[Foreign language] 各 位 投 资 界 及 媒 体 的 朋 友 们 ， 大 家 午 安 。 我 是 台积电 企 业 讯 息 处 的 孙又文 ， 欢 迎 您 今 天 来 参 加 我 们 2016 年 第 一 季 的 法 人 说 明 会 。 由 于 本 次 法 说 会 是 向 全 球 投 资 人 同 时 连 线 转 播 ， 所 以 我 们 会 全 程 使 用 英 文 ， 请 您 见 谅 。</Foreign language>Welcome to TSMC's first quarter 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 at www.tsmc.com. If you are joining us via the conference call, your dialing lines are in listen only mode.
As this conference is being viewed by investors around the world, we will conduct this event in English only. The format for today's event will be as follows: first, TSMC's Senior Vice President and CFO, Ms. Lora Ho, will summarize our operations in the first quarter of 2016, followed by our guidance for the second quarter. Afterwards, Ms. Ho and TSMC's two Co-CEOs, Dr. Mark Liu and Dr. C.C. Wei, will jointly provide our key messages. We will open both the floor and the line for Q&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 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. Now I would like to turn the podium to TSMC CFO, Ms. Lora Ho, for the summary of operations and current quarter guidance.
Thank you, Elizabeth. Good afternoon, everyone. Thank you for joining us today. My presentation will start from financial highlights for the first quarter, followed by the guidance for the second quarter. First quarter revenue came out slightly better than we had expected. Although the February 6th earthquake caused some delay in wafer shipments in the first quarter, we saw business upside resulting from demand increases in mid and low-end smartphone segment and customers' inventory restocking. Therefore, our first quarter revenue was essentially flat from the fourth quarter last year compared to about 2% decline we guided three months ago. Our first quarter gross margin was 44.9%, and operating margin was 34.8%. Both are 3.7 percentage point lower than fourth quarter last year due to lower utilization and the negative impact from the earthquake, which I will provide more detail later. Overall, our first quarter EPS was TWD 2.50.
Let's take a look at revenue contributed by applications. During the first quarter, communication and consumer increased 4% and 15% respectively, while computer and industrial standard decreased 7% and 9% respectively. Let's take a look at revenue by technology. 16 and 20 nanometer contributed 23% of our total wafer revenue in the first quarter. In addition, 28 nanometer saw a nice rebound in demand and contributed 30% of our total wafer revenue. Together, these three advanced technologies accounted for 53% of total wafer revenue. Moving into the balance sheet. We ended the first quarter with cash and marketable securities of TWD 648 billion, an increase of TWD 62 billion. On the liability side, current liabilities increased TWD 24 billion. The increase included the reclassification of TWD 10 billion bonds payable from long-term to current.
During the year of 2011 and 2013, TSMC issued corporate bonds totaling TWD 211 billion to support the capital expenditure. These bonds will gradually become due starting from this current quarter. On financial ratios, accounts receivable turnover days remain at 41 days. Days of inventory decreased by eight days to 54 days, reflecting more shipments from finished wafers and earthquake impact. Let me make a few comments on cash flow and CapEx. During the first quarter, we generated about TWD 122 billion cash from operations spend TWD 38 billion in capital expenditure. As a result, we generated free cash flow of TWD 83 billion this quarter, and overall cash balance increased TWD 55 billion to reach TWD 618 billion at the end of the first quarter. I have finished my financial summary. Let me turn to the second quarter outlook.
We expect our business in the second quarter will benefit from continued inventory restocking and the recovery of the delayed shipment from the earthquake. Based on our current business outlook and exchange rate assumptions of one US dollar to TWD 32.30, we expect second quarter revenue to be between TWD 215 billion and TWD 218 billion, which represents 6%-7% sequential increase. Gross profit margin to be between 49% and 51%, and operating margin to be between 38.5% and 40.5%. In the second quarter, we will again need to accrue the 10% tax on undistributed retained earnings. As a result, our quarterly tax rate will be about 24% in the second quarter. The tax rate will then fall back to 11% level in the third and fourth quarter, and full-year tax rate will be about 14%.
Let me give you some comments about the earthquake impact and this year's profitability and CapEx. On February 6th this year, an earthquake of 6.4 magnitude struck southern Taiwan and caused damages to certain parts of our tool in our manufacturing site in Tainan, and it disrupted production. As a result of wafer shipment delays, we have pushed our delivery of about 90,000 12-inch wafer from first quarter to second quarter. The financial impact of this earthquake to TSMC is as follows. First, it reduced our first quarter revenue by about TWD 7 billion, and it lowered first quarter gross margin by 2.2 percentage point. About 1.1 percentage point reduction is due to the losses associated with the property damage and the wafer scrap, net of insurance claim. Another 1.1 percentage point is contributed by the loss of productivity.
The impact to our first quarter operating margin is about 2.4 percentage point. The negative impact to first quarter operating income in dollars is about TWD 7 billion. Wafer shipments that are delayed to second quarter will benefit our second quarter revenue by about TWD 7 billion, and contributed positively to second quarter gross margin by about 0.7 percentage point, to operating margin by about 0.9 percentage point, and a positive impact to second quarter operating income in dollars is about TWD 5 billion. On a full-year basis, overall impact from the earthquake reduces our gross profit and operating profit margin by about 0.2% each point each, and reduces our 2016 operating income by TWD 2 billion. Let me say a few words about 2016's profitability and capital expenditure.
Regarding our structural profitability, as you may know, in the past six to seven years, we increased our structural profitability by four to five percentage point to the upper 40% range. We are optimistic that we can maintain that level in 2016. My last comment is about 2016 CapEx. In the last investor conference three months ago, we have stated our 2016 capital budget to be between $9 billion-$10 billion. We maintain the same guidance range today. This ends my remarks. I would like to turn the podium to our Co-CEO, Mark Liu.
