Taiwan Semiconductor Manufacturing Co Ltd Q1 FY2022 Earnings Call

Good afternoon, everyone, and welcome to TSMC’s First Quarter 2022 Earnings Conference Call. This is Jeff Su, TSMC’s Director of Investor Relations and your host for today. To prevent the spread of COVID-19, TSMC is hosting our earnings conference call via live audio webcast through the company’s website at www.tsmc.com, where you can also download the earnings release materials. The format for today’s event will be as follows: first, TSMC’s Vice President and CFO, Mr. Wendell Huang, will summarize our operations in the first quarter 2022, followed by our guidance for the second quarter 2022. Afterwards, Mr. Huang and TSMC’s CEO, Dr. C.C. Wei, will jointly provide the company’s key messages. Then we will open the line for Q&A. As usual, I would like to remind everybody that today’s discussions may contain forward-looking statements that are subject to significant risks and uncertainties, which could cause actual results to differ materially from those contained in the forward-looking statements. Please refer to the Safe Harbor notice that appears on our press release. And now I would like to turn the call over to TSMC’s CFO, Mr. Wendell Huang, for the summary of operations and the current quarter guidance.

Thank you, Jeff. Good afternoon, everyone. Thank you for joining us today. My presentation will start with financial highlights for the first quarter 2022. After that, I will provide the guidance for the second quarter. First quarter revenue increased 12.1% sequentially at NT terms or 11.6% in U.S. dollar terms as our first quarter business was supported by strong HPC and automotive-related demand. First quarter gross margin increased 2.9 percentage points sequentially to 55.6%, mainly as we continue to sell our value and improve cost. Operating margin increased 3.9 percentage points sequentially to 45.6%, primarily due to lower vaccine donation expense as compared to the fourth quarter. Overall, our first quarter EPS was TWD 7.82, and ROE was 36.2%. Now let’s move on to revenue by technology. 5-nanometer process technology contributed 20% of wafer revenue in the first quarter, while 7-nanometer accounted for 30%. Advanced technologies, which are defined as 7-nanometer and below, accounted for 50% of wafer revenue. Now moving on to revenue contribution by platform. All 6 platforms increased in the first quarter. Smartphone increased 1% quarter-over-quarter to account for 40% of our first quarter revenue. HPC increased 26% to account for 41%. IoT increased 5% to account for 8%. Automotive increased 26% to account for 5%. And DCE increased 8% to account for 3%. Moving on to balance sheet. We ended the first quarter with cash and marketable securities of TWD 1.3 trillion. On the liability side, current liabilities increased by TWD 83 billion, mainly due to the increase of TWD 63 billion in accrued liabilities and others and the increase of TWD 30 billion in short-term loans, partially offset by the decrease of TWD 21 billion in accounts payable. Long-term interest-bearing debt increased by TWD 19 billion as we raised TWD 20 billion of corporate bonds during the quarter. On financial ratios, accounts receivable turnover days decreased 2 days to 38 days, while days of inventory remained at 88 days. Now let me make a few comments on cash flow and CapEx. During the first quarter, we generated about TWD 372 billion in cash from operations, spent TWD 262 billion in CapEx and distributed TWD 71 billion for second quarter ‘21 cash dividend. Bonds payable increased by TWD 20 billion due to the bond issuances. Overall, our cash balance increased TWD 87 billion to TWD 1.2 trillion at the end of the quarter. In U.S. dollar terms, our first quarter capital expenditures totaled $9.38 billion. I have finished my financial summary. Now let’s turn now to our current quarter guidance. Based on the current business outlook, we expect our second quarter revenue to be between USD 17.6 billion and USD 18.2 billion, which represents a 1.9% sequential increase at the midpoint. Based on the exchange rate assumption of USD 1 to TWD 28.8, gross margin is expected to be between 56% and 58%, operating margin between 45% and 47%. In addition, we maintain our 2022 capital budget to be between USD 40 million and USD 44 billion. This concludes my financial presentation. Now let me turn to our key messages.

