Taiwan Semiconductor Manufacturing Company Ltd.

Ladies and gentlemen, good afternoon. I am Su Zhikai, the legal officer of TSMC. I welcome you to participate in the TSMC's second legal session in 2020. In order to prevent the spread of the COVID-19 epidemic, this legal session will still be held by telephone. Since this law will be broadcast to global investors at the same time, we will use English all the time. Please forgive us. Ladies and gentlemen, welcome to TSMC's second quarter 2020 earnings conference call. This is Jeff Hsu, 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 Vice President and CFO, Mr. Wendell Huang, will summarize our operations in the second quarter 2020, followed by our guidance for the third quarter 2020. Afterwards, Mr. Huang and TSMC's CEO, Dr. Cici Wei, will jointly provide the company's key messages. Then, TSMC's chairman, Dr. Mark 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 in our press release. And now I would like to turn the call over to TSMC CFO, Mr. Wendell Huang, for the summary of operations and current quarter guidance.

Thank you, Jeff. Good afternoon, everyone. Second quarter revenue was flat sequentially as the continued 5G infrastructure deployment and HPC-related product launches offset weaknesses in other platforms. Gross margin increased 1.2 percentage points sequentially to 53%, mainly due to continuing high level of utilization in the absence of unfavorable inventory valuation adjustment, partially offset by NT dollar appreciation in the second quarter. Total operating expenses increased by 1.19 billion NT, mainly as TSMC supported a range of COVID-19 relief efforts. Operating margin increased by 0.8 percentage points sequentially to 42.2%. Overall, our second quarter EPS was 4.66 NT and ROE was 28.5%. Now let's move on to the revenue by technology. 7-nano process technology contributed 36% of wafer revenue in the second quarter, while 16-nanometer contributed 18%. Advanced technologies, which are defined as 16-nanometer and below, accounted for 54% of wafer revenue. Moving on to revenue contribution by platform, smartphones contributed decreased 4% quarter over quarter to account for 47% of our second quarter revenue. HPC increased 12% to account for 33%. IoT decreased 5% to account for 8%. Automotive decreased 13% to account for 4%. Digital consumer electronics decreased 9% to account for 5%. Moving on to the balance sheet. We ended the second quarter with cash and marketable securities of $605 billion NT. On the liability side, current liabilities increased by $25 billion NT, mainly due to the increase of $30 billion NT in short-term loans. On financial ratios, accounts receivables turnover days increased two days to 44 days. Days of inventory also increased two days to 55 days, mainly due to N5 ramp and stronger N7 demand. Now let me make a few comments on cash flow in CAPEX. During the second quarter, we generated about $170 billion NT in cash from operations, spent $127 billion in CAPEX, and distributed $65 billion for third quarter cash dividends. We also increased $30 billion in short-term loans and issued $36 billion of corporate bonds. Overall, our cash balance increased $37 billion to $468 billion at the end of the quarter. In U.S. dollar terms, our second quarter capital expenditures amounted to $4.2 billion. I have finished my financial summary. Now let's turn to our third quarter guidance. Based on the current business outlook, we expect our third quarter revenue to be between $11.2 billion and $11.5 billion, which represents a 9.3% sequential increase at the midpoint. Based on the exchange rate assumption of $1 to $29.5 NT, gross margin is expected to be between 50% and 52%. operating margin between 39% and 41%. Now I will hand over the call to C.C. for his key messages.

