United Microelectronics - Earnings Call - Q2 2020
July 29, 2020
Transcript
Jason Wang (Director and President)
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.
Michael Lin (Head of Investor Relations)
Thank you and welcome to the UMC Conference Call for the Second Quarter of 2020. I'm joined by Mr. Jason Wang, the President of UMC, and Mr. Chitung Liu, the CFO of UMC. In a moment, we will hear our CFO present the Second Quarter financial results, 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 these risks, please refer to UMC's filing with the SEC in the US and the ROC Securities Authority. Now, I would like to introduce UMC's CFO, Mr. Chitung Liu, to discuss UMC's Second Quarter 2020 financial results.
Chitung Liu (SVP and CFO)
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 three, the Second Quarter of 2Q20 consolidated revenue was TWD 44.39 billion, with gross margin at 23.1%. The net income attributable to the stockholder of the parent was TWD 6.68 billion, and earnings per ordinary shares were TWD 0.55. Utilization rate in the second quarter improved to 98% from 93% in the previous quarter. On the next page, page four, on the 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 TWD 10.25 billion, 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 TWD 5.8 billion, 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 TWD 6.68 billion, 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 TWD 86.6 billion, partially due to the combination of USJC, which contributed around 10% of the revenue top line. And gross margin was 21.2% or TWD 18.38 billion. And net income attributable to the stockholder of the parent was TWD 8.88 million 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 six, our cash has reached almost TWD 100 billion. And for the total equity in the first half of 2020 was TWD 209 billion. On page seven, ASP increased by a low single-digit percentage, mainly due to the surge in our 28-nanometer revenue shipment.
On page eight, the revenue breakdown, Asia stayed around 55%, and Japan also remained around 9%. For page nine, IDM and Fabless remain unchanged at 12% and 88% respectively. On page ten, communication declined 3 percentage points to 51% and made up by computer and others segment. And on page 11, as I mentioned, ASP increased by low single-digit percentage points, mainly due to the surge in our 28nm shipment, which now reached 13% of the total revenue in the second quarter compared to 9% in the previous quarter.
Capacity still remained a minor increase quarter over quarter, and CapEx remained at $1 billion for the whole 2020. The above is a summary of UMC's results for the 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 Wang.
Jason Wang (Director and President)
Thank you, Chitung. Good evening, everyone. Here I would like to update the second quarter operating result 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 the 2019 cash dividend distribution to approximately TWD 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 tape outs during the first half of 2020 compared to the year ago, and expect additional 28nm and 22nm product tape outs in the third quarter. We are also moving new 28nm products into volume production for wireless applications such as the 4G and the 5G smartphones, which will enhance our business traction and diversify UMC's customer exposure across different 28nm 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 investor 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 dollars is expected to remain flat. However, the accounting result will reflect the adverse effect in the NT dollar appreciation. Gross profit margin will be approximately 20%. Capacity utilization rate will be in the mid-90% range. Our 2020 CapEx budget will be $1 billion. That concludes my comments. Thank you all for your attention. Now we are ready for questions.
Operator (participant)
Thank you, President Wang. 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. The first question is coming from Randy Abrams, Credit Suisse. Go ahead, please.
Randy Abrams (Head of Asia Technology Research and Semiconductors Securities Research)
Okay. Yes. Good afternoon, Jason and Chi-Tung. Yeah, good result. I wanted to ask the first question where, Jason, when you were going through the prepared remarks, you discussed the business remaining pretty strong, and it does sound like 28's 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.
Michael Lin (Head of Investor Relations)
Sure.
Jason Wang (Director and President)
Let me capture the feel of your questions. One is you mentioned based on the remark, we foresee the demand remains strong. And however, we guided the shipment, and the ASP is flat. Is that correct?
Randy Abrams (Head of Asia Technology Research and Semiconductors Securities Research)
Yeah, that's correct. Also with 28, presumably ramping to have flat. And yeah, so kind of factors for it's 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.
Jason Wang (Director and President)
Okay. Let me see how to address that. First, in Q3, we do foresee change in the 28nm product mix, okay, which will have a mild lift of the ASP. So the 28nm demand increase 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 ship in capacity utilization rate across the different nodes. So therefore, the possible impact on the 28 is not as significant in Q3 at this time. Does that answer your question?