Thank you, Wendell. We hope everybody is staying safe and healthy during this time. First, let me start with our near-term demand and inventory. We concluded our first quarter with revenue of TWD 491.1 billion or USD 17.6 billion, which is above the high end of our guidance, mainly due to better demand from smartphone and automotive-related applications than our forecast 3 months ago and customer’s continuing need to ensure supply security with the emergency of COVID-related uncertainties. Moving into second quarter 2022, we expect our business to be supported by HPC and automotive-related demand, partially offset by smartphone seasonality. On the inventory front, we expect the supply chain to continue to maintain a higher level of inventory as compared to the historical seasonal level for a longer period of time, prolonged by recent COVID-related supply chain disruptions and uncertainties brought about by geopolitical tension. On the demand side, despite the recent macro-related uncertainties, we continue to observe the structural increase in long-term semiconductor demand, underpinned by the industry makeup trend of 5G and HPC-related applications. This multiyear megatrend will support device unit volume growth, and much more importantly, drive substantial semiconductor content enrichment in many young devices across HPC, smartphone, automotive, and IoT applications. With our technology leadership, TSMC is well positioned to capture the strong structural demand with our advanced and specialty technologies. And we expect our capacity to remain tight throughout 2022. 2022 will be another strong growth year for TSMC. And we expect our full year growth to likely be at or exceed the high end of our guidance range of mid- to high 20s percent in U.S. dollar terms. Next, given the recent constraint in the tool supply chain, let me talk about the tool delivery update. As a major player in the global semiconductor supply chain, TSMC worked closely with all our tool suppliers to plan our CapEx and capacity in advance. However, like many other industries, our suppliers are facing great challenges in their supply chain from the continued impact of COVID-19, which are creating labor component and chip constraints in their supply chains and extending towards delivery lead time for both advanced and mature nodes. TSMC is working closely with our suppliers and taking several actions to do our part to address the supply chain challenges. We have increased regular high-level communications to trace the progress. We have sent several teams on-site to support our suppliers and are working closely with them to identify critical chips that are gauging the tool delivery. We are working with our customers to prioritize our wafer capacity to support those critical chips to help mitigate the chip constraint issue. By taking such actions, we do not expect any impact to our 2022 capacity plan, and we continue to work closely with our suppliers on 2023 and beyond so that we can ramp up our capacity to meet customers’ demand. Now I will talk about the materials supply update. TSMC operates a well-established enterprise risk management system to identify and access all relevant risks and proactively implement risk mitigation strategies. In terms of material supply, TSMC’s strategy is to continuously develop multi-source supply solutions to build a well-diversified global supplier base and to improve the local supply chain. For specialty chemicals and gases, including neon, we source from multiple suppliers in different regions, and we have prepared a certain level of inventory stock on hand. We are also working closely with our suppliers to further strengthen the resilience and the sustainability of our supply chain. Thus, we do not expect any impact on our operations from material supply. Finally, let me talk about the N3 and N3E status. Our N3 technology will use FinFET transistor structure to deliver the best technology maturity, performance, and cost for our customers. Our N3 schedule is unchanged, and we’re on track for volume production in the second half of 2022 with good yield. We expect the ramp of N3 to be driven by both HPC and smartphone applications. We continue to see a high level of customer engagement at N3 and expect more new tape-outs for N3 for the year as compared with N5 and N7. N3E will further extend our N3 family with enhanced performance, power, and yield. We also observed a high level of customer engagement at N3E, and volume production is scheduled for 1 year after N3. Our 3-nanometer technology will be the most advanced foundry technology in both PPA and transistor technology when it is introduced. In terms of profitability, the initial outlook for new nodes is always challenging. And the increasing process complexity of leading nodes such as the N3 brings even greater challenges to achieving the corporate average gross margin in 7 to 8 quarters, particularly as our corporate profitability has improved with a long-term gross margin target of 53% and higher. As we have done at prior nodes, we will continue to work diligently with our cost improvement and reduction efforts to ensure that we earn the right profitability and return on N3. With our technology leadership and strong customer demand, we are confident that our N3 family will be another large and long-lasting node for TSMC. This concludes our key message, and thank you for your attention.

Thank you, C.C. This concludes our prepared remarks. Should you wish to raise your question in Chinese, I will translate into English before our management answers your question. Now let’s begin the Q&A session. Operator, can we please proceed with the first caller on the line?

Yes. The first one to ask a question is Bruce Lu from Goldman Sachs.

Congratulations on the great result. I think the first one is still focused on the macro and inflation concerns. How does TSMC evaluate the impact from the inflation and the geopolitical tension? We understand that TSMC works with customers closely, but most of your customers probably don’t have the full picture of end demand fluctuation. At the same time, TSMC has to bear the risk to build capacity a couple of years ahead to make the decision earlier, so how can TSMC provide more color to strengthen investor confidence? Do we have any changes on our multiyear capacity expansion plan?

Bruce, this is C.C. Wei. Let me answer your question. As you said, TSMC works closely with our customers to plan capacity. And our CapEx and capacity expansion plan are actually based on customers’ long-term demand profile, underpinned by the industry megatrend. We do not build capacity based on speculation. In advanced technology nodes, we have a leading position. In our mature nodes, our capacity is built to support customer demand for our differentiated specialty technologies. And we focus on building effective capacity, which is capacity that produces specialized technology with high yield rather than just plain capacity. Thus, we are confident our capacity is built to support our customers’ growth, and our utilization and profitability will be sustained.

