ASE Technology - Q2 2020

Transcript

Ken Hsiang (Head of Investor Relations)

Hello, I am Ken Hsiang, the Head of Investor Relations for ASE Technology Holdings. Welcome to our Second Quarter 2020 Earnings Release. Thank you for attending the conference call today. Please refer to our Safe Harbor notice on page two. All participants consent to having their voices and questions broadcast via participation of this event. 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 a high degree of risk, and our actual results may differ materially. For the purposes of this presentation, our dollar figures are generally stated in new Taiwan dollars, unless otherwise indicated. As a Taiwan-based company, our financials are presented in accordance with Taiwan IFRS. Results presented using Taiwan IFRS may differ materially from results using other accounting standards. For today's call, I will be going over financial results.

Afterwards, we will have a Q&A session with Joseph Tung, our Chief Financial Officer. Entering the second quarter, we were concerned about supply chain durability and COVID-19's impact on overall electronics demand. After, we do believe that supply chains generally held up while COVID-19 appears to have bolstered consumers' demand for electronics. On page three is a high-level first-half recap. Holding company revenues grew 18% year-over-year on US dollar terms. ATM revenues grew 23% year-over-year on US dollar terms, with gross margins improving 3.8 percentage points or 5.3 percentage points, excluding foreign exchange impact. EMS revenues grew 12% year-over-year in US dollar terms. We continue to see strong demand from our various business lines. In particular, our SiPbusiness is driving our ATM and EMS business growth. SiP, for the first half of this year, grew 20% year-over-year in US dollar terms.

We actually expect SiP growth to accelerate in the back half of 2020 for both our ATM and EMS businesses. Our fan-out business grew 68% year-over-year in U.S. dollar terms, and our test business also continues to outpace assembly growth, growing 30% year-over-year in U.S. dollar terms. For the second quarter, our ATM business somewhat outperformed our initial expectations. We believe that our geographical diversification and Taiwan's lower manufacturing risk continue to benefit us. For our factories during 2020, business has been much more linear. Given strong demand during the first quarter, we started the quarter from a seasonally high base, and as such, it didn't take particularly long for key capacities to start running tight. Our ATM business also encountered a strengthening N.T. dollar environment.

Our first half year-over-year sales growth was 19% on NT dollar terms, while it was 23% by US dollar terms. For the second quarter, on a year-over-year basis, NT dollar appreciation negatively impacted our sales by 3.6% and gross margin by 1.8 percentage points. We continue to see a strong NT dollar environment, though, at least through the third quarter. For our EMS business, the second quarter usually represents the trough quarter in terms of seasonality. However, our EMS business started its seasonal manufacturing ramp somewhat earlier than usual, as well as seeing SiP upside in demand. As a result, our EMS business significantly outperformed our initial expectations. What you'll find going through our second quarter results is that both quarter-over-quarter and year-over-year comparisons are overwhelmingly positive.

We also have a bit of a tax surprise benefit to discuss, and we will discuss the geopolitical situation towards the end within the outlook part of our discussion. Please turn to page four, where you will find our second quarter consolidated results at the holding company level. In this section, we will generally defer business explanations to our ATM and EMS P&L discussions. Intercompany transactions between our ATM and EMS businesses have been eliminated during consolidation. For the second quarter, we recorded fully diluted EPS of $1.60 and basic EPS of $1.63. Consolidated net revenue was $107.5 billion, representing a 10.5% increase quarter-over-quarter and a 18.5% increase year-over-year. We had a gross profit of $18.8 billion with a gross margin of 17.5%. Our gross margin improved by 0.9 percentage points quarter-over-quarter and 2.1 percentage points year-over-year.

The sequential improvement is primarily the result of typical seasonal loading patterns. The year-over-year increase in gross margin is primarily the result of stronger overall loading offset by higher EMS revenue mix and a stronger Taiwan dollar. Our operating expenses increased by $0.3 billion during the second quarter to $10.4 billion. This was primarily the result of slightly higher operating expenses in both our ATM and EMS business units. However, when viewed relative to sales, we were able to keep our operating expenses in check with our second quarter operating expense percentage declining 0.7 percentage points sequentially and 1.1 percentage points year-over-year to 9.7%. Operating profit was $8.4 billion, representing a 39% improvement sequentially and a 103% improvement year-over-year. Sequentially, operating margin improved 1.6 percentage points to 7.8% while being up 3.2 percentage points year-over-year. Tax expense for the quarter was $1.7 billion.

The effective tax rate for the second quarter was 19%. We do have some important news here. On May 8th, we received clarification from Taiwan's Ministry of Finance that AASE, SPIL and USI's Taiwan capital spending may generate tax credits, which can be used to offset undistributed earnings tax at the holding company level. As such, during the quarter, we booked a net undistributed earnings tax reversal of $0.2 billion, representing tax credit claimable related to 2019 capital spending. With the inclusion of this, the expected effective tax rate for 2020 year should be slightly above 20%. More importantly, on an ongoing basis, we will continue to be able to generate tax credits in this manner. We estimate that we can now lower our ongoing tax rate by about 2 percentage points to be in the range of 21%-22%.

