Taiwan Semiconductor Manufacturing Company Ltd.

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Good afternoon, everyone. I am Su Zhikai from Taichi.com's Legal Relations Department. I welcome you to participate in the first legal explanation session of Taichi's company in 2023. Since this law session is broadcast to investors around the world at the same time, we will use English throughout. Please forgive us. Good afternoon, everyone, and welcome to TSMC's first quarter 2023 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 the 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 first quarter 2023, followed by our guidance for the second quarter 2023. 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 questions and answers. 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. Thank you for joining us today. My presentation will start with the financial highlights for the first quarter 2023. After that, I will provide the guidance for the second quarter 2023. First quarter revenue decreased 18.7% sequentially in NT, or 16.1% in U.S. dollar, as our first quarter business was impacted by weakening macroeconomic conditions and softening end market demand, which led customers to adjust their demand accordingly. Gross margin decreased 5.9 percentage points sequentially to 56.3%, mainly reflecting lower capacity utilization and a less favorable foreign exchange rate, partially offset by more stringent cost controls. Total operating expenses accounted for 10.8% of net revenue. which is lower than the 12% implied in our first quarter guidance, mainly due to stringent expense control and lower employee profit sharing. Operating margin was 45.5%, down 6.5 percentage points from the previous quarter. Overall, our first quarter EPS was 7.98 NT and ROE was 27.5%. Now let's move on to revenue by technology. Five nanometer process technology contributed 31% of wafer revenue in the first quarter, while seven nanometer accounted for 20%. Advanced technologies defined as seven nanometer and below accounted for 51% of wafer revenue. Moving on to revenue contribution by platform. HPC declined 14% quarter over quarter and accounted for 44% of our first quarter revenue. Smartphone declined 27% to account for 34%. IoT declined 19% to account for 9%. Automotive increased 5% to account for 7%. And DCE decreased 5% to account for 2%. Moving on to the balance sheet, we ended the first quarter with cash and marketable securities of 1.59 trillion NT or 52 billion US dollars. On the liability side, current liabilities decreased by 71 billion NT, mainly due to the decrease of 65 billion in accounts payable. On financial ratio, accounts receivable turnover days decreased two days to 34 days, while days of inventory increased three days to 96 days.

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Regarding cashflow and CAPEX, During the first quarter, we generated about $385 billion in cash from operations, spent $302 billion in CAPEX, and distributed $71 billion for second quarter 2022 cash dividend. Overall, our cash balance increased $42 billion to $1.39 trillion at the end of the quarter. In U.S. dollar terms, our first quarter capital expenditures total $9.94 billion. I have finished my financial summary. Now, let's turn to our current quarter guidance. We expect our business in the second quarter to continue to be impacted by customers' further inventory adjustments. Based on the current business outlook, we expect our second quarter revenue to be between 15.2 billion and 16 billion U.S. dollars, which represents a 6.7% sequential decline at the midpoint. Based on the exchange rate assumption of one US dollar to 30.4 NT, gross margin is expected to be between 52% and 54%. Operating margin between 39.5% and 41.5%. This concludes my financial presentation. Now, let me turn to our key messages. I will start by making some comments on our first quarter 23 and second quarter 23 profitability. Compared to fourth quarter, our first quarter gross margin decreased by 590 basis points sequentially to 56.3%, primarily due to a lower capacity utilization. Compared to our first quarter guidance, our actual gross margin exceeded the high end of the range provided three months ago by 80 basis points, mainly due to more stringent cost control efforts. We have just guided our second quarter gross margin to be 53% at the midpoint, mainly due to a lower capacity utilization rate and higher electricity costs in Taiwan. After last year's electricity price increase of 15% in the second half of 2022, TSMC's electricity price in Taiwan has increased by another 17% starting April 1st this year. This is expected to take out 60 basis points from our second quarter gross margin. We expect the impact from higher electricity costs to continue throughout the second half of this year and dilute our full year gross margin by about 50 basis points. In 2023, our gross margin faces challenges from lower capacity utilization due to semiconductor cyclicality The ramp up of N3 oversees fab expansion and inflationary costs, including higher utility costs in Taiwan. To manage our profitability in 2023, we will work diligently on internal cost improvement efforts while continuing to sell our value. Excluding the impact of foreign exchange rate, which we have no control over, we continue to forecast a long-term growth margin of 53% and higher is achievable. Next, let me talk about 2023 capital budget. Every year, our CAPEX is spent in anticipation of the growth that will follow in future years. As I have stated before, given the near-term uncertainties, we continue to manage our business prudently and tighten up our capital spending where appropriate. That said, our commitment to support customers' structural growth remains unchanged, and our disciplined CAPEX and capacity planning remains based on the long-term market demand profile. Thus, we expect our 2023 capital budget to be between 32 billion and 36 billion U.S. dollars. With this level of CAPEX spending in 2023, we reiterate that TSMC remains committed to a sustainable and steadily increasing cash dividend on both an annual and quarterly basis. 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.

