Taiwan Semiconductor Manufacturing Company - Q2 2024

Transcript

Jeff Su (Head of Investor Relations)

Good afternoon, everyone, and welcome to TSMC's second quarter 2024 earnings conference and conference call. This is Jeff Su, TSMC's Director of Investor Relations, and your host for today. Today's event is being webcast live through TSMC'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 Senior Vice President and CFO, Mr. Wendell Huang, will summarize our operations in the second quarter 2024, followed by our guidance for the third quarter 2024. Afterwards, Mr. Huang and TSMC's Chairman and CEO, Dr. C.C. Wei, will jointly provide the company's key messages. Then, we will open both the floor and the line for the Q&A session.

As usual, I'd like to remind everybody that today's discussions may contain forward-looking statements that are subject to significant risk and uncertainties, which would 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. Now, I would like to turn the microphone 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 second quarter of 2024. After that, I will provide the guidance for the third quarter, 2024. Second quarter revenue increased 13.6% sequentially in NT, or 10.3% in U.S. dollars, as our business was supported by strong demand for our industry-leading 3- and 5-nanometer technologies, partially offset by the continued smartphone seasonality. Gross margin increased 10 basis points sequentially to 53.2%, mainly reflecting cost improvement and a more favorable foreign exchange rate, partially offset by the margin dilution from N3 ramp. Due to the operating leverage, total operating expense accounted for 10.5% of net revenue as compared to 11.1% in the first quarter.

Thus, operating margin increased 0.5 percentage points sequentially to 42.5%. Overall, our second quarter EPS was TWD 9.56, and ROE, 26.7%. Now, let's move on to revenue by technology. 3-nanometer process technology contributed 15% of wafer revenue in the second quarter, while 5-nanometer and 7-nanometer accounted for 35% and 17%, respectively. Advanced technology, defined as 7-nanometer and below, accounted for 67% of wafer revenue. Moving on to revenue contribution by platform. HPC increased 28% quarter-over-quarter to account for 52% of our second quarter revenue, surpassing 50% for the first time. Smartphone decreased 1% to account for 33%. IoT increased 6% to account for 6%. Automotive increased 5% to account for 5%, and DCE increased 20% to account for 2%.

Moving on to the balance sheet. We ended the second quarter with cash and marketable securities of TWD 2 trillion, or $63 billion. On the liability side, current liabilities increased by TWD 23 billion, mainly due to the increase of TWD 16 billion in accounts payable. Long-term interest-bearing debt increased by TWD 9 billion, mainly as we raised TWD 12 billion in corporate bonds. On financial ratios, accounts receivable turnover days decreased by 3 days to 28 days. Days of inventory decreased by 7 days to 83 days, primarily due to higher N3 wafer shipment. Regarding cash flow and CapEx, during the second quarter, we generated about TWD 378 billion in cash from operations, spent TWD 206 billion in CapEx, and distributed TWD 91 billion for third quarter 2023 cash dividend.

Overall, our cash balance increased 101 billion TWD to TWD 1.8 trillion at the end of the quarter. In US dollar terms, our second quarter capital expenditures total $6.36 billion. I've 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 $22.4 billion and $23.2 billion, which represents a 9.5% sequential increase or a 32% year-over-year increase at the midpoint. Based on the exchange rate assumption of 1 US dollar to 32.5 TWD, gross margin is expected to be between 53.5% and 55.5%. Operating margin between 42.5% and 44.5%. This concludes my financial presentations.

Now, let me turn to our key messages. I will start by talking about our second quarter 2024 and third quarter 2024 profitability. Our second quarter gross margin was 53.2%, slightly ahead of the high end of our guidance, mainly as we saw a higher-than-expected overall capacity utilization rate as compared to our forecast three months ago. We have just guided our third quarter gross margin to increase by 1.3 percentage points to 54.5% at the midpoint. This is primarily due to the higher overall capacity utilization rate in the third quarter and better cost improvement efforts, including productivity gains, partially offset by continued dilution from N3 ramp-up, N5 to N3 tool conversion costs, and higher electricity prices in Taiwan.

Excluding the impact of foreign exchange rate, of which we have no control over, and factoring in the margin impact from our global manufacturing footprint expansion plans, we continue to forecast a long-term gross margin of 53% and higher is achievable. Next, let me talk about our 2024 capital budget. Every year, our CapEx is spent in anticipation of the growth that will follow in the future years, and our CapEx and capacity planning is always based on the long-term market demand profile. As the strong structural AI-related demand continues, we continue to invest to support our customers' growth. We are narrowing the range of our 2024 capital budget to be between $30 billion and $32 billion, as compared to $28 billion-$32 billion previously. Between 70% and 80% of the capital budget will be allocated for advanced process technologies.

About 10%-20% will be spent for specialty technologies, and about 10% will be spent for advanced packaging, testing, mask making, and others. At TSMC, a higher level of capital expenditures is always correlated with the higher growth opportunities in the following years. Now, let me turn the microphone over to CC.

Che-Chia Wei (Chairman and CEO)

Thank you, Wendell. Good afternoon, everyone. First, let me start with our near-term demand outlook. We concluded our second quarter with revenue of $20.8 billion, above our guidance in US dollar terms. Our business in the second quarter was supported by strong demand for our industry-leading three-nanometer and five-nanometer technologies, particularly offset by continuous smartphone seasonality. Moving into third quarter 2024, we expect our business to be supported by strong smartphone and AI-related demand for our leading-edge process technologies. Looking at the full year 2024, we forecast the overall semiconductor market, excluding memory, to increase by about 10%, which is unchanged from our forecast three months ago. At this time, we would like to expand our original definition of foundry industry to Foundry 2.0, which also includes packaging, testing, mask making, and others, and all IDM, excluding memory manufacturing.

