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Advanced Semiconductor Engineering, Inc. (NYSE:ASX)

Q3 2007 Earnings Call

October 30, 2007, 8:00 AM ET

Executives

Joseph Tung - VP and CFO

Analysts

Steven Pelayo - HSBC

Frank Wang - Morgan Stanley

Szeho Ng - BNP Paribas Peregrine

Chitra Gopal - Nomura International

Randy Abrams - Credit Suisse

Dhruv Vohra - CLSA Asia

Presentation

Operator

Welcome and thank you for standing by. At this time I would like to inform all participants that you'll be able to listen-only until the question and answer session of today's conference call. Today's conference is being recorded, if you have any objection you may disconnect at this time.

I would now like to turn the conference over to Mr. Tung. Thank you sir you may begin.

Joseph Tung - Vice President and Chief Financial Officer

Thank you. Good morning and good evening everyone. Thank you for attending ASE Q3 2007 earnings release conference call. Before we get into the financial report, let me recap you on the recent announcements ASE has made. On September 4th, ASE Inc. and ASE Test, a majority owned subsidiary of ASE Inc, jointly announced that the two companies' have signed a scheme implementation agreement for ASE Inc. to acquire the remaining ASE test ordinary shares which ASE Inc. does not direct or indirectly own with all cash considerations.

The proposed acquisition will be down to a scheme of arrangement under Singapore law. Total cash considerations is U.S. $868 million, based on the per share offering price of U.S. $14.78. In connection with the proposed scheme ASE Inc. and ASE Test will file a statement of 30E3 with the U.S. Securities and Exchange Commission, which will contain in this brochure document with a proposed scheme, the so called Scheme Document. The final Scheme Document will be mailed to the shareholders of ASE Test when it is available.

Okay. Now let's get into our Q3 financial results. Please turn to page 1 looking at our consolidated income statement. We had a very good third quarter as our consolidated revenue grew 19% sequentially, other than the guided 15% and the total consolidated revenue reached NT$27.7 billion. This revenue growth came mainly from across the board seasonal demand pick up in all three sectors.

Gross profit went up 32% sequentially to NT$8.4 billion and operating profit grew 57% to reach NT$6.1 billion. After deducting total non-operating expenses of NT$280 million, pre-tax income amounted to NT$5.8 billion and net income went up 64% from previous quarter's NT$4.2 billion after recognizing tax of NT$1 billion, the minority interest adjustment of NT$596 million. EPS for the quarter was NT$0.79 up from NT$0.48 a quarter ago.

Individually, assembly revenue grew 20% and test revenue 12%, and also in line with higher assembly volume and increased direct sales to third parties, material revenue grew 33%. Utilization rate rose to 90% for assembly and 85% for test in third quarter.

In terms of profit margin; gross margin climbed further up from 27.4% to 30.4% due to overall higher volume. Material costs inched up from 27.3% to 28.2% of sales due to product mix change and higher material cost for substrate. Depreciation and labor cost, as a percentage of revenue, both decreased 14.8% and 13.9% respectively, compared to 17.6% and 14.7% a quarter ago.

Total depreciation expense plus machine rental stayed flat at NT$4.1 billion. Total operating expense came down NT$193 million in Q3; the total amount of operating expense was NT$2.3 billion. Given higher revenue and lower operating expense; operating expense as a percentage of revenue went down from 10.8% a quarter ago to 8.4%.

R&D and selling expenses both went down as a percentage of sales to 2.7% and 1% respectively from 3.1% and 1.1% a quarter ago, G&A went down to 4.7% from 6.6% a quarter ago. With the higher gross margin and substantially lower operating expense ration, operating margin improved from 16.6% a quarter ago to this quarter's 42%. Q3 total non-operating expense was NT$307 million, but then the total non-operating expense, interest expense went down from NT$305 million to NT$273 million through largely to repayment of outstanding loans.

Foreign exchange gain and evaluation gain was NT$179 million in the quarter due to largely to appreciating NT dollar and Renminbi nominated asset. Long-term investment gains of NT$111 million consist of NT$82 million of the investment income from USI, NT$30 million profit from Hung Ching Construction and NT$1 million loss from Hung Ching.

No, one-time charge was regularized in Q3, comparing to one-time bonus impact of NT$25 million from USI in Q2. EBITDA for the quarter was NT$10.3 billion, up substantially from NT$8.1 billion a quarter ago as a result of improved profitability. EBITDA margin went up for 34.6% a quarter ago to 37%.

