Good afternoon, everyone. Welcome to TSMC's Q2 2021 Earnings Conference Call. This is Jeff Su, TSMC's Director of Investor Relations and your host for today. To prevent spread of COVID-nineteen, 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: 1st, TSMC's Vice President and CFO, Mr. Wendell Huang, will summarize our operations in the Q2 2021, followed by our guidance for the Q3 of 2021. Afterwards, TSMC's CEO, Doctor. C.
C. Wei Mr. Huang and TSMC's Chairman, Doctor. Mark Liu, will jointly provide the company's key messages. Then we will open the line for Q and A.
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. 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.
Thank you, Jeff. 2nd quarter revenue increased 2.7 sequentially in NT dollar terms or 2.9% in U. S. Dollar term. Our 2nd quarter business was supported by continued strength in HPC and automotive related demand.
Gross margin decreased 2.4 percentage points sequentially to 50%, mainly due to N5 dilution, the slower rate of cost improvement and the absence of positive inventory revaluation. Total operating Expenses slightly increased NT1.47 billion. Therefore, operating margins decreased 2.4 percentage points sequentially to 39.1%. Overall, our 2nd quarter EPS was Nt5.18 and ROE was 27.3%. Let's move on to revenue by technology.
5 nanometer process technology contributed 18% of wafer revenue in the 2nd quarter, while 7 nanometer accounted for 31%. Advanced technologies, which are defined as 7 nanometer and below, accounted for 49% of wafer revenue. Moving on to revenue contribution by platform. Smartphone decreased 3% quarter over quarter to account for 42% of our 2nd quarter revenue. HPC increased 12% to account for 39%.
IoT decreased 2% to account for 8%. Automotive increased 12% to account for 4%, and DCE decreased 12% to account for 4%. Moving on to the balance sheet. We ended the 2nd quarter with cash and marketable securities of TWD 871,000,000,000 On the liability side, current liabilities decreased TWD 14,000,000,000, mainly due to the decrease of KRW 23,000,000,000 in accrued liabilities and others, partially offset by the increase of TWD 6,000,000,000 in dividend payable. Long term interest bearing debt increased by TWD 134,000,000,000, mainly as we raised RMB137,000,000,000 of corporate bonds during the quarter.
Our financial ratios, accounts receivables turnover days increased 2 days to 42 days, While days of inventory also rose 2 days to 85 days, primarily due to M5 wafer prebuilt. Now let me make a few comments on cash flow and CapEx. During the Q2, we generated about TWD 187,000,000,000 in cash from operations, spent TWD 167,000,000,000 in CapEx and distributed RMB65 1,000,000,000 for Q3 of 2020 cash dividend. Short term loans increased RMB4 1,000,000,000, while bonds payable increased by 137,000,000,000. Overall, our cash balance increased 83,000,000,000 to RMB748 1,000,000,000 at the end of the quarter.
In U. S. Dollar terms, Our second quarter capital expenditures totaled US5.97 billion dollars I have finished my financial summary. Now let's turn to our Q3 guidance. Based on the current business outlook, We expect our 3rd quarter revenue to be between $14,600,000,000 $14,900,000,000 which represents a 11% sequential increase at the midpoint.
Based on the Change rate assumption of USD 1 to USD 27.9, gross margin is expected to be between 49.5 percent 51.5 percent, operating margin between 38.5% 40.5%. This concludes my financial presentation. I will turn the microphone over to our CEO, C. C.
Thank you, Wingo. We hope everybody is staying safe And here's it during this time. First, let me start with TSMC's long term growth outlook and investment plan. We are witnessing a structural increase in underlying semiconductor demand as a multiyear megatrend of 5 and HPC related applications are expected to fuel massive increase in computation power and greater need for energy efficient computing, which will require leading edge technologies. COVID-nineteen has also fundamentally accelerated the digital transformation, making semiconductors more pervasive and essential in people's life.
With our technology leadership, manufacturing excellence and customer trust, we are well positioned to capture the structural growth from the fiber industry megatrend With our differentiated technologies, we now expect our long term revenue CAGR from 2020 to 2025 to be near the high end of our 10% to 15% CAGR range in U. S. Dollar terms. In the near term, We continue to observe both short term imbalances in the supply chain, driven by the need to ensure supply security as well as structural increase in long term demand. While the short term imbalance may or may not persist, We expect our capacity to remain tight throughout the year and into 2022, fueled by strong demand for our industry leading advanced and spatial technologies.
For the full year of 2021, We now forecast the overall semiconductor market, excluding memory, to grow about 17%, While foundry industry growth is forecast to be about 20%.
We now
expect for TSMC, we are confident we can outperform the foundry revenue growth and grow above 20% in 2021 in U. S. Dollar terms. To address the structural increase in long term market demand profile. TSMC is working with closely our customer to plan our capacity and investing in leading edge and specialty technologies to support their demand.
Our capital investment decision are based on 4 disciplines that is technology leadership, flexible and responsive manufacturing, retaining customers of trust and earning the proper return. To ensure a proper return from the investment, Both pricing and cost are important. TSMC's pricing strategy is strategic, not opportunistic. At the same time, we face manufacturing cost challenges due to increasing process complexity at leading node, New investment in mature nodes, expansion of our global manufacturing footprint and writing materials and basic commodities cost. Therefore, we are firming up our wafer pricing.
We will continue to work closely with our customers to provide our value. We will also continue to work diligently with our supplier to deliver on cost improvement. By taking such actions, We believe we can continue to earn proper return that enable us to invest to support our customers, of course, and deliver long term profitable growth for our shareholders. Next, Let me talk about automotive supply update. TSMC has actively taken steps throughout the first half of this year, And we will continue to do so in the second half to address the chip supply challenges for our automotive customers.
