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.

Thank you, CC. This concludes our prepared remarks. Before we begin the Q&A session, I would like to remind everybody to please limit your questions to two at a time to allow all the participants an opportunity to ask their 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 and then 2. Now let's begin the Q&A session. Our chairman, Dr. Mark Liu, will be the host.

Hello, everyone. Thank you for coming to this conference. I wish you all healthy and well. I think we hope the above reports already answer some of your questions. But it definitely shows this company stands on firm ground. And we will be prepared, prudently going through this near-term uncertainty. In the meantime, we'll be also confident and well prepared for our next growth, period. So now the floor is open for your question.

Thank you, Chairman. Operator, please proceed with the first caller on the line.

Yes, I first want to ask questions. Wendy Evans, British Way.

Okay, yes, thank you. Congratulations on the good outlook. My first question, I wanted to ask on your view on the business cycle. You raised your outlook to 35% in the strong third quarter. With that strong outlook, I wanted to see what is driving your expectation for inventory drawdown in second half and how broad you're seeing the inventory drawdown. And the follow-up question I wanted to ask to that is, what is your view on the first half? With your view, customers will be drawing down through the first half. Do you see underutilization, and how severe do you expect that correction?

Okay, Randy, please allow me to summarize your first question. So I think Randy, his first question is in looking at TSMC's third quarter guidance and also looking at our full year growth to be mid-30s. He's wondering, I believe, Randy, how to reconcile this with our expectation of the inventory adjustment in the second half and also into the first half next year. So how do we reconcile our view on the inventory cycle against our own business? Is that correct, Mandy?

Yeah, that's correct. It's an initial view on first half, how much correction you're looking for in your business.

Randy, this is CC Wei. Let me answer your question. Yes, we do have mid-30s growth this year, but we also expect our customers start to take action to decrease their inventory level. How far we expect that a few quarters, at least into the first half of 2023, they will continue to do the inventory correction. And did that lead to TSMC's utilization? Let me say that. Despite ongoing inventory adjustment and macro uncertainties, the structural growth trajectory in the long-term semiconductor demand remains firm. With our leading and differentiated appliance and specialty technologies and a strong HPC portfolio and strategic customer relationship, we expect our capacity to remain tight and our business to be more resilient, and we are confident in both our near-term and long-term growth outlook. Did that answer your question?

Yes, I mean, to clarify, do you expect even through first half to remain tight, factoring in your tech position and some of the projects you have?

Yeah, you remain. So I think Randy wants to ask in the first half of next year, do we expect, how do we see our capacity utilization given the ongoing inventory adjustment?

I cannot give you exactly the number that we are talking about, but let me say it's healthy. Okay.

Okay, great. My second question on the CapEx, two parts, just want to understand The push-outs, a little more what it's affecting, the 3-nanometer on which ramp, the 5-nanometer or mature nodes. And if you could also discuss the framework for next year's CapEx. I think you've made comments about we could be above $40 billion. If you could give a framework for how you're thinking about next year CapEx.

Okay, so Randy's second question is on the CapEx. He wants to know, with some of the tool delivery issues, the CapEx push out, is this more for three nanometer, is this for five nanometer, or is this more on the mature node side? And he also wants to know, how does this impact our CapEx for 2023? As we said before, that 2023 could be 40 billion or higher.

Okay, Randy, this is Wendell. The first question, as CC said in his prepared remarks, that the schedule, the tool delivery schedule changes currently as in both the advanced and the mature nodes. Okay. And your second question is about next year's CAPEX. It's too early to talk about next year's CAPEX, but as we always said, we invest the CAPEX in the year for the future opportunities. So as long as the outlook, the future outlook is good, we will continue to invest, but of course in a disciplined manner.

Just for this year with the push out, what's your expectation for how much this year would be? That's my final question. Thank you.

I think next year will be too early, but I can tell you that this year it will be closer to the lower end of our previous guidance.

So closer to the lower end of the guidance of $40 to $44 billion, Randy? Yes. Okay. Great. Thank you. Operator, can we move on to the next participant, please?

Next one to ask questions is Bruce Lou from Goldman Sachs.

