TSM 台积电

Elizabeth Sun

Welcome to TSMC's Third Quarter 2014 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 via TSMC's Web-site at www.tsmc.com. If you are joining us through the conference call, your dialing lines are in listen-only mode. As this conference is being viewed by investors around the world, we will conduct 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 third quarter, followed by our guidance for the current quarter. Afterwards, Lora and TSMC's two co-CEOs, Dr. Mark Liu and Dr. C.C. Wei will jointly provide our key messages. Then we will open both the floor and the line for the 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 Web-site 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 the actual results to differ materially from those contained in the forward-looking statements. Please refer to the Safe Harbor notice that appears on our press release. And now, I will like to turn the podium to TSMC's CFO, Ms. Lora Ho, for the summary of operations and current quarter guidance.

Lora Ho

Thank you, Elizabeth. Good afternoon, everyone. Thank you for joining us today. I will start my presentation with financial highlights for the third quarter and follow by the guidance for the fourth quarter. We had a good quarter. The third quarter, we have set a new record of revenue and profitability, thanks to strong demand and our successful ramp of 20 nanometer. Our revenue increased 14% sequentially and 29% on a year-over-year basis to reach NT$209 billion. Our gross margin exceeded 50% to reach 50.5%, which is also a record since the second half 2006. Compared with second quarter, gross margin improved 0.7 percentage points. The higher margin was contributed by consistent cost improvement, variable inventory valuation adjustment, partially offset by 20 nanometer dilution as we are still in the early stage of the production. Operating margin was 40.4%, up 1.8 percentage point from the second quarter, reflecting an improving operating efficiency for the Company. After a big jump in tax rate in the second quarter due to an accrual of 10% retained earning tax, in the third quarter the effective tax rate fell back to normal level of about 11% of profit before tax versus the 20% in the second quarter. Overall, the third quarter EPS increased 47% sequentially to NT$2.94. The single quarter ROE was 33.3%. Let's take a look at revenue by application. Compared to the second quarter, communication showed strongest growth. Revenue increased by 26%, industrial related revenue also increased 9%, while computer and consumer declined 6% and 3% during the third quarter. By technology, after two years of meticulous preparation, we began volume shipments of 20 nanometer wafers. The revenue contribution went up from 0% to 9% of the third quarter wafer revenue. This is the fastest and the most successful ramp for new technology in TSMC's history. In addition, customer demand for 28 nanometer wafers continues to be strong. Our 28 nanometer wafer revenue continue to grow sequentially in the third quarter, representing 34% of total wafer revenue. Accordingly, the two advanced technologies, 20 nanometer plus 28 nanometer, represented 43% of our third quarter total wafer revenue, increased from 37% a quarter ago. Now let's move on to the balance sheet. We ended the third quarter with cash and marketable securities of NT$290 billion. Current liability decreased by NT$74 billion mainly due to we paid out the NT$78 billion of cash dividend in August. On the financial ratios, accounts receivable turnover days is 44 days which is the normal level of our average days of receivable. Days of inventory increased five days to 56 days, mainly due to higher work-in-process inventories associated with the fast ramp and the longer cycle time for 20 nanometer. Now let me make a few comments on cash flow and CapEx. During the third quarter, we generated NT$91 billion cash from operations, invested NT$48 billion in capital expenditure and paid out NT$78 billion in cash dividend. At the end of the third quarter, our cash balance decreased NT$29 billion to NT$255 billion. Free cash flow for the third quarter was an inflow of NT$43 billion, a big improvement versus previous quarters. In U.S. dollar, our second quarter CapEx was US$1.6 billion. This adds to the total of US$7.8 billion for the first three quarters. Regarding our capacity, we expect to increase our capacity by 12% from last year. Total annual capacity will reach 8.2 million 12-inch equivalent wafers this year, slightly higher than our previous estimate of 8.1 million. I have finished my report on the financial part. Now let me turn into the fourth quarter outlook. Based on our current business outlook and the forecasted exchange rate of 30.30, we expect our fourth quarter revenue to be between NT$217 billion and NT$220 billion. This will translate into around 4% to 5% quarter over quarter increase. On the margin side, we expect the fourth quarter gross margins to be between 48% and 50%, and operating margins to be between 38% and 40%. You may ask why we guide slightly lower margin rate despite 4% to 5% revenue growth. This is because we will continue to ramp our 20 nanometer to more than 20% of our wafer revenue in the fourth quarter, we expect to see a mild margin dilution with our aggressive productivity improvement efforts. This concludes my remarks. Thank you very much.

Elizabeth Sun

Alright, now we will deliver our key messages. They will be offered by our CFO as well as by the two Presidents and co-CEOs. We will start with CFO, Lora Ho, first.

Lora Ho

I will talk about the three items, the CapEx, free cash flow and supply-chain inventory. Let me start with CapEx. In January of this year, we guided TSMC's 2014 CapEx budget to be between US$9.5 billion to US$10 billion. Today, we are able to provide more specific number, which is about US$9.6 billion. Majority of this U.S. CapEx budget is spent for 20 nanometer expansion. In 2015, we will continue our investment in 16 nanometer capacity installation and 10 nanometer engineering capacity. Based on our current plan for 2015, our CapEx budget for the next year is likely to be slightly higher than US$10 billion. On free cash flow outlook, you may recall in the past four years TSMC has increased CapEx substantially to capture the growth opportunity brought by the mobile computing devices. As a result, our free cash flow dropped to about US$1 billion to US$2 billion per year, which were below the cash dividend we paid. The cash dividend, [street dollar] (ph) cash dividend, is about US$2.6 billion a year. However, with the substantial increase in operating cash flow this year and a similar level of capital expenditure compared to last year, we expect to more than double our free cash flow in 2015 and we are confident that the free cash flow level will rise further in the foreseeable future. The sustainably higher free cash flow should enable TSMC to afford paying a higher level of dividend per share going forward. The Board of Directors will consider increase in cash dividend in February of next year. Now regarding the supply-chain inventory, we have noted in our last quarterly conference that we estimate fabless DOI will increase and be two days above seasonal at the end of third quarter, and then fabless DOI will decrease and be two days below seasonal level at the end of this year. Our daytime model for the forecast still warrants the same estimate today. You can see from this chart, we estimate 4Q'14 fabless DOI will be two days below seasonal, but compared with 4Q'13 last year, which is one year ago, the fabless DOI was six day below seasonal. Based on our model, we anticipate a much milder inventory correction in fourth quarter this year. With that, I will turn the podium to Mark who will share with you our view on the near term demand.

