Taiwan Semiconductor Manufacturing Company Ltd.

Good evening, friends of the investment world and the media. I am Su Zhikai from Taichi.com's Legal Relations Department. I would like to welcome you to participate in the legal explanation meeting of the fourth quarter of Taichi's company in 2023. Due to the fact that this law will be broadcasted to global investors at the same time, we will use English all the time. Please forgive us. Good afternoon, everyone, and welcome to TSMC's fourth quarter 2023 earnings conference and conference call. It's great to see everyone in person once again. This is Jeff Hsu, TSMC's Director of Investor Relations and your host for today. Today's event is being webcast live through TSMC's website at www.tsmc.com, where you can also download the earnings release materials. If you're 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 fourth quarter 2023 and full year of 2023, followed by our guidance for the first quarter 2024. Afterwards, Mr. Huang, TSMC's CEO, Dr. Cici Wei, and TSMC's chairman, Dr. Mark Liu, will jointly provide the company's key messages. Then TSMC's chairman, Dr. Mark Liu, will host the Q&A session where all three of our executives will take your questions. As usual, I'd 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 on our press release. And now, I would like to turn the microphone over to TSMC's CFO, Mr. Wendell Huang, for the summary of operations and the current quarter guidance.

Thank you, Jeff. Happy New Year, everyone. Thank you for joining us today. My presentation will start with financial highlights for the fourth quarter and a recap of full year 2023. After that, I will provide the guidance for the first quarter 2024. Fourth quarter revenue increased 14.4% sequentially in NT dollar, or 13.6% in US dollars, as our fourth quarter business was supported by the continued strong ramp of our industry leading three nanometer technology. Gross margin decreased 1.3 percentage points sequentially to 53%, primarily due to margin dilution from three nanometer ramp. Operating margin decreased 0.1 percentage points sequentially to 41.6%, slightly ahead of our guidance, mainly due to operating leverage on higher revenue. Overall, our fourth quarter EPS was 9.21 NT and ROE was 28.1%. Now, let me move on to revenue by technology. Three nanometer process technology contributed 15% of wafer revenue in the fourth quarter, while five nanometer and seven nanometer accounted for 35% and 17% respectively. Advanced technologies, defined as 7 nanometer and below, accounted for 67% of wafer revenue. On a full year basis, 3 nanometer revenue contribution came in at 6% of 2023 wafer revenue. 5 nanometer was 33%, and 7 nanometer was 19%. Advanced technologies accounted for 58% of total wafer revenue, up from 53% in 2022. Moving on to revenue contribution by platform, HPC increased 17% quarter over quarter to account for 43% of our fourth quarter revenue. Smartphone increased 27% to account for 43%. IoT decreased 29% to account for 5%. Automotive increased 13% to account for 5%. And DCE decreased 35% to account for 2%. On a full year basis, smartphone, IoT, DCE decreased 8%, 17%, and 16% respectively. HPC remained flat, while automotive increased 15% in 2023. Overall, HPC accounted for 43% of our 2023 revenue. Smartphone 38%, IoT 8%, and automotive 6%. Moving on to the balance sheet. We ended the fourth quarter with cash and marketable securities of 1.7 trillion NT or 55 billion US dollars. On the liability side, current liabilities decreased by 56 billion NT, mainly due to the decrease in accounts payable. On financial ratios, accounts receivable days decreased four days to 31 days, while days of inventory also declined 11 days to 85 days, primarily due to higher three nanometer wafer shipments. Regarding cash flow and CAPEX, during the fourth quarter, we generated about 395 billion NT in cash from operations, spent 170 billion in CAPEX, and distributed 78 billion for the first quarter 23 cash dividend. Overall, our cash balance increased 154 billion to 1.47 trillion at the end of the quarter. In US dollar terms, our fourth quarter capital expenditures totaled 5.24 billion. Now let's look at the recap of our performance in 2023. 2023 was a challenging year for the global semiconductor industry, but our technology leadership enabled TSMC to outperform the foundry industry. Our revenue decreased 8.7% in US dollar terms to 69 billion US, or decreased 4.5% in NT terms to 2.16 trillion NT. Gross margin decrease 5.2 percentage points to 54.4%, mainly reflecting lower overall capacity utilization and three nanometer ramp, partially offset by a more favorable foreign exchange rate. To extend our technology leadership, We continue to expand our R&D investment in three nanometer and two nanometer development despite a lower revenue base in 2023. Thus, operating margin decreased 6.9 percentage points to 42.6%. Overall, full year EPS declined 17.5% to 32.34 NT and ROE was 26.2%. On cash flow, we spent 30.45 billion US dollars, or 950 billion NT in CAPEX, while generating 1.7 trillion NT in operating cash flow and 292 billion in free cash flow. We also paid 292 billion NT in cash dividends in 2023. I have finished my financial summary. Now let's turn to our current quarter guidance. We expect our business in the first quarter to be impacted by smartphone seasonality, partially offset by continued HPC related demand. Based on the current business outlook, we expect our first quarter revenue to be between 18 billion and 18.8 billion US dollars, which represents a 6.2% sequential decline at the midpoint. Based on the exchange rate assumption of one US dollars to 31.1 NT, gross margin is expected to be between 52 and 54%. operating margin between 40 and 42 percent. This concludes my financial presentation. Now let me turn to our key messages. I will start by making some comments on our fourth quarter 23 and first quarter 24 profitability. Compared to third quarter, our fourth quarter gross margin decreased by 130 basis points, sequentially to 53%, primarily due to the margin dilution from the continued ramp up of our three nanometer technology. We have just guided our first quarter gross margin to be flat sequentially at 53% at the midpoint, primarily as a less favorable foreign exchange rate assumption is offset by product mix changes due to smartphone seasonality. Looking at full year 2024, given the six factors that determine our profitability, there are a few puts and takes I would like to share. On the plus side, we expect our utilization rate to rise in 2024 as our business recovers. However, as we have said before, N3 is expected to dilute our gross margin by about three to four percentage points for the full year of 2024, as the revenue contribution will be much higher than in 2023. In addition, we have a strategy so that some of our N3 capacity can be supported by N5 tools, given the strong multi-year demand. Such a plan will enable higher capital efficiency in the mid to long term, but requires cost and effort in the near term. Most of this conversion will occur in second half of 2024, and we expected to dilute our gross margin by about one to two percentage points in second half of 2024. Finally, we have no control over the foreign exchange rate, but that may be another factor in 2024. Long-term, excluding the impact of foreign exchange rate and considering our global manufacturing footprint expansion plans, we continue to forecast a long-term gross margin of 53% and higher is achievable. Next, let me talk about our 2024 capital budget and depreciation. Every year, our CAPEX is spent in anticipation of the growth that will follow in future years. In 2023, we spent 30.4 billion US dollars, lower than our prior guidance of approximately 32 billion, as we continue to tighten up our capital spending where appropriate, given the near-term uncertainties. In 2024, our capital budget is expected to be between 28 billion and 32 billion US dollars as we continue to invest to support customers' growth. Out of the 28 to 32 billion CAPEX for 2024, between 70 and 80% of the capital budget will be allocated for the advanced process technologies. About 10 to 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 expected to increase close to 30% year over year in 2024. Mainly as we ramp up our three nanometer technologies. Finally, let me make some comments on our long-term CAPEX and cash dividend distribution policy. At TSMC, a higher level of capital expenditures is always correlated with higher growth opportunities in the following years. In the past few years, we have sharply increased our CAPEX spending in preparation to capture and harvest the growth opportunities from HPC, AI, and 5G megatrends. Despite a challenging 2023, Our revenue remains well on track to grow between 15 and 20% CAGR over the next several years in US dollar terms, which is the target we communicated back in January 2022 investor conference. With our 2024 CAPEX guidance of 28 to 32 billion, the rate of increase of our capital spending has begun to level off as we capture and harvest the growth. The objectives of TSMC'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 November, TSMC's board of directors approved the distribution of a 3.5 NT per share cash dividend for the third quarter of 2023, up from 3 NT previously. This will become the new minimum quarterly dividend level going forward. Third quarter 23 cash dividend will be distributed in April 2024. In 2023, TSMC's shareholders received a total of 11.25 NT cash dividend per share, and they will receive at least 13.5 NT per share cash dividend for 2024. In the next few years, we expect the focus of our cash dividend policy to continue to shift from a sustainable to a steadily increasing cash dividend per share. Now let me turn the microphone over to CC.

