[Foreign Language] Welcome to TSMC's Third Quarter 2018 Earnings Conference and Conference Call. This is Elizabeth Sun, TSMC's Senior 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 through the 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, Ms. Lora Ho, will summarize our operations in the third quarter 2018, followed by our guidance for the fourth quarter. Afterwards, Ms. Ho and TSMC's CEO, Dr. C.C. Wei, will jointly provide company's key messages. Then we will open both the floor and the line for the Q&A. For those participants on call, if you do not yet have a copy of the press release, you may download it from TSMC's website at www.tsmc.com. Please also download the summary slides in relation to today's earnings conference presentation. As usual, I would like to remind everybody that today's discussions may contain forward-looking statements that are subject to significant risks and uncertainties, which could cause actual results to differ materially from those contained in the forward-looking statements. So please refer to the safe harbor notice that appears on our press release. And now, I would like to turn the microphone to TSMC's CFO, Ms. Lora Ho, for the summary of operations and current quarter guidance.

Good afternoon, everybody. Thank you for joining us today. My presentation will start with financial highlights for the third quarter and followed by the guidance for the fourth quarter. Third quarter revenue in U.S. dollar reached $8.49 billion, which increased 8.1% sequentially, reflecting customers' new product launches using our 7-nanometer and a more favorable foreign exchange rate. Third quarter revenue came in stronger than the revised guidance that considered the impact from the August 3rd virus incident as we were able to make up most of the delay in shipments. In NT dollars, revenue increased 11.6% sequentially. Compared with second quarter, gross margin decreased 0.4 percentage point to 47.4% as the unfavorable technology mix was partially offset by the profitability improvement in the back-end business, while the more favorable exchange rate offset the virus incident impact. Total operating expenses increased by NT$1.7 billion. The increase was mainly for 5-nanometer and 7-nanometer plus development. Thanks to operating efficiency, total operating expenses represented 10.8% of revenue versus 11.3% in the second quarter. So our operating margin improved 0.4 percentage point sequentially to 36.6%. On tax expenses, after a step-up in tax rate to 17.5% in the second quarter due to the accrual of retained earning tax, our effective tax rate fell back to 10% in the third quarter. We expect the full year tax rate to be about 12%. Overall, our second quarter EPS was TWD NT$3.44 and ROE was 23.2%. Now let's take a look at wafer revenue contribution by application. During the third quarter, Communication and Industrial/Standard increased 24% and 6%, respectively, while Computer and Consumer decreased by 35% and 1%, respectively. Now let's take a look at revenue by technology. 7-nanometer process technology contributed 11% of total wafer revenue in the third quarter. 10-nanometer accounted for 6%, while the…

Thank you, Lora. Good afternoon, ladies and gentlemen. Let me start with 2018 year's outlook. For the full year of 2018, we forecast the overall semiconductor market excluding memory will grow between 5% and 7%, while foundry is expected to grow between 6% and 7%. For TSMC, as Lora has just indicated, that our second half of 2018 business will be strongly supported by the 7-nanometer ramp-up, which is mainly driven by a few new smartphone launches. However, our business is also negatively impacted by further weakening of cryptocurrency mining demand. As a result, we estimate our 2018 growth rate will be about 6.5% in U.S. dollar term, which is close to the foundry industry's growth but slightly below our 7% to 9% guidance given in the last conference. Now let me update you about the August 3 virus incident. On August 3, TSMC experienced a computer virus outbreak, which affected a number of computer systems and fab tools. The infection was due to misoperation and insufficient firewall controls. We have since corrected this problem to ensure such viruses will not happen again in the future. Our remediate actions including the following: implementing an automated system to guarantee foolproof execution so that such misoperation will not happen again; enhanced firewall control for fab isolation; and network control to each individual computer. More enhancement now are ongoing, too, for further improve tool immunity against future infections. TSMC sets top priority for such security enhancement. Now let me talk about the N7 and N7+ and the EUV's progress. TSMC's N7 technology is now available for customers to unleash their innovations. This is the first time in the semiconductor industry the most advanced logic technology is available for all product innovations at the same time. We continue to work with many customers on…

Thank you. This concludes our prepared statements. [Operator Instructions] Deutsche Bank, Michael Chou first.

Thanks. Two questions. One is what is the outlook for 7-nanometer sales portion in 2019? Can you give some color at this moment based on your current visibility or some tape-out numbers?

Michael, your question is what is the outlook of 7-nanometer.

In 2019.

In 2019.

In terms of the sales portion or any indication.

I would like to answer the question and say it's a very strong demand in all the play forms, in all the market sector, which including the mobile phone, high-performance computing, that's included graphic, a lot of AI accelerator, FPGA, you name it. A lot of customer are working with us, as I just stated, and we expect 100 or more than 100 tape-outs – product tape-outs in year 2019. So did I answer your question?

Is that fair to say that 7-nanometer sales portion will be more than 20% of total sales for the whole year next year?

Next year?

