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.

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 participants an opportunity to ask their questions. Should you wish to raise your questions 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? Thank you.

Yes, the first one to ask question, Goku Harihara from JP Morgan.

Yeah, hi. Congratulations on the great result and thanks for the details on N3 and N2. My first question is on the technology leadership. Given we are hearing a lot of competitive messaging from your US IDM competitor slash customer in the last few months, Intel seems to think that they will be getting into technology or process technology leadership in 2025. I just wanted to hear what does TSMC think of Intel's claim? And when TSMC thinks about customer engagement, do you feel you will lose a little bit of market share to Intel when it comes to the N2 or the first generation of nanosheet transistors? Or you think your very high market share in N3 will continue into N2? That's my first question.

Okay, thank you, Goku. Please allow me to summarize your first question. So Goku's first question is about technology leadership and competition with, I think, particularly IDM. He notes this IDM is very messaging about taking over process technology leadership from TSMC. And so, Goku's question is, how do we see this? Are we concerned that we will lose market share at NanoSheet or N2 to this IDM, given their claims of regaining process technology leadership? Is that correct, Goku?

Yeah, that's right.

Thanks. Okay. Well, Goku, this is CC Wei. Let me answer your question with a very simple answer, say no. But I will stay a little bit long. Actually, we do not underestimate any of our competitors or take them lightly. Having said that, our internal assessments show that our N3P, now I repeat again, N3P technology demonstrated comparable PPA, to 18A, my competitors are technology. But with an earlier time to market, better technology maturity, and much better cost. In fact, let me repeat again, our two nanometer technology without backside power is more advanced than both N3P and 18A, and will be semiconductor industry's most advanced technology when it is introduced in 2025. Does that answer your question, Kogu?

That's quite clear. Thank you very much. My second question is, could we talk a little bit about the AI-related demand? You've seen a pretty strong demand on the data center side, and you talked about AI being about 6% of revenues this year, mostly on the data center side. Are we starting to see more engagement on AI demand on edge devices based on TSMC's expectations? Is this going to be a big screwdriver in the next one to two years for TSMC's leading edge AI devices, sorry, AI on edge devices? Do you think that that is a bigger driver for you?

Okay, thank you, Gokul. So Gokul's second question is on AI-related demand. He notes, of course, that we have talked last time also about our AI-related demand outlook and particularly focused on what we call server AI processors, or Gokul referring to data centers. So this question is really more about on the edge devices. Are we starting to see AI related demand for edge devices? Do we expect this to be a big growth driver in the next one to two years for our leading edge technologies as well?

Well, the answer is also very simple, yes. We do see some activities from customers to add AI capability in end devices, such as a smartphone and PCs, through neural engine and AI on PC, whatever. And we certainly hope that this one will add to the goals, help TSMC more strengthen under our AI's business.

So, Zizi, do you see that happen in the next one year, or is it something that will happen in a more longer-term horizon? Just wanted to understand when to think about the cadence of this growth.

Okay. Let me answer briefly. It started right now, and we were expecting that more and more customers will put that AI's capability into the end devices, into their product.

Got it, yeah, thank you very much.

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

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

Hi, good afternoon, C.C., Mark, and Jeff. So my first question is about the cycle recovery. So much appreciate about your comments about in-demand. So my question is about when do you expect there will be an uptick of the FAB utilization, assuming demand is stabilizing and also inventory get back to the healthy level? Because it's just very hard to believe your FAB utilization outside of DDNedge will stay at only, you know, 70%, 80%. So first question is about do you see that, overall fat utilization to pick up at any time soon. Thank you.

Okay. So Charlie, I think your first question is sort of, if I'm correct, around the cycle and in terms of how do we see the cycle and the recovery? When, you know, do we see the fat utilization picking up, which really is a function of, I guess, do we see the cycle bottoming out and when do we expect the recovery? Is that correct?

Yes, thank you.

Well, Charlie, this is C.C. Wei again. Let me answer your question. As I said, we do observe some early signs of demand stabilization in PCs and smartphones and markets. Those two segments are the biggest segments for TSMC's business. We want to say that 2024 will be a very healthy growth. But right now, did we see the bottom? Very close, very close. We want to, I cannot give you a number, but it's because it's too early to call it a sharp rebound. But even with medical environment remain uncertain, We're weighing customers' inventory control in the first half of 2024. Having said that, we already said that we have strong technology leadership and a broad customer base. Those two are unique and specific to TSMC. They enable our customers to win businesses in the end market, and TSMC continues to deliver healthy growth. And that's why we can do better than overall industry. And that's why we have a confidence that we will have a healthy growth next year.