Mark Liu

Good afternoon. I will continue to cover the near-term demand. The strong demand of our 20 SoC customers enables our continued growth in the fourth quarter, overcoming our seasonal demand pattern of a sequentially weaker fourth quarter, and the cautious inventory adjustment actions taken by some of our customers rendering the slower 4Q demand. This fourth quarter demand from our customers does not validate the recent forecast by Microchip. Our recent demand in China still appears normal, little deviation from their seasonal pattern, and we see China's 4G smartphone sales and infrastructure buildup remains to be very aggressive. So we are expecting another record breaking quarter with a 4% to 5% growth in the fourth quarter. On 10 nanometer development, our 10 nanometer development is progressing according to plan. Currently we are working on early customer collaboration for product tape outs in 4Q of 2015. The [risk] (ph) production date remains targeted at the end of 2015. Our goal is to enable our customers' production in 2016. To meet this goal, we are getting our 10 nanometer design ecosystem ready now. We have completed certification of over 35 EDA tools using ARM CPU core as vehicle. In addition, we have started the IP validation process six months earlier than previous nodes with our IP partners. We are working with over 10 customers on their 10 nanometer product design. The product plans show wide range of applications, including application processors, baseband, CPU, server, graphics, network processor, FPGA and game console. Our 10 nanometer will achieve industry-leading speed, power and gate density. Then I'll cover, say a few words or clarify next growth momentum of TSMC. We think the growth of smartphones and tablets in propelling our revenue growth will continue for at least several years. In addition, the recent innovations in wearable devices including smart watch, in cloud computing, in fog computing, in Internet of things including smart car, smart homes, all are very exciting and we are currently closely working with our customers on all these applications to set the stage of the next growth wave to move us forward. That's my comment. Now I turn the microphone to C.C.

C. C. Wei

Thanks Mark. Good afternoon, ladies and gentlemen. This afternoon I will update you on the 20 nanometer ramp-up status, followed by 16 nanometer progress and 28 nanometer status. First, the 20-nanometer ramp status. We shipped 20 nanometer in high volume during the third quarter. The yield is meeting our target. Revenue generated from 20 nanometer accounted for 9% of third quarter wafer revenue. And because of the strong demand from the high end 4G smartphone which are equipped with 64-bit cores, LTE [category 6 or category 7] (ph) and more advanced graphic and video performance, our 20 nanometer will continue to grow and expected to contribute greater than 20% wafer revenue in fourth quarter. We expect the strength of our 20 nanometer business to continue in year 2015 and we expect the revenue will account for roughly 20% of next year in wafer revenue. Next I'll talk about the 16 nanometer ramp and comparative status. In 16 nanometer, we have two versions, 16 FinFET and 16 FinFET Plus. FinFET Plus has better performance and has been [adopted] (ph) by most of our customers. 16 FinFET we began the risk production in November last year and since then have passed all the reliability qual early this year. For the FinFET Plus, we also passed the fourth stage of the qualification on October 7, and since then entered the risk production. The full qualification, including the technology and product qual, expected to be completed next month. So right now we have more than 1,000 engineers working on ramp-up for the FinFET Plus. On the yield and insight, the progress is much better than our original plan. This is because the 16 nanometer uses similar process to 20 SoC, except for the transistors, and since 20 SoC has been in mass production with good yield, our 16 FinFET can therefore achieve the yield earning from 20 SoC and enjoy a good and smooth progress. So we are happy to say that 16 nanometer has achieved the best technology maturity at the same corresponding stage as compared to all TSMC's previous nodes. In addition to the processing technology, our 16 FinFET design ecosystem is ready also. It supports 43 EDA tools and greater than 700 process design kits, with more than 100 IPs. All these are silicon valley based which believe this is the biggest ecosystem in the industry today. On the performance side compared with the 20 SoC, 16 FinFET is greater than 40% speed, faster than the 20 SoC at the same total power, or consume less than 50% power at the same speed. So our data shows that in high-speed application it can run up to 2.3 GHz, or on the other hand for low power application it consumes as low as 75 milliwatts per core. This kind of performance is what gives our customer a lot of flexibility to optimize their design for different market applications. So far we expect to have close to 60 tape outs by the end of next year. In summary, because of the excellent progress in yield lending and [indiscernible] in manufacturing maturity, and also to meet customers' demand, we plan to pull in 16 nanometer volume production to the end of Q2 next year or early Q3 year 2015. The yield performance and smooth progress of our 16 FinFET product further validate our strategy of starting 20 SoC first, quickly followed with 16 FinFET and FinFET Plus. We choose this sequence to maximize our market share in the 20, 16 nanometer generation, and I would have to repeat our Chairman stated last time, in combining 20 and 16 nanometer TSMC will have [indiscernible] we have been leading share every year from year 2014. In total foundry market share, TSMC was dipped several percentage points in 2014. He also said that he is happy to add that this trend, increase in the market share, will continue in year 2015. Next, I'll talk about our 28 nanometer status. We have strong growth in the second quarter in 28 nanometer, and the business grew another quarter and accounted for 34% of TSMC's wafer revenue in the third quarter. On the technology side, we continue our efforts to improve yield and tighten the process corners so that our customers can take advantage of these activity and shrink their dye size, and therefore reduce the cost. Let me give you an example. On 28LP, the polysilicon gate version will now offer a variety of enhanced process to achieve better performance, will also offer a very competitive cost so that our customer can address the mid to low-end smartphone market. In addition to the 28LP, we also provide a cost effective high-K metal gate version, the 28HPC, for customer to further optimize the performance and the cost. Recently we added another 28 nanometer offering we call 28 ultra low power for ultra low-power applications obviously. We believe this 28ULP will help TSMC customers to expand their business into the IoT area. In summary, we expect our technology spend in 28 nanometer node while enhance TSMC's competitiveness and ensure a good market share. We also expect the strength of the demand for our 28 nanometer will continue for multi-years to come. In response we are preparing sufficient capacity to meet our customers' eventual demand. Thank you for your attention.

