Mark comment on that?
Video games.
Okay. Thank you. And a very quick one. And the last one is the on the CapEx increase about USD 500,000,000 So I wonder whether that suggests some pull in of the 10 nanometers expansion.
Yes, yes, it is. It's for 10 nanometer. Yes, we need a bigger capacity next year.
But he is asking whether it's a pull in, which is a schedule issue?
For next year, it's not. It's just higher demand. So we need more capacity.
So that's that doesn't have any correlation with the mass production schedule?
Schedule, Steve.
Okay. So a follow-up on that one is that the does the CapEx mix still about like 10% go to back end within the in terms of the new CapEx? Or they were skewed more toward the advanced packaging sorry, advanced technology migration on 10 nanometers and 7 nanometers
for this year. The back end CapEx for next year probably will be much smaller than this year because we build up in for the capacity already. Next year, we're going to be the 2nd generation, probably just improve the some features. That's all.
Thank you.
Okay. I think it's about time and thank you very much for coming to our quarterly conference and I hope you will join us next quarter. And our transcript will be available very shortly as well as the video replay. Thank you.