ASE Technology Holding Co Ltd

TWSE:3711

Earnings Call Analysis

Mixed Results and Cautious Q4 Outlook

Revenue rose 13% sequentially but fell 18% year-over-year. Gross margin improved slightly from the previous quarter by 0.2 percentage points to 16.2%, yet it decreased by 3.9 percentage points from the previous year due to reduced loading. Net income increased by TWD 1.1 billion sequentially but experienced a TWD 8.8 billion drop compared to the same period last year. The company's effective tax rate is expected to remain around 21%. Looking ahead, the ATM segment's Q4 revenue is projected to decline low to mid-single digits sequentially, with gross margin remaining steady. The EMS segment anticipates low teen revenue growth QoQ with operating margin similar or slightly above the year-to-date margin of 3.3%.

Introduction to ASE Technology Holding's Q3 2023 Earnings

The Head of Investor Relations for ASE Technology Holding, Ken Hsiang, led the discussion of the company's third-quarter results. ASE Technology, primarily operating in Taiwan, presented their financials following the country's IFRS standards.

Business Environment and Performance Summary

ASE Technology encountered a relatively soft overall business environment in Q3. Although the launch of new communication products slightly increased demand, the company continued to experience subdued demand coupled with post-COVID inventory adjustments. Unplanned orders, characterized as sporadic and spread across various product types, contributed positively but were higher than anticipated. The ATM business performance exceeded expectations, while the EMS business lagged slightly due to shifted loading into Q4. Utilization rates remained modest, averaging in the mid-60 percent range.

Financial Highlights and Currency Impacts

ASE Technology reported a basic EPS of TWD 2.04 for Q3. The company analyzed that the depreciation of the New Taiwan dollar against the US dollar positively influenced gross and operating margins, translating currency fluctuations into a tangible impact on profitability.

Profit Margins and Foreign Exchange Effects

Excluding certain expenses, the company's gross profit would be TWD 25.8 billion, which represents a gross margin of 16.8%. Specifically, for the ATM business, foreign exchange rates positively influenced margin improvements, and without specific depreciation and amortization, ATM gross profit margin would be 23.3% and operating profit margin would be 11.9%.

Revenue Trends and Market Segment Behaviors

Current financial trends have impacted the ATM business more severely than the EMS segment. The reported ATM revenues were just above levels seen in early 2022. A closer look at market segment behavior reveals a mixed performance. While the communications sector experienced seasonal growth and advanced packaging services saw increased interest, other segments such as automotive, consumer, and others faced declines indicative of broader demand softness.

EMS Business Dynamics and Capital Allocation

The EMS revenues stood at TWD 71 billion, an 18% improvement sequentially but a 22% decline on a year-over-year basis. These fluctuations were largely attributed to the seasonal characteristics of the business and a general electronic demand slowdown, respectively. The company highlighted that the consumer segment in EMS experienced seasonal growth, automotive grew in absolute terms, and expectations remain for automotive to outpace other segments. Equipment capital expenditures focused on areas like packaging and testing operations, indicating an emphasis on advanced packaging services that the company sees as future growth drivers.

Liquidity, Debt, and Investment Strategies

ASE Technology maintained a healthy cash position along with a reduction in interest-bearing debts. However, the company's net debt to equity rose due to the cash utilization for annual dividend payments. Capital expenditure remained well covered by EBITDA, and areas such as artificial intelligence-related packaging have attracted attention potentially leading to further investments, albeit conditional on financial viability.

Inventory and Product Perspective

The company acknowledged complexities in managing inventory, particularly the dynamic of wafer banks, as new wafers were replenishing what was being depleted. ASE Technology is transitioning focus toward newer generation products, hinting at an improved business environment looking into 2024. The emphasis on AI to optimize business operations and consumer lifestyles presents opportunities for targeting products at emerging consumer demands.

Outlook for Q4 2023

ASE Technology's Q4 projections include a low to mid-single-digit decline in ATM revenues and flat gross margins relative to Q3. EMS revenues are expected to grow in the low teens percentage-wise, with operating margins similar or slightly above the year-to-date margin of 3.3%. This guidance reflects a cautious stance towards an industry that has not yet fully recovered, as seasonal product cycle forces seem to overpower signs of a broader market recovery.

