Taiwan Semiconductor Manufacturing Company Ltd.

Hello, friends of the investment world and the media. Good evening, everyone. I am Su Zhikai from Taichi.com's Legal Relations Department. I would like to welcome you to participate in the Legal Explanation Conference of Taichi Company in the second quarter of 2024. Since this conference will be broadcast to global investors at the same time, we will use English throughout the conference. Please excuse us. Good afternoon, everyone, and welcome to TSMC's second quarter 2024 earnings conference and conference call. This is Jeff Su, 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 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 Senior Vice President and CFO, Mr. Wendell Huang, will summarize our operations in the second quarter 2024, followed by our guidance for the third quarter 2024. Afterwards, Mr. Huang and TSMC's chairman and CEO, Dr. Cici Wei, will join me to provide the company's key messages. Then we will open both the floor and the line for the Q&A session. As usual, I'd like to remind everybody that today's discussions may contain forward-looking statements that are subject to significant risk and uncertainties, which would 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 microphone over to TSMC CFO, Mr. Wendell Huang, for the summary of operations and the current quarter guidance.

Thank you, Jeff. Good afternoon, everyone. Thank you for joining us today. My presentation will start with the financial highlights for the second quarter of 2024. After that, I will provide the guidance for the third quarter of 2024. Second quarter revenue increased 13.6% sequentially in NT, or 10.3% in US dollars, as our business was supported by strong demand for our industry-leading three and five nanometers technologies, partially offset by the continued smartphone seasonality. Gross margin increased 10 basis points sequentially to 53.2%, mainly reflecting cost improvement and the more favorable foreign exchange rate, partially offset by the margin dilution from N3 ramp. Due to the operating leverage, total operating expense accounted for 10.5% of net revenue as compared to 11.1% in the first quarter. Thus, operating margin increased 0.5 percentage points sequentially to 42.5%. Overall, our second quarter EPS was 9.56 NT and ROE 26.7%. Now let's move on to revenue by technology. Three nanometer process technology contributed 15% of wafer revenue in the second quarter. while five nanometer and seven nanometer accounted for 35% and 17% respectively. Advanced technology defined as seven nanometer and below accounted for 67% of wafer revenue. Moving on to revenue contribution by platform. HPC increased 28% quarter over quarter to account for 52% of our second quarter revenue, surpassing 50% for the first time. Smartphone decreased 1% to account for 33%. IoT increased 6% to account for 6%. Automotive increased 5% to account for 5%, and DCE increased 20% to account for 2%. Moving on to the balance sheet, we ended the second quarter with cash and marketable securities of 2 trillion NT, or 63 billion U.S. dollars. On the liability side, current liabilities increased by 23 billion NT mainly due to the increase of 16 billion in accounts payable. Long-term interest bearing debt increased by 9 billion NT mainly as we raised 12 billion in corporate bonds. On financial ratios, accounts receivable turnover days decreased by three days to 28 days. Days of inventory decreased by seven days to 83 days, primarily due to higher N3 wafer shipment. Regarding cash flow and CAPEX, during the second quarter, we generated about 378 billion NT in cash from operations, spent 206 billion in CAPEX, and distributed 91 billion for third quarter 23 cash dividend. Overall, our cash balance increased 101 billion NT to 1.8 trillion at the end of the quarter. In US dollar terms, our second quarter capital expenditures totaled 6.36 billion. I finished my financial summary. Now let's turn to our current quarter guidance. Based on the current business outlook, we expect our third quarter revenue to be between 22.4 billion and 23.2 billion US dollars, which represents a 9.5% sequential increase or 32% year over year increase at the midpoint. Based on the exchange rate assumption of one US dollar to 32.5 NT, gross margin is expected to be between 53.5% and 55.5%. Operating margin between 42.5% and 44.5%. This concludes my financial presentations. Now let me turn to our key messages. I will start by talking about our second quarter 24 and third quarter 24 profitability. Our second quarter gross margin was 53.2%, slightly ahead of the high end of our guidance, mainly as we saw a higher than expected overall capacity utilization rate as compared to our forecast three months ago. We have just guided our third quarter gross margin to increase by 1.3 percentage points to 54.5% at the midpoint. This is primarily due to the higher overall capacity utilization rate in the third quarter and better cost improvement efforts, including productivity gains, partially offset by continued dilution from N3 ramp-up, N5 to N3 tool conversion costs, and higher electricity prices in Taiwan. Excluding the impact of foreign exchange rate, of which we have no control over, and factoring in the margin impact from 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. Every year, our CAPEX is spent in anticipation of the growth that will follow in the future years. And our CAPEX and capacity planning is always based on the long-term market demand profile. As the strong structural AI-related demand continues, we continue to invest to support our customers' growth. We are narrowing the range of our 2024 capital budget to be between 30 billion and 32 billion US dollars as compared to 28 to 32 billion US dollars previously. Between 70 and 80% of the capital budget will be allocated for 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. At TSMC, a higher level of capital expenditures is always correlated with the higher growth opportunities in the following years. Now, let me turn the microphone over to CC.