Let me answer that. You have seen our report. The third quarter 7-nanometer accounts for 11%. The fourth quarter will be more than 20%. So for whole year 2018, 7-nanometer will contribute close to 10% of total TSMC revenue. Go beyond 2018, and we will have very, very strong ramp, in 2019 as well, we expect the revenue contribution will be much higher than 20%.

Second question. C.C., you mentioned 20-nanometer oversupply in the industry could be a normal situation over the next few years. So will management consider converting some 20-nanometer to advanced node? I know you mentioned some specialty, especially PMIC in 28, CIS in 28, so – which should be a good volume product. But would you consider to conversion capacity to advanced node?

Good question, Michael. Actually, we are moving from 28-nanometer to 22-nanometer, which is a smaller geometry and more advanced. I think your question is, are we consider moving into 16, convert some of them? We keep the flexibility to moving the wafer around, so they can support each other. We already did that. So there are a lot of commonality in the tools, so some of that capacity – or part of the capacity can support other technology node.

So you mean that if – for instance, if your 16/12-nanometer demand is beyond your estimate, so you can use some 28-nanometer to some 16 node product in the future?

We have some tools that have a commonality. Several of them go in planter, right, and the cleanup and a lot of things. But let me state again, I say the overcapacity for a few years, however, we are developing 22-nanometer, we are developing a lot of specialties. And for TSMC, this is only probably a couple of years we are going to fully utilize 28-nanometer again.

Then is that fair to say your 28, 22 UTR over the next few years, that you are confident you can maintain maybe above 85%, above 90%?

I’m not going to ask – to answer this question. But after a couple of years, it will be the high utilization rate again.

Thank you.

Next question will be coming from Credit Suisse, Randy Abrams.

Okay. Yes, thank you. I wanted to ask a question about sales and also gross margins. The sales in the fourth quarters is actually fairly good, factoring in the business environment. Could you talk maybe the forward view? You mentioned also fabless days of inventory may exit the year a few days high. So with the implication for our first half, especially relative to the last two years, we saw declines in first and second quarter. So if you have a view kind of the rate or magnitude of the decline relative to what you think normal or seasonal is after first and second quarter.

Are we going to forecast that second – next year’s first quarter and second quarter.

Initial view based on inventory and demand.

We have very strong demand in 7-nanometer. Let me just continue to say that. For the last quarter of this year, you’re talking about the profit margin, right?

Yes, the second question on margin, I wanted to ask, it’s about 1 point or 2 below the traditional, say, 49 to 50 targets.

Yes.

And Lora cited product mix. Next year, 7 will be more mature. Do you think you have the catalyst to get back to that 49, 50 or other factors like 28 oversupply?

Well, let me answer the – your fourth quarter’s profit margin is a bit lower than we usually have. That’s between 49, 50. That’s because of our product mix Lora just have mentioned. Product mix, one of the major reason is the 7-nanometers ramp up much faster than we thought. And the demand is very strong. And so that draw down our margin a couple of point. But I’ll let the CFO to explain the number.

C. C. mentioned about 7-nanometer being particularly strong compared with our other leading-edge technology in the past. It does dilute our corporate margin level starting from the third quarter this year. Going to the fourth quarter, as I mentioned, the revenue contribution will be 20% – more than 20% of our fourth quarter revenue. And the margin for 7-nanometer at the beginning stage is still below corporate average. So the dilution in the fourth quarter will be more severe than the third quarter. Our estimation is between 2 to 3 percentage point for fourth quarter gross margin. Now going into 2019, SRAM will continue to be very strong, so we believe the margin dilution will be eased off when we reach to the second half of 2019.

Okay. And maybe I’ll just – to follow up on that first one about sales, you mentioned 7 is very strong. But I guess, do you have a view that the rest of the business may be doing some further inventory adjustments in the first quarter?

Lora?

There are several days above seasonal this quarter. And going into 2019, I think inventory will be gradually digest when we move into the second half of 2019.

Okay. The second question I wanted to ask was about the 7+ versus 5-nanometer. You mentioned 2020 would see the very strong ramp-up of tape-out and activity in volume on 7+. Is it your view – I think last conference, Mark said 5 was a little bit more conservative at this stage. So how’s your view now for interest activity and expectation for a steep ramp-up of 5 into 2020?

We still expect very fast ramp on 5. The reason is simple. Because of a lot of our product develop in the AI area, you need the speed, you need the lower power, and you also need a small footprint. So from this – from today, we can see when we work with our customer, the ramp will be steep again.

Okay. Do you think mobile will also contribute in that steep ramp?

Still come from the mobile phone first, followed by other applications.

Okay, great. Thank you.

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

Good afternoon. I would like to follow up for this 4Q gross margin guidance. If I compare with 4Q last year, actually, we have a similar percentage contribution from this leading edge. Last year, 4Q 10-nanometer was about 25% of the total revenue. And in 4Q this year, actually, we have a favorable exchange rate compared to 4Q last year. And also, we have this improved back-end profitability. So how come we still have a lower gross margin compared to 4Q last year?