Net income for the quarter was TWD 6.9 billion, representing an improvement of TWD 3 billion or 78% sequentially and an improvement of TWD 4.2 billion or 158% year-over-year. On the bottom of the page, we have again provided key P&L line items without the inclusion of PPA-related expenses. Consolidated gross profit excluding PPA expenses would be TWD 19.7 billion with an 18.3% gross margin. Operating profit would be TWD 9.6 billion with an operating margin of 8.9%. Net profit would be TWD 8.1 billion with a net margin of 7.5%. Basic EPS excluding PPA expenses would be TWD 1.90. On page five is our ATM P&L. It is worth noting here that the ATM revenue reported here contains revenue eliminated at the holding company level related to intercompany transactions between our ATM and EMS businesses.

For the second quarter of 2020, revenues for our ATM business were $69.5 billion, up $3.3 billion from the previous quarter and up $9.9 billion from the same period last year. This represents a 5% increase sequentially and a 17% increase year-over-year. Our ATM revenues came in somewhat ahead of our expectations due to stronger-than-expected demand related to communications products. Gross profit for our ATM business was $15.1 billion, up $1.7 billion or 13% quarter-over-quarter, and up $4 billion or 36% year-over-year. The sequential gross profit improvement is primarily due to higher loading. The year-over-year gross profit improvement is primarily driven by scale efficiencies resulting from higher loading. Gross profit margin for our ATM business was 21.7%, up 1.6 percentage points sequentially, while up 3.1 percentage points year-over-year. Margin improvement is generally the result of higher seasonal loading.

Margin improvement year over year is primarily attributable to higher relative loading and a higher mix of test revenue. During the second quarter, operating expenses were $7.9 billion, up $0.1 billion sequentially and $0.4 billion year over year. The sequential and year-over-year increases were driven by higher R&D expenses. Our operating expense percentage was 11.3%, down 0.4 percentage points sequentially and down 1.2 percentage points year over year. During the second quarter, operating profit was $7.2 billion, representing an improvement of $1.7 billion quarter over quarter and an improvement of $3.6 billion year over year. Operating margin was 10.4%, improving 2 percentage points sequentially and 4.2 percentage points year over year. Without the impact of PPA-related depreciation and amortization, ATM gross profit margin would be 23%, and operating profit margin would be 12%. On page six, you'll find a graphical presentation of our ATM P&L.

On page seven is our ATM revenue by market segment. Overall, not much has changed in the mix of our revenue. On page eight, you will find our ATM revenue by service type. During the second quarter, our test business continued to outgrow other product service types. Test now stands to be 18% of our ATM revenue. On page nine, you can see the results from our EMS business and its associated revenue by application. This was a somewhat unusual quarter for our EMS business. As mentioned in our previous earnings release, we believed that there would be some supply chain impact of business from the first quarter that would get pushed into the second quarter. Even with consideration of such, our EMS business outperformed the quarter expectation. This was primarily driven by upside demand for our SiP-related products.

During the second quarter, we had revenues of $39.7 billion, representing an increase of $7 billion or 21% sequentially and $8.2 billion or 26% year-over-year. EMS revenues increased quarter-over-quarter primarily because of upside demand. EMS revenues increased year-over-year primarily as a result of improved product demand. Our EMS gross profit was $3.7 billion, improving $0.7 billion sequentially and $0.9 billion year-over-year. The sequential and year-over-year gross profit improvements were driven primarily by stronger customer demand. Gross profit margin for the EMS business unit came in at 9.4%, an improvement of 0.1 percentage points sequentially and 0.3 percentage points year-over-year. These improvements are primarily driven by higher loading. Our EMS business unit's operating expenses closed the quarter at $2.5 billion, increasing $0.2 billion sequentially and $0.1 billion year-over-year.

Operating expenses increased primarily as a result of a larger scale of operation. Operating expense percentage was held in check at 6.3% as compared with 7% last quarter and 7.5% last year. Operating profit for the quarter was $1.2 billion, representing a $0.5 billion improvement sequentially and a $0.7 billion improvement year-over-year. The sequential operating profit improvement was primarily due to increased customer demand during the second quarter. Our operating margin came in at 3.1%, which is a 0.7 percentage point improvement sequentially and a 1.5 percentage point improvement year-over-year. On the chart on the bottom half of the page, you will find a graphical representation of our EMS revenue by application. Our communications segment here picked up after a seasonal decline.

It has been a while since we mentioned this, but it is worth noting that our EMS business unit runs under the name Universal Scientific Industrial, and it is traded as an A-share on the Shanghai Stock Exchange under the ticker number 601231. We currently own 75% of the company, which translates to roughly $5 billion. On page 10, you will find key line items from our balance sheet. At the end of the quarter, we had cash, cash equivalents, and current financial assets of $63.7 billion. Our interest-bearing debt declined $20.7 billion to $214 billion. Total unused credit lines amounted to $253.8 billion. Our EBITDA for the quarter was $22.5 billion. We continue to target a net debt-to-equity ratio of 60%-65% in the next 18 months. On page 11, you will find our equipment capital expenditures.

