Taiwan Semiconductor Manufacturing Company Ltd.

Good afternoon, everyone. Welcome to TSMC's third 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 Vice President and CFO, Mr. Wendell Huang, will summarize our operations in the third quarter 2020, followed by our guidance for the fourth quarter 2020. Afterwards, TSMC's CEO, Dr. C.C. Wei, and Mr. Huang will jointly provide the company's key messages. Then we will open the line for Q&A. 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 the current quarter guidance.

Thank you, Jeff. Good afternoon, everyone. Third quarter revenue increased 14.7% sequentially in NT dollars, or 16.9% in U.S. dollars. As we saw strong demand for our advanced technologies and special technology solutions, driven by 5G smartphones, HPC, and IoT-related applications. Gross margin increased 0.4 percentage point sequentially to 53.4%, mainly thanks to a much higher level of utilization, partially offset by the margin dilution from 5 nanometer ramp and an unfavorable exchange rate. The operating expenses increased by 7.4 billion NT, mainly attributable to a higher level of development activities for N4 and N3 technologies and one-time expenses to facilitate our expansion in Hsinchu. Therefore, operating margins slightly declined by 0.1 percentage points sequentially to 42.1%. Overall, our third quarter EPS was 5.3 NT and ROE was 31.3%. Now let's move on to the revenue by technology. Five nanometer process technology contributed 8% of wafer revenue in the third quarter, while seven nanometer and 16 nanometer contributed 35 and 18% respectively. Advanced technologies, defined as 16 nanometer and below, accounted for 61% of wafer revenue. In terms of revenue contribution by platform, smartphone increased 12% quarter over quarter to account for 46% of our third quarter revenue. HPC increased 25% to account for 37%. IoT increased 24% to account for 9%. Automotive decreased 23% to account for 2%. Digital consumer electronics decreased 24% to account for 3%. Moving on to the balance sheet, we ended the third quarter with cash and marketable securities of 742 billion NT. On the liability side, current liabilities decreased by 27 billion NT, mainly due to the decrease of short-term loans and the decrease of current portion of bonds payable. Long-term interest-bearing debts increased by 146 billion NT, mainly as we raised 145 billion of corporate bonds during the quarter. On financial ratios, accounts receivable turnover days decreased four days to 40 days, while days of inventory decreased increased three days to 58 days primarily due to N5 ramp. Regarding cash flow and CAPEX, during the third quarter, we generated about $190 billion NT in cash from operations, spent $99 billion in CAPEX, and distributed $65 billion for fourth quarter 19 cash dividends. Short-term loan decreased by 17 billion NT, while bonds payable increased by 136 billion NT, mainly due to the bond issuances. Overall, our cash balance increased 137 billion to 604 billion at the end of the quarter. In U.S. dollar terms, our third-quarter capital expenditures totaled 3.4 billion. I have finished my financial summary. Now let's turn to our fourth quarter guidance. Based on the current business outlook, we expect our fourth quarter revenue to be between 12.4 billion and 12.7 billion U.S. dollars, representing a 3.4% sequential increase at the midpoint. Based on the exchange rate assumption of 1 U.S. dollar to 28.75 NT dollars, Growth margin is expected to be between 51.5% and 53.5%. Operating margin between 40.5% and 42.5%. Now I will hand over to the call to CC for his key messages.

Thank you, Wendell. Good afternoon, everyone. We hope everybody is staying safe and healthy during this time. Now let me start with our near-term demand and inventory. We concluded our third quarter with revenue of NP 356.4 billion, or US dollar 12.1 billion, which was above our guidance, mainly due to better demand across all our platforms than our forecast three months ago. Moving into fourth quarter 2020, We expect our sequential growth to be supported by strong demand for our industry-leading 5-nanometer technology, driven by 5G smartphone launches and HPC-related applications. On the inventory front, we forecast our fabulous customers' overall inventory to exceed the year above the seasonal level, as the supply chain continues to make efforts to ensure supply chain security and actively prepare for the new 5G smartphone launches. Looking ahead, we expect our customers' overall inventory to remain above the historical seasonal level for a longer period of time, given the industry's continued need to ensure supply chain security amid its the lingering uncertainties. For the full year of 2020, although COVID-19 continues to bring some level of impact to the global economies, we also observe that COVID-19 is accelerating digital transformation, while 5G and HPC-related applications continue to drive semiconductor content enrichment. We now forecast the overall semiconductor market, excluding memory, to increase mid-single-digit percentage, while factory industry growth is expected to be close to 20% year-over-year. For TSMC, our technology leadership position enables us to capture the industry megatrend of 5G and HPC We expect to outperform the fund tree revenue growth and grow by about 30% in 2020 in U.S. dollar terms. Next, let me talk about our N5 ramp-up and N4 progress. TSMC's N5 is the fund tree 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 to further enhance our leadership in EUV technology. Due to the robust demand from 5G smartphones and HPC applications, we reaffirm N5 will contribute about 8% of our wafer revenue in 2020. and we expect even higher percentage in 2021. N4 will leverage the strong foundation of N5 to further extend our 5-nanometer family. N4 is a straightforward migration from N5 with compatible design rules while providing further performance, power, and density enhancement for the next wave 5-nanometer products. N4 risk production is targeted for 4Q 2021 and volume production in 2022. With our continuous technology enhancement, we expect our 5nm family to be a large and long-lasting node for TSMC. Now I will talk about our N3 status. N3 will be another 4-node straight from our N5. with up to 70% logic density gain, up to 15% performance gain, and up to 30% power reduction as compared with N5. We have chosen thin-thread transistor structure for our N3 technology to deliver the best technology maturity, performance, and cost for our customers. Our N3 technology development is on track, with good progress, and we will offer complete platform support for both mobile and HPC applications. Reproduction is scheduled in 2021, and volume production is targeted in second half of 2022. Our 3 nanometer technology will be the most advanced foundry technology in both PPA and transistor technology when it is introduced. Thus, we are confident our 3 nanometer will be another large and long-lasting node for TSMC. Finally, I'll talk about the TSMC 3D fabric. TSMC has developed an industry-leading and comprehensive wafer-level 3D IC technology roadmap to enhance system-level performance. Our differentiated chiplets and heterogeneous integration technologies drive better power-efficient and smaller form factor benefits for our customers while shortening their time to market. These technologies, including chip-staking solutions such as SOIC, as well as advanced packaging solutions such as Info and Coworks, we are consolidating these offerings under one umbrella and naming it TSMC 3D Fabric. As the industry continues to seek innovations to enhance system-level performance, 3D Fabric will complement our advanced technology to unleash our customers' innovation. We expect revenue from our back-end services, which include both Advanced packaging and testing to grow at a rate slightly above the corporate average in the next few years. Now let me turn the microphone over to Wendell.