We believe this new definition better reflects TSMC's expanding addressable market opportunities in the future. However, I want to emphasize here that TSMC will only focus on the most advanced back-end technologies, which help our customer in leading-edge product. Under this new definition, the size of the foundry industry was close to $250 billion in 2023, as compared to $115 billion under the previous definition. With our new definition, we forecast the foundry industry growth to be close to 10% year-over-year in 2024. TSMC's share of the foundry industry under our new definition was 28% in 2023. Supported by our strong technology leadership and broader customer base, we expect this one to further increase in 2024.

Over the past three months, we have observed strong AI and high-end smartphone-related demand from our customers as compared to three months ago, leading to increasing overall capacity utilization rate for our leading-edge 3-nanometer and 5-nanometer process technologies in the second half of 2024. Thus, we continue to expect 2024 to be a strong growth year for TSMC. We are raising our full year guidance and now expect our 2024 revenue to increase slightly above mid-20s% in U.S. dollar terms. Next, I will talk about TSMC's capacity planning process and investment disciplines. This is important, especially when we have such high forecasted demand from AI-related business. TSMC's mission is to be the trusted technology and capacity provider for the global large IC industry for years to come. The continual surge in AI-related demand supports a strong structural demand for energy-efficient computing.

As a key enabler of AI applications, the value of our technology position is increasing as customers rely on TSMC to provide the most advanced process and packaging technology at scale, in the most efficient and cost-effective manner. As such, TSMC employs a disciplined framework to address the structural increase in the long-term market demand profile, underpinned by the industry megatrend of AI, HPC, and 5G. We work closely with our customers to plan our capacity. We also have a rigorous and robust system that evaluate and judges market demand from both a top-down and a bottom-up approach to determine the appropriate capacity to build. Our capital investment decisions are based on four disciplines. That is technology leadership, flexible and responsive manufacturing, retaining customers' trust, and earning a sustainable and healthy return.

To ensure a proper return from our investment, both pricing and cost are important. TSMC's pricing strategy is strategic, not opportunistic, to reflect the value that we provide. Today, we are investing heavily in leading-edge specialty and advanced packaging technologies to support our customers' growth and enable their success. If customers do well, TSMC should do well. For example, we are happy to see many of our customers' structural profitability improving in these past few years. At the same time, we face rising cost challenges due to increasing process complexity at leading node, higher electricity costs in Taiwan, global fab expansion in higher cost regions, and other cost inflation challenges. Therefore, we will continue to work closely with our customers to share our value. We will also work diligently with our suppliers to deliver on cost performance.

We believe such actions will help TSMC earn a sustainable and healthy return, so that we can continue to invest in technology and capacity to support our customers' growth and fulfill our mission as a trusted foundry partner who are delivering profitable growth for our shareholders. Finally, I will talk about our N2 status and A16 introduction. Our 2-nanometer and A16 technologies lead the industry in addressing the incessant need for energy-efficient computing, and almost all the AI innovators are working with TSMC. We expect the number of the new tape-outs for 2-nanometer technologies in its first two years to be higher than both 3-nanometer and 5-nanometer in their first two years.

N2 will deliver full node performance and power benefit, with 10-15 speed improvement at the same power, or 25%-30% power improvement at the same speed, and more than 15% chip density increase as compared with the N3E. N2 technology development is progressing well, with device performance and yield on track or ahead of plan. N2 is on track for volume production in 2025, with a ramp profile similar to N3. With our strategy of continuous enhancement, we also introduce N2P as an extension of our N2 family. N2P features a further 5% performance with at the same power or 5%-10% power benefit at the same speed on top of N2. N2P will support both smartphone and HPC applications, and volume production is scheduled for the second half 2026.

We also introduce A16 as our next nanosheet-based technology, featuring Super Power Rail, or SPR, as a separate offering. TSMC's SPR is an innovative, best-in-class backside power delivery solution that is the first in the industry to incorporate another backside contact scheme to preserve gate density and device width flexibility. Compared with the N2P, A16 provides a further 8%-10% speed improvement at the same power, or 15%-20% power improvement at the same speed, and additional seven to ten percent chip density gain. A16 is best suited for specific HPC product with complex signal route and dense power delivery network. Volume production is scheduled for second half, 2026. We believe N2, N2P, A16, and its derivative will further extend our technology leadership position and enable TSMC to capture the growth opportunities way into the future.

This concludes our key message, and thank you for your attention.

Jeff Su (Head of Investor Relations)

Thank you, C.C. Thank you, Wendell. This does conclude our prepared remarks. 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 the participants an opportunity to ask their questions. Questions we will take both from the floor and from the call. Should you wish to raise your question in Chinese, I will translate it to English before our management answers your question. For those of you on the call, if you would like to ask a question, please press the star, then the one, on your telephone keypad now. If at any time you would like to remove yourself from the questioning queue, please press star two. Now we will begin the Q&A session.

I would like to take the first, few questions from the floor, then we will go on to the call. So let's begin. The first question we please take from, Gokul Hariharan from, J.P. Morgan. Thank you.

Gokul Hariharan (MD)

Thanks, Jeff. Good afternoon, C.C., and good afternoon, Wendell. Thanks for giving us the picture in terms of how you are planning future capacity. Just on AI accelerator and related capacity, both front-end and advanced packaging, clearly every customer is queuing up at TSMC for capacity. I think last time we talked about this, maybe a couple of quarters back, C.C., you mentioned we expect to see supply to kind of reach balance, supply-demand to reach balance by end of this year. Just wanted to see, what is your current remark? How do you think about supply-demand balance for AI accelerator and CoWoS advanced packaging capacity? And I think, in your symposium, you talked about 60% CAGR compounded growth for CoWoS capacity in the next 4-5 years.

