Earnings Call Transcript - TSM Q1 2023

Jeff Su, Director of Investor Relations

Good afternoon, everyone, and welcome to TSMC's First Quarter 2023 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. The format for today's event will be as follows: first, TSMC's Vice President and CFO, Mr. Wendell Huang, will summarize our operations in the first quarter of 2023, followed by our guidance for the second quarter of 2023. 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 questions and answers. 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.

Wendell Huang, CFO

Thank you, Jeff. Good afternoon, everyone. Thank you for joining us today. My presentation will start with the financial highlights for the first quarter 2023. After that, I will provide the guidance for the second quarter 2023. First quarter revenue decreased 18.7% sequentially in NT or 16.1% in U.S. dollars as our first quarter business was impacted by weakening macroeconomic conditions and softening end market demand, which led customers to adjust their demand accordingly. Gross margin decreased 5.9 percentage points sequentially to 56.3%, mainly reflecting lower capacity utilization and a less favorable foreign exchange rate, partially offset by stricter cost controls. Total operating expenses accounted for 10.8% of net revenue, which is lower than the 12% implied in our first quarter guidance, mainly due to stringent expense control and lower employee profit sharing. Operating margin was 45.5%, down 6.5 percentage points from the previous quarter. Overall, our first quarter EPS was TWD 7.98 and ROE was 27.5%. Now let's move on to revenue by technology. 5-nanometer process technology contributed 31% of wafer revenue in the first quarter, while 7-nanometer accounted for 20%. Advanced Technologies, defined as 7-nanometer and below, accounted for 51% of wafer revenue. Moving on to revenue contribution by platform. HPC declined 14% quarter-over-quarter and accounted for 44% of our first quarter revenue. Smartphone declined 27% to account for 34%. IoT declined 19% to account for 9%. Automotive increased 5% to account for 7%, and DCE decreased 5% to account for 2%. Moving on to the balance sheet. We ended the first quarter with cash and marketable securities of TWD 1.59 trillion or USD 52 billion. On the liability side, current liabilities decreased by TWD 71 billion, mainly due to the decrease of TWD 65 billion in accounts payable. On financial ratios, accounts receivable turnover days decreased 2 days to 34 days, while days of inventory increased 3 days to 96 days. Regarding cash flow and CapEx. During the first quarter, we generated about TWD 385 billion in cash from operations, spent TWD 302 billion in CapEx, and distributed TWD 71 billion for the second quarter 2022 cash dividend. Overall, our cash balance increased TWD 42 billion to TWD 1.39 trillion at the end of the quarter. In U.S. dollar terms, our first quarter capital expenditures totaled $9.94 billion. I have finished my financial summary. Now let's turn to our current quarter guidance. We expect our business in the second quarter to continue to be impacted by customers' further inventory adjustment. Based on the current business outlook, we expect our second quarter revenue to be between USD 15.2 billion and USD 16 billion, which represents a 6.7% sequential decline at the midpoint. Based on the exchange rate assumption of USD 1 to TWD 30.4, gross margin is expected to be between 52% and 54%, operating margin between 39.5% and 41.5%. This concludes my financial presentation. Now let me turn to our key messages. I will start by making some comments on our first quarter '23 and second quarter '23 profitability. Compared to the fourth quarter, our first quarter gross margin decreased by 590 basis points sequentially to 56.3%, primarily due to a lower capacity utilization. Compared to our first quarter guidance, our actual gross margin exceeded the high end of the range provided three months ago by 80 basis points, mainly due to more stringent cost control efforts. We have just guided our second quarter gross margin to be 53% at the midpoint, mainly due to a lower capacity utilization rate and higher electricity costs in Taiwan. After last year's electricity price increase of 15% in the second half of 2022, TSMC's electricity price in Taiwan has increased by another 17% starting April 1 this year. This is expected to take out 60 basis points from our second quarter gross margin. We expect the impact from higher electricity costs to continue throughout the second half of this year and dilute our full-year gross margin by about 50 basis points. In 2023, our gross margin faces challenges from lower capacity utilization due to semiconductor cyclicality, the ramp-up of N3, overseas fab expansion, and inflationary costs, including higher utility costs in Taiwan. To manage our profitability in 2023, we will work diligently on internal cost improvement efforts while continuing to sell our value. Excluding the impact of foreign exchange rates, over which we have no control, we continue to forecast a long-term gross margin of 53% and higher is achievable. Next, let me talk about the 2023 capital budget. Every year, our CapEx is spent in anticipation of the growth that will follow in future years. As I've stated before, given the near-term uncertainties, we continue to manage our business prudently and tighten our capital spending where appropriate. That said, our commitment to support customers' structural growth remains unchanged, and our disciplined CapEx and capacity planning remains based on the long-term market demand profile. Thus we expect our 2023 capital budget to be between USD 32 billion and USD 36 billion. With this level of CapEx spending in 2023, we reiterate that TSMC remains committed to a sustainable and steadily increasing cash dividend on both an annual and quarterly basis. 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.

