Semiconductor Manufacturing International Corporation (SMICY) Management on Q3 2020 Results - Earnings Call Transcript

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Semiconductor Manufacturing International Corporation (OTCQX:SMICY) Q3 2020 Earnings Conference Call November 11, 2020 7:30 PM ET

Company Participants

Guo Guangli - Domestic Disclosure Representative and Senior Finance Director

Zhou Zixue - Chairman

Gao Yonggang - CFO, Executive Director, and Joint Company Secretary

Zhao Haijun - Co-CEO and Executive Director

Liang Mong Song - Co-CEO and Executive Director

Conference Call Participants

Randy Abrams - Credit Suisse

Szeho Ng - China Renaissance

Huang Leping - CICC

Junjie Chen - Tianfeng Securities

Operator

[Foreign Language] Welcome to Semiconductor Manufacturing International Corporation's Third Quarter 2020 Webcast Conference Call. Today's call is hosted by Dr. Zhou Zixue, Chairman of SMIC; Dr. Zhao Haijun, Co-Chief Executive Officer; Dr. Liang Mong Song, Co-Chief Executive Officer; Dr. Gao Yonggang, Chief Financial Officer; and Ms. Guo Guangli, Vice Secretary.

Today's call will be live streamed through the Internet at SMIC's website. Webcast playback will also be available approximately one hour after the event. [Operator Instructions] Today's format will be in both Chinese and English.

Without further ado, I would like to introduce to you, Ms. Guo Guangli, Vice Secretary for forward-looking statements.

Guo Guangli

[Interpreted] Good morning and good evening. Welcome to SMIC's third quarter 2020, earning webcast conference call. Today our Chairman Dr. Zhou will make opening remarks. Following our CFO Dr. Gao will highlight our financials and give future guidance and then our Co-CEO Dr. Zhao and Dr. Liang, will provide business commentary. This will be followed by our Q&A session, hosted by Dr. Zhao, Dr. Liang and Dr. Gao. As usual, our call will be approximately 60 minutes in length.

To meet the needs of domestic and foreign investors, the format of today's earnings call will be as follows. The management team will provide their commentary in Chinese, and Investor Relations will translate to English. And for the Q&A session, we will accept questions in both Chinese and English. The earnings release and presentation are available at www.smics.com.

Let me remind you that today's presentation includes forward-looking statements that are not guarantees of future performance but represent our estimates and are subject to risks and uncertainty. Please refer to the forward-looking statement in our press release.

Today's earnings statement use international financial reporting standards, IFRS, but we will also reference financial measures that do not conform to IFRS in order to help investors compare SMIC's past performance. These non-IFRS measures may be different than similar data presented by other companies. Please refer to the tables in our press release. Please note that all currency figures are in U.S. dollars unless otherwise stated.

I will now turn the call over to our Chairman, Dr. Zhou.

Zhou Zixue

[Interpreted] In July 2020, SMIC listed on the Shanghai Stock Exchange Science and Technology Innovation Board, opening a new chapter in the Company's development. This year also marks SMIC's 20th anniversary. On behalf of SMIC, I would like to express our heartfelt and sincere thanks to our customers, suppliers, investors and the society for their trust and support over the years.

Since its founding, SMIC has consistently focused on improving core competitiveness and company value, enriching product portfolio and expanding technology platforms. In the past two decades, our production capacity has expanded steadily. Revenue has grown continuously, customers diversified and reputation sound. We have built more effective management, R&D, operations and support teams and accelerated innovation and development.

As the first red chip company listed on both the Asia and Hong Kong markets, SMIC has received extensive attention and support from capital markets at home and abroad. The company has always attached great importance to the interest of investors, disclosed its information in accordance with the regulatory requirements of all relevant jurisdictions and further improved the level of corporate governance so as to protect the rights and interest of investors.

In recent years, China's IT industry maintains good growth. However, in the area of FinTech technology, there is still a clear gap between Mainland China's companies and the industry's top tier peers in terms of equipment, technology and talent.

