Earnings Call Transcript - TSM Q2 2020

Jeff Su, Director of Investor Relations

Ladies and gentlemen, welcome to TSMC's Second Quarter 2020 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. 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 second quarter 2020, followed by our guidance for the third quarter 2020. Afterwards, Mr. Huang, and TSMC's CEO, Dr. C. C. Wei, will jointly provide the Company's key messages. Then TSMC's Chairman, Dr. Mark Liu will host a Q&A session, where all three executives will entertain your questions. 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 current quarter guidance.

Wendell Huang, CFO

Thank you, Jeff. Good afternoon, everyone. Second quarter revenue was flat sequentially, as the continued 5G infrastructure deployment and HPC-related product launches offset weaknesses in other platforms. Gross margin increased 1.2 percentage points sequentially to 53%, mainly due to the continuing high level of utilization and the absence of unfavorable inventory valuation adjustment, partially offset by NT$ appreciation in the second quarter. Total operating expenses increased by NT$1.19 billion, mainly as TSMC supported a range of COVID-19 relief efforts. Operating margin increased by 0.8 percentage points sequentially to 42.2%. Overall, our second quarter EPS was NT$4.66 and ROE was 28.5%. Now let's move on to the revenue by technology. 7 nano process technology contributed 36% of wafer revenue in the second quarter, while 16 nanometer contributed 18%. Advanced technologies, which are defined as 16 nanometer and below, accounted for 54% of wafer revenue. Moving onto revenue contribution by platform, smartphones decreased 4% quarter-over-quarter to account for 47% of our second quarter revenue. HPC increased 12% to account for 33%. IoT decreased 5% to account for 8%. Automotive decreased 13% to account for 4%. Digital consumer electronics decreased 9% to account for 5%. Moving on to the balance sheet, we ended the second quarter with cash and marketable securities of NT$605 billion. On the liabilities side, current liabilities increased by NT$25 billion, mainly due to the increase of NT$30 billion in short-term loans. On financial ratios, accounts receivables turnover days increased 2 days to 44 days. Days of inventory also increased 2 days to 55 days mainly due to N5 ramp and stronger N7 demand. Now let me make a few comments on cash flow and CapEx. During the second quarter, we generated above NT$170 billion in cash from operations, spent NT$127 billion in CapEx and distributed NT$65 billion for third quarter cash dividend. We also increased NT$30 billion in short-term loans and issued NT$36 billion of corporate bonds. Overall, our cash balance increased NT$37 billion to NT$468 billion at the end of the quarter. In U.S. dollar terms, our second quarter capital expenditures amounted to US$4.2 billion. I finished my financial summary. Now, let's turn to our third quarter guidance. Based on the current business outlook, we expect our third quarter revenue to be between US$11.2 billion and US$11.5 billion, which represents a 9.3% sequential increase at the midpoint. Based on the exchange rate assumption of US$1 to NT$29.5, gross margin is expected to be between 50% and 52%, operating margin between 39% and 41%. Now, I will hand over the call to CC for his key messages.

