SMIC (Minutes): Demand slows in the fourth quarter, currently not considering accelerating capacity expansion.

The following are the Minutes of the Q2 2025 earnings call of$SMIC(00981.HK) organized by Dolphin Research. For the earnings interpretation, please refer to "SMIC: "Hot" Valuation Meets "Cold" Results, Is the Revaluation Path Suspended?"

I.$SMIC(688981.SH) Review of Core Financial Information

1. Q3 2025 Earnings Guidance: Revenue is expected to grow by 5% to 7% quarter-on-quarter. Gross margin: Expected to be in the range of 18% to 20%.

II. Detailed Content of SMIC's Earnings Call

2.1 Executive Statements of Core Information

1. Q2 Performance Overview:

a. Revenue of $2.209 billion (QoQ -1.7%), mainly due to a 6.4% decline in Average Selling Price (ASP), partially offset by a 4.3% increase in shipment volume, driven by distributors stocking up and replenishing inventory due to changes in domestic and international policies.

b. Gross margin: 20.4% (QoQ -2.1 percentage points), mainly affected by changes in product mix and ASP decline.

c. Capacity utilization: Increased to 92.5% (QoQ +2.9 percentage points), with improvements in both 8-inch and 12-inch utilization.

2. Driving Factors:

a. Analog Chips: Significant demand growth, benefiting from domestic customers accelerating the replacement of overseas products in areas such as mobile fast charging and power management, resulting in incremental orders through deep cooperation.

b. Automotive Electronics: Maintained steady growth, with various automotive-grade chips (analog, PMIC, CIS, etc.) achieving a 20% QoQ growth overall.

c. CIS (Image Sensors): Revenue grew by more than 20% QoQ.

d. 8-inch Wafers: Strong demand, revenue grew by 7% QoQ, with capacity utilization better than peers.

3. Revenue Structure Analysis:

a. By Region: China's revenue share is as high as 84%, with a stable structure.

b. By Application: Consumer electronics (41%) remains the largest segment, followed by smartphones (25%) and computer tablets (15%).

c. By Size: 12-inch wafers contributed 76% of the revenue.

4. Future Outlook:

a. Limited visibility for Q4: As customers have already stocked up and built inventory in the first three quarters, urgent orders and stocking demand are expected to slow down in Q4. Management is collecting customer feedback for evaluation.

b. Risks previously worried about by management, such as tariff policy implementation, demand being pulled forward, and decline in commodity demand, have not yet occurred.

c. The company's overall capacity still cannot meet all market demand. Therefore, even if Q4 demand slows down, it is not expected to have a significant impact on capacity utilization.

d. Assuming no major changes in the external environment, the company maintains its goal of annual performance growth exceeding the industry average.

2.2 Q&A Session

Q: The company's Q3 guidance is strong, with robust demand in platforms such as analog, CIS, and automotive. What are the core drivers of growth for these platforms? In your view, how much of this strong growth is due to customers replenishing inventory or placing orders in advance to cope with tariff uncertainties, and how much is due to genuine demand for domestic substitution?

A: This year, the total shipment volume in the mobile phone market is expected to be flat compared to last year, and our growth in the mobile sector is mainly due to the increase in our customers' market share, rather than the growth of the overall market. Our revenue grew by 22% in the first half, which can be understood as our customers' orders also increased by this much.

There is indeed a situation of pulling forward orders to avoid tariffs, but this mainly occurs in consumer products and does not have a significant impact on us. The fundamental reasons for growth are twofold: First, geopolitical factors have prompted customers to prioritize supply chain security; second, and more importantly, our customers' product competitiveness has strengthened, iteration speed has accelerated, and they can perfectly replace foreign IDM products, amplifying product value by integrating multiple chip functions into a single package.

An important evidence is: if it were purely pulling forward orders, demand should weaken by August and September. However, the order situation we see now is that capacity remains in short supply at least until October. This indicates that the growth in customer market share is sustainable genuine demand, not just short-term stocking behavior.

Q: You mentioned that Q4 will show seasonality. Does this mean there will be a seasonal decline as in previous years? Considering the interference of factors such as tariffs this year, how should we understand and view the specific situation in Q4?

A: For Q4, the uncertainty mainly comes from the mobile terminal market. Manufacturers' stocking plans at the beginning of the year may have been overly optimistic, and if they now lower their annual expectations, they may reduce orders in Q4. However, this may not have a significant impact on SMIC for two reasons:

① Buffer from customer share increase: Our customers originally had a small market share, and the continuous growth in share has brought them significant business increments. This is real new demand for us, which can withstand market seasonal fluctuations.

② Capacity remains in short supply: We have been in a state of full load and unable to meet all orders until October. Even if some demand decreases, it only reduces the "overflow orders" we cannot fulfill, and the factory will still maintain high load operation.