Earnings Call Transcript 2023-Q3

[Kenneth Hsiang, executive]

Hello. I am Ken Hsiang, the Head of Investor Relations for ASE Technology Holdings. Welcome to our Third Quarter 2023 Earnings Release. Thank you for attending our conference call today.Please refer to our Safe Harbor notice on page 2. All participants consent to having their voices and questions broadcast via participation in this event. If participants do not consent, please disconnect at this time. I would like to remind everyone 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, dollar figures are generally stated in New Taiwan dollars unless otherwise indicated. As a Taiwan-based company, our financial information is presented in accordance with Taiwan IFRS. Results presented using Taiwan IFRS may differ materially from results using other accounting standards, including those presented by our subsidiary using Chinese GAAP.I am joined today by Joseph Tung, our CFO. For today's session, I will be giving the prepared remarks. Joseph will then be available to take your questions during the Q&A session that follows.The overall environment for our businesses during the third quarter was relatively soft from a historical perspective. Devices related to new communications products introduced during the quarter generated a small pickup in demand. But by and large, the post-COVID inventory digestion and suboptimal demand environment continued.For the third quarter, both our ATM and EMS businesses saw mild seasonal upticks. Our ATM business results were on the higher side of our expectations. We believe this is primarily attributable to higher than expected unplanned orders. In this soft loading environment, our customers have become more cautious when booking regular production forecasts on the expectation that there would be more capacity available when needed. We do to a certain extent try to apply an unplanned order rate to our outlooks, but for the third quarter, unplanned orders were a bit higher than expected. These unplanned orders were sporadic and disparate and not isolated to any particular product type or market segment. For our ATM factories during the quarter, key equipment utilization rates were still relatively low, averaging out in the mid-60s. Our EMS businesses pickup was slightly below our initial expectation. We believe this was due to some loading being pushed out into the fourth quarter.With that, please turn to page three where you will find our third quarter consolidated results. For the third quarter, we recorded fully diluted EPS of TWD 2 and basic EPS of TWD 2.04. Consolidated net revenues increased 13% sequentially and declined 18% year-over-year. We had a gross profit of TWD 24.9 billion with a gross margin of 16.2%. Our gross margin improved by 0.2 percentage points sequentially and declined by 3.9 percentage points year-over-year. The sequential improvement in margin is principally due to higher ATM business loading in the current quarter, offset in part by higher EMS revenue mix. The annual decline in gross margin is principally the result of lower loading during the current downturn.Our operating expenses increased by TWD 1.2 billion sequentially and declined by TWD 0.8 billion annually. The sequential increase in operating expenses are primarily due to higher profit sharing expenses and miscellaneous increases such as DNA, factory supplies and others. The year-over-year decline was primarily attributable to lower bonus and profit sharing expenses across the company. Our operating expense percentage declined 0.2 percentage points sequentially and increased 1.2 percentage points year-over-year to 8.8%. The sequential operating expense percentage decrease was primarily related to lower salary and bonus costs relative to revenues generated. The annual operating expense increase is primarily due to higher mix of ATM business during the quarter. Operating profit was TWD 11.4 billion, up TWD 2 billion sequentially and down $12.3 billion year-over-year. Operating margin was 7.4%, improving 0.5 percentage points sequentially and declining 5.2 percentage points year-over-year. During the quarter, we had a net non-operating gain of TWD 0.8 billion. Our non-operating gain for the quarter primarily consists of net foreign exchange hedging activities, profits from associates and other non-operating income, offset by net interest expense of TWD 1.2 billion. Tax expense for the quarter was TWD 2.9 billion, net of a one-time capital gain tax of TWD 0.7 billion. Our effective tax rate was 18.1%. We believe our full year effective tax rate to still be about 21%.Net income for the quarter was TWD 8.7 billion, representing an increase of TWD 1.1 billion sequentially and a decline of TWD 8.8 billion year-over-year. The NT dollar depreciated 2.9% against the US dollar sequentially during the third quarter and 4.5% annually. From a sequential perspective, we estimate the NT dollar depreciation had a 0.8 percentage point positive impact to the company's gross and operating margins. From a year-over-year perspective, we estimate that the depreciating NT dollar had a 1.2 percentage point positive impact to gross and operating margins. As the rule of thumb, for every percent the NT dollar appreciates, we see a corresponding 0.27 percentage point impact to our holding company gross margin.On the bottom of the page, we provide key P&L line items without the inclusion of PPA related expenses. Consolidated gross profit excluding PPA expenses would be TWD 25.8 billion with a 16.8% gross margin. Operating profit would be TWD 12.6 billion with an operating margin of 8.2%. Net profit would be TWD 9.9 billion with a net margin of 6.4%. Basic EPS excluding PPA expenses would be TWD 2.31.On page 4 is a graphical presentation of our consolidated financial performance. As you can see here, the current correction appears to have had a stronger impact on our ATM business than our EMS business. Our traditionally strong third quarter ATM revenues are just now near our first quarter 2022 levels.On page 5 is our ATM P&L. It is worth noting here that the ATM revenue reported contains revenue eliminated at the holding company level related to intercompany transactions between our ATM and EMS businesses. For the third quarter 2023, revenues for our ATM business were TWD 83.7 billion, up TWD 7.6 billion from the previous quarter and down TWD 15.1 billion from the same period last year. This represents a 10% improvement sequentially and a 15.3% decline annually. Gross profit for our ATM business was TWD 18.6 billion, up TWD 2.4 billion sequentially and down TWD 10.2 billion year-over-year. Gross profit margin for our ATM business was 22.2%, up 1 percentage point sequentially and down 7 percentage points year-over-year. Gross margin was on the higher side of our expectations. The sequential margin improvement is the result of improved scales of efficiency from higher loading, offset in part by slightly higher summer utility consumption and outsourced services, while the annual margin decline is primarily the result of lower loading due to the current downturn.During the third quarter, operating expenses were TWD 9.8 billion, up TWD 1 billion sequentially and down TWD 0.4 billion year-over-year. The sequential increase in operating expenses was primarily driven by higher compensation based expenses and higher R&D related factory supplies. The annual operating expense decline was driven primarily by lower profit sharing and bonus, offset in part by higher R&D related costs. Our operating expense percentage for the quarter was 11.7%, up 0.2 percentage points sequentially and up 1.4 percentage points annually. Sequential operating expense