Good afternoon, everyone. Let me start to give you a report on our near-term demand and inventory outlook.
Our 1Q16 revenue is essentially flat from 4Q15, however, exceeding our February 17th revised guidance. This result was helped by an increase in smartphone demand for China and emerging markets pull-in from second quarter and faster recovery from earthquake, which offset the weakness and seasonality in the high-end smartphone sector. We estimate our fabless income days of inventory to increase from two days below seasonal, exiting 4Q15, to above seasonal level ending 1Q16. Looking ahead for 2Q16, we forecast a growth of 6%-7% quarter-over-quarter in TWD, or 8%-9% in US dollars. Most of our fabless customers may see an above-seasonal growth in 2Q16, driven by OEMs' new product launches and inventory restocking in the supply chain. We estimate days of inventory will still be close to seasonal level exiting 2Q16.
Due to the world macroeconomic uncertainties, we reduced our estimate of 2016 smartphone growth from 8% to 7%, PC from -3% to -6%, tablet from -7% to -9%, while maintaining digital consumer electronics growth rate at -5%. In spite of the reductions of these growth rates, there are still growth areas in smartphones, broadband network, wireless infrastructures, and gaming. For smartphone growth, momentum comes from China's 4G+ deployment through increases of operator subsidy and a continued 3G to 4G upgrade in emerging markets. These factors will also drive the associate infrastructure growth. Recently, we also see good demand from gaming GPU and game console processor for VR applications. For the whole year of 2016, we estimate the growth of world semiconductor to be about 1%. We maintain our estimate for the foundry market growth of about 5%, and TSMC revenue growth of 5%-10% this year.
Now I move on to leading-edge technology. Let me give you a first on N10 update. We have received N10 customer product tape-outs in 1Q16. We are actively preparing for more customer product tape-outs in the following quarters. Most of our N10 users are for mobile products. We will put this technology in production in 2 of TSMC's 12-inch gigafabs. Those tape-outs will drive a sizable demand starting from 2Q17 through 2018. On 7 nanometer technology, N7, the technology development is well on track. N7 is a further extension of N10 technology, with more than 60% in logic density gain, and 30%-40% reduction in power consumption. N7 fully leverages N10 yield learning and shares more than 95% of common tools. We have expanded our N7 design ecosystem development to include both mobile and high-performance computing to enable our customers to deliver their first-to-market products.
Our N7 adoption is very strong, with customers ranging from mobile GPU, game console, FPGA, network processors, and other consumer applications. We have more than 20 customers in intensive design engagement with us and expect to have 15 customer tape-outs in 2017. The volume production of N7 will start from first half 2018. Now on EUV, we have made good progress in the EUV development with ASML. Recently, EUV development gained quite good momentum across the industry. Tool source power of 60-80 watts is capable of becoming operational in fab now. We are working on the tool reliability under fab operating condition. EUV photoresist, mass fabrication, particle control, and basic modules have all made good progress. We recently demonstrated a reasonable yield on our N7 yield vehicle, 128 megabit SRAM, using 1 EUV layer.
Currently, development of a reliable EUV mask pedicle is another focus to enable a mass production operation. Next, I want to give you an update on growth driver for our leading-edge technology. Where the demands comes from for our leading-edge technologies. First, mobile. We see continuing technology advancement in baseband application processor, RF transceiver, and wireless connectivity to meet the demand of LTE-Advanced specifications. The growth of 4G data rate through carrier aggregation and high-frequency Wi-Fi drives the need for more complex and larger chips. All the above drive the demand for our N10 and N7 technologies, which will enter production in 2017-2019. The next emerging 5G standard also prompts our customers to develop state-of-the-art base station and baseband application processors to capture early business opportunity using our N10 and N7 technologies. Second area is high-performance computing.
We also work closely with our customers to address the opportunity in the high-performance computing market. We work with Arm to co-optimize its CPU cores with TSMC solutions to enable our customer to deliver their products in a cloud computing market. Today, our customers have only a very small market share in cloud computing, mostly in networking and storage applications. With TSMC's high-performance computing technologies, we will support our customers to participate in this fast-growing cloud computing market. Last area is VR/AR, ADAS, and so forth. VR/AR, deep learning, and artificial intelligence, AI, are the emerging applications that will require leading-edge technologies. Consumer-oriented VR/AR products for immersed gaming and immersive video viewing experience have begun shipment in 1Q this year.
The data transfer rate of VR/AR products in interactive design, remote training, and multi-site conferencing must still be enhanced by 10X from today's level in order to enable quality viewing experience. All these applications require low power and high speed GPU and CPU, and therefore requires our leading-edge technologies. We see increasing demand also both in enhanced safety and improved infotainment system in automotive applications. The ADAS, Advanced Driver Assist Systems, include adaptive cruising control, emergency brake, collision avoidance, lane tracking, and auto parking assistant. The advanced infotainment system includes both high performance multimedia applications. Both automakers and tier 1 module suppliers are defining the specs and increasing their adoption for ADAS and advanced infotainment systems. This trend will certainly also speed up the adoption of TSMC's leading-edge technology. That's my report. Thank you. I'll turn the podium to C.C. Wei.
Thank you, Mark Liu. Good afternoon, ladies and gentlemen. Today I will update you the status of 16 nanometer, 28 nanometer InFO and specialty technologies. I will also talk about their role as a growth driver. First, on 16 nanometer. We continue to ramp 16 nanometer with yield and cycle time better than our targets. Applications in mobile processor, cellular baseband, video game player, PC graphic will contribute significant to our 16 nanometer shipment this year. Meanwhile, we also begin shipment for other applications such as Ethernet switch, CPU, networking processor, programmable logic device, and others. We expect 16 nanometer will contribute above 20% wafer revenue this year. As I reported here last quarter, we have completed the development of a low power and low cost version 16 FFC.