Randy Abrams (Head of Asia Technology Research and Semiconductors Securities Research)
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.
Jason Wang (Director and President)
Okay. So for the Q3, if I look at by the applications, we see stronger rebound is coming from the consumer segment, and followed by the computers and the communications. Okay. But all segments are increased. Okay. We see an increase in all segments. And mainly the reason is we're seeing, we're getting market share result from the higher penetration in the smartphone, okay, and as well as from the new customers, also from the existing customers, they're getting market share from the communication area.
The computer segment is really a result of working from home and home schooling. That's, first, 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 ASP, flatness is really a mix of I described earlier. Even the 28 help giving the product mix, we actually didn't see as significant.
Randy Abrams (Head of Asia Technology Research and Semiconductors Securities Research)
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?
Jason Wang (Director and President)
Besides those three others, there are other segments that we continuously witness, and so yes, they compensate on the growth from those three areas. Yes.
Randy Abrams (Head of Asia Technology Research and Semiconductors Securities Research)
Okay. One note I noticed has come off the last couple of quarters. 80nm, probably maybe one of the others that's a bit underutilized, but came down from 18%-13% over the last two quarters. Is there applications moving off that you could backfill, or could you upgrade that capacity to serve some of the 40 or 28 demand?
Jason Wang (Director and President)
We can be moving 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 nodes actually continue to operate at 100% loading. And the contribution of lower is really just we shuffling around the different node support. Yeah.
Randy Abrams (Head of Asia Technology Research and Semiconductors Securities Research)
Okay. And if I could ask just one final question on the CapEx, the last couple of 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 Chi-Tung, but how do you see the capacity? I know you had some 28-nm capacity set to ramp up. So do you still see reaching that or could come in a bit late? 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?
Jason Wang (Director and President)
The answer is yes, and the capacity expansion at our 12X, which is Xiamen fab, is actually on track and is expected to reach 25K per month in mid-2021. So that's part of our CapEx already. Given the growing 22 and 28nm customer demand, we actually examined the option to utilize available floor space at our Tainan facility, which is 12A, to fulfill additional business opportunity in advanced technology, which will still subject to our ROI justification we've mentioned many quarters.
Okay. We will continue to evaluate our CapEx based on what we described as stringent ROI-driven strategy to enhance our return to shareholder and employees. So that will not change. That's also in our remarks that we will continue that without any change of that. But the next phase we're looking at is more in our Tainan facility.
Randy Abrams (Head of Asia Technology Research and Semiconductors Securities Research)
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?
Jason Wang (Director and President)
Yeah. I mean, we are examining the 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.
Chitung Liu (SVP and CFO)
It's not really the absolute dollar amount that determines CapEx number. It's really the return requirement and also the customer demand. Multiple factors will lead to our CapEx decisions.
Jason Wang (Director and President)
Randy also mentioned 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 demands will continue driving that. So that's why we seriously examine the option of future capacity expansion. Meanwhile, we also focus on productivity improvements. Okay. And that will actually help as well in addition to that. And besides the growth of our top line, we foresee more room for improvement in our structural profitability, which will turn to enhance our earnings. So we continue managing the balance of those. Yes.
Randy Abrams (Head of Asia Technology Research and Semiconductors Securities Research)
Okay. No, that makes sense. I guess a good problem to have to have the demand to go invest for. Okay. Thank you.
Jason Wang (Director and President)
We have to just suspend that. Thank you.
Operator (participant)
Next we'll have Gokul Hariharan from J.P. Morgan for questions. Go ahead, please.
Gokul Hariharan (Managing Director)
Hey, 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 TWD 500 million. 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?
Jason Wang (Director and President)
I mean, yeah, first of all, thank you, Andy. Secondly, in terms of the better gross margin in Q2, we saw an increase in gross margin primarily due to the product mix improvement, which lifted 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, that led to the gross margin growth in Q2. Yeah.
Gokul Hariharan (Managing Director)
Okay, so just a quick question. Could we talk a little bit about 28-nanometer and the main fab in Japan? Are they now fairly well? 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?
