United Microelectronics Corp

TWSE:2303

Earnings Call Analysis

UMC Stability Amid Market Decline

In Q3 2023, UMC's revenue slightly grew to TWD 57.1 billion, and gross margin held steady at 35.9%, with earnings per share at TWD 1.29. Despite a 2% reduction in wafer shipments and 67% utilization rate, performance was stable, thanks to improved product mix and favorable exchange rates. Yearly, UMC saw a 20.5% revenue drop and a decrease in gross margin from 45.8% to 35.8%. The Asia region contributed 58% to the revenue, with communication increasing to 46% quarter-over-quarter. While UMC forecasts a 5% drop in Q4 shipments, with gross margins in the low 30% and utilization in the low 60%, CapEx remains on track at USD 3 billion.

UMC's Quarter of Stability Amid Market Headwinds

UMC's third quarter of 2023 stood as a beacon of stability in a tumultuous market. Despite a slight 2.3% dip in wafer shipments, the revenue climbed marginally by 1.4% to TWD 57.1 billion. The company's ability to maintain a static gross margin at 35.9% underscores its resilience, reflective of robust demand in the computing and communications segments, bolstered by product mix enhancements and favorable currency shifts. Earnings per share (EPS) also saw a modest increase from TWD 1.27 to TWD 1.29, indicating a steady profitability in the face of declining shipments and capacity utilization, which stood at 67%.

Annual Overview Reflects Market Turbulence

The first nine months of 2023 painted a contrasting picture, revealing a 20.5% year-over-year decline in top-line revenue, landing at TWD 167.5 billion. This is reflective of a broader industry downturn, with the gross margin dropping notably from 45.8% to 35.8%. Nevertheless, UMC's earnings remained robust with an EPS of TWD 3.87, supported by firm average selling prices (ASPs) and the strategic expansion of specialty technologies.

Geographic and Segment Insights Show Varied Performance

Asia continued to dominate UMC's revenue by geography with a 58% share, while Europe and North America maintained their share, and Japan saw a 2% decrease. Notably, communication segments upturned to 46%, possibly reflecting a shifting focus or burgeoning demand in that sector, whereas consumer electronics saw a decrease. The introduction of new capacity in the P6 line contributed to an increased revenue share for 22/28 nanometer technologies, hinting at UMC's operational expansion and future growth potential.

A Glimpse into Q4 2023: Projections Amidst Restraint

President Jason Wang provided guidance for the fourth quarter, projecting a 5% decrease in wafer shipments and a gross margin anticipated to hover in the lower 30% threshold. The conservative sentiment is also shared by clients, who prefer maintaining lean inventory levels, particularly in a challenging automotive sector. Yet, the foundation is laid for future growth with the production ramp of the 12A P6 fab enhancing 22/28 nanometer revenue contributions and a maintained capital expenditure plan of USD 3 billion for 2023.

Navigating the Competitive Landscape with Strategic Pricing

UMC's executive team is keenly aware of the intensifying 8-inch market competition and slower demand recovery. The strategy moving forward involves aligning prices with market dynamics while sustaining their pricing strategy and customer-centric support. This balanced approach aims to secure their client's market share and strengthen UMC's overall market position, even as industry challenges persist.

Earnings Call Transcript 2023-Q3

[Operator]

Welcome, everyone to UMC's 2023 Second Quarter Earnings Conference Call. [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. Mr. Lin, please begin.

[Michael Lin, executive]

Thank you, and welcome to UMC's conference call for the third quarter of 2023. I'm joined by Mr. Jason Wang, the President of UMC and Mr. Chi-Tung Liu, CFO of UMC. In a moment, we will hear our CFO present the third quarter financial result, followed by our President's key message to address UMC's focus and fourth quarter 2023 guidance.Once our President and CFO complete their remarks, there will be a Q&A session. 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 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 a more detailed description of these risks and uncertainties, please refer to our recent and subsequent filings with the SEC and the ROC security authorities. During this conference, you may view our financial presentation material, which is being broadcast live through the Internet.Now, I would like to introduce UMC's CFO, Mr. Chi-Tung Liu, to discuss UMC's third quarter 2023 financial results.