percentage increased as a result of higher R&D and compensation related costs. The annual increase was due to lower loading and thus lower operating leverage. During the third quarter, operating profit was TWD 8.8 billion, representing an increase of TWD 1.4 billion quarter-over-quarter and a decline of TWD 9.9 billion year-over-year. Operating margin was 10.5%, improving 0.8 percentage points sequentially and declining 8.4 percentage points year-over-year.For foreign exchange, we estimate that the NT to US dollar exchange rate had a positive 1.4 percentage point impact on our ATM sequential margins and a positive 2.2 percentage point impact on a year-over-year basis. Without the impact of PPA related depreciation and amortization, ATM gross profit margin would be 23.3% and operating profit margin would be 11.9%.On page 6, you'll find a graphical representation of our ATM P&L, revenues and their corresponding scaled efficiency are still a ways off from previous 2022 peaks.On page 7, is our ATM revenue by market segment. You can see here the seasonal pickup of some communications products during the quarter. We also saw a smaller pickup in our computing segment. Our automotive, consumer and other market segment declined on a relative and absolute basis. We believe this decline to be out of character for the seasonally strong third quarter. However, it is indicative of the current softness in demand.On page 8, you will find our ATM revenue by service type. You can see here that we are experiencing a stronger pickup in our advanced packaging services, which includes bumping and flip chip. Our wire bonding and test business saw their relative shares decline during the quarter. It is worth noting that on an absolute dollar basis, both wire bond and test service types increased revenues.On page 9, you can see the third quarter results of our EMS business and a graphical representation of its market segment allocation. During the quarter, EMS revenues were TWD 71 billion, improving TWD 10.6 billion or 18% sequentially and declining TWD 19.7 billion or 22% year-over-year. Sequential revenue increase is primarily attributable to the seasonal nature of our EMS business, while the year-over-year revenue decline is primarily due to the broad-based, soft electronics demand environment. Sequentially, our EMS businesses gross margin declined 0.2 percentage points to 9.1%, while our operating margin improved 0.4 percentage points to 3.9%. The operating margin improvements were driven primarily by loading and favorable foreign exchange impacts to raw materials. Our EMS third quarter operating profit was TWD 2.8 billion, up TWD 0.7 billion sequentially and down TWD 2.3 billion annually. For our EMS market segment, our consumer segment picked up seasonally as industrial and automotive segments declined on a relative basis. And while the automotive segment lost relative share, it grew during the quarter by 7% on an absolute dollar basis. From a full year perspective, we continue to expect our automotive market segment to outperform other segments.On page 10, you will find key line items from our balance sheet. At the end of the third quarter, we had cash and cash equivalents and current financial assets of TWD 71.9 billion. Our total interest bearing debt was down TWD 32.1 billion to TWD 219.2 billion. Total unused credit lines amounted to TWD 347 billion. Our EBITDA for the quarter was TWD 27.8 billion. As mentioned in our previous quarter, our net debt to equity this quarter was up as a result of cash usage for annual dividend payment.On page 11, you will find our equipment capital expenditures. Machinery, and equipment capital expenditures for the third quarter in US dollars totaled $239 million, of which $121 million were used in packaging operations, $89 million in test operations, $28 million in EMS operations and $1 million in interconnect material operations and others. Current quarter EBITDA of $0.9 billion continues significantly to outpace our equipment capital expenditures of $0.2 billion. It is worth noting that with more excitement surrounding AI, our leading-edge advanced packages in our vertically integrated or VIPack offerings are getting a lot more attention from our shareholders as well as our customers. At this point, we are expecting incremental customer adoptions of our fan-out and interposer-based solutions along with increasing collaboration with Upstream Foundry Partners on Leading Edge Advanced Packaging. As a result, we will be making incremental investments to support these businesses subject to financially justifiable returns. And while revenues related to these products are relatively small, representing a low single-digit percentage of ATM revenues, we believe we see significant growth opportunities in the coming year.We are in October now, and the year is almost done. Much of the original wafer banks for our ATM business still remain to be addressed. As with many situations during the downturn, our wafer bank situation has become a bit complicated. During the third quarter, while some wafer banks were gradually being looked down, the composition of some of those wafer banks appeared to be replenishing instead of just declining. In effect, we saw newer wafers started to come in and replace older ones. Devices on these older wafers may continue to be sold, perhaps by being re-skewed or by being marked down. And if that is the case, we will provide packaging and testing services for those products. But for us, the focus going forward should be placed on the newer generation of products. And while we are not in position to predict how long those new products will stay in the channel before they sell through in the end markets, we do believe that the overall environment heading into 2024 appears to be improving. Our customers have been more cautious in their approach towards restocking. Overall demand looks marginally better as consumers finish their post-COVID catchup spending. Businesses are looking to implement AI to optimize their business operations. Consumers are discovering how new AI technology may help improve their lives. It is an opportunity to target a new generation of products at a new generation of consumer demand.Looking out into the fourth quarter, we see many products continuing their seasonal builds. And while we did see a welcomed mild seasonal ramp, we have not necessarily seen a rapid recovery for the industry. As an extension to this concept, we believe the seasonal forces of product cycles are still stronger than the recovery we are encountering. As such, we see our fourth quarter revenues to be more indicative of waning seasonal builds, than the rising momentum of a full recovery. For our EMS business, the third quarter is shallower than normal product reps turn into a longer building season with a peak in the fourth quarter. Product mix and the cessation of foreign exchange benefits will result in a lower quarterly operating margin similar with year-to-date levels.We would like to summarize our outlook for the fourth quarter as follows. For our ATM business, in NT dollar terms, our ATM fourth quarter 2023 revenues should decline low to mid single digits quarter-over-quarter. Our ATM fourth quarter 2023 gross margin should be flattish as compared to third quarter 2023. For our EMS business, in NT dollar terms, our EMS fourth quarter 2023 revenues should increase percentage wise in the low teens quarter-over-quarter. Our EMS fourth quarter 2023 operating margin should be similar or slightly higher than our EMS year-to-date 2023 operating margin of 3.3%.That is the conclusion of our prepared remarks. I would like to open the floor to questions.