Hi. Thank you for taking my question. Congratulations on a great result. I think that may say that the next few years the revenue growth was still at 15 to 20 percent growth and it is driven by of the compound dollar growth. Can you. This is actually the most difficult part for the investor or the biggest discrepancy when we talk to the investor. How much is driven by the dollar content growth? Because investors do not really see the dynamics, right? So, for example, like 15% to 20% growth for the next few years, how much is driven by dollar content growth? How much is driven by the shipment or how much is driven by the ASP or product mix improvements?

OK. Bruce, thank you. Let me summarize your first question. So Bruce is really looking at our long-term growth. We said that we will grow between 15% to 20% CAGR in the next several years. He wants to know, out of this 15% to 20%, how much is driven by silicon content? How much is driven by, Bruce, I think you said, shipment? How much is driven by ASP?

Bruce? Let me answer the question, but exactly the number I cannot share with you because it's confidential. But let me say that the content increase actually is at least mid to high single digit for our edge devices. And then, even all the electronic devices, even if the core is flat or some kind of low single digit, it's still growing. It's still growing. And combined with all this and our value setting with our customer, so we are confident to say 15 to 20 percent CAGR is achievable. Okay?

Okay, thank you. So to my next question is for the mature node and the specialty capacity extension. I think Chairman recently commented that you will expand your mature node and specialized capacity by 50 percent, by zero, for your next three years. I mean, this number looks a bit big. I mean, can you tell us how do you achieve this 50% capacity expansion by the new capacity or conversion, and where are those demands? How do you see the maturity or supply and demand in the coming few years?

Okay, Bruce, let me summarize your second question, please. Okay, so Bruce's second question is on mature node and specialty capacity expansion. He's looking to say TSMC expanding our mature node specialty capacity by 50%, that looks very big. Is that all new capacity expansion? Is some of this also coming from logic conversion to specialty? And then also what applications are driving this?

Well, let me answer the question. 50% increase, we mean that 50% is in specialty technologies capacity. Doesn't mean the overall capacity increase. We did this because of our customers' need and we work closely to support their growth. So it's not a plain 50% increase in the logical capacity. No, it's a specialties.

If I may add a little bit, the expansion also includes both the new capacity and conversion of existing capacity.

So how confident you are, I mean, in terms of this kind of capacity expansion, what kind of application which will keep you confident to this kind of increase? Because in the past 20 years, your capacity expansion is mostly in the conventional.

So Bruce wants to know what is keeping TSMC confident to have such expansion on these specialty technologies as most of our expansion in the past has been focused on the advanced nodes.

Bruce, you are right. In the past years, TSMC always increased the leading edge capacities. We did not increase any specialties in the past few years, except a few upgrades from logic to specialty. But this time is different. First, because we can see the silicon content continue to increase on all the edge devices, it's included on the demand on the leading edge capacity, it also require the specialties content inside. And so at the urge of our customers request, TSMC closely work with our customer and to expand our specialty capacities. Okay, how confident? Very, very confident.

I believe so. Thank you.

Thank you.

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

Next one to ask questions, Sunny Lin from UBS.

Hi. Good afternoon. Thank you for taking my questions, and congrats on the strong results. So my first question is on the semi-cycle test. earlier that you have done some scenario analysis on the semi-cycle for 2023. So I just wonder what's your current base case for semi-growth for 2023? Do you think if you would be like a typical down cycle like in 2015, 2019, or would it be a more meaningful correction? Thank you.

Okay, Sunny, thank you. Sunny's first question is on the semiconductor cycle. She wants to know what is TSMC's base case for 2023. Do we think it will be more of a typical cycle, such as in 2015 or 2019, or it will be more of a meaningful correction, I believe are her words.

Yes, our base case is a typical, more of a typical down cycle. The inventory correction maybe go for a few quarters through the first half of 2023. It's not like a big down cycle back in 2008 or something like that.

Got it. Thank you. And so my second question is on Three nanometers, as we are ramping up the technology in second half, how should we think about the revenue contribution into 2023? In terms of profitability, will the three nanometer ramp up have any impact into Q4, or if the impact will be mostly from Q1 next year?

Okay, and so thank you, Sunny. So Sunny's second question is on three nanometer. With the ramp, she wants to know what type of revenue contribution from N3 in 2023, and also with the ramp of N3, what would be the impact to profitability? When should we see it, and what type of impact from N3? Thank you. That's correct, right, Sunny?

That's right. Thank you, Jeff.

Sure.