I can inform you today that 16 FFC is now the most adopted solution by our 16 nanometer customers, and we have entered mass production since first quarter this year. In addition to 16 FFC, we also developed an ultra-low power solution with much lower operating voltage down to a level below 0.5 V, without too much sacrifice of the circuit speed. We believe this is a superior solution compared to other technology approaches available in the low power area today, and is ideally suited for the mobile and IoT market. Both mobile and IoT will be the main growth driver in the future. Let me move on to 28 nanometer. Since our last conference, we have seen strong demand for our 28 nanometer, coming mainly from the mid and low-end smartphone related applications. As a result, the utilization rate of 28 nanometer has remained well above 90%.
We think it will stay at a high level throughout this year. Key to this strong demand has been TSMC's 28 HPC and 28 HPC Plus. In addition to the mid-low-end smartphones, applications related to networking processors and consumer products also adopt our 28 HPC Plus. Our 28 nanometer focus today is in the low power area. We developed a strong platform. Our 28 ULP Plus, and 28 HPC Plus are very effective in addressing the need for low power consumption, which is critical for the IoT market. Again, we expect IoT-related applications will become the next demand driver for TSMC's 28 nanometer technology. We are confident on the competitiveness of our 28 nanometer solutions and believe we will hold our strong market segment share over the next few years. Now let me update on InFO.
Equipment installation at our Longtan site for volume production is almost complete. We expect to complete customers of product qualification shortly and will be ready for volume production in this quarter. Our expectation of InFO contributing more than $100 million USD per quarter in 4 Q this year remain unchanged. In addition to high volume preparation and product qualification, we are working on yield improvement and cost reduction. Now let me make some comments on InFO technology. Compared to the conventional package, TSMC the InFO has advantage in form factor, such as a smaller area and the thinner thickness, and also in power efficiency that it can reduce the power consumption by as much as 20%. Meanwhile, InFO support higher memory bandwidth and therefore improves circuit performance. With TSMC the InFO technology, our customers can integrate multiple chip in the same package while reducing the overall cost.
This advantage will enable InFO technology to play an important role in the chip partitioning, which can be one of the effective ways to reduce cost for products which utilize leading-edge technology such as 7 nanometer technology and beyond. As a result, we believe InFO will be a powerful technology to capture the growth opportunity in both the mobile and IoT market. Now I will talk about the specialty technologies. Currently, specialty technologies at TSMC include embedded flash for MCU and automotive products, CMOS image sensors, image signal processors , data converter, display driver, touch controller, fingerprint and MEMS for smartphone, and also high voltage for power management. These specialty technologies have contributed increasingly to our revenue in recent years and are now accounted for more than a quarter of our total wafer revenue.
There are many exploratory efforts ongoing at TSMC. I will first talk about the largest three sectors, the embedded flash, the CMOS image sensor, and MEMS. We have completed 40 nanometer embedded flash development and have begun volume production. We are now developing 28 nanometer embedded flash for automotive-related applications While working on other nonvolatile memories for technologies beyond 28 nanometer. For CMOS image sensors, we have completed a hybrid bonding technology, which will enhance the connection between chips. This technology will push the image sensor performance to a new level and will be used by future smartphone. In addition to the mobile phone application, we are developing other CMOS image sensor technology to improve the safety feature in automobile and for use in the medical area. Now let move to MEMS. MEMS has been widely used as a motion sensor in mobile phones.
We are also developing MEMS technology for environmental and biosensors for smart healthcare and medical IoT applications. In summary, we believe both automotive, medical markets, and IoT present good growth opportunities for specialty technology in the next few years. Thank you for your attention.
All right. This concludes our prepared statements. Before we begin the Q&A session, I like to remind everybody to limit your questions to two at a time to allow all participants an opportunity to ask their questions. Questions will be taken both for and from the call. Should you wish to raise your question in Chinese, I will translate it to English before our management answers your questions. For those of you on the call, if you would like to ask a question, please press the star, then one on your telephone keypad now. Questions will be taken in the order in which they were received. If at any time you would like to remove yourself from the questioning queue, please press the pound or the hash key. Now, let's begin the Q&A session. First, we will ask Credit Suisse, Randy Abrams.
Thank you. First question, just want to ask about the business outlook. For second quarter, looks like somewhat mild growth, for like mid to high single digit growth. Just factoring of the earthquake, some shipments pushing out, smartphone launches and relatively lean inventory. Could you talk about some headwinds you may be facing just to offset some of those positive drivers? If we look ahead to second half, what does that imply factoring of the 16 nanometer and InFO starting in second half? How you feel about second half at this stage?
Well, the second half, the headwinds not much different than the first half. Second quarter's headwind is not much different than first quarter. We do see the customers, even the end market demand is increasing. The inventory restocking is still cautious. Going forward, we still watching this month by month to see the demand will change or not. This is currently our perspective. Okay.
If I could ask, for the forward technology, you're doing a much faster move to seven nanometer, where it's a new bump every one year, where some of the other foundries like Intel is going to an optimize taking longer. I'm curious on two fronts. One, if there's any trade-off or risk to your strategy moving faster. The seven, your density shrink is about a 60%, so not a full shrink. If as we go through the node, if competitors could leapfrog with a full seven nanometer, or you can upgrade the process as you move through. Maybe talk about that strategy for what you're doing on 10 and seven.
Well, I cannot tell you all our strategy. We think we are developing a technology fit for our customer's product announcement. All this strategy and roadmap is collaborating with our customer at the shortest time to be able to reach the maximum technology development benefit for their products. That has been the past two or three generations, I don't see no difference in going forward.
Quick follow-up. Can you put EUV, and you gave the update, but could you bring that in partway through seven to enhance the process, say, partway through? Or is it more targeted now for five nanometer?
