Taiwan Semiconductor Manufacturing Co Ltd

TWSE:2330

Earnings Call Analysis

TSMC's Revenue and Margin Growth Driven by Advanced Technologies

In Q2 2024, TSMC's revenue grew 10.3% in USD, driven by strong demand for 3- and 5-nanometer technologies, despite smartphone seasonality. The gross margin improved to 53.2%. Operating margin rose to 42.5%, with EPS at TWD 9.56. Advanced technologies (7nm and below) accounted for 67% of wafer revenue. High-performance computing (HPC) grew 28%, making up 52% of revenue, while smartphones fell 1% to 33%. For Q3 2024, TSMC expects continued robust demand and aims for balanced supply and demand by 2025-2026. The company maintains a positive outlook on its future growth opportunities, backed by its advanced 2nm and N16 technology developments set for 2025-2026 volume production.

Strong Financial Performance in Q2 2024

In the second quarter of 2024, TSMC reported a significant revenue increase of 13.6% sequentially in New Taiwan dollars (NTD) or 10.3% in US dollars. Strong demand for 3- and 5-nanometer technologies propelled this growth, though it was slightly offset by smartphone seasonality. Gross margin saw a modest rise to 53.2%, an improvement aided by cost efficiencies and favorable exchange rates but hindered somewhat by the N3 ramp-up. The company's operating margin grew to 42.5%, thanks to the operating leverage and reduced operating expenses which accounted for 10.5% of net revenue down from 11.1% in the first quarter. Overall, TSMC achieved an earnings per share (EPS) of TWD 9.56 and a return on equity (ROE) of 26.7%.

Revenue Breakdown by Technology and Platform

During Q2 2024, TSMC’s revenue from 3-nanometer process technology accounted for 15% of wafer revenue, while the 5-nanometer and 7-nanometer processes contributed 35% and 17%, respectively. Combined, advanced technologies (defined as 7-nanometer and below) made up 67% of wafer revenue. From a platform perspective, High-Performance Computing (HPC) was a standout performer, increasing 28% quarter-over-quarter to make up 52% of TSMC's total revenue – the first time it has surpassed 50%. In contrast, revenue from the smartphone segment saw a slight dip of 1%, contributing 33% to the total. Other sectors like the Internet of Things (IoT), automotive, and DCE saw modest growth, accounting for 6%, 5%, and 2% of the revenue, respectively.

Balance Sheet and Cash Flow

TSMC ended Q2 2024 with a robust cash and marketable securities position of TWD 2 trillion (USD 63 billion). On the liabilities front, current liabilities increased by TWD 23 billion, largely due to a TWD 16 billion rise in accounts payable. Long-term debt saw an uptick of TWD 9 billion following a corporate bond issuance. The company’s accounts receivable turnover days decreased to 28 days, and inventory days reduced by 7 to 83 days driven by higher N3 wafer shipments. Cash generated from operations stood at TWD 378 billion, with capital expenditures (CapEx) of TWD 206 billion and third-quarter dividends of TWD 91 billion, culminating in a cash balance increase of TWD 101 billion, totaling TWD 1.8 trillion at quarter’s end.

Future Guidance and Capital Expenditures

Looking ahead to Q3 2024, TSMC forecasts revenue between USD 22.4 billion and USD 23.2 billion, marking a sequential growth of 9.5% and a 32% year-over-year increase at the midpoint. The company anticipates a gross margin between 53.5% and 55.5% and an operating margin between 42.5% and 44.5%. For the full year, TSMC is revising its revenue growth guidance, expecting an increase slightly above the mid-20s percentage in USD terms. On CapEx, TSMC plans to spend between USD 30 billion and USD 32 billion for 2024, focusing 70-80% on advanced process technologies, 10-20% on specialty technologies, and around 10% on advanced packaging and testing. This revised CapEx plan underscores a commitment to supporting anticipated future growth, particularly in AI-driven demand.

Profitability and Margin Insights

TSMC’s gross margin for Q2 2024 stood at 53.2%, exceeding expectations due to higher capacity utilization. The company projects a further increase to 54.5% in Q3, facilitated by improved cost structures and productivity, despite continued expenses from the N3 ramp. Long-term, TSMC is confident that a gross margin of 53% or higher is sustainable despite overseas expansions potentially diluting margins by 2-3 percentage points in the coming years. Advanced packaging gross margins, previously below corporate average, are approaching the average due to economies of scale and cost efficiencies.

Technological Advancements and Capacity Expansion

TSMC is actively addressing the strong demand for advanced technologies such as 3-nanometer and 5-nanometer nodes, driven by AI and high-end smartphones. The company aims to double its CoWoS packaging capacity yet again in 2025, reflecting continuous efforts to meet growing customer needs. The anticipated N2 and A16 nodes are expected to significantly contribute to future revenue streams, with customers rapidly shifting to these power-efficient technologies. Despite tight current capacities, TSMC is committed to expanding its production capabilities to support this transition.

Strategic and Geopolitical Considerations

TSMC addresses geopolitical risks through strategic capacity expansion in regions like Arizona and Kumamoto, with potential future expansions in Europe. The company remains steadfast in its approach, not altering its original expansion plans despite geopolitical tensions. TSMC reassures investors that it continues to align its strategies with long-term market demands and geopolitical realities.

Earnings Call Transcript 2024-Q2

[Jeff Su, executive]

[Foreign Language] Good afternoon, everyone, and welcome to TSMC's Second Quarter 2024 Earnings Conference and Conference Call. This is Jeff Su, TSMC's Director of Investor Relations and your host for today. Today's event is being webcast live through TSMC's website at www.tsmc.com, where you can also download the earnings release materials. [Operator Instructions]

The format for today's event will be as follows: first, TSMC's Senior Vice President and CFO, Mr. Wendell Huang will summarize our operations in the second quarter 2024, followed by our guidance for the third quarter 2024. Afterwards, Mr. Huang and TSMC's Chairman and CEO, Dr. C. C. Wei, will jointly provide the company's key messages. Then we will open both the floor and the line for the Q&A session.

