Semiconductor Manufacturing International Corp

HKEX:981

Earnings Call Transcript 2018-Q2

[Operator]

Welcome to Semiconductor Manufacturing International Corporation's Second Quarter 2018 Webcast Conference Call. Today's conference call is hosted by Dr. Zhao Haijun, Co-Chief Executive Officer; Dr. Liang Mong Song, Co-Chief Executive Officer; Dr. Gao Yonggang, Chief Financial Officer; and Mr. Tim Kuo, Director of Investor Relations.

Today's webcast conference call will be simultaneously streamed through the Internet at SMIC's website. [Operator Instructions] The earnings press release is available for download at www.smics.com. Webcast playback will also be available approximately 1 hour after the event.

Without further do, I would like to introduce to you Mr. Tim Kuo, Director of Investor Relations, for the cautionary statement.

[Tim Kuo, executive]

Good morning, and good evening. Welcome to SMIC's Second Quarter 2018 Earnings Webcast Conference Call. Today, our CFO, Dr. Gao, will highlight our financial performance and give guidance for the next quarter. And then our Co-CEOs, Dr. Zhao and Dr. Liang, will provide some business commentary. This will be followed by our Q&A session. As usual, our call will be approximately 60 minutes in length. The earnings press release and financial presentation are available for you to download at www.smics.com under Investor Relations in the IR Calendar section.

Let me also remind you that the presentation we'll be making today includes forward-looking statements. These statements and other comments are not guarantees of future performance, but represent the company's estimates and are subject to risk and uncertainty. Our actual results may differ significantly from those projected or suggested in any forward-looking statements. For a more complete discussion of the risks and uncertainties that could impact our future operating results and financial condition, please see our filings and submissions with the U.S. Securities and Exchange Commission and The Hong Kong Stock Exchange Limited, including our annual report on Form 20-F filed with the United States Securities and Exchange Commission on April 27, 2018.

During the call, we will make reference to financial measures that do not conform to generally accepted accounting principles. These measures may be calculated differently than similar non-GAAP data presented by other companies. Please refer to the tables in our press release for a reconciliation of GAAP to the non-GAAP numbers we will be discussing. Please note that all currency figures are in U.S. dollars, unless otherwise stated.

I will now hand the call to our CFO, Dr. Gao, for financial highlights.

[Yonggang Gao, executive]

Thank you, Tim. Greetings to all our listeners. First, I will highlight our second quarter and the first half 2018 results and then give third quarter 2018 guidance.

In second quarter 2018, our revenue was $891 million, including the recognition of technology licensing revenue of $53 million, an increase of 7.2% quarter-over-quarter. Excluding the technology licensing revenue, revenue was $838 million, an increase of 15.8% quarter-over-quarter, mainly due to an increase in wafer shipments in the second quarter. Gross margin was 24.5%. If excluding the technology license revenue, gross margin improved 4.1 percentage points quarter-over-quarter to 19.7%, mainly due to the increased utilization and product mix change in the second quarter. Non-GAAP operating expenses were $270 million. Profits for the period attributable to SMIC was $52 million, while noncontrolling interest was $20 million of credits to SMIC's attributable profit.

Moving to the balance sheet. At the end of second quarter, cash on hand, including financial assets, were $2.7 billion. Gross-debt-to-acquisition was 45%, and net-debt-to-acquisition was 10%.

In terms of cash flow, we generated $111 million of cash from operating activities in the second quarter. If we look at our first half 2018 unaudited results, our revenue was $1.7 billion, gross profit was $438 million, and EBITDA was $637 million, all achieved at record highs.

Now looking ahead into the third quarter of 2018. Our revenue is guided to be down 4% to 6% quarter-over-quarter, mainly due to technology licensing revenue recognized in the second quarter. If excluding the technology license revenue, our revenue is guided to be flat to up 2% quarter-over-quarter in the third quarter. Gross margin is expected to range from 19% to 21%. Non-GAAP operating expenses are expected to range from $232 million to $238 million. Noncontrolling interest of our majority-owned subsidiaries are expected to range from positive $19 million to positive $21 million, which are losses to be borne by noncontrolling interests.

We reiterate our planned 2018 CapEx for foundry operations of approximately $2.3 billion, of which approximately $1.3 billion are expected to be spent for the expansion of capacity and approximately $0.4 billion for R&D equipment. The planned 2018 CapEx for nonfoundry operations are approximately $137 million, mainly for the construction of employees' living quarters. Our planned 2018 D&A is approximately $1.1 billion. If excluding the technology license revenue, our 2018 gross margin is expected to be in the high teens.

I will now hand the call over to our Co-CEO, Haijun, for general remarks.

