TSM 台积电

Presentation

Elizabeth Sun

[Foreign Language] Welcome to TSMC's Second 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 conference call your dial in lines are in listen-only mode. As this conference is being viewed by investors around the world, we will conduct this event in English only. The format for today's event will be as follows. First, TSMC's Senior Vice President and CFO, Miss Lora Ho, will summarize our operations in the second quarter of 2016, followed by our guidance for the third quarter of 2016. Afterwards, Miss Ho and TSMC's two Presidents and Co-CEOs, Dr. Mark Liu and Dr. C.C. Wei, will jointly provide our management's 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 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 statement. Please refer to the Safe Harbor notice that appears on our press release. And now I would like to turn the podium to TSMC's CFO, Miss Lora Ho, for the summary of operations and current quarter guidance.

Lora Ho

Thank you, Elizabeth. Good afternoon, everyone. Welcome to joining us today. My presentation will start with financial highlights for the second quarter and followed by the guidance for the third quarter. We had a good second quarter. Our second quarter, our second quarter revenue increased 9% sequentially to NT$222 billion, exceeding the high end of our guidance given in April, due to business upside resulting from the demand increases in mid and low end smartphones and customer inventory restocking. Gross margin was also ahead of expectation and increased by 6.6 percentage point Q over Q to a record high of 51.5%, mainly driven by improvement in utilization rate and cost reduction efforts, partially offset by an unfavorable foreign exchange rate. Operating margin also increased by a similar magnitude to reach 41.2%. As we highlighted last quarter, we incurred a higher income tax in the second quarter. The corporate tax rate rose to 23% as we accrued the 10% on undistributed retained earnings. And we estimate the 2016 full year tax rate to be about 14%. Overall, our second quarter EPS reached NT$2.80, an 8.7% decline year over year, mainly due to a non-recurring share disposal gain from ASML and Vanguard in the second quarter of the last year. Excluding the one off items, second-quarter EPS actually grew 17% year over year. Now let's take a look at revenue contribution by application. During the second quarter communication was flat from the prior quarter, while computer, consumer, industrial and standard increased by 19%, 80% and a 12% respectively. Now how about revenue by technology? Combined revenue from 16-nanometer and 20-nanometer continued to grow and they represented 23% of revenue in the second quarter, same as the first quarter. 28-nanometer contribution fell slightly to 28% versus 30% in the first quarter, due to a higher revenue base in the second quarter. But absolute dollar revenue from 28-nanometer continued to increase Q over Q. Moving on to the balance sheet, we ended the second quarter with cash and marketable securities of NT$668 billion, an increase of NT$19 billion. On the liability side, current liability increased NT$163 billion as we accrued about NT$156 billion for cash dividend, which will be paid out this month. On financial ratios, accounts receivable turnover days increased 2 days to 43 days, while days of inventory remain at 54 days, same as last quarter. Now let me make a few comments on cash flow and CapEx. During the second quarter we generated about NT$107 billion cash from operations and spent NT$100 billion and spent NT$74 billion in capital expenditure. As a result, we generated free cash flow of NT$33 billion this quarter and repaid NT$11billiom of [corporate] bonds. Our overall cash balance increased NT$4 billion to NT$622 billion at the end of the quarter. In US dollar terms, the capital expenditure spent in the first half of 2016 totaled $3.4 billion. The second half spending will be much more than the first half. I have finished my financial summary. Now let's turn to the third quarter outlook. We expect our business in the third quarter will benefit from our customers' new product launch and continued inventory restocking. Based on our current business outlook and exchange rate assumptions of $1 to NT$32.30, we expect third quarter revenue to be between NT$254 billion and NT$257 billion, which represents 14.5% to 15.9% sequential growth; gross profit margin to be between 50% and 52%; and operating margin to be between 39.5% and 41.5%. This concludes my remarks.

Elizabeth Sun

Now we will begin the management comments and we will start with TSMC's CFO, Miss Lora Ho.

Lora Ho

I would like to make a few comments on near term outlook, CapEx, profitability and the dividend. Let me start with near term outlook. Our second quarter result was helped by an increase in demand from China 4G Plus smartphone ramping and continued 3G to 4G upgrade from emerging markets. Given a stronger than seasonal business for our fabless customers in the second quarter, we estimate our fab-less customers' DOI exiting, exceeding second quarter is above seasonal level. Looking ahead to third quarter 2016, we forecast continuing inventory build by the smartphone-centric OEMs and fabless companies, stimulated by subsidy provided to the telecommunication companies by the Chinese government. We estimate fabless DOI will remain flat with the second quarter, but will be above seasonal level by a few days exiting third quarter. Fourth quarter is normally an inventory adjustment quarter, but the degree of adjustment will depend on market dynamics and the sentiment. For now, we expect the supply chain inventory to go back to the seasonal level exiting fourth quarter. For the whole year of 2016, TSMC maintains our target of between 5% and 10% growth in both revenue and operating profit, both in US dollar and in NT dollar terms. Now let me make a few comments on CapEx. Our 2016 CapEx forecast has risen from $9 billion to $10 billion to $9.5 billion to $10.5 billion because expectation for 2017 mobile market, mobile products revenue has risen as well. TSMC's CapEx-to-sales ratio, known as capital intensity, has come down significantly in the last two years. Compared with the high 40s level seen in 2011 to 2013, our capital intensity has dropped to about 31% last year. Going forward, we estimate our capital intensity will remain at mid-30s level for the next few years. One major factor contributing to this moderate level of capital intensity is our effort made to minimize the conversion loss between two adjacent technology nodes. For example, between 20-nanometer and 16-nanometer, we closely manage one peak capacity so we can minimize conversion loss. Now, we also closely manage 10-nanometer and 7-nanometer as one peak capacity to minimize the conversion loss. In terms of profitability, in the past few years, despite the higher CapEx which led to a substantial increase in depreciation expenses, we have been able to maintain and even improve our structural profitability. We expect to be able to maintain our gross margin at close to 50% level and operating margin at close to 39% level. My last comment is about dividend. We anticipate a steadily improving free cash flow in the next few years. Therefore, we expect our dividend to steadily increase in the next few years as well. Thank you. Let me turn the microphone to Mark for his comments.

