[Foreign language].
Good afternoon, everyone, and welcome to TSMC's second quarter 2022 earnings conference call. This is Jeff Su, TSMC's Director of Investor Relations, and your host for today. To prevent the spread of COVID-19, TSMC is hosting our earnings conference call via live audio webcast through the company's website at www.tsmc.com, where you can also download the earnings release materials. If you are joining us through the conference call, your dial-in lines are in listen-only mode.
The format for today's event will be as follows. First, TSMC's Vice President and CFO, Mr. Wendell Huang, will summarize our operations in the second quarter 2022, followed by our guidance for the third quarter 2022. Afterwards, Mr. Wendell Huang and TSMC's CEO, Dr. C.C. Wei, will jointly provide the company's key messages. Then, TSMC's Chairman, Dr. Mark Liu, will host the Q&A session, where all three executives will entertain your questions.
As usual, I would like to remind everybody that today's discussions may contain forward-looking statements that are subject to significant risks and uncertainties, which could cause actual results to differ materially from those contained in the forward-looking statements. Please refer to the safe harbor notice that appears on our press release. 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.
Thank you, Jeff. Good afternoon, everyone, and thank you for joining us today. My presentation will start with financial highlights for the second quarter 2022. After that, I will provide the guidance for the third quarter. Second quarter revenue increased 8.8% sequentially in TWD, or 3.4% in U.S. dollars, as our second quarter business was supported by strong HPC, IoT, and automotive-related demand.
Second quarter gross margin increased 3.5 percentage points sequentially to 59.1%, slightly ahead of our guidance as we enjoyed a more favorable foreign exchange rate, cost improvement, and value selling. Likewise, operating margin increased 3.5 percentage points sequentially to 49.1%, in line with our gross margin increase. Overall, our second quarter EPS was TWD 9.14, and ROE was 39.4%.
Now, let's move on to revenue by technology. 5 nm process technology contributed 21% of wafer revenue in the second quarter, while 7 nm accounted for 30%. Advanced technologies, which are defined as 7 nm and below, accounted for 51% of wafer revenue. Moving on to revenue contribution by platform.
All six platforms increased in the second quarter. Smartphone increased 3% quarter-over-quarter to account for 38% of our second quarter revenue. HPC increased 13% to account for 43%. IoT increased 14% to account for 8%. Automotive increased 14% to account for 5%. Digital consumer electronics increased 5% to account for 3%. Moving on to the balance sheet. We ended the second quarter with cash and marketable securities of TWD 1.4 trillion.
On the liability side, current liabilities increased by TWD 22 billion, mainly due to the increase of TWD 47 billion in accounts payable, partially offset by the decrease of TWD 29 billion in short-term loans. Long-term interest-bearing debts increased by TWD 124 billion, mainly as we raised TWD 109 billion of corporate bonds during the quarter.
On financial ratios, accounts receivable turnover days decreased one day to 37 days, while days of inventory increased seven days to 95 days as we pre-built N5 wafers and increased raw materials inventory. Now let me make a few comments on cash flow and CapEx. During the second quarter, we generated about TWD 339 billion in cash from operations, spent TWD 218 billion in CapEx, and distributed TWD 71 billion for third quarter 2021 cash dividend.
Bonds payable increased by TWD 109 billion as a result of this quarter's bond issuances. Overall, our cash balance increased by TWD 102 billion to TWD 1.3 trillion at the end of the quarter. In U.S. dollar terms, our second quarter capital expenditures totaled $7.34 billion.
I have finished my financial summary. Now, let's turn to our current quarter guidance. Based on the current business outlook, we expect our third quarter revenue to be between $19.8 billion and $20.6 billion, which represents a 11.2% sequential increase at the midpoint. Based on the exchange rate assumption of $1 to TWD 29.7 , gross margin is expected to be between 57.5% and 59.5%. Operating margin between 47% and 49%. This concludes my financial presentation.
Now let me turn to our key messages. I will start by making some comments on our second quarter and third quarter profitability. As a reminder, six factors determine TSMC's profitability. Leadership technology development and ramp-up, pricing, cost, capacity utilization, technology mix, and foreign exchange rate.
Compared to first quarter, our second quarter gross margin increased by 350 basis points sequentially to 59.1%, mainly due to a more favorable foreign exchange rate, cost improvement, and value selling. Compared to our second quarter guidance, our actual gross margins exceeded the high end of the range provided three months ago, as our guidance was based on exchange rate assumption of $1 to TWD 28.8 , whereas the actual second quarter exchange rate was $1 to TWD 29.42 .
This created about 90 basis point difference in our actual second quarter gross margin versus our original guidance. We have just guided our third quarter gross margin to decline 60 basis points sequentially to 58.5% at the midpoint. As a slightly more favorable exchange rate assumption will be more than offset by higher inflationary costs, including higher raw material and electricity costs.
Looking ahead on our profitability, we will face challenges from rising inflationary costs from raw materials, utilities and tools, increasing process complexity of leading nodes, new investments in mature nodes and overseas fab expansions. Despite the manufacturing cost challenges and excluding the impact of foreign exchange rate, of which we have no control over, taking the other five factors into consideration, we continue to believe a long-term gross margin of 53% and higher is achievable.
Next, let me talk about our effective tax rate. For 2022, we expect our tax rate to be between 10% and 11%. Starting in 2023, we will see the expiration of certain tax exemptions in Taiwan, and our effective tax rate will increase. However, Taiwan government is in the process of drafting certain new tax exemption regulations and is currently in the comment period. Therefore, we will provide a further update on the outlook of our tax rate in 2023 and beyond when more details become available. Now let me turn the microphone over to C.C.
Thank you, Wendell. We hope everybody is staying safe and healthy during this time. First, let me start with our near-term course outlook. We concluded our second quarter with revenue of TWD 534 billion, or $18.2 billion, supported by HPC, IoT and automotive related demand. Moving into third quarter 2022, we expect our business to be supported by continual demand for our industry-leading 5 nm and 7 nm technologies.
