Taiwan Semiconductor Manufacturing Company Ltd.

Good evening, everyone. I am Su Zhikai from Taiji.com's Legal Relations Department. Welcome to the 2021 Legal Explanation Conference of Taiji. In order to prevent the spread of COVID-19, the Legal Explanation Conference is still being held. Due to the fact that this conference is broadcast to global investors at the same time, we will use English throughout. Please excuse us. Good afternoon, everyone. Welcome to TSMC's second quarter 2021 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 second quarter of 2021, followed by our guidance for the third quarter of 2021. Afterwards, TSMC's CEO, Dr. Cici Wei, Mr. Huang, and TSMC's Chairman, Dr. Mark Liu, 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's CFO, Mr. Wendell Huang, for the summary of operations and the current quarter guidance.

Thank you, Jeff. Second quarter revenue increased 2.7% sequentially in NT dollar terms, or 2.9% in U.S. dollar term. Our second quarter business was supported by continued strength in HPC and automotive-related demand. Gross margin decreased 2.4 percentage points sequentially to 50%, mainly due to M5 dilution, the slower rate of cost improvement, and the absence of positive inventory revaluation. Total operating expenses slightly increased 1.47 billion NT. Therefore, operating margins decreased 2.4 percentage points sequentially to 39.1%. Overall, our second quarter EPS was 5.18 NT and ROE was 27.3%. Let's move on to revenue by technology. 5 nanometer process technology contributed 18% of wafer revenue in the second quarter, while 7 nanometer accounted for 31%. Advanced technologies, which are defined as 7 nanometer and below, accounted for 49% of wafer revenue. Moving on to revenue contribution by platform, smartphone decreased 3% quarter over quarter to account for 42% of our second quarter revenue. HPC increased 12% to account for 39%. IoT decreased 2% to account for 8%. Automotive increased 12% to account for 4%. And DCE decreased 12% to account for 4%. Moving on to the balance sheet, we ended the second quarter with cash and marketable securities of 871 billion NT dollars. On the liability side, current liabilities decreased 14 billion NT, mainly due to the decrease of 23 billion in accrued liabilities and others, partially offset by the increase of 6 billion in dividend payable. Long-term interest-bearing debt increased by 134 billion NT, mainly as we raised 137 billion of corporate bonds during the quarter. On financial ratios, accounts receivables turnover days increased 2 days to 42 days, while days of inventory also rose 2 days to 85 days, primarily due to M5 wafer pre-build. Now, let me make a few comments on cash flow and CAPEX. During the second quarter, we generated about 187 billion NT in cash from operations, spent 167 billion in CAPEX, and distributed 65 billion for third quarter of 2020 cash dividend. Short-term loans increased 4 billion, while bonds payable increased by 137 billion. Overall, our cash balance increased 83 billion to 748 billion at the end of the quarter. In U.S. dollar terms, our second quarter capital expenditures totaled 5.97 billion U.S. 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 14.6 billion and 14.9 billion U.S. dollars, which represents a 11% sequential increase at the midpoint. Based on the exchange rate assumption of 1 U.S. dollar to 27.9 NT, gross margin is expected to be between 49.5% and 51.5%, operating margin between 38.5% and 40.5%. This concludes my financial presentation. I will turn the microphone over to our CEO, C.C.

Thank you, Wendell. We hope everybody is staying safe and healthy during this time. First, let me start with TSMC's long-term growth outlook and investment plan. We are witnessing A structural increase in underlying semiconductor demand as a multi-year megatrend of 5G and HPC-related applications are expected to fuel massive increase in computation power and greater need for energy-efficient computing, which will require leading-edge technologies. COVID-19 has also fundamentally accelerated the digital transformation, making saving conductors more pervasive and essential in people's lives. With our technology leadership, manufacturing excellence, and customer trust, we are well-positioned to capture the structural growth from the fabric industry megatrend with our differentiated technologies. We now expect our long-term revenue kicker from 2020 to 2025 to be near the high end of our 10% to 15% CAGR range in U.S. dollar terms. In the near term, we continue to observe both short-term imbalances in the supply chain driven by the need to ensure supply security as well as a structural increase in long-term demand. While the short-term imbalance may or may not persist, We expect our capacity to remain tight throughout the year and into 2022, fueled by strong demand for our industry-leading advanced and special technologies. For the full year of 2021, we now forecast the overall semiconductor market excluding memory to grow about 17%, while foundry industry growth is forecast to be about 20%. We now expect for TSMC, we are confident we can outperform the foundry revenue growth and grow above 20% in 2021 in U.S. dollar terms. To address the structural increase in long-term market demand profile, TSMC is working with closely our customers to plan our capacity, and investing in leading-edge and specialty technologies to support their demand. Our capital investment decisions are based on four disciplines, that is, technology leadership, flexible and responsive manufacturing, retaining customers' trust, and earning the proper return. To ensure a proper return from the investment, both pricing and cost are important, TSMC's pricing strategy is strategic, not opportunistic. At the same time, we face manufacturing cost challenges due to increasing process complexity at leading node, new investment in mature nodes, expansion of our global manufacturing footprint, and rising materials and basic commodities costs. Therefore, we are firming up our wafer pricing, We will continue to work closely with our customers to provide our value. We will also continue to work diligently with our suppliers to deliver and cause improvement. By taking such actions, we believe we can continue to earn proper returns that enable us to invest to support our customers' growth and deliver long-term profitable growth for our shareholders. Next, let me talk about automotive supply update. TSMC has actively taken steps throughout the first half of this year, and we will continue to do so in the second half to address the chip supply challenges for our automotive customers. The automotive supply chain is long and complex with its own inventory management practices. From chip production to car production, it takes at least six months to reach the automotive OEMs, with several tiers of suppliers in between. However, we have worked dynamically with other customers to relocate our wafer capacity to support the worldwide automotive industry. In the first half of this year, we successfully increased our output for MCUs one of the key components in automotive semiconductor products, by about 30% as compared to first half 2020. For the full year, we expect to increase output for MCUs by close to 60% over the 2020 level, which also represent about a 30% increase over the 2018 pandemic level. By taking such actions, we expect the automotive component shortage from semiconductor to be greatly reduced for TSMC customers starting this quarter. Now let me talk about the N5 and N4 progress. TSMC's EN5 is the foundry industry's most advanced solution with the best PPA. EN5 is already in its second year of volume production, with yield well on track. EN5 demand continues to be strong, driven by smartphone and HPC applications, and we expect EN5 to contribute around 20% of our wave revenue in 2021. To further enhance our 5 nanometer family's performance, power, and density improvements for the next wave 5 nanometer products, we introduced N4 technology, which is a straightforward migration from N5 with compatible design rules. N4 risk production will begin this quarter and volume production in 2022. Thus, we expect demand for our N5 family to continue to grow in the next several years, driven by the robust demand for smartphone and HPC applications. Finally, I will talk about the N3 status. N3 will be another full node scaling from our N5 and will use FinFET transistor structure to deliver the best technology maturity performance, and cost for our customers. Our N3 technology development is on track with good progress. We have developed complete platform support for both HPC and the smartphone application on N3. We continue to see a high level of customer engagement at N3 and expect more new tap-outs for N3 for the first year as compared with N5. This production is scheduled in 2021, and production will start 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. With our technology leadership and strong customer demand, we are confident that both N5 and N3 will be large and long-lasting loans for TSMC and become important driver of our long-term growth. Now let me turn over the microphone to Wendell.