The automotive supply chain is known and complex, which is own inventory management practices. From chip production to car production, it takes at least 6 months to reach the automotive OEMs with several tiers of suppliers in between. However, we have worked dynamically with other customers to relocate our wafer capacity to support the worldwide automotive industry. In first half of this year, We successfully increased our output for MCUs, one of the key component in automotive semiconductor products, by about 30% as compared to first half twenty twenty. For the full year, we expect We expect to increase output for MCUs by close to 60% over the 2020 level, which also represent about a 30% increase over the 2018 pandemic level.
By taking such actions, we expect the automotive component shortage from semiconductor to be greatly reduced for TSMC customers starting this quarter. Now let me talk about N5 and N4 progress. TSMC's N5 is a foundry industry's most advanced solution with the best PPA. N5 is already in the 2nd year of volume production, which yield were on track. N5 demand continued to be strong, driven by smartphone and HPC applications.
And we expect Yanfai to contribute around 20% of our wafer revenue in 2021. To further enhance our 5 nanometer families of performance, Power and density improvements for the next wave 5 nanometer products, we introduced N4 technology, which is a straightforward migration for Mi M5 with comparable design rules. M4 risk production will begin this quarter and volume production in 2022. Thus, we expect demand for our N5 family to continue to grow in the next several years, driven by the robust demand for smartphone and HPC applications. Finally, I will talk about N3 status.
N3 will be another 4 node scaling from RN5 And why use FinFET transistor structure to deliver the best technology maturity, performance and cost for our customers? Our N3 technology development is on track with good progress. We have developed complete platform support for both HPC and smartphone application on N3. We continue to see a high level of customer engagement N3 and expect more new tape outs for N3 for the 1st year as compared with N5. Rich production is scheduled in 2021 and production will start in second half of twenty twenty two.
Our 3 nanometer technology will be the most advanced foundry technology in both PPA and transistor technology When it is introduced, with our technology leadership and strong customer demand, we are confident The both N5a and N3 will be large and long lasting nodes for TSMC and become important driver of our long term growth. Now let me turn over the microphone to Wendell.
Thank you, Cinci. Let me start by making some comments on our near term demand and inventory. We concluded Our second quarter with revenue of NT 372.1 billion or USD 13,300,000,000 slightly above our guidance, mainly due to better demand from HPC, IoT and automotive related applications than our forecast 3 months ago. Moving into Q3 2021, We expect our business to be supported by strong demand for our industry leading 5 nanometer and 7 nanometer technologies, driven by all 4 growth platforms, which are smartphone, HPC, IoT and automotive related applications. On the inventory side, we expect our fabless customers' overall inventory to exit the Q2 of 2021 at a healthy level.
We expect our customers and the supply chain to gradually prepare higher levels of inventory in the second half of the year as compared to the historical seasonal level, Given the industry's continued need to ensure supply security following supply chain disruptions due to COVID-nineteen and uncertainties brought about by geopolitical tensions. Next, Let me talk about our profitability. Our 2nd quarter gross margin of 50% was slightly below the midpoint of our guidance, mainly due to an unfavorable foreign exchange rate. Our gross margin guidance provided 3 months ago was based on exchange rate assumption of 1 to 28.4, whereas the actual 2nd quarter exchange rate was USD 1 to TWD 28.01. This created about 0.5 percentage point difference in our actual second quarter gross margin versus our original guidance.
In other words, if the exchange rate had maintained at $1 to NT28.4, Our 2nd quarter gross margin would have been 50.5%. Based on the exchange rate assumption of 1 U. S. Dollar to 27.9 percent. We have just guided Q3 2021 gross margin to increase by 0.5 percentage points sequentially to 50.5% at the midpoint, mainly due to better back end profitability.
Despite the rapidly rising depreciation costs and unfavorable foreign exchange rate, we are able to maintain our gross margin at above 50% in both 2nd quarter and third quarter. Although a higher level of capital intensity is necessary in the near term, As we are accelerating our investment pace in anticipation of the strong growth that will follow, We expect to continue to earn a similar level of long term return. Our long term financial objectives remain unchanged. We reiterate the long term gross margin of about 50% is achievable, with operating margin to be about 39% and ROE to be above 20% through the cycle. Now let me make some comments on our cash dividend distribution policy.
TSMC remains committed to a sustainable cash dividends on both an annual and quarterly basis. In June, TSMC's Board of Directors approved the distribution of a TWD2.75 per share cash dividend for the Q1 of 2021, which will be distributed in October 2021. Therefore, TSMC's shareholders will receive a total of TWD10.25 cash dividend per share in 2021. That also means shareholders will receive at least TWD11 per share cash dividend for 2022 and the quarterly cash dividends is expected to be at least TWD2.75 per share. Now let me turn the microphone over to our Chairman, Mark.
Thank you. Thank you, Wendell, And good afternoon, everyone. Today, I will talk about TSMC's global manufacturing footprint. TSMC's mission is to be the trusted technology and the capacity provider for the global logic IC industry For years to come, TSMC always treat our customers as partners. We do not compete with our customers.
We grow our business by unleashing our customers' innovations and enabling their success. We earn our business by providing solid values, by providing industry leading technologies, The world's largest logic capacity and efficient and cost effective manufacturing to our customers, while maintaining trusting relationship with them. In our capital investment, Our responsibility as TSMC Management is to make the best decision in the interest of the company and our customers. For semiconductor infrastructure security has increased in recent years. We are expanding our global manufacturing footprint to sustain and enhance our competitive advantages and to better serve our customers in the new geopolitical environment.
In Taiwan, we are building capacity for N5 and N3 In Tainan Science Park, due to the strong customer demand, we have further expand plan to expand in northern, central and southern science parks in Taiwan. And Taiwan will continue to be the home base and center of R and D for TSMC. As the initial phase of volume production of a leading edge technology has to be in close proximity and closely coupled with R and D fab due to massive collaborative engineering activities. Our leading node will continue to be ramped in Taiwan as well. In the U.