Thank you, Wendell. Good afternoon, everyone. First, let me start with our near-term demand outlook. We concluded our second quarter with revenue of U.S. dollar 20.8 billion, above our guidance in U.S. dollar terms. Our business in the second quarter was supported by strong demand for our industry-leading 3-nanometer and 5-nanometer technologies. particularly offset by continuous smartphone seasonality. Moving into third quarter 2024, we expect our business to be supported by strong smartphone and AI related demand for our leading edge process technologies. Looking at the full year 2024, we forecast the overall semiconductor market excluding memory to increase by about 10%, which is unchanged from our forecast three months ago. At this time, we would like to expand our original definition of foundry industry to Foundry 2.0. which also includes packaging, testing, mass making, and others, and all IDM excluding memory manufacturing. We believe this new definition better reflects TSMC's expanding addressable market opportunities in the future. However, I want to emphasize here that TSMC will only focus on the most advanced back-end technologies which help our customers in leading-edge products. Under this new definition, the size of the foundry industry was close to $250 billion in 2023, as compared to $115 billion under the previous definition. With our new definition, we forecast the foundry industry growth to be close to 10% year over year in 2024. TSMC's share of the foundry industry, under our new definition, was 28% in 2023. Supported by our strong technology leadership and broad customer base, we expect this one to further increase in 2024. Over the past three months, we have observed strong AI and high-end smartphone-related demand from our customers. As compared to three months ago, leading to increasing overall capacity utilization rate for our leading-age 3 nm and 5 nm process technologies in the second half of 2024. Thus, we continue to expect 2024 to be a strong growth year for TSMC. We are raising our full-year guidance and now expect our 2024 revenue to increase slightly above mid-20s percent in US dollar terms. Next, I will talk about TSMC's capacity planning process and investment disciplines. This is important, especially when we have such high forecasted demand from AI-related business. TSMC's mission is to be the trusted technology and capacity provider for the global logic IC industry for years to come. The continued surge in AI-related demand supports a strong structural demand for energy-efficient computing. As a key enabler of AI applications, the value of our technology position is increasing. as customers rely on TSMC to provide the most advanced process and packaging technology at scale in the most efficient and cost-effective manner. As such, TSMC employs a disciplined framework to address the structural increase in the long-term market demand profile underpinned by the industry megatrend of AI, HPC, and 5G. We work closely with our customers to plan our capacity. We also have a rigorous and roll-out system that evaluates and judges market demand from both a top-down and a bottom-up approach to determine the appropriate capacity to build. Our capital investment decisions are based on four disciplines. that is technology leadership, flexible and responsive manufacturing, retaining customers' trust, and earning a sustainable and healthy return. To ensure a proper return from our investment, both pricing and cost are important. TSMC's pricing strategy is strategic, not opportunistic, to reflect the value that we provide. Today, we are investing heavily in leading-edge specialty and advanced packaging technologies to support our customers' growth and enable their success. If customers do well, TSMC should do well. For example, we are happy to see many of our customers' structured profitability improving in these past few years. At the same time, we face rising cost challenges due to increasing process complexity at leading nodes, higher electricity costs in Taiwan, global fare expansion in higher cost regions, and other cost inflation challenges. Therefore, We will continue to work closely with our customers to share our value. We will also work diligently with our suppliers to deliver on-cost performance. We believe such actions will help TSMC earn a sustainable and healthy return so that we can continue to invest in technology and capacity to support our customers' goals and fulfill our mission as a trusted, friendly partner who are delivering profitable growth for our shareholders. Finally, I'll talk about our N2 status and A16 introduction. Our two nanometer and A16 technologies lead the industry in addressing the insatiable need for energy efficient computing. And almost all the AI innovators are working with TSMC. We expect the number of the new tape-outs for two nanometer technologies in its first two years to be higher than both three nanometer and five nanometer in their first two years. And to what deliver full load performance and power benefit, with 10 to 15 speed improvement at the same power, or 25 to 30% power improvement at the same speed, and more than 15% chip density increase as compared with the N3E. And to technology development, its progression well, with device 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. With our strategy of continuous enhancement, we also introduced N2P as an extension of our N2 family. N2P features a further 5% performance with the same power or 5% to 10% power benefit at the same speed on top of the N2. N2P will support both smartphone and SPG applications, and volume production is scheduled for the second half of 2026. We also introduced the A16 as our next network-based technology, featuring Super Power Rail, or SPR, as a separate offering. TSMC's SPR is an innovative, best-in-class, backside power delivery solution that is a force in the industry to incorporate another backside contact scheme to preserve gate density and device with flexibility. Compared with the N2P, A16 provides a further 8-10% speed improvement at the same power, or 15-20% power improvement at the same speed, and additional 7-10% chip density gain. H16 is best suited for specific HPC product with complex signal route and dense power delivery network. Volume production is scheduled for second half 2026. We believe N2, N2P, A16, and its derivative will further extend our technology leadership position and enable TSMC to capture the growth opportunities well into the future. This concludes our key message, and thank you for your attention.