Therefore, when we say "unclear," it refers to the final direction of the entire terminal market, but we are still very confident about our own order situation.

Q: The company's Q2 financial report shows that the revenue share from North America is 12.9%. What is the proportion of business directly sold to the US mainland? Considering recent news reports that the US may impose high tariffs (even 100%) on semiconductor products from China, how does management assess the direct impact of this potential policy on the company's business?

A: We evaluated the impact of high tariffs with all overseas customers in May and June this year. The conclusion at that time was that the impact of tariffs on affected customers' business was less than 10%. Based on our North American total revenue share of 13%, the final impact on the company's total revenue is expected to be less than 1.3%.

Now, after a few more months, customers have made more adequate preparations, such as stocking up in advance or finding alternative suppliers. Therefore, we believe the actual impact now will be smaller than initially assessed.

Q: The depreciation and amortization in operating costs decreased by 6% QoQ. What is the specific reason for this? Considering management's statement that depreciation may increase in the third quarter, what is the company's overall outlook for future depreciation expenses? How will this affect future gross margin levels?

A: This is mainly due to the improvement in capacity utilization and wafer output. Although the company's overall depreciation total has increased due to the commissioning of new capacity, higher output has diluted the fixed depreciation cost allocated to each wafer. Therefore, the total depreciation included in "operating costs" has actually decreased. Simply put, the higher the utilization rate, the lower the proportion of depreciation in total costs.

As new capacity continues to be commissioned, the total depreciation in Q3 will increase significantly, putting great pressure on the gross margin. Therefore, our Q3 gross margin guidance (18%-20%) is flat with Q2, based on the need to maintain very high capacity utilization to offset the impact of rising depreciation with increased output.

Q: The company previously planned to enter the power device market. What specific progress has been made in product development and customer introduction? With the increasing power requirements of AI servers, this brings new market opportunities for power devices and analog chips. How does management view this trend? How does the company plan to seize the growth opportunities brought by AI-related business?

A: Our development of the power device business is mainly driven by customer demand. In the past, we focused on advanced logic processes and outsourced power devices. But now, both foreign IDM and domestic terminal customers require us to provide a "Total Solution" that includes power devices, no longer accepting single product procurement. To meet the needs of these important customers, we must do it ourselves. With our existing technical foundation and production line advantages, our power device business has rapidly scaled up and is currently in short supply.

Our positioning is very clear: not participating in price competition in the general market, but focusing on providing supporting and customized capacity for strategic customers, building according to their future needs, and not making unnecessary investments.

Q: The company's performance in Q2 and Q3 is favorable, with significant improvement in 8-inch demand. Are these new demands mainly from domestic customers or foreign customers? Considering that European customers are also promoting the China for China strategy, what new progress can the company share in attracting international customers in areas such as power devices?

A: Our newly built 8-inch capacity in recent years is mainly customized to meet the needs of specific major customers, so the equipment is advanced and highly automated, with competitive advantages.

International customers are the main body: International customers' orders and shipment volume currently account for more than 50%, and are still growing. We are cooperating with their China for China strategy, establishing supporting capacity for their new demands in power devices, third-generation semiconductors, etc. Domestic customers are growing rapidly: Domestic design company customers are growing at ten times the speed, causing our 8-inch capacity to be in serious short supply.

To balance supply and demand, we are actively guiding the rapidly growing domestic customer orders from 8-inch to our newly built, technically superior 12-inch compatible production lines (such as nodes above 90nm). Customer introduction is currently smooth, and orders for the 12-inch compatible platform are also growing rapidly.

Q: The company expects ASP to increase in the third quarter. Is this increase mainly due to product mix optimization (higher value product share increase), or is there a possibility of directly raising product prices due to full orders? Is there room for price increases in the future?

A: Our ASP increase in the third quarter is not due to proactive price increases, but due to two structural changes: ① Product mix optimization: Some previously low-priced, discounted 12-inch orders have returned to normal prices, naturally raising the average price. ②High-value product share increase: The new capacity mainly consists of higher-value 12-inch wafers, whose shipment share has increased, raising the overall weighted average price.

Our pricing strategy is very clear:

• Not proactively raising prices: We will not lead price increases, but if comparable peers in the industry raise prices, we may follow.
• Not proactively lowering prices: We adhere to the price bottom line. The only exception is to provide strategic price support to help our strategic customers cope with price competition in their market and maintain their share.

Q: You mentioned high prosperity in fields such as analog IC and automotive electronics. From different downstream sub-markets, is there a difference in order visibility? Can you provide an outlook for each situation? Although the company itself has not proactively raised prices, from the customer level, do you think your customers (design companies) have the potential to further raise prices on their own products?

