Taiwan Semiconductor Manufacturing Company Limited (NYSE:TSM) Q4 2022 Earnings Call Transcript

Taiwan Semiconductor Manufacturing Company Limited (NYSE:TSM) Q4 2022 Earnings Call Transcript January 12, 2023

Jeff Su: Good afternoon, everyone and welcome to TSMC’s Fourth Quarter 2022 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 fourth quarter 2022, followed by our guidance for the first quarter 2023. Afterwards, Mr. Huang and TSMC’s CEO, Dr. C. C. Wei, will jointly provide the company’s key messages.

Then TSMC’s Chairman, Dr. Mark Liu, will host the Q&A session, where all three executives will entertain your questions. As usual, I would like to remind everybody that today’s discussions may contain forward-looking statements that are subject to significant risks and uncertainties and which could actual results could 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.

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Wendell Huang: Thank you, Jeff. Happy New Year everyone. Thank you for joining us today. My presentation will start with financial highlights for the fourth quarter and a recap of full year 2022. After that, I will provide the guidance for the first quarter 2023. First quarter revenue decreased 1.5% sequentially in U.S. dollar terms as our business was dampened by the end market demand softness and customers’ inventory adjustment despite the continued ramp up of our industry leading 5-nanometer technologies. It is at the low end of our previous guidance. In NT dollar terms, revenue increased 2% in the fourth quarter due to a more favorable foreign exchange rate. Gross margin increased 1.8 percentage points sequentially to 62.2% mainly due to a more favorable foreign exchange rate and cost improvement efforts, partially offset by lower capacity utilization.

Total operating expenses accounted for 10.3% of net revenue. Operating margin was 52%, up 1.4 percentage points from the previous quarter. Overall, our fourth quarter EPS was TWD11.41 and ROE was 41.7%. Now, let’s move on to the revenue by technology. 5-nanometer process technology contributed 32% of wafer revenue in the fourth quarter while 7-nanometer accounted for 22%. Advanced Technologies defined as 7-nanometer and below, accounted for 54% of wafer revenue. On a full year basis, 5-nanometer technology contributed 26% of 2022 wafer revenue. 7-nanometer was 27%. Advanced Technologies accounted for 53% of total wafer revenue, up from 50% in 2021. Moving on to revenue contribution by platform. HPC increased 10% quarter-over-quarter to account for 42% of our fourth quarter revenue.

Smartphone decreased 4% to account for 38%, IoT decreased 11% to account for 8%, automotive increased 10% to account for 6% and DCE decreased 23% to account for 2%. On a full year basis, all 6 platforms had year-on-year growth. HPC increased 59% year-on-year to account for 41% of our 2022 revenue. Smartphone increased 28% to account for 39%, IoT increased 47% to account for 9%, automotive increased 74% to account for 5%, and DCE increased 1% to account for 3%. Moving on to the balance sheet, we ended the fourth quarter with cash and marketable securities of TWD1.56 trillion or $51 billion. On the liability side, current liabilities increased by TWD137 billion, mainly due to the increase of TWD48 billion in accounts payable, an increase of TWD93 billion in accrued liabilities and others.

On financial ratios, accounts receivable turnover days remain at 36 days while days of inventory increased 3 days to 93 days. Regarding cash flow and CapEx, during the fourth quarter, we generated about TWD487 billion in cash from operations, spent TWD337 billion in CapEx and distributed TWD71 billion for first quarter 2022 cash dividend. Overall, our cash balance increased TWD47 billion to TWD1.34 trillion at the end of the quarter. In U.S. dollar terms, our fourth quarter capital expenditures totaled $10.82 billion. To recap our performance in 2022, we had a strong growth in 2022 as our technology leadership position enabled us to capture the industry’s megatrends of 5G and HPC. Our revenue increased 33.5% in U.S. dollar terms to reach $76 billion and 42.6% in NT terms to reach TWD2.26 trillion.

