Taiwan Semiconductor Manufacturing Company Ltd.

Good afternoon, everyone. I am Su Zhikai from the Legal Affairs Department of TSMC. I welcome you to participate in TSMC's 2022 Legal Explanation Conference. In order to prevent the spread of the COVID-19 pandemic, the Legal Explanation Conference will still be held via telephone. Since this conference will be broadcast to global investors at the same time, we will use English throughout. Please excuse us. Good afternoon, everyone, and welcome to TSMC's second quarter 2022 earnings conference call. This is Jeff Hsu, TSMC's director of investor relations and your host for today. To prevent the spread of COVID-19, TSMC is hosting our earnings conference call via live audio webcast through the company's website at www.tsmc.com, where you can also download the earnings release materials. If you are joining us through the conference call, your dial-in lines are in listen-only mode. The format for today's event will be as follows. First, TSMC's Vice President and CFO, Mr. Wendell Huang, will summarize our operations in the second quarter 2022, followed by our guidance for the third quarter 2022. Afterwards, Mr. Huang and TSMC's CEO, Dr. Cici Wei, will jointly provide the company's key messages. Then, TSMC's chairman, Dr. Mark Liu, will host the Q&A session, where all three executives will entertain your questions. As usual, I would like to remind everybody that today's discussions may contain forward-looking statements that are subject to significant risks and uncertainties, which could cause actual results to differ materially from those contained in the forward-looking statements. Please refer to the safe harbor notice that appears on our press release. And now, I would like to turn the call over to TSMC's CFO, Mr. Wendell Huang, for the summary of operations and the current quarter guidance.

Thank you, Jeff. Good afternoon, everyone, and thank you for joining us today. My presentation will start with financial highlights for the second quarter 2022. After that, I will provide the guidance for the third quarter. Second quarter revenue increased 8.8% sequentially in NT or 3.4% in U.S. dollars as our second quarter business was supported by strong HPC, IoT, and automotive-related demand. Second quarter gross margin increased 3.5 percentage points sequentially to 59.1%, slightly ahead of our guidance as we enjoyed a more favorable foreign exchange rate, cost improvement, and value selling. Likewise, operating margin increased 3.5 percentage points sequentially to 49.1%, in line with our gross margin increase. Overall, our second quarter EPS was 9.14 NT and ROE was 39.4%. Now, let's move on to revenue by technology. 5 nanometer process technology contributed 21% of wafer revenue in the second quarter, while 7 nanometer accounted for 30%. Advanced technologies, which are defined as 7 nanometer and below, accounted for 51% of wafer revenue. Moving on to revenue contribution by platform. All six platforms increased in the second quarter. Smartphone increased 3% quarter over quarter to account for 38% of our second quarter revenue. HPC increased 13% to account for 43%. IoT increased 14% to account for 8%. Automotive increased 14% to account for 5%, and digital consumer electronics increased 5% to account for 3%. Moving on to the balance sheet, we ended the second quarter with cash and marketable securities of 1.4 trillion NT. On the liability side, current liabilities increased by 22 billion NT, mainly due to the increase of 47 billion NT in accounts payable, partially offset by the decrease of 29 billion NT in short-term loans. Long-term interest-bearing debts increased by 124 billion NT, mainly as we raised 109 billion NT of corporate bonds during the quarter. On financial ratios, accounts receivable turnover days decreased one day to 37 days, while days of inventory increased seven days to 95 days as we pre-billed M5 waivers and increased raw materials inventory. Now let me make a few comments on cash flow in CAPEX. During the second quarter, we generated about $339 billion NT in cash from operations, spent $218 billion in CAPEX, and distributed $71 billion for third quarter 21 cash dividend. Bonds payable increased by 109 billion as a result of this quarter's bond issuances. Overall, our cash balance increased by 102 billion to 1.3 trillion NT at the end of the quarter. In U.S. dollar terms, our second quarter capital expenditures totaled 7.34 billion. I have finished my financial summary. Now, let's turn to our current quarter guidance. Based on the current business outlook, we expect our third quarter revenue to be between $19.8 billion and $20.6 billion, which represents an 11.2% sequential increase at the midpoint. Based on the exchange rate assumption of $1 to 29.7 NT, gross margin is expected to be between 57.5% and 59.5%, operating margin between 47% and 49%. This concludes my financial presentation. Now let me turn to our key messages. I will start by making some comments on our second quarter and third quarter profitability. As a reminder, six factors determine TSMC's profitability. Leadership technology development and ramp-up, pricing, cost, capacity utilization, technology mix, and