S, we are increasing our presence with an advanced 12 inches semiconductor fab in Arizona, And the progress is well on track with our plan. We are actively in a fast learning phase to optimize the operating efficiency for the U. S. Fab. The first wave of U.
S. Hired engineers arrived Taiwan in late April for training on 5 nanometer technology. Construction of the fab has already begun With equipment moving in, scheduled for second half twenty twenty two, Phase 1 volume production of 20 ks wafer per month Our 5 nanometer technology will begin in Q1 2024. At that time, Our 5 nanometer family will still be the most advanced high volume production technology commercially available in the U. S.
Our customers welcome us to build capacity in the U. S. And pledged their strong support and business commitments. Therefore, we do not rule out the possibility of a second phase of expansion to meet our customers' strong demand. In China, as our fab construction in Nanjing has already completed in 20 17, we have completed the Phase 1 volume ramp in Q3 2020, now reaching 25 ks wafer per month capacity of 16 nanometer technology.
We are further expanding our presence in Nanjing With 28 nanometer technology to support our customers' urgent needs, with volume production beginning in 2nd half twenty twenty two and reaching 40 ks wafer per month capacity by mid-twenty 23. For the long term, we forecast 28 nanometer will be the sweet spot for our embedded memory applications And our structural demand for 28 nanometer will be strongly supported by multiple specialty technologies. Our global manufacturing expansion strategy is based on customer needs, business opportunities, operating efficiencies and the cost economics considerations. While overseas fab are not initially able to match the cost of our Manufacturing operations in Taiwan, we will work with governments to minimize the cost gap to ensure we start with a level playing field. We are working closely with our customers to firm up our wafer pricing to reflect the cost increases and ensure we earn a proper return.
We will work diligently on enhancing our operations and service capabilities and optimize our efficiencies in overseas locations to continue to provide technology leadership with efficient and cost effective manufacturing for our customers. By taking such steps, we believe an expansion of our global manufacturing footprint will enable us to reach global talents, better serve our customers' needs, earn the proper return from our investment and deliver long term profitable growth for our shareholders. Thank you for your attention.
Thank you, Chairman. This concludes our prepared statements. Before we begin the Q and A session, I would like to remind everybody to please Should you wish to raise your question in Chinese, I will translate it to English before our management answers your question. Now let us begin the Q and A session. Operator, can we please proceed with the first caller on the line?
Good afternoon. Thanks for taking my question. Maybe my first question, I would focus on the semiconductor supply and demand. Potentially through next year as well. Could you talk about when do you expect supply and demand to come back into balance?
Do you see a situation where your customers go into a bit of an inventory sometime soon or you think that the structurally higher inventory is something that is likely to last for Much longer period of time than what originally the market thought.
Okay. Gokul, let me summarize your Gokul's first question is on the semiconductor supply and demand outlook. He notes that C. C. Has said our capacity will be tight throughout this year and into 2020.
Sorry, operator, we can hear you. Can you please press mute?
All right.
So let me summarize Gokul's question again on semiconductor supply demand. He's wondering or asking, When do we see supply and demand in the semiconductor coming back into the balance? Is there a risk of an inventory correction anytime soon? And how long can a higher level of inventory continue?
Well, Gokul, let me answer your question. Let's let me share with you our perspective on The shortage right now. The current semiconductor capacity shortage is being driven by both our structural increase in long term market demand and also a short term imbalance in the supply chain Due to uncertainties from COVID-nineteen and political tensions, and that may or may not persist. We do not rule out the possibility of an inventory correction in the future, but we expect our capacity to remain tight throughout this year and extend at least into 2022. But let me share with you also that even Inventory correction to occur, we believe it will be less volatile than previous downturn As the underlying structural megatrend of 5 gs related and HPC application will continue.
Do I answer your question?
Gokul, does that address your first question? And do you have a second question, if so? All right. Operator, I think we have lost Gokul. Maybe we'll move on to the next caller first.
Yes. The next one is Randy Atkins, Credit Suisse. Go ahead, please.
Yes. Thank you. I wanted to ask the question on the trend for cost per transmitter. I'm curious for 5 nanometer and 3 nanometer, how you're seeing continued improvement? And for the customer motivation to migrate, How is that shifting between our performance density and cost versus also increasingly seek out the Back end system level integration.
Okay. Randy, let me summarize your first question. Your first question is on the cost per transistor. Randy wants to know What is the cost present transistor trend at 5 nanometer and 3 nanometer? And also what do I guess, Randy, your question is sort of what are the customers value or evaluate when they look at the technologies as well.
Is that correct?
Yes, right. Between power performance density versus cost and also back end integration.
Okay.
Randy, no, actually, Today, the technology has Getting more complex than the simple scaling. Actually, we work with our customer very closely. And we have been working on the performance and energy efficiency of a technology. And we took several approach, of course, material innovation, transistor structure innovation. We also in recent generations, we worked heavily on the design and technology cooperation.
And also, more recently, we work on the 3DICs. All these innovation combined is to deliver the value for our customer to improve the system performance and the systems power efficiency. And TSMC is at the forefront of delivering this value. And as evidenced by the strong demand and continued technology migration at 5 to 3. So in doing that, we believe we can continue earn a proper return for our investment.
Thank you. Randy?
Okay. My second question, if you could give an update on the 5 nanometer, where there's So some dilution, maybe how much dilution you see in second half? An update on how you see it trending toward the And as we look to next year, if Read and Animator ramping late in the year, Do we see a favorable like a bit more of a sweet spot for profitability as you have a more mature 5 nanometer, but not a new node yet ramping?
Randy, this is Wendell. Let me answer your question. The 5 nanometer contribution to our revenue will be much Higher this year compared to last year. Therefore, we expect that the margin dilution from M5 this year will be between 2 to 3 percentage points. Now we also expect that N5, like previous notes, We'll be able to reach the margin will reach the corporate average in about 7 to 8 quarters.
