David Pasquale - Global IR Partners S.J. Cheng - Chairman and President Silvia Su - Senior Director, Finance and Accounting Management Center.

Richard Shannon - Craig-Hallum Capital Group Jerry Su - Credit Suisse.

Greetings, and welcome to the ChipMOS Third Quarter 2017 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. David Pasquale with Global IR Partners. Thank you. You may begin..

Thank you, operator. Welcome, everyone, to ChipMOS’ Third Quarter 2017 Results Conference Call. Joining us today from the Company are Mr. S.J. Cheng, Chairman and President; and Ms. Silvia Su, Senior Director of Finance and Accounting Management Center. S.J. will review business highlights from 3Q 2017 and provide color on the operating environment.

Silvia will then review the company’s key financial results. We are also joined on the call today by Mr. Lafair Cho, Senior Executive Vice President and COO and spokesperson; Vice President, Mr. David Wang; and Deputy Director, Mr. G.S. Shen. All company executives will participate in the Q&A session after management’s formal remarks.

If you have not yet received a copy of today’s results release, please email Global IR Partners at imos@globalirpartners.com, or you can get a copy of the release off of ChipMOS’ website www.chipmos.com. As with prior quarters, we hosted a call in Mandarin after the close of the Taiwan Stock Market a few hours ago.

This is part of the company’s ongoing efforts to broaden investor and analyst following in the domestic Asian market, given the full Taiwan listing. The prepared comments management will cover here are the same as those covered on the earlier call.

The second call is intended to give the company’s English-speaking investors the same opportunity to both hear directly from management and ask questions pertaining to results and the operating environment. With that said, we must also make a disclaimer regarding forward-looking statements.

During this call, management may make forward-looking statements within the meaning of Section 27A of the U.S. Securities Act of 1933, as amended; and Section 21E of the U.S. Securities Exchange Act of 1934, as amended.

Such forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause the actual performance, financial condition or results of operation of the company to be materially different from any future performance, financial condition or results of operations implied by such forward-looking statements.

Further information regarding these risks, uncertainties and other factors is included in the company’s most recent annual report on Form 20-F, which was filed with the U.S. Securities and Exchange Commission and is in the company’s other filings with the SEC.

At this time, I would like to now turn the call over to the company’s Chairman and President, Mr. S.J. Cheng. Please go ahead, sir..

Yes. Thank you, David. Welcome, everyone, to our third quarter of 2017 conference call. Hopefully, you all had time to review our earnings release. The third quarter has come in as we expected. As we know, a few months ago, we expect some frustration in our revenues due to allocation change at our largest memory customers.

We continue to manage this relationship closely. We do, however, focus our resource on the [indiscernible] in our business, several of which are long term but bringing us opportunity. Our efforts are helping us to absorb the low allocation change in our commodity DRAM business.

As a result, our commodity DRAM revenue was about 8% of the revenue in Q3 compared to 13.1% in Q2. As noted on our last call, this change was a strategic decision for ChipMOS. We continue to maintain a good relationship with the customer in-source capability in its own Tele facility.

It is still early, but based on the customer feedback we expected this one customer will bottom out in a single digit percentage of the revenue level. On the offsetting positive side, we are making good progress on several new DDIC program, with the customer ramped starting in Q3.

DDIC demand continued to grow as the 4K2K, UHD and LCD TV panels, et cetera increased. We are also producing a benefit from increased driver demand from the smartphone market. Full screen panel and nano for the design require higher COF capacity and gold bumping.

We continue to work closely in support of our customer in order to act on requirement capacity to meet their higher demand level. Additional color on Q3. Flash memory including Mask ROM growth 6.6% compared to second quarter represented 20.1% of our Q3 revenue.

We are very encouraged by the strong demand of NOR Flash, led by our wafer testing business for NOR Flash. And as a result, all our NOR Flash testing capacity remains fully utilized. Another bright spot was revenue from assembly and testing service of DDIC, which grew 7.1% in Q3 compared to the Q2. This represent about 28.1% of our Q3 revenue.

Reflecting macro demand trend, revenue from our driver, large panel COF increased 9.7%. Our gold bumping business increased 22.6% in Q3 compared to the previous quarter, representing about 18.5% of Q3 revenue. As I mentioned earlier, 18 by 9 screen for smartphone and narrow bezel or a full screen panel design require higher capacity.