On the inventory side, due to the softening device momentum in smartphone, PC, and consumer end market segments, we observe the supply chain is already taking action and expect inventory level to reduce throughout the second half 2022. After two years of pandemic-driven stay-at-home demand, this type of adjustment is reasonable in our view.
Our expectation is for the excess inventory in the semiconductor supply chain to take a few quarters to rebalance to a healthier level. We believe the current semiconductor cycle will be more similar to a typical cycle with a few quarters of inventory adjustment, likely through first half 2023. We have also internally modeled and prepared ourselves for various different scenarios in case it is necessary.
On the demand side, while we observe uncertainties in consumer end market segment, other end market segments such as data center and automotive related remain steady, and we are able to reallocate our capacity to support these areas. Despite the ongoing inventory correction, our customers demand continue to exceed our ability to supply.
We expect our capacity to remain tight throughout 2022, and our full-year growth to be mid-30s% in U.S. dollar terms. Three key factors in supporting TSMC's strong structural demand are our technology leadership and differentiation, our strong portfolio in high-performance computing, and our strategic relationship with customers. All of these factors are TSMC's strengths in the foundry industry.
First, our technology leadership and differentiation. TSMC's technology position is much stronger today as compared to previous years. Looking ahead to 2023, we are working diligently to provide the industry's most advanced technologies, and making it available to all the product innovators. With the successful ramp of N5, N4P, N4S, and the upcoming ramp-up of N3, we will expand our customer product portfolio and increase our addressable market. Thus, while macroeconomic uncertainty may persist into 2023, our technology leadership will continue to advance and support our growth.
Secondly, the massive structural increase in the demand for computation, underpinned by the industry megatrend, continues to fuel greater need for performance and energy-efficient computing, which requires use of leading-edge technologies. Through our comprehensive IP ecosystem and optimized process technology, we are able to address and capture the structural demand and build a strong portfolio in high-performance computing.
We expect HPC to be the main engine of TSMC's long-term growth, and the largest contributor in terms of our incremental revenue growth in the next several years. Third, our strategic relationships with our customers are long-term in nature, developed and built through many years of collaboration and investment to enable customers' success in their end markets. We continue to work closely with our customers on technology development, capacity planning, and pricing to support their long-term demand and growth. With all these three differentiating factors, we expect our capacity utilization to remain healthy in 2023, and our business to be less volatile and more resilient, supported by the strong demand for our differentiated and leading advanced and specialty technologies.
Now let me talk about TSMC's long-term growth outlook. While macroeconomic headwinds bring near-term uncertainties that may persist, we believe the fundamental structural growth trajectory in the long-term semiconductor demand remain firmly in place. We continue to observe silicon content increase across many end devices, fueled by process technology migration and increased functionality. For example, the number of CPUs, GPUs, and AI accelerators in a data center are increasing. A 5G smartphone carries substantially higher silicon content as compared to 4G smartphone. The amount of silicon content in today's car continue to rise.
Thus, while the device unit growth of many electronic devices may be flattish to low-single-digits percentage range. In the next several years, the silicon content growth will be higher in the mid- to high-single-digits percentage range, and support the long-term structural semiconductor demand and increase our addressable wafer demand.
TSMC's CapEx and capacity planning are always based on the long-term structural market demand profile, not near-term factors. We are working closely with our customer to plan our long-term capacity and investing in leading-edge and specialty technology to support their growth. We will manage our business prudently through the near-term uncertainties, and we remain highly confident in our long-term growth outlook.
With our technology leadership, manufacturing and capacity support, and customers' trust, TSMC is well-positioned to capture the strong multiyear growth from the favorable structural mega trend of 5G and HPC-related applications, and deliver profitable growth for our shareholders. We reiterate our long-term revenue to be between 15% and 20% CAGR over the next several years in U.S. dollar terms.
Next, let me talk about the tool delivery update. As a major player in the global semiconductor supply chain, TSMC work closely with all our tool supplier to plan our CapEx and capacity in advance. However, like many other industries, our suppliers have been facing greater challenges in the supply chains, which are extending tool delivery lead times for both advanced and mature nodes.
As a result, we expect some of our CapEx this year to be pushed out into 2023. TSMC is actively doing its part to help our tool suppliers address the supply chain challenges. In April, we said that we have increased regular high-level communications to trace the progress and send several teams on-site to support our suppliers. Since then, we have worked closely to identify critical chips that are gating the tool delivery.
We are working dynamically with our customers and prioritize our wafer capacity to support these critical chips to help mitigate the chip constraint issues. While challenges remain, the situation is improving. We do not expect any impact to our 2022 capacity plan, and we are able to pull in the delivery schedule for a certain amount of tools for our 2023 capacity. We have been working closely with our customer for 2023 so that we can support their demand.
Now let me talk about the N3 and N3E status. N3 is on track for volume production in second half of this year with good yield. We expect revenue contribution starting first half, 2023, with a smooth ramp in 2023, driven by both HPC and smartphone applications. N3E will further extend our N3 family with enhanced performance, power, and yield. N3E will offer complete platform support for both smartphone and HPC applications. We observe a high level of customer engagement at N3E, and volume production is scheduled for around one year after N3. 3 nm technology will be the most advanced semiconductor technology in both PPA and transistor technology when it is introduced. Thus, we are confident that our N3 family will be another large and long-lasting node for TSMC.
Finally, let me talk about the N2 status. Our N2 technology development is on track and progressing well to our expectations, with risk production scheduled in 2024 and volume production in 2025. After careful evaluation and extensive period of development, our 2 nm technology will adopt nanosheet transistor structure to provide our customers with the best performance, cost, and technology maturity.
N2 will deliver full node performance and power benefit to address the increasing need for energy-efficient computing, with 10-15 speed improvement at the same power, or 20%-30% power improvement at the same speed, and logic density of more than 20% increase as compared with N3E. Our 2 nm technology will be the most advanced semiconductor technology in the industry in both density and energy efficiency when it is introduced, and will further extend our leadership position well into the future.