Thank you, Cici. Thank you, Wendell. This does conclude our prepared remarks. Before we begin the Q&A session, I would like to remind everybody to please limit your questions to two at a time to allow all the participants an opportunity to ask their questions. Questions we will take both from the floor and from the call. Should you wish to raise your question in Chinese, I will translate it to English before our management answers your question. For those of you on the call, if you would like to ask a question, please press the star, then the one on your telephone keypad now. If at any time you would like to remove yourself from the questioning queue, please press star two. Now we will begin the Q&A session. I would like to take the first few questions from the floor, then we will go on to the call. So let's begin. The first question we please take from Goku Hariharan from JP Morgan. Thank you.

Thanks, Jeff. Good afternoon, Cece, and good afternoon, Wendell. Thanks for giving us the picture in terms of how you are planning future capacity. Just on AI accelerator and related capacity, both front end and advanced packaging, Clearly, every customer is queuing up at DSMC for capacity. I think last time we talked about this, maybe a couple of quarters back, CC, you mentioned we expect to see supply to kind of reach balance, supply-demand to reach balance by end of this year. Just wanted to see what is your current remark. How do you think about supply-demand balance for AI accelerator and Covax advanced packaging capacity? And I think in your symposium, you talked about 60% CAGR component growth for Covax capacity in the next four, five years. So could you talk a little bit about how much capacity for Covax would you be planning to build next year as well? Like last year, you said you're going to be doubling the capacity this year. Now that we are in the middle of this year, maybe can we get a view on what is the capacity expansion for next year? That's my first question. Thank you.

Okay. Gokul. All right. For the benefit of the audience online and in person, please allow me to kind of try to summarize your question. So Gokul's question, first of all, he understands and appreciates TSMC's discipline framework in terms of looking at how to build capacity. His question is that it seems that everyone today, AI accelerators and advanced packaging, is queuing at TSMC to ask for capacity. So his question is, when do we, CC, expect supply-demand to reach a balance, both for the accelerator side and then for the co-ops? At the symposium, we said co-ops capacity will grow at a 60% CAGR the next few years. He also wants to know what are we planning to build or increase for 2025 co-ops.

I also try to reach the supply and demand balance, but I cannot today. The demand is so high, I had to work very hard to meet my customers' demand. We continue to increase. I hope sometime in 2025 or 2026, I can reach the balance. You're talking about CAGR or those kind of increment, increase of the cold water capacity. Now it's out of my mind. I mean, we continue to increase whatever, wherever, whenever I can. Okay. The supply continue to be very tight all the way through probably 2025 and I hope it can be eased in 2026. That's today's situation.

Any thoughts on next year capacity? Like, are you going to double your capacity again next year for co-ops?

The last time I say that this year I doubled it, right? More than double. Okay. So next year, if I say double it, probably I will answer your question again next year and say more than double. Okay. We are working very hard, as I said. wherever we can, whenever we can. Okay, thank you.

My second question is regarding gross margins. I think second half guidance already seems to be better than what originally we were thinking, that gross margin could drop in second half, but it looks like it's actually going up. and uh looks like a lot of the headwinds on gross margin is coming in this year so how should we think about gross margin looking forward for tsmc are we going to get back to the high 50 60 gross margin that we saw in 2022 given that you got you're selling more of your value you have uh some of the entry tailwinds in terms of yield improvement coming through. Into that, I will also ask, how should we think about impact of subsidies and ITC credits as you start ramping your overseas locations? How does that impact cost and gross margin? Because there's also some subsidies coming in and currently TSMC is mostly talking about gross capex and gross spend.

okay so let me uh summarize goku's second question is around gross margin and profitability uh he notes second half uh 24 gross margin seems to be uh better than uh we the expectation so his question is really how should we think about gross margin in the next several years he notes you know as we said we will sell our value and the dilution of entry will gradually reduce So, you know, where can the gross margins go back to a high 50s or 60 percent? That kind of level that we saw a few years ago in 2022. Maybe that that's the first part of it. That's a good question. I'll stop here. Then I'll get to this thing.

Sure. Goku, let me share with you some of the puts and takes on gross margin 2025 and a little bit beyond that. You already talked, there are positives and there are negatives. You already mentioned positive will be a decrease in dilution from N3. We're selling our value. And we continue to drive down our cost, increase the productivity. That is, we are very good at that. On the other hand, let's use N5 conversion to N3 as an example. We are not ruling out the possibility of further converting more M5 to M3 because we're seeing very strong demand for M3. If we decided to do that, of course, there will be a negative impact on the year that we do that. But in the future years, that will be beneficial. We continue to face cost challenges, inflation cost challenges, including electricity prices, et cetera. And also, we are beginning the production of our overseas FAB, two overseas FABs next year, the phase one of Arizona FAB and phase one of the Kumamoto FAB. We expect that the overseas FABs will dilute our gross margins by between two to three percentage point next year and in the next several years. So those are the puts and takes to give you the concept. However, we've taken all that into considerations with our efforts in manage the cost gap, especially between the overseas factor and Taiwan. We're repeating and confident to say that 53% and higher gross margin is achievable. So I think that's the first part of your question.

