TSMC Q1 23 earnings call: Q2 bottomed out, 3nm mass production coming soon.

Taiwan Semiconductor (TSM) released its Q1 2023 earnings report (ending in March 2023) before the US market opened on the afternoon of April 20, 2023. The highlights are as follows:

A quick comparison of core data versus market expectations for this quarter are:

1. Revenue: TSM achieved $16.72 billion in quarterly revenue, down 16.7% month-on-month and hitting the lower end of its guidance range of $16.7 to $17.5 billion.
2. Gross Margin: The quarterly gross margin reached 56.3%, down 5.9 points quarter-on-quarter, and exceeding the guidance range of 53.5%-55.5%.
3. Business Situation: High-performance computing has become the largest source of revenue, with 51% of 5nm+7nm.
4. Guidance: The revenue guidance for Q2 2023 is $15.2 billion to $16 billion (lower than the market expectation of $16.1 billion), and gross margin guidance is 52%-54% (in line with market expectations of 52.57%).

For more detailed financial information, please refer to Changqiao Dolphin's review "Taiwan Semiconductor: The Strongest Warrior, But also Struggled in the Cycle."

Incremental Information from the Conference Call

1.1 Reasons for Declining Gross Margin: Mainly due to lower production capacity utilization and higher electricity costs in Taiwan. 1.2 Semiconductor Inventory Adjustment: May continue until Q3 of this year and then balance out at a healthier level. For the full year of 2023, the company lowered its forecast for the semiconductor market excluding memory, which is expected to decline by a low single digit while the wafer outsourcing industry is expected to decline by a high single digit. 1.3 Full-Year Revenue for 2023: It is expected that the full-year revenue in 2023 (in US dollars) will decline to a low single digit. The production capacity utilization rate will bottom out in Q2, and growth will come in the second half of the year. 1.4 Progress of 3nm: N3's substantial revenue contribution is expected to begin in 3Q23. In 2023, N3 is expected to contribute a low single-digit portion to our total wafer revenue. 1.5 Global Layout: 1) In Arizona, USA, the first factory is planned to start production of N4 in late 2024; 2) In Japan, a professional technology factory is being established and is scheduled to be put into operation by the end of 2024; 3) In Europe, the possibility of constructing a professional factory for automobile-specific technology is being evaluated; 4) In China, we are expanding our 28nm production capacity as planned to support our customers in China in Nanjing; 5) In Kaohsiung, Taiwan, our factory construction is still ongoing, but we have adjusted our previous plan to expand the 28nm capacity and are currently focusing on expanding capacity of more advanced processes. 1.6 Situation of Each Downstream Area: PC and smartphone demands continue to be weak; automobile demand remains stable, but there are signs that demand will decline in the second half of this year. The demand for AI-related products has recently seen a continuous increase, which is helpful for digesting inventory. The capacity utilization rate of 7nm will gradually recover in 23H2 because N6/N7 processes are still used for HPC and smartphones.

2.1 CFO Wendell Huang:

1Q23 Financial Information for the Quarter:

Revenue decreased 18.7% quarter-on-quarter in New Taiwan Dollar terms and 16.1% quarter-on-quarter in US Dollar terms. The first quarter business was affected by the impact of weak macroeconomic conditions and weak demand in the terminal market, resulting in a corresponding adjustment in customer demand.

Gross margin decreased continuously by 5.9% to 56.3%, mainly reflecting the decline in capacity utilization and less favorable exchange rates, partially offset by stricter cost controls.

Operating expenses amounted to 10.8% of net revenue, lower than our guidance for the first quarter of 12%, mainly due to strict cost controls and lower employee profit sharing.

Operating profit margin was 45.5%, down 6.5% from the previous quarter,

Earnings per share were NT$7.98, with ROE of 27.5%.

Revenue Breakdown by Process:

5nm process accounted for 31% of wafer revenue, and 7nm accounted for 20%. Advanced technology (7nm and below) accounted for 51% of wafer revenue.

Revenue Breakdown by Platform:

HPC accounted for 44%, down 14% quarter-on-quarter.

Smartphones accounted for 34%, down 27% quarter-on-quarter.

IoT accounted for 9%, down 19% quarter-on-quarter.

Automotive products accounted for 7%, up 5% quarter-on-quarter.

DCE accounted for 2%, down 5% quarter-on-quarter.

Balance Sheet:

As of the end of the first quarter, our cash and marketable securities were NT$1.59 trillion or US$52 billion.

Current liabilities decreased by NT$71 billion, mainly due to a decrease in accounts payable of NT$65 billion.

