TSMC 2023 Q2 Earnings Conference Full Transcript

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TSMC held its Q2 earnings conference today (20th). TrendForce utilized AI tools to transcribe and made slight edits, presenting the full text of TSMC’s operational status report delivered by Chairman Mark Liu, CEO C.C. Wei, and CFO Wendell Huang.

TSMC CFO Wendell Huang

My presentation will start with financial highlights for the second quarter 2023. After that, I will provide the guidance for the third quarter. Second quarter revenue decreased 5.5 percent sequentially in NT, or 6.2 percent in U.S. dollars, as our second quarter business was impacted by the overall global economic conditions, which dampened the end market demand and led to customers’ ongoing inventory adjustment. Growth margin decreased 2.2 percentage points sequentially to 54.1 percent, mainly reflecting lower capacity utilization and higher electricity costs, partially offset by more stringent cost control and a more favorable foreign exchange rate. Despite the industry’s cyclical downturn, we continued to invest in R&D to support our N3 and N2 development. Thus, operating margin was 42 percent, down 3.5 percentage points sequentially.

Overall, our first quarter EPS was 7.01 NT, and ROE was 23.2 percent. Now let’s move on to revenue by technology. 5 nanometer process technology contributed 30 percent of our wafer revenue in the second quarter, while 7 nanometer accounted for 23 percent. Advanced technologies, defined as 7 nanometer and below, accounted for 53 percent of wafer revenue. Moving on to revenue contribution by platform, HPC decreased 5 percent quarter over quarter to account for 44 percent of our second quarter revenue. Smartphone decreased 9 percent to account for 33 percent. IOT decreased 11 percent to account for 8 percent. Automotive increased 3 percent to account for 8 percent. And DCE increased 25 percent to account for 3 percent.

Moving on to the balance sheet, we ended the second quarter with cash and marketable securities of 1.5 trillion NT, or 48 billion U.S. dollars. On the liability side, current liabilities decreased by 62 billion NT, mainly due to the net decrease of 87 billion in income tax payable as we pay 120 billion for 2022 income tax, offset by 33 billion accrued tax payables for the second quarter. Long-term interest bearing debt increased by 53 billion NT, mainly as we raised 41 billion in corporate bonds.

On financial ratios, accounts receivable turnover days decreased 2 days to 32 days, while days of inventory increased 3 days to 99 days, primarily due to entry ramp during the quarter.

Regarding cash flow and KPACs, during the second quarter, we generated about 167 billion NT in cash from operations, spent 251 billion in KPACs, distributed 71 billion for third quarter 2022 cash dividend, and raised 41 billion from corporate bond issuances. Overall, our cash balance decreased by 109 billion to 1.3 trillion NT at the end of the quarter. Free cash flow was negative 83 billion NT during the quarter, as operating cash flow was more than offset by capital expenditures, partly due to the income tax payment of 120 billion. In U.S. dollar terms, our second quarter capital expenditures totaled 8.17 billion.

I have finished my financial summary. Now let’s turn to our current quarter guidance. Based on the current business outlook, we expect our third quarter revenue to be between 16.7 billion and 17.5 billion U.S. dollars, which represents a 9.1 percent sequential increase at the midpoint. Based on the exchange rate assumption of 1 U.S. dollar to 30.8 NT, gross margin is expected to be between 51.5 percent and 53.5 percent, operating margin to be between 38 percent and 40 percent.

This concludes my financial presentation. Now, let me turn to our key messages. I will start by making some comments on our second quarter 23 and third quarter 23 profitability. Compared to first quarter, our second quarter gross margin decreased by 220 basis points sequentially to 54.1 percent, primarily due to the exchange rate sequentially to 54.1 percent, primarily due to a lower capacity utilization. Compared to our second quarter guidance, our actual gross margin slightly exceeded the high end of the range provided three months ago, mainly due to more stringent cost control efforts and a slightly more favorable foreign exchange rate.

We have just guided our third quarter gross margin to decline by 1.6 percentage points to 52.5 percent at the midpoint, primarily as a higher level of capacity utilization rate is offset by two to three percentage points margin dilution from the initial ramp up of our three nanometer technology. Looking ahead to the fourth quarter, we expect a continuous steep ramp up of our three nanometer to dilute our fourth quarter gross margin by about three to four percentage points.

In 2023, our gross margin faces challenges from lower capacity utilization due to semiconductor cyclicality, the ramp up of N3, overseas fab expansion and inflationary costs, including higher utility costs in Taiwan.