Thank you, Wendell. Good afternoon, everyone. First, let me start with our 2024 outlook. 2023 was a challenging year for the global semiconductor industry, but we also witnessed the rising emergency of generative AI-related applications, with TSMC as a key enabler. In 2023, weakening global macroeconomic conditions and high inflation and interest rates exacerbated and prolonged the global semiconductor inventory adjustment cycle. Concluding 2023, The semiconductor industry, excluding memory industry, declined about 2%, while foundry industry declined about 13% year-over-year. TSMC's revenue declined 8.7% year-over-year in U.S. dollar term. Despite the near-term challenges, our technology leadership enabled TSMC to outperform the funding industry in 2023, while we are positioning us to capture the future AI and high performance computing related growth opportunities. Entering 2024, we forecast fiberless semiconductor inventory to have returned to a wholesale level exceeding 2023. However, macroeconomic weakness and geopolitical uncertainties persist. potentially further weighing on consumer sentiment and the market demand. Having said that, our business has buttoned out on a year-over-year basis. and we expect 2024 to be a healthy growth year for TSMC, supported by continuous strong ramp of our industry-leading 3nm technologies, strong demand for the 5nm technologies, and robust AI-related demand. Coming off the steep inventory correction and low base of 2023, for the full year of 2024, we forecast the overall semiconductor market excluding memory to increase by more than 10% year-over-year, while foundry industry growth is forecast to be approximately 20%. For TSMC, supported by our technology leadership and broader customer base, we are confident to outperform the foundry industry growth. We expect our business to grow over quarters throughout 2024, and our four-year revenue expect to increase by low to mid 20% in U.S. dollar terms. Next, let me talk about our N3 and N3E ramp-up and progress. Our 3 nanometer technology are the most advanced semiconductor technology in both PPA and transistor technology. As a result, almost all the world's smartphone and SPC innovators are working with TSMC on 3 nanometre technologies. Our N3 successfully entered volume production and enjoyed a strong ramp in second half 2023, accounting for 6% of our total waiver revenue in 2023. N3E further leveraged the strong foundation of N3 to extend our N3 family with enhanced performance, power, and yield. N3E has already entered volume production in the fourth quarter of 2023. Supported by robust demand from customers in both smartphone and HPC applications, We expect revenue from our 3 nanometer technology to more than triple in 2024 and account for mid-teens percentage of our total waiver revenue. We also continue to provide further enhancement of our N3 technology, including N3P and N3X. With our strategy of continuous enhancements of our 3nm process technologies, we expect strong multi-year demand from our customers and are confident that our 3nm family will be another large and long-lasting node for TSMC. Now, I will talk about AI-related demand and our end-to-end status. The surge in AI-related demand in 2023 supports our already strong conviction that the structural demand for energy efficient computing will accelerate in an intelligent and connected world. TSMC is a key enabler of AI applications. No matter which approach is taken, AI technology is evolving to use more complex AI models as the amount of computation required for training and inference is increasing. As a result, AI models need to be supported by more powerful semiconductor hardware, which requires use of the most advanced semiconductor process technologies. The value of TSMC technology position is increasing, and we are all well positioned to capture the major portion of the market in terms of semiconductor component in AI. To address in cerebral, AI-related demand for energy efficient computing power, customers rely on TSMC to provide the most leading edge processing technology at scale, with a dependable and predictable cadence of technology offering. At the same time, as process technology complexity increase, the engagement lead time with customers also start much earlier. Thus, almost all the AI innovators are working with TSMC and we are observing a much higher level of customer interest and engagement at N2 as compared with N3 at a similar stage from both HPC and the smartphone applications. 2 nanometre technology will adopt narrow-sheet transistor structure and be the most advanced semiconductor technology in the industry in both density and energy efficient when it is introduced in 2025. N2 technology development is progressing well, which divides performance and yield on track or ahead of plan. N2 is on track for volume production in 2025 with a RAM profile similar to N3. As part of our N2 technology platform, we also developed the N2 with backside power rail solution, which is better suited for specific HPC applications based on performance, cost and maturity considerations. N2 with backside power rail will be available in the second half of 2025 to customers with production in 2026. With our technology of continuous enhancement, N2 and its derivative will further extend our technology leadership position and enable TSMC to capture the AI-related growth opportunities way into the future. Finally, let me talk about our specialty technology strategies at mature node. For TSMC today, around 70% of our total revenue is 16 nanometre and more advanced node. With rising contribution from 3 nanometre and 2 nanometre technologies in the next several years, this number will only increase. Thus, our mature node exposure is around 20% of our total revenue. TSMC's strategy at Mature Knowledge is to work closely with strategic partners to develop specialty technology solutions to meet customers' requirements and create differentiated and long-lasting value to customers. Our focus is to build a high yield capacity for specialty technologies rather than just a nominal capacity. through the deployment of differentiated specialty technologies, the profitability of our mature nodes can be around our corporate average gross margin. Looking ahead, we forecast 28 nanometres will be the sweet spot for our embedded memory applications, and we expect our long-term structural demand at 28 nanometer to be supported by multiple types of specialty technologies. Thus we are expanding our 28 nanometer specialty manufacturing capacity overseas to support the long-term structural market demand. We believe demand for the differentiated specialty technology will remain steady despite the potential industry capacity increase and our utilization rate and structural profitability can be well protected in the future. This concludes my prepared remarks and now let me turn the microphone over to Mark.

