The earnings call for Taiwan Semiconductor Manufacturing

TSM, or Taiwan Semiconductor Manufacturing, is -5.03 percent.

Q1 Earnings Call for 2024.

at two in the morning. M. EST.

Contents:.

Prepared Statement.

Questions and Responses.

Attendees of the Call.

Notes that are ready:.

Su Jeff.

[In foreign language] Good afternoon to all, and thank you for joining TSMC’s earnings conference call for the first quarter of 2024. Your host for the day is Jeff Su, the director of investor relations at TSMC. Our earnings conference call is being broadcast live and in audio over the company website, www.TSMC.com. tsmc . com, where you can soon download the materials related to the earnings release. [Instructor instructions] The schedule for today’s event is as follows: Senior Vice President and CFO of TSMC, Mr.

Wendell Huang will give an overview of our operations for the first quarter of 2024 and then provide our outlook for the second quarter of the same year. Afterwards, Mr. Huang and TSMC’s CEO, Dr. C. C.

Wei, together, will deliver the main messages of the organization. After that, the lines will be open for questions and answers. As usual, I would like to remind everyone that there may be forward-looking statements in today’s discussions. These statements are subject to significant risks and uncertainties, which could cause actual results to differ materially from those projected. Please see our press release’s safe harbor notice for more information.

And now for the operations summary and the current quarter guidance, I’d like to hand the call over to Mr. Wendell Huang, the CFO of TSMC.

Wendell Huang, Chief Financial Officer and Vice President.

Many thanks, Jeff. Greetings to all of you in the afternoon. We appreciate your presence here today. I’ll begin by going over the financial highlights for the first quarter of 2024.

After that, I’ll give the second-quarter 2024 guidance. First-quarter revenue decreased 5.3 percent sequentially in NT dollars or 3.8 percent in U. S. dollars as the seasonality of smartphones affected our business, albeit the demand for HPC-related products continued to offset this. The seasonality of smartphones caused changes in the product mix, which in turn compensated for a less favorable foreign exchange rate. The gross margin increased by 0.1 percentage points sequentially to 53.1%.

Due mostly to stricter cost controls, total operating expenses for the first quarter came in at 11.1 percent of net revenue, less than the 12 percent that we had anticipated. Operating margin thus rose to 42 percent, a sequential increase of 0.4 percentage points. Overall, we had NT$8.7 EPS and a 25.4 percent return on equity for the first quarter. Currently, let us discuss revenue generated by technology.

In the first quarter, wafer revenue was accounted for by 9 percent of processes using 3-nanometer technology, compared to 37 percent and 19 percent using 5-nanometer and 7-nanometer technology, respectively. Semiconductor revenue was 65 percent driven by advanced technologies, which are classified as 7 nanometers and below. Next up is revenue contribution broken down by platform. Our first-quarter revenue came from HPC, which grew by 3% on a quarter-over-quarter basis.

The percentage of smartphones decreased by 16 percent to 38 percent. IoT grew by 5% to make up 6% of the total. DCE increased by 33% to account for 2% of the total, while automotive stayed flat and accounted for 6%. Now let’s look at the balance sheet.

Our cash and marketable securities at the end of the first quarter totaled NT$1.9 trillion, or $60 billion. The increase of NT$140 billion in accrued liabilities and other liabilities was the primary cause of the NT$113 billion increase in current liabilities on the liability side. A decrease of NT$44 billion in accounts payable was a partial offset of this increase. The reclassification of the temporary customer receipt from long-term liabilities was the primary cause of the increase in accrued liabilities and other. Our financial ratios showed that, mostly as a result of the ramp of 3-nanometer technologies, days of inventory increased five days to 90 days, while accounts receivable turnover days stayed at 31 days.

in relation to capital expenditures and cash flow. We earned approximately NT$436 billion in operating cash during the first quarter, incurred NT$181 billion in capital expenditures, and disbursed NT$78 billion as a cash dividend for the second quarter of 2023. We also raised NT$23 billion in cash through the sale of bonds. By the end of the quarter, we had NT$233 billion more in cash than we had at the beginning.

Within U.S. S. In terms of money, we spent $5.77 billion on capital projects during the first quarter. My financial summary is now complete. Now let’s talk about our guidance for the current quarter.

Strong industry-leading 3-nanometer and 5-nanometer technology demand is expected to sustain our business, somewhat offsetting the ongoing seasonality of smartphones. We anticipate our second-quarter revenue to be between $19.6 billion and $20.4 billion, which, at the midpoint, would represent a sequential increase of 6 percent and a year-over-year increase of 27.6 percent, based on the current business outlook. The gross margin is anticipated to range from 51 to 53 percent, and the operating margin to range from 40 to 42 percent, assuming an exchange rate of $1 to NT$32.3. We will also have to accrue the tax on the undistributed retained earnings in the second quarter.

It follows that our tax rate for the second quarter will be marginally higher than 19%. In the third and fourth quarters, the tax rate will revert to 13–14 percent, and for the entire year, it will range from 15–16 percent, as opposed to 14–5% in 2023. My presentation on finances is now complete. Let me now address our main takeaways.

I’ll start by discussing the effects of the earthquake that occurred on April 3. Our fabs had a maximum magnitude of five during the 7.2 magnitude earthquake that struck Taiwan on April 3. All TSMC employees are safe because safety procedures and systems were put in place right away at our fabs. Based on TSMC’s deep experience and capabilities in earthquake response and damage prevention as well as regular disasters drills, the overall tool recovery in our fabs reached more than 70 percent within the first 10 hours and were fully recovered by the end of the third day.

No power outages, no structural damage to our fabrication facilities, and no harm to our vital tools—all of our EUV lithography tools, among others—were reported. However, we anticipate that the majority of the lost production will be recovered in the second quarter, minimizing the impact to our revenue for the second quarter. Nevertheless, a certain number of wafers that were in the process were affected and had to be scrapped. We anticipate that the entire effect of the earthquake will lower our gross margin for the second quarter by roughly 50 basis points, mostly as a result of material loss and wafer scrap losses. I’ll now discuss our profitability for the first and second quarters of 24.