[Haijun Zhao, executive]

Thank you, Yonggang. Thank you all for joining us on today's call. SMIC is in a period of transition and preparation. We are making encouraging progress in advancing our technology, building up our technology platforms and forging partnerships. At the same time, we are on track to grow high single digit annual revenue as demand and utilizations recovered in second quarter and as we continue to enhance our technology platforms and push forward on R&D.

In the second quarter, our total revenue grew 7.2% quarter-over-quarter and 18.6% year-over-year. We met our Q2 gross margin guidance on the high end as utilization increased. When including the USD 52.8 million from the technology licensing, our revenue increased 15.8% Q-over-Q and 11.5% year-over-year. Revenue growth was mainly from the sequential increase of 28-nanometer, 55-nanometer and 0.18-micron. We benefited from the recovery of smartphones and tablet PC business. Meanwhile, newly growing home appliance business also added some incremental revenue. Our revenue from these 3 segments grew 27% sequentially and 32% year-over-year. Gross margin, excluding technology licensing revenue, was at 19.7%, an increase from 15.6% as we recovered from low seasonality and utilization.

Through rigorous planning and efficient execution, we have made good progress on expanding and enhancing our mature nodes platforms. Our power management business platform is among the leading in the market share in the foundry industry. Power is one of the key revenue drivers for this year, and we see good momentum. Our revenue from power, CIS and nonvolatile memory grew 5% sequentially and 34% year-over-year in the second quarter 2018.

Our revenue in the second quarter from the China region grew 53.2% year-over-year and, when excluding the technology license revenue, grew 14% sequentially and 38% year-over-year. As the preferred foundry partner in China, we are positioned to benefit from the growth opportunities of China IC market. China continues to represent the single largest market for consumer electronics, with a CAGR of 6% from 2016 to 2021.

And home appliance are the largest subsegment within consumer electronics and represents one of the largest IoT opportunities for us. We already see an increase in demand in home appliance and other consumer applications from our second quarter revenue, with a 12% sequential growth and 18% year-over-year growth when compared to the second quarter last year.

As we look into the second half of this year, our business has stabilized, and the margins are looking better than previously expected. As mentioned last quarter, we target revenue growth in high single digits percentage, which is in line with the foundry industry growth rate. We also target a positive annual NAND profitability attributable to shareholders. We are pleased to adjust our previous gross margin target from teens percentage now to high teens percentage when excluding the technology license revenue.

In closing, we are in the middle of a transition. It will still take time to be fundamentally strong, but we are confident that we are well positioned in China. We'll secure our position by working closely with our customers, setting up long-term relations and aim to capture the market opportunities presented before us. Moreover, we will continue to expand and enhance both our mature and advanced technology platforms to provide our customers with comprehensive and competitive services in the mainstream foundry market.

I will now turn the call over to our Co-CEO, Mong Song, for further comments.

[Mong Song Liang, executive]

Thank you, Haijun, and good morning, everyone. Thank you for joining us today. I would like to take this opportunity to share the latest progress on R&D and business development.

Before that, I want to thank our hardworking employees that worked tirelessly in the past quarters. I have witnessed our engineers pulling consecutive late nights to help the company achieve its goals. A refined SMIC culture has begun to evolve. Because of our team's execution, we have seen increased customer engagement and tighter relations with partners.

I'm happy to announce we have reached yet another important milestone in our R&D. In addition to our 28-nanometer PolySiON and HKC, our HKC+ technology development is now complete. Our 28-nanometer HKC continues to ramp up as its yield meets industry benchmark. As we complete our 28-nanometer HKC+ R&D, we target pilot production by the end of this year. We continue to enhance our 28-nanometer performance outlook and expand portfolios and derivatives to address applications such as application processes, radio frequency, high-voltage controllers and embedded memory used in consumer, Internet of Things and auto-related products. We target to become more competitive by narrowing the gap with leading peers on these derivatives.

We are pleased to say that we have achieved significant progress on our 14-nanometer FinFET development. The R&D of our first version of FinFET technology is now ready for business engagement. We are in the process of customer assessments, IT alignments and reliability ratification. We are on target to start with production in the first half of next year. I'm confident to say that we are now at full speed to further expand our FinFET technology portfolios.

To conclude my remarks, to date, we continue to fulfill our customers' needs by providing more comprehensive and competitive technology platforms. We strive hard to accelerate, execute and deliver for the sustainable profitability and growth of the company. As we are preparing for the future, we accelerate our technology and solidify partnerships to secure our position as the preferred foundry partner in China.

Thanks to all our listeners for your continued support, and look forward to giving you our future developments. I will now hand the call back to Tim for the Q&A session of this call.