Elizabeth Sun

Alright, this concludes our prepared statements. Before we begin the Q&A session, I would 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 from the floor and from the call. Should you wish to raise your questions in Chinese, I will translate it to English before our management answers your questions. (Operator Instructions) Now let's begin the Q&A session.

Elizabeth Sun

Our first question comes from the floor of Deutsche Bank, Michael Chou.

Michael Chou

Two questions. First question is, you mentioned your [indiscernible] production by end of Q3 next year will be [indiscernible]. Does that imply you will have earlier schedule than you claimed before?

Mark Liu

Yes.

Michael Chou

Okay. Second question is, do you have any comments for your market share for next year in 16, 14 nanometer?

C. C. Wei

Very hard for me to comment on the whole market share, but if there is any indication, I will say that we narrowed the gap with our competitor.

Michael Chou

Okay, so it means your viewing now is more positive than three months ago, can we say that?

C. C. Wei

Yes.

Elizabeth Sun

Alright, next question still comes from the floor, it will be from [indiscernible].

Unidentified Analyst

It's almost been a while. The first question is about your 20 nanometer ramp-up. I think it's been a progress in quite a while and [indiscernible] around 20% by the end of Q4, so I wonder if by that level, 20% at the end of Q4 in terms of revenue, would that reach your corporate average margin?

Lora Ho

No, you will not. We have talked about this several times. Any new leading-edge technology, it would take seven to eight quarters to reach corporate average. So if you count the 20 nanometer ramp starting from third quarter shipment status, it's by mid 2016 you will get to corporate level profitability.

Unidentified Analyst

Alright, thank you so much. So that would be the same for 16 nanometer I assume, right?

Lora Ho

Yes, we count the 20 and 16 as one node in terms of ramping and scheduled capacity and so on and so forth.

Unidentified Analyst

This doesn't count as the second question.

Elizabeth Sun

Alright, you can have a second question.

Unidentified Analyst

Okay, so second question is more about the picture about your China competition. I think recently we had observed quite a lot of move inside China including the [indiscernible] and [indiscernible] could be another target issue for. Also your competitor, UMC, last week announced that they are going to set up a 12-inch joint venture with the local government. So I think my feeling is, these guys seem to be aiming for the next growth potential market which is IoT and by taking the leverage of the huge demand market in China number one and also the very favorable Chinese government policy in favorable local production, so my feeling is are you worried about this kind of potential competition in the long run because you only operate in [indiscernible] China or do you have any strategy to cope with this potential threat from China in the next couple of years?

Mark Liu

This is a complicated question. Let me put this question into two parts. One is the China government's subsidy effects, secondly is the IoT opportunities. On China government's subsidy, the recent announcement about RMB1,200 billion subsidy, does cost a lot of activities across the industry. For us, we think currently we have very strong penetration on our China design houses, many of them over 80%, and they are most of them are cling towards leading-edge, and with these subsidies they will be more aggressive, and we think that is – we will be ready to capture the business, given the existing good penetration. And this subsidy may also bring into a merger position because China government wants to small company bringing to big to be more competitive, and I do think that is a healthy development for the industry with the bigger, stronger design houses to compete with. Of course there will be downsize because on the back of this subsidy maybe some of the company will under the influence of using local foundry and capacities, and that is a threat, may I put this way. But putting these positive and negative factors together, so long as we have technology leadership, so long as we have a strong manufacturing, so long as we have a good service, customer service, we think our business opportunity in China will grow, will be bigger with this development. On the IoT, IoT indeed, IoT has been anticipated by many companies including us. For us, we are currently actively developing IoT related technologies and including sensors, including processors, including wireless connectivity, advanced packaging and power management IC are included, all are trying for ultra-low power and in the power our technology provide lower power designs. On the capacity, yes, we are increasing our mature technology capacities today and we will continue to expand the mature technology capacity deviating from our past strategy, increasing those capacity to capture the potential growth of demand. In terms of further new fab, we don't exclude any possibility including the fab in China.

Unidentified Analyst

Thank you so much.

Elizabeth Sun

Alright, next question will also be coming from the floor, it will be from Bank of America Merrill Lynch's Dan Heyler.

Daniel Heyler

So a couple of questions. So as you are expanding your capacity in mature technologies for the IoT and MEMS and NFC and the whole range of things and you're expanding your advanced technology, TSMC has held a dominant position in 28 nanometer for almost four years and 28 nanometer accounts for 34% of revenue now. As your key customers are moving to 28 and 16 and the competition is obviously heating up as well, I'm wondering what steps you guys are taking to keep your 28 nanometer fabs fully utilized. You talked about HPC as a cost down version. Will this be a potential headwind to keep those fabs full in 2015, and if so how you are able to address the competition as well?