Our first-quarter gross margin increased by 10 basis points sequentially to 53.1%, mainly as a result of changes in the product mix brought on by the seasonality of smartphones, as compared to the fourth quarter of 2023. As we recently discussed, the impact of the April 3rd earthquake and rising electricity costs in Taiwan are the main reasons for our guidance that our second quarter gross margin will drop by 1.1 percentage points to 52.1 percent at the halfway point. Commencing on April 1st of this year, TSMC’s electricity price in Taiwan has increased by a further 25 percent, following the 17 percent increase in electricity prices from the same date last year. Our second-quarter gross margin is predicted to decrease by 70 to 80 basis points as a result.

We anticipate that the impact of increased electricity costs will persist into the second half of the year and reduce our gross margin by 60 to 70 basis points. We also expect the higher electricity cost to indirectly lead to higher materials, chemical and gases, and other variable costs. Furthermore, we anticipate a stronger overall business in the second quarter of the year compared to the first half. Additionally, it is anticipated that 3-nanometer technologies will contribute more revenue, which will reduce our gross margin by 3 to 4 percentage points in the second half of 24 as opposed to 2 to 3 percentage points in the first half.

Finally, considering the strong multiyear demand, as we have previously stated, we have a plan to convert some 5-nanometer tools to support 3-nanometer capacity. In the latter half of 2024, we anticipate that this conversion will reduce our gross margin by one to two percentage points. We will put a lot of effort into internal cost-improvement initiatives while keeping up our value-selling to manage our profitability in the second half of 2024. We continue to predict that a long-term gross margin of 53 percent or higher is achievable, assuming that the impact of foreign exchange rates is excluded and that our plans to expand our global manufacturing footprint are taken into account.

Jeff Su.

Alright. I apologize for interrupting you, Wendell, but it appears that some audience members are experiencing trouble connecting to the call via the website. So let’s take a brief break and resume after we have resolved the IT problem. I sincerely appreciate everyone’s patience.

All right. I sincerely appreciate everyone’s patience. I apologize for the technical problems. We believe the webcast, if you’re through the TSMC website, you should be able to log back in and listen to the webcast.

I believe you should try the webcast first for those of you who are on the line or experiencing trouble with the phone; the phone line should be available soon. I appreciate your patience and apologize once more for the inconvenience. Wendell Huang, our CFO, will likely provide our guidance first because of the technical difficulties we encountered. Following that, we will deliver our prepared remarks. I am grateful.

Vice President and Chief Financial Officer Wendell Huang.

Jeff, thank you. Apologies to all of you. Permit me to restate the second quarter’s projections. Strong demand for our industry-leading 3-nanometer and 5-nanometer technologies is expected to support our business in the second quarter of 2024, somewhat offsetting the ongoing seasonality of smartphones.

Our second-quarter revenue is expected to be between $19.6 billion and $20.4 billion based on the current business outlook. At the midpoint, this translates to a 6 percent sequential increase or a 27.6 percent year-over-year increase. It is anticipated that the gross margin will range from 51 to 53 percent and the operating margin from 40 to 42 percent based on the exchange rate assumption of $1 to NT$32.3. Tax on the undistributed retained earnings will also need to be accumulated in the second quarter. Our tax rate for the second quarter will therefore be marginally higher than 19%.

After that, the tax rate will drop to between 13 and 14 percent in the third and fourth quarters. For the entire year, the tax rate will be between 15 and 16 percent, down from 14.5 percent in 2023. The financial presentation is now complete. I’ll now restate our main points. I’ll start by discussing some of the effects of the earthquake that occurred on April 3.

An earthquake with a magnitude of 7:2 occurred in Taiwan on April 3rd, and the highest magnitude recorded at our factories was 5. All TSMC employees are safe because safety procedures and systems were put in place right away at our fabrication facilities. The total tool recovery in our fabs reached more than 70% within the first 10 hours and was fully recovered by the end of the third day, thanks to TSMC’s extensive experience and capabilities in earthquake response and damage prevention as well as regular disaster drills. There were no outages of electricity, no harm to our fabrication facilities’ structural integrity, and no damage to any of our vital instruments, including our whole set of EUV lithography instruments.

Although some wafers that were in the process had to be scrapped due to the impact, we anticipate that the majority of the production lost would be made up in the second quarter, which will have a negligible effect on our revenue for that quarter. We anticipate that the entire effect of the earthquake will lower our gross margin for the second quarter by roughly 50 basis points, mostly as a result of material loss and wafer scraps losses. The profitability of our first and second quarters of 2024 will be discussed next. Compared to fourth quarter of 2023, our first quarter gross margin slightly increased by 10 basis points sequentially to 53.1 percent, primarily driven by product mix changes due to smartphone seasonality.

We have just guided our second quarter gross margin to decline by 1.1 percentage points to 52 percent at the midpoint, primarily due to impact from the earthquake on April 3rd, as just discussed, and higher electricity costs in Taiwan. Following an increase of 17 percent in electricity prices on April 1st of last year, TSMC’s electricity price in Taiwan was raised by an additional 25 percent on April 1st of this year. This is expected to take out 70 to 80 basis points from our second-quarter gross margin. In the second half of the year, we anticipate that the impact of increased electricity costs will persist and reduce our gross margin by 60 to 70 basis points.

Additionally, we anticipate that higher materials, chemical, gas, and other variable costs will follow the increase in the price of electricity. Furthermore, we anticipate that the second half of the year will see a stronger overall business than the first. And revenue contribution from 3-nanometer technologies is expected to increase as well, which will dilute our gross margin by 3 to 4 percentage points in second half ’24, as compared to 2 to 3 percentage points in first half of ’24. Lastly, in light of the robust multiyear demand, as we have previously stated, we have a plan to convert some 5-nanometer tools to support 3-nanometer capacity.

We expect this conversion to dilute our gross margin by about 1 to 2 percentage points in the second half of 2024. Working hard on internal cost improvement initiatives and keeping up our value-selling will help us manage our profitability in the second half of 24. Over an extended period, accounting for the influence of fluctuations in currency rates and taking into account our intentions to expand our manufacturing footprint worldwide, we maintain our prediction that a long-term gross margin of 53 percent or more is feasible. Let me now discuss our capital budget for 2024.

We invest in capital projects each year with the expectation of continued growth in the years to come. Our capacity and capex planning is always determined by the long-term demand profile of the market. We reiterate our 2024 capital budget is expected to be between $28 billion and $32 billion as we continue to invest to support customers’ growth. The advanced process technologies will receive between 70 and 80 percent of the $28 billion and $32 billion capital budget for 2024; the specialty technologies will receive between 10 and 20 percent, and the advanced packaging, testing, mask making, and other technologies will receive about 10 percent.