[Tim Kuo, executive]

Thank you, Dr. Liang. Today's Q&A will be hosted by our Co-CEOs, Dr. Zhao and Dr. Liang and our CFO, Dr. Gao. I would now like to open up the call for Q&A. [Operator Instructions] Operator, please assist.

[Operator]

[Operator Instructions] Your first question comes from the line of Randy Abrams from Crédit Suisse.

[Randy Abrams, analyst]

Yes, first question, just a couple of parts to it. For the second half outlook, for third quarter, just the factors to guide flat to up 2% after the strong 16% rebound in second quarter, if there's applications or technology nodes that are relatively stronger and any areas that are weaker. And the second part of that, in the full year, where you mentioned the high single-digit growth, does that include the $150 million license, as it would have some implications for the fourth quarter implied guidance? And then the final part of the question is just factoring in the gross margin and OpEx. It looks it would be loss making, but I'm curious if you could talk about outlook for some of the other items like the grants, whether you can still maintain breakeven.

[Haijun Zhao, executive]

Randy, thanks for those questions. Basically, our current overall business thinking for the second half takes into consideration the first half, then we'll come to the full year forecast. Okay, the first one, you asked why the sort of color is flat after a very strong rebound in the second quarter. And we should say it this way, SMIC is in a very good situation in utilization. So second quarter, we already found this kind of utilization, already made this type of utilization. So quite difficult to make the third quarter even more -- even higher utilization unless we build up more capacities. And traditionally, if you look at the backtrack over many years, SMIC, the second quarter always be -- that's the best season of the year; and the third quarter more or less is similar, sequential. And we should say we are in a very good situation, but it's quite difficult to add more because we are running at full capacity stage. And as for the whole year, you mentioned that we forecast to high single digits. Yes, that's true. And we might not be -- it's a very strong pricing pressure for the mobile phone-related type of business, basically overall in this market. And so to make a full year without the capacity means a very high utilization and taking into the overall situation the market on the average. And this year, we could not expect a very high growth in the revenue. Especially when we think about it, there are a lot of transitions. There is the 40-nanometer loadings transfer to 28-nanometer loadings. 55-nanometer loadings will be converted to CIS, memories, MCU, high-Vs. And this kind of thing, they take time to make it and 100% convert it. That's in the conversion stage. That's why this year, we do not target that high. And your last question is whether this company can make it -- realize the promise that they'd be breakeven profitable. Yes, that's our guidance to our shareholders, that we'll make the company profitable. And we are already running now in August, and this year has got 4 months left. So the visibility to the end of this year, at least we see through the third quarter and the early fourth quarter, the situation's there, and we have the confidence that we can make the -- just now, you used the word, breakeven, and make the company profitable.

[Randy Abrams, analyst]

Okay. And then the second question I wanted to ask. For the blended pricing, it looks like it dipped in the first half, and I think you did talk about more pricing, just ongoing pressure. Could you give a view just pricing from here now that you're operating pretty full on capacity, if you're seeing, I guess on both areas, firming pricing on mature nodes? And then from the 28 work you're doing, if any potential that can start to lift as you bring out more HKC or HKC+.

[Haijun Zhao, executive]

For the pricing things, everybody knows 48-inch and the price stabilized and the demand is over the capacity. That is a universal situation. But for the 12 nan -- I mean, 12-inch, everybody knows the overcapacity situation in 28-nanometer technology nodes. And when a customer want to move from 55-nanometer and 40-nanometer to 28-nanometer technology, and on the average of the market pricing, and gross margin is getting lower. That is the situation. So SMIC, we are balancing both. On the one hand side, we need to support our customers' technology transfer from the legacy technology of 40-nanometer and 55-nanometer to 28. And in the meantime, we need to consolidate the other part running to make sure that they cancel each other so that we can guide the overall revenue and at the same time maintain the profitability. 28-nanometer, yes, and we see the pressure from the market on pricing, yes.

[Randy Abrams, analyst]

Okay. And then finally, to clarify on the $150 million license. When you mentioned high single-digit growth, is that including the $150 million? Or you'll grow high single even excluding that license fee?

[Haijun Zhao, executive]

Yes, including that.

[Operator]

Your next question comes from the line of Leping Huang from CICC.

[Leping Huang, analyst]

[Foreign Language] I'll translate by myself. So I have 2 questions. So the first question about the 14-nanometers. So can you help us to understand what does the ready for business engagement actually means from the technology perspective? And what's your plan to develop your 14-nanometer business? And the second question is what's your plan beyond the 14-nanometer?