There’s about 2 percentage point difference this 4Q versus last 4Q, okay? So one reason is product mix issue. I’m particularly talking about 28-nanometer. You know our 28-nanometer is very profitable, and the contribution to corporate revenue has declining from last year to this year. So these two reasons, product mix because 28 declining and also because the utilization of 28 is not full, yes. That’s one reason that there’s a new phenomenon.

Okay. So how about the standout gross margin, does it change?

Structural profitability is still intact, no change.

Okay. And also last quarter, you talked about, for longer term, our financial objective for gross margin is 50%. So is this 50% a fixed number? Or this 50% is average for the upcoming few years?

50% is our goal. We aim to achieve that. If we can’t have higher utilization, I am quite confident we can achieve that.

Okay. So this year I think that probably we are not able to achieve this 50%.

No, not…

Because of the utilization?

Not this year. And also because the 7-nanometer ramp is more severe than previous node. So first year dilution is slightly bigger, okay?

Okay, thank you. My second question is AMD starts its 7-nanometer CPU from server. And also, ARM recently also talked, they have this new brand server product. So is server CPU going forward to be a very significant part of our business going forward? Thank you.

It will be an important part. Significant, maybe.

So your 4-course play for smartphone, HPC, IoT and the automotive, and so this server CPU will be in HPC then?

That’s right.

Okay, thank you. Can you just reiterate the growth breakdown for this 4 play for next year? Thank you.

Okay, let me give you some color on it. In the next few years, if we look at ahead, actually, the smartphone going to be in our daily life even more and more. So we have a 4-course engine: one is a mobile phone, actually it’s a high-end smartphone; second one is a high-performance computing; automotive; IoT. The mobile phone probably for TSMC will have a – in five years, a CAGR, if I look at it right from today, it will be mid-single digit is the growth. And the all others three play form will have a very comfortably double-digit growth in the five years time frame. And so that’s a – did that answer your question? That’s…

Yes, thank you.

You’re welcome.

Next question will be coming from UBS, Bill Lu.

Thank you very much. First question is on First question is on China. So a lot of concerns about the trade tension, about the economy slowing down, et cetera. Can you talk a little bit about what feedback you might be getting from your Chinese customers, both short term and long term? And short term meaning whether you’re seeing any increasing levels of conservatism on ordering, on demand. Longer term, is there any change in the strategies of these Chinese customers in terms of perhaps less reliance on the U.S., et cetera? Thank you.

To answer your question, for the short term, we did not see any impact, if there’s any at all. So our China customer, no, they did not change their behavior. So we continue to work with the customer to produce their product. For the long-term, long-term, due to the trade tension, your question is due to the quotient?

Yes.

Let me answer the question by another way. TSMC has been proud to be the everybody’s foundry. So if there’s a trade tension, if there is, and if it continues, I think that TSMC – the impact to TSMC would be less or minimized because if – we still need the semiconductor device, and TSMC is everybody’s foundry, right, so whether they produce here, produce there, it’s all TSMC’s customer.

Thank you. Great. I know 2018 is not over yet, but if you think about the next couple of years, I know TSMC has talked about a long-term growth rate of 5% to 10%. Now I feel like more recently, you’ve talked a lot more about the progress on 7-nanometers. We all know about Intel’s struggles with their process technology. And it’s public information. They’ve announced it, right? So – and then you’ve got some good design wins. Can you talk about your long-term outlook in 2019? Given these drivers you just said, out of the – three out of the four new drivers will be above 10%. So are we looking at something more towards the high end of that? Or how do you think about that?

We continue to say 5% to 10% growth rate. Probably I would like to – following your question, I would like to say probably tends to be the higher side of that 5% to 10%. Does that answer your question?

Yes. Thank you very much.

Next question will be coming from Daiwa’s, Rick Hsu.

Thank you, [indiscernible]. My first question is, I know since you were talking about your more than 100 tape-outs for N7 and N7+. Can you give us a little bit more of – a little bit of breakdown? I would like to know how many tape-out for N plus and also what kind of application for that.

Okay. In process our tape-out – product tape-outs, I’m talking about product tape-outs, is still a small percentage of the total N7 nanometer as a node, as I just mentioned. But then up to 2019, I expect the 2020, when the current customer, they start to design on their second-wave products, then there will be more of them, N7 – N7+. So I don’t have a specific number for you on 2020.

Okay. Thank you. My second question is, you also mentioned that your N7 will likely be another long node. So I presume it will be probably something like N28 in term of success. So my question is, in term of capacity build – I know you don’t have the capacity number, but in term of capacity build, would you benchmark your N28 into more capacity number?

We build out capacity according to the customer demand, and that – I can assure you that. Compared with the 28-nanometer? I cannot make any comment right now.

Thank you so much.

