Taiwan Semiconductor Manufacturing Company Ltd.

Ladies and gentlemen, everyone is safe. I am Su Zhikai, the legal officer of Taichi store. Welcome to the first legal explanation meeting of Taichi company in 2020. In order to prevent the spread of COVID-19 epidemic, this legal explanation meeting will be rescheduled. Because this law will be broadcasted to global investors at the same time, we will use English all the time. Please forgive us. Ladies and gentlemen, welcome to TSMC's first quarter 2020 earnings conference call. This is Jeff Su, TSMC's Director of Investor Relations and your host for today. To prevent the spread of COVID-19, TSMC is hosting our earnings conference call via live audio webcast through the company's website at www.tsmc.com, where you can also download the earnings release materials. If you are joining us through the conference call, your dial-in lines are in listen-only mode. The format for today's event will be as follows. First, TSMC's Chairman, Dr. Mark Liu, will provide the opening remarks. Next, TSMC's Vice President and CFO, Mr. Wendell Huang, will summarize our operations in the first quarter 2020, followed by our guidance for the second quarter 2020. Afterwards, Mr. Huang and TSMC CEO, Dr. C.C. Wei, will jointly provide the company's key messages. Then Dr. Liu will host a Q&A session where all three executives will entertain your questions. As usual, I would like to remind everybody that today's discussions may contain forward-looking statements that are subject to significant risks and uncertainties, which could cause actual results to differ materially from those contained in the forward-looking statements. please refer to the safe harbor notice that appears on our press release. And now, I would like to turn the call over to TSMC's Chairman, Dr. Mark Liu, for his opening remarks.

Good afternoon, everyone. My name is Mark Liu here. Before we start our financial report, I want to take a moment to thank each of you for joining us online today. To many of you from different parts of the world, in this very time of devastating pandemic, our thoughts and hearts are with you. TSNC so far safeguarded our global operations successfully, but we do not take it for granted. We will continue our utmost effort to weather this storm, and we are in this together. In the meantime, I want to send our best wishes to you and your families for staying safe and healthy. So now let me turn the microphone over to Wendell for the summary of operations and current quarterly guidance.

Thank you, Mark. Good afternoon, everyone. My presentation will start with the financial highlights for the first quarter followed by the guidance for the current quarter. First quarter revenue in NT decreased 2.1% sequentially, which is less than seasonality due to the increase in HPC-related demand and the continued ramp of 5G smartphones. Growth margin increased 1.6 percentage points sequentially to 51.8%, thanks to higher level of utilization, which was partially offset by an unfavorable exchange rate. Total operating expenses decreased by 2.6 billion NT, mainly as 5 nanometer technology moved from R&D stage to mass production during the first quarter. Operating margin increased by 2.2 percentage points sequentially to 41.4%. Overall, our first quarter EPS was 4.51 NT and ROE was 28.4%. Now let's move on to the revenue by technology. 7 nanometer process technology contributed 35% of wafer revenue in the first quarter. 10 nanometer was 0.5% and 16 nanometer was 19%. Advanced technologies, which are defined as 16 nanometer and below, accounted for 55% of wafer revenue. Now, move on to the revenue contribution by platform. Smartphone decreased 9% quarter over quarter to account for 49% of our first quarter revenue. HPC increased 3% to account for 30%. IoT increased 8% to account for 9%. Automotive decreased 1% to account for 4%. Digital consumer electronics increased 44% to account for 5%. Moving on to balance sheet. We ended the first quarter with cash and marketable securities of $562 billion NT. On the liability side, current liabilities remain relatively flattish. On financial ratios, accounts receivable turnover days was 42 days. Days of inventory decreased 2 days to 53 days with higher wafer shipment in the quarter. Now, let me make a few comments on cash flow and CAPAC. During the first quarter, we generated about 203 billion NT in cash from operations, spent 193 billion in KPACs, and distributed 65 billion NT for second quarter 19 cash dividend. We also increased 20 billion NT in short-term loans mainly for hedging purposes. Overall, our cash balance decreased 25 billion to 431 billion NT at the end of the quarter. In U.S. dollar terms, our first quarter capital expenditures reached 6.4 billion U.S. I have finished my financial summary. Now, let's turn to our second quarter guidance. Based on the current business outlook, we expect our second quarter revenue to be between 10.1 billion and 10.4 billion U.S. dollars, which represent a 0.6% sequential decrease at the midpoint. Based on the exchange rate assumption of $1 to 30 NP, gross margin is expected to be between 50 and 52%, operating margin between 39 and 41%. Now I will hand over the call to CC for his key message.

