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. [Operator Instructions] For your information, this conference call is now being broadcasted live over the Internet.

Webcast replay will be available within an hour after the conference is finished. Please visit our website, www.umc.com under the Investor Relations, Investors, Events section. And now I would like to introduce Mr. Michael Lin, Head of Investor Relations at UMC. And Mr. Lin, please begin..

Thank you, and welcome to the UMC conference call for the second quarter of 2020. I'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 U.S. and the ROC security authorities. Now I would like to introduce UMC's CFO, Mr.

Chitung Liu, to discuss UMC's second quarter 2020 financial results..

Thank you, Michael. I would like to go through the 2Q 2020 investor conference presentation material, which can be downloaded from our website. Starting on Page 3, the second quarter of 2Q 2020, consolidated revenue was NT$44.39 billion, with gross margin at 23.1%.

The net income attributable to the stockholder of the parent was NT$6.68 billion and earnings per ordinary shares were NT$0.55. Utilization rate in the second quarter improved to 98% from 93% in the previous quarter.

On the next page, Page 4, on the quarter-over-quarter comparison, revenue grew 5% to NT$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 NT$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 NT$5.8 billion, with the reverse of our non-operating items from the revaluation of our investments.

Our net income attributable to the stockholder of the parent in quarter two reached NT$6.68 billion or 15.1% net income margin. EPS was NT$0.55 in quarter two compared to NT$0.19 in first quarter of 2020. On Page 5, the first six months comparison.

Revenue increased 26% to NT$86.6 billion, partially due to the combination of USJC, which contributed around 10% of the revenue topline. And gross margin was 21.2% or NT$18.38 billion.

And net income attributable to the stockholder of the parent was NT$8.888 million in first six months of 2020, and EPS is NT$0.74 for the first two quarters of the year. On the next page, Page 6, our cash has reached almost NT$100 billion. And for the total equity in the first half of 2020 was NT$209 billion.

On Page 7, ASP increased by a low single-digit percentage, mainly due to the surge in our 28 revenue shipments. On Page 8, the revenue breakdown. Asia stayed around 55%, and Japan also remained around 9%. For Page 9, IDM and fabless remain unchanged, at 12% and 88%, respectively.

On Page 10, communication declined 3 percentage points to 51% and made up by computer and other segments. And on Page 11, as I mentioned, ASP increased by low single-digit percentage point mainly due to the surge in our 28-nanometer shipment, which now reached 13% of the total revenue in the second quarter compared to 9% in the previous quarter.

And capacity still remain a minor increase quarter-over-quarter and CapEx remained at US$1 billion for the whole 2020. So the above is the summary of UMC's results for second quarter of 2020. More details are available in the report, which has been posted on our website. I will now turn the call over to President of UMC, Mr. Jason Wang..

Thank you, Chitung. Good evening, everyone. Here, I would like to update the second quarter operating results of UMC. During the second quarter, consolidated operating margin reached 13.2%, while utilization rate increased to 98%. Lifting wafer shipments to 2.22 million 8-inch equivalent wafer.

The increase in wafer shipments mainly reflect the computing segment demand 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 a customer, recognize UMC with the 2019 Supplier Excellence Award for the demonstrating excellent performance in the area of cost, environmental and social responsibility, technology, responsiveness, assurance of a supply and quality.

In addition to serving customers to the best of our ability, UMC also increased 2019 cash dividend distribution to approximately NT$0.8 per share, reflecting the recent company buyback of the treasury shares. Looking into the third quarter, our market demand remains strong.

We have experienced a surge in 28-nanometer tape-outs during the first half of 2020 compared to the year-ago. And expect additional 28-nanometer and 22-nanometer product tape-outs in the third quarter.

We are also moving new 28-nanometer products into volume production for wireless applications such as 4G and 5G smartphones, which will enhance our business traction and diversify UMC's customer exposure across different 28-nanometer market segment.

Moreover, we have observed efforts 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 Specialty Technologies, our ROI-driven corporate strategy remains unchanged.

As UMC secure new business we will closely examine returns on invested capital to optimize the company's capital deployment and further enhance our financial performance. Let's move on to the third quarter 2020 guidance. Our wafer shipment will remain flat. ASP in U.S. dollar 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 US$1 billion. That concludes my comments. Thank you all for your attention. Now we are ready for questions..