Okay, Sunny. In terms of revenue contribution from M3, I have to say that nowadays it's less meaningful to talk about the revenue contribution of a leading node at the very beginning when we start to ramp it compared to in the past because the total pie is increasing and we believe it will continue to increase. Dollar amount wise is certainly bigger than the previous notes at the very beginning stage. This is your first question. In terms of profitability dilution, we expect that it will impact between two to three percentage points in gross margins in the first year, 2023. Thank you.

Got it. Thank you. That's very clear. Thank you very much.

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

Now it's time for Goku Harihalan, JP Morgan. Go ahead, please.

Goku, are you on the line? You might have to unmute.

Hi, sorry. My first question is on the

Gokul, sorry, you're breaking up. Can you try again? Repeat your question, please.

Yeah, sure. My first question went to recycle.

Gokul, sorry. Okay, let's try one more time because you continue to break up. Let's try one more time. If not, I will have to ask you to dial back in. Sorry, please repeat your question again.

Sure. Hi. Can you hear me now?

Yes.

Okay. That's fine. Could you talk a little bit about what is the expectation? Is that

Okay, Goku, I'm sorry, I'm sorry, your line is very unstable, so I will ask you to please try to get back into the queue, and we'll address your question, okay? Operator, can we move on to the next caller, please? Apologies for that.

Next one to ask question, Brett Simpson, Arate Research.

Yeah, thanks very much. I had a question on the inventory burn-off that you were signalling potentially for first half 23. Can you talk more broadly about fabulous days of inventory today and how you see this trending in the second half of the year? And then in terms of your outlook for the overall semis industry, what is your current view for 2022 growth and 2023 growth? And has your view changed in the last three months? Thank you.

Okay, thank you, Brett. So Brett's first question is looking at inventory and the overall industry. So his first question is about the inventory adjustment. We have said that it will likely be through first half 2023. So what do we see for the Fabless DOI trending in second half of this year?

Yeah, yes, Brett. We expect the FABIS DOI to come down in the second half of this year gradually. And your second question?

Come down throughout the second half of this year, correct? Yes, yes. And then the second part of his question is, Brett, sorry, again, your second part is looking at the industry. What is our current view on the semiconductor industry for 2022 and 2023, and how has our forecast changed or not?

That's right.

Well, let me answer the question. Our forecast for the semiconductor excluded memory, and the forecast on the voluntary growth in 2022 remains the same as we projected earlier. For 2023, it's too early to forecast, but as we said, the inventory correction will continue to go on, And for TSMC, because our technology position is much stronger today, and we also have a very strong portfolio in HPC, and we have a long-term strategic relationship with customer. So we think 2023, even just inventory correction, is still a growth year for TSMC. Okay.

Jeff, can I just have a second question? Is that possible?

Sure. One more second question.

Yeah. So we've been hearing from some other leading-edge chip manufacturers that they are looking at the opportunity to work with project financing companies when it comes to new fab builds. I think, you know, companies like Brookfield has been mentioned. How does TSMC view this trend? And is there a fab rental model or a way to reduce the free cash flow burden in this industry as you bring on new fabs? Thank you.

All right, so Brett's second question is he wants to know what is TSMC's view? His observation is other companies in the industry are using project financing to build new fabs, this new fab rental model. So what is TSMC's view on this?

But we are not considering project financing now. Normally, project financing entails stringent, stricter terms and higher costs. We will finance the expansion mainly from our operating cash flow and borrowing using our strong balance sheet. That's our current policy.

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

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

Hello. Good afternoon. And also congratulations for your results. So my first question is about your HPC and high demand because our view is that the macro slowed down or should impact cloud CapEx and the high-end consumption. So, management, do you think that the so-called inventory digestion will sooner or later apply to your data center-saving customers and the high-end smartphone customers older in the coming quarters? Thank you.

Okay, so Charlie's first question is looking at the inventory adjustment in light of the macro slowdown. He wants to know, do we believe or see impact to cloud service provider CapEx or high-end smartphone sort of to have inventory adjustment next? Is that correct, Charlie?

Yes, thank you, Jeff.