Okay. Okay. Thank you. Yeah. So just I want to kind of verify because we do see some green shoots and some rush orders to wafer foundry sector. Thank you. But second question is also about AI. My question is about, over the past three months, do you see any upward revision of the forecast from the GPU or the custom chip? And I know it's very, very recent, right? Just two days ago, the US had put some additional export control on the AI shipment to China. Do you think that that is going to have any kind of near-term or long-term impact to your AI semi-revenue growth assumption. Thanks.

Okay, thank you, Charlie. So Charlie's second question is related to AI, two-parter. First, do we see over the last three months, I think his words were an upward revision in the demand from AI in the last three months. And then he wants to know, given the recent additional regulations announced, what would the impact to the AI demand be to TSMC, both for the short term and the long term?

Charlie, the AI demand continues to grow stronger and stronger. So from TSMC's point of view, now we have a capacity limitation to support them, to support the demand. We are working hard to increase the capacity to meet their demand. That's for one thing. Now, U.S. government put a new regulation and to, for some of the product cannot be shipped to mainland China. However, it is, you know, just for a couple of days we are still in evaluation, we are still doing our assessment, but so far we can tell you that the impact to TSMC is limited and manageable. At least for the short term, for the long term we are still evaluating what is the consequence.

Got it. So actually, there was one embedded question about the custom chip. So may I know your perspective about this custom chip, long-term kind of Gensher or outgrow GPU products? So what's your assumption for this custom chip in terms of the real contribution within AI or to TSMC? May I ask this as a follow-up?

Okay, let me answer it. Whether customer develop the CPU, GPU, AI accelerator or AC for all the type of AI applications, the commonality is that they all require usage of a leading edge technology with stable yield delivery to support larger die size. and a strong foundry design ecosystem. All of those are TSMC's strengths. So we are able to address and capture a major portion of the market in terms of a semiconductor component in AI.

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

Next one to ask question, Bruce Liu from Goldman Sachs.

Okay, thank you for taking my question. I think the question is try to ask about the outlook for next two years. I think I do recall that management mentioned about like 15 to 20% revenue kickers from 21 to 26. The smartphone business is supposed to be in line or slightly below the corporate average. in terms of the growth rate. But the smartphone business was down meaningfully in 2023. Do we expect to see a sharp rebound for the smartphone business to get back to the corporate average in terms of growth rate? Also, the management also mentioned that the backend business will grow in line with the corporate average. Will we see a much stronger growth from the backend business in the coming two years?

Okay, so Bruce's question really is looking at, we have indeed, you're right, Bruce, we have said we will grow between 15 to 20% revenue CAGR in U.S. dollar terms from 2021 to 2026. So Bruce's question wants to break down the components here to look at smartphone in particular, given that it has been a slower going market these last few years. How do we see the growth of the smartphone market the next one to two years in the context of this CAGR? And then also, I think Bruce is also asking about the back-end growth. We have said previously it will grow slightly faster than the corporate average. What is the current expectation now also for the next one to two years? Is that correct, Bruce?

Yes, thank you. Right, Bruce, this is Wendell. Yeah, in the next two to three years, backing up to 21 to 26, we still expect that the smartphone as a whole will grow slightly slower than the corporate average. We still think that HPC will be the strongest one and will be the major growth contributor to our multi-year growth. This is your first question. As to the growth of back-end business, we still expect that the back-end business as a whole will grow slightly faster than the corporate average in the five-year time period.

Ivy, thank you. So the next question is for the technology cadence. I mean, for TSMC, you know, for revenue contribution for 5 nanometers, we start to see the meaningful revenue contribution for 5 nanometers starting at third quarter 2020. And 3 nanometers is third quarter 2023. So the cadence, it looks like it's longer for 3 nanometers versus 5 nanometers and 7 nanometers. What is the technology cadence moving forward? Are we able to see meaningful revenue contribution in two years' time frame or three years' time frame? I think the technology migration cadence is an important indicator.