Thank you, Wendell. Good afternoon, ladies and gentlemen. We hope everyone is staying safe and healthy. Let me start with COVID-19 preventive measurement at TSMC. To prevent the epidemic of COVID-19, many of us around the world have had to change the way we live and work since mid-January. Let me start by sharing something that what we take at TSMC. Our top priority is to protect the health and safety of all our employees at all times. As the outbreak of COVID-19, we immediately suspended all non-critical business travel and restricted visits on site access with mandatory health screening. All employees are required to do daily temperature checks with self-declaration, wear masks all the time, and practice social distancing in the office. Since late March, we have taken further preventive actions, such as having employees work from home where possible, and physically separating unsigned employees into red and blue teams to reduce the risk of community spread. On March 18th, we found one employee who tested positive for COVID-19 and immediately began receiving appropriate care. Today, this employee has recovered, is out of the hospital, and is staying at home for additional quarantine. We were able to swiftly trace all the other individuals who were in contact. The neighboring employees have all tested negative, while all other employees who were in contact have entered and completed the 14-day self-quarantine and are now back to work. As a result of the strict preventive measures taken by TSMC, we have not seen any disruption of our FAP operations so far. Now I will talk about our near-term demand outlook. We concluded our first quarter with revenue of NT $310.6 billion, or US dollar $10.3 billion, in line with our guidance given three months ago. quarter business declined about 1% sequentially, which is much less than seasonality due to the increasing SPC related demand and the continued ramp of 5G smartphone. Moving into second quarter 2020, we expect our revenue to be flattish as weaker mobile product demand is expected to be balanced by continual YG deployment and HPC related product launches. While we have not seen significant order reduction from our customers so far, we do observe supply chain dislocation and weaker end market demand from COVID-19 in the first half of this year. In the near term, we have observed weaker and demand in applications such as consumer electronics and automotive. Meanwhile, we have also observed better demand from HPC as compared to three months ago, driven by the trend such as work from home. Looking ahead to the second half of this year, due to the market uncertainty, we adopt a a more conservative view as we expect COVID-19 to continue to bring some level of disruption to the yen market demand. For the whole year of 2020, we now forecast the overall semiconductor market, excluding memory growth, to be flat to slightly decline, while foundry industry growth is expected to be high single digit to low teens percentage. For TSMC, although this uncertainty exists, we believe we can do better and grow at mid-to-high teens percentage in 2020 in U.S. dollar term. All the above forecasts for semiconductor-excluded memory market, foundry, and TSMC are based upon the assumption of COVID-19 stabilizing in June of this year. Now let me talk about the progress and development of 5G and HPC. With the recent disruption from COVID-19, we now expect global smartphone units to decline high single digit year over year in 2020. However, 5G network deployment continues and OEMs continue to prepare to launch 5G phones. We maintain our forecast for mid-teens penetration rate for 5G smartphones of the total smartphone market in 2020. We continue to expect faster penetration of 5G smartphones as compared to 4G over the next several years with substantially higher silicon content. Thus, we believe 5G as a multi-year megatrend is still strong. and will fuel the growth of all four of our growth platforms in the next several years. HPC will be another major long-term growth driver for TSMC. In the next few years, a smarter and more intelligent world connected by 5G networks will require massive increase in computation power. CPU, networking, and AI accelerators will be the main goals area for our HPC platform. Thus, while near-term uncertainty exists, we are continuing to invest in our R&D and technology capabilities to capture the future opportunities from the strong 5G-related and HPC mega-trend. We reaffirm our goal-to-goal at a high end of our long-term goals projection of 5% to 10% in US dollar terms. Now let me talk about the ramp up of N7, N7 Plus, and the status of N6. In its third year of ramp, N7 continued to see very strong demand across a wide spectrum of products for mobile, HPC, IoT, and automotive applications. Our N7 Plus is entering its second year of ramp using EUV lithography technology, while tapping the wave for N6. Our N6 provides a clear migration path for next wave N7 products, as its design rules are fully compatible with N7. N6 has already entered risk production, and is on track for body production before the end of this year. N6 will have one more EUV there than N7+, and will further extend our 7nm family way into the future. We expect our 7nm family to continue to grow in its third year and reaffirm it will contribute more than 30% of our wafer revenue in 2020. Now let me talk about our N5 status. N5 is already in volume production with good yield. Our N5 technology is a four-node stride-former N7 with 80% logic density gain and about 20% speed gain compared with N7. N5 will adopt EUV extensively. We expect a very fast and smooth ramp of N5 in the second half of this year, driven by both mobile and SPC applications. We reiterate 5 nanometers will contribute about 10% of our vapor revenue in 2020. N5 is the factory industry's most advanced solution with best PPA. We observe a higher number of tap-outs as compared with N7 at the same period of time. We will offer continuous enhancements to further improve the performance power and density of our 5nm technology solution into the future as well. Thus, we are confident that 5nm will be another large and long lasting node for TSMC. Finally, I will talk about our N3 status. Our N3 technology development is on track. With reproduction scheduled in 2021, and target volume production in second half of 2022. We have carefully evaluated all the different technology options for our N3 technology, and our decision is to continue to use FinFET transistor structure to deliver the best technology maturity, performance, and cost. Our N3 technology will be another four-node stride from our N5, with about a 70% logic density gain, 10 to 15 speed gain, and 25 to 30% power improvement as compared with N5. Our 3 nanometer technology will be the most advanced 1.3 technology in both PTA and transistor technology when it is introduced, and will further extend our leadership position way into the future. Now, let me turn the microphone over to our CFO.

Thank you, CC. Let me start by making some comments on our second quarter and second half profitability outlook. We have just guided second quarter of 2020 gross margin to be similar to the first quarter. Looking ahead to second half, we expect a steep ramp-up of our 5 nanometer. We'll dilute our second half gross margin by about 2 to 3 percentage points. In addition, our overall capacity utilization may be impacted by the uncertainty from COVID-19. Thus, our gross margin in the second half of this year may be several percentage points lower than in the first half. Looking at our other profitability factors, our leadership in technology development and ramp-up remains strong. we continue to provide value to our customers and drive aggressive cost reduction. Thus, we believe our long-term gross margin target of above 50% is still a good target. Now let me talk about our capital budget for this year. Every year, our CAPEX is spent in anticipation of the growth that will follow in the future years. While the impact of COVID-19 virus brings near-term uncertainties, we expect the multi-year megatrends of 5G related and HPC applications to continue to drive strong demand for our advanced technologies in the next several years. Thus, we reaffirm our 2020 capital budget to be between 15 and 16 billion US dollars. Now, I will make some comments on our capital management and shareholder returns. The objectives of TSMC's capital management are to fund the company's growth organically, generate good profitability, preserve financial flexibility, and distribute a sustainable cash dividend to shareholders. With our solid financial performance, strong balance sheet and cash position, and capacity to take on debt, were able to aggressively invest in our future to enhance our technologies and capabilities. This enables us to continue to outgrow the semiconductor industry, even in an extreme macroeconomic environment like this year. With our rigorous capital management, we remain committed to a sustainable cash dividends on both an annual and quarterly basis. Meanwhile, with the semiconductor industry's highest credit rating, were able to bolster our cash balance by issuing corporate bonds at a low interest rate. That concludes my message.