And then also, how do we think about the impact of inflation.

Well, the inflation definitely impacts the consumers’ buying patterns. But let me stress on overall demand, under the inflation environment, while the momentum in certain end-market segments may slow down or adjust in terms of device units, other end-market segments remain strong. In fact, we expect our HPC platform to be TSMC’s strongest growing platform in 2022 and the largest contributor to our growth, fueled by the structural megatrend driving increasing need for greater computation power and energy-efficient computing. But then more importantly, the increasing silicon content in end devices such as 5G smartphones, PCs, servers, networking, and automotive applications are a much more important factor in supporting our strong semiconductor demand. And with our industry-leading technology, we are well positioned to capture all the opportunities.

Okay. Bruce, does that answer your first question?

Yes. Okay. I want to go for the second question. I think in the prepared remarks, I noticed that there was no mentioning about the N2 schedule. Both of your competitors accelerated their schedule for the next-generation transistor. Can you comment on TSMC’s status for the N2, especially in performance and the ramp-up schedule?

Our N2 development is on track, including new transistor structure and progressing to our expectation. We expect our N2 delivery to be the best technology, maturity, performance, and cost for our customers. And we are confident that N2 will continue our technology leadership to support our customer growth. And we still plan for production in 2025.

So the 2-year cadence remains unchanged for the N2?

It won’t.

Okay. Thank you, Bruce. Operator, can we move on to the next participant, please?

The next one to ask a question is Gokul Hariharan from JP Morgan.

My first question is about N3. Since we are less than a year away from the start of N3 mass production, could you discuss how we should expect N3 revenues to ramp up next year? Will it resemble what we observed with N5 and N7, with approximately 10% of next year’s revenues coming from N3? Additionally, I understand there may be more challenges in achieving profitability for N3 relative to the corporate average due to various factors. Can we expand on that as well? That’s my first question.

Okay. Gokul, please allow me to summarize your question. So Gokul’s question is really related to N3. He wants to know with the ramp-up of N3 what kind of revenue contribution can we expect. Will it be similar to the past patterns of N5 and N7 for about 10% of wafer revenue in the first year? And also, he would like to ask given C.C.’s comment about process complexity challenges, what is the profitability outlook for N3. Is that correct, Gokul?

Yes. Gokul, this is Wendell. It’s too early to talk about the revenue contribution as N3 will not begin volume production until the second half of 2022 with revenue contribution starting in 2023. In addition, as the structural demand underpinned by the industry megatrends is driving growth across all our nodes, the specific percentage of the new nodes as compared to the historical pattern may be less meaningful in the future. But overall, we are confident that our 3-nanometer will be the most advanced foundry technology when it is introduced. And with the strong customer engagement and tape-out activity, our N3 family will be another large and long-lasting node for TSMC, just like N5 and N7 families. Now about the gross margin, as C.C. said, the initial outlook for new nodes is always challenging. And the increasing process complexity of leading nodes such as N3 brings even greater challenges to achieving the corporate average gross margin in 7 to 8 quarters, and partially also because our corporate profitability has increased and our new long-term gross margin target of 53% and higher. Now it is a bit early to say when N3 can reach the corporate average gross margin at this stage because the volume production hasn’t started yet. However, we will continue to work diligently on selling our value and cost improvement to ensure that we earn the right profitability and return. Now even considering the increasing process complexity of advanced nodes such as N3, we believe our technology leadership, manufacturing, and capacity support, and ability to earn our customers’ trust will enable us to earn a long-term gross margin of 53% and higher.

Got it. My second question is on the more mature process technologies. Could TSMC give us some view on the industry growth for specialty and mature technologies? I think based on the data we look at, historically, that has only grown at maybe low to mid-single digits. But right now, we see a lot of capacity being announced from many foundries in these older specialty and mature process technologies, let’s say, defined as 28-nanometer and above. So could TSMC talk a little bit about the growth rate for these mature process technologies going forward? Is it going to be materially higher than the 3% to 5% that we have seen in the past? In most cases, we have seen older nodes grow for 4 to 5 years and then kind of stagnate. Do we see that pattern changing because of some of the content per box or content per device dynamics that you talked about? Yes.

Okay. Gokul asked about the growth outlook for mature nodes, specifically how we perceive growth in these areas. Historically, growth has been around 3% to 5%. Is there potential for it to be significantly higher for nodes defined as 20-nanometer and above?