Yes. On EUV, even though the recent progress is good, however, as you see, our seven nanometer development is already on full steam and is getting to yield enhancement mode now. Production is imminent. It's the beginning of 2018. Looking at this schedule, EUV is hard to reach for be able to contribute. For N7 is purely a development vehicle for EUV. We do plan to use EUV on our N5, and that is our plan, and we look at the schedule, appears that will fit probably EUV. Given some margin, it still will fit. It depends on the following progress for the EUV.
Thank you.
All right. Next question will be coming from Deutsche Bank, Michael Chou.
Thank you. Regarding your comments on 10-nanometer, you mentioned you have more than 20 customers for 10-nanometer. Am I right?
Seven.
Yeah. Does that mean you actually think they're stronger than expected 10-nanometer compared to six months ago based on your progress? In the past, it seems that the management mentioned 10-nanometer will be smaller than 16-nanometer line. Based on latest progress, are you seeing the better demand outlook for 10-nanometer?
When I talk about 20 customer, it's on seven nanometer.
Okay.
Seven nanometer, indeed, we see stronger adoption in the past quarters. That's what I was addressing.
Okay. Second question is for IoT. Is there any way management can quantify the IoT sales portion? It seems that a lot of people are saying IoT will be an important growth driver in the long term, but we still cannot see a lot of IoT product coming out, mainly for infrastructure build-up. Is there any way you can try to quantify?
Well, I don't think that we can really quantify what is the IoT market today. A lot of products that, for example, connect the sensors, that essentially that IoT's most important product. One of the IoT most important is the sensors, including CMOS image sensor and the MEMS that you can see today. You want to quantify the whole IoT market, no, we cannot.
One follow-up question is, will some of the IoT use advanced node, or they will just use 28 or 16 in the long term?
It should be, because IoT related to a lot of data transmission, data communication. The computation, the high-speed computation is one of the essential part of the IoT area.
Thank you.
Next question will be coming from J.P. Morgan's Gokul Hariharan.
Thanks. The first question is on a little bit of granularity on the 2Q outlook. Could you talk a little bit about advanced node versus older node, given that there is a lot of restocking at 28 and below? Is it fair to say 16 nanometer is probably weaker than other nodes in second quarter?
I think you are asking us about the restocking in the second quarter, whether it is a certain node.
It is primarily on older nodes, 28 and below.
Yes, right.
28 and above
Whether the restocking is on the advanced nodes or across the board.
The restocking is mostly on 28, 40, 65.
Second, I think, you mentioned about cloud computing, high-performance compute as a potential market, and you're working with Arm on seven nanometer high-performance compute product as well. I think a year or a couple of years back, you'd mentioned that software ecosystem readiness has still been an issue for this market. Any thoughts on what you're seeing from your customer side on this front, how far we have gone, and how is this market likely to evolve, given that, as you said, right now it's not really addressing the meat of the market, which is servers. It's primarily on the periphery.
That momentum has collected quite a bit recently, as you hear from Red Hat with software developer and from some of our customers, software alliances, you know, has collected quite a bit. They are services, cloud services for application software development on several sides. The application software development also on progress. Those part of the momentum that we see increases. For TSMC, of course, we will support our customers in that kind of high-performance computing platform. For us, mostly is the technology development. Technology development also including the interface circuit development with our customers, also including the packaging solutions for that application. I think that compared with a couple of years ago, indeed, you must seen a lot of reports that momentum is collecting quite a bit recently. All the parts have we see the drivers for that into the high-performance computing market.
Just one follow-up. If you have to take a guess right now, is that going to be mostly merchant fabless or system fabless, like you mentioned as a potential growth driver in the last couple of calls?
We see both. Including the service provider. They participate, too.
All right, next question will be coming from Citigroup 's Roland Shu.
Thanks. Good afternoon. First question is, for the second quarter guidance, now it's TWD 216 billion-TWD 218 billion. If we exclude the pushout should be the shipment pushout from first quarter, that should be about TWD 7 billion, right? That actually is about TWD 208 billion-TWD 211 billion. That actually is much smaller than if we times March sales by three. That is TWD 219 billion. I think for this quarter, in second quarter, for this quarter, I think is this what you expected earlier this year, or are you going to see because of some weakness on the demand?
There's a factor that affect our second quarter. One factor is exchange rate.
We're using 32.30, which is very close to today's market.
In first quarter, our exchange rate was 33.1. There's a 2.2% depreciate, appreciate, actually. That affect 2% of revenue. Another reason is what Mark was mentioning, that we see the inventory restocking continues throughout the second quarter. That's another factor, that we have a weaker-than-expected second quarter.
Okay. Also, for the shipment delay. I think according to your news release previously, you said probably about 100,000 of 12-inch wafer shipment have been delayed. However, I think earlier you said you probably ship about 90,000. Why is the difference between this 10,000? Because canceled by customer, or we are going to further delay to 3Q?
No. In fact, people work really hard to recover customer shipments. Actually, we do better. I think we have announced 120,000 in our press release, and it come out around 90K, so it's about 30% lower.
Okay. I think my second question is, I think Gartner just reported for TSMC last year, the overall foundry market share was about 64.5%. I think for this year we are recovering 16 nanometer market share aggressively. Also, we are also going to production 10 nanometer with a very high market share next year. I believe for the 7 nanometer production in 2018, NetServices will be much ahead of the peer. Question is, after this three-year technology leadership, what do you think your market share will be?
Well, the battle is still ahead of us, so I cannot claim any territory yet. We try to improve our market share just according to what you mentioned, the factors.
Well, the 50% of market share achievable?
Anything is achievable.
Of course.
At least 50%.
That's not what I said.
Okay. Thank you. I think with this three years of technology leadership with 30, are you going to have any upside for your EPS target? I think now you said for five years, EPS target is to grow by 10% in CAGR. With this technology leadership, any upside on this EPS target?
Well, the competition is still ahead of us. Right now it's just not the time to talk about what the trophy is.
Thank you.
Next question comes from Daiwa's Rick Hsu.