Allow me to pass the microphone to C now. C.

C. D. Wei is the CEO.

I am very grateful, Wendell. Good afternoon to all of you. Prior to commencing, allow me to pause and offer a few observations. TSMC was struck by a major-scale earthquake with a magnitude of 7:2.

All of the people impacted by this tragedy have our sincere sympathies and hearts. In addition, I would like to express my gratitude to each and every one of our suppliers and staff for their commitment and diligence during this period. Even though it was Taiwan’s biggest earthquake in the previous 25 years, our teamwork was unwavering, and within three days, we were able to resume operations at all of our factories with the least amount of disruption possible. This showed how resilient our operations are in Taiwan. As we attempt to make up for the lost output during the second quarter, I would also like to express our sincere gratitude to our customers for their cooperation and understanding.

Now, let me begin by outlining our demand outlook for the near future. With revenue of $18.9 billion at the end of the first quarter, we slightly exceeded our guidance in U.S. S. in terms of dollars. Seasonality in smartphones had an effect on our business in the first quarter, but demand for HPC-related products also continued to be strong.

As we approach the second quarter of 2024, we anticipate that the robust demand for our industry-leading 3-nanometer and 5-nanometer technologies will sustain our business, with the ongoing seasonality of smartphones serving as a partial offset. Looking at the full year 2024, macroeconomic and geopolitical uncertainty persists, potentially further weighing on consumer sentiment and end-market demand. We thus expect the overall semiconductor market, excluding memory, to experience a more mild and gradual recovery in 2024. We lowered our forecast for the 2024 overall semiconductor market, excluding memory, to increase by approximately 10 percent year over year, while foundry industry growth is now forecast to be mid- to high-teens percent, both are coming off the steep inventory correction and/or base of 2023.

Having said that, we continue to expect 2024 to be a healthy growth year for TSMC. Supported by our technology leadership and broader customer base, we expect that our business to grow quarter over quarter throughout 2024 and reaffirm our full-year revenue to increase by low to mid-20 percent in U. S. dollars and cents. Subsequently, I will discuss the promising demand outlook for AI.

Our conviction that the structural demand for energy-efficient computing is growing in an intelligent and connected world is strengthened by the ongoing surge in demand related to artificial intelligence. TSMC is a key enabler of AI applications. As AI technology develops, it will employ ever-more complex AI models, which will require stronger semiconductor hardware to support. Whichever strategy is chosen, the most cutting-edge semiconductor process technologies must be used.

Thus, the value of our technology position is increasing as customers rely on TSMC to provide the most advanced process and packaging technology at scale with a dependable and predictable cadence of technology offering. In summary, our technology leadership enable TSMC to win business and enables our customer to win business in their end market. Almost all the AI innovators are working with TSMC to address the insatiable AI-related demand for energy-efficient computing power. We project that several AI processors will contribute more than twice as much revenue this year, making up the low teens of our overall revenue by 2024.

We predict that it will grow at a 50 percent compound annual growth rate (CAGR) over the next five years, accounting for more than 20 percent of our revenue by 2028. Several AI processors are narrowly defined as GPUs, AI accelerators and CPU’s performing, training, and inference functions and do not include the networking edge or on-device AI. In the upcoming years, we anticipate that a few AI processors will be the main factor driving the expansion of our HPC platform and the biggest contributor to our overall incremental revenue growth. Let me now discuss our updated global manufacturing footprint.

The goal of TSMC is to become the world’s most reliable source of technology and capacity for the IC—logic IC industry for many years to come. Given the strong HPC and AI-related demand, it is strategically important for TSMC to expand our global manufacturing footprint to continue to support our U. S. customers’ development, boost their confidence, and increase our prospects for future growth. It is with great commitment and support that we in Arizona have received from our U. S.

clients and intend to construct three fabrication plants, which contribute to increased economies of scale. The clean-room area of each of our fabs in Arizona will be roughly twice as large as that of a conventional logical fab. We have made significant progress in our first fab, which has already entered engineering wafer production in April with the N4 process technology. We are well on track for volume production in first-half 2025.

Our second fab has been upgraded to utilize 2-nanometer technologies to support a strong AI-related demand in addition to the previously announced 3-nanometer. We recently completed the tapping off, in which the last steel construction beam was raised into place, and volume production is scheduled to begin in 2028. We also recently announced plans to build a third fab in Arizona using 2-nanometer or more advanced technologies, with production beginning by the end of the decade. We are confident that once we begin volume production, we will be able to deliver the same level of manufacturing quality and reliability in each of our fab in Arizona as from our fab in Taiwan.

In Japan, we held an opening ceremony in February in Kumamoto for our first specialty technology fab. This fab will utilize the 12/16 and the 22/28-nanometer process technologies and is on track for volume production in the fourth quarter of this year. Together with our JV partners, we also announced a plan to build a second specialty fab in Japan with 40, 12/16 and the 6/7-nanometer process technologies to support a strategic customer for consumer, automotive, industrial and HPC-related applications. Construction is scheduled to begin in second half ’24 with production target by the end 2027.

In Europe, we plan to build a specialty technology fab in Dresden, Germany, focusing on automotive and industrial applications with our JV partners where construction is scheduled to begin in fourth quarter this year. Our overseas decision are based on our customers’ need and the necessary level of government support. This is to maximize the value for our shareholders. In today’s fragmented globalization environment, cost will be higher of everyone, including TSMC, our customers, our competitors and the entire semiconductor industry.

We plan to manage and minimize the overseas cost gap by, first, pricing strategically to reflect the value of geographic flexibility; second, working closely with government to secure their support; and third, leveraging our fundamental advantage of manufacturing technology leadership and our large-scale manufacturing base, which no other manufacturer in this industry can match. So, even after accounting for the higher cost of overseas fabrication, we are confident that we will meet our commitment to our shareholders to deliver a long-term gross margin of 53% and a higher and sustainable ROE of more than 25%. Meanwhile, in the area where we do business, TSMC will be the most productive and economical manufacturer. To assist in their expansion, we will keep offering our clients the newest technology available at a large scale.