Thank you, Wendell. Good afternoon, ladies and gentlemen. Let me start with our near-term demand outlook. We concluded our second quarter with revenue of NT$310.7 billion, or US dollar 10.4 billion, in line with our guidance given three months ago. Our second quarter business increased slightly in U.S. dollar terms as a continual 5G infrastructure deployment and HPC-related product launches upset weakness in other platforms. Moving into third quarter 2020, we expect our business to be supported by strong demand for our industry-leading 5-nanometer and 7-nanometer technologies, driven by 5G smartphone, HPC, and IoT-related applications. Looking at the second half of this year, COVID-19 continues to bring some level of disruption to the global economies, and uncertainty remains. We have observed weak consumer demand in the first half of this year and now expect global smartphone units to decline low teens percentage year over year in 2020. However, amid the COVID-19 pandemic, we also observed the supply chain making effort to ensure supply chain security and actively preparing for new 5G smartphone launches. We raised our forecast for 5G smartphone penetration rate to high teens percentage of the total smartphone market in 2020. For the full year of 2020, 5G and HPC-related applications will continue to drive semiconductor content enrichment. We now forecast the overall semiconductor market excluding memory growth to be flat to slightly increasing, while foundry industry growth is expected to increase to be mid to high teens percentage. For TSMC, Although COVID-19-related uncertainties remain, our technology leadership position enables us to outperform the fund-raising revenue growth. We believe we can grow above 20% in 2020 in U.S. dollar terms, including the impact from the new U.S. regulations, which I will discuss in the next session. Our 2020 business will be supported by strong demand for our industry-leading 5-nanometer and 7-nanometer technologies and our specialty technology solutions, driven by customers of 5G smartphone-related product launches and expanding HPC-related opportunities. Now let me talk about the impact of new U.S. regulations. On May 15th, the U.S. Department of Commerce announced a set of new export control regulations. As a global and law-abiding company, TSMC will follow all the rules and regulations fully, no doubt about it. While there may be some impact from the new U.S. regulations, TSMC's purpose to unleash innovation remains unchanged. Our leading position in the semiconductor industry We hold upon our technology leadership, manufacturing excellence, and customers' trust also remain unchanged. We will continue to build upon our trinity of strengths and conduct our business with integrity to ensure our value and contribute to the semiconductor industry. In the near term, we will work dynamically with our customers to minimize the impact to our business from new U.S. regulations. In the mid- to long-term, we believe the underlying megatrend of 5G-related and HPG applications remain intact, and supply chains can adjust and rebalance themselves. With our technology leadership, we are well positioned to capture the mid- to long-term growth opportunities. We reaffirm our goal to grow at the high end of our long-term growth projection of 5% to 10% in U.S. dollar terms. Next, let me talk about our N5 ramp-up and N4 introduction. N5 is the front-end industry's most advanced solution with the best PPA. N5 is already in volume production with good yield while we continue to improve the productivity and performance of the EUV tools. We are seeing robust demand for EN5 and expect a strong ramp of EN5 in the second half of this year, driven by both 5G smartphones and HPC applications. As we observed some delays earlier this year in EN5 tool deliveries due to COVID-19, we now expect 5 nanometer to contribute about 8% of our wafer revenue in 2020. We also introduced N4 as an extension of our 5nm family. N4Y have compatible design rules and a highly competitive performance to cost advantages as compared to N5 and will target next wafer of N5 products. Volume production is targeted for 2022. Thus, we are confident that our 5 nanometer family will be another large and long-lasting node for TSMC. Now I will talk about our N3 status. N3 will be another full node straight from our N5, with about a 70% large density gain, 10 to 15% speed gain, and 25 to 30 power improvement as compared with 5 nanometers. Our N3 technology will use FinFET transistor structure to deliver the best technology maturity, performance, and cost. Our N3 technology development is on track with good progress. N3 risk production is scheduled in 2021, and volume production is targeted in second half of 2022. We have already demonstrated 256-megabit SRAM functionality. N3 logic test chip is fully functional with yield ahead of plan. The device performance is also on track. R3 nanometer technology will be the most advanced factory technology in both PPA and transistor technology when it is introduced, which will further extend our leadership position right into the future. Finally, let me talk about our U.S. FAB plan. On May 15th, we announced our intention to build an advanced semiconductor FAB in the U.S. We have received the commitment to support this project from both the U.S. federal government and the state of Arizona. We are working closely with them, as well as our supply chain partners, to build an effective supply chain and make up the cost gap. These five will start with 5 nanometer technology with 20,000 wafer per month capacity. Production is targeted to begin in 2024. The U.S. five will enable TSMC to expand our technology ecosystem and better service our customers and partners. At the same time, as TSMC's global presence increases, It will allow us to better reach global talent to sustain our technology leadership. Now let me turn the microphone over to our CFO.

Thank you, C.C. Let me start by making some comments on our second half profitability outlook. We have just guided third quarter 2020 gross margin to decline by two percentage points sequentially to 51% at the midpoint. primarily due to the margin dilution from the initial ramp-up of our 5-nanometer technology in the third quarter and the less favorable foreign exchange rate. As compared with our expectation three months ago, our third quarter gross margin midpoint is higher, mainly supported by a high level of overall capacity utilization despite the uncertainty from COVID-19. Looking ahead to the fourth quarter, we expect a continuous steep ramp up of our five nanometer to dilute our fourth quarter gross margin by about two to three percentage points. 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 next few years. While the impact of COVID-19 virus brings uncertainties in 2020, we have seen our business holding up well so far, thanks to our technology leadership at 5 and 7 nanometer nodes. Looking ahead, the multi-year megatrends of 5G-related and HPC applications are expected to continue to drive strong demand for our advanced technologies in the next several years. In order to meet this demand and support our customers' capacity needs, we have decided to raise our full-year 2020 CAPEX to be between $16 to $17 billion. We also reiterate that TSMC is committed to sustainable cash dividends on both an annual and quarterly basis. That concludes my key messages.

Thank you, Wendell. This concludes our prepared statements. 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 participants an opportunity to ask questions. Should you wish to raise your question in Chinese, I will translate it to 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 zero then one key on your telephone keypad now. Questions will be taken in the order in which they are received. If at any time you would like to remove yourself from the questioning queue, please press 02. Now let's begin the Q&A session. Operator, please proceed with the first caller on the line.

Yes, thank you. The first to ask question, Goku Harihalan, JP Morgan. Go ahead, please. Yeah, hi, good afternoon, and thanks for taking my question, and great results in a tough time. Just a quick question on how we think about N3 development. Do we feel that N3, since we talk about mass production in the second half of 2022, usually the new node starts sometime in Q2. I just want to understand, are we thinking about a slightly slower ramp for N3 compared to what we have had in the first year for N5 as well as N7? That is my first question. My second question is, when we think about leading edge, once the U.S. revolution starts to come in, How do we think about managing capacity? Do we feel that the capacity can get filled up relatively quickly once one of our leading customers, you have to start treatment to them? Or do we feel that there could be a couple of, there could be some time where there could be a little bit of underutilization?

Okay. Thank you, Gokul. Let me try to allow me to summarize your question. Your first question is related to N3. How do we think about the N3 development? We have said the mass production timing is in second half 22 versus typically the second quarter. So should we expect a slightly lower ramp of N3? This is your first question.

Okay. Let me answer that, Goku. In fact, we develop our new leading edge technology. We work closely with our customer. So The schedule and also the ramp-up, also the progress, we're all working with customers closely and determine when to be the best timing. So far, our N3 development is very smooth and successful, and we still target the risk production in next year and ramp-up in the second half. All the schedule is working with our customers.

Okay. And then, Gokul, your second question is on the leading edge. And in light of the recent U.S. regulations, how will we manage our capacity at the leading edge? Will we see a gap in the utilization, or will we be able to fill it up?