Yeah. Good afternoon. Just one question from me. About your second quarter guidance, I think it looks to me it's a bit below seasonal, right? In terms of sequential growth momentum. You also mentioned that the demand is mainly from the 28 nanometer, 40 and 65 nanometer, not much for the 16 nanometer. You also mentioned that your 16 nanometer for this year, the full-year revenue contribution will come to about 20%. Can I take that as a, your Q3 momentum is going to be really strong and like above seasonal?
Yes. Can you elaborate a little bit more?
Actually, the high volume ramp we expect in the second half of this year for the 16 FinFET. That's because of leading edge for the high-end smartphone. Okay. Other applications actually in the 16 FinFET is continuous on, and we saw a lot of tape out since last year. The momentum accumulated, and I believe in the second half of this year, we will see a higher growth.
Thank you so much.
That's all.
I think we need to go to the line for some questions. Operator, could you please have the first caller on the line? We'll take the next question from the call.
Our next question comes from the line of Mr. Donald Lu of Goldman Sachs. Please ask your question.
Hey, good afternoon. I have two questions. One is on InFO. I think C.C. just commented that you're packaging more chips and the cost will come down. In what year, which year, do you think the InFO cost will be similar or even lower than the conventional packaging? Also, assuming it will happen this 10 nanometer, seven nanometer, will TSMC expect your mobile market share to increase significantly at seven nanometer versus 10 nanometer or 16 nanometer global market share? That's question number one. Question number two is in second quarter, does TSMC's 16 nanometer utilization is going to decline from Q1? Thank you.
Donald's first question is if we can package multiple chips in InFO, which is the chip partitioning, and reduce the cost. He asked which year we will begin to see that the cost on InFO is lower than the cost from conventional packaging, if we can apply this very useful technology on 10 nanometer and seven nanometer, does that mean that our mobile market share will be higher at seven and 10 nanometer compared to our mobile market share at 16 nanometer? That's the first question. Second question is do we have a utilization decline at 16 nanometer in the second quarter?
Let me answer the first question on the InFO. Is it on? Yes. I mentioned that the InFO was here of the chip partitioning, and that is here of reducing the cost. Actually, this kind of thing will incur the design architecture different changes. We are working with the customer. I cannot give a very certain date of which year that it will be in the market compare with the conventional packaging method. Our analysis show that in any year when we introduce this kind of technology and this kind of new approaches, it certainly will be better in performance than in cost as compared with the conventional packagings. Whether it will help us to increase market segment share in the mobile, certainly we hope so, but I cannot give you a number. What is the second question?
But--
Second quarter.
Sorry. Just particularly at 7 nanometer, would you see new customers will adopt TSMC 7 nanometer together with InFO at this stage?
We are working with customers. That's all I can answer your questions. Okay, the second quarter, our utilization rate for the 16 nanometer-
16 nanometer
decreasing?
Decline.
No. Okay.
Sorry, if I can add some comment on 16 nanometer. We are ramping at very fast speed on 16 nanometer across the whole year. Second quarter utilization for 16 nanometer will be much higher than first quarter. All right, we will go to the next caller on the line. Operator, please help.
Your next question comes from the line of Mr. Brett Simpson of RBC. Please ask your question.
Yeah, thanks very much. I just had a quick question on 28 nanometer. We saw a nice recovery there in Q1. You have a lot of 28 nanometer customers migrating to 16 nanometer going into second half 2016. How do you see 28 nanometer outlook as you start to see this big shift in mobile, low-end smartphones, gaming? What impact do you think that has on your 28 nanometer outlook, and what areas might backfill that 28 nanometer node? Thank you.
Brett, your question is even if we are seeing very good recovery of 28 nanometer in the first quarter, but since a lot of the customers' products will be migrating to 16 nanometer in the second half, you are asking us what kind of applications or business we can have to fill 28 nanometer in second half of the year. Is that your question?
That's right. Whether you think 28 nanometer can maintain these revenue levels.
Okay.
A decline.
Okay, let me answer the question. Actually, he asked whether that this 28 nanometers strong demand can continue or not because of smartphone will adopting the 16 nanometers technology quickly. Actually, in the smartphone, we have high-end smartphone, mid and low-end smartphone. For the high-end smartphone, moving to the 16 nanometer is a natural choice, then they're moving very fast. Yes. Then the mid and low-end smartphone, that demand increase. A lot of them adopting TSMC's 28 HPC+.
Furthermore, that in the future, we saw that IoT mobile application for the low power consumption is very important, and TSMC offer a very competitive platform in this area. We believe the 28 nanometers demand will continue to be strong. Thank you.
Thank you. I just had a sort of industry question as my second question. There's a lot of talk about the rising cost of developing chips at leading edge. How much do you think it costs your customers to develop chips at 10 nanometer and seven nanometer compared with 28? I think you mentioned you're engaged with 20 customers on seven nanometer. Can you talk a bit about how big the customer engineering teams are that you're engaging with at these nodes? Thank you.
Well, I cannot comment on the exact number of the NRE, new engineering expense for the new N. Of course, each node the development cost is higher. On the other hand, the chip integration is also increases. Where it used to be several chips, right now is being developed in one chip. Secondly, actually, although we have, as mentioned, 15 tape outs, typically the first tape out incurs the highest cost, and the following tape outs can be synergistic. Indeed, customers see this seven nanometer is a long-standing, long node. I think the customer is willing to put into their investment resources in it for many years to come.
Thank you. Could I ask a third question?
All right.
Maybe just, I wanted to ask on graphics, because you talked a number of times in your prepared remarks about VR and graphics and game console. There's quite a big performance jump coming as some of these customers go to 16 nanometer later this year. What sort of growth are you seeing in gaming and graphics, specifically, at the moment this year? Thank you.
