Earnings Call Transcript - TSM Q2 2022

Jeff Su, Director of Investor Relations

Good afternoon, everyone, and welcome to TSMC's Second Quarter 2022 Earnings Conference Call. This is Jeff Su, TSMC's Director of Investor Relations and your host for today. To prevent the spread of COVID-19, TSMC is hosting our earnings conference call via live audio webcast through the company's website at www.tsmc.com, where you can also download the earnings release materials. 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 2022, followed by our guidance for the third quarter 2022. 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 the 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 on our press release. And now I would like to turn the call over to TSMC's CFO, Mr. Wendell Huang, for the summary of operations and the current quarter guidance.

Wendell Huang, CFO

Thank you, Jeff. Good afternoon, everyone, and thank you for joining us today. My presentation will start with financial highlights for the second quarter 2022. After that, I will provide the guidance for the third quarter. Second quarter revenue increased 8.8% sequentially in NT or 3.4% in U.S. dollars, as our second quarter business was supported by strong HPC, IoT and automotive-related demand. Second quarter gross margin increased 3.5 percentage points sequentially to 59.1%, slightly ahead of our guidance, as we enjoyed a more favorable foreign exchange rate, cost improvement and value selling. Likewise, operating margin increased 3.5 percentage points sequentially to 49.1%, in line with our gross margin increase. Overall, our second quarter EPS was TWD 9.14 and ROE was 39.4%. Now let's move on to revenue by technology. 5-nanometer process technology contributed 21% of wafer revenue in the second quarter while 7-nanometer accounted for 30%. Advanced technologies, which are defined as 7-nanometer and below, accounted for 51% of wafer revenue. Moving on to revenue contribution by platform. All six platforms increased in the second quarter. Smartphone increased 3% quarter-over-quarter to account for 38% of our second quarter revenue. HPC increased 13% to account for 43%. IoT increased 14% to account for 8%. Automotive increased 14% to account for 5%. And digital consumer electronics increased 5% to account for 3%. Moving on to the balance sheet. We ended the second quarter with cash and marketable securities of TWD1.4 trillion. On the liability side, current liabilities increased by TWD 22 billion, mainly due to the increase of TWD 47 billion in accounts payable, partially offset by the decrease of TWD 29 billion in short-term loans. Long-term interest-bearing debts increased by TWD 124 billion, mainly as we raised TWD 109 billion of corporate bonds during the quarter. On financial ratios, accounts receivable turnover days decreased one day to 37 days while days of inventory increased seven days to 95 days as we prebuild M5 wafers and increased raw materials inventory. Now let me make a few comments on cash flow and CapEx. During the second quarter, we generated about TWD 339 billion in cash from operations, spent TWD 218 billion in CapEx and distributed TWD 71 billion for third quarter '21 cash dividend. Bonds payable increased by TWD 109 billion as a result of this quarter's bond issuances. Overall, our cash balance increased by TWD 102 billion to TWD 1.3 trillion at the end of the quarter. In U.S. dollar terms, our second quarter capital expenditures totaled $7.34 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 third quarter revenue to be between $19.8 billion and $20.6 billion, which represents an 11.2% sequential increase at the midpoint. Based on the exchange rate assumption of $1 to TWD 29.7, gross margin is expected to be between 57.5% and 59.5%, operating margin between 47% and 49%. This concludes my financial presentation. Now let me turn to our key messages. I will start by making some comments on our second quarter and third quarter profitability. As a reminder, six factors determine TSMC's profitability: leadership technology development and ramp-up, pricing, cost, capacity utilization, technology mix and foreign exchange rate. Compared to first quarter, our second quarter gross margin increased by 350 basis points sequentially to 59.1%, mainly due to a more favorable foreign exchange rate, cost improvement and value selling. Compared to our second quarter guidance, our actual gross margins exceeded the high end of the range provided three months ago as our guidance was based on exchange rate assumption of $1 to TWD 28.8 whereas the actual second quarter exchange rate was $1 to TWD 29.42. This created about a 90 basis point difference in our actual second quarter gross margin versus our original guidance. We have just guided our third quarter gross margin to decline 60 basis points sequentially to 58.5% at the midpoint, as a slightly more favorable exchange rate assumption will be more than offset by higher inflationary costs, including higher raw material and electricity costs. Looking ahead on our profitability, we will face challenges from rising inflationary costs from raw materials, utilities and tools, increasing process complexity of leading nodes, new investments in mature nodes and overseas fab expansions. Despite the manufacturing cost challenges, and excluding the impact of foreign exchange rate, of which we have no control over, taking the other five factors into consideration, we continue to believe a long-term gross margin of 53% and higher is achievable. Next, let me talk about our effective tax rate. For 2022, we expect our tax rate to be between 10% and 11%. Starting in 2023, we will see the expiration of certain tax exemptions in Taiwan, and our effective tax rate will increase. However, the Taiwan government is in the process of drafting certain new tax exemption regulations and is currently in the comment period. Therefore, we will provide a further update on the outlook of our tax rate in 2023 and beyond when more details become available. Now let me turn the microphone over to C.C.