Thank you. This concludes our prepared remarks. Before we begin the Q&A session, I would like to remind everybody to please limit your questions to two at a time to allow all the participants an opportunity to ask questions. Should you wish to raise your question in Chinese, I will translate into English before our management answers your question. For those of you on the call, if you would like to ask a question, please press the star then 1 on your telephone keypad now. Questions will be taken in the order in which they were received. If at any time you would like to remove yourself from the question in queue, please press the pound or the hash key. Now let's begin the Q&A session. Operator, can we please proceed with the first caller on the line, please? Thank you.

The first question we have is from the line of Randy Abrams from Credit Suisse. Your line is now open.

Okay, Melissa. Thank you. Good afternoon. First question is just two parts. We wanted to go into the change in forecast versus January. If you could give an update on the change in expectation across your both platforms, in which areas are you revising? And have you seen – I'm curious if you've seen the change – in customer orders or you're proactively expecting those to come. And the second part is you sometimes give a view on inventory levels. Factoring your sales have held up implied in guidance. If you could give an expectation on where you think inventory levels at your customers are trending and if you're factoring in any risk of correction on inventory levels as some of the supply bottlenecks ease.

Okay. Randy, please allow me to try to make sure I repeat your question. So your first question is two parts. You want to know what is driving the change in our forecast as compared to what we had said in January. Have we seen a change in the outlook for our different platforms? Have we seen changes in customer orders? Or is part of our forecasting assumption of sort of what will happen in the second half? And then the second part of the question is on the fabulous inventory level that we see. Is that correct?

Yeah, that's correct.

Thanks.

All right. This is Xixi Wei. Let me answer that while we change our forecast. Because we do observe some of the yen markets become soft. As I stated in the statement, that we saw some consumer electronics such as smartphone or those kind of things has been in the end market become much softer than we thought. However, so we do the forecast now based on the customer's order because of, you know, customer today, as I said, we did not see any significant reduction in our customer demand, but we do expect the end demand will have some impact in the following second half of this year. As a result, we changed our, or we modified our forecast as compared with January, the number. To be specific, except for the HPC, the HPC has been very strong All other three areas, like smartphone, IoT, or automotive, are decreasing our forecast as compared with the way we announced it in January.

Okay, let me take the inventory part. The inventory level of our fabulous customers that we tracked was healthy, exiting fourth quarter of last year. However, given the disruption from COVID-19, we currently expect the inventory level to rise in the first half of 2020 before digesting in the second half of 2020.

Okay, Randy, do you have a second question?

Yeah, okay, second question, and it really gets into the U.S. There's been press stories about them considering equipment license restrictions And I'm curious if you can discuss how you're managing the risk or how much risk you see from that equipment license requirement that could affect one of your two customers. And in terms of the CapEx budget for this year, do you still have flexibility to make any changes this year, either for this factor or for COVID-19 if the impact appears a bit worse? Or is it pretty much locked in for 2020? Yeah.

Okay. Sorry, Randy, you're a little bit breaking up. So let me try to summarize your question. So your second question, first you relate to some of the news reports on the potential for U.S. equipment license restrictions. So you want to understand how does TSMC manage this risk? And then also as related to part of that, what is our CAPEX flexibility for 2020 in case COVID-19 situation or these restrictions? Is there flexibility in our CAPEX?

Yes, that's correct. Thank you. Okay, let me answer your question as much as I can. We are now aware that the recent development of U.S. trade rule changes. However, these rule changes is still under draft. And there are information, but we know that the final rule is not yet finalized. And after the finalized draft, there will be another 30 days of grace period for the industry to respond. In general, we share the concerns, all the concerns of US semiconductor communities, such as voices from Semi or from SIA. While the draft is not finished, we have studied the various scenarios And yes, there may be some near-term impact. And we will work with our customer dynamically. And we will take appropriate measures to minimize the impact to TSMC. However, for the mid to long term, we think the underlying megatrend still holds And some supply chain will be readjusted and the balance is out. So we will be able to still capture mid to long-term growth opportunities. And therefore, the current long-term CAPEX, we do not see its impact by this change.

Okay. Does that answer your question, Randy?

Yeah, and maybe it is that contingency if there's any flexibility, either from this fact that it doesn't go ahead or if it's more, would be more on a forward basis. But if there's flexibility, say the COVID-19 doesn't get contained, it's largely most of the spending already planned out. Kind of time to those megatrends, but if you do have flexibility, suggest that or any potential in a downside case.

So Randy is asking, then for our 2020 CapEx, what is our flexibility in case of COVID-19 uncertainty and such?

Right. We will remain as flexible as we can as we continue to monitor the virus situation and work very closely with our customers. At the same time, the majority of our CapEx is spent on advanced nodes that drives our growth in the next year and beyond. As we expect the multi-year megatrends of 5G-related and HPC applications to drive strong demand for advanced technologies in the next several years to continue, we will continue to prudently invest for our future growth.

Okay, thank you, Wendell. Let's move on to the next caller on the line.

The next question is from the line before.

Hi, thanks for taking my question. So could we go through a little bit in terms of how we think about forecasting growth? I think even that if you look at the last two, three times where we have had economic corrections, semiconductor industry has seen meaningful declines in revenues. Now we are looking at largely flattish for semi-X memory. So are we expecting that we get a pretty strong rebound into the second half of the year in terms of – so just wanted to go through – the SMC's process of thinking about overall semiconductor industry growth. And since we also expect small inventory connections happening in the second half of the year, and I have a follow-up question as well.

Okay. Gokul, let me summarize your question. I think your question is asking, in the past, when there's a severe economic correction, the semi-industry also sees a large revenue decline. So why is semi- ex-memory this year kind of flackish and how do we explain our four year outlook of mid to high teens and do we expect a more meaningful inventory correction in the second half of this year? Is that right?

That's right, yeah. Well, the semiconductor excluding the memory, as I said, that the end market is the consumer electronics were declined. However, I also mentioned that because of work from home or those communications created a lot of demand on the server, on the world communications, so the HPC will be very good as compared with our forecast in January. Net-net, so we give a kind of standard The semiconductor industries, of course, this year, probably the low single digital to be a little bit negative. That's based on what our forecast today. And what is the second question?