Thank you, Wendell. Good afternoon, everyone. First, let me start with our near-term demand and inventory. Three months ago, We said we expect fiber semiconductor inventory to start gradually reducing for Q 2022, and we forecast a sharper reduction throughout the first half of 2023. However, due to weakening macroeconomic conditions and softening in market demand, fiber semiconductor inventory continue to increase in the fourth quarter and exit 2022 at a much higher level than we expected. In addition, the recovery in end-market demand from China's reopening is also lower than our expectation. Therefore, the fiber semiconductor inventory adjustment in first half 2023 is taking longer than our prior expectation. It may extend into third quarter this year before rebalancing to a wholesale level. For the full year of 2023, we lower our forecast for the semiconductor market excluding memory to decline mid-single-digit percent. while the foundry industry is forecast to decline high single-digit percent. We now expect our full-year 2023 revenue to decline low to mid-single-digit percent in U.S. dollar terms and our business to do better than both semiconductor ex-memory and foundry industries supported by our strong technology leadership and differentiation. We conclude our first quarter with revenue of U.S. dollar $6.7 billion, which is toward the low end of our guidance range provided in U.S. dollar terms. Moving into second quarter 2023, we expect our business to continue to be impacted by customers' further inventory adjustment. We now expect our revenue in the first half of 2023 to decline by about 10% over the same period last year in U.S. dollar term as compared to mid to high single-digit percent decline previously. Having said that, we believe we are passing through the bottom of the cycle of TSMC business in the second quarter. While we forecast only a gradual recovery, For the semiconductor ex-memory industry in second half 2023, TSMC's business in the second half of this year is expected to be stronger than the first half, supported by customers' new product launches. Next, let me talk about our N3 and N3E status. Our 3-nanometer technology is the first in the semiconductor industry to high-volume production with good yield. As our customers' demand for N3 exceeds our ability to supply, we expect N3 to be fully utilized in 2023, supported by both HPC and smartphone applications. Sizable N3 revenue contribution is expected to start in third quarter 23, and N3 will contribute mid-single-digit percentage of our total waiver revenue in 2023. N3E will further extend our N3 family with enhanced performance, power, and yield, and offer complete platform support for both HPC and smartphone applications. N3E has passed the qualification and achieved performance and yield targets and volume production is scheduled for second half 23. Despite the ongoing inventory correction, We continue to observe a high level of customer engagement at both N3 and N3e, with a number of tape outs more than 2x that of N5 in the first and second year. Our 3 nanometer technology is the most advanced semiconductor technology in both PPA and transistor technology. Thus, we expect customers a strong multi-year demand for our N3 technologies and are confident that our 3nm family will be another large and long-lasting node for TSMC. Now I will talk about our N2 status. Our N2 technology development is progressing well and on track for volume production in 2025. Our N2WAR adopts narrow-sheet transistor structure to provide our customers with the best performance, cost, and technology maturity. Our narrow-sheet technology has demonstrated excellent power efficiency, and our N2WAR delivers full node performance and power benefits to address the increasing need for energy-efficient computing. At EN2, we are observing a high level of customer interest and engagement from both HPC and the smartphone applications. Our two nanometer technology will be the most advanced semiconductor technology in the industry in both density and energy efficiency when it is introduced and will further extend our technology leadership well into the future. Finally, I will talk about TSMC's global footprint and talent development status. As we have said before, we are expanding our global manufacturing footprint to increase customer trust, expand our future growth potential, and reach for more global talents. In Arizona, despite some challenges in obtaining permits, our first fab is scheduled to begin production of N4 processing technology in late 2024. In Japan, we are building a specialty technology fab, and volume production is scheduled for late 2024. In Europe, we are engaging with customers and partners to evaluate the possibility of building a special defect focusing on automotive-specific technologies based on the demand from customers and level of government support. In China, we are expanding 28 nanometers in Nanjing as planned to support our customers in China, and we continue to follow all rules and regulations fully. At the same time, we continue to invest in Taiwan and expand our capacity to support our customers' growth. In Kaohsiung, our fab construction continues, but we have adjusted our previous 28-nanometer expansion plan to now focus on capacity expansion for more advanced nodes, and we will remain flexible going forward.

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In terms of talent development, a key to TSMC's success is adherence to our core value of integrity, commitment, innovation, and customer trust, and our discipline and spirit of working together as one team. In both the US and Japan, we're recruiting from the top local colleges and universities, and our progress is well on track. We have hired more than 900 US employees today in Arizona, and more than 370 in Japan, We also plan to hire more than 6,000 employees in Taiwan in 2023. All of our hirings are to support our future growth potential. In addition to providing extensive training program for new overseas employees, many of them are brought to Taiwan for hands-on experience in our fast so that they can further their technical skills who are being immersed in TSMC's operation environment and culture. As we expand our global footprint, our priority will continue to be identify, attract, and hire talent whose core values and principles are aligned with TSMC's, so that we can establish TSMC culture in all our employees, no matter where we operate. This concludes our key message. Thank you for your attention.

Thank you, CC. 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 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 star then one on your telephone keypad now. If at any time you would like to remove yourself from the questioning queue, please press star then two. Now, let's begin the Q&A session. Operator, can we please proceed with the first caller on the line?

Yes, Jeff. The first one to ask question, Goku Harihalan from JP Morgan.

Good afternoon, and thanks for taking my question. First of all, can I ask a bit about the near-term demand dynamics? Could you talk a little bit about what you're seeing by segments? Is the inventory correction trend largely similar across HPC, smartphone, IoT, and auto, or are you seeing any different dynamics in these segments, especially auto? You saw some shortage still in the last quarter. And maybe also talk a little bit about 7 nanometer. Previously, we had an expectation 7 nanometer will start recovering in second half of this year. Do we think 7 nanometer will still be recovering in second half? That's my first question.

