Hong Shi Tung - Chief Financial Officer and Director

David Duley Szeho Ng - BNP Paribas, Research Division Gokul Hariharan - JP Morgan Chase & Co, Research Division

Good morning and good evening, everyone. Thank you for attending the ASE Q2 2014 Earnings Release Conference Call.

Let's proceed. Here on Page 1 is the Safe Harbor notice.

I would like to remind everyone on this call that the presentation that follows may contain forward-looking statements. These forward-looking statements are subject to high degrees of risk, and our actual results may differ materially from these forward-looking statements.

For the purposes of this call and presentation, all dollar values are meant to be stated in NT or New Taiwan dollars, unless otherwise noted. So let's proceed.

In -- we ended Q2 with record revenues from our IC ATM business. We also had record gross profits at our IC ATM and group consolidated levels.

The quarter was somewhat atypical. We saw strength with smart device-related products to start off the quarter, only to have the products trail off slightly towards the end of the quarter.

We believe the situation to be related to some of our customers being cautious ahead of major product launches. A such cautious climate continues presently, and most likely should persist into the latter part of the coming quarter.

Our SiP technology-related products continued to see seasonal softness during the second quarter. We believe that our SiP-related business should start to ramp towards the latter half of the coming quarter.

Let's get into the details for the quarter. Page 2, quarter-over-quarter consolidated P&L.

Generally, after the seasonally down first quarter, our second quarter returned to levels achieved in the fourth quarter of last year. On a fully consolidated basis, the company delivered EPS for the second quarter of TWD 0.64 versus TWD 0.44 in Q1.

During Q2, on a consolidated basis, we saw our IC packaging, test and direct materials businesses increase by 15%, 14% and 12%, respectively. Our EMS business decreased by 4%.

Our consolidated gross margins bounced back to 21.5%, a 2.6-percentage-point increase and returning close to last Q4 levels. Gross profit increased to TWD 12.6 billion.

Our operating margins increased to 11.3% from 9.3% and ahead of last Q4 levels. Operating profit finished at TWD 6.6 billion.

During Q2, our nonoperating loss was primarily composed of ECB mark-to-market and interest expense, offset in part by foreign exchange activities and other nonoperating gains. Pretax profit was TWD 6.1 billion.

Net income for the second quarter was TWD 5.1 billion. Net margin increased to 8.7%.

Page 3. You can see the quarterly results on a year-over-year basis here.

From here, you should note that net revenues have increased 15%, with gross profit margins increasing from 20.6% to 21.5%. These margin improvements are the result of improved product mix.

Operating profit has increased 22% from TWD 5.4 billion to TWD 6.6 billion. Operating margins also improved 0.7 percentage points to 11.3% from 10.6%.

Net income increased 33% from TWD 3.8 billion to TWD 5.1 billion when comparing Q2 with the same period last year. Net margins increased from 7.5% to 8.7%.

EPS increased 28% to TWD 0.64 from TWD 0.50. Page 4, the -- our IC ATM P&L.

Let's take a closer look at the results of our IC ATM business. Please note, the intercompany revenues, including the SiP technology business performed by our IC packaging business unit on behalf of our EMS business unit, are eliminated during consolidation.

Our IC ATM revenue increased during the second quarter to TWD 39.3 billion. Revenues from the IC packaging, test and direct materials businesses increased by 14%, 14% and 12%, respectively.

NT dollar appreciation had a fairly insignificant impact on revenue and margins this quarter. For Q2, our gross profit improved to TWD 10.6 billion from TWD 8.2 billion, while our gross margin improved by 3 percentage points from 24% to 27%.

The gross margin improvement was the result of higher revenue within our semi-fixed cost structure and favorable product mix. In particular, margin improvement was related to labor and depreciation expenses.

Labor expenses increased TWD 0.7 billion to TWD 7.3 billion. However, as a percentage of revenue, labor decreased 0.7 percentage points from 19.3% to 18.6%.

Depreciation expense stayed flat at TWD 5.6 billion. However, as a percentage of revenue, depreciation decreased 2.1 percentage points from 16.3% to 14.2%.

Total operating expenses increased by TWD 0.6 billion to TWD 4.6 billion. Operating expenses as a percentage of revenue edged up slightly to 11.8% from 11.7%.

Higher operating expenses were primarily driven by higher labor cost within R&D and admin and R&D factory supply costs. As a result, operating margins increased to 15.2% from 12.3%.