Thank you, C.C. Let me start by making some comments on our near-term demand and inventory. We concluded our second quarter with revenue of 372.1 billion NTD or US$13.3 billion, slightly above our guidance, mainly due to better demand from HPC, IoT, and automotive-related applications than our forecast three months ago. Moving into third quarter 2021, we expect our business to be supported by strong demand for our industry-leading 5nm and 7nm technologies, driven by all four growth platforms, which are smartphone, HPC, IoT, and automotive-related applications. On the inventory side, we expect our fabulous customers' overall inventory to exit second quarter of 2021 at a healthy level. We expect our customers and the supply chain to gradually prepare higher levels of inventory in the second half of the year as compared to the historical seasonal level given the industry's continued need to ensure supply security following supply chain disruptions due to COVID-19 and uncertainties brought about by geopolitical tensions. Next, let me talk about our profitability. Our second quarter gross margin of 50% was slightly below the midpoint of our guidance, mainly due to an unfavorable foreign exchange rate. Our gross margin guidance provided three months ago was based on exchange rate assumption of $1 to 28.4 NT, whereas the actual second quarter exchange rate was $1 to 28.01 NT. This created about 0.5 percentage point difference in our actual second quarter gross margin versus our original guidance. In other words, if the exchange rate had maintained at $1 to 28.4 NT, our second quarter gross margin would have been 50.5%. Based on the exchange rate assumption of $1 to 27.9 NT, we have just guided third quarter 2021 gross margin to increase by 0.5 percentage points sequentially to 50.5% at the midpoint, mainly due to better back-end profitability. Despite the rapidly rising depreciation costs and unfavorable foreign exchange rate, we are able to maintain our gross margin at above 50% in both second quarter, and third quarter. Although a higher level of capital intensity is necessary in the near term, as we are accelerating our investment pace in anticipation of the strong growth that will follow, we expect to continue to earn a similar level of long-term return. Our long-term financial objectives remain unchanged. we reiterate the long-term gross margin of above 50% is achievable, with operating margin to be above 39% and ROE to be above 20% through the cycle. Now, let me make some comments on our cash dividend distribution policy. TSMC remains committed to a sustainable cash dividends on both an annual and quarterly basis. In June, TSMC's Board of Directors approved the distribution of a 2.75 NT per share cash dividend for the first quarter of 2021, which will be distributed in October 2021. Therefore, TSMC's shareholders will receive a total of 10.25 NT cash dividend per share in 2021. That also means that shareholders will receive at least 11 NT per share cash dividend for 2022, and the quarterly cash dividends is expected to be at least 2.75 NT per share. Now let me turn the microphone over to our chairman, Mark.