Thank you, C.C. Let me start by making some comments on our profitability. Our third quarter gross margin exceeded the high end of our guidance to reach 53.4%. mainly as we saw a much higher-than-expected overall capacity utilization rate in the third quarter. That helped to offset the margin dilution from the initial ramp-up of our 5-nanometer technology. We have just guided fourth quarter gross margin to decline by 0.9 percentage points sequentially to 52.5% at the midpoint, primarily due to the margin dilution from the continuous steep ramp up of our five nanometer and the less favorable foreign exchange rate in the fourth quarter. Looking to 2021, we expect a strong ramp of N5 to contribute a higher percentage of revenue as compared to 2020. The yield rate of N5 continues to improve. Similar to prior notes, we forecast M5's gross margin to take seven or eight quarters to reach the corporate average level. Thus, M5 is expected to dilute our gross margin by about two to three percentage points for the full year of 2021. As a reminder, the following six factors determine TSMC's profitability. Leadership technology development and ramp-up, pricing, cost reduction, capacity utilization, technology mix, as well as foreign exchange rate. Taking all these factors into consideration, we believe a long-term gross margin of about 50% is achievable. Now let me talk about our capital budget for this year. Our business outlook is supported by strong demand for our industry-leading advanced technologies and specialty technology solutions driven by the industry megatrends of 5G and HPC-related applications. In order to meet this demand and support our customers' capacity needs, we now expect our full-year 2020 CAPEX to be about $17 billion. Now I will make some comments on our corporate bond issuances and capital structure. The multi-year mega trends of 5G related and HPC applications are expected to continue to drive strong demand for our advanced technologies in the next several years. Given the macro economic uncertainties this year, a current low interest rate environment and ability to diversify our funding sources, TSMC's Board of Directors has so far approved the issuance of $120 billion in NT dollar denominated corporate bonds and $4 billion in U.S. dollar denominated corporate bonds. Year-to-date, we have issued $89.5 billion in NT dollar denominated and $4 billion in U.S. dollar denominated corporate bonds with favorable pricing terms. With our solid financial performance, strong balance sheet and cash position, and capacity to take on debt, we are able to aggressively invest in our future to enhance our technologies and capabilities. This enables us to continue to outgrow the semiconductor industry through the cycles. With our disciplined capital management, we remain committed to a sustainable cash dividends on both an annual and quarterly basis.

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 0, then the 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 questioning queue, please press 02. So now let's begin the Q&A session. Operator, can we please proceed with the first caller on the line?

The first caller on the line is . Go ahead, please.

Great quarter, and thanks for taking my question. My first question is on and capital intensity. Looks like this year it will come in around 36, 37% capital intensity. Could we talk a little bit about how we should think about capital density and absolute capex as well, looking forward, at least on a directional basis? Seems like the investment cycle is still going to be pretty much intact going into next year, also looking at some of the financial options in terms of bond raising, et cetera, that the agency has undertaken. That is my first question. My second question is on N5. I think in previous calls we had indicated that while N5 will be a long and large node, it may not have the same number of hit-outs as N7 has had, which is probably the historical high. Is our view changing on N5? Could we talk a little bit about will N5 exceed N7 in terms of vapor capacity as well as vapor revenue in the next two years or so?

Thank you. Okay, cool, cool. Thank you very much. We'll take your questions one by one. Please allow me to summarize your question. Your first question relates to our CapEx and capital intensity. You point out that with the guidance that our capital intensity this year, in your estimation, is probably around 36% to 37%. So your question is, how should we think about CapEx and capital intensity in the next few years? if we cannot give a quantitative number directionally, how do we see CapEx and capital intensity, and how does this tie in with our recent things such as bond issuances and fundraising? How does that factor in? That's the first question. Maybe CFO Wendell can address.

Yes. Goku, our capital intensity, as you are right, this year will be lower than 40%. In the next several years, longer term, we expect the capital intensity to be around mid-30 percentage point. However, having said that, there may be years where capital intensity is higher if we see the strong demand for our technologies or capacity and we decide to invest.

Okay. Okay. And then your second question, Goko, please allow me to summarize again, is regarding to our 5 nanometer that we have said that it's a long and large node, but that the number of tape outs of N5 versus N7 may be lower. So your question is, can N5 exceed N7? Do we believe 5 nanometer can be a bigger node than 7 in terms of revenue and capacity?