Charlie, this is Xi Xiwei. I think to answer your question, you might think they have too much of inventory in the HPC area. But as we said, you know, there are In our life, there are so many edge devices that continue to create data, and those data need to be processed with sufficient speed and efficient power consumption, and that requires our leading edge technology to provide the solution. in even just an inventory correction or something like that we expect our business to be less volatile and more resilient through the near-term uncertainties and also we are highly confident in our long-term course outlook yeah yeah so how about the high-end smartphone inventory correction do you expect that uh

you know, top-ranked inventory, smartphone inventory to see correction as well on the semiconductor demand. Thank you.

So Charlie also wants to know, do we expect high-end smartphone inventory correction on the semi-demand?

To be frank with you, we did not see too much of an inventory on the high-end smartphone build-up. So, no.

Okay, great. Thank you. That's very helpful. And my second question is about your future technology development, right? So, either Mark or Cici, can you please help me? So, this is the first time you've disclosed the N2GAA large-density improvement. I think a more than 20% large-density increase is still better than other market channels. But compared to the previous node, there's a significant slowdown. So do you think that, first of all, N2 is a full node migration? And do you think that there is a kind of a significant slowdown of a more slow? And what does that mean to your kpx per k for N2 versus N3? And lastly... Backside Power BI. So I'm very interested in your kind of end to what it means to the long-term technology and also KPACs.

Okay, maybe I'll summarize Charlie's second question into a few different parts. His first question is on N2 technology, and he notes that the logic density gain is more than 20%, but does this represent a significant slowdown, especially in the context of Moore's Law, and what does this mean for technology as a whole? Maybe Chairman can address.

Let me answer your question. First of all, CC just mentioned our N2 would be the most advanced semiconductor technology in the industry when it is introduced. Because this technology, we work closely with our customers regarding the scaling factor included. But Charlie, from now on, we have to look at the technology in a platform fashion. The N2 technology is not just the wafer scaling. The N2 technology includes the transistor scaling, but also includes the new power line structure, and also includes the new chiplet technology to allow the more... architectural innovation in our customers. So this is a whole set of technology offering composed to be N2 nanometer. The scaling factor is smaller, but we really know the customer's needs today is really about the power efficiency. And this will be a full node power efficiency migration. And to control the cost, that is the reason we control the scaling factor while maintaining the same value for the new generation of technology. So that's my report, yeah.

Great, and also Charlie is asking about the backside power on N2.

Okay, let me add some viewpoint. On the backside power delivery, actually we call the super power rail, it's part of our N2 platform offering. And at the proper time, we'll introduce it to the market whenever our customer need it.

Yeah, so if you put that together, right, it seems like a lower, But you have this power of VR. What does that mean to your tech experts in the coming years? Thank you very much.

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

Next one to ask questions, Laura Chen from Citigroup.

Hi, thank you for taking my questions and congrats for the good result. My first question is about your view on the key applications. Actually starting from the last quarter we already see that computing PC has been the key catalyst for TSMC. So I'm just wondering your view on the various architecture like ARM-based or x86. Can you share with our view that what will be the key driver for TSMC for the next few years? Do you see there will be more from the ARM-based CPU or more upside from the x86 And also on the smartphone space, I recall that in the previous analyst call, you mentioned that penetration rate for the 5G, you expect there will be about like 50%. But given the weak demand curve, what's your latest view on the 5G smartphone penetration? That's my first question. Thanks.

Okay, so Laura's first question. First, she wants to know on HPC. She notes HPC has become the largest contributor by platform to our revenue. So she wants to know, you know, when we look out over the next several years, how do we see HPC? Is this driven by ARM-based or versus x86? I think that's the first part of her first question.

Laura, our HPC definitely is growing healthy, and since TSMC is everybody's foundry, so we support both x86 and ARM-based, you know, what do you say, for the high-performance computing, both. And both are significantly growing in TSMC.

And then she also wants to, sorry.

Yeah, but since like TSS already has a very high exposure on base, so can we expect the next few years for the gross driver to more come from the x86?

Can I answer this question? We have very high exposure to x86 also.

But Laura, I think we have said numerous times and it still holds true that HPC will be the largest contributor and increasingly the main driver of TSMC's growth over the next several years.

Laura, your second question is the 5G smartphone penetration rate. We're still looking at about 50% at this moment.

Okay, thank you. And if I can ask the second question about the growth margin outlook, I think 59% is really amazing. And considering your CapEx discipline and the consistent delivery in the advanced know, or maybe price hike as well, can we expect that we'll have more upside to your current 53% growth margin targets?