Thank you, President, Wang. And ladies and gentlemen, we will now begin our question-and-answer session. [Operator Instructions] And the first question is coming from Randy Abrams, Credit Suisse. Go ahead please..

Okay. Yes. Good afternoon, Jason and Chitung. 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 28s ramping. So I was curious the guidance where shipments and ASPs are guided flat.

So if you could discuss a bit on if any areas of softness to offset that or trends you're seeing on application to drive the flat guidance?.

Sure. Let me capture the field your questions. One is you mentioned based on the remarks, we foresee the demand remains strong. And however, we guided the shipments and the ASP is flat.

Is that correct?.

Yes, that's correct. Also with 28, presumably ramping to have flat – and yes, so kind of factors for it soft.

And also, maybe to add to it, if any, capacity constraints, where there might be certain demands you just can't fill right now?.

Okay. Let me see how to address that. First, in Q3, we do foresee change in the 28-nanometer product mix, okay, which will have a mild lift of ASP. So the 28-nanometer 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 shift in capacity utilization rate across the different nodes. So therefore, the profit impact on the 28 is not as significant in Q3 at this time.

Does that answer your question?.

Yes, that does partially.

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

Okay. So for the Q3, if I look by the applications, we see strong – strongest rebound is coming from the Consumer segment and followed by the computer and the communications, okay. But all segments are increased, okay. We see an increase of all segments.

And some the reason is we're seeing, we're gaining market share results on the [indiscernible] higher penetration in a smartphone, okay, and as well as from the those from a new customers, also from the existing customers, they're getting market share from a communication area.

The Computer segment is really a result of working from home and home schooling, that, first, the continuous demand in both Consumer and Computer segment. So that's really where we're coming from the application point of view.

On the ASP, flatness is really a mix that I described earlier, even the 28 help, given the product mix, we actually didn't see as a significant..

Okay. And if you could clarify, you mentioned all segments up.

Is it the other category that's coming – I mean, just to be flat overall first shipments? Is it then from that area that's offsetting the others?.

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

Okay. One note, I noticed has come off the last couple of quarters. 80-nanometer, probably maybe one of the other sits a bit underutilized, but came down from 18% to 13% over the last two quarters.

Is there applications moving off that, that you could backfill or could you upgrade that capacity to serve some of the 40 or 28 demand?.

We can really 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 node that should continue to upgrade at 100% loading. And the contribution lower is really just – we're shuffling around the different node support..

Okay. And if I could ask just one final question on the CapEx, well that's couple of years, you maintained NT$1 billion, but then under spent as we went through the year. And it looks that way through first half. But I guess maybe for Chitung, but how do you see the capacity? I know you had some 28 were Xiamen capacity set to ramp up.

So do you still see reaching that or could come in a bit light? And then maybe as a medium term, with utilization this year getting up to mid- to high-90s, do you need to start ramping up a bit more on the CapEx, just to satisfy the demand and continue to maintain some of the growth?.

The answer is yes. And the capacity expansion at our 12X, which is Xiamen is actually on track and is expected to reach NT$25,000 per month in the mid-2021. So that's part of our CapEx already.

Given the growing 22 and 28-nanometer customer demand, we actually examining the option to utilize available floor space at our Tainan facility, which are 12A to fulfill additional business opportunity in advanced technology. Which was still subject to our ROI justification we didn't mentioned many quarters, okay.

We will continue to evaluate our CapEx based on what we described, a stringent ROI-driven strategy to enhance our return to shareholder employees. So that will not change. That's also in our remarks that we'll continue that without any change of that. But the next phase that we're looking at is more in our Taiwan, Tainan facility..

If you get back to growth, do you think NT$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?.

Yes. I mean, we are examining that option right now. So it's too premature to giving the guidance of the CapEx numbers. But for the 2020, the NT$1 billion will remain, yes..

I can't really the absolute dollar amount that determines CapEx numbers. Really the return requirement and also the customer demand are multiple factors will lead to our CapEx decisions..

