Taiwan Semiconductor Manufacturing Company Ltd.

Thank you very much. Good afternoon, everyone, and welcome to TSMC's third quarter 2022 earnings conference call. This is Jeff Su, TSMC's Director of Investor Relations, and your host for today. TSMC is hosting our earnings conference call via live audio webcast through the company's website at www.tsmc.com, where you can also download the earnings release materials. If you are joining us through the conference call, your dial-in lines are in listen-only mode. The format for today's event will be as follows. First, TSMC's Vice President and CFO, Mr. Wendell Huang, will summarize our operations in the third quarter 2022, followed by our guidance for the fourth quarter 2022. Afterwards, Mr. Huang and TSMC's CEO, Dr. Cici Wei, will jointly provide the company's key messages. Then we will open the line for Q&A. As usual, I would like to remind everybody that today's discussions may contain forward-looking statements that are subject to significant risks and uncertainties, which could cause actual results to differ materially from those contained in the forward-looking statements. Please refer to the Safe Harbor Notice that appears in our press release. And now I would like to turn the call over to TSMC CFO, Mr. Wendell Huang, for the summary of operations and the current quarter guidance.

Thank you, Jeff. Good afternoon, everyone, and thank you for joining us today. My presentation will start with financial highlights for the third quarter 2022. After that, I will provide the guidance for the fourth quarter. The third quarter revenue increased 14.8% sequentially in NT dollar, or 11.4% in U.S. dollars, as our third quarter business was supported by strong demand for our industry-leading 5 nanometer technology. Third quarter gross margin increased 1.3 percentage points sequentially to 60.4%, slightly ahead of our guidance as we enjoyed a more favorable foreign exchange rate and cost improvement efforts. Total operating expenses accounted for 9.8% of net revenue as compared to 10% in the previous quarter. Operating margin increased 1.5 percentage points sequentially to 50.6%, mainly due to better operating leverage. Overall, our third quarter EPS was 10.83 NT, and ROE was 42.9%. Now let's move on to revenue by technology. 5 nanometer process technology contributed 28% of wafer revenue in the third quarter, while 7 nanometer accounted for 26%. Advanced technologies, which are defined as 7 nanometer and below, accounted for 54% of wafer revenue. Moving on to revenue contribution by platform. Smartphone increased 25% quarter over quarter to account for 41% of our third quarter revenue. HPC increased 4% to account for 39%. IoT increased 33% to account for 10%. Automotive increased 15% to account for 5%. And DCE decreased 2% to account for 2%. Moving on to the balance sheet, we ended the third quarter with cash and marketable securities of 1.5 trillion NT. On the liability side, current liabilities decreased by 38 billion NT, mainly due to the decrease of 116 billion NT in short-term loans, partially offset by the increase of 70 billion NT in accrued liabilities and others. Long-term interest-bearing debt increased by 88 billion NT, mainly as we raised 60 billion NT of corporate bonds during the quarter. On financial ratio, accounts receivable turnover days decreased one day to 36 days. Inventory days decreased five days to 90 days, primarily due to higher wafer shipment during the quarter. Now, let me make a few comments on cash flow and CAPEX. During the third quarter, we generated about $413 billion NT in cash from operations, spent $266 billion in CAPEX, distributed $71 billion in fourth quarter 21 cash dividends, and raised $60 billion from corporate bond issuances. Overall, our cash balance increased by $43 billion to $1.3 trillion NT at the end of the quarter. In U.S. dollar terms, our third quarter capital expenditures totaled $8.75 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 fourth quarter revenue to be between $19.9 billion and $20.7 billion U.S., which represents a 0.4% sequential increase at the midpoint. Based on the exchange rate assumption of $1 to 31.5 NT, growth margin is expected to be between 59.5% and 61.5%, operating margin between 49% and 51%. This concludes my financial presentation. Now, let me turn to our key messages. I will start by making some comments on our third quarter and fourth quarter profitability. Compared to the second quarter, our third quarter gross margin increased by 130 basis points sequentially to 60.4%, mainly due to a more favorable foreign exchange rate and cost improvement efforts, despite continued inflationary cost pressures. Compared to our third quarter guidance, our actual gross margin exceeded the high end of the range provided three months ago, as our guidance was based on exchange rate assumption of one US dollar to 29.7 NT, whereas the actual third quarter exchange rate was one US dollar to 30.32 NT. This created about 80 basis point difference in our actual third quarter gross margin versus our original guidance. We have just guided our fourth quarter gross margin to be flattish sequentially to 60.5% at the midpoint as a more favorable exchange rate assumption will be offset by a lower capacity utilization rate. As a reminder, six factors determine TSMC's profitability. Leadership technology development and ramp-up, pricing, cost reduction, capacity utilization, technology mix, and foreign exchange rate. Looking ahead to 2023, we face challenges from N3 ramp dilution, higher year-over-year increase in depreciation costs, rising inflationary costs, semiconductor cyclicality, and overseas fab expansions. To manage our profitability in 2023, we are working closely with our customers to support their growth and continue to strategically and consistently sell our value. We are also working diligently on our internal cost improvement. Excluding the impact of foreign exchange rate, of which we have no control over, and taking the other five factors into consideration, we believe a long-term gross margin of 53% and higher is achievable. Next, let me talk about our 2022 CAPEX. As I have stated before, every year our CAPEX is spent in anticipation of the growth that will follow in future years. Three months ago, we said our 2022 CAPEX would be closer to the lower end of our $40 to $44 billion range. Now, We are further tightening up this year's capital spending and expect our 2022 CAPEX to be around $36 billion. About half of the change is due to capacity optimization based on the current medium-term outlook, and the other half is due to continued tool delivery challenges. Out of the around $36 billion CAPEX for 2022, between 70% to 80% of the capital budget will be allocated for advanced process technologies. About 10% will be spent for advanced packaging and mask making, and 10% to 20% will be spent for specialty technologies. Looking ahead, we will continue to manage our business prudently given the near-term uncertainties and adjust and tighten up our capital spending where appropriate. That said, our commitment to support customers' growth remains unchanged, and our disciplined CAPEX and capacity planning remains based on the long-term structural market demand profile. We will continue to work closely with our customers to plan our long-term capacity and invest in leading-edge and specialty technologies to support their growth while delivering profitable growth to our shareholders. Now, let me turn the microphone over to CC.