Okay. Gokul, we forecast the growth rate of the overall semiconductor ex-memory industry to accelerate to high single-digit percentage level in the next 5 years as compared to around 4% CAGR in the past 10 years. The higher demand at mature nodes will be driven by structural factors, such as an increase in long-term demand for certain specialty technologies due to the multiyear industry megatrends of 5G and HPC and increasing silicon content in many end devices as well as the acceleration of digitalization. TSMC’s strategy at mature nodes is to work closely with our customers to develop specialty technology solutions to meet their requirements and create differentiated and long-lasting value to customers. We believe our differentiated specialty technologies will enable us to capture the structural demand generated from the industry megatrends and continue to support our customers’ growth.

Gokul, does that answer your second question?

Yes.

Okay. Thank you, Gokul. Operator, can we move on to the next caller, please?

Next one to ask a question is Charlie Chan from Morgan Stanley.

Congratulations for the great results, management. My first question is about the semi-inventory debate. So may I clarify with C.C. that the company still believes that supply chain needs to keep high inventory for several reasons. But in fact, we are seeing that PC, smartphone OEMs, they’re working down channel inventory even, as you know, that they are working down the channel inventory. So do you think that the high inventory is actually a signal of a weaker demand? Or anything that we miss here because, in fact, we are seeing consumer tech inventory, we are seeing a correction?

Okay. Charlie, let me summarize your first question. You noted that certain segments of consumer end demand appear to be weaker than anticipated. How does this impact our perspective on the elevated inventory levels? Essentially, you are asking for our outlook on end demand considering the potential softness in consumer market segments, as well as our stance on inventory. Is that correct?

Charlie, this is C.C. Wei. You are correct that we are seeing some softness in certain end market segments, specifically in smartphones, PCs, and tablets. However, other segments continue to show very strong performance. When examining the supply chain, particularly in the MCU and power-managed IT areas, demand remains robust. The ongoing supply chain disruptions due to COVID-19 uncertainties have led our customers to maintain higher inventory levels for extended periods. We are witnessing this trend. Consequently, TSMC's capacity is expected to remain very tight throughout the entirety of 2022.

I see. Okay. So is it more specific to those industrial automotive industry insights for consumer tech? Am I right about your comments about inventory level?

Yes, you are right. The important thing is a structural megatrend. My customer requires greater computational power and energy-efficient computing, which is actually a strong point of TSMC’s technology.

I see. And my second question is about your N3 progress. So we continue to hear a lot of good news and anecdotes about your N3E is actually progressing very, very well. So do you think there is a possibility that you could actually pull in your N3E for maybe 1 or 2 quarters to address the customers’ demand, right? So I think it could be a win-win for both TSMC and your customers. Do you see that kind of a possibility and maybe convert some N3 projects to N3E earlier?

Okay. So Charlie’s second question is on N3E. He notes the progress is going very well. So his question is, is there a possibility to bring in the timing of N3 to earlier? And will we convert N3 capacity to N3E?

Okay. Charlie, you are right again. I mean that our N3E result is quite good. And the progress is actually ahead of our schedule. And pull in, yes, we are considering that. So far, I still did not have a very solid data to share with you that how many months we can pull in. But yes, it’s in our plan. And also the capacity, since we have a very strong demand on the N3 and N3E, we are still planning to have enough capacity to support our customer.

All right. Thank you, Charlie. Operator, can we move on to the next participant, please?

Next one to ask question is Randy Abrams from Credit Suisse.

I wanted to follow up on your updated outlook, where you've raised your expectations from the mid-20s to the high 20s or above. Can you discuss this change in light of the current macroeconomic conditions and the softening consumer trends? Specifically, what factors contributed to this shift? How much of it is related to market share technology or particular platforms? Additionally, could you provide an update on your perspective regarding the different platforms? Did you notice any decline in any of the four platforms?

Thank you, Randy. To summarize, Randy's first question pertains to our full year outlook. As C.C. highlighted in his key messages, we anticipate being at or possibly exceeding the high end of our guidance, which is in the mid- to high 20s. Randy is asking what has influenced our improved full year outlook in light of a more uncertain macro environment. Is this due to technology, market share, or other factors? Additionally, he inquires about the outlook for each platform.

Randy, we expect our HPC platform to be TSMC’s strongest growing platform this year and the following years. And it will be the largest contributor to our growth. And this is all because of a structural megatrend driving increasing need for greater computation power and energy-efficient computing. As I said, these kinds of technologies happen to be TSMC’s strong point. So that all I can share with you is that we have confidence that it will be exceed or at the high end of our guidance.

Okay. And a follow-up just on the first. Did you change your view on...?

Yes, and then also... .

Yes, so I wanted to know the other platforms, and if you take your view on.

Now for this year, Randy, we can share with you that we expect HPC and automotive to grow faster than the corporate average. IoT is similar. And smartphone is approaching the corporate average.