Accounts receivable turnover days decreased by 2 days to 34 days, and inventory turnover days increased by 3 days to 96 days.

Cash Flow and Capital Expenditure:

In the first quarter, we generated approximately NT$385 billion in cash from operations, with NT$302 billion in capital expenditures, and distributed NT$71 billion in cash dividends for the second quarter of 2022. Overall, our cash balance increased by US$4.2 billion to US$139 billion as of the end of this quarter. In US dollar terms, our total capital expenditures for the first quarter amounted to US$9.94 billion.

2Q23 Guidance:

We expect our business in the second quarter will continue to be affected by further inventory adjustments by customers. Based on current business prospects, we expect second-quarter revenue to be between US$15.2 billion and US$16 billion, which represents a continuous decline. According to the exchange rate of 1 USD to 30.4 TWD, assuming a gross profit margin of between 52% and 54%, and an operating profit margin of between 39.5% and 41.5%.

Outlook for 2023:

Gross profit margin: We have set our guidance for Q2 gross profit margin at 53%, mainly due to lower production utilization rates and higher electricity costs in Taiwan. After a 15% rise in electricity prices in the second half of last year 2022, Taiwan's electricity prices rose another 17% starting April 1st this year, which is expected to reduce our Q2 gross profit margin by 60 basis points. We expect the impact of rising electricity costs to continue into the second half of this year and dilute our full-year gross profit margin by about 50 basis points in 2023. Our gross profit margin faces challenges, including declining production utilization rates caused by the semiconductor cycle, increased expansion into overseas factories, and inflation costs, including the rise in Taiwan's utility costs. To manage our profitability in 2023, we will work to improve internal costs while continuing to sell our value. Excluding the impact of exchange rates beyond our control, we continue to predict a long-term gross profit margin of 53%, and even higher is achievable.

Capital budget: Each year, our capital expenditures are used for expected growth over the next few years. As I said before, given short-term uncertainties, we will continue to carefully manage our business and tighten our capital expenditures when appropriate. Nevertheless, we remain committed to supporting customer structural growth. Our rigorous capital expenditure and capacity planning are still based on the long-term market demand. Therefore, we expect our 2023 capital budget to be between USD 32 billion and USD 36 billion.

Given the level of capital expenditures in 2023, we reaffirm that TSMC remains committed to steadily and steadily increasing dividend payments on an annual and quarterly basis. We will continue to work closely with our customers to plan our long-term capacity and invest in cutting-edge and professional technologies to support their growth and bring profit growth to our shareholders.

2.2 CEO C.C.Wei

2.2.1 Market and Industry Outlook:

Three months ago, we expected semiconductor inventory to gradually decrease from 22Q4 and sharply decrease in 1H23. However, due to the macroeconomic environment and weak end-market demand, semiconductor inventory continues to increase to levels far above our expectations. In addition, the recovery of end-market demand in China, which has reopened, is lower than our expectations. As a result, the adjustment of semiconductor inventory may last longer than we previously expected and may continue until the third quarter of this year before rebalancing to a healthier level.

For the full year 2023, we have lowered our forecast for the semiconductor market excluding memory - down in the mid-single digits - while the wafer foundry industry is expected to decline in the high single digits. We expect full-year revenue in 2023 (in US dollars) to decline to mid-single digit percentage, but our business will outperform the semiconductor (excluding memory) and foundry industries, supporting our strong technological leadership and differentiation. Our Q1 revenue was $16.7 billion, close to the low end of our guidance range provided in US dollars.

In 2Q23, we expect our business to continue to be impacted by customer inventory adjustments. We now expect to reduce revenue by about 10% YoY in the first half of 2023, in US dollars, compared to our previous guidance of mid-to-high single digit decline.

Nonetheless, we believe we are experiencing the bottom of the business cycle. We expect the semiconductor industry to gradually rebound in 2H23. With support from customers and new product launches, the SMB business is expected to be stronger in 2H23 than 1H23.

2.2.2 Progress on N3/N3E:

Our 3nm technology is the first production-ready technology in the semiconductor industry. Due to the high demand for N3 from our customers, which exceeds our supply capacity, we expect N3 capacity to be fully utilized in 2023, supported by HPC and smartphone demand.

N3's significant revenue contribution is expected to start in 3Q23. In 2023, N3 is expected to contribute mid-single digit percentage to our total wafer revenue.

N3E will further expand our N3 series, improving performance capability and yield, and providing a complete platform support for HPC and smartphone applications. N3E has been qualified and achieved some accomplishments, meeting the EU's plan. N3E mass production is planned for 2H23. Despite inventory adjustments, we continue to observe high customer participation in N3/N3E.

