Taiwan Semiconductor Manufacturing Company Ltd.

Good afternoon, everyone, and welcome to TSMC's second 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 listen-only mode. The format for today's event will be as follows. First, TSMC's Vice President and CFO, Mr. Wendell Huang, will summarize our operations in the second quarter of 2023, followed by our guidance for the third quarter of 2023. Afterwards, Mr. Huang, TSMC's CEO, Dr. C.C. Wei, and TSMC's Chairman, Dr. Mark Liu, will jointly provide the company's key messages. Then we will open the line for a question and answer session. 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 second quarter of 2023. After that, I will provide the guidance for the third quarter. Second quarter revenue decreased 5.5% sequentially in NT, or 6.2% in U.S. dollars, as our second quarter business was impacted by the overall global economic conditions, which dampened the end market demand and led to customers' ongoing inventory adjustment. Gross margin decreased 2.2 percentage points sequentially to 54.1%, mainly reflecting lower capacity utilization and higher electricity costs, partially offset by more stringent cost control and a more favorable foreign exchange rate. Despite the industry's cyclical downturn, we continue to invest in R&D to support our N3 and N2 development, Thus, operating margin was 42%, down 3.5 percentage points sequentially. Overall, our first quarter EPS was 7.01 NT, and ROE was 23.2%. Now let's move on to revenue by technology. Five nanometer process technology contributed 30% of our welfare revenue. in the second quarter, while 7 nanometer accounted for 23%. Advanced technologies, defined as 7 nanometer and below, accounted for 53% of wafer revenue. Moving on to revenue contribution by platform, HPC decreased 5% quarter over quarter to account for 44% of our second quarter revenue. Smartphone decreased 9% to account for 33%. IoT decreased 11% to account for 8%. Automotive increased 3% to account for 8%. And DCE increased 25% to account for 3%. Moving on to the balance sheet. we ended the second quarter with cash and marketable securities of 1.5 trillion NT, or 48 billion U.S. dollars. On the liability side, current liabilities decreased by 62 billion NT, mainly due to the net decrease of 87 billion in income tax payable, as we pay 120 billion for 2022 income tax, offset by 33 billion accrued tax payables for the second quarter. Long-term interest-bearing debt increased by 53 billion NT, mainly as we raised 41 billion in corporate bonds. On financial ratios, accounts receivable turnover days decreased two days to 32 days, while days of inventory increased three days to 99 days, primarily due to N3 ramp during the quarter. Regarding cashflow and KPACs, During the second quarter, we generated about $167 billion NT in cash from operations, spent $251 billion in CAPEX, distributed $71 billion for third quarter 2022 cash dividend, and raised $41 billion from corporate bond issuances. Overall, our cash balance decreased by 109 billion to 1.3 trillion NT at the end of the quarter. Free cash flow was negative 83 billion NT during the quarter as operating cash flow was more than offset by capital expenditures, partly due to the income tax payment 120 billion. In US dollar terms, our second quarter capital expenditures total 8.17 billion. I have finished my financial summary. Now let's turn to our current quarter guidance. Based on the current business outlook, we expect our third quarter revenue to be between 16.7 billion and 17.5 billion US dollars, which represents a 9.1% sequential increase at the midpoint. Based on the exchange rate assumption of one US dollar to 30.8 NT, Gross margin is expected to be between 51.5% and 53.5%. Operating margin to be between 38% and 40%. This concludes my financial presentation. Now, let me turn to our key messages. I will start by making some comments on our second quarter 23 and third quarter 23 profitability. Compared to first quarter, our second quarter gross margin decreased by 220 basis points sequentially to 54.1%, primarily due to a lower capacity utilization. Compared to our second quarter guidance, our actual gross margin slightly exceeded the high end of the range provided three months ago, mainly due to more stringent cost control efforts and a slightly more favorable foreign exchange rate. We have just guided our third quarter gross margin to decline by 1.6 percentage point to 52.5% at the midpoint, primarily as a higher level of capacity utilization rate is offset by two to three percentage points margin dilution from the initial ramp up of our three nanometer technology. Looking ahead to the fourth quarter, we expect the continuous steep ramp up of our three nanometer to dilute our fourth quarter gross margin by about three to four percentage points. In 2023, our gross margin faces challenges from lower capacity utilization due to semiconductor cyclicality, The ramp-up of M3 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. While we face near-term challenges, we continue to forecast a long-term growth margin of 53% and higher is achievable. Next, let me talk about our 2023 capital budget and depreciation. Every year, our CAPEX is spent in anticipation of the growth that will follow in future years. Given the near-term uncertainties, we continue to manage our business prudently and tighten up our capital spending where appropriate. We now expect our 2023 capital budget to be towards the lower end of our range of between 32 and 36 billion U.S. dollars. Our depreciation expense is now expected to increase by mid-20s percent year-over-year in 2023, mainly as we ramp our 3-nanometer technologies. Despite near-term inventory cycle, 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. We will continue to work closely with our customers to plan our long-term capacity and invest in leading-edge specialty and advanced packaging technologies to support their growth while delivering profitable growth to our shareholders. Now, let me make a few comments on our cash dividend distribution policy. The objectives of TSNC's capital management are to fund the company's growth organically, generate good profitability, preserve financial flexibility, and distribute a sustainable and steadily increasing cash dividend to shareholders. As a result of our rigorous capital management, in May, PSMC Board of Directors approved the distribution of a 3 NT per share cash dividend for the first quarter of 2023, up from 2.75 NT previously. This will become the new minimum quarterly dividend level going forward. First quarter 2023 cash dividend will be distributed in October 2023. For 2023, TSMC shareholders will receive a total of 11.25 NT per share dividend and at least 12 NT per share cash dividend for 2024. Going forward, as our capital intensity begins to decline in the next several years, the focus of our cash dividend policy is expected to shift from a sustainable to a steadily increasing cash dividend per share in the next few years. Now let me turn the microphone over to C.C.

Thank you, Wendell. Good afternoon, everyone. First, let me start with our near-term demand and inventory. We concluded our second quarter with revenue of $15.7 billion in line with our guidance in US dollar terms. Our business in the second quarter was impacted by the overall global economic conditions, which dampened the end market demand and customers' ongoing inventory adjustment. Moving into third quarter 2023, while we have recently observed an increase in AI-related demand, it is not enough to offset the overall cyclicality of our business. We expect our business in the third quarter to be supported by the strong ramp of our three nanometer technologies, partially offset by customers' continued inventory adjustments. In the last quarterly conference, we said we expect fabulous semiconductor inventory to rebalance to a healthier level exiting the third quarter. This statement continues to hold true. However, due to persistent weaker overall macroeconomic conditions, slower than expected demand recovery in China, and overall soft-end market demand conditions, customers are more cautious and intend to further control their inventory into 4Q23. Thus, while we maintain our forecast for the 2023 semiconductor market excluding memory to decline mid-single-digit year-over-year, we now expect the foundry industry to decline mid-teens and our four-year 2023 revenue to decline around 10% in U.S. dollar term. With such inventory control, we also forecast a fabulous semiconductor inventory to exit 4Q23 at a healthier and lower level as compared to our expectation three months ago. Next, let me talk about HPC and TSMC's long-term growth outlook. As we have said before, the massive structural increase in demand for computation underpinned by the industry megatrend of 5G and SPC continues to drive great need for performance and energy-efficient computing, which require use of leading-edge technologies. These megatrends are expected to fuel TSMC's long-term growth. Even with a more challenging 2023, Our revenue remains well on track to grow between 15 and 20 kegels over the next several years in U.S. dollar terms, which is a target we communicated back in January 2022 investor conference. The recent increase in AI-related demand is directionally positive for TSMC. Generative AI requires higher computing power and interconnected bandwidth, which drives increasing semiconductor content. Whether using CPUs, GPUs, or AI-accelerated and related ASICs for AI and machine learning, the commonality is that it requires use of leading-edge technology and a strong factory design ecosystem. These are all TSMC's strengths. Today, server AI processor demand, which we define as CPUs, GPUs, and AI accelerators that are performing training and inference functions, accounts for approximately 6% of TSMC's total revenue. We forecast this to grow at close to 50% CAGR in the next five years and increase to 0.10% of our revenue. The inaccessible need for energy-efficient computation is starting from data centers, and we expect it will proliferate to edge and end devices of time, which will drive further long-term opportunities. We have already embedded certain assumptions for AI demand into our long-term CAPEX and growth forecasts. Our HPC platform is expected to be the main engine and the largest incremental contributor to TSMC's long-term growth in the next several years. While the quantification of the total addressable opportunity is still ongoing, Generative AI and large language model only reinforce the already strong conviction we have in the structurally megatrend to drive TSMC's long-term growth, and we will closely monitor the development for further potential upside. Now let me talk a lot about our N3 and N3E status. Our 3 nanometer technology is the most advanced semiconductor technology in both PPA and transistor technology. N3 is already in volume production with good yield. We are seeing robust demand for N3 and expect a strong ramp of N3 in the second half of this year, supported by both HPC and smartphone applications. N3 is expected to continue To contribute a mere single-digit percentage of our total wafer revenue in 2023, N3EE further extend our N3 family with enhanced performance, power, and yield, and provide complete platform support for both HPC and smartphone applications. N3E has passed the qualification and achieved performance and yield targets, and will start volume production in the fourth quarter of this year. With our continuous enhancement of 3 nanometer process technologies, we expect strong multi-year demand from our customers and are confident that our 3 nanometer family will be another large and long-lasting node for TSMC. Finally, I'll 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. As part of N2 technology platform, we also develop N2 with backside power rail solution, which is best suited for HPC applications. Backside power rail will provide 10% to 12% additional speed gain and 10% to 15% larger density boost on top of the baseline technology. We are targeting backside power rail to be available in the second half of 2025 to customers with production in 2026. We are observing a high level of customer interest and engagement at N2 from both HPC and 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 to further extend our technology leadership way into the future. This concludes my prepared remarks, and now let me turn the microphone over to Mark.