Yeah, that's right. And then maybe also just Goku asked if it's possible to get back to the high 50, 60% level that we saw in 2022.

Yeah, if we have a very high utilization rate, everything else stays the same, possible.

And then the second part of his question was, what is the impact from the different government incentives, including the CHIPS Act, ITC credits in the U.S., et cetera, to the financials, and also, I think, partly gross capex and net capex.

Thank you. Generally speaking, when subsidies are received, then you see that on the cash flow statement. it will be used to offset the asset value. That will be on the balance sheet. When this FAB begins to production, the P&L impact will come in. So generally speaking, it's like that. Different government has different approach in providing the grants. So that's a different story. But you can look at our financial statements. There will be actual subsidy received in the periods of previous quarter and previous year. For example, 2023, we received a total subsidies of slightly higher than 1.5 billion U.S. equivalent. And we received that mainly in Japan.

Okay, all right, great, thank you. Let's move on. We'll take the next one from Charlie Chan from Morgan Stanley, then we'll go to Bruce Lu from Goldman.

Thank you. Hi, C.C. Wendell and Jeff. Great to see you in person again. So my first question is really about your progress of selling the value. I'm not sure what's the progress. And do you think for next year, your leading edge capacity is going to be in shortage? Is there a case whether that increase your chance to sell more value to your customers? Thank you.

Okay, so Charlie's first question is around pricing, and he wants to understand the progress of, I guess, selling our value, and also in next year, looking at next year, particularly for the leading-edge nodes, do we expect that in terms of the demand to be very full?

Charlie, this kind of pricing strategy is very strategic. You are asking me about the status. So far, so good. This is an ongoing and continuous process. We are continuing to share our value. By the way, my customers are doing very well also. Okay, you knew that. So we should do well also.

So that is actually my follow-up question on this first question. For different segments, for example, HPC customers are doing very, very well. But for smartphone customers, probably more sensitive to the cost. Do you expect a kind of difference of value increase for different customers, even at the same node?

So Charlie is asking, how will we do the pricing? Will it be different between, for example, an HPC customer versus a smartphone customer at the same node? And also his question earlier was, do we expect the demand for the leading nodes to be very high next year?

Since pricing is strategic, so it won't be flat for every product sector. So it will be different. That all I can share with you. And all my customers, they are looking for leading-edge capacity for next few years, and we are working with them. And so far we try our best to support them, both in pricing and in capacity.

Thank you. And second topic is definitely over the past two days, those GLP co-rails. So Mr. Donald Trump took about maybe a few years ago, Taiwan slash TSMC took a 100% basis from the U.S. So congrats on the post, very high market share. However, the concern is growing, right, that the U.S. continues to depend on our islands, TSNC, and the chip production. So our question is for shareholders, right, how TSNC is going to mitigate this potential geopolitical risk. For example, whether you are going to further expand your U.S. capacity or even share the ownership, right, with the U.S. governments. And maybe a technical question to Wendell, For today, if we are shipping chips to the US customers, do we need to pay for the US tariff?

Okay, sorry. So Charlie's second question is around sort of overseas expansion and geopolitical risk. He notes the comments from former President Trump a few days ago that Taiwan's semiconductor has taken, you know, 100% of the business. So his question is really how does TSMC plan to mitigate the geopolitical risk? Does this include expanding capacity overseas, particularly in the U.S.? ? Would we consider, I think part of his question was some JV or joint investments, whether with government or whether with partners? And the last question I think was more for Wendell about the tax or the tariffs, so to speak.

Okay. Charlie, so far we did not change any of our original plan of expansion of our overseas file. We continue to expand it in Arizona. in Kumamoto, and maybe future in Europe. No change to our strategy. We continue our current practice. You mentioned about the JV. No. Okay.

On the tariff, not that we know of. Normally, if there's an import tariff, the customers will be responsible for that. But no discussion, nothing.

Okay, thank you. Thank you, Charlie. All right, we'll take the next question from Bruce Liu from Goldman Sachs in the front, then we'll move online.

Thank you for taking my question. All right, my question is like, why don't we take up our gross margin or structural profitability target? I mean, TSMC has been saying for selling your value for past couple quarters without changing the margin target, i.e., you know, most likely you are passing through all the costs. But, you know, please, I do recall in 2021, I mean, TSMC do raise the gross margin target by then because to support the future growth with more R&D. As the technology continues to be enhanced and more difficult, and one of your customers at least is supportive to suggest that you should charge even more So my question is why is that you don't raise your gross margin target when you are trying to sell your value, which we believe you deserve much higher value.