[Operator]

Now we would like to open the floor for questions. [Operator Instructions] We have a question from Mr. Gokul Hariharan of JP Morgan.

[Gokul Hariharan, analyst]

So my first question is on the wafer bank comment, quite interesting. Could you talk a little bit more, Ken and Joseph on the composition of that wafer bank. Are you seeing new wafers coming in for one kind of application while the older wafers that are not yet getting fully depleted is for some other kind of application? Is there any difference by application that you are seeing in terms of the wafer bank inventory buildup and reduction? And to the extent that you have visibility for, could you talk a little bit about how quickly this wafer bank could potentially get depleted over the next maybe a couple of quarters or so? That's my first question.

[Joseph Tung, executive]

Well, I don't think we can predict how fast or how, what kind of a pace that the original wafer bank will be worked out. We are seeing these original wafer banks being progressively working down to a certain level. But at the same time the overall wafer bank is still at a relatively high level because of some of the wafer banks are being replaced by the new wafers that are coming in. And I think at this point it's really the new products that we launched, which is mostly in communication, consumer as well as in computing area. It's quite widespread in terms of new wafers coming in and I think the overall inventory digestion is still going on. It should continue for some time. I think the bright side of it is we are seeing that being worked out and we're seeing signs of this inventory being consumed and the digestion -- we should be at the tail end of the industry digestion now.

[Gokul Hariharan, analyst]

So if you look at the Q4 guidance down low to mid single digit, you saw a pretty good improvement in communication by both auto and industrial kind of tailed-off in Q3. Is that the same trend going into Q4 that communication and consumer is relatively strong while you see the drop off continuing in auto and industrial?And lastly, I think on the auto industrial side, any thoughts on how this is likely to play out given it's been a sector, which has been relatively strong until very recently, seems like seeming to go into inventory correction now. Based on prior history and your judgment, do you think this is going to be still a drag for most of next year, like first half of next year at least?

[Joseph Tung, executive]

I think overall situations are stabilizing now. And auto remains to be one of the brighter spots and we are making quite a bit of progress in moving up the auto part of the business. I think last year we have overall about 7% of our revenue coming from automotive and that ratio has been up to around 10% for this year. And we believe it will continue to grow, although we are seeing some level of the growth, momentum seems to be slowing down a little bit because in certain area there will be some inventory that needs to be digested. But overall I think the overall trend is still going fairly healthy. For quarter four, I think it's across the board. I think a lot of the new products are being introduced and we are seeing the seasonal uptick from these new products that are being launched.