C. C. Wei, CEO

Thank you, Wendell. Good afternoon, everyone. First, let me start with our near-term demand and inventory. Three months ago, we said we expect fabless semiconductor inventory to start gradually reducing in Q4 2022, and we forecast a sharper reduction throughout the first half of 2023. However, due to weakening macroeconomic conditions and softening end market demand, fabless semiconductor inventory continued to increase in the fourth quarter and exited 2022 at a much higher level than we expected. In addition, the recovery in end market demand from channels reopening is also lower than our expectation. Therefore, the fabless semiconductor inventory adjustment in the first half of '23 is taking longer than our prior expectation. It may extend into the third quarter this year before rebalancing to a healthier level. For the full year of 2023, we do our forecast for the semiconductor market, excluding memory, to decline mid-single-digit percent, while the foundry industry is forecast to decline high single-digit percent. We now expect our full-year 2023 revenue to decline low to mid-single-digit percent in U.S. dollar terms, and our business to do better than both semiconductor ex-memory and foundry industries, supported by our strong technology leadership and differentiation. We concluded our first quarter with revenue of USD 6.7 billion, which is towards the low end of our guidance range, provided in U.S. dollar terms. Moving into the second quarter 2023, we expect our business to continue to be impacted by customers for the inventory adjustment. We now expect our revenue in the first half of 2023 to decline by about 10% over the same period last year in U.S. dollar terms as compared to mid- to high single-digit percent decline previously. Having said that, we believe we are passing through the bottom of the cycle of TSMC's business in the second quarter. While we forecast only a gradual recovery for the semiconductor ex-memory industry in the second half of 2023, TSMC's business in the second half of this year is expected to be stronger than the first half, supported by customers' new product launches. Next, let me talk about our N3 and N3E status. Our 3-nanometer technology is the first in the semiconductor industry to high-volume production with good yield. As our customers' demand for N3 exceeds our ability to supply, we expect N3 to be fully utilized in 2023, supported by both HPC and smartphone applications. Sizable N3 revenue contribution is expected to start in the third quarter, and N3 will contribute mid-single-digit percentage of our total wafer revenue in 2023. N3 will further extend our N3 family with enhanced performance, power, and yield, and offer complete platform support for both HPC and smartphone applications. N3E has passed the qualification and achieved performance and yield targets, and volume production is scheduled for the second half of '23. Despite the ongoing inventory correction, we continue to observe a high level of customer engagement with both N3 and N3E with a number of tape-outs more than 2x that of N5 in the first and second half of the year. Our 3-nanometer technology is the most advanced semiconductor technology in both PPA and transistor technology. Thus, we expect strong multi-yield demand for our N3 technologies and are confident that our 3-nanometer family will be another large and long-lasting node for TSMC. Now I will talk about our N2 status. Our N2 technology development is progressing well and on track for volume production in 2025. Our N2 transistor structure provides our customers with the best performance, cost, and technology maturity. Our nanosheet technology has demonstrated excellent power efficiency, and our N2 will deliver full node performance and power benefits to address the increasing need for energy-efficient computing. At N2, we are observing a high level of customer interest and engagement from both HPC and smartphone applications. 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 technology leadership well into the future. Finally, I will talk about TSMC's global footprint and talent development status. As we have said before, we are expanding our global manufacturing footprint to increase customer trust, expand our future growth potential, and reach for more global talents. In Arizona, despite some challenges in obtaining permits, our fourth fab is scheduled to begin production of N4 processing technology in late 2024. In Japan, we are building a specialty technology fab, and the volume production is scheduled for late 2024. In Europe, we are engaging with customers and partners to evaluate the possibility of building a specialty fab focusing on automotive-specific technologies based on the demand from customers and level of government support. In China, we are expanding 28-nanometer in Nanjing as planned to support our customer in China, and we continue to follow all rules and regulations fully. At the same time, we continue to invest in Taiwan and expand our capacity to support our customers' growth. In Kaohsiung, our fab construction continues, but we have adjusted our previous 28-nanometer expansion plan to now focus on capacity expansion for more advanced nodes, and we will remain flexible going forward. In terms of talent development, a key to TSMC's success is adherence to our core value of integrity, commitment, innovation, and customer trust and our discipline and spirit of working together as one team. In both the U.S. and Japan, we are recruiting from the top local colleges and universities, and our progress is well on track. We have hired more than 900 U.S. employees today in Arizona and more than 370 in Japan. We also plan to hire more than 6,000 employees in Taiwan in 2023. All of our hirings are to support our future growth potential. In addition to providing an extensive training program for new overseas employees, many of them are brought to Taiwan for hands-on experience in our fabs so that they can further their technical skills while being immersed in TSMC's operational environment and culture. As we expand our global footprint, our priority will continue to be identifying, attracting, and hiring talent whose core values and principles are aligned with TSMC's so that we can establish TSMC culture in all our employees, no matter where we operate. This concludes our key message. Thank you for your attention.

Jeff Su, Director of Investor Relations

Thank you, C.C. This concludes our prepared statements. Before we start the Q&A session, I want to remind everyone to limit your questions to one at a time. If you prefer to ask your question in Chinese, I will translate it to English before our management provides an answer. Now, let's begin the Q&A session. Operator, can we proceed with the first caller on the line?

Operator, Operator

Yes, Jeff. The first one to ask a question is Gokul Hariharan from JPMorgan.

Gokul Hariharan, Analyst

First of all, can I ask about the near-term demand dynamics? Could you discuss what you're observing by segments? Is the inventory correction trend largely similar across HPC, smartphone, IoT, and auto? Or are there different dynamics in these segments, particularly in auto, where there were still some shortages last quarter? Additionally, could you address the status of 7-nanometer? We previously expected it to begin recovering in the second half of this year. Do we still anticipate 7-nanometer recovery in the second half? That's my first question.

