United Microelectronics Corporation (NEW)

Welcome everyone to UMC's 2020 second quarter earnings conference call. All lines have been placed on mute to prevent background noise. After the presentation, there will be a question and answer session. Please follow the instructions given at that time if you would like to ask a question. For your information, this conference call is now being broadcast live over the internet. Webcast replay will be available within an hour after the conference is finished. Please visit our website www.umc.com under the Investor Relations, Investors, Events section. And now I would like to introduce Mr. Michael Lin, Head of Investor Relations at UMC. And Mr. Lin, please begin.

Thank you and welcome to the UMC Conference Call for the second quarter of 2020. I am joined by Mr. Jason Wong, the President of UMC, and Mr. Chi-Dong Liu, the CFO of UMC. In a moment, we will hear our CFO present the second quarter financial result, followed by our President's key message to address UMC's focus and the third quarter 2020 guidance. Once our President and the CFO complete their remarks, there will be a Q&A section. UMC's quarterly financial reports are available at our website, www.umc.com, under the Investors Financial section. During this conference, we may make forward-looking statements based on the management's current expectations and beliefs. These forward-looking statements are subject to a number of risks and uncertainties that could cause actual results to differ materially, including the risks that may be beyond the company's control. For this risk, please refer to UMC's filing with the SEC in the U.S. and the ROC security authorities. Now, I would like to introduce UMC CFO, Mr. Chi-Dong Liu, to discuss UMC's second quarter 2020 financial results.

Thank you, Michael. I would like to go through the 2Q20 investor conference presentation material, which can be downloaded from our website. Starting on page 3, the second quarter of 2Q20 consolidated revenue was $44.39 billion NTD. with gross margin at 23.1%. The net income attributable to the stockholder of the parent was $6.68 billion NT, and earnings per ordinary shares were $0.55 NT. Utilization rate in the second quarter improved to 98% from 93% in the previous quarter. On the next page, page four, quarter-over-quarter comparison, revenue grew 5% to $44.3 billion due to the combination of ASP increase as well as the wafer shipment increase. Gross margin, as a result, climbed to 23.1% or 10.25 billion NT, up 26% sequentially. All the operating expenses are under control, and therefore we see OPEX decline slightly by 0.8% quarter over quarter. As a result, operating income jumped 71% quarter over quarter to 5.8 billion NT, with the reverse of our non-operating items from the revaluation of our investment, our net income attributable to the stockholder of the parent in quarter two reached 6.68 billion NT or 15.1% net income margin. EPS was 0.55 in quarter two compared to 0.19 in first quarter of 2020. On page five, the first six months comparison, revenue increased 26% to 86.6 billion NP, partially due to the combination of USJC, which contribute around 10% of the revenue top line. And gross margin was 21.2%, or 18.38 billion NT. And net income attributable to the stockholder of the parent was 8.888 million NT in the first six months of 2020. And EPS is 0.74 for the first two quarters of the year. On the next page, page 6, our cash has reached almost $100 billion NT dollars. And for the total equity in the first half of 2020 was $209 billion NT. On page 7, KSP increased by a low single-digit percentage, mainly due to the surge in our 28 revenue shipments. On page 8, the revenue breakdown, Asia stayed around 55% and Japan also remained around 9%. For page 9, IBM and Fabulous remained unchanged at 12% and 88% respectively. On page 10, communication declined 3 percentage points to 51% and made up by computer and others segments. And on page 11, as I mentioned, ASP increased by low single-digit percentage point, mainly due to the surge in our 28 nanometer shipment, which now reached 13 percent of the total revenue in the second quarter, compared to 9 percent in the previous quarter. And capacity still remained minor increase quarter over quarter, and CAPEX remained at 1 billion US dollars for the whole 2020. So the above is a summary of UMC's results for second quarter of 2020. More details are available in the report, which has been posted on our website. I will now turn the call over to President of UMC, Mr. Jason Wong.