Dr. C. C. Wei, CEO

Thank you, Wendell. Good afternoon ladies and gentlemen. Let me start with our near-term demand outlook. We concluded our second quarter with revenue of NT$310.7 billion or US$10.4 billion in line with our guidance given three months ago. Our second quarter business increased slightly in U.S. dollar terms as continued 5G infrastructure deployment and HPC-related product launches offset weakness in other platforms. Moving into third quarter 2020, we expect our business to be supported by strong demand for our industry-leading 5 nanometer and 7 nanometer technologies, driven by 5G smartphones, HPC, and IoT-related applications. Looking at the second half of this year, COVID-19 continues to bring some level of disruption to the global economies and uncertainty remains. We have observed weak consumer demand in the first half of this year and now expect global smartphone units to decline in the low teens percentage year-over-year in 2020. However, amid the COVID-19 pandemic, we also observed the supply chain making efforts to ensure supply chain security and actively preparing for new 5G smartphone launches. We raised our forecast for 5G smartphone penetration rate to the high teens percentage of the total smartphone market in 2020. For the full year of 2020, 5G and HPC-related applications will continue to drive semiconductor content enrichment. We now forecast the overall semiconductor market, excluding memory growth, to be flat to slightly increased, while foundry industry growth is expected to increase to mid-to-high teens percentage. Regarding TSMC, also COVID-19 related uncertainties remain. Our technology leadership position enables us to outperform the foundry revenue growth. We believe we can grow above 20% in 2020 in U.S. dollar terms, including the impact from the new U.S. regulations, which I will discuss next. Our 2020 business will be supported by strong demand for our industry-leading 5 nanometer and 7 nanometer technologies and our specialty technology solutions, driven by customers of 5G smartphone-related product launches and expanding HPC-related opportunities. Now let me talk about the impact of new U.S. regulations. On May 15, the U.S. Department of Commerce announced a set of new export control regulations. As a global and law-abiding company, TSMC will follow all the rules and regulations fully, no doubt about it. While there may be some impact from the new U.S. regulations, TSMC's purpose to unleash innovation remains unchanged. Our leading position in the semiconductor industry leverages our technology leadership, manufacturing excellence, and customers' trust also remains unchanged. We will continue to build upon our strengths and conduct our business with integrity to ensure our value and contribute to the semiconductor industry. In the near term, we will work dynamically with our customers to minimize the impact on our business from new U.S. regulations. In the mid- to long term, we believe the underlying megatrend of 5G-related and HPC applications remains intact, and the supply chain can adjust and rebalance themselves. With our technology leadership, we are well positioned to capture all the mid- to long-term growth opportunities. We reaffirm our goal to grow at the high end of our long-term growth projection of 5% to 10% CAGR in U.S. dollar terms. Next, let me talk about our N5 ramp-up and N4 introduction. N5 is the foundry industry's most advanced solution with the best PPA. N5 is already in volume production with good yield, while we continue to improve the productivity and performance of the EUV tools. We are seeing robust demand for N5 and expect a strong ramp of N5 in the second half of this year, driven by both 5G smartphones and HPC applications. As we observed some delays earlier this year in N5 deliveries due to COVID-19, we now expect 5 nanometer to contribute about 8% of our wafer revenue in 2020. We also introduced N4 as an exchange in our 5 nanometer family. N4 has comparable design rules and highly competitive performance tool cost advantages as compared to N5, and we are targeting the next wave of N5 products. Volume production is targeted for 2022. Thus we are confident that our 5 nanometer family will be another large and long-lasting node for TSMC. Now I will talk about our N3 status. N3 will be another full node stride from our N5 with about 70% larger density gain, 10% to 15% speed gain, and 25% to 30% power improvement as compared with 5 nanometer. Our industry technology will use FinFET transistor structure to deliver the best technology maturity, performance, and cost. Our industry technology development is on track with good progress. N3 production is scheduled in 2021, and volume production is targeted for the second half of 2022. We have already demonstrated the ability to handle 56 mega from our tests. N3 documented testing is fully functional, and we are ahead of plan. The device performance is also on track. Our 3 nanometer technology will be the most advanced foundry technology with the best PPA when it is introduced, which will also extend our leadership position well into the future. Finally, let me talk about our U.S. fab plan. On May 15, we announced our intention to build an advanced semiconductor fab in the U.S. We have received a commitment to support this project from both the U.S. Federal Government and the State of Arizona. We are working closely with them as well as our supply chain partners to build an effective supply chain and manage the cost scale. This fab will start with 5 nanometer technology, with a capacity of 20,000 wafers per month. Production is targeted to begin in 2024. The U.S. trade situation has enabled TSMC to expand our technology ecosystem and better serve our customers and partners. At the same time, as TSMC's global presence increases, it will allow us to better reach global talent to sustain our technology leadership. Now let me turn the microphone over to our CFO.

Wendell Huang, CFO

Thank you, CC. Let me start by making some comments on our second half profitability outlook. We have just guided third quarter 2020 gross margin to decline by 2 percentage points sequentially to 51% at the midpoint, primarily due to the margin dilution from the initial ramp-up of our 5 nanometer technology in the third quarter and a less favorable foreign exchange rate. As compared with our expectations three months ago, our third quarter gross margin midpoint is higher, mainly supported by a high level of overall capacity utilization despite the uncertainty from COVID-19. Looking ahead to the fourth quarter, we expect a continued steep ramp-up of our 5 nanometer to dilute our fourth quarter gross margin by about 2 to 3 percentage points. Now let me talk about our capital budget for this year. Every year our CapEx is spent in anticipation of the growth that will follow in the next few years. While the impact of the COVID-19 virus brings uncertainties in 2020, we have seen our business holding up well so far, thanks to our technology leadership in 5 and 7 nanometer nodes. Looking ahead, the multi-year megatrends of 5G related and HPC applications are expected to continue to drive strong demand for our advanced technologies in the next several years. In order to meet this demand and support our customers' capacity needs, we have decided to raise our full year 2020 CapEx to be between US$16 and US$17 billion. We also reiterate that TSMC is committed to sustainable cash dividends on both an annual and quarterly basis. That concludes my key messages.