Operating profit in Q2 increased to TWD 6.0 billion from TWD 4.2 billion in the previous quarter. Net margins increased to 13% from 10%.

Page 5, IC ATM on a year-over-year basis. Our IC ATM business had 8% revenue growth.

Gross profit increased from TWD 8.7 billion to TWD 10.6 billion, representing a 21% increase from a year ago. Gross margins improved 3.0 percentage points to 27% from 24%.

The gross margin improvement was primarily the result of better utilization of equipment and efficiencies achieved through scale from each of our business units. Operating profit increased from TWD 4.8 billion to TWD 6.0 billion, a 24% improvement.

Operating margins climbed to 1.9 percentage points from 13.3% to 15.2%. Page 6, packaging operations.

Packaging revenue increased 14.4% quarter-over-quarter in Q2 to TWD 31.8 billion. Our packaging gross margin increased 2.6 percentage points to 24.2%.

The gross margin increase is principally a result of a recovery from the Q1 seasonal soft quarter. As a percentage of revenue, relative decreases in labor and depreciation expenses accounted for the majority of the packaging margin improvement.

Labor expenses increased TWD 533 million, however, as a percentage of revenue, decreased 0.6 percentage points. Depreciation and amortization expense stayed flat at TWD 3.8 billion, however, as a percentage of revenue, decreased 1.7 percentage points.

During the quarter capital expenditures for our packaging operations amounted to USD 257 million, of which USD 46 million was used for wafer bumping and flip-chip packaging equipment. USD 182 million for common equipment using -- including SiP, and USD 29 million for wirebond-specific purposes.

Our capacity overview. During the quarter, we added 470 wirebonders and retired 83.

We exited the quarter with a total of 15,762 wirebonders in operation. 8-inch bumping capacity remained unchanged at 95,000 wafers per month, and 12-inch bumping capacity increased to 60,000 wafers per month.

Page 7. Within our packaging product breakdown, our advanced packaging, including SiP, edged down to 26%.

Our IC wirebonding business stayed flat at 64%, and our Discrete and others segment increased slightly to 10%. It's worth noting that all segments were growing in absolute dollars, with Discrete and others slightly outpacing IC wirebonding.

Advanced packaging and SiP segment share decrease should reverse in the coming quarter, given the business' seasonal nature. Page 8, test operations.

Our cash revenues increased by 14.1% sequentially, up to TWD 6.6 billion in Q2. Gross margins for our test business improved to 37.2% from 32.3%.

The increase in gross margins were principally the result of higher revenues within a semi-fixed cost structure. In particular, test gross margin improvement, primarily due to a $12 million decline in depreciation expenses.

As a percentage of revenues, depreciation decreased by 3.3 percentage points to 22.2% of test revenues. Also contributing to the gross margin improvement, labor expenses increased TWD 100 million to TWD 1.4 billion.

However, as a percentage of revenue, labor expenses decreased 1.2 percentage points to 20.6% of revenues. The remainder of the gross margin improvement was due to small percentage improvement within maintenance and utility expenses, offset in part by increased rental expenses.

Our testing utilization rate improved to near 80%. CapEx for the test business was USD 54 million in Q2.

We added 138 and retired 49 testers during the quarter. At the end of Q2, our total tester count stood at 3,244.

Page 9, our material business. In Q2, revenue from our material business increased to $2.5 billion.

$873 million was from sales to external customers, representing an increase of 12%. Our internal self-sufficiency rate increased from 30% to 34% during this period.

Gross margins increased 3.6 percentage points to 20.3% during the second quarter, up from 16.7%. Gross margins within our interconnects business increased because of more beneficial product mix and better loading within a semi-fixed cost environment.

Page 10, our EMS operations. Revenues from our EMS business declined to TWD 20.5 billion from TWD 21.4 billion, down 4%.

Our overall EMS gross profit margins edged up to 10% from 9.6% a quarter ago. The higher gross margins in the current quarter are a result of our EMS business' product mix with continuing low levels of SiP and WiFi module products.

Given that we expect our SiP business to ramp during the latter part of the third quarter, we expect our EMS business' gross margin to reflect a corresponding decline. Given the decline in revenues, EMS gross profit decreased 0.8% or TWD 16 million, ending at TWD 2 billion.

Page 11, EMS product mix. Q1 and Q2 looked fairly similar in terms of product mix for our EMS business.

The communication segment continued to decline with slight increases in our other segments. However, with ramping SiP business during the latter part of Q3, we expect this trend to reverse.