OK, thank you, Goku. Let me please allow me to summarize your first question. So Goku's first question is more focusing on the near term dynamics. He wants to know basically about the inventory trend across different segments and also the end demand status across the different segments, including auto. And then also, what about particularly for TSMC, the seven nanometer status in terms of the utilization recovery?

Okay, Goku, let me answer the question. We observe the PC and smartphone market continue to be soft at the present time, while automotive demand is holding steady for TSMC. And it is showing signs of softening into second half of 2023. I'm talking about automotive. On the other hand, we have recently observed incremental upside in AI-related demand, which helps the ongoing inventory digestion. What is the second question?

And the second part is on 7 nanometer. We had really previously said 7 nanometer utilization is lower. Do we expect this to pick up or recover in the second half?

It will be recovered, but slowly. As I said, most of the N6, N7 technology loading still in HPC and smartphone. However, looking into the future, some of the specialties such as RF, connectivity, Wi-Fi, all those kinds of things will start to build up their loading, their demand. And we expect in the long term, 7 nanometers loading will become more hearsay.

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Can I answer the question?

Yes, that's very clear. Thank you. My second question, I just wanted to get DSMC's opinion on competitive landscape. Your IDM competitor is getting into Foundry. Intel has been claiming that they will be attaining process parity and then process leadership by 2025. and talking about engaging with several fabulous companies. How does TSMC see this competitive threat, and how do you benchmark TSMC N3 and N2, which is coming in 2025, with Intel's offerings over the next, let's say, two to three years? And maybe, I think TSMC has not commented about Foundry market share for quite some time, so could you talk a little bit about what you see entry market share in the next couple of years for TSMC now that you're ramping up that node as well. Thank you.

Okay, thank you, Gokul. Let me summarize your second question. A lot of it is related to the competitive landscape. I think Gokul's question is specifically in terms of an IDM that has been claiming it will achieve process parity in terms of technology with TSMC and absolute process leadership. So he wants to know, and they're also talking about engaging with several large Fabless customers. So Goku would like to know, how do we see or comment on this competitive threat? How do we benchmark RN3 or RN2 process technologies versus this IDM's offerings for the next two to three years? And lastly, if we have any comment on what market share we believe we can achieve. That's a long question.

Goku, this is CC Wei again. Let me say that, as usual, we don't comment on our competitors' status. But then we emphasize, again, on our 3 nanometer and 2 nanometer. Our 3 nanometer is the first in the semiconductor industry to high-volume production. And I believe it is the most advanced semiconductor technology in both PPA and transistor technology. And for two nanometer technology, that was again to be the most advanced semiconductor technology in the industry and one we introduced into mass production. And this one, we are fully confident that we will further extend our leadership position well into the future. As for the market share, we are very confident that we continue to have a very high market share. And I cannot tell you that the real number, but very high percentage.

Okay. Maybe if I ask, thanks, Sisi, for that. If I ask, is N3 your expectation that N3 market share will be higher than N5 at the same time, based on what you see today?

Well, very hard to answer your question, but let me say that it was very similar in a very high percentage.

Got it. Thank you.

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

The next one to ask questions, Bruce Liu from Goldman Sachs.

Hi. Thank you for taking my question. I want to ask about a I want to ask about the AI for the machine learning and AI, which management has been saying that that is a key growth driver. Can we have more quantitative implication to TSMC? What is the dollar content per server or how big is the addressable market for TSMC in 2025? Is the reason new AI or chat GBT, you know, the business already embedded in your long-term growth target, which is 15 to 20%, or can we see some incremental upside?

Okay, Bruce, thank you. So Bruce's first question is around, I guess, AI and machine learning. He wants to know if we have any quantitative numbers to give in terms of, for example, dollar content, sorry, semiconductor content per server, dollar value, or in terms of the addressable TAM. How do we see this growth of this market? And have we already embedded this into our forecast? Is that correct, Bruce?

That's right. Thank you.

Okay. Hi, Bruce. Let me answer this question. We certainly, we have observed an incremental increase in AI-related demand. It also helped the ongoing inventory digestion. The trend is very positive for TSMC. But today, if you ask me to quantitatively to say that how much of the amount increase or what is the data content in the server, it's too early to say. It still continues to be developed. And chat GPT right now, reinforce the already strong conviction that we have in HPC and AI as a structurally megatrend for TSMC's business growth in the future. Whether this one has been included in our previous announcement, say that we have a 15% to 20% CAGR, the answer is probably partly yes, because for several we have accelerated into our consideration. But this CHAT-GBT, this large language model, is a new application. And we haven't really have a kind of number that put into our CAGR. But it's definitely, as I said, it really reinforced our already strong conviction that HPC and AI will give us much higher opportunities in the future.

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Okay, Bruce, does that answer your first question?

Thank you.

Yep. Sorry, go ahead.

Yes, thank you. Yes, I want to move on to a different topic, which is cash dividends. I mean, TSNC distributed about like, their dividend policy was 70% of the free cash flow. And we do see the free cash flow is getting stronger, especially the KPS growth rate is slower, especially for next year. Can we expect TSMC to maintain the dividend policy, which is 70% of the free cash flow next year? Or we would like to improve our balance sheet given the current rate hike environment?