The fragmentation of the global industry supply chain and high-end continuous investments are unique characteristics of foundry industry. As the largest foundry in scale in mainland China through study and analysis of long-term market demand, the company has driven a continuous development cycle of its old and new fabs based on 20 years of operational experience. And we steadily expand production capacity, improved operational efficiency, optimize our product portfolio and strive to enhance the competitiveness of the company.

This year the global economy has slowed down, which ultimately results in some negative impacts to the end demand of the semiconductor industry. However, the unfortunate epidemic has also led to the emergence of new formats, models and applications, which has ushered in a booming market opportunity. This year, customer demand continued to be strong and the company continued to maintain high utilization. In the ever-changing macro environment, we are pleased to see that our third quarter performance continued to reach new record high. We have also raised our annual revenue guidance up to 24% to 26%.

Currently, the international situation has become increasingly complex. SMIC is a foundry that serves diverse customers, domestic and overseas. Since its inception, SMIC strictly operates in compliance with the laws and regulations of all jurisdictions in which it operates. We feel deep regret in regard to U.S. export restrictions.

At present, the company is operating as usual. And though the export restriction will have an impact on SMIC in the near-term, we believe its manageable. We will continue to follow up on this matter and further evaluate the impact. The company will maintain close cooperation with suppliers and customers and continue to maintain active communication with the relevant department of the United States government working to resolve possible differences.

The world has entered Internet of Everything era. The interest of all countries are closely tied and their outcomes are shared. Although the current global trade situation has many uncertainties and external environment is becoming more complex, we believe that the pace of innovation and development in the semiconductor industry will continue. In the long run, the demand for the IC industry remains strong and challenges and opportunities coexist.

SMIC will continue to pursue openness, cooperation, development and successful collaboration, deepening cooperation with domestic and foreign customers, suppliers and partners contributing to promote the development and innovation of the semiconductor industry. Thank you.

Guo Guangli

[Interpreted] Thank you, Dr. Zhou. I will now hand the call over to our CFO, Dr. Gao Yonggang, for financial highlights.

Gao Yonggang

[Interpreted] Thank you, Dr. Zhou and Guangli. Greetings to all our listeners. Please be reminded that all earnings figures are prepared in accordance with IFRS unless otherwise stated.

First, I will highlight our third quarter results and give the fourth quarter 2020 guidance. Our third quarter 2020 revenue reached another record high of $1,083 million, an increase of 15.3% sequentially and 32.6% year-over-year, mainly due to strong customer demand and sequential increase in wafer ASP. In addition, incremental growth in other revenue was also another major driver for the revenue increase.

Our third quarter 2020 gross profit also hit another record high of $262 million. Gross margin was 24.2% higher than original guidance, mainly due to better product mix and growth in wafer ASP and other revenue. Gross margin was sequentially down mainly due to higher depreciation and amortization in the third quarter 2020.

Non-IFRS operating expenses were $215 million lower than guidance range, mainly because of the control of R&D and G&A expenses. Profit for the period attributable to SMIC was $256 million, another all-time high, while non-controlling interest was $7.15 million of debit to SMIC's attributable profit. EBITDA also achieved a record high of $653 million and increased 14.3% sequentially.

Moving to the balance sheet. At the end of third quarter, cash on hand, including current financial assets and restricted cash, was close to $12.3 billion. Total assets were close to $29 billion and total equity was around $21 billion, including non-controlling interest. Gross debt to equity was 20.3% and net debt to equity was negative 38.4%.

In terms of cash flow, we generated a historical high of $719 million of cash from operating activities in the third quarter. On July 16, SMIC listed on the stock market and raised total net bonds close to RMB52.5 billion, including the green shoe option. According to our plan, RMB18 billion will be used for SN1 project, RMB17.7 billion will be used to supplement working capital, RMB9.8 billion will be used for capacity buildup for non-FinFET technology, RMB7 million will be used as reserve funds for research and development of FinFET and non-FinFET technology. We thank our domestic and overseas investors for your support and trust.

Now looking ahead into the fourth quarter of 2020, our revenue is guided to be down 10% to 12% quarter-over-quarter, mainly due to one, a decrease in wafer shipments; two, a decrease in other revenue. However, if you look at the midpoint of guidance, our revenue in the fourth quarter is expected to grow around 15% compared to the fourth quarter of last year.