We should be no problem because, as we just stated, that the 5G is a megatrend, and also HPC-related applications continue to be very strong. And we observe that all our customers are very actively prepared for these two applications, 5G and HPC. In addition to that, we also observe that all our customers try to secure their supply chain security and which is very important with this COVID-19 uncertainty.

Do you feel that even for N5, that is applicable?

Even with N5, yes.

Let me add to that. I think for the short term, some impact is inevitable. Currently, we work closely with our customer very dynamically, trying to fill up the capacity. And for the long term, as CC mentioned, we are very, we're still optimistic.

Okay. Thank you, Gokul. Can we have the next caller, please?

Next to ask questions, Sebastian Ho, the LSA. Go ahead, please.

Hi, good afternoon, gentlemen. Thank you for taking my questions. So my first one is I wanted to get your brain about how do you evaluate the feasibility and possibility of building up an advanced note FAB without any American contents, be it technology, equivalent IP material, et cetera, in the next five years or 10 years or even longer? Is it worth it or even... Even if it takes a long time and tremendous effort, would KCMC ever consider that? Thank you.

Well, let me answer that question. You know, we know that the U.S. fire as compared with the fire in Taiwan, the cost structure is actually a little bit higher, and that's why we say that we are working with the federal government and also the state of Arizona. To close again.

Sorry. Just to repeat the question, I think Sebastian's question is asking about building up an advanced node fab or production line without using any so-called American contents, whether in terms of equipment, technology, or IP materials. He wants to know in the next five to ten years, is it feasible? Is it worth it? And is this something that TSMC would consider?

Let me pick up this one here. The semiconductor technology is very unique in this industry. The technology continues to improve. Every two years, there will be a new generation of technology come out to serve the best performance product. And therefore, we, I think our main force is still pursuing the technology leadership, trying to overcome each generation's challenge. And to do that, I think our current focus is still working with our equipment partners, dealing with, utilize the best of the kind equipments that we can have to pursue our business growth. So you're right, the two... If we do that otherwise, the technology advancement will be extremely challenging, will be extremely difficult, not to talk about five to ten years alone. So that is not our current effort at this point.

Okay, Sebastian, do you have a second question?

Yes, yes, thank you for that, very clear. Second question I'd like to follow on the, as about the inventory situation. First, can you update us on how you see the status of inventory at the end of Q2 and how you see that in the second half this year? And also on the inventory side, it looks like it's getting increasingly difficult to look at the inventory from the comprehensive perspective. Fabus DOI may not be enough because apparently there's a lot of the Chinese companies stockpile the inventory in fear of being sanctioned. And also across the board globally, the whole supply chain has been raising the 6-dollar level of inventory in the past few months in fear of supply chain destruction caused by COVID-19. But those are not reflected in FABUS DOI. So how do we see about this inventory and potentially hidden excessive inventory situation going forward? Do you consider about that to be a potential overhand at some point that this talking could come? Thank you.

Okay, let me summarize your second question, Sebastian. If both of it relates to the inventory situation, the first part, is what is, for TSMC, tracking our Fabless customers? What is the Fabless DOI exiting 2Q and the Outlook into second half? That's the first part of your question. And then your second part of your question is, are we concerned that the inventory situation may see some hidden or discrepancies due to whether it's COVID-related supply chain disruption, or the U.S. regulation and such, will this lead to a hidden inventory risk, and is there a risk of inventory correction?

Let me answer that. The inventory level of our Fabless customers that we tracked exited first quarter above the seasonal level. We expect a further increase in second quarter and then stay at the high level in the second half as the supply chain is making efforts to ensure supply chain security and our customers are in high anticipation and preparing for new 5G smartphone product launches in the second half of this year. We cannot rule out the possibility of an inventory correction sometime down the road. We observe the supply chain active making efforts to ensure the securities and active preparation for 5G smartphone launches. we will just have to wait and see how the sell-through goes.

Okay. Thank you, Sebastian. Can we move on to the next caller, please? Operator, please move on to the next caller.

Thank you. The next caller is Bill Liu from UPS. Go ahead, please.

Yeah, hi. Thank you. Thanks for taking my question. I'm wondering if you can comment on the CapEx guidance for this year. It's not raised to $16 to $17 billion. I'm wondering what that increase is on, whether it's 5 nanometer or something different. Secondly, related to that, can you talk about your CapEx intensity? whether this increase is temporary and whether this is pulled in from next year, therefore maintaining the longer-term intensity, or how we should think about that.

Thanks. Okay. Let me summarize your two questions, Bill. Your first question is in relation to our 2020 CapEx guidance and the range of $16 to $17 billion. So Bill wants to know what is driving this increase. And then secondly, in terms of the capital intensity outlook over the next few years.

Okay. The CAPEX increase from three months ago for this year is basically comes from the advanced technologies. And the capital intensity this year will be slightly lower than 40%. And over the long term, it will gradually go down to about mid-30s. Okay.

Okay. Thank you, Bill. Let's move on to the next caller, please. Operator.

The next caller is Brett Simpson from RIT Research.

Go ahead, please. Yeah, thanks very much. I want to ask about your relationship with Huawei and how you see the impact of the U.S. regulation on your business with Huawei in the second half of the year. My understanding is that you will still have a relationship. You will still be shipping waivers probably at elevated levels in Q3. But can you confirm whether or not you'll have any sales with Huawei in Q4? And if not, how do you manage your 5-millimeter utilization, you know, given the importance of Huawei as a customer? Thank you.