As usual, I'd like to remind everybody that today's discussions may contain forward-looking statements that are subject to significant risks and uncertainties, which could cause actual results to differ materially from those contained in the forward-looking statements. Please refer to the safe harbor notice that appears in our press release. And now I would like to turn the microphone over to TSMC's CFO, Mr. Wendell Huang, for the summary of operations and the current quarter guidance.

[Jen-Chau Huang, executive]

Thank you, Jeff. Good afternoon, everyone. Thank you for joining us today. My presentation will start with the financial highlights for the second quarter of 2024. After that, I will provide the guidance for the third quarter 2024. Second quarter revenue increased 13.6% sequentially in NT or 10.3% in U.S. dollars, as our business was supported by strong demand for our industry-leading 3- and 5-nanometer technologies, partially offset by the continued smartphone seasonality. Gross margin increased 10 basis points sequentially to 53.2%, mainly reflecting cost improvement and a more favorable foreign exchange rate, partially offset by the margin dilution from N3 ramp. Due to the operating leverage, total operating expense accounted for 10.5% of net revenue as compared to 11.1% in the first quarter. Thus, operating margin increased 0.5 percentage points sequentially to 42.5%. Overall, our second quarter EPS was TWD 9.56 and ROE 26.7%. Now let's move on to revenue by technology. 3-nanometer process technology contributed 15% of wafer revenue in the second quarter, while 5-nanometer and 7-nanometer accounted for 35% and 17%, respectively. Advanced technology, defined as 7-nanometer and below, accounted for 67% of wafer revenue. Moving on to revenue contribution by platform. HPC increased 28% quarter-over-quarter to account for 52% of our second quarter revenue, surpassing 50% for the first time. Smartphone decreased 1% to account for 33%. IoT increased 6% to account for 6%. Automotive increased 5% to account for 5% and DCE increased 20% to account for 2%. Moving on to the balance sheet, we ended the second quarter with cash and marketable securities of TWD 2 trillion or USD 63 billion.

On the liability side, current liabilities increased by TWD 23 billion, mainly due to the increase of TWD 16 billion in the accounts payable. Long-term interest-bearing debt increased by TWD 9 billion mainly as we raised TWD 12 billion in corporate bonds. On financial ratios, accounts receivable turnover days decreased by 3 days to 28 days. Days of inventory decreased by 7 days to 83 days, primarily due to higher N3 wafer shipment. Regarding cash flow and CapEx. During the second quarter, we generated about TWD 378 billion in cash from operations, spent TWD 206 billion in CapEx and distributed TWD 91 billion for third quarter '23 cash dividend. Overall, our cash balance increased TWD 101 billion to TWD 1.8 trillion at the end of the quarter. In U.S. dollar terms, our second quarter capital expenditures totaled TWD 6.36 billion.

I 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 USD 22.4 billion and USD 23.2 billion, which represents a 9.5% sequential increase or 32% year-over-year increase at the midpoint. Based on the exchange rate assumption of USD 1 to TWD 32.5, gross margin is expected to be between 53.5% and 55.5%, operating margin between 42.5% and 44.5%. This concludes my financial presentations.

Now let me turn to our key messages. I will start by talking about our second quarter '24 and third quarter '24 profitability. Our second quarter gross margin was 53.2%, slightly ahead of the high end of our guidance, mainly as we saw a higher-than-expected overall capacity utilization rate as compared to our forecast 3 months ago. We have just guided our third quarter gross margin to increase by 1.3 percentage points to 54.5% at the midpoint. This is primarily due to the higher overall capacity utilization rate in the third quarter and better cost improvement efforts, including productivity gains, partially offset by continued dilution from N3 ramp-up, N5 to N3 tool conversion costs and higher electricity prices in Taiwan. Excluding the impact of foreign exchange rate, of which we have no control over and factoring in the margin impact from our global manufacturing footprint expansion plans, we continue to forecast a long-term gross margin of 53% and higher is achievable.

Next, let me talk about our 2024 capital budget. Every year, our CapEx is spent in anticipation of the growth that will follow in the future years, and our CapEx and capacity planning is always based on the long-term market demand profile. As the strong structural AI-related demand continues, we continue to invest to support our customers' growth. We are narrowing the range of our 2024 capital budget to be between USD 30 billion and USD 32 billion as compared to USD 28 million to USD 32 billion previously. Between 70% and 80% of the capital budget will be allocated for advanced process technologies. About 10% to 20% will be spent for specialty technologies, and about 10% will be spent for advanced packaging, testing, mass-making and others. At TSMC, a higher level of capital expenditures is always correlated with the higher growth opportunities in the following years. Now let me turn the microphone over to C. C.

[C.C. Wei, executive]

Thank you, Wendell. Good afternoon, everyone. First, let me start with our near-term demand outlook. We concluded our second quarter with revenue of USD 20.8 billion, above our guidance in U.S. dollar terms. Our business in the second quarter was supported by strong demand for our industry-leading 3-nanometer and 5-nanometer technologies, particularly offset by continuous smartphone seasonalities. Moving into third quarter 2024. We expect our business to be supported by strong smartphone and AI-related demand for our leading-edge process technologies.

Looking at the full year 2024, we forecast the overall semiconductor market, excluding memory to increase by about 10%, which is unchanged from our forecast 3 months ago. At this time, we would like to expand our original definition of foundry industry to foundry 2.0, which also includes packaging, testing, mass-making and others and all IDM, excluding memory manufacturings. We believe this new definition better reflects TSMC's expanding addressable market opportunities in the future. However, I want to emphasize here that TSMC will only focus on the most advanced back-end technologies which help our customers in leading-edge product. Under this new definition, the size of the foundry industry was close to USD 250 billion in 2023 as compared to USD 115 billion under the previous definition.