For the full year.

For the full year.

It seems like there hasn't been much change. My second question relates to concerns about whether we might enter a downturn or experience a slowdown. Could you discuss the flexibility of your expansion plans if we were to enter a recession? Specifically, how adaptable are your fab plants in the U.S., Taiwan, Japan, and Nanjing? Additionally, regarding prepayments and deposits, will there be flexibility in the timing of shipments to accommodate customers who may need to adjust to declining demand?

Okay. So Randy’s second question is about if there’s a downturn or a slowdown, will this change? Or how flexible is the timeline for our new fab and capacity expansion plans whether in Taiwan, Japan, and overseas if the outlook changes for the worse? And what is the flexibility of our prepayments with customers if there was a downturn or slowdown?

Randy, this is C.C. Wei. Our CapEx and capacity expansion plan are always based on our customers’ long-term demand profile. This is underpinned by an industry megatrend. As long as the mega trend continues, which we believe it will, we will continue to invest to capture the growth that will follow. So even a short term with the possibility of downturn, which we don’t think it will impact too much to TSMC, if even it happens, we will continue our plan and we have confidence to invest to capture the growth that will follow.

Okay. And regarding the customer side for their deposits and the capacity they are securing?

Randy, actually, we believe signing contracts to guarantee the loading in the future is not a common practice. We focus really on technology leadership, manufacturing excellence and earning customer trust as a more effective way to secure customer commitments. Now we work closely with our customers to plan the capacity, including receiving their prepayments for capacity support. And we will continue to work with them to determine the best way to support them.

Yes, Randy. So I think the answer for customer side and capacity side is pretty aligned or similar. Does that answer your second question?

Yes. I mean, I guess, just like in the past, it was the flexibility like we saw the slowdown in utilization. So I mean I would think it’s still working with customers on their plans if they need to reschedule because we’ve seen in the past like if they have to adjust their utilization. Like I don’t know if anything’s changed in the model on that element?

No, no, nothing changed in the model. Yes.

Okay. Thank you, Randy. Operator, can we move on to the next caller, please?

Next one is Sunny Lin, UBS.

Congratulations on the strong performance. So my first question is on the pricing strategy for you going forward. I mean if we look at this up-cycle, the tight supply and the strong restocking demand has supported pretty meaningful price increase for the foundry industry and TSMC throughout 2021. So from here, would you look to further raise prices for some of the technologies to justify rising costs of expansion? And on the other hand, if the supply demand starts to normalize, do you think there could be any risk to pricing?

Okay. So Sunny, let me summarize your first question. You asked about pricing on both sides during this up-cycle. Given the cost challenges we are facing, will TSMC consider raising prices further? And on the other side, if demand were to soften, will there be any risk of lowering prices? Is that correct?

Okay. Sunny, this is C.C. Wei. We do not comment on our pricing detail. But let me assure you that our pricing strategy is strategic, not opportunistic or short term. And customers understand our effort to support their growth. As you said that if there is a downturn coming and on the flip side, TSMC going to drop our price, the answer is no. Did I answer your question?

That’s very helpful. So my second question is to follow up on the N3 ramp-up. So just trying to get a bit of a color on 2023. I understand the demand is pretty robust. But when we think about the potential revenue contribution for 2023, with the less equipment supply and delivery time, would that be a capping factor for 3-nanometer to exceed the typical 10% revenue contribution for next year? Or do you think there’s still some time for you to try to accelerate the equipment expansion?

Okay. So, Sunny’s second question is on N3 and the ramp-up. Her question once again is sort of around the revenue contribution of N3. And specifically, she is asking whether the equipment supply or some of the tool delivery issues would affect the ramp-up of N3 in next 2023 and, thus, the revenue contribution.

Well, we did see some of the issues on the tool delivery and we are still working on it. As I said in the statement, we are working on 2023 right now, and we hope that we won’t have any big issue. But right now, we are not ready yet to share with you that how much we can resolve the issue. But we have strong demand. We try to build enough capacity for our customers. And we are working with our equipment supplier to get enough tools to expand our capacity.

Okay. Thank you, Sunny. Operator, can we move on to the next participant, please?

Next one to ask questions, Rick Hsu from Daiwa.

Yes. My first question is regarding your revenue guidance for this year. I think you think that it should be at or even exceed your mid- to high 20s guidance in U.S. dollar terms. So in that case, are you revising your forecast for the global semiconductor ex-memory for this year and also the global foundry market forecast for this year?

Okay. Rick’s first question is about our 2022 outlook. Sorry, Rick, let me try to summarize. So Rick notes that C.C. said, our 2022 growth will likely be at or exceed the high end of our revenue guidance of mid- to high 20s. So he wants to know what does this mean for our forecast or expectation for the semiconductor ex-memory and foundry markets.