[Chi-Tung Liu, executive]

Thank you, Michael. I'd like to go through the third quarter 2023 Investor Conference presentation material, which can be downloaded or viewed in real time from our website.Starting on Page 4, the third quarter of 2023, consolidated revenue was TWD 57.1 billion, with gross margin at 35.9%. Net income attributable to the shareholder of the parent was TWD 16 billion, and the earnings per ordinary shares were TWD 1.29, which is slightly better than the previous quarter of TWD 1.27. And our shipment in the third quarter declined sequentially about 2%, and capacity utilization rate in the third quarter was 67%.Page 5 is the income statement for the third quarter, and revenue grew 1.4% sequentially to TWD 57 billion, due to better mix and also better blended ASP, as well as helped by the favorable exchange rate.Gross margin remained somewhat similar to the previous quarter, at 35.9%, or TWD 20.4 billion. Operating income reached about TWD 15.96 billion, which is equivalent to TWD 1.29 EPS in the third quarter of 2023.On Page 6, is the first 9-months performance. Because of the downturn of the cycle, we witnessed around 20.5% year-over-year decline in our top line, which was TWD 167.5 billion. Gross margin rate dropped from 45.8% in the previous year to the first 3 quarters of the year of 2023 of 35.8%. And EPS for the first 3 quarters of the year reached TWD 3.87 per share.On Page 7, the cash on hand is still around TWD 140 billion, with the total asset is more than TWD 547 billion.On Page 8, our blended ASP, as I mentioned earlier, due to the better mix and also the difference in between 12-inch and 8-inch wafer capacity utilization rate, our blended ASP in the third quarter continued to edge up in the third quarter of 2023.For revenue breakdown on Page 9, Asia remained the biggest segment of the pie around 58%, which grew about 2 percentage points from the previous quarter. And Europe and North America remained unchanged when Japan declined by about 2 percentage points in terms of revenue breakdown.IDM versus Fabless on Page 10 remained unchanged quarter-over-quarter. On Page 11, we see a small increase in communication, which is 46% in the third quarter. And consumer dropped from 26% in the second quarter to 23% in the third quarter of 2023.On Page 12, along with our increased capacity coming out of P6 in 22/28 nanometer, our revenue also grew accordingly, now reached 32% in the third quarter of 2023. For total revenue for 49 nanometer and below in the third quarter, reached 45%, which compared to 41% in the previous quarter.For capacity breakdown on a quarterly basis on Page 13, as P6 continued to have new capacity come on stream, we see about more than 1% capacity increase in the third quarter. And the following quarter in Q4, we expect to see more than 2% sequential capacity growth, also mainly due to the capacity increase in our Tainan P6 facility.On the last page of my presentation is on Foundry CapEx, which currently running on track, and its budget to be remained unchanged around USD 3 billion for year 2023.So the above is the summary of UMC results for third quarter of 2023. More details are available in the report, which has been posted on our website.I will now turn the call over to President of UMC, Mr. Jason Wang.

[Jason Wang, executive]

Thank you, Chi-Tung. Good evening, everyone. Here, I would like to share UMC third quarter results. During the third quarter, despite a 2.3% decrease in wafer shipments, quarterly revenue and gross margin remained firm quarter-over-quarter, which is primarily attributed to the demand strength in computing and communication segment, continuous product mix enhancement, as well as a favorable currency movement.From end market perspective, strength in computing application was propelled by LCD controllers, Wi-Fi, codec, and touch IC controllers, while shipments in communication segment increased due to demand for RF front-end IC and networking chips.Looking back at 2023, although foundry industry experienced a significant decline in market demand, UMC maintained solid structural profitability, supported by firmness in blended ASP due to continuous product mix optimization efforts and the increased contribution from specialty technologies.As UMC continues to introduce new specialty technology to solidify our differentiation, we will strengthen the competitiveness of our customers and enhance their respective market position.For the fourth quarter, with the recent rush order from PC and smartphones, we expect demand has gradually stabilized. However, customers still employ a cautious and conservative approach in maintaining a lean inventory level, while automotive business conditions appear challenging.For 2024, we anticipate the production ramp of our 12A P6 fab will further enhance revenue contribution from 22/28 nanometer, continuing the robust business traction for UMC. In addition, through our technology leadership, we will ramp up our offering on 22 nanometer derivative products, which will further our specialty technology product pipeline.Now, let's move on the fourth quarter 2023 guidance. Our wafer shipment will decline by approximately 5%. ASP in U.S. dollars will remain flat. Gross margin will be in the low 30% range. Capacity utilization rate will be in the low 60% range. Our 2023 cash-based CapEx will be budgeted at USD 3 billion.That concludes my comments. Thank you all for your attention, and now we are ready for questions.

[Operator]

Thank you, President Wang. And ladies and gentlemen, we will now begin our question and answer session. [Operator Instructions] And our first question is from Sunny Lin, UBS.

[Sunny Lin, analyst]

So, my first question is on gross margin. Q1 -- I mean, Q3 gross margin was actually better than guidance, but even with that Q4 gross margin, it's got to drop towards low 30%. And so, what's the key factors affecting gross margin into Q4?

[Jason Wang, executive]

Well, first of all, for Q4 gross margin, guidance will be at a low 30% range, mainly due to a decline in utilization rate. As we expected, there will be probably a 5% decline in shipment.

[Sunny Lin, analyst]

Got it. Then on the overall pricing environment, are you seeing any differences, i.e. intensifying competition because of the slower demand recovery for the coming few quarters?