Randy, I will also mention, in addition to the CapEx spending, we look at our topline growth we see the market applications such as the 5G handsets. The increase of silicon content in the 4G phone, those demand will continue driving that. So that's why we seriously examine the option of a future capacity expansion.

Meanwhile, we also focus on productivity improvements, okay. And that will actually help us well in addition to that. And besides the growth of a topline we foresee more room for improving our structure profitability, which we were trying to enhance our earnings. So we continue managing the balance of those..

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

We're happy to sustain that. Thank you..

It means we'll have Gokul Hariharan from JPMorgan for questions. Go ahead please..

Thanks and congratulations for the good result. First question I had, could you talk a little bit about – I think 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 NT$500 million, but even with some currency appreciation.

Can you talk about what was the reason for the gross margin improvement? Is it all primarily to do with better utilization and better product mix? Or are there any specific factors related to, let's say, Fujitsu, the fab or anything specific that we should be looking at?.

Well, I mean, yes, first of all, thank you and secondly, in terms of the better gross margin. In Q2, we show an increased gross margin profit primarily due to the product mix improvement, which lifts the ASP that help. And secondly, given the lower unit cost per wafer from the higher loading at a 98%, that's also a benefit factor.

The third is we do have ongoing cost reduction activities. So combining all three as a result, we led to a growth of the Q2 gross profit..

Okay. So just a quick question.

Could we talk a little bit about 28-nanometer and May fab in Japan? Are they now fairly – where are they in terms of gross margin compared to the corporate average? Are they still a big drag or the drag is much smaller now?.

So after a few quarters of synergy improvement, our 12M profitability has improved every quarter since becoming part of UMC. We have implemented integration effort in fab operations incorporated fast know-how sharing and streamlined procurement, et cetera. So all of these efforts have improved the cost structure of 12M the SUSJC 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 topline as well as our bottom line. So we think going forward, our profitability of 12M or USJC will be largely dependent on its own demand supply dynamics..

Okay.

Any thoughts on 28-nanometer, given the capacity is now filling up with a strong traction from some of the new takeouts? How much of a drag is 28-nanometer is 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?.

Well, I mean, we actually don't look at the final basis on the margin drag. Our expectation on the 28-nanometer is based on the progress of our 28 product pipeline as strong as what we've seen today with the business traction continuing into the second half of 2020, we foresee our 28-nanometer utilization will grow.

And so we actually feel pretty confident about our 28-nanometer contribution to the company overall. With the product mix improvement and we believe that will help us with the ASP list in terms of generating much better profitability for the company as a whole..

Okay. And one last question from me. Chitung, 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 roiling over, over the next couple of years? Like 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 [indiscernible] coming down?.

It's pretty much what we said in the past. We are seeing some low single-digit decline in overall depreciation expenses in 2020 as far 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..

Okay. Got it. Thank you very much..

And the next question is coming from Szeho Ng of China Renaissance. Go ahead please..

Hi. Good afternoon, gentlemen. My question is regarding 28-nano. It seems like that you're still sticking to having 25,000 capacity ready middle of next year, right, at the Xiamen fab? So I wonder what would be the next expansion.

Would that happened in Taiwan? Or would continue to be in Xiamen?.

We actually mentioned this earlier, after the 25,000 in Xiamen, the next phase of growth or capacity expansion will happen in our Taiwan, Tainan facility. That's what we're referring to a 12A facility. And given the available floor space and that will be the best ideal location for us to do the next expansion..

Okay.

And what would be the size of the expansion in Taiwan?.

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

Okay. That's useful.

And my second question, is it possible to give an update on the operation status for the Japan fab?.

The operating profit impact in the 2019 was a negative of high single-digit percentage point. This year, because of the strong demand coming from 28-nanometer and also enlarging economy of scales, now has significantly reduced. And now the impact is around mid-single-digit percentage point.

And certainly, we see further improvement once we reach 25,000 in 2021..

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

Thank you..

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

Hi, good afternoon. First, for your 28-nanometer utilization. So you said in second quarter, actually, your overall utilization that was about 98%, and you still expect 28-nanometer utilization will increase in 3Q. So I just want to ask you.

What kind of the magnitude of this utilization will increase for 28-nanometer? And after the utilization increase, what of the percentage point are the revenue contribution for 28-nanometer will be in second half? This is my first question. Thanks..