Machinery and equipment capital expenditures for the second quarter in U.S. dollars totaled $495 million, of which $287 million were used in packaging operations, $133 million in testing operations, $70 million in EMS operations, and $5 million in interconnect materials operations and others. Given the current business climate, we continue to be cautious with our capital expenditures. However, even in this time of change, we are seeing a number of opportunities appearing for our businesses. These include opportunities as a result of manufacturing capacities relocating away from geopolitical risk and other supply chain shifts. As you may be aware, on May 15th, the United States Bureau of Industry and Security announced plans to protect U.S. national security by restricting the use of U.S. technology and software to design and manufacture its semiconductors abroad. After September 14th, 2020, semiconductor manufacturers will be under order by the U.S. to restrict product shipments.

The U.S. BIS has not finalized this pronouncement, but whatever format it takes on, we would comply. With the restriction left in its current format, we expect this ruling may start impacting our revenues beginning in late August. But with that said, we do not believe that geopolitical disruptions fundamentally alter long-term demand of communication products and infrastructure. For instance, if a consumer drops their smartphone and one particular brand is not available, there are many substitute smartphones. As such, we believe that the majority of the impact will be more of a near-term nature. But as demand resettles over the following quarters, product flow and competition will reestablish a new equilibrium. And given our capability and market share of advanced packaging, we believe much of the potentially impacted business will go back into the market and get redistributed back to us.

We expect this process will take some time to fully play out. We do not opine on the validity of this proposed restriction one way or the other. We also definitely believe that this is an ongoing situation. We have evaluated many possible scenarios, and even in a worst-case scenario, we believe that we would be able to contain the impact of such a restriction to a mid to high single-digit decline to our ongoing ATM business over the coming year. This would represent direct business restricted in full, and that market share is reshuffled back from other customers. In the end, we believe in our own capabilities and the strength of Asian semiconductor manufacturing. For the third quarter, outside the impact of geopolitical disruption, we see the communications market picking up, driven by strength in 5G.

To the contrary of what many market research firms are concluding for the logic semiconductor market, we are seeing strong business growth. It is necessary to point out that we do not just service traditional semiconductors. In fact, one of our fastest-growing segments is our SiP business, which creates systems and subsystems not captured within the semiconductor market. Our products enable our customers to add new features to their products, such as with current-generation products enabling millimeter-wave 5G technology. We believe that our SiP business will continue to pick up momentum in the back half of the year. Entering the third quarter, our factories are generally already running at or near full capacity. We actually see a mid single-digit growth for our ATM business. However, we also estimate that we will also see a 5% business impact from the U.S. restriction.

If we do not see relief from the US restriction, given product cycle times, we will start seeing impact in late August. Growth net of this restriction will result in what appears to be a flattish outlook for the third quarter. Also, of concern to our ATM business during this time frame is the strength of the Taiwan dollar. For our third quarter gross margins, we estimate we will see a 0.6 basis point impact from NT dollar appreciation from a sequential perspective. Further, as geopolitical disruption takes shape in mid-August, we also see some margin impact during the back half of the third quarter. The outlook, ATM and NT dollar terms, ATM third quarter 2020 business should be similar to second quarter 2020 levels. ATM third quarter 2020 gross margins should be similar with first quarter 2020 levels.

For EMS and NT dollar terms, EMS third quarter 2020 business should be similar with third quarter 2019 levels, and EMS third quarter 2020 operating margin should be similar with third quarter 2019 levels. That concludes the prepared remarks. Please open the floor for Q&A.

Operator (participant)

Yes, ladies and gentlemen, if you need to ask questions, please press zero one on your telephone keypad to enter the Q&A queue. If you want to remove yourself from the Q&A queue, please dial zero two on your telephone keypad. Thank you. Now, please press zero one if you would like to ask questions. Thank you. The first to ask questions, Randy Abrams, Credit Suisse. Go ahead, please.

Randy Abrams (Managing Director and Head of Semiconductor Research)

Okay. Yes, thank you. Good afternoon. Yeah, the first question wanted to just ask on the third quarter outlook. I guess maybe big picture, the mid single-digit growth, maybe factors comparing to foundry or TSMC, which is quite optimistic. But I'm curious if you're seeing any timing difference from the, I think now even the flagship customers noted a little bit later build, if there's a different seasonal profile for your second half from just different timing this year for both segment, ATM and EMS. That's kind of the first part. The second part, if you could clarify the impact from the restriction. Just want to make sure I get it right, that it's mid single-digit third quarter. And then if I could understand after that, like a full quarter and fourth quarter, once that customer is out, what the impact is.

Then I think I heard medium term, it's still a mid- to high single-digit impact even with new customers. So I guess if you could just clarify how that impact will play out after or going into second half and then beyond.

Joseph Tung (CFO)

Well, I think in terms of TSMC's situation and our comparison, I think we're not a full reflection of whatever TSMC is projecting at this point because of the different customer portfolio and also different level of capacity or technology in the two different segments. So I think what we are projecting on our end is really the forecast that we're getting and the situation that we are in today. In terms of third quarter, I think what I can just mention is that if you're credibly just looking at the forecast, we should be having a 5% or mid-single-digit growth in the quarter. But we are looking at the U.S. export restriction impact on us, and we're taking the although the pronouncement is not finalized yet and exactly how much and what kind of an impact on us is still remaining to be seen.