Well, let me say that we don't comment on how many tape-outs so far, but we continue to see strong tape-out activities at N5 from both HPC and the smartphone applications. And the revenue for this year we just mentioned is 8% of the waiver revenue. And next year it will be even higher than, you know, close to you know, or 20 or something like that, the exact number we are still not able to come in. But I can assure you that our five nanometer family will be another big and long-lasting node for TSMC.

Okay. Thank you, Gokul. Why don't operator, can we move on to the next caller, please?

Next one we have Randy Abrams for this piece.

Randy Abrams Okay, yes, thank you. My first question I wanted to ask on, Wendell, you raised the gross margin originally was 50%. Could you discuss now where you're saying it could be above 50%, the factors driving that change, and could you clarify on the two to three point impact on five nanometer I think you already have that impact. So does that apply for next year? Pretty similar to the type of gross margin you're running now are potentially even better.

Okay. Randy, I'll summarize your question. Your first question is in regards to, I believe, our gross margin and long-term gross margin. I think you're asking that we raise our target margin. But I think we, as Wendell said, 50% is achievable for us. But you're also asking as part of that, the dilution from five nanometer, how will that impact our gross margin next year? And where should we, I guess, be thinking about gross margin for 2021? Okay.

Randy, maybe let me answer this like this. We have a very high gross margins in the third quarter, and we believe we will continue to have a pretty high margin in the fourth quarter. And main reason is that we are enjoying a very high utilization across almost all the nodes at this moment. But the very high utilization may not continue forever. So our long-term growth target or long-term growth goal for our growth margin continues to be about 50%. In terms of dilution from M5, we see the dilution of M5 for next year to be around two to three percentage point, similar to previous notes. And remember that the M5 will account for a much bigger percentage of our revenue next year. So as we ramp up quickly, the dilution will continue to exist. However, we are still expecting that it will reach the corporate margin but in seven to eight quarters.

Okay. No, great. Thanks. I misunderstood. I thought I heard the word above for 50, but thanks for the clarification. Second question, on the recent U.S. restriction on SMIC, I'm curious if you're seeing any additional diversification or increase for business. And given they're more on the mature nodes, how you're positioned if you are seeing those to take on business on the mature nodes.

Okay, Randy. Let me just summarize your second question. Your second question is regards to the recent restrictions on SMIC. And Randy is wondering whether we are seeing any types of diversification or inquiries from customers in regards to business and, you know, especially at the mature nodes.

Well, Randy – Let me answer the question. Actually, we are still evaluating the impact to the semiconductor industry due to the ban on SMIC. But let me say that our capacity planning and all our CAPEX continue based on the long-term demand profile. That is underpinned by the industry megatrend, such as 5G-related and HPC application. All right. Does that answer your question?

Yeah, or maybe just one quick, but for the mature nodes which are running tight across the industry, just if it's so that there's an incremental surge, how well could you handle incremental business, let's say, in this type of piece? if it were to come through.

So Randy is asking, if we were to see a surge in demand at the mature nodes, how ready or do we have capacity to take on or handle this type of surge demand?

Well, we continue to work with our customer dynamically, and we try our best to meet their demand. That's all I can say for today.

Okay, great. Thank you.

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

The next one is Sebastian Ho from CLSA.

Thank you. Good afternoon, gentlemen. My first question is, I think besides the higher than usual inventory, which may be a new norm because of the supply chain fear of disruption, I'm curious about how does TSMC assess customers' overbooking or pulling behavior and the magnitude? In particular, based on the recent smartphone OEMs' aggressive procurement about assuming Huawei is going to be dead next year, how do you assess that kind of potential overbuilt inventory risk that may potentially lead to a destocking correction sometime next year? This is my first question. Thank you.

Okay, Sebastian, let me repeat or try to summarize your question. Your question is basically related to the inventory, and you want to ask how does TSMC assess the risk that there is overbooking in light of the restrictions on Huawei, and therefore what type of levels or magnitude of inventory overbuild is there, and does this create the risk of inventory correction sometime next year?

Well, let me share with you our view on these inventory-related issues. First, I want to say that due to the pandemic, actually the digital transformation has been accelerated, and that creates a demand on 5G and HPC-related products. And so for the long term, longer-term basis, we do expect our customers' overall inventory to remain above the seasonal level for a longer period of time, majority partly because they have some concern on industry's supply chain security due to the uncertainties. And so that's what the high-level inventory or sustain, continue for a longer period of time. That we can say that.

Okay, Sebastian, do you have a second?

Yeah, all right. Sorry. Yeah, okay. All right, anyway, but that isn't actually what I'm looking for. But anyway, thank you for that, CC. And my second question is, On the HPC business, apparently, I think since you mentioned the primary mark that you see a lot of growth this quarter and also continuous trend next quarter, and driven by the XR in digital transformation, you just said it, led by the pandemic, and we're from home demand, like to stay for longer, and also the continued market share again on TSMC against IDM. And when do you expect your HPC revenue exposure to crossover with smartphone revenue percentage. It's possible to see that by the end of next year or 2022. Thank you.

Okay. Sebastian, let me just summarize your question, which is regards to our HPC platform business. You point out that there is the trends of the accelerating digital transformation and the work from home and also market share gains versus IDM. So you want to know when do we see our HPC platform revenue crossing over with the, you know, smartphone or others to become the primary?

Okay. Let me answer the question. We do see HPC platforms' growth rate is higher among our four platforms. which is smartphone, HPC, automotive, and IoT. And in the next few years, we continue to expect or we forecast that HPC's growth will be higher than the corporate level. When you are crossover, I don't make any comment right now.

Okay? Okay, thank you. Thank you, Sebastian. Operator, can we have the next caller, please?

Next one, we have Bruce Liu from Goldman Sachs.