So let me answer your question. So far, we are confident on TSMC’s performance. But the whole industry, semiconductor’s foundry industry remains that it will be around 20% year-over-year as a growth. All others, we are still trying to understand the status and not very ready to share with you yet.

Okay. So basically, the strength is more TSMC company specific, right?

That’s because our leadership in the technology, and you are right.

Okay, great. C.C., for the second question, it seems like your customers have been waiting in line since last year. I’m aware there are macro issues this year and some demand slowdown, but some areas are still performing well. I assume that any capacity released by customers will be quickly taken up by others. Are you indicating that the queue is getting shorter? If so, when do you expect the queue to completely disappear?

Rick's second question is regarding the capacity that C.C. mentioned will remain tight throughout 2022. He is specifically asking about the queue or waitlist. While we noted that some end market segments may experience a slowdown or adjustment, others continue to show strength. Rick wants to know if the waitlist is getting shorter and when we might expect that to happen.

Rick, so far, as I said, TSMC’s capacity will be very tight, not enough to support our customers. So if you ask whether the list in the queue will be longer was smaller, it doesn’t matter. It’s still just not enough to support our customers. And we are working very hard to support them. That’s what I can share with you.

Okay. Thank you, Rick. Operator, can we move on to the next participant, please?

Next one, we have Brett Simpson from Arete Research.

Yes. I had a question on your overseas fab expansion plans. I guess today, if we look at your wafer capacity, it’s 100% in Taiwan. Are you seeing any pressure from your strategic customers to accelerate your overseas plans for fab expansion? And can you also share with us if you have a target for what portion of your wafer capacity long-term might come from your overseas fabs? And in what time period might that happen?

Okay. So Brett’s first question is about our overseas expansion and global manufacturing footprint. His question is that, are we seeing any pressure from strategic customers to expand overseas? And he wants to know what proportion or percentage of our capacity will be overseas by what time frame?

Okay. Let me answer the question. In fact, talking about the overseas supply or the capacity we are building, our responsibility as TSMC’s management is to make the best decision for our customers and in the best interest of TSMC. And we are in close and constant communication with all of our customers. And so far, actually, their priority is securing capacity, enough capacity to support their business and also working with TSMC on technology development. That’s what TSMC’s focus is on. And for how much of the capacity to build outside, let me share with you, right now, we have a fab in Arizona with 5-nanometer, a fab in Japan which are 28 and 16 FinFET technology and expanding our capacity in China with 16 FinFET and 28. Also, we’re building in Taiwan for more 28-nanometers of capacity. We definitely have some future plans, but while increasing in the next several years, but not enough to share with you say how many percentage in total compared with TSMC’s technology. Does that answer your question?

Yes, that’s great. And perhaps I can ask a follow-up question. You mentioned that N3E is scheduled to be released a year after N3. Could you provide an update on the timeline for the 2-nanometer technology, which I understand will feature a new transistor architecture? The transition from N5 to N3 took over two years, which aligns with your usual schedule. Will we return to a two-year interval for N2, resulting in a potential introduction of N2 by the end of 2024, or will it take longer?

Okay. So Brett’s second question is really on N2 and the cadence. He wants to know that N5 to N3 is about more than a 2-year cadence between those 2 nodes. For N3 to N2, will it be back on a 2-year cadence? And what’s the time frame for N2?

Brett, our progress so far today for the N2 is on track. And all I want to say is, yes, at the end of 2024, you will enter risk production. 2025, it will be in production, probably close to the second half or the end of 2025. That’s our schedule.

All right. Thank you, Brett. Operator, can we move on to the next participant, please?

Next one, we have Laura Chen, KGI.

My first question is about the advanced packaging development. Can you share with us your view on TSMC’s current progress in advanced packaging in terms of the revenue contribution and the growth trend? And since we know that there are a lot of high computing PC clients relied on TSMC advanced packaging or 3D packaging service, so can we expect your advanced packaging revenue will be kind of part of your high computing PC growth outlook? That’s my first question.

Okay. So Laura’s first question is on our 3D IC or advanced packaging progress. She wants to know the progress in terms of the revenue contribution, the growth outlook for the packaging business and how correlated it is to the high HPC platform.

Right. Lauren, let me answer the first part. In 2021, the advanced packaging generated $4.1 billion of revenue. Now we expect that this year, the growth will be similar to the corporate growth. And during the next 5 years, we expect its growth in CAGR will be slightly higher than the corporate.

And the correlation with HPC?