Page 12, the balance sheet. For our balance sheet this quarter, our cash and cash equivalents and current financial assets declined to TWD 45.4 billion from TWD 48.9 billion the previous quarter.

In Q2, our interest-bearing debt declined to TWD 87 billion from TWD 89.6 billion the prior quarter. We still have TWD 132.1 billion in unused credit lines.

Page 13, CapEx. In Q2, our CapEx was USD 360 million.

USD 257 million was used for packaging, USD 54 million for testing, USD 43 million for EMS and USD 6 million for interconnect materials. We are on track with our capital equipment spending plan.

However, we may adjust such plan in accordance with the needs of our customers. EBITDA for the second quarter amounted to USD 435 million.

Our investment spending for the year should principally continue to focus on our advanced packaging and SiP businesses. SiP -- CapEx for the third quarter may outpace our EBITDA amount.

Page 14 shows our IC ATM market segment exposure. We saw Q2 business strength in our automotive and industrial segments, mainly due to increased outsourcing and market share gain at certain Europe and U.S.

IDMs. Despite the communication segment losing -- despite the communication segment losing segment share to the computer, automotive and consumer segments, the communication segment revenue still increased in absolute dollars.

Then finally, Page 15, this is our third quarter 2014 outlook. During the quarter, the outlook for the coming quarter appears somewhat unclear.

Some customers have been adjusting their forecasts down, while others have held fairly steady. Still, other customers are preparing their devices to be included in product launches, which may propel upside demand for their devices in the coming quarter.

Given a large portion of our market is driven by various smart communication devices, such revisions in volatility appear to make sense to us and does not, in itself, signal anything more than competitive selling strategies taking form. We are actually changing the methodology of our forward-looking outlook.

In Q3, our outlook is as follows: An overall stable ASP environment, even considering product mix. Our IC ATM production capacity should increase by roughly 4% quarter-over-quarter.

Our blended IC ATM utilization rate should increase between 2 to 4 percentage points from roughly 80% in the second quarter. The pace of our EMS business' first half year-over-year growth should carry into Q3.

Let me repeat that. The pace of our EMS business' first half year-over-year growth should carry into Q3.

Gross margins for the company as a whole should edge down, and operating margins for the company should edge up. And Jason, we are ready to take questions.

I noticed you're now giving guidance as far as utilization rate goes instead of forward growth guidance. Could you just talk about why you're changing your methodology?

This is due to some [indiscernible] regulation changes that we'll not be able to give specific numbers.

Okay. Then as I think about the segments in the third quarter in your IC ATM business, I think you mentioned that you might have been seeing a little bit of a, perhaps, inventory correction going on in the mobility business.

Does that carry forward to the third quarter? And then could you give us an update on the plant closure -- your plant closure and when that would expected to be opened?

Okay. I'll answer the latter question first.

I think the K7 factory has gone through the, what we call the final inspection of the trial run, and we have been notified as we have seen in the press today in the afternoon that we have been given conditional approval for full resumption of works. There are a few conditions that we need to meet, and a lot of it is really documentation, and we need to bring these responses over to the Environmental Protection Bureau and waiting for their official approval to be granted, and we expect to receive that within the next few weeks.

And the first question was?

Could you talk about the segments of revenue in your IC ATM business in the third quarter and just talk about the, perhaps, inventory correction you're seeing in the mobility business or what -- however you'd like to talk about it?

Yes, I think the -- in terms of application, I think the -- in the third quarter, the communication will have the strongest growth and therefore, the percentage will increase, more or less at the expense of computing. Although in terms of absolute numbers, all 3 segments will continue to grow in the second quarter -- in the third quarter.

And then are you seeing -- could you just talk about the mobility businesses? There's some sort of inventory correction going on there.

Your prepared comments were talking about how customers were cautious in some customers' forecasts.

I think, as mentioned in the presentation, there are customers revising down their forecasts, and there are some steady -- having steady forecasts, while some customers are preparing for their product launches actually have increased the forecast. So it's a mix at this point, and we are not seeing really a major inventory pileup at this time.

Okay. And final question for me, I'll get back in the queue, is there's been lots of chatter about a big customer of TSMC moving -- big customers moving from foundry to foundry, and I wouldn't think that would really impact the back end.

But could you just talk about what your views are there if big customers of TSMC move to Korea?

I think, they'll -- what's been talked about is really a fraction of our business, and I think our capacity is really prepared for to serve the whole industry and multiple customers. So I think the -- if there is any impact, it will be very minimal.

With regard to your fan-out technology, are you seeing more customers showing interest in this?

Can you repeat the question again?

Yes. For the fan-out technology, are you seeing many customer activities going on now?

Not really.

Okay. So any chance you see revenue contribution, let's say, in 2015?

I think it's too early to tell. We don't really have a sense of it.

Okay, no worry. And for the -- based upon the capacity, can you give us an update for the installed capacity for Q2?

And what will be the plan for year-end capacity plan?

Right now, we have about 95k 12-inch capacity, 95k for 8-inch bumping and 60k for 12-inch. And I think by the end of third quarter or early fourth quarter, we will have -- we will increase our 12-inch bumping to 70k.

70k.

70 to 75.

Okay. All right.

Is it a more linear expansion? That means that we should assume something like 60k in Q3?

Right now, it's 60k, and I think by end of third quarter, early fourth quarter, we will have 70k to 75k already.

Could you talk a little bit more about what you expect your SiP business to do in the second half of the year? And then also, could you clarify a little bit more about how you account for this business and what the impact is on the gross margins of the IC ATM business?

I think the -- our SiP business will be back-end loaded, and I think by end of fourth quarter, on a consolidated basis, it will represent close -- around 20% of our overall revenue.

From what today, I'm sorry?

To about 20 -- from about 6% in the second quarter.

Okay. So very rapid growth in the second half of the year.

And what's the key reason that you're going to see all of this growth?

Well, it's just the scheduled product ramp-up.

And could you talk about -- the second question was how you account for this business and how it impacts the gross margins of the IC ATM business. Really, what I'm looking for is how -- what sort of positive impact does it have on that business?

I think the business model-wise, it's really -- we're looking the SiP business as part of the EMS business. So we're using EMS units to take on the order for -- and also to this particular project to handle all the logistic support.

Whereas the manufacturing process is really being subbed [ph] over to the IC ATM operating units. In terms of the margin, I think at this point, it has some positive impact on the overall IC ATM margin.

Is there -- could you help me with -- as a number of percentage points, is it 2 percentage points of positive impact for IC ATM? Or is it 1 or a rough cut about what the impact is?

Sorry, I cannot provide that.

And then I think one of your competitors raised their CapEx and talked about capital intensity of advanced packaging. I was just wondering if you might be able to give us your views of, number one, how much of your CapEx budget will be spent on advanced packaging and talk about the capital intensity of it versus your other businesses.

Well, I think the -- we have already explained that in second quarter, we have [indiscernible]. In second quarter, we have -- out of $257 million CapEx for packaging, we have about $46 million invested in flip chip and bumping, and I think going into quarter 3, the -- that amount will significantly increase for the bumping capacity that I just mentioned -- for the bumping capacity expansion.

And I think at this point, the overall capacity, industry capacity for bumping is -- we're still in the -- trying to catch up with the demand and although eventually, there will be fluctuation in terms of demand/supply balances. Well, I think the overall, right now, we're still looking at a healthy pace, and the investment discipline is still being maintained in our segment.

And we don't believe in short term that there will be major oversupply situation.

Okay. That's good to know that you don't think there's oversupply in advanced packaging.

Could you just give us an idea about the capital intensity levels? Does it require $1 of spending to generate $1 of revenue?

Or what's the ratio there?

I think, as a whole, that's correct. I think the -- for the IC ATM business, including packaging and test, $1 of investment pretty much gives you $1 of additional annual revenue.

And you think that's true for the cap [ph], the flip chip and bumping part of the business.

So that's just the overall, and we're not seeing that trend changing that much.

I had a question on SiP. Could you talk about when some of these new products that you talked about in your analyst meeting in Taipei today afternoon, when some of these new products start to come in, how quickly can your customer concentration within SiP diminish?

Is that something that we should expect in the next couple of years? Or it's going to be a bit more longer term?

And I had one more question on SiP.

In terms of customer expansion, I don't think we have a fixed time line for it. I think this is a -- the whole business model is a bit different.

We -- in terms of the traditional IC ATM, we're serving the whole industry with multiple customer in each and every different segments. But for SiP, it's more likely to be single customer, single product and therefore -- and also the products tend to be more consumer driven and therefore, the life cycle of each generation of such product is shorter.

So -- and the -- so I think we need -- we want to be selective in terms of dealing with our customers. We want to take one step at a time.