With respect to 2022, it's a bit too early to talk about it. But we believe Our long term gross margin target of 50% continues to be achievable.
Okay. Thank you, Randy. Operator, can we move on to the next participant on the line, please?
Yes. The next one is Bruce Lu from Goldman Sachs. Go ahead, please.
Hello. Thank you for taking my question. I think a lot of your Customer has like different supply chain management policy now. A lot of your customers find that long term contract with other franchise players with favorable pricing and payment terms. So does TSMC expect this will become the new norm for the Does the industry wide profit pool become bigger and the earning fluctuation will be less in the future?
Okay. Thank you, Bruce. Let me summarize your first question. Bruce's first question is about the semiconductor supply chain. And He's observed that a lot of customers seem to be signing long term contracts with foundries.
So do we expect this to be the new norm in the future? And could this drive a bigger or larger industry wide profit pool?
Okay. Bruce, let me answer the question. We are not able to comment on specific business terms with customers. However, we are working closely with our customers on different ways to secure their commitment. And customers understand our effort to support their growth.
And if we plan our capacity will, based on the structural increase in the long term market demand profile, we believe our utilization and profitability can be maintained.
Okay? Thank you. Bruce, do you have a second question?
Sure. So I want to focus on the automotive. Automotive revenue is roughly less than RMB 2,000,000,000 in 2020 out of like 40,000,000,000 market. So with most of the automotive IDM companies are passive in capacity expansion, This creates a big addressable market for the foundry. So what is the addressable market for foundry in the automotive semi industry In the coming years?
Okay. Bruce, let me summarize your second question. So Bruce is asking about the longer term outlook for the automotive was less than 2,000,000,000 of our revenue last year, but he points out the automotive TAM is about 40,000,000,000. So he's wondering about sort of the long term TAM addressable market for TSMC.
Well, let me answer again. We are quite positive on the long term trend of the semiconductors in semiconductor content in automotive. As the trend towards safer, greener and smarter vehicle will continue to drive silicon content increase as well as demand for advanced and specialty technology both.
Okay. Thank you. Does that answer your question, Bruce?
Can we have somehow like some specific numbers? Can you quantify that a little bit?
We cannot forecast in the future very accurately, right? I mean that's it's so dynamic. But let me assure you the silicon content will be very important and will be increased.
Okay. Thank you.
Thank you, Bruce. Operator, let's move on to the next participant, please.
The next one, sir, ask question, Gokul Hadi Han, JP Morgan. Hello, Gokul Hadi
Han, JP Morgan.
Hello, Gokul Hadi Han.
Thank you very much. Yes, let me ask my second question. My second question is that on your 3 nanometer business, Clearly, the market is expecting you to make a lot more inroads into the HPC segment. 1 of your Existing IDM customers have redoubled their efforts to get back into the foundry business. Could you talk a little bit about how you manage this
kind of
what they call as Competition as well as cooperation. How does TSMC think about this when it thinks about capacity allocation, Given that HPC is now becoming a very important driver for growth and this is probably the biggest HPC customer out there in terms of revenue size. Thank you.
Okay, Gokul, thank you for your second question. Let me summarize. He points out that HPC is seems to become a larger and larger contributor or driver, particularly at our 3 nanometer. He also points out that existing IDM customers are redoubling their efforts. So his question is really how I guess, how do we manage this duality, how do we manage the capacity allocation and the relationship?
Okay. Let me answer the question by first, you mentioned that IDM is our important customer. Let me say that and we are collaborating in some area and might compete in other area. But let me explain again. TSMC is everybody's foundry, and we support all our customers' opening and fairly.
We will allocate the necessary engineering resources to ensure all of our customers' product success, Actually, our capacity planning is based on the long term market demand, and that is underpinned by the by the industry makeup trend. Okay. Does that answer your question, Gokul?
So maybe just one follow-up is, do you require a lot more assurance in terms of Demand, solidity and demand longevity from IDM customers given they are also competing in process technology with you compared to pure fabless.
So Gokul is asking whether that we would require more longer term assurance from our IDM customers versus our fabless customers?
We will
not specifically comment on that I'm with certain customer.
Okay?
Okay. Thank you.
Thank you, Gokul, and sorry for the disruption. All right. Let's move on to the next caller, please.
Next one to ask question Charlie Chan from Morgan Stanley.
Thanks for taking my question. And first of all, I would like to thank TSMC for the donation Of the way back to Taiwan, I think that ensures business continuity of TSMC and also global semi supply chain. And my question is about still your gross margin trend. So first of all, is your 3 d IC or advanced packaging. It seems like Wind mentioned that the back end product possibilities are getting better in 3Q.
I'm not sure You said it's true. So the question is that currently the percentage of advanced packaging of case sensitive revenue And we currently still believe 3 d packaging can still outgrow the wafer business and whether they would Create margin dilution. So the first question is about the 3 d advanced packaging.
Okay. Let me summarize your question, Charlie. You're asking about our 3 d IC business, about our 3 d IC business. Charlie is asking the back end profitability that Windows side did improve in the 3rd quarter. Is this the truth?
And then also sort of the outlook for our 3 d IC business in comparison to our overall business and whether 3 d IC business will dilute our profitability?
Okay, Charlie. First of all, the gross margin that I was talking about improvement of back end service in the 3rd quarter actually It's a seasonal factor. As you know, our back end services has seasonality. So second half Normally has a higher gross margin. But longer term, we expect its margin to continue to improve.
Although, it's Still not as high as a gross margin of our wafer revenue, but it has a lower asset Capital intensity, therefore, the returns from back end services is satisfactory. In terms of the revenue percentage, we expect back end services to account for about 8% of our total revenue this year. And in the next 5 years, we expect it will grow Slightly higher than the corporate average.