[Mong Song Liang, executive]

Thank you, Mr. Huang. That is very good question, sir, and it's also not easy to clarify. But let me try my best to answer your question, okay. The definition of the customer engagement means we've reached our process as well as we deliver our version 1.0 PDK for customer to do the circuit evaluations. So that is the -- we call it a business engagement start. And of course, we also qualify our process already. Then your second part of the first question is our business plan, okay. So other than the high-speed AP, application process, I think the mainstream mobile application are just migrating from 28-nanometer to 14 or more advanced nodes. So we do see growing mobile and wireless connectivity with more 4G, LTE, in the future, 5G in China, where we think our customer traditionally have strong demands in that area. And in addition to mobile application, we are also seeing demands from emerging applications such as AI, IoT, automotive industry sectors. So we will plan to expand our 14-nanometer portfolios to cover those areas that I just described here.

And your second question, actually, is also very important, and I've been thinking about this for a long time. After the 14-nanometer, there are many nodes. The 10-nanometer, 8-nanometer, 7-nanometer, 6-nanometer, 5-nanometer. Some people even have 4-nanometer. So indeed, it's a bit confusing for a technology node [ memory ] and contents. We work based on the SMIC customers' requirements as well as the internal capability to define our second-generation FinFETs. Of course, we will also benchmark the industry practice and market demands. The most important thing, I think we will assure post-technology competitiveness. That means PPAC, power, performance, area, cost, and as well as the SMIC, the long-term business growth. And that will determine and define our next-generation FinFET technology. I hope I answered most of your questions.

[Operator]

Your next question comes from the line of Charlie Chan from Morgan Stanley.

[Charlie Chan, analyst]

So my first question is more about near term. Can you comment a little bit on the second half demand by end market? Because recently, we are seeing some noise about income buffer demand, mainly from automotive vendor like Renesas and also, on microchip, also reported a kind of a bearish outlook. So can you give us some color about your second half business outlook?

[Haijun Zhao, executive]

Charlie, thank you for the questions. And actually, what we saw at this moment, the demands just stabilized. We did not see an obvious downtrend. And for SMIC, we are, no doubt, very excited. You know that, Charlie. And we've diversified our mature technologies. Just now in my quarterly review, I already say that we expand our technology platform in the mature nodes, such as analog-power/BCD, high-voltage driver, CMOS, C-Major, memory, MCU, IoT, these type of things. And we are in a transition stage. When this kind of pipeline is fully in position, and we expect -- from SMIC point of view, we expect SMIC's demands will get much higher than today and to fulfill our expansion plan. And at this moment, my comments for the market is -- for mature technology nodes is that it's stabilized. And we know that for the agent, the capacity is still in a very shortage to support the analog power and the power devices. And for 12-inch, we really see the high-Vs and the IoTs, CIS are in high demand. And you are right, we see this stabilization [ are likely to ] be downtrends and the competitiveness of memory, stand-alone memory, especially for NAND Flash. But for SMIC, the exposure to this area is not that big, and we also have the conversion of our NAND Flash convertible to the technology nodes just now I mentioned.

[Charlie Chan, analyst]

Okay. And next one is more about your mid-, long-term plan, right? So it's about your capital intensity, right. So now apparently, the company is are still investing. So what will be the long-term capital intensity? If you want to benchmark from your peer, TSMC is 25% to 30%. And what does that mean to your mid- to long-term cash flow and fund raising plan? So actually, I'm curious, right, since you are converting your 40- and 55-nanometer capacity to 28-nanometer, why do you still need to spend such high CapEx for this year?

[Haijun Zhao, executive]

Charlie, this year, we said that we -- just now, Dr. Gao already specified the total spending of USD 2.3 billion this year for CapEx. And we supply this kind of spending, a part of it of 24% for the new equipment for leading-edge technology R&D and the remaining to build up the power lines for the FinFET manufacturing. And we do not build up that much for 28-nanometer. Currently, we should say this, on the SMIC side, it's small. We account for 5% of the total foundry market only. But our customer demand is way above this 5% capability. And we do not build up the capacity for a potential market but build up the capacity for the true customer demands. And we reached a strategic alliance with our customers on both the leading-edge and the mature technology nodes. And then we make the long-term, like 3 years, planning, and then we gave the promise that we'll build up the capacity accordingly. So for this year, we'll have this kind of spending. And for next year, more or less, the visibility now is to see 3 years, and we expect a similar type of spending year-on-year. That's mainly to support our customers' demands, and in the meantime, for a very stable, healthy growth of SMIC in capacity.

[Operator]

Your next question comes from the line of Rick Hsu from Daiwa Securities.

[Rick Hsu, analyst]

This is Rick. My first question is a bit housekeeping. In the second quarter, how much the [ supplement from the government ] did you guys receive in the second quarter?

[Haijun Zhao, executive]

Rick, I will turn this question to our CFO, Dr. Gao, to give you the answer.