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

Thank you. So my first question is regarding the semiconductor inventory. So in which segment do you see more inventory? Because we are hearing lots of noise about automotive, industrial segment weakness and some CapEx cut, right? So can you give us some color about where do you see the inventory and also your 8-inch fab utilization rate? Thanks.

Well, I don’t think we want to specify which product sector that have high inventory. But let me assure you that this year’s – at the end of this year, the inventory level actually as compared with the last year’s same time is much smaller. So even we have some kind of inventory adjustment, I don’t think the impact to the next year’s quarter or next year’s first half would be as severe as we saw this year, right? So that’s all I can say because it’s very dynamic. Lora, you want to add something?

Just if I can add some color to your questions, if I look at the fourth quarter, we have just guided the 10.7% growth quarter-over-quarter. But looking at the segment, fourth quarter, Communication will grow very strong. Computer, small growth, lower than the corporate growth, so that area’s relatively weak. Consumer’s is weaker, it’s negative growth. And Industrial is a small decline. So maybe this can give you some color about the – which segment has more inventory.

Thanks. Yes. So maybe this is also related to – it was a previous question, right? So when you analyze this inventory, customers’ demand, do you think there is any impact from any macro factor, including the China-U.S. trade tension? Or it’s just a normal semiconductor cycle?

I will say it’s just a normal inventory cycle.

Okay. Thanks. Yes, and next question is also related to the 7-nanometer plus, right? So you mentioned only a few tape-outs. But sometimes, one tape-out can be very significant to revenue, right? So can you give us some comments regarding the 7-nanometer-plus revenue contribution next year?

No, I don’t want to specifically say which one.

All right. Thank you.

I think at this point, we would like to turn the questioning to the callers on the line. So operator, could you please put the first caller on the line first?

The first question is from the line of Mehdi Hosseini from SIG. Your line is now open. Mr. Hosseini, your line is now open.

Yes. Thanks for taking my question. Just want to go back to your view on 2019, an interesting year because you have the migration from 4G to 5G [indiscernible], which could adversely impact strong demand, but you also have AI and IoT ramping. How should we think about the mix changing? And would new applications and continued share gain would enable you to actually offset any adverse impact as we move from 4G to 5G?

Mehdi, in fact, we can only hear your voice in a discontinued manner. So could you please repeat your question again? Maybe keep your voice a little bit away from the microphone.

Okay. Sorry about that. I’m just trying to better understand how you’re thinking about 2019. It seems like there are many new projects that are ramping given the number of tapeouts at 7-nanometer. And we also know that in this mark for market, we’re in transition from 4G to 5G. In that context, should we expect new products, especially for AI and IoT, to get strong enough to offset any adverse impact from migration from 4G to 5G?

So you want to repeat the question?

All right. Let me try. I think Mehdi’s question is that he is very positive about the outlook for us in 2019 because we have so many new product launches from our customers using 7-nanometer as smartphone is entering into a 5G era. And so he thinks that we may get a lot of new products in AI and IoT, which would be able to offset the migration from 4G to 5G.

From 4G to 5G, well, that’s a question. So looks like the question says – indicate that 4G to 5G will have a dip. Actually, it’s not. 5G in 2019, we expect to start to grow, but not a significant number. So most of the phone – the smartphone, I mean, it will be in 4G still in 2019. However, I mentioned about the AI and other product segment, yes, that will start to grow in 2019 and we expect a lot of new product other than the smartphone will contribute to 2019 7-nanometer business.

Sir, could new product actually be big enough to help you with a 5% to 10% revenue growth? And I’m asking you this because this year, we have had adverse impact from customer inventory and the currency that impacted your overall growth target for 2018. But in 2019, would new products offset any weakness that is associated with the mature products?

Well, in 2019, as I just mentioned, the inventory correction will be much less, in fact, as compared with the 2018, beginning of 2018. So definitely, our growth rate in the 5% to 10% would be much likely in the high side, that’s what I say. Not only because of the…

Okay. That’s clarified.

So Mehdi, accept our very positive outlook for 2019, good. And so operator could you please go to the next caller on the line. Thank you.

Thank you. The next question is from the line of Gokul Hariharan from JPMorgan. Your line is now open.

Yes. Hi. Thanks for taking my question. My first question is on the China demand and capacity buildout. Could you talk a little bit about the progress of the buildout for N16 in Nanjing? What is the schedule for phase 2? And has there any change in plan both the weakness that we have seen in cryptocurrency demand for some of the Chinese customers. That’s my first question.

So Gokul’s first question is he asks us to update our Nanjing fab’s progress and he asks if we have any changes in plans to this ramp-up in Nanjing fab because of the weakness in cryptocurrency mining.

Nanjing Chairman, you want to answer that?

We had a 10,000 wafer per month installed capacity currently. And then we’re planning to increase the capacity to 20,000 wafer per month next year. And we are developing customer as well as some derivative technology that are related to the 16-nanometer. So we have progressed as we planned.