Jeff Su, Director of Investor Relations

Thank you, Gokul. Let me summarize your first question. You are inquiring about the near-term dynamics, specifically regarding the inventory trend across various segments and the status of end demand in those segments, including automotive. Additionally, you would like to know about the recovery of utilization for TSMC's 7-nanometer technology.

C. C. Wei, CEO

Okay. Gokul, let me answer the question. We observed the PC and smartphone market continue to be soft at the present time, while automotive demand is holding steady for TSMC and it is showing signs of softening into the second half of 2023. I'm talking about automotive. On the other hand, we have recently observed incremental upside in AI-related demand, which helps the ongoing inventory digestion. What is the second question?

Gokul Hariharan, Analyst

The second part is on 7-nanometer. We previously mentioned that 7-nanometer utilization is lower. Do we expect this to pick up or recover in the second half?

C. C. Wei, CEO

It will be recovered but slowly. As I said, most of the N6 and N7's technology loading is still in HPC and smartphone. However, looking into the future, some of the specialties such as RF, connectivity, and WiFi, all those kinds of things will start to build up the loading their demand. And we expect in the long term, 7-nanometer loading will become healthier. Did I answer the question?

Gokul Hariharan, Analyst

Yes. That's very clear. My second question, I just wanted to get TSMC's opinion on competitive landscape. Your IDM competitor is getting into foundry. Intel has been claiming that they will be attaining process parity and then process leadership by 2025 and talking about engaging with several fabless companies. How does TSMC see this competitive threat? And how do you benchmark TSMC N3 and N2, which is coming in 2025 with Intel's offerings over the next, let's say, 2 to 3 years? And maybe I think TSMC has not commented about foundry market share for quite some time. So could you talk a little bit about what you see N3 market share in the next couple of years with TSMC now that you're ramping up that node as well.

Jeff Su, Director of Investor Relations

Okay. Thank you, Gokul. Let me summarize your second question. A lot of it is related to the competitive landscape. I think Gokul's question is specifically in terms of IDM that has been claimed meaning it will achieve process parity in terms of technology with TSMC and absolute process leadership. So he wants to know and they're also talking about engaging with several large fabless customers. So Gokul would like to know how do we see or comment on this competitive threat. How do we benchmark our N3 or our N2 process technologies versus this IDMs offerings for the next 2 to 3 years? And lastly, if we have any comment on what market share we believe we can achieve.

C. C. Wei, CEO

That's a long question. Gokul, this is C.C. Wei again. Let me say that, as usual, we don't comment on our competitors' status, but then we emphasize again on our 3-nanometer and 2-nanometer. Our 3-nanometer is the first in the semiconductor industry to high-volume production. And I believe it is the most advanced semiconductor technology in both PPA and transistor technology. And for 2-nanometer technology, that was, again, to be the most advanced semiconductor technology in the industry when we introduce it into mass production. And this one, we're fully confident that we will further extend our leadership position well into the future. As for the market share, we are very confident that we continue to have a very high market share. And I cannot tell you the real number, but it is a very high percentage.

Gokul Hariharan, Analyst

Okay. Thanks, C.C., for that. Is it your expectation that N3 market share will be higher than N5 at the same time based on what you see today?

C. C. Wei, CEO

Very hard to answer your question, but let me say that it's well very similar in a very high percentage.

Jeff Su, Director of Investor Relations

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

Operator, Operator

The next one to ask questions, Bruce Lu from Goldman Sachs.

Bruce Lu, Analyst

I want to ask about AI, for machine learning AI, which management has been saying that that is a key growth driver. Can we have more quantitative implication to TSMC? What is the dollar content per server, or how big the addressable market for TSMC in 2025? Is the recent new AI or ChatGPT, the business already embedded in your long-term growth target, which is 15% to 20%? Or can we see some incremental upside?

Jeff Su, Director of Investor Relations

Thank you, Bruce. Your first question pertains to AI and machine learning. You're looking for quantitative data regarding dollar content per server, semiconductor content, or the size of the addressable market. How do we view growth in this sector, and have we incorporated this into our forecasts? Is that correct, Bruce?

C. C. Wei, CEO

Bruce, let me answer this question. We certainly have observed an incremental increase in AI-related demand. It will also help the ongoing inventory digestion. The trend is very positive for TSMC. But today, if you ask me to quantitatively to say that how much of the amount increase or what is the dollar content in the server, it's too early to say. It is still continuing to be developed. And ChatGPT right now reinforces the already strong conviction that we have in HPC and AI as a structural megatrend for TSMC's business growth in the future. Whether this one has been included in our previous announcement that said that we have a 15% to 20% CAGR, the answer is probably partially yes, because for servers we have accelerated into our consideration. But this ChatGPT is a large language model and is a new application. And we haven't really have a kind of a number that put into our CAGR. But is definitely, as I said, it reinforces our already strong conviction that HPC and AI will give us much higher opportunities in the future.

Bruce Lu, Analyst

Okay, Bruce. Does that answer your first question? Yes, sorry, go ahead. Yes, I want to move on to a different topic, which is the cash dividend. I mean TSMC distribute like a dividend policy that was 70% of the free cash flow. And we do see the free cash flow is getting stronger, especially CapEx growth rate is slower, especially for next year. Can we expect TSMC to maintain the dividend policy, which is 70% of the free cash flow next year? Or would you like to improve our balance sheet given the current rate hike environment?