Gross margin is expected to range from 16% to 18%, mainly because of one, sequential decrease in other revenue. Two, increase in depreciation and amortization. Three, decrease in utilization to a healthy [ph] level. Foundry is a CapEx intensive industry with a large investment cycle. The initial introduction of products in the new fab lines has negative impact to the overall profitability due to depreciation costs.

In addition, referencing industry's practice, we will not provide guidance for non-IFRS OpEx and non-controlling interest starting this quarter. However, I will give some color on the two index to help investors to better understand the outlook of the fourth quarter. Now IFRS OpEx is expected to have no big difference compared with third quarter, while losses to be borne by non-controlling interest are expected to be substantially higher than previous quarters.

To look into the year of 2020, we revised our new revenue growth targets of mid to high teens, to an increase of 24% to 26%. Our annual gross margin target remains to be higher than last year. In terms of capital spending, we decreased our CapEx plans from $6.7 billion to $5.9 billion, mainly due to one extended or uncertain delivery lead times of certain equipment from U.S. suppliers due to export restriction. Two, delay in equipment moving scheduled caused by logistics.

Annual depreciation and amortization is expected to be close to $1.3 billion. Annual EBITDA is expected to be close to $2 billion. This concludes the financial remarks. Thank you.

Guo Guangli

[Interpreted] Thank you, Dr. Gao. I will now hand the call over to our Co-CEO Dr. Zhao Haijun, for his business remarks.

Zhao Haijun

[Interpreted] Thank you all for joining us. This year is a very special year. The world has encountered a huge epidemic, major customer has seen change and urgent demand has emerged in the market.

In the third quarter and since the beginning of this year, SMIC continued to maintain high utilization. Operating results were in line with expectations. And the full year is forecast to reach a growth of 24% to 26%. Recently, news of U.S. imposed export restrictions on SMIC has resulted in concerns with regard to the company's future developments.

I thank all of you for your consideration and reiterate that SMIC only provides products and services for civilian end users, and has no military end users. As an international foundry, SMIC strictly complies with the laws and regulations of all jurisdictions where we conduct business. Over the years, we have established good cooperative relations with well-known customers, and semiconductor equipment suppliers in the United States and internationally. After the event, we immediately issued an announcements, sorted through the information with our suppliers, and informed customers of possible risks.

At the same time, we have communicated and exchanged with relevant U.S. government departments. At present, the company is operating as usual. However, since U.S. original equipment fabs and raw materials may have certain delivery lead times. We hope to build more trust through openness and transparency, and restore normal procurement processes as soon as possible. We also thank our customers and suppliers for their trust and support.

Now I will briefly report on the status of our new FinFET technology platform operations in the third quarter. By product segments, power management, radio frequency signal processors, fingerprint sensors, and image signal processor-related wafer revenue grew 8% quarter over quarter, and 22% year-over-year. Microprocessors and specialty memory related wafer revenue grew 6% quarter-over-quarter and 26% year-over-year.

Looking at application market, the rapid upgrade to 5G mobile phones and the change of at home work and study during the pandemic has triggered global acceleration of demand for internet and consumer products. With revenue from smartphone and consumer electronics grew 13% sequentially and 25% year-over-year. The fourth quarter will follow the trend of the first three quarters maintaining strong demand for CMOS image sensors, image signal processor, RF IoT DC power management and specialty memory. The capacity shortage is still significant for 40-nanometer 65-55 nano and 0.15, 0.18 micro process nodes.

Looking at industrial landscape and customer events, it is expected that FinFET capacity will be relatively tight through the first half of next year for the whole industry. We will work hard to cultivate our segmented product platform to meet customer and market develop development needs.

Guo Guangli

[Interpreted] Thank you. Dr. Zhao. I will now hand the call over to our co CEO Dr. Liang Mong Song for his business remarks.

Liang Mong Song

[Interpreted] Thank you. Guangli. Thank you all for joining us today. This year is unusual year for the semiconductor industry and SMIC. Everyone is very concerned about SMIC's current situation. As we stated in our previous webcast, we have always operated in compliance with the relevant laws and regulations of all jurisdictions where we do businesses.