Good afternoon, everyone. First, let me start with TSMC's more resilient near-term demand outlook. We concluded our third quarter with revenue of NT 613.1 billion, or U.S. dollar 20.2 billion, supported by strong demand for our industry-leading 5 nanometer technologies. Moving into the first quarter of 2022, we expect our business to be flattish, as customers' ongoing inventory adjustment is balanced by the continuous ramp-up of our 5nm technologies, supported by smartphone and HPC applications. We expect our four-year growth in 2022 to be mid-30% in U.S. dollar terms. On the demand side, we continue to observe softness in consumer and market segments. Other end market segments such as data centers and automotive related remain steady for now for TSMC. But we start to see the possibility of adjustment down the road. On the inventory side, our customers and the supply chain continue to take action to adjust their inventory. We expect the semiconductor supply chain inventory to peak in third quarter this year and start to reduce in fourth quarter this year. We also expect it will take a few quarters through first half 2023 to rebalance to a healthier level. While the ongoing inventory correction will also affect TSMC, we expect our business to be less volatile and more resilient than the overall semiconductor industry during this period, supported by three key factors that are TSMC's core strengths in the front-end industry. First, our technology leadership and differentiation is much stronger today as compared to previous years. This enables TSMC to win business and enables our customers to win business in their end markets despite the semiconductor secrecy. Secondly, through our comprehensive design ecosystem and optimized process technologies, We are able to address and capture the structural increase in demand for computation and build a strong portfolio in high-performance computing. Third, our strategic relationship with our customers are long-term in nature, and we continue to work closely with our customers on technology development, capacity planning, and pricing to support their long-term demand and goals. As a result, we continue to see strong demand for our leading node, accepted N7, and steady demand for our differentiated spatial technologies on mature nodes. Looking ahead to 2023, with the successful ramp-up of N5, N4P, N4X, and the upcoming ramp-up of N3, we will continue to expand our customer product portfolio and increase our addressable market. Thus, while the ongoing semiconductor inventory correction will affect our first half 2023 utilization rate, we expect our business to be supported by stronger demand for our differentiated and leading advanced and specialty technologies, and for 2023 to be a growth year for TSMC. Next. Let me talk about the N7, N6 demand outlook. Due to the market weakness in smartphones and PCs, and customers' product schedule delay, starting 4Q this year, our N7, N6 capacity utilization will not be as high as it has been in the past three years. We expect this to persist for a few quarters through first half 2023. As the semiconductor supply chain inventory takes a few quarters to rebalance to a healthy level, and we have adjusted our N7-N6 CAPEX accordingly. We believe the N7, N6 demand is more a cyclical issue rather than structural, and expect our N7, N6 demand to pick up in second half 2023. Longer term, we continue to work closely with our customers to develop specialty and differentiated technology and are confident to drive additional wave of structural demand to backfill our N7 and N6 capacity over the next several years. Thus, our 7 nanometer family will continue to be a large and long lasting node for TSMC. Now I will talk about our N3 and N3E status. N3 is on track for volume production later this quarter, with good yield. We expect a smooth ramp in 2023, driven by both HPC and smartphone applications. Our customers' demand for N3 exceeds our ability to supply, partially due to the ongoing tool delivery issues, and we expect N3 to be fully utilized in 2023. We expect N3 revenue in 2023 to be higher than N5 revenue in its first year in 2020, and for N3 to contribute a mere single-digit percentage of our wafer revenue in 2023 as our overall revenue base is much larger today than in 2020. N3E will further extend our N3 family with enhanced performance, power, and yield, and offer complete platform support for both smartphone and HPC applications. N3E development is progressing ahead of plan, and volume production is now scheduled for second half 2023. Despite the ongoing inventory correction, we observe a high level of customer engagement at both N3 and N3E, with a number of tap-outs more than 2x than that of N5 in its first and second year. We are working closely with our tool supplier to address the tool delivery challenges and prepare more 3 nanometer capacity to support our customers' strong demand in 2023, 2024, and beyond. Our 3 nanometer technology will be the most advanced semiconductor technology in both PPA and transistor technology when it is introduced. We are confident that N3 firmly will be another large and long-lasting node for TSMC. Finally, let me talk about the future driver of leading node adoption. TSMC's mission is to be the trusted technology and capacity provider for the global logic IC industry for years to come. Our job is to help our customers unleash their innovations and enable them to capture greater value and win in their end markets. As the industry continues to pursue scaling, it is true that the geometry shrink is slowing down and becoming more challenging for everyone due to rising process complexity. However, it is also true that demand for energy-efficient computing is accelerating in an intelligent and connected world as technology is becoming more pervasive and essential in people's lives. Thus, the semiconductor industry value in the supply chain is increasing. and the value of technology platform is expanding beyond the scope of geometry shrink alone and increasingly toward greater power efficiency. As a result, our customers value much more than simply transistor cost. System performance and power efficiency has become key motivation for customers to adopt our leading node technologies. By working closely with our customers on technology development, our N3 and N2 will deliver full-node strikes in performance and power benefits while offering the industry's most advanced transistor scaling. We expect strong demand for our leading-node technologies driven by both smartphone and and HPC applications to fuel our long-term revenue growth of 15% to 20% CAGR over the next several years in U.S. dollar terms. With our leadership in both leading-edge process technology and 3D solutions, TSMC's technology cadence remains constant to deliver the value of our technology platform. We will continue to extend our overall competitiveness and technology leadership while delivering a predictable technology cadence that helps our customers to enhance their product competitiveness and grow their markets well into the future. This concludes our key message, and thank you for your attention.