So Laura's second question is on the gross margin. She notes that gross margin for second quarter, 59.1% is very high. So is there upside to our long-term gross margin target of 53% and higher?

Laura, as we mentioned before, there are six factors that affect our profitability every year, excluding the foreign exchange rate, of which we do not have any control on. The other factors taken into consideration, we are confident that a long-term gross margin of 53% and higher is achievable, and we certainly will try to work hard to deliver better than that.

Okay, thank you very much. That's very helpful.

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

Next one, we have Topu Harihalan from JP Morgan. Thanks.

Let me try again. My first question is on the U.S. expansion. There have been a lot of commentary around very high costs for U.S. expansion. I think Founder Chairman for U.S. fabs compared to Taiwan. Could you talk a little bit about the U.S. expansion and how the Air Force fabs are doing? What kind of cost differential is TSMC seeing? And what is your negotiations with Arizona government as well as customers in terms of filling up the cost differential? That's my first question.

Okay, Goku, I have to say again, you're breaking in and out. Let me try to summarize your question. Make sure we got it right. So Goku's first question is about our US fab. He notes that the cost is higher. Our founder has recently said this as well. So Goku, I think your question, again, you broke up, but I think your question is about how do we manage the cost? How will we manage the cost gap and close the cost gap? Is that your question?

And what is your discussion, the negotiation with customers and governments regarding higher costs as well as subsidies?

So, okay, thank you, Gokul. So Gokul wants to know, with the higher costs, how are negotiations and discussions with governments, how are negotiations and discussions with customers about this cost differential?

Okay. Hey, Gokul, yeah. Yes, I did mention that the cost in the FAB in the U.S. is higher than we expected. We are still in the construction stage of the FAB. And during this past two years, we found that the labor cost in the States is higher than we planned. And also some of the COVID supply chain interruption also was unexpected. And we did confer this information to the government at the location and give them a full perspective of the cost gap. But Goku is indeed our customer in US. They all want to load that fab. I mean, this is a niece from our customers. And we also believe there is a ample, amplify our business opportunity. So the cost is increasing, but cost is not the only factors. And we're still working on the government subsidy, and we'll continue working on the cost reduction. And every company have different ways to reduce the cost. So that is the work in the process.

Thank you. Thank you very much. My second question, would TSMC consider any kind of joint venture fab in the U.S. with potential large customers? Historically, TSMC has done this with some of the customers like Altera and NXP long back. Would you consider any kind of joint venture fabs potentially with any of the customers in the U.S. if the outsourcing opportunity is big enough?

Thank you. Okay. So Gokul's second question is, again, would TSMC consider any type of joint venture FAB in the U.S. for outsourcing? He notes we have done certain JVs in the past. So is this something we will consider in the U.S. for outsourcing opportunities?

Yes. Let me answer this question again. Yes, TSMC indeed has some joint venture arrangements. uh... maybe twenty years ago uh... within u s But right now, we understand with that experience, we understand our customers' demand will go up and down. And also, we don't want to limit this FAB into a specific set of customers. It's open to our old customers' base to utilize. So, no, at this point, we do not plan to have a joint venture arrangement in the U.S.,

Okay, go cool. Operator, go cool. Okay, thank you, go cool. Operator, can we move on to the next participant, please?

Next one to ask questions, Chao Shi from Niem and Company.

Hi, good afternoon. Thank you for taking my question. I want to go back, a quick clarification about M3 gross margin. You kind of mentioned, probably first time quantified, how much dilution you are expecting, 2% to 3%. Can you let us know dilution relative to which number, because there's one long-term gross margin number, which is 3% and higher, and there is another one, which is where your gross margin is tracking. That's a few points above your long-term target. This is kind of a little bit moving target here, so can you clarify with us? Thank you.

So Charles is asking if we can clarify our gross margin target. His question, well, I think, again, when we talk about N3 diluting 2 to 3%, it is for the first year, which is 2023. And so he's wondering, you know, I think, Charles, your question is, does this dilution continue? Does this change our long-term gross margin target? And maybe more, I think he's thinking about what are the gross, yeah, sorry, let me stop there. Is that your question, Charles? Yes.

No, no, no. The 2% to 3% dilution, dilution relative to what is my question. Is it relative to your long-term growth target, 53% and higher, or where you are tracking, which is 59%, 58%? Yeah, that's my question.