He's asking sort of then, do we expect a meaningful inventory correction going into the second half?

We cannot forecast it so accurately.

Let me add something, some colors. Now, as Citi just mentioned, based on our current outlook, our second half revenue is somehow flattish or may decline slightly. That really gives you an idea that the inventory is digesting in the second half of the year, for now, as we can see.

Okay, Gokul, does that address... Yeah, go ahead, your second question.

Yeah, that addresses my first question. Thank you. A second question, could you talk a little bit about the shape of the 5-nanometer ramp-up in second half of the year? I think previously, I think we have talked about this being faster than 7-nano in 2018 and probably around 10% of revenues there. Are you seeing any changes to that as a result of some of the weakness that we have seen in the consumer electronic vertical? Or for 5nm, we are still expecting a similar kind of ramp as we expected in January? Thank you.

To be sure, we don't expect any change as compared with in January, our forecast. Today, we still see the tape out very unscheduled. and the ramp-up is also unscheduled. Although we did see some of the equipment delivery has been delayed a little bit, but we are working with the equipment vendor. All in all, we think that the five nanometers ramp-up is on track, and we still see that you are contributing about 10% of the total revenue, wave of revenue.

Okay, thank you, Siti. Let's move on to the next caller on the line, please.

We have the next question from the line of Roland Shue from Siti. Your line is now open.

Hi, good afternoon. First, congratulations for the very good first quarter result. I would like to follow up for these whole year revenue goals, Kuching. I think now you are looking for these mid to high pins percentage plus goals for the whole year revenue. So, Kuching, do you actually need any equipment, material, or any kind of equipment a ramp-up gauge of disruption of the supply chain due to this travel ban?

Okay. No, we did not see any disruption from the material supply or any supply chain activity that has been in disruption mode. Although I did say that because of shelter-in-home, that some of the tool delivery has been delayed from two weeks to about one month. However, as I said, we continue to work with the tool vendors and minimize the impact on the capacity building. So for the whole year, we don't expect to have a big impact.

But how about for the equipment startup? Because for this shuttle in Hong Kong, I think the equipment vendor probably won't have enough engineers to do the equipment startup. Will that be in the real-life stages?

Well, that has been planned. From the outbreak of COVID-19, we already worked with the equipment vendor, so they arranged enough engineering resources in Taiwan or, you know, all over the world. So we don't worry about poaching.

Okay, thank you. For my second question, I would like to ask about your capital management. Normally, I think in the past, you found that all of your cash has been spent from your operating cash flow, and now you just probably fund it by issuance of the corporate bank. Again, when the expense is spent, this actually I would like to preview cash for investment net growth. The question is, first, for this issuance of the corporate bond, is there any upper limit you have in order to fund your cap? Will you continue to issuance this corporate bond?

Roland, first of all, we expect our operating cash flow to continue to be sufficient to finance our capital expenditures. Secondly, the decision to issue a corporate bond was made before COVID-19. We looked at our future expansion plan, we looked at the current interest rates, and we decided it's good timing to issue a low-cost corporate bond just for any uncertainties.

Understood. Okay. And so your cash dividend, I think I remember you said that you would like to start maintaining a sustainable cash dividend in both the quarterly and the annual basis. So I understand, I think that your annual basis policy is paying a total cash no less than previous years. And how about your quarterly cash dividend policy? In this right now, I make the $2.5 per share per quarter a policy to TSMC.

Okay. Roland, so your question on the cash dividend, you say that our sustainable cash dividend policy on an annual basis means we will not pay less than 10 NT in any year going forward. Then your question is on a quarterly basis, will we pay less than 2.5 NT on a quarterly basis?

No, no.

Yeah. Okay?

Well, the quarterly cash dividend will be up here to change. However, the whole year annual cash dividend, I think that will be still maintained to no less than previous years, right?

No, no less. The quarterly cash dividend will not be lower than the previous quarter. And as a result, you won't have a lower annual dividend than the previous year.

Okay. So even for now, we are paying $2.5 per share for crypto. That means going forward, I'll quickly catch this one. It won't be less than $2.5 going forward.

Yes, you are correct.

Yes.

Okay.

Okay. Thank you, Olin. Let's move on to the next caller on the line, please.

Next question is from Daryl Lee from UDS. Your line is all open.

Yeah, hi there. Good afternoon, and thanks for taking my question. My first question is on 5 nanometers. It is PSMC's first full EUV node, and it is non-production. So two-part question. One is I know this year it is on track, but if you look at the customer adoption going through 2021, can you give us some ideas for maybe the number of customers that are going to use 5 nanometers for maybe revenue contributions? Secondly, now that we're in production, can you talk about the learning on PHY so far? Specifically, can you talk a little bit about maybe cyclotime versus 7 nanometers, the year ramp, and maybe on the cost, how it compares to 7, just because it is the first EUV node. Thank you.

All right. You want to repeat the question? Sure.

Okay. Okay, so Bill's question is on 5 nanometer in UV, two parts. One, he wants to know that we are ramping, we see a steep ramp in the second half of this year, but what does 5 nanometer look like for 2021 in terms of customer adoption, the number of customers or the revenue percentage contribution in 2021? That's the first part. And then the second part is, Can we share some of the learning that we have seen on our 5 nanometer in terms of cycle time, yield, or cost versus 7 nanometer?

Well, Theo, let me answer the first part first. This year, as we said, we are going to ramp up steeply and smoothly. And how about the 2031? We'll continue to ramp up. That's it. that I can answer you. So, how many customers or how many tap-outs? Actually, the customers come from everywhere. I mean, that's a mobile phone, HPC-related, and maybe some of them are from the IoT and automotive. We don't know yet, but today we got a lot of tap-out from mobile and HPC-related. The cycle time, the yield today is quite good. Actually, it's ahead of our plan. And what is the cost? Cost is reasonable. Of course, we are continuing to work on productivity improvement so that we can share with our customer. But as far as I can know, I can understand the cost, the cycle time are all very good, you know. That's all I can say.