Go ahead, please. Hi, Dr. Kenyon. So I want to ask about the 5G penetration rate. What is the latest forecast for the total smartphone growth and 5G penetration rate in 2020? And maybe a little bit of color on 2021 as well. So we also see that some of the telco is slowing down their 5G base station installation. You know, what kind of impact will you see at this moment?

Okay, Bruce. Your question is regards to 5G and smartphones. You want to know what is the smartphone growth and 5G penetration rate for 2020 as well as 2021? and then in light of the telecoms potentially slowing down the deployment. Correct?

Yes. All right. Thank you. Let me answer the question. We continue to expect the faster penetration of 5G smartphone as compared to 4G, and for this year we still forecast a high teens penetration rate, and next year even higher, much higher, let me say that. And that's all we have today.

Oh, and any impact on the tail coast of business as well?

Oh, I think all countries and all regions are preparing to build up the infrastructure right now, and I believe next year, even not 100% completed, but all the regions, all the countries have a lot of 5G phone being introduced, and that creates a a higher percentage penetration rate.

Okay, I understand. My next question is that, you know, I'm a little bit surprised that the China revenue contribution only increased slightly from 22% to 23% in third quarter. So which region will we see the strongest growth in the fourth quarter?

Okay, Bruce, your question is regards to our revenue by geography. And you want to know for the fourth quarter which region will contribute the most growth in the fourth quarter.

Okay, Bruce. We're not prepared to comment on geographic allocation among revenues in the fourth quarter. I can share with you that we expect the platforms that will grow in the fourth quarter will be smartphone and automotive. And the other two we're likely to be down.

I understand that. Thank you. All right. Thank you, Bruce. Operator, can we move on to the next caller, please?

Hi.

Good afternoon. Thank you for taking my question. So my first question is on 5 nanometer demand. So into next two to three years, what do you think revenue split could be by smartphone, HPC, et cetera? And do you think the mix could be a bit different from 7 nanometer?

Sorry, can you repeat your question, Sunny? You broke up a little bit.

Sure, sure, no problem. Sorry about that. So I wonder, for 5 nanometer demand into next two to three years, what does the management think the revenue mix could be by smartphone, HPC, et cetera? And would the product mix be a bit different from 7 nanometer?

Okay, all right. Let me summarize. Thank you, Sunny. Your question is in regards to 5 nanometer demand. And then when we look out over the next three years, how do we see the demand of 5 nanometer, the mix changing in terms of smartphone, HPC, different platforms, and then how does this compare to 7 nanometer? Correct?

That's right.

Thank you, Jeff. Hi. We don't break it down or disclose the platform mix of certain nodes, but we can share with you, as Cici just mentioned, In the next several years, we expect HPC to be the largest contributor of our growth. So that should give you some idea. And these guys use advanced technologies.

Sure, got it. And my second question is that for this year, a key part of your growth in smartphones is driven by higher silicon content for 5G and your share again. So I wonder if you could walk us through how your average silicon content in smartphone may trend into 2021 and 2022. Thank you very much.

Okay. So, Sunny, your second question is regards to the silicon content in 5G phones. The silicon content increase in 5G phone along with share gain is contributing to our smartphone growth this year. So she wants to know, What is the silicon content outlook for 2021 and 22?

You know, this is pretty hard for me to answer because I cannot release all the information I got from my customer. But let me say that on the average, the 5G phone have about 30% to 40% more silicon content as compared with 4G. Did that give you some kind of idea?

Sure. So I have a very quick follow-up. I wonder if you could give us some color regarding your expectation for your market share for smartphone into next two, three years.

So Sunny is asking whether we can give some comment on the market share, our market share in 5G phones the next two to three years.

No, it's not very appropriate for me to give some kind of estimate right now. But let me say that as long as we have a technology leadership position, we are very confident that we are going to have a high market share.

Okay.

Sure, got it. Thank you very much.

Thank you, Sunny. All right, let's move on. Operator, can we move on to the next caller on the line, please?

Next, we have Roland Shi from Citigroup.

Hi, good afternoon. My first question is, can you update the status of your license applications for shipment to Huawei? When do you expect to receive approval from U.S. government? And also, does your 4Q revenue forecast include any weather shipment to Huawei? Okay. This is my first question. Thanks.

Okay, Roland. So your question is regards to he wants an update of our license application status regarding Huawei, and he also wants to know does our fourth quarter guidance include any shipments to Huawei?

Roland, we are compliant fully with the regulations, and so... And we also noticed that there is a report saying that the TSMC got the license. We are not going to comment on this unfunded speculation. And we also don't want to comment on our status right now. For the 4Q shipment to Huawei, no. You know, the ban, the regulation already say that after September 17th, zero. 15th. September 15th? Okay.

Okay, thank you. Okay, my second question is how is the pricing pressure across all technology nodes so far? Some of your frontiers are considering to raise with the ASP given a very high utilization at 8-inch fat. So will you consider to follow to raise the pricing on 8-inch or other mature technology nodes?

Thanks. Okay, Roland, thank you. So your second question is regards to pricing pressure. Your note is that some of the foundry peers are considering to raise the 8-inch wafer price. So you want to know, does TSMC plan to raise our 8-inch wafer pricing or also raise our pricing on the mature nodes?

Let me answer the question. The answer, the big answer is no. No. We continue to work with customers, and customers are our partners. So for short-term supply shortage, we are definitely not using this kind of opportunity to raise our price. Our wafer price, we are selling our values, our service to our customer, not including the technology, delivery, quality, everything. Certainly, TSMC is working with all the customers and view them as partners, and so we don't use this opportunity to raise our wafer price. Did that answer your question?