Thank you, CC. Good afternoon, everyone. First, let me talk about our global manufacturing footprint update. TSMC's mission is to be the trusted technology and capacity provider for the global logic IC industry for years to come. In today's fractured globalization environment, our strategy is to expand our global manufacturing footprint to increase our 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 subsidy or support. This is to maximize the value for our shareholders. Firstly, in Japan, we are building a specialty technology fab in Kumamoto. which will utilize 12 and 16 nanometer and 22 and 28 nanometer process technologies. We will hold an opening ceremony for this FAB on February 24th next month. And volume production is on track for the fourth quarter of 2024. In Arizona, we are in close and constant communication with the U.S. government on incentive and the tax credit support and making strong progress in facility supply chain infrastructure, utility supply and equipment installation for our first FAP. We continue to work closely and develop strong relationships with our local union and trade partners in Arizona, including recently signed an agreement with Arizona Building and Construction Trades Council on a new framework for cooperation. This agreement extends our collaboration across enhanced workforce training and development shared commitment to site safety, hiring local workers and establishing regular communication. It is a win-win for all parties. We are well on track for volume production of N4 or four nanometer process technology in first half of 25 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 Europe, we plan to build a specialty technology fab in Dresden, Germany, focusing on automotive and industrial applications with our joint venture partners. We continue to be in close communication with the German federal, state, and city governments, and their commitment to this project remains strong and unchanged. FAB construction is scheduled to begin in Q4 2024, this year. In Taiwan, of course, we continue to invest in and expand our advanced technology capacities to support our customers' needs and their growth. Given the robust multi-year demand for our three nanometer technologies, we are expanding our three nanometer capacity in Tainan Science Park. We are also preparing our N2 volume production starting in 2025. We plan to build multiple FAPs or multiple phases of two nanometer technologies in both Jin Chu and Kaohsiung Science Parks to support the strong structural demand from our customer CZ just mentioned. In Taichung Science Park, the government approval process is ongoing and is also on track. While the initial cost of overseas FAB I previously mentioned are higher than TSMC's FAB in Taiwan, we are confident to manage and minimize the cost gap and remain committed to deliver profitable growth and maximize the value for our shareholders. Now, let me talk about my retirement. On December 19th last year, I announced that I have decided not to seek nomination of board members for the next term and will retire from the company after the 2024 annual shareholders meeting in June. Allow me to say this, over the past 30 years, I have been incredibly fortunate to be able to work at and contribute to TSMC I started at TSMC 30 years ago as a leader of a small four-person fab construction team. It has been my privilege to serve as chairman of TSMC. And after our legendary founder, Dr. Morris Chang, over the last six years. During this time, we have reaffirmed our commitment to our mission to be the trusted technology and capacity provider to the global logic IC industry for years to come, while adhering to our core values of integrity, commitment, innovation, and customer trust. TSMC's success is predicated on providing the industry's most leading-edge processing technology at scale. in the most efficient and cost-effective manner to enable all the innovators to successfully offer their best products to the world. We together have worked diligently to enhance our focus on our technology leadership, competitiveness, global manufacturing footprint, digital excellence, sustainability, and corporate governance to maximize the value for our customers and our shareholders. The past 30 years with TSMC has been an extraordinary journey for me, and I want to extend my sincerest thanks to our incredible, talented team and all our TSMC's colleagues, whose diligence, dedication, and can-do spirit have made the company into what it is today. Now, TSMC's nomination, Corporate Governance and Sustainability Committee of the Board has recommended Dr. C.C. Wei to succeed as the company's next chairman, subject to the election of the incoming board in June 2024. If Dr. Wei is elected to be chairman, he should also continue in his current role as CEO. supported by a deep and experienced team of senior executives, many of whom have been with TSMC for many, many years. As I look ahead to spend more time with my family and starting the next chapter of my life after our AGM in June, I remain fully confident in TSMC's strategy, leadership, and execution and firmly believe TSMC will continue to perform outstandingly in the years ahead. Thank you for your trust in TSMC and the best is yet to come for the company and its shareholders. This concludes my messages and our key messages together. Thank you for your attention.

