Taiwan Semiconductor Manufacturing Co Ltd Q3 FY2022 Earnings Call

Good afternoon, everyone, and welcome to TSMC's Third Quarter 2022 Earnings Conference Call. This is Jeff Su, TSMC's Director of Investor Relations and your host for today. 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. If you are joining us through the conference call, your dial-in lines are in listen-only mode. The format for today's event will be as follows. First, TSMC's Vice President and CFO, Mr. Wendell Huang, will summarize our operations in the third quarter 2022, followed by our guidance for the fourth 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 in 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. And thank you for joining us today. My presentation will start with financial highlights for the third quarter 2022. After that, I will provide the guidance for the fourth quarter. The third quarter revenue increased 14.8% sequentially in NT dollar, or 11.4% in US dollars, as our third quarter business was supported by strong demand for our industry-leading 5-nanometer technology. Third quarter gross margin increased 1.3 percentage points sequentially to 60.4%. Slightly ahead of our guidance, as we enjoyed a more favorable foreign exchange rate and cost improvement efforts. Total operating expenses accounted for 9.8% of net revenue as compared to 10% in the previous quarter. Operating margin increased 1.5 percentage points sequentially to 50.6%, mainly due to better operating leverage. Overall, our third quarter EPS was NT$10.83, and ROE was 42.9%. Now, let's move on to revenue by technology. 5-nanometer process technology contributed 28% of wafer revenue in the third quarter, while 7-nanometer accounted for 26%. Advanced technologies, which are defined as 7-nanometer and below accounted for 54% of wafer revenue. Moving on to revenue contribution by platform. Smartphone increased 25% quarter-over-quarter to account for 41% of our third quarter revenue. HPC increased 4% to account for 39%, IoT increased 33% to account for 10%. Automotive increased 15%, to account for 5% and DCE decreased 2% to account for 2%. Moving on to the balance sheet, we ended the third quarter with cash and marketable securities of NT$1.5 trillion. On the liability side, current liabilities decreased by NT$38 billion, mainly due to the decrease of NT$116 billion in short-term loans, partially offset by the increase of NT$70 billion in accrual liabilities and others. Long-term interest-bearing debt increased by NT$88 billion mainly as we raised NT$60 billion of corporate bonds during the quarter. Our financial ratio, accounts receivable turnover days decreased 1 day to 36 days. Inventory days decreased five days to 90 days, primarily due to higher wafer shipment during the quarter. Now, let me make a few comments on cash flow and CapEx. During the third quarter, we generated about NT$413 billion in cash from operations, spent NT$266 billion in CapEx, distributed NT$71 billion in fourth quarter '21 cash dividends and raised NT$60 billion from corporate bond issuances. Overall, our cash balance increased by NT$43 billion to NT$1.3 trillion at the end of the quarter. In US dollar terms, our third quarter capital expenditures totaled NT$8.75 billion. I have finished my financial summary, now let's turn to our current quarter guidance. Based on the current business outlook, we expect our fourth quarter revenue to be between $19.9 billion and $20.7 billion US, which represents a 0.4% sequential increase at the midpoint. Based on the exchange rate assumption of $1 to NT$31.5. Gross margin is expected to be between 59.5% and 61.5%, operating margin between 49% and 51%. This concludes my financial presentation. Now, let me turn to our key messages. I will start by making some comments on our third quarter and fourth quarter profitability. Compared to the second quarter, our third quarter gross margin increased by 130 basis points sequentially to 60.4% mainly due to a more favorable foreign exchange rate and cost improvement efforts, despite continued inflationary cost pressures. Compared to our third quarter guidance, our actual gross margin exceeded the high end of the range provided three months ago, as our guidance was based on exchange rate assumption of $1 to NT$29.7, whereas the actual third quarter exchange rate was $1 to NT$30.32. This created about an 80 basis point difference in our actual third quarter gross margin versus our original guidance. We have just guided our fourth quarter gross margin to be flat sequentially at 60.5% at the midpoint, as a more favorable exchange rate assumption will be offset by lower capacity utilization rates. As a reminder, six factors determine TSMC's profitability: leadership technology development and ramp up, pricing, cost reduction, capacity utilization, technology mix, and foreign exchange rate. Looking ahead to 2023, we face challenges from entry ramp dilution, a higher year-over-year increase in depreciation cost, rising inflationary cost, semiconductor cyclicality, and overseas fab expansions. To manage our profitability in 2023, we are working closely with our customers to support their growth and continue to strategically and consistently sell our value. We are also working diligently on our internal cost improvements. Excluding the impact of foreign exchange rates, which we have no control over and taking the other five factors into consideration, we believe a long-term gross margin of 53% and higher is achievable. Next, let me talk about our 2022 CapEx. As I have stated before, every year our CapEx is spent in anticipation of the growth that will follow in future years. Three months ago, we said our 2022 CapEx will be closer to the lower end of our $40 billion to $44 billion range. Now, we are further tightening up this year's capital spending and expect our 2022 CapEx to be around $36 billion. About half of the change is due to capacity optimization based on the current medium-term outlook. And the other half is still to continue dealing with challenges. Out of the around $36 billion CapEx for 2022, between 70% to 80% of the capital budget will be allocated for advanced process technologies, about 10% will be spent for advanced packaging and mask making, and 10% to 20% will be spent for specialty technologies. Looking ahead, we will continue to manage our business prudently given the near-term uncertainties and adjust and tighten up our capital spending where appropriate. That said, our commitment to support customer growth remains unchanged. And our disciplined CapEx and capacity planning remains based on the long-term structure and market demand profile. We will continue to work closely with our customers to plan our long-term capacity and invest in leading-edge and specialty technologies to support their growth while delivering profitable growth to our shareholders. Now, let me turn the microphone over to C.C.