Okay. Thank you. So my second question is on N7 and N7+. Now TSMC appears to be in the best position to comment about the benefits of EUV given that you have N7 NAND, N7+, one in production, one in reduced production. Could you talk a little bit about the kind of improvements that we are seeing either from the EUV perspective or reduction in mask layers, et cetera, and the impact in terms of overall cycle time for the fab comparing N7 and N7+.

Okay, actually the question is about the EUV and how much of the benefit we can get from the EUV, right? Usually, if we are not using the EUV, sometimes for the very critical dimension on the N7, you have to – N7+ you have to use the four layers of lithography to pattern one of the critical dimension. Now using the EUV, you're just using one layer so that you reduce the cycle time by four times of photolithography, four times of etch. Now you become one lithography, one etch. In total, how many layers we reduced? That depends on the customer's requirement, but usually I just give you a hint already, right, four layer can become one and we are replacing some of the three layers to become one and we have a few layers of that. So that give you a hint. Cycle time reduction, definitely because you do four times into one times, that's a big advantage. Productivity-wise, today, EUV is progress we will – up to our expectation. And in fact, TSMC has turned on the 250-watt power and we believe we are the only one company continues to run the 250 watts EUV power so far today. Okay.

Okay. That’s very helpful. Thanks.

Now we can come Next question will be coming from CL Securities, Sebastian Hou.

Thank you. My first question is on the trailing-edge profitability and outlook. So a couple of your peers in the past 12 – well, past two years have decided to not – to stop going advanced. So now their strategy is to focus on the node they are already – they already have and China is already ramping up some trailing edge technology capacity so it seems they are more focused on there. And understand that TSMC, as we generate a lot of profit and cash flow from trailing-edge technology, so how do you see this dynamic going forward? Is there potential for you to – for this to negative impact your trailing edge profitability? That's the first question.

Okay. Actually, I don't want to comment on my competitors' strategy. But let me, again, trace our what you all know as strategy. We continue to develop some of the specialty technology to meet the customer's requirement, right, I just stated in that. And yes, a lot of specialty technology we are doing, I give you some example already, power management IC, CMOS, MEMS, everything. So that will help us to compete with our competitor. Actually, this kind of specialty technology particularly we have to work with the customer. And so that's why I say working with the customer to meet their requirement. And that, in turn, to keep TSMC's business. And that's a way that we migrate the technology – pure logic technology to the more advanced node. But for the existing capacity, we develop into the specialty technology. And so our strategy is still meet customer's requirement, but we don't increase the existing logic capacity.

Right. But I thought TSMC has been doing this for a long time.

Yes.

So you'll keep doing this? But the real change is not what you are doing, but the real change is what your competitors, the dynamic, there are more competition threat from it?

Well, we already have a lot of competition. Before they announced that, we still see the other competitor, no doubt about it. Not because they dropped out of some of the technology node they don't want to do, no, we are not going to change our strategy because of that.

Fair. Thank you. Second question is still on the node profitability. So I remember the rule of thumb for TSMC: node profitability is N-minus-2 now usually have very good or probably the highest profitability of – for TSMC. So now we're already ramping up seven, so the N-minus-2 for you is 16. Understand that the 28 used to be very profitable, as Lora just said. So I'm just wondering, if based on the – assuming 16 and 20 – we compare 16 and 28 assuming they are both depreciated at the same utilization rate, will 16 be more profitable than 28? Or similar?

Wow, this is very specific, you asked the profitability. Lora, are we going to answer that one?

I probably cannot quantify that, but we don't know whether you said N-minus-2 is the most profitable node is correct. But eventually, I think, as we continue to improve productivity and we keep very competitive, specialty technology for the mature node, our margin will be all very good.

Okay, let me ask from another perspective is that the – some of this capacity on 16 or 20 was installed in 2014, 2015, so which means that they will become fully depreciated very soon. So which means that these will become margin profitability tailwind for TSMC starting from next year and partially offset some of the 20 headwinds. Is that the right way to look at it?

We certainly expect that, all right. You are talking about a fully depreciated tool to generate more profit. Yes, you can calculate. We have a five-year depreciation period.

So which means that by the same time next year, regardless of the utilization rate or whatever pricing, 16 will likely to be more profitable than 20?

actually, TSMC's 20-nanometer is very profitable. And that is, what should I say, you say 16 is better than 28? And I hope so, but I cannot tell you the true number.

Okay. Thank you.

I think our profitability is not depending on which node is better than which other node. We want all the nodes to be very profitable. Okay. Next question will be coming from Morgan Stanley's Charlie Chan.

Thanks for taking my follow-up questions. So after a recent industry consolidation, does that change anything like your bargaining power and also your thinking about cash return? So what does it change your thinking about, for example, the payout ratio going forward? The industry consolidation?

Industry consolidation?

Yes.