C. C. Wei, CEO

Thank you, Wendell. We hope everybody is staying safe and healthy during this time. First, let me start with our near-term growth outlook. We concluded our second quarter with revenue of TWD 534 billion or $18.2 billion, supported by HPC, IoT and automotive-related demand. Moving into the third quarter of 2022, we expect our business to be supported by continued demand for our industry-leading 5-nanometer and 7-nanometer technologies. On the inventory side, due to the softening device momentum in smartphones, PCs and consumer end market segments, we observe the supply chain is already taking action and expect inventory levels to reduce throughout the second half of 2022. After two years of pandemic-driven stay-at-home demand, this type of adjustment is reasonable, in our view. Our expectation is for the excess inventory in the semiconductor supply chain to take a few quarters to rebalance to a healthier level. We believe the current semiconductor cycle will be more similar to a typical cycle, with a few quarters of inventory adjustment likely through the first half of 2023. We have also internally modeled and prepared ourselves for various different scenarios in case it is necessary. On the demand side, while we observe softness in the consumer end market segment, the end market segments such as data center and automotive-related remain steady. And we are able to reallocate our capacity to support these areas. Despite the ongoing inventory correction, our customers' demand continues to exceed our ability to supply. We expect our capacity to remain tight throughout 2022 and our full year growth to be mid-30% in U.S. dollar terms. Three key factors supporting TSMC's strong structural demand are our technology leadership and differentiation, our strong portfolio in high-performance computing and our strategic relationship with customers. All of these factors are TSMC's strengths in the foundry industry. First, on technology leadership and differentiation, TSMC's technology position is much stronger today as compared to previous years. Looking ahead to 2023, we are working diligently to provide the industry most advanced technologies and making it available to all the product innovators with the successful ramp of N5, N4P, N4X and the upcoming ramp-up of N3, we will expand our customer product portfolio and increase our addressable market. The macroeconomic uncertainty may persist into 2023. Our technology leadership will continue to advance and support our growth. Secondly, the massive structural increase in the demand for computation, underpinned by the industry megatrends, continues to fill a greater need for performance and energy-efficient computing, which require the use of leading-edge technologies. Through our comprehensive IP ecosystem and optimized process technology, we are able to address and capture the structural demand and build a strong portfolio in high-performance computing. We expect HPC to be the main engine of TSMC's long-term growth and the largest contributor in terms of our incremental revenue growth in the next several years. Third, our strategic relationship with our customers is long-term in nature, developed and built through many years of collaboration and investment to enable customer success in the high-end market. We continue to work closely with our customer on technology development, capacity planning and pricing to support their long-term demand and growth. With all these three differentiating factors, we expect our capacity utilization to remain healthy in 2023. And our business to be less volatile and more resilient, supported by the strong demand for our differentiated and leading advanced and specialty technologies. Now let me talk about TSMC's long-term growth outlook. While macroeconomic headwinds bring near-term uncertainties that may persist, we believe the fundamental structural growth trajectory in the long-term semiconductor demand remains firmly in place. We continue to observe an increase in silicon content across many end devices, fueled by process technology migration and increased functionality. For example, the number of CPUs, GPUs and AI accelerators in the data center are increasing. 5G smartphones carry substantially higher silicon content compared to 4G smartphones. The amount of silicon content in today's cars continues to rise. While the device unit growth of many electronics devices may be flattish to low single-digit percentage range in the next several years, the silicon content growth will be higher, in the mid- to high single-digit percentage range and support the long-term structural semiconductor demand and increase our addressable wafer demand. TSMC's CapEx and capacity planning are always based on the long-term structural market demand profile, not near-term factors. We are working closely with our customers to plan our long-term capacity and investing in leading-edge and specialty technology to support their growth. We will manage our business prudently through the near-term uncertainties, and we remain highly confident in our long-term growth outlook. With our technology leadership, manufacturing and capacity support, and customers' trust, TSMC is well-positioned to capture the strong multi-year growth from the favorable structural megatrends of 5G and HPC-related applications and deliver profitable growth for our shareholders. We reiterate our long-term revenue to be between 15% and 20% CAGR over the next several years in U.S. dollar terms. Next, let me talk about the tool delivery update. As a major player in the global semiconductor supply chain, TSMC works closely with all our tool suppliers to plan our CapEx and capacity in advance. However, like many other industries, our suppliers have been facing greater challenges in their supply chains, which are extending toward delivery lead times for both advanced and mature nodes. As a result, we expect some of our CapEx this year to be pushed out into 2023. TSMC is actively doing its part to help our tool suppliers address the supply chain challenges. In April, we said that we have increased regular high-level communications to trace the progress and send several teams on-site to support our suppliers. Since then, we have worked closely to identify critical chips that are gauging toward delivery. We are working dynamically with our customers and prioritize our wafer capacity to support these critical chips to help mitigate the chip constraints issues. While challenges remain, the situation is improving. We do not expect any impact to our 2022 capacity plan. And we are able to put in the delivery schedule for a certain amount of tools for our 2023 capacity. We have been working closely with our customers for 2023 so that we can support their demand. Now let me talk about the N3 and N3 status. Our N3 is on track for volume production in the second half of this fiscal year. We expect revenue contribution starting first half of 2023, with a smooth ramp in 2023, driven by both HPC and smartphone applications. N3 will further extend our N3 family with the enhanced performance, power and yield. N3 will offer complete platform support for both smartphone and HPC applications. We observed a high level of customer engagement at N3, and volume production is scheduled for around one year after N3. Our 3-nanometer technology will be the most advanced semiconductor technology in both PPA and transistor technology when it is introduced. Thus, we are confident that our N3 family will be another large and long-lasting node for TSMC. Finally, let me talk about the N2 status. Our N2 technology development is on track and progressing well to our expectation, with risk production scheduled in 2024 and volume production in 2025. After careful evaluation and extensive period of development, our 2-nanometer technology will adopt the narrow sea transistor structure to provide our customers with the best performance, cost, and technology maturity. N2 delivers full node performance and power benefits to address the increasing need for energy-efficient computing, with a 10% to 15% speed improvement at the same power or a 20% to 30% power improvement at the same speed and larger density of more than 20% increase compared with N3E. Our 2-nanometer technology will be the most advanced semiconductor technology in the industry in both density and energy efficiency when it is introduced and will further extend our leadership position well into the future. This concludes our key message, and thank you for your attention.