Thank you, Qidong. Good evening, everyone. Here I would like to update the second quarter operating results of UMC. During the second quarter, consolidated operating margin reached 13.2%, while utilization rate increased to 98%, lifting wafer shipments to 2.22 million 8-inch equivalent wafers. The increase in wafer shipments mainly reflected computing segment demands for connectivity, display driver, and flash controller, as well as the inventory replenishment in the computing market. As we continue to strive to supply worldwide foundry services, our efforts have been appreciated by our customers. In Q2, Texas Instruments customers recognized UMC with the 2019 Supplier Excellence Award for demonstrating exemplary performance in the area of cost, environmental and social responsibility, technology, responsiveness, assurance of supply, and quality. In addition to serving customers to the best of our ability, UMC also increased 2019 cash dividend distribution to approximately NT$0.8 per share, reflecting the recent company buyback of the Treasury shares. Looking into the third quarter, current market demand remains strong. We have experienced a surge in 28nm takeouts during the first half of 2020. compared to a year ago, and expect additional 28-nm and 22-nm product tape-outs in the third quarters. We are also moving new 28-nm products into volume production for wireless applications such as 4G and 5G smartphones, which will enhance our business traction and diversify UMC's customer exposure across different 28-nm market segments. Moreover, we have observed efforts to minimize supply chain disruptions amid uncertainty during the COVID-19 pandemic. While inventory replenishment is continuing across multiple market segments, with the efforts continuing to push customer adoption of UMC's specialty technologies, our ROI-driven corporate strategy remains unchanged. As UMC secures new business we will closely examine returns on invested capital to optimize the company's capital deployment and further enhance our financial performance. Let's move on to the third quarter 2020 guidance. Our wafer shipment will remain flat. ASP in US dollar is expected to remain flat. However, the accounting result will reflect the adverse effect in the $90 appreciation. Growth profit margin will be approximately 20%. Capacity utilization rate will be in the mid-90% range. Our 2020 CAPEX budget will be US $1 billion. That concludes my comments. Thank you all for your attention. Now we are ready for questions.

Thank you, President Wong. And ladies and gentlemen, we will now begin our question and answer session. If you have a question for any of today's speakers, please press 01 on your telephone keypad, and you will enter the queue. After you are announced, please ask your question. If you find that your question has been answered before it is your turn to speak, please press 02 to cancel the question. Thank you. And the first question is coming from Randy Abrams, Credit Suisse. Go ahead, please.

Randy Abrams, Credit Suisse. Okay, yes, good afternoon, Jason and Chi-Tung. Yeah, good result. I wanted to ask the first question. Jason, when you were going through the prepared remarks, you discussed the business remaining pretty strong, and it does sound like 28 is ramping. So, I was curious the guidance where shipments and ASPs are guided flat. So, if you could discuss a bit on any areas of softness to offset that or trends you're seeing on application to drive the flat guidance.

Sure. Let me capture a few of your questions. One is you mentioned, based on the remark, we foresee the demand remains strong. And however, we guided the Sherman and the AST is flat. Is that correct?

Yeah, that's correct. Also, with 28, presumably ramping to have flat. And, yeah, so it kind of factors for it soft. And also, maybe to add to it, if any capacity constraints where there might be certain demand you just can't fill right now.

Okay. Let me see how to address that. First, in Q3, we do foresee change in the 28 nanometer product mix, okay, which will have a mild lift of ASP. So the 28 nanometers demand increases will actually help us with the ASP lift. However, the blended ASP still depends on multiple factors, such as the product mix of other nodes and shift in capacity utilization rate across the different nodes. So therefore, the positive impact on the 28 is not as significant in Q3 at this time. Does that answer your question?

Yeah, that does partially. I guess then just for overall business, if you could maybe say by application or nodes, like if 28's improving, maybe which areas might be coming down a bit, either by application or technology area?

Okay. So for the Q3, if I look at by the applications, We see strongest rebound is coming from the consumer segment and followed by the computer and the communications. Old segments are increased. We see an increase of old segments. The reason is we see we're getting market share result from the consumer segment. the higher penetration in a smartphone, as well as those from the new customer and also from the existing customer, they're getting market share from the communication area. The computer segment is really a result of working from home and home schooling that spurs the continuous demand in both consumer and computer segment. So that's truly where we're coming from the application point of view. On the AST, flatness is really a mix of what I described earlier. Even at 28 health, giving the product mix, we actually didn't see as significant.

Okay. And if you could clarify, you mentioned all segments up. Is it the other category that's coming? I mean, just to be flat overall for shipments. Is it then from that area that's offsetting the others? Yes.

Besides those three, there are other segments that we continue to see weakness. And so, yes, they compensate some of the growth from those three areas, yes.

Okay. One note I noticed has come off the last couple quarters. 80 nanometer, probably maybe one of the others that's a bit underutilized, but came down from 18% to 13% over the last two quarters. Is there... applications moving off that that you could backfill, or could you upgrade that capacity to serve some of the 40 or 28 demand?

We can't really move in 80 and 90 to serving the 40 and 28, but we are migrating that to, for example, 55 or 65 area. So in Q2, our 80 and 90 know that you continue to operate at 100% loading, and the contribution lower is really just we're shuffling around the different node support.

Okay. And if I could ask just one final question on the CapEx, the last couple years you maintained $1 billion, but then underspent as we went through the year. And it looks that way through first half. But I guess maybe for Chitang, but how do you see the capacity? I know you had some 28 or shaman capacity set to ramp up. So do you still see reaching... that or could come in a bit light. And then maybe as a medium term, with utilization this year getting up to mid to high 90s, do you need to start ramping up a bit more on the CapEx just to satisfy the demand and continue to maintain some of the growth?