Okay, thank you, Bruce. So Bruce's second question is around our cash dividend policy. He notes that in the past we have said our cash dividend will be based on 70% of free cash flow distribution. But his question is, you know, as our capex is slowing, our free cash flow is going stronger. do we still adhere to 70% of free cash flow? Or because of the environment, are we more focused on, I think Bruce, in terms of maintaining a, improving our balance sheet strength?

Okay, Bruce, this is Rando. Let me make a few comments on the dividends. TSMC is committed to a sustainable and steadily increasing dividends. During the periods of high capital intensity or high capital investment, more of the focus is on sustainable. But when we start to capture and harvest the capital investments spent, the commitment is, or the focus is more towards steadily increasing. The 70% ratio is a guideline. Let me give you an example. If in the particular year the free cash flow is much lower because of higher CAPEX or lower profits, then to maintain a sustainable dividend, the ratio of free cash flow to be dispersed could be higher. And on the other hand, in a year where free cash flow is particularly high, the ratio can be 70%, but it can be lower because we need to look forward into the year behind that specific year and to make sure it is sustainable. Okay, does that answer your question?

Yes. Yes. But, you know, but if we do see a comfortable range for the free transfer, we can still expect a reasonable high payout ratio, right?

Yeah. Yeah. As I said, the principal is 70%, but it has to be sustainable and steadily increasing.

I see. I understand. Thank you.

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

Next one to ask question, Randy Abrams from Credit Suisse.

Randy Abrams Okay, yes, thank you. I wanted to ask a question just on the CapEx in two parts. First, as you look at the three nanometer where you mentioned supply is still short of demand and have a lot of applications coming in, do you have plans for potential reuse of five nanometer in the next one to two years as you bring up more of the three nanometer? And then the second part of the question, I wanted to ask more on that Kaohsiung FAB shift. If you could go through why the plan to pull back on 28, and then what the intention for where you would shift that investment, because I know you did cancel the 7 nanometer for that line. So, if you could discuss the change you're making to Kaohsiung, and does it affect the timing to ramp that FAB?

Okay, thank you, Randy. So Randy's first question is kind of related to our CAPEX and capacity plan. His question partly is in terms of, you know, CC noted that the N3 demand exceeds our ability to supply. So he is asking, will we consider to reuse or convert N5 tools to N3 in the next few years? And also he wants to know related to our plans in Kaohsiung, what is the thinking or the reasoning for pulling back on the 20 nanometer expansion in Kaohsiung?

Okay, Randy. You got a very good question about whether we convert some of the N5's capacity to N3 because N3 today we are short of support to our customer. Instead of saying that convert N5 to N3, let me say that we develop a strategy and a methodology to make some of the N3's tool can be supported by N5. And we take this kind of flexibility into our consideration so that we can fulfill our commitment to support our customers in Gen 3 as much as possible. Although still not enough, but we are doing that. So that answers the first part of your question. You asked about Kaohsiung's plan. Let me say that we look at the market situation today. And we are going to build, initially, the 28 nanometers demand is so high, so that we have to put Kaohsiung into our consideration. However, you know, the market situation is so dynamic, and we look at our plan. One of the plan is in Japan, we build a new fire for 28 nanometers specialty. By the way, TSMC expand the mature nodes capacity all for specialties. We don't increase capacity just for pure logic application. That one, no, we don't do. So in order to avoid some of the overcapacity. So we build one in Japan. We also expanding our capacity, 28 nanometer capacity in Nanjing, that's the second one. And then we are considering of the Europe, that might be the third one for automotive application. Put all three together, we don't think today that Kaohsiung, if we build 28 nanometer, probably it won't be a... you know, kind of financially feasible. So we diverted, now adjusted to become a more advanced node, which we are still in shortage. And Kaohsiung is so close to Tainan so that we can have more flexibility in between.

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Randy, did that answer your question?

Yeah, no, that's helpful. It sounds like it'll be very much advanced capacity than like the 5.3 and below. Maybe I have one follow-up on the first question. It's on the CapEx framework. With the expectation if your second half kind of rebound with the share gains comes through, considering the new nodes more capital intensive, should we think of this CapEx having an up direction as we look ahead to next year?

Okay, so Randy, I'll allow this to be a follow-up, but Randy's question is basically, well, considering the second half business will be stronger, I think, Randy, basically you're asking we have provided the guidance range of between $32 to $36 billion. You're asking could that be upside or revised higher. Is that correct?

Yeah, more the framework into next year since this is more kind of prudent management, a bit recessionary.

Right. Randy, let me answer that. As we stated before, every year our CAPEX is spent for the opportunities in the future years. So although there are short-term cyclicality in the industry, but we believe if the structure of long-term demand is there and the future opportunities is there, we will continue to invest That would be the framework that we can provide to you.

Okay, Randy? Do you have a quick second question?

Yeah, I'll do the quick second. So for two nanometer, if you could clarify the ramp, do you expect this steep ramp to be in 2025 or is it more 2026? And do you also view that ramp being much more with the SOIC, the back-end integration chiplet?

Okay, so Randy's second question is on 2 nanometer. We have said volume production in 2025. Will the large volume be in 2025 or 26 as part of this question? And does this mean it will go hand in hand, I guess, with SOIC and advanced packaging?