[Operator]

Our next question is from Ms. Laura Chen of Citigroup.

[Chia Yi Chen, analyst]

My first question is about the COAS or substrate advanced packaging expansion. Can you provide us more detail about how big of the capacity you are preparing and also in terms of the growth outlook, even though so far is at very low single digit of the IC ATM business. But just wondering your view on the capacity expansion plan and also the growth outlook? That's my first question.

[Joseph Tung, executive]

Well, instead of giving out the numbers for capacity, I think what we can say is we have the sufficient installed capacity that are generating the revenue that we're generating now. And we do see pretty good potential going forward and we'll be making the necessary investment, provided those are financially justifiable. And most of the CapEx that we are going to put in or the investment we're going to put in are for de-bottling the capacity. And at this point we are confident that we should easily double that part of the revenue next year.

[Chia Yi Chen, analyst]

And also my second question is also just wondering that you see the ATM business will see slightly down but at the same time the gross margin seems to be resilient at the current level. So just wondering like in terms of the technology mix or applications, what have you held relatively well for the profitability into Q4, even though we see still some softness?

[Joseph Tung, executive]

Well, a lot of it comes with the product mix that we're building. In quarter three and also in quarter four we are seeing that the higher margin products being representing a higher percentage of our overall revenue and also, I think the pricing continued to be resilient and given our scale and our technology offering and the efficiency or the level of automation that we have, we have continued to being able to maintain a reasonable price level and also to have pretty good control over our cost making the margin at, you know, we are not totally happy, but quite satisfactory level at this point. Even when we are anticipating a mild decline in revenue going into quarter 4, given the efforts that we put in we believe that we can maintain whatever margin we achieved in quarter 3, if not higher, a little bit higher.

[Operator]

Next question is from Mr. Bruce Lu of Goldman Sachs.

[Zheng Lu, analyst]

The management sounds a lot more bullish or positive in terms of AI revenue potentials. Given that the technology for AI in terms of packaging is so complicated for me, can you tell us what is the service you provided for AI. It's more linked to fan-out or on sub-tray or anything? What kind of profitability, what kind of return on equity, what kind of capital intensity for this business?

[Joseph Tung, executive]

Well, we are getting pretty good traction with our customers in terms of both our [indiscernible] as well as interposer-based kind of packaging products. And we will be aggressively engaging these customers and try to feed their needs. But at the same time, we are also increasing our collaboration with the upstream foundries in providing the sufficient capacity into this area. So we are optimistic about the revenue from these different package type products coming from both directions. One is our own solutions, and the other is really the collaboration with foundries.

[Zheng Lu, analyst]

But which one is stronger for the past 3 months which one turns out to be more positive to give the management like stronger confidence? Collaboration with foundries or yourself?

[Joseph Tung, executive]

The collaboration is more stable there and it's more obvious. In terms of our own solution, I think the design or the process of this is still subject to a lot of the customer discussions and also co-working with our customers. But we are making a lot of progress on that. And we're actually in mass production, but in terms of real volume, I think we should be seeing that coming from next year.

[Zheng Lu, analyst]

Okay. Sorry. So what was the profitability for that? Capital intensity -- the profitability for the AI-related business and capital intensity for that?

[Joseph Tung, executive]

Well, you're seeing our margin being gradually improving. So at least the margin should be accretive.

[Operator]

Our next question is from Mr. Charlie Chan of Morgan Stanley.

[Charlie Chan, analyst]

So first of all, congrats for the great execution, especially for first quarter gross margin improvement. And so first question -- yes, sure. So first question is about your view about the cycle. I know right now, customers placing rush orders, the wafer bank get depleted, but do you think that right now is the hard bottoming cycle, meaning for the first quarter, you wouldn't expect a further decline of the fab utilization? Can you just give us some color about the cycle recovery?

[Joseph Tung, executive]

Well, I certainly don't have the crystal ball for us. I think the market is still very volatile. I think one good sign of it is we, same as everybody else, we believe that we are at least at the -- maybe at nearing the end of the inventory digestion. But still, I think that's -- we did not -- at this point, I don't -- I personally don't believe that this is really the real issue here. I think the real issue is still whether the overall consumption will recover more -- in a stronger case than what we're witnessing now. That really involves a lot of different various exogenous factors.The recent war that's going on in the Middle East, certainly, it doesn't help the situation. And we thought that the inflation is in check now. But with the war going on, that may have another -- put in another variable into it. So it's very hard to predict how soon or how fast the industry will recover. We're just going to play by ears. I think there are good signs, there are bad signs, but overall I think we were just focusing on what we do best and serve our customers.And we are cautiously about next year -- cautiously optimistic about next year. We believe that going into Q1, all over -- throughout the whole year of next year, we will continue to see year-over-year growth.

[Charlie Chan, analyst]

Okay. Thanks, Joseph. So, just to look back. When did you start to see or feel the so-called the rush orders? Can you give us kind of a timing, when did you start to see that?

[Joseph Tung, executive]

We have been seeing rush orders throughout the years, particularly at the -- last month of any particular quarter, we will -- we see some rush orders coming in across the board. I think that's the reason -- the reason for that is customers are, like Ken mentioned, is at this point more cautious about restocking. And since there are ample capacity as well as wafers and also materials, I think the customers will tend to wait till the last minute until they see -- they have a clearer view of their upcoming demand that will put -- they will put the orders in. So that's what we have been seeing for the past few quarters and we are seeing that still going on at this point.

[Operator]

Next question is from Mr. Rick Hsu of Daiwa Securities.

[Rick Hsu, analyst]

Can you guys hear me?

[Operator]

Yes.

[Rick Hsu, analyst]

Okay. Great. First question is regarding your capacity utilization across the board, ATM. I think if I don't remember wrong, Ken said something about mid-60s for Q3, right? So I assume, given your expected decline in Q4 ATM revenue, so your loading should be below mid-60s in Q4, is that right?

[Joseph Tung, executive]

It will be slightly lower than 65%, yes.

[Rick Hsu, analyst]

Okay. Great. Second question. Your foundry partners, like the TSMT and UMC, see some good early signs of demand stability from PC and smartphone consumer electronic products. Do you guys agree? And if so, do you see any counter seasonal possibility for your Q1 loading, assuming there's already some demand recovery from this consumer space?

[Joseph Tung, executive]

Well, there are spotty signs of optimism, but -- and demand remains to be seen. There could be some volatility in 2023. But we believe that things are starting to look up. And that's why we -- like I said earlier, we are cautiously optimistic about next year.

[Operator]

Next question is from Brad Lin of BofA.

[Brad Lin, analyst]

I have 2 questions. One on generative AI and second on the silicon photonics. So, basically, firstly, we are encouraged to learn the management's positive comments on the new generation of the consumer demand. I'm quite curious about what kind of the new application should we expect for the consumer market and what are the applications that are inside for the ASE? And also, what time do we expect it to, well, take off?

[Joseph Tung, executive]

Take off in what? In silicon photonics?

[Brad Lin, analyst]

No, no. For the new generation of the consumer demand, which may be brought by the generative AI.

[Joseph Tung, executive]

I think the AI is coming and we're expecting the AI technology to proliferate into so many different kinds of edge devices. And it will be the main thing for the next few years. It will be a mega driving force for the industry to grow, and we're certainly going to be well-prepared for it. I think the real cream for us is not just the AI chip itself, but the proliferating applications into all different kinds of devices that will create tremendous peripheral chips demand for us to satisfy.

[Brad Lin, analyst]

Got it. So that's a structural trend, and then we should see a lot of the new applications to come in the coming years.

[Joseph Tung, executive]

Yes. Exactly. And I think the momentum will start to -- really start to accelerate going to 2024.

[Brad Lin, analyst]

Got it. Got it. And then my second question is on the CPO. So we have learned that ASE started development of the CPO or silicon photonics for a couple of years during the SEMICON. So may we learn the opportunities and also the implication of the new technology and what are the key barriers or challenges for ASE here in this new technology?

[Joseph Tung, executive]

Well, now, being a technology guy, I think from what I heard, that's still a few years away. Right now, we're still focusing on the silicon photonic chips packaging test. Going forward, I think the technology will just -- will push the development of CPO and we're still at the investing stage. And when the demand really comes, we will be ready for it.

[Operator]

Next question is from Ms. Sunny Lin of UBS.

[Sunny Lin, analyst]

Could you hear me okay?

[Operator]

Yes.

[Sunny Lin, analyst]

So my first question is on interposer-based 2.5D package. I think currently the mainstream solution is based on silicon interposer, but there's increasing discussions on the technology move into RDL-based 2.5D package. And so based on your engagement with the key customers, when do you think that shift will start to happen? And for ASE, I assume that you should be getting more opportunities if the industry does start to make that shift?

[Joseph Tung, executive]

Yes. We're seeing that happening now, and we are aggressively engaging our customers who are looking for more cost-effective kind of solution. At this point, I think if you call silicon-based -- silicon interposer-based, it's still a bit more matured kind of technology and I think the RDL-based, there will still be some discussions in terms of the design or the process of it that needs to be worked on individually with the customers that we are engaging now.We are in mass production at this point, but with limited amount. But we see this has a pretty good potential, and we will continue to make investment into it and continue to work very closely with our customers to start expanding that part of the business for us.

[Sunny Lin, analyst]

Got it. So a quick follow-up on this part of the business. And so in terms of the competition, obviously, the leading foundry is also aggressive on the overall technology road map. Some of your competitors are also focusing on exploring the opportunities. And so for ASE, what are some of the competitive advantage that you think you have when competing with the key projects?

[Joseph Tung, executive]

Well, our long partnering relationship with the foundry or the foundry certainly gives us an edge. And given our scale and the technology that we have been brewing over the years, I think we are certainly ahead of our competitors in whatever products that we are building today or whatever technology that we're developing. So we -- competition is given. There's always going to be competition. The key here is really to stay focused and continue to bring out the satisfactory offering to our customers as well as our upstream foundry partners.

[Operator]

Next question is from Mr. Szeho Ng of China Renaissance.

[Szeho Ng, analyst]

My first question is regarding the pricing environment. So far, it seems to be quite stable. But would there be a risk that the pricing environment would be more aggressive when the inflation point really kicks in, when the market rate bottoms?

[Joseph Tung, executive]

Well, pricing is -- pricing pressure is always there and -- but given our scale and our leading position, I think our pricing is more resilient than our competitors. And we'll continue to find the most suitable pricing strategy for -- to satisfy ourselves as well as our customers.

[Szeho Ng, analyst]

I see. All right. And second question regarding the CapEx this year and also any initial outlook for next year's CapEx?

[Joseph Tung, executive]

Nothing for next year, but for this year, we are sticking to our original CapEx roughly for equipment about TWD 1 billion. And the split of it will be around 50% in assembly, 30% in test, 17% in EMS, and 3% for material.

[Operator]

Next question is from Mr. Gokul Hariharan of J.P. Morgan.

[Gokul Hariharan, analyst]

So for some of these 2.5D packaging and advanced generative AI-related products, could you talk a little bit about how much more capital intensive these investments are? I think long time back we used to talk about [ TWD 1.1 ] revenue for TWD 1 of CapEx for flip chip and much lower for wirebond. Could we talk a little bit about how we are seeing this capital entity going up for some of these investments?Second, what is ASE's stance on taking some customer-supported capacity buildups? Some of your competitors or some of your peers have kind of done some of the capacity expansion in partnership with some of these AI customers. Any thoughts on how ASE is approaching this kind of capacity build out?And lastly, I think we've been seeing CapEx cuts, CapEx declining since 2021. So do we feel like we are reaching an inflection where we start to have to add some capacity, increase CapEx in next year? Or you think given utilization is still mid-60s, next year outlook is still not that clear to guide for any meaningful CapEx increase?

[Joseph Tung, executive]

Well, like I said, we are seeing a better overall market environment for next year. I wouldn't be surprised that we -- next year's CapEx, although I don't have the number here, but I do believe that the CapEx that we need to put in for next year will be higher than this year.In terms of the advanced packaging, I think, like we said, the -- right now, we're still at the early -- very early stage in developing this part of the business. And so I think we don't have sufficient data points to come on with a real or more precise investment intensity at this point. Plus, like I mentioned earlier on, whatever investment that we are on the table today for this type of products is mostly for debottling the current capacity that we have.So I don't have a real number for -- in terms of capital intensity for this type of product, until we collect more data points and until this part of the business becomes a larger enough pool of business that we can come up with the more meaningful real numbers for it. I think whatever we're going to do is really, we will look at the demand, we will look at the technology that's required or the equipment that's required, and also the business terms that we can get. So when we put the investment in, it will be suitable for the demand and also that can create a justifiable financial return for us.

[Gokul Hariharan, analyst]

Okay. Got it. My second question is on the adoption of chiplet. We've seen a lot of that happen in the HPC side. Broadly, could you talk a little bit about how the chiplet adoption helps or changes ASE's role, either adds to it or takes away something, but just how you think about it? And more specifically, do you see more chiplet-related packaging potentially getting adopted even in the communication, the mobile smartphone segment which is largely monolithic right now, looking out maybe a couple of years in terms of what you see and have discussions with your key mobile customers?

[Joseph Tung, executive]

Well, I guess chiplet is certainly the technology that's required for, especially for advanced nodes and there's physical boundaries that we need to break through the chiplet packaging. So it is a growing trend, and we will -- at this point, we think it's still predominantly in the HPC area or networking. When or how fast it will move into other areas, I think it will take some time for us to have a better grasp of its development.

[Operator]

Next question is from Bruce Lu of Goldman Sachs.

[Zheng Lu, analyst]

Joseph, I want to ask about the dividend. Given your EBITDA is so much stronger than the CapEx, can we expect a higher dividend payout ratio moving forward or at least for this year? You are paying TWD 8, TWD 7 for the last two years given the weakness of this year, but your cash flow is still very strong. So can we expect a higher payout ratio this year?

[Joseph Tung, executive]

I think we have been paying 60% to 65% over the years, and this is not up for me to answer. I think this has to go through the Board. And given the circumstance, I think we will have good discussion on how we address this issue. Sorry...

[Zheng Lu, analyst]

I understand that just like, if you maintain the 60%, 70%, given that the earnings decline more than that, so we don't want to see the dividend per share goes down much. I mean just an investor feedback.

[Joseph Tung, executive]

Yes, yes, yes. I understand.

[Zheng Lu, analyst]

Another question for your testing. I mean, I think I do recall in early 2022, management turned more aggressive in testing, which generated pretty stronger growth and earnings. However, if you look at from the second, third quarter, your testing revenue, the growth rate was substantially slower than your packaging business. At the same time, your peers, their testing business has been pretty good with very impressive share price. So what kind of testing strategy can we expect? Do we expect some change for the testing? Do we turn more aggressive into the testing? Do we get involved in the wafer-level testing moving forward? What kind of strategy we're going to -- can we expect?

[Joseph Tung, executive]

Well, we still have the same view on testing that we believe still has -- it does have good potential for us. We want to maintain -- remain aggressive in making tests. This is a larger part of our overall. And we're going to come back and revisit the overall situation and see how we can move further toward our target and to bring this part of the business up. What are the right businesses that we should be pursuing? What kind of new technology that we should be investing in? That's an ongoing process.I think the recent kind of a slower growth pace in tests is because of the overall product shifting in this market at this point. So, I think that's one of the main reasons why we're seeing some of the differences in the test business growth pattern between us and our competitor. But we're going to look into this and we're going to put our focus back on test and we'll continue to drive that business.

[Operator]

Next question is from Mr. Szeho Ng of China Renaissance.

[Szeho Ng, analyst]

Yes. Regarding the interposer business, do you have any plan to get into the fabrication part of the business?

[Joseph Tung, executive]

I'm sorry, I didn't get your question.

[Szeho Ng, analyst]

Do you have any plan to build interposer internally?

[Joseph Tung, executive]

Build interposer internally?

[Szeho Ng, analyst]

Right.

[Joseph Tung, executive]

I wish we could, but, no. I don't think we have any plans of doing that.

[Szeho Ng, analyst]

I see. Because it doesn't fit our DNA, right, I think for interposer?

[Joseph Tung, executive]

Doesn't fit what?

[Szeho Ng, analyst]

It doesn't fit our DNA. I mean the business or the know-how.

[Joseph Tung, executive]

I'm not sure this is really what our strength is. And this is a wafer process and we're assembly house. So I don't see the -- a real good fit in it.

[Operator]

Next question is from Mr. Charlie Chan of Morgan Stanley.

[Charlie Chan, analyst]

So, I'm not trying to be picky, but I'm very interested about your previous comments. You said that usually in the previous quarters, right, rush order only happen in the quarter end. But now we are at the beginning of the quarter, do you still see rush orders coming? Am I getting anything wrong or is that a sign of kind of demand is actually better than expected? How do we read this?

[Joseph Tung, executive]

No, I'm saying the pattern seems to be remaining. That's to say, by end of the quarter, we could see some other rush orders coming in. I'm simply trying to say that the quarter-end rush order seems to be the pattern up until now, yes.

[Charlie Chan, analyst]

Okay. Okay. So another follow-up question or 2, if I may. One is the AI chip testing business, right, [ GPU or ASIC]. It seems like your competitor in testing business are gaining a lot of market share. I just wanted to know any fundamental reason behind that?And second part of question is more about long term because as you can see that for mature foundry, that's a capacity expansion happening in China. So I'm just wondering if China in the long term will gain market share, whether that means ASE in the back end foundry service will lose market share because you're probably -- I'm not sure, right, but you probably sold your China operation a couple of years ago?

[Joseph Tung, executive]

Well, I think the -- our China operation remained in Suzhou, which is under SPIL. It's a bit different from -- it's quite different from the 4 factories that we sold 2 years ago. I think the Suzhou factory today is a more advanced facility than the 4 that we sold. And it does address the growing demand in China, particularly when the -- when things are -- the whole industry is kind of polarizing at this point where China demand remains into China and the outside of China goes to outside.So I think the Suzhou being a more advanced, more efficient and a more cost-effective kind of facility, I think it does -- it's doing quite well actually in China, particularly in terms of serving the China customer -- Chinese customers with higher-end technology requirement. So we're confident that in China we could be losing some revenue in terms of dollar, but in terms of business, we're actually gaining better quality business in China.

[Charlie Chan, analyst]

Testing, yes, for that GPU and ASIC, yes.

[Joseph Tung, executive]

Other than congratulating, our competitors are doing a very good job in securing that type of business. Well, we have some catch-up to do, and we will do so.

[Operator]

[Operator Instructions] There is no more question.

[Joseph Tung, executive]

Okay. Thank you all for coming. Sorry for my low voice because I caught a cold. But thank you again for joining us and we'll see you next quarter.