This VR and AR is still its emerging application. The growth rate come from very small numbers. Probably I cannot put into accurate number. Currently, this product is under the application software development. I think you've been tried several VRs and ARs products. Many of the application software is a demo softwares, and all the producer of the chips right now create their software development platform. This is at this stage. We just see a starting shipment, but is yet to be a volume quantity this year for this application.
Okay, thank you.
All right. We will continue to have the next caller from the line. Operator, could you please have the next caller on the line?
Our next question comes from the line of Ms. Mehdi Hosseini of SIG. Please ask your question.
Yes. Thanks for taking my question. Going back to your prepared commentary, where you described smartphone unit growth that is going to be less than your prior expectation. Which is also, in my opinion, has been having adverse impact on your assumptions for semiconductor revenue growth. How is it going to impact your revenue expectation growth for this year? The range of 5%-10% has remained unchanged, but the largest end market, smartphone, you have downticked on that, and then the semiconductor industry revenue is also going to be up only 1%. In that context, if you could help us understand how this downtick is impacting the range. Do you see your revenue coming to the low end, to the high end, or are you still on track to hit the midpoint of the guide range given all the programs that are coming to the fruition?
All right. I think Mehdi's question was that since we have revised on some of the growth rates like smartphones and semiconductor revenue, et cetera, how would TSMC still keep our revenue guidance? He was saying whether we are on the high end of the guidance range or low end of the guidance range, et cetera.
Well, on semiconductor growth, we forecast 1%. Part of it is memory market appears to be shrinking this year. Excluding memory, it will be about 2%. Our system is very complicated. It's very difficult for me to describe everything for you here. For the smartphone growth, this year, it's mostly from the mid end and the low end, in terms of unit growth. If that want to reconcile for your numbers. Our number for this year is to maintain 5%-10%. That is nor aggressive, nor conservative. It is still the same number.
Sure. Let me rephrase the question. Historically, you have had more content in high-end smartphones, but the growth rate for low to mid-range is much higher than the high-end smartphone growth rate. Would it be fair to assume that if the growth rate for the low to mid-range is offsetting lower growth rate for high end, even though the high end gives you higher content?
It's possible. We see the over TWD 500 phone is reducing, but TWD 400 phone is increasing quickly. Both high-end and mid-range silicon content are increasing with a high single digit. The unit of the mid-range phone increase, and high-end unit number decreases this year.
Okay.
Okay.
I have a follow-up on my second question.
Yes.
In that context, should we assume that the 10 nanometer will be a shorter node? If so, what happens to backfilling? You mentioned that 90% of the 10 nanometer equipment could be used for seven nanometer. Is that going to have an impact on your spending, which ties into backfilling? Any color there would be great.
Okay. Mehdi's question is that he's happy to see that we have a leadership at seven nanometers. However, does that mean that we will have a short node for 10? If it is a short node, what would happen to this common tools, this equipment being 90%+ common? What's the impact to our capital spending?
I think this 10 nanometer will went very fast, but it appears to be a much shorter node than that of a seven nanometer. The picture could be similar to our 20 and 16. Also, we anticipated this before enough that we tried to maximize the common tool from 10 nanometer to seven nanometer. This is 95% is by design, so that when the 10 nanometer, after three years, it reduces, the tool can be readily expand into the capacity for seven nanometer ramp.
Impact to spending. Yes. What's the impact to spending?
The question is impact spending?
Impact to our capital spending.
Oh, that has been long been planned into our capital expense. It's an integrated number, what we offer to you.
Now we come back to the floor. The next one will be from UBS, Leo Lu.
Thank you very much. Going back to the InFO, I'm trying to figure out when this might broaden out. I've spoken to a couple of your customers and maybe some of the back-end players. What I'm hearing pretty consistently is cost and the fact that this is a TSMC proprietary. Other than that, people seem to love it. I know you're working very hard on cost. In terms of this being TSMC proprietary, I'm wondering what you are telling your customers to sort of convince them. I think it looks to me like it's going to be TSMC with InFO, everybody else with some sort of other fan-out technology. Is that the way that you see developing? I guess number 2 is Would you consider possibly licensing InFO? Because we've certainly seen success stories in terms of licensing in semiconductors.
I think that would help out your customers. Just want your thoughts on that. Thanks.
Okay. We developed InFO technology that with much lower cost than the CoWoS that we introduced earlier. InFO give advantage, as I said in the presentation. We have mentioned that in the last quarter that right now, we only focus on the few high volume customers because we start to ramp it up. I also said in the presentation that we are working on the yield improvement and the cost reduction. That's meaning that today, we still have some improvement ongoing. Once we complete it in our high volume production this year, we believe we will be very competitive. However, in every technology node, we work with the OSAT people and to better serve our customer. For now, we also see that the cooperation between TSMC and back-end people.
For this year, before we complete the volume production and ready for other consideration, this year, we only focus on our own bringing up of this InFO volume production.
Yeah. Thank you. That is very clear. I guess I am just wondering what happens beyond this year as you start thinking about more customers.
We will tell you next time.
Okay. Sorry, my second question was the one that Mehdi just asked, but maybe I will just follow up. If it turns out that 10 nanometer turns out to be a little bit smaller than what you expected previously, but seven turns out to be much bigger, and you only spent TWD 1 billion in the first quarter of this year versus your guidance for the year of TWD 9 billion-TWD 10 billion, is it a possibility that maybe the CapEx becomes very back-end loaded or some of it gets pushed out into 2017?
It is true, we spend much less in the first half. This year, the CapEx will be very much back-end loaded. Reason being, because we are preparing the capacity for 10 and seven nanometers. Those spending gets mostly spent in second half of the year.
All right. Next question will be coming from Morgan Stanley's Charlie Chan.
Thanks for taking my question. Very quick follow-on on Leo's question on InFO. What would be the margin impact to your corporate margin from the InFO business when you get to a mass production?
Since the InFO volume is still small for this year, C.C. was mentioning about TWD 100 million by fourth quarter compared to the total revenue is still small. It will have very small dilution to this year's corporate average margin.