Good afternoon everyone. First, let me start with TSMC's more resilient near-term demand outlook. We concluded our third quarter with revenue of NT$613.1 billion or US dollar $20.2 billion, supported by strong demand for our industry-leading 5-nanometer technologies. Moving into fourth quarter 2022, we expect our business to be flat, as customers' ongoing inventory adjustment is balanced by the continued ramp-up of our 5-nanometer technologies supported by smartphone and HPC applications. We expect our full-year gross margin in 2022 to be in the mid-30% in US dollar terms. On the demand side, we continue to observe softness in the consumer end market segment. Other end market segments such as data center and automotive-related remain steady for now for TSMC. However, we are beginning to see the possibility of adjustments unfold. On the inventory side, our customers and the supply chain continue to take action to adjust their inventory. We expect the semiconductor supply chain inventory to peak in the third quarter this year and start to reduce in the fourth quarter this year. We also expect it will take a few quarters, through the first half of 2023, to rebalance to a healthier level. While the ongoing inventory correction will also affect TSMC, we expect our business to be less volatile and more resilient than the overall semiconductor industry during this period. This is supported by three key factors that are TSMC's advantages in the foundry industry. First, our technology leadership and differentiation are much stronger today compared to previous years. This allows TSMC to win business and enables our customers to have success in high-end markets, despite semiconductor cyclicality. Second, through our comprehensive design ecosystem and optimized process technologies, we are able to address and capture the structural increase in demand for computation and build a strong portfolio in high-performance computing. Third, our strategic relationships with our customers are long-term in nature, and we continue to work closely with our customers on technology development, capacity planning, and pricing to support their long-term demand and growth. As a result, we continue to see strong demand for our leading node except N7 and steady demand for our differentiated specialty technologies and mature nodes. Looking ahead to 2023, with the successful ramp-up of N5, N4P, N4X, and the upcoming ramp of N3, we will continue to expand our customer product portfolio and increase our addressable market. While the ongoing semiconductor inventory correction will affect the utilization rate in the first half of 2023, we expect our business to be supported by stronger demand for our differentiated and leading advanced and specialty technologies, making 2023 a growth year for TSMC. Next, let me discuss the N7 and N6 demand outlook. Due to end market weakness in smartphones and PCs, along with customer product schedule delays starting in the fourth quarter this year, our N7 and N6 capacity utilization will not be as high as it has been in the past three years. We expect this to persist for a few quarters through the first half of 2023 as the semiconductor supply chain inventory takes a few quarters to rebalance to a healthier level, and we have adjusted our N7 and N6 CapEx accordingly. We believe the N7 and N6 demand is more of a cyclical issue rather than structural, and we expect our N7 and N6 demand to pick up in the second half of 2023. Longer-term, we continue to work closely with our customers to develop specialty and differentiated technology and are confident we will drive an additional wave of structural demand to backfill our N7 and N6 capacity over the next several years. The 7-nanometer family will continue to be a large and long-lasting node for TSMC. Now I will talk about our N3 and N3E status. Our N3 is on track for volume production later this quarter with good yield. We expect a smooth ramp in 2023, driven by both HPC and smartphone applications. Our customers' demand for N3 exceeds our ability to supply partially due to ongoing tool delivery issues, and we expect N3 to be fully utilized in 2023. We expect N3 revenue in 2023 to be higher than N5 revenue in its first year in 2020 and for N3E to contribute mid-single-digit percentage of our wafer revenue in 2023, as our overall revenue base is much larger today than in 2020. N3E will further extend our N3 family with the enhanced performance, power, and yield, and offer complete platform support for both smartphone and HPC applications. N3E development is progressing ahead of plan, and volume production is now scheduled for the second half of 2023. Despite the ongoing inventory correction, we observe a high level of customer engagement at both N3 and N3E with the number of tape-outs more than double that of N5 in its first and second year. Thus, we are working closely with our tool suppliers to address delivery challenges and prepare more 3-nanometer capacity to support our customers’ strong demand in 2023, 2024, and beyond. Our 3-nanometer technology will be the most advanced semiconductor technology in both performance and transistor technology when it is introduced. We are confident that the N3 family will be another large and long-lasting node for TSMC. Finally, let me talk about the future drivers of leading node adoption. TSMC's ambition is to be the trusted technology and capacity provider for the global logic IC industry for years to come. Our job is to help our customers unleash their innovations and enable them to capture greater value and win in their end markets. As the industry continues to pursue scaling, it is true that technology shrink is slowing down and becoming more challenging for everyone due to rising process complexity. However, it is also true that demand for energy-efficient computing is accelerating in an intelligent and connected world, as technology becomes more pervasive and essential in people's lives. The semiconductor industry value in the supply chain is increasing, and the value of technology platform is expanding beyond the scope of geometry shrink alone and is increasingly focused on greater power efficiency. As a result, our customers value much more than simply transistor cost. System performance and power efficiency have become key motivations for customers who adopt our leading node technologies. By working closely with our customers on technology development, our N3 and N2 will deliver full node strides in performance and power benefits while offering the industry's most advanced transistor scaling. We expect strong demand for our leading node technologies driven by both smartphone and HPC applications to fuel our long-term revenue growth of 15% to 20% CAGR over the next several years in U.S. dollar terms. With our leadership in both leading-edge process technology and 3D solutions, TSMC's technology cadence remains constant, delivering the value of our technology platform. We will continue to extend our overall competitiveness and technology leadership while delivering a predictable technology cadence that helps our customers to enhance their product competitiveness and grow their market well into the future. This concludes our key message, and thank you for your attention.