Well, the overall company's utilization rate will be a 95%..

Mid-90s..

Okay, mid-90s as we guided. And on a blended basis, the 8-inch, we're running at full, and 12-inch, we're running at 90%, okay. So that will give us approximately the mid-90s utilization guidance across older notes of the company. And we continue to see there is a room for the 28-nanometer to increase.

And so we think that 28-nanometer utilization rate will continue to increase on a quarter-to-quarter basis at this time..

Yes. Understood. But second quarter, your overall corporate average utilization was 98%.

So what's the 28-nanometer utilization in second quarter?.

So again, our overall capacity in the third quarter were increased by approximately 1%, addition of 1%. And also in the second quarter, as Jason mentioned, 8-inch are 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 maybe single-digit percentage point utilization increase for 28-nanometer? Or more than that?.

Yes. We don't give the numbers on single node utilization, right. So we can give you a relative ideas about how we compare to our corporate average..

Okay. So how about the – in second half, the revenue contribution from 28-nanometer.

In second quarter, it was 13%, and how about in second half?.

It should gradually trend up quarter-over-quarter..

We see a slightly increase on the 28-nanometer in the next quarter..

A slightly increase in 3Q, right?.

Right. Yes..

Okay. Thank you..

Well, I mean we have been talking about our 28-nanometer business for multiple quarters. I think most of you know about that, right. Now in the Q2, in our view, this is truly start seeing a meaningful 28-nanometer growth quarter-over-quarter.

This is very much in line to our expectation and it's reflecting the materialization of our long-term game plan. So I just kind of want to add that. I understand we've been talking about this for a really long time. We finally will start seeing that, and meaningful growth coming in now..

Yes. Okay. Thank you. My second question is on for the 14-nanometer. I just looked at your annual report. You have continued investing in 14-nanometer finFET technology. And your 14-nanometer FFC is [indiscernible] from second half this year. But for you, you only have a very limited 14-nanometer capacity.

So question is, are you considering to further expand your 14-nanometer capacity anytime soon? And if you want to do that, how much CapEx will 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 have – 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 continually investing and want to make sure that we develop the technology as well as other technology, the area that we are focused on is 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 go – we'll go ahead the extent based on an ROI basis. So I'm never going to rule out the chance of putting the new capacity on a 14, but at this point, it's not on our plan yet..

Yes. So by what kind of criteria or what kind of consideration, you are going to expand or raise the capacity for 14-nanometer? I think actually every year, you spend big money on R&D for this 14 finFET technology.

But if you don't have a big – have the capacity, I think how are you going to monetize the investment on these finFET technology development?.

Well, 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 – but if you look at the addressable market, at this point, we're considering anything 14-nanometer and above are our addressable market.

So we always have to examine our addressable market and whether the demand is valid. And then we come back and look at the application if that makes sense for us to invest into capacity. Meanwhile, we do have about 2,000 to 3,000 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 share – all stakeholders. So we're going to continue to follow that strategy, yes..

Understood.

You said a 2,000 to 3,000 capacity for 14-nanometer, right? It's not additional 2,000 to 3,000, total 2,000 to 3,000, right?.

No. This is what we have right now..

Okay, understood. Okay, thank you..

Sure, thank you..

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

Thank you for taking my question. I guess a question about competition landscape at 28-nanometer and also the other mature 12-inch node. I think particularly 28-nanometer – I think this question has been asked a few times.

When Jason, you said, it's an oversupply to be of the supply for 28-nanometer for foundry industry, but you are able to manage your 28-nanometer to do better and better every quarter. So I want to know your view on the competition landscape at 28-nanometer and also the other mature 12-inch nodes. Thank you..

Sure. So let me start off with the 28-nanometers. First of all, we're 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-nanometers and 22-nanometer solution have finally provided competitive advantage for our customers. Like I said earlier, the progress of our 28-nanometer product pipeline remains very strong.

The search of the 28 and a 22 tape-outs also shows that, and will continue to increase our exposure to a more diversified 28 customer base and product portfolio. So we are expecting our 28-nanometer revenue contribution in Q3 will continue and to increase.