[Yonggang Gao, executive]

Okay. [Foreign Language]

[Tim Kuo, executive]

So we are seeing the R&D expenses has increased since the beginning of this year. So if you look at our second quarter, R&D expenses to sales ratio is around 20%.

[Yonggang Gao, executive]

[Foreign Language] .

[Tim Kuo, executive]

So the R&D funding that we have received in the second quarter is around USD 19 million. And for the full year, we are expecting to have roughly USD 100 million for the R&D funding.

[Rick Hsu, analyst]

Right. Great. Yes. That's very helpful. My second question is regarding your 28-nanometer development. So you mentioned about the price competition, because this capacity is still underutilized industry-wide. So I'm a bit curious, could you give me -- could you give us more data about your 28-nanometer revenue contribution in Q3 and also the trend toward second half and next year? I know you did a pretty good job in second quarter. I think it rose to almost like high single digits. So will you expect this rising trend to continue in Q3 and Q4?

[Haijun Zhao, executive]

Rick, we are running our 28-nanometer loading to customer demands, and as you said, and just now, I also mentioned the same. 28-nanometer unit worldwide is over capacity and the pricing game is very high. So we do not really push very hard for the ramp-up of 28 to the maximum capacity stage. We just balance. Just now we said that we like to achieve a balance in loading, both 28 and the other technology node, and the special case so that we can meet our guidance of the gross margin for 28-nanometer revenue for this year, and we will maintain at mid-single digits percentage.

[Rick Hsu, analyst]

All right. Great. Just one quick follow-up. When you start to commercialize your HKC+, I assume starting to commercialize in the first half next year. Can I assume your 28-nanometer revenue contribution will accelerate in 2019 to double digit?

[Haijun Zhao, executive]

At this moment, our plan is to maintain the gross margin for the overall. We do not have that aggressive plan to push very hard to the high volume of 28 High-K Metal Gate C+, even though we have the demands there. But we need to balance them both.

[Operator]

Your next question comes from the line of Bill Lu from UBS.

[William Lu, analyst]

My first question is on technology. It was in the news that SMIC ordered an EUV tool and it will be delivered in 2019. I wonder if you could talk a little bit more about your strategy in terms of using that EUV tool. What is the timing for production? What node will it be?

[Mong Song Liang, executive]

Okay. That's a good question as well. But we don't comment on the procurements of any specific equipment. What I can say is we don't have problems of purchasing equipment from our vendors. So we will carefully make the equipment procurement plan based on our needs, okay. That is the thing I can tell you. But you asked a specific question about which nodes to use the EUV. I think that is -- depends on each company's strategy. As I mentioned earlier, the PPAC, the last one, C, of course, is a very critical, of course, area. The EUV will help area shrinkage as well as a cost reduction if the EUV technology mature. In part, I believe most company understand this. For SMIC, which node will use the EUV? That is still under debate, okay, because of the area reduction and cost benefit, at this moment, it's still not very clear. What I can say is probably, if we think our 14 is N node, our N-plus node will be our next one. And EUV will use probably the N-plus-2 nodes. And the N-plus-2 node, which is 5 or 6 or 7, is really not decided yet. And that's all I can tell you at this moment.

[William Lu, analyst]

Great. That's very helpful. My second question is on your growth outlook. This year, the revenue growth is a little bit below your long-term guidance. I'm wondering if we can talk a little bit more about 2019. Do you think there's the possibility that you'd get back on the trend line? And secondly, you've talked about some of the conversions and capacity being an issue. How do we think about that capacity next year? And what node can we debottleneck next year?

[Haijun Zhao, executive]

SMIC has announced a couple of constructions of new wafer fab shells. We have Tianjin. We have Beijing and Shenzhen and Shanghai. Shanghai 1 specialized in the FinFET. Next year, we'll see a low-volume ramp-up. That's the FinFET portion. But for Tianjin, some legacy fab will ramp up, 8-inch at this moment, and very limited by the supply of the machines. And the delivery of the machines these days has become a very long lead time. And basically, what we want to go for are very conservative and solid growth in the mature nodes. And so far, we already have very big customer base demands for 8-inch. 8-inch is in short supply. But just now, I mentioned that even though we want to expand the supply of 8-inch, both the brand new and the secondhand are very, very long lead time. And so next year, we do not see a very big jump in this kind of capacity. For 12-inch, just now we mentioned that for 28-nanometer, we'll maintain a similar capacity because of the oversupply stage for 28-nanometer, overbuilt capacity type in the markets. And where do we expand for 12-inch next year? Mainly on the area we have very strong customer demand and market demands. We mentioned a couple of segmentations just now. For this kind of area, next year, we will see a ramp-up. And we'll mainly buy enough machines to cover the missing part. That means a lot of capacity converted from the original loading production line, but we need other unique tools to cover that so that we can run analog power, CIS, MCU and a stand-alone memory high-V driver type. So we will see the mature nodes next year, like 55-, 65-, 40-nanometer, we will do the transition, and that capacity will see increase mainly to cover -- make full use of the existing loading in addition to meet customers' requests in the market. So in general, we should say that -- in general, we do not see a very big jump in the capacity building.

