Taiwan Semiconductor Manufacturing Company Ltd.

Good afternoon everyone and welcome to TSMC's third 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 third quarter 2023, followed by our guidance for the fourth 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 the 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. Thank you for joining us today. My presentation will start with financial highlights for the third quarter 2023. After that, I will provide the guidance for the fourth quarter 2023. Third quarter revenue increased 13.7% sequentially in NT dollars, or 10.2% in US dollars, as our third quarter business was supported by the strong ramp of our industry-leading 3-nanometer technology and higher demand for 5-nanometer technologies, partially offset by customers' ongoing inventory adjustments. Gross margin increased 0.2 percentage points sequentially to 54.3%, mainly reflecting higher capacity utilization, partially offset by the margin dilution from N3 ramp. Total operating expenses accounted for 12.6% of net revenue, as compared to 12.1% in the second quarter, mainly due to higher R&D expenses to support our 3nm and 2nm development. Operating margin was 41.7%, down 0.3% from the previous quarter. Overall, our third quarter EPS was 8.14 NT dollars and ROE was 25.8%. Now let's move on to the revenue by technology. Three nanometer process technology contributed 6% of wafer revenue in the third quarter, while five nanometer and seven nanometer accounted for 37% and 16% respectively. Advanced technologies, defined as 7 nanometer and below, accounted for 59% of wafer revenue. Moving on to revenue contribution by platform, HPC increased 6% quarter over quarter to account for 42% of our third quarter revenue. Smartphone increased 33% to account for 39%. IoT increased 24% to account for 9%. Automotive decreased 24% to account for 5%. And DCE decreased 1% to account for 2%. Moving on to the balance sheet, we ended the third quarter with cash and marketable securities of 1.55 trillion NT or 48 billion US dollars. On the liability side, current liabilities increased by 159 billion NT, mainly due to the increase of 95 billion in accounts payable and the increase of 59 billion in accrued liabilities and others. Long-term interest-bearing debt increased by 30 billion NT, of which 10 billion from new issuance and 20 billion from foreign exchange rate movement. On financial ratio, accounts receivable turnover days increased three days to 35 days, while days of inventory decreased three days to 96 days. Regarding cash flow and CAPEX, during the third quarter, we generated about 295 billion NT in cash from operations, spent 227 billion in CAPEX, and distributed 71 billion for fourth quarter 22 cash dividend. Overall, our cash balance increased 35 billion to 1.31 trillion NT at the end of the quarter. In US dollar terms, our third quarter capital expenditures total $7.1 billion. I have finished my financial summary. Now let's turn to our current quarter guidance. Based on current business outlook, we expect our fourth quarter revenue to be between 18.8 billion and 19.6 billion U.S. dollars, which represents a 11.1% sequential increase at the midpoint. Based on the exchange rate assumption of 1 U.S. dollar to 32 NT, gross margin is expected to be between 51.5% and 53.5%. 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 third quarter 23 and fourth quarter 23 profitability. Compared to second quarter, our third quarter gross margin increased by 20 basis points sequentially to 54.3%, primarily due to a higher capacity utilization rate and a more favorable foreign exchange rate, partially offset by the margin dilution from the initial ramp up of our three nanometer technology. Compared to our third quarter guidance, our actual gross margin exceeded the high end of the range provided three months ago by 80 basis point, mainly due to a more favorable foreign exchange rate. We have just guided our fourth quarter gross margin to decline by 1.8 percentage points to 52.5% at the midpoint, primarily due to the continued margin dilution from this steep ramp of our three nanometer technology. 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. To manage our profitability in the next several years, we will work diligently on our internal cost improvement while continuing to strategically sell our value. Excluding the impact of foreign exchange rate, of which we have no control over, we continue to forecast a long-term gross margin of 53% and higher is achievable. Next, let me talk about our 2023 CAPEX 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 have tightened up our capital spending throughout the year where appropriate. We now expect our 2023 CAPEX to be approximately $32 billion. Out of the approximately $32 billion CAPEX for 2023, about 70% of the capital budget will be allocated for advanced process technologies. About 20% will be spent for specialty technologies and about 10% will be spent for advanced packaging, testing, mask making and others. Our depreciation expense is now expected to increase by low 20s percentage year over year in 2023 as compared to our January forecast of approximately 30% year over year increase. Despite the near-term inventory cycle, our commitment to support customers' growth remains unchanged, and our disciplined CAPEX and capacity planning remains based on the long-term structure 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 turn the microphone over to CC.