Well, Randy, let me answer the question. Two nanometer technology definitely will start to ramp in 2025. And you ask about the volume. The volume in 2026 certainly is much higher than 2025 because 2025 is the first year. But saying that, I mean that we are having HPC customer and the smartphone customer now engage with the N2 and will be ramping up in 2025. Now, whether it's related to chip rates or not, it depends on customers' product and their plan. And today, I don't have – I cannot share with you all those kind of minor details because they're related to customers' product plan. Okay, great. Thank you, Sisi.

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

The next one to ask question, Charlie Chan from Morgan Stanley. Go ahead, please.

Thanks for taking my question. Good afternoon, Cece, Wendell, and Jeff. So first of all, congrats for the first quarter gross margin, and great to hear that N3E ERA continued to improve. So let me stay with the CAPEX question for a little bit as my first question. So first of all, you know, the major equipment supplier, ASML, yesterday suggested that EUV orders get pushed out a little bit. And we all know that your company is a major user of the EOV. So can Major answer the question, you know, first of all, whether the CAPEX this year will be lower end of your guidance range? And also for next year, whether your CAPEX intensity would decline year on year given that EOV push out? Thank you.

Okay, so Charlie's first question is related to CapEx. He points out that newspaper talks about EUV orders being pushed out. So his question is really, for our CapEx in 2023, do we think it will be towards the lower end of the range? And then also, any indication for 2024 in terms of both CapEx and capital intensity? Is that correct, Charlie? Yes. Thank you. Okay. Maybe Wendell can answer.

Hi, Charlie. This is Wendell. First of all, we don't comment on specific suppliers or customers or competitors. Regarding this year's CAPEX, when we gave all the CAPEX range $32 to $36 billion, we have already started or tightened up our 2023 capital budget. At this moment, we believe this range is appropriate and it's prudent under today's economic environment. That range is still valid. Now, for next year, it's too early to talk about next year, but as I just stated, the CAPEX spend this year will be for future years, and CAPEX spend next year will be for even future years. So if we see the growth opportunities is there, then we will continue to invest. That's the main policy, the principle that we have.

Yes.

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Yeah, thanks for the clarification. So I guess the question is if, right? Whether those growth drivers are still there, meaning big customers outsourcing for 2024, and whether your customers are aggressively adopting your N3 and N2. Yeah, I guess that's why we are concerned about whether 2024, you're reducing some CAPEX. But anyway, let me shift to the next one. I think lots of investors are also quite interested about the U.S. CHIPS Act. So I remember a chairman shared some concern about those requirements. I'm not sure which one is specifically a concern. For example, I need to disclose customer information, profit sharing, some restriction for the future China FAB investments. So my question is that how TSNC is going to reconcile your own interests versus the U.S. government's requirements? And if it is hard to reconcile, whether TSNC would consider not to take U.S. government's grants? Thank you.

Okay, so Charlie's second question is regarding the CHIPS Act. He notes we have recently said that some of the terms may be not acceptable. So he wants to understand how will TSMC reconcile its own interests versus some of the guidelines or guardrails around the CHIPS Act, and is there a possibility that we will not accept or participate in the CHIPS Act?

Okay. Charlie, let me make a few comments on this one. We are currently in the application process, and therefore we're not able to comment on specific details. However, we are in close and constant communication with the U.S. government so that we fully understand all the details and provide our feedback and comments to them. At the end, all the decisions that we make will be based on the best interest of TSMC.

Okay. Okay, same for that. Yeah, I will be back to the queue.

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

Yes, the next one to ask question, Brett Simpson from Aratea Research.

Yeah, thanks very much. Wendell, I wanted to just talk a bit about Arizona and now that you're scheduled to move into production next year and you've been hiring a lot of people. How do we think about the cost premium for TSMC operating in the US? And then when it comes to the pricing for the wafers, would this be something that you charge a premium for for accessing US capacity? Or would you be sort of offering similar wafer pricing to what you offer in Taiwan. Thank you very much.

Okay, thank you, Brett. So Brett's first question is regarding our Arizona fab. He notes that the volume manufacturing schedule is on track, and we've hired lots of people. So his first question is to Wendell around sort of what is the cost premium that we face in Arizona, and how will we manage this, including our wafer pricing? Will we charge a different price for a different fab, or how do we intend to do it?

Okay, Brett. The overseas FABs is indeed, the cost is higher, at least in the first several years. We stated last time that some of the components, like the construction costs, may be as high as five times. Now, the way to mitigate that, first of all, it represents our global expansion, represent a value to the customers, then we will be selling that value as well. And secondly, because of our large base and volume, we'll be able to leverage that big base and volume to lower down the cost. And at the same time, of course, we will need to secure the necessary level of government support. So putting all these efforts together, our job is to minimize the cost gap and make a proper return. For the whole company on a combined basis, the 53% and higher growth margin remains our long-term financial goal and is achievable.

Great. Thanks for that, Wendell. And maybe just a follow-up. I wanted to ask about the... the subsidies that TSMC are getting today, particularly in areas like Japan. How much is this going to be in 2023? And are you expecting a meaningful increase in support in the second half of the year? I'm just trying to understand what's embedded in guidance and how to think about accounting for the support that you're expecting. over the medium term. Thank you.

Okay, so Brad has a quick follow-up in regards to Japan. His question in terms of the government support or incentives we may receive, how will we account for it? How much will it be in 2023? And how significant is most of it in second half?