Thank you, C.C. This concludes our prepared statements. Before we begin the Q&A session, I would like to remind everybody to please limit your questions to two at a time to allow all participants the opportunity to ask questions. Should you wish to raise your question in Chinese, I will translate it to English before our Management answers your question. Operator instructions. Now let's begin the Q&A session. Operator, can we please proceed with the first participant on the line.

Yes, Jeff. The first one to ask questions is Gokul Hariharan from JPMorgan. Go ahead, please.

Yes, good afternoon and thanks for taking my question. Congrats on the great results, especially on the margins. So the first question is on N7 and N6, this utilization slack that we are observing. Could we give a little bit more detail on why that is happening and why we think this is short-lived, a couple of quarters issue and we get a pick back in the utilization in the second half of the year? And I think last time we saw, this was for 28-nanometer, but that lasted for a much longer period of time. So could you also give us some kind of comparison with what happened back in 28-nanometer and why this is going to be very different? And maybe a little bit more color on what are the areas of backfill demand for N7 and N6 as the high-end smartphone processors and HPC start to move on to N5 and then N3. That's my first question.

Okay, Gokul, let me please summarize your first question. So Gokul's first question is on N7 and N6. He wants to understand what is driving the utilization slack. Why do we believe it is short-lived and that the demand for N7 and N6 can pick up in the second half? And then also on the longer-term outlook, why we believe that N7 can be backfilled, and it will not be like N28 a few years ago with a few years of underutilization.

Well, Gokul, let me answer your question first on why demand dropped. Demand dropped because the market has become soft. As we said, in the weakness in the smartphone and PC segment. And also a big factor is our customers' product schedule delays. All in all, when putting all of these together, we think that our utilization has been affected in the fourth quarter this year and all the way to the first half of 2023. For the longer term, we continue to work closely with our customers. Let me also say that this is a cyclical issue. So it will pick up anyway. We believe it will pick up in the second half of 2023. And for the longer term, we continue to work closely with our customers to develop specialty and differentiated technology to drive an additional wave of structural demand from consumer, RF, connectivity, and other applications to backfill our N7 and N6 capacity over the next several years.

Does that answer your first question, Gokul?

Yes. My second question would be on the CapEx outlook. Now that we bring down the CapEx slightly for 2022, could you talk a little bit about what the outlook direction for 2023 is at least; if not absolute numbers, but just direction? Are we going to be flattish or it's likely to be going down? Second is, could you also give us an update on the schedule for the new fabs, Arizona, Kumamoto, Nanjing? Is there any change in the schedules in terms of these fabs coming into production? Thank you.

Okay, thank you, Gokul. So Gokul's second question is on CapEx and capacity. So first, he wants to hear, of course, he says that we have tightened up our CapEx in 2022. So he is asking for 2023 directionally, is there an indication of 2023 CapEx? And then he would also like an update on our expansion plans in Guosheng, Nanjing, Arizona, and Kumamoto.

Okay, Gokul, let me answer the first part. For 2023 CapEx, it is too early to comment. We will provide you with a specific guidance in January. However, as we said, we have tightened up our 2022 CapEx to reflect the current medium outlook, as well as two delivery issues. Looking ahead to 2023, we will continue to be careful and manage our business prudently given the near-term uncertainties. We will adjust and tighten up our capital spending where appropriate, but we will continue to work closely with our customers to invest for the long-term structural market demand profile to support their growth.