This concludes our key message, and thank you for your attention.
Thank you, C.C. This concludes 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. 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 zero then one on your telephone keypad now. Questions will be taken in the order in which they are received. If at any time you would like to remove yourself from the questioning queue, please press zero and then two. Now let's begin the Q&A session. Our chairman, Dr. Mark Liu, will be the host.
Hello, everyone. Thank you for coming to this conference. I wish you all healthy and well. I think we hope the above reports already answer some of your question. It definitely shows this company stands on firm ground. We will be prudently going through this near-term uncertainty. In the meantime, we'll be also confident and well-prepared for our next growth period. Now the floor is open for your question.
Thank you, Chairman. Operator, please proceed with the first caller on the line.
Yes. The first one to ask question, Randy Abrams, Credit Suisse.
Okay. Yes, thank you. Congratulations on the good outlook. My first question, I wanted to ask on your view on the business cycle. You raised your outlook to 35% in a strong third quarter. With that strong outlook, wanted to see what is driving your expectation for inventory drawdown in second half, and how broad you're seeing the inventory drawdown. The follow-up question I wanted to ask to that is what is your view on the first half. With your view, customers will be drawing down through the first half. Do you see underutilization, and how severe do you expect that correction?
Okay. Randy, please allow me to summarize your first question. I think Randy, the first part—his first question is, in looking at TSMC's third quarter guidance and also looking at our full year growth to be mid-30s, he's wondering, I believe, Randy, how to reconcile this, with our expectation of the inventory adjustment, in the second half and also into the first half next year. How do we reconcile our view on the inventory cycle, against our own business? Is that correct, Randy?
Yeah, that's correct. Just an initial view on first half, how much correction you're making for in your business.
Randy, this is C.C. Wei. Let me answer your question. Yes, we do have mid-30s growth in this year, but we also expect our customers start to take action to decrease their inventory level. How far we expect that a few quarters, at least into the first half of 2023, they will continue to do the inventory correction. Does that lead to TSMC's utilization?
Let me say that despite the ongoing inventory adjustment and macro uncertainties, the structural growth trajectory in the long-term semiconductor demand remain firm. With our leading and differentiated advanced and specialty technologies and a strong HPC portfolio and strategic customer relationship, we expect our capacity remain tight and our business to be more resilient, and we are confident in both our near-term and long-term growth outlook. Did that answer your question?
Yes. I mean, to clarify, do you expect even through first half to remain tight factoring in your tech position and some of the projects you have?
Yeah, it remains.
I think Randy wants to ask, in the first half of next year, how do we see our capacity utilization given the ongoing inventory adjustment?
I cannot give you exactly the number that we are talking about, but let me say it's healthy. Okay.
Okay, great. Hey, my second question on the CapEx, two parts. Just wanna understand the pushouts, a little more what it's affecting, the 3 nm, how much ramp, the 5 nm or mature nodes. If you could also discuss the framework for next year's CapEx. I think you've made comments about, we could be above $40 billion. If you could give a framework for how you're thinking about next year CapEx.
Okay. Randy, second question is on the CapEx. He wants to know, with some of the tool delivery issues, the CapEx push out, is this more for 3 nm? Is this for 5 nm or is this more on the mature node side? He also wants to know, how does this impact our CapEx for 2023, as we said, before, that 2023 could be $40 billion or higher.
Okay, Randy, this is Wendell. The first question, as C.C. said in his prepared remarks that the schedule, the tool delivery schedule changes currently in both the advanced and the mature nodes. Okay. Your second question is about next year's CapEx. It's too early to talk about next year's CapEx. But as we always said, we invest the CapEx in a year for the future opportunities. As long as the future outlook is good, we will continue to invest, but of course, in a disciplined manner.
Okay. Just for this year with the pushout, what's your expectation for how much this year would be? That's my final question. Thank you.
I think next year will be too early, but I can tell you that this year it will be closer to the lower end of our previous guidance.
Closer to the lower end of the guidance of $40 billion-$44 billion, Randy. Yeah.
Thanks. Yeah. Thank you, Jeff.
Okay. Great. Thank you. Operator, can we move on to the next participant, please?
Next one to ask questions is Bruce Lu from Goldman Sachs.
Hi. Thank you for taking my question. Congratulations on the great result. I think the management has said that the next few years, the revenue growth will still at the 15%-20% growth, and it is driven by the compound dollar compound growth. This is actually the most you know a difficult part for the investor or the biggest discrepancy when we talk to the investor. How much is driven by the dollar compound growth? Because investors do not really see the dynamics, right? For example, like 15%-20% growth for next few years, how much is driven by dollar compound growth? How much is driven by the shipment or how much is driven by the ASP or product mix improvement?
Okay. Let me, Bruce, thank you. Let me summarize your first question. Bruce is really looking at our long-term growth. We said that we will grow between 15%-20% CAGR in the next several years. He wants to know out of this 15%-20%, how much is driven by silicon content, how much is driven by, Bruce, I think you said, shipment, how much is driven by ASP. Bruce?
Let me answer the question, but exactly the number I cannot share with you because it's confidential. Let me say that the content increase actually is at least mid- to high-single-digit for our edge devices. Even that all the electronics devices, even the core is flatish or some kind of a low-single-digit, it's still growing. Combined with all this and our value selling with our customer, we are confident to say 15%-20% CAGR is achievable. Okay.
Okay. Thank you. To my next question is for the mature node and the specialty capacity expansion. I think Chairman recently commented that you will expand your mature node and specialized capacity by 50%, 50, in next three years. I mean, this number looks a bit big. I mean, can you tell us that how do you achieve this 50% capacity expansion by the new capacity or conversion, and where are those demand? How do you see the mature node supply and the demand in the coming few years?