Okay. Thank you. Wendell, do you have a second question, Charlie?
Yes. My next question is about the long term Gross margin trend, right, because we did create some debate about how the charge will be higher CapEx intensity, you're bargain power against current vendors and also customers. So really I want to ask this openly To company management, does TSMC believe you has acquired the monopoly Of the eN edge industry, why and why not? And if yes, you do think you have them monopoly, why cannot TSMC charge higher weather price to cover the steep increase of tech intensity. And lastly, if the company were to Need to choose between the margin sustainability and also the market share, what would be your choice?
Okay. Let me summarize your second question, Charlie. So Charlie is asking about the long term gross margin trend and Bargaining Power. And he is wondering, he wants to know whether we see or believe we have a monopoly at the leading edge or not. And if we do, I guess part of your question, Charlie, is then how pricing.
And then also if we have to choose between market share and profitability, how should we choose?
Charlie, Let me answer this question. First, we do have a very high market share on the leading edge technology node, But our pricing strategy is strategic, and we don't take an optimistic approach. And it's far away from you say that we try to bargain in power. In fact, we work with our customer closely, and we want to help them to be successful while we get proper return. That's all I can answer for you for our pricing.
And looking ahead, We continue our practice, trying our best to hear our customer to grow. And we want to get the proper returns, so that's why we are firming up our wafer pricing. And We are confident that we can get our gross margin about 50% or above
participants, please.
The next one, I have a question, Nicholas
Yes. Good afternoon. Thanks for taking my question. Earlier you referred to your expansion of capacity at 28 nanometer in Nanjing for about 15 ks wafers per month. If the demand in trailing edge is effectively structurally higher and tying up to the leading edge, Are we going to see additions in capacity in the trailing edge becoming more of a recurring feature for TSMC As for the rest of the industry going forward.
Thank you.
Okay. Nick, let me try to summarize your first question. So Nick is saying that, As Chairman said, we are expanding our capacity in Nanjing for 28 nanometer. So his question is that, do we see the demand at the trailing edge or the mature nodes becoming structurally higher? And then will we consider or add capacity in those trailing edge nodes?
Okay. This is Mark. Let me answer your question. Our strategy more recently at mature node is to work closely with our customer to develop specialty technology solution. This is not described by the numbers.
Actually, we are leading in many 28 nanometer specialty technologies And we can meet their requirement and create differentiated long term value for them. And we expect This structural demand will continue. And of course, we'll focus on our investment on specialty technology to support that. So for the manufacturing greenfield knows expansion and we do not root it out. We will build case by case as long as economics can justify and customer commitment can be secured.
Okay? Thank you. Nick, you have a second question.
Yes, very quickly. Thank you, Jeff. A clarification effectively. For the investment in the U. S, you said equipment moving in H2 'twenty two and then Production in Q1 'twenty four, it's a reasonably long runway, I guess.
So is that because new fab, you You need to obviously run preproduction when qualification time will be reasonable.
Yes. We make prepared a little bit longer preparation time just because that's a new semiconductor environment for our operations. But of course, we will continue to compress the schedule as much as we can.
Okay.
Thank you.
Thank you, Nick. Operator, can we move on to the next participant, please?
The next one is your question Roland Xie from Citigroup.
My first question is for your Japan R and D center. So it is, say, there are more than 20 Japanese companies will work with you at your 3 d IC IMV center in Japan. So I want to know what are the roles and the responsibilities for Are every party including yourself in this Japan R and D center? And also do you plan to start
Okay. Roland's first question, he wants to know about our 3 dIC Research Center in Japan. There's more than 20 companies involved according to him. So what are the roles and responsibilities of that. And also, will we build a packaging 3DIC, packaging integration facility in Japan?
And will we consider a wafer fab in Japan? So three parts to this question.
Okay, Roland, let me answer your question. First, yes, there's more than 20 membership to join this Japan's 3DIC's Research Center. In fact, what's the role and responsibility, TSMC is in charge of this one. And we also in technology, we also in charge of that integration for all The major partner together to so that we can be successful in the most otherwise packaging technology, which include TSMC's 3DIC and some of our partners In advanced material and our partners are the most advanced substrate technology. Everything put together, which is necessary for the future HPC's application that we needed.
Do we have a plan to mass production in the 3 d IC in Japan? It's not in our current planning yet. Okay. And what's your next question?
And we'll reconfirm
the Wafer fab.
The Wafer fab, we are actually, let me say that We do not rule out any possibility. And in Japan, we are in due diligence process now To do that wafer fab, Let me say that clearly.
Okay. My second question is, Mark Also said that the key concern to build a bank overseas is considering the cost gap. And you are working with the government to cost to support U. S. Priorities.
So will this change U. S. Government plan and lead to fail to close the cost gap
Okay. Let me summarize Roland's second question. It's about our U. S. Fab and The cost gap, he points out that recently there is some discussion for U.
S. Incentives to invest in domestic companies. And so therefore, if this were to be the case, how would that affect TSMC And how would we manage the cost gap?
Okay. Roland, right? This is I think this current band is still developing. You know that in U. S, The originally proposed CHIPS for American Act has gained bipartisan support.
And we are very happy that in the Senate, they passed a bill of U. S. Innovation and Competitive Act already passed in Senate. Right now, it's in the hand of House of Representatives. And we are very optimistic that they will gain bipartisan support.
The reason we the bipartisan support for this is to create a level playing field For the semiconductor fab investment in U. S, so that there will be a renewal fab industry in the U. S. Of course, how well it can be done in operation up to each company to do the operation Well, and we are still learning the cost structure in the U. S.
But in the meantime, In addition to take on this level playing field opportunities And further on, the operating cost will have to be shared with our customers. So that's a part of our firm up price. Firming our pricing, including the increased global Manufacturing footprint. So we believe that Okay.
So pricing firming up will continue.