Chitung Liu (SVP and CFO)
So after a few quarters of synergy improvement, our profit and profitability has improved every quarter since becoming part of UMC. We have implemented integration efforts in fab operations, incorporated fast know-how sharing and streamlined procurement, etc. So all of this effort has improved the cost structure of 12M, the USJC in Japan. So UMC's integration efforts are resulting in positive synergy in line with our expectations. So this acquisition has financially contributed to our pipeline as well as our bottom line. So we think going forward, the profitability of 12M or USJC will be largely dependent on its own demand supply dynamics.
Gokul Hariharan (Managing Director)
Okay. Any thoughts on 28nm given the capacity is now filling up with a strong traction from some of the new tape-outs? How much of a drag is 28nm still, or are we kind of, do we have line of sight in terms of 28 gross margins improving closer to the corporate average levels?
Jason Wang (Director and President)
I mean, we actually don't look at the by-node basis on the margin drag. Our expectation on the 28nm 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 28nm utilization will grow, and so we actually feel pretty confident about our 28nm contribution to the company overall. With the product mix improvement, and we believe that will help us with the ASP lift and in turn generating much better profitability for the company as a whole.
Gokul Hariharan (Managing Director)
Okay. Thank you. One last question from me. Chi-Tung, 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 the next couple of years? I think we were expecting a bigger drop-off in 2022. If you want to get into a little bit more of a capacity expansion mode, should we think about a slightly different schedule for the depreciation kind of coming down?
Chitung Liu (SVP and CFO)
I think pretty much like 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 trends still remain unchanged.
Gokul Hariharan (Managing Director)
Okay. Got it. Thank you very much.
Operator (participant)
And the next question is coming from Szeho Ng of China Renaissance. Go ahead, please.
Szeho Ng (Managing Director)
Oh, hi. Good afternoon, gentlemen. My question is regarding 28 nano. It seems like you are still sticking to having 25K capacity ready middle of next year at the Xiamen Fab. So I wonder what would be the next expansion? Would that happen in Taiwan or would continue to be in Xiamen?
Jason Wang (Director and President)
We actually mentioned this earlier. After the 25K in Xiamen, the next phase of growth or capacity expansion will happen in our Tainan, Taiwan facility. That's what we're referring to, a 12A facility, and given the available floor space, that will be the best ideal location for us to do the next expansion.
Szeho Ng (Managing Director)
Okay. And what would be the size of the expansion in Taiwan?
Jason Wang (Director and President)
We're still at the stage of examining that right now. So it could, based on different ranges, 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. We think by end of this year, we'll have a better clarity on that.
Szeho Ng (Managing Director)
Okay. Thank you, sir. And my second question, is it possible to give an update on the operation status for the Japan Fab?
Chitung Liu (SVP and CFO)
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 28nm and also enlarging economy of scales, 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.
Szeho Ng (Managing Director)
Okay. All right. Thank you very much. Congratulations on great results.
Jason Wang (Director and President)
Oh, thank you.
Operator (participant)
The next one is coming from Roland Shu of Citigroup. Go ahead, please.
Hi. Good afternoon. First of all, your 20nm utilization. CEO said in second quarter, actually, your overall utilization was about 98%. And you still expect 20nm utilization will increase in 3Q. So I just want to ask what kind of the magnitude of this utilization will increase for 20nm? And after the utilization increase, what the percentage point of the revenue contribution for 20nm will be in second half? This is my first question. Thanks.
Jason Wang (Director and President)
The overall company's utilization rate will be at 95%.
Chitung Liu (SVP and CFO)
Mid-90s.
Jason Wang (Director and President)
Okay. Mid-90s as we guide it. On a blended basis, the 8-inch, we're running at 84%. And 12-inch, we're running at 90%. Okay. That will give us approximately the mid-90s utilization guidance for the quarter overall as a company. We continue seeing there's room for the 28nm to increase. We think that 28nm's utilization rate will continue to increase on a quarter-to-quarter basis at this time.
Yeah. Understood. But second quarter, your overall corporate average utilization was 98%. So what's the 20nm utilization in second quarter?
Chitung Liu (SVP and CFO)
So, again, our overall capacity in third quarter will increase by approximately 1%. Additional 1%. And also in the second quarter, as Jason mentioned, 8-inch is full, around 100%. And 12-inch is 90-ish%. And so 28 is, I think, a little bit less than the 12-inch average.