Well, let me answer the second part of Gokul's question. Gokul, you asked about the progress of our Arizona fab, Nanjing fab, and the Kumamoto fab. Let me say that the Arizona fab work will continue and is on schedule. There's no doubt about it because this is an N5 family, which still has very strong demand. For Nanjing, we just received our one-year authorization for 28-nanometer expansion. So it is on schedule also. For Kumamoto, initially, we planned two fabs at the beginning of the 28-nanometer expansion and the N7. Now N7 has been adjusted. But the 28-nanometer expansion is continuing and on schedule.

And also Kumamoto.

Okay. Also the Japan fab is on schedule to meet the customer's demand.

Got it. Thank you very much.

Alright, thank you, Gokul. Operator, can we move on to the next participant please.

The next one to ask questions is Bruce from Goldman Sachs. Go ahead, please.

Thank you for taking my questions. So my first question is regarding HPC, which is a key growth driver for TSMC for the coming years. However, with the recent U.S. restrictions to China, what do you think about the HPC demand moving forward? What kind of impact do you expect to see on a slowdown from China? Or are you going to see collaborations from the non-China side?

Okay, so Bruce's first question is on HPC. He notes HPC, we have said repeatedly, will be TSMC's key growth driver and main engine in the next few years. He wants to know the impact of the recent U.S. regulations; does that affect the overall HPC demand or the overall profile. Is that correct?

Yes, what's the impact from these new restrictions on TSMC and the overall industry?

Okay, let me answer that. Bruce, based on our initial reading and feedback from our customers, the new regulation set the control for very high-end specifications, which are primarily used for AI or supercomputing applications. Therefore, our initial assessment is that the impact to TSMC is limited and manageable. We will continue to closely monitor the situation to ensure that we are fully compliant with all the rules and regulations. And for the longer term, it's too early to really assess all the true impact or influence, but we will give you the update in the following earnings call.

Okay, understand that. Thank you. So my next question is regarding the cyclical nature for the 7-nanometer. But we also noticed that most of your other nodes, the capacity utilization rate is still at a very, very high level, or at least much better than 7-nanometers as management mentioned. Why is 7-nanometer so cyclical? Is it because you guys are too big in the industry or what is the difference between your 7-nanometers and your other nodes?

Okay, so Bruce's second question is focused on the 7-nanometer technology. He wants to know why the utilization for 7-nanometers appears to be more cyclical and is not as high as it has been, especially since our other nodes seem to be maintaining strong utilization levels. Is that correct, Bruce?

Yes.

Okay. It just happens that most of my smartphone and PC customers are using N7 and N6 nodes. And it just so happens that the market weakness in the smartphone and PC segments is occurring at the same time. Additionally, other customers' product schedule delays are all contributing factors, which is why it becomes a lower utilization rate as compared with other nodes. If you want to compare with the N5 or 28-nanometer, our orders are still very much in high demand, and we will continue to enjoy a higher market share.

I want to dig in a bit because we get used to TSMC managing your customers' products and overall outlook. Even with some delays, you can make it out with someone else. But is there anything different this time with N7 that you cannot have as good as your other nodes?

Well, again, Bruce, we work closely with our customers, but our customers got caught in this inventory correction and the market downturn. They didn't foresee this likely until one or two quarters before. At the beginning of this year, they still provided us with a very high number of their forecasts. It just happened. But as we said, we believe this is a cyclical issue, and it will pick up. However, it probably will take a few quarters.

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

Next, we have Randy Abrams from Credit Suisse.

Yes, okay. Thanks for taking my question. I wanted to ask a two-part first question. You mentioned in the prepared remarks about HPC and auto continuing to be stable, but seem to signal it may change. If you could give your view on how you see inventory levels and some of the forward demand outlook from those areas. And the second part, I just want to see if we could get a bit better visibility on the first half, first quarter; how do you see it versus normal seasonal? And then for the trough, do you expect the first quarter could be the bottom, or do you see the trend that we could be toward the second quarter?

Okay, so Randy's question is really looking at again from the end demand segment. Data center and automotive, we say are remaining steady at TSMC for now. He wants to understand though, what is the outlook down the road, and what does that mean for inventory levels? And then secondly, he also wants to see if we can provide some more granularity about the first quarter outlook versus seasonality; and whether we think the first quarter can be the bottom for the industry.