Jeff Su, Director of Investor Relations

Thank you, Wendell. 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 an 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. Now let's begin the Q&A session. Operator, please proceed with the first caller on the line.

Operator, Operator

Yes, thank you. The first to ask questions, Gokul Hariharan, J.P. Morgan. Go ahead, please.

Gokul Hariharan, Analyst

Yes, hi. Good afternoon and thanks for taking my questions and great results in a tough time. Just a quick question on how we think about N3 development? Do we feel that N3, since we talk about mass production in the second half of 2022, usually then you don’t start sometime in Q2, I just wanted to understand, are we thinking about a slightly slower ramp for N3, compared to what we have had in the first year for N5 as well as N7? That is my first question. My second question is, when you think about leading edge once the U.S. regulation starts to come in, how do we think about managing capacity? Do we feel that the capacity can get filled up relatively quickly when one of our leading customers, you have just talked to them, or do we feel that there could be a couple of, there could be some time where there could be a little bit of underutilization?

Jeff Su, Director of Investor Relations

Okay, thank you Gokul. Let me try to, allow me to summarize your question. Your first question is related to N3, how do we think about the N3 development? We have said the mass production timing is in the second half of 2022 versus typically the second quarter, so should we expect a slightly lower ramp of N3? This is your first question.

Dr. C. C. Wei, CEO

Okay, let me answer that Gokul. In fact, we develop our new leading-edge technology. We work closely with our customer. So, the schedule and also the ramp-up, also the progress we are all working with customer closely and determine when and to be the best timing. So far, N3 development is very smooth and successful, and we still target the mass production in next year and ramp-up in the second half. There is all the schedules, it is working with our customers.

Jeff Su, Director of Investor Relations

Okay, and then Gokul, your second question is on the leading edge, and in light of the recent U.S. regulations how will we manage our capacity at the leading edge? Will we see a gap in the utilization, or will we be able to fill it up?

Dr. C. C. Wei, CEO

We should have no problem because as we just stated that the 5G is a megatrend and HPC-related applications continue to be very strong. And we observed that all our customers are very actively prepared for these two applications 5G and HPC. In addition to that, we also observed that all our customers are trying to secure their supply chain security, which is very important, with this COVID-19 uncertainty.

Gokul Hariharan, Analyst

Do we feel that even for N5 that is applicable or…

Dr. C. C. Wei, CEO

Yes, even with N5, yes.

Dr. Mark Liu, Chairman

Let me answer that. I think for the short-term some impact is inevitable. Currently, we work closely with our customer very dynamically trying to fill up the capacity. And for the long-term, as CC mentioned, we are still optimistic.

Jeff Su, Director of Investor Relations

Okay, thank you Gokul. Can we have the next caller, please?

Operator, Operator

Next question is from Sebastian Hou, CLSA. Go ahead please.

Sebastian Hou, Analyst

Hi, good afternoon gentlemen. Thank you for taking my questions. So my first one is, I wanted to get some, get your brain about how do you evaluate the feasibility and probability of building up advanced new fab without American content, be it technology equivalent IP material etc., in the next five years or 10 years or even longer? Does it work or even if it takes a long time instrumented efforts would TSMC ever consider that? Thank you.

Dr. C. C. Wei, CEO

Well, let me answer that question. We know that the U.S. fab as compared with the fab in Taiwan, the cost structure is actually a little bit higher and that's why we say that we are working with the Federal Government and also the State of Arizona, due to close cooperation.

Jeff Su, Director of Investor Relations

Yes, sorry. Just to repeat the question. I think Sebastian's question is asking about building up an advance node fab or production line without using any so-called American content, whether in terms of equipment, technology, or IP materials. He wants to know in the next five to 10 years, is it feasible? Is it worth it? And is this something that TSMC would consider?

Dr. Mark Liu, Chairman

Let me pick up this one here. The semiconductor technology is very unique in this industry. The technology continued to improve, every two years, there will be a new generation of technology that comes out to serve the best performance product. Therefore, I think our main force is still pursuing technology leadership, trying to overcome each generation's challenges. To do that, I think our current focus is still working with our equipment partners, utilizing the best of the kind of equipment that we can have, to advance our business growth. So, you're right, if we do that otherwise, technology advancement will be extremely challenging and difficult, not to talk about five to 10 years alone. So that is not our current effort at this point.