C. C. Wei

We believe the demand in 28 nanometer will continue, as I stated in my statement.

Daniel Heyler

From where?

C. C. Wei

From where? Okay. All the mobile devices and IoT and also applications. Actually the 28 nanometer today [with $1] (ph) is a very cost-effective technology. This is the last node that you enter into the 2P2E, double edge double pattern. So its application is very widely adapted. So we expect that demand for the next few years or actually for a long time will continue to increase and a lot of companies will attempt their advantage of the cost-effective and the performance also. So as we said [indiscernible] from the application side, application side is also all the mobile devices and all the consumer, even on the industrial part we can find some applications.

Daniel Heyler

Okay, great. And I presume you intend to hold market share, do you need to hold the current market share in order to prevent a falling utilization?

C. C. Wei

You bet.

Daniel Heyler

Okay great. And then the second question is with regard to 20 nanometer margins I guess for Lora, so looks as 20 will be over 20% of revenue in the fourth quarter and your guidance is for 20 to be about 20% contribution for all of next year. So that implies pretty much flat. How do you achieve margin expansion on flat revenue?

Lora Ho

Fourth quarter 20% is not equal to whole year 20%. So it increased quite significantly, that's number one. So the whole year 2015 20% is a big number. How do we hold the profitability? I would say, today's 20, 16 profitability is acceptable. I won't say it's great but it is acceptable and we continue to work on it, as we have done for other nodes in the past, and the margin will gradually improve as we have more volume coming on the line. So I feel still what I said and we believe we can achieve corporate level margin in eight quarter timeframe, 2016.

Daniel Heyler

Yes, my question was just around 28 margins, so yes, so will kind of additional customers coming into 28 because you previously said you felt this was going to be a major node, so is part of this margin expansion or margin improvement a function of different more products coming in that will help margin or is it more internal efficiencies and getting smarter and better about how you're doing things?

Mark Liu

Both. Our 28 nanometer currently 80% of them are high-K metal gate and 20% of them roughly about 28LP, and next year we'll compete on both fronts, we will compete on 20LP and we are planning to increase the capacity on 28LP also. That's [indiscernible] the next year's 28 nanometer will be bigger than this year. Competition will always be there of course. This is already, from 2011 this is the fifth year of 28 nanometer production. The learning curve brings us to a very, very mature state that all the cost reduction and many of the yield improvement will be our competitive advantage and also increase our margins.

Elizabeth Sun

Alright, I think we will now take our next question from the call. Operator, please proceed with the first caller on the line.

Operator

The next question comes from the line of Donald Lu from Goldman Sachs. Please ask your question.

Donald Lu

My first question is on smartphone. Can you let us know what percent of revenues in Q4 for example is from smartphone and also what will be the TSMC addressable market for smartphone, i.e., like on average how much revenue you can generate on average from smartphone this year and next year?

Elizabeth Sun

Okay, Donald, let me repeat your question. Your question is, how much percent of revenue TSMC derives from smartphone related applications? Your second question is in terms of revenue per smartphone box, what is TSMC's revenue per smartphone on average?

Donald Lu

Yes.

Lora Ho

Donald, we actually don't comment on quarterly basis percentage from smartphone, but I can tell you I can say for the whole year 2014 there will be a little bit more than 50% of our revenue coming from the smartphone.

Elizabeth Sun

And revenue per box?

Lora Ho

Revenue per box, the average $8 this year, which is an improvement from last year's $7.

Donald Lu

Okay. And how about the trend for next year, do we have any estimate?

Lora Ho

It's probably too premature to talk about next year but I would think the percentage will be very similar to this year.

Donald Lu

Okay great. Just my second question is more on structural profitability. Given all the moving parts, depreciation trend, et cetera, for next year what will be the [indiscernible] if you maintain a similar kind of structure visibility with the 20, 16 nanometer ramp moving slightly?

Lora Ho

We continue work on productivity and cost reductions. So from what we can see now, we believe we can maintain the same level of structural profitability next year versus this year.

Elizabeth Sun

Alright, so now we are coming back to the floor. Our next question comes from the floor from Credit Suisse, Randy Abrams.

Randy Abrams

I want to ask one follow-up on the 16, if you could talk about what you expect the revenue contribution now given you're pulling in earlier, and do you still see any material swing factors that could swing that ramp up at this stage?

C. C. Wei

Randy, you're saying the 16 FinFET?

Randy Abrams

For 16 FinFET for next year when you ramp it up in second half percent of revenue, and also if there is any material swing factors up or down that could swing the magnitude of that ramp up?

C. C. Wei

Probably too early to comment on the revenue side, but I would give you a hint, the ramp up was a little bit faster than 20 SoC and we have customer committed high volume for the tape out already.

Randy Abrams

Congratulations. Okay, my follow-up question actually just more looking at your outlook, given the comments you made on inventory, I think you put the chart not quite as lean coming out of fourth quarter, still coming down in Q4, but given you have a strong ramp up in 20, should we expect as we go into first quarter, one, if you think it will use first quarter to build product again like if we have a lower utilization you may build product early through first quarter, and then also if you expect a little bit of a gap or slowdown coming out of fourth quarter?

Lora Ho

We prefer not go into the first quarter next year, but as I just showed you the inventory cycle is two days below seasonality and it's going to be a mild correction, not as severe as last year. So that should give you some idea about the first quarter.

Elizabeth Sun

Next question also comes from the floor, it will be from Morgan Stanley's Bill Lu.

Bill Lu

Can I just start with a housekeeping question? That inventory chart that you showed, can I just ask you if it includes you've got a big systems house customer that we cannot track but perhaps you can, does it include the system house?