Regarding export restrictions, we are actively communicating with the U.S. government and co-working with our U.S. suppliers to apply for the required export licenses for certain U.S. origin equipment parts and raw materials, in accordance with relevant laws and regulations. We are keeping communication channels open and are in close contacts with our customers and suppliers to reiterate our robust clients' procedures. While export restriction may lead to extended lead time or uncertainty, we are still evaluating the overall impact.

I would like to share some details on our current FinFET technology progress. As a pure play international foundry, we provide services to a variety of commercial and civilian customers. Our first generation FinFET technology, 14 nano platform is relatively comprehensive. Our product covers a wide range of applications, including but not limited to communication, consumer, computer, IoT, auto and others.

Last year 14-nano process entered into mass production in the fourth quarter and our yield has already reached industry standards. As we showcase our ability to execute in research and development, customers' confidence in SMIC's technology capability has also gradually increased. We will continue to enhance the competitiveness of our products and services and join more customers locally and abroad.

Our second generation FinFET technology and N+1 is progressing steadily. Our N+1 process is undergoing customer verification and entering small body of test production. This product will be mainly used for high performance computing applications.

As compared to the first generation FinFET technology, our second generation FinFET technology platform is driven by lower cost, more engaged customization. And when comparing to our 14-nano process, the performance is improved by 20%, power consumption reduced by 57%, logic area reduced by 63%, and SOC area reduced by 55%.

Overall, we are currently working on more than a dozen FinFET tapeout projects for technology 14 nano and below with both domestic and overseas customers. We believe with the rise of 5G IoT and the digitization in schools and workplaces, there will be huge market opportunities for the IT industry.

To promote innovation and development the company will continue to push forward with our R&D activities, so we can meet the needs of our customers and the growing digital consumer market. The development of these new nodes and projects take time. We will expand our FinFET technology one step at a time.

In terms of capacity we commit to prudent planning to build capacity based on the market and our customers' demand. As a foundry we are actively engaging with global customers to create a more diversified customers and products portfolio.

Our FinFET technology capacity is comparatively small in scale, and our extension is relatively steady. At the same time for equipment that may be adversely impacted by an export restriction, we are actively resolving the issues and coming up with corresponding solutions with our suppliers.

To conclude, we have reached our R&D milestone for this year. And I want to take this opportunity to thank our team for their hard work and perseverance. Although, we have accomplished certain achievements in the R&D and operations of FinFET technology, we are still lagging behind the top tier peers in terms of technology. There's still a long way to go. We are an independently operated international foundries and we endeavor to serve the global customers.

Although we are now facing some difficulties, we are actively responding and carefully assessing the overall impact of the export restrictions and corresponding solutions. We will continue to pay close attention to this matter, and will share further information as appropriate, if there are any significant changes or progress.

We thank you for your continued support and thank you for joining us today. I will now turn the call over to Guangli for Q&A session.

Guo Guangli

[Interpreted] Today's Q&A will be hosted by our CO-CEOs Dr. Zhao and Dr. Liang and our CFO Dr. Gao. We will accept questions in both Chinese and English. Questions asked in Chinese will be answered in Chinese. Questions asked in English will be answered in English. As usual, please be reminded to limit your questions to two per person.

I would now like to open up the call for Q&A.

Question-and-Answer Session

Operator

[Foreign Language] [Operator Instructions] Your first question comes from Randy Abrams from Credit Suisse. Please ask a question.

Randy Abrams

Okay. Yes, thank you. And I appreciate the updates on the business situation. My first question, you mentioned in the remarks, the restriction will have some impact near-term on SMIC. Could you elaborate which areas you see the impact in terms of revenue, capacity expansion or technology development?

Zhao Haijun

Hi, Randy. Here's Haijun. I'd like to answer your question this way. The first impact is the schedule of the capacity expansion. And we do have some machines scheduled to support the roadmap in the fourth quarter and the first quarter next year. But now, we are still in the process of application. So we already have two months type of delay for certain type of machine, like the high-energy implanter type of machines, that’s the delaye.