Okay, thank you, Bruce. So Bruce's second question, again, as he said, is around the technology cadence. He notes that 5 nanometers started contributing revenue in 3Q20, but I think you're saying 3 nanometers revenue is contributing in 3Q23. So the cadence is growing longer to kind of three years between five and three. So what will be the technology cadence in the future? And thus for two nanometer, when should we expect meaningful revenue as well? Is that correct, Bruce? That's correct. Okay. Thank you.

Okay, Bruce. Uh, let me answer the question. I think that, um, We develop the technology to meet the customer's demand. That's a first priority to us. But then different customer may have a different product schedule consideration. And as time goes by, the technology complexity actually become more and more complicated. And our customer will design their product and react to the market situation. So let me answer the question that's in a very simple way. TSMC's technology cadence remains constant and to support our customers' growth. But whether we got the same amount or same percentage of the revenue will depend on customers' product schedule.

But the follow-up question is that if the customer doesn't really need the advanced technology, you know, as

fast as before maybe we slow it down a bit which will make a better returns right so bruce's follow-up is so if the customers do not need the leaning node as fast or as soon as before then slow down the cadence does that mean we will see better returns

Well, we don't slow down our technology development per se. We might slow down our capacity expansion according to customer's demand. Did I answer your question, Bruce? That's what we are doing right now.

I understand. Thank you.

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

Yes, the next one, we have Laura Chang from Citi.

Hello, hi, Gretchen. Thank you for taking my question. I think my question is also similar to what Bruce mentioned about the capacity expansion plan. As we see that healthier inventory situation right now, At the same time, the most advanced process now depends on customer's demand. So I just want to get your feeling about the overall the CapEx outlook or capacity outlook into the next two years. Do you feel that will be better to resume the year-on-year CapEx next year or later? Considering there's still quite a strong demand on N3, N2 Rambab at the same times, The most of the rents now seems you will see maybe two times more expensive on N2 versus N3. So my question is just about the future capacity expansion plan. Yeah, thank you.

Okay, so Laura's first question, again, is on the capacity expansion plan. She notes that, of course, the inventory, as we said, is becoming healthier, but also with N3 and N2. So she really wants to know what is the CapEx and capacity outlook plan for the next one to two years?

Right. Hi, Laura. This is Wendell. CZ just mentioned a capacity plan will really depend on the customer's product plan. Now, in terms of CAPEX, what we can see now is that we, in the past few years, have invested very heavily to capture the growth in the next few years. And as we begin to harvest those investments, we expect the increase of our CAPEX to be leveling off in the next few years. That doesn't mean the dollar amount is going to reduce, but the capital intensity is expected to decline in the next few years. That's what we can see at this moment.

Thank you, Wendell. I recall that previously we mentioned about like we target longer term to back to like mid-30s for our capex intensity. So is any possibility we see we achieve that target next year?

First of all, it's not a target. It's a forecast based on the customer's demand. And secondly, it's like three or five years out. It's not the immediate next year.

Okay, thank you. Very clear. And also my second question is about end-to-progress. I appreciate Cici's previous sharing on the progress and also the backside power timeline. I'm just wondering that what would be the most challenging part if we migrate to like a basic power? And also, since the transistor density will become a total different now. So I'm just wondering that the client's migration or intention to adapt the most advanced node into next two, three years. And what will be the most challenging in technology perspective? Thank you.

Okay, so Laura, let me make sure I got this right. So your second question is about N2, and you want to know with the adoption of backside power rail, what is the most challenging part from a technology perspective? And then how do we see the customer adoption?

Yes, correct. Thank you.

Laura? I answer that, you know, As technology is moving into more and more advanced nodes, the challenge is always there. Technology complexity increased dramatically, but we can do it, no doubt about it. And we still remain the technology leadership in this industry. If you ask me what is the most challenging part, I would say it's cost. I mean, you look at it today, inflation, everything, and the tool have become more and more expensive. Although we can do it on time to meet customers' requirement, our challenge right now, actually, I would say, number one, cost. I want to reduce the cost so more customers can afford it. But even with that, actually, we have a lot of customers interested and engaged with the TSMC today. actually is probably higher than the N3 at a similar stage. Okay. Did I answer your question?

Yes, very clear. Thank you very much, CC.

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

Right now we have Brett Simpson from Aratea Research.