And given why I also mentioned earlier, driven by the higher penetration rate in the smartphone and continued demand in the computing segment. So we expect this 28-nanometer – now that this business momentum will benefit by those, okay.

If you look at the other 12-inch mature nodes for the 40-nanometers, we foresee a positive demand in the second half as well. And due to an increase of the customers' 40-nanometer adoption in a larger device, driven by the wireless applications. So there are other applications coming into the 40-nanometer as well.

And looking beyond the 2020 and we are considering to migrate portion of the 40-nanometer capacity to support our unfulfilled 28-nanometer demand to enhance our ASP and profitability. So in the longer-term, I think there will be a demand-supply balance on the 40-nanometer. So we are considering to migrating some of our 40s to 28, okay.

Then if we're coming down to 55 and 65, our 55 and 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 most applications moving into the 55, and we start seeing a very, very strong momentum on 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 running up rates 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 the – on those nodes that we're serving today..

That's super clear. Perhaps a second question, which probably, I don't know if we can have your answer, it's about a lawsuit and I think a few – maybe a few months ago, we saw an article saying that General Counsel at UMC commented that the lawsuit will not be concluded in two, three years' timeframe.

So I just want to know how should we think about the timeframe and I don't know, any update on this topic?.

Well, 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 the – wherever that court require us, okay. We remain – we restate our believing in ourselves. And so we don't believe there's any false wrongdoing in terms of UMC.

And so we stay believing that, and we just have to trust that the court system will eventually give us a fair result, okay. So since it's in the legal proceeding, it's truly not in our position to comment that at this time..

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

Sure, thank you..

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

Hi, good afternoon. Thank you for taking my question. My questions will probably for – 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 that in terms of expansion and also your – whether you have more priority or selective on the product you do going forward? Thank you..

I mean, you're right. And we do see the 8-inch has been continuing for many quarters. And it's our belief will remain full and throughout the second half of 2020. And so we are constantly looking into options to further expanding our 8-inch capacity. But given the ASP situation, any organic growth in the 8-inch will be very limited.

We'll continue looking for those options, and which we did in the past years, we actually increased our 8-inch capacity organically as well. So by continue migrating some of our fabs to support our customer in the advanced 8-inch area, particularly. So we're going to continue doing that.

And sometimes inorganically, it has to be – it had to come by those opportunity, we have to go out search for it. So – and we'll continue as well. And so – and meanwhile, in terms of the tightness of the 8-inch situation, it does affect some of the prioritization, as you mentioned about allocation.

So our focus in 8-inch is also on the area of the product mix improvement. So we'll continue migrating some of our legacy to the advance and continue migrating some of the better product mix to help us enhance our ASP as well as profitability of the 8-inch, and that is an ongoing basis.

Given that we foresee a strong demand and continue leading to the supply tightness, okay, not only – or by the way, not only to the 8-inch, but also on some of the specific 12-inch, I talked about earlier, we were actually – we think there's going to be – the market pricing situation will probably become more in favor of the foundry from now, yes..

Okay. Thank you..

That will probably help us well, yes..

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

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

Can you repeat that?.

The question is that given that you can be more selective and prioritize the business, the product application that more favorable to our profitability.

Then how do you see that reflected on the 8-inch foundry price?.

Well, I mean, the pricing discussions are ongoing. Right now – well, first of all, do value our long-term customer partnerships. So we need to – seeking for a win-win cooperation with them. So we need to continue to align with our customers. For the year 2021, we already have an ongoing discussion on this alignment, 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 supply situation, I think the pricing situation outlook is more in favor of the foundry right now..

Got it. Just a last follow-up on this. I remember the last time we – the 8-inch foundry price has – we are able and [indiscernible] our peers are able to raise the price that was back in, I think 2018. And also coincidently, there are also the cost increase from the rail wafer.

So we have a very good reason to want to negotiate with our clients that we can pass the cost to the customers. So it justify our reasoning for raising or adjusting the price higher. How about this time? I mean it looks like the wafer allover price may – 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 acceptive about this price negotiation?.

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 pass down to the customer. This time is a difference. This time is mainly because 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 discussion is ongoing at this time..

Okay. Thank you..

Sure..

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

Hi. Thank you for taking my question. A very, very good result. I have a question again to the 28-nanometer profitability.