[Jason Wang, executive]

Well, I mean, we're very much aware of the market situation and we respect the foundry market and pricing trend. We're aware of the market dynamic and competitive landscape, so we will close monitoring the market aligned with our customer pricing position to ensure our customers' competitiveness. And along with securing their market share, that will be our objective.UMC maintains our pricing strategy. In addition, we do believe our value-added technology, manufacturing quality, and capacity alignment that support our customers to enhance their market position.However, we observed that 8-inch market landscape has intensified, like you said. But we may have to adjust some pricing or some market segment to align with the market dynamics. For the 12-inch business, we will remember our pricing position, which will reflect our value.

[Sunny Lin, analyst]

So my second question is on 28-nanometer. UMC has built a fairly strong presence in some of the products, like OLED driver, Wi-Fi, ISP, et cetera, but I believe some of your competitors are also trying to ramp up capacities and capabilities, especially for OLED driver and Wi-Fi. And so going forward, looking into next 2 or 3 years, how should we think about the overall competitive landscape for 28-nanometer? And what are some of the new product opportunities that you will look to ramp in the coming few years?

[Jason Wang, executive]

Well, I mean, there's a couple of questions. One is our current 28-nanometer outlook, right? For the 22 and the 28-nanometer loading, we have remained resilient amid near-term market volatility. Well, thanks to our customers' stickiness, our diversified product portfolio and technology differentiation. And we will continue to expand our 22 and 28-nanometer market share with the application like OLED driver, ISP, Wi-Fi, SoC processors, while we are working with the leading companies to bring up more application on 22 and 28-nanometer platform.As far as the competition, we do believe, there's always a competition there, and we will try to compete with that, particularly in the 28 high-voltage space. You mentioned, well, we believe -- first of all, we believe the OLED market will continue to grow, and we will continue to maintain our leadership technology position and the market share position, even though we are cooperating with multiple leading customers in those key markets.

[Operator]

Next question, Nicolas Baratte, Macquarie.

[Nicolas Guy Gabriel Baratte, analyst]

When you guide for a 4Q wafer shipment to decline 5% Q-on-Q, is there any segment specifically that we can attribute this to? And what I mean in particular is, you mentioned better demand from computer and communication in 3Q. Is it still the case in 4Q? Or what is changing into 4Q that you could talk about?

[Jason Wang, executive]

Sure. For the Q4 outlook, and currently we see the PC and the Chinese smartphone segment will remain in line with the Q3. However, for the automotive market, given that the customer have been accumulating backlog from early, last year till probably Q1 this year, we expect higher than expected inventory build up already.As a result, our auto business is projected to decline in Q4. But 4 years, automotive contribution will still count for mid-teens as a percentage of our wafer revenue.

[Nicolas Guy Gabriel Baratte, analyst]

I don't think you report your revenue exposure to the Industrial segment, but do you see similar trend in industrial?

[Jason Wang, executive]

It's similar, but it's actually better than automotive right now. Both automotive and industrial is covered under the others, but the major decline is coming mostly from automotive space.

[Nicolas Guy Gabriel Baratte, analyst]

Maybe for Chi-Tung, any updated view on depreciation this year compared to last year?

[Chi-Tung Liu, executive]

This year, it's like...

[Nicolas Guy Gabriel Baratte, analyst]

Still declining a little bit.

[Chi-Tung Liu, executive]

Yes. In terms of absolute depreciation expenses, this year, 2023 is likely to be the bottom of recent years. We probably will witness the lowest point in terms of absolute depreciation expenses in 2023.Going to 2024, because of our P6 expansion in Tainan coupled with the shell construction in Singapore, the overall depreciation will start to rebound, and the increase rate in 2024 will be more than double digit, which will provide a more precise number -- precise range in the next quarter's conference call.

[Nicolas Guy Gabriel Baratte, analyst]

I understand next quarter, Chi-Tung, but my mechanical model, very mechanical projection, percentage of PP&E tells me next year, depreciation could go up 25%. Does that sound vaguely possible?

[Chi-Tung Liu, executive]

Well, again, this year, we will see a 5% to 10% decline first. So it's a really recent low in terms of annual numbers. But next year, 2024, yes, your number is in the ballpark.

[Operator]

Next one, Gokul Hariharan, JPMorgan.

[Gokul Hariharan, analyst]

First of all, Jason, could you talk a little bit about all this capacity that's been announced and coming online in so many places, but especially in China. We start to hear a lot from your customers also about pretty aggressive price code from Chinese foundries and some of your customers starting to consider some of the capacity as well.So my question is like a little bit longer-term. How do you think about pricing, given that the foundry industry has seen a pretty nice price increase through the last 2, 3 years, the pandemic years especially. And what kind of a price premium can UMC maintain in like 28, 40, 65-nanometer kind of nodes who are some of the more aggressive competitors that are coming up? And also, could you kind of refresh our memory on what is your current LTA coverage, given that you have some of the new capacity that has come online with pretty high LTA coverage?