So could you talk a little bit about how much capacity for CoWoS would you be planning to build next year as well? Like last year, you said you're going to be doubling the capacity this year. Now that we are in the middle of this year, maybe can we get a view on what is the capacity expansion for next year? That's my first question. Thank you.

Jeff Su (Head of Investor Relations)

Okay, Gokul. All right, for the benefit of the audience online and in person, please allow me to kind of try to summarize your question. So Gokul's question, first of all, he understands and appreciates TSMC's discipline framework in terms of looking at how to build capacity. His question is that it seems that everyone today, AI accelerators and advanced packaging, is queuing at TSMC to ask for capacity. So his question is: When do we, C.C., expect supply-demand to reach a balance, both for the accelerator side and then for the CoWoS? At the symposium, we said CoWoS capacity will grow at a 60% CAGR the next few years. He also wants to know what are we planning to build or increase for 2025 CoWoS.

Che-Chia Wei (Chairman and CEO)

Gokul, I also try to reach the supply and demand balance, but I cannot today. The demand is so high, I had to work very hard to meet my customers' demand. We continue to increase. I hope sometime in 2025 or 2026, I can reach the balance. You're talking about the CAGR or those kind of increment increase of the CoWoS capacity. Now, it's out of my mind. I mean, we continue to increase whatever, wherever, whatever I can. Okay. The supply continue to be very tight all the way through probably 2025, and I hope it can be eased in 2026. That's today's situation.

Gokul Hariharan (MD)

Any thoughts on next year capacity? Like, are you going to double your capacity again next year for CoWoS?

Che-Chia Wei (Chairman and CEO)

The last time I say that, this year I doubled, right? More than double. Okay. So next year, if I say double it, probably I will answer your question again next year and say more than double. Okay. We are working very hard, as I said, wherever we can, whenever we can. Okay.

Gokul Hariharan (MD)

Okay. Thank you. My second question is regarding gross margins. I think second half guidance already seems to be better than what originally we were thinking, that gross margin could drop in second half, but it looks like it's actually going up... and looks like a lot of the headwinds on gross margin is coming in this year. So how should we think about gross margin looking forward for TSMC? Are we going to get back to the high 50, 60% gross margin that we saw in 2022, given that you're selling more of your value, you have some of the N3 tailwinds in terms of yield improvement coming through? Into that, I will also ask: how should we think about impact of subsidies and ITC credits as you start ramping your overseas locations?

How does that impact cost and gross margin? Because there's also some subsidies coming in, and currently TSMC is mostly talking about gross CapEx and gross spend.

Jeff Su (Head of Investor Relations)

Okay. So let me summarize Gokul's second question is around gross margin and profitability. He notes second half, 2024 gross margin seems to be better than the expectation. So his question is really: how should we think about gross margin in the next several years? He notes, you know, you know, as we said, we will sell our value, and the dilution of N3 will gradually reduce. So, you know, where can the gross margins go? Back to a high 50s or 60%, that kind of level that we saw a few years ago in 2022. Maybe that's the first part of his question. I'll stop here, then I'll get to the second.

Wendell Huang (CFO)

Sure. Gokul, let me share with you some of the puts and takes on gross margin, 2025 and a little bit beyond that. You already talked, there are positives and there are negatives. You already mentioned, positive will be a decrease in dilution from N3. We're selling our value, and we continue to drive down our costs, increase the productivity. That is. We are very good at that. On the other hand, let's use N5 conversion to N3 as an example. We are not ruling out the possibility of further converting more N5 to N3, because we're seeing very strong demand for N3.

If we decided to do that, of course, there will be a negative impact on the year that we do that, but, in the future years, that will be beneficial. We continue to face cost challenges, inflation cost challenges, including electricity prices, et cetera. And also, we are beginning the production of our overseas fab, 2 overseas fabs next year: the phase one of Arizona fab and phase one of the Kumamoto fab. We expect that the overseas fabs will dilute our gross margins by between 2-3 percentage points next year and in the next several years. So those are the puts and takes to give you the concept. However, we've taken all that into considerations with our efforts in manage the cost gap, especially between the overseas fab and Taiwan.

We're repeating and confident to say that 53% and higher gross margin is achievable. I think that's the first part of your question.

Gokul Hariharan (MD)

Yeah, that's right.

Jeff Su (Head of Investor Relations)

And then maybe also just Gokul asked if it's possible to get back to the high 50-60% level that we saw in 2022.

Wendell Huang (CFO)

Yeah. If we have a very high utilization rate, everything else stays the same, possible.

Jeff Su (Head of Investor Relations)

And then the second part of his question was, what is the impact-

Wendell Huang (CFO)

Yeah

Jeff Su (Head of Investor Relations)

... from the, you know, different government incentives, including-

Wendell Huang (CFO)

Right

Jeff Su (Head of Investor Relations)

... the CHIPS Act, ITC credits in the U.S., et cetera-

Wendell Huang (CFO)

Yeah

Jeff Su (Head of Investor Relations)

... to the financials, and also, I think, partly gross CapEx and net CapEx. Thank you.

Wendell Huang (CFO)

Yeah. Generally speaking, when subsidies are received, then you see that on the cash flow statement. It will be used to offset the asset value, that will be on the balance sheet. When this fab begins to production, the P&L impact will come in. So generally speaking, it's like that. Different government has different approach in providing the grants, so that's a different story. But you can look at our financial statements. There will be actual subsidy received in the periods of previous quarter and previous year. For example, 2023, we receive a total subsidies of slightly higher than $1.5 billion US equivalent, and we receive that mainly in Japan. Yeah.

Jeff Su (Head of Investor Relations)

Okay. Okay? All right, great. Thank you. Let's move on. We'll take the next one from Charlie Chan from Morgan Stanley, and then we'll go to Bruce Lu from Goldman. Thank you.

Charlie Chan (MD, Research Analyst)

Thanks. Hi, C.C., Wendell, and Jeff. Great to see you in person again. So I have-- my first question is really about your progress of selling the value. I'm not sure what's the progress, and do you think for next year, your leading-edge capacity is going to be in shortage? If that's the case, whether that increase your chance to sell more value to your customers. Thank you.

Jeff Su (Head of Investor Relations)

Okay. So Charlie's first question is around pricing, and he wants to understand the progress of, I guess, selling our value. Also in next year, looking at next year, particularly for the leading-edge nodes, do we expect that in terms of the demand to be very full?

Che-Chia Wei (Chairman and CEO)

... Charlie, this kind of pricing strategy is very strategic. You are asking me about the status. So far, so good. And this is ongoing and continuous process. We are continuing to share our value. And, by the way, my customer are doing very well also. Okay, you knew that, so we should do well also.

Charlie Chan (MD, Research Analyst)

Yeah, so that is actually my follow-up question on this first question. For different segments, for example, HPC customers are doing very, very well. But for smartphone customers, probably more sensitive to the cost. Do you expect a kind of difference of kind of value increase for different customers, even at the same node?

Jeff Su (Head of Investor Relations)

Charlie is asking: how will we do the pricing? Will it be different between, for example, an HPC customer versus a smartphone customer at the same node? And also, his question earlier was: Do we expect the demand for the leading nodes to be very high next year?

Che-Chia Wei (Chairman and CEO)

Since the pricing is strategic, so it won't be flat for every product sector. It will be different. Okay, that all I can share with you. All my customers, they are looking for leading-edge as a capacity for next few years, and we are working with them. So far, we try our best to support them, both in pricing and in capacity.

Charlie Chan (MD, Research Analyst)

Thank you. And second, topic is definitely... Over the past two days, there's a geopolitical risk, right? So, Mr. Donald Trump talked about maybe a few years ago, right? Taiwan/TSMC took a 100% chip business from, from the U.S. So Congress on their part, very high market share. However, the concern is growing, right? That the U.S. continue to depends on, our islands, TSMC, on the chip production. So, our question is that for, for shareholders, right? How TSMC is going to mitigate this potential geopolitical risk. For example, whether you are going to further expand your U.S. capacity or even share the ownership, right, with the, the U.S. governments. And maybe a technical question to Wendell. For today, right?

If we are shipping chips to the U.S. customers, do we need to pay for the U.S. tariff? Thanks.

Jeff Su (Head of Investor Relations)

Okay, sorry. So Charlie's second question is around sort of overseas expansion and geopolitical risk. He notes the comments from former President Trump a few days ago, that Taiwan Semiconductor has taken, you know, 100% of the business. So his question is really: How does TSMC plan to mitigate the geopolitical risk? Does this include expanding capacity overseas, particularly in the U.S.? Would we consider... I think part of his question was some JV or joint investments, whether with government or whether with partners. And the last question, I think, was more for Wendell, about the tax or the tariffs, so to speak.

Che-Chia Wei (Chairman and CEO)

Okay. Charlie, so far, we did not change any our original plan of expansion of our overseas fab. We continue to expand in Arizona, in Kumamoto, and maybe future in Europe. No change to our strategy. We continue our current practice. You mentioned about a JV? Mm, mm, no. Okay.

Jeff Su (Head of Investor Relations)

On the tariff, not that we know of. Normally, if there's an import tariff, the customers will be responsible for that, but no discussion, nothing.

Charlie Chan (MD, Research Analyst)

Okay.

Jeff Su (Head of Investor Relations)

Thank you.

Charlie Chan (MD, Research Analyst)

Understood. Thank you.

Jeff Su (Head of Investor Relations)

Thank you, Charlie. All right, we'll take the next question from Bruce Lu, from Goldman Sachs in the front, then we'll move online.

Bruce Lu (MD)

Thank you for taking my question. All right, my question is, is that, why don't we take up our gross margin or structural profitability target? I mean, TSMC has been saying for selling your value for past couple quarters without changing the margin target, i.e., you know, most likely you are passing through all the costs. But, you know, please, I do recall in 2021, I mean, TSMC do raise the gross margin target by then, because to support the future growth with more R&D. As the technology continue to be enhanced and more difficult, and one of your customer, at least, is supportive that to suggest that you should charge even more.

My question is that, why is that you don't raise your gross margin target when you are trying to sell, when you try to sell your value, which we believe you deserve much higher value?

Jeff Su (Head of Investor Relations)

Okay. So thank you, Bruce. So Bruce's first question is about profitability and value. Bruce seems to agree that TSMC is providing value to our customers. He also notes, in 2021, indeed, a few years ago, our gross margin target, long-term gross margin target, was about 50%, and we're able to increase that to 53% and higher. So his question is really, with everything that is going on today, with the value of our technology enabling our customers more and more, why doesn't TSMC increase or revise up our long-term gross margin target from the current 53% and higher? Is that the essence, yeah?

Che-Chia Wei (Chairman and CEO)

... Bruce, thank you for recognizing TSMC's value. I'm working with our customer. As I said, this kind of pricing is a strategic, and certainly we want to share our value. Changing the target at this moment, I think I would like to emphasize 53% and higher. Please put more attention to and higher. The number, I'm not going to change it at this time. When I have a more conversation with my customer and discuss with them, and I probably will give you in the higher portion. Okay. Thank you.

Jeff Su (Head of Investor Relations)

Okay, thank you. My next question is for advanced packaging. So, management used to mention that the advanced packaging margin was lower than the corporate average, but with higher ROICs. But given the recent progress for the CoWoS and everything, you know, do we see a much better profitability for the CoWoS? And given that it's so difficult to expand the capacity, are you planning to work with more partners to increase your CoWoS supply, which will solve your current supply chain issues? Okay, thank you, Bruce. So Bruce's second question is around advanced packaging. Part of it is in terms of the profitability. He notes we used to say, which is true, it's lower than the corporate average profitability, but can earn a similar return or ROE.

But his question is now, with more and more CoWoS demanding greater scale, is the profitability of advanced packaging, I think, approaching or at or above the corporate average? And also, given the tight supply, would we consider to work with more partners to help increase the capacity for CoWoS to support our customers' growth?

Che-Chia Wei (Chairman and CEO)

You are right. For advanced packaging, the gross margin used to be much lower than the corporate average. Now, it's approaching corporate average. We are improving it as because of scale of the economics, and we put a lot of effort to reduce our cost. So, gross margin is greatly improving in these two years. As for the working with outside partners, yes, we are doing it, because of... I just answer the question, say whether the CoWoS capacity is enough or not. It is not enough, and in great shortage, and that will limit my customers, of course. So we are working with our outside partner and try to give more capacity to my customer so that they can grow healthily, and so the TSMC's wafer can be sold healthily. Okay.

Jeff Su (Head of Investor Relations)

Okay. Thank you, C.C. Thank you, Bruce. Operator, can we move to the first participant online for their quest- his or her questions, please?

Operator (participant)

Yes, the first one, we got Brett Simpson, Arete Research.

Brett Simpson (Co-Founder and Senior Analyst)

Yeah, thanks very much. My question was really about your capacity plans for the next node. That's N2, including A16. We're hearing that AI chipmakers are looking to migrate more aggressively from N minus one to the leading edge, particularly due to backside power, because they're trying to lower their power budgets going forward. So my question, can you support this move? And if so, should we be expecting N2A16 to be structurally a much bigger node than we've seen in the past few nodes? Thank you.

Jeff Su (Head of Investor Relations)

Okay, Brett, thank you. So Brett's first question is on capacity planning, particularly at the leading edge, N2 and A16. So he notes rightly that AI customers are migrating aggressively from N minus one in the past to the most leading node. He notes particularly A16, driven by the interest in backside power. So his question is, can we support this move in terms of capacity to support the customers? And also, whether thus N2 and A16 will be a much bigger node than our nodes in the past.

Che-Chia Wei (Chairman and CEO)

Brett, you are right. All the people want to moving into kind of a power-efficient mode, and so they are looking for the more advanced technology so that they can save power consumption. And so a lot of my customer want to move into N2, N2P, A16 quickly. We are working very hard to build the capacity to support them. Today is a little bit tight. Not a little bit, actually, today is very tight. I hope in next year or the next two years, so we can build enough capacity to support this kind of a demand. Today, yes, we are working hard to support them, and enough? Not yet, but we are working hard to get it.

Jeff Su (Head of Investor Relations)

... Does that answer your first question, Brett?

Brett Simpson (Co-Founder and Senior Analyst)

Okay, thank you. Yeah, that's, that's great, yes. Thank you, C.C. Wei. My follow-up question was for Wendell. I wanted to just dig into the gross margin dilution from N3. Where is that at today? And does the introduction of N3E structurally improve your N3 returns? I guess N3E is less capital intensive, there's less EUV layers, so I'm keen to understand if this drives better economics for TSMC, particularly as you start to ramp more N3 capacity in the second half of this year. Thank you.

Jeff Su (Head of Investor Relations)

All right. Thanks, Brett. So Brett's second question is on the, the gross margin, dilution from, N3. He notes that N3E uses less EUV layers, less capital intensity. So his question is, as we ramp N3 more and more, does N3E structurally improve the returns and gross margin of N3 as a whole?

Wendell Huang (CFO)

Okay, Brett, we don't break it down between the different nodes within a family. But I can share with you, overall speaking, as we said before, N3 takes a longer while to reach the copper mark. In the past, it was about 8-10 quarters. For N3, we're looking at 10 to maybe 12 quarters. But it is improving, and we expect it to continue to improve. Okay.

Brett Simpson (Co-Founder and Senior Analyst)

Thank you.

Jeff Su (Head of Investor Relations)

Okay. Thank you, Brett. Operator, let's take the next set of questions from the next participant on the call, please.

Operator (participant)

Next one to ask question, Charles Shi from Needham & Company. Go ahead, please.

Charles Shi (MD and Senior Research Analyst)

Hi, yeah. Thanks for taking my questions. Maybe the first one, I just wanna follow up. Wendell, I think I heard you talking about that, potentially more, N, N5 to N3 conversion, maybe beyond the, what you are trying to do right now, the conversion. I just wanna understand the overall, philosophy here, 'cause I think in the past, that TSMC does do this n-node-to-node conversion, quite actively, let's say 10-nanometer to 7-nanometer, yeah, and probably even earlier, 20-nanometer to 16-nanometer. And I think you, you, you told us, basically treat 10 and 7 as one large node, 20 and 16 as one large node.

Should we start to really think about maybe five and three are just one big node and, maybe more conversion, we should just think about more of the N3 capacity growth will come from conversion going forward, less from the greenfield investment? That's the first question.

Jeff Su (Head of Investor Relations)

Okay, Charles. So Charles' first question is really look at our conversion strategy. He notes that, you know, we have always talked about building in tool commonality to provide us flexibility. We have done so in the past at certain nodes, like 20 and 16, 10 and 7. So his question is really, you know, we have said that we potentially convert more N5 tools to support the strong demand for N3 capacity. So his question is, should we, investors, analysts, start to think about N5 and N3 as one big node?

Wendell Huang (CFO)

Right. You mentioned about 12 and 16, they are a big family. Seven and ten are a big family. But five and three are not a big family in our definitions. At the same time, there are node-to-node tool commonality in TSMC is pretty high. So for five and three, the commonality of tools is over 90%, and these two nodes are adjacent. They're all in Tainan Science Park, and so it's very easy to do the conversions. Did I answer your questions?

Charles Shi (MD and Senior Research Analyst)

Yes. May I ask a second question?

Wendell Huang (CFO)

Certainly.

Charles Shi (MD and Senior Research Analyst)

Thanks. Maybe a question about CoWoS. I think I heard, C.C., you said maybe, there's some technical difficulty on my side. I just want to clarify. Maybe you may double the CoWoS capacity again in 2025. But a little bit more technical question, I want—I do want to better understand the technology constraints, because your customers seems to be migrating from CoWoS-S to the more advanced version, CoWoS-L, CoWoS-R. And we learned that the CoWoS-L, R does not require TSV, does not require a large silicon interposer. Does that help, at least to some degree, the capacity constraints you are facing on overall CoWoS?

Does that help to maybe achieve that goal of maybe getting to the supply-demand balance?... Some point in 2025, 2026? That's a two-part question. Thank you.

Jeff Su (Head of Investor Relations)

Okay, Charles. So Charles' question is really on CoWoS. First, he would like to clarify, we said that, CoWoS capacity is more than doubling in 2024. He said, is he correct to understand we said it will double again in 2025? That's the first clarification. And then he would like to know, as customers migrate from CoWoS-S to CoWoS-L and CoWoS-R solution, a lot of technical challenges or benefits, changes, sorry, not challenges. Does it help alleviate the capacity constraints, and would that allow CoWoS to reach supply-demand balance in 2025? So one to clarify and one on the different solutions.

Che-Chia Wei (Chairman and CEO)

Well, boy, Charles, you really know all the detail of the technology. You know, the CoWoS-R, CoWoS-S, CoWoS-L, blah, blah, blah. All these kind of thing is because of our customer's requirement. So, even the same customer, they have different approaches for their different product. When I say that we double the capacity, this is summing all the different version of the CoWoS together. Which portion is really double, which portion is much more than the other one, I'm not going to share with you because this is related to my customer's demand. So from last year to this year, we have more than doubled, and as I said, from this year to next year, we want to double again or probably we want to more than double again.

But still, I have to work with our OSAT partner to increase the overall supply to support my customer. Whether that's this kind of different version of the CoWoS will give me some flexibility today, yes and no. Because different version has a different tool set, but in common, some of the tools can be used by all the CoWoS. Okay, but different version, I have a different demand.

Jeff Su (Head of Investor Relations)

Okay. Thank you, C.C. Thank you, Charles. We'll come back to the floor for the next two questions, please. We'll take the first one from Laura Chen from Citigroup, and then we'll go to Sunny Lin from UBS.

Laura Chen (Head of Taiwan Equity Research and Research Analyst)

Thank you, Jeff. Thank you for taking my question. My first question is also on the advanced node. I remember, C.C., you mentioned earlier that every clients are now engaged with you on, the two nanometers, migration. So I'm just wondering that when we entering maybe 2026, the second year, can we expect that, the revenue contribution initially will be larger than, what we had, comparing to N3? And also, wondering that, since the performances are much better, so can we expect the dilutions period will also be shorter than N3?

Jeff Su (Head of Investor Relations)

Okay. Oh, sorry.

Che-Chia Wei (Chairman and CEO)

Go ahead.

Jeff Su (Head of Investor Relations)

Sorry. So Laura's first question is about N2, basically, that you know, almost every customer is engaging with TSMC on 2-nanometer technology. So her question is: do we expect the revenue contribution from N2 in 2026, therefore, to be larger than compared to N3 at a similar point in time of the ramp? And also, correspondingly, would the N2 margin dilution be less or better than N3, basically?

Che-Chia Wei (Chairman and CEO)

I will give this kind of a money question to the CFO.

Jeff Su (Head of Investor Relations)

Okay. All right, Laura, the revenue, yes, it's gonna be bigger. Okay? Gross margin dilution, it'll be faster to reach corporate average. Yeah.

Che-Chia Wei (Chairman and CEO)

Thank you.

Laura Chen (Head of Taiwan Equity Research and Research Analyst)

That, that's very clear and helpful. Thank you. And also, my second question is also on the packaging side. So we know that, last time we also discussed on the edge AI will also benefit for TSMC in terms of the advanced nodes, die areas. Just wondering that, do you also see your, edge AI device clients, they are moving to, 3-D IC or SoIC anytime, in the next two years? Or before that happening, can we expect that more clients on the smartphone side, they will also adapt, maybe InFO first? Because so far, our understanding is that InFO, you only have, one advanced, one single client. I'm just wondering that if we see that more clients to move to, on the edge AI side on advanced packaging. Thank you.

Jeff Su (Head of Investor Relations)

Okay, so Laura's second question is very specific, but again, in regards to advanced packaging, with more and more customers working on edge AI devices, without well, being overly specific, but what does it mean or the implication for advanced packaging solutions? Do we expect in the next two years to see these edge AI customers start to use SoIC or 3D IC, particularly smartphone? Will they still be using InFO, or will they also consider these solutions as well? Is that correct, Laura? Okay.

Che-Chia Wei (Chairman and CEO)

Well, very technical questions. Let me share with you, as my customer moving into 2-nanometer or A16, they all need to, probably take in the approach of chiplets. So once you use your chiplets, you have to use advanced packaging technologies... on the edge AI for those kind of, smartphone, customer, as compared with the HPC customer, HPC is moving faster because of, bandwidth concern, latency of, footprint, all those kind of things. For smartphone customer, they need to, pay more attention, to the footprint, as well as the functionality increase. So, you observe my, big customers taking the InFO first, and then for, for a few years, nobody catch it up. They are, they are catch it up. Okay. Thank you very much, C.C.

Jeff Su (Head of Investor Relations)

Okay. Thank you, Laura. We'll take the next question from Sunny Lin from UBS, and then we'll go back to the call.

Sunny Lin (Stock Analyst)

Thank you, Jeff. Good afternoon, C.C. and Wendell. Thank you for taking my questions. So my first question is on your business opportunities for smartphone and PC. Last few years, both were some were like ex-growth for quite some time. And so how should we think about the units and silicon content for the coming 2, 3 years? First part, a lot of questions on the tight supply for 5 and 3 nanometer. And so are your customers engaging with you early on the planning into 2025 capacities for a better upgrade cycle? And then for silicon content, recall a few years back when 5G just started to ramp, you used to provide the silicon content expectations for 5G high-end and mid-end and low-end smartphones.

I wonder, at this point of time, if you have any estimates for AI, for smartphone going to next 2, 3 years?

Jeff Su (Head of Investor Relations)

Okay, several parts to Sunny's first question. She's looking at smartphone and PC. So the first part is, she wants to know, in terms of unit and silicon content, what is our expectation for smartphone and PCs the next few years? N5 and N3, supply is very tight, in terms of the capacity. Do we have enough capacity to support, a potential unit or upgrade cycle? And last but not least, she's asking us to quantify the silicon content, per device, per, segment from, Edge AI.

Che-Chia Wei (Chairman and CEO)

That's a very long question, but let me answer the content first. AI is so hard, so that's right now, everybody, all my customer want to put their AI functionality into the edge devices, and so the die size will be increased. Okay. How much? I mean, the... It, it's different from my customer to customer's product, but basically, probably 5%-10% die size increase will be a general rule. Unit growth, not yet, okay? Because of we did not see a kind of a unit growth suddenly increase, but we expect this AI functionality will stimulate some of the demand, so stimulate the replacement to be shorter.

So in terms of a unit growth, that in a few years later, probably 2 years later, you will start to see a big increase in the edge device, that's a smartphone and the PC.

Jeff Su (Head of Investor Relations)

Will we have enough capacity to support?

Che-Chia Wei (Chairman and CEO)

That's the one I try to avoid the answer. It's very, very tight, and we are working very, very hard to get enough capacity to support my customer from now all the way to next year, to 2026.

Sunny Lin (Stock Analyst)

Got it. Thank you, C.C., for the answer. So my second question is try to look at the demand profile from different perspectives. If we look back in 2021 or early 2022, back then, demand was also pretty high. Customers were very aggressive on the demand forecast. Now looking at Gen AI, obviously the technology has lots of great potential, but a new technology could also have lots of volatilities when it start to ramp. And so how are we managing the volatilities of the demand? Why do you think this time around is different versus the COVID period? How do we get comfortable with our capacity planning?

Jeff Su (Head of Investor Relations)

Okay. Thank you, Sunny. So Sunny's second question is goes back to TSMC's capacity planning and CapEx framework. So she notes we, you know, today, generative AI-related demand is very strong, but she also notes a few years ago, back in 2021 and 2022, demand was also very strong. Many customers were also very positive or upbeat on the future demand. And so today, with such strong generative AI demand, how does TSMC plan its capacity appropriately? How do we manage, I think your word was volatility? How do we manage the risk, basically, I guess, of not overbuilding capacity in this type of environment?

Che-Chia Wei (Chairman and CEO)

I thought I explained that our capacity planning process, right, and the investment we have. I put a wording of discipline. That means we are not going to repeat the same kind of mistake that we have in 2021, 2022. Now, this time, we look at the overall very big demand forecast for my customer, and so, I look it into actually the whole company with many people now examining and study that really is, AI is so useful, will be used by a lot of people or not. And we test ourself first. Inside TSMC, we are using AI, we are using machine learning skill to improve our productivity, and we found out it's very useful.

And so I also in the line to buy my customers a product, and we have to form in the line. I get no privilege here, I'm sorry, but it's useful. And so I believe that this time, AI's demand is more real than two or three years ago. At that time, it's because people are afraid of a shortage, and so automotive, everything, you name it, they are all in shortage. This time, AI alone, only AI alone, it will be a very useful tool for the human being to improve all the productivity in our daily life. Be it in medical industry or in any product manufacturing industry or autonomous driving, everything, you need the AI. And so I believe it's more real.

But even with that, we also have a top-down, bottom-up approach, and discuss with our customer and ask them to be more realistic. I don't want to repeat the same kind of mistake two or three years ago, and that's what we are doing right now.

Sunny Lin (Stock Analyst)

Great to know. Thank you very much.

Jeff Su (Head of Investor Relations)

Okay, thank you. Operator, can we move on to the next participant from the line, please? Okay, if not, then maybe we'll take the last two questions from the floor, or one or two. Let's start here and then here, so we'll start with Arthur Lai from Macquarie.