Thank you, Chairman. This concludes our prepared statements. So before we begin the Q&A session, I would like to remind everybody to please, again, limit your questions to two at a time so we can allow all the participants an opportunity to ask their questions. Questions will be taken both from the floor and also from the call online. Should you wish to raise your question in Chinese, I will translate it to English before our management answers your question. So for those of you on the call, if you would like to ask a question, please press the star then one button on your telephone keypad now. If at any time you'd like to remove yourself from the questioning queue, please press star then two. So now let's begin the Q&A session. Again, our chairman, Dr. Mark Liu, will be the host. Let's take the first two questions from the floor, please. Okay. Our first question comes from Charlie Chen from Morgan Stanley.

Thank you, Jeff and Mark, Cece and Wendell. It's great to see you again in person. Happy New Year. Allow me to remain seated. I have some long questions to you. The first question is to Cece. I am very curious about your comments about the technology leadership, right, because you're compared and also customer intel states that their PPA is ahead of your two nanometer, even the cost is lower. So I want to consult your opinion why there's a different story and how do we judge. And given these debates, how TSNC is going to plan the future capacity for this customer and also competitor. We want to seize this opportunity, but also avoid any over expansion. Thanks.

Okay. Thank you, Charlie. Just please allow me for the benefit of the audience here in person and online to summarize your question. So Charlie, first question is around sort of the technology leadership and also our relationship, I guess, or capacity planning with a specific IDM. So the first part of his question is on the technology part. He notes this IDM. It says their PPA is ahead of TSMC's two nanometer, and the cost can be lower. Yet we said our technology is industry-leading, so how do we reconcile the difference? And also, how do we plan the future capacity planning for such type of customer?

Charlie? You named my customer's name. That's my customer, yeah, my competitor. Let me repeat the last time when I comment on their technology. The comment stays the same. So that their newest technology will be very similar or equivalent to TSMC's N3P. We further check again with all the specs, all the possible published in technology, transistor technology, and everything. My comments stay the same. We saw big advantage in the technology maturity. because in 2025 when they say that their newest technology will be go on production for TSMC, that will be the third year with a very high volume production in the fabs. So again, I don't want to make too much of a comment on my customers' claim, but let me assure you, We continue to have technology leadership and we continue to have a broader base of customers and almost everybody, almost, they are working with TSMC.

Thank you.

Certainly, we are expand our capacity with 28 to 32 billion. That's a big money. That will be used for three nanometer and two nanometers of capacity.

Let me add some color to this, Cici. I think Cici has been very modest. I think he's claimed that RN3P is comparable to their I18A. We still affirm our statement. But I would like you to look at a different perspective. And what the other side claim might be right, but it's only to their own product. And IDM typically optimize their technology for their own product. Where Foundry, us, we optimize our technology for our customer's product. So that's a big difference. What's useful for the high power server could be very different than what used with the sketches on your hand, smartphone, or even the large data AI processors. So you should look at this. I think the time compared with PPA, we still confirm our statement. But I think just look at our customer's action that just tells us all the stories.

Thanks. Thanks, Mark. So Jeff, can I go for a second one? Yes. So Mark, so first of all, I really appreciate your leadership. I believe global investors appreciate your past six years, create lots of shareholders' value. Thank you. So my question is about the content of your speech in November. you the the speech was about the tsnc in the era for ai and you mentioned some uh very interesting data points you use the ai technology to improve the defects clarification also the uv throughput by for example ten percent right so now it's the generative ai can be very uh a big breakthrough in terms of technology do you think uh samsung or Intel by leveraging the generative AI can really break through and catch up your technology. And also before your retirement, any kind of a big unfinished goal or targets for TSMC. Thank you.

Okay, thank you, Charlie. So Charlie's second question is directed to Chairman. He noted in November, Chairman gave a speech where he shared how TSMC has always been utilizing big data, machine learning, and AI to improve our operational efficiencies. His question is whether now with generative AI, will this enable or allow our competitors to do the same thing and catch up and narrow the gap? Yeah.