[Jason Wang, executive]

Well, okay. Yes, sure. Well, I mean, the competition is always going to be there. As you said, there's many new capacity announced, particularly coming out from the China. And from UMC, we have always tried to maintain our competitiveness through a few area. One is a continuous technology innovation.Second is diversify the production side with a sizable capacity offering, and which is actually become increasingly important. Third is the manufacturing excellence. We all know both cycle time quality as well as the yield is so important to customers and for them to be competitive. And the fourth is with a broader customer base and a product portfolio.With this compelling differentiation, we believe we can continue to provide a reliable and dependable path to secure future growth for our customers. So that's pretty much on a higher level.Your question relate to in terms of the pricing. Like I mentioned earlier, we respect the market dynamics and we will stay competitive and supporting our customer to be competitive. And right now, we have discussed and continue aligning with our customer, usually on an annual basis, so one-off pricing alignments. And we'll continue with that practice and with the understanding of the market outlook.And for that, and that will be a different pricing position in terms of different technology nodes, like you said. For 28, and we are remaining resilient and amid the near-term market volatility as well as the forward-looking product pipeline. And so we feel rather comfortable about the confidence about our 28 nanometers.For the mature 12-inch outlook, we will transition into more specialty technology for our mature 12-inch nodes and where we foresee promising new opportunities, which coming into notebook and tablet space, such as RF SOI, non-volatile memory, and high voltage. And we anticipate a 55 and a 40 nanometer will be a mainstream for RF SOI and MCUfor a broader range of the market, including the wireless, automotive, and industrial application. So again, we will stay competitive and then we will align with the market dynamics and to support our customer in terms of the commercial needs.

[Gokul Hariharan, analyst]

Could you also refresh your memory on roughly what is your LTA coverage now? I think it used to be about 30 to 40%, but it looks like that's gone up given the new capacity that's coming.

[Jason Wang, executive]

If you're talking about NTA or LTA?

[Chi-Tung Liu, executive]

LTA.

[Gokul Hariharan, analyst]

LTA, sorry, LTA.

[Jason Wang, executive]

The LTA has been, stays fairly flat. It's about 25% to 30% coverage. And we've been reporting many times in the past, the LTA still is a mechanism to support both customer and UMC on the longer-term perspective. And particularly given the recent market dynamics, and we both are examining our current LTA quality as well as the status on the LTAs. And because our customers continue wanting to make sure their supply resilience and align with our interest of protecting our investment. So many LTAs have been reviewed and we actually believe those LTA has mutual commitment as a -- to them. So the 25% and 30% remains fairly resilient at this time, yes.

[Gokul Hariharan, analyst]

Okay. One follow-up on the LTAs. Are you seeing any price downward negotiations on any of the LTAs given that you mentioned that you're seeing some of the reviews on the LTAs right now?

[Jason Wang, executive]

Well, during the downturn cycle, we definitely work with our customer and look at the market situation and giving a change in the demand of supply dynamics. And we -- between the UMC and our customer remain confident in the long-term objective, but in the short-term, we do have some tactics and flexibility to make the customer and UMC collective to navigate through this market fluctuation. So yes, there are some flexibility in terms of that. With the long-term contractual obligation commitment that they are still intact.

[Gokul Hariharan, analyst]

Understood. One last question from me. How do you think about capacity expansion given the downturn seems to be lasting a little bit longer than expected and you're running at 60% or low 60s utilization except during the year? Do you have any thinking about pushing out some capacity expansion further, especially for some of the new capacity in Singapore? Importantly though, because the depreciation burden is also rising quite a bit going into next year?

[Jason Wang, executive]

Absolutely. For the P6, we're already in the process of ramping up. So it's harder to making adjustment on those. So we anticipate our 12A P6 monthly capacity will still reach to 12K per month by end of 2023. And it will reach its design capacity of 31.5K per month by September 2024. And that's still there.And for the P3 Singapore, we have deployed a clean room construction. So the clean room will still be ready by the first half of 2024. And, but however, we expect the P3 capacity ramp starting time at April 2025 without change. And because we have alignment with some of the customer already, however, the ramp profile will be moderated based on the market dynamics, which that has some adjustment to the ramp profile.

[Operator]

Next one, Bruce Lu of Goldman Sachs.