Jeff Su, Director of Investor Relations

Thank you, Bruce. Your second question relates to our cash dividend policy. Previously, we mentioned that our cash dividend would be based on 70% of free cash flow distribution. With our capital expenditures slowing and free cash flow increasing, do we still plan to stick to the 70% of free cash flow, or are we more focused on strengthening our balance sheet given the current environment?

Wendell Huang, CFO

Okay, Bruce. This is Wendell. I would like to share some insights on the dividends. TSMC is dedicated to maintaining a sustainable and gradually increasing dividend. During times of high capital intensity or investment, the focus leans more towards sustainability. However, once we start to realize the benefits of our capital investments, our focus shifts towards consistent growth. The 70% ratio serves as a guideline. For instance, if a certain year sees significantly lower free cash flow due to increased capital expenditures or lower profits, we may opt to distribute a higher proportion of cash flow to uphold a sustainable dividend. Conversely, in a year with particularly strong free cash flow, while the ratio might be 70%, it could also be lower as we need to consider future prospects and ensure sustainability. Does that address your question?

Bruce Lu, Analyst

Yes. Yes. But if we do see a comfortable range about the free cash flow, we still expect like reasonable high payout ratio, right?

Wendell Huang, CFO

Yes. Yes. As I said, the principle is 70%, but it has to be sustainable and steadily increasing.

Jeff Su, Director of Investor Relations

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

Operator, Operator

Next one to ask questions, Randy Abrams from Credit Suisse.

Randy Abrams, Analyst

I wanted to ask a question just on the CapEx in 2 parts. First, as you look at the 3-nanometer, where you mentioned supply still short of demand and have a lot of applications coming in. Do you have plans for potential reuse of 5-nanometer in the next 1 to 2 years as you bring up more of the 3-nanometer? And then the second part of the question, I wanted to ask more on that Kaohsiung fab shift. If you could go through why the plan to pull back on 28. And then with the intention for where you would shift that investment. Because I know you did cancel the 7-nanometer for that line. So if you could discuss the change you're making to Kaohsiung and does it affect the timing to ramp that fab?

Jeff Su, Director of Investor Relations

Thank you, Randy. Randy's first question relates to our capital expenditure and capacity plan. He mentioned that the demand for 3-nanometer technology exceeds our current supply capability. He is asking whether we will consider repurposing or converting 5-nanometer tools to 3-nanometer tools in the next few years. Additionally, he is inquiring about our plans in Kaohsiung and the reasoning behind the decision to scale back on the 28-nanometer expansion there.

C. C. Wei, CEO

Thank you for your question, Randy. You asked whether we are converting some of the N5's capacity to N3, especially since we currently have insufficient support for our customers in N3. Instead of converting N5 capacity directly to N3, I want to clarify that we have established a strategy and methodology to allow some N3 tools to be supported by N5. This flexibility is crucial for us to meet our commitments to customers in N3, even though it isn't completely sufficient yet. Now, addressing the second part of your question regarding Kaohsiung's total addressable market, we are considering the market situation and initially focusing on the high demand for 28 nanometers, which warrants including Kaohsiung in our plans. However, the market is very dynamic, and we have a plan in Japan to build a new fab for specialty 28 nanometers. TSMC has expanded capacity related to mature nodes and specialties, but we are not increasing capacity purely for logic applications to prevent overcapacity. In addition to Japan, we are also expanding our 28-nanometer capacity in Nanjing and exploring opportunities in Europe for automotive applications. When combining all three, we believe that building the 28-nanometer capacity in Kaohsiung may not be financially feasible at this time. Therefore, we have decided to adjust our focus towards more advanced nodes, for which we still see a shortage. Kaohsiung's proximity to Tainan allows for greater flexibility between the two locations. I hope that answers your question.

Randy Abrams, Analyst

Yes, that's helpful. It sounds like the capacity will be much more advanced than the 5, 3, and below. Additionally, I have a follow-up regarding the CapEx framework. With the expectation of a rebound in the second half and anticipated share gains, considering that the new nodes are more capital-intensive, should we expect an upward trend in CapEx as we look forward to next year?

Jeff Su, Director of Investor Relations

Okay. So Randy, I'll allow this to be a follow-up, but Randy's question is basically, well, considering the second half business will be stronger. I think, Randy, basically, you're asking, we have provided the guidance range of between $32 billion to $36 billion. Are you asking could that be upside or revised higher, is that correct?

Wendell Huang, CFO

Randy, let me answer that. As we stated before, every year, our CapEx is spent for the opportunities in the future years. So although there are short-term cyclicality in the industry, we believe if the structural long-term demand is there and the future opportunities are there, then we will continue to invest. That will be the framework that we can provide to you.

Jeff Su, Director of Investor Relations

Okay, Randy. You have a quick second question.

Randy Abrams, Analyst

Yes, I'll do the quick second. So for 2-nanometer, if you could clarify the ramp, do you expect this steep ramp to be in 2025? Or is it more 2026? And do you also view that ramp being much more with the SOIC, the back-end integration throughput?

Jeff Su, Director of Investor Relations

Okay. So Randy's second question is on 2-nanometer. We have said volume production in 2025. Will the large volume be in '25 or '26 as part of this question? And does this mean you will go hand-in-hand, I guess, with SoIC and advanced packaging?

C. C. Wei, CEO

Randy, to address your question, the ramp-up for 2-nanometer technology is indeed set to begin in 2025. You mentioned volume; the volume in 2023 will be significantly higher than in 2025 since that is when we expect the ramp-up to occur. However, we are currently collaborating with high-performance computing customers and smartphone clients who are now engaged with N2 and the ramp-up expected in 2025. Whether this is influenced by the CHIPS Act varies based on the customers' products and their plans. Currently, I can't disclose specific minor details as they pertain to customers' product strategies.