A: The areas with high growth certainty mainly include:

• Network communications (wired/wireless): The domestic substitution process is very fast, with significant order growth.
• Memory supporting chips: As domestic memory manufacturers expand capacity, their supporting control chips and other logic circuit orders also grow with high certainty, and most are outsourced to us.

Stable and continuous growth areas:

• Mobile phones: Although total mobile phone sales are stable, benefiting from two major trends: first, our customers' share is increasing; second, "function sinking" (high-end functions spreading to mid-to-low-end phones) has increased the chip usage per unit. Therefore, orders will continue to grow.
• Industrial and automotive: Despite global market adjustments, benefiting from China's huge domestic demand and customer share increase, our orders are still growing.

It is worth mentioning that the verification cycle for domestic substitution in automotive electronics is very long (a product cycle exceeds one year), and customer introduction is cautious. Therefore, although we are actively deploying, this part of the business will maintain growth, but the speed is relatively slow and will not explode in the short term.

Q: Can you further elaborate on the high-growth "network communications" field you mentioned earlier, including which specific product types?

A: The network communications products we refer to cover multiple levels and application scenarios, with the common feature being the rapid iteration and switching speed of the products themselves and suppliers. Specifically, they include:

1. Civil/consumer-grade connection chips: Such as wired Ethernet, Wi-Fi, Bluetooth, etc.
2. Network system-level equipment chips: This part is broader, including chips used in communication base stations, cell networks, industrial networks, and even data centers. These scenarios require processing large amounts of wired and wireless data import and conversion.

Q: From Q3 2023 to now, the semiconductor industry has been moderately rising for nearly two years, experiencing inventory replenishment and demand recovery. From a more mid-term perspective, how do you judge the current stage of the industry cycle? Looking ahead, do you think this boom cycle will continue to rise smoothly, or is there a risk of decline?

A: The semiconductor cycle is closely linked to the macroeconomic cycle. Major recessions in history, such as the 1998 Asian financial crisis, the 2001 internet bubble burst, and the 2008 subprime mortgage crisis, were all triggered by external macroeconomic or financial crises, rather than issues with the semiconductor industry itself.

Therefore, the key to judging the cycle is whether there is a crisis risk in the macroeconomy. Based on all the reports we currently see, and the analysis of the international financial system, it is generally believed that the likelihood of a macroeconomic crisis occurring in the next two years is low. Based on this, industry forecasts generally believe that even excluding the high-growth AI segment, the global semiconductor industry, measured in USD, will maintain a stable growth of 5%-6%. Considering the annual natural price decline of 3%-5% for existing products, this means the actual shipment volume growth will be higher.

Unless an unpredictable extreme event (black swan) occurs, we expect the semiconductor industry to have a stable growth trend in the next two years, without seeing a cycle decline.

Q: You mentioned a full order outlook for Q3. Can you specifically forecast the trend of capacity utilization for 8-inch and 12-inch wafer fabs in Q3 and the second half of the year? Can we see a stable and increasing state?

A: The 92%-93% capacity utilization rate we provided actually represents a full-load state where orders far exceed capacity. This number does not reach 100% mainly due to the following structural reasons:

1. R&D occupation: A significant portion of our capacity is fixed for R&D, which is not used for production, so the theoretical upper limit of capacity utilization will not be 100%, usually not exceeding 95%.
2. Accounting calculation method for new equipment capacity: We follow very cautious financial rules. Once equipment enters the factory and is included in capacity, it is counted as the denominator. But in reality, every product on new equipment requires a long verification cycle of up to 9 months (domestic customers) or even longer (international customers) by customers, and before verification is completed, these new equipment cannot be truly used for mass production orders.
3. "Burden" of continuous expansion: We have a large amount of new capacity added every year (such as 60-70 thousand pieces/month). This means that at any point in time, a large portion of the total capacity is in the "already included in the denominator but cannot be used for order production" verification stage. This naturally lowers the overall capacity utilization number.

Our capacity utilization numbers are strictly calculated according to the highest industry standards and have not sacrificed the verification process for production like memory manufacturers. Therefore, the current 92%-93% utilization rate is basically equivalent to a full-load state where orders cannot be fulfilled.

Q: Since the current capacity utilization remains high and orders are in short supply, will the company consider accelerating expansion plans in the future?

A: We currently do not consider accelerating expansion. In fact, our annual capital expenditure (Capex) in the past few years has reached $7-8 billion, a number that even exceeds our annual revenue, which is already a very fast development and investment speed in the industry. After comprehensive risk management considerations and consulting shareholders and other parties, our current strategy is to maintain a stable and balanced expansion speed, rather than leapfrog development.

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