Jeff Su, Director of Investor Relations

Thank you, C.C. This concludes our prepared remarks. Now let's begin the Q&A session. Our Chairman, Dr. Mark Liu, will be the host.

Mark Liu, Chairman

Hello, everyone. Thank you for joining this conference. I hope you are all well. I believe the reports shared have addressed some of your questions, and they clearly demonstrate that our company is on solid ground. We will be carefully prepared to navigate the current uncertainty. In the meantime, we remain confident and well-prepared for the upcoming growth phase. Now, I welcome your questions.

Randy Abrams, Analyst, Credit Suisse

Thank you and congratulations on the positive outlook. My first question is about your perspective on the business cycle. You increased your outlook to 35% in the strong third quarter. With this strong outlook, I'm curious about what is influencing your expectation for inventory drawdown in the second half and how widespread you anticipate this inventory drawdown will be. Additionally, regarding the first half, since you believe customers will be reducing inventory through that period, do you foresee any underutilization, and how significant do you expect that correction to be?

C. C. Wei, CEO

Randy, this is C.C. Wei. Let me answer your question. Yes, we do have mid-30s growth in this year. But we also expect our customers to start to take action to decrease their inventory level. How far? We expect that a few quarters, at least into the first half of 2023, they will continue to do the inventory correction. And according to TSMC's evaluation, let me say that despite ongoing inventory adjustment and macro uncertainties, the structural growth trajectory in the long-term semiconductor demand remains firm. With our leading and differentiated advanced specialty technologies and a strong HPC portfolio and strategic customer relationships, we expect our capacity to remain tight and our business to be more resilient. And we are confident in both our near-term and long-term growth outlook. Did that answer your question?

Wendell Huang, CFO

Randy, this is Wendell. The first question, as C.C. said in his prepared remarks, the schedule, the tool delivery schedule changes currently as in both the advanced and the mature nodes. Okay. And your second question is about next year's CapEx. It's too early to talk about next year's CapEx. But as we always said, we invest the CapEx in the year for the future opportunities. So as long as the outlook, the future outlook is good, we will continue to invest, but of course, in a disciplined manner.