Thank you. Thank you, Wendell. And good afternoon, everyone. Today I will talk about TSMC's global manufacturing footprint. TSMC's mission is to be the trusted technology and capacity provider for the global logic IC industry for years to come. TSMC always treat our customers as partners. We do not compete with our customers. We grow our business by unleashing our customers' innovations and enabling their success. We earn our business by providing solid values, by providing industry-leading technologies, the world's largest logic capacity, and efficient and cost-effective manufacturing to our customers while maintaining trusting relationship with them. In our capital investment, our responsibility as TSMC management is to make the best decision in the interest of the company and our customers. And our fiduciary duty is to our shareholders. As the need for semiconductor infrastructure security has increased in recent years, we are expanding our global manufacturing footprint to sustain and enhance our competitive advantages and to better serve our customers in the new geopolitical environment. In Taiwan, we are building capacity for N5 and N3 in Tainan Science Park. Due to the strong customer demand, we have further planned to expand in northern, central, and southern science parks in Taiwan, and Taiwan will continue to be the home base and center of R&D for TSMC. As the initial phase of volume production of a leading-edge technology has to be in close proximity and closely coupled with R&D FAB due to massive collaborative engineering activities, our leading node will continue to be ramped in Taiwan as well. In the U.S., we are increasing our presence with an advanced 12-inch semiconductor FAB in Arizona, and the progress is well on track with our plan. We are actively in a fast-learning phase to optimize the operating efficiency for the U.S. fab. The first wave of U.S.-hired engineers arrived Taiwan in late April for training on 5-nanometer technology. Construction of the fab has already begun, with equipment moving in scheduled for second half 2022. Phase one volume production of 20K wafer per month of five nanometer technology will begin in first quarter 24. At that time, our five nanometer family will still be the most advanced high volume production technology commercially available in the US. Our customers welcome us to build capacity in the US. and pledged their strong support and business commitments. Therefore, we do not rule out the possibility of a second phase of expansion to meet our customers' strong demand. In China, as our fab construction in Nanjing has already completed in 2017, we have completed the phase one volume ramp in third quarter 2020, now reaching 25K wafer per month of 16 nanometer technology. We are further expanding our presence in Nanjing with 28 nanometer technology to support our customers' urgent needs with volume production beginning in second half 2022 and reaching 40k wafer per month capacity by mid-2023. For the long term, we forecast 28 nanometer capacity will be the sweet spot for our embedded memory applications. And our structural demand for 28 nanometer will be strongly supported by multiple specialty technologies. Our global manufacturing expansion strategy is based on customer needs, business opportunities, operating efficiencies, and cost economics considerations. While overseas fab are not initially able to match the cost of our manufacturing operations in Taiwan, we will work with governments to minimize the cost gap to ensure we start with a level playing field. We are working closely with our customers to firm up our wafer pricing to reflect the cost increases. and ensure we earn a proper return. We will work diligently on enhancing our operations and service capabilities and optimize our efficiencies in overseas locations to continue to provide technology leadership with efficient and cost-effective manufacturing for our customers. By taking such steps, we believe an expansion of our global manufacturing footprint will enable us to reach global talents, better serve our customers' needs, earn the proper return from our investment and deliver long-term profitable growth for our shareholders. Thank you for your attention.

Thank you, Chairman. 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 the 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 1 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 0 then 2. Now, let us begin the Q&A session. Operator, can we please proceed with the first caller on the line?

Yes, the first caller, Gokul Hariharan. Go ahead, please.

Gokul?

Good afternoon. Thanks for taking my question. Maybe my first question, I would focus on the semiconductor supply and demand. CC, you mentioned that you're expecting demand to still remain extremely strong, supply to remain tight through end of this year, potentially through next year as well. Could you talk about when do you expect supply and demand to come back into balance? Do you see a situation where your customers go into a bit of an inventory correction mode sometime soon, or do you think that the structurally higher inventory is something that is likely to last for a much longer period of time than what originally the market thought?

Okay, Gokul, let me summarize your first question. Gokul's first question is on the semiconductor supply and demand outlook. He notes that CC has said our capacity will be tight throughout this year and into 2020. Sorry, operator, we can hear you. Can you please press mute?

I'm sorry.

All right, so let me summarize Gokul's question again on semiconductor supply and demand. He's wondering or asking, when do we see supply and demand in the semiconductor coming back into the balance area? Is there a risk of an inventory correction anytime soon? And how long can a higher level of inventory continue?

Well, Goku, let me answer your question. Let me share with you our perspective on the shortage right now. The current saving conduct capacity shortage is being driven by both a structural increase in long-term market demand and also a short-term imbalance in the supply chain due to uncertainties from COVID-19 and their political tensions. And that may or may not persist. We do not rule out the possibility of an inventory correction in the future, but we expect our capacity to remain tight throughout this year and extend at least into 2022. But let me share with you also that even inventory correction to occur, we believe it will be less volatile than previous downturn as the underlying structural megatrend of 5G related and HPC application will continue. Do I answer your question?

Gokul, does that address your first question, and do you have a second question, if so? All right, operator, I think we have lost Gokul. Maybe we'll move on to the next caller first.

Yes, the next one is Randy Evans, Credit Suisse. Go ahead, please.

Yes, thank you. I wanted to ask the question on... the trend for cost per transistor. I'm curious for 5 nanometer and 3 nanometer, are you seeing improvement? And for the customer motivation to migrate, how is that shifting between power performance density and cost versus also increasingly seek out the back-end system level integration?

Okay. Randy, let me summarize your first question. Your first question is on the cost per transistor. Randy wants to know What does the cost present transistor trend at 5 nanometer and 3 nanometer? And also, what do, I guess, Randy, your question is sort of what are the customers value or evaluate when they look at the technologies as well. Is that correct?

Yeah, right, between power performance density versus cost and also back-end integration.

Okay. Okay.

Randy, no, actually, today the technology has getting more complex than the simple scaling. Actually, we work with our customer very closely. And we have been working on the performance and energy efficiency of a technology. And we took several approach, of course, material innovation, transistor structure innovation. We also, in recent generations, we work heavily on the design and technology cooperation. And also, more recently, we work on the 3D ICs. All these innovation combined is to deliver the value for our customers to improve the system performance and the system's power efficiency. And TSMC is at the forefront of delivering this value, and as evident by the strong demand and continued technology migration at 5 to 3. So in doing that, we believe we can continue to earn a proper return for our investment. Thank you, Randy.

Okay. Yeah, my second question, if you could give an update on the five nanometer, where there's still some dilution, maybe how much dilution you see in the second half, an update on how you see it trending toward the corporate gross margin. And as we look to next year, if three nanometer ramping late in the year, did we see a favorable, like a bit more of a sweet spot for profitability as you have a more mature 5 nanometer but not a new node yet ramping.

Okay, Randy, this is Wendell. Let me answer your question. The 5 nanometer contribution to our revenue will be much higher this year compared to last year. Therefore, we expect that the margin dilution from M5 this year will be between 2 to 3 percentage points. Now, we also expect that M5, like previous notes, will be able to reach the margin, will reach the corporate average in about seven to eight quarters. With respect to 2022, it's a bit too early to talk about it, but we believe our long-term gross margin target of 50% continues to be achievable.