Okay, so thank you, Bruce. So Bruce's first question is about profitability and value. Bruce seems to agree that TSMC is providing value to our customers. He also notes in 2021, indeed, a few years ago, our gross margin target, long-term gross margin target, was about 50%, and we're able to increase that to 53% and higher. So his question is really with everything that is going on today, with the value of our technology enabling our customers more and more, why doesn't TSMC increase or revise up our long-term gross margin target from the current 53 and higher? Is that the essence? Yeah.

Bruce, thank you for recognizing TSMC's value. I'm working with our customer. As I said, this kind of pricing is strategic. And certainly, we want to share our value. Changing the target at this moment, I think I would like to emphasize 53% and higher. Please put more attention to and higher. The number, I'm not going to change it at this time. When I have a more... conversation with my customer and discuss with them. And I probably will give you in the higher portion. Okay, thank you.

Thank you. My next question is for advanced packaging. So management used to mention that advanced packaging margin was lower than the corporate edge but with higher RICs. But given the recent progress for the cohorts and everything, do we see a much better profitability for the co-workers? And given that it was so difficult to expand the capacity, are you planning to work with more partners to increase your co-workers' supply, which will solve your current supply demand issues?

Okay, thank you, Bruce. So Bruce's second question is around advanced packaging. Part of it is in terms of the profitability. He notes we used to say, which is true, it's lower than the corporate average profitability but can earn a similar return or ROE. But his question is now with more and more co-ops demanding greater scale, is the profitability of events packaging, I think, approaching or at or above the corporate average? And also, given the tight supply, would we consider to work with more partners to help increase the capacity for co-ops to support our customers' growth?

Yeah. You are right. For advanced packaging, the gross margin used to be much lower than the corporate average. Now it's approaching corporate average. We are improving it because of scale of the economics, and we put a lot of effort to reduce our cost. Cross-margin is greatly improving in these two years. As for the working with OSET partners, yes, we are doing it. Because of, I just answered the question, say whether the cold water capacity is enough or not. It is not enough. And in great shortage. And that limited my customers' growth, so we are working with our OSEP partner and try to give more capacity to my customer so that they can grow healthily. And so the TSMC's waiver can be sold healthily.

Okay, thank you, Cece. Thank you, Bruce. Operator, can we move to the first participant online for his or her questions, please?

Yes, the first one, we got Brad Simpson, Eritrea.

Yeah, thanks very much. My question was really about your capacity plans for the next node, that's N2 including A16. We're hearing that AI chip makers are looking to migrate more aggressively from N-1 to the leading edge, particularly due to backside power, because they're trying to lower their power budgets going forward. So my question, can you support this move? And if so, should we be expecting N2A16 to be structurally a much bigger node than we've seen in the past few nodes? Thank you.

Okay, Brett, thank you. So Brett's first question is on capacity planning, particularly at the leading edge, N2 and A16. So he notes rightly that AI customers are migrating aggressively from N-1 in the past to the most leading node. He notes particularly A16, driven by the interest in backside power. So his question is, can we support this move in terms of capacity to support the customers? And also, whether thus N2 and A16 will be a much bigger node than our nodes in the past.

Brett, you are right. All the people want to move into kind of a power-efficient mode, and so they are looking for the more advanced technology so they can save power consumption. And so a lot of my customers want to move into N2, N2P, A16 quickly. We are working very hard to build the capacity to support them. Today is a little bit tight. Not a little bit, actually. Today is very tight. I hope in the next year or the next two years, we can build enough capacity to support this kind of demand. Today, yes, we are working hard to support them. Enough? Not yet. But we are working hard to get it.

Does that answer your first question, Brett?

Okay, thank you. Yeah, that's great, Jeff. Thank you, CC Wade. My follow-up question was for Wendell. I wanted to just dig into the gross margin dilution from N3. Where is that at today? And does the introduction of N3E structurally improve your N3 returns? I guess N3E is less capital intensive, there's less EUV layers, so I'm keen to understand if this drives better economics for TSMC particularly as you start to ramp more NC capacity in the second half of this year. Thank you.

All right. Thanks, Brett. So Brett's second question is on the gross margin dilution from N3. He notes that N3E uses less EUV layers, less capital intensity. So his question is, as we ramp N3 more and more, does N3E structurally improve the returns and gross margin of N3 as a whole?

Okay, Brad, we don't break it down between the different nodes within the family, but I can share with you, overall speaking, as we said before, N3 takes a longer while to reach the copper margin. In the past, it was about 8 to 10 quarters. For N3, we're looking at 10 to maybe 12 quarters. But it is improving, and we expect it to continue to improve. Okay.

Thank you.

Okay, thank you, Brett. Operator, let's take the next set of questions from the next participant on the call, please.