Okay. So you probably in 3Q, we are going to see this may be a single-digit percentage point utilization increase for 20-nanometer or more than that?
Yeah. We don't give the numbers on single-node utilization, but we can give you a relative idea about how it compares to our corporate average.
Okay. So how about in second half, the revenue contribution from 28nm in second quarter? It was 13%. And how about in second half?
It should gradually trend up quarter over quarter.
Okay.
Jason Wang (Director and President)
Yes, we see a slight increase on the 28nm in the next quarter.
Slight increase in 3Q, right?
Right. Yes.
Okay. Thank you.
Well, I mean.
Sorry.
Yeah. I mean, we have been talking about our 28nm. This is for multiple quarters. I think most of you know about that, right, and now in Q2, in our view, this is truly starting a meaningful 28nm growth quarter over quarter. This is very much in line to our expectation, and it reflects 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 will start seeing that and meaningful growth coming in now. Yeah.
Yeah. Okay. Thank you. My second question is for the 14nm. I just looked at your annual report. You have continued investing in 14nm FinFET technology. And your 14nm FinFET is mass production from second half this year. But for you, you only have a very limited 14nm capacity. So question is, are you considering to further expand your 14nm capacity anytime soon? And if you want to do that, how much capacity will it be by this case? So this is my second question. Thank you.
Sure. I mean, we also have 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 from a technology development standpoint, we are relevant to the focus area. And beyond that point, as far as the CapEx decision, and then we'll go ahead to examine based on our ROI basis. So I'm never going to rule out the chance of putting the new capacity on the 14, but at this point, it's not on our plan yet.
Yeah. So by what kind of criteria or what kind of consideration you are going to expand or raise the capacity for 14nm? 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, I think that how are you going to monetize the investment on this FinFET technology development?
That's really a good question. And if you look at the investment perspective, between the R&D investment and the capacity investment, the R&D is actually relatively small. It's a much smaller investment. And so 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 that makes sense for us to invest into capacity. Meanwhile, we do have our 2 to 3K capacity in place. And so we're not going to completely waste in terms of our R&D investment. So we think this is more prudent for all stakeholders. So we're going to continue to follow that strategy. Yeah.
Understood. You said the 2 to 3K capacity for 14nm, right? It's not additional 2 to 3K?
No.
Total 2-3K, right?
This is what we have right now.
Okay. Understood. Okay. Thank you.
Sure. Thank you.
Operator (participant)
The next one is coming from Aaron Jeng of Nomura Securities. Go ahead, please.
Aaron Jeng (Head of Equity Research)
Thank you for taking my question. I got a question about competition landscape at 28nm and also the other mature 12-inch node. I think particularly at 28nm, I think this question has been asked a few times when Jason said it's an oversupply, severe oversupply for 28nm for the fab industry, but you are able to manage your 28nm to do better and better every quarter. So I want to know your view on the competition landscape at 28nm and also the other mature 12-inch nodes. Thank you.
Jason Wang (Director and President)
Sure. So let me start off with the 28nms. 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 22nm solution have finally provided competitive advantage for our customers. Like I said earlier, the progress of our 28nm product pipeline remains very strong. The surge of the 28 and the 22 tape-outs also shows that.
And we'll continue to increase our exposure to a more diversified 28 customer base and product portfolio. So we are expecting our 28nm revenue contribution in Q3 will continue to increase. And given 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 28nm business momentum will benefit by those. Okay. If you look at the other 12-inch mature nodes, for the 40nms, we foresee a positive demand in the second half as well.
And due to the increase of the customers' 40nm adoption in the logic device, driven by the wireless application. So there are other applications coming into the 40nm as well. And looking beyond the 2020, we are considering to migrate portion of the 40nm capacity to support our unfulfilled 28nm demand to enhance our ASP and margin profitability. So in the longer term, I think there will be a demand and supply balance on the 40nms. So we are considering to migrate down our 40s to 28. Okay.
Then if we're coming down to 55 and the 65, our 55 and the 65 business 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. And of course, we talked about 80 and 90 earlier. Right now, we're operating at 100% loading for Q2.
For the second half, we do see some demand within the 80 and 90 applications are stronger than the others, 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 flavor of our view on those nodes that we're serving today. Yeah.