Let me address this question. Currently, our customers are providing their demand forecasts, indicating that the data center and automotive segments remain stable. However, the market has softened, leading our customers to take a more cautious approach in their planning for 2023. While we acknowledge the possibility of some adjustments, we haven't observed any significant changes at this point. Regarding inventory correction in 2023, we anticipate that the semiconductor industry may experience a decline. Nonetheless, TSMC is not immune to these trends. We believe our technological advantages, robust portfolio in high-performance computing, and long-term strategic relationships with customers will help us maintain better stability compared to the broader semiconductor industry. Therefore, we project that 2023 will still be a growth year for TSMC, even though the overall industry may face a downturn.

Okay. Again, and I'll ask a quick follow-up, and then the second question. I guess just a sense because it's still very firm in fourth quarter, if you're seeing a pretty meaningful falloff into first quarter, like some years 10%. 2019 declined over 20%. So just trying to get a rough feel of the type of decline factoring you're seeing in the first quarter.

Okay, Randy. So let me summarize. So Randy, quick, I think we will not comment on the first quarter, but I think we can make some comment just sort of in terms of the overall inventory picture in looking into next year.

Well, actually, if you ask my opinion on the inventory picture and the inventory correction, it's too early to provide a specific number. However, the inventory correction will likely see its biggest impact during the first half of 2023.

Okay, and then the second part related to the gross margin, maybe Wendell can address what is the outlook for depreciation next year and how it relates to the CapEx.

Okay, Randy. For the full year depreciation for next year, it's too early to talk about that. But this year is mid-single-digit increase year-on-year. But next year, we expect it to be meaningfully higher. We will give you the guidance in January. As to the dilution from N3, it will be between 2 to 3 percentage points on a whole year basis on our gross margins.

Okay, and actually, one follow-up. Do you think on a single quarter with the inventory correction, do you expect to keep the 53% and above, factoring in we are coming from a very high level even through that first half inventory correction?

Right. It is too early to talk about 2023 gross margin including quarter-over-quarter. But even with all these cost challenges, we believe our structural profitability can be maintained, and we are confident to deliver a long-term gross margin of 53% and higher.

Okay, great, thanks.

Thank you, Randy. Operator can we move on to the next participant please.

Next one to ask questions, Charlie Chan from Morgan Stanley.

Good afternoon, and thanks for taking my questions. So my first question to management is about whether the company will consider a share buyback because the company seems to suggest that the recent inventory correction is cyclical, and you're still very positive on the long term. Also, I think the share price really reflects long-term value, right? Also, shareholders' value. So I'm not sure if a company wants to do share buybacks or cash returns?

Okay. So Charlie's first question is that although there's cyclicality, the long-term outlook appears good. Would the company consider doing a share buyback?

Yes, Charlie, we constantly review all the different options of returning cash to shareholders. For share buyback, at this moment, we are not considering it. We think our cash on hand will be better kept to invest in our capital expenditure to make a better return for our shareholders.

Thank you for the information. My second question is regarding the impact of U.S. sanctions. I understand that the company mentioned limited non-performing assets and that the long-term effects are still uncertain. However, I would like to know if the China market for TSMC remains as strategic as it was prior to these developments.

Okay, so Charlie's second question; he wants to know with the recent U.S. regulations and the impact, how do we see the China market? Is it still a strategic market for TSMC? Is that correct, Charlie?

Yes, meaning how this company thinks about China for TSMC's long-term picture, and how important it is to China moving forward?

Charlie, I want to say that every region is important to TSMC. However, I will say that, while we comply with all the rules and regulations, TSMC will continue to serve all customers all over the world. That's our position.

Okay, including China?

All the customers.

Okay, got it. Thank you. Those are my questions.

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

Next one to ask questions, Sunny Lin from UBS.

Hi, thank you for taking my questions. Congrats on the steady performance. My first question is on the geopolitical tensions. I wonder, given some of the considerations regarding the geopolitical issues, how would you evaluate a longer-term impact from customers potentially diversifying from Asian foundries? And how are you managing the risk? Thank you.

Okay, so Sunny's first question is that given the geopolitical tensions, how do we evaluate the long-term impact and the risk of customers using other foundries? Is that correct, Sunny?

Correct. Thank you.

Sunny, we still believe that the most important factors are technology leadership, manufacturing, and our customer trust. So no matter where we manufacture, we still think that technology leadership is the most important thing. And so that's our strategy. We make it simple: technology, manufacturing, and customer trust.

Got it. And so a quick follow-up. Should we assume an acceleration of your overseas expansions just to diversify the production site, i.e., if there could be a fab built in Europe?

Okay, so Sunny's second question then, can we assume that we will continue to increase our global footprint expansion and also particularly in Europe?

We will continue to increase our overseas manufacturing based on customers' needs and business opportunities, as well as based on operational efficiency and economics. We are currently in preliminary evaluation for potential locations, including Europe, and we will not rule out any possibility. Again, I want to emphasize that decisions will be based on our customers' needs, business opportunities, operational efficiency, and cost economics.

Got it, thank you. I actually have a second question on HPC. So with the increasing usage of chiplets, how would you manage the risk in the case that some dies are made at other foundries and those have production issues, therefore impacting production at TSMC as well? Thank you very much.