Next one to ask question, Charles Shi from LinkedIn. Go ahead, please.

Thanks for taking my questions. Maybe the first one, I just want to follow up. Wendell, I think I heard you talking about that potentially more N5 to N3 conversion, maybe beyond what you are trying to do right now, the conversion. I just want to understand the overall philosophy here, because I think in the past the TSMC does do this node-to-node conversion quite actively, let's say 10 nanometer to 7 nanometer, and probably even earlier, 20 nanometer to 16 nanometer. And I think you told us basically treat 10 and 7 as one large node, 20 and 16 as one large node. Should we start to really think about maybe five and three are just one big node and maybe more conversion. We should just think about more of the N3 capacity growth will come from conversion going forward, less from the greenfield investment. That's the first question.

Okay, Charles. So Charles' first question is really look at our conversion strategy. He notes that, you know, we have always talked about building in tool commonality to provide us flexibility. We have done so in the past at certain nodes like 20 and 16, 10 and 7. So his question is really, you know, we had said that we potentially convert more N5 tools to support the strong demand for N3 capacity. So his question is, should we investors and analysts start to think about N5 and N3 as one big node?

Right. You mentioned about 12 and 16. They are a big family. 7 and 10 are a big family. But 5 and 3 are not a big family in our definitions. At the same time, there are know-to-know tool commonality in TSMC is pretty high. So for 5 and 3, the commonality of tools is over 90%. And these two nodes are adjacent. They're all in Tainan. and so it's very easy to do the conversions. Did I answer your questions?

Yes. May I ask a second question?

Certainly. Thanks.

Maybe a question about co-ops. I think I heard CC, you said maybe there's some technical difficulty on my side. I just want to clarify. Maybe you may double the co-op capacity again in 2025. But a little bit more technical question, I do want to better understand the technology constraints because your customers seems to be migrating from Co-Op S to the more advanced version, Co-Op L, Co-Op R. And we learned that Co-Op L does not require PSV, does not require a large silicon interposer. Does that help, at least to some degree, the capacity constraints you are facing on overall COAS? And does that help to maybe to achieve that goal of maybe getting to the supply-demand balance some point in 2025, 2026? That's a two-part question. Thank you.

Okay, Charles. So Charles' question is really on COAS. First, he would like to clarify, we said that COAS capacity is more than doubling in 2024. He said, did we say, is he correct to understand we said it will double again in 2025? That's the first clarification. And then he would like to know, as customers migrate from COAS S to COAS L and COAS R solution, a lot of technical challenges or benefits, changes, sorry, not challenges, does it help alleviate the capacity constraints, and would that allow COAS to reach supply-demand balance in 2025? So one to clarify and one on the different solutions.

Well... Boy, Charles, you really know all the detail of the technology. You know the COAS R, COAS S, COAS L, blah, blah, blah. All this kind of thing is because of a customer's requirement. So even the same customer, they have different approaches for their different product. When I say that we double the capacity, this is summing all the different versions of the cohorts together. Which portion is really double, which portion is much more than the other one, I'm not going to share with you because this is related to my customer's demand. So from last year to this year, we have more than doubled. And as I said, from this year to next year, we want to double again or probably we want to more than double again. But still, I have to work with our OSEP partner to increase the overall supply to support my customer. Whether that's this kind of different version of the CoWAS or give me some flexibility today, yes and no. Because different version has a different tool set. But in common, some of the tools can be used by all the CoWAS. But different version have a different demand.

Okay, thank you, Cece. Thank you, Charles. We'll come back to the floor for the next two questions, please. We'll take the first one from Laura Chen from Citigroup, and then we'll go to Sunny Lin from UBS.

Thank you, Jeff. Thank you for taking my question. My first question is also on the advance note. I remember, Cici, you mentioned earlier that every client is now engaged with you on the two nanometers migration. So I'm just wondering that when we enter in maybe 2026, the second year, Can we expect that the revenue contribution initially will be larger than what we had comparing to N3? And also wondering that since the performance is much better, so can we expect the dilution period will also be shorter than N3?

Okay. Oh, sorry. Go ahead. Sorry. So Laura's first question is about N2, basically, that, you know, almost every customer is engaging with TSMC on two nanometer technologies. So her question is, do we expect a revenue contribution from N2 in 2026, therefore, to be larger than compared to N3 at a similar point in time of the ramp? And also, correspondingly, would the N2 margin dilution be less or better than N3, basically?

I will give this kind of a money question to the CFO.

All right. Laura, the revenue, yes, it's going to be bigger. Gross margin dilution, it will be faster to reach corporate average.

That's very clear and helpful. Thank you. And also, my second question is also on the packaging side. We know that last time we also discussed that HAI will also benefit for TSMC in terms of the advanced nodes, die areas. Just wondering that, do you also see your HAI device clients, they are moving to 3DIC or SOIC any time in the next two years, Or before that happening, can we expect that more clients on the smartphone side, they will also adapt maybe info first? Because so far, our understanding is that info, you only have one advance, not one single client. I'm just wondering if we see that more clients to move to on the HAI side, advanced packaging. Thank you.