Lora Ho

That's our fabless customer. The chart shows fabless only.

Bill Lu

Okay, great. The second question is a comment that I think Mark and Lora have both talked about, which is smartphones is going to drive growth for multiple more years. I think that's a little bit different from what is the consensus view which is that you're going to get unit growth but a lot of it going forward is going to be more lower end, and Lora also said just now that percentage-wise smartphone is going to be about the same next year. So can you talk about what you think is going to drive growth for a few more years, what do you see that gives you the confidence?

Mark Liu

Yes, smartphone revenue next year appears flattened out total but we see next year it's still going to be increased, but our growth are propelling what TSMC can grow is mainly from the market share in that smartphone segment that we think given the 20 nanometer going forward and 16 and 10, we think our market share in the smartphone will continue to grow.

Bill Lu

I thought Lora's comment was that percentage of total revenue, smartphone is not going up next year, right, versus last couple of years it's been increasing. So next year smartphone is not going to outgrow the overall company?

C. C. Wei

[Indiscernible] are fairly similar, actually that it will be increased.

Bill Lu

Alright, thanks.

Lora Ho

You forget that we're going to grow next year, the Company.

Bill Lu

No, I understand that.

Lora Ho

So it's the growth above the average, yes.

Elizabeth Sun

Alright, next question comes from the floor and it will be from Citi's Roland Shu.

Roland Shu

First question is 20 nanometer gross margin. Lora, if I have read you right, you said the increasing volume to ramp up new technology actually the key factor for bringing up the gross margin overall, and also I look at in the past how you said it takes about seven to eight quarters to bring up the new technology gross margin to corporate level. That actually seven to eight quarter also was around the time you ramped up the total revenue to above 20%, probably 23%, 25%. So my question is for your 20 nanometer in 4Q, that is the revenue is above 20%. So is this 20% actually a big threshold level for you to bring up the gross margin because with this 20% total revenue contribution I think the volume is a bit enough [indiscernible] another factor to have a low margin for 20 nanometer?

Lora Ho

Actually this is a unique way of associating with the percentage of revenue to the gross margin and you talk about 20 nanometer as a separate node. When we look at 20 and 16, we feel it's the same node because 16 is a continuation of 20 nanometer and they use a lot of the same equipment and the same process almost. So if you combine those two nodes together and I cannot say if 20% is a threshold or not, what we look in the Company is we're looking to how efficient can we run this node and what will be the scale and what's our engagement with the customers and how effectively we bring down the capital efficiencies, bring up the capital efficiency, so on and so forth. So we don't usually link that to a percentage of contribution to Company revenue.

Roland Shu

But for the [indiscernible] actually I think it is big enough now, so is it possible for 20 nanometer actually to bring up the 20 nanometer gross margin to corporate level in less than seven to eight quarters, maybe in three quarters, four quarters?

Lora Ho

It's not possible because the 20 nanometer will be very soon migrating to 16 and 16 will take the momentum from 20 and it's going to ramp very, very fast not only on the volume also on the profitability side as well.

Roland Shu

Okay, little bit complicated. Okay, switch to second question, second question is TSMC actually has been doing a very good job. I think from 2010 to 2014 you have two strategic financial goals, one is your PBT to grow more than 10% in CAGR, the other one is ROE to be above 20%. I think from 2010 to 2014, [indiscernible] there is performances above your goal. So how about the expectations for next five years, 2015 to 2018 or 2019, how do you feel comfortable with this double-digit PBT growth going forward?

Lora Ho

We believe we will still grow faster than a semiconductor and actually in the past few years we have grown 2x of semiconductor, and we continue to gain foundry market share in the next five years, this is what we believe. So our financial objectives will remain unchanged. PBT, CAGR, either equal to 10% and ROE bigger than 20% from 2015 to 2019.

Elizabeth Sun

Alright, let's go back to the call. We will take our next question from the call. Operator, please proceed with the next caller.

Operator

Your next question comes from the line of [indiscernible]. Please ask your question.

Unidentified Analyst

This is a question for Mark or C.C. I'm just looking where the end market focus for TSMC, PC has never been a big part of your business but when I look at AP for next year, the transition to 64-bit and the introduction of FinFET, are we moving, is the AP moving into a world where it can realistically address mainstream PCs, now that we've got Windows 10 coming and we have [Broadwell] (ph) ramping up and Android is moving to 64-bit, how do you see this AP evolving into mainstream computing? And maybe just a follow-up to that, can you maybe just compare and contrast if you are an ARM fabless chipmaker building these APs for computing, how would you compare the cost and the performance using 64-bit ARM and your FinFET Plus versus Intel's Broadwell? Do you think it would be cost competitive versus Intel's Broadwell and do you think it will be performance competitive versus Intel's Broadwell?

Elizabeth Sun

Alright, let me repeat your question. You basically are asking us whether or not the migration of technologies and then with the arrival of ARM based 64 bit core the fabless today can design application processors that can go into the mainstream PC market, and if they could how would they compare with the existing incumbent players such as Intel in terms of cost and performance, that's your question right?

Unidentified Analyst

That's right, Elizabeth, and it's really comparing next year's AP to Intel's Broadwell, whether you think the new Broadwell platform from Intel which is 40 nanometer, how might we see fabless players running TSMC FinFET Plus and 64-bit ARM versus those platforms from Intel from cost and performance perspective?

Elizabeth Sun

So you are specific to 2015, you're asking 2015?

Unidentified Analyst

That's right.

Mark Liu

We certainly hope the ARM based core can get into PC faster. However the recent trend seems to be slowing down and we do not count on that, but our customers continue to making this ARM based core into a mainstream PC application and I think it's more than power and performance of those chips, they have a lot to do with the ecosystem around x86 core. So this is up to our customers and their customers how we together get into this but definitely this industry needs alternative in the PC world.