Yes, I mean, GLOBALFOUNDRIES exceed 7-nanometer and Intel seems to be struggling with their leading edge. So I would assume competition in leading edge is getting less, right? So in that case, maybe your bargaining power can increase and also you have more cash may free up to return to shareholders. I don't want to say that because of my competitor. Well, in fact, Intel is my customer, so we respect their performance, of course. But TSMC's strategy actually is working with the customer. And the way that I have a competition or I don't have a competition, that's independent of that. And so we think we offer a very good technology value to our customer. Customer are happy, so we are working together and growing the business together. I'm not going to tell you that's my pricing strategy, that's not in discussion. Okay.

Yes. So your current payout ratio is around 60%, right? So in what kind of circumstance in the long term would you consider to revise your payout ratio to maybe 70% or even above?

Actually, we have been paying around 70% in the past few years. And I have said many times, and with 5% to 10% growth, we are confident we can continue to generate increasing free cash flow. That will be the source for the increasing of cash dividend. So we're still within that kind of commitment.

Thank you. And next follow-up is regarding that EUV question, right? I know it could be too direct to ask about revenue contribution from 7-nanometer plus. But from another angle, what keep your customer hesitating to get that 7-nanometer plus, right, because you mentioned few tapes. Is there any concern about – sorry, the throughput of EUV or capacity of EUV, what keep the customer hesitating about EUV adoption next year?

No, let me give you some explanation. Because of TSMC's 7-nanometer is very successful, so customer using the design on 7-nanometer first. But N7+ have some, certainly, have some advantages, right. We’re using the EUV, you have a shorter cycle time. And I just say that it’s kind of a better pattern control, so that means your critical dimension has been tightly controlled that help the performance also. So we expect the customer moving their second wave product. A lot of them will go to 7+. And any concern about the EUV’s maturity, that actually is what you are asking.

Everything sounds very decent, right? So what was the issue? Price or any issue?

What’s the issue. Okay. Okay. EUV progressed steadily to our expectation. But as compared with EUV photo, the maturity is not comparable, not yet, not yet. EUV is still climbing up and we hope that the productivity can be better and better. But today, not yet. You just look at how many debut we have and how many EUV we have, you know what I’m talking about, I mean, that in the industry, just here in the industry.

Lastly, if I may, right? I think AI semi has been a very topical growth driver. So I think the reason it is getting more clear that some SC claims their performance can be eight times better than GPU. Those are general purpose, right? So now with less of a new SC coming to light, do you think that is going to impact your overall AI semiconductor revenue? Or put it in another perspective, do you expect any reacceleration or slowdown of your AI semiconductor business in the coming year?

I think the AI’s application would be everywhere, actually from the several edge server or to the end device that’s just like the smartphone of everybody. So this kind of a development is to our advantage because TSMC certainly have a technology leadership. In order the AI would be effective, you need a very advanced technology for the highest performance computing. So I don’t see the effect that you are talking about, this application is better than that so that affected the course or something. No, it will be continues to grow. And I expect this growth much faster than I predicted here.

Next will be coming from Deutsche Bank as a follow-up question.

Thanks for taking my follow-up questions. Regarding the 7-nanometer tapeout next year. So C.C., can you give some color regarding the portion of 7 nano versus of 7 nano plus EUV? So customer shift to 7 nano plus EUV the question would be in the second half next year into 2020?

Your question is…

You mentioned more than 100 tapeout numbers, right, for next year, right, by the end of next year. So would the majority of that be 7-nanometer or 7-nanometer plus EUV.

Next year is still 7-nanometer.

Okay.

Because 7 plus, we’re working with a customer and some of the customer moving a little bit faster, some of them – and for those customers already in the 7-nanometer, they are planning on the second wave product in the 7 plus. Okay. So next year, I can say most of them are still in 7. But then activity will start to repeat course in the second half and then 2020 that will be even grow faster.

Okay. But for the whole year tapeout number, right, so can we say that 7-nanometer plus EUV tapeout number increase quarter-by-quarter through end of next year? Can we say that?

What increase quarter-by-quarter? Yes, you can say that. This is still a smaller portion of the total 7-nanometer node.

Okay. So based on the 7-nanometer plus EUV tapeout by customer planning, right, so can you expect the 2020 we will see very big volume 7 nano plus EUV mix production and the revenue contribution? Because you mentioned increase quarter by quarter, right? So we’re just trying to find out if it will become very big revenue contributor and – yes.

If I can forecast well, I mean, that one tapeout, especially for some of the application, it takes about one year to – for ramp-up. So 7+ will be increasing, but the revenue I would expect 2020, 2021 start to see the big number. But not 2019, not the first half of 2020.

Okay. How about second half next year? Do you think that, that will be.

You continue to nail down the number?

I’m sorry.

Okay. 2019, less than NT$1 billion.

Less than NT$1 billion. Thank you so much.

All right. Hopefully next question will be better and it will be coming from UBS, Bill Lu.

Hi, thanks again for taking my question. So it’s a bit more of a long-term question. Hoping to ask you about R&D and maybe this is both for Dr. Wei as well as Lora. If you look at Moore’s Law, certainly not getting easier. If you look at the number of players that can share the R&D burden, I think it’s getting less. And number three, TSMC is clearly ahead of the competitors now in terms of process development. So as you look out the next two, three years, do you have to think about R&D increasing at a faster rate? Thank you.