N2 technology development is progressing well and is expected to achieve mass production in 2025. Our N2 will use nano-sheet transistor structure to provide customers with the best performance, cost, and technological maturity. Our nano-sheet technology has demonstrated excellent effectiveness, and our goal is to provide complete node performance and power advantages to address the growing demand for energy-efficient computing.

In N2 technology, we are seeing high interest and participation from HPC and smartphone customers. When our 2nm technology is introduced, it will be the most advanced semiconductor technology in density and energy efficiency in the industry, further expanding our future technology leadership position.

2.2.3 Global layout:

In Arizona, USA, despite some challenges in obtaining permits, our first factory is planned to commence production of N4 processing technology at the end of 2024.

In Japan, we are building a professional technology factory, which is scheduled to be put into operation at the end of 2024.

In Europe, we are working with customers and partners to evaluate the possibility of building a professional factory for specific automotive technology based on customer demand and government support level. In China, in Nanjing, we are expanding our 28nm production capacity as planned to support our customers in China. At the same time, we continue to invest in Taiwan. Our factory construction in Kaohsiung is ongoing, but we have adjusted our previous 28nm expansion plans and are now focusing on expanding the capacity of more advanced processes, while continuing to comply with all regulations.

Regarding talent development, we are successfully recruiting from top local colleges and universities in the US and Japan. We have employed over 900 American employees in Arizona and over 370 employees in Japan. We also plan to employ over 6,000 employees in Taiwan in 2023. All of our recruitment is aimed at supporting our future growth potential, and we provide extensive training programs for our new overseas employees.

Q&A:

Q1: What are the inventory trends of different departments, and what is the final demand situation, including automotive? Will the capacity utilization rate of 7nm recover?

A1: PC and smartphone demand continue to be weak. Automotive demand remains stable, but there are signs that demand will decline in the second half of this year. AI-related demand has recently seen sustained growth, which helps to digest inventory. The capacity utilization rate of 7nm will gradually recover in 23H2, as the N6/N7 process is still used in HPC and smartphones. In the long run, some specialized technologies such as RF, interconnect, WiFi, etc. will gradually recover, and the utilization rate of 7nm production capacity will be more healthy.

Q2: What is the competitive landscape with IDM companies? What is the outlook for market share?

A2: We usually do not comment on the status of competitors. Our 3nm is the first mass-produced in the industry, and it is the most advanced technology in terms of PPA and transistors. The situation is the same for 2nm, so our leadership position will be maintained, and market share will remain high, similar to the situation when we entered the N5 process.

Q3: How do you consider the incremental impact of AI? Has it been taken into account in performance guidance?

A3: Indeed, the company has recently seen growth in AI-related demand, which helps to digest inventory. The overall trend is very positive, but it is still too early to quantify the incremental impact on the business. chatGPT strengthens the company's advantage in the HPC business, and we have partially incorporated it into our previous CAGR growth expectation of 15-20%. chatGPT is a large language model, and there is no exact growth rate expectation yet, but this reinforces our expectation that high growth will be brought to HPC in the future.

Q4: Regarding the cash dividend policy, with the slowdown in capital expenditures, will you still adhere to the 70% free cash flow policy?

A4: A4: The company aims for stability and continuity in dividend payouts, especially during periods of high capital expenditures. However, when our capital expenditure has yielded returns, our focus shifts to stable growth. The 70% figure serves as a guideline, but if in a certain year the free cash flow is significantly lower than normal, the dividend ratio may be higher than 70%; conversely, if in a certain year the free cash flow is significantly higher than normal, the dividend ratio may be lower than 70%, and the remaining cash flow will be used for future development plans.

Q5: Regarding the details of capital expenditures, in the situation where the supply of 3nm is unable to meet the demand, is there a plan to reuse 5nm equipment?

A5: We have developed a strategy where some N3 tools can be supported by N5 equipment. We have indeed considered this flexibility to fulfill our promise and support our N3 customers as much as possible. Although this may not be enough, we are indeed doing it.

Q6: What are the specific circumstances and considerations regarding the change in plans for the Kaohsiung factory?

A6: The market is constantly evolving, and we currently have a new plan to build a new 28nm factory in Japan. The investment is not only in logical chips, but also in feature processes. At the same time, 28nm has expansion plans in Nanjing and planned production lines in Europe. Therefore, at present, building a 28nm production line in Kaohsiung is not a feasible option from an economic standpoint. Kaohsiung will focus on advancing more advanced processes that have a tighter production capacity.