Okay, let me summarize your question, Brett. In regard to the relationship with Huawei, Brett wants to know what is the impact on our business from Huawei in the second half of this year. Will we continue to ship wafers to this customer in the fourth quarter? If we do not, then how will we manage the impact to our 5 nanometer?

Okay, let me answer your question. SEC just reported that we are complying fully with all the regulation and we did not take any new orders or production starts from this customer since May 15th. Although this regulation is just finished their public comment period, the BIS has not did a final ruling change at this point. And so it's very early, still early to confirm. But under this current status, we do not plan to ship wafers after September 14th. And yes, there will be a challenge to work dynamically with other customers. That's currently we're working with them. But as you heard, we made a decision CC just made about 2020's guidance is above 20%. That tells you we are relatively progressing well in filling up the left capacity, left open.

Yeah. Okay. Brett, thank you. Do you have a second question?

Yeah, thanks Jeff. Just to follow up, I wanted to ask about depreciation for this year. I think previously you talked about mid to high teen growth of the depreciation in 2020. Can you confirm whether that's still the case? You know, and I look at the first half depreciation and it looks like depreciation costs are down year on year. So in order to get to mid to high teens growth, that would imply a large increase in depreciation sort of in the third and fourth quarter. So if you can just clarify exactly how we should think about depreciation for the next couple of quarters, that would be great. Thank you.

Okay. Brett is asking his second question is our depreciation outlook for 2020. Do we still maintain, you know, what is our depreciating for 2020 year on year? And then does this imply a pickup in depreciation in the second half on a quarterly basis?

Okay, Brett. Our current estimate on 2020 depreciation year-on-year growth is still high teens growth. So that gives you an idea of what the second half depreciation will be. It will be higher than the first half.

Okay. Thank you, Brett. Can we have the next question on the line, please?

The next one on the line is from XIG. Please ask your question.

Yes, thanks for taking my question. I want to go back to your N4 and N3. How should we think about the migration and specifically to what extent this is driven by converting rather than installing new equipment? And I have a follow-up.

Okay, sorry, Madi. Let me make sure we understood your first question. You're asking about N4 and N3, how to think about the migration, and is there a conversion, tool conversion involved between N4 and N3? Is that your question? Correct.

Okay. All right. Actually, the N4 is a kind of improvement, continuous improvement from N5. So it has a little improve the speed, improve the geometry just a little bit. N3 is totally a new node. All right. So that's N4 using the same equipment as N5. N3, we expect to have a high percentage of the tool continue to be used from the N5, but N3 is a totally new node.

Okay. Thank you. Do you have a second question, Middy?

Yes, and my second question has to do with your HPC revenue growth in Q2. It was significantly higher compared to Q1. Can you please elaborate which specific sub-segment within HPC is doing better? Is it driven by communication or computer? And how do you see those trends trending into Q3?

So, Madi, your second question is looking at our HPC sequential growth in the second quarter. Madi wants to know what specific segments are driving that increase and what is the outlook?

Well, Madi, I don't think we want to break down the details on the different platforms. Sorry about that.

Okay, Madi?

The concern is that Maybe perhaps Huawei may have pulled in before you stopped taking over this and trying to understand how that particular customer has procured wafer in the first half versus second half.

Sorry, Maddy. No, we don't comment on specific customer.

Okay. Thank you, Maddy. Thank you. Thank you. Can we have the next caller on the line, please, operator?

Yes, next one, we're having Randy Abrams for this wave. Go ahead, please.

Okay, yes, thank you. My first question, I wanted to ask a bit more on the cap x-rays, as that's more a function of what you mentioned, the forward demand outlook. If you could give a view on 21, I know it's in early stage, but just back during a full year where you mentioned Huawei and also mentioned potential, like you don't rule out an inventory correction. And it does seem like Samsung at least is discussing a bit about some graphics and high-end smartphone business. So I'm curious, like, the CapEx raise, what's driving it, if there's certain drivers that may be lifted on the 2021, how you're seeing that. And implication, it follows up on Bill's question, but implication for 2021, if it seems like it might be a bit lower CapEx, if you're spending a bit ahead of that now.

Okay. Okay. So, Randy, let me summarize your first question. Your first question is really what is driving our race for the 2020 CapEx? What is the drivers for that? And then what is the outlook for 2021 CapEx?

CapEx and sales. The sales just factor in your comments about inventory. If your competitor is taking a bit of – and also your view that we could have a, or don't rule out an inventory adjustment.

Let me discuss. CAPEX is a, we do the CAPEX based on long-term perspective. If you talk about this year's CAPEX, mainly, of course, this shows our demand of N5 is very strong. If you talk about the next year's CAPEX, It's really talking about 2022's demand, which we see the continued increase of N5 demand, and also we see the starting of launch of N3 technology. And we'll see by then how much the CAPEX will increase, and we'll report to you in due time.

Okay. Do you have a second question, Randy? Okay.

And if I could follow up, because you mentioned, like, so the higher CapEx this year is a function that you expect next year to be even stronger. So could you talk a bit about what – I know you talked about the megatrends, but I'm curious if you're thinking about just what you mentioned also, like, could next year have impact from the high base this year on the inventory buildup? And also that you have a full year – like, in the first quarter, Huawei is out. there's probably pent-up demand being tight, but have you view a full year if you're not shipping to Huawei, unless you're counting on, by that point, some partial license, or if in your base case you're assuming not shipping to Huawei next year.

Okay, Randy's second question, he is thinking that with potential possibility of inventory correction with the U.S. regulations, What is the impact to 2021 growth outlook in CapEx?

Randy, it's just too early for us to discuss anything about 2021. So we'll just wait until when the time approaches.