Unidentified Analyst

Great. Maybe just a follow-up for Lora. If I look on the balance sheet of TSMC, there is a large amount of construction and progress, so capital has been spent but at not expected capacity. Can you maybe just give us a sense for how this trends over the next three or four quarters and how depreciation might trend as well on the back of that?

Elizabeth Sun

So your question is looking at our balance sheet with a very large item called construction in progress, which of course eventually will become capacity, and you want to know what is the trend leading from this large accounting construction in progress into the impact of our depreciation?

Unidentified Analyst

That's right.

Lora Ho

We are building out new facilities to ramp the 20 and 16 nanometer which will be located [indiscernible]. So the number you see in the balance sheet is associated with those building constructions and some of them are equipment purchase. What I can tell you, the depreciation change and this year was 9.6 billion CapEx, the depreciation year-over-year change will be roughly 30%. I wish that [indiscernible] actually been lower. I was telling somebody 35 earlier, now it's come out to about 30%. With slightly more CapEx for next year as I was talking about, the depreciation increase will be much smaller than this year versus last year, in the mid teens range, certainly below 20% increase year-over-year.

Elizabeth Sun

Okay, now let's come back to the floor and Andrew is eagerly anticipating me, so we'll have Andrew from Barclays.

Andrew Lu

[Foreign language].

Elizabeth Sun

Okay, I have to translate your question into English. Andrew's question is, given there will be a faster ramp of 16 nanometer, does this mean that next year's third quarter, fourth quarter revenue from 16 nanometer will be bigger than this year's third quarter, fourth quarter revenue from 20 nanometer?

Mark Liu

No.

C. C. Wei

Actually if you look at what we announced early this year, we said that the 20 SoC is in production. That means we start our wafer production and the shipment, the wafer shipment actually is in the third quarter. So you know that for this kind of a cycle time, it will run through the line [indiscernible] the packaging and then the revenue. 16 FinFET actually is longer because they have a more mask in there. So when we start at the end of the second quarter, you can estimate that what will be the volume shipment translate into revenue. That's what I can…

Andrew Lu

[Foreign language]

C. C. Wei

It is two quarter late, two quarter difference.

Lora Ho

[Indiscernible] the shipments.

C. C. Wei

1.5 quarter, to be exact, alright.

Andrew Lu

[Foreign language]

C. C. Wei

In fourth quarter, it was the contribution.

Andrew Lu

[Foreign language]

C. C. Wei

High single digit.

Andrew Lu

The other question, this time I use English, for 10 nanometer ramp-up, you mentioned the starting point year 2016. Is that similar timeframe to ramp out 16 nanometer ramp up next year or further delay another one or two quarters to generate revenue?

Mark Liu

I said, we will try to enable our customers maybe to ramp up in 2016, I think towards the end of 2016, and really it's up to the customers ramp, but I think in terms of revenue it will be much lower than 16 nanometer in 2015. So the real volume will happen beginning of 2017.

Elizabeth Sun

Next question also comes from the floor, it will be HSBC's Steven Pelayo.

Steven Pelayo

When I look back at 28 nanometer, you had seven quarters of solid absolute dollar growth sequentially. Now when I look at 20 nanometer, you're already at 20% revenues in two quarters, such a steep ramp. Do you suspect that 20 nanometer in absolute dollars on a quarterly basis can continue to grow every quarter like that for seven quarters that you saw in 28 nanometer?

C. C. Wei

Yes, we still see the 20 nanometer continue to grow next year.

Steven Pelayo

So even quarterly in the first quarter, second quarter with seasonality, you still will see sequential dollar on dollar growth?

C. C. Wei

We might have some kind of synergy but on the average, yes, still growing.

Steven Pelayo

I understand. And then, Lora, a question for you, I know the Board is going to talk about the dividend next year in February, you have about 300 billion in cash, you're generating about 40 billion a quarter, how much cash do you need to run this business? We are trying to all figure out what kind of magnitude, could you afford $4, could you afford more even, it seems like you could, so maybe you could talk a little bit about what are the inputs that go into that decision on where you would like to take the dividend?

Lora Ho

I think the key inputs is the sustainability of free cash flow generation. Consider the potential CapEx for the future years and operating cash flow we can generate with that kind of business growth, that's the key decision factor. I probably cannot tell you how was magnitude because we need to discuss it with the Board, but as I said earlier in my comments we feel that we are affordable to raise the dividend level and therefore we'll decide the numbers.

Steven Pelayo

I'm sorry if I could just sneak in a follow-up to that first question to you, if you do have some seasonality in 20 nanometer in the first half of next year, do you worry at all about the margin implications there if you're not fully utilized on that very expensive capacity?

C. C. Wei

Very hard to answer your question. Although I say seasonality, but I don't expect too much of a drop if there is a drop. You can see the smartphone [indiscernible]. I cannot say which one but… and I will let Lora answer this question because…

Lora Ho

It's too early to give a guidance on the margins.

Mark Liu

Yes but we think the seasonality – since last year we have this mechanism of pre-built work with our customers to smooth out the utilization and for the 20 nanometer we intend to do that and I think in terms of the product complexity it's much simpler, which we should be able to minimize the impact.

Elizabeth Sun

Next question comes from the floor, it will be from UBS' Eric Chen.

Eric Chen

My first question regarding to the 20 and 16 FinFET technology, you mentioned that equipment in between both FinFET are pretty similar, so I assume that your 16 FinFET, even 16 FinFET Plus, is pretty high, so I'm just wondering why the all equipment moving is so conservative compared to our competitor and the 14 FinFET technology in terms of equipment moving?