Jeff Su, Director of Investor Relations

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

Operator, Operator

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

Charlie Chan, Analyst

C.C., Wendell and Jeff, so first of all, congrats for the first quarter gross margin and great to hear that N3E continues to improve. So let me stay with the CapEx question for a little bit as my first question. So first of all, the major equipment supplier ASML, has suggested that EUV orders get pushed out a little bit. And we all know that your company is a major user of EUV. So can anyone answer the question? First of all, whether the CapEx this year will be lower end of your guidance range? And also for next year, whether your CapEx intensity would decline year-on-year given that EUV push out?

Jeff Su, Director of Investor Relations

Okay. So Charlie's first question is related to CapEx. He points out that newspaper talks about EUV orders being pushed out. So his question is really for our CapEx in 2023, do we think it will be towards the lower end of the range? And then also any indication for 2024 in terms of both CapEx and capital intensity. Is that correct, Charlie?

Wendell Huang, CFO

Charlie, this is Wendell. First of all, we don't comment on specific suppliers or customers or competitors. Regarding this year's CapEx when we gave out the CapEx range, $32 billion to $36 billion, we have already started or tightened up our 2023 capital budget. At this moment, we believe this range is appropriate and prudent under today's economic environment; that range is still valid. Now for next year, it's too early to talk about next year. But as I just stated, if the CapEx spend this year will be for future years, and CapEx spends next year will be for even future years. So if we see the growth opportunities, we will continue to invest. That's the main policy, the principle that we have.

Charlie Chan, Analyst

Yes. Yes, thanks for the clarification. So I guess the question is if, right, whether those growth drivers still there, meaning because it was outsourcing for 2024, and whether your customers are aggressively adopting your N3 and N2. Yes, I guess that's why we are concerned about whether 2024, you're reducing some CapEx. But anyway, let me shift to the next one. I think a lot of investors also quite interested about the U.S. CHIPS Act. So I remember Chairman showed some concern about those requirements. I'm not sure which one is specifically concerned, for example, I need to disclose customer information, profit sharing, some restrictions for the future China fab investments. So my question is that how TSMC is going to reconcile your own interest versus the U.S. government's requirement? And if it is hard to reconcile, whether TSMC would consider not to take U.S. government's grants.

Jeff Su, Director of Investor Relations

Okay. So Charlie's second question is regarding the CHIPS Act. He notes we have recently said that some of the terms may not be acceptable. So he wants to understand how will TSMC reconcile its own interest versus some of the guidelines or guardrails around the CHIPS Act. And is there a possibility that we will not accept or participate in the CHIPS Act?

Wendell Huang, CFO

Okay, Charlie, let me make a few comments on this one. We are currently in the application process and therefore we're not able to comment on specific details. However, we are in close and constant communication with the U.S. government so that we fully understand all the details and provide our feedback and comments to them. At the end, all the decisions that we make will be based on the best interest of TSMC.

Operator, Operator

The next one to ask questions is Brett Simpson from Arete Research.

Brett Simpson, Analyst

Yes. Wendell, I wanted to just talk a bit about Arizona. And now that you're scheduled to move into production next year and you've been hiring a lot of people, how do we think about the cost premium for TSMC operating in the U.S.? And then when it comes to the pricing for the wafers, would this be something that you charge a premium for, for accessing U.S. capacity? Or would you be sort of offering similar wafer pricing to what you offer in Taiwan?

Jeff Su, Director of Investor Relations

Thank you, Brett. Brett's first question is about our Arizona fab. He mentions that the volume manufacturing schedule is on track and that we've hired a lot of people. His question for Wendell is about the cost premium we face in Arizona and how we plan to manage this, including our wafer pricing. Will we have a different price for a different fab, or how do we intend to handle it?

Wendell Huang, CFO

The cost of the overseas fab is indeed higher, especially in the first few years. Last time, we mentioned that certain components, like construction costs, could be as high as five times more. To address this, it signifies our global expansion, which adds value for our customers, and we plan to sell that value. Additionally, due to our large base and volume, we can leverage this scale to reduce costs. We will also need to secure adequate government support. By consolidating these efforts, our aim is to minimize the cost gap and ensure a reasonable return. For the company overall, maintaining a gross margin of 53% or more remains our long-term financial objective and is attainable.

Brett Simpson, Analyst

Great. And maybe just a follow-up. I wanted to ask about the subsidies that TSMC is getting today, particularly in areas like Japan. How much is this going to be in 2023? And are you expecting a meaningful increase in support in the second half of the year? I'm just trying to understand what's embedded in guidance and how to think about accounting for the support that you're expecting over the medium term.

Jeff Su, Director of Investor Relations

Okay. So Brett has a quick follow-up with regards to Japan. His question in terms of the government support or incentives we may receive. How will we account for it? How much will it be in 2023 and how significant? Is it most of it in the second half?

Wendell Huang, CFO

Brett, regarding this issue, our total capital expenditures in Japan are approximately $8 billion, and we anticipate receiving about 50% from the government. We plan to halt production by the end of next year. The government incentives will depend on the progress we make with building our fabs. This should give you an idea of the amount we can expect this year and next year. We will account for these incentives as a reduction in depreciation.