To manage our profitability in 2023, we will work diligently on internal cost improvement efforts while continuing to sell our value. While we face near term challenges, we continue to forecast a long term gross margin of 53 percent and higher is achievable.

Next, let me talk about our 2023 capital budget and depreciation. Every year, our capex is spent in anticipation of the growth that will follow in future years. Given the near term uncertainties, we continue to manage our business prudently and tighten up our capital spending where appropriate. We now expect our 2023 capital budget to be towards the lower end of our range of between 32 and 36 billion U.S. dollars.

Our depreciation expense is now expected to increase by mid 20s percent year over year in 2023, mainly as we ramp our three nanometer technologies. Despite near term inventory cycle, our commitment to support customer structure growth remains unchanged and our discipline capex and capacity planning remains based on the long term market domain profile. We will continue to work closely with our customers to plan our long term capacity and invest in leading edge specialty and advanced packaging technologies to support their growth while delivering profitable growth to our shareholders.

Now, let me make a few comments on our cash dividend distribution policy. The objectives of 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 May, TSMC Board of Directors approved the distribution of a three NT per share cash dividend for the first quarter of 2023, up from 2.75 NT previously. This will become the new minimum quarterly dividend level going forward.

First quarter 23 cash dividend will be distributed in October 2023. For 2023, TSMC shareholders will receive a total of 11.25 NT per share dividend and at least 12 NT per share cash dividend for 2024. Going forward, as our capital intensity begins to decline in the next several years, the focus of our cash dividend policy is expected to shift from a sustainable to a steadily increasing cash dividend per share in the next few years.

TSMC CEO C.C. Wei

Good afternoon, everyone. First, let me start with our near-term demand and inventory. We concluded our second quarter with revenue of 15.7 billion US dollars in line with our guidance in US dollar terms. Our business in the second quarter was impacted by the overall global economic conditions, which dampened the end market demand and customers’ ongoing inventory adjustment.

Moving into third quarter 2023, while we have recently observed an increase in AI-related demand, it is not enough to offset the overall cyclicality of our business. We expect our business in the third quarter to be supported by the strong ramp of our three nanometer technologies, partially offset by customers’ continued inventory adjustment.

In the last quarterly conference, we said we expect Fabless semiconductor inventory to rebalance to a healthier level exceeding the third quarter. This statement continues to hold true. However, due to persistent weaker overall macroeconomic conditions, slower than expected demand recovery in China, and overall softer end market demand conditions, customers are more cautious and intend to further control their inventory into 4Q23. Thus, while we maintain our forecast for the 2023 semiconductor market as crude in memory to decline mid-single digit year over year, we now expect the foundry industry to decline mid-teens in our four-year 2023 revenue to decline around 10% in US dollar terms. With such inventory control, we also forecast the Fabless semiconductor inventory to exit 4Q23 at a healthier and lower level as compared to our expectation three months ago.

Next, let me talk about HPC and TSMC’s long-term growth outlook. As we have said before, the massive structural increase in demand for computation underpinned by the industry megatrend of 5G and HPC continues to drive greater need for performance and energy-efficient computing, which require use of leading-edge technologies. These megatrends are expected to fuel TSMC’s long-term growth.

Even with a more challenging 2023, our revenue remains well on track to grow between 15% and 20% CAGR over the next several years in US dollar terms, which is a target we communicated back in January 2022 investor conference.

The recent increase in AI-related demand is directionally positive for TSMC. Generative AI requires higher computing power and interconnected bandwidth, which drive increasing semiconductor content. Whether using CPUs, GPUs, or AI-accelerated and related ASIC for AI and machine learning, the commonality is that it requires use of leading-edge technology and a strong foundry design ecosystem. These are all TSMC’s strengths. Today, server AI processor demand, which we define as CPUs, GPUs, and AI-accelerators that are performing training and inference functions, accounts for approximately 6% of TSMC’s total revenue. We forecast this to grow at close to 50% CAGR in the next five years and increase to low 10% of our revenue.

The accessible need for energy-efficient computation is starting from data centers, and we expect it will proliferate to edge and end devices of time, which will drive further long-term opportunities.

We have already embedded certain assumptions for AI demand into our long-term capex and growth forecast. Our HPC platform is expected to be the main engine and the largest incremental contributor to TSMC’s long-term growth in the next several years.

While the quantification of the total addressable opportunity is still ongoing, generative AI and large-language model only reinforce the already strong conviction we have in the structural mega-train to drive TSMC’s long-term growth, and we will closely monitor the development for further potential upside.