Finally, I will talk about our N2 status. Our N2 technology leads our industry in addressing the insatiable need for energy-efficient computing, and almost all AI innovators are working with TSMC. We anticipate that there will be more new tape-outs from 2-nanometer technology in its first two years than from 3-nanometer and 5-nanometer technology in their respective first two years, as we are seeing a high degree of customer interest and engagement at N2. As the most advanced technology in the semiconductor industry in terms of density and energy efficiency, our 2-nanometer technology will use the structure of nanosheet transistors.

The development of N2 technology is moving along nicely, with device performance and yield either on schedule or above expectations. With a ramp profile akin to that of N3, N2 is expected to reach volume production in 2025. With our strategy of continuous enhancement, N2 and its derivative will further extend our technology leadership position and enable TSMC to capture the AI-related growth opportunities well into future. This concludes our key message, and thank you for your attention.

Jeff Su.

OK. Thank you, C. C. This concludes our prepared remarks. Again, thank you, everyone, for your patience.

[Operator instructions] So now let’s begin the QandA session. Operator, can we please proceed with the first caller on the line? Thank you.

Questions & Answers:.

Operator.

Yes. The first one to ask questions is Gokul Hariharan, J. P. Morgan.

Gokul Hariharan — JPMorgan Chase and Company — Analyst.

Yeah. Hi. Good afternoon, and thanks for taking my question. My first questions are on demand.

So C. C. , you kind of reduced the expectation for the overall semiconductor industry growth. Could you talk a little bit about where is the area where you have seen that slower pickup in demand? I think you talked about smartphone a couple of times in the call. Is it primarily the smartphone area where you’ve seen a slower pickup in terms of demand? And previously, a couple of quarters back, you talked about cannibalization or decline in regular data center demand due to the crowding out of AI and being a drag for TSMC. Do you see that the regular compute, regular data center networking kind of demand is coming back? Or is it still remaining muted and most of the demand uptick is still focused on AI?

Jeff Su.

OK. So, Gokul, thank you. So Gokul’s first question is a little bit two parts. So he notes that we have lowered our overall semiconductor ex-memory growth forecast for this year to approximately 10 percent and foundry now to mid to high teens.

So Gokul wants to understand, in what segments or applications or areas are we seeing a slower pickup in demand? And then also, in terms of specifically AI versus traditional servers, how are you seeing that demand shape out? And what is the impact to TSMC? Is that generally correct, Gokul?

Gokul Hariharan — JPMorgan Chase and Company — Analyst.

Yes. And I think maybe since you called out smartphone, just maybe mention how you see the smartphone demand compared to maybe three months back as well.

C. C. Wei — Chief Executive Officer.

Well, Gokul, this is C. C. Wei. Let me answer your questions and some of your comment also. Yes, smartphone end-market demand is seeing gradual recovery and not a steep recovery, of course.

PC has been bottomed out and the recovery is slower. However, AI-related data center demand is very, very strong. And the traditional server demand is slow, lukewarm. IoT and consumer remain sluggish.

Automotive inventory continue to correct, OK? What does that mean to TSMC? The budget for a hyperscale player, their wallet share shifted from traditional server to AI server is favorable for TSMC. And we are able to capture most of the semiconductor content in an AI server’s area as we define the GPU, edge AI networking processor, etc. Well, we have a lower presence in those CPU-only, CPU-centric traditional server. So we expect our growth will be very healthy.

Do I answer your question, Gokul?

Gokul Hariharan — JPMorgan Chase and Company — Analyst.

Alright. So, yeah, that’s what I wanted to ask: is the primary difference between now and, say, January, when you had over 10 percent growth for semi, or are you seeing a slower recovery overall?

Su Jeff.

So Gokul is asking sort of versus three months ago, where have we seen the major shift in the overall end market? Is there a particular area that we have seen?

Wendell Huang — Vice President and Chief Financial Officer.

Yes, Gokul. Three months ago, we project that one of the platforms, the automotive platform was — will increase this year, but now we’re expecting it to decrease. So I think that is the one area that we saw was different.

Gokul Hariharan — JPMorgan Chase and Company — Analyst.

OK. My second question, just wanted to understand gross margin trends. We talked about 3 to 4 percentage point gross margin dilution from N3 ramp in second half of the year. Should we think that the N3-related gross margin drag is more severe than usual for what we have seen for leading-edge nodes in the past? Or is it largely similar to what we have seen in N5 or N7? And when we go to N2, do you think that this will kind of be the similar pattern? Or do you think that the gross margin dilution will be lower when we go to like future process nodes given that N3 seems to be, at least compared to previous cycle, seems to be dragging a little bit more compared to like N5 or N7 in the past few years?

Jeff Su.

Okay. Thank you, Gokul. So let me summarize your second question, basically, is on gross margin. Gokul notes that N3, as Wendell said, will dilute our margin by 3 to 4 points, percentage points in the second half.

He asks, “So, it appears that compared to previous nodes like N5 and N7, the gross margin dilution or drag is more severe at N3?”. Is that the case? And also, of course, with N2 upcoming, will we face a similar pattern? Or what is the margin profile for N2? Which I think Wendell can address, yes.

Wendell Huang — Vice President and Chief Financial Officer.

Yes, Gokul, it is true that N3 is taking longer time to reach the corporate margin than the other nodes like N5 or N7. N5 or N7 before, it was like 8 to 10 quarters to reach the corporate. But for N3, we think it will take about 10 to 12 quarters. And this is probably because N3 process complexity has increased, and also our corporate average gross margin also increased during the period.

But another reason is that we set the pricing of N3 very early, several years ahead of production. However, we experienced a lot of cost inflation pressures in the following years. So as a result, N3 will take a longer time than N5 and N7 to reach the corporate average gross margin. For N2, based on what we can see so far is that we are doing a better job in cost and selling our value, and we expect N2 to have a better margin profile than N3.

Gokul Hariharan — JPMorgan Chase and Company — Analyst.

OK. That’s very clear. Thank you.

Jeff Su.

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

Operator.

The next one to ask a question, Brett Simpson, Arete.

Brett Simpson — Arete Research — Analyst.

Yeah. Thanks very much. I had a question on the AI returns at TSMC. So I think it’s clear that AI is producing a large profit pool at your customers.