Jeff Su, Director of Investor Relations

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

Operator, Operator

Next, we have Sunny Lin from UBS.

Sunny Lin, Analyst

So my first question is on the pricing. So I think, just now, management again reiterated that your supply chain value is increasing and you look to sell that value. And so with that, as you are about to start ramping overseas capacity more significantly into the next couple of years, how should we think about your ASP trend?

Jeff Su, Director of Investor Relations

Okay. So Sunny's first question is also related to pricing. She notes that semiconductor industry value in the supply chain TSMC is increasing. Her question is that, Sunny, I believe as we expand our footprint and capacity beyond Taiwan and go overseas, what will be the ASP trend in the next few years. Is that correct?

C. C. Wei, CEO

Okay. Sunny, I answer this question. First, actually, our pricing strategy is actually strategic and long-term. We work with our customers. Yes, you are right. I mean that the inflation or all others, the cost is increasing, especially in the overseas fab. However, we already put all those kinds of things into consideration. And we have a lot of action items to work with internally and also with our partners, our supply partners, to lower down all the costs. And we're also working on the supply chain management. So we hope that we will control that, even with today's very tough situation.

Sunny Lin, Analyst

Got it. Sorry, if I could have a very quick follow-up. And so how should we think about the mechanism? For you to reflect that supply chain value, would it be an annual pricing negotiation? And I also wonder what's the customer feedback under the current situations.

Jeff Su, Director of Investor Relations

Sunny wants to know how we will handle pricing. Will it be done annually? What feedback have we received from customers?

C. C. Wei, CEO

Sunny, this is very specific, but let me emphasize again. Our pricing is strategic, and we reflect our value. Now our value includes the value of geographic flexibility. Did that give you some hint?

Sunny Lin, Analyst

Got it. That's very helpful. My second question is on your CapEx expansion. And so I wonder, if we look at the equipment lead time, are you seeing ongoing improvement? What I'm trying to understand is if you need to tighten up the CapEx. But let's say, if later on, demand starts to recover or get better into the second half of the year, how much flexibility do you have to pull in the equipment?

Jeff Su, Director of Investor Relations

Okay. So Sunny's second question is around capacity expansion and equipment lead time. She notes that we have said we're tightening up our CapEx this year and being prudent given the economic environment. But her question is if the demand recovers in the second half, how quickly can we adjust our equipment and capacity? And would the equipment lead time then become a bottleneck? Is that correct, Sunny?

C. C. Wei, CEO

Thank you for the question, Sunny. We are indeed tightening our capital expenditures, but we also intend to remain flexible. If demand increases quickly, we want to ensure we have sufficient capacity for our customers to expand. Both aspects are crucial, and we are collaborating with all our suppliers in preparation. We're planning for long-term capacity growth while allowing for adjustments in the meantime. This gives us the agility to ramp up quickly or to scale back on capital expenditures if necessary. However, our overall outlook remains positive as we believe that trends in AI and 5G will continue to drive growth, and TSMC's business will keep expanding.

Jeff Su, Director of Investor Relations

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

Operator, Operator

Next one, we have Laura Chen from Citi.

Laura Chen, Analyst

My first question is about the data center and server space. We know that in the high computing PC category, which includes some PC CPU or consumer-related applications, there may be some weakness indicated by the quarter-on-quarter decline in Q1. However, I'm curious about the promising growth in AI servers. What is the current contribution of AI-related growth, and what outlook do you anticipate for it?

Jeff Su, Director of Investor Relations

Laura's question highlights that our HPC platform encompasses both consumer-facing elements like PC CPUs and also data center and server components. She is inquiring about TSMC's perspective on the growth potential for AI data centers and the significance of this growth for our HPC business.

C. C. Wei, CEO

Laura, let me answer this question. We did see some positive signs of the people getting much more attention to AI application, especially in the ChatGPT area. However, as I said, quantitatively, we don't have enough data to sum it up to see what is the contribution and what kind of percentage to TSMC's business. But we remain confident that this trend is definitely positive for TSMC.

Jeff Su, Director of Investor Relations

And we don't break down our HPC platform into those types of subsegments.

Laura Chen, Analyst

Okay. Understood. And then my second question is also related to the high computing PC angle. Just wondering about your expansion and trend in advanced packaging, so we know that many of those AI or server high-computing PC CPUs require the advanced packaging like CoWoS or 2.5D, 3D packaging. So I'm just wondering if there's any more capacity you require right now. And what's the current capacity or revenue you can share with us and also the growth trend?

Jeff Su, Director of Investor Relations

Okay. So Laura's second question is on the advanced packaging. She notes that applications like HPC, PC CPUs, etc., require CoWoS or 3D stacking, and 3D IC advanced packaging technology. So her question is, what is the capacity expansion outlook or plan for our advanced packaging? And also what is the revenue growth outlook, I guess, over the next few years? Is that correct, Laura?

Wendell Huang, CFO

Okay. Laura, let me start. For the advanced packaging, the back-end services, we think that its growth in the next about five years will be slightly higher than the corporate average. However, for this year, the revenue will be lower than that of last year because of customer demand. Last year, the revenue accounted for about 7% of our total revenue. This year is somewhere between 6 to 7%. So that should give you an idea of the overall packaging.

Laura Chen, Analyst

Okay. So in terms of the capacity, is there any change in this year versus last year?

C. C. Wei, CEO

Well, Laura, I mean, recently I received a phone call requesting a significant increase in the back-end capacity, particularly in the CoWoS. We are still evaluating that.