Jeff Su, Director of Investor Relations

Okay, Sebastian. Do you have a second question?

Sebastian Hou, Analyst

Yes, yes, thank you for that very clear one. Second question is I'd like to follow about the payment situation. The first, can you update us on how you see the fabless data inventory at the end of Q2 and how do you see that in the second half of this year? And also on the inventory side, it looks like it is getting increasingly difficult to get the inventory from a comprehensive perspective, fabless DOI may not be enough because apparently there are a lot of the Chinese companies stockpile the inventory in fear of being sanctioned and also across the board globally, the whole supply chain has been raising the stakes or levels of inventory in the past few months due to fears of supply disruptions caused by COVID-19. So, but those are not reflected in fabless DOI. So, how do we see about this inventory and potentially hidden excessive inventory situation going forward? Do you consider that to be a potential risk and at some point the destocking could come? Thank you.

Jeff Su, Director of Investor Relations

Okay, let me summarize your second question, Sebastian. Both of them relate to the inventory situation. The first part is, what is in for TSMC tracking our fabless customers? What is the fabless DOI exiting to Q2 and the outlook into the second half? That's the first part of your question. And then the second part of your question is, are we concerned that the inventory situation may see some hidden or discrepancies due to whether it's COVID-related supply chain disruption, or the U.S. regulation and such, will this lead to a hidden inventory risk, and is there a risk of inventory correction?

Dr. Mark Liu, Chairman

Let me answer that. The inventory level of our fabless customers that we track exited the first quarter above the seasonal level. We expect a further increase in the second quarter, and then stay at the high level in the second half as the supply chain is making efforts to ensure supply chain security and our customers are in high anticipation and preparing for new 5G smartphone product launches in the second half of this year. We cannot rule out the possibility of an inventory correction sometime down the road. We observe the supply chain actively making efforts to ensure the securities and preparing actively for 5G smartphone launches. We will just have to wait and see how the sell-through goes.

Jeff Su, Director of Investor Relations

Okay, thank you Sebastian. Can we move on to the next caller please? Operator, please move on to the next caller.

Operator, Operator

Thank you. The next caller is Bill Lu from UBS. Go ahead, please.

Bill Lu, Analyst

Yes, hi. Thank you. Thanks for taking my question. I'm wondering if you can comment on the CapEx guidance for this year, it's now raised to 16 billion to 17 billion. I'm wondering what that increase is, whether it's 5 nanometer or something different? Secondly, related to that, can you talk about your CapEx intensity structurally whether this increase is temporary and whether this is pulling in front for maintaining the dollar-driven intensity or how we should think about that? Thanks.

Jeff Su, Director of Investor Relations

Okay, let me summarize your two questions, Bill. Your first question is in relation to our 2020 CapEx guidance and the range of 16 billion to 17 billion. So, Bill wants to know what is driving this increase? And then secondly, in terms of the capital intensity outlook over the next few years?

Wendell Huang, CFO

Okay. The CapEx increase from three months ago for this year is basically driven by the advanced technologies, and the capital intensity this year will be slightly lower than 40% and over the long-term, it will gradually go down to above mid-30s.

Jeff Su, Director of Investor Relations

Okay, thank you, Bill. Let's move on to the next caller, please? Operator?

Operator, Operator

The next caller is Brett Simpson from Arete Research. Go ahead please.

Brett Simpson, Analyst

Yes, thanks very much. I wanted to ask about your relationship with Huawei and how you see the impact of the U.S. regulation on your business with Huawei in the second half of the year. My understanding is that you will still have a relation - you will still be shipping wafers, probably at elevated levels in Q3. So can you confirm whether or not you'll have any sales with Huawei in Q4? And in a note how do you manage your 5 nanometer utilization, given the importance of Huawei as a customer? Thank you.

Jeff Su, Director of Investor Relations

Okay. Let me summarize your question, Brett, is regard to the relationship with Huawei, but wants to know what is the impact on our business from Huawei in the second half of this year? Will we continue to ship wafers to this customer in the fourth quarter? If we do not, then how will we manage the impact to our 5 nanometer?

Wendell Huang, CFO

Okay, let me answer your question. As CC just reported we are complying fully with all the regulations and we did not take any new orders or production starts from this customer since May 15. Although this regulation is just finished their public comment period, the BIS has not made a final ruling change at this point and so it's very early to confirm. But under this current status, we do not planning to ship wafers after September 14. And yes, there will be a challenge to work dynamically with other customers, thus currently we're working with them. And, but as you heard, we made a - CC just made our 2020 guidance above 20%. That tells you we are relatively progressing well in filling up the capacity left open.