Thank you, C.C. 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. If at any time you would like to remove yourself from the questioning queue, please press 02. Now let's begin the Q&A session. Operator, can we please proceed with the first participant on the line?

Yes, Jeff. The first one to ask question Go ahead, please.

Yeah, good afternoon, and thanks for taking my question. Congrats on the great results, especially in the margins. So first question is on N7 and N6. This utilization slack that we are observing, Could we give a little bit more detail on why that is happening and why we think this is a short-lived couple of quarters issue and we get a big back in the utilization in second half of the year? And I think last time we saw this was for 28 nanometer, but that lasted for a much longer period of time. So could you also give us some kind of comparison with what happened back in 28 nanometer and why this is going to be very different and maybe a little bit more color on what are the areas of backfill demand for N7 and N6 as the high-end smartphone processors and HPC start to move on to N5 and then N3? That's my first question.

Okay. Gokul, let me please allow me to summarize your first question. So Gokul's first question is on N7, N6. He wants to understand what is driving the utilization slack. Why do we believe it is short-lived and that the demand for N7, N6 can pick up in second half? And then also on the little bit longer-term outlook, why we believe that N7 can be backfilled and it will not be like N28 a few years ago with a few years of underutilization.

Goku, let me answer your question first. Why demand drop? Demand drop because of market become soft, as we said in the weaknesses in the smartphone and PCs. And also a big factor is our customers' product schedule delay. all in all put all together so we think that our utilization has been affected in the first quarter this year and all the way to the first half of 2023 for the longer term We continue work closely with our customer. And actually, let me also say that this is a cyclical issue. So it will pick up anyway. And we believe it will pick up in the second half of 2023. And for the longer term, We continue to work closely with our customer to develop specialty and differentiated technology to drive additional wave of structural demand from consumer, RF, connectivity, et cetera, and other application to backfill our N7, N6 capacity. And so for the next several years.

That's all I. Does that answer your first question, Gokul?

My second question would be on the CAPEX outlook. Now that we bring down the CAPEX slightly for 2022, could you talk a little bit about what is the outlook direction for 2023 at least, if not absolute numbers, but just direction? Are we going to be flattish or it's likely to be going down? Second is also, could you also give us an update on the schedule for the new fabs Kaohsiung, Kumamoto, Nanjing, and Arizona? Is there any change in the schedules in terms of these fabs coming into production? Thank you.

OK, thank you go cool so go cool. Second question is on capex and capacity. So first he wants to hear. Of course it says that we have tightened up our capex in 2022 so he is asking for 2023 directionally. Is there an indication of 2023 capex and then he would also like an update on our expansion plans in Kaohsiung, Nanjing, Arizona and Kumamoto.

Okay, Goku, let me answer you the first part. For 2023 CAPEX, it is too early to comment. We will provide you with a specific guidance in January. However, as we said, we have tightened up our 2022 CAPEX to reflect the current medium outlook, as well as two delivery issues. Looking ahead to 2023, we will continue to be careful and manage our business prudently given the near-term uncertainties. We will adjust and tighten up our capital spending where appropriate, but we will continue to work closely with our customers to invest for the long-term structure market demand profile to support their growth.

Well, let me answer the second part of Goku's question. Goku, you asked about the progress of our Arizona 5, Nanjing 5, and Kaohsiung. And let me say that Arizona 5 will continue and unscheduled. There's no doubt about it because this is a N5 family. We still have a very strong demand. And for Nanjing, we just get our one-year authorization for 28 nanometers expansion. So it is on schedule also. For Kaohsiung, initially we planned a two-fab at the beginning of a 28-nanometer expansion and the N7. Now N7 has been adjusted, but 28-nanometer expansion is continued and on schedule.

And also Kumamoto?

Oh, okay. Also the Japan fab is on schedule to meet the customer's demand.

Okay, Gokul. Got it. Thank you very much.