The worse thing for us is really to prepare -- to pull all the resources to put up with a large team and making a lot of capital investment turnout. If the customer comes in and asking for 30 million units capacity, ended up selling 3 million, that will be the worst-case scenario.

So in that case, we really need to be selective. [indiscernible] our business model first.

So I'm not -- don't have a really fixed time frame for when we'll have multiple customers.

Okay. And the second question is, do you see other competitors also trying to come into this SiP segment?

Do you think you'll still retain significant share in your key customer in the next 12 to 18 months still? Or is there any changes happening there?

Right now, we're not -- we haven't seen any major changes in terms of the competition landscape. I think one very important thing to notice is that to be able to do SiP in effective manner, you really need to have all 4, including front-end, system-level technology and design capability.

Whereas for -- to actually build these -- the products, you need to use semiconductor-level assembly and test technology. And if you're shrinking everything to a chip-size type of a board, then the board really is the -- what we use in the semiconductor world, the substrate.

So I think to be effective, you really need to have all 4 of them. Right now, we haven't seen any real competitors that have all the ingredients involved.

Okay, okay. One more question, on the wafer bump capacity increase, is it by any chance you're increasing the capacity because you have some uncertainty regarding K7 resumption?

Or the -- when we talk about going from 60 to 75 for 12-inch bump, is that including the K7 capacity or is that excluding K7?

Including. I think it's worth mentioning that K7 has already gone into what we call a full-scale trial run.

At this point, about 80% to 85% of the capacity has already been utilized.

I have one follow-up on the wafer bump part and wafer-level packaging, in particular. Could you talk a little bit about where the demand is coming from for wafer-level packaging?

It seems to be that market is starting to see a lot more demand coming through. Your competitors also -- you're probably actually a bit slower in terms of the pace of expansion compared to some of your competitors who are going very quickly.

So could you talk a little bit about what you're seeing? What kind of products are going to wafer-level packaging?

And how -- what does it really replace? Is it replacing traditional wirebond?

Is it actually replacing some flip chip with wafer-level CSP kind of stuff?

Actually, most of the -- we're seeing a lot of connectivity devices, WiFi, Bluetooth and so on and so forth. Those devices are using wafer-level packaging today, although some of them are still using wirebonds.

Also there are some demand from our analog customers, MCU customers. But like I said, the majority of wafer-level packaging capacity is being used by connectivity devices.

Also that -- there are also gaming [ph], for example. [indiscernible]

That is primarily the 8-inch wafer bump capacity, right?

Well, actually, it's -- some of them are utilizing 8-inch bumping, and they are in flip-chip package. But they are also -- many of them are in wafer-level packaging.

And also, like I mentioned, a lot of connectivity devices like WiFi combo chips, they are in wafer-level packaging.

Yes. I just have a clarification question on your forward guidance.

When you talk about overall utilization rates of the IC ATM business, I guess, increasing about 4% from about 80%, I think that indicates low -- less than 10% sequential growth or less-than-typical growth seasonality. Maybe just talk about it that way.

It appears that this is less than seasonal growth. What are the key reasons for that?

I wouldn't actually say the coming Q3's growth is really out of character. I think the -- we can only base -- we can only look at our own customers' forecast and come out with the estimates.

But case in point that in third quarter last year, the sequential growth was only about 4%.

Yes. I think the typical seasonal growth is 8% to 12% or 8% to 10%, so just kind of wondering why you're seeing it lower than, let's say, the 5-year average.

Yes, I think the first and -- particularly in the second quarter, I think the sector's momentum was actually quite strong. And if you look at our own business, we have about 14% growth and also, Amkor has about 10% in the second quarter, whereas SPIL has about 20-some percent.

So I think the overall Q2 has a -- pretty strong, I think, and this is going into Q3. I think the -- we should be looking at such strong pace of growth repeating.

I think there's no further questions. Let me wrap up.

I think we had a very good second quarter both in terms of top line growth, as well as margin improvement. And for the year, although we apologize we will not be able to give specific numbers for guidance, I think what we are providing is sufficient to help to bring some color to the coming quarters.

I think one thing is -- we can be sure is that for the year, for IC ATM, we will have -- we'll continue to see sequential growth on a quarterly basis. Whereas the -- from EMS point of view, the growth will be second-half heavy, and we should be having a very healthy coming 2 quarters.

Thank you very much, and that will conclude the call today.