With our new definition, we forecast the foundry industry growth to be close to 10% year-over-year in 2024. TSMC's share of the foundry industry under our new definition was 28% in 2023, supported by our strong technology leadership and broader customer base, we expect this one to further increase in 2024. Over the past 3 months, we have observed strong AI and high-end smartphone-related demand from our customers as compared to 3 months ago, leading to increasing overall capacity utilization rate for our leading edge 3-nanometer and 5-nanometer process technologies in the half of 2024, thus we continue to expect 2024 to be a strong growth year for TSMC. We are raising our full year guidance and now expect our 2024 revenue to increase slightly above mid-20s percent in U.S. dollar terms.

Next, I will talk about TSMC's capacity planning process and investment disciplines. This is important especially when we have such high forecasted demand from AI-related business. TSMC's ambition is to be the trusted technology and capacity provider for the global logic IC industry for years to come. The continued surge in AI-related demand supports a strong structural demand for energy-efficient computing. As a key enabler of AI applications, the value of our technology position is increasing as customers rely on TSMC to provide the most advanced process and packaging technology at scale in the most efficient and cost-effective manner. As such, TSMC employs a disciplined framework to address the structural increase in the long-term market demand profile underpinned by the industry megatrend of AI, HPC and 5G. We work closely with our customers to plan our capacity.

We also have a rigorous and [ rollout ] system that evaluates and judges market demand from both a top-down and bottom-up approach to determine the appropriate capacity to build. Our capital investment decisions are based on 4 disciplines, that is technology leadership, flexible and responsive manufacturing, retaining customers' trust and earning a sustainable and healthy return. To ensure a proper return from our investment, both pricing and costs are important. TSMC's pricing strategy is strategic, not opportunistic to reflect the value that we provide. Today, we are investing heavily in leading-edge, specialty and advanced packaging technologies to support our customers' growth and enable their success. If customers do well, TSMC should do well.

For example, we are happy to see many of our customers structure profitability improving in these past few years. At the same time, we faced rising cost challenges due to increasing project complexity, a leading node, higher electricity costs in Taiwan, global fab expansion in higher cost regions and other cost inflation challenges. And therefore, we will continue to work closely with our customers to see our value. We will also work diligently with our suppliers to deliver on cost performance. We believe such actions will help TSMC earn a sustainable and healthy return so that we can continue to invest in technology and capacity to support our customers' growth and fulfill our mission as a trusted foundry partner while delivering profitable growth for our shareholders. Finally, I'll talk about our N2 status and N16 introduction. Our 2-nanometer and N16 technologies, this is an industry in addressing the sensible need for energy-efficient computing and almost all the AI innovators are working with TSMC. We expect the number of the new tape-outs for 2-nanometer technologies in its first 2 years to be higher than both 3-nanometer and 5-nanometer in their first 2 years. N2 deliver full node performance and power benefit which 10 to 15 speed improvement at the same power or 25% to 30% power improvement at the same speed and more than 15% chip density increase as compared with N3E.

N2 technology development is progressing well with device performance and yield on track, all ahead of plan. N2 is on track for volume production in 2025 with a ramp profile similar to N3. With our strategy of continuous enhancement, we also introduced N2P as an extension of our N2 family. N2P features a further 5% performance with -- at the same power or 5% to 10% power benefit at the same speed on top of N2. N2P will support both smartphone and HPC applications and volume production is scheduled for the second half 2026. We also introduced N16 as our next nano chip-based technology, featuring super power rail or SPR, as a separate offering. TSMC's SPR is innovative, best-in-class backside power delivery solution that is the first in the industry to incorporate a novel backside contact scheme to preserve gate density and device with flexibility. Compared with N2P, N16 provides a further 8% to 10% speed improvement at the same power or 15% to 20% power improvement at the same speed and additional 7% to 10% chip density gain. N16 is best suited for specific HPC product with complex signal route and dense power delivery network. Volume production is scheduled for second half 2026. We believe N2, N2P, N16 and its derivatives will further extend our technology leadership position and enable TSMC to capture the growth opportunities well into the future. This concludes our key messages, and thank you for your attention.

[Jeff Su, executive]

Thank you, C. C. Thank you, Wendell. This does conclude our prepared remarks. [Operator Instructions] Now we will begin the Q&A session. I would like to take the first few questions from the floor, then we will go on to the call. So let's begin.

[Jeff Su, executive]

The first question, we please take from Gokul Hariharan from JPMorgan.

[Gokul Hariharan, analyst]

Thanks for giving us the picture in terms of how you are planning future capacity. Just on AI accelerator and related capacity both front end and advanced packaging, clearly, every customer is queuing up at TSMC for capacity. I think last time we talked about this maybe a couple of quarters back, C. C., you mentioned we expect to see supply to kind of reach balance -- supply/demand to reach balance by end of this year. Just wanted to see what is your current remark. How do you think about supply/demand balance for AI accelerator and CoWoS advanced packaging capacity? And I think in your symposium, you talked about 60% CAGR, compounded growth for CoWoS capacity in the next 4, 5 years. Could you talk a little bit about how much capacity for CoWoS would you be planning to build next year as well? Like last year, you said you're going to be doubling the capacity this year. Now that we are in the middle of this year, maybe can we get a view on what is the capacity expansion for next year? That's my first question.

[Jeff Su, executive]

Okay, Gokul. All right. For the benefit of the audience online and in person, please allow me to kind of try to summarize your question. So Gokul's question, first of all, he understands and appreciates TSMC's disciplined framework in terms of looking at how to build capacity. His question is that it seems that everyone today, AI accelerators and advanced packaging is queuing at TSMC to ask for capacity. So his question is, when do we, C. C., expect supply/demand to reach a balance both for the accelerator side? And then for the CoWoS. At the symposium, we said CoWoS capacity will grow at a 60% CAGR the next few years. He also wants to know what are we planning to build or increase for 2025 CoWoS.