Well, let me answer that correlation. Actually, very advanced SoICs technology serves for the HPC high-end applications. So that requires high bandwidth, very low power, and very high performance. And so far, we just entered a small volume of the production in 2022, and we expect this one will continue to grow. That’s what we have today.

Okay. That’s very clear. And my second question is more like a follow-up. I think C.C. already mentioned a lot about the strategy of the CapEx expansion in the longer term. But we know that the equipment lead timeline has been quite longer. So I’m just wondering any specific area or process you are seeing the biggest impact? And what’s your action accordingly? Or do you have any priorities for various technology nodes?

Laura's second question is about capacity expansion and equipment lead time. Given the tool delivery that C.C. discussed, she wants to know what areas or nodes are experiencing the biggest impact and how we are prioritizing this.

Laura, we have been experiencing unexpected tool delivery issues since the beginning of this year. We are diligently collaborating with our tool suppliers to address all the problems. Both leading-edge and mature node technology capacity expansions are being affected. To meet our customers' strong demand, we are continuing to work hard with our suppliers to resolve these issues. So far, there have been no problems in 2022, and we are focused on 2023 and beyond. I hope that in a few months, we can report that the issue has been resolved. For now, we are still working very hard with our suppliers to tackle all the challenges. That's all I can share at this moment.

Okay. Thank you, Laura. Operator, can we move on to the next participant, please?

Next one to ask questions, Mehdi Hosseini from SIG.

Yes. My first one has to do with better understanding demand dynamics. You highlighted better-than-average growth from HPC. And in that context, I’m just wondering how I should think about the mix of 5 and 7-nanometer node by year-end ‘22 or second half of ‘22?

Okay. So Mehdi’s first question is looking at the demand and also by node, he wants to know how should he expect the contribution or the mix from N5 and N7 in the second half of this year.

It will be greater than we just reported of 50%, right? I mean for the second half of this year, the contribution to TSMC’s revenue will be greater than 50%, combining 7 and 5 together.

Okay. I was just trying to better understand how that increase would look like compared to prior years where in the second half, usually the advanced node contribution increases and with the leap in mix. I was just trying to better understand how the second half of ‘22 will look like in the past years.

Yes. Mehdi, I think that the second half revenue is normally higher, partially because of seasonality of some of the products.

Okay. Great. And one more follow-up. And thank you so much for the color on the next technology migration of 2-nanometer. You highlighted the transistor change. But I also want to understand what is the underlying assumption, especially as it relates to lithography. We also have another change coming up as going from EUV to high NA. And I’m just curious to know if you are assuming if you will be using EUV, or you would need high NA as you go into HBM for 2-nanometer in the second half of ‘25?

Okay. So Mehdi’s second question is on N2, a very specific question. He wants to know with N2, there’s a change in transistor structure. He also wants to know on the lithography side, will we be using EUV or high NA, correct, Mehdi?

Well, let me answer the question. We are the largest user of EUV tool today in the industry. And so we have intensively evaluated and are very familiar with those high-end EUV tools for wire. And we will continue to evaluate and adopt the high-end tools whenever we think is necessary and is ready and cost-effective. Whether it is an N2 or not, I have not yet been able to share with you.

Okay. Thank you, Mehdi. Operator, can we move on to the next participant?

Next one to ask questions, Charles Shi from Needham & Company.

I want to ask my first question a little bit longer term. One of your IDM customers, well, I don’t want to call the name. But their CEO, I believe, revisited you twice over the last 6 months. They think they can both buy wafers from you and, at the same time, compete with your technology. And they are hoping in 2025 and beyond, we’ll compete with you in the foundry business. So there has been concerns that you may not really get a fair deal out of this a little bit of complex relationship. One concern, very specifically, I heard this that you may end up basically teaching this competitor, enabling their accelerated roadmap. But in the end, they will break away from you and compete against you, especially in the foundry business. So maybe can you address this concern and provide us some high-level thinking to the investor community and the public?

Okay. Charles, let me summarize your first question. His first question is on the IDM customer that wants to buy wafers or outsource to TSMC, but also said that they would like to compete in the foundry industry. So Charles, your question is really, I guess, 2 parts in the sense that how will TSMC end up teaching this IDM and enabling the roadmap? And how will we compete on the foundry side?

Well, Charles, let me address your question about the competition first. As a leading pure-play foundry, TSMC has faced competition throughout our 35-year history, and we know how to compete effectively. You also asked about how we protect TSMC’s intellectual property and technology details. We have a well-established process and design enablement system that ensures productive engagement with all our customers while safeguarding both our own and our customers’ intellectual property. We do not foresee any issues. Looking ahead, these IDM customers are indeed bringing some of their activities back in-house, and we have already taken this into account in our capacity planning. Did I answer your question, Charles?