Okay, thank you, Charlie. The talk I gave in last November was the audience is the Taiwan's industry companies. The purpose I want to give that is I see artificial intelligence can be a great opportunity for the industry in Taiwan. Just like Taiwan is a big country for semiconductor, it can be a big country for artificial intelligence in the future. That's how I encourage them. And as far as whether our competitor are using AI, of course, of course they use AI. And just look at all the company, AI company in Silicon Valley or in US. That's not a secret. But on the other hand, AI is only in its nascent stage. Only last November, the first large language data is... announced, we only see the tip of the iceberg. So I want to give industry an optimistic note that even though one nanometer or sub-one nanometer could be challenging, but we have a new technology capability using AI to accelerate the innovation in science. And that is a part. And we have been working on that for many years already. So we opened, of course, it's a fair competition. It's no secret. Oh, you have another question about one? Well, I still have a, yes, indeed, I will retire in June. And from now to June is a long time. And the company, a lot of things can happen. And I think, I hope we definitely execute to CC's forecast of this year. I think by the middle of this year, I think we're pretty sure we can accomplish that. And of course, CC just mentioned our technology development is on the slew of success. And by June next, this year, we will know what we are going to fare in 2025. And I give our executive a milestone. I don't want to share with you, but it's going to be very exciting for TSMC. And of course, from now on, I simply want to encourage our people in TSMC that the world has changed. Just like you mentioned, we have to use artificial intelligence for future technology. So we will go into global, we try our global footprint. And we are trying our digital excellence. By digital excellence, you mean we can't count on the hard working of Taiwan engineer. Only we have to recreate our job to tap their talents and lift up the semiconductor technology engineering to a different level based on what we already have. And of course, the corporate governance is one thing I always in my heart. During this transition, I want every executive and our board to adhere to the sound corporate governance so that make sure all the process steps is abided by our ethical governance rules. Thank you.

Okay. Thank you, Chairman. Let's take the move on to the second person from the floor. I think in front, Bruce Liu of Goldman Sachs, please.

Thank you. Again, the question is definitely coming from the AI for sure. I think as CC mentioned, almost every AI chip is working with TSMC. However, the investor's concern is always like the dollar content as a percentage of customer's cost for AI is a lot lower than smartphone or other chips. So as also CC mentioned that you sell a wafer for your customer, but when you buy it back, it's a lot more expensive. So can we expect that the dollar generated by TSMC from AI can be increased in the coming years, whether it's through no migration or advanced packaging or anything we can expect, or what kind of rate we can expect for that?

Okay, let me summarize Bruce's first question. I think, again, it's around AI-related. He notes that basically almost all the innovators are working with TSMC at AI, but the value per chip that we seem to be capturing is lower than for a smartphone or PC. So his question is that, I think, can we expect the dollar value captured by TSMC to increase in the next few years, and will this be this additional value more come from the front end process node wafer production, or will it be through the advanced packaging solutions?

Well, let me answer the easiest one first. The revenue comes from the front end and back end together. To capture the value, yes, we are working on it, definitely. But first, let me say that I'm very happy that my customer has been very successful in the AI area. And we are a key enabler for the AI applications. So far today, everything you saw on the AI came from TSMC. Now here comes the question, how are we going to capture the value? We are working on it and actually we see Today, let's say that the component, the total value in the AI, the whole AI data centre is a very small percentage amount. If we narrow down the AI component or the semiconductor's value in the whole system, yes, it's a small percentage. But for TSMC, we look at it ourselves, the AI is a kegger. The growth rate every year is about 50%. And we are confident that we can capture more opportunities in the future. So that's why we said that Up to 2027, we are going to have high teams of the revenue from very narrow we define the AI application process. Not to mention about the networking, not to mention about all others. And to further extend our value, actually, all the edge devices, including smartphone, including the PC, they start to put the AI applications inside. They have some kind of a neural processor, for example. So the silicon content will be greatly increased. Although the unit is actually a low single digit in CAGR, but the silicon content is more important. So put all together, if we run some of the AI-related application, actually it's quite a big amount for TSMC to grow.

Okay. Bruce, do you have a second question, please?

Yeah. The second question is more for the, you know, technology leadership. I mean, as we're moving into the nanoship or, you know, the advanced node, we see another technology divide nowadays. You know, as, for example, like a high NA, you know, EUV tools. You know, TSMC seems to have a different view with other peers. I mean, in the past like 20, 30 years, you know, there are several technology divide that TSMC always choose the right decisions, right? So can you tell us that why you choose, you know, your current route compared to your peers? What is the pros and cons and what's the advantage and how confidence that TSMC can leverage that to be the key success factor for the leading edge?

okay uh bruce's second question is in regards i think to technology development and decision making basically he notices that uh today there's divergence or his words divide between uh different companies technology decision whether to adopt manual sheet transistor structure whether to adopt high-end tools he notes in the past that this has always occurred in our industry, but TSMC has somehow managed to make the right decision. So he is asking especially, what do we look at or evaluate in our decision-making process? What are the pros and cons and advantages? And probably most importantly, how confident are we about our technology decisions going forward, whether nanosheet or high NA, given our competitors' actions?

Ruth, you ask a very technical question. I'm not very sure everybody know the high-end A or is narrow-sheet or get-all-run, but let me answer the question. We always make the right decision, and our track record shows that. Is that enough? Okay, let me elaborate a little bit more. Because of technology itself is no value, only when it can serve your customer. So we always work with our customer to give them the best transistor technology and the best power-efficient technology and at a reasonable cost. And more importantly, the technology maturity that in the high volume production. That's all important, everything. Everything counted together so every time we know that there are some new structure, there are new tools such as high-end EUV, We look at it carefully, look at the maturity of the tools, look at the cost of the tools, and look at the schedule of how to achieve it. We always make the right decision at the right moment to serve our customer. And so far, all our customers are happy with TSMC's progress. Okay, did that answer your question? Almost everybody work with TSMC on two nanometer except one. Thank you.