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

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

Thank you for taking my question. So my first question is regarding to the HPC, which is the key driver for TSMC for the coming years. However, with the reason the U.S. new restriction to China, What do you think about the HPC demand moving forward? What kind of impact? It's going to see a slowdown from China or you're going to see the saturation from the non-China side?

Okay, so Bruce's first question is on HPC. He notes HPC, we have said repeatedly, will be TSMC's key growth driver and main engine the next few years. He wants to know, I believe, Bruce, the impact of the recent U.S. regulations, does that affect the overall HPC demand or the overall profile? Is that correct?

Yes, what's the impact from this new restriction to TSMC and overall industry?

Okay, let me answer that. Bruce, it's based on our initial reading and feedback from our customers. The new regulation set the control threshold at very high-end specification, which is primarily used for AI or supercomputing applications. Therefore, our initial assessment is the impact to TSMC is limited and manageable. We will continue to closely monitor the situation to ensure that we are all in full compliance with all the rules and regulations. And for the longer term, it's too early to really assess all the true impact or influence, but we will give you the update in the following earning call.

Okay. Okay, I understand that. Thank you. So my next question is regarding to the cyclical measure for the 7 nanometers. But we also noticed that most of your other nodes, you know, the capacity retention rate is still at a very, very high level, or at least much better than 7 nanometers, as the manager mentioned. Why is 7 nanometers so cyclical? Because, you know, maybe because you guys are too big that you have to deal with the industry? Or what is the difference between your 7 nanometers and your other nodes?

OK, so Bruce's second question is looking at N7 specifically. He wants to know, are other nodes seem to utilization still seems to be holding up well? So why specifically N7 is more cyclical and utilization is not as high as it has been? Is that correct, Bruce?

Yes. Okay. It just happened, you know, that most of my smartphone and PCs are customer are using N7, N6, N6 node. And, you know, it just happened. The market weakness in smartphone and PC happened at the same time. And also, other customers' product schedule delay, all in all, that's why it become lower utilization rate as compared with other node. If you want to compare with a N5 or you compare with a 28 nanometer, all those are very, you know, it's still a very high demand. And we continue to enjoy the higher market share.

I want to dig in a bit because we get used to, like, you know, GSMC well manage your customer's product and overall outlook.

Even with some PayPal today, you can figure it out with someone else. But, you know, anything different with this time, that 7 nanometer, you cannot have as good as, you know, your other nodes.

So Bruce wants to still understand why the seven nanometer utilization cannot be as high as the other nodes if we work closely with customers and it's well planned.

Well, again, Bruce, we work closely with our customer, but our customer get caught in this inventory correction and the market downturn. They didn't know this one probably two quarter before and And at the beginning of this year, they still give us a very high number of their forecasts. And it just happened. It just happened. But as we said, we believe this is a cyclical issue. And it will pick up. But before that, it probably will take a few quarters.

I see. I understand. Thank you. We just get too used to it to be like, to expect it and always believe a much better result. I understand. Thank you.

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

Next, we have Randy Abrams from Credit Suisse.

Yes. Okay. Thanks for taking my question. I wanted to ask a two-part first question. You mentioned in the prepared remarks about HPC and auto continue to be stable, but seem to signal it may change. If you could give your view how you see inventory levels and some of the forward demand outlook from those areas. And the second part, just want to see if we could get a bit better visibility on first half. First quarter, how do you see it versus normal seasonal? And then for the trough, do you expect first quarter could be the bottom, or do you see the trend that we could be towards second quarter?

Okay. So Randy's question is really looking at, again, from the end demand segments, data center and automotive, we say are remaining steady at TSMC for now. He wants to understand, though, what is the outlook down the road and what does that mean for inventory levels? And then secondly is also he wants to see if we can provide some more granularity about first quarter outlook versus seasonality and whether we think the first quarter can be the bottom for the industry. Is that correct, Randy?

Yeah, that's correct.

OK, let me answer this one. Of course, we say that so far our customers give us their demand forecast, so the data center and automotive related are still steady. But now the market becomes soft, and we are taking a more conservative way in our planning for 2023. And that's why we say that we don't rule out the possibility. They might have some correction also, but, you know, we did not see it right now, to be frank with you. And for the inventory correction in the 2023, all you want to say is like that. We expect probably 2023 the semiconductor industry will likely to decline. But TSMC also is not immune, but we believe our technology position, strong portfolio in HPC and longer term strategic relationship with customer will enable our business to be more resilient than the overall semiconductor industry. And that's why we say in 2023 is still a growth year for TSMC, and the overall industry probably will decline.

Okay. Again, and I'll ask a quick follow-up and then the second question. I guess just the sense, because it's still very firm in fourth quarter, if you're seeing a pretty meaningful fall-off into first quarter. Like some years, 10 percent. 2019 declined over 20 percent. So just try to get a rough feel of the type of decline factor when you're gaining some content and share. That's the follow-up to the first. And then the second question, actually, just on gross margin, because of a lot of headwinds I think, Wendell, you talked about, if you could give, just on a couple of these, depreciation, factoring the recent capex, how much up, and whether it's also front-end or more back half-loaded, given the three-nanometer ramp. And then for the startup cost for N3, if you expect similar to N5, given smaller percent of revenue, how much dilution from N3? Okay, thank you.

Okay, Randy, so let me summarize. So Randy, quick, I think we will not comment on the first quarter, but I think we can make some comment just sort of in terms of the overall inventory picture looking into next year.