Q7: Regarding capital expenditures, if there is a rebound in the second half of the year, will there be an upward trend in capital expenditures next year?

A7: As we mentioned before, every year's capital expenditures are used to consider opportunities for the future. Therefore, despite the short-term cyclicality of the industry, we believe that if there are structured long-term demands, there will be opportunities in the future, and we will continue to invest. This is the framework we can provide.

Q8: Will mass production of 2nm begin in 2025 or later? Will it be used for advanced packaging such as SOIC?

A8: The production volume in 2026 will be much larger than in 2025, because 2025 is the first year of mass production. Currently, HPC and smartphone clients are mainly involved in N2. Whether it will be used for Chiplet depends on the clients' products and plans.

Q9: Orders from EUV clients are delayed. Will the company's 2023 capital expenditure approach the lower limit of guidance, and is it possible to reduce capital expenditures in 2024?

A9: We do not comment on specific suppliers, customers, or competitors in terms of this year's capital expenditures. The 320-360 billion US dollar capital expenditure guidance for this year has already been tightened and is appropriate and cautious for now. Discussion of next year's capital expenditures is premature and we will continue to invest if there is a demand for it.

Q10: Regarding the new US bill that discloses a lot of information, how will the company reconcile its own interests with government requirements in situations where some provisions are difficult to accept?

A10: We cannot comment on specific details. We maintain close and continuous communication with the US government so that we can fully understand all the details and provide them with feedback and suggestions. All decisions we make will be based on the best interests of the company.

Q11: Arizona's production line will be mass-produced next year. Considering cost issues, how should we consider pricing premiums in the United States compared to Taiwan?

A11: Indeed, the overall cost in the United States is higher, and some costs, such as construction costs, may increase by 5 times. However, building a factory in the United States represents the company's global expansion, which is valuable to customers, and this value will be reflected in sales. The economies of scale brought about by mass production will ease cost pressures, and the company needs to ensure necessary government support. The company needs to compress costs as much as possible while ensuring substantial revenue to maintain a gross margin of 53% or even higher.

Q12: What kind of support will Japan's new production line receive from the government? What is our expected capital expenditure? How much of it is reflected in the guidance?

A12: The total capital expenditure is $8 billion, with an expected 50% from the government, and production will begin by the end of next year. Government incentives will be based on the progress of the factory we are building. Basically, (government incentives) will be offset by depreciation.

Q13: When it comes to the company's global expansion, how is the future ASP trend considered?

A13: The company's pricing is strategic and long-term. Considering inflation and other factors, costs may increase (especially the costs of overseas factories). The company is addressing cost issues through internal efforts and cooperation with suppliers. We hope that even in these challenging times, we can control them.

Q14: What is the mechanism for reflecting the value of the supply chain? What is the customer feedback?

A14: This is a very specific issue. It should be emphasized that the company's pricing strategy reflects the value of geographical flexibility.

Q15: Regarding capital expenditures, if there is a period of recovery in demand in the second half of this year, how will the company adjust the speed of equipment supply and production capacity?

A15: The company is indeed tightening capital expenditures but also maintaining a certain degree of flexibility. Once demand rapidly increases, the company needs to provide sufficient capacity for customers. The company is preparing for this by cooperating with all suppliers. Considering long-term capital expenditures, we seek to find a balance between rapidly expanding production capacity and contracting capital expenditures. The company believes that demand for AI, 5G, and other things will continue to grow, and the company's business will continue to grow.

Q16: HPC customers include consumer applications, data centers, server applications. How does the company view the development of AI data centers and their impact on HPC businesses?

A16: As mentioned earlier, the company sees positive trends brought about by AI applications, but the incremental growth in the ChatGPT field cannot be quantified yet, and there is not enough data to measure how much it contributes to the company's business. However, this trend is definitely positive. The company has not split up the HPC business as you mentioned.

Q17: Advanced packaging such as 2.5D and 3D is required for HPC, AI, and server applications. What are the prospects for and plans for expanding advanced packaging capacity in the next few years? A17: The growth of advanced packaging in the next 5 years will be slightly higher than the industry average. However, this year (2023) revenue will be lower than last year because of weak customer demand. Last year, this part of the revenue accounted for 7%, and this year it accounts for 6-7%. These days we received calls from customers requesting an increase in packaging capacity, and the company is confirming the evaluation.

Q18: I cannot answer this question directly, but here is a hint: customers are launching new products using 3nm, so our 3nm platform needs to ramp up production capacity quickly. Almost all platforms will see increased demand in the second half of the year, and Q2 production utilization rate will reach the bottom.