Okay, Brett, let me reply this manner. In Japan, our total CAPEX is about 8 billion, and we expect about 50% to receive from the government. And we will start production at the end of next year. So the incentives from the government will be based on the progress that we are building our FAPs. So that gives you some idea of how much we can receive this year and next year. How do we account for it? Basically, that will be accounted for as an offset of depreciations.

Okay.

Great. Thanks very much. Very helpful.

Okay. Thank you, Brett.

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Operator, can we move on to the next participant then?

Next we have Sunny Lin from UBS.

Thank you very much. Good afternoon. So my first question is on the pricing. So I think just now management again reiterated that your supply chain value is increasing and you look to sell that value. And so with that, as you are about to start ramping overseas capacity more significantly into the next couple of years, how should we think about your ASP trend?

Okay, so Sunny's first question is also related to pricing. She knows that semiconductor industry value in the supply chain, TSMC said, is increasing. Her question is that, Sunny, I believe as we expand our footprint and capacity beyond Taiwan and go overseas, what will be the ASP trend in the next few years? Is that correct?

That's right. Thank you very much.

Okay. Sunny, I'll answer this question. First, actually, our pricing strategy actually is strategic and long-term. We work with our customer. Yes, you are right. I mean that the inflation or all others, the costs are increasing, especially in the overseas fab. However, we already put all those kind of things into consideration, and we have a lot of action items to work with internally and also with our partners, our supply partners, and to lower down all the costs. And we also working on the supply chains management. So we hope that we will control that, even with today's very tough situation.

Got it. Sorry, if I could have a very quick follow-up. And so how should we think about the mechanism for you to refine that supply chain value? Will it be an annual pricing negotiation? And I also wonder what's the customer feedbacks under the current situations?

All right, so Sunny wants to know how will we do the pricing? Is it on an annual basis? What's the feedback from customers?

Sunny, this is very specific, but let me emphasize again. Our pricing is strategic and we reflect our value. Now our value includes the value of geographic flexibility. Did I give you some hint?

Got it. Thank you. That's very helpful. My second question is, is on your CAPEX expansion. And so I wonder if we look at the equipment lead time, are you seeing ongoing improvements? What I'm trying to understand, if you need to tighten up the CAPEX, but let's say if later on demand start to recover or get better into second half of the year, how much flexibility you have to pulling the equipment?

Okay, so Sunny's second question is around capacity expansion and equipment lead time. She notes that we have said we're tightening up our cap tax this year and being prudent given the economic environment. But her question is if the demand recovers in the second half, how quickly can we adjust our equipment and capacity and would equipment lead time then become a bottleneck? Is that correct, Sunny?

That's right. Thank you, Jeff.

Okay.

Sunny, this is a very, very good question. We are tightening up on the CAPEX, but at the same time, we also remain flexible that once demand pick up quickly, We should have prepared enough capacity for our customer to grow. And so both factors are very important, and we are working with all the suppliers, preparing for that. In fact, we are planning our long-term capacity expansion. And then with some kind of adjustment in between. So we have a flexibility to increase quickly. We also have a flexibility to tighten the CAPEX. But the main trend stays the same because we believe AI, 5G, the mega trend will continue to grow. And TSMC is a business will continue to grow.

Got it. Thank you very much.

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

Next one, we have Laura Chen from Citi.

Yes, hi, good morning. Thank you very much for taking my question. My first question is about the data center and server space. We know that in the high computing PC category that also includes some of the PC CPU, or consumer-related applications. So that may show some weakness as we see the quote-unquote decline in Q1. But I'm just wondering that since we see quite promising AI server growth, what specifically if we look at the AI-related contribution at current right now or what the growth outlook you may looking for?

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Okay, so Laura's question, she notes that our HPC platform includes more consumer-facing things such as PCs, CPUs, but it also includes data center and servers. So her question is really, I guess, what is TSMC's view on the growth outlook for AI data centers and how significant this could be for HPC business?

Yes, so if we're excluding those like gaming GPU or consumer PC CPU in this category, so what's the data server and server business look like now? Thank you.

Laura, let me answer this question. We did see some positive sign of the people getting much more attention to AI application, especially the chat GPT area. However, as I said, quantitatively, we haven't have a enough data to sum it up to see what is the contribution and what kind of percentage to TSMC's business. But we remain confident that this trend is definitely positive for TSMC.

And we don't break down our HPC platform into those type of sub-segments. Thank you.

Okay, understood. Thank you very much. And my second question is also related to that high computing PC angle. I'm just wondering that your expansion and plan in advanced packaging, we know that many of those like AI or server high computing PC CPU, they require advanced packaging like a COAS or 2.5D, 3D packaging. So I'm just wondering that any More capacity you are required right now and what's the current capacity or revenue you can share with us and also the growth trend. Thank you.

Okay, so Laura's second question is on the advanced packaging. She notes that applications like HPC, PC CPUs, et cetera, require COAS or 3D stacking, 3D IC, advanced packaging technologies. So her question is, what is the capacity expansion outlook or plan for our advanced packaging? And also, what is the revenue growth outlook, I guess, over the next few years? Is that correct, Laura?

Yes, thank you very much. Okay, Laura, let me start. For the advanced packaging, the back-end services, we think that its growth in the next five years will be slightly higher than the corporate average. However, for this year, the revenue will be lower than that of last year because of customer demand. Last year, the revenue accounted for about 7% of our total revenue. This year is somewhere between 6% to 7%. So that should give you an idea of the overall.