Well, actually, if you ask my opinion on the inventory picture and the inventory correction, It's too early to provide a specific number. However, the inventory correction will likely see its biggest impact sometime in the first half of 2023. Okay.

And then the second part related to the gross margin, maybe Wendell can address what is the outlook for depreciation next year? And then is it front or back end loaded? And also what type of dilution we expect from three nanometer as it ramps in 2023?

OK, Randy, for full year depreciation for next year, it's too early to talk about that. But this year is missed single-digit increase year on year. But next year, we expect it will likely to be meaningfully higher. We will give you the guidance in January. As to the dilution from N3, it will be between two to three percentage point from the whole year basis on our gross margins.

And actually, one follow-up. Do you think on a single quarter with the inventory correction, do you expect to keep the 53 and above factoring we're coming from a very high level even through that first half inventory correction?

Right. It is too early to talk about 2023 gross margin, including quarter over quarter. But even with all these cost challenges, we believe our structural profitability can be maintained, and we are confident to deliver a long-term gross margin of 53% and higher.

Okay?

Okay, great. Thanks a lot.

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

Next one to ask questions, Charlie Zhang from Morgan's Lending.

Hi, good afternoon. Thanks for taking my question. So my first question to management is about whether the company considers a share buyback because the company seems to suggest the recent inventory correction is just a sickly cold. You're still very positive on the long term. And I think a share price really reveals a company's long-term value, right? Also a shareholder's value. So I'm not sure if a company wants to to share buyback or cash returns?

OK, so Charlie's first question is that although there is cyclicality, the long-term outlook appears good. Would the company consider doing share buyback?

Yeah, Charlie, we constantly review all the different options of returning cash to shareholders. For share buyback, at this moment, we are not considering it. we think our cash on hand will be better kept to invest in our capital expenditure to make a better return for our shareholders.

Okay, understood. Thank you. And also, my second question is also about the U.S. sanction impact. I know the company said that impact is limited and long-term impact remains to be seen, right? My question is about the China market to TSMC. Is that as strategic as before after this event?

Okay, so Charlie's second question, he wants to know with the recent U.S. regulations and the impact, how do we see the China market? Is it still a strategic market for TSMC? Is that correct, Charlie?

Yeah, meaning meaning whether whether others company think about China for TSNC is a long term picture of how important China are going forward.

Charlie. I would like to say that every region is important to TSMC. However, let me say that under the condition of full compliance with all the rules and regulations, TSMC will continue to serve all the customers all over the world. That's our position.

Okay, including China?

All the customers.

OK, OK, got it. Thank you. Those are my questions. Thank you.

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

Next one to ask questions, Sonny Lin from UBS.

Hi, thank you for taking my questions. Congrats on the study performance. So my first question is on the geopolitical tensions. I wonder, given some of the considerations regarding the geopolitical issues, how would you evaluate a longer-term impact from customers potentially diversifying from ancient foundries, and how are you managing the risk? Thank you.

Okay, so Sunny's first question is that given the geopolitical tensions, you know, how do we evaluate the long-term impact and the risk of customers using other foundries? Is that correct, Sunny?

That's right. Thank you.

Okay.

Sunny, we still believe the most important thing is technology leadership in manufacturing and our customer trust. And so in different location, manufacturing or whatever, we still think that technology leadership is the most important thing. And so that's our strategy. We make it simple, that technology, manufacturing, and customer trust.

Got it. And so a quick follow up is that going forward, should we assume an acceleration of your overseas expansions just to diversify the production sites, i.e., if there could be a FAP built in Europe?

Okay, so Sunny's second question then, can she assume that we will continue to increase the overseas global footprint expansion and also particularly in Europe?

Well, We will continue to increase our overseas portion in manufacturing based on customers' need. In fact, based on the business opportunity and also based on the operations efficiency and economics. And so whether we are going to be in Europe, we are in preliminary evaluation and do not rule out any possibility. AGAIN, I WOULD LIKE TO SAY THE DECISION WAS BASED ON CUSTOMER'S NEED, BUSINESS OPPORTUNITIES, OPERATION EFFICIENCY, AND COST ECONOMICS.

GOT IT. THANK YOU. I ACTUALLY HAVE A SECOND QUESTION ON HPC. SO WITH THE INCREASING USE OF CHIPLETS, HOW WOULD YOU MANAGE THE RISK IN THE CASE THAT SOME are made at the other foundries and that have production issues and therefore impacting the production at TSMC as well. Thank you very much.

Okay, so, Sunny, second question is with increasing usage and adoption of chiplets in HPC, how would we manage the risk in case, I think, Sunny, you're saying if dyes at other companies or places have production if used, how do we manage the risk of that impacting TSMC?

Well, Sunny... Thank you.

Sunny, in fact, we would like our customer manufacturing every chip inside TSMC for sure. But if there's a case that they have to use other companies' dies, we will work with our customer closely and minimize all the risk as time goes by. That's what we are doing right now.

Got it. THANK YOU, THAT'S VERY HELPFUL. THANK YOU.

THANK YOU, SONNY. OPERATOR, CAN WE MOVE ON TO THE NEXT PARTICIPANT, PLEASE?

RIGHT NOW WE HAVE LAURA CHEN FROM CITY.