Aaron Jeng (Head of Equity Research)
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 lawsuit. And I think maybe 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-to-three years' timeframe. So just want to know how should we think about the timeframe? And I don't know any update on this topic. Thank you.
Jason Wang (Director and President)
I mean, right now, the lawsuit is in the legal proceedings, and so it's really not in our control in terms of the timeline of the process, but we do follow that wherever that court requires us. Okay. We remain. We stay our belief in ourselves, and so we don't believe there's any wrongdoing in terms of UMC, and so we stay believing in that, and we just have to trust that the court system will eventually give us a fair result. Okay. Since it's in the legal proceeding, and it's truly not in our position to comment that at this time. Yeah.
Aaron Jeng (Head of Equity Research)
Thank you. I will go back to the Q. Thank you very much.
Jason Wang (Director and President)
Sure. Thank you. Yeah.
Operator (participant)
The next to ask a question is from Sebastian Hou, CLSA. Go ahead, please.
Sebastian Hou (Investment Analyst)
Hi. Good afternoon. Thank you for taking my questions. My questions will probably just focus on the 8-inch side. 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.
Jason Wang (Director and President)
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 expand our 8-inch capacity. But given the ASP situation, any organic growth in the 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 fab to support our customers in the advanced 8-inch area, particularly. So we're going to continue doing that.
And sometimes inorganically, it has to come by those opportunities that we have to go out search for. And we'll continue that as well. Meanwhile, in terms of the tightness of the 8-inch situation, it does affect some of the prioritization, as you mentioned, about allocation. Our focus in the 8-inch is also on the area of product mix improvement. Continue migrating some of our legacy to the advanced and continue migrating some of the better product mix to help us enhance our ASP as well as profitability of the 8-inch.
And that is on an ongoing basis. Given that we foresee a strong demand continuing to lead to the supply tightness, okay, not only by the way, not only to the 8-inch, but also on some of the specific 12-inch nodes I talked about earlier, we will actually think the market pricing situation will probably become more in favor of the foundry from now on. Yeah.
Okay. Thank you.
That will probably help as well. Yeah. Yeah.
Sebastian Hou (Investment Analyst)
Got it. Thank you. Just to follow up on, given that we have a privilege or more flexibility about doing things that is more earnings equitable to us, so how do you see about the overall pricing outlook for the 8-inch going forward? Thank you.
Jason Wang (Director and President)
I'm sorry. I didn't catch the question again. Can you repeat that?
Sebastian Hou (Investment Analyst)
Oh, the question is that given that you can be more selective and prioritize the product application that is more favorable to our profitability, then how do you see that reflected on the 8-inch foundry price?
Jason Wang (Director and President)
Oh, 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 aligned with our customer. For the year 2021, we already have ongoing discussion on this alignment. Okay, and so the pricing will be a result of those alignments. And I would not give you a specific at this time, but 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 foundry right now. Yeah.
Sebastian Hou (Investment Analyst)
Got it. Got it. Just a last follow-up on this. I remember the last time the 8-inch foundry price as we were able, and including our peers, able to raise the price. That was back in, I think, 2018. And also coincidentally, the cost increased from the raw material. 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? I mean, it looks like the raw material price maybe 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 that kind of the cost justification, but when you negotiate this with customers, the customers still pretty accepted about this pricing negotiation? Thank you.
Jason Wang (Director and President)
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 passed on to the customer. This time is different. This time is mainly because of the demand and supply alignment situation. We do see a very strong demand in the 8-inch advanced nodes area. So given the tightness of the situation, we have to prioritize our resources and along with our partnership relationship. So we are managing the balance of that. But again, I think customers appreciate that and understand it. So those discussions are ongoing at this time. Yeah.
Okay. Thank you.
Sure.
Operator (participant)
The next question is coming from Bruce Lu of Goldman Sachs. Go ahead, please.
Bruce Lu (VP and Equity Analyst)
Hi. Thank you for taking my question. A very, very good result. I have a question again on the 28nm profitability. I'm actually very surprised to see that the management did not take each node profitability. Because management also mentioned that your new investment is based on a better return, which means that when you try to increase your 28nm capacity, you believe that incremental capacity can give you a better return. So my question is that when do we expect that 28nms should be the corporate average profitability and margin? And is that the reason why we want to increase the 28nm capacity?