Please turn to next page, to look at year-on-year comparisons. Comparing to the same period of last year, consolidated revenue went up 4% with assembly and material each grew at 6% and 20%. Our test revenue declined from last year by 9%. Both gross margin and operating margin came close to historical peak of 13.9% and 22.8% a year ago. Net income also grew 1% from NT$4.18 billion to NT$4.23 billion.

Next page looking at consolidated revenue and margin trends for the past 7 quarters. The chart shows that the revenue and profit trend in the last 7 quarters. Consolidated revenue and gross margin both reached historical high in Q3 '06 and trended downwards since. In Q3 this year, we have passed the revenue peak, but still a notch behind margin wise, which we are confidant to gain back in Q4.

Next page, looking at IC Packaging operations; packaging revenue and margins bottomed in Q1 '07 at only 21%. In Q3, packaging revenue grew 20% quarter-on-quarter and 6% year-on-year which is NT$21.6 billion. Gross margin in the third quarter of '07 was 25.7%. It was 0.4% higher than last year and 2% higher than the previous quarter.

In terms of packaging capacity, at the end of Q3, we have totaled 7,649 wire bonders. And during the quarter we added 645 new bonders, which includes 20 bonders acquired as a result of ASE and... as a result of the joint venture between ASE and NXP. 36 bonders were scraped during the quarter and most of the newly added bonders were at Kaohsiung, and ASE Shanghai. Utilization rate in the quarter remained at 90% plus with added capacity.

AST went through a slight decline of 2% to 3%. As with wafer bumping capacity, 8-inch capacity reached 85,000 pieces per month, running at full capacity and 12-inch wafer bumping capacity reached 16,000 pieces per month running at around 85%.

CapEx for packaging business totaled $83 million in quarter three with 81 million going for wirebonding and rest of the... and the rest for wafer bumping and flip-chip packaging equipment. CapEx for Q4 will be at around $80 million level mostly for the ramp up of Shanghai operation and some for upgrades in Kaohsiung and Korea.

Next page, on packaging revenue breakdown. In the quarter, revenue from advanced substrate and leadframe based packaging remained unchanged at 85% of total, while flip-chip packages and wafer bumping services represents 11% of the total packaging revenue.

Next page, on testing operations. Test revenue also grew 12% from last quarter, primarily due to higher volume, while ASP declined slightly on selective customers. Gross margin went up from 35% to 41% reflecting the high margin or contribution of incremental test revenue. Test CapEx amounts to U.S. $55 million in the quarter, mainly for communication related test requirements.

Test utilization rate in Q3 was around 85% blended and during the quarter, we added 138 testers, while disposing 21 testers. Out of the 138 testers added, 86 of them were very low end rec and spec [ph] testers confined by our all customers. 36 were newly purchased or leased and 16 were from the ASE-NXT JV. By the end of Q3, we have a total of 1,502 testers in our operations.

Q4 CapEx for tests is budgeted at around U.S. $35 million and which is evenly distributed among Taiwan, Singapore and Shanghai operation for their respective ramp up requirements.

Next page, looking at test revenue breakdown, 76% was for final test, 3% was for engineering test and wafer sort accounted for 21% total. There is not much of a different change from previous quarter in terms of the revenue breakdown.

Moving forward material operations; Q3 material revenue went up 19%... excuse me, Q3 material revenue went up 33%, outperform assembly revenue due to higher growth in direct sales, and increased percentage of internal supply. Consequently, gross margin went up from 20.7% a quarter ago to 24.1%. As we are holding our flip-chip capacity of 1 million unit per month, in Chung-li and standard PBGA substrate capacity of 52 million units per month; no CapEx or additional capacity was spent in a quarter, except $2 million for upgrades. We continue to budget very low CapEx for material in Q4, which is at about $2 million again, and only for upgrades.

Next page, on balance sheet information. Looking at our balance sheet, our cash and cash equivalent totaled NT$24.6 billion, down from NT$26.7 billion a quarter ago, due to cash dividend payout and loan outstanding pay down. Also, interest bearing debts of NT$38 billion consist of NT$7.3 billion revolver for working capital financing, NT$20.8 billion long-term borrowings and NT$7.7 billion long-term bonds, and NT$2.3 billion in current portion of long-term borrowings.

This puts our net debt-to-equity ratio for the Company at a healthy level of 0.16, which is unchanged from previous quarter. Our current ratio improved to 1.69 from 1.55 as a result of lower total current liabilities. Separately for acquiring ASE Test shares, we have arranged long-term banks financing up to U.S. $750 million and expect to fund the remaining part with internal cash flow.