HELLO, HI. THANK YOU FOR TAKING MY QUESTION. I APPRECIATE THAT IF YOU CAN SHARE WITH YOUR LATEST PLAN IN 19-5, LIKE C.C. ALREADY MENTIONED, YOU GOT THE LICENSE FOR THE 28 NIROMETER. So I'm just wondering that, do you also need a license for the 16 nanometer in the Nanjing Fab? And also, going forward, what's your plan of your operation in China? That's my first question. Thank you.

Okay, so Laura's first question is about Nanjing FAB and our plans. She notes that we have received the one-year authorization, so our 28-nanometer expansion continues as planned. Her question is, do we also need a license for the 16-nanometer that we have in Nanjing? And then also, what is our long-term future expansion plans in China?

Sandy, let me answer the first part. Sorry, Laura. Let me answer the first part. The one-year authorization that we received covered the Nanjing facility. So it's both the 28 and 16.

Okay, great. Thank you.

And then the second part is what is our long-term expansion plans for China?

Okay, as CC said, we will be operating, serving all the customer under the condition that we will fully follow in compliance with all the rules and regulations.

Okay, that's very clear. My second question is also about the FAB globally in the longer term. We know that in overseas operation, usually they will have a much higher operational cost. So how would that impact that TSMC is a long-term margin trend in our view? Or maybe you can give us some estimation about your estimate of the percentage of the margin in different region or the cost difference comparing to Taiwan.

Okay, so Laura's second question is around our global expansion of our global manufacturing footprint. She wants to know that overseas fabs are the cost higher. Do we have a breakdown how much the cost difference is in Japan and US versus Taiwan? And then overall, with overseas expansion and if there are higher costs, how does this impact our long-term profitability and margin?

Okay, Laura, let me answer this question. The initial costs of overseas FABs are indeed higher than TSMC's FABs in Taiwan, and it's mainly because of higher labor costs in different layers of the supply chain. We continue to work closely with the U.S. governments as well as with our customers and supply chain partner to manage and minimize the cost gap. Now, through these efforts, we believe we can continue to earn the proper return and deliver the long-term gross margin of 53% and higher. Okay, that's very clear.

Thank you very much.

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

Next one to ask questions is Rob Boak from New Street Research.

Thank you for taking my question. I was hoping you could give some more context around the three nanometer tool shortages that you mentioned. Is that primarily lithography and then specifically EV related? Or do you also see shortages in other tool segments? Thank you.

Okay, so Rolf's first question is around 3 nanometer and the tool shortages. He wants to know if this is just specific to lithography tools and EUV specifically, or is it more, I guess, broad-based?

Let me answer the question. Actually, it's more broad-based because our demand is high. And certainly the photoresorgery tool is included and one of the most important ones.

Thank you. That's very useful. Then as my follow-up question, it would be great to get an update on your N2 nodes. With your current visibility, is the node still on track timing-wise? And is there anything you can share on how you think about yields of N2 versus N5 and N3 at the same stage of development.

Okay, so Rolf's second question is on N2. He would like an update. Are we still on track? What is the timing for N2? And also if there's an update on yields as compared to N3 and N5 at similar stage.

Okay. I said before N2 is a very difficult one, but our progress so far so good, actually is a little bit ahead. And we are going to have a mass production introduced in 2025. And our customers engagement so far are very, let me say that, comparable with the N3, N5. And the status today, is very comparable to the N5 and also N3. So we are happy to see that, you know, our progress so far.

Does that answer your question, Rolf? Thank you very much. Thank you, Rolf. Okay, operator, let's move on to the next participant, please.

Next one we have Chao Shi from Niden Company.

Oh, good afternoon. Thank you for taking my questions. I have two, both on CapEx. The first question is really, and I understand you are not here to guide 2023 CapEx, but I think a few years ago, you did provide some long-term CapEx, a range of CapEx, when your long-term CAGR guidance was applied to 10%, and you think 10 to 12 billion CapEx is going to support that long-term CAGR. I think you just reiterated your long-term CAGR to be 15% to 20%. Do you kind of have a similar range of CapEx for us to think about over long-term? Again, I'm not asking you about 23 CapEx a year.

OK, so Charles, first question is about really, I think, Charles, you're asking about Capex correlation with growth. So he notes that in the past we had said our long term growth would be five to 10 percent. So during that period, we said we would spend between 10 to 12 billion. So without asking about 2023 specifically, Charles wants to know, now we believe we will grow between 15 to 20% CAGR in the next few years. What type of capex range does that imply or should he assume? Is that correct, Charles?

Yeah, correct.

Okay, Charles, I think it would be, let me try to answer this question from the capital intensity point of view. When we invest heavily to capture the future growth, the capital intensity will be high, like last year and this year. But if the growth slows down, the capital intensity may become lower. Now, longer term wise, we think that a normal or reasonable capital intensity may be somewhere between mid to high 30 percentage longer term wise.

Thank you. The second question is about very near into the next quarter, basically, because you just slashed your 2022 CapEx, I mean, from what you guided one quarter ago by about $4 billion. If I hear correctly, half of that can be attributed to the tool delivery issues. But the other half, can you clarify a little bit because you You kind of said it's about capacity optimization. Is that kind of like a $2 billion reduction in capex, mostly a reduction of the equipment spending, or is it something else you are reducing here and trying to improve the capacity optimization here? Thank you.