Okay. The first is just the margin is slightly below corporate average, even if it is small?
It is below.
Okay, thanks. My second question is regarding the EUV adoption. It seems like it is already a done deal that you will adopt EUV at the five nanometer. The production time is sometime like 2020. From now to 2020, do you think the capital intensity will increase? I know the company gave guidance before that the new node will be 30%-35%. In terms of the ratio, do you think you will grow, especially when you mass produce the seven nanometer? Thank you.
Well, I try to answer what I heard from you all. Yes, we plan to use EUV on our five nanometers, and we have already three EUV tools on the floor, and the fourth is coming. All these are using actively for the development. Until 2020, when N5 is currently planning to production, yes, it will be adopted. Just remind you that if you think about CapEx, don't think about everything we're going to change to EUV, okay? There are 80 layers, and only 10. There are about 50, 60, if you discount the multiple patterning. Only the 10 of them roughly will use EUV. A lot of tools still be able to come up, common tools. Did I answer your question?
Just want to clarify because, I thought the quadruple patterning or multi-patterning will cause a lot of CapEx. You mentioned that you will use a common tool strategy to reduce the CapEx. Just magnitude in terms of CapEx, in terms of absolute dollars versus TWD 10 billion level, or in terms of CapEx ratio versus 35% in the coming four years. Do you think you will increase or decrease? That was essentially my question.
Cannot be so specific as you said. In general speaking, converting a tool is cheaper than buying a new tool. More conversion is beneficial to the CapEx.
All right. Next question will be a follow-up from Credit Suisse, Randy Abrams.
Yeah, thanks for fitting me back in. For the second half, you mentioned a lot of the ramp will be 16 nanometer, which is still a relatively new node. The second quarter, you're already 49%-51% gross margin. I'm curious with further growth to come from that project, if 16's approaching corporate average, and we could get further leverage to the model in second half from that growth.
For this year's 16 nanometer, profit margin is improving as we have much more higher volume, but it's still below corporate average this year. We expect the 16 nanometer will get close to corporate average by second half of 2017.
Okay. I guess for second half, if you net out the ramp of 16 still below corporate, can we get some incremental leverage from that filling up utilization that we normally see? Like from first half to second half, if there's potential for further margin expansion, where we normally get pickup from utilization improving.
Utilization will be better in second half. That's number one. We have other technology, we have high utilization with very good profit margin. That kind of mix issue.
Okay, thanks. The second question I want to ask, you mentioned, Mark, in your prepared remarks about the server opportunity and development moving along on software applications. If you could think about for your technology, when you think we start to get the first volume where it could, say, get to 1%, 2% of revenue, if that's timed say around seven nanometer, or you think it'll take more time, it might be further out?
We think it's on seven nanometer that we'll see one, significant inroads.
Okay, thank you.
All right. We need to go back to the line. Operator, could you please have the next caller on the line?
Our next question comes from the line of Mr. Steven Pelayo of HSBC. Please ask your question.
Just first, a follow-up there. On capital spending, you mentioned it being back-end loaded this year. I'm curious, does that, for a run rate basis, really start to suggest what may happen in 2017? Or do you think 35% of sales is kind of a normalized CapEx level, even though you're getting kind of high reuse rate at 16 today, but maybe not so high at 10 nanometer before 7 kicks in. CapEx to sales next year, kind of sticking the 35% range? What do you think?
All right. The question is, this year's CapEx is back-end loaded, like 35% - 65% with the same pattern, similar pattern in 2017. What will be our CapEx to sales ratio next year?
Probably cannot tell about the 2017, where it's going to be front-end loaded or back-end loaded. In terms of capital intensity, we have went through this high intensity period since last five years, and it has come down to mid 30 range. We believe this 30 to 35 range will be for the next few years.
Okay, excellent. Thank you. In your 20F filing this week, we see that your largest customer fell from 21% of revenues to 16% of revenues. You obviously made it up with some other customers, with good growth last year. I guess my question is, expectations as you go through 2016, do we have to worry about that kind of significant decline to your largest customers continuing?
All right. The question is, we used to have a very big customer that accounted for 21% of our revenue last year, and this year is probably in the mid-teens. What would be in the future? What if the percentage drops? What's the impact?
Yeah, just to clarify, Elizabeth, it was in 2014, it was 21% of revenues. 2015, it was 16% of revenues. I'm curious if you have any concern over that trend continuing, could they fall to single-digit percentage of revenues?
Don't comment.
Well, we'll support our customer fully and let them grow.
All right. I think, Steven.
Thank you.
I think we have answered your questions. Thank you. Operator, could you please have the next caller on the line?
Our next caller comes from the line of Mr. Donald Lu of Goldman Sachs. Please ask your questions.
Hi. I have a question on 28. I think the conventional wisdom is that 28 will be a long and very strong node. I checked in Q4 last year, 28, it's only maybe less than 5% higher than 65 nanometer at the same stage of the node. My question is, have you done any study to see how much bigger 28 will be for the next few years relative to 65? The reason I ask this is a lot of your competitors are actually increasing their CapEx this year for 28. I'm afraid that we might have a price war.
Okay. Donald's question is that 28 nanometer last quarter, 4Q 2015, which I think we said it was 25% of our revenue, and he said that this is only five percentage points higher than 65 nanometer, at the same stage. Since many of our competitors are building up capacity for 28 nanometer, Donald is asking us how big can 28 nanometer really be and whether we will have a price war.
Well, I cannot say too specifically for the quantity, but I say that we saw the strong demand that's due to TSMC's technology being very competitive. For this year, that the mid-low end smartphone increased a lot. We also developed a very competitive low-power technology, which we think is much better than our competitors. We continue to have confidence that we will continue to have strong demand and hold our market share.