Jeff Su, Director of Investor Relations

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

Operator, Operator

Yes. Next one to ask questions, Mehdi Hosseini from SIG.

Mehdi Hosseini, Analyst

Yes. Your guide for June and also 2023 revenue suggests revenues in the second half of the year would be up by 25% versus the first half. And what I want to better understand is how will new product ramps drive this growth. Is there anything quantitative or qualitative that you can offer us to understand the mechanics or the drivers behind this 25% growth in revenue from the first half into the second half? And I have a follow-up.

Jeff Su, Director of Investor Relations

Okay. Thank you, Mehdi. So Mehdi's first question is, looking at our guidance, his calculation implies around mid-20s half-on-half growth in the second half. So he wants to know how much is new projects or new business driving that percentage of the growth.

C. C. Wei, CEO

Well, I can answer that question. To give you a hint, we talk about customers' new product launch that is using a 3-nanometer. So you can understand that we start to ramp up the 3-nanometer quickly because it's fully utilized and still not enough to meet customers' demand. In addition to that, all the platforms, their performance, and their demand will increase in the second half.

Mehdi Hosseini, Analyst

So as these new products drive wafer shipment increase, we should assume that utilization rates would bottom in June and improve into the second half, right?

Jeff Su, Director of Investor Relations

Mehdi wants to know if we can expect utilization to bottom in the second quarter and then improve in the second half of the year.

Wendell Huang, CFO

Yes, Mehdi, that's a reasonable view.

Jeff Su, Director of Investor Relations

C.C. has already said the second half will be stronger than the first half. Do you have a second question, Mehdi?

Mehdi Hosseini, Analyst

I have a question for Wendell. This is about capital intensity, which comes up in every earnings call. Should we consider that, as you reduce your CapEx projects this year, especially with declining revenues throughout the year, we are nearing the end of high capital intensity? Or should we think that after significant investments in the past couple of years, you're planning to scale your revenues starting next year? Is that the correct perspective on the investments you've made?

Jeff Su, Director of Investor Relations

Mehdi's second question is about capital intensity. He wants to know if, based on the guidance we provided for 2023, we are nearing the end of the higher capital intensity period. He also wants to know if we will start to see a reduction in capital intensity next year or over the next few years.

Wendell Huang, CFO

Mehdi, I am not going to share with you the peak, where the peak is. But I can tell you from my current five-year outlook, we are looking at about mid-30s percentage of capital intensity.

Jeff Su, Director of Investor Relations

Thank you, Mehdi. Operator, let's move on to the next participant.

Operator, Operator

Yes. The next one to ask questions is Krish Sankar from TD Cowen.

Krish Sankar, Analyst

My first one is on your comment that the N3 capacity will be fully utilized this year; is that capacity that will be online in the second half the same or higher or lower than what you planned a year ago? And also at this point, do you see the N3 wafer demand profile to be similar or better than N5 at the same point in the cycle? And then I have a follow-up.

Jeff Su, Director of Investor Relations

Okay. So Krish's first question is on N3 capacity. Note we said they will be fully utilized this year. He wants to know the capacity that we build or plan for N3 this year and in the second half. How does that capacity amount compare to what we expected a year ago?

C. C. Wei, CEO

Well, I can answer the question. Actually, the demand is higher than we thought a year ago, and that's why we need to work very hard to meet customers' demand. Did that answer your question, Krish?

Krish Sankar, Analyst

Got it, got it. And then just a quick follow-up. You spoke about AI being a positive and all the innovation happening in generative AI today. Just from a TSMC standpoint, is it fair to assume that what you're going through today is more on the training stage and therefore is more semiconductor and wafer intensive, but when you go into more inference, that intensity has to decrease? Is that a fair assumption? Or do you think that this level of intensity will continue growing from a TSMC standpoint for AI?

Jeff Su, Director of Investor Relations

Okay. So Krish's second question is regarding generative AI and these type of applications. His observation is that the majority is training today, which seems to be beneficial. But as training moves to inference, would it be less semi-intensive or semi-content intensive? And then, therefore, would that be, i.e., lower benefit to TSMC?

C. C. Wei, CEO

Krish, I mean, today, your observation is right because right now, most of the AI concentrate or focus on training. And in the future, it will be inference. But let me say that, no matter what kind of application, they need to use a very high-performance semiconductor component, and that actually is a TSMC's advantage. So we expect that semiconductor content starting from a data center for edge devices will need very high-speed computing that is very power-efficient. And so we expect it will add to TSMC's business a lot. Qualitatively, as I said, we didn't know yet. We hope that in the next few quarters, we can give a clearer picture.

Jeff Su, Director of Investor Relations

Okay. Thank you. Operator, in the interest of time, we will take the last two questions from the last two participants, please. So can we proceed to the next participant?

Operator, Operator

Next one is Brad Lin from Bank of America.

Brad Lin, Analyst

I have two questions, one on the internal organization change and the other on the recently announced strategic alliance. So while the global expansion is a key focus of TSMC, I noticed that TSMC set up a new unit called overseas operations office, OOO. What are the targets and impact that the TSMC management will look for from this new unit? That's my first question.

Jeff Su, Director of Investor Relations

Okay. So Brad's first question is about our internal organization change. We set up a unit called OOO. So he wants to know what is the purpose of this organization or office. What are its targets and purpose?