Mark Liu

Good afternoon, everyone. Thank you for joining us. I'd like to deliver you the message firstly on leading-edge technology status that includes 10-nanometer, 7-nanometer and 5-nanometer. First, on 10-nanometer, our 10-nanometer has been transferred from R&D to production. Our first 10-nanometer customer product has been produced with satisfactory functional yield. So far, three customer products have been taped out to us. More customer product tape-outs are expected later this year. Those product tape-outs will start a revenue stream starting first quarter 2017, which will ramp steeply throughout 2017. On 7-nanometer, our 7-nanometer technology development is well on track. Its 256-megabit SRAM yield improvement is ahead of our schedule. In addition, we believe our 7-nanometer PPA that is power, performance and area density, with its schedule is ahead of our competitors. This technology has been aggressively adopted, not only by mobile customers, but also by high-performance computing customers. They all have aggressive product tape-out plan in first half 2017, with volume production planned in early 2018. On 5-nanometer, we have been executing our 5-nanometer development since the beginning of this year. TSMC's 5-nanometer will achieve 1.9 times of logic density over our 7-nanometer. We plan to extensively use EUV lithography in 5-nanometer through improved density, simplified process complexity and reduced cost. The 5-nanometer risk production qualification in first half 2019 remains unchanged. Secondly, on EUV status, we plan to adopt EUV extensively in our 5-nanometer technology. Today EUV technology uses 7-nanometer as a development vehicle. We have good integration progress in EUV scanner, EUV mask and EUV photoresist. Same yield level has been repeatedly demonstrated using two EUV layers in 7-nanometer. Currently we are running four state-of-the-art EUV scanners for EUV infrastructure development and for N7 and N5 technology development. We will move in another two EUV high-volume production tools, that is NXE3400, in first quarter 2017, next year. Recently we successfully implemented 125-watt EUV source in our EUV3350 to improve productivity. In our in-house mask shop, we have developing unique EUV mask technologies on mask blank, material, inspection and repair, to seamlessly integrate our EUV lithography total solution. With all the encouraging developments and progresses made at EUV, we estimate that EUV will be cost effective tool for high volume manufacturing by 2020, in time for our 5-nanometer ramp. Should EUV become cost-effective earlier, say around 2019, we believe we can still benefit from the earlier available of EUV for our 7-nanometer high-volume manufacturing. Thirdly, on growth drivers. First, smartphone as a growth driver. We expect smartphone related demand will support half of our growth in the next five years. It will come from unit growth as well as increasing silicon content. Despite a weak semiconductor industry growth this year, we estimate the smartphone unit growth rate will be about 6%. And the silicon content growth rate per smartphone will increase by a double digit for high and mid end and about flattish for the low end. We estimate total semiconductor revenue, excluding memory in smartphone, will increase about 7% this year. Longer term, we believe the smartphone unit will continue to grow at a mid single-digit rate and the silicon content will continue to increase. This silicon content increase is driven by increasing adoption of innovative smartphone features, such as dual camera, security sensing, augment reality, virtual reality and migration of 4G, 4G Plus and to 5G. Most of the high end smartphone features are also proliferating into lower end smartphones, because those innovative features usually require more advanced technologies. With our customers, we will gradually increase our market share in the smartphone market. As to high performance computing, as a growth driver, as the digital trend develops in all industry worldwide today, silicon IC will needed to take up vast amount of computation load in the future. We estimate computing opportunities will support about one quarter of our growth in the next five years. In TSMC, we work with IC innovators around the world. We see momentum building up in the computing space for our customers. In May, this year, seven companies announced that they are forming an interconnect consortium, called CCIX, to enable heterogeneous computing in datacenters. In China, cloud leaders and a technology company formed Green Computing Consortium, aiming to develop energy efficient datacenters. We also see increasing activities around machine learning, where system companies differentiate down to the silicon level. TSMC as a foundry player, focuses on enabling our customers' innovation through providing leading-edge technology. Other innovations in computing area are augment reality, virtual reality, gaming and ADAS, or advanced driver assistance systems. TSMC has been developing suitable process technologies and design enablements for all those innovations. Above is my message. Thank you. Now I turn the microphone to C.C.

C.C Wei

Thank you, Mark. Good afternoon, ladies and gentlemen. Let me start with our 16-nanometer status. We continue to ramp 16-nanometer with bigger density and a cycle time better than ours plan. Major applications this year include mobile processor, cellular baseband, graphic and video game. We are happy to report that we have been recognized by a major customer for our contribution to the success of a deep learning chip using TSMC's 16 FinFET Plus. We expect our 16-nanometer business will continue to increase in the second half of this year, with most of the products adopting our 16FFC, which is a low-power and low-cost version of the 16-nanometer process. We expect to generate more than 20% wafer revenue from 16-nanometer in this year. Now 28-nanometer, our 28-nanometer has entered its sixth year of volume production. TSMC's 28HPC and HPC+ have been widely adopted by most of the mobile application processor suppliers for the faster growing mid to low-end smartphones and other applications, such as Wi-Fi, digital TV set-top box, box controller, etc. With our differentiated technology, stable yield, short cycle time and large capacity support, we expect stronger demand for our 28-nanometer [indiscernible] through this year. Now let me touch a little bit on our competiveness for those technologies which have been in volume production, namely 16-nanometer, 28-nanometer and so on. TSMC continues to improve our technologies and development and develop new variants, even after these technologies have entered mass production stage. For example, to meet the changing market requirement we introduced a low-cost, low-power version 16FFC this year after 16-nanometer started volume production last year. We also lowered the operating voltage of our 16-nanometer process to 0.5 volt to meet the requirement for IoT applications. Similarly, at 28-nanometer node, we introduced 28HPC and 28HPC+ for the low-power solutions who are keeping the speed at almost the same level. For 14-nanometer, TSMC also introduced 14 low power for low-power applications. For 55-nanometer and older node we apply similar approaches as well. Since we are able to start volume production ahead of our competition, TSMC has enjoyed a substantial advantage in learning curve. We are able to accumulate enough experience faster than our foundry peers. And therefore we can better improve our cost and device performance for each technology node. Because of the learning curve advantage, we believe we are highly competitive in both performance and cost. Now let me talk about our another growth driver which is IoT, in addition to mobile and high speed computation market which Mark just explained. Driven by innovative business model we expect the diversified and fragmented IoT applications will become one of the most important growth drivers for future semiconductor business. IoT applications require not only the collection of huge amount of data but also the ability to analyze the data and utilize the data to improve our daily lives, such as security and health. In the near term we can see smart band and smart watch for healthcare and smart meter for efficient energy and cost saver. Longer term, we expect ATOS and autonomous driving be widely adopted. Smart home, smart city, Robot, drone are also progressing along. We believe TSMC's specialty technology development in CMOS image sensor, MEMS, RF, power management IC and emerging memory are well positioned to capture the IoT opportunities. Now let me talk about our advanced backend technology, first on InFO. We are in volume production now. Our focus today is to continue yield improvement and cost reduction. We expect InFO will contribute more than U.S. 100 million revenue in 4Q this year, with moderate gross margin. At the same time we are also developing the next generation InFO technology for products planned for next year and beyond. Now, on CoWoS, we have seen strong momentum from high memory bandwidth and high performance driven applications, such as the [band working], deep learning and artificial intelligence. While our CoWoS is still in small volume production for those very high speed applications, we see the potential of the band increase as well. We expect to support our customer to grow their business in the high speed computing space with our cohorts as part of our advanced technology offer. Thank you for your attention.