This model will use more advanced driver solution with fine pitch COF packaging versus conventional COG form factor. We start production of this advanced COF solution in Q3. As we look forward into the fourth quarter of 2017, we are expecting the quarter to develop more or less like Q3.

We see many positive [indiscernible] but also expect the continued headwind in our commodity DRAM business, from a low allocation headwind. On the positive side, we expected growth in the Niche DRAM, NOR Flash, DDIC and gold bumping.

We continue to see a material uptick in demand on Niche DRAM, NOR Flash, driven by automobile, electronics and consumer product demand. Everything is moving to the high-end characters, which means higher silicon compound and increase also of demand.

Based on customer and market effect, demand for NOR Flash and Niche DRAM product remains healthy and is expected to last for a few quarters, led by product upgrading and the new aggregation of mobile device.

We also expect DDIC demand will continue to improve as we benefit from ongoing 4K2K UHD TV market development, combining with the new model feature introduction and requirement for -- from smartphones, including 18 by 9 with a narrow bezel or full screen panel, OLED and TDDI.

In addition to increased driver volumes, this trend means longer testing time and require larger testing capacity from us, and also require small 12-inch fine pitch COF capacity. Finally, we continue to work with our partners and now are well positioned in the optical sensor related market. This is a developing area.

We are moving forward conservatively. We are past this, however, because we already have some project introductions. After gaining initial assessment in Q4, those products will be able to capture growth, market opportunity in 2018. With that, let me now turn the call over to Ms.

Silvia Su, our Senior Director of Finance and Accounting to review the third quarter financial results. Silvia, go ahead..

Thank you, S.J. All dollar amounts stated in our presentation are in U.S. dollars. We have provided both U.S. dollars and NT dollars in our press release. The following numbers are based on the exchange rate of TWD 30.33 against US$1 as of September 29, 2017.

Net earnings for the third quarter of 2017 was $0.13 per diluted ADS compared to $0.25 per diluted ADS in Q2. This represents net income of US$5.3 million and $0.01 per basic and $0.01 per diluted common share compared to a net income of US$10.6 million and $0.01 per basic and $0.01 per diluted common share in the second quarter of 2017.

Please note there was a US$2.2 million loss in Q3, which was booked as a reversal of gain on disposal of discontinued operations in connection with the disposal of Tsinghua Shanghai equity interest. The loss is an accrual, based on the best estimate and may change slightly when finalized in Q4.

Results were also negatively impacted by Taiwan’s massive power outage in Q3. We have dealt with these issues in the past and got everything up and running as quickly as possible to limit the impact. For the first 9 months of 2017, total revenue was US$446.2 million.

Net earnings for the first 9 months of 2017 were $2.19 per diluted ADS, with $0.11 per diluted common shares in the same period. Our operating expenses in Q3 were US$12.7 million, or 8.7% of our Q3 revenue compared to US$16.3 million, or 10.5% of our revenue in Q2.

Other operating income in Q3 was $0.9 million, or net -- and net non-operating expenses in Q3 was $3.8 million. Income tax expense for Q3 was $2 million compared to $2.3 million in Q2. On a segment basis, revenue breakdown of third quarter was 26.6% in testing, 27.3% in assembly, 27.2% in LCD driver business and 18.9% in bumping.

Total capacity utilization was 76% for the third quarter of 2017 compared to 77% for the second quarter of 2017. Our Q3 testing capacity utilization was 75% as compared to 82% of Q2. Assembly capacity utilization was running at 63% in Q3 as compared to 73% in Q2. LCD driver capacity was running at 87% utilization in Q3 as compared to 87% in Q2.

And bumping utilization was 77% in Q3 compared to 63% in Q2. We spent $36.9 on CapEx in Q3 compared to $46 million for our second quarter 2017. The breakdown of CapEx for the third quarter was 17.3% for testing, 12% for assembly, 63.1% for LCD driver, and 7.6% for bumping capacities.

As you can see, the majority of our CapEx was invested in expanding our DDIC test capacity to meet current and expected customer demand levels. Depreciation and amortization expenses were $24.5 million, or approximately 16.8% of revenue in the third quarter. EBITDA for Q3 was $37.8 million, or 25.9% of revenue.