[William Lu, analyst]

Okay. Do you think you could clarify a little bit more, on the mature 12-inch, how much capacity might increase next year?

[Haijun Zhao, executive]

We do not have a solid number because that needs our Board of Directors' approval. And our 12-inch wafer fab currently, we only have 2. In Shanghai, we have one R&D fab and that's up to 15,000 wafer per month. We are running -- already running at full capacity. Additional capacity mainly for R&D. And for Beijing, we have the mature fab. The capacity is at 50,000 wafer per month and currently running at full capacity. And for the second phase of Beijing, that's the joint venture, we already fulfilled the first half. And the only missing part in SMIC inside the -- that means inside the fab shell, inside the fab, only have the Beijing Phase 2 that can be filled up next year.

[William Lu, analyst]

Sorry, can I ask one last follow-up on that topic? So if I was to think about the company getting back on the higher growth trajectory, should I be looking at really a bigger increase in 8-inch at some point in the future as well as 14-nanometer ramping up? Are those the key growth drivers maybe 2019 and beyond? Or what should I be thinking about?

[Haijun Zhao, executive]

SMIC, currently, we can say that we more or less build -- we build up the things -- a balanced type of capacity, match our technology and strengths. And so for the mature technology nodes, we do have more customers than our capacity. But we need to build up the fab and also take a very long time to get the machine. So we cannot expect the mature technology nodes to get a very high percentage of growth next year. For the leading edge, just now I already say that, for 28-nanometer, overall, I mean, in the world, this technology node, the capacity is seriously overbuilt. And when we move to the FinFET and we just build our capacity to meet our customers' request, we will slowly build up customer base. So in that sense, we do not really build up at a very high pace on this kind of capacity. We should say, overall, SMIC will go for very a solid healthy growth rate in the capacity buildup and depends on customers' requests and our competitiveness in markets.

[Operator]

Your next question comes from the line of Szeho Ng from China Renaissance.

[Szeho Ng, analyst]

Two questions from my side. The first one, regarding 28-nano, what is your long-term strategy going forward? Should we expect more derivative solution coming out in either 22-nano or 22-nano SD -- SOI? And then the second question would be on 14-nanometer. What are the product sets you guys are targeting initially? And when we should expect revenue coming out from 14-nano?

[Mong Song Liang, executive]

Okay, Mr. Ng, let me try to answer the -- your first question. And for the second part of the second question, about the revenue of the 14, I will leave to Dr. Zhao to answer that. So let me try to answer the 28-nanometer technology. We think 28-nanometer is -- will be a long node, okay, particularly for the High-K Metal Gate. So we are working closely with our customer throughout multiple enhancement of the 28-nanometer High-K Metal Gate. And as Dr. Zhao mentioned, in fact, for SMIC, the technology, 28-nanometer High-K Metal Gate technology, is not a bottleneck in terms of the process variant. The more important is because the 28 has been such a long node, so the worldwide capacity is overbuilt, okay. But we still think there are other derivatives for a future business opportunity. So such as like AP and consumer IF for the high-voltage driver embedded in our volatile memory and as well as the total grid products. So we think there are still good opportunity, business opportunity over there. So by doing that, we think we could utilize our capacity and also narrow the gap with leading peers on those derivatives and become more competitive. You asked about the 22-nanometer. 22-nanometer -- we also have the 22-nanometer in our technology portfolio. At this moment, our 22-nanometer development is nearly complete, but our schedule and customer engagement were based on customers' actual needs and the market demands as well as SMIC overall 28-nanometer ramp-up plans. So that is my question about 28, 22-nanometer. Then your second question, your first half -- okay, so I will give the call back to Dr. Zhao to answer your second question about this revenue contribution, about -- on the 14.

[Haijun Zhao, executive]

Okay. And at this moment, we are working closely with our customers on the new product design, and it takes time to guide the products in. And based on the current schedule, we expect the revenue of 14-nanometer to start appearing in the later part of next year.

[Mong Song Liang, executive]

Yes, I think that's probably the good answer, because our -- as we said, our 14-nanometer ramp-up will start first half next year with a small volume, of course, right. So to project those revenue contribution is a little bit difficult to see at this moment.