[Bruce Lu, analyst]

I want to ask you about the outlook for 2024. I mean, based on my mechanical mathematics, it seems to be very comfortable for your P6 expansion with LTA remain on track. So which P6 will give you 30,000 wafer per month capacity for next year. Each wafer should be $3,000 to $3,500. If you multiply by that, you can easily get like 15% plus revenue growth. In addition, you should have some inventory restocking commitment for that. So that can easily give you like 15 plus percent revenue growth for 2024. So is that sounds right? I mean, at least you can get the revenue growth on your LTA contribution from P6.

[Jason Wang, executive]

I mean, yes, I mean, of course the revenue growth for the 2024 is a composition between the volume and the ASP. So for the 2024, our early view for the next year, we will expect our loading and wafer shipment will increase year-over-year. And so that's it. However, we have to look at quarterly outlook by quarterly, given we're saying the current customers behavior are more cautious and conservative. So we will provide quarterly outlook on quarterly basis.And so in terms of actual, what will be the growth for the next year? We probably will probably give you a bit of a more clarity in the upcoming calls.

[Bruce Lu, analyst]

But at least for the LTA pricing and environment is for sure, right?

[Jason Wang, executive]

I mean, yes. I mean, LTA right now is still intact. And so for that portion, it is, but that's still some base that have to align with the market dynamics. And also on the same time, we did talk about for the LTA, there are some flexibility in terms of adjustment, but the longer-term perspective on LTA did not change, but the short-term LTA, it has some flexibility that we are trying to align with our customer with. So they also account for the next year's projection, yes.

[Bruce Lu, analyst]

I see. I understand because the reason I asked is that LTA alone is 1-5, 15% plus for the world unless you have a lot of push out or additional ASP erosion. Otherwise that should be the base case.

[Jason Wang, executive]

Well, theoretically that's correct assumption, but you have to look at the mix, right, yes?

[Bruce Lu, analyst]

I understand that. The second thing is that I tried to ask a bit different question is that, if you look at your customer profile, Asia customer contribute a lot more than most of your peers. The communication also consume a lot, a major portion of it, which result in a much bigger fluctuation in terms of revenue, order visibility, longevity. Do you see any possibility to see meaningful changes in terms of your customer profile and application profile in the coming year?

[Jason Wang, executive]

I mean -- we'll continue enhance our product mix, right? I mean, not only from the broader customer mix point of view also look at from the product mix point of view. So I think that's the clear focus, right?However, whether the addressable, we have to also address align to our addressable market and whether the addressable market is representing higher percentage of the communications and computing throughout the consumer and which is highly aligned with the Asia market. We may not be able to immune from that, but we definitely want to continue to increase the quality of that mix. And that will be our objective here, not typically from the geographical standpoint.

[Bruce Lu, analyst]

So can we foresee a narrower range for the pick and drop market moving forward? Because the margin volatility is still very, very big. It's still a lot of investors don't feel comfortable, right?

[Jason Wang, executive]

Right. So like we said, the technology innovation, differentiation, giving the diversified capacity located in a different region, and giving the specialty offering, we think that will help us to defend that to a certain extent.The other approach is, we are committed to continue developing the FinTech technology that will actually enlarge the differentiation offering as well. And we will continue with that development and in terms of the -- and we see some of the progress on our FinTech development as well.Having successfully entering into the mass production of our 22-nanometer business, and we have witnessed some steady rise of the revenue from 22 and then which we can build upon our 22. Low-power logic expanding into the specialty now, at the same time, we, based on that customer base, continue migrating to the FinTech. We think that will also help us in terms of differentiation.

[Operator]

Next question, Charlie Chan, Morgan Stanley.

[Charlie Chan, analyst]

And first of all, congratulations for great results. The gross margin sustained at a very, very good level. So my first question is really a follow-up on your 12-nanometer. So I do agree that it's the key approach for UMC to differentiate yourself, especially compared to China competitors. So since you mentioned that there are some kind of demand from certain customers, can you elaborate a little bit, first of all, when are you going to spend CapEx for data FinFET capacity?And secondly, you mentioned about low-power logic. Can you give us some hints of what kind of application or product for those 12-nanometer FinFETs?

[Jason Wang, executive]

Sure. Well, first of all, FinFET does give you a power leakage benefit.So there is continuing with the low power benefit on the FinFET. Well, our plan is to fully exploit the DUV capability, which, we can continue migrating to FinFET for that reason.So we're actively progressing with the development of specialty FinFET based on the 14 FinFETs that we have. And also the 12 FinFETs based upon the current FinFET technology. We are currently engaging with customer on product spec performance criteria to fulfill their needs. And as far as for the capacity expansion, the future FinFET expansion consideration, all business was still subject to our ROI justification to ensure the proper return on investment.For the capacity preparation, the method that we approach, the approach that we have is we will employ a cost effective approach using the existing 22 and 28-nanometer capacity pool to transition into the FinFET based on a high 2 conversion rate.So that will help us to achieve our ROI driven criteria. And meanwhile, we will give you more update on our FinFET technology development when it's more appropriate.