Okay. Do you have a second question, Bill?

Yeah, the second question is on COVID-19. And, you know, it looks like the company is doing a really good job of managing it in terms of factor operations. But I'm wondering if you could talk a little bit more about how this might impact your decision-making longer term. How would you change how you're managing the company, given COVID-19? For example, does it change the view at all in terms of building it back in the U.S.?

I don't think that because of COVID-19, we change our decision-making process or we reduce our efficiency. You know, I do believe this is a temporary phenomenon. And although I did say that we have... red and blue teams, I can say that we have practiced some work from home, but I don't anticipate that this one will continue. So for the long term, there's no change. TSMC will continue to work closely with our customers who have devoted our resources into R&D, and we are pursuing the manufacturing excellency. affecting the Fed to build a Fed in the U.S.? I'll let Mark to make some comments.

Well, we do the long-term planning always to the interest of TSMC. And currently, this U.S. Fed planning is more to, for the long-term, tap global talent for TSMC, rather than the risk management. Because we think that this COVID-19 is an impact on human beings, mankind, but it's the once in a century, and I think we will learn to deal with COVID-19 as a global community, and we'll keep our supply chain cost-effective and efficient at the same time. So that is what I think. So there's no abrupt decision change because of COVID-19 regarding this FAB distribution construction.

Does that answer your question still?

Yes, thank you very much.

All right, thank you. Operator, can we move on to the next caller, please? Sure.

The next question is from the line of truth, loose, and government facts. You may now proceed.

Hi, Dr. Miller. I wanted to ask about the 5G smartphone. So, Miriam mentioned that 5G, a total smartphone, appears with the best on the 5G smartphone, but the penetration with the 5G went unchecked. So, can you tell us that, you know, with this COVID-19 or the current situation, every product makes a shift when you do the revision? Or, you know, why is that, you know, high-end 5G phone or low-end smartphone, they're becoming, again, why is the communication using on church? And in addition, do you see that 5G smartphone communication in different geography, do you see any changes in this revision?

Okay, Bruce, sorry, let me repeat your question to make sure we understand. Your question is on the 5G smartphone. As CC highlighted, we revised the total shipments down to a high single-digit decline, but why do we still maintain a mid-teens penetration rate for 5G smartphones? You want to know if we can talk about any product mix shifts that we see in these smartphones, for example, high-end versus mid-end versus low-end, and why our mid-teens have not changed, and also if we can add some detail or color by geography.

Well, let me answer the question first. We did lower down our expectation, or our forecast on the smartphone, the total unit, by a high single digit. However, we still see the penetration of the 5G smartphone at the same kind of mid-teens sub-percentage. But the number of the 5G smartphone also reduced because of the same percentage with the total number being reduced so that the 5G phone also reduced. That's one thing. And what is the second question?

Bruce wants to know do we have any detail on between high, mid, low end or by geography?

That's too much of the details. I cannot release that information. But let me say that 5G smartphone has been very, very popular. And we expect that one to grow. Okay. Okay. Do you have any?

Yeah. I tried to follow up. I tried to follow up this because for the first quarter, you definitely see that expensive, higher-priced smartphones, the sales fee is much weaker than the medium and low-end ones. So that's why we are surprised that the penetration rate for the smartphones, the price of smartphones is on change. Do you have any version there to support the third part?

Well, there is a sexy name called 5G, right? And all I can say is that it's going to be very popular.

I see. Okay, thank you. The second thing is that, you know, we have a lot of investors asking that because of the current situation, the end consumer, the demand is saving some collections. Why is that you can see as a standard supply for everyone to not see a move for others called assets now? I mean, why is that to cause this kind of big time lag between the real and domestic situation and their production?

Okay, let me just repeat your question, Bruce. Your question is when you, you know, investors are asking when you look at the end consumer, you could see a very big correction. But why is TSMC not seeing any types of order cuts? Why is there a deviation between what we are seeing and the market?

For the big time lag, as mentioned earlier, management also expects or prepares some orders cut in the second half. So the time lag between the production control and the consumer demand, the production, needs some more than three months or so. Why is that cost so delayed?

First, you are talking about TSMC's observation from the end market to TSMC's business. TSMC has leadership in the technology and we are ramping up the five nanometer and seven nanometer and that have been very popular and widely used by all the customer. And not every country offer this kind of a technology coverage, right? And so we are not, we, you know, in our technology and our ramping up, we are not seeing any big effect yet. So that will be some delay, the end market to TSMC's business. But we do see that the end market is dropping, so we also expect some demand from TSMC's customers will be adjusted. However, in this COVID-19 impact, we do believe that TSMC will be less affected as compared with other countries.

I would like to say yes, but let's wait and see. Okay, thank you.

Okay, thank you, Bruce. Operator, let's move on to the next caller on the line.

The next question is from the line of Sebastian, who's from CLSA. Your line is now open.

Thanks, Jane, for taking my questions. Those are my, like, two follow-up on the CAPEX. So, historically, when the TSMC, if I remember right, when TSMC, every time when TSMC lowered revenue guidance within the year, the CAPEX would be adjusted very accordingly. Even with just the 5% adjustment on the revenue, you also adjust the CAPAC. Sometimes you can do the math with you. It looks like this time the revenue adjustment is as long as 8%, the high center digit. The CAPACs remain the same. So my question is, first, is it because the QMTCs, something very important, very big, and very confirmed in the pipeline, here at the end of this year, 2021, that you still need to extend in the megawatt. Or, to a certain extent of losing stuff that they're able to hear, given that some equipment supplier, or maybe one particular equipment supplier, has no learning time in the amount of their power, to some extent, and we are surprising with the competitive setting with that visibility, so we don't want to cancel that at this point. Which one is more true? Thank you.