Okay, so Laura's second question is very specific, but again, in regards to advanced packaging, with more and more customers working on edge AI devices, without, well, being overly specific, but what does it mean or the implication for advanced packaging solutions? Do we expect in the next two years to see these Edge AI customers start to use SOIC or 3D IC, particularly smartphone? Will they still be using info, or will they also consider these solutions as well? Is that correct, Laura? Okay.

Well, very technical questions. Let me share with you, as my customer moving into 2 nanometer or A16, they all need to... probably taking the approach of chiplets. So once you use your chiplets, you have to use in advanced packaging technologies. And the edge AI for those kind of smartphone customer, as compared with the HPC customer, HPC is moving faster because of bandwidth concern, latency of footprint, all those kind of thing. For smartphone customer, they need to pay more attention to the footprint as well as the functionality increase. So you observe my big customers taking the info first and then for a few years nobody catch it up. They are. They are catch it up.

Thank you very much, Cece.

Okay. Thank you, Laura. We'll take the next question from Sunny Lin from UBS, and then we'll go back to the call.

Thank you, Jeff. Good afternoon, Cece and Wendell. Thank you for taking my questions. So my first question is on your business opportunities for smartphone and PC. Last few years, both were exports for quite some time. And so how we should think about the units and silicon content for the coming two, three years? First part, a lot of questions on the tight supply for 5 and 3 nanometer. And so are your customers engaging with you early on the planning into 2025 capacities for a better upgrade cycle? And then for silicon content, recall a few years back when 5G just started to ramp, you used to provide the silicon content expectations for 5G high-end and mid-end and low-end smartphones. So I wonder at this point of time if you have any estimates for AI for smartphones going to next two or three years.

Okay, several parts to Sunny's first question. She's looking at smartphone and PC. So the first part is she wants to know in terms of unit and silicon content, what is our expectation for smartphone and PCs the next few years? N5 and N3 supply is very tight in terms of the capacity. Do we have enough capacity to support a potential unit or upgrade cycle? And last but not least, she's asking us to quantify the silicon content per device, per segment from Edge AI.

That's a very long question, but let me answer the content first. AI is so hard so that right now, everybody, all my customers want to put their AI functionality into the edge devices. And so the die size will be increased. Okay. How much? I mean, it's different from my customer to customer's product. But basically, probably 5% to 10% die size increase will be general rule. Unit growth, not yet, because we did not see a kind of a unit growth suddenly increase, but we expect this AI functionality will stimulate some of the demand, so stimulate the replacement to be shorter. So in terms of a unit growth, that in a few years later, probably two years later, you will start to see a big increase. In the edge device, that's a smartphone and a PC.

And will we have enough capacity to support?

That's what I try to avoid the answer. It's very, very tight. And we are working very, very hard to get enough capacity to support my customer from now all the way to next year to 2026. Got it.

Thank you, CC, for the answer. So my second question is try to look at the demand profile from different perspectives. If we look back in 2021 or early 2022, back then demand was also pretty high. Customers were very aggressive on the demand forecast. Now looking at GNI, obviously the technology has lots of great potential, but a new technology could also have lots of volatilities when you start to ramp. And so how are we managing the volatilities of the demand? Why do you think this time around is different versus COVID period? How do we get comfortable with our capacity planning?

Okay. Thank you, Sunny. So, Sunny's second question goes back to TSMC's capacity planning and CapEx framework. So, she notes today, generally, AI-related demand is very strong, but she also notes a few years ago, back in 2001 and 22, demand was also very strong. Many customers were also very positive or upbeat on the future demand. And so today, with such strong generative AI demand, how does TSMC plan its capacity appropriately? How do we manage, I think your word was volatility, how do we manage the risk, basically, I guess, of not overbuilding capacity in this type of environment?

I thought I explained that our capacity planning process, right, and the investment, we have... I put a wording of discipline. That means we are not going to repeat the same kind of mistake that we have in 2021, 2022. Now this time, again, we look at the overall very big demand forecast for my customer. And so I look into actually the whole company with many people now examining and study that really is AI is so useful or be used by a lot of people or not. And we test ourselves first. inside TSMC, we are using AI, we are using machine learning skill to improve our productivity. And we find out it's very useful. And so I also in the line to buy my customers a product, and we have to form in the line. I get no privilege, I'm sorry, but it's useful. And so I believe that this time, AI's demand is more real than two or three years ago. At that time, it's because people are afraid of a shortage, And so automotive, everything you name it, they are all in shortage. This time, AI alone, only AI alone, it will be a very useful tool for the human being to improve all the productivity in our daily life, be it in medical industry or in any product, manufacturing industry or autonomous driving, everything, you need AI. And so I believe it's more real. But even with that, we also have a top-down, button-up approach and discuss with our customer and ask them to be more realistic. I don't want to repeat the same kind of mistake two or three years ago. And that's what we are doing right now.