Michael Lin (Head of Investor Relations)
So for increasing incremental 28-nanometer capacity, sometimes it helps the overall bigger picture. So if we don't have adequate capacity or economies of scale, it's difficult to reach our long-term goal in terms of profitability. So 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 28nms, it's going to fulfill our requirement for a longer-term picture.
Bruce Lu (VP and Equity Analyst)
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.
Michael Lin (Head of Investor Relations)
Certainly, we follow your view as well. But sometimes it just, in reality, doesn't come in the preferred sequence. So for example, our 8-inch today, as our president just mentioned, the pricing environment is really in 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.
Bruce Lu (VP and Equity Analyst)
I understand. Just a little bit follow-up for the 28. So moving into the second half, our 28nm utilization is slightly below the 12-inch average, which means that incrementally utilization might not be a big moving factor for your 28nm profitability. So can we expect that? How can we see a better profitability for 28 in the second half? Maybe we use the tool for the 28 alone, or any other ways we can see that, or how should we see the profitability improvement in the second half for 28?
Michael Lin (Head of Investor Relations)
I think as a finance person, maybe Jason can jump in later on. As a finance person, the depreciation curve needs to come down, so that's exactly the situation for our Xiamen Fab, and it may take another couple of years to see the curve to peak, to decline, to help our overall 28 profitability.
Our 12A in Taiwan 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 our 12A 28 expansion we did back a few years ago, so depreciation will come down, and hopefully, our product mix amortization I mean, product mix enhancement will also help our overall blended ASP for 28nm.
Bruce Lu (VP and Equity Analyst)
Okay. I'll get one last question for the 8-inch. Management mentioned that the pricing environment is better, but the third-quarter guidance for the ASP still remains flat. So when can we expect some improvement in terms of 8-inch blended ASP?
Jason Wang (Director and President)
I mentioned many of the discussion about that is for the year 2021. So that alignment is ongoing. And all our 2020 demands, the support has been aligned previously. And we're considering the long-term partnership that we have, and that will be only selected area with the upside with the better pricing. But in general, we did not move the pricing in 2020. But for 2021, given the demand and supply situation change, and it's more of the discussion today is for 2021. Meanwhile, for the 2020, all the pricing adjustment is given on the upside support area.
Bruce Lu (VP and Equity Analyst)
I see. I understand. So we can expect much better ASP trend in 2021, at least for 8-inch.
Jason Wang (Director and President)
By then, we actually will give you a much better score.
Bruce Lu (VP and Equity Analyst)
I understand that. I just can't wait.
Jason Wang (Director and President)
I definitely share the same thought, but later, when the time comes, we will give you a really clear guidance on that.
Bruce Lu (VP and Equity Analyst)
I understand that. Thank you very much.
Jason Wang (Director and President)
Sure.
Operator (participant)
The next question is coming from Charlie Chen of Morgan Stanley. Go ahead, please.
Charlie Chen (VP in Investment Banking)
Thanks. Hi, gentlemen. Good afternoon. And congratulations for very good results. 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. You said, "Oh, due to the ramp of the 28nm mix." And I'm not really sure because supposedly the higher utilization should mean a better margin. Why the margin would decline in third quarter? Thank you.
Jason Wang (Director and President)
Okay. For the Q3, the next quarter gross margin guidance, we are expecting the margin will be challenged by the foreign exchange market because the stronger NT dollar will dilute our profitability. That's one of the reasons. In addition, we are entering into the summer season. So every year, annually, that will lead to higher utility costs during the time. So we are factoring those into the calculation as well. Yeah.
Charlie Chen (VP in Investment Banking)
Okay. Thanks. And next is about your top line. I mean, 28nm goes up, and you mentioned that across segments, demand remains to be very strong. If that's the case, why the revenue is only flat for one quarter?
Jason Wang (Director and President)
Again, given the product mix that we are projecting today, and we do think there will be some help, but there's going to be some other nodes that compensate with the upside of the 28. That will give us the flatish 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 mid-90s, which is mid-90s utilization rate guidance, we consider that's fairly high already. We feel this is probably a reasonable guidance at this time. Yeah.