Elizabeth Sun

All right. 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 questions. Questions will be taken both from the floor and from the call. Should you wish to raise your questions in Chinese, I will translate it to English before our management answers your question. [Operator Instructions]

A

All right. Now let's begin the Q&A session. I think we will have the pessimistic analyst from JPMorgan to ask the first question, Gokul?

Gokul Hariharan

Thank you very much. First of all on smartphones, and growth coming from smartphones being half of the growth and computer also contributing to quarter of the growth, could you talk about what is the growth picture for the whole company? Are we going to maintain the 5% to 10% growth that we are predicting for this year into the next five years? Or how should we think about the growth pattern? And I have a follow-up on the computer side as well.

Mark Liu

Okay. Thank you. You talk about the growth model, right? Okay. We do have a growth forecast within the company, but let me share you with the big picture. In our model, semiconductor has been staying on 0% growth for the past two years, but next five years, we estimate about between to [queue up] between 2% or 2% plus to 3%. And the fabless company, because of the business model advantages and the leading edge technology advantages, they will grow about 5% per year in the next five years. And semiconductor and the TSMC with this, not only the fabless company but also the system company and IDM also seeing. We estimate will grow, our current estimate will be about between 5% to 10% depending on the macroeconomics and the semiconductor events. This model is assuming that there is no killer application happen in the next five years. Okay? And as to the background of this growth model, we have, we are focusing on four areas, as I presented to you earlier. First is the smartphone, mobile devices, mostly smartphones. And that will drive about the growth 50% of that growth in the next five years. And the high performance computing, that will include the learning, artificial intelligence, the machine learning, AI, gaming, that will grow that would drive about 20, about a quarter of our driving growth in the next five years. And autonomous car and IoT and the rest will take up another quarter of the drive growth for the next five years. So this is the, largely our growth model, yes.

Gokul Hariharan

Just on the smartphone bit, are we, I think we have seen smartphone estimates getting, coming down for the last six quarters. Are we expecting that smartphone units stay at this 5% to 6% growth rate? Or could, in think in most tech markets, once the saturation hits we get down to probably GDP growth rate, which is like 2% or something like that. Are we anticipating that? And is the future growth in smartphones primarily coming from content growth, which is still pretty decent?

Mark Liu

Indeed, the smartphone has been slowing down in the past six quarters, particularly for the high end. And actually, but at the same time, the mid end, certainly in content, is increasing very fast. And the unit number at the low end also increasing very fast. As far as the high end, we don't believe the trend for the last year drop will continue. Okay? Innovation will surface to drive the momentum of the unit growth. So in total, we still estimate the growth rate will be about 5% in unit growth. Significant content I mentioned is also about equally important. So that's the general model we have.

Gokul Hariharan

Just a question on the compute side. Could you talk a little bit about the take up of the revenues, given that you're expecting tape outs in first half next year? Typically the end market that you serve in compute, especially the datacenter compute, takes a bit longer for qualification, if you look at server market, for example. Are we anticipating revenues coming in with 7-nanometer in 2018 itself for compute, or could you talk about your revenue model for the compute part? Thanks.

Mark Liu

The question is regarding the high-performance computing, how would that, appears to be? At this point we think, first of all, many of the low end servers has, some of our smaller customer has penetrated already. But for the ballpark, the main portion of the server, I think it will wait for the 7-nanometer to get some share by our customers. But in the next, at least in the next, so 7-nanometer will happen in 2018 and afterwards, so it will start from 2019 and beyond. So it will, for the datacenter I think it will be more a hockey stick beyond, probably really bigger portion beyond 2020. So in the next five years, mostly are the computing of the cloud edge devices, of course including the networking, storage and other cloud edge devices I just mentioned.

Gokul Hariharan

Okay. Thank you.

Elizabeth Sun

Next we will have Credit Suisse, Randy Abrams, to raise the question.

Randy Abrams

Yes. Thank you. I wanted to ask the first one actually, another one on the growth drivers, just to get a feel for the base. The computing, should we think of computing now just that computer end market that's 8% of revenue? Is that when you're thinking about computing, driving a quarter of the growth it's only 8% of revenue now? Like are we thinking the same definition? And within computing, how much are you banking on ARM and IBM-based servers, versus some of the other things, like the deep learning, or if it's like the AR/VR graphics that you're banking on for most of that growth?

Mark Liu

Can you repeat the question?

Randy Abrams

Yes. So the question, the starting point is computing, when you're referring to computing driving a quarter of the growth, is it 8% of revenue now we should think of your computing end market category? And for the growth, are you factoring most of that growth from the ARM IBM based servers, or is most of it more from the VR/AR, AI type stuff?

Mark Liu

Okay. When I talk about computing, it doesn't include a lot of PC or tablets or current computing. I am more category the high-performance computing part. Of course, datacenter, networking storage, but mostly it's in the next three years I think it will be mostly the machine learning, AI, augmented reality, gaming, those are, those computing devices. Datacenter will not, I don't think it will come out the big volume until 2018.

Randy Abrams

Okay. The second question, I had a two part question on the gross margin. For third quarter, if you could go into the factors. Sales are up 15% but the gross margin's kind of flattish. If you could talk about the factors, say from InFO or ramp of 16-nanometer, what's driving kind of the factors? You're not single leverage from Q2 to Q3 in gross margin with the higher sales? And then the second part is as you ramp 10-nanometer next year, this year you had the benefit of 16 being a more mature process, borrowing from 20, so would there be any margin impact on the first year of the 10-nanometer ramp in 2017?

Lora Ho

So, Randy, you referred to the margin for the third quarter. As we are continual ramping 16-nanometer, so 16-nanometer will account for a bigger part of our revenue in third quarter versus the second quarter. As this year is only the second year of the 16 ramp, so it still has some dilution to corporate average gross margin. So this is a negative for third quarter.

Randy Abrams

Most of its just a 16 and InFO?

Lora Ho

InFO is very small quantity, and the quantity comes on the line fourth quarter.

Randy Abrams

Okay.

Lora Ho

C.C. was mentioning the fourth quarter will be bigger than $100 million with the modest margin. So it will have some dilution as well, but it's very small.

Randy Abrams

Okay. The second part was if any start-up impact on 10-nanometer next year, since this year 16 was second year and also helped by the 20 learning? So if 10 might have an impact?