Just for the conservative perspective, we are saying that we are thinking that the 5% or the mid-single-digit growth in our ATM business should be offset by this U.S. export restriction. Therefore, in our guidance, we're saying that we're going to have a similar quarter in third quarter comparing to the last quarter. For the fourth quarter, I think, again, nothing is finalized yet, and there will be further revisions or modifications in the restriction. So the net impact of that still remains to be seen. At this point, we're not giving out any fourth quarter projection yet.

Randy Abrams (Managing Director and Head of Semiconductor Research)

Okay. Could you clarify the comment, the mid- to high single-digit impact? Is that the one, even including some other customers making up the difference? So that's what you still see as net impact, even factoring some benefits, or do you expect, I don't know, in a medium term, you'd get back to run rates? I'm just curious that second part of the guidance, what you were implying.

Joseph Tung (CFO)

I think what we're saying is really, again, to be conservative, although nothing is confirmed yet, but just for the conservative per se, we are saying that we if we look at full year next year, there could be a mid- to high single-digit impact on our revenue. But still, it depends on what kind of a year in 2021 in front of us. And there are a lot of things that are still moving parts, and we're just trying to be conservative about it. And there are a lot of things to be considered, including new products coming out, including the COVID-19 situation, including the overall demand situation in the whole world and the 5G deployment status. And also, there's going to be if one customer is impacted, there could be other customers having some reshuffling of business in terms of these competition landscape.

So all things put together, it's still a very vague or very unclear situation in front of us. But just to be conservative, we want to say there could be a mid to high single-digit impact on our revenue for next year.

Randy Abrams (Managing Director and Head of Semiconductor Research)

Okay. Yeah, no, thanks for the clarification. Then if you could give an update, I think right after the merger, you had mentioned about the synergy that you could have, I think, 2 points at the operating margin level. And it looks like first half, I think you're on track with that. But the sales are also recovered in first half. But I guess now that you've had a bit more time to assess, if you could give a view how to think about the margin, if it's in measure of synergy, and then how we can think about the OPEX growth and also the CAPEX outlook now.

Joseph Tung (CFO)

I think after lifting off the restriction, I think we have been initiating quite a bit of efforts in terms of having a better alignment with SPIL. And that includes some of the capacity sharing, procurement, also CAPEX alignment, and so on and so forth. And we are seeing very good progress in the first half, although the COVID-19 situation, also the US restriction, may have some of the offsetting impact on us. But nonetheless, I think in terms of operating expense, I think we are definitely on track in terms of getting back to the 2018 level, which was 9.4%. In fact, by the way it's going, even with a lot of the uncertainties in front of us, our expectation is that we're not only going to be hitting that target but also maybe ahead of that target a bit.

We are seeing some of the synergies being created with a better cooperation, a better alignment with the two entities.

Randy Abrams (Managing Director and Head of Semiconductor Research)

Okay. Great. And for CAPEX, if you have a view of now, I think you mentioned a little bit of conservatism, but then some new opportunities. So how that may net out for overall CAPEX spending?

Joseph Tung (CFO)

I think for this year, we're still maintaining our original budget. We're saying we have been telling the streets that we are expecting similar level of CapEx for this year, and that hasn't been changed yet.

Randy Abrams (Managing Director and Head of Semiconductor Research)

Okay. Yeah, and if I can ask one final on the, I guess, the latest news from Intel, where they're starting to consider at the foundry, one is a chiplet strategy, and then the second is potentially contingency plan to do some outsourcing. I'm curious if you see opportunity on the CPU market or from some of this potential contingency or strategy shift maybe taking place.

Joseph Tung (CFO)

Well, I think it's still early to comment on that. I think the overall impact still remains to be seen. But generally, we are seeing Intel's competitors that are ramping up, and that certainly benefits our overall business. Going forward, it's kind of a natural tendency that if TSMC does better, we do better.

Randy Abrams (Managing Director and Head of Semiconductor Research)

Okay. Great. No, thanks a lot, Joseph.

Joseph Tung (CFO)

Thank you.

Operator (participant)

Next one, we are having Gokul Hariharan, JPMorgan. Please ask your questions.

Gokul Hariharan (Managing Director)

Yeah, thanks. Well, thank you for the question. So the first question I had is just to understand the impact of this U.S. restriction. I think if you think about your market share and various competitors of this company, which has been restricted, how quickly do you think you start to get back some of this market share, even if these restrictions were to remain in place? And secondly, since we don't have clarity in terms of how the final restrictions are going to shape up, if we think about, I think you talked about 5%-6% mid single-digit growth in Q3 without these restrictions coming into place. Would you think that if it's a normal kind of year without these restrictions coming into place, would you have expected that Q4 also would be kind of a growth quarter for IC ATM?

I had a follow-up question on this as well.

Are we clear on the question?