Yes, Yes. We believe that in that way, we can continue to sustain our profitability as before.
Okay. Thank you.
Thank you, Chairman. Thank you, Roland. Operator, can we move on to the next participant, please?
Next one, we have Laura Chen from KGI.
Hi. Thank you for taking my question. Can you hear me?
Yes, we can hear you, Laura.
Yes. First of all, I just want to ask about our global expansion plan. More details about our expansion trends other than like the advanced node in the U. S. Mark just mentioned that the 20 NRE will be the 3 spots.
So will we expand more other than China or other region, we will consider that. And how would that impact our already announced US100 $1,000,000,000 FEPAS The next 3 years. That's my first question. Thank you.
Okay. Laura, let me summarize your question. Your question is about our global manufacturing footprint. And I think your question is on our mature node. Do we have plans for further expansion of mature nodes in different locations?
And if so, how will this affect our CapEx in the next few years?
Yes. Laura, I think several project is still Under planning, we do not rule out the possibility in Japan. Actually, C. C. Just mentioned that we are in the due diligence process now To have a specialty technology fab in Japan, but of course, the decision is still Too early to disclose because the final decision will base on our customer needs, operating efficiency evaluation and the cost Economics.
So for those projects, we have not included into the $100,000,000,000 CapEx budget.
Okay. Very clear. Thanks. Yes, and my second question is about the 16 12 nanometer. We know that the current The supply is also quite tight and the client demand is very strong in particularly for the RF transceiver, etcetera.
So I'm just wondering, do you also have the plan to expand now 1612?
Okay. And so Laura's second question continues to more specifically on 16 nanometer12 nanometer, the supply continues to be tight, demand is very strong. Do we have any plans to expand at this node?
Well, Laura, let me answer this question. We again, This is kind of mature node for TSMC. And we will expand our capacity We saw the customers' commitment and also We have to consider the economics. And so if everything is positive, And in fact, we will consider to expand the capacity to support our customer actually.
Thank you.
Okay. Thank you, Laura. Operator, can we move on to the next caller, please?
Next one, we have Brett Simpson from RTO Research.
Thanks very much. I had a question on gross margins. I guess you've talked about 50% gross margin as a long term target for quite some time now. And I understand there's been FX headwinds and the 5 nanometer ramp is a headwind. But if I look at your big fabless customers, they are delivering structurally much higher gross margins As a result of access in your leading edge capacity, particularly in the last 12 months when Europe gross margins are going down.
And I'd just like to ask, given your position in the industry, do you really think 50% is an appropriate level of return? And doesn't your position warrant some structural margin expansion at the gross margin level? Thanks.
Okay. Brett's first question is about our gross margin. He notes that, of course, we have been facing headwinds from the foreign exchange rate and also the 5 nanometer ramp, which carries some level of dilution. But he points out that our customers' gross margin is particularly in the last 12 months, it's been structurally higher than ours. So he wants to know, given our position, Do we think 50% is the achievable?
Why would it not be something structurally higher? Is that correct, Brett?
Yes. Really whether it's whether 50% is appropriate level of return, Given everyone else is right, delivering higher gross margins, why wouldn't TSMC Look for structured and high gross margins as well like everyone else.
Right. This is Wendell. Let me answer your question. First, If we look at shorter term, you talked about in the last 12 months, foreign exchange does play a very big role In the gross margin between last year and this year year to date, last year, the dollar against NT rate was 29.43 in average. This year, year to date is 28, somewhere around 28.
That creates a 2 percentage points difference in gross margin, I. E, if the Gross margin I mean, the foreign exchange rate stays where it was last year. We would be having a 52% Gross margin in the 2nd quarter already. And also, I talked about the dilution from The M5 this year, another 2 to 3 points. So with all these negatives, we still can make 3% in 2nd quarter and 3 and the 3rd quarter.
That's the short term. Now longer term, the investment that we are making It's for future business growth. At some point of time, at the beginning, we made The short term as the advanced technology is getting more and more challenging in cost, We are working closely with our customers to firm up the wafer pricing and also working with our suppliers to ensure that the cost improvement can be delivered. And with all these efforts, we still think that 50% is a good target And it's achievable.
Okay. Thank you, Brendon. And maybe just a follow-up. I noticed your China business grew from 6% of sales in Q2 sorry, 6% of sales in Q1 to 11 percent of sales in Q2. Can you talk about some of the drivers that deliver that upside?
And long term, How do we think about China scaling within your business? Do you think we'll get back to sustainably double digit percent of sales? And what would drive that? Thank you.
Okay. So Brett's second question is related to our China business. He notes in the near term that China contribution has gone from 6% in the Q1 to 11%. So he wants to know what is driving this. And then he has a longer term question, which is how should we think about our China business over the next few years?
And can it return or sustain at an improving or double digit level?
Let me summarize it. I think China remains a very strong and growing market. And we have developed a large customer base in China, and we'll work with them to grow our business And expect our business from China will continue to increase in all the market sector That's we're talking about smartphone, HPC, IoT and automotive also.
And also, Brett's question on the improvement from China from 6% in Q1 to 11% in the second quarter. What is driving that?
That's because mainly the HPC platform.
Okay. Thank you.
Okay. Thank you.
Thank you, Brett. Operator, let's move on to the next question.
Next one, we have Charles Hsieh from Megan and Company.
Hi. Thanks for taking my question. Can you guys hear me?
Yes, we can hear you fine, Charles.
So
I want to ask the first question. Really is about your the adoption of your most leading edge node process. Historically, if I understand correctly, your smartphone platform seems to lead the adoption in the past, At least especially in the 1st year of the production ramp. And I think you did say that the high performance computing will becoming Increasingly important. So the question really is about 3 nanometer, which we are about a year away from the mass production.