Next page, our capital expenditure, we are ramping up capacity in ASE Shanghai, Kaohsiung and Power ASE, Q3 CapEx was U.S. 140 million, of which U.S. 83 million was for assembly, U.S. 55 million for test and U.S. 1 million... and U.S. 2 million for material. Year-to-date CapEx amounted to U.S. $284 million and we expect full year CapEx to be at $400 million range a level.

Next page, on our customers. Our top 5 customers accounted for 26% of our total revenue and top 5 accounted for 43%. No customer accounted for over 10% of our revenue. In terms of IDM and Fabless breakdown, IDM represents 38% of our total revenue and Fabless 62%.

Next, our market segment exposure. On the chart you can see there is not much change of in terms of our segment breakdown between consumer, communication and computing. In Q3, we see consumer representing 33% of total, communication 44% and computing 22%.

In the quarter, consumer percentage inched up as such increase is basically a specific customer driven. In Q4, looking at our forecast, we believe PC will have... PC computing sector will have a stronger momentum in the quarter although all three sectors will continue to see growth.

With that, let me give you our guidance for Q4. Judging from our customer forecast, we are expecting Q4 top line to continue to grow at mid single digit percentage and with the expanding revenue gross margin should continue to improve incrementally to be close to a 31%. And as mentioned earlier, our full year CapEx is expected to be at around $400 million level.

With that I will like to open the floor for questions. Thank you.

Question And Answer

Operator

Thank you. [Operator Instructions]. Our first question is from Shailesh Jaitley [ph]. Your line is open, you may ask your question.

Unidentified Analyst

Yes. Thanks for taking my question and congratulations for very good set of results.

Joseph Tung - Vice President and Chief Financial Officer

Thank you.

Unidentified Analyst

Yes. With the testing utilizations at 85%, which historically you have maintained as probably the max, probably you can get and packaging utilizations also running at about 90%. I was wondering that are these the peak margins or there is further room for improvement. If there is, what exactly needs to be done, what you would plan to do basically to improve the margins further?

Joseph Tung - Vice President and Chief Financial Officer

Well of course, we will continue to seek for efficiency improvement as well as cost structure improvements and as there are certainly further room for improvements as we have pointed out. Of course the economy of the scale is one of the very important factor involved, so in quarter four was the only 5%, our mid single digit increase in top line. We are still expecting improvement in... further improvement in margin. And I think the areas including that, in terms of the growth of our revenue, if we look at the assembly and test, we are seeing a slower test revenue growth in assembly, I think the main reason for that is because there is a natural time lag or the test revenue grows to catch up with assembly. And with that situation improved, the margin contribution from test operation will continue. We'll start to have some impact on margin expansion, and as I mentioned, we are also pull this thing on the improving our yield on material and also the ramp up of material operation and that will also have an impact on the margin as well.

Unidentified Analyst

Okay. And looking at your CapEx profile, definitely a 3Q CapEx was... a 3Q and 4Q both was lot higher as compared to what you spend in the first time. I was just trying to understand that minority of CapEx, does that imply that you are expecting stronger first half '08? And if so where do you see that strength coming?

Joseph Tung - Vice President and Chief Financial Officer

Okay, I think, well Q3 CapEx is basically, we are renting up for our Q4... of course at Q2 and beginning of Q3, we are already seeing very, very tight capacity and we need to add some new capacity to meet that growing demand. For Q4, I think the most part of the CapEx is really in preparation for ramping up our China operation. We are taking a new initiative in ramping up our Shanghai operation focusing on traditional leadframe based packages, which is a market that we have been... we have nothing putting a lot of focus on in the previous years.

Reasons being that before, we don't have the right cost structure here in Taiwan or any other site for that part of the business. But, since we have acquired the JPG [ph] operation in China, we certainly now have the platform to go into that area again to refocus on the area again. And for that we actually have pretty aggressive plans and the Q4 CapEx is really for us to gear up the capacity there and have the capacity installed in the early part of next year to run through qualification process with our customers and we have initial... we have contacted lot of the particularly IDM customers and this part, in this business already and the initial response was very positive. We have got a lot of the customers asking for RF skews and believe they have a very, very good potential for us to penetrate.

Unidentified Analyst

So this CapEx which was added in 4Q would start contributing to revenues right from 1Q, is that the right way to think about it?

Joseph Tung - Vice President and Chief Financial Officer

Starting from Q2 next year and I think the bulk of that we start to have... to have it in the second half of next year.