Lora Ho

Yes. The answer is yes. And we will start to mass produce 10-nanometer from the first quarter next year, so the whole year, the 10-nanometer margin will be below corporate average, so it will be a dilution factor for the next year, whole year.

Operator

Next question will be coming from Citigroup's Roland Shu.

Roland Shu

Hi. Good afternoon, Mark, C.C. and Lora. The first question is on the high-performance computing. The onset for the ARM-based CPU for server won't be -- have a significant market share until 2020. At that time there is better part of 25% of the share. So that means on your -- for this ARM-based CPU in this high-performance computing probably won't be a very limited from now on to maybe 2018. And so that means on your -- for application point -- process point of view I think that you -- that actually will be using our 16-nanometer and even 10-nanometer, because our 7-nanometer I think the one next production from 2018. So my question is then, is there any performance gap on this 16-nanometer or 10-nanometer in terms of this ARM-based CPU performance? So that's why for people cannot use or adopt ARM-based CPU on the server or even on this high-performance computing quickly. Thank you.

Mark Liu

On the ARM-based server, or anyway, the CPU chip was server indeed. To the main bulk of the CPU it will take, we will have to work with our customer on 7-nanometer and it is ongoing actively. Before that, I think there are customers working on 16 and even 28 to enter low-end server already also. But for the other high-performance computing application, really the entry technology is spread quite wide. Just take the ADAS, for example. 28-nanometer is prevailing entry for the ADAS technology in many of the high-end cars already. For machine learning, 16-nanometer, what you see already, high volume is on 16-nanometer in entry to developed market already. The gaming is already also entry in the 16-nanometer soon. It has just started in the 16-nanometer already. So for other high-performance computing, the application will happen much earlier, already on 28 and 16, and 10 also. So that is different than the datacenter.

Roland Shu

Okay. So for this high-performance computing will account for one-quarter of the -- on this five years' growth. So how big it will be from this high-performance CPU for server or for this at the last enter?

Mark Liu

Well that depends on how much growth we have, right? Right now I think it's currently because the forecast has a big range between 5% to 10%, so it is very difficult to pin down a specific number, but it's about one-quarter of the growth portion.

Roland Shu

On the ARM-based CPU in notebook or PC, I think the last quarter, Mark, you said you expect it will happen for maybe tablet first. So are you still seeing the same change and how big it will contribute to our revenue for the next five years? I look at the transcript.

Mark Liu

Okay.

Roland Shu

Yes, of course.

Mark Liu

Tablet, of course, the tablet has been -- application processor has been widely used in tablet already. It's only the tablet. The growth rate is not growing. The unit number is not growing, so you can calculate how much the revenue is already. So it's not a big number.

Roland Shu

My second question is I look at your second quarter result. Your 65-nanometer revenue actually has been increased a lot. So I think there actually has been -- 65-nanometer revenue has been declined for continuous four quarters. And I think that will be a first quarter in maybe one or two years we see the growth. So can you elaborate me on why? What's the growth driver for this 65-nanometer increase in second quarter? Thank you.

C.C Wei

You are asking about 65-nanometer, why it's increased?

Roland Shu

Yes.

C.C Wei

It's because of some major customer. They have increased their demand in automotive area. I cannot say more than that.

Roland Shu

Will this be continue into second half or into next year?

C.C Wei

I will believe so because the automotive business is a very steady business and it's increasing in the number of units and we enter into mass production since the beginning of this year. And that's why you see a sudden increase.

Elizabeth Sun

Okay. Next question will be coming from Morgan Stanley, Charles. Charlie Chan.

Charlie Chan

Thanks for taking my question and congratulations for a great result, very good execution. So, first question is regarding your smartphone contemporary box. Last year you gave us some data points. I think this super helpful. So if you can quantify the absolute data of the contents in high end, mid and low end, I think that that would be very helpful. So last year a manager mentioned that the high end content is around TWD18 to TWD19, mid end TWD6 to TWD6.4, low end is around TWD3.4. So what do we see it today?

Lora Ho

I probably cannot provide specific dollar, but what I can say is the high end content will continue to increase even to the next year. And the mid end and low end is flattish.

Charlie Chan

And my next question is on CapEx spending. So you mentioned that increased CapEx for this year is actually for next year demand. So is that more for 28-nanometer, 16-nanometer or 10-nanometer spending?

Lora Ho

It's mainly for a 10-nanometer and 7-nanometer combined. We see a stronger demand than we earlier expect and we required to build more capacity next year.

Charlie Chan

Just a very quick clarification about the management's comments, so firstly is on the cash dividend increase, you mentioned that your increase steady in coming years. How about next year? Is it a done deal?

Lora Ho

I will not tell you how much. It's steadily increasing. You will know by then. Okay?

Charlie Chan

But will you start from next year? Will you start from next year?

Lora Ho

Yes, we mean -- we have the increase in dividend quite a bit and we mean it. When we say steady increase we mean every year we'll consider to increase dividend.

Charlie Chan

And Mark mentioned that you will…

Elizabeth Sun

Well, Charlie, this is already going beyond two questions, please.

Charlie Chan

Okay. Sorry about that.

Elizabeth Sun

The next question will be coming from Goldman Sachs, Donald Lu.

Donald Lu

My first question is on 7 EUV. I think TSMC and Mark has commented that TSMC plans to insert EUV at 7-nanometer if it is mature enough, before 2020, before 5-nanometer. My question is if another foundry, let's say, starts 7-nanometer with EUV versus TSMC insert EUV at 7-nanometer, what's the implications on performance and product? For example, will TSMC's customers have to redesign the 7-nanometer when you insert EUV in the second year of the technology ramp? So that's my first question. The second question is on demand. I think -- what is the smartphone as a percent of revenues in the third quarter? Will this be, let's say, 60% revenue or less? And also when you're saying in the next few years smartphone would be half of the growth, would you imply smartphone and non-smartphone will grow at about the same pace?

Mark Liu

On the first question, on EUV, our 7-nanometer will be qualified first quarter next year, so it's only three quarters from now. Definitely EUV will not be ready. And our customer product tape-out will happen in the first half next year. Definitely we cannot put our customer at risk using EUV. So this is because we are very aggressive in delivering 7-nanometer and indeed, adoption is very wide range. Our plan to aggressively using EUV will be in 5-nanometer, where the 5-nanometer will start, we'll finish core in the first half of '19, and so we're already starting 5-nanometer development. And EUV at this time, we cannot use that as a volume for R&D, because doing R&D a lot of activity, a lot of activity going on. So we choose that we aggressively get into 7-nanometer without EUV. And we extensively target EUV on 5-nanometer. Yes, indeed, some of our customer -- one of our customer planned the EUV on their 7-nanometer. But that is only very -- schedule wise it's very similar to our -- maybe a little bit ahead of our 5-nanometer a few quarters. But our 5-nanometer is two steps down. The density is very aggressive, using EUV and learning after 7-nanometer will be very safe on the 5-nanometer. Had the EUV available before 2020 we consider using our 7-nanometer technology as a base to adopt an EUV for probably the second wave products. But we want to minimize the design changes so that all the customers coming to our 7-nanometer will be easily adopt what we can reap from the EUV on 7-nanometer. So that is our plan. I think we develop our technology at the best timing for our customers' products. So that is our current plan.