[Charlie Chan, analyst]

Got it. So Jason, so yes, so just roughly, roughly since you have a great idea about the end demand event, some smart and efficient way, right, to converge capacity from 28-nanometer for that demand. So can we get a sense when you're going to see a first development contribution from a 12-nanometer?

[Jason Wang, executive]

For the 12 nanometers, the process will be free in early 2025. So I think that probably there will be time after that. Well, so when the time comes, we'll probably better that we give you more precise projection, because the process will be free by probably Q1, 2025.

[Charlie Chan, analyst]

And then coming back to more kind of short-term questions. So you mentioned about some rush orders, but you also said that customers want to keep the inventory buffer very, very lean. So my question is, first of all, do you expect those rush orders keep coming in the coming quarter? And compared to the traditional system, do you think your first quarter, the revenue or fab utilization that will be better than historical system energy?

[Jason Wang, executive]

Well, I mean, we certainly hope that the rush orders will come in. Well, as far as for the Q1 outlook, we will provide that in the upcoming January call. The -- on the inventory, I mean, the fundamentally is we believe, given the rush order coming up on the PC and the smartphone space, and we believe there's a sign that indicates, there's going to be an early sign of it asset in the inventory correction for this segment. And however, there are other market segment that still having inventory build out that could lingering into 2024.So we just have to -- we have -- we are optimistic, but we have to be cautious about that.So we will continue monitoring the rush order situation as well as the DOI situation on those segment. Hopefully we can validate that some of the segment is for sure out of the inventory correction cycle, but we do know the outflow will probably lingering into 2024.

[Charlie Chan, analyst]

Got it. And my next 2 questions for Chi-Tung, if that's okay. So it seems like you have a ballpark depreciation increase for next year. And Jason, can you share some confidence about the pricing trend, especially for 12-inch. So I'm wondering whether for year 2024, you can maintain course margin at above 30% because based on the third quarter trend and the fourth quarter guidance, I feel like there is a kind of achievable target, but I really want to get some comments or confirmation from management.

[Chi-Tung Liu, executive]

Yes, we cannot commit on the numbers, but we do foresee headwinds from micro uncertainty such as utility, the green power associated carbon cost and increasing depreciation in 2024. So -- but we will strive our best to maintain our profitability structure. So we will continue with our cost reduction effort. Hopefully can offset the impact from those headwinds I just mentioned. But in terms of number is still will be on a quarterly basis and we will provide that next quarter.

[Jason Wang, executive]

And Charlie, if I may add, our perspective now is that amid an inventory correction cycle, we have dramatically improved our structural profitability compared to the pre-pandemic period and have strengthened by the stable ASP cost reduction -- conducting many cost reduction activities, and continuous product mix optimization, and increasing contribution from specialty technology.All this activity will work-off to offset the headwinds, such as rising cost and depreciation. We do expect when the demand returns, our profitability will also return to a healthier level. We can't really guide you a number right now, but we also understand and humble enough to understand that we will be -- we will foresee some of the cost increase headwinds and we will continue to manage that cautiously as we have done in those few years.

[Charlie Chan, analyst]

Got it. And Jason, sorry, I -- I come up with a follow-up question to your previous 12 nanometer comment. So, I am a little bit surprised that you plan to convert some 28/22 nanometer for the FinFETs. Is that because you have some conservatism for your long-term 28 nanometer demand or why don't you try to buy new equipment for the FinFET capacity extension?

[Jason Wang, executive]

I mean, clearly, I mean, we have for the past few years, we have driven, we do have an ROI-driven principle that we have obeyed by. So the converting a 22/28 nanometer capacity is a one of a possibility, but that's the only possibility. So we will look at overall ROI and also the company's financials and to determine what would be the best approach. Yes.

[Charlie Chan, analyst]

Okay. So I don't need to interpret it that as kind of some constant about the 28 nanometer over capacity on the long-term.

[Jason Wang, executive]

Right, like I said, the earlier, once this is more clear, and we will report that at the appropriate time.

[Charlie Chan, analyst]

Okay. And sorry, the last question to Chi-Tung is really about, sorry, actually 2 questions. So first of all, for your third quarter gross margin, how much of that is coming from the currency depreciation help? And second, small question is about the China government subsidy contribution to your OpEx. And would that totally go away in 2024?

[Chi-Tung Liu, executive]

So every 1 percentage point change in currency, it will cost around 0.4% -- percentage point change in our gross margin. So that answers your first question. And secondly, for the subsidy for our Xiamen fab, that numbers goes along with our depreciation curve for our Xiamen facility, which has come to an end of, majority of that has come to an end by end of this year. So going forward, we will still have some small portion of subsidy coming in, but it will not go back to the previous level.

[Charlie Chan, analyst]

So may we know a rough difference between this year and the next year in terms of the total amount of the subsidy from China government? That's a rough idea.