We do see the – continue going on the smaller geometry takes a lot of effort to develop the technology. But I would like to use TSMC’s [indiscernible] wording to answer your question. So long as some people can develop it, TSMC will be there. That’s our commitment to the customer, all right? And in addition to smaller geometry, actually, TSMC also develop the wafer level’s packaging, advanced packaging to help the customer improve their systems’ performance. And we think we have these two opening heads and so we are in a very good position to compete in that field.

I guess, I’m not doubting TSMC’s abilities to develop it. But I think TSMC has taken on more of the burden now, and you also have to add the cost for advanced packaging R&D as well, right? So I’m just talking about the cost.

Yes. The cost? Actually, I would like to say the value of our technology, all right? That’s what we discuss with our customer. The cost, we continue to working on it, and we hope TSMC has a capability and ability to roll down the cost as we already proven in the previous years.

But I think Bill’s question is whether or not R&D, as a percent of our revenue, will increase in the future because of our taking up a bigger burden.

We might, but I cannot tell you that exact number. So that’s a cost.

Yes. Thank you.

All right. Follow-up question from Citigroup’s Roland Shu.

Just a follow-up question for the profitability but I’m talking about the back end side because since last quarter, you kept talking about that you have this improving profitability on back end. And also in second quarter, in last quarter, you said on the back end, actually, the – was able to partly offset the lower gross margin from this poor product mix. But consider your back end, it’s just a relative small part of your total revenue, so it has to be – with a very good gross margin in order to partially offset the unfavorable product mix. So how does your back end gross margin compare to your corporate average right now? Thank you.

Back end margin is indeed improving, but we don’t compare back end margin with corporate average. Because back end, the nature of back-end is there’s a very high asset turnover and lower margin compared with wafer. So the overall investment return is pretty good. If you look at ROIC, it’s very good, so we don’t compare back end margin with corporate average. So if our back end revenue continue to increase, it may dilute a little bit of corporate margin, but overall investment is pretty good, okay? And we have seen our advanced packaging. The – we continue to invest in capital, and we see more customer adoptions. So we are increasing the size and the business volume of the back end. And of course, we continue improving the productivity. So back-end is – will be accretive to TSMC going forward.

Okay. can we have the rough number of how much the revenue is coming from back end so far?

It’s around 2.5 billion this year.

2.5 billion this is include with wafer bumpy [ph]? Or is this purely for info and the CoWoS?

Including that all the back end that including the wafer bumpy [ph], testing, info, CoWoS, everything.

Okay. That’s roughly a little more than 7% of this year’s revenue.

Okay. Lora, you said on your – if the back end revenue is – exceed a certain portion of the total revenue, probably, the corporate average gross margin will be diluted. So what is the ratio for the facility of the back end?

No, the back end is only 7%. It’s still low compared to our very big wafer size. But back end, I think the back end is probably cyclical because this is very concentrated on several segment. Cyclicality is more of an issue. But in terms of financial return, we have guarding our model. So we’re not worried about them. Of course, we continue to improve the profitability in that.

Okay. Thank you.

Follow-up question from Morgan Stanley’s Charlie Chan.

Thanks for accommodating another follow-up, right? So, I think because, this time, market weakness, so I need to use the microscope on your comments on near-term, right? So C.C., you previously mentioned that 2019 inventory correction in 1Q wouldn’t be as severe as the beginning of this year, right? So – I don’t know why now you have this kind of visibility. You said because of customers’ order behavior or what have you seen for the coming 1Q that can make your inventory correction less severe than the beginning of this year?

You ask where I get that – those information to get the conclusion that next year, the 1Q inventory correction would be less…

Severe than this year.

Less severe. That’s interesting because of – we work with customers, right? And though I just mentioned about those market segments; Communication, Consumer and Computer, and we look at that, we work with the customer and we understand the business, not 100%, but we understand quite well. And so we can do this kind of a forecast, okay?

So, is that fair to link the Industrial segment decline to the 1-inch utilization rate? Can I assume that the 1-inch utilization is not that full – as full as before? Is that a fair assumption?

You can repeat what I said to answer that question, all right? I mean, that’s – you’re asking a very specific that utilization and the customers’ demand. Actually, let me say that we are very optimistic because of – we work with the customer. As I said, we work with the customer. We understand their business. And going forward, we know that we are doing the inventory adjustment. But they also discuss about what they want in the 2019, which I’m not going to give you some forecast today, not yet.

Okay. Thanks. Sorry for those very detailed questions. Thank you.

questions will be coming from CL Securities, Sebastian Hou.

Thank you. A follow-up on the advanced packaging. I have the impression that of this year, more than 50 7-nanometer tape-outs, a huge part of that or a large portion of the customers will use our advanced packaging solution. So, moving to next year, so our tape-out number will be 100 or 100 more on 7. So, it’s still – that kind of the percentage was still the same, which means that the advanced packaging customers on 7-nanometer will also double.