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

The next one is Roland Chee from Steady Group. Please ask your question. Hi, there. Good afternoon. First question is can you remind me again how does the inventory variation adjustment work every quarter? How about the 3Q? Is this inventory variation adjustment favorable or unfavorable to the gross margin? This is my first question. And second question is you talk about you are working with a customer. to minimize the impact of U.S. new regulation and how are you going to do working on that? Thanks.

Okay. So, Roland, your two questions, your first question is what is the impact of inventory revaluation? And then in the third quarter, will it be a favorable or unfavorable impact? And your second question is you want to know how we are dynamically working with customers to mitigate the impact of the new U.S. regulation.

Okay. Hi, Roland. Let me make some comments on the inventory valuation adjustment first. The impact on margins from inventory valuation adjustment is inversely correlated to that from changes in utilization. We normally report the net impact on margins from these two factors together. When we compare margins quarter over quarter, we will report the Q on Q change in impact from inventory valuation adjustments when it is more significant. In the second quarter, the quarter over quarter change in impact from inventory valuation adjustments was more significant. And if you ask about third quarter, at this moment, we believe the impact is less significant.

Okay. And then he's asking about how we work with customers dynamically to mitigate the impact of Huawei ban. I cannot tell you how we are going to do it because this is our company's strategy and our strength. But one thing I can tell you, We are based on the technology leadership and the excellent manufacturing. That's all we did.

Okay, thank you. Operator, can we move on to the next caller, please?

Yes, the next to ask question, Charlie Chang, Morgan Stanley.

Go ahead, please. Hi, good afternoon, management team. So my first question is really about your overall revision of the four-year revenue guidance. So compared to last time, it was a mid-to-high 15%, and now it's above 20%. I think there's at least a 5% point of revenue growth in 2020. But last time, your assumption is that pandemic can get controlled by June. And now, generally, there's a second wave, third wave pandemic in many countries. So how are you going to reconcile this kind of weak economy or healthcare crisis issue versus your very strong Should I just attribute that to the higher 5G smartphone penetration, or there's other factors that we should pay attention to?

Okay. Let me summarize your first question, Charlie. You're asking basically we have increased the four-year outlook, but the risk of COVID-19 continues to remain. So how to reconcile a weak global economy with TSMC's four-year outlook and what will be driving this, you know, besides 5G smartphone preparation?

Well, Charlie, we do observe the 5G smartphone, the momentum is getting stronger. So we... we understand the situation. However, we also observed that our customer are making effort to ensure supply chain security. So they might expect that there is a second wave, third wave, COVID-19, but since the end demand looks very promising, so they are not afraid to to make sure that their supply chain will not be disrupted. Because of 5G, as you just mentioned, 5G smartphones, you know, demand is continuing to increase.

Okay. Do you have a second question, Charlie?

Yes, I do. Thanks. So I think a lot of things happened over the past month, right? Another I would take it as a U-turn. Is your decision for the U.S. Fed intention? Because half year ago, I remember the comments was like the cost is pretty high, logistics doesn't make sense. So what exactly is the trigger for you to change this U.S. operation decision? And you'd be very kind of you if I can add a very small question. because the investors may care as well, your first quarter sustainability. Because based on your new four-year guidance, if you take it as a 20% or 21% low bar, the first quarter revenue may decline sequentially. Is that a kind of fair comment? Thank you.

Okay. Well, Charlie, your second question relates to our U.S. FAB plan and You want to know why six months ago we were talking about the cost gap being the major challenge, and now we have decided to go ahead. So what has changed?

Okay.

Well, as you know, with expanding our technology ecosystem and reach to global talent, closer to our customer to get a better service, all benefits increased. are they fab in U.S.? But in the past, indeed, the cost, the gap, prohibited us to make those decisions. More recently, I think since last December, and I think the thing is getting a turn, and we did get positive encouragement from the U.S. administration about The cost gap, and actually the U.S. administration and the state of Arizona combined, they seem to be able to close the cost gap we used to hold up against this decision. With their commitment, and we are preparing for that. And how do they close the cost gap? As you have reading, the U.S. Congress, both in Senate and House, are all driving for the incentive packages aimed at revive U.S. semiconductor manufacturing. And with that, I think they do have a way to fulfill that commitment to make up the cost gap. And that was the major decision turning point.

And then Charlie, he snuck in a third question, which he wants to know our outlook for fourth quarter given the full year guidance. Okay.

Well, Charlie, it's also too early to talk about fourth quarter, but I think you can do the math and come up with certain estimation. But what we can say is our second half, will be growing, will be higher than the first half.

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

The next one to ask questions, Bruce Liu, Goldman Sachs. Go ahead, please.

Hi. Thank you for taking my question. I think given your positive progress in three nanometers and five nanometers, especially regional terrapests, Can we assume that similar to previous note, like, you know, 7 nanometer or 12 nanometer, that the first year of 3 nanometer can achieve 10% of the wafer revenue, and the second year of the 5 nanometer can achieve 30% of the wafer revenue?

Okay. So, Bruce, your first question is regards to N5 and N3. Bruce wants to know, with the progress in N3, can it be contribute 10% of the wafer revenue in the first year? And he also wants to know, can N5 contribute 30% of the wafer revenue in its second year?

Okay. Bruce, both of them are really too early to talk about it. We certainly hope that there will be pretty big notes, but we will definitely let you know when times is closer.

Do you have a second question, Bruce?

Yes, I think just double check that we raised our 5G penetration shipment forecast, but we lowered the overall smartphone shipment forecast for 2020. And how about the actual number for the 5G smartphone shipment? Is that the penetration is up because of the lower total smartphone shipment or the 5G smartphone shipment itself is going up as well?