And the HBM is also driving super-normal returns for memory players. So my question is, does TSMC believe they’re getting their fair share of the returns in the AI value chain today? And is there scope for TSMC to raise pricing for AI chips in the future?

Jeff Su.

OK. Thank you, Brett. Thus, examining the demand related to AI is Brett’s first query. He mentions that clients of AI are receiving excellent returns on investment, along with HBM and other components.

His question therefore is, “TSMC, do you feel that we are earning or capturing our fair value or right value of the returns?” and, in terms of pricing, how would we essentially price for AI? I apologize; I take it that you have that question.

Analyst Brett Simpson, Arete Research.

And that’s it.

C. C. Wei is the CEO.

Okay, allow me to respond to your queries. Although we constantly state that we wish to sell our value, TSMC is in the process of doing so. Furthermore, allow me to assure you that we are addressing it. The fact that our customers are prospering makes us happy.

Additionally, TSMC benefits when its customers do well. Allow me to summarize it. We are attempting to sell our value while we work on it.

Brett Simpson, Analyst, Arete Research.

That’s correct. I wanted to ask a follow-up question and, yes, Jeff, that’s great. My subsequent inquiry concerned the lighting edge nodes at TSMC. Furthermore, your total revenues for these nodes collectively were down 20% year over year in Q1 sales for 12-nanometer and above, and they only accounted for 35% of your total sales.

And we’re seeing a lot of government support in building out new fabs in the U.S.; could you perhaps share with us whether you see a recovery at all this year at these nodes? s. and China around lighting edge nodes. So are you concerned at all about structural overcapacity for the older nodes to the cycle?

Jeff Su.

OK. Thank you, Brett. So, Brett’s second question is more on the mature nodes. He notes that the demand for our mature nodes, 12-nanometer and older, are down year over year.

So he wonders sort of what is the outlook for the recovery of mature nodes in the second half of the year. I think that’s the first part of his question.

C. C. Wei — Chief Executive Officer.

All right. Brett, let me answer this question. First, the mature node demand remains sluggish because of a site. As we just announced it, the whole semiconductor industry is gradually recovering, but not fast enough.

So we expect to gradually improve in the second half of 2024. As you mentioned that you — do we have a concern on the overcapacity because of some of the companies, they continue to build a lot of mature node capacity. For us, actually, our strategy at a mature node is work closely with our strategic customers to develop specialty technology solution to meet their requirement. And we create an appreciated and long-lasting value to customers.

So we have less exposed to this possible overcapacity environment. And we believe that our utilization and profitability on mature node can be well protected.

Jeff Su.

Does that answer your second question, Brett?

Brett Simpson — Arete Research — Analyst.

That’s clear.

Jeff Su.

OK. Thank you, Brett.

Analyst Brett Simpson, Arete Research.

Yeah. It’s fantastic. Thank you, Jeff.

Jeff Su.

Everything is fine. Regards, Brett. Operator, can we move on to the next participant, please?

Operator.

Next one, we have Randy Abrams, UBS.

Randy Abrams — UBS — Analyst.

Yes. Hi. Thank you. I wanted to ask a question, following up on C. C. ‘s comment about a ramp profile similar to 3-nanometer for 2-nanometer.

Could you clarify for the timing of the meaningful revenue ramp for that node? Is the expectation that would be starting early 2026 and ramping up steep through 2026? Or any potential to pull that in? And then just a second question on that is you noted that tape-outs are higher. Would there be potential with higher tape-outs in three and five for either steeper or it ramps to be larger than the prior nodes once underway or looking out a couple of years?

Jeff Su.

OK. So Randy’s first question is around 2-nanometer. So his first question is to C. C. with that we said that the N2 ramp profile will be similar to N3.

We also said, of course, the production begins in 2025. So his question partly is, when do we expect to see the revenue contribution, meaningful revenue contribution from N2? And then also that with N2, the tape-outs being higher, what is the multiyear opportunity or contribution from N2 maybe in terms of the revenue as compared to N3 or other nodes?

C. C. Wei — Chief Executive Officer.

Randy, the N2’s ramp profile we say is very similar to N3 because of, look at the cycle time, we start the N2 production in the second half of 2025, actually in the last quarter of 2025. And because of the cycle time and all the kind of back-end process, and so we expect the meaningful revenue will start from the end of the first quarter or beginning of the second quarter of 2026. That’s what we mean that is the profile is very similar to N3. Now your second question is there have been a lot of engagement and the tape-out will be higher, and do we see a very steep kind of a production? Well, we do expect that, but let me say again, N2 is a very complicated work or a very complex technology node.

So my customer, they also take a little bit longer time to prepare for the tape-out. So that’s why they all engage with TSMC in the early stage. And — but for their product ramp-up, they will have their own product road map and their own business consideration. However, we still say that N2 will be a very, very big node for TSMC.

Randy, does that answer your question?

Analyst at UBS, Randy Abrams.

OK. Great. No, that’s helpful color. Yes.

It does indeed. No, helpful hue. My second question is just relating to the upward expectations you gave for the AI accelerators. Curious how that ties to how you’re looking at the capex, if you say that we’re entering either higher growth or investment cycle, where capital intensity could need to rise up above that mid-30s range that you set or at least in absolute dollars from the $30 billion this year, we should start growing or thinking about capex at least growing with revenue.

Su Jeff.

All right. So Randy’s second question is basically, I think, with such strong AI-related demand, what does this mean for our capex and capacity planning? And also, what does this mean for our capital intensity outlook?

Wendell Huang — Vice President and Chief Financial Officer.

Yes. Randy, for TSMC, a higher level of capital expenditure is always correlated with higher growth opportunity in the following years. We work with our customers closely, and our capex and capacity planning are always based on the long-term structural market demand profile that is underpinned by the multiyear megatrends. We always review our capex plan on an ongoing basis.

And as a key enabler of AI, we will work with our customers closely to plan the appropriate level of capacity to support their needs.

Jeff Su.

And then in terms of the capital intensity and capex dollar outlook.

Wendell Huang, Chief Financial Officer and Vice President.

Indeed. The previous few years had a high capital intensity because we made significant investments to keep up with the high demand from customers. Now the increase — the rate of increase for the capex is leveling off. For the upcoming years, we anticipate that the capital intensity will be approximately in the mid-30s.

Having said that, though, we will make the appropriate investments if there are opportunities in the upcoming years.