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

Yes, the next one is Bruce Liu from Goldman Sachs. Go ahead, please.

Hello, thank you for taking my question. I think a lot of your customers have, like, different supply chain management policy now. A lot of your customers find a long-term contract with other foundry players with favorable pricing and payment terms. So does TSMC expect this will become the new norm for the foundry industry? Does the industry-wide profit pool become bigger and the earning fluctuation will be less in the future?

Okay, thank you, Bruce. Let me summarize your first question. Bruce's first question is about the semiconductor supply chain, and he observes that a lot of customers seem to be signing long-term contracts with foundries. So do we expect this to be the new norm in the future, and could this drive a bigger or larger industry-wide profit pool?

Okay, Bruce, let me answer the question. We are not able to comment on specific business terms with customers. However, we are working closely with our customers on different ways to secure their commitment, and customers understand our effort to support their growth. And if we plan our capacity well based on the structural increase in the long-term market demand profile, We believe our utilization and profitability can be maintained.

Okay. Thank you. Bruce, do you have a second question?

Sure. So I want to focus on the automotive. Like automotive revenue is roughly less than $2 billion in 2020 out of a $40 billion market. So with most of the automotive IDM companies are passive incapacity expansion, this creates a big addressable market for the foundry. So what is the addressable market for foundry in the automotive industry in the coming years?

Okay, Bruce, let me summarize your second question. So Bruce is asking about the longer-term outlook for the automotive industry. Automotive was less than $2 billion of our revenue last year, but he points out the automotive TAM is about $40 billion. So he's wondering about sort of the long-term TAM addressable market for TSMC.

Well, let me answer again. We are quite positive on the long-term trend of the semiconductors in semiconductor content in automotive. As a trend towards safer, greener, and smarter vehicle will continue to drive silicon content increase as well as a demand for advanced and specialty technology both.

Okay. Thank you. Does that answer your question, Bruce?

Can we have somehow like some specific numbers? Can you quantify that a little bit?

We cannot forecast in the future very accurately, right? I mean, that's, you know, it's so dynamic. But let me assure you that silicon content will be very important and will be increased.

Okay. Thank you. Thank you, Bruce. Operator, let's move on to the next participant, please.

The next one to ask a question, Goku Harihalan, JP Morgan. Thank you.

Thank you very much. Let me ask my second question. My second question is that on your three nanometer business, clearly the market is expecting you to make a lot more inroads into the HPC segment. One of your existing IDM customers have redoubled their efforts to get back into the foundry business. Could you talk a little bit about how you manage this kind of what they call as competition as well as cooperation? How does DSMC think about this when it thinks about capacity allocation, given that HPC is now becoming a very important driver for growth, and this is probably the biggest HPC customer out there in terms of revenue size? Thank you.

Okay, Gokul, thank you for your second question. Let me summarize. He points out that HPC seems to become a larger and larger contributor or driver, particularly at our three nanometer. He also points out that existing IDM customers are redoubling their efforts. So his question is really how, I guess, how do we manage this duality? How do we manage the capacity allocation and the relationship?

Okay. Let me answer the question. But first, you mentioned that IDM is our important customer. Let me say that. And we are collaborating in some area and might compete in other area. But let me explain again. TSMC is everybody's fund tree, and we support all our customers openly and fairly. We will allocate the necessary engineering resources to ensure all of our customers' product success, both existing customers and for the future customers. How to plan our capacity to support? Actually, our capacity planning is based on the long-term market demand, and thus is underpinned by the industry megatrend. Okay, does that answer your question, Goku?

So maybe just one follow-up is, do you require a lot more assurance in terms of demand solidity and demand longevity from IDM customers, given they are also competing in process technology with you compared to Pure Fabulous?

So Goku is asking whether that we would require more longer-term assurance from our IDM customers versus our Fabulous customers.

We will not specifically comment on that. I'm a certain customer.

Okay? Okay, thank you. Thank you, Gokul, and sorry for the disruption. All right, let's move on to the next caller, please.

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

Thanks for taking my question. First of all, I would like to thank TSMC for the donation of the vaccine to Taiwan. I think that ensures business continuity of TSMC and also global semi-supply chain. And my question is about still your gross margin trend. So first of all is your 3D IC or advanced packaging. It seems like Wendell mentioned that the back-end possibilities are getting better in 3Q. I'm not sure if that's true. So the question is that currently the percentage of advanced packaging applications is revenue, and would companies still believe 3D packaging can still outgrow the way for business, and whether they would create a margin dilution? So the first question is about 3D advanced packaging. Thank you.

Okay, let me summarize your question, Charlie. You're asking about our 3DIC business. Charlie is asking, you know, the back-end profitability that Wendell cited improving in the third quarter. Is this the truth? And then also sort of the outlook for our 3DIC business in comparison to our overall business and whether 3DIC business will dilute our profitability.

Okay, Charlie. First of all, the gross margin that I was talking about, improvement of back-end service in the third quarter actually is a seasonal factor. As you know, our back-end services has seasonality. So second half normally has a higher gross margin. But longer term, we expect its margin to continue to improve. Although it's still not as high as the gross margin of our welfare revenue, but it has a lower asset capital intensity. Therefore, the returns from back-end services is satisfactory. In terms of a revenue percentage, we expect back-end services to account for about 8% of our total revenue this year. And in the next five years, we expect it will grow slightly higher than the corporate average.

Okay. Thank you, Wendell. Do you have a second question, Charlie?