Yes, thank you. Okay, thank you, Roland. Let's move on, operator, to the next caller.

Yes, next we're having Brett Simpson from RSA Research. Go ahead, please.

Thanks very much. I just had a question on your long-term capacity planning. I mean, you've laid out the view that we're going to see some structural tightness for the next couple of years and foundries potentially. And I'm just wondering if you see, you know, you have a very strong growth position in HPC, but you still have a very low market share in like x86 or, you know, PC and servers broadly. I'm just wondering if we do see Intel looking to outsource major CPU lines to Foundry, it could be a large one-time boost to the industry, to the Foundry industry. So would TSMC be in a meaningful, would they be able to meaningfully support Intel's needs if there was a big one-time outsourcing? And would you be prepared to take capital intensity to much higher levels should the opportunity arise? Thank you.

Okay, Brett, let me try to summarize your question. Your question basically is premised around our long-term capacity planning and pointing out that there's a structural tightness in foundry, and TSMC has a strong growth position. So your question specifically relates to x86 and Intel. If Intel were to outsource to foundry, Your premise is that this could be a one-time big outsourcing opportunity, and so how would we prepare or handle for this?

Well, let me say that we do not comment on the specific customers nor on the specific product. But let me say our capacity planning is based on the long-term demand profile. That is underpinned by the industry's mega trend to meet our customers' demand. And India is one of our important customers, and we continue to work with them.

Okay, thank you. And maybe just a follow-up regarding your capacity plans over the near term. Are you planning to add any capacity at the mature nodes, you know, maybe not so much 8-inch, but certainly sort of 28-nanometer or even 16-nanometer? And do you foresee putting any customers on allocation, you know, given the backdrop with tightness at the moment? Thank you.

Okay. So, Brett, your second question is regards to our capacity plans in the near term, specifically at some of the mature nodes like 28- and 16-nanometer nodes. Are we planning to add capacity and with the tightness our customers on allocation?

Well, again, let me say that we plan our capacity to meet the customer's demand. Whether it's a leading edge or mature node or specialties, we always work with the customer dynamically and also work with them closely to plan our capacity. And definitely today there are some shortage, but we are doing our best to serve our customers.

Okay. Thank you, Brett. Thanks very much. Thanks a lot, Brett. All right, operator, can we move on to the next caller on the line, please?

Next one to ask question, Charlie Chang from Morgan Stanley. Go ahead, please.

Thanks, and good afternoon, gentlemen. My first question is about your two nanometer progression because I think a couple weeks ago there was a news talking about you may see the two nanometer immense production in 2024. So I just want to get companies' clarification about your progress here, maybe your technology roadmap, and that realistic timing for the immense production. Thank you.

Okay, so Charlie's first question is in regards to our two nanometer. He says, according to news reports, that the production is going to begin in 2024. So he wants to know whether we can share the technology roadmap requirements and the timing of our two nanometer.

Charlie, let me say frankly, we are not ready to make any comment on the two nanometer yet. All right? Mm-hmm.

Okay. Yeah, but there seems to be some comments from your technology forum. So any reason why you can't disclose that to investors' society yet?

No, I think, Charlie, all we have disclosed about our 2 nanometer is the location, which will be in Shenzhou. We have not commented yet. on the technology specifications, the timing, or anything beyond that. So that is you, as you said, according to your reading the news, that is not TSMC's comment. And as CC said, we are not prepared to comment on two nanometer.

Okay, okay, no problem at all. And my second question is for me to window about the gross margin trend follow-up. So Based on your current depreciation table, when do you think the depreciation is going to peak in the coming years or coming quarters? At what point? And also, I think you mentioned that the new node ramp is a key factor to the gross margin dilution, but I think 4 nanometer is a part of the 5 nanometer family, right? So can we expect that in 2022, there's not going to be any kind of margin dilution from the 4 nanometer.

Thank you. All right. So, Charlie, your second question is regards to depreciation and gross margin. Charlie wants to know when do we expect depreciation to peak out on a quarterly or an annual basis, and he also wants to know that depreciation would we expect dilution from 4 nanometer in 2022, given that 4 nanometer is an extension of our 5 nanometer? Should there therefore not be dilution from 4 nanometer?

Okay, Charlie. The first question, really difficult to answer, because if you continue to invest, you may not have a peak in depreciation, just as if you continue to have strong growth, you may not have a peak in your revenue. So the second question, yes, we still expect that M5 family, the gross margin to reach corporate average in about seven or eight quarters, which is sometime in 2022.

Great. All right. Very helpful. Thank you.

Thank you, Charlie. Operator, let's move on to the next caller on the line, please.

Right now we're having Laura Chen from KGI. Go ahead, please.

Hi. Thank you for taking my question, and congratulations for the good result. My first question is regarding the 3 nanometer. Can you give us an update on current engagement? And we know that CC just mentioned we will have risk production next year, and Mass production probably on second half 2020. Just one thing, will the smartphone or HPC go first? That's my first question. Thanks.

Okay. So, Laura, your first question is regards to our 3 nanometer. She wants to know what is the current engagement with customers, and then with the volume production targeted for second half 2022, is it going to be smartphone or HPC driven? Okay.

All right, let me answer the question first on the engaging with customer. We are engaging with more customer at N3 as compared with N5 and N7 at a similar stage. Okay, so there's a lot of customers working with us. And now, which one in the second half of 2022, which one will be the first product? Actually, in... smartphone and HPC applications, both.