Okay, thank you, CC. All right, let's go to the online, take the next two questions from the participants who are dialing in via the conference call, please. Operator, could you please state the name and company name?

Yes, sir. First of all, the last question from the line is from . Yeah, hi.

Thank you for taking the question. . uh...

Okay, I need you to slow down a bit because the line is not that clear. I do think I got his question, which is he wants to confirm. CC, you mentioned that we have a very narrow definition. We call server AI processor contribution, and that you said it can be high teens in five years' time because the last time we said low teens.

The demand is suddenly being... increase since last year, the first quarter, up to March or April when chat GPT become popular. customers respond quickly and ask TSMC to prepare the capacity both in front-end and the back-end. That's why we have a confidence that this AI's revenue will increase. We only narrow down to the AI application process, by the way. We look at ourselves that we prepare the technology and the capacity in both our front-end and also back-end. It's in the early stage so far today. We already see the increase, the momentum, and we expect if you guys continue to track this one, the number will increase. I have confidence to say that, although I don't know how much. So high teens, you confirm.

Or higher. OK. So, OK, Gokul, hopefully that clarifies that first question.

OK, thank you very much.

My second question is about stock market. In the down zone, we are forming out at much higher stock market levels than before. Could you talk a little bit about what happens when we get back to close to full utilization? So we are still running at well below full utilization in 2023. And could you also explain the gross margin dilution that you're expecting in second half 23 because of this capacity conversion? What exactly leads to that gross margin dilution? And is that a like a one-time kind of valuation that lasts for a little bit of time and kind of levels off in 2025.

Okay, thank you, Gokul. So if I heard correctly, Gokul's second question is around gross margin. So two parts to it. Maybe the second part first, which is he is asking, I believe, about the gross margin in the second half of this year. particularly with what Wendell had described, our plan to convert some of the capacity, the gross margin impact here, and is this a one-time thing? Is this better capital? What does this mean in the mid- to long-term profitability? That's the first part, and then I'll go to the second part.

Right. Second half. The, as I said, there are two negatives factors affecting our gross margin this year. The first one is the N3 dilution. N3 volume will be much bigger in the second half than the first half. So the second half impact from N3 dilution will be between three to four percentage points. And also the N5 capacity converted to N3, that will mostly take place in the second half as well. So that will be one to two percentage point. That's for this year. For the longer term, if you look at these two factors, our N3 dilution will gradually reduce because the profitability will continue to improve or increase in the next several years. And N5 converted to N3, it's a one-time short-term impact on profitability, which will bring capital efficiency to us in the middle to long term. And the benefits together will be much bigger than the one-time hit in the short term. So if you're talking about a longer term profitability, including these two factors, plus we are, selling our value, our technology value, as CC mentioned. We continue to drive down the cost. We build our capacity based on the long-term market profile and not the short-term cyclicality, and therefore enable us to have a pretty good utilization. The only thing we are not able to control is foreign exchange rate. So if you put all these together, we still believe that 53% and higher long-term gross margin is achievable.

Okay, Gokul, does that answer both parts of your question?

Yeah, so just to clarify, so given we are at a much lower utilization than normal, what you suggest, Vendul, is that gross margin should get back to the mid to high 50s once the up cycle starts to gain more momentum, just like what we saw in 2022. Is that a reasonable expectation? Yeah.

Okay. Thank you, Gogo. So Gogo really, he's asking 53% and higher, can it be higher? Because, of course, he looks at last year, the utilization was lower, and we still managed to deliver. So he's wondering once utilization goes back to full, can it get to mid to high 50s?

We are working on it. Certainly we prepare our capacity according to customer's demand. Last year is very challenging because everybody missed their forecast. And so did TSMC. And so the utilization rate is pretty bad. And I believe everybody got more experience in the next few years, and so TSMC's utilization rate will continue to increase. I guarantee that.

Okay, thank you. So the question is, we're working on it. It can be.

Okay, thank you, Gokul. Thank you. Operator, let's move on to take the question from the second participant on the call.

The second one to ask question is Randy Abrams from UPS.

Okay, yes, thank you, and good luck to both Mark and Cece as you go through the upcoming transition. I wanted to ask, going back to the question on the IBM, I think earlier you conceded that your competitor's process is actually pretty good for optimized to their own products. Could you talk about your view on sustainability of the ramp of that IBM outsourcing with your own products and HPC? If you look at over the next two to three years, if you see that continuing to grow or reverse, where there could be a bit of a cooling off from some of the opportunity you have right in front of you now? Sure.

Okay, thank you, Randy. So Randy's first question goes back to the IDM. His question is, you know, with the IDM saying their technology is pretty good, what is the risk or how do we see the sustainability of this IDM's outsourcing business to TSMC in the next two to three years? Can this continue to grow or will this reverse and go back in-house to the IDM and how do we manage or plan for this?

Randy, that's a good question. Actually, we have taken into account all the considerations, including the IDM can do it by themselves. We have put that one into consideration actually in our capacity planning. Actually, we took a very conservative way to prepare our capacity in this kind of a situation. Okay. I cannot speak more because of, you know, that's our strategy.