Okay. Bruce , let me summarize your second question, please. All right. Bruce 's second question is on mature node and specialty capacity expansion. He's looking to say, TSMC expanding our mature node specialty capacity by 50%, that looks very big. Is that all new capacity expansion? Is some of this also coming from logic conversion to specialty? What applications are driving this?
Well, let me answer the question. 50% increase, we mean that 50% is in specialty technologies capacity. Doesn't mean the overall capacity increase. Okay. We did this because of our customers' need, and we work closely to support their growth. It's not a plain 50% increase in the logic capacity. No. It's specialties.
If I may add a little bit, the expansion also includes both the new capacity and conversion of existing capacity.
How confident you are, I mean, in terms of this kind of capacity expansion, what kind of application which will keep you confident for this kind of increase though? Because in the past, like, 20 years, your capacity expansion is mostly in the advanced node.
Bruce wants to know what is keeping TSMC confident to have such expansion on the specialty technologies, as most of our expansion in the past has been focused on the advanced nodes.
Bruce, you are right. In the past years, TSMC always increased the leading-edge capacities. We did not increase any specialties in the past few years, except a few upgrade from logic to specialty. This time it's different. First, because of we can see the silicon content continue to increase on all the edge devices. It's included on the demand on the leading-edge capacity. It also require the specialties content inside. At the urging of our customers' request, TSMC closely work with our customer and to expand our specialty capacities. Okay. How confident? Very. Very confident.
I believe so. Thank you.
Thank you.
Thank you, Bruce. Operator, can we move on to the next participant, please?
Next one to ask questions, Sunny Lin, from UBS.
Hi, good afternoon. Thank you for taking my questions, and congrats on the strong results. My first question is on the semi cycle earlier, that you have done some scenario analysis on the semi cycle for 2023. I just wonder, what's your current base case for semi growth for 2023. Do you think if it'll be like a typical down cycle like in 2015, 2019, or would it be a more meaningful correction? Thank you.
Okay. Sunny, thank you. Sunny's first question is on the semiconductor cycle. She wants to know what is TSMC's base case for 2023. Do we think it will be more of a typical cycle, such as in 2015 or 2019, or it will be more of a meaningful correction, I believe are her words.
Yeah. Hey, Sunny. Yes, our base case is more of a typical down cycle. The inventory correction may go for a few quarters through the first half of 2023. It's not like a big down cycle back in 2008 or something like that.
Got it. Thank you. My second question is on 3 nm As we are ramping up the technology in second half, how should we think about the revenue contribution into 2023? In terms of profitability, will the 3 nm ramp-up have any impact into Q4 or if the impact will be mostly from Q1 next year?
Okay. Thank you, Sunny. Sunny's second question is on 3 nm. With the ramp, she wants to know what type of revenue contribution from N3 in 2023, and also with the ramp of N3, what would be the impact to profitability? When should we see it and what type of impact from N3? Thank you. That's correct, right, Sunny?
That's right. Thank you, Jeff.
Sure.
Okay, Sunny. In terms of revenue contribution from N3, I have to say that nowadays it's less meaningful to talk about the revenue contribution of a leading node at the very beginning, when we start to ramp it, compared to in the past. Because the total pie is increasing, and we believe it will continue to increase. Dollar amount-wise, it's certainly bigger than the previous nodes at the very beginning stage. This is your first question. In terms of profitability dilution, we expect that it will impact between 2-3 percentage points in gross margins in the first year, 2023. Thank you.
Got it. Thank you. That's very clear. Thank you very much.
Thank you, Sunny. Operator, can we move on to the next participant, please?
Now it's turn for Gokul Hariharan, JPMorgan. Go ahead, please.
Gokul, are you on the line? You might have to unmute.
Yeah. Hi, sorry. My first question is.
Gokul, sorry, you're breaking up. Can you try again? Repeat your question, please.
Yeah, sure. My first question went to Michael.
Gokul, sorry. Okay, let's try one more time, 'cause you continue to break up. Let's try one more time. If not, I will have to ask you to dial back in. Sorry. Please repeat your question again.
Sure. Hi. Can you hear me now?
Yes.
Okay. That's good. [Audio distortion] .
Okay. Gokul, I'm sorry. Your line is very unstable, so I will ask you to please try to get back into the queue, and we'll address your question. Okay? Operator, can we move on to the next caller, please? Apologies for that.
Next one to ask question, Brett Simpson, Arete Research.
Yeah. Thanks very much. I had a question on the inventory burn off that you were signaling potentially for first half 2023. Can you talk more broadly about fabless days of inventory today, and how you see this trending in the second half of the year? In terms of your outlook for the overall semis industry, what is your current view for 2022 growth, and 2023 growth, and has your view changed in the last three months? Thank you.
Okay. Thank you, Brett. Brett's first question is looking at inventory and the overall industry. His first question is about the inventory adjustment. We have said that it will likely be through first half 2023. What do we see for the fabless DOI trending in second half of this year?
Yes, Brett. We expect the fabless DOI to come down in the second half of this year gradually. Your second question?
Come down throughout second half of this year.
Yes.
Correct.
Yes.
The second part of his question is, Brett, sorry. Again, your second part is looking at the industry. What is our current view on the semiconductor industry for 2022 and 2023, and how has our forecast changed or not?
That's right.
Okay.
Well, let me answer the question. Our forecast for the semiconductors excluding memory and the forecast on the foundry growth in 2022 remain the same as we projected earlier. For 2023, it's too early to forecast, but as we said, the inventory correction will continue to go on.
For TSMC, because our technology position is much stronger today, and we also have a very strong portfolio in HPC, and we have a long-term strategic relationship with customer. We think 2023, even there's an inventory correction, it's still a growth year for TSMC.
Okay. Jeff, can I just have a second question? Is that possible?
Sure. One more second question. Yeah.
