Taiwan Semiconductor Manufacturing Company Ltd. 2026 Q3 Earnings Call

Good afternoon, everyone, and welcome to TSMC's third quarter 2026 earnings conference call. This is Jeff Su, TSMC's Director of Investor Relations and your host for today. TSMC is hosting our earnings conference call via live audio webcast through the company's website at www.tsmc.com, where you can also download the earnings release materials. If you are joining us through the conference call, your dial-in lines are in listen-only mode. The format for today's event will be as follows. First, TSMC's Senior Vice President, third quarter 2026, followed by our guidance for the fourth quarter 2026. Then Mr. Huang and TSMC's Chairman and CEO, Dr. C.C. Wei, will jointly provide the company's key messages. Then we will open the line for the Q&A session.

As usual, I would like to remind everybody that today's discussions may contain forward-looking statements that are subject to significant risk and uncertainties, which could cause the 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. Now, I would like to turn the call over to TSMC CFO, Mr. Wendell Huang, for the summary of operations and the current quarter guidance.

Thank you, Jeff. Good afternoon, everyone. Thank you for joining us today. My presentation will start with financial highlights for the third quarter of 2026. After that, I will provide the guidance for the fourth quarter of 2026. Third quarter revenue increased 17.6% sequentially in TWD, supported by strong demand for our leading-edge process technologies. In USD term, revenue increased 16.2% sequentially to $46.7 billion, above the high end of our third-quarter guidance. Gross margin decreased by 1.3 percentage points sequentially to 66.4%, primarily due to margin dilution from 2-nanometer ramp. Total operating expenses accounted for 7.8% of net revenue. Operating margin was 58.7%. Overall, our third-quarter EPS reached TWD 29.43 and ROE was 45.5%. Now, let's move on to revenue by technology.

2-nanometer process technology contributed 8% of wafer revenue in the third quarter, while 3-nanometer, 5-nanometer, and 7-nanometer accounted for 33%, 28%, and 10% respectively. Advanced technologies, defined as 7-nanometer and below, accounted for 79% of wafer revenue. Moving on to revenue contribution by platform. HPC increased 22% quarter-over-quarter to account for 68% of our third-quarter revenue. Smartphone increased 10% to account for 21%. IoT increased 5% to account for 4%. Automotive increased 23% to account for 4%, while DCE declined 12% to account for 1%. Moving on to the balance sheet. We ended the third quarter with cash and marketable securities of TWD 4 trillion, or $126 billion.

On the liability side, current liabilities increased by TWD 110 billion quarter-over-quarter, mainly due to the increase of TWD 46 billion in current portions of bond payable and bank loans and TWD 26 billion in dividend payable. In terms of financial ratios, accounts receivable turnover days decreased by one day to 28 days. Inventory days decreased by five days to 82 days, primarily due to the increase in wafer shipment. Regarding cash flow and CapEx, during the third quarter, we generated about TWD 920 billion in cash from operations, spent TWD 443 billion in CapEx, and distributed TWD 156 billion for fourth quarter 2025 cash dividends. Overall, our cash balance increased TWD 488 billion to TWD 3.6 trillion at the end of the quarter. In U.S. dollar terms, our third-quarter capital expenditures totaled $13.8 billion. I have finished my financial summary. Now, let's turn to our current quarter guidance.

Based on the current business outlook, we expect our fourth quarter revenue to be between $52.3 billion and $54.3 billion, which represents a 14% sequential increase or a 58% year-over-year increase at the midpoint. Based on the exchange rate assumption of one U.S. dollar to TWD 31.8, gross margin is expected to be between 65% and 67%, operating margin between 56.5% and 58.5%. This concludes my financial presentation. Now, let me turn to our key messages. I will start by talking about our third quarter 2026 and fourth quarter of 2026 profitability. Compared to second quarter, our third quarter gross margin decreased by 130 basis points sequentially to 66.4%, primarily due to the margin dilution from the initial ramp-up of our 2 nanometer technology.

We have just guided our fourth quarter gross margin to decrease by 40 basis points to 66% at the midpoint, primarily due to the continued margin dilution from the steep ramp-up of our 2 nanometer technology, as well as dilution from overseas fabs. These impacts are expected to be partially offset by cost improvement efforts, including productivity gains and across node capacity optimization. While the cost of overseas fabs remain higher, thanks to the company's overall larger scale and cost improvement efforts, we now expect the gross margin dilution from the ramp-up of our overseas fabs to be closer to 2% more effort to support the strong structural demand from our customers. More fabs will be ramping up in the U.S. Thus, we expect the dilution from our overseas fabs to widen to 3%-4% in the next few years.

We will leverage our increasing size in Arizona and work on our operations to improve the cost structure. We will also continue to work closely with our customers and suppliers to manage the impact. Overall, with our fundamental competitive advantages of manufacturing technology leadership and large-scale production base, we are confident that TSMC continues to be the most cost-efficient manufacturer in every region that we operate. Next, let me make some comments on our 2026 capital budget. At TSMC, a higher level of capital expenditures is always correlated with higher growth opportunities in the following years. Given the continued robust multi-year demand from our customers, including the emerging agentic AI market, we reiterate our full year 2026 capital budget to be between $60 billion and $64 billion.

We continue to expect our CapEx investment from 2026 to 2028 to be even more significantly higher than the past three years as we continue to invest heavily to support our customers' growth. Additionally, while the tool supply is tight, we always collaborate closely with our tool suppliers well in advance to prepare the capacity, just like our customers collaborate with us well in advance to plan our capacity. Even as we invest for the future growth with this level of CapEx spending in the next few years, we remain committed to delivering profitable growth to our shareholders. We also remain committed to a sustainable and steadily increasing cash dividend per share on both an annual and quarterly basis. Now, let me turn the microphone over to C.C.

Thank you, Wendell. Good afternoon, everyone. First, let me start with our near-term demand outlook. We concluded our third quarter with a revenue of $46.7 billion, higher than our guidance in U.S. dollar terms, driven by strong demand for our leading-edge process technologies. Moving into fourth quarter 2026, we expect our business to be supported by continued strong demand for our leading-edge process technologies, including the steep ramp-up of our 2 nanometer technology. Looking ahead, we continue to observe consumer and price-sensitive end market segment are being challenged due to the impact of rising component prices and macroeconomic uncertainties. As such, we are being prudent in our business planning going into 2027 while focusing on the fundamentals of our business to further strengthen our competitive position.

Having said that, demand for our leading-edge technologies continue to be extremely robust, supported by our strong technology differentiation and broader customer base. Therefore, we now expect our full year 2026 revenue growth to be around 44% year-over-year in U.S. dollar term. Next, let me talk about the AI-related demand outlook. The AI market continues to be very strong. Recent developments are very positive to AI's long-term demand outlook. We observe increasing AI demand fueled by the rising adoption of agentic AI as we transition from chatbot to AI assistance. In addition, we are observing great adoption of open source AI models. This will drive greater efficiency and help lower the barrier to future AI usage, and result in more and more demand for leading-edge silicon. Thus, AI-related demand is being supported by strong underlying demand for AI accelerators.

In addition, the emergence of agentic AI CPUs and the continued demand for networking chips are driving further silicon demand. Therefore, semiconductor will remain essential in the AI mega trend. The value of semiconductors in the global supply chain is set to continue to increase in our view. This will create more value opportunities for our customers to capture and more value opportunities for TSMC as well. No matter which approach is taken, you will require use of the most advanced semiconductor process technology. With our technology leadership, manufacturing excellence, global capacity expansion, and customer trust, we are well-positioned to capture the full multi-year structural AI-related demand. Therefore, all the AI players are working with TSMC. Next, let me talk about TSMC's capacity expansion strategy. As a foundry, our first responsibility is to provide our customer with the best technologies and effective capacity support to unleash their innovations.

To address the structured increase in the long-term semiconductor market demand profile, TSMC collaborate closely with our customers, yet our customer's customer to plan for our capacity. In addition, we are now going one step further and sending our own teams of people to check on the data center build-out progress and power supply situation in the U.S. The feedback is so far so good, and the CSPs has been well-prepared. Internally, TSMC employed a disciplined capacity planning system to assess the market demand from both a top-down and bottom-up approach. This is a continuous and ongoing process. Given the fundamental complexity of leading-edge technologies and the design in and lead time involved, we already have a very good idea of customers' multi-year product roadmap and production plans. Thus, we continue to hold strong conviction in the AI mega trend.

We are moving full speed ahead to increase our capacity to meet our assessed demand, and stepping up our CapEx investment to support our customers' future growth. TSMC is expanding at unprecedented pace with a nearly 20 fabs worldwide in progress. We are building 13 leading-edge and advanced packaging fab in Taiwan over the next several years, and another 5 to 6 fabs overseas. Our new node, N2, has already entered high-volume manufacturing in the fourth quarter of 2025 with good yield. N2 is ramping successfully in multiple phases at both Hsinchu and Kaohsiung site. We expect our N2 family technologies annual capacity to more than double in 2027, supported by strong demand from both smartphone and HPC AI applications. We are also leveraging our manufacturing excellence to generate more N2 wafer output, further increasing our capacity support to customers.