Okay, Sebastian, let me re-summarize your question to make sure we understand. Your question is on our CAPEX, and your question is that while we have our full year outlook, we have adjusted versus what we said in January, we are reaffirming our CapEx guidance in January. So you want to know why are we not adjusting our CapEx or because our full year outlook has been adjusted. And you propose two reasons. Is it because A, we have confirmed customer demand profile that goes into 2021 and beyond. So that's why we continue to invest. Or is it B, that certain of our equipment suppliers may have a very strong bargaining power So we have no choice, so to speak, but to continue to spend because our equipment supplier has a strong position. Is that correct? Exactly.

Thanks. Sebastian, as we mentioned earlier, that we are looking at this megatron, multiple year of megatrons of 5G related and HPC applications. And these trend continues. the demand for advanced technology will continue. Most of the CAPEX that we spend this year is for the growth of next year and beyond. And that is the reason that we are reaffirming our CAPEX numbers at this moment. To a certain extent, it may tend to go with your number one options, option A.

I think that's quite clear. Do you have it? Okay, is it?

Yeah. Yeah, my 15, okay, thank you. So my 15 questions is, I think last quarter, the company gave us some guidelines about reforming the top 10. HBC, mobile, 20% cash, IRG, all are going to be changed. Can you give us an update on that?

Okay, so, Sebastian, you want to know what is our updated forecast for the four growth platforms for 2020?

For the whole year?

Yes, for this year.

Okay, smartphone and HPC platform growth will be slightly higher than the corporate average. IoT will be similar, and automotive will be below corporate average. Those are all in U.S. dollar terms.

Okay.

Does that answer your question? The answer is I have a follow-up on this one. That the smartphone is still above the cover average. So that means the smartphone is still very near to high trends. So the TSMC forecast the smartphone shipment to decline high single digits. So this year. So which means that the content In fact, the combat increase for TLC is as high as 20% plus this year in total. Is that right?

You have a very good calculation, and you are right.

Okay. Got it.

Thank you. Okay. Thank you, Sebastian. Let's move on, operator, to the next caller on the line.

The next question is from Charlie Chan from Morgan Stanley. Please proceed.

Hi. Good afternoon. Thanks for taking my question. So I have got two questions. One is more short-term, and another one is long-term. Maybe I'll run it for you later. So those are the – that compare your guidance versus the previous forecast. It seems like a little cost. with regards to your third quarter revenue. So do you think this year the third quarter revenue is going to be successful in terms of that change in growth? Sorry.

Charlie, Charlie, Charlie, Charlie, we cannot hear you clearly. Can you please move closer to the phone line and start? We couldn't hear your first question. Please repeat it.

Okay, I actually use the AirPod Pro, so let me try it again. So the first question is about your third quarter revenue. For you, is that the growth is going to be successful now? And as you mentioned, it's not going to go to cost. For you, the C7 millimeter capacity is in shortage in this year. Thank you.

Okay, so Charlie is asking a short-term question on third quarter. Do we expect our revenue to be third quarter revenue to be sub-seasonal? Do we expect 7 nanometer to remain full for third quarter?

Charlie, we're not giving out the guidance for the third quarter yet. And it's still early, especially under this uncertain environment. We will have a clearer picture in July and share with you. Okay.

What's your second question, Charlie?

Yeah, it actually links to the data. Again, to address your survey, I want to note your internal scenario analysis of the COVID-19 impact. As I mentioned, I kind of assumed that the virus would peak in June, but there seems to be some signs of the second wave outbreak globally. So, In your 2nd and 3rd scenario, what would be the differences in 2020? And by the way, the 2nd question is very simple. On 3rd manometer, I believe that the customer number and demand in 3rd manometer can compare to what we will have on 5th manometer. Those 2 questions are those. Thank you.

Okay. That's a little more than 2, but okay. Let me just repeat your two questions. One, you want to know our internal scenario for COVID-19. We had said, NCC had said that it, you know, stabilized by June. What if it's worse? What happens to our forecast? That's number one. And then number two, for three nanometer, what does our customer, number of customers and the demand profile as compared to five?

Okay, let me answer the second question first. Under three nanometer, all right? 3 nanometers, as I said, our technology development is on track, and we are working with customers to further define the specs and then define the technologies. So as to which one, I cannot say, but again I can share with you, it's in mobile phone and HPC-related applications. Now, the first one, we are talking about the impact of COVID-19. And we are giving our forecast based on the COVID-19 will be stabilized. The impact or the spread over will be stabilizing in June. What happens if it's longer than that? I don't know. I mean, if it's longer than that, the macroeconomics will be much worse than we thought. And definitely will affect the semiconductor industry, will affect the factory industry, and certainly also will affect the TSMC. But we don't know yet. Let's be hopeful that all the human beings will be safe and healthy and everything stabilizing in June.

Okay. Thank you, CC. Operator, can we move on to the next caller on the line, please?

So the next question is from Madhu Vizunu from FIG.

Yes, thanks for asking my question. I want to go back to your comment about gross margin trend in the second half of 2020. And you highlighted the fact that the mix would have adverse impact by as much as several coin. I want to get your view of your flexibility. In case coronavirus impact were to be more than just one quarter, what can you do to better manage utilization rate and therefore minimize risk? the gross margin impact to only a couple of percentage points. And I have a follow-up.

Okay, Madi, let me repeat your question. You're asking about our second half gross margin outlook. Our CFO has already highlighted the two factors impacting our second half gross margin. You want to know what if COVID-19 worsens, what measures can we further take to better manage, well, can we do things to better manage our utilization rate to better support or help our gross margin?

Okay, generally speaking, if COVID-19's impact prolongs, we will expect a lower utilization. At the same time, what we have done before, and we may be able to do the same, is to preview some of the products that our customer said they will be looking for to receive. That's one way of minimizing the impact.

Do you have a second question, Mehdi?

Yes. Just as a follow-up, if you were to pre-build for a customer and customers demand that we can, then perhaps customers' orders beyond the second half, looking into the first half of next year, could be adversely impacted. So maybe the adverse impact of a more prolonged coronavirus would have a gross margin downside into next year, into 2021. Into the fact that you're pre-building for customers?