[Haijun Zhao, executive]

Yes, and a little bit more comments on the 28-nanometer technology, or another so-called 22-nanometer, is this way. It is very important technology node. SMIC has put in a lot of resources. And we compare it to the long nodes of 55-nanometer and 0.18-micron technology. You know that 0.18-micron technology, aluminum today is still a very big part of every foundry, very, very strong. And these days, still, the capacity is in shortage. But 0.18-micron technology has been there for almost 20 years. It is long node. And another 25-nanometer currently is also in shortage in capacity because it's another long node. It's just before the transition to the immersion scanner. And we really believe that 28 and 22, we can see that as the same node, will be a long node, maybe in the next 20 years, continue to be there. But it takes time to absorb the current overbuilt capacity. For SMIC to stay with a very high, I would say, momentum is that we do not overbuild additional things. But we need to deepen our technology understanding and platforms diversified, guiding customer base. And for the future, we still have very big hope there. At this moment, we will also do, just now we say, that mid-single digits type of percentage revenue on these technology nodes but just to maintain a very high [ receive ] stage on this technology volume.

[Szeho Ng, analyst]

Yes. That sounds great. And a last question from my side. Do you expect 14-nano to be a bigger node than 28-nano, from SMIC's perspective?

[Tim Kuo, executive]

Szeho, could you say your question again?

[Szeho Ng, analyst]

Yes, yes. Would you expect 14-nano revenue potential will get a lot bigger than 28-nano for SMIC's case?

[Mong Song Liang, executive]

Let me try to answer part of that. Just, I do believe. Because the 14-nanometer and 20-nanometer, in terms of technology, they are very different equipment in there. 28 High-K Metal Gate is the last planar -- high-performance, low-power planar technology, 28, or 22. But for the FinFET, that's a difference thing. FinFET will be -- have a technology shrinkage plus higher performance as well as a lower power. So to compare the 28 and the 14 lag time, I believe that we think 14 FinFET should have a longer node, a longer lifetime than the 28. But of course, that depends on the application as well. So it depends on those mainstream mobile migration. Right now, mainstream mobile applications start from the 40-nanometer and migrate to 28. Then if they migrate to 14 faster, all the cost is more justified. And we believe the speed, the migration speed will be faster, okay. So to maintain the 14-nanometer PPAC advantage as well as the low cost is very important for SMIC as well as for the industry technology migration. That's my comments.

[Operator]

Your next question comes from the line of Gokul Hariharan from JPMorgan.

[Gokul Hariharan, analyst]

First of all, I just had a quick question on R&D spending. It has gone up quite a bit as the focus on leading edge has come back in the last couple of years. What do you think is the optimal level to support your ambitions, especially in 14-nanometer and beyond? And now that we are toning down the expansion in terms of capacity on 28 to adjust to market reality, will we also think about adjusting R&D expense to kind of adjust to slower industry revenue growth? Or that is still going to continue regardless? That's my first question.

[Tim Kuo, executive]

Gokul, could you specify your question again about the R&D part?

[Gokul Hariharan, analyst]

Yes. So I was asking, R&D has stepped up quite a bit in the last couple of years. Are we expecting this to continue to move up in the next couple of years as we get closer to 14-nanometer? The second part of that is if the newer nodes are slower in terms of ramp-up, would we adjust down R&D spending just like we are adjusting down the capacity spend? Or R&D spending is going to move up regardless of the ramp-up of the new process nodes?

[Mong Song Liang, executive]

Okay. Let me try to address this one, okay. The R&D spending definitely is not uncontrolled, okay. R&D spending were based on our revenue and as well our gross margin consideration. And at this moment, the reason our R&D spending is higher because we tried to speed up our first generation's FinFET technology. But beyond that, actually, the second-generation, third-generation FinFET, it doesn't need to build a whole -- doesn't use the whole new equipment. There's a lot of commonality in equipment that could be used. So R&D spend expansion -- spending will increase slightly but not as rapid as you can see recently. That's my comment.

[Gokul Hariharan, analyst]

Okay, that's very helpful. My second question is on all the trade wars and tariffs. I think there's been a lot of discussion about that. Could you talk about what has been your feedback talking to both your customers, both the non-China customers as well as China customers as well as maybe with your equipment and material vendors also? Many of them are from the U.S. as well. So can you talk about what has been your feedback over the last 3, 4 months while this has been in a very high degree of focus?