We've been hearing from some other leading-edge chip manufacturers that they are looking at the opportunity to work with project financing companies when it comes to new fab builds. I think, you know, companies like Brookfield has been mentioned. How does TSMC view this trend? Is there a fab rental model or a way to reduce the free cash flow burden in this industry, as you bring on new fabs? Thank you.
All right, Brett's second question is he wants to know what is TSMC's view. His observation is other companies in the industry are using project financing to build new fabs. You know, this new fab rental model. What is TSMC's view on this?
Brett, we are not considering project financing now. Normally, project financing entails stringent, stricter terms and higher costs. We will finance the expansion mainly from our operating cash flow and borrowing using our strong balance sheet. That's our current policy.
Okay. Quite clear.
Great. Thank you. Thank you.
Thank you, Brett. All right, operator, let's move on to the next participant, please.
Next one to ask question, Charlie Chan from Morgan Stanley.
Hello. Good afternoon, and congratulations on great results. My first question is about your HPC and high-performance demand, because our view is that the macro slowdown or a recession should impact the cloud CapEx and the high-end consumption. I'm wondering, do you think that the so-called inventory digestion will sooner or later apply to your data center customers and the high-end smartphone customers' orders in the coming quarters? Thank you.
Charlie's first question is looking at the inventory adjustment in light of the macro slowdown. He wants to know, do we believe or see impact to cloud service provider CapEx or high-end smartphone sort of to have inventory adjustment next? Is that correct, Charlie?
Yes. Thank you, Jeff.
Charlie, this is C.C. Wei. I think, to answer your question, you might think they have too much of inventory in the HPC area. As we said, you know, that there are so many edge devices continue to create data, and those data need to be processed, and with sufficient speed and efficient power consumption. That require our leading-edge technology to provide the solution. In even just inventory correction or something like that, we expect our business to be less volatile and more resilient through the near-term uncertainties. Also, we are highly confident in our long-term growth outlook.
Yes. How about the high-end smartphone inventory correction? Do you expect that, you know, top brand inventory, smartphone inventory to see correction as well on the semiconductor demand? Thank you.
Charlie also wants to know, do we expect high-end smartphone inventory correction on the semi demand?
To be frank with you, we did not see too much of inventory on the high-end smartphone buildup. No.
Mm.
Okay?
Great. Thank you. That's very helpful. My second question is about your future technology development, right? Either Mark or C.C., can you please help me? This is first time you've disclosed the N2 GAA logic density improvement. I think more than 20% logic density increase still better than three other market trends. But compared to the previous nodes, there's a significant slowdown. Do you think first of all, N2 is a full node migration? And do you think that there is a kind of a significant slowdown of Moore's law? And what does that mean to your CapEx per K for N2 versus N3? And lastly, backside power delivery, right?
I'm very interested in your kind of N2, what it means to the long-term technology and also CapEx. Thank you.
Okay. Maybe I'll summarize Charlie's second question into a few different parts. His first question is on N2 technology, and he notes that the logic density gain is more than 20%. But does this represent a significant slowdown, especially in the context of Moore's Law, and what does this mean for technology as a whole? Maybe Chairman can address.
Well, let me answer your question. First of all, as you just mentioned, our N2 will be the most advanced semiconductor technology in the industry when it is introduced. Because this technology, we work closely with our customers and about regarding the scaling factor included. Charlie, from now on, we have to look at the technology in a platform fashion. The N2 technology is not just the wafer scaling. The N2 technology include the transistor scaling, but also include the new power line structure, and also include the new chiplet technology to allow the more architectural innovation in our customers. This is a whole set of technology offering composed to be N2 nanometer.
The scaling factor is smaller, but we really know the customer's needs today is really about the power efficiency, and this will be a full node power efficiency migration. To control the cost, that is the reason we control the scaling factor while maintaining the same value for the new generation of technology. That's my report. Yeah.
Great. Also, Charlie.
Yeah.
Is asking about the backside power on N2.
Let me add a few points. On the backside power delivery, actually we call it Super Power Rail, is part of our N2 platform offering. At the proper time, we'll introduce it to the market whenever our customer need it.
Yeah. If you put that together, right, it seems like lower. You have this power via, what does it mean to your CapEx burden in the coming years? Thank you very much.
Yeah. Okay. Thank you, Charlie. Operator, can we move on to the next participant, please?
Next one to ask questions, Laura Chen from Citigroup.
Hi, thank you for taking my questions, and congrats for the good result. My first question is about your view on the key applications. Actually starting from the last quarter, we already see that high computing PC has been the key catalyst for TSMC. I'm just wondering, your view on the from various architecture, like Arm-based or x86. Can you share your view that what will be the key driver for TSMC for the next few years? Do you see there were more from the Arm-based CPU or more upside from the x86? Also on the smartphone space, I recall that in the previous analyst call, you mentioned that penetration rate for the 5G, you expect there will be about like 50%.
Given the weak demand growth, well, what's your latest view on the 5G smartphone penetration? That's my first question. Thanks.
Okay. Laura's first question. First, she wants to know on HPC. She notes HPC has become the largest contributor by platform to our revenue. She wants to know, you know, when we look out over the next several years, how do we see HPC? Is this driven by Arm-based or versus x86? I think that's the first part of her first question.
Laura, our HPC definitely is growing healthy. Since TSMC is everybody's foundry, so we support both x86 and Arm-based, you know, what do you say, for the high performance computing, both. Both are significantly grow in TSMC.
And then she also wants to-
Okay.
Sorry.
Yeah. Sir, yeah. Seems like TSMC already has a very high exposure on the Arm-based. Can we expect the next few years for the growth driver to more come from the x86?
I cannot answer this question. We have very high exposure to x86 also.
Laura, I think we have said numerous times, and it still remains holds true, that HPC will be the largest contributor and increasingly the main driver of TSMC's growth over the next several years.
Yeah. Thank you.
Okay.
Yeah. Laura, your second question is the 5G smartphone penetration rate. We're still looking at about 50% at this moment.