[C.C. Wei, executive]

Gokul, I also tried to reach the supply and demand balance, but I cannot today. The demand is so high. I had to work very hard to meet by customers demand. We continue to increase. I hope sometime in 2025 or 2026, I can reach the balance. You're talking about the CAGR of gross increase of the CoWoS capacity. Now it's out of my mind. I mean we continue to increase whatever, wherever, whatever I can, okay? The supply continues to be very tight all the way to probably 2025 and hope it can be eased in 2026. That's today's situation.

[Gokul Hariharan, analyst]

Any thoughts on next year capacity? Like are you going to double your capacity again next year for CoWoS?

[C.C. Wei, executive]

The last time I say that this year, I doubled it, right, more than double, okay? So next year, if I say double it, probably, I will answer your question again next year, and say more than double, okay? We're working very hard, as I said, wherever we can, whenever we can.

[Gokul Hariharan, analyst]

My second question is regarding gross margins. I think second half guidance already seems to be better than what originally we were thinking that gross margin could drop in second half, but looks like it's actually going up. And it looks like a lot of the headwinds on gross margin is coming in this year. So how should we think about gross margin looking forward for TSMC? Are we going to get back to the high 50%, 60% gross margin that we saw in 2022, given that you got -- you're selling more of your value, you have some of the N3 tailwinds in terms of yield improvement coming through? Into that, I will also ask how should we think about impact of subsidies and ITC credits as you start ramping your overseas locations? How does that impact cost and gross margin? Because there's also some subsidies coming in and currently, TSMC is mostly talking about gross CapEx and gross spend.

[Jeff Su, executive]

Okay. So let me summarize Gokul's second question is around gross margin and profitability. He notes second half '24 gross margin seems to be better than the expectation. So his question is really, how should we think about gross margin in the next several years? He notes as we said, we will sell our value and the dilution of N3 will gradually reduce. So where can the gross margins go back to a high 50s or 60% that kind of level that we saw a few years ago in 2022. Maybe that's the first part of his second question. I'll stop here, then I'll get to the second.

[Jen-Chau Huang, executive]

Sure. Gokul, let me share with you some of the puts and takes on gross margin 2025 and a little bit beyond that. You already talked -- there are positives and there are negatives. You already mentioned a positive will be a decrease in dilution from N3. We're selling our value, and we continue to drive down our costs, increase the productivity. That is -- we are very good at that. On the other hand, let's use N5 conversion to N3 as an example. We are not ruling out the possibility of further converting more N5 to N3 because we're seeing very strong demand for N3 if we decided to do that, of course, there will be a negative impact on the year that we do that. But in the future years, that will be beneficial.

We continue to face cost challenges, inflation cost challenges, including electricity prices, et cetera. And also, we are beginning the production overseas fab, 2 overseas fabs next year. the Phase 1 of Arizona fab and Phase 1 of the Kumamoto fab. We expect that the overseas fabs will dilute our gross margins by between 2 to 3 percentage points next year and in the next several years. So those are the puts and takes to give you the concept. However, we've taken all that into considerations with our efforts in managing cost fab especially between the overseas fab in Taiwan, we're repeating and confident to say that 53% and higher gross margin is achievable. So I think that's the first part of your question.

[Gokul Hariharan, analyst]

Yes, that's right.

[Jeff Su, executive]

And then maybe also just Gokul asked if it's possible to get back to the high 50%, 60% level that we saw in 2022?

[Jen-Chau Huang, executive]

Yes, if we have a very high utilization rate, everything else stays the same, possible.

[Jeff Su, executive]

And then okay. And then the second part of his question was what is the impact from the different government incentives, including the CHIPS Act, ITC credits in the U.S., et cetera, to the financials and also, I think, partly gross CapEx and net CapEx.

[Jen-Chau Huang, executive]

Generally speaking, when subsidies are received, then you see that on the cash flow statement, it will be used to offset the asset value that will be on the balance sheet. When this fab begins to production, the P&L impact will come in. So generally speaking, it's like that. Different government has different approach in providing the grants. So that's a different story. But you can look at our financial statements, there will be actual subsidy received in the period of previous quarter and previous year. For example, 2023, we received a total subsidies of slightly higher than USD 1.5 billion equivalent, and we received that mainly in Japan. Yes.

[Jeff Su, executive]

Okay. All right. Great. Let's move on. We'll take the next one from Charlie Chan from Morgan Stanley and then we'll go to Bruce Lu from Goldman.

[Charlie Chan, analyst]

So I have -- my first question is really about your progress of selling the value. I'm not sure what's the progress, and do you think for next year, your leading edge capacity is going to be in shortage? If that's the case, whether that increases your chance to sell more value to your customers?

[Jeff Su, executive]

Okay. So Charlie's first question is around pricing, and he wants to understand the progress of, I guess, selling our value. And also next year, looking at next year, particularly for the leading-edge nodes, do we expect that in terms of the demand to be very full.

[C.C. Wei, executive]

Charlie, this kind of pricing strategy is very strategic. You are asking me about the status, so far, so good. And we are continue -- this is an ongoing and continuous process. We are continuing to share our value. And by the way, my customer are doing very well also, okay? You knew that. So we should do well also.

[Charlie Chan, analyst]

Yes, so that is actually my follow-up question on this first question. For different segments, for example, HPC customers are doing very, very well. But for smartphone customers probably more sensitive to the cost. Do you expect the kind of difference of kind of value increase for different customers, even at a same node?

[Jeff Su, executive]

So Charlie is asking how will we do the pricing? Will it be different between, for example, an HPC customer versus a smartphone customer at the same node? And also his question earlier was, do we expect the demand for the leading nodes to be very high next year?