[Haijun Zhao, executive]

Gokul, here's Haijun. Yes, we saw the impacts were very limited because SMIC does not produce the end products. And our percentage in the overall IC world is also quite limited. And at this moment, we just carefully observe the development of the situation internationally. But we strictly follow our commitment to our customers. And SMIC in China, actually, is an international company. We are listed in Hong Kong ADR these days. And we have -- maintaining a very good balance between the overseas customers and domestic customers in the past many years. We do not comment on specific equipment or materials, but at this moment, we do not meet up any problems with these kind of things. And we do not see in the short term such kind of problems. And -- but just now, I mentioned that we watch very carefully on the development of the situation.

[Gokul Hariharan, analyst]

Okay, that's very clear. Just one more clarification, if I may, on one of the earlier questions. You mentioned that the high single-digit growth for 2018 is including the tech licensing. Does it imply that in Q4, we are kind of expecting a sequential decline in revenues for wafer revenues? I just wanted to understand what is the rationale behind that given, in the last few years, Q4 has been largely flattish or even higher than Q3.

[Haijun Zhao, executive]

At this moment, we do not have the full visibility on the fourth quarter. But tentatively, just now, if you were to calculate the guidance we gave, you'll run off certain conclusions. And we haven't reached that conclusion yet. On our side, we still working with our customers. At this moment, we still do see very good trends for customer loading. But again, the visibility is not that clear for the fourth quarter.

[Operator]

Your next question comes from the line of Roland Shu from Citigroup.

[Roland Shu, analyst]

First question is on your second quarter product mix change, positive or negative to your gross margin. If I look at your technology breakdown, you have about 5.4 percentage points revenue increase on 28-nanometer. And 40- and 55-nanometer altogether was similar as the first quarter. And 90 and above actually are lower than first quarter. So just wondering, for this kind of the product mix change, was it positive or negative to your gross margin in second quarter?

[Haijun Zhao, executive]

Basically, this way, our -- almost every foundry company have a similar situations there. Their 8-inch legacy node are fully loaded and in shortage. So more or less, we see the product mix in the 8-inch wafer fabs, there's no impact, almost no impact to the gross margins. And however, [ they swap ] to meet our customers' request, their loadings, their margins there. And the product mix impact mainly come from 12-inch. And just now, I mentioned that 28-nanometer overcapacity situation is serious. When we convert from 40-, 55-nanometer to 28-nanometer, because of the serious depreciation of the capacity, the gross margin from 28-nanometer is very low. So the product mix, when we have more 28-nanometer High-K Metal Gate type of products running, we have less 40- or 55-nanometer, then we see the gross margin guiding lower. That's why from previous question, we keep answering that to maintain a balance between 28-nanometer revenue and the other revenue is very important. We have to balance that to maintain the guidance of gross margin.

[Roland Shu, analyst]

Understood. So 28-nanometer, now, your gross margin's still below corporate average, isn't this right?

[Haijun Zhao, executive]

Yes.

[Roland Shu, analyst]

Okay. My second question is you're talking about your second generation of FinFET. So is this second-generation FinFET going to be adopted on the 14-nanometer? Or adopted on your N-plus 1 or N-plus-2 technology? And the second -- a follow-up is on what's the difference between your first-generation and second-generation FinFET?

[Mong Song Liang, executive]

Okay. To answer your question. N-plus-1, our second-generation FinFET, we define -- again, it's power, performance, area and cost. So power will be 40% reduction, and speed will be 30% enhanced. For the logic area, we'll have a 50% reduction. That is our technology definition.

[Roland Shu, analyst]

Yes. So is this going to be atop 14-nanometer or N-plus-1?

[Mong Song Liang, executive]

Okay. The definition of the technology node, as I mentioned earlier, right, up to 14 -- from 10- to 5-nanometer definition. So as I told you, we have -- we will base on our customers' demands and our company's core structure and define our second-generation FinFET technology.

[Operator]

Your last question comes from the line of [ Chan Wenzhang ] from [ Po Tai Securities ].

[Unknown Analyst]

Congratulations on our great progress in R&D. My question is 14-nanometer is a relatively mature node for our competitors. So what is a relative competitiveness or advantage for our company in 14 nanometers?

[Mong Song Liang, executive]

Okay. So for the 14-nanometer technology definition, at the beginning, we benchmark our 28-nanometer second-generation High-K Metal Gate. That means 28 HKC+. So using the 28 HKC+ as a reference, we define our 14-nanometer, which can provide a 60% speed gate and 70% power reduction as well as a 50% logic area reduction. So those are the numbers and targets we already achieved before possible for that. So that is the definition of our first-generation FinFET.

[Operator]

I would now like to hand the call back to IR Director, Tim Kuo, for closing remarks.

[Tim Kuo, executive]

In closing, we would like to thank you, everyone, who participated in today's call, and again, thank all of you for your trust and support to SMIC. Thank you very much.

[Operator]

This is the end of SMIC's second quarter earnings conference call. We thank you for joining us today.