So could high performance computing from what you see today really play a bigger role or even like the leading role in the first ramp up the 3 nanometer, especially in the 1st year. Do you even see like high performance computing could eventually be like the actual Your lead adopter of the leading edge nodes going forward.
Okay. So Charles, first question is about the drivers of leading node adoption. He notes in the past traditionally has clearly come from smartphones, but HPC also seems to be becoming more important. So his question is On N3, do we expect HPC to play a bigger role in the ramp of N3, particularly in the 1st year? And could N3 become the 1st adopter or primary adopter?
Charles, this is C. C. Wei. Let me answer this one. The entry is the 1st year's ramping up, still smartphone plays the biggest role.
Of course, your observation is correct. HPC application is also important And getting more and more important. And in fact, HPC will be our largest revenue driver in the next 5 years. So in the entry node, in addition to the smartphones, We do expect that HPC's application will become important also. Does that answer your question?
Yes, yes. Excellent. Thank you so much. So maybe the second question, I still want to touch upon your global expansion. I know you probably are tired of answering that already, but forgive me, I'm going to ask another one.
You announced your fab in Arizona, which the technology now will be 5 nanometer. And as I understand, Your 5 nanometer wafers will very likely require your in house advanced packaging solutions like either Info, Cobas or maybe even SOIC going forward. So but your current Packing facilities, as I know, are 100% in Taiwan. And I can imagine that if you are really Outputting wafers from Arizona for 5 nanometer, based on your current footprint, you got to ship those back Taiwan for packaging and send back to your customers, which I can imagine it's like could be a little bit challenging in terms of cost, logistical efficiency. So I'm not going to ask for specific plan, but do you kind of foresee maybe you want to set up advanced packaging
Right. So Charles, shorten your second question, I think Charles is asking, In Arizona, we are building wafer capacity with 5 nanometer. Will we also consider setting up 3 d IC integration capacity or in Arizona as well?
This is Mark, Charlie. I understand your concern, but if you look at the current industry landscape, what you just said is nothing new. Everyone have their wafer produced in one location and packaged in another, even including major chip producer in U. S. So for that matter, we do not see in compose any logistic difficulties.
We just continue to evaluate. And currently, we do not have that 3 d IC fab in Arizona at this point.
Okay. Thank you, Chairman. Thank you. Operator, can we move on to the next caller, please?
Next one, we have Andrew Lu from Bank of Bank of Bank Securities.
Is that me?
Hello, Andrew. You are on the line now.
Okay. Thank you. Thank you for taking my question. My first question is regarding 3 nanometer ramp up for second half, starting from second half next year. I recall the 7 nanometer ramp up in year 2018 Q2 with some revenue contribution And the 5 nanometer in Q2 last year, year 2020, but it seems like 3 nanometers Clearly, there's some delay for second half this next year.
So I want to ask, Is that because of technology difficulty we cannot ramp out in Q2 or we don't have a big customer to use 3 nanometer at beginning stage, that's why we'll push back the ramp up in second half next year. That's my first question. Thank you.
Okay. So Andrew's first question, let me summarize, is asking about our 3 nanometer ramp. He notes that 5 nanometer and 7 nanometer in the past few years basically ramped in the middle of the year. N3, we said the ramp will be in second half next year. So what is the reason behind this?
Andrew, you have a very good observation. And you calculate that So yes, about 3 to 4 months is a delay as compared with 5 nanometer. Yes. 3 nanometer technology actually is very complicated. And in both processing technology And also the customer's product design.
So we work with customer. And finally, we decided to ramp up in the second half of next year. And this is We decided with our customer and we have to best fit their need.
Okay.
Thank you.
Okay. My second question is Recently, we believe AXP, Infineon and Renesys earlier either have some power down outage And also the fire resulting the 2nd quarter or 1st quarter utilization down to almost 0. And recently we are hearing these guys are backing the utilization rate to 100%. The wafer output may start appear in Q4. Most of these companies are leading company in automotive semiconductor, including MCU.
Do we have some concern Once these customers are ramping up their own fab and that will resolve the next year or starting from Q4, The order on automotive semiconductor to us will be reduced, largely reduced. Thank you.
Okay. So Andrew's second question is on automotive. He asked as IDMs ramp up their production in the second half. Are we concerned or do we have concerns that heading into the end of this year or into 2022 that TSMC's automotive customers will greatly reduce their orders to TSMC.
Andrew, this is C. C. Wei again. Let me answer your question. A very short answer is no, we don't have any concern.
The reason is very simple because of We offer the technology and our customer working closely with us. And for some of the technologies, Mostly in the leading edge, not the leading edge, I'm sorry, is 55, 14 nanometer and 28 nanometer that our customer need the TSMC support and the demand will continue to grow. And so We don't worry about that when they bring up Jialfab and then TSMC's demand will be decreased. The answer is no. And it remains very tight and actually very tight in 2022 also.
Okay.
Thank you.
Thank you, Andrew. Operator, can we move on to the next caller, please?
Next one, we have Martin Lau from SSSA. Go ahead, please.
Hello. Hi. Thank you for your time for the business afternoon. The first question relates to politics. I counted you set geopolitical risk 5 times During today's call, and someone mentioned about the vaccine and it seems in Taiwan with vaccine things are getting even more political.
I just wonder For management, how concerned are you with politics? It seems the U. S. Sometimes is fighting against China, Taiwan. And what things have you thought about in to mitigate, if anything, such political risk?
And also, are your customers concerned when COVID happened in Taiwan, when China from time to time threatened a war
Okay. So Martin's question is about politics and geopolitical risks. He notes that geopolitical is talked about more and more. His observation is that vaccines in Taiwan has become political issue as well. So he wants to know how does TSMC manage or mitigate the political risks looking at U.
S, China, Taiwan relations? And do our customers have concerns on things such as the recent increase in COVID or the threat of invasion from China and how does TSMC manage these risks?