Thank you, Charles. So Charles is asking, when we talk about 2% to 3% dilution, are we looking at 53% diluting from there, or are we looking at 59% diluting from here?

Charles, it's diluting from next year's gross margin as we forecast. It's neither 53 nor 59. Bear in mind that when we talk about 53 and higher, it already included the dilution effects from the N3 dilutions.

Okay, Charles. Thank you very much. Do you have a second question?

I do. I have a more long-term question. Thank you, Chairman, for mentioning N2's full package, which includes chiplets. I want to specifically ask you about chiplets, 3DIC. I think we recently talked about expanding SOIC capacity by 20 times through 2026. That's quite a big amount of capacity allocation. I think one year ago, you sort of mentioned SOIC is something you're targeting for high-performance computing applications. But given the amount of capacity increases you're planning, any updated thoughts on whether that can be a technology possibly at the end to be used for a smartphone platform? Any other color you can give us would be great. Thank you.

Okay, thank you, Charles. So Charles' second question is on 3DIC. He notes that in particular we are talking about SOIC and also expanding the capacity there. We have said in the past this is primarily adopted by HPC applications. His question is with such capacity expansion, do we also expect smartphone customers to adopt 3DIC solutions like SOIC at some point in the future? Is that correct, Charles?

Yes, thank you very much. Okay, let me answer this question, Charles. So far, the SOIC is primarily adopted by the HPC applications. Okay, because that is very fit for their high speed and power efficiency. But for mobile adoption, you are dependent on their chip-less architecture. interconnect density requirement, thermal or other requirement, and we will have other solution to address the mobile requirement.

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

Next one to ask question, Mati Husseini from Susquehanna International.

Yes, thank you for taking my question. I just want to go back to the CapEx. I think the chairman had guided, back in 2021, the chairman guided to about 100 billion CapEx during the 2021 through 2023 period. And now this morning, you're highlighting the fact that CapEx PC could be 40 billion. So if I use the 100 billion as a bogey, it suggests to me that your cap tax could be down by as much as 8% to 10% in 2023, unless you are raising that $100 billion. I just want to get some color on this, and I'll have a follow-up.

Okay, so Madi's first question is on our CapEx. He notes back in April of 2021, we had guided for 100 billion CapEx in the next three years. And so now he's adding the math up for last year and this year and wondering, does that imply a decline in our CapEx for 2023, or do we have a new revised guidance for the CapEx spend?

Matthew, let me answer this. We're not going to talk about $100 billion today. We're not going to comment CAPEX beyond 2022. We've already given the guidance range of 2022. Now, as we mentioned before, every year when we invest in CAPEX, it is for the future growth opportunities. So as long as we believe the future outlook is good, we will continue to invest in a disciplined manner.

Got it. Just a quick follow-up here. Despite the fact that CapEx was up 76% last year in 2021, the depreciation so far has been tracking slavish. It was flat in Q1 and down 3% in Q2. Should I expect a big step up in depreciation going forward?

Okay, so Mindy also wants to follow up to ask about depreciation. Despite the increase in CapEx, why is the depreciation growth pretty flattish or low so far this year? And then should we expect a step up in depreciation for 2023?

Every year there are new depreciation coming in, but at the same time there are depreciation getting out of the depreciation table. So some comes in, some goes out. This year we expect the depreciation will grow about single digits from last year. It is lower than when we guided at the beginning of the year because of some tool delivery schedule change as Cici mentioned earlier. Now for next year, it's too early to give a specific number, but the depreciation will be much higher than this year.

Okay. And Jeff, since everyone had multiple chicken questions, may I squeeze one quick follow-up?

Well, you have one and a half. I'll let you another half question, please, Madi, because we still have a few people on the line.

Sure. I'll make it very quick. When I look at your customers, their inventories are at a 25-year high, and I think everyone is going to take a look at the seasonality in the second half. And I'm just curious, What are the key variables, what are the key metrics, or what are the key strategies that you have in place that mitigate the gross margin downside if your customers become more aggressive in inventory corrections into next year?

Okay, so Mehdi's question is noting customer inventory at customers are very high. So what would be the key variables or metrics for TSMC to mitigate our gross margin downside or risk if customers were to adjust their inventory further? Is that correct, Mehdi?