The answer is yes. And the capacity expansion at our 12X, which is Shandong Fed, is actually on the track. and is expected to reach 25K per month in mid-2021. So that's part of our cap-ass already. Given the growing 22 and 28 nanometer customer demand, we actually are examining the option to utilize available full space at our Tainan facility, which is 12A, to fulfill additional business opportunity in advanced technology. which was still subject to our ROI justification. We've been mentioned many quarters. We will continue to evaluate our CapEx based on what we described, a stringent ROI-driven strategy to enhance our return to shareholders and employees. So that will not change. That's also in our remark. We'll continue that without any change of that. But the next phase that we're looking at is more in our Taiwan timeline facility.

If you get back to growth, do you think $1 billion is still the level, because you had the underutilization on 28, but now with that full, is it a bit higher level now if you start to evaluate the growth out of Taiwan?

Yeah, I mean, we are examining that option right now, so it's too premature to give you the guidance of the CapEx numbers. But for the 2020, the $1 billion will remain, yeah.

It's not really the absolute dollar amount that determines the CAPEX number. It's really the return requirement and also the customer demand. Multiple factors will lead to our CAPEX decisions.

Randy, I will also mention, in addition to the CAPEX spending, we look at our top-line growth. we see the market applications such as the 5G handsets, the increase of silicon content in the 4G phone, those demand will continue driving that. So that's why we seriously examine the option of future capacity expansion. Meanwhile, we also focus on productivity improvements. And that will actually help as well in addition to that. And beside the growth of a top line, we foresee more room for improvement on our structural probability, which will tend to enhance our earnings. So we continue managing the balance of those, yes.

Okay. No, that makes sense. I guess a good problem to have, to have the demand to go invest for. Okay, thank you.

We have to just suspend that. Thank you.

And next we'll have Goku Harihalen from J.P. Morgan for questions. Go ahead, please.

Thanks and congratulations for the good results. First question I had, could you talk a little bit about, I think the gross margin in Q2 was clearly quite surprising, the jump in gross margin. Could you talk a little bit about, I think we saw that the depreciation did drop off by about $500 billion, but even with some currency appreciation, could you talk about what was the reason for the gross margin improvement? Is it all primarily to do with better utilization and better product mix, or are there any specific factors related to, let's say, Fujitsu, the fab, or anything specific that we should be looking at?

Well, I mean, yes, first of all, thank you, Andy. Secondly, in terms of the better growth margin, in Q2, we show an increase of growth margin primarily due to the product mix improvement, which lives the ASP, that helped. And secondly, given the lower unit cost per wafer from the higher loading at 98%, that's also a benefit factor. The third is we do have ongoing cost reduction activities. So combining all three as a result, we led to the growth of the Q2 growth process.

OK. So just a quick question. Could we talk a little bit about 28 nanometer and MAISAB in Japan? Are they now fairly, where are they in terms of gross margin compared to the corporate average? Are they still a big drag or the drag is much smaller now?

So after a few quarters of synergy improvement, our tough end probability has improved. every quarter since becoming part of UMC. We have implemented integration efforts in five operations, incorporated fast know-how sharing and streamlined procurement, etc. So all of these efforts have improved the cost structure of 12M, the USJC in Japan. So UMC's integration efforts are resulting positive synergy in line with our expectation. So this acquisition has financially contributed to our top line as well as bottom line. So we think going forward, the profitability of 12M or USJC will be largely dependent on its own demand-supply dynamics.

Okay. Any thoughts on 28 nanometers given the capacity is now filling up with a strong traction from some of the new tape-outs? How much of a drag is 28 nanometers still, or are we kind of, do we have line-of-sight in terms of 28 ROS margins improving closer to the corporate coverage levels?

Well, I mean... We actually don't look at the final basis on the margin drag. Our expectation on the 28 nanometer is based on the progress of our 28 product pipeline, as strong as what we've seen today. With the business traction continuing into the second half of 2020, we foresee our 28 nanometer utilization will grow. And so we actually feel pretty confident about our 28 nanometer contribution to the company overall. With the product mix improvement, and we believe that will help us with the ASP list in terms of generating much better profitability for the company as a whole.

OK. Thank you. One last question from me. Could you talk a little bit about any updated view on how we should think about depreciation? Do we have a little bit more color in terms of how we see the depreciation rolling over over the next couple of years? We were expecting a bigger drop-off in 2022. If you want to get into a little bit more of a fantastic expansion mode, Should we think about a slightly different schedule for the depreciation coming down?

This is pretty much what we said in the past. We are seeing some low single-digit decline in overall depreciation expenses in 2020 as well as 2021. But in 2022, we are seeing more than double-digit decline. in our overall depreciation expenses. So the major change still remain unchanged.