Thanks very much. I had a question for CC. regarding the hyperscalers. Major US hyperscalers are hiring a lot of chip designers at the moment and looking to make their own AI silicon going direct to TSMC, much like Apple has done over the years. Is TSMC generally supportive of this trend or not? And can you give us your perspective as to whether hyperscalers have the in-house IP capability and skills to cut out the ASIC suppliers or not and go direct to TSMC. Thank you.

Okay, Brett, thank you. So Brett's first question is looking at his observation, U.S. hyperscale companies are hiring a lot of people to do AI custom chips, silicon, and working directly or coming directly to work with TSMC. So his question is, does TSMC support such efforts, and how do we see such type of customers, I guess? Is that your question, Brett?

Yeah, and to generally just share your perspective on how you see this part of the business developing at TSMC. Thank you.

Hi, Brett. Okay, those are hyperscalers. I don't comment on the specific customer, but all customers All we know or our fundamental rule is whether customer develop the CPU, GPU, AI accelerator or ASIC for their own application or for any purpose in the AI area, we will support them actually. And because of our technology leadership and our good manufacturing, so we are able to address and capture a major portion of the market. And so you are asking whether we support it or not. We support every customer all over the world.

Okay, thanks. That's very clear. And maybe just as a follow-up, I wanted to ask about some of the areas in the quarter that were weaker than expected, namely 7 nanometer. I think it's half year-on-year. and also automotive that saw a decline sequentially, a meaningful decline sequentially. Can you just help us understand how you built back up seven nanometer? You know, what led to the weakness and what's happening in automotive and how do you assess prospects for automotive over the next, you know, six, nine months or so? Thank you.

Okay, so two parts to Brett's question. Maybe I'll start with the second. But anyway, looking at automotive demand and the weakness in the past quarter, how do we see the automotive demand? And then also his question is about 7 nanometer also year-on-year sharp revenue decrease. So how do we see the outlook for 7 nanometer as well?

Well, let me answer the question on automotive demand. In fact, in the past three years, automotive demand has been very strong. And we deliver whatever they ask. Today, I think the automotive demand already entered the inventory adjustment mode in the second half of 2023. However, we still expect automotive demand will increase again in 2024 because more and more EV, more and more functionality being added to automotive, and that's what we saw. Now talking about the N7, the seven nanometers technology, why we have such a low utilization or the revenue decrease. It goes beyond our original plan because we expect the N7 to be very fully utilized even now, but it is not. Let me answer the question because we suddenly have in 10 years, you know, the smartphone demand dropped dramatically from about 1.4 billion units to about 1.1 billion now. So that exactly in this timeframe, the N7 utilization has been impacted and followed by one major customer who delayed their product introduction. And so that's why we have a low utilization. Seeing that, we are confident to backfill our 76 nanometer capacity with additional wave of specialty demand from consumer, RF, connectivity, and other applications, and will return to a health level of utilization over the next several years. This is very similar to a situation that we have a 28 nanometer back in 2018 and 2019 timeframe. Okay. At the beginning, it was underutilized for a period of time, and we work hard with our customer and then for development of some specialty technologies, and then now we have to expand 28 nanometers specialty capacity. That's the same kind of a story. Brett, did I answer your question? Thank you. Okay, thanks a lot. Thanks very much.

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

Next one to ask questions, Brad Ling from Bank of America.

Thank you for taking my question. So first of all, congrats on the strong result and then also the impressive gross margin. So I have two questions. One is on the end device AI, HAI, and the other is on the CPO. So appreciate the management's constructive comments and growth outlook on the HAI. So besides the, well, interesting engagement with the clients, what are the implications for the wafer consumptions for the firm? And also, eyeing on the computing power and energy consumption angle, on the end device with additional AI functions? Should we expect it to re-accelerate the node migration for the end devices? That's my first question. Thank you.

Okay, so Brad's first question is about edge and end device AI. He wants to know what is the implications for wafer consumption and then with the increasing need for energy efficiency and power, he is wondering does this re-accelerate or increase the node for, I guess his words is node migration or adoption of leading edge technologies.