Martin, this is Mark. Thank you for asking. First of all, the on the recent COVID situation in Taiwan, I think the confirmed case has dropped. And of course, the current first priority is to get people of Taiwan get vaccinated upon variance keep coming. But I'm really grateful that Us and Yongmin and FastCon come together a humanitarian donation Of 10,000,000 doses of vaccine to the Taiwan government, CDC, Taiwan CDC and be able to vaccinate our people in Taiwan because PSMC's employees inevitably embedded in the Community of Taiwan and that is important.
The reason this could be political in the beginning, But at the end, we completed the contract and we did get support from all sides. So I don't think at the end is as political anymore. Otherwise, this donation wouldn't be successful. In a global sense, the geopolitical Development is continuing. I think this is a challenge for every company.
Every Company's management has to deal with it. And but I think In the new administration from U. S, I think the development It's more predictable, more rule based. So as long as they're rule based, I think it's better for every company to adapt it to. So that Also prompt the talk I have earlier give it earlier that the global manufacturing footprint I need to do an adjustment for our customers.
Our customers in different country, Their infrastructure supply security, semiconductor related infrastructure supply security Maybe come up a higher priority and we do that adjusted to it. But of course, it is the customers' needs that we are adjusting to upon the greater geopolitical development. As to as invasion of China, let me tell you, nobody I mean, everybody wants to have a peaceful Taiwan Strait. And because not only Because it is to every country's benefit, but also Because of the semiconductor supply chain in Taiwan, no one wants to disrupt it. You have a COVID Only a COVID situation already made a major disruption for the global economy.
And I don't think there Any disability in Taiwan Strait is any country we wish to Make it happen. So I'm optimistic on that. Thank you, Martin.
Thank you. Do you have a second question, Martin?
Yes, yes, yes. Can I follow-up with the second one? It's kind of related. You mentioned about global manufacturing. You also mentioned about the need You will maintain your highest Bose Fan technology in Taiwan because of the proximity to R and D.
My understanding is majority of your engineers are from Taiwan. As you go for this global manufacturing, do you can you talk about how you are changing, say, for example, your talent acquisition, like how you try to Get more people outside Taiwan so that maybe over time you can become more manufacturing outside Taiwan. And also Maybe on the Board, I mean, because when I look at the Board, it remains largely Taiwanese. The recent two additions, one is Doctor. Kong, who's My name is Tianzi, who is from Delta.
Do you see also the board maybe changing, become more international Or maybe if I try to put some debate, I have a mainland Chinese on the board. Thank you.
Okay. So Martin's second question is around talent and board composition. Basically with our expanding manufacturing footprint, He wants to know what is our strategy to attract more global talents for TSMC. And his secondary question is also on the Board. His observation is that we the new Board members are primarily only from Taiwan.
So will we consider Board members from other countries?
The question about talent, indeed, I think We have been advocating the talent development in semiconductor field in Taiwan as well as in U. S. I think semiconductor industry talent has been underdeveloped over the past decades. And today, everyone look at the semiconductor as a key economic drivers. So the talents needs to be connected with that.
And in Taiwan, I think we have been advocating the government to set up High end advanced research colleges in across the Taiwan major universities. In the U. S. And also President Biden talked about the semiconductor human infrastructure That is to develop the human talent in semiconductor through the vast investment of the R and Ds. So this is catching up in every place.
And particularly in Taiwan, we get very strong support from the local government to be able to continue to supply talents in Taiwan. As far as the Board member, yes, Delta, E and C has joined a year ago. And more recently, I think this is coming shareholder meeting, we will nominate Rafael Reif, who is the President of MIT, to come to our Board. And we hope that it will go through the blessing of our shareholders. And that is a major increment of our corporate governance, In particularly, in the area of the talent development, we invited share Board members, upon they have a very strong knowledge and experience on the Corporate Governance, and that is we'll continue to look for and without Any differentiation of our personalities?
Okay. Thank you, Chairman. Thank you, Martin. In the interest of time, I think we'll take the questions from the last
The last one to ask question, Chris Sankar from Cowen and Company.
Yes. Hi. Thanks for taking my question. I had 2 of them. The first one, you spoke about investing $300,000,000,000 in CapEx over the next 3 years and how that does not include specialty processing like the ones in Japan.
I'm kind of curious, can you just Be more specific on how much you plan to invest in your U. S, Arizona fab or fab cluster Over the next 3 years in terms of CapEx? And then I have a follow-up.
Okay. So Chris's first question is about our investment in CapEx. Looking at the next 3 years, he wants to know how much specifically we are investing in Arizona?
Okay, Chris. We have announced that the Arizona project will be a $12,000,000,000 project. This was announced last year.
Got it. And can you just elaborate how much you're trying to do it over the next 3 years?
So he wants to Chris is asking how much will we invest in Arizona over the next 3 years?
Yes, JPY12 1,000,000,000.
Next 3.
Next 3. Next 3. Basically, next 3 years is about RMB 8,000,000,000.
Okay. All right.
Perfect. And then
a quick follow-up. Your auto revenues was 4% of total revenue. What technology node is that product over?
Okay. So Chris, your second question is on automotive. It was 4% of our revenue. What particular specific nodes is automotive using?
Chris, I think I have mentioned that automotive's MCU is the biggest one that we have and it's in 55, 40 and 28 nanometer With majority still in 55 and 40. And in the next 2 to 3 years, it will be moved to 28 nanometer. That's in our current plan, and we are working with our customers on that.
Thank you, C. C.
Thank you,
Krish. All right. This concludes our Q and A session. Before we conclude today's conference, please be advised that The replay of the conference will be accessible within 4 hours from now and the transcript will become available 24 hours from now, both of these which will be available through TSMC's website at www.tsmc.com. So thank you for joining us today.
We hope Everyone continues to stay safe and healthy, and we hope you will join us again next quarter. Thank you, and have a good day or good evening.