In the next two years, if you look out, compared to 65, do you think 28 nanometer will have 10% more revenue than 65 at the same stage after launch? Is 5%, 10% or 15%? Is there a number that we can use in our model? Approximate.
Donald, this is Elizabeth. Let me answer your question. This percentage-
Okay
basically is not directly comparable because the base is different. 65 nanometer, 30% back in, say, 2012, is a much smaller number than 28 nanometer at 30% in today's number. In fact, if you look at the same stage, say 65 nanometer after five years and 28 nanometer after five years, 28 nanometer in terms of TWD is almost twice as big as 65 in terms of TWD.
No, actually, sorry, Elizabeth. I'm comparing is I compared 65 nanometer revenue absolute numbers of all the foundries I can find, versus the same foundries, total 28 nanometer revenue. The total 28 nanometer revenue in Q4 last year was only 5% higher than total 65 nanometer revenue at the same stage after launch.
You are talking about market share %, not revenue %. Is that correct?
Not the market share, the total absolute amount. I think TSMC has much more information than us in terms of looking forward, in terms of capability, et cetera. Do you think 28 nanometer is a long node, a stronger node than 65, and by how much? For the whole market, not just TSMC.
Well, let me answer the question again. It seems to me that you are not so confident on the 28 nanometer demand, but it is strong and this is a very sweet node. Offer low power, but very competitive performance, and the cost structure is also good. I want to say again that TSMC's technology is very competitive, and we will hold our market share, and we are confident in that.
Let me add some comment to this one. Donald, I think you're trying to figure out how big is 28 versus the 65 nanometer. Is that what you're asking for?
Yes, exactly. That is for the whole market. Yes. That's my question.
Okay. I think, I don't know about market, but for us, if I look at the number, 65 nanometer revenue versus 28 nanometer revenue, if you look at the peak revenue versus 65 peak revenue, I would think that 28 nanometer revenue is much bigger than 65 nanometer at the same stage.
Okay. I will follow up with Elizabeth on the question. I think, the 28 ramped up very fast and dropped very quickly, too, for the whole industry. The question is going forward, whether it will be bigger, how much bigger it will be, versus 65. I will follow up. Thank you.
Thank you. Let's come back to the floor. Next question comes from Citigroup's Roland Shu.
Thanks. Just a follow-up on the InFO question. I think Leo just asked about the collaboration, with InFO, with OSAT our likely candidate. I would like to hear from or learn from you about the competition for InFO line. Is there any close competitor who can do InFO production as quickly as you're doing in the near term? Thank you.
There's a lot of fan- out technology available today. TSMC developed InFO because we developed technology that, which has some certain advantages, just like I mentioned, that we have thinner thickness that's suitable for your smartphone, because today the smartphone needs to be thinner and thinner. Also, we found out that our approaches can give a benefit or advantage for the higher bandwidth, which is important for the smartphone, for all the application also. We believe among all fan-out technologies, TSMC, the InFO is the best. When we ramp it up, that will be the highest volume of fan-out technology in the industry. Our main purpose is to help our customers who are trying to have their product into the market, with very competitive performance and cost.
Thank you. Conclusion is, I think you think probably it's very little chance for any competitor to do the similar job as TSMC to compete with you at the same customer or same application. Am I reading you right?
I don't want to say that, you might be right.
Thank you.
Okay. Follow-up question from Deutsche Bank, Michael Chou.
Hi, C.C., is there any way you can mention whether Aketo module be using InFO as well as the RF transceiver, this kind of product?
Yes, to answer your question, today, we focus on a very limited customer with a high volume. In the future, of course, it will be adopted by a lot of customers in a lot of different applications. That, we expect.
Thank you.
I think in the interest of time. Sorry. There's a question. Sebastian Hou in the back from CLSA.
Thanks for taking my question. My first one is, if you look at, based on the inventory cycle, so we started to see some rush orders toward the end of last year. In first quarter, we also have some business upside because of the inventory restock, and now in second quarter, you just comment that you continue to see some inventory restocking into second quarter. That's about the fifth month or fourth month of inventory restocking. Where do you think that most of your customers are now in the inventory cycle? Apart from your largest customer, which are starting to build soon, but apart from that, what about the rest of your customers?
What we see, the fourth quarter last year, if you remember, is people drastically reduced their inventory. We only see the restocking almost after the Chinese New Year. That's where, if you count the cycles. I don't see signs of overbuild at this point. People are still cautious. That's what we see, the cycle. How long it will last, I don't know. Depends on, I addressed on my prepared message, even to the end of Q2, appears the inventory was still above the seasonal level. It's restocking, but at about the seasonal level at the end of Q2. That'll be four months into the building. It's still a cautious condition.
Thank you. My second question is on your revenue application side, because you break down revenue into four parts, and one of that is the industrial/standard. We've seen very strong growth for the past four years, about 27% CAGR, very similar growth to the communication category. I wonder, can you provide some of your expectation for the CAGR for the next couple of years? If you can talk about what the specific driver inside that industrial/standard, and what kind of profitability is above company average or above the other application? Thank you.
Actually, the industry, industrial, and the standard, for example, including the MCU, we put in that category. Power management in that category. Both of those components still also used in the smartphone. When we talk about smartphones growth in the past few years, it includes some of the, what we categorize into the industrial and standard. That's the reason you see the growth. Part of it is contributed from the smartphone.
What's the growth outlook for the next couple of years?
I cannot forecast into the exact number for you, but it will be a growth situation. Yes. It will be still a growth pattern, I think.
Will it be continuing similar to the communication application growth, or would it be higher or lower?
That's hard to predict. I hope the communication grow faster, That's hard to predict.
Okay. Thank you.
Okay, before we conclude today's conference, please be advised that the replay of the conference will be accessible within three hours from now. Transcripts will become available 24 hours from now, both of which will be available through our website. Thank you for joining us today. We hope you will join us again next quarter. Goodbye, have a good day.