Well, the edge device start to, that's including smartphone and PCs, start to incorporate AI functionality inside. We observe some of the neural engines has been added increasingly. So... the die size will increase, even the unit did not increase dramatically, but the die size, you know, is in mid-teens, no, I mean, mid-single digits, the die size increased so far. And I expect that this kind of trend will continue. And so more and more application of the, on the AI side, what be incorporated into those kind of edge device and that one need have very power efficient chips to put into the edge device, especially when it is a mobile. So I do expect, from my own perspective, I do expect that my customers will move into the leading edge node more and more quickly to compete in the market.

Thank you very much, CC. A bit of a follow up is that well now it accounts for some well missing go digit of the die size incremental for a chip. So does that or are we seeing that to enlarge to something like meetings or or well even bigger in the well mid to long term.

So Brad's quick follow up is if you know the AI portion is kind of mid single digit now, how should we expect can we expect mid teens or what type of percentage in a few years time?

Well, I will answer the question. Actually, we see the increase on the diet size, but we cannot nail down the, we say the mid-single-digit, but I expect it to start to increase. And whether that will increase our forecast on our growth or something, it's still too early to say at this moment.

Yeah, but we're still quantifying the impact from this development. So we're maintaining the previous statement that we expected to grow to about mid- in five years about mid single digit, I'm sorry, mid teens of our revenue.

Yeah, I think Brad, probably just very simply, as we said, edge AI, we do see some activity. It will drive silicon content, but this will occur over time. Okay. And we don't have any quantitative number to share. All right. Got it. Thank you. Okay. What is your second question?

Okay, so the second question is on CPO. So basically, we have learned that TSMC is doing quite well and also leading the industry in CPO or so-called Sleekon Photonics and has introduced a platform to clients with the technologies. So may we learn about the opportunities and implications of the new technology for the industry and for our firm? And also, should we expect the platform to offer additional competitive advantage for TSMC in the long run? Thank you.

So Brad, your second question is on silicon photonics. Is that correct?

Yes.

So he wants to know our positioning or progress on silicon photonics. How important is this? And will this be a competitive advantage for TSMC going forward in the future?

Okay, let me answer that question. Silicon photonics actually is growing its importance because there is a large amount of data that needs to be collected, processed, and transferred in an energy efficient manner. Silicon photonics tends to be the best fit for that role. TSMC has been working on silicon photonics for years, and most importantly, we are collaborating with multiple leading customers to support their innovations in this field. It takes a lot of time to develop the technology and to build the capacity. And when we increase the volume production, we believe that TSMC's silicon photonics will be the best technology. And when customers roll out all their innovations. But as I said, it's gradually increasing in their activity and gradually increasing their demand as of today. Got it.

Thank you very much.

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

Next one, we have Stanley Lin from UBS.

Good afternoon. Thank you very much for taking my questions. So my first question is on advanced packaging. Incrementally, we are hearing more customer interest in the adoption to achieve better heterogeneous integrations. But I want to get your thoughts on what could be the potential impact of customers relying a bit more on packaging to improve the system performance and perhaps less on the process migrations given cost considerations. Meanwhile, SOIC has been introduced for quite a while, whereas the customer adoption still seems to be limited at this point. And so when should we expect a more meaningful pickup of SOIC and what could be the major catalyst? Thank you.

Okay, so Sunny, sorry, I may have missed a little bit of the first part, but I think her question is on overall advanced packaging. Looking at this trend and the move to more, of course, heterogeneous integration, what are the cost implications and how does advanced packaging work and go together with the process technology standpoint? And then also a question about the update or progress of SOIC. Is that correct, Sunny?

Well, so maybe if I may clarify a bit. So for the first part, I wonder if customers may consider relying a bit more on packaging, whereas slowing down a bit on the process migration because of increasing costs.

Okay, so she's asking, will customers, because of the increasing cost of the process technologies, will customers rely more on advanced packaging as a result?

Let me answer that. It's not because of increasing of the cost in the more advanced node. It actually, they try to, our customers try to maximize The system performance, that's the major portion. That including the kind of speed improvement or the power consumption decrease, all those kind of things. Put it all together and maybe cost is also part of the consideration. which we noticed about. And so more and more customers are moving into the very advanced technology node, and they start to adopt the chipless approaches. And so, you know, that no matter what, TSMC provide the industry-leading solution in both very leading technology and also very advanced packaging technology. And to work with our customer for their product, have a best system performance. And the other one is you are asking about the SOIC, when it will become a high volume and more substantial revenue for TSMC It's coming, it's coming. Actually, the customer already ready to announce that their new product which are widely adopt. And I expect, you know, starting from now and next year, the SOIC will generate revenue and become one of the faster growing advanced packaging solution in the next few years.