Bruce Lu, Analyst, Goldman Sachs

Hi, thank you for taking my question. Congratulations on the great result. I believe that in the coming years, we will continue to see revenue growth in the range of 15% to 20%, driven by the increase in dollar content. This aspect often poses a challenge for investors, as it's difficult for them to gauge how much of the growth is attributed to dollar content. For instance, out of the projected 15% to 20% growth over the next few years, can you clarify how much is from dollar content growth, how much stems from shipments, and how much is a result of improvements in average selling price or product mix?

C. C. Wei, CEO

Bruce, let me answer the question. But exactly the number, I cannot share with you because it's confidential. But let me say that. The content increase actually is at least mid- to high single digit for our edge devices. And then even all the electronics devices, even the growth is flattish or some kind of a low single-digit. It's still growing. It's still growing. And combined with all these and our value selling with our customer, so we are confident to say 15% to 20% CAGR is achievable. Okay.

Sunny Lin, Analyst, UBS

Hi, good afternoon. Thank you for taking my questions, and congrats on the strong results. So my first question is on the semi cycle earlier, that you have done some scenario analysis on the semi cycle for 2023. So I just wonder what your current base case for semi growth for 2023. Do you think it will be like a typical down cycle like in 2015, 2019? Or would it be a more meaningful correction? Thank you.

Wendell Huang, CFO

Yes, our base case is more in line with a typical down cycle. The inventory correction may last for a few quarters, through the first half of 2023. It's not expected to be as severe as the downturn experienced in 2008.

Krish Sankar, Analyst, Cowen & Company

Yes, hi. Thanks for taking my questions. I have two of them. The first is, when I look at your full year guidance of 35% revenue growth, it looks like calendar 4Q or the December quarter is going to be sequentially down more than 10%. And that hasn't happened in a long time. So I'm kind of curious, how much of that is driven by demand versus FX? And then the second question, a follow-up is, if I look at your CapEx run rate, the first half is running at about TWD 17 billion, which is below the lower end of your full year guidance. So I'm kind of curious, what are the tool delays that's causing the pushout of CapEx into next year? Is it like EUV? Is it like depth edge tools? Any color on that would be super helpful. Thank you very much.

Wendell Huang, CFO

No. I don't think we can go into that kind of details. But some of them got pushed out to next year, as C.C. mentioned. And every year, the CapEx profile can be different quarter-by-quarter.

Frank Lee, Analyst, HSBC

Thank you. I wanted to just ask a question on the overall profitability and also pricing. It seems like this year, we start to see a foundry price increase and a bit unusual for TSMC. And going into next year, it looks like there's some manifestation of further price increases. But at the same time, we're also seeing potentially inventory correction. So just trying to understand the pricing strategy itself, is this more of a reflection of perhaps the structural profitability for this cycle being different than the past? Or are there any kind of costs that we're seeing this time that we haven't seen in past cycles.

Wendell Huang, CFO

Yes. We do not comment on our pricing details. These are the private discussions between us and our customers. Having said that, our pricing is strategic and value-driven, not opportunistic or cost plus. We work closely with our customers to provide our value. And we will continue to ensure that our pricing reflects our value creations, including technology, ecosystem, services, and capacity support. By taking all these actions, we believe we can achieve a long-term gross margin of 53% and higher. We do face manufacturing cost challenges. As we mentioned, rising raw materials, utilities, and tool costs, et cetera. But having said that, we still think that the 53% long-term gross margin is achievable, and 53% and higher.

Robert Sanders, Analyst, Deutsche Bank

Yes. Thanks for taking my questions. I just have two. The first one is just if you could just discuss how much of next year's revenue is under LTA. The reason I'm asking is because there are some people in the market thinking that customers may be fearful of pushing our wafers because they may be jeopardizing agreements for next year. And then the second question would be just on the chiplet question. I was just wondering what percentage of the 2-nanometer HPC designs will be using a chiplet architecture. Is it the majority? What's the adoption rate? Thanks.

Wendell Huang, CFO

Yes. Robert, we don't discuss the details like that. We work very diligently and closely with the customers to plan the capacity including receiving the prepayments for capacity support. And we will continue to work with them to determine the best way to support them going forward.

C. C. Wei, CEO

I cannot release the number. But let me assure you that the number of the customers using the chiplet in the N2 or the 2-nanometer technology will start to increase and that will become a major approach in the 2-nanometer and the following technologies.

Jeff Su, Director of Investor Relations

Okay, thank you, C.C. Thank you, Robert. And thank you, everyone. This concludes our Q&A session. Before we conclude today's conference, please be advised that the replay of the conference will be accessible within one hour from now and the transcript will become available 24 hours from now. Both of which you can find available through TSMC's website at www.tsmc.com. So 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.