[Chi-Tung Liu, executive]

Yes, on average, it will be slightly -- slowly decline from the third quarter level, which is a little bit over TWD 500 million.

[Charlie Chan, analyst]

Okay. So TWD 500 million in third quarter, and we'll gradually phase out to like USD 100 million by the end of next year, the quarter?

[Chi-Tung Liu, executive]

It will gradually decline, but we will continue to apply for merit-based incentives, not only in China, but in many other production sites as well. So there will still be some, yes.

[Operator]

Next one, Szeho Ng, China Renaissance.

[Szeho Ng, analyst]

My first question regarding second interposer. For the capacity we put in, will it be dedicated for interposer production only, or will it be fungible between interposer and silicon wafer fabrication?

[Jason Wang, executive]

Well, I mean, the silicon interposer is a part of the capacity. For the dedicated to silicon interposer it cannot be converted back to the other use, but there are common tools that can be used. So -- I don't know if that qualifies as a fungibility, but yes. On a dedicated to standpoint, no, it's not. But that's a relatively small portion, yes.

[Szeho Ng, analyst]

All right, got you, got you. And the other question regarding the automotive inventory adjustment. You mentioned that Q4 we start to see some adjustment, but how long would it last, in your opinion?

[Jason Wang, executive]

Well, I mean, they started adjust after the Q2 this year. And so we have facing the automotive inventory, I mean, demand adjustment happening starting from Q3 already. And we do believe this will probably lingering into 2024.

[Szeho Ng, analyst]

2024, the entire year or the first half of next year?

[Jason Wang, executive]

Well, I mean, it is also subject to the end market consumptions, right? We hope the correction will be ended in the first part or first half, but also subject to the end market and macro environment. So we'll continue monitoring that. Right now, we for sure, there's inventory buildup for automotive space. And we do believe that will linger into 2024.In terms of whether they will be depleted by early or mid or later, we will continue to update that on a quarterly basis. And it is our hope that they can deplete as early as possible, yes.

[Szeho Ng, analyst]

I see, I see. Based on the initial selling, do you think the adjustment will be more severe in Q1 compared to Q4? I mean, for the automotive vertical?

[Jason Wang, executive]

Well, I mean, we already see quite a bit of adjustment in Q3 already, and we continue to adjust in Q4. And so, and we do believe that will linger into Q1. In terms of magnitude, again, we're subject to the macro situation. So we just have to, we have to see it. We also kind of updated earlier saying, because giving the customer current behavior, this behavior is more of a cautious and conservative. So the visibility is much shorter. And so we'll probably better that, if we give you more precise view on the quarterly basis. Right now, our view is that inventory will linger into 2024.

[Szeho Ng, analyst]

I see. All right, fair enough.

[Operator]

Next question, Brad Lin of Bank of America.

[Brad Lin, analyst]

Jason and Chi-Tung, congrats on the strong third quarter results. And I have 2 questions. So basically one on the generative AI, and another is on the wafer-to-wafer technology of UMC. So firstly, have the firm seen business opportunities also rising from the end device AI application? And if any, what are the key specs of those chips? And what time do we expect it to take-off?

[Jason Wang, executive]

I mean, for sure. Of course, the end of quarter for sure, but before that, your question about AI. AI is a mega trend. And it has rapidly emerged as we see. And there will be a strong demand on related chips on various functionality such as sensing, MTU connectivity. And so that's within our addressable market. And so UMC is proactively preparing those solutions for this market. And that includes the interposer solution as well. And we hope that having those solutions prepared, that we can enable our customers to capture those market share in the AI applications.So many of the products that we're engaging today, we do see there's a high possibility they will start adding the AI function into it. And so we just have to align with the product specification, make sure we can enable and support them with that.As far as the near-term, very specifically on the interposers, we're already in interposer production. Currently, UMC interposer capacity plan will be doubled to reach 6K per month by Q1, 2024. At this point, any additional capacity for interposer expansion will depend on customer demand outlook as well. So, meanwhile, we're continue developing the active interposer, which is support the DTC, the deep trench capacitor, and for the active interposer, so on. So the roadmap is also aligning with the customer for the future growth in the interposer space.

[Brad Lin, analyst]

Got it. So for the interposer expansion, we believe it definitely depends on, very much depends on the client demand. So compared to our last earnings call, do we see the demand is getting stronger or it's just, well, flattish in terms of availability?

[Jason Wang, executive]

We already increased double to 6K, and beyond that 6K, we have not have any alignment for increase that beyond the 6K. Right now, the focus is more on the pipeline of continuity for the interposer solution. So in terms of technology development, that's already aligned for the next generation. But in terms of capacity, there's no number beyond the 6K yet. Once there's any number increase, we can also report that.