Su Jeff.

I hope that clarifies Randy’s second question.

Analysis by Randy Abrams of UBS.

If I could ask a quick follow-up. Yes, it does. Sorry, I’ll ask a quick follow-up. Is this — would this be viewed as a bit of a digestion year since you ramped a lot of the 3-nanometer spending in the past couple of years? So then as you kick off to — like I mean, should we look at it at a lower — or should we see this as kind of a normal in that trend?

Jeff Su.

So I think Randy’s question is with — Randy, you’re still asking about capex. So is that correct?

Randy Abrams — UBS — Analyst.

Yes. Sorry, still on capex. If it’s a capex digestion year, since you’ve ramped a lot of three spending already in the 2-nanometer still, a lot of that is still in front of us.

Wendell Huang — Vice President and Chief Financial Officer.

Yes, Randy, I wouldn’t call it a digestion year. I mean every year, we invest based on the forward-looking business opportunities, and we constantly review that. So this is what we’re seeing in the future, and that’s why we’re — the funds that we’re investing in. So no, I wouldn’t call it a digestion year.

OK?

Randy Abrams — UBS — Analyst.

OK. Good.

Operator.

And next one to ask questions, Charlie Chan from Morgan Stanley.

Charlie Chan — Morgan Stanley — Analyst.

So my first question is about selling the value. I think another caller also addressed this topic, but I want to go a little bit deeper. Because given all the efforts you made, right, and also ongoing cost challenge made at the coming U. S. fab, electricity cost hike, I’m not sure if you can give investors kind of a range about a potential price adjustment or kind of the value you’re going to sell to your customers.

Based on our back testing, I think based on your revenue and shipments in 2022 and 2023, we calculate your price hike could be around 10 percent in 2022 and the price hike of 5 percent in 2023. So C. C. , I’m not sure whether you are planning to hike price in this kind of a range or magnitude for 2025, so we can be comfortable you can achieve the 53 percent gross margin in 2025.

Jeff Su.

OK. So Charlie’s first question is about TSMC’s pricing strategy. He notes that TSMC, of course, makes a lot of efforts to deliver technology leadership and manufacturing excellence to our customers, but we also face a lot of cost challenges, whether from electricity price hikes or the higher cost of overseas fabs. So his question is, number one, I guess, what is our intention about pricing strategy to sell our value; and then, number two, he would like to know what percentage range, if any?

C. C. Wei — Chief Executive Officer.

OK, Charlie. This is C. C. Wei. First, I would like to emphasize again this kind of a pricing strategy is very confidential and totally between TSMC and the customer.

However, let me expand a little bit, we do encounter some kind of higher cost in the overseas or even recently, the inflation and the electricity. We expect our customers to share some of the higher cost with us, and we already started our discussion with our customers. And as I said, for the overseas fab, we want to share our value, which also includes the flexibility of geopolitical location or something like that. If my customer requests to be in some certain area, then definitely, TSMC and the customer had to share the incremental cost.

Charlie, did I answer your question?

Charlie Chan — Morgan Stanley — Analyst.

Yes, I think that answers my question. I think passing through some cost or all the cost to — incremental cost to customers should be fair, especially you are creating lots of value to your customers. And my second question is about AI. I know the — your cost capacity has been very tight, very strategic.

But I’m wondering how you’re going to judge the demand and allocate the capacity to all the different type of AI semi customers. Because we’re hearing your major customer is demanding for two times capacity next year. So I’m wondering how you’re going to allocate, so I mean, will you still reserve a certain percentage for some smaller or strategic customers no matter if it’s ASIC or smaller GPU vendors? So what is the kind of benchmark you’re going to allocate those capacity to customers? And are you OK with that if your major customers’ demand cannot be fulfilled by you? Are you OK to give out or do some market share to some of your industry competitors?

Jeff Su.

OK. So Charlie’s second question is around, I guess, basically, our advanced packaging and more specifically, CoWoS. And he, of course, notes that the CoWoS capacity, the demand is very strong today and also into 2025. So the capacity is very tight.

There are multiple aspects to his question, which are how does TSMC determine how to allocate capacity to customers, how do we support smaller customers in addition to large ones, and would we be okay if customers wanted to use someone else?

C. B. Wei — Chief Executive Officer.

Charlie, let me say it again, the demand is very, very strong, and we have done our best where we put all the effort to increase the capacity. It’s probably more than double this year as compared with last year. However, it’s still not enough to meet the customers’ demand, and we leverage our OSAT partners to complement of TSMC’s capacity to fulfill our customers’ need. Still not enough, of course.

But in my mind, my first priority is to make our customer to be successful, no matter which one. And of course, the long-term partners will have a better cooperation with TSMC in terms of technology and processing complexity, so much easier to be ramped up. However, no matter what, let me say again, the demand is very high, extremely high. And we do our best to increase the capacity to alleviate the shortage.

We also leverage the OSAT partners. We want to make sure that all our customers get supported, probably not enough this year; but for next year, we try, we try very hard. And you mentioned about giving up some market share, that’s not my consideration. My consideration is to help our customers to be successful in their market.

Charlie Chan — Morgan Stanley — Analyst.

I see. So since your major customers said there’s no room for other type of AI computing chips, but it seems like TSMC is happy to see some similar customers, right? So is that the right interpretation about your comments?

C. C. Wei — Chief Executive Officer.

Yes.

Jeff Su.

Yes. C. C. said all customers, yes. Thank you, Charlie.

Operator.

Next one to ask questions, Bruce Lu from Goldman Sachs.

Bruce Lu — Goldman Sachs — Analyst.

I think, again, the question is coming back to AI still. I think currently, most of the AI accelerators are mostly in 5-nanometers, which is N minus one comparing to a smartphone for now. So when do we expect them to catch up or surplus in terms of technology node? Do we see them to be the technology driver in 2 nanometers or above?

Jeff Su.

OK. So Bruce’s first question is about, again, looking at AI accelerators. He notes that in his view, they’re currently at 5-nanometer now. His question is, do we expect them to catch up? How do we see AI accelerators and also maybe HPC as a whole being the driver or adopter of TSMC’s most leading-edge or advanced technology node? Is that correct, Bruce?

Bruce Lu — Goldman Sachs — Analyst.

Yes. That’s correct.