Okay. Thank you. If I can ask, the second question about the gross margin outlook. I think, 59% is really amazing. Considering your CapEx discipline and the consistent delivery in the advanced node or maybe price hike as well, can we expect that we'll have more upside to your current 53% gross margin target?
Laura's second question is on the gross margin. She notes that gross margin for second quarter, 59.1% is very high. Is there upside to our long-term gross margin target of 53% and higher?
Laura, as we mentioned before, there are six factors that affect our profitability every year. Excluding the foreign exchange rate, of which we do not have any control on.
The other factors, taking into consideration, we are confident that a long-term growth margin of 53% and higher is achievable, and we certainly will try to work hard to deliver better than that.
Okay. Thank you very much. That's very helpful.
Okay, thank you. Operator, can we move on to the next participant, please?
Next one we have Gokul Hariharan from JPMorgan.
Thanks. Let me try again. My first question is on the U.S. expansion. There's been a lot of commentary around very high costs for U.S. expansion. I think founder, chairman-
Go-
For the U.S. fabs compared to Taiwan. Could you talk a little bit about the U.S. expansion and how the [audio distortion], what kind of cross differentiating level is the TSMC seeing and what is your negotiations that [audio distortion].
Okay, GokuI I have to say again you're breaking in and out. Let me try and summarize your question, I'll make sure we got it right. So Gokul's first question is about our U.S. fab, he notes that the causes our founder has recently cited this as well. So Gokul I think your question is about how do we manage the cost gap and close the close gap. Is that your question?
[Audio distortion]
So okay. Thank you, Gokul. So Gokul wants to know how are our negotiations and discussions with our governments. How are our negotiations and discussions with customers, about this cost differential.
Okay, hey Gokul. Yes, I did mention that the cost in the fab in the U.S. is higher than we expected. We are still doing the construction stage of the fab. And during the past two years, we found that the labor cost in the States is higher than we planned. We also [audio distortion] COVID supply chain interruption also was unexpected. And we did try to confer this information to the government at the location and it gave them a full perspective of the cost gap.
But Gokul, yes indeed. Our customer in U.S. they all want to know that fact, this is a need from our customers. And we also agreed that there is an ample business opportunity. So the cost is increased, but cost is not the only factor. We are still working on the government subsidy, continue working on the cost reduction, and every company have a different way to reduce the cost so that is a work in the process.
Thank you. Thank you very much. My second question, would the TSMC consider any kind of a joint venture fab in the U.S. with potentially large customers? Historically, TSMC has done this with some of the customers like Altera and NXP long back. Would you consider any kind of joint venture fabs potentially with any of the customers in the U.S. if the outsourcing opportunity is big enough? Thank you.
Gokul's second question is, again, would TSMC consider any type of joint venture fab in the U.S. for outsourcing? He notes we have done certain JVs in the past. Is this something we will consider in the U.S. for outsourcing opportunities?
Yes. Let me answer this question again. Yes, TSMC indeed had some joint venture arrangement, maybe 20 years ago, within the U.S. Right now, we understand with that experience, we understand our customers' demand or will go up and downs. We want—we don't—we also don't want to limit this fab into specific set of customers. It's open to our old customer base to utilize. No, at this point, we do not plan to have a joint venture arrangement in the U.S.
Okay, Gokul?
Thank you.
Operator. Oh, Gokul. Okay, thank you, Gokul. Operator, can we move on to the next participant, please?
Next one to ask questions, Charles Shi from Needham & Company.
Hi. Good afternoon. Thank you for taking my question. I wanna go back, a quick clarification about N3 gross margin. You kinda mentioned probably first time quantified how much dilution that you are expecting, 2%-3%. Can you let us know dilution relative to which number? Because there's one long-term gross margin number, 53% and higher, and there is another one which is where your gross margin is tracking. That's a few points above your long-term target. This is the kind of little bit moving target here. Can you clarify with us? Thank you.
Charles is asking, if we can clarify, our gross margin target. His question. Well, I think, again, when we talk about N3, diluting 2%-3%, it is for the first year, right, which is 2023. He's wondering, you know. I think, Charles, your question is, does this dilution continue? Does this change our long-term gross margin target? And maybe more, I think he's thinking about what are the gross. Yeah, sorry. Let me stop there. Is that your question, Charles?
Yeah. No, no. The 2%-3% dilution relative to what is my question. Is it relative to your long-term growth target?
Oh, okay.
53% and higher.
Got it.
Where you are, where you're tracking, which is 59%, 58%.
Okay.
Yeah, that's my question.
Thank you, Charles. Charles is asking, when we talk about 2%-3% dilution, are we looking at 53% diluting from there, or are we looking at 59% diluting from here?
Charles, it's a dilution from next year's gross margin as we forecast. It's neither 53% nor 59%. Bear in mind that when we talk about 53% and higher, it already included the dilution effects from the N3 dilutions.
Okay, Charles.
Thank you very much.
Yeah. Do you have a second question?
I do. I have a more long-term question. Thank you, Chairman, for mentioning N2's full package, which includes chiplets. I wanna specifically ask you about chiplets, 3D IC. I think that you recently talked about expanding SOIC capacity by 20 x through 2026. That's quite a bit amount of capacity addition. I think that one year ago, you sort of mentioned SOIC is something you're targeting for high performance computing applications. Given the amount of capacity increases you're planning, any updated thoughts on whether that can be a technology possibly at N2 be used for smartphone platform. Any other color you can give us would be great. Thank you.
Okay. Thank you, Charles. Charles' second question is on 3D IC. He notes that, in particular, we have talked about SOIC and also expanding the capacity there. We have said in the past this is primarily adopted by HPC applications. His question is, with such capacity expansion, do we also expect smartphone customers to adopt 3D IC solutions like SOIC at some point in the future? Is that correct, Charles?
Yes. Thank you very much.