Okay, thanks. And my second question is about our supply chain equipment procurement plan. I think given our positive outlook and continuous cap-up, so do we plan to evaluate more local suppliers So I think given TSMC's leading position in the global foundry space, I think that's a good position to lead the localization equipment. So can you give us some color about what's your view to buy more equipment from the Taiwanese supplier or current status of the total procurement percentage per year from Taiwanese vendors, something like that?

Okay, Laura, so your second question is regards to our vendor and supply chain procurement strategy. Your question is really, are we considering, will we consider to use more local Taiwan suppliers? Do we have any type of percentage breakdown or anything like that? Correct?

Yes, yes, right, thanks.

Okay, we develop the technology while we maintain the technology and the manufacturing process. based on the best performance and the best cost structure. So we did not put, you know, where it came from, or we did not put the regions into consideration, to be frank with you. So the best technology, the best manufacturing cost is what we count. And so we don't have any certain percentage limitation on which area or the equipment came from. All right?

Okay. Does that answer your question, Laura? Okay, thank you. Operator, let's move on to the next caller, please.

Next one would have Chris Sandgren, Cohen & Company. Go ahead, please.

Yeah, hi. Thanks for taking my question. I have two of them. First one is on the matured nodes, i.e., 28 nanometer and above. Not currently, but over the next few years, how do you expect the revenue and wafer starts to trend on the matured nodes, especially as some of your customers start migrating to the leading edge? And then my second question is, in the past, you've spoken about converting some 28 nanometer plus capacity to 20 nanometer or so for IoT and other applications. Can you provide us an update on how this transition is going?

Okay, thank you, Krish. Let me try to summarize your questions. Maybe I'll summarize the first one, and then we can summarize the second. Your first question is regards to our mature nodes, specifically 20 nanometer and above. You want to know in the next few years what is the revenue outlook and also the demand or wafer starts outlook. over the next few years, especially as customers may start to migrate to more leading nodes, what do we do at the 28 nanometer and above? What is the outlook?

Well, let me answer that specifically on the 28 nanometer. We continue to improve the technology, and now we offer 22 nanometers ultra low power, and that's for IoT applications. And we also work with the customer to migrate the product from 65, 55, 245, to 28, and to 22. Today, the loading is not perfect yet, but we expect in one or two years, and then we expect the loading will greatly improve. And so, to To answer your question on all the mature nodes, we still are improving our technologies, and we still expect the growth.

Okay. And I think, Chris, just to clarify, the second question was in regards to 28, and your question was conversion to 20. But as C.C. said, we're converting 28 to 22. Hopefully that also addressed your second question.

All right? Yes, it does. Thank you, sir. Thank you.

Sure, Chris. Thank you very much. All right. Let's move on, operator, to the next caller, please.

Next one, we are having Richie from Taiwan Securities. Go ahead, please.

Yeah, hi. Good afternoon, guys. Okay, my first question, I just want to make a little clarification about your capex for this year. I think Wendell said about it's going to be around $17 billion, or it's going to be over $17 billion? Can you classify on this? And also give us a little bit of color about the capex for next year, please.

So your first question, to clarify, are 2020 capex requirements. What is, is it about or above 17?

Yeah, it's about, about 17.

Okay.

Yeah. For 2021, I'm sorry.

Yeah, yeah, yeah, please, go ahead.

Yeah, your second question is about 2021 CAPEX. It's too early to discuss the 2021 CAPEX at this moment. But as, if we see strong demand, and we will make the investment, because the CAPEX investment this year is always for the demand in the following years. So if we see the following year have strong demand, we will invest.

All right, thank you so much. I presume the, it's not a second question, just a follow-up, right?

Can I ask one more? Your second question, please.

Okay, so second question is about the inventory. I think CC did mention that right now because of the micro-insurances, COVID-19, et cetera, so customers intend to keep their inventories above seasonal for a longer period of time. But what if, because unless the uncertainty remains structural and it goes on forever, Otherwise, one day when it's already removed, you worry about your customer to unwind inventory and cause some business correction.

Okay, Rick. So your second question is in regards to inventory. Although there is macro uncertainty in COVID-19, but someday this will be over. So does this worry us? Will we see a sudden sharp correction or inventory drop as a result?

Okay. Let me share with you Again, our view on inventory. In fact, we don't worry too much about it because of, as I said, now because of a pandemic, the digital transformation has been accelerated. And that created a lot of new demand. Let me say that. It looks like, take for example, Now work from home, so now everybody buy a PC. Every kid had to buy a PC. And then just look again on the 5G smartphones benefit. The advantage on the bandwidth, on the speed, on the low latency, everything. And people are going to need it in this digital transformation. And so even right now, we expect the inventory is higher than historical high level. But the demand will pick up. And, you know, next year or 2022, we are confident that demand will pick up. And so that minimize or mitigate the impact of the inventory correction that everybody has a doubt on their mind.

Okay.

Okay, great. Thank you so much.

Sure. Thank you, Rick. Operator, let's move on to the next caller, please.

Next one is Mati Hussaini from SIG.

Yes, sir. Thank you for taking my question. First one, if your customers are willing to have inventories above this average trend line, should we assume that your wafer shipment in the first half of 2021, specifically Q1, would also follow a better than seasonal trend. I don't have a follow-up.

Okay, so Mindy's first question is regarding to basically our first quarter. If customers are willing to hold a higher level of inventory, should we assume that wafer shipments in the first quarter will also be much better?

We are going to share with you in the first investor conference. All right. Right now, we're not ready to make any comment on 2021, especially the first quarter.

Okay. Your second question, Medhi? Okay.

Sure. Can you please remind us how we should think about PayPal activity, specifically at the end for M5, and how does it compare to M7? Any follow-up would be great.

So your question is the tape-out activity at N4 and N5 as compared to N7.