Q19: It is difficult to judge where the peak of capital expenditure is, but the forecast for the next five years is that the capital intensity will remain around 35%.

Q20: Regarding N3 capacity, it will be fully utilized this year, and the demand for N3 is greater than expected a year ago, so the company needs to work hard to meet the needs of customers.

Q21: Your observation is correct. AIGC is currently focused on training, but in the future, it will mostly transition to inference. However, regardless of this transition, these activities still require high-performance chips, which is the company's strength. They need efficient, high-speed calculations as support, so the impact of these next few quarters on the company's performance can be seen more clearly.

Q22: The number of the company's overseas factories is increasing, and overseas factories need to have consistent culture and core values with the headquarters. The company needs to ensure that the Taiwan headquarters can provide sufficient support for overseas factories to maintain consistency with the headquarters. It is more important to make overseas factories profitable in the future.

Q23: The cuLitho technology was invented by NVIDIA, and the company is participating in the cooperation. It mainly accelerates computing problems using GPU through software and hardware cooperation, which helps the company to have a deeper understanding of photolithography. The company hopes that it can help us save costs and enhance industry competitiveness.

Q24: At the end of 2022, the amount of equipment being installed and under construction on the company's balance sheet is very high. There is a $40 billion investment, but no revenue has been generated. In 2023, the company will tighten capital spending. Will the amount of this project continue to grow, and will it bring more revenue to the company in 2024? A24: The $40 billion assets under construction are mainly concentrated in N3 and N5, and their capacity is gradually increasing. The number of assets under construction will gradually decrease in the next few years. It's too early to talk about next year's revenue, but as long as there are growth opportunities, the company will continue to invest.

Q25: Can the company quantify the possible impact of subsidies and taxes from the chip bill?

A25: It's still under negotiation and we can't disclose any information at the moment.

Dolphin's research on TSMC and the wafer manufacturing industry

TSMC

April 20, 2023 earnings review: "TSMC: The strongest king, but cannot escape the cycle of ups and downs"

January 12, 2023 conference call: "Inventory adjustment will continue for six months, and growth will have to wait until the second half of the year (TSMC 22Q4 conference call)"

January 12, 2023 earnings review: "TSMC's thunder cannot be stopped despite Buffett adding to his position"

October 13, 2022 TSMC conference call: "Even with impressive earnings, TSMC cannot avoid the industry recession (third quarter conference call)"

October 13, 2022 earnings review: "TSMC: How long can the 'lonely hero' last in the dark night?"

July 14, 2022 TSMC conference call: "How will TSMC sustain growth under the downward semiconductor cycle? (TSMC conference call)"

July 14, 2022 earnings review: "TSMC: The 'alternative' backbone in the wave of order cuts"

April 14, 2022 TSMC conference call: "2nm on the schedule (TSMC conference call)"

April 14, 2022 earnings review: "TSMC: Strong "faith", regardless of the cycle" On April 8, 2022, TSMC's individual stock depth report "TSMC (part 2): discounted prices, unwavering faith" was released; on March 16, 2022, TSMC's individual stock depth report "After the Market Crash, Let's Talk About the Graveyard-Level Foundry King TSMC" was released; on January 13, 2022, TSMC's conference call "What Did the TSMC Management Discuss After Giving Strong Quarterly Guidance?" and TSMC's financial report review "TSMC Is Too Good at What It Does, and the 'Cycle' Is Being Bypassed" were released; on October 14, 2021, TSMC's financial report review "TSMC: The First to Lead the Charge, Still the Leader" was released.

In the semiconductor/wafer manufacturing industry, the comprehensive report on the industry was released on December 29, 2022 "Semiconductor Avalanche? True Resilience Only Comes After the Most Brutal Decline" and on June 24, 2022, the comprehensive report on the industry was released "Canceling Orders, Canceling Orders, Canceling Orders, Is the Semiconductor Industry Going to Have a 'New Era'?".

On September 3, 2021, the comprehensive report on the wafer manufacturing industry was released "Higher Performance vs Lower Stock Prices: Should SMIC and Other Wafer Suppliers Be 'Killed' or 'Wrongly Killed'?", and on July 16 and July 9, 2021, the individual stock depth report for SMIC was released respectively, "SMIC (part 2): The Undervalued Chinese 'Chip'" and "SMIC (part 1): Discussing the 'Chip' Strategy of the Leader".

Risk Disclosure and Statement for this Article: Dolphin Research's Disclaimer and General Disclosure