Yes, I do. Thanks, Wendell. Yeah, my next question is about the long-term investment. growth margin trend, right? Because, you know, we did create some debates about the higher capacity intensity, you know, your bargaining power against trend vendors and also customers. So really I want to ask this openly to competitive management. Does TSMC believe you have acquired the monopoly of the leading edge in the industry? Why and why not? And if yes, you do think you have them, why cannot TSNC charge higher with a price to cover the state of increase of tax intensity? And lastly, if the company were to need to choose between the margin sustainability and also the market share, what would be your choice? Thanks. Thanks.

Okay, let me summarize your second question, Charlie. So Charlie is asking about the long-term gross margin trend and bargaining power. And he is wondering, he wants to know whether we see or believe we have a monopoly at the leading edge or not. And if we do, I guess part of your question, Charlie, is then how, you know, pricing. And then also, if we have to choose between market share and profitability, how should we choose?

Charlie, let me answer this question. First, we do have a very high market share on the leading-edge technology node, but our pricing strategy is strategic and we don't take an optimistic approach. And You know, it's far away from you say that we try to bargain in power. In fact, we work with our customer closely, and we want to help them to be successful while we get proper return. That's all I can answer for you for our pricing. And looking ahead, we continue our practice. trying our best to help our customers to grow, and we want to get the proper return, so that's why we are firming up our wafer pricing, and we are confident that we can get our gross margin about 50% or above in the long term.

Okay. Thank you. Okay. Thank you. Thank you. All right, operator, let's move on to the next participant, please.

The next one to ask a question, Niklas Godoy from UBS.

Yes, good afternoon. Thanks for taking my question. Earlier you referred to your expansion of capacity at 28 nanometers in Nanjing for about 15K wafers per month. If the demand in training edge is effectively structurally higher and tying up to the leading edge, are we going to see additions in capacity in the training edge becoming more of a recurring feature for TSMC as for the rest of the industry going forward? Thank you.

Okay, Nick, let me try to summarize your first question. So Nick is saying that, As Chairman said, we are expanding our capacity in Nanjing for 28 nanometer. So his question is that do we see the demand at the trailing edge or the mature nodes becoming structurally higher, and then will we consider or add capacity in those trailing edge nodes?

Okay. This is Mark. Let me answer your question. Our strategy more recently and mature note is to work closely with our customer to develop specialty technology solution. This is not described by the numbers. Actually, we are leading in many 28 nanometer specialty technologies and we can meet their requirement and create differentiated long-term value for them. And we expect this structural demand will continue. And, of course, we'll focus on our investment on specialty technology to support that. So for the manufacturing, Greenfield knows expansion, and we do not rule it out. We will build case by case as long as economics can justify and customer commitment can be secured.

Okay. Thank you. Nick, you have a second question.

Thank you. Yes, very quickly. Thank you, Jeff. Clarification effectively. For the investment in the U.S., you said equipment moving in H222 and then production in Q124, reasonably long runway, I guess. So is that because new fab, you need to obviously run pre-production, then qualification time can be reasonably long?

Yes, we make prepared a little bit longer preparation time just because that's a new semiconductor environment for our operations. But, of course, we will continue to compress the schedule as much as we can.

Okay. Thank you, Nick. Operator, can we move on to the next participant, please?

And next one to ask question, Roland Shi from Citigroup.

Hi, good afternoon. My first question is for Japan R&D Center. So it is said more than 20 Japanese companies will work with you at your 3D IC R&D center in Japan. So I want to know what are the rules and the responsibilities for every party, including yourself, in this Japan R&D center. And also, do you plan to start 3D IC packaging manufacturing in Japan one day? And do you plan to build a waiver step in Japan for foundry business going forward?

Okay, Roland's first question, he wants to know about our 3DIC research center in Japan. There's more than 20 companies involved, according to him. So what are the roles and responsibilities of that? And also, will we build a packaging 3DIC packaging integration facility in Japan? And will we consider a wafer fab in Japan? So three parts to this question.

Okay, Roland, let me answer your question. First, yes, there's more than 20 membership to join this Japan's 3D IC's research center. In fact, what's the role and responsibility? TSMC is in charge of this one. And we also, in technology, we also in charge of that integration for all the major partners together so that we can be successful in the most advanced packaging technology, which includes TSMC's 3D IC and some of our partners' advanced material and our partners' most advanced substrate technology. Everything put together which is necessary for the future HPCs application that we needed. Do we have a plan to mass production in the 3DIC in Japan? It's not in our current planning yet. Okay. And what's your next question?

How about the wafer 5?

The wafer 5, we are actually, let me say that we are We do not rule out any possibility. And in Japan, we are in due diligence process now to do that wave of FIAP. Let me say that clearly.

Okay. Thank you. My second question is Mark also said that the key concern to build a Fed overseas is considering the cost gap. And you are working with the government to close the cost gap. However, I think recently there were some noises in the U.S. to request the U.S. government to invest wisely in domestic companies to support U.S. authorities. So will it change U.S. government's plan and the need to fail to close the cost gap to TSMC in U.S. operations. And how are you going to close the cost gap if there is no adequate support from the U.S. government?

Okay, let me summarize Roland's second question. It's about our U.S. FAB and the cost gap. He points out that recently there is some discussion about for U.S. incentives to invest in domestic companies. And so, therefore, if this were to be the case, how would that affect TSMC, and how would we manage the cost gap?

Okay. Roland, right? This is a – Yeah. This is a – I think this current event is still developing, right? You know that in U.S., the originally proposed CHIPS for American Act has gained bipartisan support. And we are very happy that in the Senate, they passed the bill of U.S. Innovation and Competitive Act, already passed in Senate. Right now, it's in the hand of House of Representatives. And we are very optimistic that they will gain bipartisan support. The reason the bipartisan support for this is to create a level playing field for the semiconductor fab investment in U.S. so that there will be a renewal fab industry in the U.S. Of course, how well it can be done in operation up to each company to do the operation well and We are still learning the cost structure in the U.S., but in the meantime, in addition to take on this level playing field opportunities, and further on, the operating cost will have to be shared with our customer. So that's a part of our firm up price, firming up pricing, including the increased global manufacturing footprint.

So we believe that... Yes, yes.

We believe that in that way we can continue to sustain our profitability as before.

Okay. Thank you. Thank you, Chairman. Thank you, Roland. Operator, can we move on to the next participant, please?

Next one, we have Laura Chang from KGI. Hi.

Hi. Thank you for taking my question. Can you hear me?

Yes, we can hear you, Laura.

Yes. First of all, I just want to ask about our global expansion plan. Can you give us more details about our expansion plans other than like the advanced node in the U.S.? Mark just mentioned that 2019 will be the three spots. So will we expand more other than China or other regions? Will we consider that? And how would that impact our already announced $100 billion U.S. dollar impact for the next three years? That's my first question. Thank you.

Okay, Laura, let me summarize your question. Your question is about our global manufacturing footprint, and I think your question is on our mature note. Do we have plans? for further expansion of mature nodes in different locations? And if so, how will this affect our CapEx in the next few years?

Laura, I think several projects are still under planning. We do not rule out the possibility in Japan. Actually, C.C. just mentioned that we are in the due diligence process now. to have a specialty technology FAB in Japan. But, of course, the decision is still too early to disclose because the final decision will be based on our customer needs, operating efficiency evaluation, and cost economics. So for those projects, we have not included into the $100 billion CAPEX budget.

Okay? Okay, very clear. Thank you. Yeah, and my second question is about the 16 and 12 nanometers. We know that the current supply is also quite tight, and the client demand is very strong, particularly for the RF transceiver, et cetera. So I'm just wondering, do you also have the plan to expand on 16 and 12?

Okay, and so Laura's second question continues to more specifically on 16 nanometer slash 12 nanometer, the supply continues to be tight, demand is very strong. Do we have any plans to expand at this node?

Well, Laura, let me answer this question. Again, this is a kind of mature node for TSMC, and we will expand our capacity We start the customers, you know, commitment, and also we have to consider the economics. And so if everything is positive, in fact, we will consider to expand the capacity to support our customer, actually.

Thank you.

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

Next one, we have Brett Simpson from Arrow 2 Research.

Thanks very much. I had a question on gross margins. I guess you've talked about 50% gross margin as a long-term target for quite some time now, and I understand there's been FX headwinds and the 5-nanometer ramp as a headwind. But if I look at your big fabulous customers, they are delivering structurally much higher gross margins as a result of accessing your leading edge capacity, particularly in the last 12 months when your gross margins are going down. And I'd just like to ask, you know, given your position in the industry, do you really think 50% is an appropriate level of return? And, you know, doesn't your position warrant some structural margin expansion at the gross margin level? Thanks.

Okay, Brett's first question is about our gross margin. He notes that, of course, we have been facing headwinds from the foreign exchange rate and also the 5-nanometer ramp, which carries some level of dilution. But he points out that our customer's gross margin is, you know, particularly in the last 12 months, it's been structurally higher than ours. So he wants to know, given our position, do we think 50% is achievable, why would it not be something structurally higher? Is that correct, Brett?

Yeah, really whether 50% is an appropriate level of return, given everyone else is delivering higher gross margins, why wouldn't TSMC look for structurally higher gross margins as well like everyone else?

Right. This is Wendell. Let me answer your question. First, if we look at shorter term, you talked about in the last 12 months, foreign exchange does play a very big role in the gross margin between last year and this year, year-to-date. Last year, the dollar against NT rate was 29.43 in average. This year, year-to-date, is 28, somewhere around 28. that creates a two percentage points difference in gross margin, i.e. if the foreign exchange rate stays where it was last year, we would be having a 52% gross margin in the second quarter already. And also, I talked about the dilution from the M5 this year, another two to three points. So with all these negatives, we still can make 50% in second quarter and the third quarter. That's the short term. Now, longer term, the investment that we are making is for future business growth. At some point of time, at the beginning, the short term, as the advanced technology is getting more and more challenging in cost, that we are working closely with our customers to firm up the wafer pricing and also working with our suppliers to ensure that the cost improvement can be delivered. And with all these efforts, we still think that 50% is a good target and is achievable.

Okay. Thank you, Wendell. And maybe just a follow-up. I noticed your China business grew from 6% of sales in Q1 to 11% of sales in Q2. Can you talk about some of the drivers that delivered that upside? And long-term, how do we think about China scaling within your business? Do you think we'll get back to sustainably double-digit percent of sales? And what would drive that? Thank you.

Okay, so Brett's second question is related to our China business. He notes in the near term that China contribution has gone from 6% in the first quarter to 11%, so he wants to know what is driving this. And then he asks a longer-term question, which is how should we think about our China business over the next few years, and can it return or sustain at an improving or double-digit level?

Well, Brett, Let me summarize it. I think China remains a very strong and growing market, and we have developed a large customer base in China, and we'll work with them to grow our business and expect our business from China will continue to increase in all the market sector. We're talking about smartphone, HPC, IoT and automotive also.

And also, Brett's question on the improvement from China from 6% in first quarter to 11% in the second quarter. What is driving that?

That's because mainly the HPC platform.

Okay. Thank you. Okay, thank you. Thank you, Brett. Operator, let's move on to the next question.

Next one, we have Charles Shi from Neaton Company.

Hi. Thanks for taking my question. Can you guys hear me?

Yes, we can hear you fine, Charles.