I'm actually very surprised to see the management did not take each node profitability, because company management also mentioned that your new investment is based on a better return, which means that when you try to increase your 28-nanometer capacity, you believe that incremental capacity can give you a better return? So my question is that when do we expect that 28-nanometer should be the corporate average profitability and margin? And is that the reason why we want to increase the – repeat the 28-nanometer capacity?.

So for increasing incremental 28-nanometer capacity, sometimes it helps the overall bigger pictures. So if we don't have adequate capacity or economy of scales, 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 spend is what we are really considering. So yes, if we are considering to expand our 28-nanometer is going to fulfill our requirement for a longer-term picture..

But I thought that maybe we can somehow raise the ASP first to improve the margin or profitability, then we do the capacity expansion or any other ways to boost for the margin?.

Well, certainly, we follow your view as well, but sometimes it just in reality, it 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 the favor of foundry.

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 thought and well we wish that to happen as well.

But the more important is really to fulfill the meeting parts and to reach the economy of scale and to have adequate capacity for our key customers..

Understand. Just a little bit follow-up on the – for the 28-nanometer. So moving into the second half, our 28-nanometer utilization is slightly below the 12-inch average, which means that incrementally iteration rate might not be a big moving factor for your 28-nanometer profitability.

So can we expect that – how can we see a better profitability for 28-nanometer in the second half? Maybe we use the tool for the 28-nanometer alone or we – any other ways we can see that – or how should we see the profitability improvement in the second half for 28-nanometer?.

I think for – as a finance person – maybe Jason can jump in later on. As a finance person, the depreciation curve, need to come down. So that's exactly the situation for our Xiamen fab, and it may take another couple of years to see the curve to peak to decline to help our overall 28-nanometers profitability.

And our 12A in Thailand has pretty much reached the inflection point. So by year 2022, overall company, we will see a significant decline in depreciation expenses, which is largely related to our 12A 28-nanometers expansion we did back in a few years ago. So depreciation will come down.

And hopefully, our product mix amortize – I mean, our product mix enhancement will also help our overall blended ASP for 28-nanometers..

Okay. I've got one last question for the 8-inch. Management mentioned that the pricing environment is better, but the third quarter guidance for the ASP is still remain flattish.

So when can we expect some like improvement in terms of 8-inch blended ASP?.

I mentioned the – many of the discussion about that is for the year 2021. So that alignment is ongoing. And all our 2020s demands the supply – the support is being aligned previously.

And so – and we considering the long-term partnership that we have and that will be only a selective area with the upside with a better pricing, but in general, we did not move the pricing in 2020. Now for 2021, given the demand supply situation change and it's more of the discussion today is for 2021.

Meanwhile, for 2020, all the pricing adjustment is given on the upside support area..

I see. Understand. So we can expect like much better ASP trend in 2021 at least for 8-inch..

By then, we actually will give you a much better....

I understand that. I just can't wait..

I definitely share the sense of, but there's – when the time come, we will give you a really clear guidance on that..

Understand that. Thank you very much..

Sure..

The next question is coming from Charlie Chan of Morgan Stanley. Go ahead please..

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're guiding third quarter margin to decline from second quarter.

Is that all due to the ramp of 28-nanometer mix? And I'm not really sure because suppose the higher iterations should mean a better margin, why the margins would decline in third quarter? Thank you..

Okay. For the Q3, the next quarter gross margin guidance, we are expecting it will be – the margin will be challenged by the foreign exchange market. Thus the stronger dollar, NT dollar will dilute our profitability that's one of the reasons. In addition, we are entering into the summer section.

So every year, annually, that will lead to higher utility costs during the time. So we are factoring those into the calculation as well, yes..

Okay. Thanks. And next is about your topline. I mean 28-nanometer goes up and you mentioned that across segments demand remains to be very strong.

Is that the case, why the revenue is only flat for one quarter?.

Well, 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 the other node that compensated with the upside of the 28-nanometers. So that will give us the flattish outlook at this point.

From the utilization rate point of view, for the Q3, there will be an overall capacity increase about what over a little bit over 1%. And besides giving the mid-90, which, let's say, mid-90 utilization rate guidance, we consider that's very high already. So we feel this is probably a reasonable guidance at this time, yes..