Got it. Thank you very much. If I may, a quick follow up. Three months ago, you had a target to double your co-op capacities. And just now you mentioned AI demand continue to surprise on the upside. So wonder if there's any update on your co-op capacity expansion?

OK, so I will take this as your second question, Sonny, but she's asking about co-op expansion. We had said that we will double the capacity three months ago. Can we provide an update on the overall co-op capacity? And I guess CapEx and capacity go hand in hand. What is our plan?

Well, Sunny, you know, the last time we say that we are double our capacity, we are working very hard to increase the capacity more than double. But today is limited by my supplier's capability or their capacity. So we still maintain that we will double our capacity by the end of 2024. But the total output actually is more than double from 2023 to 2024 because of a very high demand from our customer. So this kind of a trend will continue to increase our COAS capacity to support our customer even into 2025.

Okay, Sunny, does that answer your question? Okay, thank you. Operator, can we move on to the next caller, please?

Next one, please welcome Mati Husaini from SIG.

Mati Husaini Yes, thanks for taking my question. I understand there are a number of new products that you're ramping into year-end and into first half of 2024 for various end markets. And I want to understand how the ramp of these new products are to impact the seasonality. Could we see a scenario where in the first half the ramp of these new products, especially at the leading edge, to somewhat offset the seasonal factors? And any thoughts there? And I have a follow-up.

All right, Madi. Well, Madi's first question is in terms of new products, which, of course, customer products we don't comment on, but he said we're ramping products into the second half. And so how will this ramp of new products go into as we go into first half 24? And can this offset or mitigate some of the seasonality?

Let me rephrase that. Contribution of customers. the contribution of customers' new product, and how would that impact, or how could that offset seasonal factors?

Yeah, Mehdi, I don't think we can comment on specific customer products, but I can tell you that we're not seeing any dramatic change in the seasonality as of now.

Okay. Because I was looking at your year calendar, Tony, three And given your Q4 guide, you're actually doing better than what you guided three months ago. You said revenues could be down 10% U.S. dollar, and now it could actually be down by a single digit. Is that a combination of a stronger new product ramp and better pricing? Is that a fair assessment?

Okay, so Madi is really looking at, he rightly notes that three months ago we said this year will decline around 10% in US dollar term. Now with the fourth quarter implied guidance is slightly better. So he wants to know what is the implication or behind this.

Well, let me give you one simple reason. Because our ramp up of N3 because of the demand of N3 is strong. So ramp up quickly to meet customers' demand. So the final result is better than we expected three months ago. Yeah.

And we have also said that strong ramp of N3 will continue in next year. Okay. That's about all the seasonality color we can give.

Gotcha. Okay. And then... Perhaps if I were to ask a second question, I just want to better understand your view on your customers' inventory correction. We're reaching the bottom, but we don't have any visibility on how quickly they're going to refresh inventory. The slope of the recovery is still not clear. Did I understand you correctly?

So the second question, you would like to clarify. So are we saying that customers inventory is reaching or approaching a bottom, but the slope of the inventory is not clear? Is that what we are saying?

Okay, I'll answer the question. You know, in these couple months, we start to see the demand stabilized in the PC and smartphone market. And in fact, we see some kind of urgent PO ask for more device to be shipped to their place to meet the demand. That give us a hint of the inventory control already become more healthier than we thought. So in terms of uncertain macro, it probably will continue, but our expectation is very close to a healthy condition. So that's why we say we can expect 2024 to be a healthy growth year for TSMC. Okay. Did I answer your question? Great. Thank you.

Okay, in the interest of time, thank you, Madi. In the interest of time, we'll take questions from the last two participants, please.

Next one to ask question is Chris Sankar from TD Cohen.

Yeah, hi, thanks for taking my question. I had two of them. First one is on gross margin. Where do you expect N3 to reach corporate average gross margin? And as you look into next year, as more mature node capacity comes online across the industry, how do you think about mature node gross margins also? And I'll follow up after that.

Okay, so Krish's first question is on gross margin. When do we expect 3 nanometer or N3, I should say, to reach the corporate average gross margin? And how do we see the gross margin trend for the more mature nodes?