So Sunny's second question is with increasing usage and adoption of chiplets in HPC, how would we manage the risk in case dies at other companies or places have production issues; how do we manage the risk of that impacting TSMC?

Sunny, in fact, we would like our customers to manufacture every chip inside TSMC for sure. But if there is a case that they have to use dies from other companies, we will work closely with our customers to minimize all the risks that can occur. That's what we are doing right now.

Got it. Thank you, that's very helpful. Thank you.

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

Right now, we have Laura Chen from Citi.

Thank you for taking my question. I appreciate it if you can share your latest plan in your Nanjing fab. Like C.C. already mentioned, you got the license for the 28-nanometer in Nanjing. So I'm just wondering if you also need a license for the 16-nanometer in the Nanjing fab? And also going forward, what is your trend of your operation in China? That's my first question. Thank you.

Okay, so Laura's first question is about the Nanjing fab and our plans. She notes that we have received the one-year authorization, so our 28-nanometer expansion continues as planned. Her question is, do we also need a license for the 16-nanometer that we have in Nanjing? And then also her second question is what is our long-term future expansion plans in China.

Laura, let me answer the first part. The one-year authorization that we received covers the Nanjing facility. So it's both the 28 and 16.

Okay, great. Thank you.

And then the second part is what are our long-term expansion plans for China?

As C.C. mentioned, we will be serving all customers while ensuring full compliance with all rules and regulations.

Okay, that's very clear. My second question is also about the fab globally in the longer term. We know that in overseas operation, usually, they will have much higher operational costs. So how would that impact TSMC's long-term margin trend in your view? Or maybe you can give us some information about your estimate of the percentage of the margin in different regions or the cost difference compared to Taiwan?

Okay, so Laura's second question is around our expansion of our global manufacturing footprint. She wants to know specifically whether overseas fabs have higher costs; do we have a breakdown of how much the cost difference is in Japan, U.S. versus Taiwan? And then overall, with overseas expansion and higher costs, how does this impact our long-term profitability and margin?

Okay, Laura, let me answer this question. The initial cost of overseas fabs is indeed higher than TSMC's fab in Taiwan. This is mainly due to higher labor costs in different layers of the supply chain. We continue to work closely with the U.S. government, as well as with our customers and supply chain partners to manage and minimize the cost gap. Now through these efforts, we believe we can continue to earn the proper return and deliver a long-term gross margin of 53% and higher.

Okay, that's very clear. Thank you very much.

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

Next one to ask questions is Rolf Bulk from New Street Research.

Thank you for taking the questions. I was hoping you could give some more context regarding the 3-nanometer tool shortages that you mentioned. Is that primarily lithography, and then specifically EUV related, or do you also see shortages in other tool segments? Thank you.

Okay, so Rolf's first question is about 3-nanometer and the tool shortages. He wants to know if this is just specific to lithography tools and EUV specifically, or is it a broader issue?

Let me answer the question. Actually, it's more broad-based because our demand is high and certainly, the photolithography tool is included and is one of the most important.

Thank you. That's reasonable. As my follow-up question, it would be great to get an update on your N2 nodes, which your current visibility is now; is it still on track timing-wise, and is there anything you can share on how you think about yields of N2 versus N5 and N3 at the same stage of development?

Okay, so Rolf's second question is on N2. He would like an update. Are we still on track? What is the timing for N2? And also if there's any update on yields as compared to N3 and N5 at similar stages?

N2 is a significant quarter one for us, and our progress is looking good, even slightly ahead of schedule. We plan to begin mass production in 2025. Customer engagement so far has been comparable to what we experienced with N3 and N5. Currently, the status of N2 aligns well with that of N5 and N3, so we are pleased to see that we are on track.

Does that answer your question, Rolf?

Thank you very much.

Thank you, Rolf. Okay, operator, let’s move on to the next participant please.

Next one, we have Charles Shi from Needham & Company.

Good afternoon. Thank you for taking my questions. I have two, both on CapEx. The first question is about long-term CapEx. A few years ago, you provided a range of CapEx when your long-term CAGR guidance was 5% to 10%, suggesting that $10 billion to $12 billion in CapEx would support that long-term CAGR. You have now reiterated your long-term CAGR to be 15% to 20%. Do you have a similar range of CapEx for us to consider over the long term? Again, I'm not inquiring about 2023 CapEx year.

Charles' first question is about the correlation between CapEx and growth. He notes that in the past, we have indicated our long-term growth would be 5% to 10%. During that time, we mentioned spending between NT$10 billion to NT$12 billion. Without specifically referring to 2023, Charles wants to know what type of CapEx range we believe corresponds to our expectation of growing between 15% to 20% CAGR in the next few years. Is that correct, Charles?