Well, okay.

The demand is very strong in N4, N5, and we are engaging many customers. So the exact number of the tape-outs right now is all in our planning, but I can share with you that customers' demand is very strong. and what will continue to be strong for the next couple of years.

Okay. All right. Thank you, Madi. Operator, can we move on to the next caller, please?

Right now we have Gokul Harihalan from JP Morgan.

Thanks for the follow-up question. There's been a lot of discussion on market share on leading edge. So, PC, could you comment a little bit on how do we think about the S&P market share in N7, which I think is probably like 85, 80, 80 percent or even higher, and compare that with what are we expecting for the N5 family, if we include N5 and N4? And I had a second question as well. Thank you.

All right. Goku's first follow-up question is in terms of market share. He wants to ask CC, what do we see in terms of our market share at 7 nanometer, and what is our expectation or outlook at the 5 nanometer family?

Goku, since I continue to say we have technology leadership, so I can share with you that we have very high percentage of market share. but what exactly the number is not appropriate to announce it because it's all our own estimate. But, again, the most important thing is not the market share. The most important thing for us is continue to maintain the technology leadership, and we are focused on that.

Okay. Okay. Okay, just a quick question on that. Could we say at least directionally if N5 market share in our own estimate higher than N7 or similar to N7?

Okay, so the second question Goku wants to ask is still our market share. Do we see directionally will N5 market share be higher than that of N7?

Yeah, very similar because we are always the technology leader. When we introduced the N7, we are the technology leader. And when we introduced the N5 this year in mass production, we continue to be the technology leader. So they are very similar.

Okay. Thank you. Thanks, Gokul.

Can I ask one more question?

I think, Gokul, sorry, that's two. Sorry, I would like to ask you to get back in the queue because we still have, I think, quite a few people. But thank you. All right. Operator, let's move on to the next caller, please.

Next one, we have Randy Abrams from Cato Suisse.

Okay. Thanks for the follow-up. I wanted to ask on the R&D has stepped up faster in the quarter. From this higher level, could you discuss the investment rate that you're expecting for R&D, say, as a percent of sales? And would the new advanced nodes and packaging investments start to increase the R&D intensity?

Okay. So Randy's first question is that he noticed or points out, actually, that R&D has increased or stepped up. in the third quarter this year. So he wants to know, given advanced packaging and the continued technology leadership, what is the R&D percentage of sales outlook that we should expect?

Randy, let me share with you that in the third quarter, the R&D expenses are higher because of our development activities in N4 and N3. longer term we're still expecting the R&D expense to be about 8% or slightly higher than 8% of our revenue.

Okay, great. I appreciate that. And the second follow-up question I had, just on a couple of segments, Otto, I think you mentioned earlier about coming back. It was soft in the quarter. Could you discuss now as a growth driver – From a low base, if you're finally seeing some of those content drivers for next one to two years, there could be a meaningful pickup, even without auto, but from a content. And then the other side on consumer, which was quite weak just despite a lot of work from home in consumer electronics coming through. So if you could give color maybe on something happening in the consumer segment.

Okay. So Randy's second question is really a little bit split into two, but he wants to know, With the automotive business seeming to bottom out, how do we view our automotive platform as a growth driver or outlook over the next few years? And then similarly, he also is asking about digital consumer.

All right. Actually, let me comment on the automotive platform. Actually, the COVID-19 has a major impact on the automotive market and supply chain this year have all been affected. But we are seeing the sign of recovery in 4Q. In the longer term, the trend towards safer, greener, and smarter vehicles will continue to drive silicon content increase as well as a demand for advanced and specialty technology. And again, I want to emphasize, with our technology leadership, we are well positioned to capture the opportunities. The growth rate, you know, will continue to pick up, but still behind the HPC's growth rate. And for the digital consumer, it's kind of flat or it's a little bit gross that I can see today. Does that answer your question, Randy?

Yes. Yeah, just maybe the near term, I was surprised it was as much down, factoring in their stay-at-home consumer electronics demand. But I don't know if anything just specific or short-term in nature on that.

Okay. Actually, you know, some of the product, you know, because of stay-at-home or the work from home, some of the product we put into the HPC category.

That's right. Okay. All right. Thank you.

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

The next one is Sebastian Ho, CLSA.

Hello, Sebastian. You may need to unmute.

Okay. Sure, exactly. Thank you, Jeff. So let me, first question, let me try the overbooking inventory question in another way, again, if I may. So we understand the hybrid inventory is structural, led by carbon-19. But how about the higher inventory that's led by customers' fear of laundry capacity tightness, which is now under supply almost everywhere from leading edge to traveling edge? And based on the past cycle's experience, the tighter the supply of any components, the higher the risk of supply chain overbooking. And hence, I'm curious whether TSMC is seeing any gap between customers' ordering volume and your internal forecast on ending them, or is not a concern at all, as all the strong owners are just a reception of the real demand. Thank you.

Okay, so Sebastian's question is around the inventory. And while his view, some of the inventory may be related to COVID-19 and more structural or linger for a while, he wants to know, is there a concern, does TSMC have a concern that because the foundry is tight, that therefore their customers are doing a lot of overbooking or so-called double bookings, And also, therefore, does this create a concern for TSMC when we look at our internal forecast for the end demand market versus customers booking that there is a large gap and risk of shortfall?

Well, Sebastian, actually, in TSMC's view, all my customers are our partners. So we work with them very closely. And so to, you know, to They say that minimize the fear of overbooking because they don't have to be afraid of capacity shortage and then do the overbooking to TSMC. No, we work with them as a partner, and both parties, all my customers work with TSMC and tell us their view on the market, and we share our view on the market with them also. So this one minimize a lot of the possibility of overbooking. And that's the way that TSMC working with our customers. They are all our partners. Did that answer your question, Sebastian?