Okay, so Charles' second question is on the CapEx, and he is asking, we have now guided to around $36 billion versus close to $40 billion last time. We have said half of it is related to tool delivery, and the other half is capacity optimization for the midterm demand outlook. So his question is, With the capacity optimization, is this mainly also reduction in tools, or is this some other issue? Is that correct, Charles?

Yes, correct. Thank you.

Okay, Charles, I think you're right. Half of that difference comes from tool delivery issue. The other half is the capacity optimization. And that's because of the current uncertainty in market conditions, so we're tightening up our capital budget. And it relates to the whole capacity. including tools, including the other stuff within the CAPEX. Yeah, and it's mainly N7. Thank you very much. Yeah.

Yeah, and so I think... Thank you, thank you. Yeah, it's tools and also as CC and Wendell mentioned, some of the adjustments we have made to our N7, N6 capacity in CAPEX due to the aforementioned reasons. Thanks. Okay, thank you, Charles. Operator, can we move on to the next participant?

Next one we have from PLA Securities. Go ahead, please.

Thank you very much for taking my question. So first of all, still, congratulations on the strong earnings. And my first question is about, well, if we look at the loan pages of the new regulations from the U.S. on China, it can be really broad and with a key, of course, with a key on the supercomputing. But, however, given the wide variety and also wider application of chips that TSNC makes, Is it, in theory, difficult to identify and make sure the chairperson and the business are complying with the regulation? Or will there be some extra costs and overhead costs by that, which we should notice in the future? Thank you. That's my first question.

Okay, so Brad's first question is with the new U.S. regulations, he knows it's very long and very wide in scope, so he is wondering if it's very hard to interpret and therefore will this result in greater overhead costs for TSMC to ensure that we are and continue to be fully compliant with all the regulations?

Well, actually, although it looks about more than 100 pages, but we are initial reading and feedback from our customer. Actually, the regulation is very simple to be understood, like a control threshold at a very high-end specification. For example, like 600 bit per seconds, you know, that bandwidth or those kind of thing. Or it's very... very easily to be understood, and we continue to work with our customer to make sure that we fully comply with the regulation.

And so Brad would also like to know, Wendell, from a financial standpoint, will we incur more overhead costs as a result?

At this moment, we don't think so.

I see. Thank you very much. Just a slight follow-up, because the regulation is just aiming at the supercomputing, but I know in a supercomputer, definitely there are still some low-end chips used inside. So if we happen to make those, and we are not sure that it is going there when we produce them, would that cause some confusion or bring some trouble to us? Thank you.

So, Brad's second question is, you know, in a supercomputer, there may be very specific high-end restrictions, but there's also, you know, companion chips, other chips used. Would that cause us an issue?

The companion chip, yes and no. No restriction or no regulation at all. So we rely on our customer to work with their own customer for that kind of a product.

Got it. Thank you very much. And then maybe if I may, second question would be clearly many countries would like to build their own foundry or build their own domestic supply chain. We have learned that the cost will be a major downside. So my question would be can we charge different pricing? that's basically demanded by our clients, right? So with higher cost, if they want to buy from U.S. or buy from Europe, can we charge a higher pricing if that's based on the same note? And also, but if we think about the bright side, would you please share how TSMC could well utilize these kind of opportunities to strengthen our competitiveness in the long run? Thank you. That'll be my all questions.

So, Brad, second question is about, you know, he notes that many countries would like to have domestic semiconductor manufacturing. TSMC, we are, as Cici said, also increasing and expanding our global manufacturing footprint. So with higher cost, will we be able to charge a higher price? I guess that is essentially his question.

Actually, TSMC's pricing is strategic and consistent, and all I can say is we will continue to share our value. The value comes from the technology, manufacturing, and also that our our relationship with our customers. Whether it is in a different country or it's a different place, it's not in our consideration. Again, I would like to say we continue to share our value and our pricing is strategic.

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

Next one, we have from Susquehanna International. Go ahead, please.

Yes, thanks for taking my question. I also have my first multi-part question. I'm just looking at your customers' inventories that are on a days of inventory are at a 25-year high. And it seems, based on your commentary, that the demand forecast, especially looking at the first half, has weakened. So it seems to me that the inventory correction is going to sustain to Q2, and most likely your shipment would be declining sequentially in Q1 and Q2. Just looking at your customers' inventory, is that a realistic view of the first half? Because you also, highlighted the fact that inventory correction is going to sustain throughout the first half. I'm not asking for a guide. I'm just trying to better reconcile your customer's inventory with your community, and I have a follow-up.

Okay, so Midee's first question is on inventory. He notes customers' inventory levels are very high. We have talked about our observation from an industry level that demand is softening in consumer segments. And so his question is, what is the outlook and do we expect the inventory correction, I guess, to be more notable as we go into first half 23? Is that correct, Midee?

Yes, and particularly, you've always had your wafer shipment up in Q2, and I think 23 could be an exception, and it could probably decline. And that's how I spring my question. So the question is, could wafer shipment decline in Q2 for the first time in many, many years?

Well, many. Our current forecast, actually, Our supply chain inventory was peaking in the third quarter this year. And we observed that our inventory was starting to reduce in the fourth quarter, last quarter of this year. And we expect to see the biggest impact in the first half, actually, first half of 2023. The detail of the first quarter, second quarter, or something like that, we are not ready to share with you yet. Because we continue to work with our customer and to understand their demand.