Okay, so your question, second question, Bruce, is that the global small function may be now lower to low teens decline, but we raise the 5G penetration to high teens. Is this simply because of a lower, smaller global base, or what is the 5G penetration number?

Well, the 5G penetration, as I said, the momentum continues to increase, so Even with the total smartphone number being decreased at the low teams, but the 5G's percentage continue to increase. And that's what we observe. And also the 5G's semiconductors content is higher than the 4G, and especially high-end is much higher. So that's what we base on.

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

The next on the line is Alan Cheng from Nomura Securities. Go ahead, please.

Thank you for taking my question. Can I have a follow-up to Bruce's question just right now? He was asking, by lowering the total smartphone demand, to low things, down to 15% now from the earlier version of down 5% to 10%, but raising the 5G penetration rate to 15% to 20% from earlier only meeting, say, 15%. In terms of the absolute 5G phone demand or selling number, it's a number being raised pretty much the same as the prior version. That's a follow-up. Actually, this is a part of my first question, but it just happens to be a follow-up to Bruce's question.

Okay. Aaron, let me summarize your first question. Basically, Aaron wants to know is our forecast for 5G smartphone in terms of units increased? The answer is yes. Yes. Okay? Okay, thank you. What is your second question?

Okay, let me, so, okay, this question that, I was trying to compare the outlook offered by TSMC for industry and the outlook given in the year beginning six months ago. In the year beginning, TSMC was saying that SEMI, S-code memory, was going to grow by 8%. And now it's going to be flattish to slightly grow, which means I think overall demand, including everything, is lower than it was six months ago. The country growth in the year beginning was 17%, but now it's pretty much unchanged and mid-to-high-teens growth. TSNC's growth in the year beginning was above the industry growth. Now it's above 20% growth. Okay, so my question is, over the last six months, TSMC, along with actually everyone in the world, particularly in tech, has experienced two difficult challenges, including one, COVID-19, and two, Huawei issues. But it turns out that TSMC is doing even better than there was not two of these issues. So I wonder, obviously, I think the CEO already answered that the 5G absolute unit demand is going to be higher than you saw six months ago, which is one, I think, key reason. But it looks to me that the factors, two negative factors, are still huge. Actually, either one of them, It's big, right? But here it turns out to be better than if there's no true negative impact. So how do we think about this?

Earlier also Chairman said that... Aaron, okay, I think let me summarize your question because it is quite long. I think to, in essence, what you're asking is, When you look at the industry framework that TSMC provided in the beginning of the year, and you look at the framework now, you point out that the semi-X memory growth in January, we said plus eight. Now we said flat to slightly up. Foundry growth in January, we said 17 percent increase year on year. Now we say mid to high teens. But for TSMC growth, we're now saying greater than 20 percent. So given the challenges in this year from COVID-19 and such, what is driving TSMC's stronger growth?

Well, I can answer that question by simply one word, technology leadership. Actually, we see a very strong demand from our 7 nanometer and 5 nanometer technology and 5G infrastructure. Again, I would like to say that 5G is the momentum is getting strong. Okay. And including also HPC. I'm sorry.

Sorry, yeah. All right, thank you. Operator, can we move on to the next question, please, from the line?

Next, we're having Goku Harihara, JP Morgan. Go ahead, please. Thanks for picking up a lot of questions. First of all, I just wanted to understand, we are running at 20-plus percent growth this year. Any thoughts on, I think we expect some of these mechanisms to last. Any thoughts on why we aren't changing our long-term 5- to 30-percent target, especially given you're also spending more cash. So if the ROIC is similar, then probably we need to be at a slightly higher growth rate. That's my first question. I just wanted to understand what is management's view on how much of this year's outgrowth compared to the semiconductor industry has been some of this inventory build that your customers have undertaken over the last several years. So it's very few years that TSMC outgrows the semiconductor industry or the foundry industry by a significant margin. And this seems to be one of those years where even smartphone is probably growing, actually declining. while TSMC is growing more than 20%. So just want to understand, there's quite a bit of that, which is real demand and market share gain in leading edge. But any thoughts on how much of that do you feel that some of this inventory and supply chain security inventory that your customers are building?

Okay. Gokul, let me summarize your two questions. Maybe I'll start with the second question first. You just want to know, management's view, the fact that TSMC's growth in 2020 is outpacing the foundry industry, can we break down what is driving this? How much of it is from supply chain efforts to ensure supply chain security? How much of it is market share gains? How much of it is due to leading edge?

We certainly At this time, I don't think we can separate them so clearly on each one that is because of technology, because of share game, because of HPC or something like that. Again, I would like to emphasize the need on the leading edge technology node on seven and five, and that's what we gain our advantage.

Okay. Okay, and then your second question, Gokul, to repeat again. is that with the strong growth we see this year and the megatrends that we identify for the next several years, will there be a change in our long-term growth target?

Well, we continue to emphasize that we will be at the high end of 5% to 10% CAGR. Remember, this kind of forecast is a rolling forecast, so we continue to have confidence in our technology and also our market share and so our growth.

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

Next one, we are having Sebastian Ho from CLSA. Go ahead, please.

Sebastian, are you on the line?

Sorry, I forgot to unmute. Can you hear me now?

Yes, we can hear you. Please go ahead.

Okay. Okay, thank you. So I have the two follow-up. First one is that the fine nanometer revenue contribution is lower from 10% to 8%. The total revenue outlook is 8%. So if we do the math, the fine nanometer revenue is probably lower by 15% compared to April. And if we compare it to January guidance, it's actually 20% lower. So how do we attribute this to the customers that got sanctioned in May or any other reasons? And furthermore, it also means that the other technology nodes are actually growing stronger. So I wonder what's driving the other applications, the nodes, and also can you give us an update on their expectation of growth for the four major platforms with the new real-life app guidance? Thank you.