Gross margin increased 8 percentage points to 59.6%, mainly reflecting a more favorable foreign exchange rate, value-selling efforts and cost improvement, partially offset by lower capacity utilization. Thanks to better operating leverage, operating margin increased 8.6 percentage points to 49.5%. Overall, full year EPS increased 70.4% to TWD39.2 and ROE was 39.8%. On cash flow, we spent $36.3 billion or TWD1.1 trillion in CapEx. We generated TWD1.6 trillion in operating cash flow and TWD528 billion in free cash flow. We also paid TWD285 billion in cash dividends in 2022, up from TWD266 billion in 2021. I have finished my financial summary. Now, let’s turn to our current quarter guidance. As overall macroeconomic conditions remain weak, we expect our business to be further impacted by continued end market demand softness and customers’ further inventory adjustment.

Based on the current business outlook, we expect our first quarter revenue to be between $16.7 billion and $17.5 billion, representing a 14.2% sequential decline at the midpoint. Based on the exchange rate assumption of $1 to TWD30.7, gross margin is expected to be between 53.5% and 55.5%, operating margin between 41.5% and 43.5%. Starting in 2023, certain tax exemptions from the Taiwan government have expired. However, the government has recently passed the amendments to the statute for industrial innovations. All things considered, we expect our effective tax rate in 2023 and beyond to be approximately 15%. This concludes my financial presentation. Now let me turn to our key messages. I will start by making some comments on our fourth quarter €˜22 and first quarter €˜23 profitability.

Compared to third quarter, our fourth quarter gross margin increased by 180 basis points sequentially to 62.2%, of which 140 basis points was contributed by a more favorable foreign exchange rate. Meanwhile, cost improvement efforts also helped offset the impact from lower capacity utilization. Compared to our fourth quarter guidance, our actual gross margin exceeded the high-end of the range provided 3 months ago, mainly due to cost improvement efforts. We have just guided our first quarter gross margin to be 54.5% at the midpoint mainly due to a lower capacity utilization rate as customers further adjust their inventory levels and a less favorable foreign exchange rate. In 2023, our gross margin faces challenges from lower capacity utilization due to semiconductor cyclicality, the ramp-up of entry, overseas fab expansion and inflationary cost.

In addition, R&D expenses accounted for 7.2% of our net revenue in 2022. In 2023, we as we increase our focus on technology development and add more resources, we expect R&D expenses to increase by about 20% year-on-year and account for 8% to 8.5% of our net revenue. To manage our profitability in 2023, we will work diligently on internal cost improvement efforts while continuing to strategically and consistently sell our value. Excluding the impact of foreign exchange rate, 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. As I have stated before, given the near-term uncertainties, we continue to manage our business prudently and tighten up 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. In 2022, we spent $36.3 billion to capture the structural demand and support our customers’ growth. In 2023, our capital budget is expected to be between $32 billion and $36 billion. Out of the $32 billion to $36 billion CapEx for 2023, about 70% will be allocated for advanced process technologies, about 20% will be spent for specialty technologies, and about 10% will be spent for advanced packaging, mass making and others. Our depreciation expense is expected to increase by approximately 30% year-over-year in 2023 mainly as we ramp our 3-nanometer technologies.

With this level of CapEx spending in 2023, we reiterate that TSMC remains committed to sustainable cash dividends 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: Thank you, Wendell. Good afternoon, everyone. First, let me start with our 2023 outlook. Concluding 2022, the semiconductor industry growth excluding memory, was about 10%, while foundry industry increased about 27% year-over-year. TSMC’s revenue grew $33.5 million year-over-year in U.S. dollar terms. Our business was supported by our strong technology leadership and differentiation, even as our semiconductor inventory correction began to dampen the momentum in second half 2022. Entering 2023, we continue to observe softness in consumer end market segment, while other end market segments such as data center related have softened as well. As customers and the supply chain continue to take action, we forecast a semiconductor supply chain inventory, while reduced sharply through first half 2023, to rebalance to a healthier level.

In the first half of 2023, we expect our revenue to decline mid to high single-digit percent over the same period last year in U.S. dollar terms. Having said that, we also start to observe some initial signs of demand stabilization and we will watch closely for more signals. We forecast the semiconductor cycle to bottom sometimes in first half 2023 and to see a healthy recovery in second half this year. In the second half of 2023, we expect our revenue to increase over the same period last year in U.S. dollar terms. For the full year of 2023, we forecast the semiconductor market, excluding memory, to decline approximately 4%, while foundry industry is forecast to decline 3%. For TSMC, supported by our strong technology leadership and differentiation, we will continue to expand our customer product portfolio and increase our addressable market and we expect 2023 to be a slight growth year for TSMC in U.S. data terms.