On the others, we need to work together with our customers, with this kind of delay on expansion of capacity, how can we settle down their requirements in the fourth quarter and first quarter next year?

Liang Mong Song

Hi, Randy, this is Mong Song. I will add on Haijun's comment on technology development. Technology development side, there is a very limited impact. We would proceed as our plan, yes.

Randy Abrams

Okay. And if I could ask just one follow-up to that and then I have a second. Are there any critical bottlenecks to maintaining production on mature 8-inch or 12-inch? And maybe now it's okay, but are there any bottlenecks if the restrictions continue, that may open up a few quarters? Or do you expect - do you have the tools and spare parts to at least maintain your 8-inch and 12-inch operations?

Zhao Haijun

Hi, Randy, here is Haijun again. We do not have immediate issues for the short-term. But in the long run, you know that, certain type of material, especially for the consumables cannot be stored for very long time. So currently, I work together with our suppliers, including the second tier suppliers on - to get a solution to this kind of concerns. So far, both parties are working together, including our counterparts in the United States. And we have concerns but we have the confidence that we can resolve it without impact on the normal production of the running so far in the factories. No impact to the deliveries to our customers.

Randy Abrams

Okay, great. And then my second question on the fourth quarter sales decline, your growth in third quarter was led by advanced nodes, 40, 28, 14. For fourth quarter, would advance nodes pull back more and maybe the reason. And also could you discuss the other revenue that grew in third quarter and now declining in fourth quarter?

Zhao Haijun

Randy, you already mentioned that the decline on the advanced technology part mainly cover on the other revenues. And the other revenues are actually this way, and SMIC, if you see the third quarter, actually, it's very special. That means there are urgent requirements on the delivery, the customer has deadlines to deliver these kind of products. So, we have to slowdown certain type of the other products, not that urgent and get everything done to customer requests in the third quarter.

So that means if we swap certain type of capacity and the products in the third quarter and make it third quarter so high and the other quarter, fourth quarter seems lower. But if we normalize the two production and the loading situation in SMIC suffers, actually, we are very normal running. And floating in fourth quarter, floating in third quarter, it's just swapping. And that's why I mentioned the - that's hard.

And another thing other revenues also means certain part of a turnkey and our subsidiaries in the backend wafer bunking this kind of revenues. And they also have the same pattern. That means we were pulling in, they do more. And when we finish that part, they also recover to normal.

Randy Abrams

Okay. And to follow-up, do you expect to recover rebound the other and advanced technology after the fourth quarter pullback?

Zhao Haijun

Hi, Randy. In advanced technology, the customer needs to take about a year-and-a-half to start from design to production. So when we cannot serve for a key customer, existing key customers’ production and it might take some time or few quarters to recover our utilization in advanced technology production.

Randy Abrams

Okay, great. Thank you. Yes, good luck on resolving everything. Thank you.

Zhao Haijun

Thanks, Randy.

Operator

Your next question comes from Szeho Ng from China Renaissance. Please ask a question.

Szeho Ng

[Foreign Language]

Zhao Haijun

[Foreign Language]

Szeho Ng

[Foreign Language]

Zhao Haijun

[Foreign Language]

Operator

Your next question comes from Huang Leping from CICC. Please ask the question.

Huang Leping

[Foreign Language]

Zhao Haijun

[Foreign Language]

Operator

We got time for one final question. And your last question comes from Junjie Chen from Tianfeng Securities. Please ask the question.

Junjie Chen

[Foreign Language]

Zhao Haijun

[Foreign Language]

Junjie Chen

[Foreign Language]

Liang Mong Song

[Foreign Language]

Junjie Chen

[Foreign Language]

Zhao Haijun

[Foreign Language]

Junjie Chen

[Foreign Language]

Operator

[Foreign Language] I would like to hand the call back to Ms. Gao for closing remarks.

Guo Guangli

[Interpreted] In closing, we would like to thank everyone who participated in today's call. And again, thank all of you for your trust and support. Thank you.

Operator

This concludes SMIC's third quarter earnings conference call. We thank you for joining us today.

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