foreign exchange rate. Compared to first quarter, our second quarter growth margin increased by 350 basis points sequentially to 59.1%, mainly due to a more favorable foreign exchange rate, cost improvement, and value selling. Compared to our second quarter guidance, our actual gross margins exceeded the high end of the range provided three months ago, as our guidance was based on exchange rate assumption of $1 to 28.8 NT, whereas the actual second quarter exchange rate was $1 to 29.42 NT. This created about 90 basis point difference in our actual second quarter growth margin versus our original guidance. We have just guided our third quarter gross margin to decline 60 basis points sequentially to 58.5% at the midpoint, as a slightly more favorable exchange rate assumption will be more than offset by higher inflationary costs, including higher raw material and electricity costs. Looking ahead on our profitability, we will face challenges from rising inflationary costs from raw materials, utilities, and tools, increasing process complexity of leading nodes, new investments in mature nodes, and overseas fab expansions. Despite the manufacturing cost challenges and excluding the impact of foreign exchange rate of which we have no control over, taking the other five factors into consideration, we continue to believe a long-term gross margin of 53% and higher is achievable. Next, let me talk about our effective tax rate. For 2022, we expect our tax rate to be between 10 and 11%. Starting in 2023, we will see the expiration of certain tax exemptions in Taiwan, and our effective tax rate will increase. However, Taiwan government is in the process of drafting certain new tax exemption regulations and is currently in the comment period. Therefore, we will provide a further update on the outlook of our tax rate in 2023 and beyond when more details become available. Now, let me turn the microphone over to CC.

Thank you, Wendell. We hope everybody is staying safe and healthy during this time. First, let me start with our near-term growth outlook. We concluded our second quarter with revenue of NT$534 billion, or US dollar $18.2 billion, supported by HPC, IoT, and automotive-related demand. Moving into third quarter 2022, we expect our business to be supported by continuous demand for our industry-leading 5nm and 7nm technologies. On the inventory side, due to the softening device momentum in smartphone, PC and consumer earmarked segments, we observe the supply chain is already taking action and expect inventory level to reduce throughout the second half of 2022. After two years of pandemic-driven stay-at-home demand, this type of adjustment is reasonable in our view. Our expectation is for the excess inventory in the semiconductor supply chain to take a few quarters to rebalance to a healthier level. We believe the current semiconductor cycle will be more similar to a typical cycle with a few quarters of inventory adjustment likely through first half 2023. We have also internally modeled and prepared ourselves for various different scenarios in case it is necessary. On the demand side, while we observe softness in consumer and market segments, as the end market segments such as data center and automotive related remain steady, then we are able to reallocate our capacity to support these areas. Despite the ongoing inventory correction, our customers' demand continues to exceed our ability to supply. We expect our capacity to remain tight throughout 2022 and our four-year growth to be mid-30% in U.S. dollar terms. Three key factors in supporting TSMC's strong structural demand are our technology leadership and differentiation, our strong portfolio in high-performance computing, and our strategic relationship with customers. All of these factors are TSMC's strengths in the foundry industry. First, on technology leadership and differentiation, TSMC's technology position is much stronger today as compared to previous years. Looking ahead to 2023, we are working diligently to provide the industry's most advanced technologies and making it available to all the product innovators. With a successful ramp of N5, N4P, N4X, and the upcoming ramp-up of N3, we will expand our customer product portfolio and increase our addressable market. Thus, while macroeconomic uncertainty may persist into 2023, our technology leadership will continue to advance and support our goals. Secondly, The massive structural increase in the demand of computation, underpinned by the industry megatrend, continues to feel great need for performance and energy-efficient computing, which require use of leading-edge technologies. Through our comprehensive IP ecosystem and optimized process technology, we are able to address and capture the structural demand and build a strong portfolio in high-performance computing. We expect HPC to be the main engine of TSMC's long-term growth and the largest contributor in terms of our incremental revenue growth in the next several years. Third, our strategic relationship with our customers are long-term in nature, developed and built through many years of collaboration and investment to enable customers' success in their end market. We continue to work