Arthur Lai (MD and Head of Tech Research, Asia)

Hi, C.C., Wendell, and Jeff. Thanks for taking my question. Arthur Lai from Macquarie. I used to cover the downstream tech, and especially data center before, and so I want to ask C.C. about the SPR, the... because I think this is very important, from the data center perspective. So, when you bring the new technology can save around 20% power, can we also think about, you can save the total system's power consumption by another 20%? So it's a, you know, it's a big change, and from the customer you ask, you spoke to, they can also, you save their total cost of own operation. So it becomes the, the more you buy, the more you save. Yeah. Thank you.

Jeff Su (Head of Investor Relations)

Okay, so Arthur's first question, he would like to understand more about Super Power Rail or our, you know, best-in-class backside power solution as it relates to data center demand. He notes, as we said, that it brings greater power efficiency from the chip level. His question, without specific numbers, but what does this mean for the system-level power consumption saving? What does it mean for our customers' customers' ability in terms of total cost of ownership, in terms of the power savings? And does it mean that the more you buy, the more you save?

Che-Chia Wei (Chairman and CEO)

The more you buy TSMC's wafer, the more you save. Yes. Sorry, I just want to... I like my customer. Your question, Arthur, you say that 20% saving the chip's power consumption, does that directly reply to, you know, indicate that the system power consumption will reduce by 20%? Probably not, because of the whole system, including the connection, including the networking, including the processor's power consumption. So unless every component save 20%, then you can achieve 20%. But again, the accelerator or the CPU is a big portion of the whole system's power consumption, so even if it is not a 20%, it's significant portion of it.

And so that's why all my customer want to using the leading edge, and they are very aggressive to move into the 2-nanometer technology.

Arthur Lai (MD and Head of Tech Research, Asia)

Thank you. So I also, you know, encourage company to do the right thing. So energy efficiency computing is definitely our goal for human beings. And then, so I also would like to get more color about when you go into the next A16, and when we expand the capacity, what do you think the biggest bottleneck would be?

Jeff Su (Head of Investor Relations)

Okay, so Arthur's second question is, in terms of A16, what would be the biggest bottleneck to expand our capacity of A16 to support our customers, if any?

Che-Chia Wei (Chairman and CEO)

We always say that, you know, when TSMC want to expand the capacity, we need the land, we need the electricity, we need the talented people, and so all the above. Okay.

Arthur Lai (MD and Head of Tech Research, Asia)

Thank you, C.C.

Jeff Su (Head of Investor Relations)

Okay, thank you. And then in the interest of time, we'll take question from the last participant on the floor, which is Brad Lin from Bank of America Merrill Lynch.

Brad Lin (Director and Equity Research Analyst)

... Thank you, Jeff, for taking my question. So I have two questions. The first one will be on the Computex. We obviously have seen quite some big tech companies announce that they are going to accelerate the product launch cadence. So what's the implication to TSMC? Should that give TSMC a better visibility on the product pipeline and also the capacity planning? And on the other side, what are the major challenges that you might face with this faster cadence?

Jeff Su (Head of Investor Relations)

Okay, so Brad's first question is that Computex recently several companies announced their intention to accelerate their product cadence or product launches. So his question is, what does this mean, implications to TSMC in terms of capacity planning, in terms of supporting our customers, et cetera, et cetera. Is that right?

Brad Lin (Director and Equity Research Analyst)

Yes.

Jeff Su (Head of Investor Relations)

Okay.

Che-Chia Wei (Chairman and CEO)

Well, we like this kind of a trend because TSMC is very good at the leading-edge development. And so, we actually, every product, when they design, it at least takes 1.5-2 years. So we got this kind of message, but quite a long time ago. My customer announce it because they are so happy, and so, we are happy also because they want us to share our value. So I take that advice. But, Gokul, don't ask. Okay, so, to answer your question, yes, we have been prepared, and, not only because in June they announced it, we much earlier we already discussed with them, and, we prepare for these kind of changes.

Brad Lin (Director and Equity Research Analyst)

Got it. Thank you very much. So I would assume that would help us, well, kind of sell the value easier. So the second question will be on the... Well, obviously, we also see the bigger footprint of the AI chips. So well, there are quite some activities about the fan-out panel level packaging. So, do you think that solution will become a mainstream in the mid to long run, or, does TSMC have any plan to do the related investment? Thank you.

Jeff Su (Head of Investor Relations)

Okay, so Brad's second question is that, again, with AI-related chips, that they're larger and larger die sizes. His question is in terms of advanced packaging and specifically fan-out panel level packaging, is this something that TSMC is looking at or exploring to do? Would this be something for TSMC in the mid to long term?

Che-Chia Wei (Chairman and CEO)

Yes, we are looking at this as kind of a panel-level fan-out technology. But the maturity today is not yet. So I personally, I would think it's about at least 3 years later. Within these 3 years, we don't have any very solid solution for a die size bigger than 10 times of the reticle size. Today, we support our customer all the way to 5x, 6x, so chip size. I'm talking about the feature size, the biggest of feature size. 3 years later, I believe the panel fan-out will start to be introduced, and we are working on it.

Brad Lin (Director and Equity Research Analyst)

We will be ready for it as well, of course.

Che-Chia Wei (Chairman and CEO)

Yes.

Jeff Su (Head of Investor Relations)

All right. Thank you, C.C. Thank you, Brad. 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 which are gonna be available through TSMC's website at www.tsmc.com. So thank you, everyone, for joining us today. We hope everyone continues to stay well, and we hope you will join us again next quarter. Goodbye, and have a great day.