C. C. Wei, CEO

Well, the purpose is very simple, because we need to have all the organization. Now the fab is overseas fab's number and the amount would be more and more. So we need to have coherence and the culture, everything aligned to the headquarter to TSMC's core value. So we established this overseas operation office to make sure that headquarter's support to each overseas fab is sufficient and enough. And so that the performance will be aligned or matched with TSMC's fab in Taiwan. But more importantly, because of we have this organization, we can help them to succeed and, in the future, can be more profitable.

Jeff Su, Director of Investor Relations

Thank you, C.C. Brad, would you like to address your second question?

Brad Lin, Analyst

Sure. So my second question will be on the recently announced strategic alliance. As there is no migration, the foundry's competition focus, and we know that TSMC leadership in the leading edge. We recently see TSMC hang up with NVIDIA, Synopsys, and ASML on 2-nanometer production and beyond. And what is the target? And how is the progress so far? And TSMC is currently the only foundry within that group. Should we expect an even larger gap to peers with this? Or should we allow more companies or competitors to join this group?

Jeff Su, Director of Investor Relations

Brad, let me clarify to ensure we understand your second question. You mentioned an alliance, which I believe refers to ASML and NVIDIA. Are you referring to the recent announcement about cuLitho?

Brad Lin, Analyst

Exactly, yes, computational litho.

C. C. Wei, CEO

Okay. That's a good question. It is an initiative invented by TSMC's customer NVIDIA. And actually, we are working with them. And this, particularly the software and the hardware, together will help speed up computational lithography by moving expensive operations to GPU, which will help us deploy lithography solutions like inverse lithography technology, deeper learning more broadly, etc. And because of this one, we got involved with our customer and our supplier. And we expect that this will give us some advantage over our cost improvement and also competition.

Jeff Su, Director of Investor Relations

Sure. Thank you, Brad. Operator, then can we move on to the last participant, please?

Operator, Operator

The last questions are from Charles Shi from Needham & Company.

Charles Shi, Analyst

I have a question about your CapEx. Maybe I want to start with one item you disclosed in your filings. On your balance sheet, you have an item called equipment under installation and construction in progress. That number has hit a record high, I think, over USD 40 billion as of the end of fourth quarter '22, which kind of means there are $40 billion investment. You put money in, but you are not harvesting that investment yet. But there's no revenue dollars being generated. But now I think you said you're tightening the CapEx for 2023, but you're reiterating that $32 billion to $36 billion CapEx. That seems to be adding on top of that $40 billion. A lot more investment is still expected in this year. So my question really is about this. Are you expecting a significantly higher incremental revenue opportunity in 2024 and beyond to justify that $40 billion plus, maybe another $32 billion investment? Or is the cycle time between you putting the money in, putting the investment into the time you harvest the investment, the generated revenue is getting a little bit longer than usual? So hopefully, you can clarify this.

Jeff Su, Director of Investor Relations

Okay, Charles. That is a very long question. Please let me try to summarize it a little bit into two parts. I think Charles' question, he does rightly note that on our balance sheet, equipment under installation reached roughly about $40 billion at the end of 2022. He notes this is a very high level. His concern, maybe Wendell can address, as we also guided for $32 billion to $36 billion CapEx this year. So is this number going to only increase? And what is driving this? Is this preparing for significant revenue opportunities in 2024 and beyond? So this is his first question.

Wendell Huang, CFO

The $40 billion in assets under construction at the end of last year primarily comes from two nodes, the N3 node and the N5 node. We are ramping up the N3 nodes, and we are also increasing our capacity at the N5 node. Consequently, these two factors contribute to the larger asset under construction figure at the end of last year. Looking ahead, I expect this number to gradually decrease over the next few years.

Jeff Su, Director of Investor Relations

Okay, Charles.

Charles Shi, Analyst

Yes. The other part of this question pertains to the $32 billion to $36 billion figure. It's difficult for me to understand how this number could decrease within the next year. How should I interpret that? Are you anticipating significant incremental revenue for TSMC next year?

Wendell Huang, CFO

Charles, as we said, it's too early to talk about next year. But we also said that if we continue to see the future growth opportunities there, we will continue to invest.

Charles Shi, Analyst

May I ask the second question?

Jeff Su, Director of Investor Relations

Sure.

Charles Shi, Analyst

The second question is about the CHIPS Act. I understand you provided some insights for another analyst. Could you quantify the potential benefits from the U.S. CHIPS Act related to the manufacturing incentives, which I believe include both grants and investment tax credits? This seems important for our future modeling. Additionally, one of your U.S. competitors appears to prefer investment tax credits over grants and seems to want only the investment tax credits. What is TSMC's perspective on these two different funding options?

Jeff Su, Director of Investor Relations

Okay. Thank you, Charles. So Charles' second question is around the CHIPS Act. He is asking if you can quantify the potential benefits, both in terms of grants and also in terms of tax credits. And also, do we favor one over the other or preference for one over the other?

Wendell Huang, CFO

Charles, as I said, we are in the process of the application, so we're not in a position to disclose any details. I will refrain from sharing more information at this moment.

Jeff Su, Director of Investor Relations

Okay. Thank you, Wendell. All right. So thank you, everyone. This concludes our Q&A session. Before we conclude today's conference, please be advised that the replay of the conference will be accessible within 30 minutes from now, and the transcript will become available 24 hours from now. Both of these will be available through TSMC's website at www.tsmc.com. So thank you, everyone, for joining us today. We hope you all continue to stay well, and we look forward to joining us again next quarter. Goodbye, and have a great day.