closely with our customers on technology development, capacity planning and pricing to support their long-term demand and growth. With all these three differentiating factors, we expect our capacity utilization to remain healthy in 2023 and our business to be less volatile and more resilient, supported by the strong demand for our differentiated and leading advanced and specialty technologies. Now let me talk about TSMC's long-term growth outlook. While macroeconomic headwinds bring near-term uncertainties that may persist, we believe the fundamental structural goals trajectory in the long-term semiconductor demand remain firmly in place. We continue to observe silicon content increase across many end devices fueled by process technology migration and increase the functionality. For example, The number of CPUs, GPUs, and AI accelerators in a data center are increasing. A 5G smartphone carries substantially higher silicon content as compared to a 4G smartphone. The amount of silicon content in today's cars continues to rise. Thus, while the device unit growth of many electronic devices may be flattish to low single-digit percentage range, in the next several years, the silicon content growth will be higher in the mid to high single-digit percentage range and support the long-term structural semiconductor demand and increase our addressable wafer demand. TSMC's CAPEX and capacity planning are always based on the long-term structural market demand profile, not near-term factors. We are working closely with our customers to plan our long-term capacity and investing in leading-edge and specialty technologies to support their growth. We will manage our business prudently through the near-term uncertainties and we remain highly confident in our long-term growth outlook. With our technology leadership, manufacturing and capacity support, and customers' trust, TSMC is well positioned to capture the strong multi-year growth from the favorable structural mega-trend of 5G and HPC-related applications and deliver profitable growth for our shareholders. We reiterate our long-term revenue to be between 15 and 20 CAGR over the next several years in U.S. dollar terms. Next, let me talk about the tool delivery update. As a major player in the global semiconductor supply chain, TSMC works closely with all our tool suppliers to plan our CAPEX and capacity in advance. However, like many other industries, our suppliers have been facing greater challenges in the supply chains, which are extending toward delivery lead times for both advanced and mature nodes. As a result, we expect some of our CAPEX this year to be pushed out into 2023. TSMC is actively doing its part to help our tool suppliers address the supply chain challenges. In April, we said that we have increased regular high-level communications to trace the progress and sent several teams on-site to support our suppliers. Since then, we have worked closely to identify critical chips that are gating the tool delivery We are working dynamically with our customers and prioritize our wafer capacity to support these critical chips to help mitigate the chip constant issues. While challenges remain, the situation is improving. We do not expect any impact to our 2022 capacity plan, and we are able to pull in the delivery schedule for a certain amount of tools for our 2023 capacity. We have been working closely with our customers for 2023 so that we can support their demand. Now let me talk about N3 and N3E status. N3 is on track for volume production in second half of this year with good yield. We expect revenue contributions starting first half 2023 with a smooth ramp in 2023 driven by both HPC and smartphone applications. N3E will further extend our N3 family with enhanced performance, power, and yield. N3E will offer complete platform support for both smartphone and HPC applications. We observe a high level of customer engagement at N3E. Then volume production is scheduled for around one year after N3. 3 nanometer technology will be the most advanced semiconductor technology in both PPA and transistor technology when it is introduced. Thus, we are confident that our N3 family will be another large and long-lasting node for TSMC. Finally, let me talk about the N2 status. Our N2 technology development is on track and progressing well to our expectation, with risk production scheduled in 2024 and volume production in 2025. After careful evaluation and extensive period of development, our 2nm technology wall adopted narrow-sheet transistor structure to provide our customers with the best performance, cost, and technology maturity. And to deliver full node performance and power benefit to address the increasing need for energy-efficient computing, with 10 to 15 speed improvement at the same power, or 20 to 30 percent power improvement at the same speed and larger density of more than 20 percent increase as compared with N3E. Our two nanometer technology will be the most advanced semiconductor technology in the industry in both density and energy efficient when it is introduced. and will further extend our leadership position well into the future. This concludes our key message, and thank you for your attention.