Charlie Chen (VP in Investment Banking)
Thanks. Oh, 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, you said maybe there is still an overhang, and your business fundamental is quite strong. Why not management or company consider to do a settlement with the US or Micron earlier, even if there will be some potential compensation? Thank you.
Jason Wang (Director and President)
Again, since this is in the legal proceeding, it's not appropriate for us to comment on our legal thinking as well as the strategies. So we'll report accordingly and by the regulator towards policy, and on a timely basis. But we would prefer not to comment during the call right now.
Charlie Chen (VP in Investment Banking)
I see. So from the finance perspective, I'm not sure if this will need to book some contingent loss. I remember when I was in college, there was some contingency expense. So I'm not sure if maybe this question is to key on whether we need to book some contingency expense on that litigation issue.
Michael Lin (Head of Investor Relations)
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. And 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.
Charlie Chen (VP in Investment Banking)
Got it. Thanks. And my last question.
Jason Wang (Director and President)
I would also like to add, UMC, we have appointed a finance legal counsel, and we'll rigorously respond to both litigation in US and Taiwan. And the second time, we will make every effort to enhance our profitability and preserve the best interest for our shareholders in case to mitigate that potential risk. But as far as the assessment for the risk, we truly would 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. Yeah.
Charlie Chen (VP in Investment Banking)
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 kind of pandemic or healthcare crisis with consumer demand versus your decent or good second-half outlook? Thank you.
Jason Wang (Director and President)
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 as 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 opening of the economy. So we do see people view this a little bit different. There could be a new norm, okay? 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, okay, as we expect more opportunity was driven by the 5G handset and the PC. Notebook demand will pick up associated with the work-from-home and the homeschooling trend.
Despite the smartphone shipment actually declined this year, overall smartphone but we expect to capture higher smartphone market share driven by the 5G in China. This year, we see about 200 million units from 20 million units in 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 customer is also expecting to gain 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 a higher confidence in the second-half outlook. Yeah.
Charlie Chen (VP in Investment Banking)
Yeah. That's very, very helpful. That will be all my questions. Really, really appreciate your time and the insight. Thank you.
Jason Wang (Director and President)
You're welcome.
Operator (participant)
The next question is coming from Julie Tsai of UBS. Go ahead, please.
Julie Tsai (Head of International Sales)
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.
Jason Wang (Director and President)
You're talking about in the Q2. The increase in 28-nanometer demand in Q2 is attributed to communication and consumer in the connectivity, AV segment, and in the 5G phone, and as well as the work-from-home applications. That's where the mix of the 28nms in Q2.
Julie Tsai (Head of International Sales)
I see, and then also, you did mention that Q3 gross margin could be adversely impacted because of the NT dollar appreciation, but we're already seeing that happen in Q2, but are you also foreseeing that again to be adversely impacted in Q3 though?
Michael Lin (Head of Investor Relations)
Yeah. In the magnitude of NT dollar appreciation, it's 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.
Julie Tsai (Head of International Sales)
Okay. Got it. All right. Thank you.
Jason Wang (Director and President)
Sure.
Operator (participant)
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.
Randy Abrams (Head of Asia Technology Research and Semiconductors Securities Research)
Okay. Yeah. Thank you for squeezing me in at the end. Maybe just a 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.
Jason Wang (Director and President)
I mean, it's very similar to the Q2. We see the Q3 was driven by, I mentioned many times earlier, the smartphone and the continued demand in the computer segment. And so the 28 will mainly be driven by those two segments. And not much has changed from the Q2. It's very similar. Yeah.
Randy Abrams (Head of Asia Technology Research and Semiconductors Securities Research)
Okay. The second question I wanted to ask is maybe the direction. You talked about actually fairly good strengths. 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 get toward year-end, and I'm curious [about] 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.
Jason Wang (Director and President)
Well, I mean, instead of talking about Q4, let's look at the past couple of 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 recovering. But given the past history of this year being down and 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.
Randy Abrams (Head of Asia Technology Research and Semiconductors Securities Research)
Okay. Great. No, appreciate that. Thank you.
Jason Wang (Director and President)
All right.
Operator (participant)
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.
Michael Lin (Head of Investor Relations)
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 [email protected]. Have a good day.
Operator (participant)
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.