[Brad Lin, analyst]

Got it. So the second question is on the wafer-to-wafer technology. So we have learned UMC has been investing in this technology for many years. And what time do we expect the contribution to rise? And what are the key application that we expect to adopt this kind of the technology?

[Jason Wang, executive]

Yes. The first product by using the hybrid bunk will be in the RF front-end module. So -- and that's already, the development's already underway. And so we do believe that will provide many benefits. So we have some expectation on that. So, but the program is under development and the product application will be for the RF front-end.

[Brad Lin, analyst]

Got it. And then, may I know the potential margin profile for this kind of the product?

[Jason Wang, executive]

I mean, as we said, we continue to enhance our product portfolio and the product mix. And for those specialty technology, it will continue helping us to achieve that target. So from the mix standpoint, it will be benefit from it, yes.

[Brad Lin, analyst]

Got it. That's a very clear.

[Operator]

Ladies and gentlemen, we're running out of time. So we're taking the last one. And the last question, Gokul Hariharan, JPMorgan.

[Gokul Hariharan, analyst]

Yes. I just have one question. Given this comment about the depreciation of fees next year, could you talk a little bit about what are our medium-term gross margin targets? Like, do we expect to still remain within the 35% to 40% kind of gross margin range? And especially, I think you're also thinking about potentially developing some FinFET nodes, especially the 12 nanometer nodes in 2025 and beyond, which are likely to be a little bit more expensive. Just wanted to understand what is the rough gross margin kind of range that management is comfortable operating in over the next couple of years?

[Jason Wang, executive]

Yes, of course. When Charlie asked about our margin and the outlooks, I kind of added a comment about it's our belief that our structural probability is become much resilient and healthier. And so it's also our belief once the loadings return and the probability will also return to a healthier level. When we talk about healthier level, we believe it's going to be in the high 30%, 40% range for in a very high-loading situation. So we continue marching to that direction and we have confidence that that's fairly achievable. But given the past few years, we've just gone through the super cycle and now we're going through the down cycle and we want to test that situation and hopefully that we can report to you more clearly in a later date.But while we have a mapping now and model it, we think we have a roadmap to achieve that. And in turn, when can we achieve that? We'll giving -- let's give that test and then we'll report that on the tiny bit, yes.

[Chi-Tung Liu, executive]

Yeas, as for 12 FinFET capacity buildup, as Jason mentioned, it has to be ROI justified. So we will do it with the precondition that it won't damage to our overall corporate average structure margin. So we mentioned that it could be coming from some of the conversion of 20 to 28 capacity which will result in a better margin compared to Greenfield FinFET capacity. But we are also working on other solution too. So it will be a few years out in terms of massive FinFET capacity. So we still will have a few more options coming in the pipeline.

[Jason Wang, executive]

So we'll definitely keep that discipline as you can see for the past few years, we have been keeping that discipline, yes.

[Gokul Hariharan, analyst]

Definitely. One last question is on the 8-inch side. It seems like in this downturn, 8-inch is facing a lot more pressure. Many staple products on 8-inch have already migrated to mature 12-inch, whether it's 65, 55 nanometer or even 40 nanometer. So, how do you see the 8-inch evolution in the next couple of years? Do you feel that 8-inch, at least some of the capacity will start becoming a little bit obsolete in the industry, given many applications, especially high volume applications that are migrating to mature 12-inch, this and that?

[Jason Wang, executive]

Sure, I mean, the reason 8-inch loading has declined as a result of the immense softness across communication, consumer and computing segments. We still believe that 8-inch is the mainstream node for PMIC, high voltage application. So we expect that 8-inch loading will improve when the market rebounds. Meanwhile, we do see some intensified competition in the 8-inch landscape, like you said, such as a 12-inch supplier, participating in the 8-inch business, even with some of the questions earlier, the Chinese local manufacturer fulfilled the demands for the domestic demand and the pricing pressure as well.So UMC will continue to strengthen our technology, competitiveness, enhance our product and customer portfolio to adjust and also adjust our pricing strategy to address the 8-inch competition.Now, as far as the loading recovery, in the short term, I think the pricing will mitigate some of the 8-inch business when the demand recovers. For the longer-term, we're giving the time and the resource required to enhance the fundamental position for the competitive solution, where the pricing is not only alternative. And we probably have to do with all above mentioned effort and focus. And however, we do expect 8-inch loading and product composition will improve to a healthier level. And for the recovery mode, we'll probably undertake for at least 12 months, yes.

[Operator]

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

[Michael Lin, executive]

Thank you 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.

[Operator]

Thank you. Ladies and gentlemen, that concludes our conference for 3Q '23. Thank you for your participation in UMC's conference. There will be a webcast replay within 2 hours. Please visit www.umc.com under the Investors Event section. You may now disconnect. Goodbye.