Thank you, Wendell. Good afternoon, everyone. First, let me start with our near-term demand and inventory. We concluded our third quarter with revenue of US$17.3 billion in line with our guidance in US dollar terms. Our business in the third quarter was supported by the strong ramp of our industry-leading 3nm technology and higher demand for 5nm technologies, partially offset by customers' ongoing inventory adjustment. Moving into first quarter 2023, While AI-related demand continues to be strong, it is not enough to offset the overall cyclicality of our business. We expect our business in the first quarter to be supported by the continuous strong ramp of our 3nm technology, partially offset by customers' continued inventory adjustment. On the inventory side, we expect the fiber semiconductor inventory to have continuously reduced in the third quarter. However, due to the persistent weaker overall macroeconomic conditions and slow demand recovery in China, customers remain cautious in their inventory control. Thus, we expect the inventory digestion to continue in the fourth quarter. Having said that, we are observing some early signs of demand stabilization in the PC and smartphone end market. Together with such level of inventory control, we forecast the fiber semiconductor inventory to further reduce and exit 4Q23 at a healthier level. Next, let me talk about our global manufacturing footprint update. TSMC's mission is to be the trusted technology and capacity provider of the global logic IC industry for years to come. As we have said before, our strategy is to expand our global manufacturing footprint to increase customer trust, expand our future growth potential, and reach for more global talents. Our overseas decisions are based on our customers' needs and the necessary level of government support. This is to maximize the value for our shareholders. In Europe, after conducting extensive due diligence, we announced our plan to build a specialty technology plant in Dresden, Germany, focusing on automotive and industrial applications. We have received a strong commitment to support this project from our GERI partners, the European Commission Government, and German federal, state, and city governments. These five were utilized 22 and 28 nanometer and 12, 16 nanometer technologies for semiconductor wafer fabrication. Fab construction is scheduled to begin in second half 2024, and production is targeted to begin in late 2027. In Arizona, we are receiving strong support from the City of Phoenix, State of Arizona, and U.S. Federal Government, and continue to develop positive relationship and work closely with our local trade and union partners. We are making good progress on the FAB infrastructure, utilities, and equipment installation issues in our first FAB, and the situation is improving. We have also begun early preparation for our Arizona FAB operations and hired close to 1,100 local TSMC employees so far. Many of them has been brought to Taiwan for extensive hands-on experience in our fair so that they can further their technical skills while being immersed in TSMC operation environment and culture. We continue to target volume production of N4 process technology in first half 2025 and are confident that once we begin operations, we will be able to deliver the same level of manufacturing quality and reliability in Arizona as from our fabs in Taiwan. In Japan, we built a specialty technology fab which will utilize 12 and 16 nanometer and 22 and 28 nanometer process technologies. We have hired approximately 800 local TSMC employees so far, with the majority having similar being brought to Taiwan for hands-on experience. Equipment moving has begun this month, and volume production is on track for late 2024. In China, we have recently received an extension from the US Bureau of Industry and Security to continue our operation in Nanjing. We are currently in the process of applying for validated end-user authorization and expect to receive a permanent authorization in the near future. From a cost perspective, the initial costs of overseas FABs are higher than TSMC-5 in Taiwan due to, first, smaller FAB scale. Second, higher costs throughout the supply chain. And third, the early stage of semiconductor ecosystem overseas as compared to a matured ecosystem in Taiwan. TSMC's responsibility to manage and minimize the cost gap to maximize the return for our shareholders. Our pricing will also remain strategic to reflect our value, which includes the value of geographic flexibility. We will also work closely with government to secure their support. At the same time, we are leveraging our fundamental competitive advantage of manufacturing technology leadership, large volume, economies of scale to continuously drive our costs down. By taking such actions, TSMCY have the ability to absorb the higher cost of overseas fax and still deliver the long-term gross margin of 53% and higher and sustainable ROE of greater than 25%. We remain firm in our commitment to maximize the value for our shareholders. Now let me talk about the N3 and N3E ramp-up and progress. Our 3nm technology is the most advanced semiconductor technology in both PPA and transistor technology. N3 is already in volume production with good yield, and we are seeing a strong ramp in the second half of this year, supported by both HPC and smartphone applications. We reaffirm NCUA contributed mean single-digit percentage of our total waiver revenue in 2023, and we expect a much higher percentage in 2024, supported by robust demand from multiple customers. N3E will leverage the strong foundation of N3 to further extend our N3 family with enhanced performance, power and yield and provide complete platform support for both SPC and the smartphone applications. N3E has passed qualification and achieved performance and yield targets and will start volume production in fourth quarter of this year. We also continue to provide further enhancement of N3 technology, including N3P and N3X. With our strategy of continuous enhancement of our 3nm process technologies, we expect strong multi-year demand from our customers, and we are confident that our 3nm family will be another large and long-lasting node for TSMC. Finally, I will talk about the N2 status. The recent surge in AI-related demand supports our already strong conviction that demand for energy-efficient computing will accelerate in an intelligent and connected world. Thus, the value of a technology platform is expanding beyond the scope of geometry shrink alone and increasing toward greater power efficiency. In addition, as process technology complexity increases, the lead time and engagement with customer also start much earlier. As a result, we are observing a strong level of customer interest and engagement at our N2, similar to or higher than N3 at a similar stage 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 in 2025. Our N2 technology development is progressing well and on track for volume production in 2025. Our N2 will adopt nano-sheet transistor structure which has demonstrated excellent power efficiency. NTUWA delivers full-node performance and power benefits to address the increasing need for energy-efficient computing. As part of NTUWA's technology platform, we also developed NTUWA with backside power rail solution, which is best suited for HPC applications. We are targeting backside power rail to be available in the second half of 2025 to customers with production in 2026. With our strategy of continuous enhancement, end-to-end is derivative while further extend our technology leadership way into the future. This concludes our key message and thank you for your attention.