EBITDA was calculated by adding depreciation and amortization together with operating profit. We reduced our short-term bank loans by about $34 million in Q3. We also paid cash dividend of approximately $28.2 million in Q3. When taken together, our balance of cash and cash equivalents decreased by about $79.5 million as compared to Q2.

Overall, free cash flow in Q3 was negative $30.5 million, which was calculated by adding depreciation, amortization, interest income, together with operating profit, and then subtracting from -- subtracting CapEx, interest expense, income tax expense and dividend from the sum.

As of September 30, 2017, our net debt balance was $94.2 million, which result in a net debt to equity ratio of 15.8%. While EBITDA, free cash flow and net debt to equity ratio are not defined by generally accepted accounting principles, we believe those are helpful indicators to measure our financial strength.

Accounts receivables turnover days in Q3 were 78 days compared to 71 days in Q2. Inventory turnover days were 48 days in Q3 compared to 48 days in Q2. As of October 31, 2017, the company’s outstanding ADS number was approximately 10.9 million units, which represents around 25.4% of the company’s outstanding common shares.

Operator, that concludes our formal remarks. We can now take questions.

Operator?.

[Operator Instructions] Our first question comes from the line of Richard Shannon with Craig-Hallum Capital Group..

I guess a few you questions from me. I’ll start out with S.J. Maybe if you could help us understand the dynamics regarding your commodity DRAM business? I think you made a comment regarding bottoming out in the single digit percentage of sales.

I wonder if you can be a little bit more accurate or precise on that? Single digit could be 9% or could be much lower. So wanted to get a sense of what that is.

And do you see that in dollar terms improving over time?.

Okay. Thank you, Richard, for the questions. As we talked this subject about 6 months ago, this is a strategic decision for ChipMOS, because we do not participate, our key customer, [Xian campus] program.

So after they completed Xian assembly line, their strategy reduced allocation, and which we already saw enough time to find and diversify our product and the customer base in order to minimize this impact. As we report in the script, I read out that this customer occupied around 8% of our revenue. And last quarter will be at 13%.

And I think that will be the -- continue in the Q4. And since right now PC memory also had a recovery, so I think this number will maintain. And we keep very closely working with that in order to maintain the good relationship.

So I think right now we’re also successful to diversify to the NOR Flash area, Niche DRAM and also optical sensor product areas. So you can see that our revenue in the October is vis-à-vis better than the September, which we just announced. And I think that, based on the current market and customer feedback, our Q4 will be almost equal like Q3.

Does that answer your question?.

Yes, it does. And you also gave me a very good entree into my second question, which is talking about the outlook for your fourth quarter. You said close to third quarter levels. I’m presuming that, especially referring to sales here, it sounds like maybe DRAM could be down, but some of your niche memory sounds like it’s doing pretty well.

Curious what’s implied with your base LCD test assembly and gold bumping businesses. Is that expected to be up sequentially in the fourth quarter? If you can help us understand, that would be great, please..

Okay. You can see there’s a -- even we invest a lot of CapEx in DDIC testing area, our utilization rates are still maintained at very high 87%, means all our new investment already fully utilized. And second one is that, regarding the gold bumping, increased a lot Q3 compared with the Q2. That’s coming two area.

One is 12-inch gold bumping increased a lot from our domestic customers and also from our Korean customers. And the other one is some customers use their IPO solution in our gold bumping. So we can see through this one. And for the next year, we also invest for 12-inch fine pitch COF capacity and capability for both sides.

First one, in order to do this kind of high performance fine pitch COF, there clearly [indiscernible] need to upgrade it. And second one is that they need a longer testing time and also fine pitch [indiscernible]. And this we invest and we already started production. So that will be good for us for long term wise.

But today since we invest a lot of high CapEx, they might slightly impact our gross margin, because of higher depreciation. And then regarding to the latest one, we also got a good feedback from our Korean side and also local design house.

Right now, they also are starting to allocate lot of resource in order to establish their major infrastructure across the TDIC..