Okay.

Got it.

Thank you very much.

And the next question is coming from Zi Hong of China Renaissance. Go ahead, please.

Oh, hi. Good afternoon, gentlemen. My question is regarding 28nano. It seems like you're still sticking to having 25K capacity ready in the middle of next year at the Shaman Fed. So I wonder what would be the next expansion. Will that happen in Taiwan or will it continue to be in Shaman?

We actually mentioned this earlier. After the 25K in Xiamen, the next phase of growth or capacity expansion will happen in our Taiwan-Tainan facility. That's what we're referring to, a 12A facility. And given the available floor spacing, that will be the best ideal location for us to do the next expansion.

Okay, and what would be the size of the expansion in Taiwan?

Well, we're still at the stage of examining that right now. So it could be based on different range of the size of the investment. Given that we have not concluded that and still in the third quarter, we prefer not to comment at this point. And we think by end of this year, we'll have a better clarity on that.

Okay, that's it. And my second question, is it possible to give an update on the operations data for the Japan staff?

The operating profit impact in 2019 was a negative of high single-digit percentage point. But this year, because of the strong demand coming from 20 nanometer and also enlarging economy of skills, the loss has significantly reduced, and now the impact is around mid-single-digit percentage point. And certainly, we see further improvement once we reach 25K in 2021. Okay.

All right. Okay. Okay. Thank you very much. Congratulations on great results. Oh, thank you.

And the next one is coming from Roland Xu of Citigroup. Go ahead, please.

Hi, good afternoon. First, for your 20 nanometer utilization, CEO said in second quarter, actually, your overall utilization was about 98%, and you still expect 20 nanometer utilization to increase in 3Q. So I just want to ask what kind of the magnitude of this utilization will increase for 20 nanometer. And after the utilization increase, what the percentage point of the revenue contribution for 20 mm will be in second half? This is my first question. Thanks.

Well, the overall company's utilization rate will be at 95%. Mean 90s. Mean 90s as we guide it. And on a blended basis, the 8 inch, we're running at 4. And 12-inch, we're running at 90%. So that will give us approximately the mid-90s utilization guidance across all the nodes of the company. And we continue to think there's room for the 28 nanometers to increase. And so we think that 28 nanometers utilization rate will continue to increase on quarter-to-quarter basis at this time.

Yeah, understood. But second quarter, your overall corporate average utilization was 98%. So what's the 10 nanometer utilization in second quarter?

So again, our overall capacity in third quarter were increased by approximately 1%, additional 1%. And also in the second quarter, as Jason mentioned, 8 inches full. around 100%. And 12-inch is 90-ish. And so 28 is, I think, a little bit less than the 12-inch average.

OK. So you probably, in 3Q, we are going to see this may be a single-digit percentage point utilization increase for 28 nanometer or more than that.

Yeah, we don't give the numbers on single-node utilization rate, but we can give you a relative idea about how we compare to our corporate average.

OK. So how about in second half, the revenue contribution from 28 nanometer? In second quarter, it was 13%. And how about in second half?

It should gradually trend up quarter over quarter.

We see a slight increase on the 28 nm in the next quarter.

Slightly increase in 3Q, right? Right, yes.

Okay, thank you. We have been talking about our 28 nm business for multiple quarters. I think most of you know about that, right? Now in the Q2, in our view, this is truly starting a meaningful 28 nanometers growth, quarter over quarter. This is very much in line to our expectations, and it's reflecting the materialization of our long-term game plan. So I just kind of want to add that. I understand we've been talking about this for a really long time, and we finally start seeing that, and meaningful growth coming in now.

Okay, thank you. My second question is for the 14 nanometer. I just looked at your annual report. You have continued investing in 14 nanometer FinFET technology. And your 14 nanometer FFC is mass production from second half this year. But for you, you only have a very limited 14 nanometer capacity. So our question is, are you considering to further expand your 14 nanometer capacity anytime soon? And if you want to do that, how much capacity it will be by this case? So this is my second question. Thank you.

Sure. I mean, we've also been talking about this for a long time. We will closely examine all the return on capital expenditure and optimize our capital deployment to elevate our financial performance. So every time when we start talking about CapEx and we have to go back to that, we have to make sure that we have justified the CapEx decisions. And for 14, from a technology development point of view, it's important to us. So we have been continuing investing and want to make sure that we develop the technology, as well as other technology, the area that we are focused on right now. in the specialty area. We want to make sure that we, from a technology development standpoint, we are relevant to the focus area. And beyond that point, as far as the CAPAC decision, and then we'll go ahead to the exam based on ROI basis. So I'm never going to rule out the chance of putting the new capacity on the 14th, but at this point, it is not on our plan yet.