Thank you so much. So I want to ask the first question really is about the adoption of your most leading-edge node process. Historically, if I understand correctly, your smartphone platform seems to lead the adoption in the past, at least especially in the first year of the production ramp. And I think you did say that the high-performance computing will becoming increasingly important. So the question really is about 3 nanometer, which we are about a year away from the mass production. So could high-performance computing from what you see today really play a bigger role or even like the leading role in the first ramp of the three nanometers, especially in the first year? Do you even see like high-performance computing could eventually be like the actual lead adopter of the leading edge nodes going forward?

Okay, so Charles, first question is about the drivers of leading node adoption. He notes in the past traditionally he is paying income from smartphones, but HPC also seems to be becoming more important. So his question is, on N3, do we expect HPC to play a bigger role in the ramp of N3, particularly in the first year, and could N3 become the first adopter or primary adopter?

Sure. This is CC Wei. Let me answer this one. The entry is the first year's ramping up. Still, smartphone plays the biggest role. Of course, your observation is correct. HPC application is also important and getting more and more important. And, in fact, HPC will be our largest revenue driver in the next five years. So, in the entry node... In addition to the smartphones, we do expect the HPC's application will become important also. Did that answer your question?

Yes, yes, excellent. Thank you so much. So maybe the second question, I still want to touch upon your global expansion. I know you probably are tired of answering that already, but forgive me, I'm going to ask another one. You announced your fab in Arizona, which the technology note will be 5 nanometer. And as I understand, your 5 nanometer wafers will very likely require your in-house advanced packaging solutions, like either Info, COAS, or maybe even SOIC going forward. So, yeah. But your current packaging facilities, as I know, are 100% in Taiwan, and I can imagine that if you are really outputting wafers from Arizona for 5 nanometers, based on your current footprint, you've got to ship those back to Taiwan for packaging, then send back to your customers, which I can imagine it could be a little bit challenging in terms of cost, logistical efficiency. So I'm not going to ask for a specific plan, but do you kind of foresee maybe you want to set up an advanced packaging facility in Arizona in the near future?

Right. So, Charles, to shorten your second question, I think Charles is asking, in Arizona we are building a wafer capacity with five nanometre, Will we also consider setting up 3D IC integration capacity in Arizona as well?

This is Mark Charles. I understand your concern, but if you look at the current industry landscape, what you just said is nothing new. Everyone has their wafer produced in one location and packaged in another, even including major manufacturers. chip producer in U.S. So for that matter, we do not see it compose any logistic difficulties. We just continue to evaluate, and currently we do not have that 3D IC FAB in Arizona at this point.

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

Next one we have Andrew Lu from Bank of Bank Security.

Is that me?

Yes. Hello, Andrew, you're on the line now.

Okay. Thank you. Thank you for taking my question. My first question is regarding three nanometer ramp out for second half, starting from second half next year. I recall the seven nanometer ramp out in year 2018 second quarter with some revenue contribution. And 5 nanometers in second quarter last year, year 2020. But since that, 3 nanometers clearly some delay for second half next year. So I want to ask, is that because of technology difficulty, we cannot ramp up in second quarter or we don't have a big customer to use 3 nanometer at beginning stage. That's why we push back the ramp up in second half next year. That's my first question. Thank you.

Okay, so Andrew's first question, let me summarize, is asking about our 3 nanometer ramp. He notes that 5 nanometer and 7 nanometer in the past few years basically ramped in the middle of the year. In three, we said the ramp will be in second half of next year. So what is the reason behind this?

Andrew, you have a very good observation. And you calculated that, you know, just about three to four months is a delay as compared with five nanometer. Yes, three nanometer technology actually is very complicated. and in both processing technology and also the customer's product design. So we work with customer, and finally we decided to ramp up in the second half of next year, and this is we decided with our customer, and we set the best fit to their need.

Okay, thank you.

Okay. My second question is, recently we believe NXP, Infineon, Renesas, earlier either have some power down outage and also the fire, resulting their second quarter or first quarter utilization down to almost zero. And recently we are hearing these guys are backing the utilization rate to 100%. the wafer output may start to appear in Q4. Most of these companies are leading companies in automotive semiconductors, including MCU. Do we have some concern once these customers are renting out their own fab and that will result the next year or starting from Q4, the order on automotive semiconductors to us will be reduced, largely reduced. Thank you.

Okay, so Andrew's second question is on automotive. He asked, as IDMs ramp up their production in the second half, are we concerned or do we have concerns that heading into the end of this year or into 2022, that TSMC's automotive customers will greatly reduce their orders to TSMC?

Andrew, this is CC Wei again. Let me answer your question. The A very short answer is no, we don't have any concern. The reason is very simple, because we offer the technology and our customer working closely with us, and for some of the technologies, mostly in the leading edge, not the leading edge, I'm sorry, it's 55, 40 nanometer and 28 nanometer, that our customer need the TSMC's support. And the demand will continue to grow. And so we don't worry about the one day bring up gel fab and then the TSMC demand will be decreased. The answer is no. And remember, it's tight. And actually very tight in 2022 also.

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

Next one we have Martin Lau from SSA. Go ahead, please.

Hello, hi. Thank you for your time for this afternoon. The first question relates to politics. I counted you set geopolitical risk five times during today's call, and someone mentioned about the vaccine, and it seems in Taiwan with vaccine, things are getting even more political. I just wonder, for management, How concerned are you with politics? It seems the U.S. sometimes is fighting against China, China, Taiwan. And what things have you thought about to mitigate, if anything, such political risk? And also, are your customers concerned when COVID happened in Taiwan, when China from time to time threatened a war against Taiwan? Are your customers concerned that they're so reliant on you? Thank you.

Okay. So Martin's question is about politics and geopolitical risks. He notes that geopolitical is talked about more and more. His observation is that vaccines in Taiwan has become a political issue as well. So he wants to know how does TSMC manage or mitigate the political risks, looking at U.S.-China-Taiwan relations, and do our customers have concerns? on things such as the recent increase in COVID or the threat of invasion from China, and how does TSMC manage these risks?