Great to know. Thank you very much.

Okay, thank you. Operator, can we move on to the next participant from the line, please? Okay. If not, then maybe we'll take the last two questions from the floor, or one or two. Let's start here and then here. So we'll start with Arthur Lai from Macquarie.

Hi, Cici and Wendell and Jeff. Thanks for taking my question. Arthur Lai from Macquarie. I used to cover the downstream tech, and especially data center before. And so I want to ask about the SPR, because I think this is very important from the data center perspective. So when you bring the new technology, you can save around 20% power. Can we also think about you can save the total system's power consumption by another 20%? So it's a big change. And from the customer you spoke to, they can also save their total cost of operation. So it becomes the more you buy, the more you save. Thank you.

Okay, so Arthur's first question, he would like to understand more about SuperPower Rail or our best-in-class backside power solution as it relates to data center demand. He notes, as we said, that it brings greater power efficiency from the chip level. His question, without specific numbers, but what does the mean for the system level power consumption saving? What does it mean for our customers' ability in terms of total cost of ownership in terms of the power savings? And does it mean that the more you buy, the more you save?

The more you buy TSMC's waiver, the more you save. Yes. Sorry, I just want to... I like my customer. Your question. Arthur, you say that 20% saving the chip's power consumption. Does that directly reply to indicate that the system power consumption was reduced by 20%? Probably not, because of the whole system, including the connection, including the networking, including the processes of power consumption. So unless every component is saved 20%, then you can achieve 20%. Again, the accelerator or the CPU is a big portion of the whole system's power consumption. So even if it is not 20%, it's a significant portion of it. And so that's why all my customers want to use the leading edge, and they are very aggressive to move into the two nanometer technology.

Thank you. So I also, you know, encourage company to do the right thing. So energy efficiency computing is definitely our goal for human beings. And then, so I also would like to get more color about when you go into the A16 and when we expand the capacity, what do you think the biggest bottleneck would be?

Okay, so Arthur's second question is in terms of A16. What would be the biggest bottleneck to expand our capacity of A16 to support our customers, if any?

We always say that, you know, when TSMC want to expand the capacity, we need the land, we need the electricity, we need the talented people. And so all the above. Okay. Thank you, CC. Thank you.

Okay, thank you. And then in the interest of time, we'll take question from the last participant on the floor, which is Brad Lynn from Bank of America Merrill Lynch.

thank you jeff for taking my question so i have two questions the first one will be on the during the computer test we obviously have seen quite some big tech companies announce that they are going to accelerate the product launch cadence so what's the implication to tsmc i showed that give tsmc a better visibility on the product pipeline and also the capacity planning. And on the other side, so what are the major challenges that you might face with this phasor cadence?

Okay, so Brad's first question is that Computex recently, several companies announced their intention to accelerate their product cadence or product launches. So his question is, what does this mean, implications to TSMC in terms of capacity planning, in terms of supporting our customers, et cetera, et cetera. Is that right? Yes. Okay.

Well, we like this kind of a trend because TSMC is very good at the leading edge development. And so we actually, every product when they design, it takes one and a half years to two years. So we got this kind of message quite a long time ago. My customer announced it because they are so happy, and so we are happy also because they want us to share our value. So I take that advice. But go cool, don't laugh. Okay, so to answer your question, yes, we have been prepared. And not only because in June they announced it, much earlier we already discussed with them and we prepared for these kind of changes.

Got it. Thank you very much. So I would assume that would help us, well, kind of sell the value easier. So the second question will be on the, well, obviously we also see the bigger footprint of the AI chips. So, well, there are quite some activities about the fan. fan-out panel-level packaging. So do you think that solution will become mainstream in the mid to long run, or does TSNC have any plan to do the related investment? Thank you.

Okay, so Brad's second question is that, again, with AI-related chips, that they're larger and larger die sizes. So his question is in terms of advanced packaging. and specifically fan-out panel-level packaging. Is this something that TSMC is looking at or exploring to do? Would this be something for TSMC in the mid to long term?

Yes, we are looking at this as kind of a panel-level fan-out technology. But the maturity today is not yet. So personally, I would think it's about at least three years later. Within these three years, We don't have any very solid solution for a die size bigger than 10 times of the radical size. Today we support our customer all the way to 5X, 6X chip size. I'm talking about the fuel size, the biggest fuel size. Three years later, I believe the panel will now start to be introduced and we are working on it. and we will be ready for it as well, of course.

All right. Thank you, CC. Thank you, Brad. Thank you, everyone. This concludes our Q&A session. Before we conclude today's conference, please be advised that the replay of the conference will be accessible within 30 minutes from now, and the transcript will become available 24 hours from now, both of which are going to be available through TSMC's website at www.tsmc.com. So thank you, 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.