So in terms of the capacity, is there any change in this year versus last year?

So also part of the question is specific to the capacity for packaging. What is the year-on-year growth in the advanced packaging capacity?

Well, Laura, no, no, no. I mean, that's a... say that actually just recently in these two days I received a customer's phone call requesting a big increase on the back end's capacity, especially in the cold wars. We are still evaluating that.

Okay, got it. Very clear, very helpful. Thank you very much.

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

Yes, next one to ask questions, Amadi Hosseini from SIG. Go ahead, please.

Yes, thank you for taking my question. Your guide for June and also 2023 revenues suggest revenues in the second half of the year would be up by 25% versus the first half. And what I want to better understand is, How will new product ramps drive this growth? Is there anything quantitative or qualitative that you can offer us to understand the mechanics or the drivers behind this 25% growth in revenue from first half into the second half? And I have a follow-up.

Okay, thank you, Madi. So Madi's first question is in looking at our guidance, his calculation implies it's around mid-20s, half-on-half growth in the second half. So he wants to know how much is new projects or new business driving that percentage of the growth?

Well, I can answer that question. To give you a hint, I mean that we talk about a customer's new product launch and which uses 3 nanometer. So you can understand that we start to ramp up 3 nanometer quickly because it's fully utilized and still not enough to meet customer's demand. In addition to that, actually, all the platforms, their performance, their demand, were increased in the second half.

So as these new products drive weight for shipment increase, we should assume that utilization rates would bottom in June and improve into the second half, right?

So Madi wants to know, can you assume utilization bottoms in 2Q and improves in second half?

Yeah, Madi, that's a reasonable view.

CC has already said second half will be stronger than first half, yeah. Do you have a second question?

Yes, I have one for Wendell. This question comes up every earning conference called capital intensity. Should we assume that as you tighten your CapEx project for this year, and especially in the context of declining revenues for the whole year, are we at the tail end of elevated capital intensity? Should we assume that over the past couple of years there has been significant investment and starting next year you're going to be able to scale your revenues? Is that the right way of thinking about all these investments that you have done?

Okay, so Mehdi's second question is around capital intensity. He wants to know, given the guidance we have provided for 2023, are we at the tail end of the higher capital intensity period or elevated capital intensity period? And then will we start to, I guess, harvest or see that capital intensity come down next year or into the next few years?

Mehdi, I'm not going to share with you the peak, where the peak is, but I can tell you from my current five-year outlook, we are looking at about mid-30s percentage of capital intensity.

Okay, great. Thank you. Okay, thank you, Mehdi. Operator, let's move on to the next participant.

Yes, the next one to ask questions, Chris Sankar from TD Cohen.

Hi, thanks for taking my question. My first one is on your comment that the M3 capacity will be fully utilized this year. Is that capacity that will be online in the second half same or higher or lower than what you planned a year ago? And also at this point, do you see the M3 wafer demand profile to be similar or better than M5 at the same point in the cycle? And then add a follow-up.

Okay, so Chris's first question is on N3 capacity. He knows we said it will be fully utilized this year. He wants to know the capacity that we build or plan for N3 this year and in the second half. How does that capacity amount compared to what we expected a year ago?

Well, I can answer the question. Actually, the demand is higher than we thought a year ago. And that's why we need to work very hard to beat customer demand. Did that answer your question, Chris?

Yeah, it does. Thank you for that, C.C. And then just a quick follow-up. You know, you spoke about AI being a positive and all the, you know, innovations happening in generative AI today. Just from a TSMC standpoint, is it fair to assume that what you're going through today is more on the training stage and therefore it's more semiconductor and vapor intensive but when you go into more inference that uh intensity has to decrease is that a fair assumption or do you think that this level of intensity will be growing from a tsmc standpoint for ai

Okay, so Krish's second question is regards to generative AI in these type of applications. His observation is that the majority is training today, which seems to be beneficial, but as training moves to inference, would it be less semi-intensive or semi-content intensive, and then therefore would that be, i.e., lower benefit to TSMC?

Chris, I mean, that's, you know, today your observation is right because right now most of the AI concentrate or focus on training. And in the future, you will be inference. But let me say that, you know, no matter what, no matter what kind of application, they need to use a very high-performance semiconductor component. And that actually is the TSMC's advantage. So we expect that semiconductor content, starting from a data center, to a device, and H device, or those kind of things, put all together. They need a very... high-speed computing with a very power-efficient one. And so we expect it will add to TSMC's business a lot. Quantitatively, as I said, we didn't know yet. We hope that in the next few quarters we can give a more clear picture.

Thanks, CC. Thanks, Jeff.

Okay, thank you. Operator, in the interest of time, we'll take the last two questions from the last two participants, please. So can we proceed to the next participant?

Yes, of course. Next up is Brad Ling from Bank of America. Go ahead, please.

Thank you for taking my question. I have two questions, one on the internal organization change and the other on a recently announced strategic alliance. So while the global expansion is the key focus of TSMC, I noticed that TSMC set up a new unit called Overseas Operations Office, OOO. What are the targets and impacts that the TSMC management would look for from this new unit? Thank you, that's my first question.

Okay, so Brad's first question is about our internal organization change. We set up an overseas office we call OOO. So he wants to know what is the purpose of this organization or office? What is its targets and purpose?