Jeff Su, Director of Investor Relations

Okay, Brett. Thank you. Do you have a second question?

Brett Simpson, Analyst

Yes, thanks Jeff. Just a follow-up and I wanted to ask about depreciation for this year. I think previously you've talked about mid-to-high teen growth of this depreciation in 2020. Can you confirm whether that's still the case? And I look at the first half depreciation and it looks like depreciation costs are down year-on-year. So in order to get to the mid-to-high teens growth, that would imply a large increase in depreciation in the third and fourth quarters. So if you can just clarify exactly how we should think about depreciation for the next couple of quarters, that would be great? Thank you.

Jeff Su, Director of Investor Relations

Okay, Brett is asking his second question is our depreciation outlook for 2020, do we still maintain, what is our depreciation for 2020 year-on-year, and does this imply a pickup in depreciation in the second half on a quarterly basis?

Wendell Huang, CFO

Okay, Brett. Our current estimate on 2020 depreciation year-on-year growth is still in the high teens growth. So that gives you an idea of what the second half depreciation will be. It will be higher than the first half.

Brett Simpson, Analyst

Thank you.

Jeff Su, Director of Investor Relations

Okay, thank you, Brett. Can we have the next question on the line, please?

Operator, Operator

The next one on the line is Mehdi Hosseini from SIG. Please ask your question.

Mehdi Hosseini, Analyst

Yes, thanks for taking my questions. I wanted to go back to your N4 and N3, and how should we think about the migration and specifically to what extent it is driven by converting rather than installing new equipment? And I have a follow-up.

Jeff Su, Director of Investor Relations

Okay, sorry Mehdi. Let me make sure we understood your first question. You're asking about N4 and N3, how to think about the migration and is there a conversion, tool conversion involved between N4 and N3? Is that your question?

Mehdi Hosseini, Analyst

Correct.

Dr. C. C. Wei, CEO

Alright, actually the N4 is kind of improvement, continuous improvement from N5, so it has improves the speed, improved geometry just a little bit. N3 is a totally new node alright? So that’s N4 used in the same equipment as N5. N3 we expect to have a high percentage of the tool continue to be used from the N5, but N3 is a totally new node.

Jeff Su, Director of Investor Relations

Okay, thank you. Do you have a second question Mehdi?

Mehdi Hosseini, Analyst

Yes, and my second question has to do with your HPC revenue growth in Q2 you were significantly higher compared to Q1 within the - and can you please elaborate which specific sub-segment within HPC is doing better, is it driven by communication or computer, and how do you see those trends trending into Q3?

Jeff Su, Director of Investor Relations

So Mehdi, your second question is looking at our HPC sequential growth in the second quarter, Mehdi wants to know what specific sub-segments are driving that increase and what is the outlook?

Wendell Huang, CFO

Well Mehdi, I don't think we want to breakdown the details on the different platforms. Sorry about that.

Jeff Su, Director of Investor Relations

Okay, Mehdi?

Mehdi Hosseini, Analyst

The concern is that maybe perhaps Huawei may have pulled in before you stopped taking orders and I'm trying to understand how that particular customer has computed wafers in the first half versus second half?

Wendell Huang, CFO

Sorry Mehdi, no we don’t comment on specific customers.

Jeff Su, Director of Investor Relations

Okay, thank you Mehdi.

Mehdi Hosseini, Analyst

Thank you.

Jeff Su, Director of Investor Relations

Thank you. Can we have the next caller on the line, please?

Operator, Operator

Yes. Next one, Randy Abrams from Crédit Suisse. Go ahead please.

Randy Abrams, Analyst

Okay, yes. Thank you. My first question, I wanted to ask a bit more on the CapEx rates as that’s more of a function of what you mentioned the forward demand outlook. If you could give a view on 2021, I know it’s in early stage, we just factoring a full year, how we mentioned Huawei and also mentioned potential, but you don't rule out an inventory correction, and it does seem like Samsung and this is discussing a bit about some graphics and high-end smartphone business, some situations like it seems like the CapEx rate is what's driving it, if there are certain drivers that may be lifted on the 2021, how you're seeing that and implication is a follow-up on Bill Lu’s question, but implication for 2021 if it’s impact it might be a bit lower CapEx that you are spending at a bit head of that now.