Okay, so, Mindy, your question is a follow-up to Wendell. If we pre-build but the customer demand continues to weaken or worsen, then won't that create more issues for TSMC in 2021?

When we pre-build, we are pretty sure that the customers will take it. Yeah, the demand will be there.

Does that answer your question? Yeah. Okay? Yes, thank you. All right, thank you. Let's move on to the next caller, please.

The next question is from that person from a recent cheer line. Is that okay?

Yeah, thanks very much. I just had a question on your second half implied outlook question. I think it's for down 3%. Revenue just backing out what you said about Q2 and what you delivered in Q1. Now, you mentioned in your prepared remarks that you've seen no major order cuts as yet. But if I do step back and look at your Q1, TSMC just posted smartphone sales growth up 50% year-on-year in smartphones when smartphone end demand is negative. Your China business in Q1 is up almost 80%. year-on-year, and your biggest customer in China, Huawei, has posted inventory up 75% in 2019. So just looking at all this, maybe fabulous customers are not building inventory per se, but it's clear that at the end, customers, the OEMs, seem to be significantly stockpiling and they're not cutting orders yet. So given all this, I'm just wondering how big you think the stockpiling is at present further up the food chain and why it won't lead to a more material decline in your second half outlook than you're suggesting. Thank you.

Okay, Brett. So your question is basically when you're saying that if you look at our first quarter of business, there's a large increase year on year in our smartphone, in our revenue from China and increased as certain, Huawei has seen an increase in their inventory year on year as well. So your question is, how to reconcile this with TSMC's business outlook? But let me remind you, last year, 2019 first quarter, if you're looking first quarter, year on year, our business was impacted by photo resist. So it's not an apples to apples, but your question.

Right. So basically... The first quarter of this year, we see an inventory increase in our fabulous customers. And we expect that continue to rise because of this COVID-19 impact. And it will start to digest in the second half.

Does that answer your question, Brett?

Well, just to understand better how you are thinking about this, because We haven't seen an inventory build up like this at the OEM level for some years, and I just wanted to understand how big you think this is at the moment at the end customer.

This is a very uncertain time. We don't want to quantify the numbers at this moment, but it is building, and it's above the last year's year-end level.

Okay. Thanks very much.

Okay. Thank you, Brett. Let's move on to the next caller on the line. We still have a few more.

The next question is from Francis from HSBC. Please proceed with your question.

Thank you. Sean, I have two questions. My first question is more on just a bit of housekeeping related to your previous guidance you gave. I think back in January you had guidance for founder growth to be up 17%, excluding Samsung's captive supply. But you just gave a new guidance of the year. Is that an apple and apple? Are you including Samsung or not including Samsung in that number?

Not including Samsung. It's an apple to apple comparison.

Okay. And then the second question I had, you've also talked quite a bit on this call about the work from home guiding your HPC business gets stronger and you continue to guide that business. But outside of HPC, have you seen, or I guess maybe this relates as well, what about just overall If you extend it to the overall PC market, are you seeing some signs of stronger than expected? And could we see potential stronger than expected PC market for this year as a result of this trend?

We saw the demand from tablets has been increasing. That's what we saw. On the PC, probably flat-ish. And on the gaming console, increasing. That's so far today that we observed.

Okay? Okay, thank you. And also, just to, as CC said, both are forecast for foundry in January, and today are included Samsung, so it's apples to apples, just to make that clear. Okay, operator, let's move on to the next caller, please.

Next is Frank. If you care, Frank, and to follow your lines, that will do.

Hi, I just want to understand a bit more about your virus assumption. You said that you're assuming the virus will stabilize in June. Can you translate the virus assumption stabilizing in June into hence that demand? How much are you looking at after the demand for 2Q and 2Q? Thank you.

Okay. So your question is under our assumptions for COVID-19, What is our assumption for the handset demand in 2Q and 3Q?

We give you a whole year's assumption, but I cannot be more specific. In 2Q, let's say that seasonality, every year's seasonality, the smartphone actually decreases, all right, and starts to bounce back in third quarter and fourth quarter. But how many units I can be so specific to share with you.

Okay. Does that answer it? Do you have a second question?

Does some key content increase in tech news mainly throughout the year or more towards the second half? That's the last question. Thank you.

He's asking the silicon content increase for 5G. Is it throughout the year, or is it mainly in the second half of this year?

Yeah, so throughout the year.

Okay, operator, let's move on to the next caller. I believe it's a follow-up question from Gokul at J.P. Morgan, please.

Yes. Gokul, do you mind if I open it?

Thanks for taking my follow-up question. So first of all, could you talk, I mean, just maybe stepping away from COVID-19, hopefully we all can soon. So in the past bound terms, we have seen meaningful idea outsourcing happen. I think if I think about GSMC, we had multiple current customers of GSMC give up leading edge and move to GSMC. How should we think about the potential for further IDM outsourcing over the next two to three years as we get through this process, which will potentially put some pressure on some of the potential IDMs as well? And a related question is, I think Mark has answered in the past about potential M&A opportunities. Do we consider overseas FAB acquisition as for TSMC if it comes with a meaningful customer attached to it. I know that TSMC has not really done any meaningful FAB acquisition for a long time. I think probably the person was the last being who won. But just wanted to understand how the management team thinks about FAB acquisition as a potential strategy or any thoughts around that. Thank you.

Okay. So, Coco, you have two questions. One is on the IDM outsourcing, and then do we see the further potential for further IDM outsourcing under this environment in the next few years? And the second part of your question relates to our potential M&A, and your question is that in terms of an overseas FAB acquisition, will we consider an overseas FAB acquisition if meaningful customer business were to be attached to it?

Well, let me answer the IDM outsourcing sub-question first. You know, the current downturn might further accelerate outsourcing for IDMs, but we don't know yet. However, in the long term, IDM outsourcing will continue as the 1G model has proven to be an economic win-win situation for both 1G and its customers. That's As we said, we expect this one to continue to happen. This is a long-term strategy.