Yeah, so by what kind of criteria or what kind of, you know, consideration, you are going to expand or raise the capacity for 14 nanometers. I think that actually every year you spend big money on R&D for this 14 FinFET technology, but if you don't have the capacity, how are you going to monetize the investment on this FinFET technology development?

Well, that's really a good question. If you look at the investment perspective, between the R&D investment and the capacity investment, the R&D is relatively small. It's a much smaller investment. But if you look at the addressable market, at this point we're considering anything 14 and above our addressable market. So we always have to examine our addressable market and whether the demand is valid. And then we come back and look at the application if that makes sense for us to invest into capacity. Meanwhile, we do have about 2 to 3K capacity in place. And so we're not going to complete waste in terms of our R&D. So we think this is more prudent for all shareholders, all stakeholders. So we're going to continue to follow that strategy.

Honestly, you said that 2 to 3K capacity for 14 nanometers, right? It's not additional 2 to 3K?

No.

Total 2 to 3K, right?

This is what we have right now.

Okay. Understood. Okay, thank you.

Sure, thank you.

And the next one is coming from Aaron Chen of Nomura Securities. Go ahead, please.

Thank you for taking my question. I got a question about competition landscape at 20 nanometer and also the other mature 12-inch node. I think particularly at 20 nanometer, I think this question has been asked a few times. when TSMC said it's an oversupply, severe oversupply for 28 nanometer for a factory industry, but you are able to manage your 28 nanometer to do better and better every quarter. So I want to know your view on the competition landscape at 28 nanometer and also the other mature 12-inch nodes. Thank you.

Sure. So let me start off with the 28 nanometers. First of all, we are unable to comment on our peers, and we don't know much about them internally. So I understand what they said, but we shouldn't be commenting about that. But let's look at UMC. We do believe our 28 and 22-neometer solution have finally provided competitive advantage for our customers. Like I said earlier, the progress of our 28 nanometer product pipeline remains very strong. The search of the 28 and the 22 tape-outs also shows that, and will continue to increase our exposure to a more diversified 28 customer base and product portfolio. So we are expecting our 28 nanometer revenue contribution in Q3 will continue. and to increase, and giving what I also mentioned earlier, driven by the higher penetration rate in the smartphone and continued demand in the computing segment. So we expect this 28, now the business momentum will benefit by those. If you look at the other 12-inch mature nodes, for the 40 nanometers, we We've perceived a positive demand in the second half as well, and due to an increase of the customer's 40 nanometer adoption in the logic device, driven by the wireless application. There are other applications coming into the 40 nanometer as well. Looking beyond the 2020, we are considering to migrate portion of 40 nanometer capacity our unfulfilled 28 nanometer demand to enhance our ASP and probability. So in the long term, I think there will be a demand, a supply balance on the 40 nanometers. So we are considering to migrating some of our 40s to 28. Then if we're coming down to 55 and 65, our 55 and 65 businesses For the second half of this year, we are very confident that our demand will remain strong, mainly coming out from the smartphone segment, again, associated with the 5G RF switch and the TDDI, which will be driven by the higher adoption of the 120-hertz display panels. So we think those applications are moving into the 55, and we start seeing a very strong momentum on the 55 and 65, and we think In the foundry landscape, the 55 and 65 will have a very strong demand over the supply. Of course, we talked about 80 and 90 earlier. Right now, we operate at 100% loading for Q2. For the second half, we do see some demand within the 80 and 90 applications are stronger than the other, some stronger, some weaker, but the overall 80 and 90 demand outlook is still in line with our 12-inch corporate average. So I think that will give you a favor of our view on those notes that we're serving today.

Thank you. That's super clear. I have a second question, which probably I don't know if we can have the answer. It's about a lawsuit. And I think a few months ago, we saw an article saying that the general counsel at UMC commented that the lawsuit will not be concluded in two or three years' time frame. I just want to know how should we think about timeframe and any update on this topic? Thank you.

Right now, the lawsuit is in the legal proceedings. It's really not in our control in terms of the timeline of the process, but we do follow wherever that court requires us. you know, we stay our believing ourselves, and so we don't believe there's any false wrongdoing in terms of UMC, and so we, you know, we stay believing that, and we just have to trust that the court system will eventually give us a fair result, okay? So since it's in the legal proceeding, it's truly not in our position to comment that at this time.

Thank you. I will go back to the queue. Thank you very much.

Sure. Thank you.

And the next to ask a question is from Sebastian Ho, CLSA. Go ahead, please.

Good afternoon. Thank you for taking my questions. My questions will probably just focus on the 8-inch system. So I think the company has been running a very high utilization rate for many quarters already. So I wonder what's your strategy here in terms of expansion and also whether you have more priority or selective on the product you do going forward. Thank you.

Well, I mean, you're right. And we do see the 8-inch has been continued for many quarters. And it's our belief will remain for and throughout the second half of 2020. And so we are constantly looking into options to further expanding our 8-inch capacity. But given the ASP situation, any organic growth in an 8-inch will be very limited. We will continue looking for those options, which we did. In the past years, we actually increased our 8-inch capacity organically as well, so by continuing migrating some of our fat to support our customers in the advanced 8-inch area, particularly. We're going to continue doing that, and sometimes inorganically, it has to come by, those opportunities that we have to go out and search for. We'll continue that as well. Meanwhile, in terms of the tightness of the eight-inch situation, it does affect some prioritization, as you mentioned about allocation. Our focus in the 8-inch is also on the area of a product mix improvement. We'll continue migrating some of our legacy to the advance and continue migrating some of the better product mix to help us enhance our ASD as well as profitability of the 8-inch. That is ongoing basis. given that we foresee the strong demand and continue leading to the supply tightness. By the way, not only to the 8-inch, but also on some of the specific 12-inch that I talked about earlier, we think there's going to be a market pricing situation where Aldo will probably become more in favor of the foundry from now on.

Okay, thank you.

That will probably help as well.

Got it, thank you. Just a follow-up on, given that we have a privilege or more flexibility about doing things that is more earnings-accurative to us, so how do you see it about the overall pricing outlook for the 8-inch going forward? Thank you.

I'm sorry, I didn't catch the question again.

The question is that given that you can be more selective and prioritize the business, the product application that is more favorable to our profitability, then how do you see that reflected on the 8-inch foundry price?

Well, I mean, the pricing discussion is ongoing. Right now... Well, first of all, we do value our long-term customer partnerships. So we need to be seeking for a win-win cooperation with them. So we need to continue to align with our customers. For the year 2021, we already have an ongoing discussion on this alignment. And so the pricing will be a result of those alignments. And I would not give you a specific at this time, but I Again, I will probably say at this point, given the demand and supply situation, I think the pricing situation outlook is more in favor of the foundry right now.

Got it. Got it. Just a last follow-up on this. I remember the last time the Ainge Foundry Prize has, we were able, and including our peers, able to raise the prize. That was back in, I think, 2018. And also... Coincidentally, the cost increased from the road wafer, so we have a very good reason to negotiate with our clients that we can pass the cost to the customers, so it justifies our reasoning for raising or adjusting the price higher. How about this time? It looks like the road wafer price, we haven't heard there will be some adjustment yet. I'm not sure it's going to happen next year, but given that we don't have the cost justification, but When you negotiate this with customers, the customer is still pretty acceptive about this pricing negotiation? Thank you.

First of all, you have a very good memory. Yes, you're right. Last time, the price increase is mainly driven by the raw material cost increases. And so we more or less pass down to the customer. This time is different. This time is mainly because the demand and supply alignment situation. We do see a very strong demand in the 8-inch defense note area. So given the tightness of the situation, we have to prioritize our resources along with our partnership relationships. So we are managing the balance of that. Again, I think customers appreciate that and understand it. So those discussion is ongoing at this time.

Okay. Thank you.

Sure.

And the next question is coming from Bruce of Goldman Sachs. Go ahead, please.

Hi. Thank you for taking my question. A very, very good result. I have a question, again, to the 28 nanometer profitability. I'm actually very surprised to see that the management did not take the each node profitability. because company manager also mentioned that you a new investment is based on a better return which means that when you try to increase your 28 nanometer capacity you believe that incremental capacity can give you a better return so can so my question is that you know when do we expect that 28 nanometers should be the corporate average profitability and margin and Is that the reason why we want to increase the 28 nanometer capacity?

So for increasing incremental 28 nanometer capacity, sometimes it helps the overall bigger pictures. So if we don't have adequate capacity or economy or skills, it's difficult to reach our long-term goal in terms of profitability. We just cannot look at the incremental per se. It's really the overall result in a longer-term time span is what we are really considering. So, yes, if we are considering to expand our tangent nanometer, it's going to fulfill our requirement for a longer-term picture.

but I thought that maybe we can somehow raise the ASP first to improve the margin or profitability. Then we do the capacity expansion or any other ways to better boost for the margin.

Well, certainly we follow your view as well, but sometimes it just in reality doesn't come in the preferred sequence. So for example, our age today, as our president just mentioned, The pricing environment is really in the favor of foundries, and hopefully we believe with our competitiveness and also the readiness of our technology, somehow the pricing bargaining power will return to the foundry side as well. So yes, we certainly follow your thoughts, and we wish that to happen as well, but the more important thing is really to fulfill the missing parts and to reach the economy of scale. and to have adequate capacity for our key customers.

I understand. Just a little bit follow-up for the 28. So moving into the second half, you know, our 28 nanometer utilization rate is slightly below the 12 feature average, which means that incrementally utilization rate might not be a big moving factor for your 28 nanometer profitability. So can we expect that, you know, how can we see a better profitability for 28 in the second half? Maybe we use the tool for the 28 alone or we, you know, any other ways we can see that, you know, or how should we see the profitability improvement in the second half for 28?

I think for as a finance person, maybe Jason can jump in later on. As a finance person, the depreciation curve need to come down. So that's exactly the situation for our shaman fat. It may take another couple years to see the curve to peak, to decline, to help our overall 20-year profitability. And our 12A in Thailand has pretty much reached the inflection point. So by year 2022, Overall company, we will see a significant decline in depreciation expenses, which is largely related to 12A, 28A expansion we did back in a few years ago. So depreciation will come down, and hopefully our product mix enhancement will also help our overall blended ASP for 28 nanometers.

OK, I'll get one last question for the age. The manager mentioned that the pricing environment is better, but the third quarter guidance for the ASP is still flat. So when can we expect some improvement in terms of blended ASPs?

I mentioned many of the discussion about that is for the year 2021. So that alignment is ongoing. All our 2020 demand for the support is being aligned previously, and we're considering the long-term partnership that we have, and that will be only selected area with the upside with a better pricing. But in general, we did not move the pricing in 2020. given the demand and supply situation change and is more of the discussion today is for 2021. Meanwhile, for the 2020, all the pricing adjustments are given on the upside support area.

I see. I understand. So we can expect much better ASP trend in 2021, at least for an inch.

By then, we actually will give you a much I understand that.

You know, I just can't wait.

I definitely share the same thought, but when the time comes, we will give you a really clear guidance on that.

I understand that. Thank you very much.

Sure.

And the next question is coming from Charlie Chen from Morgan Stanley. Go ahead, please.

Thanks. Hi, gentlemen. Good afternoon. And congratulations for a very good resource. So I also have a follow-up question on gross margin. And it seems like you are guiding third quarter margin to decline from second quarter instead due to the ramp of 28 nanometer mix. And I'm not really sure because the Supposedly, the higher insertion should mean a better margin. Why the margins would decline into the quarter? Thank you.

Okay. For the Q3, the next quarter's gross margin guidance, we are expecting the margin will be challenged by the foreign exchange market. The stronger dollar, NT dollar, will dilute our probability. That's one of the reasons. In addition, we are entering in the summer section. So every year, annually, that will lead to a higher utility cost during the time. So we are factoring those into the calculation as well.

OK, thanks. And next is about your top line. 20 nanometer goes up, and you mentioned that across segments, demand to be very strong. Is that the case? Why the revenue is only flat quote-unquote?

Well, again, given the product mix that we are projecting today, and we do think there will be some help. There's going to be some of the other nodes that compensate with the upside of the 28. That will give us the faddish outlook at this point. From the utilization rate point of view, for the Q3, there will be an overall capacity increase of a little bit over 1%. Besides, given the Mi-90 utilization rate guidance, we can see that that's very high already. So we feel this is probably a reasonable guidance at this time.

Thank you. And the next is about your mitigation risk. So may I confirm you did expect that the lawsuit wouldn't conclude in the coming two to three years. Is that really what your official comments? And actually, my own opinion is that maybe there is still an overhand and your business fundamental is quite strong. Why not management of companies consider to do a settlement with the U.S. or Micron earlier? Even there will be some potential compensation. Thank you.

Well, since this is, again, since this is in the legal proceeding, it's not appropriate for us to comment on our legal thinking as far as the strategies. So, you know, we'll report accordingly and by the regulator, you know, toward this policy. So, and on a tiny basis. but we would prefer not to comment during the call right now.

I see. So from the finance perspective, I'm not sure if this will need to book some contingent laws. I remember when I was in college, there was some contingency expense. So I'm not sure if... Maybe this question is to Xi Tong, whether we need to put some contingency expense on that litigation issue.

Well, UMC did not violate the Trade Secrets Act, which we already have appealed to the appeal court in Taiwan. So it's a non-guilty appeal, so there's no reason for us to do the contingency estimate. However, our accounting book has always accrued some small percentage of revenue as legal-related expenses. So those two things are not linked to each other, but we do have our own legal reserve, if you will, for all sorts of general legal-related expenses.

I would also like to add the...

UMC, we have appointed a finance legal council and will rigorously respond to this false litigation in U.S. and Taiwan. At the same time, we will make every effort to enhance our profitability and preserve the best interest for our shareholders to mitigate that potential risk. But as far as the assessment for the risk, we're truly not but not like to respond because at this point it's related more of a speculation and hypothetical. So that's why it's a bit difficult for us to comment right now.

Yep, that is reasonable. And that's why maybe either Jason or Dr. Wang can help me. You said the company or the foundry overall seems to be still very healthy into second half. How do you reconcile the pandemic or healthcare crisis with consumer demand versus your decent or good second half outlook? Thank you.

This is definitely a very interesting time right now. Previously, if you remember, we actually talked about the inventory correction potentially impacting demand. during the beginning of the COVID-19 pandemic. However, now we actually have seen the inventory level increase of semiconductor vendors and OEMs have kept pre-building in order to avoid supply chain disruption. And also, businesses have carried buffer inventory to accommodate a rebound of opportunity arising from the reopening of the economy. So we do see people view this a little bit different. There could be a new norm. So we have a much better clarity now. And given that and our view on the overall demand outlook, we have not seen a significant order cut at this time. And we will be cautiously optimistic in the second half. We expect more opportunity will be driven by the 5G headset and the PC. Noble demand will pick up social with the work from home and home schooling trend. Despite the smartphone shipment actually declined this year, overall smartphone, but we expecting capture higher smartphone market share driven by the 5G handset launch. this year we see about 200 million units from 20 million units from 2019. And the silicon content of 5G phone will also increase such as PMIC and RF switch. This will actually position us to take advantage of that market trend. Besides the significant 5G phone shipments, our customers are also expecting to get smartphone market share this year. So this will more than offset the decline of the smartphone units that we see. So that's why we actually have higher confidence in the second half of the year.

Yeah, that's very, very helpful. That will be all my questions. Really, really appreciate your time and the insight. Thank you.

You're welcome.

And the next question is coming from Julie Tsai of UBS. Go ahead, please.

Thank you, management. There's a lot of discussion about 28 just now, but looking at your Q2 product breakdown, it is not very clear where the 28 application is coming from. Could you give us a bit more detail on that? Thank you.

You're talking about in the Q2. The increase in 28 nanometer demand in Q2 is attributed to a communication and consumer in a connectivity, AV baseband, and in a 5G phone, and as well as the work from home applications. That's where the mix of the 28 nanometers in Q2.

I see. And then also, you did mention that Q3 growth margin could be adversely impacted because of the NT dollar appreciation, but we're already seeing that happen in Q2. But are you also seeing that again to be adversely impacted in Q3, though?

Yeah, and the magnitude of NT dollar appreciation is actually more in third quarter than that in second quarter. So yes, we do foresee that to have some negative impact for both our top line and bottom line.

Okay, got it. All right, thank you.

Sure. Ladies and gentlemen, we're running out of time, so we're taking the last one. The last question is coming from Randy Abrams, Credit Suisse. Go ahead, please.

Okay, thank you for squeezing me in at the end. Maybe just to follow up to that last question on the 28, If you could give maybe a forward view. You mentioned another surge of tape outs. Just talk a bit more about the new applications that you have coming onto that node over the next few quarters.

Well, I mean, it's very similar to the Q2. We see the Q3 was driven by the, you know, I mentioned many times earlier, the smartphone and the continued demand in the computer segment. And so the 28 were mainly driven by those two segments and not much of a change from the two. It's very similar, yeah.

Okay. The second question I wanted to ask is maybe the direction. You talked about actually fairly good strength. So I'm curious, fourth quarter, just an early look at it, sometimes has a bit of seasonal decline. But just factoring your comments, if it looks like this year, based on your demand and customers wanting to carry inventory, if it looks like it's holding firm as we go toward year end. And I'm curious, the other product, which I presume it's auto-industrial, which is the weaker area, if you're seeing any signs of stabilization, bottom-out, or recovery in that area.

Well, I mean, instead of talking about Q4, let's look at the past couple quarters and the outlook of Q3. In those other areas, besides the communication, consumer, and computing, we do see the other areas being up and down throughout the year so far. And we see a slowdown, we see a rebound, and then we see a slowdown again. So I think given the discussion with the customer, we do see the market start stabilizing and start to see the sign of a recovery. But given the past history of this year being up and down, we just have to cautiously look at it. And I think if we're talking about Q4, we'll give you a much better clarity in the next conference call.

Okay, great. I appreciate that. Thank you.

All right.

And ladies and gentlemen, we thank you for all your questions. That concludes today's Q&A session. I'll turn things over to UMC Head of IR for closing remarks.

Thank you, everyone, for attending this conference today. We appreciate your questions. As always, if you have any additional follow-up questions, please feel free to contact UMC at ir.umc.com. Have a good day.

Thank you. And ladies and gentlemen, that concludes our conference for second quarter 2020. Thank you for your participation in UMC's conference. There will be a webcast replay within an hour. Please visit www.umc.com under the Investors Event section. You may now disconnect. Goodbye.