Jeff Su, Director of Investor Relations

Okay, so Randy, let me summarize your first question. Your first question is really, what is driving our rates for the 2020 CapEx? What are the drivers for that? And then what is the outlook for 2021 CapEx?

Randy Abrams, Analyst

CapEx and sales, the sales just factored in your comments about inventory. If your competitor is taking a bit of sounding business and also your view that we could have a - or don’t rule out the inventory adjustment?

Dr. C. C. Wei, CEO

Let me discuss CapEx is a - we do the CapEx based on long-term perspective. If you talk about '20, this year's CapEx, mainly of course this shows our demand of N5 is very strong. And if you talk about the next year's CapEx, it's really talk about 2022's demand, where we see the continuous increase of N5 demand and also we see them starting the launch of N3 technology. And we'll see by then, how much the CapEx will increase and we will report to you in due time.

Jeff Su, Director of Investor Relations

Okay. Do you have a second question, Randy?

Randy Abrams, Analyst

Yes, and if I could follow up because you mentioned, like to the higher CapEx for this year is a function that you expect next year to be even stronger. So could you talk a bit about when - I know you talked about the megatrends, but I'm curious if you're thinking about just what you mentioned also, could next year have an impact from the high base this year on the inventory build-up? And also you have a full year, like in the first quarter far ways out, there's probably pent-up demand being tight. But how do you view a full year if you're not shipping the following, unless you're counting on by that point some partial license to work in your base case you're assuming not shipping to Huawei by next year?

Wendell Huang, CFO

Yes, Randy. It's just too early for us to discuss anything about 2021. So we'll just wait until when the time approaches.

Jeff Su, Director of Investor Relations

Okay, thank you Randy. Let's move on to the next caller please.

Operator, Operator

The next one is Roland Shu from Citigroup. Please ask the question.

Roland Shu, Analyst

Hi, there, good afternoon. First question is, can you remind me again how does the inventory ratio adjustment work every quarter? How about the 3Q, if based on your inventory ratio adjustment favorable or unfavorable to the gross margin? This is my first question. Second question, which is you talked about that you are working with top customer to minimize the impact of the U.S. new regulation and how are you going to – are working on that? Thanks.

Jeff Su, Director of Investor Relations

Okay. So, Roland your two questions. Your first question is, what is the impact of inventory revaluation and then in the third quarter will it be a favorable or unfavorable impact? And your second question is, you want to know how we are dynamically working with customers to mitigate the impact of the new U.S. regulations?

Wendell Huang, CFO

Roland, let me make some comments on the inventory valuation adjustment first. The impact on margins from inventory valuation adjustments is inversely correlated to that from changes in utilization. We normally report the net impact on margins from these two factors together. We will compare margins quarter-over-quarter, and we will report the Q-on-Q change in impact from inventory valuation adjustments when it is more significant. In the second quarter, the quarter-over-quarter change and impact from inventory valuation adjustments was more significant. And if you ask about the third quarter, at this moment, we believe the impact is less significant.

Dr. C. C. Wei, CEO

Okay. And then asking about how we work with customers dynamically to mitigate the impact of Huawei ban, I cannot tell you that how we are going to do it because this is our company's strategy and our strength, but one thing I can tell you we are based on the technology leadership and the excellent manufacturing. That's all we did.

Jeff Su, Director of Investor Relations

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

Operator, Operator

Yes. The next question, Charlie Chan, Morgan Stanley. Go ahead please.

Charlie Chan, Analyst

Hi, good afternoon, management team. So, my first question is really about your upward revision of the full year revenue guidance. So compared to last time, it was a mid-to-high-teen percent and now it is above 20%. I think this is a lift of 5 percentage points of revenue growth in 2020. But last time your assumption is that the pandemic can get controlled by June and now generally there is a second wave of the pandemic in many countries. So how are you going to reconcile this kind of weak economy or a healthcare-related issue versus your very strong revenue guidance? Should I just attribute that to the higher 5G smartphone penetration or are there other factors that we should pay attention to?

Jeff Su, Director of Investor Relations

Okay. Let me summarize your first question, Charlie. You are asking, basically we have increased the full-year outlook, but the risk of COVID-19 continues to remain. So how to reconcile a weak global economy with TSMC's full-year outlook and what will be driving this besides 5G smartphone preparation?

Dr. C. C. Wei, CEO

Well, Charlie, we too observe the 5G's smartphone, the momentum is getting stronger, so we understand the situation. However, we also observed our customers are making efforts to ensure supply chain security. So they might expect there's a second wave, third wave of COVID-19, but since the end demand looks very promising, so they are not afraid to make sure that their supply chain will not be disrupted. Because of a 5G, as you just mentioned, the 5G smartphones demand has continued to increase.