[C.C. Wei, executive]

I think the pricing is strategic. So it won't be flat for average product sector. So it will be different, okay? That all I can share with you. And all my customers, they are looking for leading-edge as a capacity for the next few years, and we are working with them. And so far, we try our best to support them, both in pricing and in capacity.

[Charlie Chan, analyst]

And second topic is definitely over the past 2 days, there is a geopolitical risk, right? So Mr. Donald Trump talked about maybe a few years ago, right, Taiwan/TSMC took 100% chip business from U.S.. So congrats on the bounce back pretty high market share. However, the concern is growing, right, that the U.S. continues to depend on our Tainan, TSMC and the chip production. So our question is for shareholders, right, how TSMC is going to mitigate this potential geopolitical risk? For example, whether you are going to further expand your U.S. capacity or even share the ownership, right, with the U.S. government? And maybe a technical question to Wendell, for today, right, if we are shipping a chip to the U.S. customers, do we need to pay for the U.S. tariff?

[Jeff Su, executive]

Okay. Sorry. So Charlie's second question is around sort of overseas expansion and geopolitical risk. He notes the comments from former President Trump a few days ago that Taiwan semiconductor has taken 100% of the business. So his question is really how does TSMC plan to mitigate the geopolitical risk? Does this include expanding capacity overseas, particularly in the U.S.? Would we consider -- I think part of his question was some JV or joint investments, whether with government or whether with partners. And the last question, I think, was more for Wendell about the tax or the tariffs, so to speak.

[C.C. Wei, executive]

Okay, Charlie. So far, we did not change any of our original plan of expansion of our overseas fab. We continue to expand in Arizona, in Kumamoto and maybe future in Europe. No change to our strategy. We continue our current practice. You mentioned about the JV, no. Okay.

[Jen-Chau Huang, executive]

On the tariff, not that we know of. Normally, if there's an import tariff, the customers will be responsible for that, but no discussion, nothing.

[Jeff Su, executive]

Okay. Thank you, Charlie. All right. We'll take the next question from Bruce Lu from Goldman Sachs in the front, then we'll move online.

[Zheng Lu, analyst]

All right, my question is that, why don't we take up our gross margin or structure profitability target? I mean TSMC has been saying for selling your value for past couple of quarters without changing the margin target, i.e., most likely you are passing through all the costs. But please, I can recall in 2021, I mean, TSMC do raise the gross margin target by then because to support the future growth with more R&D, as the technology continues to be enhanced and more difficult and one of your customers and this is supportive that to suggest that you should charge even more. So my question is that why is that you don't raise your gross margin target when you are trying your -- when you try to sell your value, which we believe we deserve much higher value.

[Jeff Su, executive]

Okay. So thank you, Bruce. So Bruce's first question is about profitability and value. Bruce seems to agree that TSMC is providing value to our customers. He also notes in 2021, indeed, a few years ago, our gross margin target, long-term gross margin target was about 50%, and we're able to increase that to 53% and higher. So his question is really with everything that is going on today with the value of our technology, enabling our customers more and more, why doesn't TSMC increase or revise up our long-term gross margin target from the current 53% and higher? Is that the essence?

[Zheng Lu, analyst]

Yes.

[C.C. Wei, executive]

Bruce, thank you for recognizing TSMC's value. I'm working with our customer. As I said, this kind of pricing is strategic. And certainly, we want to sell our value. Changing the target in -- at this moment, I think I would like to emphasize 53% and higher, please put more attention to and higher. The number, I'm not going to change it at this time. When I have more conversation with my customer and discuss with them, and I probably will give you and higher portion, okay? Thank you.

[Zheng Lu, analyst]

Okay. My next question is for advanced packaging. So management used to mention that Advanced Packaging margin was lower than the corporate average, but with higher ROEs. But given the recent progress for the CoWoS and everything, do we see a much better profitability for the CoWoS? And given that it's so difficult to expand the capacity, are you planning to work with more partners to increase your CoWoS supply, which will solve your current supply and demand issues?

[Jeff Su, executive]

Okay. Thank you, Bruce. So Bruce's second question is around advanced packaging. Part of it is in terms of the profitability. He notes we used to say, which is true, it's lower than the corporate average profitability but can earn a similar return or ROE, but his question is now with more and more CoWoS demand and greater scale is the profitability of advanced packaging, I think, approaching or at or above the corporate average? And also, given the tight supply, would we consider to work with more partners to help increase the capacity for CoWoS to support our customers' growth.

[C.C. Wei, executive]

You are right, for advanced packaging, the gross margin used to be much lower than the corporate average. Now it's approaching corporate average. We are improving it that's because of scale of the economics, and we put a lot of effort to reduce our cost. So gross margin is greatly improving in these 2 years. As for the working with OSAT partners, yes, we are doing it because of -- I just answered the question whether the CoWoS capacity is enough or not? Is not enough. And in great shortage, and that limited my customers' growth. So we are working with our OSAT partner and trying to give more capacity to my customer so that they can grow here. And so the TSMC's wafer can be sold here. Okay.

[Jeff Su, executive]

Okay. Thank you, C. C. Thank you, Bruce. Operator, can we move to the first participant online for their -- his or her questions, please?

[Operator]

Yes. The first one, we've got Brett Simpson, Arete.

[Brett Simpson, analyst]

Yes. My question was really about your capacity plans for the next nodes at N2, including A16. We're hearing that AI chipmakers are looking to migrate more aggressively from N-1 to the leading edge, particularly due to backside power because they're trying to lower their power budgets going forward. So my question, can you support this move? And if so, should we be expecting N2, A16 to be structurally a much bigger node than we've seen in the past few nodes?

[Jeff Su, executive]

Okay. Brett, thank you. So Brett's first question is on capacity planning, particularly at the leading-edge N2 and A16. So he notes rightly that AI customers are migrating aggressively from N-1 in the past to the most leading node. He notes particularly A16 driven by the interest in backside power. So his question is can we support this move in terms of capacity to support the customers and also whether thus N2 and A16 will be a much bigger node than our notes in the past?

[C.C. Wei, executive]

Brett, you are right. All the people want to move into kind of a power-efficient mode. And so they are looking for the more advanced technology so that they can save power consumption. And so a lot of my customers want to move into N2, N2P, A16 quickly. We are working very hard to build the capacity to support them. Today, it's a little bit tight, not a little bit, actually, today is very tight. I hope in next year or the next 2 years, we can build enough capacity to support this kind of demand. Today, yes, we are working hard to support them. And enough? Not yet, but we are working hard to get it.

[Jeff Su, executive]

Does that answer your first question, Brett?

[Brett Simpson, analyst]

Okay. Yes, that's great. My follow-up question was for Wendell. I wanted to just dig into the gross margin dilution from N3, where is that at today? And does the introduction of N3E structurally improve your N3 returns? I guess N3 is less capital intensive. There's less EUV layers, so I'm keen to understand that this drives better economics for TSMC, particularly as you start to ramp more N3 capacity in the second half of this year?

[Jeff Su, executive]

All right. Thanks, Brett. So Brett's second question is on the gross margin dilution from N3. He notes that N3E uses less EUV layers, less capital intensity. So his question is, as we ramp N3 more and more, does N3E structurally improve the returns in gross margin of N3 as a whole.

[Jen-Chau Huang, executive]

Okay. Brett, we don't break it down between the different nodes within the family. But I can share with you, overall speaking, as we said before, N3E takes a longer while to reach the copper mark. In the past, it was about 8 to 10 quarters. For N3, we're looking at 10 to maybe 12 quarters. But it is improving, and we expect it to continue to improve.

[Jeff Su, executive]

Okay. Thank you, Brett. Operator, let's take the next set of questions from the next participant on the call, please.

[Operator]

Next one to ask a question, Charles Shi from Needham.

[Yu Shi, analyst]

Maybe the first one, just want to follow up. Wendell, I think I heard you talking about that potentially more imply to N3 conversion. Maybe beyond what you're trying to do right now, the conversion. I just want to understand the overall philosophy here because I think in the past, the TSMC does do this node-to-node conversion quite actively, let's say, 10-nanometer to 7-nanometer, and probably even earlier 20-nanometer to 16-nanometer. And I think you told us basically treat 10 and 7 as 1 large node, 20 and 16 as 1 large node. Should we start to really think about maybe 5 and 3 are just 1 big node and maybe more conversion -- we should think about more of the N3 capacity growth will come from conversion going forward less from the greenfield investment? That's the first question.

[Jeff Su, executive]

Okay, Charles. So Charles' first question is really look at our conversion strategy. He notes that we have always talked about building in tool commonality to provide us flexibility. We have done so in the past at certain nodes like 20 and 16, 10 and 7. So his question is really we have said that we potentially convert more N5 tools to support the strong demand for N3 capacity. So his question is should we, investors, analysts start to think about N5 and N3 as 1 big node.

[Jen-Chau Huang, executive]

Okay, right. You mentioned about 12 and 16, they are a big family. 7 and 10 are a big family. But 5 and 3 are not a big family in our definitions. At the same time, there are node-to-node tool commonality in TSMC is pretty high. So for 5 and 3, the commonality of tools is over 90%, and these 2 nodes are adjacent. They're all in Tainan Science Park. And so it's very easy to do the conversions. Did I answer your questions?

[Yu Shi, analyst]

Yes. May I ask a second question?

[Jeff Su, executive]

Certainly.

[Yu Shi, analyst]

Maybe a question about CoWoS. I think I heard C. C., you said maybe there's some technical difficulty on my side. I just want to clarify, maybe you may double the CoWoS capacity again in 2025. But a little bit more technical question I do want to better understand the technology constraints because your customers seems to be migrating from CoWoS-S to the more advanced version CoWoS-L, CoWoS-R and we learned that CoWoS L, R does not require TSV, does not require a large silicon interposer, does that help at least to some degree, the capacity constraints you're facing on overall CoWoS? And does that help maybe to achieve that goal of maybe getting to the supply/demand balance some point in 2025, 2026? That's a two-part question.

[Jeff Su, executive]

Okay, Charles. So Charles' question is really on CoWoS. First, he would like to clarify, we said that CoWoS capacity is more than doubling in 2024. He said, did we say, is he correct to understand, we said it will double again in 2025. That's the first clarification. And then he would like to know as customers migrate from CoWoS-S to CoWoS-L and CoWoS-R solution, a lot of technical challenges or benefits -- changes, sorry, not challenges. Does it help alleviate the capacity constraints? And would that allow CoWoS to reach supply/demand balance in 2025? So one to clarify and one on the different solutions.

[C.C. Wei, executive]

Well, all right. Charles, you really know all the details of the technology. The CoWoS-R, CoWoS-S, CoWoS-L blah, blah, blah. All these kind of things because of our customers' requirement. So even the same customer, they have different approaches for their different products. When I say that we doubled the capacity, this is summing all the different version of the CoWoS together. Which portion is really double which portion is much more than the other one, I'm not going to share with you because this is related to my customers' demand. So from last year to this year, we have more than doubled. And as I said, from this year to next year, we want to double again or probably we want to more than double again. But still, I have to work with our OSAT partner to increase the overall supply to support my customer. Whether that this kind of different version of the CoWoS will give me some flexibility today, yes, and no, because different version has a different tool set. But in common, some of the tools can be used by all the CoWoS, okay, but different versions have like a different demand.

[Jeff Su, executive]

Okay. Thank you, C. C. Thank you, Charles. We'll come back to the floor for the next 2 questions, please. We'll take the first one from Laura Chen from Citigroup, and then we'll go to Sunny Lin from UBS.

[Chia Yi Chen, analyst]

My first question is also on the advanced node. I remember C. C., you mentioned earlier that every clients are now engaged with you on the 2-nanometer's migration. So I'm just wondering that when we enter in maybe 2026, the third -- the second year, can we expect that the revenue contribution initially will be larger than what we had comparing to N3? And also wondering that since the performance is much better. So can we expect the dilution's period will also be shorter than N3?

[Jeff Su, executive]

Okay. Sorry. Sorry. So Laura's first question is about N2 basically that almost every customer is engaging with TSMC on 2-nanometer technology. So her question is do we expect the revenue contribution from N2 in 2026, therefore, to be larger than compared to N3 at a similar point in time of the ramp and also correspondingly with the N2 margin dilution be less or better than N3, basically.

[C.C. Wei, executive]

I will give this kind of money's question to the CFO.

[Jen-Chau Huang, executive]

Okay, all right. Laura, the revenue, yes, it's going to be bigger, okay? Gross margin dilution, it will be faster to reach corporate average.

[Chia Yi Chen, analyst]

That's very clear and helpful. And also my second question is also on the packaging side. So we know that last time we also discussed an edge AI will also benefit for TSMC in terms of the advanced nodes, the dye areas. Just wondering that do you also see your edge AI device clients they are moving to 3DIC or SoIC anytime in the next 2 years? Or before that happening, can we expect more clients on the smartphone side, they will also adapt maybe info first. Because so far, our understanding is that info only have one advanced 1 single client. I'm just wondering that if we see that more clients to move to on the edge AI side on advanced packaging.

[Jeff Su, executive]

Okay. So Laura's second question is very specific, but again, in regards to advanced packaging with more and more customers working on edge AI devices without -- well, being overly specific, but what does it mean or the implication for advanced packaging solutions that we expect in the next 2 years to see these edge AI customers start to use SoIC or 3DIC particularly smartphone? Will they still be using info? Or will they also consider these solutions as well. Is that correct, Laura? Okay.

[C.C. Wei, executive]

Well, very technical questions. Let me share with you as my customer moving into 2-nanometer or A16, they all need to probably take in the approach of chiplets. So once you use your chiplets, you have to use in advanced packaging technologies. On the edge AI, for those kind of smartphone customer, as compared with the HPC customers, HPC is moving faster because of bandwidth concerns, latency of footprint or all those kind of thing. For smartphone customer, they need to pay more attention to the footprint as well as the functionality increase. So you observe my big customers taking the info first and then for a few years, nobody catch it up. They are catching up okay?

[Jeff Su, executive]

Okay. Thank you, Laura. We'll take the next question from Sunny Lin from UBS, and then we'll go back to the call.

[Sunny Lin, analyst]

So my first question is on your business opportunities for smartphone and PC. Last few years, both were [indiscernible] growth for quite some time. And so how we should think about the units and silicon content for the coming 2, 3 years? First part, a lot of questions on the tight supply 5 and 3-nanometer? And so are your customers engaging with you early on the planning into 2025 capacities for a better upgrade cycle? And then for silicon content, recall a few years back when 5G just started to ramp you used to provide the silicon content expectations of 5G high-end and mid-end and low-end smartphones, so I wonder at this point of time, if you have any estimates for AI for smartphone going to next 2, 3 years?

[Jeff Su, executive]

Okay. Several parts to Sunny's first question. She's looking at smartphone and PC. So the first part is she wants to know in terms of unit in silicon content, what is our expectation for smartphone and PCs in the next few years? N5 and N3 supply is very tight in terms of the capacity. Can -- do we have enough capacity to support a potential unit or upgrade cycle? And last but not least, she's asking us to quantify the silicon content per device per segment from edge AI.

[C.C. Wei, executive]

That's a very long question. But let me answer the content first. AI is so hard. So that's right now everybody -- all my customers want to put the AI functionality into the edge devices and so the dye size will be increased, okay? How much? I mean it's different from my customer-to-customers product. But basically, probably 5% to 10% dye size increase will be a general rule. Unit growth, not yet, okay? Because we did not see kind of unit growth suddenly increased, but we expect this AI functionality was stimulated some of the demand to stimulate the replacement to be shorter. So in terms of unit growth that in a few years later, probably 2 years later, you will start to see a big increase in the edge device that's a smartphone and the PC.

[Jeff Su, executive]

And will we have enough capacity to support?

[C.C. Wei, executive]

That's the one I tried to avoid the answer. It's very, very tight, and we are working very, very hard to get enough capacity to support my customer from now all the way to next year to 2026.

[Sunny Lin, analyst]

So my second question is try to look at the demand profile from different perspectives. If we look back in 2021 or early 2022, back then demand was also pretty high. Customers were very aggressive on the demand forecast. Now looking at GenAI, obviously, the technology has lots of great potential, but a new technology also have lots of volatilities where you start to ramp. And so how are we managing the volatilities of the demand? Why do you think this time around it is different versus COVID period? How do we get comfortable with our capacity planning?

[Jeff Su, executive]

Okay. Thank you, Sunny. So Sunny's second question, is goes back to TSMC capacity planning and CapEx framework. So she notes we -- today, generative AI-related demand is very strong, but she also noted a few years ago back in 2021 and '22, demand was also very strong. Many customers were also very positive or being on the future demand. And so today, with such strong generative AI demand, how does TSMC plan its capacity appropriately? How do we manage -- I think your word was volatility? How do we manage the risk? Basically, I guess, of not overbuilding capacity in this type of environment?

[C.C. Wei, executive]

I thought I explained that our capacity premium process, right, and the investment, we have -- I put a wording of discipline. That means we are not going to repeat the same kind of mistake that we have in 2021, 2022. Now this time, again, we look at the overall very big demand forecast for my customer. And so I look at it into actually the whole company with many people now examining and study that really is AI is so used for will be used by a lot of people or not. And we test ourself first inside TSMC, we are using AI, we are using machine learning skill to improve our productivity, and we found out it's very useful. And so I also in the line to buy my customer's product, and we have to form in the line, like I cannot privilege here, I'm sorry, but it's useful.

And so I believe that this time, AI's demand is more real than 2 or 3 years ago. At that timing it is because people were afraid of a shortage, and so automotive, everything, you name it, they are all in shortage. This time, AI alone only AI alone, it will be a very useful tool for the human being to improve all the productivity in our daily life, be it in medical industry or in any product, manufacturing industry or autonomous driving, everything you need AI. And so I believe it's more real. But even with that, we also have a top-down bottom-up approach and discuss with our customers and ask them to be more realistic. I don't want to repeat the same kind of mistake 2 or 3 years ago, and that's what we are doing right now.

[Jeff Su, executive]

Okay. Thank you. Operator, can we move on to the next participant from the line, please? Okay. If not, then maybe we'll take the last 2 questions from the floor or 1 or 2. Let's start here and then here. So we'll start with our third line from Arthur Lai from Macquarie.

[Yu Jang Lai, analyst]

Arthur Lai from Macquarie. I used to cover the downstream tech and especially data center before. And so I want to ask about the SPR because I think this is very important from the data center perspective. So when you bring the new technology, you can save around 20% power. Can we also think about you can save the total systems power consumption by another 20%. So is a big change. And from the customer you asked or you spoke to, is the -- they can also you said the total cost of our own operation. So it becomes the more you buy, the more you save. Yes.

[Jeff Su, executive]

Okay. So Arthur's first question, he would like to understand more about super power rail or our best-in-class backside power solution as it relates to data center demand. He knows as we said that it brings greater power efficiency from the chip level. His question without specific numbers, but what does it mean for the system level power consumption saving? What does it mean for our customers' ability in terms of total cost of ownership in terms of the power savings? And does it mean that the more you buy, the more you save?

[C.C. Wei, executive]

The more you buy TSMC's wafer, the more you save. Yes. Sorry, I just want to -- I like my customer. Your question, Arthur, you say that 20% sales in the chips power consumption does that directly reply to indicate that the system power consumption was reduced by 20%. Probably not because of the whole system including the connection, including the networking, including the processes of power consumption. So unless every component save 20%, then you can achieve 20%. But again, the accelerator or the CPU is a big portion of the whole system's power consumption. So even it is not 20%, it's a significant portion of it. And so that's why all my customers want to using the leading edge, and they are very aggressive to move into the 2-nanometer technology.

[Yu Jang Lai, analyst]

Thank you. So I also encourage the company to do the right thing. So energy efficiency computing is definitely our goal for human beings. And so I also, I would like to give more color about when you go into the A16 and when we expand the capacity, what do you think the biggest bottleneck would be?

[Jeff Su, executive]

Okay. So Arthur, second question is in terms of A16 what would be the biggest bottleneck to expand our capacity of A16 to support our customers, if any.

[C.C. Wei, executive]

We always say that when TSMC wants to expand the capacity, we need the land, we need the electricity, we need the talented people and so all the above.

[Jeff Su, executive]

Okay. Thank you. And then in the interest of time, we'll take questions from the last participant on the floor, which is Brad Lin from Bank of America Merrill Lynch.

[Brad Lin, analyst]

I have two questions. The first one would be on the, during the compute test. We obviously have seen quite some big tech companies announced that they are going to accelerate the launch cadence. So what's the implication to TSMC? Should that give TSMC a better visibility on the pipeline and also the capacity planning? And on the other side, so what are the major challenges that you might face with this phase [indiscernible]?

[Jeff Su, executive]

Okay. So Brad's first question is that COMPUTEX recently, several companies announced their intention to accelerate their product cadence or product launches. So his question is, what does this mean implications to TSMC in terms of capacity planning in terms of supporting our customers, et cetera, et cetera. Is that right? Okay.

[C.C. Wei, executive]

Okay. Well, we like this kind of a trend because of TSMC is very good at the leading-edge development. And so we -- actually, every product once they design it takes 1.5 years to 2 years. So we got this kind of message, but quite a long time ago. My customer announce it because they are so happy. And so we are happy also because they want us to see our value. So I take that otherwise. But Gokul last. Okay. So to answer your question, yes, we have been prepared. And not only because of in June, they announce it, we much earlier, we already discussed with them, and we prepare for these kind of changes.

[Brad Lin, analyst]

So I would assume that would help us kind of sell the value easier. So the second question will be on the -- well, obviously, we also see the bigger footprint of the AI chips. So while there are quite some activities about fan-out panel-level packaging. So do you think that, that solution will be mentioned in the mid- to long run? Or does TSMC have any plan to do the related investment?

[Jeff Su, executive]

Okay. So Brad, second question is that, again, with AI-related chips that they're larger and larger die sizes. So his question is in terms of advanced packaging and specifically fan-out panel-level packaging. Is this something that TSMC is looking at or exploring to do? Would this be something for TSMC in the mid- to long term?

[C.C. Wei, executive]

Yes. we are looking at this as kind of a panel level fan-out technology. But the maturity today is not yet, so I -- personally, I will think it's about at least 3 years later, okay? In this, within these 3 years, we don't have any very solid solution for a dye size bigger than 10x of the radical size. Today, we support our customer all the way to 5x, 6x chip size. I'm talking about the [ fuel ] size, the big [indiscernible] size. 2 years later, I believe the panel fan-out will be -- start to be introduced and we are working on it.

[Brad Lin, analyst]

And we will be ready for it as well.

[C.C. Wei, executive]

Of course.

[Jeff Su, executive]

All right. Thank you, C. C. Thank you, Brad. 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 30 minutes from now, and the transcript will become available 24 hours from now, both of which are going to be available through TSMC's website at www.tsmc.com. So thank you, everyone, for joining us today. We hope everyone continues to stay well, and we hope you will join us again next quarter. Goodbye, and have a great day.