Thank you. Yes, yes, that's a very, very great answer. Thank you, CC. My second follow-up question is that We've seen the rising cross-border relationship risk in recent months. So I'm wondering if TSMC or your customers are concerned or discuss with you about the potential risk in production operation as most of your fabs are located in Taiwan. And if such heightened risk continue for longer than just months, whether TSMC will consider most of fab bill out in Taiwan or increase investment in other regions? Thank you.

Okay, Sebastian, thank you. Let me summarize your second question. Your question is regarding that, you know, you observed the rising or growing risks in the cross-strait relationships, and so therefore for our customers, do they feel there's a heightened risk, and thus is there a need for TSMC to, I guess, paraphrase, expand our manufacturing footprint into other locations given the state of cross-strait relations? in the next few years.

Okay, Sebastian. In fact, TSNC will continue to focus on Taiwan. I mean, that's our center of R&D and majority of our production facts will continue to be located in Taiwan, regardless of all the geopolitical tension or any kind of disruption. Did that answer your questions?

Yes, yes. That's correct. Thank you, C.C., and thank you, Jeff.

Sure. Thank you, Sebastian. All right, operator, let's move on to the next caller, please.

Next one we have Bruce Liu from Goldman Sachs.

Okay, so the question is for the advanced packaging. What is the revenue growth for the advanced packaging in 2020? You know, the growth rate seems to be very strong, but the management also only guided for, like, you know, the future growth for the advanced packaging is only slightly higher than the corporate average. This is much slower than what we have in the past three years. Any reasons behind that? And what's the profitability for the advanced packaging right now?

Okay, so Bruce, your first question is regards to our advanced packaging business. You want to know what is the growth of the advanced packaging business in 2020, and also what is the profitability of the advanced packaging?

Yeah, Bruce, the growth of our advanced packaging in this year is close to the corporate, but not as high. In the next several years, we do expect that on a character basis, it will grow faster than the corporate average. And in terms of margins, its margins is lower than the corporate. However, its investment intensity, capital intensity is lower. Therefore, on a return basis, ROIC basis, it is acceptable to us.

Okay. Do we... Okay, so the next question is for the 28 nanometers. I want to clarify something. You know, in the fourth quarter of 2019, I think the management showed very high confidence that 28 nanometer utilization rate went back to the corporate average, driven by the more of patients such as CMOS, unit sensor, etc. However, if my understanding is correct, management still expects it will be lower than the corporate average in the coming years in terms of utilization rate. You know, is that what I'm understanding right now?

Okay, so your second question, Bruce, is regarding our 28 nanometer. 28. I'm sorry? 28. 28.

I'm sorry, 28 nanometer.

Yes, 28 nanometer. And that you said that we had commented in the fourth quarter 19 earnings result January this year that our 28 nanometer utilization would improve in one to two years' time. and to the corporate average. And now your question is, does that statement still hold true?

Bruce, let me say that. The progress is a little bit slower than we expected, but still, in one to two years, the utilization rate of the 28 nanometer, particularly we advanced it to 22 nanometer, will be reaching the corporate average.

Okay. Thank you.

All right. Thank you. Thank you, Bruce. All right. In the interest of time, we will take the question from the last caller or last participant, please.

The last one to ask question is Roland Shi from Citigroup. Go ahead, please.

Yes, your N6 technology is with one more EUV layer insertion than 7 Plus, but N4 is with reduced mask layers from inside, and it's with a simplified process. So can you elaborate your technology development logic between N6 and N4, and also the target market for N6 and N4, and how will N6 and N4 contribute to your business respectively going forward?

Okay, Roland, so your question is regards to N6 versus N4 positioning. You point out technology-wise N6 has one more EUV layer than 7+, but N4 may have reduced mask layers versus N5 and with simplified process. So you're asking does N4 serve the same group or target the same group of customers as N6, Or are they separate markets or targeting separate customers and applications?

Correct. Thanks. Roland, it's actually very hard to answer your question whether the N6 is the same kind of group of the N4. Let me give you some kind of idea. N6 is kind of development platform. continued enhancement of the N7 or N7+. And so all the second wave of the customer will use the N6 when they want to enter the 7 nanometer family. And because of that, they'll offer the better density, better performance, and better power consumption. Now, similar to N6, N4 is also, we continue to improve the N5. And we also observed that if we can reduce the mask count, we can improve the defect density, we can improve the cycle time, and we also, at the same time, we also offer the better density, better performance, et cetera, et cetera. And so, are they the same group? I cannot answer this question, but it's the same purpose. We offer N6 to be the second wave of the N7 customer. We offer the N4 also to offer to the second wave of the customer of N5.

Okay, thanks. Yeah, a little bit complicated. And so is there any performance enhancement to M5? Because this is with the simplified process. And it's still laser, you know. I can understand laser, you know, the improvement on this defect on this production cycle type, but how about it from the performance point of view? Is it going to be enhancement in M5?

Okay, so your second question, Roland, continues to ask about the 4 nanometer. Will N4, does it carry any performance enhancement or PPA improvement as compared to N5?

Yes. The short answer is yes. We improve the density. We improve the performance, including the transistor performance.

Okay. Thank you, Roland. Thank you. Yep. Thank you very much. All right. 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 become available 24 hours from now. Both of them are going to be available through TSMC's website at www.tsmc.com. Thank you everyone for joining us today. We hope everyone continues to stay safe and healthy. And we hope you will join us again next quarter. Goodbye and have a good day.