Donald Lu

Second question is on smartphone as a percent of revenue in third quarter after Apple ramp. And also would you imply smartphone non-smartphone will grow at the same rate?

Mark Liu

I don't know about the third quarter, but generally currently the smartphone is about 55% of the corporate revenue -- wafer revenue, okay? And yes, if the growth in the next five years smartphone related, will be half of that. Yes.

Donald Lu

Related to this, what about earnings volatility, because for '16 or especially 10-nanometer your largest customer will be essentially dominating this particular node? So if this customer has a seasonal or inventory issues, how can TSMC fill the leading edge capacity with very limited number of customers?

Mark Liu

I think, first of all, we are everyone's foundry. Our customer covers all areas of the application. We do have big customers. That is not new. I think your question is the volatility of the big customers…?

Donald Lu

Yes. For 10-nanometer let's say, your largest customer takes 80% of the capacity. And if he has two seasonal or inventory issues then you will then fill it.

Mark Liu

I see. Well that's why we design our 7-nanometer, equipment wise is 95% convertible. So ballpark can consider investment wise, 10-nanometer and 7-nanometer can be converted easily. So that's how we minimize the volatility of the 10-nanometer.

Elizabeth Sun

Next question will come from Deutsche Bank's, Michael Chou.

Michael Chou

Hey Lora, one question, do you expect the ASP increase for this year?

Lora Ho

You're asking ASP?

Michael Chou

Yes, ASP increase for this year for whole year.

Lora Ho

You're talking about a blended ASP?

Michael Chou

Blended ASP.

Lora Ho

Yes. We expect blended ASP will go up this year.

Michael Chou

Would it be low single digit or?

Lora Ho

I prefer not to quantify that.

Michael Chou

Thanks. Second question is C.C., you mentioned the second generation of InFO for next year product. Would that be for 7-nanometer product or 10-nanometer?

C.C Wei

Starting with 10.

Michael Chou

Starting with 10. Right. So, it will start to have the revenue contribution next year, second stage? It should have over the first half or second half? Second half probably more probably. Thank you.

Elizabeth Sun

All right, I think we will start questions that has been queuing in the line for quite sometime. Operator, could you please have the first caller on the line?

Operator

Our first question is from the line of Brett Simpson, Arete Research. Please ask the question.

Brett Simpson

Thanks very much. With regards to InFO and their CoWoS, as I see it, you're moving from 7 wafers to 7 turnkey chips on a good die, which is a big change in your business model. If you look out over the next few years when you ramp 7-nanometer, what portion of your leading edge sales might be adopting this new turnkey model? And when it comes to [eRAM] memory in package, does TSMC take responsibility for sourcing and holding inventory for memory, or do you expect your customers to fix this? Thank you.

Elizabeth Sun

Okay. Let me repeat Brett's question. He's asking how much of our 7-nanometer business will also be using either InFO or CoWoS that TSMC's providing a turnkey solution? What's the proportion of our 7-nanometer business that will be of this type of business model? And then the second part is about memory in the packaging solution. If memory has any problem, whether it will be TSMC or the customer who is responsible for that problem.

C.C Wei

Well let me answer the 7-nanometer, that how much of the percentage who use CoWoS and the InFO together, or it's just the CoWoS?

Elizabeth Sun

Just turnkey solution.

C.C Wei

Just turnkey solution. Probably quite a big portion because of we offer InFO for very cost effective packaging surveys and that we are here to improve the total packaging, the efficiency in terms of chip area or in terms of a service. For CoWoS, you are here up to 7-nanometers high computation space to compete in a very high performance area. That would be a smaller percentage, but we see the potential. That's what I just mentioned in my presentation. So put altogether, I would expect quite a significant amount of 7-nanometers a product will be using either CoWoS or InFO. That's one thing. Talking about the memory, stacking together with 7-nanometer chips, we certainly we offer the turnkey solution. But we are very flexible in working with the customer that all the possible combinations are all possible.

Brett Simpson

Does that mean that you would purchase the memory and book the memory sale within the overall package, or would you leave your customers to purchase the memory and take inventory risk?

Elizabeth Sun

Well let me see if I hear you correctly. You are asking whether or not we are paying for the memory and then charge the customer as part of the revenue that we obtain from InFO or it is separated?

Brett Simpson

Exactly. Yes.

Elizabeth Sun

Okay.

C.C Wei

Okay. We don't buy the memory per se. We work with the memory supplier so that their spec, in terms of mechanical stress, in terms of a lot of things at the [factories] or those kind of things. We work with them but we don't buy memory and resell to the customer. However, we are responsible to stacking them together and as a whole packaging to our customer.

Brett Simpson

Thank you. And maybe just one final question. When you look at TSMC 7-nanometer for high performance computer, can you give us your perspective? How would you technically compare them to Intel's 10-nanometer, which will be in production relatively similar timescales? Yes. Thank you.

Mark Liu

Can you repeat the question?

Elizabeth Sun

Yes. How do we compare our 7-nanometers performance and whatever the characteristics versus Intel's 10-nanometer, which Brett believes that timeframe wise we are about to offer in these two technologies about the same time.

Mark Liu

Well you have to ask our customers. I cannot speak for them. They have they definitely have their plan and we deliver our technology. And of course, as they deliver their architecture differentiations. So, really the end product performance depends on multiple factors. So, I cannot speak for my customers at this point on this.

Elizabeth Sun

Okay. Let's move to the next caller on the line. Operator, please.

Operator

Our next question comes from the line of Steven Pelayo from HSBC. Please ask your question.

Steven Pelayo

Yes, first question on 28-nanometer. It's still your largest segment, but it did decline last year, yet the total Company still managed to grow about 10% or more in 2015. What do you think for 28-nanometer this year? What type of growth, I assume you think it's going to grow this year, are you expecting?

Elizabeth Sun

Steven, we really cannot hear you that well. Can you move a little bit away from the microphone? You're asking about revenue contribution from different geometries.

Steven Pelayo

Maybe you can hear me a little better now.

Elizabeth Sun

Yes. Please.

Steven Pelayo

No, I was asking specific to 28-nanometer node. It's still your largest node and yet it declined last year. And I was asking for this year, do you expect it to grow and by how much?

Elizabeth Sun

Okay. Whether or not we will grow 20-nanometer and by how much in this year?

Steven Pelayo

Correct.

Elizabeth Sun

Well, Steven, in fact, we deliberately combine 16-nanometer with 20-nanometer and we report that as one node, so we do not separate that. Sorry.

Steven Pelayo

I was saying specifically 28-nanometer. That's your largest node. Do you expect that to grow?

Elizabeth Sun

28-nanometer? I see. Sorry. 28.

Steven Pelayo

Yes.

Elizabeth Sun

28-nanometer. Do we grow 28-nanometer and by how much this year?

Steven Pelayo

Correct.

C.C Wei

While Lora is checking with the number, all I can say is our revenue this year slightly lower than last year. Slightly. But percentage wise, because our revenue increased, so the percentage of the 28-nanometer revenue.

Lora Ho

C.C., actually, according to our forecast, 28-nanometer, dollar wise, will be higher this year than last year.

C.C Wei

Will be higher?

Lora Ho

Yes.

C.C Wei

Okay. Good. Okay. As I said, stronger demand in the second half.

Lora Ho

So I confirm that. Okay.

C.C Wei

I apologize.

Steven Pelayo

Okay. Slight growth. That's fine. The reason why I'm asking the question is really to talk a little bit about above 28-nanometer. Competitors like SMIC are growing very fast this year and their capacity constraint, they don't really have any 28-nanometer really to speak of. So what's going on with the above 28-nanometer nodes? So above 28-nanometer, it seems like maybe TSMC's a big share. Is that right? Is that just China's influence? How would you respond to that question?

Elizabeth Sun

All right. His question is for bigger nodes, bigger than 28-nanometer, how does TSMC, what's our strategy compared to other foundries who are growing shares in those bigger nodes?

C.C Wei

Okay. For the older generations, our strategy is simple. We don't particularly to increase the capacity. We, instead, we develop some derivative technology, such as in the CMOS image sensor, embedded Flash, power management IC. So to keep that whole capacity fully loaded, that's our strategy right now. We don't substantially increase the capacity as other foundry peers do it.

Lora Ho

And maintain good profitability.

Steven Pelayo

Okay. That's great.

Elizabeth Sun

Thank you. Okay.

Steven Pelayo

My last question, if I can just sneak in here, is about the cap, the dividend. You're raising your dividend yet you're generating more free cash flow every year so you're growing your cash balance. And seriously, when does this become too much? When does it start to impact your goal of sustaining greater than 20% ROE? Is there an optimal cash level and an optimal capital structure we could talk about instead of focusing on a dividend payout ratio?

Elizabeth Sun

So Steven's question is we have been growing free cash flow every year and our cash balance continues to go up. What would be a capital structure of TSMC or a payout ratio?

Lora Ho

Steven, we don't use payout ratio. You know our dividend policy has [alluded] sustainability and we have started to pay dividend since 2008, since 2004 actually. And there's a very long period of time we pay NT$3 every year for consecutive eight years, and then we significantly increased the dividend to NT$4.50 a year ago and then to NT$6 today. So if I look at from today's forecast, and we have confidence we can continue to grow our free cash flow every year, that is why I say the dividend policy will change from sustainable to sustainable and increasing. So that's the thinking that we have in mind.

Steven Pelayo

The current NT$660 billion in cash is that an excess amount that you need or what is an optimal cash level to run your business? That's my last question.

Lora Ho

The optimal cash position depends on what you do with your cash. I think for now our cash is mainly to support our organic growth. We may have some M&A, but we don't know at this moment. So we will try to be a little bit conservative in keeping enough cash to do the both, one way to support a sustainable increase in dividend, on the other hand to have some buffer if there's M&A case.

Elizabeth Sun

All right. Operator, let's move on to the next caller on the line, please.

Operator

Your next question comes from the line of Mehdi Hosseini from SIG. Please ask your question.

Mehdi Hosseini

I have two questions, one on CapEx. A couple of years ago when you first started investing in 20-nanometer, there was a surge in CapEx as you were preparing 20. Now it seems like 10 and 7 are pretty much comparable to 20 and 16. And back then, a couple of years ago, after significant spending in 20, then there was a period where your CapEx came in flat, or even last year it declined. Should we assume the same kind of CapEx spending looking forward, especially since 10 and 7 are comparable to 20 and 16?

Lora Ho

Can you repeat the question, please?

Elizabeth Sun

Mehdi's question is when last time he saw TSMC having a surge in CapEx that was the time when we built 20-nanometer, when we ramped 20-nanometer. He's asking whether same type of CapEx pattern will be repeated in the future when we ramp, say, for example, 10-nanometer.

Lora Ho

We don't believe so because, as Mark was mentioning, there's a very high percentage of conversion rate. So when we roll to the next generation of technology, a big part of it will be converted from the previous generation. So you will not see a step up type of things that we have experienced in the past; it will be gradually increase.

Mehdi Hosseini

Right. The step up is happening in 2016. So in 2017 your CapEx may not increase, actually may be flat or down as the conversion starts to take place. Is that correct?

Elizabeth Sun

Whether 2017 CapEx will be flat or down compared to this year because of conversion.

Lora Ho

It will not. It will not. As I just said earlier, I think you will not see a step up kind of things. But we will look at the business every year. And depending on how much leading-edge capacity we want to build in that year, also depending on the profile of the ramping, that's also another factor that will affect our CapEx. It's probably better to follow my earlier guidance that we believe in the next five years our CapEx intensity will be in the range of mid 30s.

Elizabeth Sun

Okay, now.

Mehdi Hosseini

Okay. Great. I have a follow-up question regarding the near-term trend. You said that the customer days of inventory is going to increase in Q3 and you're not sure about the sell-through. Is it going to take a couple more months to better determine if customers are over-building, or do we have to wait till January/February timeframe? How do you assess this because your commentary is a little bit confusing, especially regarding days of inventory?

Elizabeth Sun

All right. Mehdi's question is how do we know whether or not the inventory that we are seeing today will be too much? Do we have to wait until next January or February to know, or do we have a method to assess?

Mark Liu

Well, indeed, we cannot see crystal about sell-through. What we have told you about the unit growth is really the sell-in, sell-in to the phone service providers. So sell-through, indeed, there are uncertainties. But we see the growth of -- we assume the growth of 6% increase. And the model we -- the inventory level we cited is assuming the sell-through is also a 6% increase. If this differs then the inventory level will also differ accordingly.

Elizabeth Sun

All right. Thank you, Mehdi. Now let's come back to the floor. The next question will be from Credit Lyonnais, Sebastian Hou.

Sebastian Hou

Thanks for taking my questions. So my first question is to follow on the advanced backend technology. So, C.C. guided this year fourth quarter revenue of InFO will be above at least $100 million. So can you give us some guidance for fourth quarter next year, and also the fourth quarter 2018 when InFO and CoWoS combined?

C.C Wei

The fourth quarter this year is high volume ramping. Following next year, it's supposed to continue this kind of a production, I believe. So next year, the whole year will be much better than just this quarter times four. You are talking about in 2018 CoWoS and InFO together, or 2017?

Sebastian Hou

2018.

C.C Wei

2018. I believe CoWoS has a high potential but is still a small volume as compared with InFO. InFO is much more high-volume production, so most of the revenue will come from InFO.

Sebastian Hou

So based on your fourth-quarter 2016 guidance, it will probably account for 1% to 2% of your 4Q revenue for InFO. So is there any, in terms of revenue contribution percentage for 2018 in terms of InFO and CoWoS combined, would it be higher than this 1% to 2% run rate?

C.C Wei

I would hope so, but I don't know the 2018 revenue yet.

Sebastian Hou

And my second question is on the 7-nanometer and 10-nanometer. Six months ago, I remember I asked the questions and Mark and C.C. answered me that the 10-nanometer revenue contribution in 4Q next year will be higher than the revenue contribution of 20-nanometer back in fourth quarter 2014, so I wonder, does that still hold?

Lora Ho

Elizabeth, can you repeat the question? I don't quite get it.

Elizabeth Sun

Sebastian's question is compared to 2014 fourth quarter revenue from 20-nanometer with 2017 fourth-quarter revenue from 10-nanometer, which one will be bigger?

C.C Wei

Right now, the dollar wise, we think it's bigger, but the percentage wise is next year's business. So those numbers are too early to predict at this point. But 10-nanometer is very strong and we cannot give you a specific number for that. It would be around similar level, I think.

Elizabeth Sun

I think 4Q 2014, our 20-nanometer was 21%.

C.C Wei

Yes.

Elizabeth Sun

But 2014 compared to 2017 will be a smaller year overall-wise.

Sebastian Hou

Okay, I understand. And given that you have more tape-outs on the end design -- tape-outs on the 7-nanometer compared to 10-nanometer, so we could assume that by fourth quarter 2018, the 7-nanometer revenue contribution, or in dollar amounts, should be a lot higher than 10-nanometer contribution fourth quarter 2017.

Lora Ho

This is 2018 and we are middle of 2016, Sebastian.

Sebastian Hou

Yes, but --

Lora Ho

Whatever the guidance we can give you may not be reliable.

Sebastian Hou

But you guys have a very long visibility, I thought so.

Lora Ho

Not that long. Not two and a half years.

Sebastian Hou

Okay.

C.C Wei

But I think we will going through ramp, 10-nanometer going through ramp next year. And 7-nanometer will -- 7-nanometer and 10-nanometer will continue the ramp in 2018. Okay? Thank you.

Sebastian Hou

Okay. Thanks.

Elizabeth Sun

Okay. Next question will be a follow-up from Morgan Stanley's Charlie Chan.

Charlie Chan

So I just want to clarify Mark's comments on smartphone market share. So you mentioned that you believe you can continue to gain market share in the smartphone semiconductors, but now you essentially have very high market share now, except for those in house production from Samsung. So where is the upside for this market share in smartphone?

Mark Liu

Well, we and our customers work together to increase their shares yes, currently our smartphone with our customer market share is already very high. But we will gradually increase. We think we will gradually increase further. Many of our customers today in mid end were also attempting to get into the high end of the year and particularly the silicon content of high end and mid end also increasing, which favors leading edge technology that we provide. So those are the advantages that we have with our customer to be able to get the increase the market share we have.

Charlie Chan

Okay. That's very clear. So, gain market share along with your customers. Okay. So I just want to follow Donald's question on this short-term volatility because you risk CapEx for next year 10-nanometer demand. But I think the fact is that you disclosed in your 20F, Apple and Qualcomm each accounts for 15% of your 2015 revenue. And we all know that Qualcomm may walk away to Samsung temporarily. And for Apple you also mentioned that you cannot predict that sales of let's say, iPhone 7. So how can you be that confident to spend that CapEx for 2017 10-nanometer demand? Thanks.

Mark Liu

We cannot give you a specific number. It doesn't mean we are not confident. I think, of course we want to support our customer for any growth opportunities they can possibly achieve. At the same time we manage carefully about our capacity buildup. So this is a very complicated discussion with our customers. So at this point I think we will -- those capacities we built will be needed by our customers.

Charlie Chan

Is there any early indicator you will win -- keep very high market share as a 10-nanometer project for big customer?

Lora Ho

Yes. We have been working with customer for a long time for 10-nanometer and we believe our market share will be more than 70% next year.

Charlie Chan

Okay. Thanks.

Elizabeth Sun

Okay. Follow-up questions from Citigroup's, Roland Shu.

Roland Shu

Thanks. I just want to take your assumption for 16-nanometer gross margin to be about 1 percentage point dilution of the corporate average in second quarter and 3Q. So I just did the calculation. It seems like in 3Q actually we don't have any benefit for the higher utilization on the gross margin point of view. So does that mean that in 3Q the average of 15% revenue growth in mainly from the product mix change?

Lora Ho

The hotel is announcing a fire on the 29 floor.

Roland Shu

We have time now.

Lora Ho

Are you sure? Okay it's not a real fire it's just a drill. It’s a fire drill taking place at this time so we will continue.

Roland Shu

Okay.

Lora Ho

Yes Roland please.

Roland Shu

I think my question, just to repeat my question. I just take your assumption, 16-nanometer gross margin to be 1 percentage point dilution of the corporate average in second quarter and 3Q, and my calculation showed in 3Q even though we have about 16% revenue growth, however we don't -- it seems that we don't have any gross margin benefit on the higher utilization. So does that mean this 16% revenue increase is mainly from the product change, or in 3Q we have a higher depreciation to have a drag of the gross margin? Thank you.

Elizabeth Sun

So, basically Roland, your question is whether or not we will have a higher utilization rate or a lower utilization rate in the third quarter compared to the second quarter, and that's the reason for not giving you a 55% gross margin, right?

Roland Shu

Yes. And if the depreciation is much higher than second quarter?

Elizabeth Sun

Higher depreciation, yes.

Lora Ho

It's a combination of many factors. We do have higher depreciation. Just imagine, we have backend loaded CapEx, so it's naturally depreciation would go up from second half, that's one thing. And also we are ramping 16-nanometer, which we still have some dilutions. And we have a better utilization in third quarter as well. So, if you took all those three factors together, that's the guidance that was provided, broadly based on those.

Roland Shu

Yes. So can we have a rough number for how high the depreciation in 3Q it will be?

Elizabeth Sun

I think its NT$2.5 billion more.

Lora Ho

Yes. It's about NT$2.5 billion quarterly depreciation.

Roland Shu

So, it's about 1 percentage point lower in gross margin.

Lora Ho

Roughly.

Roland Shu

Yes. Okay. And the whole year depreciation is still increased about mid-to-high single digit, is that the same?

Lora Ho

It's in the range of mid-teens year-over-year. Mid teens.

Roland Shu

Mid teens?

Lora Ho

Mid teens, yes.

Roland Shu

That is very different from the number you talked.

Lora Ho

No, I was talking about the same thing. Depreciation year-over-year will increase by mid-teens. I didn't change that.

Roland Shu

Okay. No? I think it's not.

Lora Ho

Low single digit?

Roland Shu

Mid-to-high single digit.

Lora Ho

I'm sorry. I was looking at the wrong line. Yes.

Roland Shu

Thank you for the clarification. And the last question, for the DoI inventory, you said in 3Q we are still customers are still restocking in 3Q and in 4Q will be destocking and inventory days will be back to seasonal level. So does that mean that from first quarter next year, are we going to see a normal seasonality, normal quarter in first quarter or customers are going to restocking again from first quarter next year? Thank you.

Lora Ho

I think there are still uncertainties depending on how the inventory situation in the fourth quarter and over sentiment in the fourth quarter, so it's a little bit too early to say that.

Elizabeth Sun

Okay, a follow up question from Credit Suisse, Randy Abrams.

Randy Abrams

Thank you. Just to follow up on Roland's question, to pull it back to fourth quarter, where you talked about the inventory and the high base, is there a way to think about it relative to seasonal? Like what's the seasonal fourth quarter and then if you're thinking it's normal or below seasonal? The question is fourth quarter, what you would expect normal seasonal, can you mention it's normally a correction quarter. So what's the normal magnitude and then how you see, at this stage, it could change, but at this stage how you see it relative to seasonal?

Mark Liu

Fourth quarter is a seasonally will correct. It will correct and what we say from third quarter, a little bit higher than seasonal going to fourth quarter seasonal, including both factors, correcting the deviation of seasonal. And also between third quarter and fourth quarter, seasonal will be corrected. The days will decrease.

Randy Abrams

Okay. But do you think the decline because it was above seasonal in third quarter and inventory above, we could see below seasonal fourth quarter? Do you expect you could see a below seasonal fourth quarter?

Lora Ho

No, no. We see it's close to seasonal.

Randy Abrams

Okay. My follow up question, IoT is one of your growth drivers. Your competitors, like Samsung and GlobalFoundries, have been pitching FD-SOI. Do you see any merits to that track or how do you see customer interest in that relative to the strategy that you're adopting, and any need to consider that in the future?

C.C Wei

Well let me answer that question. For the FD-SOI, the main merit is kind of the low power consumption, which I think TSMC has offered a complete set of technology roadmap for the low power applications. We started from 14-nanometers low power and enter into 28-nanometer, now ever 16 FinFET, we offer down to 0.5-volt operation voltage. Our experience, we're talking and working with our customers, the roadmap has been very satisfactory to their product needs. So we expect we are very well positioned to capture all the opportunities.

Mark Liu

Let me add to that. I think FD-SOI may be useful for specific products, but our bulk CMOS ultra low power has a much bigger design ecosystem. And IoT is a very fragmented design. And many, many customers are trying to enter that. So we think the ecosystem of bulk CMOS is much, much useful for our customers than niche FD-SOI application.

Randy Abrams

Thank you.

Elizabeth Sun

Okay. There's a question in the back. I think you are Merrill Lynch sales, right? No, you are not. UBS, sorry. The lady in the back is sales from UBS.

Unidentified Analyst

Thank you, Dr. Sun. This is Julie from UBS. My question will be actually more simple than the analysts'. I'm actually quite interested regarding to the market share comment that Mark has made. I'm just wondering, regarding to the market share gain, would that be coming in from, let's say, your existing clients making into higher end of smartphone, tapping into areas they never have been before? That's one thing that's called market share gain, right? Secondly, is it existing clients coming back to you that's also a market share gain? So which one would that be?

Mark Liu

Both.

Unidentified Analyst

Okay.

Mark Liu

Yes.

Unidentified Analyst

So which one is happening faster?

Mark Liu

They happen at the same time.

Unidentified Analyst

Okay. And would you be able to quantify the market share of TSMC in smartphone?

Mark Liu

Currently we're about 55% and we expect to increase from that number further up gradually.

Unidentified Analyst

Okay. My second question is actually what's TSMC's view on ASML buying Hermes? Does that help you going forward in terms of tools for procurement, or could you comment on that?

Mark Liu

HMI Hermes has this same defect inspection tool. It can detect very fine feature on wafers. And ASML and HMI merger intends to be able to develop the lithography more precisely controlled according to the wafer images. So I can only speak from industry or technical perspective. That definitely will help the capability of lithography tools and therefore help the technology capability and help the technology development for their customers. That's my comment.

Elizabeth Sun

All right. Last question coming from Credit Lyonnais, Sebastian Hou.

Sebastian Hou

Thank you, Dr. Sun. Just two quick follow-ups. The first one is that we noticed the consumer application in second quarter increased significantly, both from quarter-and-quarter and year-on-year perspective. Can you, C.C. or Mark, comment on that?

Elizabeth Sun

Video games.

Sebastian Hou

Okay. Thank you. And a very quick one. The last one is on the CapEx increase, above $500m, so I wonder whether that suggests some pull-in of the 10-nanometer expansion?

Lora Ho

Yes, it is. It's for 10-nanometer because we need a bigger capacity next year.

Elizabeth Sun

But he's asking whether it's a pull-in, which is a schedule issue.

Lora Ho

For next year it's not; it's just higher demand so we need more capacity.

Sebastian Hou

So that doesn't have any correlation with the mass production schedule?

Elizabeth Sun

The schedule stays the same.

Sebastian Hou

Okay. So a follow-up on that one is that the -- does the CapEx mix still about 10% go to back end within the -- in terms of the new CapEx? Or they were skewed more towards the advanced packaging -- sorry, advanced technology, micro cell [ph] 10-nanometers and 7-nanometers for this year?

C.C Wei

The back-end CapEx for next year probably will be much smaller than this year, because we build up InFO capacity already. Next year we are going to be the second generation, probably just improve some features, that's all.

Elizabeth Sun

Okay. I think it's about time. And thank you very much for coming to our quarterly conference. I hope you will join us next quarter. Our transcript will be available very shortly, as well as the video replay. Thank you.