C. C. Wei — Chief Executive Officer.

OK. Bruce, let me answer the questions. Yes, your observation is right. Today, all the AI accelerators, most of them are in the 5- or 4-nanometer technology.

But my customers are working with TSMC for the next node. Even for the next, next node, they have to move fast because, as I said, the power consumption has to be considered in the AI data center. So the energy-efficient is fairly important. So our 3-nanometer is much better than the 5-nanometer.

And again, it will be improved in the 2-nanometer. So all I can say is all my customers are working on this kind of a trend from 4-nanometer to 3 to 2. Bruce?

Bruce Lu — Goldman Sachs — Analyst.

But if that is the case, do we see — yes, if that is the case, do we see a bigger revenue in the first two years of the 2-nanometers? Because in the past, it’s only smartphone. But in 2-nanometer, it would be both smartphone and HPC customers.

Jeff Su.

So Bruce is asking then, well, then with such strong AI-related demand, should we see more revenue from 2-nanometer in its first two years compared to past nodes?

Wendell Huang — Vice President and Chief Financial Officer.

Yes, Bruce, as we said, we believe that it will be — our advanced technologies will be long-lasting nodes and larger nodes, N2, then N3 or N5. So the dollar value will certainly be larger.

Jeff Su.

I think, Bruce, we’re locating at these opportunities in a multiyear period. So as Wendell and C. C. just said, certainly, with the demand that we’re seeing, we do expect N2 revenue contribution to be even larger than N3, just like three has a larger contribution or larger node than five, etc. , etc.

Bruce Lu — Goldman Sachs — Analyst.

I see. So my second question is for dividends. We do see very strong free cash flow in the first quarter. And the capital intensity, as Wendell mentioned, is stabilizing.

And we even started to pay a huge amount of return in tax. So do we — can we turn more aggressive in terms of dividends? The current dividend level is much, much lower than 70 percent of free cash flow in the back-of-envelope calculation. So can we expect to see more dividends in the coming quarters?

Jeff Su.

OK. Thank you, Bruce. So Bruce’s second question is on the cash dividend policy. He notes that in the first quarter, we’re generating very, very strong free cash flow.

As we have said, the capital intensity is beginning to stabilize and also that we are paying a very high retained earnings tax. So his question, I think, is, what is the outlook? Can we pay more dividends in the coming quarters? Or what should investors expect?

Wendell Huang — Vice President and Chief Financial Officer.

Yes. Bruce, the — our dividend policy is, in principle, to pay 70 percent of our free cash flow in a year as cash dividends. So I would not just look at quarterly cash, free cash flow to make a judgment. But indeed, as we said before, now that we’re harvesting the heavy investment that we did in the past few years, we expect our dividend policy to switch to steadily increasing from the sustainable in the past few years.

Operator.

Next one, we have Laura Chen from Citi.

Laura Chen — Citi — Analyst.

My question is about the edge AI. We know that C. C. mentioned that the smartphone and the PC recovery is still probably prolonged, yet we are also seeing that the AI PC or AI smartphone is getting quite topical. My first question is, what does TSMC think will happen to it if this kind of edge AI device becomes popular, perhaps in 2025 or later? What are the implications for TSMC?

Su Jeff.

Okay. Regards, Laura. Therefore, Laura’s initial query focuses on edge, or what we refer to as on-device, AI. She mentions that artificial intelligence is being added to both pcs\. and smartphones.

It’s very current. She thus wants to know how we interpret this trend and, more crucially, what it means for TSMC. Laura, is that correct?

Citi analyst Laura Chen.

Yes.

C. C. Wei — Chief Executive Officer.

OK, Laura. Let me answer the question. The edge AI or the on-device AI, the first order of magnitude is the die size. We saw without the AI — with the AI for neuroprocessor inside.

The die size will be increased, OK? That’s the first we observed. And it’s happening. And then for the future, I would think that replacement cycle for smartphone or for those kind of a PC will be accelerated a little bit in the future, at least. It’s not happening yet, but we do expect that it will happen soon.

And all in all, I would say that on-device AI will be very positive for TSMC because we capture the larger share of the market. Did I answer the question, Laura?

Laura Chen — Citi — Analyst.

Yes. And so in that case — yes, very helpful. So in that case, can we expect that our demand — and see, because now it’s still mostly on the smartphone or mobile. So can we expect that N3’s revenue contribution in second half or next year will be bigger, say, like a 20 percent plus in the second half of this year?

Jeff Su.

OK. So well, Laura’s follow-on to the first question is then should we expect that N3 demand in the second half or into 2025. Sorry, I didn’t catch the exact percentage, but a large percentage or significantly larger than it is today. Is that correct, Laura?

Laura Chen — Citi — Analyst.

Yes.

C. C. Wei — Chief Executive Officer.

OK. Certainly, as I said, we expect to happen at a larger die size. As I said, we already observed that. And for the replacement cycle to be accelerated, it will happen, but I cannot give you a definite number because of — it’s too early to predict in 2025.

But it’s an upward trend, no doubt about it, and we expect we have a good business.

Wendell Huang — Vice President and Chief Financial Officer.

Just to follow up on C. C. ‘s comments. Last time, we also said that this year, N3 revenue will be more than triple than the revenue in 2023.

Laura Chen, Citi, Analyst.

Okay. That’s very clear. My second question is about, again, advanced packaging. We know that TSMC is working on the 3DIC for many years.

So I’m just wondering that what’s the current progress? Will we expect to see more meaningful take-off with our N2 ramp-up for like a high-computing PC? And between different kind of technology, like hybrid bonding or TSV, what’s TSMC’s major consideration?

Jeff Su.

OK. So Laura’s, I guess, second question, although — yes, fine. Second question is about our advanced packaging solutions and 3DIC solutions. She is wondering, what is the outlook or take-up for the demand for the next several years? And she also would like us to comment on the consideration of TSV versus hybrid bonding and such.

C. C. Wei — Chief Executive Officer.

Wow, you asked a very technical question about the TSV and the hybrid bonding. It’s all together. The 3DIC’s packaging technology is very complicated, and our customers start to adopt it. Not a big volume yet, but we expect it to start to grow from this year.

How big it will be? It’s hard to say, but I think it is a trend. Whether it is a micro-bumping or it’s a hybrid connection, that it depends on the customer’s product requirement.

Jeff Su.

OK, Laura?