Let me answer this question, Charles. So far, the SOIC is primarily adopted by the HPC applications, okay? Because it is very fit for their high speed and power efficient. For mobile adoption, it will depend on their chiplet architecture, interconnect density requirement, thermal or other requirement, and we will have other solution to address the mobile requirement.
Okay. All right. Thank you, Charles.
Yeah.
Thank you. Operator, can we move on to the next participant, please?
Next one to ask question, Mehdi Hosseini from Susquehanna International Group.
Yes, thank you for taking my question. I just wanna go back to the CapEx. I think the chairman had guided back in 2021 to a hundred billion of CapEx during the 2021 through 2023 period. Now this morning, you're highlighting the fact that CapEx this year could be $40 billion. If I use the hundred billion as a bogey, it suggests to me that your CapEx could be down by as much as 8%-10% in 2023, unless you are raising that hundred billion guide. I just wanna get some color on this, and I have a follow-up.
Okay. Mehdi's first question is on our CapEx. He notes, back in April of 2021, we had guided for $100 billion CapEx in the next three years. Now he's adding the math up for last year and this year, and wondering, does that imply a decline in our CapEx for 2023, or do we have a new revised guidance for the CapEx then?
Okay. Mehdi, let me answer this. We're not going to talk about the $100 billion today. We're not going to comment on CapEx beyond 2022. We've already given the guidance range of 2022. Now, as we mentioned before, every year when we invest in CapEx, it is for the future growth opportunities. As long as we believe the future outlook is good, we will continue to invest in a disciplined manner.
Got it. Just a quick follow-up here. Despite the fact that CapEx was up 76% last year in 2021, your depreciation so far has been tracking flattish. It was flat in Q1 and down 3% in Q2. Should I expect a bigger step-up in depreciation going forward?
Mehdi also wants to follow up to ask about depreciation. Despite the increase in CapEx, why is the depreciation growth pretty flattish or low so far this year? Should we expect a step up in depreciation for 2023?
Mehdi, every year there are new depreciation coming in, but at the same time there are depreciation getting out of the depreciation table. Some comes in, some goes out. This year, we expect the depreciation will grow about mid single digits% from last year. It is slower, lower than when we guided at the beginning of the year because of some tool delivery schedule change, as C.C. mentioned earlier. Now for next year, it's too early to give a specific number, but the depreciation will be much higher than this year.
Okay. Just since everyone has multi-part second question, may I squeeze one quick follow-up?
Well, you have one and a half. I'll let you another half question please, Mehdi, because we still have a few people.
Okay.
On the line.
Thank you.
Yeah.
Sure. I'll make it very quick. When I look at your customers, their inventories are at a 25-year high, and I think everyone is gonna take a look at the seasonality in the second half. I'm just curious, what are the key variables, what are the key metrics or what are the key strategies that you have in place that could mitigate the gross margin downside risk if your customers become more aggressive in inventory correction into next year?
Mehdi's question is noting customer inventory at customers are very high. What would be the key variables or metrics for TSMC to mitigate our gross margin downside or risk if customers were to adjust their inventory further? Is that correct, Mehdi?
Yes. If they become more aggressive in inventory correction into first half next year.
If customers were to become more aggressive on their inventory correction into first half next year.
Well, let me answer the question. As I stated in the remark, you know, our customer are doing the inventory correction, but I said that customers' demand still exceed TSMC's capability to support for this year. Even they do the inventory adjustment or let's say that they decrease their demand versus their original number, TSMC's capacity is still very tight, and we remain very healthy in the utilization. That's why we can keep our gross margin intact. Did I answer your question?
Thank you.
Okay. Thank you, Mehdi. Operator, let's move on to the next participant, please.
Next one to ask questions is Brad Lin from Bank of America.
Hello, good afternoon, everyone. Thank you for taking my question. First, congratulations once again on the strong earnings. My first question is about advanced packaging. We learned advanced packaging is very, very important for TSMC's long-term growth, and TSMC has a great variety of offering to provide higher value to customers.
Would you please share your insight on what the key barriers are for a wider adoption by clients? Would you expect the contribution mix to increase gradually or if there is a point to see an explosive growth on the advanced packaging? By the way, we saw the news about the 3D IC R&D center in Japan, and how will that center accelerate the progress? Thank you very much.
Brad's question is on advanced packaging. I believe if I heard you correctly, what are the key barriers for wider adoption of our packaging solutions by customers? What is the long-term revenue growth outlook of advanced packaging? Is it going to be explosive growth or growth similar to the corporate average? Also the role of our 3D IC center in Japan in developing advanced packaging solutions.
Okay. That's a very long question, but let me answer one by one. First, we developed a very advanced packaging technology to meet the customers' demand. So far today, 3D IC or SOIC we develop for the high-speed performance HPC applications first. The other one mostly starting to be adopted by all HPC customers starting from today. We expect it will gradually ramp up and until that is a 2 nm, I think it will have a much more demand in that technology node for the 3D IC. That's what we expect. We expect the growth of this 3D ICs business will be healthy, probably a little bit ahead of TSMC's growth forecast. Now let me turn to the 3D IC center in Japan.
We established a 3D IC center because of Japan has a fundamental advantage on the raw material also on the packaging area. For example, the substrate. They are the number one in the world, and we need that one technology to complement the TSMC's 3D IC technology, so we can serve our customer better. That's why we are establish a 3D IC technology development center over there. Did I answer your question?
Yes. Very clear. Thank you. Thank you, sir. Maybe another follow-up that's also about the IC substrate. ABF IC substrate currently plays a very important role in the best packaging of course, especially for CoWoS. The substrate area demand potentially enlarges with the increasing advanced packaging penetration. With the rising integration level of a chip, do you expect the new material to potentially replace ABF? Any plan to secure substrate supply or upgrade the design for TSMC for future requirements? Maybe one last follow-up is that if we compare 2.5D and 3D, would you need more substrate for 3D? Thank you.