Okay, that’s helpful. Probably just two more questions for me. I want to ask you about gross margins here. We saw your numbers here for the third quarter which are a bit lower than we were expecting, and I think kind of at the lower end of the range we’ve seen for the last couple of years.

Wondering if you’d give us a sense of what does the path look like for gross margins to get above that 20% level and stay above there, at least from your consolidated reporting perspective? I mean, is that likely to happen and can you sustain it there? Or are we going to see results more likely below the 20% level than above here in the near future?.

Yes. Just based on our current forecast, I think that you might see back to the 20% second half of the next year..

Second half of next year. Okay, great. And just last question from me, I’ll jump on the line. Wondering if you’d give us -- characterize activities going on with the JV in terms of investments, expected business there, profitability, et cetera.

How fast -- any way you can help us understand how fast that operation is growing? And if you can make any comments about the competitive environment within China for test and assembly services for LCD, obviously given what Chipbond has announced in relationship, I think, with the BOE would be great to hear as well..

Yes. I’m sorry, I don’t have any comment about the BOE and with the Chipbond, because it’s not my -- I’m not the right person to answer the question. And regarding to the China JV, since right now we are consolidate into the long term investment. So just before the Q2 revenue around US$9 million slightly up in the Q3.

And right now, it since you know that our partner is pretty aggressive working in the cross area. So Shanghai will be to pull this new development, allocate more resource in the flash memory. And the second one I would like to mention here is the long approval process from both Taiwan and China governments.

We just completed the first fundraising in June 30th. And after we got a fundraising, then we speed up the investment. So the [indiscernible] project is delayed almost six months. So please give some time. When we hear a good news, we can share with you..

[Operator Instructions] There are no further questions at this time, I’d like to turn -- one moment, please. We have another question from the line of Jerry Su with Credit Suisse..

Just wondering that if you could give us more color about the optical sensing business that you have mentioned.

What kind of contribution you’re seeing right now? And how big can that grow into -- entering the 2018?.

Yes. I think maybe hours later you can get more color on it from our partner. We’re working for this project for quite a long time and we start the production maybe next July. And so far so good.

And so we are going to provide any spec to other application which our customers get that and I think we have engineering capability and capacity to support this development. So we are committed and very optimistic for 2018..

And then how much CapEx you plan to spend for remaining of this year and also 2018? And how -- and then how would that impact your depreciation and also your dividend payout policy?.

I think that -- let me answer your question like this. I think 2018 and -- is a very big diversification for ChipMOS. The great thing about the business is customer and end market diversification. This give us strength as we de-risk any one customer and is adding profitability of our business.

The majority of our business and customer are performing well as of Q4, and we are optimistic about the prospects for 2018 given everything we had discussed on the call. And based on our discussion with customers, there are also growth opportunities.

As we mentioned, 3D sensing, OLED and the 12-inch fine pitch COF that should start to gain revenue next year. I think the headwind is the low allocation with Richard just asking before, I also had no answer to it. And important point to our customer used to represent high 10 of our revenue in any given quarter.

We have already moved down to a single digit. So while we think the allocation may go a little bit lower, we are really nearly de-risk position with the other customers and anytime will not be material on our results.

And internally guide -- internally that’s our patent will be [Indiscernible] normally patent for the year following growth for Q2, Q3 and see it slightly drop in the Q4. And this is expected of broader semiconductor industry. And 2018, based on the current measure, should be higher than 2017. And our internal long term goal in package is our modeling.

Obtaining a growth -- revenue growth is around 5% a year and CapEx investment is around 15% to 30% of our revenue. In gross margin, we set a target, is 17% to 30%. This is [Indiscernible] package. And we can adjust our CapEx. And based on the customer feedback, [Indiscernible]. So this is to answer your question..

And how about the dividend payout?.

Dividend payout our internal is -- we set a goal, is around 50% to 60% of our net income, and depends on the CapEx and free cash flow is also for because a lot of shareholders also ask we had a big gain in the Q1. And right now we’re working very closely with the U.S.

shareholder and local shareholder, and our board to see which is the best to the shareholder, also can [Indiscernible] some tax effect..

At this time, there are no further questions. I’ll turn the floor back to management for final remarks..

Yes. Thank you, everyone, who joined our Q3 conference call. Thank you again. Bye-bye..

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation..