Taiwan Semiconductor Manufacturing Company Limited (NYSE:TSM) Q2 2023 Earnings Call Transcript
Taiwan Semiconductor Manufacturing Company Limited (NYSE:TSM) Q2 2023 Earnings Call Transcript July 20, 2023
Taiwan Semiconductor Manufacturing Company Limited beats earnings expectations. Reported EPS is $1.55, expectations were $1.07.
Jeff Su: [Foreign Language] Good afternoon, everyone, and welcome to TSMC's Second 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. If you are joining us through the conference call, your dial-in lines are in listen-only mode. The format for today's event will be as follows: first, TSMC's Vice President and CFO, Mr. Wendell Huang, will summarize our operations in the second quarter 2023, followed by our guidance for the third quarter 2023. Afterwards, Mr. Huang, TSMC's CEO, Dr. C. C. Wei; and TSMC's Chairman, Dr. Mark Liu, will jointly provide the company's key messages.
Then we will open the line for a question-and-answer session. 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: Thank you, Jeff. Good afternoon, everyone, and thank you for joining us today. My presentation will start with financial highlights for the second quarter of 2023. After that, I will provide the guidance for the third quarter. Second quarter revenue decreased 5.5% sequentially in NT or 6.2% in U.S. dollars as our second quarter business was impacted by the overall global economic conditions, which dampened the end market demand and led to customers' ongoing inventory adjustment. Gross margin decreased 2.2 percentage points sequentially to 54.1%, mainly reflecting lower capacity utilization and higher electricity cost, partially offset by more stringent cost control and a more favorable foreign exchange rate. Despite the industry's cyclical downturn, we continue to invest in R&D to support our N3 and N2 development.
Thus, operating margin was 42%, down 3.5 percentage points sequentially. Overall, our first quarter EPS was NT7.01 and ROE was 23.2%. Now let's move on to revenue by technology. 5-nanometer process technology contributed 30% of our wafer revenue, excuse m e, in the second quarter, while 7-nanometer accounted for 23%. Advanced technologies, defined as 7-nanometer and below, accounted for 53% of wafer revenue. Moving on to revenue contribution by platform. HPC decreased 5% quarter-over-quarter to account for 44% of our second quarter revenue. Smartphone decreased 9% to account for 33%. IoT decreased 11% to account for 8%. Automotive increased 3% to account for 8%, and DCE increased 25% to account for 3%. Moving on to the balance sheet. We ended the second quarter with cash and marketable securities of NT1.5 trillion or USD 48 billion.
On the liability side, current liabilities decreased by NT62 billion, mainly due to the net decrease of NT87 billion in income tax payable as we pay NT120 billion for 2022 income tax, offset by NT33 billion accrued tax payables for the second quarter. Long-term interest-bearing debt increased by NT53 billion mainly as we raised NT41 billion in corporate bonds. On financial ratios, accounts receivable turnover days decreased 2 days to 32 days, while days of inventory increased 3 days to 99 days, primarily due to entry ramp during the quarter. Regarding cash flow and CapEx. During the second quarter, we generated about NT167 billion in cash from operations, spent NT251 billion in CapEx, distributed NT71 billion for third quarter 2022 cash dividend and raised NT41 billion from corporate bond issuances.
Overall, our cash balance decreased by NT109 billion to NT1.3 trillion at the end of the quarter. Free cash flow was negative NT83 billion during the quarter as operating cash flow was more than offset by capital expenditures, partly due to the income tax payment of NT120 billion. In U.S. dollar terms, our second quarter capital expenditures totaled NT8.17 billion. I have finished my financial summary. Now let's turn to our current quarter guidance. Based on the current business outlook, we expect our third quarter revenue to be between NT16.7 billion and USD 17.5 billion, which represents a 9.1% sequential increase at the midpoint. Based on the exchange rate assumption of USD 1 to NT30.8, gross margin is expected to be between 51.5% and 53.5%, operating margin to be between 38% and 40%.
This concludes my financial presentation. Now let me turn to our key messages. I will start by making some comments on our second quarter '23 and third quarter '23 profitability. Compared to first quarter, our second quarter gross margin decreased by 220 basis points sequentially to 54.1%, primarily due to a lower capacity utilization. Compared to our second quarter guidance, our actual gross margin slightly exceeded the high end of the range provided 3 months ago, mainly due to more stringent cost control efforts and a slightly more favorable foreign exchange rate. We have just guided our third quarter gross margin to decline by 1.6 percentage points to 52.5% at the midpoint, primarily as the higher level of capacity utilization rate is offset by 2 to 3 percentage points margin dilution from the initial ramp-up of our 3-nanometer technology.
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Looking ahead to the fourth quarter, we expect the continued steep ramp-up of our 3-nanometer to dilute our fourth quarter gross margin by about 3 to 4 percentage 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. While we face near-term challenges, we continue to forecast a long-term gross margin of 53% and higher is achievable. Next, let me talk about our 2023 capital budget and depreciation. Every year, our CapEx is spent in anticipation of the growth that will follow in future years.
Given the near-term uncertainties, we continue to manage our business prudently and tighten up our capital spending where appropriate. We now expect our 2023 capital budget to be towards the lower end of our range of between USD 32 billion and USD 36 billion. Our depreciation expense is now expected to increase by mid-20s percent year-over-year in 2023, mainly as we ramp our 3-nanometer technologies. Despite near-term inventory cycle, 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. We will continue to work closely with our customers to plan our long-term capacity and invest in leading-edge specialty and advanced packaging technologies to support their growth while delivering profitable growth to our shareholders.
Now let me make a few comments on our cash dividend distribution policy. The objectives of TSMC's capital management are to fund the capital - the company's growth organically, generate good profitability, preserve financial flexibility and distribute a sustainable and steadily increasing cash dividend to shareholders. As a result of our rigorous capital management, in May, TSMC Board of Directors approved the distribution of NT3 per share cash dividend for the first quarter of 2023, and up from NT2.75 previously. This will become the new minimum quarterly dividend level going forward. First quarter '23 cash dividend will be distributed in October 2023. For 2023, TSMC shareholders will receive a total of NT11.25 per share dividend and at least NT12 per share cash dividend for 2024.
Going forward, as our capital intensity begins to decline in the next several years, the focus of our cash dividend policy is expected to shift from a sustainable to a steadily increasing cash dividend per share in the next few years. Now let me turn the microphone over to C. C.
C. C. Wei: Thank you, Wendell. Good afternoon, everyone. First, let me start with our near-term demand and inventory. We concluded our second quarter with revenue of USD 15.7 billion [ph] in line with our guidance in U.S. dollar terms. Our business in the second quarter was impacted by the overall global economic conditions, which dampened the end market demand and customers' ongoing inventory adjustment. Moving into third quarter 2023. While we have recently observed an increase in AI-related demand, it is not enough to offset the overall cyclicality of our business. We expect our business in the third quarter to be supported by the strong ramp of our 3-nanometer technologies, partially offset by customers continued inventory adjustment.
In the last quarterly conference, we said we expect fabless semiconductor inventory to rebalance to a healthier level exiting the third quarter. This statement continue to hold true. However, due to persistent weaker overall mega economic conditions slower-than-expected demand recovery in China and overall softer end market demand conditions, customers are more cautious and intend to further control their inventory into 4Q '23. Thus while we maintain our forecast for the 2023 semiconductor market, excluding memory, to decline mid-single digit year-over-year, we now expect the foundry industry to decline mid-teens and our full year 2023 revenue to decline around 10% in U.S. dollar term. With such inventory control, we also forecast the fabless semiconductor inventory to exit 4Q '23 at a healthier and lower level as compared to our expectation 3 months ago.
Next, let me talk about the HPC and TSMC's long-term growth outlook. As we have said before, the massive structural increase in demand for computation underpinned by the industry megatrend of 5G and HPC continues to drive greater need for performance and energy-efficient computing, which require use of leading-edge technologies. These megatrends are expected to fill TSMC's long-term growth. Even with a more challenging 2023, our revenue remains well on track to grow between 15 and 20 CAGR over the next several years in U.S. dollar terms, which is a target we communicated back in January 2022 Investor Conference. The recent increase in AI-related demand is directionally positive for TSMC. Generative AI requires higher computing power and interconnect bandwidth, which drive increasing semiconductor content.
With using CPUs, GPUs or AI accelerator and related ASIC for AI and machine learning, the commonality is that it requires use of leading-edge technology and a strong foundry design ecosystem. These are all TSMC's strengths. Today, server AI processor demand, which we define as CPUs, GPUs and AI accelerators that are performing training and influence [ph] functions accounts for approximately 6% of TSMC's total revenue. We forecasted this to grow at close to 50% CAGR in the next 5 years and increase to low teens percent of our revenue. The sensible [ph] need for energy-efficient computation is starting from data centers, and we expect [indiscernible] proliferate to edge and devices of time, which will further long term, which will drive further long-term opportunities.
We have already embedded a certain assumption for AI demand into our long-term CapEx and growth forecast. Our HPC platform is expected to be the main engine and the largest incremental contributor to TSMC's long-term growth in the next several years. While the quantification of the total addressable opportunity is still ongoing, generative AI and large language model only reinforce the already strong conviction we have in the structural mega trend to drive TSMC's long-term growth, and we will closely monitor the development for further potential upside. Now let me talk about our N3 and N3E status. Our 3-nanometer technology is the most advanced semiconductor technology in both PPA and transistor technology. N3 is already involved in production with good yield.