Okay. So let me summarize Sebastian's question. He wants to know, what is driving the difference in terms of M5 today versus six months ago, and what other nodes then are stronger. And then he also wants to know the 2020 outlook, growth outlook by platform.

Okay, Sebastian. Actually, compared to six months ago, our M5 revenue actually increases significantly. And so do the other nodes. Maybe you can double check the math. Okay.

And then the 2020 growth outlook by the four platforms.

Oh, okay. All the platform will grow except the automotive. Okay?

Okay. Okay, my second question is also follow on the 5G smartphone and also the total smartphone guidance you just gave and the other analysts you asked about. So it looks like the total 5G smartphone numbers, absolute number is raised. And I wonder, are you based on the forecast on the final sale of numbers, or based on the forecast that you're seeing from your smartphone SOC, FAPIS? Thank you.

Well, we're based on the one we work with our customer. So that's a number that the customer demand to TSMC. Of course, they are also doing their forecast, as we did.

Okay, thank you, Sebastian. Yeah, Sebastian, sorry. Okay, let's move on to the next caller.

Next one, we're having Madin Hosseini, FIG. Go ahead, please.

Yes, thank you so much for taking my follow-up. I'm a little bit confused, and I was wondering if you could help me. All the 5G smartphone data points suggest that the smartphones that are serving through are priced well less than $300. And also, your commentary suggests that despite the fact that COVID has had a second wave, your outlook is actually stronger. So how can I reconcile a 5G smartphone, which is mostly driven by low end, and the second wave of COVID with your outlook.

Okay, Madi, your question is how your observation is that 5G smartphone sell-through is mainly coming through at the low-end 5G smartphones priced at $300 or less. And with the potential second wave of COVID, How can you reconcile this low-end demand with what TSMC is seeing? Is that correct? And also, your outlook for the year, because earlier in the last conference call, you said your outlook is based on COVID notizing by June, but it seems like there's a second wave. So Medea is also asking because in April we said our outlook was premised on stabilization of COVID by June, but now it looks like COVID-19 continues.

Actually, we don't confirm there is a second wave of COVID-19 per se, but we leave that one alone. We do observe that our customers are dependent to TSMC. And you mentioned that the 5G is only in the low end. We do expect there's a lot of new 5G phones, pretty high end, in the second half of 2020. And that's what we base on our assumption. Okay?

Thank you. May I ask one follow-up on CapEx?

Okay?

The one billion of increase to 2020 CapEx, is that equally distributed between front-end equivalent and back-end, or is it more in one particular area? What's driving the incremental increase?

Okay, so, Madi, your second question is what's the increase in the CapEx guidance? Is it more driven by the front-end or the back-end? for 2020.

Yeah, well, basic is front end.

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

Next one, we are having Laura Chang from KGI. Go ahead.

Hi, good afternoon. Thank you for taking my question and congratulations for the good result. Actually, the question is also related to the advanced packaging. I recall that we mentioned that we had about $3 billion for the advanced packaging last year for the revenue contribution. I'm just wondering what the latest guidance for this year, any revenue target for advanced packaging, and also what's our plan looking for in this space? The incremental increase CapEx Do we also have some plans in this space?

Okay, so Laura's question is related to the advanced packaging. She wants to know, last year it was not $3 billion, it was $2.85. So what is the growth outlook for this year, number one, and then what's the plan for advanced packaging, the outlook going forward?

Okay. We expect that the the advanced packaging will grow probably similar to our corporate average this year. As to the CAPEX increase, yes, a little bit, but mostly at the front end and with the advanced technology.

Okay. Do you have a second question, Laura?

Yes. Yes, my second question is about the legacy process and also like a 28-millimeter. We all know that advanced packaging – We are very strong and fully loaded. I'm just wondering that for the legacy capacity and the utilization rate, and especially for 28 nanometers, as Sissy also mentioned before, that you see structurally overcapacity in this space. Looking forward, can we expect improvement in second half of next year, given our good progress in the RFIC or the CIS, et cetera?

Okay, so let me summarize your second question, Laura. It is looking at our mature nodes. What is the utilization outlook for our mature nodes, and specifically for 28 nanometer? Do we see improvement in second half or 2021?

All right, let me answer that. Our mature node, or we call it spatial T, our mature nodes are loading actually quite good, except 28 nanometer. I still want to emphasize that 28 nanometers has been overcapacity for the whole industry. But we continue to improve it, and slowly. Of course, we can see the CMOS image sensor and also other applications that will move into 28 nanometers. But it's slower than we thought. However, it will be improved. We have confidence to say that.

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

Next one to ask questions, Reddy Abrams, Credit Suisse. The line is open now. Okay, yes, thank you for the following questions.

First one, I wanted to just go back to the clarification on the Huawei. If you're factoring in for the future view and the potential shipments, I think one is, the regulations seem to allow some ways to shift. I know you'll comply by the rules, but it seems to allow some way to shift directly to OSETs. I'm curious either from that or perspective that you get a partial or full license if you're building that into the base case.

Actually, the current regulation spells do not prohibit it. the standard product or general product be able to ship to Huawei. And therefore, we think Huawei's smartphone business will most likely, they may strategize to stay by procuring general purpose products.

I think, Randy, part of your question is that from TSMC's perspective, Are there alternative ways to ship to this customer, such as shipping to OSAT, or will we have a partial license?