Now, let me talk about our N3 and N3E status. Our 3-nanometer technology is the most advanced semiconductor technology in both PPA and transistor technology. N3 is already in volume production with good yield. We are seeing robust demand for N3 and expect a strong ramp of N3 in the second half of this year, supported by both HPC and smartphone applications. N3 is expected to continue to contribute a single-digit percentage of our total wafer revenue in 2023. N3E further extends our N3 family with enhanced performance, power, and yield and provide complete platform support for both HPC and smartphone applications. N3E has passed the qualification and achieved performance and yield target and will start volume production in the fourth quarter of this year.

With our continuous enhancement of 3-nanometer process technologies, we expect strong multi-year demand from our customers and are confident that our 3-nanometer family will be another large and long-lasting node for TSMC. Finally, I’ll talk about our N2 status.

Our N2 technology development is progressing well and on track for volume production in 2025. Our N2 will adopt nanosheet transistor structure to provide our customers with the best performance, cost, and technology maturity.

Our nanosheet technology has demonstrated excellent power efficiency, and our N2 will deliver full node performance and power benefits to address the increasing need for energy-efficient computing. As part of N2 technology platform, we also developed N2 with backside power rail solution, which is best suited for HPC applications. Backside power rail will provide 10 to 12 percent additional speed gain and 10 to 15 percent logic density boost on top of the baseline technology.

We are targeting backside power rail to be available in the second half of 2025 to customers with production in 2026. We are observing a high level of customer interest and engagement at N2 from both HPC and smartphone applications. Our 2-nanometer technology will be the most advanced semiconductor technology in the industry in both density and energy efficiency when it is introduced. N2 will further extend our technology leadership way into the future.

TSMC Chairman Mark Liu

TSMC’s mission is to be the trusted technology and capacity provider of the global logic IC industry for years to come. Our strategy is to expand our global manufacturing footprint, to increase customer trust, and to expand our future growth potential and to reach for more global talents. Our overseas decisions are based on our customers’ needs and the necessary level of government support. That is to maximize the value of our shareholders and to fulfill our fiduciary duty.

In Arizona, we are building a first fab to provide U.S.’s most advanced semiconductor technology in mass production to support the needs for U.S. semiconductor infrastructure. Our fab in Arizona started construction in April 2021 with an aggressive schedule. We are now entering a critical phase of handling and installing the most advanced and dedicated equipment. However, we are encountering certain challenges as there is an insufficient amount of skilled workers with those specialized expertise required for equipment installation in a semiconductor-grade facility. While we are working on to improve the situation, including sending experienced technicians from Taiwan to train the local skilled workers for a short period of time, we expect the production schedule of N4 process technology to be pushed out to 2025.

In Japan, we are building a specialty technology factory, which will utilize 12, 16, and 22, 28 process technologies. Volume production is on track for late 2024.

In Europe, we are engaging with customers and partners to evaluate building a specialty fab in Germany, focusing on automotive-specific technologies based on the demand from our customers and the level of government support.

In China, we are expanding 28nm in Nanjing as we planned to support our customers in China, and we continue to follow all rules and regulations fully. At the same time, we continue to invest in Taiwan and to expand our capacity to support our customers’ growth.

From a cost perspective, the initial costs of overseas fabs are higher than TSMC’s fabs in Taiwan, due to 1. the smaller fab scale, 2. higher costs throughout the supply chain, and 3. the early stage of semiconductor ecosystem on those overseas sites, as compared to a matured ecosystem in Taiwan.

In our recent meetings with senior government officials in the U.S., Japan, and Europe, we discussed our plans to expand our global manufacturing footprint to them. We also emphasized one of our major responsibilities is to manage and minimize the cost gap to maximize return for our shareholders. Those discussions went very well. All sides understand the critical and integral role TSMC plays in the semiconductor industry, and we appreciate all the government’s ongoing support in working with TSMC to help narrow down the cost gap. We will continue to work closely with all the governments to secure the further support.

Our pricing will also remain strategic to reflect our value, which includes the value of geographic flexibility. At the same time, we will leverage our fundamental competitive advantage of manufacturing technology leadership, large volume, and economies of scale to continuously drive our costs down. By taking such actions, TSMC will have the ability to absorb the higher costs of overseas fab, while remaining the most efficient and cost-effective manufacturer, no matter where we operate. Thus, even as we expand our capacity overseas, TSMC’s long-term gross margin of 53% and higher and sustainable ROE of greater than 25% is achievable, and we will continue to maximize the value for our shareholders. This concludes our key messages. Thank you for your attention.

(Photo credit: TSMC)