Okay, Charles, I think it will be helpful to address this question from the perspective of capital intensity. When we make significant investments to seize future growth opportunities, the capital intensity tends to be high, as we've seen last year and this year. However, if growth starts to slow, the capital intensity could decrease. Long-term, we believe that a typical reasonable capital intensity will likely fall between mid to high 30 percentages.

The second question is about the very near term into the next quarter basically because you just slashed your 2022 CapEx, I mean from what you guided one quarter ago by about $4 billion. If I hear correctly, half of that can be attributed to the tool delivery issues. But the other half, can you clarify a little bit, because you said it's about capacity optimization. Is that a kind of like a $2 billion reduction in CapEx, mostly a reduction of the equipment spending, or is it something else you are reducing here and trying to improve the capital capacity optimization?

Okay, so Charles' second question is on the CapEx and he is asking we have now guided to around $36 billion versus close to $40 billion last time. We have said half of it is related to tool delivery and the other half is capacity optimization for the mid-term demand outlook. So his question is with the capacity optimization is this mainly also a reduction in tools, or is there some other issue right? Is that correct, Charles?

Okay, Charles, I think you're right that half of that difference comes from the tool delivery issue. The other half is the capacity optimization by that, and that's because of the current uncertainty in market conditions. So we're tightening up our capital budget. And it relates to the whole capacity. It's including tools, including the other expenditures within the CapEx. Yes, and it's mainly N7.

Thank you very much.

Yes, it's tools and also as C.C. and Wendell mentioned, some adjustments we have made to our N7 and N6 capacity and CapEx due to the aforementioned reasons. Thanks. Okay, thank you, Charles. Operator can we move on to the next participant?

Next one, we have Brad Lin from BoA Securities. Go ahead please.

Thank you for taking my questions. Congratulations on the strong earnings. My first question is regarding the new loan regulations from the U.S. concerning China, which could be quite broad, especially with regard to supercomputing. Given the diversity and broader applications of the chips that TSMC produces, isn't it theoretically challenging to ensure that the chipsets comply with these regulations? Will there be additional costs or overheads that we should be aware of in the future? Thank you.

Okay. So Brad's first question is with the new U.S. regulations, he notes it's very long and very wide in scope. So he is wondering if it's very hard to interpret and therefore, will this result in greater overhead cost for TSMC to ensure that we are and continue to be fully compliant with all the regulations.

Well, actually, although the rule is about more than 100 pages, based on the initial reading and feedback from our customers, the regulation is very easy to understand, like control switch holds at very high-end specification. For example, like 600 bit per second bandwidth or those kinds of things; it's very easily understood, and we continue to work with our customers to make sure we fully comply with the regulation.

And so Brad would also like to know, Wendell, from a financial standpoint, will we incur more overhead costs as a result?

At this moment, we don't think so.

Thank you very much. I have a quick follow-up regarding the regulation, which focuses on supercomputing. I understand that supercomputers still incorporate some low-end chips. If we were to manufacture those, and we are uncertain about their use, could that lead to confusion or issues for us?

So Brad's second question is in a supercomputer; there may be very specific high-end restrictions, but there are also companion chips, other chips used. Would that cause us an issue?

The company achieves, there are no restrictions or no regulations at all. So we reran on our customer to work with their own customer for that kind of product.

Got it. Thank you very much. And then maybe, if I may, second question will be clearly, many countries would like to build their own foundry or their own domestic supply chain. We've learned that the cost will be a major downside. So my question would be can we charge different pricing basically based on the demands from our clients, right? So with higher costs, if they want to buy from the U.S. or buy from Europe, can we charge a higher pricing if that's based on the node? And also, if we think about the bright side, would you please share how TSMC could well utilize these kinds of opportunities to strengthen our competitiveness in the long run? That will be my all questions.

So Brad's second question is about he notes that many countries would like to have domestic semiconductor manufacturing. TSMC, as C.C. said, is also increasing and expanding our global manufacturing footprint. So with higher costs, will we be able to charge a higher price? I guess that is essentially his question.

TSMC's pricing is strategic and consistent, and I can confidently say that we will continue to emphasize our value. This value comes from our technology manufacturing and our relationships with customers, regardless of their location. I want to reiterate that we will maintain our focus on our value and our pricing strategy.

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

Next one, we have Mehdi Hosseini from Susquehanna International.

Yes, thanks for taking my questions. I also have my first multipart question. I'm just looking at your customers' inventories that are at a 25-year high. And it seems based on your commentary that the demand forecast, especially looking at the first half, has weakened. So it seems to me that the inventory correction is going to sustain into Q2, and more slightly, your shipment would be declining sequentially in Q1 and Q2. Just looking at your customers' inventory, is that a realistic view for the first half? Because you also highlighted the fact that the inventory correction is going to last throughout the first half. I'm not asking for a guide, I'm just trying to better reconcile your customers' inventory with your comment.