Martin, this is Mark. Thank you for asking. First of all, on the recent COVID situation in Taiwan, I think the confirmed case has dropped significantly. And of course, the current first priority is to get the people of Taiwan get vaccinated upon variants as keep coming. But I'm really grateful that us and Yonglin and Foxconn come together a humanitarian donation of 10 million doses of vaccine to the Taiwan people. government, CDC, Taiwan CDC, and be able to vaccinate our people in Taiwan because TSMC's employees are inevitably embedded in the community of Taiwan, and that is important. The reason, you know, this could be political in the beginning, but at the end, we completed the contract, and we did get... support from all sides. So I don't think at the end is as political anymore. Otherwise, this donation wouldn't be successful. In a global sense, the geopolitical development is continuing. I think this is a challenge for every company. Every company's management has to deal with it. But I think in the new administration from U.S., I think the development is more predictable, more rule-based. So as long as they're rule-based, I think it's better for every company to adapted to. So that also prompted the talk I have given earlier that the global manufacturing footprint might need to do an adjustment for our customers. Our customers in different countries, their infrastructure, supply security, semiconductor related infrastructure, supply security in may become a higher priority, and we do that, adjust to it. But of course, it is the customers' needs that we are adjusting to upon the greater geopolitical development. As to the invasion of China, let me tell you, nobody, I mean, everybody wants to have a peaceful Taiwan Strait. And because not only because it is to every country's benefit, but also because of the semiconductor supply chain in Taiwan, no one wants to disrupt it. You have a COVID, only a COVID situation already made a major disruption for the global economy. And I don't think that any... Disability in Taiwan Straits is any country we wish to make it happen. So I'm optimistic on that. Thank you, Martin.

Thank you. Do you have a second question, Martin?

Yeah. Can I follow up with a second one? It's kind of related. You mentioned about global manufacturing. You also mentioned about the need to maintain your highest technology in Taiwan because of the Approximately to R&D, my understanding is majority of engineers are from Taiwan. As you go for this global manufacturing, do you talk about how you are changing, say, for example, your talent acquisition, like how you try to get more people outside Taiwan so that maybe over time you can become more manufacturing outside Taiwan? And also, maybe on the board, I mean, because when I look at your board, it remains largely Taiwanese. The recent two additions, one is Dr. Kong, who's a minister, and Yanxi, who's from Delta. Do you see also the board maybe changing, become more international, or maybe if I try to provoke some debate, have a mainland Chinese on the board? Thank you.

Okay, so Martin's second question is around talent and board composition. Basically, with our expanding manufacturing footprint, he wants to know what is our strategy to attract more global talents for TSMC. And the secondary question is also on the board. His observation is that the new board members are primarily only from Taiwan, so will we consider board members from other countries?

The question about talent, indeed, I think we have been advocating the talent development in semiconductor field in Taiwan as well as in U.S. I think semiconductor industry talent has been underdeveloped over the past decades. And today, everyone look at the semiconductor as the key economic drivers. So the talents needs to be connected with that. And in Taiwan, I think we have been advocating the government to set up the high-end advanced research colleges across the Taiwan major universities. in the U.S., and also President Biden talked about the semiconductor human infrastructure, that is to develop the human talent in semiconductor through the vast investment of the R&Ds. So this is catching up in every place, and particularly in Taiwan, we get very strong support from the local government to be able to continue to supply talents in Taiwan. As far as the board member, yeah, Delta Yancy has joined a year ago. And more recently, I think this is coming shareholder meeting, we will nominate Rafael Reif, who is the president of MIT, to come to our board. And we hope that it will go through the blessing of our shareholders. And that is a major increment of our corporate governance, particularly in the area of the talent development. We invited SHARE board members upon they have a very strong knowledge and experience on the corporate governance. And that is we will continue to look for and without differentiation about nationalities.

Okay. Thank you, Chairman. Thank you, Martin. In the interest of time, I think we will take the questions from the last participant, please, Operator.

Yes, the last one to ask question, Chris Sankar from Cohen & Company.

Hi, thanks for taking my question. I had two of them. The first one You spoke about investing $100 billion in CAPEX over the next three years and how that does not include specialty process nodes like the ones in Japan. I'm kind of curious, can you just be more specific on how much you plan to invest in your U.S., Arizona FAB or FAB cluster over the next three years in terms of CAPEX? I'm going to add a follow-up.

Okay, so Krish's first question is about our investment in CAPEX. looking at the next three years. He wants to know how much specifically we are investing in Arizona.

Okay, Chris. We have announced that the Arizona project will be a $12 billion project. This was announced last year.

Got it. And can you just elaborate how much you plan to do it over the next three years?

So Chris is asking how much will we invest in Arizona over the next three years?

Yeah, $12 billion.

Next three.

Next three. Oh. Well, basically, next three years is about $8 billion. $8 billion.

Okay, all right, perfect. And then a quick follow-up. Your auto revenues was 4% of total revenues. What technology node is that?

Okay, so Chris's second question is on automotive. It was 4% of our revenue. What particular specific nodes is automotive using?

Chris, I... I think I have mentioned that automotive's MCU is the biggest one that we have, and it's in 55, 40, and 28 nanometer, with the majority still in 55 and 40. And in the next two to three years, it will be moved to 28 nanometer. That's in our current plan, and we are working with our customers on that.

Thank you, C.C. Thank you. Thank you, Chris. 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, and the transcript will become available 24 hours from now, both of these which will be available through TSMC's website at www.tsmc.com. So thank you for joining us today. We hope everyone continues to stay safe and healthy. And we hope you will join us again next quarter. Thank you and have a good day or good evening.