Joseph Tung (CFO)

I think it's fair to say that, without the US export restriction impact, we should have a stronger [second half] than what we're projecting now second half. And there was a fair chance that we would continue to see quarter-on-quarter growth in terms of the overall business. But still, I want to qualify by saying that nothing is finalized yet, and how big the impact will be still remains to be seen. And we're just taking one step at a time. Without any changes so far, we're just projecting that in third quarter, there may be some impact on us, which could be a mid-single-digit kind of impact on our revenue.

Gokul Hariharan (Managing Director)

Okay. Just quickly on the margin, I think just following up on Randy's comment, I think previously, we had talked about 200 basis points for margin expansion in IC ATM as a result of the recombination synergies, etc. When should we expect that to come through? Is that something that you now expect maybe sometime next year, or would that be affected by this US restriction as well for the medium term?

Joseph Tung (CFO)

Well, I think, well, certainly, the first half, we have reached our target. But going into the second half, I think there's a lot of uncertainties in front of us, including the COVID-19 situation that has an impact on our overall situation and the U.S. restriction. And by and large, I think the NT dollar appreciation also had a very large impact on us. So I think it will become a bit difficult for us to reach our 2% margin improvement target for the year. We will work on it, and situation changes, and then we need to perhaps put in more efforts in terms of controlling our costs. And hopefully, we can maintain that we can reach that target sometime in next year.

Gokul Hariharan (Managing Director)

Okay. Got it. I just one small question on SiP. I mean, you talked about some of the new millimeter-wave-related projects coming through. How should we think about the new wave of SiP projects that ASE is entering? Should we expect that that will be more margin accretive to the business, or would they be similar to the margins that you're making in the current EMS business?

Joseph Tung (CFO)

One second, please.

Operator (participant)

Gokul, are you still with us?

Joseph Tung (CFO)

Yes, I'm with you. I think the new products that we are going in, particularly in the SiP products, I think right now, we're in the stage of ramping up, and we're expecting fairly good progress or momentum going into the second half, particularly on some of the new projects that we're going in. I think in terms of margin, I think these new projects should be margin accretive, and that will help our overall momentum for the year and following to next year. We have been making a lot of progress in our SiP business buildup. I think in terms of our EMS business, right now, I think about 40%. In second quarter, it's about 40% of the overall business, and that percentage will continue to rise. And in terms of ATM, it's on the mid single-digit level.

We're seeing this SiP business momentum start to accelerate in the second half. We set out to say that we have a goal of new SiP business revenue to be $100 million a year, and it looks like we're going to triple that, more than triple that in 2020. We're making a lot of headways or progress in terms of building the SiP business, which is not only help the revenue but also on the margin.

Gokul Hariharan (Managing Director)

Thank you.

Operator (participant)

Right now, we're having Roland Shu from Citigroup. Go ahead, please.

Roland Shu (Analyst)

Hi. Good afternoon. For U.S. restriction, I would like to know what extent of the U.S. technology, equipment, or software you are using for doing your business. Is it possible for you to build a production line totally without using U.S. technology or equipment going forward?

Joseph Tung (CFO)

There is a portion of our equipment or capacity that are U.S.-made or with U.S. content. There are other alternative solutions to that, although I don't think that is really the main issue. I think this result is reflected in the whole value chain, whole manufacturing chain. It's not just on the assembly and test per se. So it comes all the way from chip design to foundry to wafer fabrication to assembly and test. So we cannot isolate this just by looking at whether we can replace our capacity or equipments with non-U.S. equipments to try to solve that problem.

Roland Shu (Analyst)

Understood. But for the assembly and testing point of view, I think the extent of this U.S. technology or equipment, I think that this service will be much lower than the foundry or others, right?

Joseph Tung (CFO)

That's correct.

Roland Shu (Analyst)

Okay. Understood. Okay. Second question. Can you just say you started EMS seasonal production earlier than previous years? And also, I think this morning, I think the key system house company talked about their smartphone launch schedule will be about a week later than expected. So for that one, I think this actually is a little bit different from what the customer is talking about. So I'm wondering what kind of product you started the production in second quarter for EMS business. And with this early start, will that result the full queue, the EMS revenue will be lower than previous years? Thank you.

Joseph Tung (CFO)

I think we're talking about two different things. I think in the second quarter, the better-than-expected revenue growth, it was twofold. One is some of the quarter one demand because of the operation disruption, it was being pushed out to second quarter. And second is that we did have a better-than-expected ramp on some of the SiP products, which are not related to the smartphone that are coming on stream in third quarter, although there's a bit of a delay. But what happened in second quarter is not related to that.

Roland Shu (Analyst)

So what kind of the product it is? So is that for computer or for other?

Joseph Tung (CFO)

It's for communication and for consumer as well.

Roland Shu (Analyst)

Understood. Yeah. So then you think other seasonality for your EMS business in three-queue and four-queue will be well maintained. So definitely, we are not going to see four-queue seasonality will be impacted, right?

Joseph Tung (CFO)

Judging from whatever forecast we're getting, we're seeing a very strong momentum in the second half, and we will see quarter-to-quarter growth as well.

Roland Shu (Analyst)

Understood. Okay. Thanks. These are my questions. Thank you.

Joseph Tung (CFO)

Thank you.

Operator (participant)

Right now, we are having Bruce from Goldman Sachs. Please go ahead and ask your questions.

Bruce Lu (Managing Director)

Hi. I wanted to take on more about the gross margin for the ATM business. I think that we do see the currency impact in the second quarter already, but management mentioned that there will be another close to 1% gross margin impact. Can you be more quantified that what is the impact from that lower inflation rate in the second part of the quarter and also the Forex for the second quarter? I'm sorry, for the third quarter.

Joseph Tung (CFO)

I think in terms of the utilization in the second quarter, we're looking at around 85% across the board, including assembly and test. Going into third quarter, I think in the first two-thirds of the quarter, I think we will remain to be full, fairly high, a very high utilization. But just to be conservative, we're saying we could see some impact starting from late August, and therefore, the utilization may drop a bit to still above 80%. So overall, I think the margin impact because of the utilization rate differences is very marginal. I think most of the margin pressure will really come from the NTD appreciation.

Bruce Lu (Managing Director)

Oh, I see. So compared to earlier this year, if you use a similar foreign exchange rate, what kind of gross margin we are looking at for third quarter?

Joseph Tung (CFO)

So the question I'm trying to ask is that without the Forex impact, are you on track to deliver the gross margin improvement? Because Forex is not something we can control, but the product mix, the cost saving is something the management can do. Yes. I think, as I mentioned earlier on, we are on track in terms of controlling our OPEX. And like I said, on the cost of goods sold side of it, aside from the currency issue, there is a little bit of an impact not on the utilization but really on the utility costs because we're in the summer period. Therefore, there could be some impact on the margin.

Bruce Lu (Managing Director)

Oh, I see. I see. Lastly, again, I want to follow up with Roland's question about the seasonality for the EMS business. I think third quarter, you are guiding for flatish year-on-year decline. I'm sorry, flatish year-on-year revenue. But your key customer is having some delay for their production, and you have very, very strong second quarter as well. So can you walk us through the seasonality again for your EMS business?

Joseph Tung (CFO)

You're referring to third quarter?

Bruce Lu (Managing Director)

Yes. Because you are guiding third quarter revenue to be year-on-year flatish, right?

Joseph Tung (CFO)

Yes.

Bruce Lu (Managing Director)

Right. But your key customer is actually having some delay in terms of their production. So how can you deliver the flatish year-over-year growth?

Joseph Tung (CFO)

Well, I think what we're saying here is we are using NT dollar for third quarter. But if you look at it in US dollar terms, there's still actually some growth.

Bruce Lu (Managing Director)

I see. I see. So even though your customer might delay their production, you are still generating revenue growth for the third quarter, for the EMS business?

Joseph Tung (CFO)

A week? Yeah. I don't think our third quarter is still growing in terms of our EMS. One-week delay, I'm not sure how much it will impact.

Bruce Lu (Managing Director)

I should ask this way. Do you see any schedule delay for your customer for your production in the third quarter as a year-on-year basis?

Joseph Tung (CFO)

No.

Bruce Lu (Managing Director)

I see.

Joseph Tung (CFO)

No comment?

Bruce Lu (Managing Director)

No, or no comment. It's very different. Okay. Okay. I'll back to the queue.

Operator (participant)

We are now taking questions from Sebastian Hou, CLSA.

Sebastian Hou (Managing Director)

Yes. Thanks for taking my question. So my first question, sorry, that I probably will join later. So I just want to clarify one thing, that the mid- to high-single-digit impact from this year's extension on one of your customers, is that for next year or for third quarter over second half this year? Thank you.

Joseph Tung (CFO)

Both.

Sebastian Hou (Managing Director)

Okay. Got it. But you see that, okay. Okay. So but for third quarter, the impact should be less. Is that right?

Joseph Tung (CFO)

The third quarter impact will be what?

Sebastian Hou (Managing Director)

Will be less than that magnitude because you are probably still shipping something to that customer in the first half of the third quarter.

Joseph Tung (CFO)

We're not commenting on any particular customer.

Sebastian Hou (Managing Director)

Oh, okay. Got it. Right. But if I look at the guidance you have, I understand there's a time difference between you and foundry, but I think clearly, I think TSMC will also have a similar exposure to you to the customer, that customer in question. But apparently, that company, TSMC, seems to be able to backfill or find other customers to fill that hole pretty soon, so even raise a full-year guidance. So my question to ASE is that it is just a temporary issue that you have, given the time difference, time lag between foundry and OSAT. So probably some of that strength will be seen in fourth quarter, or there's a bigger crush, bigger issue where I think TSMC can find someone to backfill while it's difficult for us to do that.

Joseph Tung (CFO)

Well, I responded to this question earlier on. I think, first of all, we're not a full reflection of TSMC's business model. We do have different customers. We do have different technology. We're not exactly in the same arena. So there's going to be some natural differences between us. Second is, like I said, nothing is finalized yet. So whatever impact on us may or may not be the same as everybody else. And we're not even sure how much of an impact and how long the impact will be because nothing is finalized yet. What we're trying to say is if we have to be on the more on the conservative side, we're trying to say that this thing could be contained. And also, it doesn't really change the overall ongoing growth driver for our industry remains the same, 5G, HPC.

There's also all kinds of different new applications and new products that are coming on stream. So there are a lot of uncertainties involved and also different players. There's going to be a lot of reshuffling in the industry. So there's so many different factors that could have an impact on the overall situation. So whatever we're saying now is really just a guesstimation that what could be the impact on us.

Sebastian Hou (Managing Director)

Got it. Got it. Let's see here. Can I revisit my previous question? So you probably mentioned before, I just want to clarify, that the mid to high single-digit driver's impact is for the consolidated revenue or for the IC ATM only?

Joseph Tung (CFO)

IC ATM only.

Sebastian Hou (Managing Director)

ATM. Okay. Got it. The last question from me is on the SiP business. I think that currently, we have been pretty positive and have a leading technology here. How do you evaluate this opportunity when we go to 2021, and how do you see the competition? Do you see the competition is intensifying, or the gap between us and the second or third-tier players are getting widening or narrowing based on your judgment? Thank you.

Joseph Tung (CFO)

Well, there's going to be any industry or any market, there's going to be ins and outs of different competitors, and we're totally open to that. I think the key strategy for us is to continue to maintain our leadership in technology and also our product offerings and solution offerings. So the overall impact remains to be seen. But I think the overall growth momentum in the SiP business is still very strong, and we're definitely the dominant player in this. And there will be others coming in as a second or third source. And we actually welcome that because it adds to the integrity of the whole business. Hello?

Sebastian Hou (Managing Director)

Oh, I'm still on. Yeah. Thank you. Thank you very much. That's good.

Joseph Tung (CFO)

Thank you.

Operator (participant)

Next one, we are having Gokul Hariharan from JPMorgan. Go ahead, please.

Gokul Hariharan (Managing Director)

Yeah. Hi. Just a quick follow-up question from me. I think we had talked about very strong growth in our turnkey business and increasing the exposure for tests. With this U.S. restriction coming in, do you see that the growth in tests is likely to slow down as well? I think some of your equipment vendors have talked about orders drying up pretty quickly as a part of this restriction earlier today or actually yesterday. So could you just talk about what is the outlook for the tester, especially the turnkey part? Are other customers picking up some of the capacity over the next two-three quarters? Thank you.

Joseph Tung (CFO)

Yeah. I think there could be some short-term impact, but overall, I think the general trend remains to be the same. And we do plan to continue to leverage on our turnkey capabilities and continue to drive the test business of ours. I think there's still plenty of room for us to grow in this particular area. And this is a business that has ample growth opportunity, and also, it's a margin-accretive business for us to continue to focus on.

Gokul Hariharan (Managing Director)

Okay. Could you talk a little bit about what is the status of Asteelflash? How quickly should we see that consolidation coming into the P&L for ASE? And what are the things that you're looking for to kind of drive some synergies off given that the revenue mix for that company seems to be a little bit different?

Joseph Tung (CFO)

Well, I think the schedule remains the same, that we are expecting to close this by end of third quarter. And I think the very rationale for having this acquisition is really the businesses are very complementary to each other. I think the Asteelflash, first of all, has a very extensive footprint, particularly in the Europe area. And also, its product and service offerings are very complementary to USI. And also, the business model-wise, is also very complementary. While Asteelflash is mostly in the early stage, smaller quantity, going into mass production type of business, while USI is very, very strong in mass production. So I think the two entities have very, very strong synergy that can be created among the two.

Gokul Hariharan (Managing Director)

Okay. Thank you.

Joseph Tung (CFO)

Thank you.

Operator (participant)

Next one to ask questions, Rick from Daiwa. Go ahead, please.

Speaker 8

Yeah. Hi. It's Joseph and Ken Hsiang. This is Rick. So I guess just one question from me. Do you guys worry about the year-end inventory risk? Because the reason why I'm asking is I think one of the reasons why the demand strength in Q3 across the board of the IDM companies is the continuous stocking from customers because of the worry of the COVID-19 will continuously affect the supply chain operation. But on the other hand, the inventory at the end of the second quarter is already kind of excessive. And the COVID-19 overhang will likely further weigh down the demand in second half. So I'm just wondering whether you guys worry about any big mismatch between the sell-in and sell-through when we move toward the end of this year.

Joseph Tung (CFO)

Well, I think like everybody else, we cannot exclude the possibility of there could be some inventory buildup because of the overall supply chain situation. But so far, we are running based on the forecast that we're getting. And we're not in one particular area, and we have a diversified customer base and product offerings. So we're seeing a fairly strong overall momentum going forward. So we're not overly concerned on that.

Speaker 8

Okay. Just one quick follow-up. I think some management indicate this high inventory build could become a new norm in this industry going forward. Do you guys agree? Hello?

Joseph Tung (CFO)

Can you repeat the question again?