If I may have just a quick follow up to that. Does that imply that your customer progress are changing so rapidly that we have to wait for January call to get the final read on the first half?

No, Madi, I think we have always in the past, we will guide for 2023 and talk about 2023 outlook and first quarter during the January conference, right? But I think CC has already said that with the inventory correction, we expect our business to be more resilient during both the down and upturn given our technology leadership and that 2023 is a growth year for TSMC. Okay. We will not comment further on first quarter or second quarter.

Okay. And my second question has to do with depreciation that was down in Q3, down year over year, and Q over Q. And this is despite the fact that CapEx was up 65% in 2021. Does that have anything to do with – to optimization and to that extent as a second part of the question, would you consider converting seven nanometer tool to five and three?

So the second question first is depreciation, why it is down queue on queue and year on year. And then also would we consider converting capacity?

OK, THE DEPRECIATION, WE LOOK AT IT FROM A WHOLE YEAR POINT OF VIEW. FOR THIS YEAR, AS I MENTIONED, WE EXPECT IT TO BE UP YEAR ON YEAR BY MID-SINGLE DIGIT. AND FOR NEXT YEAR, IT WILL BE MEANINGFULLY HIGHER, BUT WE WILL SHARE WITH YOU MORE IN JANUARY. PLEASE UNDERSTAND THAT EVERY YEAR THERE ARE DEPRECIATION NEWLY going into the depreciation table, and also there are depreciation coming off of the depreciation table. So what you're looking at is the net result. As to converting N7 capacity to N5, as we mentioned earlier, N7 demand issue is cyclical rather than structural. So at this moment, I don't think we have that kind of plan.

Okay. Thank you, Madi. In the interest of time, operator, maybe we can take the last, the questions from the last two participants, please.

Yes, sir. Next one to ask question, Patrick Chang from CLSA. Go ahead, please.

Thank you for taking my question. You talked about 2023 to be still a growth year. Would you say that growth is pretty much the same compared to what you expected a quarter ago, or it is lower? And if so, what's driving this lower growth expectations?

Okay, so Patrick's first question is about 2023. Is the growth that we see for 2023, how does it compare versus our expectation for three months ago for 2023 and what is driving this?

Yeah, well, I think it's too early to talk too much about 2023, but we maintain our statement that 2023, we still expect it as a growth year.

Do you have a second question, Patrick?

Okay, yeah, that's helpful. And maybe a follow-up, if I may, any leading indicators that you are monitoring that could help you or help us determine the growth outlook aside from monitoring the client's waiver orders?

Okay, so Patrick's second question is looking with inventory correction. He wants to know if there's any leading indicators that we can look at or he should look at to see when, you know, indication that the cycle is bottoming.

That's very hard to answer your question. Actually, you know, if you look at the whole industry, from the smartphone and PCs, and you read all the quarterly report from all major players, you can sense that when it will go up and when it's a downturn. We definitely have some information. Internally, we do the analysis. And today, we are taking a very conservative way for our planning. That's all I can share with you.

Thank you. And I guess that's what we've been doing as well. But obviously, we don't have a... Well, I don't have any further questions. Thank you for taking my question. Thank you.

Okay. Thank you. Operator, can we take the last participant, please?

Yes. The last one to ask question is, frankly, from HSBC. Don't I have this?

All right. Thank you. I wanted to ask, I guess, a question on your N3, N3E. Is the ramp for both nodes going to be around the same time, or is there going to be some difference in scheduling.

Okay, so Frank's first question is on ramp for N3 versus N3E. Is it at the same time?

Yes. Okay, actually it's not at the same time. Right now we are ramping up by N3, and N3E is supposed to be one year apart, but because of the progress so well, so we might pull in a little bit for two or three months, that's all. So they are still not at the same time.

Okay. And my second question is, you know, I know you've re-rated your long-term gross margin target being unchanged. But I guess given the headwinds you're seeing now through the first half of next year, you know, with the currency move already gone up quite a bit, utilization rates dropping, is this – Are you going to see any potential change in the pricing strategy? I know I can't comment too specifically, but, you know, you have seen some price increases in the last 12 months or so. So from going forward, would the pricing strategy still be relatively unchanged given the change in the overall market environment?

Okay, so Frank's second question is related to pricing. With the inventory correction and with some of the cost challenges, he wants to know, will there be any changes to our pricing strategy during this correction? Is that correct, Frank?

Yes, thanks. Okay, Frank, let me answer the question. Again, I want to stress that our pricing actually is strategic and consistent. So you say that do we have any plan to change it? No. It will be consistent, all right? And not based on any cycle or opportunistic, And we actually, most importantly, we always work closely with our customer to provide our value and to help them to win their own in markets.

Right. No, I'm not suggesting there's any optimistic pricing, but I just get the market situation has changed for your clients who are probably going through a more difficult time. Would there be some change the strategy to help align with them as well? Or would it largely still be the same policy that we've seen?

We stay the same. We are consistent. Okay. Okay, thank you.

Thank you, Frank. 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 one hour from now. The transcript will become available 24 hours from now, both of which will be available through TSMC's website at www.tsmc.com. Thank you for joining us today, and we hope you will join us again next quarter. Goodbye and have a good day.