Yeah, let me answer the second question about the overseas FAB acquisition. We do have continuous scouting about the possible FAB, but those are mostly only mature FABs, and we don't exclude the possibility, but it all depends on the investment and return. If it economically makes sense, then we'll go it. But it's also, it's very challenging for the mature FAB to be again financially viable so far we've seen. But we still continue evaluating. But overseas FAB acquisition is unlikely to be a leading FAB because our leading FAB is a technology with very sophisticated complexity And also, there's none of the FAB has performed like a TSMC FAB. It's really a service body, technical service body. Instead of the structure, facility, or equipment, our FAB really is a technical service body. That has to be built. And therefore, that challenges us to acquire the leading edge FAB overseas.

Okay? Okay? Does that answer your question, Gokul? That's very helpful. Thank you. Okay, great. In the interest of time, maybe we'll take about two more questions. Let's move to the next caller, please.

This is from Charlie Chen from Morgan Stanley. Is that open?

Thank you very much. So those are some of the questions that I wanted to get really into because I have to In fact, for example, not my acquaintance, but any chance to be able to establish in the U.S. to raise that first question. Also, I think that's a good question because I'm Asian, because when we've been researching China, in fact, like different countries came here, and I can see that it makes some sense because China is pursuing globalization, so... Thank you. Okay.

So you have two questions, Charlie. One is what is our plans for a FAB in the U.S., to build a FAB in the U.S.? And then secondly, you're asking about China, that SMIC is gaining market share. There's increased localization. So what is TSMC's shared outlook for China and strategy to protect ourselves?

Okay, let me answer the first question regarding U.S. FAB. We are now actively evaluating the U.S. FAB plan. And as I told the investor before, there is a cost gap, which is significant. It's hard to accept at this point. Of course, we're doing a lot of things to reduce that cost gap. There are two obstacles currently under activity evaluating. If we do a US FAB, it will have to be a leading-edge FAB, or at least close to leading-edge FAB. And the supply chain for the leading-edge FAB And at this point, it appears that we need to also establish at the same time. And currently we are serving our supply chain partners, whether they will be able to go along so that the quality of the material to support the leading edge fat can be cost effective in US. And secondly, of course, As I said earlier, this FAB has to be an engineering service body. In Taiwan, all the FAB are very highly technical people. In the FAB, all master degree and above. And we try to duplicate that in the U.S. It takes a lot of planning and organization to be able to enable such a FAB. So, but they are, as I said, they are opportunities for us in there. We tried, hopefully we can better tap the global talent for TSMC for the long term, expanding a new site in the U.S.

All right, Jeff, would you repeat the second question?

The second question is that how do we view the competition and the market in China? Charlie points out that he believes SMIC is gaining share. and there's increasing trend of localization. What is TSMC's strategy?

Oh, okay. I don't think that SMIC is gaining share to answer your question first. TSMC has been very competitive in everywhere. We are everybody's boundary. In every location, we offer the best technology, best service. We're working with... customers closely. So we are pretty successful in gaining market share rather than just losing the market share. Let me say that. And specifically for China's country, we are also very competitive because a lot of China customers have been working with TSMC. I know that SMIC has been very aggressive But so far, we are competing very well. That's all I can say.

Okay. Thank you. Operator, I believe we... Thank you. Thank you, Charlie. Operator, let's move on to the last question from Sebastian at CLSA.

Sebastian? Hello, Mr. Sebastian.

Thank you. Thank you, sir, for speaking with me. So I have two final thoughts. The first one, I just want to make sure if I read that correctly, I think the CCU already mentioned that we have the higher numbers of TIPR on M5 versus M7 at the same stage. Is that right?

That's right.

Okay. So if my note is correct, then in the year one manufacturing, the year one mass production for seven, you have 30 plus 3,007. Where you have 50 plus, and then you go on to 100 something. So I think this year is year one for five. So we can say that you have 30 plus.

Well, I'm not willing to release the actual number, but all I can say is now in N5, we have a customer from smartphone, customer from HPC-related area. And the activity, actually we saw more tap-outs as compared with the same period of N7, Because the EN5 actually is complicated, and I would believe the customer will take more time to work with TSMC as early as possible. That's what they are thinking.

Okay, okay. Do you expect M5 to be the future beta of M7?

Yeah, certainly we expect that.

Okay, I'm the capacity-wise, not revenue, capacity.

Oh, I'm the capacity-wise.

Where's the norm in right now?

We don't comment on the capacity by node, Sebastian. But as CC said, N3 will be a very big node. Do you have a second question?

Yes. The next question is, I remember at the most of the time, I think it was the past few months, when we were doing that after that, at TSMC, if questions were there, like, we were potentially a further section on how they were trying to answer the questions. I think TSMC always, I think most of the time the answer is that that is not official, especially because they don't want to answer any hypothetical questions. And I feel like I think this time CSMC, the company, is addressing the questions very clearly. There's no official announcement yet, and there's no official answer yet. So in my interpretation of that statement that I wrote, that it seems like the risk or the possibility of this potential structure is higher than it would indicate to something else.

Okay, Sebastian, let me just make sure we understand your question correctly. So your question is on the potential rule changes from the U.S. that reading news reports in the past that TSMC has always said we don't comment on hypothetical, but you see today maybe our comments, you're asking if our comments today reflect a change in the tone or the view, even though no official rule change has been announced.

Well, yeah, there's no official rules yet announced. But just to let you know, the U.S. semiconductor community, societies, wrote multiple letters to the White House as well as the Commerce Department urging this rule not to be changed. So we do sense there is an urgency from the industry that having that rule changed will hurt the U.S. semiconductor community. And we share the same feeling.

Okay? All right. Thank you, Sebastian. Okay, this concludes our Q&A session. Before we conclude today's conference, please be advised that the replay of the conference will be accessible within four hours from now. The transcript will be available in 24 hours from now. both of which will be available through TSMC's website at www.tsmc.com. So thank you for joining us today. We hope everyone continues to stay healthy and safe, and we hope you will join us again next quarter. Goodbye, and please have a good day. Thank you.