No, no, we don't. We don't have an alternative way to ship. Okay.

Okay, if I can get the second question. If you could do it.

Randy, are you still there?

If that would be the steep ramp up. That will be available in 2020.

Sorry, Randy, you dropped off for a second. Can you repeat your second question again?

Yeah, it's actually more about these half nodes. The four nanometer will be available, I think, mass production early 2022. So with three coming out late in the year, if you're expecting that would be the steep ramp so we could see high volume, it also could allow you, I think, with the tool reuse, a bit lower spend. So I'm curious how you're thinking about that. And then also on the six nanometer, if you're still seeing most of the customers on seven migrate, to six, where I think previously expected majority could end up going to that half node. Thank you.

Okay. Your second question, Randy, is related to N4 and N3. And thus, with the timing differences of N4 and N3, will we see a lower spend as a result? Randy's view is that N4 will be early 2022. N3 will be late 2022. And then so with some conversion, will that result in lower spend? And he also wants to know for our N6, we've talked about it before, do we see still a strong migration of our customers from N7 to the XN6?

But let me answer the second one first. On the N6, yes. We have been... offer to our customer is compatible, actually is fully compatible to N7, so it will have a very good opportunity to catch the second wave of 7 nanometers product. With the same kind of strategy, we offer N4 to follow the N5. So we do expect the N5 as a product. Finally, a lot of a large portion of the N5 product will move to N4. So it's not to mix with N3 as a progress or N3 as a ramp up. N3 is another full node. It's more advanced by nature than N5. So N3 is a N3. N4 is a N4. And then N6, do we still see strong mic? Yeah, I already said that N6 is following the N7.

Okay. Okay, operator, let's move on to the next caller.

Next one, we're having Charlie Chan, Morgan Stanley. But now I'm open to you now.

Thanks for taking my follow-up question. So two parts. Firstly, it's about your N3 and the CAPAC. Do you... spend some capex for N3 this year. So that's another reason why, you know, you see a capex upward revision.

Okay, Charlie, your first question is that for 2020 capex, do we spend, does it include spending for N3?

Charlie, part of the capex this year is for N3, but that's not the reason for increasing capex.

Okay, and do you have a second question, Charlie?

Yeah, I do. So every quarter, I ask this question about the Chinese competition, and notably, your China competitors, to me, they do an Asia IPO with a very high valuation. And supposedly, those rest of the money can spend for their future CapEx or even real new growth, right? So I'm not saying about in the recent quarter, but in the long term, Do you think that is a threat and you probably may lose market share to China players even they want localization? Or do you have any China strategy to accommodate to China's localization policy? Thank you.

Okay, so Charlie, your question is that what is the threat from Chinese foundry competition? Do we see it as a growing threat? How do we...

Well, Charlie, I also answer every time that we compete in technology and manufacturing and the customer relationship. And whether it's in China, in other area, we stay the same. We compete in technology, manufacturing, and we have been keeping good relationship with our customer. We want their trust.

Okay, thank you. In the interest of time, I think we'll take the last two callers on the line.

Next one we are having Bruce Liu, Goldman Sachs. Go ahead, please.

Oh, good. Thank you for taking my follow-up question. The first question is for the norm for the capital intensity. I think I remember like six months ago, the manager was talking about capital intensity will go back to 30% to 35% for 2021. But earlier, the manager was talking about it will go back to closer to 35%. So do we foresee that the capital intensity norm will be closer to 35% or the norm will shift still remain at 30 to 35%.

Okay, Bruce, I think our comment is over the long run, it will go to about 35%, and that remains the same.

I see.

I understand that.

The second question is that we saw that TSMC announced a new factory for the packaging this year, just through the groundbreaking, and the size for the factory is pretty big. Do we anticipate that the advanced packaging penetration rate will be a lot higher in the advanced note? And, you know, what's the future outlook for the advanced packaging?

Okay, so your second question is Bruce wants to know that we announced a large advanced packaging site recently. So he wants to know what is the penetration rate, so to speak, of advanced packaging in the leading nodes going forward, and what is the outlook?

Well, we do work with our customer closely, and we do see some increase on the demand of advanced packaging. And therefore, we try to enlarge our capacity, that's for sure. But let me stress that we enlarge our advanced packaging capacity is for leading edge, also for specialties. There's a new demand coming out, and we have to work with our customer to meet their requirement.

Okay?

Operator, thank you.

Bruce, operator, can we take the last caller on the line, please?

Yes. The last one to ask questions, Sebastian Ho, CBLSA. Go ahead, please.

Thank you. Can I follow on the CapEx increase, the $1 billion CapEx increase? Which particularly nodes do that go to? Thank you.

Sebastian wants to know with the increase in the capex to $16 to $17 billion from $15 to $16 previously, what node is the capex spending going to?

It's leading edge.

Okay. Okay. Got it. My last question is, I think the U.S. Senator has proposed two bills, CHIPS Act and American Funds Act in June. So I wonder how does that correlate with a TSMC Arizona plan? And if that were to be passed, whether TSMC or a non-American company are eligible for the potential subsidy? Thank you.

Well, I

So, Sebastian, just to make sure we understand your question, your question is related to some of the proposed regulations in the U.S., such as the CHIPS Act and the AFA. If these bills were to be passed, would it be eligible for TSMC or the industry?

Yes, it's well aligned with our request, and yes. If those bills in different form passed, I think the administration and state of Arizona will make this project happen.

Okay. Thank you, Sebastian. Got it. Thank you, Elliot. Thank you. 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 24 hours from now. and both of them will be available through TSMC's website at www.tsmc.com. 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 have a good day.