Elizabeth Sun

So, Eric, question is he assumed that we will have a very good yield rate on the 16 nanometer FinFET, I think that's correct. So given that why are we so conservative in equipment moving?

Eric Chen

[Foreign language]

C. C. Wei

Let me answer your question. First your impression of we slowly moving 16 FinFET equipment, I think Lora just mentioned that we are going to spend also a big CapEx next year, and from this year, next year we invest on the 16 FinFET and 20 SoC also, and some of the tools actually a high portion of the tool are coming for these two nodes. So, no, it's not slowly moving as you say. Yes, we did ramp up the 16 FinFET behind our competitor, yes, and that's why Chairman said that we are going to have a smaller market share, but our situation improved as time goes by because of manufacturing maturity and good yield performance and also the customer pulling their demand, so we decided to pull in the ramp-up schedule and we are in very high [indiscernible] to bring up the 16 FinFET. I said we have more than 1,000 engineer preparing for the ramp-up. So that gives you a hint that we are full speed actually preparing for that.

Eric Chen

Okay and we believe you're going to be very aggressive in the 16 FinFET competing for next year and you are committed to run on very aggressive, probably [indiscernible] aggressive, so internally [indiscernible] a scenario and honestly to say the 14, the 16 FinFET technology in terms of competitive-wise probably will overcapacity in year 2016, the overcapacity?

C. C. Wei

We feel the capacity will meet the customer demand and we have confidence as I said, we already have customer committed high volume amount to us and we build the capacity according to the demand and we have confidence to gain large market share 2016.

Eric Chen

The year will be the key, right?

C. C. Wei

Yes.

Eric Chen

Okay. And also for Lora regarding the 20 and 16 nano FinFET, I may have lost, the equipment is not big different, so we assume that the depreciation pretty much [indiscernible] for the 20 nanometer process. So in annual can we expect the gross margin for 16, the Plus FinFET, pick up that above average probably much faster than we saw?

Lora Ho

That's the right assumption, yes.

Eric Chen

Okay. [Indiscernible] if we talk about second quarter for 20, can we assume about fourth quarter for the 16?

Lora Ho

I don't know because we only look at the two nodes together.

Eric Chen

And my second question.

Elizabeth Sun

You already had two questions. Now we have to go to someone else, sorry. We can come back to you. Next will be from Dan Heyler.

Daniel Heyler

Just a few quick housekeeping. So Lora, could you comment a little bit on the linearity of the CapEx next year in terms of first half versus second half? You normally share that with us.

Lora Ho

Next year is not decided yet. Let's see.

Daniel Heyler

I imagine front-end loaded.

Lora Ho

I don't have the number with me, I intuitively think it will be front-end loaded because we do get capacity ready for the 16 nanometer ramp.

Daniel Heyler

But kind of similar to this year then probably, right, in terms of the weighting?

Lora Ho

This year is not that front-end loaded, maybe slightly front-end loaded, I don't have a number with me.

Daniel Heyler

Okay, great, we can come back to those. So on the capacity growth, this year you grew about 12%. Could you share with us what kind of capacity growth we should expect next year, because you did alluded to some 8-inch expansion and then you also got which I'm sure is quite small but in addition to that your 20 and 16 nanometer capacity growth?

Lora Ho

I said this year we will grow about 12% in total capacity, next year about the same.

Daniel Heyler

Great. And is it fair to assume that very little 8-inch addition, that's more kind of peanuts or could we see bigger 8-inch?

Lora Ho

Couple of hundred million is not peanuts. More 8-inch than last year I will say.

Daniel Heyler

2 million?

Lora Ho

Couple of hundred million U.S. dollars.

Daniel Heyler

Couple of hundred million, okay. And then I guess what I wanted to think a little bit about the magnitude of the revenue trends in the fourth quarter, you're growing in low single-digit. The non-20 nanometer capacity, how much is that – is that growing or is that down in the fourth quarter in terms of the non-20?

Mark Liu

[Non-20] is down, it's down. For our case, a little bit more than seasonal because we are forecasting the DOI would be below.

Daniel Heyler

Looks like down low single digits is what it looks like?

Mark Liu

We don't know, probably close to double-digit size.

Daniel Heyler

Double-digit decline for non-20.

Mark Liu

For non-20, yes.

Daniel Heyler

Okay, great. And then finally, -- no, she's cutting me off.

Elizabeth Sun

Right. Next one goes to, the question will be coming from Credit Suisse, Randy.

Randy Abrams

This one might be more for C.C. I just want to see if you could give an update on the info and the fan-out wafer level packaging, just your initiatives on doing some of the integration, whether next year there's many applications or it will take time to develop would come with the following year, and what type of applications you're seeing the first interest?

C. C. Wei

[Indiscernible] for the customers really to adopt the new packaging because that affected the design architecture and also everything. So application-wise, it will be still in the mobile devices. And your question is…

Randy Abrams

Is it probably more the following year, like next year probably not much revenue but I guess at the hundreds of millions in revenue?

C. C. Wei

The significant volume will be in 2016, we already worked with the customer on that.

Randy Abrams

Then one quick follow-up on the China, there were some discussion earlier about China and now you have competitor foundries putting a fab there. Does it make sense given a lot of attention on local manufacturing and even Qualcomm going to have local China manufacturing, does it make sense at some point to consider a fab in China and are there restrictions or those removed if you wanted to have a 12-inch fab in China?

C. C. Wei

We have a fab in China today, it's 8 inch, and we are expanding that capacity also, actually today and following months, and we have space next to the fab also. So when the demand is needed, when the option is the most cost effective, that's one of the consideration. As to 12-inch, no, I think so long as [N minus 2] (ph) and below, I think that at least for the local government restriction is not there.