Yes, it could become more aggressive in inventory correction in the course of next year.

if their customers were to become more aggressive on their inventory correction into first half next year?

Well, let me answer the question. As I stated in the remark, You know, our customers are doing the inventory correction, but I say that customers that demand still exceed the TSMC's capability to support for this year. So even they do the inventory correction, adjustment, or they say that they decrease their demand versus their original number, TSMC's capacity is still very tight and will remain very healthy in the utilization. So that's why we can keep our cross-margin intact. Did I answer your question?

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

Next, I want to ask a question based directly from Bank of America.

Hello. Good afternoon, everyone. Thank you for taking my question. So, first of all, congratulations once again on the strong earnings. And my first question is about advanced packaging. We learned that advanced packaging is very, very important for TSMC's long-term growth, and TSMC has a great variety of offering to provide higher value to customers. So, would you please share your insights on what the key barriers are for wider adoption by clients, and would you expect the contribution mix to increase gradually, or if there is a point to see an explosive growth from the advanced packaging? And by the way, we saw the news about the DDIC R&D Center in Japan, and how will that center accelerate the progress? Thank you very much.

Okay, so Brad's question is on advanced packaging. I believe if I heard you correctly, what are the key barriers for wider adoption of our packaging solutions by customers? What is the long-term revenue growth outlook of advanced packaging? Is it going to be exclusive growth or growth similar to the corporate average? And also the role of our 3DIC center in Japan in developing advanced packaging solutions.

Okay, that's a very long question, but let me answer one by one. First, we developed a very advanced packaging technology to meet the customer's demand. So, so far today, 3DIC or SOIC, we develop for the high-speed performance HPC applications first. And that one is mostly starting to be adopted by all HPC customers starting from today. So we expect it will gradually ramp up and until that 2 nanometer, I think it will have much more demand in that technology node for the 3D IC. That's what we expect, and we expect the growth of these 3D ICs of business will be healthy, probably a little bit ahead of TSMC's growth forecast. Now, let me turn to the 3D IC Center in Japan. We established 3DIC Center because Japan has a fundamental advantage on the raw material, also on the packaging area. For example, the substrate. They are the number one in the world. Then we need that one technology to complement the TSMC's 3D IEC technology so we can serve our customer better. And that's why we established a 3D IEC center, technology development center over there. Did I answer your question?

Yes, yes, very clear. Thank you. Thank you, sir. So maybe another follow-up that's also about the IC substrate. So ABF IC substrate currently plays a very important role in the advanced packaging, of course, especially for co-ops. And the substrate area demand potentially enlarges with the increasing advanced packaging penetration. So with the rising integration level of a chip, do you expect new material to potentially replace ABF? and any plan to secure substrate supply or upgrade the design for TSMC for future requirements? And maybe one last follow-up is that if we compare 2.5D and 3D, would you need more substrate for 3D? Thank you.

Okay, well, Brad's second question is on substrates. He wants to know with the development of substrates and the adoption, do we see further developments in terms of new materials? Will we see more substrates used in 3D IC versus 2.5D? And how do we secure the substrate supply?

Well, this one, we are working with the substrate partner, and your question is on the 2D, 2.5D or 3D, both. Both are important. But let me tell you one further step. We're only interested in the very advanced technology. We are not going to develop any commodity of the substrate technology to compete in the market. No. We are developing for the very high performance computing or very large substrate to support TSMC's customer. That's our purpose.

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

Next one to ask questions, Chris and Carl from Covenant Company.

Yeah, hi. Thanks for taking my question. I had two of them. The first one is, when I look at your full year guidance of 35% revenue growth, it looks like calendar 4Q of the December quarter is going to be sequentially down more than 10%. And that hasn't happened in a long time. So I'm kind of curious, how much of that is driven by demand versus FX? And then the second question, a follow-up, is if I look at your CapEx run rate, The first half is running at about 17 billion, which is below the low end of your full year guidance. I'm kind of curious, what are the tool delays that's causing the push out of CapEx into next year? Is it like EUV? Is it like depth edge tools? Any color on that would be super helpful. Thank you very much.

Okay, so Chris has two questions. First, he's looking at our full year guidance to grow mid-30s, and he says this implies a decline in the fourth quarter.

No, I don't think so. We did the calculation. Maybe you can do that again. It's at least up.

Krish, I would note that when we talk about mid-30s guidance, as Cece said, that is in U.S. dollar terms, okay? And then his second question is on CapEx and sort of looking at the CapEx. His question is, we have already said it will be closer to the lower end of the range. He wants to know what is driving the CapEx's tool delays. Is it EUV, what types of equipment?

Now, I don't think we can go into that kind of details, but some of them got pushed out to next year, as CC mentioned. And every year, the CAPEX profile can be different quarter by quarter.

Yeah.

Okay. Thank you very much. Thank you.

Okay. Thank you. Operator, in the interest of time, I think we will take questions from the last two participants, please. So let's move on to the next.

Yes, the next one to ask questions frankly from HSBC.

Thank you. I want to just ask a question on, I guess, the overall profitability and also pricing, because it seems like this year we started to see, you know, a foundry price increase and a bit unusual for TSMC. And going into next year, it looks like there's some anticipation of further price increases. But at the same time, we're also seeing, you know, potentially inventory correction. So just to understand the pricing strategy itself, is this more of a reflection of, perhaps the structural probability for this cycle being different than the past, or are there any kind of costs that we're seeing this time that we haven't seen in past cycles?

Okay, so Frank's first question is on pricing. He wants to know what is driving our pricing strategy, how do the cost inflation or factors play into it, and really what drives TSMC's pricing?

Yeah, we do not comment on our pricing details. These are the private discussion between us and our customers. Having said that, our pricing is strategic and value-driven, not opportunistic or cost-plus. We work closely with our customers to provide our value, and we will continue to ensure that our pricing reflects our value creations, including technology, ecosystems, and services, and capacity support. By taking all these actions, we believe we can achieve a long-term gross margin of 53% and higher. We do face manufacturing cost challenges. As we mentioned, rising raw materials, utilities, and tool costs, et cetera. But having said that, we still think that the 53% long-term growth margin is achievable, and 53% and higher.

Okay. Frank, do you have a second question? Yeah, sorry.

Yeah. Sure, Mike. My second question is, you know, I understand the world view on that, but given what you guys just talked about, the overall cycle, I know you still have some, you know, the leadership and the event side and everything else, but is there a potential billboard effect where customers could see a stronger second half this year in anticipation of price increases and with the adjustment going into next year that we see some more weakness in the first half, more than anticipated in the first half?

Okay, well, Frank's second question is, you know, with pricing, could there be a situation where customers, I guess, will pull in more of their business to second half this year and thus we would see a weaker first half next year?

No, we did not see that. We are actually working with our customers, and we try our best to support our customers. As I said, even right now, our capacity remains very tight. So, you know, the switching between the next year's first quarter and this year's second half, no. We did not see that. Just simply put it. Okay. Okay.

Great. Thank you, Frank. Operator, can we take questions from the last participant, please?

Yes. The last one to ask questions, Robert Sanders from Deutsche Bank.

Yeah, honey. Thanks for taking my questions. I just have two. The first one is just if you could just discuss how much of next year's revenue is under LTA The reason I'm asking is because there are some people in the market thinking that customers may be fearful of pushing out wafers because they may be jeopardizing agreements for next year. And then the second question would be just to pop on the chiplet question. I was just wondering what percentage of two nanometer HPC designs will be using a chiplet architecture? Is it the majority? What's the adoption rate? Thanks.

Okay, so Robert's first question is he wants to know how much percentage of revenue do long-term agreements with customers represent for TSMC? Maybe Wendell can address this question.

Yeah, Robert, we don't discuss the details like that. We work very diligently and closely with the customers to plan the capacity, including receiving the prepayments for capacity support. And we will continue to work with them to decide to determine the best way to support them going forward.

Okay. And then his second question is on N2. He wants to know for HPC applications on N2, what is the percentage or that may adopt a chiplet architecture approach?

I cannot release the number, but let me assure you that the number of the customers using the chiplets in the N2 or the 2 nanometer technology will start to increase, and that will become a major approach in the 2 nanometer and the following technologies.

Okay, thank you, CC. Thank you, Robert, and thank you, everyone. 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 one hour from now, and the transcript will become available 24 hours from now, both of which you can find available through TSMC's website at www.tsmc.com. So thank you for joining us today. We hope everyone continues to stay healthy and safe, and we hope you will join us again next quarter. Goodbye and have a good day.