Thanks. Thank you, and the next is about your litigation risk. So May conference, you did expect that lawsuit wouldn't conclude in the coming two to three years. Is that really what your official comments? And actually, my – by our 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 U.S. or Micron earlier, even there will be some potential compensation? Thank you..

Again, this in the legal proceeding. It's not appropriate for us to comment on our legal thinking throughout the strategies. So yes, we'll report accordingly and by the regulator towards this policy. So – and on a tiny basis, but we would prefer not to comment during the call right now..

I see. So from the financial perspective, I'm not sure if this will need to book some contingent lawsuit. I remember when I was in college and some contingency expense.

Not sure if maybe this question is to Qi Dong whether we need to prove some contingency expense on that litigation issue?.

Well, UMC did not violate the Trade Secret Act, which we are already have appeal to the appeal court in Taiwan. So it's a non-duty appeal..

Yes..

So there's no reason for us to do the contingency estimate. And however, our accounting book has always closed 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 sort of general legal-related expenses..

Got it. And my last – yes, please go ahead..

I would also like to add, the UMC, we have appointed a Finance Legal Counsel and while legal team respond to this – both litigation in U.S. and Taiwan. And so – and at the same time, we will make every effort to enhance our profitability and preserve the better interest for our shareholders, so in case – to mitigate potential risk.

But as far as [indiscernible] for the risk, we truly not – 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, yes..

Yes. That is reasonable. And last one, maybe either Jason or Dong Liu can help me. You said a company or the foundry overall seems to be still very healthy into second half. How do you reconcile the kind of pandemic or health care crisis with consumer demand versus your decent or good second half outlook? Thank you..

It's 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 increased a semiconductor vendor and OEMs have kept pre-building in order to avoid supply chain disruption. So – and also business have to carry buffer inventory to accommodate a rebound of opportunity arising from the opening of economic – economy.

So we do see people view this a little bit different. It 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 are not seeing a significant order cut at this time, and we will be cautiously optimistic in the second half, okay..

Yes..

We expect more opportunity will be driven by the 5G handset and the PC. Noble demand will pick out associated with the work-from-home and home schooling trend. Despite the smartphone shipment actually declined this year, overall smartphone, but we expecting capture higher smartphone market share driven by the 5G handset launch.

This year, we see about 200 million units or 20 million units from 2019. And the silicon content of 5G phone will also increase such as PMIC and RF switch. Well, this will actually position us to take advantage of that margin trend. Besides the significant 5G phone shipments, our customer also exciting 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 competency in the second half outlook here..

Yes. That's very, very helpful. That will be all my questions. Really, really appreciate your timing and insight..

You're welcome..

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

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

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

I see. And then also, you did mention that Q3 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?.

Yes. The magnitude of $20 appreciation is actually more in third quarter than that in second quarter. So yes, we do foresee that to have some a negative impact for both our topline and bottom line..

Okay, got it. All right. Thank you..

Sure..

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

Okay. Thank you for squeezing me in at the end. Maybe just a follow-up to that last question on the 28-nanometer. 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 on to that node over the next few quarters?.

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

Okay. The second question I wanted to ask is maybe the direction. You talked about actually fairly good strength. So I'm curious, fourth quarter, just an early look at it sometimes has a bit of seasonal decline, but just factoring your comments.

If it looks like this year, based on your demand and customers wanting to carry inventory, if it looks like it's holding firm as we go toward year-end.

And I'm curious, the other products, which I presume it's auto industrial, which is the weaker area, if you're seeing any signs of stabilization bottom out or recovery in that area?.

Well I mean, instead of talking about Q4, let's look at the past couple of quarters and this outlook in Q3. In those other areas, beside the communication, consumer and computing, we did to 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 starting to stabilizing and starting to see the sign of recovery. But given the past history of this year up – being down and up and down, we just have to cautiously look at it.

And I think if you're talking about Q4, we'll give you a much better clarity in the next conference call..

Okay, great. Appreciate that. Thank you..

All right..

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

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

Thank you. And ladies and gentlemen, this 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 at www.umc.com, under the Investors Events section. You may now disconnect. Goodbye..