Yes, C.C., to follow up on the second question, which is related to my first question, there have been some press reports in the past 2 to 3 months suggesting that TSMC is potentially building a dedicated fab for this specific customer. I'm unsure if creating a dedicated fab or production line for individual customers is part of TSMC's standard practice. Can you share your thoughts on this? Would it still be a no, even if this customer is set to bring a significant volume?

Charles' second question addresses media reports about the possibility of us establishing a dedicated fab or production for a specific IDM. Is this our standard approach? Would the response still be no even if there is substantial volume linked to such dedicated capacity?

Well, Charles, to be frank with you, our capacity planning, as we have said many times, is based on the long-term market demand profile, underpinned by the industry’s megatrend of 5G and SPC and the semiconductor content enrichment in many young devices. We are not dependent on any single customer or product. Did I answer your question?

Yes.

In the interest of time, I think we’ll take the last 2 participants’ questions, please. Okay. And the next one to ask question is Krish Sankar from Cowen & Company.

I had 2 of them. The first one is for Wendell. In the March quarter, there’s quite a big difference between the revenue growth and the shipment growth. So I’m kind of curious on your full year guidance of high 20s or even beyond that for revenue growth, how much is coming from pricing? Any color there would be helpful. And then I had a follow-up for C.C.

Okay. So, Krish’s first question is in looking at our full year outlook. He wants to know how much of our growth this year, how much of it is coming from price versus volume, I guess?

Yes. Krish, volume, price, and product mix are important contributing factors in driving our growth. But we do not have a specific breakdown to share with you.

All right. No worries. And then I had a follow-up for C.C. Clearly, investors seem to be worried about a recession or a slowdown. So C.C. from your experience, when you look at price cyclical slowdowns or even macro corrections, what are the leading indicators TSMC looks for specifically? Is it a pricing slowdown? Is it pushed out of capacity? Is it customers breaking LTAs? What do you think is the first shoe to drop? Any color there would be helpful.

Krish's second question relates to the demand environment. He wants to know from C.C. what leading indicators we monitor during past recessions or slowdowns as signals. Do we observe pricing slowdowns? Do we notice reductions in capacity and capital expenditures? What indicators do we consider?

Krish, this is a tough question to be asked because we always in close working with our customers. So we know that each customer’s demand and their forecast and we plan our capacity, we plan our technology by working with them. So if there is a downturn, sure, we’ve got the firsthand information from our customers. And we collect them together, and we do get it. And we decide our long-term CapEx and capacity. But which one is a leading indicator, that, I don’t have a specific answer for your questions.

Okay. Thank you. Operator, we’ll take the questions from the last participant, please, then. Thank you.

Yes. The last one to ask question is Rolf Bulk from New Street Research.

At the beginning of the year, you guided for advanced processes to account for 70% to 80% of CapEx and specialty nodes for 20%. Now with the year now underway and you’re having better visibility on the demand in your different end markets, can you share with us if you’re thinking on capacity additions of advanced versus specialty have changed? Or whether those ratios that you gave originally still hold?

Rolf's first question is about our capital expenditures and spending. He wants to know if the allocation or breakdown between events and specialty technologies regarding our capital expenditures has changed in the past three months.

No, no, it has not.

That’s helpful. Now as a follow-up, you mentioned that you’re working with suppliers to secure and further diversify your material supply. Can you discuss whether you expect your material input costs to increase in the second half of the year? And how we should think about gross margin in the second half of 2022 in that context?

Okay. So Rolf’s second question is a little bit on materials cost. We have said that we’re diversifying our material supplier. So are we seeing the input cost increase? And then what does this mean for the margin outlook in the second half?

Yes. Well, let me answer that. Yes, we do face manufacturing cost challenges, partially due to the rising materials inflationary cost. But we always work closely with our customers to provide our value. And we will continue to ensure that the pricing strategy reflects the value creation. We will also work diligently in our fab operations and with our suppliers to deliver on cost improvements. So by taking such actions, we believe we can achieve the long-term gross margin of 53% and higher and earn greater than 25% ROE through the cycle. That will enable us to invest to support our customers’ growth and to deliver profitable growth for our shareholders.

Okay. Rolf, does that answer?

Very helpful.

Yes. Thank you, Rolf. Okay. So thank you, everyone. This concludes our Q&A session. Before we conclude today’s conference, please be advised that the replay of the conference will be accessible within 1 hour from now. The transcript will become available 24 hours from now, both of which will be available through TSMC’s website at www.tsmc.com. Thank you for joining us today. We hope everyone continues to stay healthy and safe. And we hope you will join us again next quarter. Goodbye, and have a good day.