Okay. So Mehdi's first question is on inventory. He notes customers' inventory levels are very high. We have talked about our observation from an industry level that demand is softening in the consumer segment. And so his question is what is the outlook, and do we expect the inventory correction, I guess, to be more notable as we go into the first half of '23?

Well, Mehdi, our current forecast shows that our supply chain inventory will peak in the third quarter this year. We observed that inventory will start to reduce in the fourth quarter, the last quarter of this year. We expect we will see the biggest impact in the first half, actually, of 2023. The detail regarding the first quarter and second quarter, we are not ready to share with you yet because we continue to work with our customers to understand their demand.

And if I may have a quick follow-up to that? Does that imply that your customer focus is changing so rapidly that we have to wait for the January pulse to get the final read on the first half?

No, Mehdi. I think we have always in the past, guided for 2023 and talked about the 2023 outlook in first quarter during the January conference, right? But I think C.C. has already said that with the inventory correction, we expect our business to be more resilient during both the downturn and upturn, given our technology leadership, and that 2023 is a growth year for TSMC. We will not comment further on the first or second quarter.

And my second question has to do with depreciation that was down in Q3, down year-over-year and Q-o-Q. And this is despite the fact that CapEx was up 65% in 2021. Does that have anything to do with tool optimization? Additionally, as the second part of the question, would you consider converting 7-nanometer to 5 and 3?

So, Mehdi’s second question first is depreciation; why it is down Q-on-Q and year-on-year. And then also, would we consider converting capacity?

Okay, Mehdi. The depreciation; we look at it from a whole year point of view. For this year, as I mentioned, we expect it to be up year-on-year by mid-single digits. Next year, it will likely be meaningfully higher. We will share more on this in January. Please understand that each year, there is new depreciation being added, as well as depreciation coming off the table. So what you're looking at is the net result. As for converting N7 capacity to N5, as we mentioned, N7 demand issues are cyclical rather than structural. So at this moment, I don't think we have that kind of plan.

Thank you, Mehdi. In the interest of time, operator, could we please take the questions from the last two participants?

Yes, sir. Next one to ask a question is Patrick Chen from CLSA. Go ahead, please.

Thank you for taking my questions. You talked about 2023 to be still a growth year. Would you say that growth is pretty much the same compared to what you expected a quarter ago, or is it lower? And if so, what's driving this lower growth expectation?

Okay, so Patrick's first question is about 2023. Is the growth that we see for 2023, how does it compare versus our expectation from three months ago? And what is driving this?

Yes, well, I think it's too early to talk too much about the 2023 outlook, but we maintain our statement that we still expect 2023 to be a growth year.

Do you have a second question, Patrick?

Okay, yes, that’s very helpful. And maybe a follow-up. If I may, any leading indicators that you are monitoring that could help you determine the growth outlook aside from monitoring the clients' wafer orders?

Okay, so Patrick's second question involves looking at inventory correction. He wants to know if there are any leading indicators that we can look at or he should look at to see when an indication that the cycle is bottoming.

That's really hard to answer your question. Actually, if you look at the whole industry, from the smartphone and PCs, and read all the quarterly reports from our major players, you can see that one goes up and one is in a downturn. So we definitely have some information; internally, we do the analysis, and today, we are taking a very conservative approach in our planning.

Thank you. And I guess that's what we've been doing as well. But obviously, we don't have a crystal ball. Well, I don’t have any further questions. Thank you for taking my questions.

Okay, thank you. Operator, can we take the last participant, please?

Yes, the last one to ask a question is Frank Lee from HSBC. Go ahead, please.

Thank you. I wanted to ask, I guess, a question on your N3, N3E. Is the ramp for both nodes going to be around the same time, or is there going to be some difference in scheduling?

Okay, so Frank's first question is on the ramp for N3 versus N3E; is it at the same time?

Actually, it's not at the same time. Right now, we are ramping up N3. N3E is expected to be one year apart, but because of the good progress we are making, we might pull in a little bit for two or three months. So they are still not at the same time.

My second question is about your long-term gross margin target, which you mentioned remains unchanged. However, considering the challenges you're facing in the first half of next year, with currency fluctuations and declining utilization rates, is there any possibility of a change in your pricing strategy? While I understand you may not be able to provide specific details, you've implemented some price increases over the past year. Moving forward, will your pricing strategy remain relatively stable given the current market conditions?

Okay, so Frank's second question is related to pricing with the inventory correction and some cost challenges; he wants to know if there will be any changes to our pricing strategy during this correction.

I want to stress that our pricing is strategic and consistent. Do we have any plan to change it? No, it will remain consistent; not based on any cycle or opportunistic. Most importantly, we always work closely with our customers to provide our value and help them win in their respective end markets.

Okay, thank you, Frank. Operator, can we move on to the next participant please.

Next one, we have Mehdi Hosseini from Susquehanna International.