Unidentified Analyst

Okay, thanks. If one last question I could ask on GAPT; what proportion of your...what part of your CapEx, which you are spending this year, would be allocated to GAPT and also how many wirebonders do you have at GAPT currently?

Joseph Tung - Vice President and Chief Financial Officer

Let me just get... check the number. For the whole year we have about 20% of our CapEx allocated to GAPT.

Unidentified Analyst

And the number of wirebonders?

Joseph Tung - Vice President and Chief Financial Officer

Wirebonders, I need to get back you on that. Currently, we have about 850 bounders.

Unidentified Analyst

850 at GAPT and by any chance would you have the number as to where you expect to end the year at GAPT for number of wirebonders?

Joseph Tung - Vice President and Chief Financial Officer

I think it will be over a 1000.

Unidentified Analyst

Over 1000. Thank you very much.

Joseph Tung - Vice President and Chief Financial Officer

Thank you.

Operator

Thank you. Our next question will be from Steven Pelayo [HSBC], your line is open. You may ask your question.

Steven Pelayo - HSBC

Yes, I am curious about your outlook for the fourth quarter for test revenue, obviously have kind of underperformed overall revenue, but the incremental gross margin was nearly 100% or so. What is your outlook for the fourth quarter test revenue?

Joseph Tung - Vice President and Chief Financial Officer

Fourth quarter test revenue we'll have pretty much similar growth to the overall. As we carried fourth quarter, we were expecting about mid single digit growth, top line.

Steven Pelayo - HSBC

Okay. And then it looks like in the fourth quarter that your operating margin, you don't guide there, but it looks like it could very well surpass the previous peak around 23%, does that seem like a fair number or is their anything really going to happen in the operating expense line that might surprise us?

Joseph Tung - Vice President and Chief Financial Officer

Operating wise I think it will have some incremental increase in the quarter because we will be recognizing some of the transaction related fees over expenses, given the ASE Test acquisition or privatization of transaction. So I think, right in quarter three, our operating expense ratio is about 8.5%. I think it will be very similar in quarter four, although going into Q1 next year, hopefully we can... going into next year we will continue to drive that down to our first target of 8%.

Steven Pelayo - HSBC

Okay. And then my last question was just your depreciation outlook, you have spent a fair amount of CapEx in the third quarter which I look for the fourth quarter and then for 2008, did I lose you?

Joseph Tung - Vice President and Chief Financial Officer

I am sorry.

Steven Pelayo - HSBC

I am sorry, did you get that last question. My last question was relative to depreciation in the fourth quarter and then your outlook for 2008 depreciation given your CapEx plan?

Joseph Tung - Vice President and Chief Financial Officer

Well I don't have a CapEx plan for 2008 yet, but for quarter four I think, in terms of total amount, it should grow about 3% to 5%?

Steven Pelayo - HSBC

Will depreciations go 3% to 5%.

Joseph Tung - Vice President and Chief Financial Officer

Appreciation.

Steven Pelayo - HSBC

Yes, okay, great. Thank you.

Joseph Tung - Vice President and Chief Financial Officer

Thank you.

Operator

Thank you. Our next question is from Frank Wang [Morgan Stanley], your line is open. You may ask your question.

Frank Wang - Morgan Stanley

Hi good evening. Can you talk about your current capacity utilization and the yield rate for the substrates on the flip-chip BGA?

Joseph Tung - Vice President and Chief Financial Officer

Flip-chip we have very little output at this point. In terms of PBGA, I think we are running at about 80% of our capacity and the yield rate two layer and four layer blended is about 92%.

Frank Wang - Morgan Stanley

And what do you expect the capacity for the flip-chip and BGA substrates will be by end of 2008?

Joseph Tung - Vice President and Chief Financial Officer

End of 2008, that's a question for next quarter.

Frank Wang - Morgan Stanley

Okay. But, I guess, you are going to start increasing your capacity maybe from the first quarter 2008?

Joseph Tung - Vice President and Chief Financial Officer

Well it depends on the market condition.

Frank Wang - Morgan Stanley

Right. Okay and...

Joseph Tung - Vice President and Chief Financial Officer

The expansion of our material operation is more likely to start after Q2 next year. We are subject to continuous review of the situation.

Frank Wang - Morgan Stanley

Right, understood. And then few of the increasing debt on the balance sheet for the ASE privatization, what's your view on increasing cash dividend in 2008?

Joseph Tung - Vice President and Chief Financial Officer

I think the additional debt on the transaction is well within our financial capacity and I don't think it will have any impact on our dividend payout... cash dividend payout. Although I am not here to... this is really a forced decision and exactly what the payout ratio will be. So I am not here to make that policy just by myself.

