TAIWAN-SEMICONDUCTOR Earningcall Transcript Of Q2 of 2024

Wendell Huang -- Vice President, Chief Financial Officer

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 2024. Second quarter revenue
increased 13.6% sequentially in NT or 10.3% in U.S. dollars, as our business was supported by
strong demand for our industry-leading three- and five-nanometer technologies, partially offset
by the continued smartphone seasonality. Gross margin increased 10 basis points sequentially
to 53.2%, mainly reflecting cost improvement and a more favorable foreign exchange rate,
partially offset by the margin then from M3 RAM.

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 TWD 9.56 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 TWD 2
trillion or USD 63 billion.

On the liability side, current liabilities increased by TWD 23 billion mainly due to the increase of
TWD 16 billion in accounts payable. Long-term interest-bearing debt increased by TWD 9 billion
mainly as we raised TWD 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 TWD 378 billion
in cash from operations, spent TWD 206 billion in capex, and distributed TWD 91 billion for third
quarter '23 cash dividend. Overall, our cash balance increased TWD 101 billion to TWD 1.8
trillion at the end of the quarter. In U.S.

dollar terms, our second-quarter capital expenditures totaled TWD 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 USD 22.4 billion and USD
23.2 billion, which represents a 9.5% sequential increase or 32% year-over-year increase at the
midpoint.

Based on the exchange rate assumption of USD 1 to TWD 32.5, 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 N2 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 interim 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 USD 30 billion and USD 32 billion as compared to USD
28 million to USD 32 billion 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, mass 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 C.C.

C.C. Wei -- Chief Executive Officer

Thank you, Wendell. Good afternoon, everyone. First, let me start with our near-term demand
outlook. We concluded our second quarter with revenue of USD 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 three-nanometer and five-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 USD 250 billion in 2023
as compared to USD 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 broader 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-edge three-nanometer and five-nanometer process
technologies in the 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 U.S. 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 ambition is to be the trusted technology and capacity provider for the global logical 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 number of AI applications, the value
of our technology position is increasing as customers rely on 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 robust
system that evaluates and judges market demand from both a top-down and 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 costs 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 structure profitability improving in
these past few years. At the same time, we faced rising cost challenges due to increasing
process complexity, a leading node, higher electricity costs in Taiwan, global fab expansion in
higher-cost regions, and other cost inflation challenges. And therefore, we will continue to work
closely with our customers to see our value. We will also work diligently with our suppliers to
deliver on cost performance.

We believe such actions will help TSMC on a sustainable and healthy return so that we can
continue to invest in technology and capacity to support our customers' growth and fulfill our
mission as a trusted foundry partner while delivering profitable growth for our shareholders.

Finally, I'll talk about our N2 status N16 introduction. Our two-nanometer and 16 technologies,
this is an industry in addressing the sensible 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 toward deliver full node performance and power benefit which 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 N3E. N2 technology development is progressing well
with device performance and yield on track or ahead of plan and with some trend for volume
production in 2025 with a ramp profile similar to N3. With our strategy of continuous
enhancement, we also introduced N2P as an extension of our N2 family, and two features a
further 5% performance with -- at the same power or 5% to 10% power benefit at the same
speed on top of N2. N2 supports both smartphone and HPC applications, and volume
production is scheduled for the second half 2026.

We also introduced N16 as our next nano chip-based technology, featuring Super Power Rail, or
SPR, as a separate offering. TSMC's SPR is innovative best-in-class power delivery solution that
is the first in the industry to incorporate a novel backside contact scheme to preserve gate
density and device with flexibility. Compared with N2P, N16 provides a further 8% to 10% speed
improvement at the same power of 15% to 20% power improvement at the same speed and
additional 7% to 10% chip density gain. N16 is best used for specific HPC products with
complex signal route and dense power delivery and work.

Volume production is scheduled for second half 2026. We believe N2, N2P, N16, and its
derivatives 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.