Well, Brad Lin's second question is on substrates. He wants to know with the development of substrates and the adoption, do we see further developments in terms of new materials? Will we see more substrates used in 3D IC versus 2.5D? And how do we secure the substrate supply?
Well, this one, we are working with the substrate partner. Your question on is on the 2D, 2.5D or 3D, both are important. Let me tell you one further step. We're only interested in the very advanced technology. We're not going to develop any commodity of the substrate technology to compete in the market. No. We are developing for the very high performance computing or very large substrate to support TSMC's customer. That's our purpose.
Okay. Thank you, C.C. Operator, can we move on to the next participant?
Next one to ask questions, Krish Sankar from Cowen and Company .
Yeah, hi. Thanks for taking my question. I have two of them. The first one is, when I look at your full year guidance of 35% revenue growth, it looks like calendar 4Q or the December quarter is gonna be sequentially down more than 10%, and that hasn't happened in a long time. So I'm kind of curious how much of that is driven by demand versus FX?
And then the second question, follow-up is, if I look at your CapEx run rate, the first half is running at about $17 billion, which is below the lower end of your full year guidance. So I'm kind of curious, what are the tool delays that's causing the push-out of CapEx into next year? Is it like EUV? Is it like deposition etch tools? Any color on that would be super helpful. Thank you very much.
Okay, Krish has two questions. First, he's looking at our full-year guidance to grow mid-30s%, and he says this implies a decline in the fourth quarter.
No, I don't think so. We did the calculation. Maybe you can do that again. It's at least up.
Yeah. Krish, I would note that when we talk about mid-30s guidance, as C.C. said, that is in U.S. dollar terms. Okay? And then his second question.
Got it.
Is on CapEx and sort of looking at the CapEx. His question is, we have already said it will be closer to the lower end of the range. He wants to know what is driving the CapEx tool delays. Is it EUV? What types of equipment?
No, I don't think we can go into that kind of details. Some of them got pushed out to next year, as C.C. mentioned. Every year, the CapEx profile can be different quarter by quarter.
Yeah. Okay.
Done. Thank you very much. Thank you.
Okay. Thank you. Operator, in the interest of time, I think we will take questions from the last two participants, please. Let's move on to the next.
Yes. The next one to ask questions, Frank Lee from HSBC.
Thank you. I wanna just ask a question on, I guess the overall profitability and also pricing, because seems like this year we started to see, you know, the, a foundry price increase, and a bit unusual for TSMC. Going into next year, it looks like there's some anticipation of further price increases. At the same time, we're also seeing, you know, potentially inventory correction. Just try to understand the pricing strategy itself. Is this more of a reflection of, perhaps the structural profitability for this cycle being different than the past, or are there any kind of, you know, costs that we're seeing this time that we haven't seen in past cycles?
Okay. Frank's first question is on pricing. He wants to know what is driving our pricing strategy, how do the cost inflation or factors play into it, and really what drives TSMC's pricing.
Yeah. We do not comment on our pricing details. These are the private discussions between us and our customers. Having said that, our pricing is strategic and value driven.
Not opportunistic or cost plus. We work closely with our customers to provide our value, and we will continue to ensure that our pricing reflects our value creations, including technology, ecosystem, and services, and capacity support. By taking all these actions, we believe we can achieve a long-term gross margin of 53% and higher. We do face manufacturing cost challenges, as we mentioned, rising raw materials, utilities, and tool costs, et cetera. Having said that, we still think that the 53% long-term gross margin is achievable, and 53% and higher.
Okay. Frank, do you have a second question?
Okay.
Yeah, sorry.
Yep. Sure. My second question is, you know, I understand, like, you know, the world view on that. Given what you guys just talked about the overall cycle, I know you still have some, you know, the leadership in the advanced side and everything else, but is there a potential domino effect where your customers could see a stronger second half this year in anticipation of price increases, and with the adjustment going into next year that we see some more weakness in the first half, more than anticipated in the first half?
Okay. Well, Frank's second question is, you know, with pricing, could there be a situation where customers, I guess will pull in more of their business to second half this year, and thus we will see a weaker first half next year?
No, we did not see that. We are actually working with our customers, and we try our best to support our customer. As I said, even right now, our capacity remain very tight. You know, the switching between the next year's first quarter and this year's second half, no, we did not see that. Just simply put it.
Okay.
Great. Thank you, Frank.
Thank you.
Operator, can we take questions from the last participant, please?
Yes. The last one to ask questions, Robert Sanders from Deutsche Bank.
Yeah. Hi, thanks for taking my questions. I just have two. The first one is just if you could just discuss how much of next year's revenue is under LTA. The reason I'm asking is because, you know, there are some people in the market thinking that customers may be fearful of pushing out wafers because they may be jeopardizing agreements for next year. Then the second question would be upon the chiplet question, I was just wondering what percentage of 2 nm HPC designs will be using a chiplet architecture. Is it the majority? What's the adoption rate? Thanks.
Okay. Robert's first question is he wants to know how much percentage of revenue do long-term agreements with customers represent for TSMC. Maybe Wendell can address this question.
Yeah. Robert, we don't discuss the details like that. We work very diligently and closely with the customers to plan the capacity, including receiving the prepayments for capacity support. We will continue to work with them to determine the best way to support them going forward.
His second question is on N2. He wants to know for HPC applications on N2, what is the percentage of that may adopt a chiplet architecture approach?
I cannot release the number, but let me assure you that the number of customers using the chiplets in the N2 or the 2 nm technology will start to increase, and that will become a major approach in the 2 nm and the following technologies.
Okay. Thank you, C.C. Thank you, Robert, and thank you everyone. This concludes our Q&A session. Before we conclude today's conference, please be advised that the replay of the conference will be accessible within one hour from now, and the transcript will become available 24 hours from now, both of which you can find available through TSMC's website at www.tsmc.com. Thank you for joining us today. We hope everyone continues to stay healthy and safe, and we hope you will join us again next quarter. Goodbye, and have a good day.