Okay. If I could ask a follow-up actually just to the CapEx, where I think earlier you said the rate of increase would but I think still implying it should increase over time as you grow. If you could discuss the CapEx that you guided, Boost Flat, should we think of it as a pause, whereas you start to move into true nanometers, there should be another wave of increase? And second part, somewhat related, but curious about the geographic expansion. There's been a lot of press about new fabs in Japan, second fab and potential expansion. third advanced fab. And it feels like the first fab went smoothly. So are you starting to redirect or think more expansion to Japan rather than U.S. or potentially both? Do you have both options as you move to three nanometer?

Okay, Randy, that's a lot of questions. So I'm going to take that as your second question, okay, basically. So the first part of it is about the CapEx. He notes that Wendell said the rate of increase is beginning to level off. Randy's question is, you know, for this year and take the midpoint 30 billion, it's basically flat. So is this just a temporary pause in the CapEx? And with two nanometer in the upcoming years, should we expect the dollar amount to go back up? That's the first part.

Okay, Randy, the CAPEX dollar about every year may vary. It depends on the different situation. The rate of increase definitely is slower than the past three years. And if you look at, I think the other way of looking at that is the capital intensity. In the past three years, the highest point is 2021. So it's going to be, it was over 50%, and then followed by 47 and 43. And this year, if you do the math, it's going to be mid-30s. We expect in the next several years it will remain around the 30 percentage capital intensity.

Okay, and then the other part of Randy's question is on the geographic expansion. He notes a lot of reports saying we may build a second FAB in Japan and that we even may build a third. So his question is really are we redirecting our overseas expansion focus more to Japan or has it changed anything in the U.S.? Randy, I think that's what you're trying to ask, right?

Yeah, that's what I'm trying to ask. Thank you.

Can you repeat the question again?

Sure. So Randy is saying, look, he knows there's a lot of talk. We're going to build a second FAB in Japan, maybe three. So he just wants to know, are we shifting our overseas expansion focus to Japan or from the U.S., or is there any big significant change?

No, no. I think you, Japan, the second FAB in Japan is in serious evaluation stage. We haven't announced to the public yet. And we're still discussing with the Japan government. Although many, they are very cooperative, so you might be waiting for that. But that technology will still be either seven or 16, 12 technologies. And remember our Kaohsiung FAB, the first FAB used to be 28 nanometer or seven nanometer. Now it's becoming two nanometer. So that is the shift to for the, if there is a second FAB in Japan, that's our current plan. And as far as the... That's helpful.

Yeah, thank you. To quickly talk about three nanometer, because five nanometer was slightly delayed, would three nanometers still come two years after the new plan for five in Arizona? Thank you.

So in Arizona, Randy wants to know that we have five nanometer in first half 25. What's the plan for the second FAB with three nanometer?

Yes, we are, the second FAB shell is under construction. But what technology in that shell is still under discussion and think that also has to do with how much incentives that FAB, the U.S. government can provide. And Yes, there will be a gap. At least current planning is 27 or 28. That will be that time frame. To be honest, most all the FAM in overseas, what actually be loaded, what technology being set up really IT'S A DECISION OF CUSTOMER'S DEMAND IN THAT AREA, AT THAT TIMING. SO NOTHING IS DEFINITIVE, BUT WE ARE TRYING TO OPTIMIZE THE VALUE FOR THE OVERSEAS FAB FOR TSMC.

THANK YOU, CHAIRMAN. THANK YOU, RANDY. IN THE INTEREST OF TIME, WE'LL TAKE THE NEXT TWO FROM THE FLOOR. I THINK THERE'S ONE HERE. FIRST, LAURA CHEN FROM CITY BANK.

Thank you very much for taking my question. Thank you, gentlemen, Mark, Cece, Wendell, and Jeff. Happy New Year. I think we got a lot of discussion about the leading position in the most advanced node. So I just have a question about what's your view on the mature node dynamic, and particularly We are seeing that globally considered geopolitical tension. So we are seeing that the fab over the place in the world. So do you see that in the longer term any concern on industry-wise over capacity? So what's TSMC's strategy and also what's your view on your mature nose profitability as well? That's my first part.

Okay, thank you, Laura. So Laura's first question is on mature node strategy and profitability. She notes with the geopolitical dynamics that there's a lot of capacity being built on the mature nodes. So her question is, do we see or expect an industry-wide oversupply? And probably more importantly, what is the impact to TSMC's mature node strategy and profitability?

I think your observation is right. There might be too much of a capacity being built right now for mature nodes. So the concern on overcapacity is valid. Now let's talk about TSMC. As I said, TSMC increased the mature node capacity for specialty technology, differentiated with others. We work with customers and that kind of capacity, actually effective capacity as we name it, is with a commitment from customers and for the future of business. And because we offer the value for our customer to design their product, so we believe that they can retain their products of value, even the capacity is in the industry. And so long as our customer is doing well, TSMC is doing well. And so the profitability, as I said in my statement, it will be around the corporate average. We don't have concern.

We speak for TSMC, okay? It could be industry issues.

That's very helpful. Thank you. And also, my second question is back to AI-related. As we know that a lot of investors care a lot about your advanced packaging progress. We also know that TSMC got very good progress on 3DIC, SOIC. So can you share with us your progress, development, beyond COAS, what's your plan on the 3D IC and what's the schedule and the capacity you are aiming for in the next two, three years?

Okay. Thank you, Laura. So, Laura's second question is on advanced packaging. She notes, again, the strong demand for AI-related applications. So, advanced packaging, the progress, of course, COAS demand is very strong. Her question is really, I think, beyond COAS into true 3DIC or integration solutions such as SOIC. What is the progress that we see, the engagement from customers, the capacity, and basically the outlook for these segments of the business?