Frank Wang - Morgan Stanley

All right. And I guess, last question from me that, you have any preliminary view in terms of the process for 2008 would be given that issue is quite flat for ASE which hasn't happened in... for a long time?

Joseph Tung - Vice President and Chief Financial Officer

Well I don't have any numbers, but I think what I can say is we are actually pretty optimistic about next year. Reasons being, first of all, I think the overall industry is having a very stable kind of growth with anywhere from 5 to 10% and I think that's the most ideal situation for us. If it grows too fast, we would not be able to expand quick enough to meet the demand. If it goes down too much than everybody suffers so anything within the 10% growth is a very ideal situation for us and typically the packing industry grows two times of the overall industry growth.

And also, we are... we have made a lot of progress in terms of penetrating or growing some of our... some of the major customers. We believe those growths will continue forward in the 2Q '08 and we... like I mentioned we also have new initiatives; one, is already being implemented which is the DRAM or the memory business, which is ramping up very nicely at this point, and although the DRAM market overall is going through a lot of fluctuations but and in terms of the total volume for back end is still continue to increase at a fairly fast pace.

And also, we are taking initiative to tune up our capacity, particularly in Shanghai area to focus on the traditional leadframe business. So, I think in terms of 2008, the market... overall market is favorable and we have a lot of initiatives both on the operation wise and also on customer perspective. So, I think 2008, we are actually very optimistic.

Frank Wang - Morgan Stanley

Okay. Thank you very much.

Operator

Thank you. Our next question will be from Szeho Ng [BNP Paribas Peregrine], your line is open. You may ask your question.

Szeho Ng - BNP Paribas Peregrine

Hi, Joseph, great quarter. Two questions from my side, on the BGA substrate front I just view on track to have 60 million units by end of this year?

Joseph Tung - Vice President and Chief Financial Officer

I think this will be pushed out.

Szeho Ng - BNP Paribas Peregrine

Okay. I see. So, actually is that something like 48 million end of this year, right?

Joseph Tung - Vice President and Chief Financial Officer

Yes. Depending on the devices that we are building, I think the capacities range from 48 to 52 million.

Szeho Ng - BNP Paribas Peregrine

Okay, I see. And then second question regarding your JV with NXP, is it a house gift [ph] for NXP order or are you free to approach other customers? I know that operation right now is doing okay [ph].

Joseph Tung - Vice President and Chief Financial Officer

It's very small and we are certainly is allowed to take on other businesses and I think that's the overall plan as well. But, initially I think it is only geared up to take on NXP's business at this point.

Szeho Ng - BNP Paribas Peregrine

I see. And do you have any capacity bill out plan for that JV? That you can share with us?

Joseph Tung - Vice President and Chief Financial Officer

I think the initial plan is to grow the capacity to about $200 million within the next two years.

Szeho Ng - BNP Paribas Peregrine

I see. Okay, thank you very much.

Operator

Thank you. Our next question will be from Pranab Sarma [ph], your line is open. You may ask your question.

Unidentified Analyst

Thank you. Joseph could you give us some idea about impact on your earnings because of employee stock bonus starting from first quarter of '08, what should be the impact to your operating margin?

Joseph Tung - Vice President and Chief Financial Officer

What I have said is expense, I think the total impact will be 7%, which is the payout percentage that we have already stipulated in our recovering corporation.

Unidentified Analyst

That meaning like, currently your OP margin is going around 22% that will come down to 15% by first quarter, assuming like similar?

Joseph Tung - Vice President and Chief Financial Officer

No, this is not 7% of the revenue; it's 7% of the net income.

Unidentified Analyst

Okay. Earning dilution is 7% of net income?

Joseph Tung - Vice President and Chief Financial Officer

Yes.

Unidentified Analyst

Okay. Then second one is on the CapEx side. I guess, you are not giving the 2008 CapEx guidance now, but is it fair to say that linearity in the 2008 CapEx will be quite similar to what we had this year, 2007?

Joseph Tung - Vice President and Chief Financial Officer

Actually... I actually think the 2008 CapEx could be at a higher level than this year.

Unidentified Analyst

I know, it will be higher, but how you are going to span out, whether it will be back end loaded or front end loaded?

Joseph Tung - Vice President and Chief Financial Officer

We will review that in this quarter as well as next when we are doing our full year budget for next year.

Unidentified Analyst

Okay. And...

Joseph Tung - Vice President and Chief Financial Officer

Well it's typical that the CapEx is more back end loaded.

Unidentified Analyst

Okay. Got it. Last one is on your Shanghai operations. Could you give us some update like what type of products are on that particular platform and what percentage of revenue contributed on last quarter, third quarter?

Joseph Tung - Vice President and Chief Financial Officer

In quarter three, it represents about 4, 4.5% of our total revenue.

Unidentified Analyst

And what are the products you are doing out there, now?

Joseph Tung - Vice President and Chief Financial Officer

BGAs and some of the leadframe packages.

Unidentified Analyst

Okay. Thank you.

Joseph Tung - Vice President and Chief Financial Officer

Thank you.

Operator

Thank you. Our next question is from Mehdi Hassani [ph], your line is open. You may ask your question.

Unidentified Analyst

Yes. Thank you. I joined your conference call later. I apologize if I am repeating previous questions. Regarding your Q4 guidance of up mid single digit; how does it compare to the forecast from a month or two ago and to that extent how did you close the month of October?

Joseph Tung - Vice President and Chief Financial Officer

I think the forecast hasn't changed that much since month or two months ago. In terms of October close.

Unidentified Analyst

Yes.

Joseph Tung - Vice President and Chief Financial Officer

In terms of revenue?

Unidentified Analyst

Yes, October revenue compared to September?

Joseph Tung - Vice President and Chief Financial Officer

Okay, higher.

Unidentified Analyst

Okay. Is October the peak for the fourth quarter?

Joseph Tung - Vice President and Chief Financial Officer

A typically peak sort of end of November... October and November time spread, but we will see how November will shape up.

Unidentified Analyst

Okay. And then I see a lot of activity at Fabs for some of the graphics or semiconductor companies that require flip-chip. Can you help us understand your bumping capacity? Where utilization rate is and how are you planning to increase capacity there?

Joseph Tung - Vice President and Chief Financial Officer

Currently we have about 85,000 pieces for advanced capacity for 8-inch bumping and this is running at full capacity.

Unidentified Analyst

Okay.

Joseph Tung - Vice President and Chief Financial Officer

We have about 16,000 pieces per month capacity for 12-inch and that part is running at about 85%. And we are planning to double that capacity by next year.

Unidentified Analyst

By next year, is that... I know you are not going to comment on next year's CapEx, but let's just assume that CapEx will be higher. Is this doubling in bumping capacity going to drive a higher CapEx next year? Is that why your wouldn't need to increase next year?

Joseph Tung - Vice President and Chief Financial Officer

It's included in the overall.

Unidentified Analyst

Right. Can you tell me the mix of the CapEx requirement for bumping this year?

Joseph Tung - Vice President and Chief Financial Officer

I need to run that number with you separately. I don't have it of hand.

Unidentified Analyst

Sure, thank you.

Joseph Tung - Vice President and Chief Financial Officer

Thank you.

Operator

Thank you. Our next question will be from Chitra Gopal [Nomura International], your line is open. You may ask your question.

Chitra Gopal - Nomura International

Yes, hi. Congratulations, good quarter. Just wanted to understand a little bit about the testing segment, you had mentioned that earlier you had made some share gains at communications customers and they were testing volumes that could potentially flow through to you guys. Now when do you expect that to come in because so far your testing segment has been lagging the growth seen in assembly? Is it going to be a first half story or is it more likely its going to take time?

Joseph Tung - Vice President and Chief Financial Officer

We will actually start to see some pick up in Q4, in relative term rate.

Chitra Gopal - Nomura International

Yes.

Joseph Tung - Vice President and Chief Financial Officer

And as we believe that this will continue into 2008 as well.

Chitra Gopal - Nomura International

Okay. And when I look at your testing margins, historically your peak has been about 44, 45% gross. Right now you have improved it substantially to about 41%. Is it logical to assume that those peaks could be exceeded given that your capacity base is a lot more efficient right now in terms of your testers?

Joseph Tung - Vice President and Chief Financial Officer

Yes, actually in Q4 we are expecting another of a 2% pickup in tax gross margins and there is any further room for improvement.

Chitra Gopal - Nomura International

Okay. Would you characterize this as the area which has the maximum room for improvement among your three segments looking at 2008?

Joseph Tung - Vice President and Chief Financial Officer

The maximum of what?

Chitra Gopal - Nomura International

Room for improvement in gross margins within assembly test and substrate, is it fair to say that testing is where the real leverage is?

Joseph Tung - Vice President and Chief Financial Officer

That's certainly one of the factors, but I think all three business units have room for further improvement in terms of gross margins.

Chitra Gopal - Nomura International

And how high were GAPT's gross margins in the third quarter versus the corporate average?

Joseph Tung - Vice President and Chief Financial Officer

We are not giving out any site specific gross margin, but I can say that... I can tell you that the, so far the Shanghai operation its gross margin is much be low [ph] the group overall.

Chitra Gopal - Nomura International

Okay, thank you.

Joseph Tung - Vice President and Chief Financial Officer

Thank you.

Operator

Thank you. Our next question is from Steven Pelayo, your line is open. You may ask your question.

Steven Pelayo - HSBC

Just a couple of quick housekeeping ones here. Is my model correct here did your Shanghai revenue decline quarter-over-quarter, I just might ask in Q2?

Joseph Tung - Vice President and Chief Financial Officer

No, it's growing on a quarterly basis.

Steven Pelayo - HSBC

Okay, there must be... and I'm curious if you can quantify on a dollar basis the kind of one-time impact, if you will, in the fourth quarter operating expenses from the additional transaction related fees. You mentioned as a percentage of revenue staying in the same OpEx level, but how much is that on a dollar basis? Will it be more of an ongoing?

Joseph Tung - Vice President and Chief Financial Officer

I think it will be around $5 million.

Steven Pelayo - HSBC

And then cash flow from operations in the quarter, I can't seem to give it to my cash flow statement to balance a bit?

Joseph Tung - Vice President and Chief Financial Officer

You mean operating cash flow?

Steven Pelayo - HSBC

Correct.

Joseph Tung - Vice President and Chief Financial Officer

Hey Steve, can I ask you to come offline.

Steven Pelayo - HSBC

Yes, no problem. And last one is just on what should we be thinking our tax rate in the fourth quarter and out to 2008? That's it from me.

Joseph Tung - Vice President and Chief Financial Officer

Well, I think the effective tax rate is about 15%.

Steven Pelayo - HSBC

And keep that for '08. Thank you.

Joseph Tung - Vice President and Chief Financial Officer

Thank you.

Operator

Thank you. Our next question will be from Randy Abrams [Credit Suisse]. Your line is open. You may ask your question.

Randy Abrams - Credit Suisse

Okay, thank you. I wanted to ask a follow-up to the question on the bumping capacity doubling. Could you talk about how much of the anticipated increase there is coming from some of your existing PC applications and how much will be from new applications like wireless? And what's the implication as far flip chip as a percent of revenue as we go into next year? How you see that expanding?

Joseph Tung - Vice President and Chief Financial Officer

I think the application will be primarily for the high end of PC where that's a flip-chips and... graphics and chip device entirely due [ph] to potentially be the other flip-chip DSC will also pick up next year, so that will go into the handsets. So the wafer technology is going to final geometries, reduce the growth for the PC application next year. I think clearly for this quarter the flip-chip is roughly about 11% of total and we don't expect that to grow next year.

Randy Abrams - Credit Suisse

Okay. And normally it has a little bit lower margin because you are passing through more of the substrate. Do you see it meaningful enough that we should factor in gross margin... up bit of a gross margin penalty, next year as flip-chip starts to ramp up at a faster pace?

Joseph Tung - Vice President and Chief Financial Officer

That will be, I think on long term basis, the gross margin the flip-chip packages will be listing line with our corporate packaging cost that we are looking around. So that should not cover their rural margin on long term basis.

Randy Abrams - Credit Suisse

Okay. Thanks a lot guys.

Operator

Thank you. Our next question will be from Mehdi Hassani [ph], your line is open. You may ask your question.

Unidentified Analyst

Yes, thank you. Just one final question, can you help us understand what the current visibility is into Q1 and I do understand you are not going to provide guidance for Q1, but I'm just asking that whether the current forecast indicate seasonal, below seasonal, above seasonal, just help us understand how the forecast will play?

Joseph Tung - Vice President and Chief Financial Officer

Well, the forecast, the typical seasonal decline if I... its about 10%. Given from our [ph] forecast I think, we can do better than that.

Unidentified Analyst

Sure. Would it be fair to say that, some of the excitement, with ASE group has to do with incremental business coming in from some outsourcing business getting into new markets and so forth and they not be a direct... I mean not be a fair reflection of the overall health of the semiconductor industry?

Joseph Tung - Vice President and Chief Financial Officer

I'm sorry I didn't quite catch you with the first one.

Unidentified Analyst

Earlier on you sounded very optimistic about next year, I'm just trying to understand to what extend your optimism comes from incremental revenue from outsourcing business, increase or additional outsourcing business or penetration into other markets.

Joseph Tung - Vice President and Chief Financial Officer

Well as I've finally explained I think the growth in our business for next year is coming from basically three different directions. One is we are very successful in penetrating some of the customers that we didn't. We have that bigger exposure before. We have been successful in turning a lot of that part of that business around and we are seeing continuous growth in that area. We are seeing the industry itself growing at about perhaps a high single digit, which is more ideal for us in terms of maintaining the industry discipline, in terms of CapEx. And also a more of a friendlier fighting environment.

And we... the industry per se grow... two times the industry grows. And in terms of back end it typically grows about two times the industry growth. So that's another lag of support for growth in next year. And then, the third is really the new initiatives that we are taking. One is the DRAM business that we only start incrementing and expanding it very nicely at this point. And also the China ramp up, which will be focusing on traditional leadframe business. Now we have not been focusing out for quite some time.

Unidentified Analyst

Okay. Great. Thank you.

Operator

Thank you. [Operator Instructions]. I am showing no further or comments.

Joseph Tung - Vice President and Chief Financial Officer

Okay.

Operator

I am sorry. There looks like there is one more question from Jack Lu [ph]. Jack Lu, your line is open, you may ask your question. [Operator Instructions].

Unidentified Analyst

Hi. Just can you hear me?

Joseph Tung - Vice President and Chief Financial Officer

No.

Operator

Yes.

Unidentified Analyst

Yes, can you tell us, what is your Q4 flip-chips CSP mix in terms of revenues for Q4 and what's the expectation is for Q1 if any?

Joseph Tung - Vice President and Chief Financial Officer

I think the CSP [ph] in U.S. is very-very early in stage though the percentage for the revenue is very-very small. I think that will be the same for the first quarter, but I think going to second half next year lot of our handsets relating customer was not here to stop the first CSP [ph].

Unidentified Analyst

Okay. Great, thanks. So you mean very little percent single digit?

Joseph Tung - Vice President and Chief Financial Officer

Very, very low single digit.

Unidentified Analyst

Okay. Great thanks.

Operator

Thank you we do have a question from Dhruv Vohra [CLSA Asia], your line is open, you may ask your question.

Dhruv Vohra - CLSA Asia

Yes, good evening guys. Just a couple of quick questions, one was on your bonus share policy. I think, you have mentioned earlier that the impact would be restricted to about 7%. Does this include any salary increase that you may have or are you planning any salary increases or option payments etcetera?

Joseph Tung - Vice President and Chief Financial Officer

Well I think the salary would be just the normal salary adjustment that we have on the annual basis and the 7% does not include that.

Dhruv Vohra - CLSA Asia

Okay.

Joseph Tung - Vice President and Chief Financial Officer

We are of course reviewing different kind of these attended programs and option is certainly one of the options that we have.

Dhruv Vohra - CLSA Asia

But what's your feel like, TSNC sales 15% you historically being giving in that same range also. Suddenly if you drop it to 7 do you will feel that impacts your business or it is something that will be well understood?

Joseph Tung - Vice President and Chief Financial Officer

Well I think the rule change to... rule change applies to everyone. So the... I think the impact if affects everyone in the industry so we need to... of course, we need to come up with something that's... that can keep us competitive in terms of getting human resources. And we are not lowering the bonus payout. We... surely there has been 7%. But if we have to pay everything. But now we do have this cap involved so we need to find something else to better compensate our employees and like I said the employee option is one of the currently... that we are currently contemplating.

Dhruv Vohra - CLSA Asia

Okay. And the last one for me, you said your effective tax rate was about 15%. Would we be able to extrapolate that for next year or do you think next year is going up?

Joseph Tung - Vice President and Chief Financial Officer

I think next year is more or less at a level.

Dhruv Vohra - CLSA Asia

All right. Thanks guys.

Joseph Tung - Vice President and Chief Financial Officer

Thank you.

Operator

Thank you. I am showing no further questions.

Joseph Tung - Vice President and Chief Financial Officer

Okay. If there is no more questions. Let me summarize for today. I think we had a excellent third quarter and we are expecting continuous growth on sequentially basis in quarter four along with some further margin improvements and we are actually very optimistic about 2008, which we believe we have multiple growth drivers and supporting our overall growth in the... going into the 2008.

And with that, I will like to conclude the today's conference call. Thank you very much.

Operator

Thank you. That will conclude our conference call. You may now disconnect.

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Source: Advanced Semiconductor Engineering, Inc. Q3 2007 Earnings Call Transcript
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