Next, let me talk about the N7, N6 demand outlook. 3 months ago, we set our N7, N6 capacity utilization in first half €˜23 will not be as high as it has been in the past 3 years due to end market weakness in smartphone and PCs and customer’s product schedule delay. Since then, the end market demand for smartphone and PCs has further weakened and the capacity utilization of N7, N6 is lower than our expectation 3 months ago. We expect this to persist through first half €˜23 as our semiconductor supply chain inventory takes a few quarters to rebalance to a healthier level and we expect a mild pickup in our N7, N6 demand in second half 2013 than our prior expectation. However, we continue to believe N7, N6 demand is more a cyclical issue rather than structural.

We are working closely with our customers to develop specialty and differentiated technologies to drive additional wave of structural demand from consumer, RF, connectivity and other applications to backfill our N7, N6 capacity over the next several years. Thus, we are confident our 7-nanometer family will continue to be a large and long-lasting node for TSMC. Now, I will talk about our N3 and N3E status. Our N3 has successfully entered volume production in late fourth quarter last year as planned with good yield. We expect a smooth ramp in 2023 driven by both HPC and smartphone applications. As our customers’ demand for N3 exceeds our ability to supply, we expect the N3 to be fully utilized in 2023. Sizable N3 revenue contribution, we expect to start in third quarter €˜23 and N3 will contribute mid single-digit percentage of our total wafer revenue in 2023.

We expect the N3 revenue in 2023 to be higher than N5 revenue in its fourth year in 2020. N3E will further extend our N3 family with enhanced performance, power and yield and offer complete platform support for both smartphone and HPC applications. Volume production is scheduled for second half €˜23. Despite the ongoing inventory correction, we continue to observe a high level of customer engagement at both the N3 and N3E with a number of tape-outs more than 2x that of N5 in its first and second year. Our 3-nanometer technology is the most advanced semiconductor technology in both PPA and transistor technology, thus, we expect customers a strong demand in 2023, 2024, 2025 and beyond for our 3-nanometer technologies and are confident that our N3 family will be another large and non-large node for TSMC.

Finally, let me talk about our plans to expand TSMC’s global manufacturing footprint to increase customers’ trust and expand our future growth potential. TSMC submission is to be trusted technology and capacity provider for the global IC, logic IC industry for years to come. Our job is to provide the optimal solutions for our customers to enable their success, this including technology leadership, manufacturing, cost, trust and recently also including more geographic manufacturing flexibility. Based on customers’ request, we are increasing our capacity outside of Taiwan to continue to provide our customers the optimal solution they need to be successful. TSMC’s decisions are based on our customers’ need and the necessary level of government support.

This is to maximize the value for our shareholders. Our decisions are also based on the talent pool, land, electricity and water needs for TSMC’s long-term growth. In the U.S., we are in the process of building two advanced semiconductor fabs in Arizona. Our U.S. customers welcome us to build capacity in the U.S. to support their needs and have placed their strong commitment and support. We had an opening ceremony on December 6 last year to celebrate the arrival of the fourth batch of state-of-the-art semiconductor manufacturing equipment and Fab 1 is on track to begin production of N4 process technology in 2024. We also announced the construction of a second fab, which is scheduled to begin production of 3-nanometer process technology in 2026.

TSMC Arizona will continue to provide the most advanced semiconductor technology commercially available in the U.S., enabling next-generation, high-performance and low-power computing products in the future years. Each of our fab will have a clean-room area that is approximately double the size of a typical logic fab. We will also consider building additional mature node capacity outside of Taiwan. In Japan, we are building a specialty technology fab, which will utilize 12 and 16-nanometer and 22, 28-process technologies. Volume production is scheduled for late 2024. We are also considering building a second fab in Japan as long as the demand from customers and the level of government support makes sense. 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 expand 28-nanometer in Nanjing as planned to support local customers and we continue to follow all the rules and regulation fully. At the same time, we continue to invest in Taiwan and expand our capacity to support our customer’s growth. Our N3 has just entered volume production in Tainan Science Park. We are also preparing for N2 volume production starting in 2025, which will be located in Chengdu and Taichung Science Park. While capacity is not born overnight and takes time to build, we are committed to expanding our global manufacturing footprint to increase customer trust and expand our future growth potential. Depending on the demand from customers and level of government support, our 28-nanometer and below overseas capacity could be 20% or more of our total 28 and below capacity in 5 years or more time.