Jeff Su -- Director of Investor Relations

Thank you, C.C. 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.
[Operator instructions] 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 Gokul Hariharan from JPMorgan. Thank you.

Gokul Hariharan -- Analyst

Thanks, Jeff. Good afternoon, C.C., 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 TSMC
for capacity.

I think last time we talked about this maybe a couple of quarters back, C.C., 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 CoWoS advanced packaging capacity? And I think in your
symposium, you talked about 60% CAGR, compounded growth for CoWoS capacity in the next
four, five years. Could you talk a little bit about how much capacity for CoWoS 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.

Jeff Su -- Director of Investor Relations

OK, 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 disciplined framework in terms of looking at how to build capacity.

This 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, C.C., expect
supply/demand to reach a balance both for the accelerator side and then for the CoWoS? At the
symposium, we said CoWoS 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 CoWoS.

C.C. Wei -- Chief Executive Officer

Gokul, I also tried 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 customer's demand. We continue to increase.

I hope sometime in 2025 or 2026, I can reach the balance. You're talking about the CAGR of
growth on rent increase of the CoWoS capacity. Now, it's out of my mind. I mean, we continue to

increase whatever, wherever, whatever I can, OK? The supply continued to be very tight all the
way to probably and how we can be eased in 2026.

That's today's situation.

Gokul Hariharan -- Analyst

Any thoughts on next year capacity? Like are you going to double your capacity again next year
for CoWoS?

C.C. Wei -- Chief Executive Officer

The last time I say that this year, I doubled it, right, more than double, OK? So, next year, if I say
double, probably, I will answer your question again next year, is more than double, OK? We're
working very hard, as I said, wherever we can, whenever we can.

Gokul Hariharan -- Analyst

OK. 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 it 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 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.

Jeff Su -- Director of Investor Relations

OK. So, let me summarize Gokul's second question is around gross margin and profitability. He
notes second half '24 gross margin seems to be better than the expectation. So, his question is
really, how should we think about gross margin in the next several years? He notes as we said,
we will sell our value and the dilution of N3 will gradually reduce.

So, where can the gross margins go back to a high 50s or 60% that kind of level that we saw a
few years ago in 2022? Maybe that's the first part of this question. I'll stop here, then I'll get to
the second.

Wendell Huang -- Vice President, Chief Financial Officer

Sure. Gokul, 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 costs, 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 N5 to N3 because we're seeing
very strong demand for 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, etc. And also, we are beginning the production of our
overseas fab, two overseas fabs next year, the Phase 1 of Arizona fab and Phase 1 of the
Kumamoto fab. We expect that the overseas fabs will dilute our gross margins by between two
to three percentage points 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
consideration with our efforts in managed cost fab especially between the overseas fab in
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.

Gokul Hariharan -- Analyst

Yeah, that's right.

Jeff Su -- Director of Investor Relations

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

Wendell Huang -- Vice President, Chief Financial Officer

Yeah. If we have a very high utilization rate, everything else stays the same. Possible.

Jeff Su -- Director of Investor Relations

OK. 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., etc., to the financials?
And also, I think partly gross capex and net capex.

Wendell Huang -- Vice President, Chief Financial Officer

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 period of previous quarter and previous year. For example, 2023, we
received total subsidies of slightly higher than USD 1.5 billion equivalent, and we received that
mainly in Japan. Yeah.

Jeff Su -- Director of Investor Relations

OK. All right. Great. Thank you.

Let's move on. We'll take the next one from Charlie Chan from Morgan Stanley, and then we'll go
to Bruce Lu from Goldman. Thank you.

Charlie Chan -- Analyst

I see a window, and I get to see you in person again. So, I have -- 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, you already didn't hedge capacity is going to be a shortage? Is that the case, whether that
increases your chance to sell more value to your customers? Thank you.