Let me answer the question that advanced packaging, that included CoWos and InFo. And the CoWos is for very high-speed performance, such as like wafer chip such as some of the networking processor. So, those are huge in CoWoS. And for the InFo, that a lot of them are huge InFo, the mobile phone business. So that I can answer you, but I cannot give you, say, which one.

No, no. I’m not asking which one, I’m just asking still the next year.

Yes.

100 tape-out, a large portion of this using our…

Okay, okay. Well, sorry that I misunderstood your question. So the next year, the InFo for the mobile phone application was – some of them will move into the high-performance computing also because that offer a little better cost structure. And the CoWoS continue to be the high-end, so high performance computing product. And we also introduced SOIC, as I just mentioned, that even much better system performance. So, we continue to progress our technology, and that – did that answer your question?

Sort of. Well, anyway, my question is very simple, actually. I just want to – I simply just want to know that the – your earlier comments on the large portion of the 7-nanometer customer tape-out will use our advanced packaging. And now our tape-out number is like, based on your comments, it seems like double from this year to next year. So, this large portion still apply on the double – doubling the 7-nanometer tape-out next year. Is that right?

Oh, I see. Develop one new back-end process – packaging process, it actually will last for many years. So next year, so 7-nanometer or 7 plus application for those products are still using the InFo and also using the CoWoS, yes. And whether you stop or not, I am not ready to answer that question yet.

Okay, thank you. That’s clear. Second follow-up is that I remember last quarter when, C.C., you talked about the 28-nanometer outlook or you mentioned 2019 will come down and expect the recovery – nice recovery in 2020, because of the 22-nanometer’s adoption. So today, you just mentioned that you expect the overcapacity will be unknown for several years. So, what I interpret is that it sounds to me, over the past three months; you’ve become more cautious, conservative on 28 compared to three months ago. Am I interpreting that right?

You may be right, because of recently, a lot of capacity has imbued on 28-nanometer as compared with three months, six months ago, right? So that mixed overcapacity a little bit more severe than previously predicted. However, I would like to stress again – I mean that the TSMC develop shrink of the geometry for customer to gain the benefit of performance and better density. We also develop specialties. So that’s why I say that we have confidence a couple of years later that our 28-nanometer will enter into a new era with a high inflation rate again.

Do you view those excessive 28-nanometer capacity, or the more they expanded newly add 28-nanometer capacity is a real threat to you or they’re non-event? I mean, their effective capacity or their…

We always are competing in the market, whether it be overcapacity. But of course, let me answer the question directly. Overcapacity is not good for any player in this field, definitely. Okay?

Okay. Thank you.

All right. I think given the consideration of the time, we will just have Randy Abrams [Credit Suisse] to have the last question.

Yes. Just one quick follow-up to that last line of discussion, because just in the last few months, on the 28, have you changed your view on the 16 migration? Because one factor – some foundries, if they stop at 28, can address the 16. So are you taking a more aggressive approach? So is part of your view on 28 view getting more positive on 16, and you’re trying to encourage more customers to migrate to that node where there’s fewer players?

So your question is, are we going to repeat this kind of a 28 migration on 16?

In the last few months, are you also seeing one more customer’s demand to actually migrate to 16? And is it also more of your strategy with some competitors not moving on, you actually have less – a bit less competition on 16 and below?

Yes. We have a less competition in 16 and below, yes. But then so long as you have one competitor, that’s good enough, right? I mean that you have to work really hard to compete.

All right. I guess, on the customer side, are you starting to see more – as part of your 28 coming down, you’re actually seeing more customers with an urgency or desire to actually do that shrink? So, you’re seeing any change in that cadence of customers moving from 28 to 16?

You’re more specifically on…

You’re now – you do feel like there’s more capacity on 28.

Yes.

But flip side, are you seeing some of the demand you previously expected on 28 now shifting to 16 and 12?

Okay. A lot of my competitor can do 28-nanometer. But not a lot of my competitor can do 16- or 14-nanometer, at least for today. And so far, we did not see the same phenomena as a 28- nanometer. Did that answer your question?

Yes. Just more about demand, do you see more customers now trying to make that shift to 16 from the customer side?

Okay. We will continue doing this way, actually, that the customer migrated faster than we expected in 2016, right? And you expect that in the 16 or 14 will migrate faster than we expected into 10 or 7?

No. The question is now 28; you’re more worried about oversupply. Is part of that from you’re seeing more customers migrate to 16.

Yes. Exactly, yes.

Okay. Thank you.

And that they migrate into 10 and 7 also. So, they’re faster than we expected, yes.

Okay. This will conclude our conference today. Please be advised that the replay of the conference will be accessible within four hours from now. Transcripts will be available 24 hours from now, both of which will be available through our website at www.tsmc.com. Thank you for joining us today. We hope you will join us again next quarter. Goodbye, and have a good day.