The demand actually is very strong. Today's situation that we cannot offer enough capacity to support our customer. And that condition will continue probably all the way to next year. Although we are working very hard to increase the capacity, for example, this year we are doubling our output. That's still not enough. And so we continue to increase for the next year. The progress, so far so good because we invested on the advanced packaging technology for more than 10 years already. So we expect the growth rate for co-ops, for 3DIC, or for SOIC per se, it will be more than 50% CAGR in the next few years, at least. And so we are confident that the demand is there. is TSMC's capability to offer enough capacity to support our customer.

For COAS you will be doubling and what's the idea about the next year? Do you have any preliminary thought?

I will talk to you next year.

Thank you.

Okay, thank you. We have a question here from Brad Lynn from Bank of America, Merrill Lynch. I think in the interest of time, we'll take one question from yourself, and then we'll take one more from the line, and then one more in person if there's any.

All right. Wait, hello. Okay, thank you for taking my question. So, well, so my question will be still around N3 and also IDM. So as we understand, the demand is uncertain. But we can definitely increase our business certainty by getting market share. So do we expect some more contribution or market share gain, especially from IDN side, or any more contribution from PC side, maybe by the end of the year or any time soon? Thank you.

Okay, so Brad's first question is about IDM outsourcing. I think, again, given the technology leadership that we have, he wants to know, do we expect more business or outsourcing from the IDM by the end of this year? And how do we see it? Is it uncertain going forward?

That is too specific. You say the IDM outsourcing, I know whom you talk about. So I better not to make any comment. I stay what I said. We take everything into consideration. We welcome the business, but we prepared our capacity expansion. OK.

Got it. Thank you very much.

Your second question?

Yes. So it's on the advanced packaging. So we know that the COAS-S right now is a mainstream. So have the management seen the clients converting to either COAS-R or COAS-L? And then what's the implication to revenue and margin profile?

Okay, so it's also a very specific, too specific question, but again, Brad wants to know, you know, COAS S seems to be the mainstream today. Do we see customers switching to COAS L or COAS R, and what's the margin implication?

Well, let's make a joke. I even didn't know what is co-author R, co-author L. But anyway, we are working with customer to support them with adequate capacity, although it's not 100% enough, but we do our best. And we're developing that next generation co-author L or something like that for our customer. And it's overwhelming that... It will come by all my customers, so we are preparing the capacity for it.

Okay. Got it. Thank you very much. Last but not least, another question. That's two questions. No, no, no, another question. So basically, well, I want to say, well, thank you, Mark, for your leadership contribution and endeavor for the past 30 years, not just for TSMC, but also for Taiwan. And we wish you a happy retirement and also the new chapter of life. Thank you.

okay uh we will take the final questions from the last two participants let's go online first then we have one in final in person okay operator next from the call is krishankar from td cohen go ahead please yeah hi thank you for taking the question i have two of them uh first one uh i think when we spoke about revenue growth for the year

And again, from growth margin guidance, I'm just trying to wonder how to think about growth margin for the full year in the context of the fact that here companies are only going to grow in the low to mid 20%. How do you think about growth margin for full year 2024? And then I'll add a follow-up.

Okay, Krish, again, sorry. We could not hear you that clearly online, but I think his question is, correct me if I'm wrong, with the revenue outlook that we gave low to mid-20s growth in U.S. dollar term, what is the outlook for the full year gross margin? Is that what you're asking? Yeah, okay. That's right, Jeff, yes.

Right. So I just mentioned a couple of puts and takes on the gross margin of this year. And I also said that the second half we will have a higher delusion from two factors. But we're not ready to give out a full year guidance on gross margin yet. So we'll talk about that as time goes by. But let me say this, longer term, with all the factors together, it's still 53% or higher. It's definitely, we're very confident in achieving that.

Okay, does that end? Sorry, Chris, why don't you go ahead?

Yeah, just a quick follow-up, and I just want to say thanks a lot to Mark for all his support. Just a follow-up. In terms of the revenue growth for this year, you know, December quarter you exhibited HPC and smartphone roughly 43% of revenue. What's going to drive the growth this year? Is HPC or smartphone? Which is going to be better this year to get to the low to mid-20%?

Okay, Krish, sorry. Again, we could not hear you that clearly, but I think I got the gist of your question. Maybe the way Krish's question is what, you know, the components that's driving the revenue growth this year, maybe we can share with him by the four growth platforms.

Chris, the HPC will have the highest growth, actually much higher than the corporate. The other three platforms will all grow, although slower than the corporate.

Thank you very much. Thank you, PC. Thank you, Mendel. Thank you, Mark. Thank you.

Yep, no problem, Krish. Okay, then we'll take the final question from the floor, the first row here. Nicholas Barrett of Macquarie. The microphone is on. It's on, thanks.

Very quick question. Thank you very much, Jeff. Is it possible or would you expect that some of your Arizona customers could be only customers in Arizona? That some U.S. customers only want to buy wafers made in the U.S.? ?

Sorry, your question is, will customers in Arizona only be U.S. customers?

Is it possible that some U.S. customers only want U.S.-made wafers?

Let me answer that question. Arizona fab is for everybody, but majority is a U.S. customer. You are right. Sure. Thanks.

That's all, Jeff. Thanks.

Do you have another question? No? Okay. Well, if not, then this does conclude 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 which are going to be available through our website, TSMC's website at www.tsmc.com. So thank you again, everyone, for joining us today. We hope everyone continues to stay well, and we hope you will join us again next quarter Goodbye and have a great day. Thanks.