Speaker 8

Okay. What I'm saying is some companies recently indicate that this high inventory buildup could become the new norm in the industry going forward. For example, in the past, right, they say when we talk about seasonal norm, it could be seasonal norm, they said, 70 days. But now, it could be maybe 80 days or even 90 days will become the new norm for the seasonal inventory buildup. Would you guys agree?

Joseph Tung (CFO)

I don't think we can comment on that. But inventory can come in many different shapes or forms. I think if we look at kind of the legacy products, there could be some inventory buildup. But in terms of more advanced products or new applications, I don't think there's really inventory buildup at this point.

Speaker 8

Okay. Well, fair enough. Thank you so much. Yeah.

Joseph Tung (CFO)

Okay.

Operator (participant)

As a reminder, if you would like to ask questions, please press zero or one on your telephone keypad to enter the Q&A queue. Thank you.

Speaker 9

If there are no more questions, we can, oh, wait. We have one more question. I announced it too late.

Operator (participant)

All right. So right now, we are having Randy Abrams from Credit Suisse. Go ahead, please.

Randy Abrams (Managing Director and Head of Semiconductor Research)

Okay. Thanks for fitting me. And no, I actually wanted to just clarify on fourth quarter because it's, I guess, noisy with a lot of moving parts. Because I think from the impact from the restriction, it moved from mid-single to mid- to high-single. So there's a few-point net impact. But I'm curious, you're also mentioning pretty good momentum. So is there a way to think how you're netting it out? I think in the past, sometimes when things have been good, you've said, "Hey, business actually looks so good. Fourth quarter looks like it's growing." I guess if you can give a snapshot, knowing it'll change in a few months, but how the net of all this based on forecasts looks?

Joseph Tung (CFO)

Well, I think fundamentally, I want to say that we're still seeing a very healthy and very strong demand momentum for us in the overall view of things, particularly in the 5G area, the HPC, and so on and so forth. There are a lot of new things that are going on. A lot of the front-end investment that we made last year and also the early part of this year are starting to pay off. And that's why we're seeing a very strong first half and even in the third quarter. If everything remains the same, we're still seeing quarter-to-quarter growth, and the momentum seems to be continuing. The restriction will definitely have an impact if it stays as it is. There should be a short-term impact on us. If it involves any particular customer, we are here to serve the whole industry.

There are other customers as well. Whatever that's being left out could be picked up by somebody else. It really depends on how things move along. At this point, since nothing is confirmed, we're really not saying that the things are falling apart just because of this restriction. We're just saying that to be conservative, we want to put this in the fair state of mind, I guess. Things can change. Things can change very fast. How soon and how fast things could turn around, we don't really know. We don't really have a good grasp of it. We do know that the basics remain the same. The industry is still moving toward more technology advancement, toward new products introduction, and so on and so forth.

We continue to maintain our technology leadership so that whenever there is a new opportunity, we will have the first mover advantage. Whenever there's a customer switch, market share switches, we will be best positioned to capture that opportunity as well to mitigate whatever impact it could or may or may not have. So we're just trying to put things in the right state of mind at this point. So whatever we're saying now is it's really still very, very uncertain. So hopefully, things can turn back to normal in a fairly short of time, and then we can go back to a normal growth pattern again.

Randy Abrams (Managing Director and Head of Semiconductor Research)

Okay. And is it possible to say what % of revenue, either in IC ATM or % of consolidated?

Joseph Tung (CFO)

Well, whatever we're referring to is basically on the ATM side.

Randy Abrams (Managing Director and Head of Semiconductor Research)

Or no, the contribution, what percent customer? That was just an.

Joseph Tung (CFO)

We don't comment on that.

Randy Abrams (Managing Director and Head of Semiconductor Research)

Okay. Just the last question I want to ask. To clarify, because I think your guidance, similar level for ATM is about 160 basis points. NT dollar, I think based on a moving maybe 2%-3%, is probably about half of that. You mentioned utility costs. I'm curious if anything else in terms of material. I don't think you have much gold, but there's been a huge increase. So if there's any other material costs or product mix or pricing, I just want to understand all the factors, if any others.

Joseph Tung (CFO)

Okay. Aside from the NT dollar appreciation, there could be some utilization is also one factor, and there could be some product or even business mix changes that will all have some impact on the margin. I think it's an overall consideration that we put in to look at our third-quarter margin.

Randy Abrams (Managing Director and Head of Semiconductor Research)

Okay. And to clarify, you have no real gold exposure anymore, or is there anything to that, any sensitivity anymore?

Joseph Tung (CFO)

Gold?

Randy Abrams (Managing Director and Head of Semiconductor Research)

Yeah.

Joseph Tung (CFO)

It's very, very minimum.

Randy Abrams (Managing Director and Head of Semiconductor Research)

Okay. Great. Okay. No, thanks. That's all my questions. Thank you.

Joseph Tung (CFO)

Okay. Thank you very much for attending the conference call. I think to summarize, we had a strong first half. We'll continue to see business momentum going into the second half, particularly in our SiP business as well as our EMS business. ATM-wise, there could be some more uncertainties in front of us. We're doing everything we can to try to face this challenge. And we remain very, very optimistic about the overall business momentum going forward. Thank you very much.

Operator (participant)

See you next quarter.