Well, the purpose is very simple, because we need to have all the organizations. Now the FAB, OVC FAB's number and the amount will be more and more, so we need to have a coherence, and the culture, everything aligns to the headquarter, to TSMC's core value. So we established this Overseas Operation Office to make sure that headquarters support to each overseas FAB will be sufficient and enough and so that the performance will be aligned or match with the TSMC's FAB in Taiwan. But more importantly, because we have this organization, so we can help them to succeed and in the future can be more profitable.

Thank you, C.C. Brad, do you want to? Yeah, your second question? Sure.

Thank you, Jeff. So my second question will be on the recently announced Strategic Alliance Initiative. As the no migration is the foundation competition focus, and we know that TSMC leadership in the leading edge. We recently see TSMC partner up with NVIDIA, Synapsys, and SML on two nanometer production and beyond. And what is the target and how is the progress so far? And TSMC is currently the only foundry within that group. Should we expect an even larger gap to peers with this? Or should we allow more companies or competitors to join this group? Thank you.

Brad, sorry, let me clarify, make sure we understand your second question. So your second question is talking about, you call it an alliance, but I think you refer to ASML and NVIDIA. So are you referring to this announcement recently of what is called the CU Lethal?

Exactly. Yes. Computational detail.

Yes. Okay. So, okay. Got it. Thank you. So, Brad really wants to know what is management's view towards this recently announced CU lethal? What is the implication and what does this mean for TSMC's competitiveness going forward?

Okay. That's a good question. It is initiated and invented by TSMC customer, Nvidia, and actually we are working with them. And this particularly, the software and the hardware together will help speed up computational lithography by moving expensive operation to GPU, which will help us deploy lithography solution, like inverse lithography technology, deeper learning more broadly. or et cetera. And because of this one, we get involved with our customer and our supplier, and we expect that this one give us some advantage over our cost improvement and also competition.

Got it. That's very clear. Thank you very much for the insight. Thank you, CC. Thank you, Jeff.

Sure. Thank you, Brad. Operator, then can we move on to the last participant, please?

The last questions are from Charles Shi from Niyan Company. Go ahead, please.

Thank you for squeezing me in. I have a question about your CapEx. Maybe I want to start with one item you disclosed in your filings on your balance sheet. You have an item called equipment under installation and construction in progress. That number has hit a record high, I think over $40 billion as of the end of fourth quarter 22, which kind of means there are $40 billion investment. You put money in, but you are not harvesting that investment yet. There's no revenue dollars being generated yet. But now I think that you said you're tightening the capex score 2023, but you're reiterating that 32 to 36 billion capex. That seems to be adding on top of that 40 billion, a lot more investment is still expected in this year. So my question really is about this. Are you expecting significantly higher incremental revenue opportunity in 2024 and beyond to justify that $40 billion plus maybe another $32 billion investment? Or is the cycle time between you put the money in, put the investment in, to the time you harvest the investment to generate revenue is getting a little bit longer than usual? So hopefully you can clarify this.

Okay, Charles, that is a very long question. Please let me try to summarize it a little bit into two parts. I think Charles' question, he does rightly note that on our balance sheet, equipment under installation reached roughly about $40 billion at the end of 2022. He notes this is a very high level. His concern, maybe Wendell can address, is we also guided for 32 to 36 billion capex this year. So is this number going to only increase? And what is driving this? Is this preparing for significant revenue opportunities in 2024 and beyond? So this is his first question.

Okay, Charles, the $40 billion asset under construction at the end of last year, primarily come from two nodes, N3 nodes and the N5 nodes. N3 nodes, that is because we're ramping up the N3 nodes. And N5, we continue to increase our capacity. Therefore, these two add together, you see a bigger asset under construction at the end of last year. From what I can see, going forward, this number will gradually come down in the next few years.

Okay, Charles?

Maybe the other part of this question is, because you are proceeding with that $32 to $36 billion, it's hard for me to reconcile how this number comes down, at least in in the next one year or so of the next 12 month horizon. How do I reconcile that? Or are you expecting like next year that's going to be a significant revenue, incremental revenue coming to TSMC?

Charles, as we said, it's too early to talk about next year. But we also said that if we continue to see the future growth opportunities is there, we will continue to invest.

Thank you.

Thank you.

May I ask the second question?

Sure.

Yeah, thank you for that. So the second question is about CHIPS Act. I heard you provided some help to the question from another analyst about that. Can you kind of quantify the potential benefits from the US CHIPS Act manufacturing incentives which to my understanding, including both grants and investment tax credit. I know this is kind of relevant to our modeling going forward. And maybe if I may, can I ask, one of your U.S. peers seems to be favoring investment tax credit over grants. They seem to only want the investment tax credit, not the grants. What is the TSMC thinking between these two different funding opportunities? Thank you.

Okay. Thank you, Charles. So Charles' second question is around the CHIPS Act. He is asking if we can quantify the potential benefits, both in terms of grants and also in terms of tax credits, and also do we favor one over the other or preference for one over the other?

Charles, as I said, we're in the process of application, so we're not in a position to disclose any details. I will refrain from sharing more information at this moment.

Okay, thank you, Wendell. All right, so 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 30 minutes from now, and the transcript will become available 24 hours from now. Both of these will be available through TSMC's website at www.tsmc.com. So thank you everyone for joining us today. We hope you all continue to stay well and we look forward to joining us again next quarter. Goodbye and have a great day.