Laura Chen — Citi — Analyst.

So starting from this year, we’ll see — yes, yes, just very quickly. So starting from later this year, we will see that 3DIC products from our customers, that’s the current progress?

Jeff Su.

So Laura is asking, will we start to see 3DIC products from our customers when?

C. C. Wei — Chief Executive Officer.

Now. I’m sorry, I just said that the customers start to adopt it from now, and you would expect that product in the market soon. All right?

Jeff Su.

Thank you, Laura. OK. In the interest of time, maybe we’ll take questions from the last two participants on the call. Thank you.

Operator?

Operator.

Next one, we have Rolf Bulk from New Street Research.

Rolf Bulk — New Street Research — Analyst.

Earlier on the call, you mentioned the possibility of converting so much your N5 capacity to N3. But what I was wondering, considering the strong demand for AI chips and a recovery in smartphones, is there a scenario in which you would consider similar conversions from some of your older nodes such as N7 given that utilization and revenues there are still well below peak levels?

Jeff Su.

OK. So Rolf’s first question is about our tool commonality and conversion. He notes that we have already said we are converting some of the capacity — using some of the N5 tools to support the strong multiyear demand for N3 for AI-related and such. His question is that given our 7-nanometer is still underutilized, will we also consider converting 7-nanometer tools to support more leading-edge stronger demand?

C. C. Wei — Chief Executive Officer.

Well, let me answer this question. We can convert one technology node capacity to the next one is because of our GI’s physical advantage, meaning, let me give you one example, our 3-nanometer and 5-nanometer are adjacent to each other, the fabs, and they are all connected. So it’s much easier for TSMC to convert from five to three. And that doesn’t mean that every node can do the same.

That’s one. And your question about the N7 converted to N5, presumably. No, because we expect the N7 in the next couple of years, it will pick up, the demand will pick up again. And you want repeat — probably repeat the same kind of experience we have in 28-nanometer.

So today, no, we don’t have any solid plan to convert the N7 into N5.

Jeff Su.

OK. Rolf, does that answer your first question?

Rolf Bulk — New Street Research — Analyst.

Yes. An unrelated follow-up?

Jeff Su.

Sure.

Rolf Bulk — New Street Research — Analyst.

Yes, it does. And as a side note, this is actually a response to Laura’s query. Could you comment on the likely timeline for SoIC adoption in smartphones, given that the technology is now being adopted more widely? Do you see your smartphone customer base starting to show interest in adopting SoIC as well?

Jeff Su.

Alright. In other words, Rolf’s second query essentially revisits SoIC adoption. His inquiry is actually rather simple. Do we see a time line or can we give a time line for adoption of SoIC by smartphone applications?

C. C. Wei — Chief Executive Officer.

Well, let me answer the question. Just HPC product is the first one. HPC customer is the first one to adopt, that is a 3DIC or SoIC’s advanced packaging technology. And the other area, let’s wait, wait and see.

I’m unable to comment. We’re putting some effort into it. Okay?

Jeff Su.

Good, Rolf?

Rolf Bulk — New Street Research — Analyst.

Yes.

Operator.

The last one to ask question, Mehdi Hosseini from SIG.

Mehdi Hosseini — Susquehanna International Group — Analyst.

Two from my end. You had a very nice upside to revenue expectation for the first half of ’24, but has kept the year-end unchanged. Is that a reflection of that slow recovery that you were highlighting? Or would you prefer to wait to have more visibility before updating 2024 target?

Jeff Su.

OK. So Mehdi’s first question is about our revenue outlook and guidance. His question is saying we have a nice upside to our revenue in the first half of this year, but we have kept the full year guidance in to grow low to mid-20s. So is that because we are more cautious on the second half? Or is it because we will see how things go? But I’m not sure if you mean by upside to the first half, Mehdi.

You’re saying, of course, our first quarter, as C. C. said, was slightly ahead of our guidance in U. S. dollar term, but very minutely. But — yes?

Wendell Huang — Vice President and Chief Financial Officer.

Yes. Mehdi, there was no change in our guidance for the quarterly profile. We’ve always stated that growth will occur from quarter to quarter. The advice for the entire year will not change either.

So I don’t think there is a so-called upside, as you just said.

Jeff Su.

Sure, up until the first half.

Vice President and Chief Financial Officer Wendell Huang.

Absolutely.

Analyst Mehdi Hosseini of Susquehanna International Group.

All right. And regarding the investment in U. S. , especially for 2-nanometer, does that include advanced packaging? Or would advanced packaging be mostly concentrated in Taiwan region?

Jeff Su.

OK. So Mehdi’s second question is that, of course, that we have announced to build three fabs in the U. S. , including 2-nanometer, given the strong AI-related demand. Then, he asks, what about the advanced packaging front—that is, will we construct advanced packaging facilities in Arizona, or if so, what are our plans?

C. B. Chief Executive Officer Wei.

Alright, allow me to respond to your query. Where the back-end services for their product are completed is always up to the customer. So in Arizona, we are happy to see that Amkor’s recent announcement to build an advanced packaging facility that’s very close to our AZ fab. Actually, we are working with Amkor and try to support all our customers in AZ and for their demand, for their need.

Jeff Su.

OK, Mehdi, does that address your second question?

Mehdi Hosseini — Susquehanna International Group — Analyst.

Yes.

Jeff Su.

OK. Great. All right. We’ve come to the end of our question and answer period, everyone.

Again, we do apologize for the technical difficulties. If you have anything unclear or need to follow up, please contact TSMC’s IR, and we’ll be more than happy to help. 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 again for joining us today.

We hope everyone continues to stay safe and healthy, and we hope to see you again next quarter. Goodbye, and have a good day.

Duration: 0 minutes.

Call participants:.

Jeff Su.

Wendell Huang — Vice President and Chief Financial Officer.

C. C. Wei — Chief Executive Officer.

Gokul Hariharan — JPMorgan Chase and Company — Analyst.

Brett Simpson — Arete Research — Analyst.

Randy Abrams — UBS — Analyst.

Charlie Chan — Morgan Stanley — Analyst.

Bruce Lu — Goldman Sachs — Analyst.

Laura Chen — Citi — Analyst.

Rolf Bulk — New Street Research — Analyst.

Mehdi Hosseini — Susquehanna International Group — Analyst.

More TSM analysis.