While initial cost of overseas fab are higher than TSMC software in Taiwan, our goal is €“ and minimize the cost gap. Our pricing will remain strategic to reflect our value, which also including the value of geographic flexibility. At the same time, we are leveraging our competitive advantage of lost volume, economies of scale and manufacturing technology leadership to continuously drive cost down. We will also continue to work closely with our government to secure their support. By taking such actions, TSMC will have the ability to absorb the higher cost of overseas fabs while remaining the most efficient and cost effective manufacturer, no matter where we operate. Even we increased our capacity outside of Taiwan, we believe long-term gross margin of 53% and higher continue to be achievable and we can earn a sustainable and healthy ROE of greater than 25%, while delivering profitable growth for our shareholders.

This concluding our key message. Thank you for your attention.

Jeff Su: Thank you, C. C. This concludes our prepared remarks. Now we will begin the Q&A session. Our Chairman, Dr. Mark Liu, will be the host.

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Mark Liu: Hello, everyone. It’s good to meet every one of you online again. At the beginning of the year, I wish you all stay healthy and have a happy new year. Now, let’s have answer your question.

Jeff Su: Thank you, Chairman. Operator, let’s begin. Please proceed with the first caller on the line.

Q&A Session

Operator: Thank you. The first question is come from Randy Abrams with Credit Suisse. And Randy, please go ahead.

Randy Abrams: Okay. Yes, thank you. I wanted to ask the first question just about the rising investment costs and also the cost differential with the U.S. Just based on the two press releases, the Taiwan fab, you cited Fab 18, about $60 billion investment for eight phases, which would be, I estimate about 200,000 capacity, that’s about $300 million per thousand wafer. The Arizona fab was $40 billion for about 50,000, $800 million per thousand wafers. So, just two questions on it. If you could maybe discuss a bit more if there is differences in those releases on the investment in calculation and a bit more color on the relative costs since you did the U.S. expansion? And then the second part of the question is, is the cost seeing a significant acceleration? It’s been rising with each new node. But are you seeing an accelerating pace as you move through 3 and 2-nanometer?

Jeff Su: Okay. Randy, thank you. Please allow me to summarize your question. So Randy’s first question is he wants to understand, I think, he’s referring, I think, to our press release when we €“ about N3 in Tainan and the total investment there, and how does that compare to our announcement of the investment in Arizona for two phases. Randy, if I got you correctly, basically what Randy is asking is, what is the cost in the U.S. seem much higher in terms of the investment? So what is driving this big difference or a gap, so to speak. That’s the first part of your question, right, Randy. Okay. So that’s the first part.

Randy Abrams: Right. Yes, that’s right. That’s the first part.

Wendell Huang: Okay. Hi, Randy, this is Wendell. Let me share with you this. The Arizona fab, we make the decision based on customers’ request. And so we’re planning on building the two fabs, one N5, actually N4 and the other one N3. We’re not able to share with you a specific cost gap number between Taiwan and U.S., but we can share with you that the major reason for the cost gap is the construction cost of building and facilities, which can be 4 to 5x greater for U.S. fab versus a fab in Taiwan. The high cost of construction includes labor cost, cost of permits, cost of occupational safety and health regulations, inflationary costs in recent years and people and learning curve costs. Therefore, the initial cost of overseas fabs are higher than our fabs in Taiwan.

Jeff Su: And I think the second part of Randy’s question was about the €“ how do we see the CapEx per K as we go from, I guess, Randy, you’re asking N5, N3 and 2.

Randy Abrams: Yes, it’s seeing a faster pace of expansion through these next couple of nodes.

Wendell Huang: Right. Randy, we’re not able to disclose the specific CapEx per K for each node, but certainly, the CapEx is, K is more expensive for a new node as the process capacity increases. Okay?