We are seeing robust demand for N3 and we expect a strong ramp of N3 in the second half of this year, supported by both HPC and smartphone applications. N3 is expected to continue to contribute mid-single-digit percentage of our total wafer revenue in 2023. N3E further extend our N3 family with enhanced performance, power and yield and provide complete platform support for both HPC and smartphone applications. N3E has passed the qualification and achieved performance and yield target and will start volume production in the fourth quarter of this year. With our continuous enhancement of 3-nanometer process technologies, we expect strong multi-yield demand from our customers and are confident that our 3-nanometer family will be another large and long-lasting node for TSMC.
Finally, I'll talk about our N2 status. Our N2 technology development is progressing well and on track for volume production in 2025. Our N2 top [ph] nanosheet transistor structure to provide our customer with the best performance, cost and technology maturity. Our nanosheet technology has demonstrated excellent power efficiency and our N2 watt delivered full node performance and power benefits to address the increasing need for energy-efficient computing. As part of N2-technology platform, we also developed N2 with backside power rail solution, which is best suited for HPC applications. Backside power rail will provide 10% to 12% additional speed gain and 10% to 15% large density boost on top of the baseline technology. We are targeting backside power rail to be available in the second half of 2025 to customers with production in 2026.
We are observing a high level of customer interest and engagement at N2 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 to further extend our technology leadership right into the future. This concludes my prepared remarks, and now let me turn the microphone over to Mark.
Mark Liu: Thank you, C. C. And good afternoon, everyone. Today, I want to talk about TSMC's global manufacturing footprint, status update. TSMC's mission is to be the trusted technology and capacity provider of the global logic IC industry for years to come. Our strategy is to expand our global manufacturing footprint to increase customer trust and to expand our future growth potential and to reach for more global talents. Our overseas decisions are based on our customers' needs and the necessary level of government support. That is to maximize the value of our shareholders and to fulfill our fiduciary duty. In Arizona, we are building our first fab to provide U.S. most advanced semiconductor technology in mass production to support the needs for U.S. semiconductor infrastructure.
Our fab in Arizona started construction in April, 2021 with an aggressive schedule. We are now entering a critical phase of handling and installing the most advanced and dedicated equipment. However, we are encountering certain challenges, as there is an insufficient amount of skill workers with those specialized expertise required for equipment installation in a semiconductor grade facility. While we are working on to improve the situation, including sending experienced technicians from Taiwan to train the local skill workers for a short period of time. We expect the production schedule of N4 process technology to be pushed out to 2025. In Japan, we are building a specialty technology factory, which will utilize 12, 16 and 22, 28 process technologies.
Volume production is on track for late 2024. In Europe, we are engaging with customers and partners to evaluate building a specialty fab in Germany, focusing on automotive specific technologies based on the demand from our customers and the level of government support. In China, we are expanding 28-nanometer in Nanjing as we 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 to expand our capacity to support our customers' growth. From a cost perspective, the initial cost of overseas fab are higher than TSMC's fabs in Taiwan due to: one, the smaller fab scale; two, higher costs throughout the supply chain; and three, the early stage of semiconductor ecosystem on those overseas sites, as compared to a matured ecosystem in Taiwan.
In our recent meetings with senior government officials in the U.S., Japan and Europe, we discussed our plans to expand our global manufacturing footprint to them. We also emphasize one of our major responsibility is to manage and minimize the cost gap to maximize return for our shareholders. Those discussions went very well. All sites understand the critical and integral role TSMC plays in the semiconductor industry, and we appreciate all the government's ongoing support in working with TSMC to help narrow down the cost gap. We will continue to work closely with all the governments to secure the further support. Our pricing will also remain strategic to reflect our value, which includes the value of geographic flexibility. At the same time, we will leverage our fundamental competitive advantage of manufacturing technology leadership, large volume and economies of scale to continuously drive our cost down.
By taking such actions, TSMC will have the ability to absorb the higher cost of overseas fab, while remaining the most efficient and cost-effective manufacturer no matter where we operate. Thus, even as we expand our capacity overseas, TSMC's long-term gross margin of 53% and higher and sustainable ROE of greater than 25% is achievable, and we will continue to maximize the value for our shareholders. This concludes our key messages. Thank you for your attention.
Jeff Su: Thank you, Chairman. This concludes our prepared statements. Before we start 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. Should you wish to raise your question in Chinese, I will translate it to English before our management answers your question. [Operator Instructions] Now let's begin the Q&A session. Operator, can we please proceed with the first caller on the line?
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