Jeff Su, Director of Investor Relations

Okay. Do you have a second question, Charlie?

Charlie Chan, Analyst

Yes, I do thanks. Thanks Jeff. So, I think a lot of things happened over the past months, right. And other - I would take it as a U-turn is your decision for the U.S. fab intention because half a year ago I remember the comment was like the cost is pretty high, logistics doesn't make sense. So what exactly is the trigger for you to change this U.S. operation decision? And it will be very kind of you, if I can have a very small question, because as well, your first-quarter seasonality, because based on your new full-year guidance, if we would take it as a 20% or 25% lower, the fourth quarter revenue may decline sequentially. Is that kind of a fair comment? Thank you.

Dr. C. C. Wei, CEO

Well, as you know, with expanding our technology ecosystem and reaching global talent, closer to our customers to get better service, all benefits are the fab in the U.S. But, in the past, indeed, the cost, the gap prohibited us from making those decisions. More recently, I think since last December and I think the things are getting a turn, and we did get the positive encouragement from the U.S. administration and about the cost gap. They seem to be able to close the cost gap. We used to hold up against this decision with their commitment, and we are preparing for that. They are closing the cost gap with the U.S. Congress both in the Senate and the House driving for incentives aimed at reviving U.S. semiconductor manufacturing. And with that, they do have a way to fulfill that commitment to close the cost gap and that was the major decision turning point.

Jeff Su, Director of Investor Relations

And then, Charlie, he snuck in a third question, which he wants to know our outlook for the fourth quarter, given the full-year guidance.

Wendell Huang, CFO

Okay. Well, Charlie, it's also too early to talk about the fourth quarter. But I think you can do the math and come up with certain estimations, but what we can say is our second half will be growing - will be higher than the first half.

Jeff Su, Director of Investor Relations

Yes. Okay, thank you. Let's move on to the next caller on the line, please?

Operator, Operator

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

Bruce Lu, Analyst

Hi, thank you for taking my question. I think given your positive progress in 3 nanometer and 5 nanometer and special vision of CapEx, can we assume that similar to previous nodes like 7 nanometer or 12 nanometer that the first year of 3 nanometer can achieve 10% of the wafer revenue in the second year of the 5 nanometer can achieve 30% of the wafer revenue?

Jeff Su, Director of Investor Relations

Okay. So, Bruce your first question is regards to N5 and N3. Bruce wants to know with the progress in 3, can it contribute 10% of the wafer revenue in the first year? And he also wants to know can N5 contribute 30% of the wafer revenue in its second year?

Dr. Mark Liu, Chairman

Okay, Bruce, both of them are really too early to talk about. We certainly hope that they will be pretty big nodes, but we will definitely let you know when time is closer.

Jeff Su, Director of Investor Relations

Do you have a second question, Bruce?

Bruce Lu, Analyst

Yes, I think to just double-check that, we raised our 5G penetration shipment or forecast, but we lowered the overall smartphone shipment forecast for 2020. And how about the actual number for the 5G smartphone shipment, is that the penetration is up because of the lower total smartphone shipment or the 5G smartphone shipment is servicing going up as well?

Jeff Su, Director of Investor Relations

Okay. So your question - second question, Bruce is that we - the global smartphones shipment we now lowered to low teens decline, but we raised the 5G penetration to high teens. Is this simply because of a lower, smaller global base or what is the 5G penetration number?

Dr. C. C. Wei, CEO

Well, the 5G penetration, as I said, momentum continued to increase. So even with the total smartphone number being decreased at the low-teens, but 5G's percentage continued to increase and that's what we observed and also the 5G's semiconductor content is higher than the 4G and high - especially high-end is much higher, so that's what we based on.

Jeff Su, Director of Investor Relations

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

Operator, Operator

The next on the line is Aaron Jeng from Nomura Securities. Go ahead please.

Aaron Jeng, Analyst

Hey, thank you for taking my question. Can I ask a follow-up to Bruce's question, just right now. He was asking, by lowering the total smartphone demand to low teens, 10% to 15% now from an earlier version of 5% to 10%, but raising 5G penetration rate to 15% to 20% from earlier on in mid-teens, say 15% and - but in terms of the absolute 5G phone demand or selling number, is the number being raised or is it pretty much the same as the prior version? That's a follow-up. Actually this is a part of my first question, but just happened to be a follow-up to Bruce's question.

Jeff Su, Director of Investor Relations

The answer is yes.

Aaron Jeng, Analyst

Okay, thank you.

Jeff Su, Director of Investor Relations

What is your second question?

Aaron Jeng, Analyst

Okay, good. Let me - so, okay, let me ask my - this question that - I was trying to compare the outlook offered by TSMC for the industry and the outlook given six months ago. In the year beginning of the year, TSMC was saying that semi-excluding memory was going to grow by 8%, and now it's going to be flattish to slightly grow, which means I think overall demand including everything is lower than it was six months ago. But total growth in the year beginning was 17%, but now it's pretty much unchanged, mid-to-high-teens growth. TSMC's growth in the year beginning was above the industry growth, now it's above 20% growth. So, given the challenges in this year from COVID-19 and such, what is driving TSMC's stronger growth?

Dr. C. C. Wei, CEO

Well, I can answer that question by simply one word, technology leadership. Actually, we see a very strong demand from our 7-nanometer and 5-nanometer technology. And 5G again, I would like to say that 5G's momentum is getting strong.

Jeff Su, Director of Investor Relations

Okay.

Dr. C. C. Wei, CEO

And including also HPC, I'm sorry. Yes.

Jeff Su, Director of Investor Relations

Alright, thank you. Operator, can we move on to the next question please, from the line?

Operator, Operator

Next we're having Gokul Hariharan, JPMorgan. Go ahead please.

Gokul Hariharan, Analyst

Thanks for taking my follow-up question. First of all, I just wanted to understand, we are running at 20-plus percent growth this year. Any thoughts on - I mean we expect some of these megatrends to last. Any thoughts on why we aren't changing our long-term 5% to 10% target, especially given you're also spending more CapEx for - I know IP is similar and probably we need to be at a slightly higher growth rate. That's my first question. Second, just wanted to understand what is management's view on how much of this year's outgrowth compared to the semiconductor industry has been some of this inventory build-up and over the last several years, is very good years that you've simply outgrown the semiconductor industry or the foundry industry by a significant margin. And this seems to be one of those years where even smartphone is not really growing, but you are declining, while TSMC is growing more than 20%. So just wanted to understand, there is quite a bit of gap between the real demand and market share gain in leading edge, but any thoughts on how much of that do you feel that some of this inventory and supply chain security inventory that your customers are building?

Dr. C. C. Wei, CEO

We certainly - at this time, I don't think we can separate them so clearly each one, that is because of our technology, because of the share gain, because of HPC or something like that. Again, I would like to emphasize the need and the leading edge technology node on 7 and 5 and that's what we are getting our advantage.

Jeff Su, Director of Investor Relations

Okay. And then, your second question, Gokul to repeat again, is that with the strong growth we see this year and the megatrends that we identified for the next several years, will there be a change in our long-term growth target?

Dr. C. C. Wei, CEO

Well, we continue to emphasize that we will be at the high end of 5% to 10% CAGR. Remember, this kind of forecast is a rolling forecast. So we continue to have confidence in our technology and also our market share and so our growth.

Jeff Su, Director of Investor Relations

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

Operator, Operator

Next one, we are having Sebastian Hou from CLSA. Go ahead please.

Sebastian Hou, Analyst

Thank you. Next on the CapEx increase, the 1 billion CapEx increase, which particularly node did that go to? Thank you.

Jeff Su, Director of Investor Relations

Sebastian wants to know with the increase in the CapEx to 16 to 17 billion from 15 to 16 previously, what node is the CapEx spending going to be?

Dr. C. C. Wei, CEO

It's leading edge.

Sebastian Hou, Analyst

Okay, got it. Then maybe one last question is, I think the U.S. senator has proposed two bills, the CHIPS Act and American Foundry Act in June. So I am wondering that the, how does that cover with TSMC Arizona plant and if that were to be passed will TSMC or a non-American company be eligible for the potential subsidy? Thank you.

Jeff Su, Director of Investor Relations

Well, Sebastian, just to make sure we understand your question. Your question is related to some of the proposed regulations in the U.S., such as the CHIPS Act and the AFA, if these bills were to be passed, whether it would be eligible for TSMC or the industry?

Dr. Mark Liu, Chairman

Yes, it's well aligned with our request and if those bills in different forms pass, I think the administration in the State of Arizona will make this project happen.

Jeff Su, Director of Investor Relations

Okay, thank you, Sebastian.

Operator, Operator

Thank you. 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 four hours from now. The transcript will be available 24 hours from now and both of them 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.