Elizabeth Sun

So now we are going back to Eric for his follow-up questions.

Eric Chen

Regarding to the 10 nano, the FinFET, the ASML had a conference call last night and indirectly they mentioned their sense is quite a leading player. So I just would like to know what's your strategy, I mean your equipment moving in the 16 probably not so aggressive but your strategy of the 10 nano is so aggressive, so how you look at the future outlook?

C. C. Wei

On EUV you mean the question?

Eric Chen

In terms of the 10 nano.

C. C. Wei

Our current 10 nanometer does not use EUV. All the technology developing for 10 is still using multiple patterning technology.

Eric Chen

So you used to, right, EUV and the one you mentioned?

C. C. Wei

We are working with ASML to develop EUV tools and the opportunity is to have a follow-on process simplification using EUV, masking layer simplification, but that's some way to go, could not catch our initial ramp of 10 nanometer. The current challenge is still the power of the source and the availability but still very encouraging that source power is continuing increasing and other factors as mask defects and mask technology and the photoresist have a lot of improvement. So we are looking at the follow-on insertion point after the 10 nanometer ramp for the cost reduction or before the process simplification.

Eric Chen

Okay, so the way you go for the 10 nano FinFET is the same as the Intel way or different way from the Intel?

C. C. Wei

In terms of not using EUV?

Eric Chen

Yes.

C. C. Wei

Intel announced they don't use EUV on their 10. So it's a different way.

Eric Chen

I'm sorry? I don't know the Intel technology that well. [Indiscernible] that there is a wild argument of about the 14 nano FinFET is the way Intel took up and the [indiscernible]. So once they go to the 10 nano, if they go a different way, probably we will see the two different way in the 10 nano FinFET [indiscernible] trying to choose. That probably will bring a risk on the either side. So I don't know this argument makes sense from your point of view. Does that make sense?

C. C. Wei

That's our plan. I don't know what the Intel's detailed plan is and they have announced their 10 nanometer detailed either. So we just make the best of what's being to our most beneficial way to implement the EUV.

Eric Chen

Okay, very clear.

Elizabeth Sun

Follow on questions from Andrew Lu.

Andrew Lu

Very quick two questions. First one, is the 28 nanometer high-K metal gate [indiscernible] percentage of 28 in Q3 and Q4, any rough numbers?

C. C. Wei

Probably 70 to 30.

Andrew Lu

For both quarter?

Mark Liu

Q3 is probably more than 80% high-K metal gate, less than 20% polysilicon. But going to Q4, polysilicon has a big increase from our demand. So getting to, temporarily get to 70-30 in the Q4 as C.C. just mentioned.

Andrew Lu

Because of customer, right?

Mark Liu

Because of customers.

Andrew Lu

Okay, the next one is, I remember last time Lora mentioned CapEx for next year is going to be higher than this year, but this time changing the tone saying the CapEx next year will be slightly higher than this year. So I just want to ask whether the CapEx also higher than this year for next year?

Lora Ho

I don't think I said last time that next year will be higher than this year, I didn't say that. I probably said we'll be lower than last year, that's probably what I said. Given the total CapEx, as I just indicated, will be slightly higher than 10 billion but we have not decided how much it's going to be and we don't decide the revenue of 2015, so it's probably too mature to comment on capital intensity for next year.

Elizabeth Sun

Follow-on questions from [indiscernible].

Unidentified Analyst

A quick follow-up question. Sometime Dr. Morris Chang give some color for beyond one quarter. So would you give a little bit color for your Q1 outlook because we talk about inventory, this year is very mild and demand is still pretty strong especially for these [indiscernible] has been in good shape, so some color on next year Q1?

Lora Ho

Q1 normally is the low season. You will see sequential decline for the experience we had before. I cannot comment more on that. I don't think Q1 will be very different from that pattern.

Mark Liu

Let me add some color for that if you want.

Unidentified Analyst

Sure, of course.

Mark Liu

We only expect strong inventory adjustment more than what we see in Q4. Okay, I think this is what we see from our demand forecasting.

Elizabeth Sun

Follow-up question from HSBC's Steven Pelayo.

Steven Pelayo

Just a little bit thinking about the next three years or so, the last three years you guys have clearly benefited, 28 nanometer dominance, smartphone industry going kind of 40% compounded annual growth rate, you guys have grown 20%, 25% per year I think in the last three years or so and I got to do the calculations again for this year, maybe you were actually above that, when you think about the next three years, I think people are forecasting smartphone CAGRs maybe more under 15% type range, do you think – you guys gained a lot of market share I think in the last couple of years as well, are laws of large numbers catching up to you guys, is without smartphone growth that significant increase in silicon content for phone, do you think these growth rates that you've been enjoying, this 20% plus for multiple years, are headed lower over the next few years, and then to what magnitude?

Lora Ho

You cannot expect 20% growth for every year but we are confident we can grow double-digit in the next two years.

Elizabeth Sun

Short follow-up questions from Dan Heyler.

Daniel Heyler

Got last one, thank you for letting me sneak in. I didn't forget it. So on the 20 nanometer, coming back to that, the fourth quarter contribution for this year on this percentage of sales, will this, will 20 grow one year later, so forth quarter next year, or that what contribution of sales do you expect 20 per se to be, 20 nanometer next year, because I mean you've obviously pulled in 16 nanometer so there's new dynamics, I'm wondering if you're going to see any growth year-on-year from 4Q this year to 4Q next year, will the dollar value grow year on year?

C. C. Wei

Good question. I think next year while we ramp up 16 FinFET, 20 SoC demand will be flat and the percentage will be lower. Okay, that answers your question?

Daniel Heyler

Yes, it does, thank you.