Yeah, Chris, in the past, our leading nodes normally reached gross margins, corporate margin, in about eight quarters. But as we progress with more and more leading nodes, it will become more and more challenging because of several reasons. Well, first of all, our corporate margin is higher than before. And secondly, the leading node, as I just said, is becoming more and more complex. And also, in the past few years, the inflation pressure that was not expected also contribute the higher cost in the N3. So it's going to be pretty challenging for future leading nodes to reach corporate margin as in before, like before in the same timeframe. The mature nodes, I can tell you that our mature nodes, the gross margins are really congregated around the corporate average in a pretty narrow band. Because we focus on specialty technology, it's not a commodity capacity.

Yes. Okay. Yeah. That's very helpful. Thank you for that. And then as a follow-up, on Arizona, you mentioned that you'd hired about 1,100 local employees. I'm kind of curious, is that critical mass enough for you to start four nanometer production, or do you have another... target level of employees before they can actually start getting this production since you're still maintaining the output to be in first half of 2025.

Okay, so thank you, Krish. So Krish's second question is about our first fab in Arizona. He notes that we have said we hired, you know, 1100 local employees. So his question is, is this enough critical mass or enough people basically to support the ramp of the first FAB as we planned, as we said today in first half 25?

Of course, we continue to hire the local talent to join the TSMC five in Arizona. So when we start to have a volume production, we are confident that we will have enough resources to support our rembob in Arizona.

Okay. All right. Thank you. Thank you, Krish. Operator, can we move on to the last participant, please? Yes.

The last one to ask question, Chaoshi from NIEM.

Hi. Thank you for squeezing me in. First off, I really want to congratulate GSMC for delivering good results for Q3 and very good guidance for Q4. But I want to really call out the reported revenue for five nanometers in the third quarter looks like you are showing some really good counter-cyclical strength and probably the record high. I want to understand the rebound in the 5 nanometer business in Q3. Is that going to be more in the following quarters? And what's behind that? And the relative, let's say, your expectation like three to six months ago when you were reducing your 23 outlook. Is 5 nanometer doing better than expected? And how has the demand trending in the last two months for 5 nanometer? Thank you.

Okay, so Charles' first question is about 5 nanometer. He's asking in the very near term, he notes that he saw a very strong sequential revenue increase in the third quarter. So he's wondering what is driving this. And then he's asking about what is the outlook for the next three to six months for 5 nanometers specifically.

Yeah, Charles, I can share with you the increase in revenue and five in the third quarter mainly comes from two platforms, HPC and smartphone. HPC also includes the AI related demand. Smartphone basically customers, some customers product seasonalities. Now, forward-looking-wise, I'm not going to share with you, but we will tell you in January what actual the next quarter M5 revenue will be.

The overall revenue? Yes. We don't provide revenue by process note, okay? What's your second question, Charles?

Yeah, thanks, Jeff. The other question is about CapEx. It sounds like that you're expecting CapEx on the absolute dollar may still grow going forward. I know that's a long-term comment, but I look at the near term. TSMC CapEx seems to be running at $7 billion per quarter in the second half of 2023, which kind is at a 28 billion annualized round rate. But if we are expecting total CapEx for 24 to grow in a dollar term over 23, it seems like you are expecting CapEx to ramp in 2024. Maybe that's your planning for some of the CapEx ramp in 2024. Is that the right way to think about CapEx? Is $7 billion really the bottom level run rate for TSMC CapEx at this point? Thank you.

All right. So Charles, second question is also is on CapEx. Basically, he's saying, given the guidance, he's looking at our CapEx is running at about a US dollar 7 billion run rate. So he's assuming or, you know, although we do not comment on 24, he's assuming if next year's CapEx dollar amount is going to increase, but if we're running at 7 billion run rate, does that imply 28 billion? How should he reconcile this?

Charles, every year the CAPEX is invested based on the future opportunity to growth, and we invested to capture those future opportunities. Too early to talk about 2024, really. We'll share the guidance with you in January, quarterly release.

Okay. All right. Thank you, Charles. 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. The transcript will become available 24 hours from now. Both of these are available and you can find through TSMC's website at www.tsmc.com. So thank you, everyone, for taking the time to join us today. We hope everyone continues to be well, and we hope to see you join us again in January. Goodbye and have a good day. Thank you.