Jeff Su -- Director of Investor Relations

OK. So, Charlie's first question is around pricing, and he wants to understand the progress of, I
guess, selling our value. And also, 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?

C.C. Wei -- Chief Executive Officer

Charlie, this kind of pricing strategy is very strategic. You are asking me about the status. So far,
so good. And what continue -- this is an ongoing and continuous process.

We are continuing to share our value. And by the way, my customers are doing very well also,
OK? You knew that. So, we should do well also.

Charlie Chan -- Analyst

Yes. 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 the kind of difference of kind of value increase for different customers, even at a
same node?

Jeff Su -- Director of Investor Relations

So, Charlie is asking, how will we do the pricing? Will it be different between, for example, 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?

C.C. Wei -- Chief Executive Officer

Since the pricing is strategic, so it won't be flat for average product sector. So, it will be different,
OK? That all I can share with you. And all my customers, they are looking for leading-edge as a
capacity for the 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.

Charlie Chan -- Analyst

Thank you. And second topic is definitely over the past two days, the geopolitical risk. So, Mr.
Donald Trump talked about, maybe a few weeks ago, right, Taiwan/TSMC took 100% chip
business from the U.S.

So, congrats on the bounce back pretty high market share. However, the concern is growing,
right, that the U.S. continues to depend on our Island TSMC and the chip production. So, our
question is for shareholders, right, how TSMC 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. government? And maybe a technical
question to Wendell, for today, right, if we are shipping a chip to the U.S. customers, do we need
to pay for the U.S. tariff?

Jeff Su -- Director of Investor Relations

OK. 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
semiconductor has taken 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 this
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.

C.C. Wei -- Chief Executive Officer

OK, Charlie. So, far, we did not change any of our original plan of expansion of our overseas fab.
We continue to expand 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. OK.

Wendell Huang -- Vice President, Chief Financial Officer

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.

Jeff Su -- Director of Investor Relations

OK. Thank you. Thank you, Charlie. All right.

We'll take the next question from Bruce Lu from Goldman Sachs in the front, then we'll move
online.

Bruce Lu -- Goldman Sachs -- Analyst

Thank you for taking my question. My question is that, why don't we take up our gross margin or
structure for the PBT target. I mean, TSMC has been saying for selling your value for past couple
of quarters without changing the margin target, i.e., most likely you are passing through all the

costs. But please, I can recall in 2021, I mean, TSMC do raise the gross margin target by them
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 this is supportive that 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 your
-- when you try to sell your value, which we believe we deserve much higher value?

Jeff Su -- Director of Investor Relations

OK. 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?

C.C. Wei -- Chief Executive Officer

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 sell our value.

Changing the target in -- 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, I probably will give you and
the higher portion, OK? Thank you.

Bruce Lu -- Goldman Sachs -- Analyst

OK. My next question is for advanced packaging. So, management used to mention that
Advanced Packaging margin was lower than the corporate age, but with higher ROICs. But given
the reason progress for the CoWoS and everything, do we see a much better profitability for the
CoWoS? And given that it's so difficult to expand the capacity, are you planning to work with
more partners to increase your CoWoS supply, which will start your current supply and demand
issues?

Jeff Su -- Director of Investor Relations

OK. 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 CoWoS was demand
and greater scale is the profitability of advanced 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 CoWoS to support our customers' growth?

C.C. Wei -- Chief Executive Officer

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. So, gross margin is greatly
improving in these two years.

As for the working with OSAT partners, yes, we are doing it. because of -- I just answer the
question whether the CoWoS capacity is now or not -- is not enough. And in great shortage, and
that limited my customer growth. So, we are working with our OSAT partner and try to give more
capacity to my customer so that they can grow here.

And so, the TSMC's wafer can be sold here. OK.

Jeff Su -- Director of Investor Relations

OK. Thank you, C.C. Thank you, Bruce. Operator, can we move to the first participant online for
their his or her questions, please?

Questions & Answers: