Form 20-F
Table of Contents

As filed with the Securities and Exchange Commission on June 8, 2007


SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 20-F

 


 

¨ REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

OR

 

¨ SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Date of event requiring this shell company report

Commission file number 0–31106

 


ChipMOS TECHNOLOGIES (Bermuda) LTD.

(Exact Name of Registrant as Specified in Its Charter)

 


Bermuda

(Jurisdiction of Incorporation or Organization)

11F, No. 3, Lane 91, Dongmei Road

Hsinchu, Taiwan

Republic of China

(Address of Principal Executive Offices)

 


Securities registered or to be registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange

on Which Registered

Common Shares, par value US$0.01 each

  NASDAQ Stock Market

Securities registered or to be registered pursuant to Section 12(g) of the Act:

None

(Title of Class)

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

None

(Title of Class)

 


Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

As of December 31, 2006, 70,196,303 Common Shares, par value US$0.01 each, were outstanding.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or (15)(d) of the Securities Exchange Act of 1934.    Yes  ¨    No  x

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer  ¨   Accelerated Filer  x   Non-Accelerated Filer  ¨

Indicate by check mark which financial statement item the registrant has elected to follow. Item 17  ¨    Item 18  x

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

 



Table of Contents

TABLE OF CONTENTS

ChipMOS TECHNOLOGIES (Bermuda) LTD.

 

     Page

CAUTIONARY STATEMENT FOR PURPOSES OF THE “SAFE HARBOR” PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

   1
PART I    2

Item 1.

  Identity of Directors, Senior Management and Advisers    2

Item 2.

  Offer Statistics and Expected Timetable    2

Item 3.

  Key Information    2

Item 4.

  Information on the Company    23

Item 4A.

  Unresolved Staff Comments    47

Item 5.

  Operating and Financial Review and Prospects    47

Item 6.

  Directors, Senior Management and Employees    67

Item 7.

  Major Shareholders and Related Party Transactions    76

Item 8.

  Financial Information    80

Item 9.

  The Offer and Listing    81

Item 10.

  Additional Information    82

Item 11.

  Quantitative and Qualitative Disclosure about Market Risk    90

Item 12.

  Description of Securities Other Than Equity Securities    91
PART II    92

Item 13.

  Defaults, Dividend Arrearages and Delinquencies    92

Item 14.

  Material Modifications to the Rights of Security Holders and Use of Proceeds    92

Item 15T.

  Controls and Procedures    92

Item 16A.

  Audit Committee Financial Expert    92

Item 16B.

  Code of Ethics    93

Item 16C.

  Principal Accountant Fees and Services    93

Item 16D.

  Exemptions from the Listing Standards for Audit Committees    93

Item 16E.

  Purchases of Equity Securities by the Issuer and Affiliated Purchasers    93
PART III    94

Item 17.

  Financial Statements    94

Item 18.

  Financial Statements    94

Item 19.

  Exhibits    94


Table of Contents

CAUTIONARY STATEMENT FOR PURPOSES OF THE “SAFE HARBOR” PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

Except for historical matters, the matters discussed in this Annual Report on Form 20-F are forward-looking statements that are subject to significant risks and uncertainties. These statements are generally indicated by the use of forward-looking terminology such as the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “plan,” “project,” “may,” “will” or other similar words that express an indication of actions or results of actions that may or are expected to occur in the future. These statements appear in a number of places throughout this Annual Report on Form 20-F and include statements regarding our intentions, beliefs or current expectations concerning, among other things, our results of operations, financial condition, liquidity, prospects, growth, strategies and the industries in which we operate.

By their nature, forward-looking statements involve risks and uncertainties because they relate to events and depend on circumstances that may or may not occur in the future. Forward-looking statements are not guarantees of future performance and our actual results of operations, financial condition and liquidity, and the development of the industries in which we operate may differ materially from those made in or suggested by the forward-looking statements contained in this Annual Report on Form 20-F. Important factors that could cause those differences include, but are not limited to:

 

   

the volatility of the semiconductor industry and the market for end-user applications for semiconductor products;

 

   

overcapacity in the semiconductor testing and assembly markets;

 

   

the increased competition from other companies and our ability to retain and increase our market share;

 

   

our ability to successfully develop new technologies and remain a technological leader;

 

   

our ability to maintain control over capacity expansion and facility modifications;

 

   

our ability to generate growth or profitable growth;

 

   

our ability to hire and retain qualified personnel;

 

   

our ability to acquire required equipment and supplies to meet customer demand;

 

   

our ability to raise capital as required to meet certain existing obligations;

 

   

the pending criminal indictment of our chairman and chief executive officer;

 

   

our reliance on certain major customers;

 

   

the implementation of long-term customer agreements that require us to incur significant capital expenditures;

 

   

our major customers’ willingness to purchase our services or to provide the minimum agreed compensation as provided under any long-term agreement with us, if applicable;

 

   

the success of any of our future acquisitions, investments or joint ventures;

 

   

the outcome of any pending litigation;

 

   

the political stability of our local region; and

 

   

general local and global economic conditions.

Forward-looking statements include, but are not limited to, statements regarding our strategy and future plans, future business condition and financial results, our capital expenditure plans, our capacity expansion plans, our expansion plans in Mainland China, technological upgrades, investment in research and development, future market demand, future regulatory or other developments in our industry. Please see “Item 3. Key Information—Risk Factors” for a further discussion of certain factors that may cause actual results to differ materially from those indicated by our forward-looking statements.

 

1


Table of Contents

PART I

 

Item 1. Identity of Directors, Senior Management and Advisers

Not applicable.

 

Item 2. Offer Statistics and Expected Timetable

Not applicable.

 

Item 3. Key Information

Selected Financial Data

The following tables set forth our selected consolidated financial data. The selected consolidated balance sheet data as of December 31, 2005 and 2006 and our consolidated statement of operations and cash flows data for 2004, 2005 and 2006 are derived from our audited consolidated financial statements included herein, and should be read in conjunction with, and are qualified in their entirety by reference to, these audited consolidated financial statements and related notes beginning on page F-1 of this Annual Report on Form 20-F. These audited consolidated financial statements have been audited by Moore Stephens. The selected consolidated balance sheet data as of December 31, 2002, 2003 and 2004 and the consolidated statement of operations and cash flows data for the years ended December 31, 2002 and 2003 are derived from our audited consolidated financial statements not included herein. Our consolidated financial statements have been prepared and presented in accordance with ROC GAAP, which differs in some material respects from US GAAP. Please see Note 26 to our audited consolidated financial statements for a description of the principal differences between ROC GAAP and US GAAP for the periods covered by these financial statements.

 

     Year ended December 31,  
     2002     2003     2004     2005     2006     2006  
     NT$     NT$     NT$     NT$     NT$     US$  
     (in millions, except per share data)  

Consolidated Statement of Operations Data:

            

ROC GAAP:

            

Net revenue:

            

Related parties(1)

   $ 3,665.4     $ 5,072.9     $ 4,844.4     $ 4,603.5     $ 5,654.4     $ 173.5  

Others

     2,860.5       3,953.6       10,191.4       10,610.5       14,720.8       451.7  
                                                

Total net revenue

     6,525.9       9,026.5       15,035.8       15,214.0       20,375.2       625.2  

Cost of revenue

     6,711.7       7,459.5       10,857.5       11,262.6       14,253.4       437.4  
                                                

Gross profit (loss)

     (185.8 )     1,567.0       4,178.3       3,951.4       6,121.8       187.8  
                                                

Operating expenses:

            

Research and development

     326.8       295.0       296.4       274.4       274.8       8.4  

Sales and marketing

     37.3       65.4       308.5       232.9       107.4       3.3  

General and administrative

     310.2       439.9       673.3       793.3       813.0       25.0  
                                                

Total operating expenses

     674.3       800.3       1,278.2       1,300.6       1,195.2       36.7  
                                                

Income (loss) from operations

     (860.1 )     766.7       2,900.1       2,650.8       4,926.6       151.1  
                                                

Other expenses, net

     (397.6 )     (77.1 )     (395.8 )     (506.5 )     (223.2 )     (6.8 )
                                                

Income (loss) before income tax, minority interests and interest in bonuses paid by subsidiaries(2)

     (1,257.7 )     689.6       2,504.3       2,144.3       4,703.4       144.3  

Income tax benefit (expense)

     (97.9 )     29.0       141.8       (112.0 )     (636.5 )     (19.5 )
                                                

Income (loss) before minority interests and interest in bonuses paid by subsidiaries(2)

     (1,355.6 )     718.6       2,646.1       2,032.3       4,066.9       124.8  

Minority interests

     385.3       (256.9 )     (997.9 )     (977.0 )     (1,799.4 )     (55.2 )

Interest in bonuses paid by subsidiaries(2)

     —         —         —         (127.1 )     (149.5 )     (4.6 )

Cumulative effect of changes in accounting principles

     —         —         —         —         3.3       0.1  

Pre-acquisition earnings(3)

     —         20.7       27.7       —         —         —    
                                                

Net income (loss)

   $ (970.3 )   $ 482.4     $ 1,675.9     $ 928.2     $ 2,121.3     $ 65.1  
                                                

Earning (loss) per share:

            

Basic

   $ (16.49 )   $ 8.19     $ 26.54     $ 13.74     $ 30.84     $ 0.95  

Diluted

   $ (16.49 )   $ 8.12     $ 26.38     $ 11.82     $ 25.00     $ 0.77  

Weighted-average number of shares outstanding:

            

Basic

     58.8       58.9       63.1       67.5       68.8       68.8  

Diluted

     58.8       59.4       63.5       82.6       88.3       88.3  

 

2


Table of Contents
     Year ended December 31,
     2002     2003    2004    2005    2006    2006
     NT$     NT$    NT$    NT$    NT$    US$
     (in millions, except per share data)

US GAAP:(4)

                

Net income (loss)

   $ (913.4 )   $ 485.3    $ 1,665.5    $ 805.4    $ 1,253.1    $ 38.5

Earning (loss) per share:

                

Basic

   $ (15.52 )   $ 8.24    $ 26.38    $ 11.92    $ 18.22    $ 0.56

Diluted

   $ (15.52 )   $ 8.17    $ 26.22    $ 11.21    $ 17.52    $ 0.54

Weighted-average number of shares outstanding:

                

Basic

     58.8       58.9      63.1      67.5      68.8      68.8

Diluted

     58.8       59.4      63.5      82.6      71.5      71.5

(1) Related parties include Mosel Vitelic Inc., or Mosel, Siliconware Precision Industries Co. Ltd., or Siliconware Precision, PlusMOS Technologies Inc., or PlusMOS, Ultima Electronics Corp., or Ultima, ProMOS Technologies Inc., or ProMOS, ThaiLin Semiconductor Corp., or ThaiLin, CHANTEK ELECTRONIC CO., LTD., or Chantek, Best Home Corp. Ltd., or Best Home, DenMOS Technology Inc., or DenMOS, Sun-Fund Securities Ltd., or Sun-Fund, Advanced Micro Chip Technology Co., Ltd., or AMCT, Jesper Limited, Prudent Holdings Group Ltd. and Mou-Fu Investment Ltd. See Note 19 of the notes to the consolidated financial statements contained in this Annual Report on Form 20-F. Effective April 1, 2004, PlusMOS was merged into Chantek with Chantek as the surviving entity. See “Item 4. Information on the Company—Our Structure and History—CHANTEK ELECTRONIC CO., LTD.” AMCT was liquidated in October 2004. See “Item 4. Information on the Company—Our Structure and History—Advanced Micro Chip Technology Co., Ltd.” On November 21, 2005, Chantek was merged into ChipMOS Taiwan, with ChipMOS Taiwan as the surviving company. See “Item 4. Information on the Company—Our Structure and History—ChipMOS TECHNOLOGIES INC.” On December 1, 2005, ChipMOS Logic was merged into ThaiLin, with ThaiLin as the surviving entity. See “Item 4. Information of the Company—Our Structure and History—ThaiLin Semiconductor Corp.”
(2) Refers to bonuses to directors, supervisors and employees paid by subsidiaries.
(3) For 2003, represents our share of pre-acquisition profits of ThaiLin prior to December 1, 2003, the date when we began to consolidate the accounts of ThaiLin. For 2004, represents our share of pre-acquisition profits of Chantek prior to April 1, 2004, the date when we began to consolidate the accounts of Chantek, the surviving entity after the merger of Chantek and PlusMOS.
(4) Reflects the US GAAP adjustments as described in Note 26 of the notes to the consolidated financial statements contained in this Annual Report on Form 20-F.

 

     As of December 31,
     2002    2003    2004    2005    2006    2006
     NT$    NT$    NT$    NT$    NT$    US$
     (in millions)

Consolidated Balance Sheet Data:

                 

ROC GAAP:

                 

Current assets:

                 

Cash and cash equivalents

   $ 2,487.5    $ 1,731.0    $ 4,849.1    $ 4,607.0    $ 5,895.9    $ 180.9

Restricted cash and cash equivalents

     76.9      282.4      87.0      169.3      65.1      2.0

Financial assets at fair value through profit and loss

     874.9      664.3      2,832.6      186.1      1,929.1      59.2

Notes receivable

     30.5      11.7      62.2      30.6      31.1      1.0

Accounts receivable

                 

—related parties

     1,104.4      1,342.4      1,411.0      1,418.4      1,839.1      56.4

—third parties

     562.5      1,290.7      1,926.1      2,525.9      3,190.5      97.9

Other receivables

                 

—related parties

     11.5      266.2      6.6      4.3      14.0      0.4

—third parties

     92.3      866.6      164.6      161.9      31.8      1.0

Inventories

     166.5      335.5      661.0      627.5      945.8      29.0

Prepaid expenses and other current assets

     223.2      422.2      116.9      76.7      155.8      4.8

Total current assets

     5,668.7      7,479.7      12,707.7      10,046.9      14,232.6      436.7

Long-term investments

     1,441.9      640.5      642.4      404.1      366.7      11.3

Property, plant and equipment, net

     10,043.6      11,086.8      17,426.6      20,420.1      30,494.3      935.7

Intangible assets—net

     51.9      225.2      319.1      327.1      353.0      10.8

Other assets

     747.6      233.5      449.3      559.8      565.3      17.3

Total assets

     17,953.7      19,665.7      31,545.1      31,758.0      46,011.9      1,411.8

Current liabilities:

                 

Short-term bank loans

     2,032.6      1,566.8      800.6      467.8      1,055.3      32.4

Current portion of long-term loans

     352.2      692.8      1,821.8      2,300.9      2,335.3      71.7

Current portion of long-term bonds payable

     —        —        1,200.0      —        —        —  

Convertible notes

     —        267.6      —        2,769.3      —        —  

Deferred credit

     —        —        28.0      3.5      3.6      0.1

Notes payable

     —        27.3      49.1      3.9      —        —  

Accounts payable

     145.4      345.4      607.8      728.7      803.0      24.6

Other payable

                 

—related parties

     1.3      1.0      2.8      1.2      —        —  

—third parties

     192.7      263.8      324.7      404.9      549.6      16.9

Accrued expenses and other current liabilities

     465.1      438.0      608.6      474.1      713.6      21.9

Total current liabilities

     4,083.4      3,951.1      5,915.4      7,857.5      6,747.5      207.0

Long-term liabilities

     4,011.4      3,438.9      7,608.1      4,433.9      15,900.5      487.9

Other liabilities

     258.5      599.5      768.5      374.7      479.0      14.7

Total liabilities

     8,353.3      7,989.5      14,292.0      12,666.1      23,127.0      709.6

Total shareholders’ equity (including minority interests)

     9,600.4      11,676.2      17,253.1      19,091.9      22,884.9      702.2

 

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Table of Contents
     As of December 31,  
     2002     2003     2004     2005     2006     2006  
     NT$     NT$     NT$     NT$     NT$     US$  
     (in millions)  

US GAAP(1):

            

Current assets:

            

Cash and cash equivalents

   $ 2,487.5     $ 1,731.0     $ 4,849.1     $ 4,607.0     $ 5,895.9     $ 180.9  

Restricted cash and cash equivalents

     76.9       282.4       87.0       169.3       65.1       2.0  

Financial assets at fair value through profit and loss

     869.4       660.7       2,839.6       189.2       1,929.1       59.2  

Notes receivable

     30.5       11.7       62.2       30.6       31.1       1.0  

Accounts receivable

            

—related parties

     1,104.4       1,342.4       1,411.0       1,418.4       1,839.1       56.4  

—third parties

     562.5       1,290.7       1,926.1       2,525.9       3,190.5       97.9  

Other receivables

            

—related parties

     11.5       266.2       6.6       4.3       14.0       0.4  

—third parties

     92.3       866.6       164.6       161.9       31.8       1.0  

Inventories

     166.2       335.5       661.0       627.7       946.1       29.0  

Prepaid expenses and other current assets

     223.2       422.2       116.9       76.7       155.8       4.8  

Total current assets

     5,663.0       7,476.1       12,714.7       10,050.2       14,232.9       436.7  

Long-term investments

     1,521.1       625.1       636.8       387.1       366.7       11.3  

Property, plant and equipment, net

     10,062.8       11,082.4       17,411.7       20,340.9       30,377.7       932.1  

Intangible assets—net

     33.5       225.2       319.1       327.1       446.7       13.7  

Other assets

     740.5       224.7       439.4       548.3       552.1       16.9  

Total assets

     18,020.9       19,633.5       31,521.7       31,653.6       45,976.1       1,410.7  

Current liabilities:

            

Short-term bank loans

     2,032.6       1,566.8       800.6       467.8       1,055.3       32.4  

Current portion of long-term loans

     352.2       692.8       1,821.8       2,300.9       2,335.3       71.7  

Current portion of long-term bonds payable

     —         —         1,200.0       —         —         —    

Convertible notes

     —         267.6       —         2,531.1       —         —    

Deferred credit

     —         —         28.0       3.5       3.6       0.1  

Notes payable

     —         27.3       49.1       3.9       —         —    

Accounts payable

     145.4       345.4       607.8       728.7       803.0       24.6  

Other payable

            

—related parties

     1.3       1.0       2.8       1.2       —         —    

—third parties

     192.7       263.8       324.7       404.9       549.6       16.9  

Accrued expenses and other current liabilities

     465.1       438.0       608.6       743.1       1,173.1       36.0  

Total current liabilities

     4,083.4       3,951.1       5,915.4       8,049.3       7,207.0       221.1  

Long-term liabilities

     4,011.4       3,438.9       7,608.1       4,433.9       16,836.2       516.6  

Other liabilities

     258.8       603.7       772.7       345.0       502.2       15.4  

Total liabilities

     8,353.6       7,993.7       14,296.2       12,828.2       24,545.4       753.1  

Total shareholders’ equity (including minority interests)

     9,667.3       11,639.8       17,225.5       18,825.4       21,430.7       657.6  

(1)    Reflects the US GAAP adjustments as described in Note 26 of the notes to the consolidated financial statements contained in this Annual Report on Form 20-F.

       

      Year ended December 31,  
      2002(1)     2003(1)     2004(1)     2005(1)     2006     2006  
     NT$     NT$     NT$     NT$     NT$     US$  
     (in millions)  

Consolidated Statement of Cash Flows Data:

            

ROC GAAP:

            

Capital expenditures

   $ 2,091.3     $ 2,477.9     $ 8,331.0     $ 7,677.2     $ 15,717.8     $ 482.3  

Depreciation and amortization

     2,820.6       2,715.0       3,536.8       4,339.1       5,558.8       170.6  

Net cash provided by (used in):

            

Operating activities

     1,623.0       2,281.2       4,915.7       8,822.6       7,316.4       224.5  

Investing activities

     (3,230.9 )     (1,444.7 )     (8,273.3 )     (7,622.5 )     (14,988.2 )     (459.9 )

Financing activities

     2,914.3       (1,488.0 )     6,544.3       (1,519.9 )     8,947.9       274.5  

Effect of exchange rate changes on cash

     —         (105.1 )     (68.5 )     77.7       12.8       0.4  

Net increase (decrease) in cash

     1,306.4       (756.6 )     3,118.2       (242.1 )     1,288.9       39.5  

(1) As a result of the adoption of the ROC Statements of Financial Accounting Standards No. 34, “Financial Instruments: Recognition and Measurement” (ROC SFAS No. 34), and the ROC Statements of Financial Accounting Standards No. 36, “Financial Instruments: Disclosure and Presentation” (ROC SFAS No. 36), the balances in 2002 to 2005 were reclassified to be consistent with the classification used in our consolidated statements of cash flows for 2006 included herein.

 

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Exchange Rates

References to “US$” and “US dollars” are to United States dollars and references to “NT$” and “NT dollars” are to New Taiwan dollars. This Annual Report on Form 20-F contains translations of certain NT dollar amounts into US dollars at specified rates solely for the convenience of the reader. Unless otherwise noted, all translations from NT dollars to US dollars and from US dollars to NT dollars were made at the noon buying rate in The City of New York for cable transfers in NT dollars per US dollar as certified for customs purposes by the Federal Reserve Bank of New York as of December 29, 2006, which was NT$32.59 to US$1.00. We make no representation that the NT dollar or US dollar amounts referred to in this Annual Report on Form 20-F could have been or could be converted into US dollars or NT dollars, as the case may be, at any particular rate or at all. On June 6, 2007, the noon buying rate was NT$33.01 to US$1.00.

The following table sets out, for the years and the months indicated, information concerning the number of NT dollars for which one US dollar could be exchanged based on the noon buying rate for cable transfers in NT dollars as certified for customs purposes by the Federal Reserve Bank of New York.

 

     NT dollars per US dollar noon buying rate
     Average    High    Low    Period-end

2002

   34.53    35.16    32.85    34.70

2003

   34.41    34.98    33.72    33.99

2004

   33.37    34.16    31.74    31.74

2005

   32.16    33.77    30.65    32.80

2006

   32.51    33.31    31.28    32.59

December 2006

   32.51    32.74    32.27    32.59

January 2007

   32.77    32.99    32.38    32.95

February 2007

   32.97    33.08    32.86    32.98

March 2007

   33.01    33.13    32.84    33.01

April 2007

   33.15    33.33    33.05    33.33

May 2007

   33.28    33.41    32.97    33.09

June 2007 (through June 6, 2007)

   33.00    33.01    32.99    33.01

Sources: Federal Reserve Statistical Release H.10 (512), 2002-2007, Board of Governors of the Federal Reserve System.

 

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Risk Factors

Risk Relating to Our Industry

Because we depend on the highly cyclical semiconductor industry, which is characterized by significant and sometimes prolonged downturns from time to time, our net revenue and earnings may fluctuate significantly, which in turn could cause the market price of our common shares to decline.

Because our business is, and will continue to be, dependent on the requirements of semiconductor companies for independent testing and assembly services, any downturn in the highly cyclical semiconductor industry may reduce demand for our services and adversely affect our results of operations. All of our customers operate in this industry and variations in order levels from our customers and in service fee rates may result in volatility in our net revenue and earnings. For instance, during periods of decreased demand for assembled semiconductors, some of our customers may even simplify or forego final testing of certain types of semiconductors, such as dynamic random access memory, or DRAM, further intensifying our difficulties. From time to time, the semiconductor industry has experienced significant, and sometimes prolonged, downturns, which have adversely affected our results of operations. For example, the semiconductor industry experienced a downturn beginning in the fourth quarter of 2000 until late 2002. As a result of the downturn, our net revenue and net income for 2001 decreased 36% and 219% from 2000 levels, respectively. Although the semiconductor industry has recovered from the downturn since late 2002, we cannot give any assurances that there will not be any downturn in the future or that any future downturn will not affect our results of operations.

Any deterioration in the market for end-user applications for semiconductor products would reduce demand for our services and may result in a decrease in our earnings.

Market conditions in the semiconductor industry track, to a large degree, those for their end-user applications. Any deterioration in the market conditions for the end-user applications of semiconductors we test and assemble could reduce demand for our services and, in turn, materially adversely affect our financial condition and results of operations. Our net revenue is largely attributable to fees derived from testing and assembling semiconductors for use in personal computers, communications equipment, consumer electronic products and display applications. A significant decrease in demand for products in these markets could put pricing pressure on our testing and assembly services and negatively affect our net revenue and earnings. The decrease in market demand for personal computers and communications equipment that began in the fourth quarter of 2000 adversely affected our results of operations in 2000, 2001 and 2002. While the market demand for personal computers and communications equipment has recovered since the beginning of 2003, a significant decrease in demand could again negatively affect our net revenue and earnings.

A decline in average selling prices for our services could result in a decrease in our earnings.

Historically, prices for our testing and assembly services in relation to any given semiconductor tend to decline over the course of its product and technology life cycle. Although the average selling prices for our testing and assembly services for DRAM and liquid crystal display, or LCD, and other flat-panel display driver semiconductors increased in 2006 compared to the average selling prices for these services in 2005, we cannot assure you that the average selling prices for these services will not drop significantly in the future. See also “— A decrease in market demand for LCD and other flat-panel display driver semiconductors may adversely affect our capacity utilization rates and thereby negatively affect our profitability.” If we cannot reduce the cost of our testing and assembly services, or introduce higher-margin testing and assembly services for new package types, to offset the decrease in average selling prices for our services, our earnings could decrease.

A reversal or slowdown in the outsourcing trend for semiconductor testing and assembly services could reduce our profitability.

In recent years, integrated device manufacturers, or IDMs, have increasingly outsourced stages of the semiconductor production process, including testing and assembly, to independent companies like us to shorten production cycles. In addition, the availability of advanced independent semiconductor manufacturing services has also enabled the growth of so-called “fabless” semiconductor companies that focus exclusively on design and marketing and outsource their manufacturing, testing and assembly requirements to independent companies. A substantial portion of our net revenue is indirectly generated from providing semiconductor assembly and

 

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testing services to these IDMs and fabless companies. We cannot assure you that these companies will continue to outsource their testing and assembly requirements to independent companies like us. A reversal of, or a slowdown in, this outsourcing trend could result in reduced demand for our services, which in turn could reduce our profitability.

Risks Relating to Our Business

If we are unable to compete effectively in the highly competitive semiconductor testing and assembly markets, we may lose customers and our income may decline.

The semiconductor testing and assembly markets are very competitive. We face competition from a number of IDMs with in-house testing and assembly capabilities and other independent semiconductor testing and assembly companies. Our competitors may have access to more advanced technologies and greater financial and other resources than we do. Many of our competitors have shown a willingness to reduce prices quickly and sharply in the past to maintain capacity utilization in their facilities during periods of reduced demand. In addition, an increasing number of our competitors conduct their operations in lower cost centers in Asia such as Mainland China, Thailand, Vietnam and the Philippines. Any renewed or continued erosion in the prices or demand for our testing and assembly services as a result of increased competition could adversely affect our profits.

We are highly dependent on the market for memory products. A downturn in the market or prices for these products could significantly reduce our net revenue and net income.

A significant percentage of our net revenue is derived from testing and assembling memory semiconductors. Our net revenue derived from the testing and assembly of memory semiconductors accounted for 71%, 73% and 74% of our net revenue in 2004, 2005 and 2006, respectively. In the past, our service fees for testing and assembling memory semiconductors were sharply reduced in tandem with the decrease in the average selling price of DRAM in the semiconductor industry. We cannot assure you that there will not be substantial downturns in DRAM prices in the future. Any failure of the demand for DRAM to increase or any decrease in the demand or prices for memory products may decrease the demand for our services and our service fees and significantly reduce our net revenue and net income.

A decrease in market demand for LCD and other flat-panel display driver semiconductors may adversely affect our capacity utilization rates and thereby negatively affect our profitability.

Our testing and assembly services for LCD and other flat-panel display driver semiconductors generated net revenue of NT$2,750 million, NT$3,098 million and NT$4,446 million (US$136 million) in 2004, 2005 and 2006, respectively. We spent NT$1,380 million, NT$1,803 million and NT$2,418 million (US$74 million) in 2004, 2005 and 2006, respectively, on equipment for TCP, COF and COG technologies, which are used in testing and assembly services for LCD and other flat-panel display driver semiconductors. Most of this equipment may not be used for technologies other than TCP, COF or COG. Although the market demand for LCD and other flat-panel display driver semiconductor testing and assembly services increased in 2006 compared to the market demand in 2005, any future decrease in demand for our LCD and other flat-panel display driver semiconductor testing and assembly services would significantly impair our capacity utilization rates and may result in our inability to generate sufficient revenue to cover the significant depreciation expenses for the equipment used in testing and assembling LCD and other flat-panel display driver semiconductors, thereby negatively affecting our profitability. See also “— Because of our high fixed costs, if we are unable to achieve relatively high capacity utilization rates, our earnings and profitability may be adversely affected.”

Our significant amount of indebtedness and interest expense will limit our cash flow and could adversely affect our operations.

We have a significant level of debt and interest expense. We had approximately NT$3,391 million (US$104 million) and NT$15,901 million (US$488 million) in short- and long-term indebtedness, respectively, outstanding as of December 31, 2006, including NT$2,314 million (US$71 million) of the 1.75% convertible notes due 2009 issued in November 2004, or the 2004 notes, and NT$3,259 million (US$100 million) of the 3.375% convertible notes due 2011 issued in September 2006, or the 2006 notes.

Our significant indebtedness poses risks to our business, including the risks that:

 

   

we may have to use a substantial portion of our consolidated cash flow from operations to pay principal and interest on our debt, thereby reducing the funds available for working capital, capital expenditures, acquisitions and other general corporate purposes;

 

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insufficient cash flow from operations may force us to sell assets, or seek additional capital, which we may be unable to do at all or on terms favorable to us;

 

   

our level of indebtedness may make us more vulnerable to economic or industry downturns; and

 

   

our debt service obligations increase our vulnerabilities to competitive pressures, because many of our competitors may be less leveraged than we are.

The indentures governing the 2004 notes and the 2006 notes do not limit our ability to incur additional indebtedness in the future. As we incur additional indebtedness, the risks that we face could intensify. Our ability to make required payments on the 2004 notes and the 2006 notes and to satisfy any other debt obligations will depend on our future operating performance and our ability to obtain additional debt or equity financing on commercially reasonable terms. For additional information on our indebtedness, see “Item 5. Operating and Financial Review and Prospects—Liquidity and Capital Resources—Capital Resources.”

Our results of operations may fluctuate significantly and may cause the market price of our common shares to be volatile.

Our results of operations have varied significantly from period to period and may continue to vary in the future. Among the more important factors affecting our quarterly and annual results of operations are the following:

 

   

our ability to accurately predict customer demand, as we must commit significant capital expenditures in anticipation of future orders;

 

   

our ability to quickly adjust to unanticipated declines or shortfalls in demand and market prices for our testing and assembly services, due to our high percentage of fixed costs;

 

   

changes in prices for our testing and assembly services;

 

   

volume of orders relative to our testing and assembly capacity;

 

   

capital expenditures and production uncertainties relating to the roll-out of new testing or assembly services;

 

   

our ability to obtain adequate testing and assembly equipment on a timely basis;

 

   

changes in costs and availability of raw materials, equipment and labor;

 

   

changes in our product mix; and

 

   

earthquakes, drought and other natural disasters, as well as industrial accidents.

Because of the factors listed above, our future results of operations or growth rates may be below the expectations of research analysts and investors. If so, the market price of our common shares, and the market value of your investment, may fall.

The ongoing criminal proceeding involving Mr. Shih-Jye Cheng, our Chairman and Chief Executive Officer, and Mr. Hung-Chiu Hu, our former director, could have a material adverse effect on our business and cause our stock price to decline.

Mr. Shih-Jye Cheng, our chairman and chief executive officer, was indicted by the Taipei District Prosecutor’s Office, or the prosecutor, in December 2005. Based upon information released by the prosecutor, the indictment alleges that Mr. Shih-Jye Cheng, as instructed by Mr. Hung-Chiu Hu, purchased repurchase notes on January 6, January 13, and January 28, 2004 from Founder Associates Limited, a British Virgin Islands company affiliated with Mega Securities Co., Ltd. (formerly known as Barits International Securities Co., Ltd.), with an aggregate principal amount of approximately US$29 million, by using corporate funds from ChipMOS Taiwan and ThaiLin. The indictment further alleges that these repurchase notes were used as a cover to misuse the corporate funds of Mosel, and its affiliated entities, including ChipMOS Taiwan and ThaiLin, in violation of ROC law. In addition, the indictment alleges that Mr. Hung-Chiu Hu and others were engaged in the insider trading of the securities of Mosel in violation of ROC law, but none of the current officers at ChipMOS Taiwan or ThaiLin was indicted in this regard.

 

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On January 5, 2006, our board established a special committee, comprised solely of Messrs. Yeong-Her Wang, Rong Hsu and Pierre Laflamme, three of our independent directors, to evaluate the circumstances surrounding the indictment of Mr. Shih-Jye Cheng. The special committee engaged Preston Gates & Ellis LLP as its independent international legal counsel, Baker & McKenzie as its independent ROC legal counsel, and Diwan, Ernst & Young as its financial advisor to assist in its investigation.

The special committee’s investigation focused on (1) the probability that Mr. Shih-Jye Cheng would be convicted on the charges described in the indictment, (2) whether the indictment resulted in any pecuniary or other damage to us, (3) whether there were any internal control weaknesses related to the investments in repurchase notes within ChipMOS Bermuda and its subsidiaries and (4) whether ChipMOS Bermuda is required by applicable laws or the Nasdaq Global Select Market listing requirements to take any action in connection with the indictment. The special committee did not attempt to independently determine whether Mr. Shih-Jye Cheng had engaged in any wrongdoing in connection with the investments in repurchase notes, irrespective of whether such wrongdoing would lead to a conviction on the charges under the indictment.

On June 28, 2006, the special committee issued its report, including its findings and recommendations. Based upon the results of its investigation, it found that (1) Mr. Shih-Jye Cheng has declared himself not guilty of the charges described in the indictment, (2) Baker & McKenzie, after reviewing the indictment and the prosecutor’s exhibits, has found that the evidence produced by the prosecutor seems to be inadequate and that there is a low probability of the charges in the indictment being founded, (3) the financial advisor to the special committee has found that we suffered no loss (not taking into account exchange rate factors) and that all monies (capital and interest) were remitted back to our subsidiaries involved, (4) we have suffered no identifiable harm to our reputation or business and (5) Mr. Cheng has not been impaired by the indictment to perform as our chairman and chief executive officer. The special committee recommended that our board maintain Mr. Cheng as our chairman and chief executive officer with full responsibilities and our board unanimously (with Mr. Shih-Jye Cheng having recused himself) resolved to accept and adopt the special committee’s recommendation with regard to Mr. Shih-Jye Cheng.

Our board of directors also resolved to continue the role of the special committee for the duration of the ongoing criminal proceeding involving Mr. Shih-Jye Cheng to actively monitor any developments of the criminal investigation and take or recommend any appropriate action in light of such developments.

Although our board of directors resolved on June 29, 2006 to accept and adopt the special committee’s recommendation to maintain Mr. Cheng’s positions as our chairman and chief executive officer, Mr. Cheng may still be convicted of one or more charges in the indictment or other charges that may be raised in connection with the repurchase note transactions that are the subject of the indictment. In addition, new evidence that leads to additional criminal charges and/or an adverse judgment against Mr. Cheng may be produced during the ongoing criminal investigation, and the special committee may make recommendations to our board in respect of Mr. Cheng’s positions with us or our subsidiaries. If Mr. Cheng is convicted, or in light of any new developments, the special committee recommends or our board of directors otherwise decides that it is in our best interests that Mr. Shih-Jye Cheng no longer serves in all or some of his current capacities with us or our subsidiaries, or if Mr. Shih-Jye Cheng resigns as a result of a final adverse judgment rendered against him by the court, or otherwise, the public perception of us may be seriously harmed and we would lose some or all of the services of Mr. Shih-Jye Cheng. Mr. Shih-Jye Cheng is very important to our current on-going business operations and our relationships with our customers and financing sources, and our loss of his services could materially and adversely affect our business, reputation and prospects and therefore cause our stock price to decline. In addition, if Mr. Shih-Jye Cheng is convicted and sentenced to imprisonment, the ROC Financial Supervisory Commission may subject ChipMOS Taiwan or ThaiLin to certain restrictions on financing activities if Mr. Shih-Jye Cheng continues to serve as the chairman or president of ChipMOS Taiwan or ThaiLin.

The ongoing criminal investigations and trial involving Mr. Hung-Chiu Hu, Mr. Robert Ma Kam Fook and Mr. Jwo-Yi Miao, our former directors, could have a material adverse effect on our business and cause our stock price to decline.

Mr. Hung-Chiu Hu and Mr. Jwo-Yi Miao are currently on criminal trial in the Taipei District Court, and Mr. Robert Ma Kam Fook is under criminal investigation by the Taipei Prosecutor’s Office, in connection with alleged embezzlement during the 1990s at Pacific Electric Wire & Cable Co., Ltd., or Pacific Electric, a company incorporated in Taiwan and, until April 28, 2004, listed on the Taiwan Stock Exchange. Mr. Hu and Mr. Miao have been indicted for offenses including breach of trust and violation of the Taiwan Commercial Accounting Law and the Taiwan Securities and Exchange Law. Mr. Robert Ma Kam Fook is under investigation in connection with alleged money laundering activities related to the alleged offenses of Mr. Hu. We understand that the investigations were initiated after certain directors of Pacific Electric filed a complaint in February 2004 with the Taipei Prosecutor’s Office against

 

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Mr. Hu alleging that he embezzled certain corporate funds and misappropriated certain assets while he was an executive vice president and a director of Pacific Electric. Pacific Electric and its directors have also filed similar lawsuits against certain former chairmen, directors and officers of Pacific Electric.

On December 21, 2004, our board established a special investigation committee comprised of Messrs. Pierre Laflamme and Yeong-Her Wang, two of our independent directors. Concurrent with the establishment of the special investigation committee, our board requested the resignations of Mr. Hu and Mr. Miao, who subsequently resigned from our board on June 2, 2005 and June 8, 2005, respectively. Our board also accepted the resignation of Mr. Robert Ma Kam Fook on December 18, 2004. The special investigation committee engaged Diwan, Ernst & Young as its forensic accounting advisor and Baker & McKenzie as its legal advisor to review transactions that were similar in nature to the transactions that allegedly implicated Messrs. Hu, Miao and Ma at Pacific Electric as well as significant related party transactions between ChipMOS Bermuda, including its subsidiaries and affiliates, and Messrs. Hu, Miao and Ma and any companies or entities affiliated with any of them. The special investigation committee also engaged Hong Kong counsel.

On June 23, 2005, the special investigation committee presented its final report to our board of directors. The special investigation committee concluded that the review conducted by Diwan, Ernst & Young and Baker & McKenzie did not reveal previously unknown information regarding losses suffered by ChipMOS Bermuda, other than a potential liability relating to a credit facility entered into with Trident (Asia) Investments Limited, or Trident, where Mr. Ma has served as a director since July 1996, and HSH Nordbank AG, Hong Kong Branch, or Nordbank. The special investigation committee noted that total losses from transactions reviewed by it in the amount of NT$454 million (US$14 million), relating to impairment losses and realized losses of certain investments, were reflected in our 2002, 2003 and 2004 financial statements, and a potential decline in the value of our investment in respect of Ultima Technology Corp. (BVI). In 2005, we recognized an impairment loss of NT$188 million (US$6 million) as a result of the decline in the value of our investment in Ultima Technology Corp. (BVI). See Note 7 to our audited consolidated financial statements contained in this Annual Report on Form 20-F. The special investigation committee did not make any factual findings as to the business purpose of the transactions reviewed or as to persons at the Company responsible for such transactions. On August 26, 2005, our board dissolved the special investigation committee.

Any adverse publicity from the investigation, trial or conviction of Messrs. Hu, Miao or Ma could have a material adverse effect on our business or cause the market price of our common shares to decline.

We depend on key customers for a substantial portion of our net revenue and a loss of, or deterioration of the business from, any one of these customers could result in decreased net revenue and materially adversely affect our results of operations.

We depend on a small group of customers for a substantial portion of our business. In 2006, our five largest customers accounted for 70% of our net revenue. Our two largest customers, ProMOS Technologies Inc., or ProMOS, and Powerchip Semiconductor Corp., or Powerchip, accounted for 27% and 14%, respectively, of our net revenue in 2006. ProMOS is an affiliate of Mosel, which, as of March 31, 2007, indirectly owned approximately 23.2% of our outstanding common shares. In addition, in November 2005, we entered into an assembly and testing services agreement with Spansion LLC, or Spansion, which became one of our five largest customers in 2006.

We expect that we will continue to depend on a relatively limited number of customers for a significant portion of our net revenue. Any adverse development in our key customers’ operations, competitive position or customer base could materially reduce our net revenue and adversely affect our business and profitability. Since new customers usually require us to pass a lengthy and rigorous qualification process, if we lose any of our key customers, we may not be able to replace them in a timely manner. Also, semiconductor companies generally rely on service providers with whom they have established relationships to meet their testing and assembly needs for existing and future applications. If any of our key customers reduces, delays or cancels its orders, and if we are unable to attract new key customers or use our excess capacity to service our remaining customers, our net revenue could be reduced and our business and results of operations may be materially adversely affected.

Because of our high fixed costs, if we are unable to achieve relatively high capacity utilization rates, our earnings and profitability may be adversely affected.

Our operations are characterized by a high proportion of fixed costs. For memory and mixed-signal semiconductor testing services, our fixed costs represented 58%, 69% and 70% of our total cost of revenue in 2004, 2005 and 2006, respectively. For

 

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memory and mixed-signal semiconductor assembly services, our fixed costs represented 22%, 25% and 24% of our total cost of revenue in 2004, 2005 and 2006, respectively. For LCD and other flat-panel display driver semiconductor testing and assembly services, our fixed costs represented 48%, 50% and 50% of our total cost of revenue in 2004, 2005 and 2006, respectively. Our profitability depends in part not only on absolute pricing levels for our services, but also on the utilization rates for our testing and assembly equipment, commonly referred to as “capacity utilization rates”. Increases or decreases in our capacity utilization rates can significantly affect our gross margins as unit costs generally decrease as the fixed costs are allocated over a larger number of units. In the past, our capacity utilization rates have fluctuated significantly as a result of the fluctuations in the market demand for semiconductors. If we fail to increase or maintain our capacity utilization rates, our earnings and profitability may be adversely affected. In addition, we have entered into various long-term assembly and testing services agreements with certain of our customers that may require us to incur significant capital expenditures. If we are unable to achieve high capacity utilization rates for the equipment purchased pursuant to these agreements, our gross margins may be materially and adversely affected.

We are required to make significant capital expenditures in connection with our long-term customer agreements, and our business and results of operations would be adversely affected if we are unable to obtain sufficient funding or if our customers do not fulfill their purchase commitments.

As part of our strategy, we have from time to time entered into long-term agreements with certain of our customers, and we intend to continue to do so in the future. Please see “Item 4. Information on the Company — Our Strategy — Focus on Increasing Sales through Long-Term Agreements with New and Existing Customers.” These long-term agreements may require us to acquire new equipment or construct new facilities in Taiwan and as well as outside Taiwan. In order to meet the requirements of our customers under our long-term agreements, we may have to incur significant capital expenditures and ensure we have sufficient capacity. For example, we entered into an assembly and testing services agreement with Spansion in November 2005 pursuant to which ChipMOS Taiwan agreed to install equipment and reserve capacity for assembly and testing services for Spansion, and Spansion agreed to place purchase orders and compensate us for failure to sufficiently utilize equipment installed and qualified in accordance with the agreement. We incurred approximately US$97 million in 2006, and currently anticipate incurring approximately US$7 million in 2007, in capital expenditures in connection with requirements under our current long-term customer agreements. Although we believe we have sufficient funding to meet our capital expenditures requirements in connection with our long-term customer agreements through the end of June 2008, we cannot assure you that we will be able to obtain sufficient funding thereafter. If we are unable to obtain sufficient funding, we may not be able to meet our obligations under our long-term customer agreements, and our customer relationships, business reputation and results of operations may be materially and adversely affected.

A significant amount of capital expenditures related to long-term agreements may have to be incurred up front prior to generating any significant revenue under these agreements. As a result, our gross margins may be adversely affected whenever we enter into a new long-term agreement or implement a new statement of work under an existing agreement. Also, if the customers under our long-term agreements do not meet their contractual commitments or otherwise fail to make sufficient purchases for us to maintain a high capacity utilization rate, our results of operations may be adversely affected.

The testing and assembly process is complex and our production yields and customer relationships may suffer as a result of defects or malfunctions in our testing and assembly equipment and the introduction of new packages.

Semiconductor testing and assembly are complex processes that require significant technological and process expertise. Semiconductor testing involves sophisticated testing equipment and computer software. We develop computer software to test our customers’ semiconductors. We also develop conversion software programs that enable us to test semiconductors on different types of testers. Similar to most software programs, these software programs are complex and may contain programming errors or “bugs”. In addition, the testing process is subject to human error by our employees who operate our testing equipment and related software. Any significant defect in our testing or conversion software, malfunction in our testing equipment or human error could reduce our production yields and damage our customer relationships.

The assembly process involves a number of steps, each of which must be completed with precision. Defective packages primarily result from:

 

   

contaminants in the manufacturing environment;

 

   

human error;

 

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equipment malfunction;

 

   

defective raw materials; or

 

   

defective plating services.

These and other factors have, from time to time, contributed to lower production yields. They may do so in the future, particularly as we expand our capacity or change our processing steps. In addition, to be competitive, we must continue to expand our offering of packages. Our production yields on new packages typically are significantly lower than our production yields on our more established packages. Our failure to maintain high standards or acceptable production yields, if significant and prolonged, could result in a loss of customers, increased costs of production, delays, substantial amounts of returned goods and related claims by customers. Further, to the extent our customers have set target production yields, we may be required to compensate our customers in a pre-agreed manner. Any of these problems could materially adversely affect our business reputation and result in reduced net revenue and profitability.

Because of the highly cyclical nature of our industry, our capital requirements are difficult to plan. If we cannot obtain additional capital when we need it, we may not be able to maintain or increase our current growth rate and our profits will suffer.

Our capital requirements are difficult to plan as our industry is highly cyclical and rapidly changing. To remain competitive, we will need capital to fund the expansion of our facilities as well as to fund our equipment purchases and research and development activities. We believe that our current cash and cash equivalents, cash flow from operations and available credit facilities will be sufficient to meet our working capital and capital expenditure requirements under our existing arrangements through the end of June 2008, except for our commitments to invest in ChipMOS Shanghai, a wholly-owned subsidiary of our controlled consolidated subsidiary, Modern Mind. See “— Our significant amount of indebtedness and interest expense will limit our cash flow and could adversely affect our operations,” “— If Modern Mind fails to invest an additional US$127.5 million into ChipMOS Shanghai by December 6, 2007, ChipMOS Shanghai’s business license may become automatically void and ChipMOS Shanghai may have to be liquidated, which could hurt our growth prospects and potential future profitability” and “— We are required to make significant capital expenditures in connection with our long-term customer agreements, and our business and results of operations would be adversely affected if we are unable to obtain sufficient funding or if our customers do not fulfill their purchase commitments.” In addition, future capacity expansions or market or other developments may require additional funding. Our ability to obtain external financing in the future depends on a number of factors, many of which are beyond our control. They include:

 

   

our future financial condition, results of operations and cash flows;

 

   

general market conditions for financing activities by semiconductor testing and assembly companies; and

 

   

economic, political and other conditions in Taiwan and elsewhere.

If we are unable to obtain funding in a timely manner or on acceptable terms, our growth prospects and potential future profitability will suffer.

If Modern Mind fails to invest an additional US$127.5 million into ChipMOS Shanghai by December 6, 2007, ChipMOS Shanghai’s business license may become automatically void and ChipMOS Shanghai may have to be liquidated, which could hurt our growth prospects and potential future profitability.

Under applicable regulations of the People’s Republic of China, or PRC, and the terms of the articles of association of ChipMOS Shanghai, a wholly-owned subsidiary of our controlled consolidated subsidiary, Modern Mind, the business license of ChipMOS Shanghai may automatically become void and ChipMOS Shanghai may have to be liquidated if Modern Mind fails to invest an additional US$127.5 million by December 6, 2007, unless an additional extension is obtained from the relevant PRC regulatory authorities. We may not have sufficient financial resources to meet ChipMOS Shanghai’s investment commitments without obtaining additional financing. Even if we have the financial resources available, we may decide not to fund the investment if it would cause Mosel or Siliconware Precision to violate applicable ROC laws and regulations. See “— Risks Relating to Countries in Which We Conduct Operations — The investment in Mainland China by our controlled consolidated subsidiary, Modern Mind, through ChipMOS Shanghai, and the related contractual arrangements may result in Mosel or Siliconware Precision violating ROC laws governing investments in Mainland China by ROC companies or persons. Any sanctions on Mosel or Siliconware Precision as a result of any violation of ROC laws may cause Mosel or Siliconware Precision to decrease its ownership in us significantly or cause Mosel or Siliconware Precision to take other actions that may not be in the best interest of our other shareholders.”

 

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We understand that the relevant PRC regulatory authority is not legally obligated to, but in practice may, grant Modern Mind a grace period if it submits in advance an application for extending the deadline for making the remaining investments in ChipMOS Shanghai. In March 2005, Modern Mind was granted an extension of the investment deadline from December 6, 2005 to December 6, 2007 by the relevant PRC regulatory authority. If we are unable to obtain the funding in a timely manner or on acceptable terms or if we are unwilling to provide funding to ChipMOS Shanghai through Modern Mind, ChipMOS Shanghai may lose its business license and may have to be liquidated and our growth prospects and potential future profitability may suffer.

Disputes over intellectual property rights could be costly, deprive us of technologies necessary for us to stay competitive, render us unable to provide some of our services and reduce our opportunities to generate revenue.

Our ability to compete successfully and achieve future growth will depend, in part, on our ability to protect our proprietary technologies and to secure, on commercially acceptable terms, critical technologies that we do not own. We cannot assure you that we will be able to independently develop, or secure from any third party, the technologies required for our testing and assembly services. Our failure to successfully obtain these technologies may seriously harm our competitive position and render us unable to provide some of our services.

Our ability to compete successfully also depends on our ability to operate without infringing upon the proprietary rights of others. The semiconductor testing and assembly industry is characterized by frequent litigation regarding patent and other intellectual property rights. We may incur legal liabilities if we infringe upon the intellectual property or other proprietary rights of others. The situation is exacerbated by our inability to ascertain what patent applications have been filed in the United States or elsewhere until they are granted. If any third party succeeds in its intellectual property infringement claims against us or our customers, we could be required to:

 

   

discontinue using the disputed process technologies, which would prevent us from offering some of our testing and assembly services;

 

   

pay substantial monetary damages;

 

   

develop non-infringing technologies, which may not be feasible; or

 

   

acquire licenses to the infringed technologies, which may not be available on commercially reasonable terms, if at all.

Any one of these developments could impose substantial financial and administrative burdens on us and hinder our business. We are, from time to time, involved in litigation in respect of intellectual property rights. Any litigation, whether as plaintiff or defendant, is costly and diverts our resources. If we fail to obtain necessary licenses on commercially reasonable terms or if litigation, regardless of the outcome, relating to patent infringement or other intellectual property matters occurs, our costs could be substantially increased to impact our margins. Any such litigation could also prevent us from testing and assembling particular products or using particular technologies, which could reduce our opportunities to generate revenue. For more information on litigation in respect of intellectual property rights, see “Item 8. Financial Information — Legal Proceedings.”

If we are unable to obtain raw materials and other necessary inputs from our suppliers in a timely and cost-effective manner, our production schedules would be delayed and we may lose customers and growth opportunities and become less profitable.

Our operations require us to obtain sufficient quantities of raw materials at acceptable prices in a timely and cost-effective manner. We source most of our raw materials, including critical materials like leadframes, organic substrates, epoxy, gold wire and molding compound for assembly, and tapes for TCP/COF, from a limited group of suppliers. We purchase all of our materials on a purchase order basis and have no long-term contracts with any of our suppliers. From time to time, suppliers have extended lead times, increased the price or limited the supply of required materials to us because of market shortages. Consequently, we may, from time to time, experience difficulty in obtaining sufficient quantities of raw materials on a timely basis. In addition, from time to time, we may reject materials that do not meet our specifications, resulting in declines in output or yield. Although we typically maintain at least two suppliers for each key raw material, we cannot assure you that we will be able to obtain sufficient quantities of raw materials and other supplies of an acceptable quality in the future. It usually takes from three to six months to switch from one supplier to another, depending on the complexity of the raw material. If we are unable to obtain raw materials and other necessary inputs in a timely and cost-effective manner, we may need to delay our production and delivery schedules, which may result in the loss of business and growth opportunities and could reduce our profitability.

 

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If we are unable to obtain additional testing and assembly equipment or facilities in a timely manner and at a reasonable cost, we may be unable to fulfill our customers’ orders and may become less competitive and less profitable.

The semiconductor testing and assembly business is capital intensive and requires significant investment in expensive equipment manufactured by a limited number of suppliers. The market for semiconductor testing and assembly equipment is characterized, from time to time, by intense demand, limited supply and long delivery cycles. Our operations and expansion plans depend on our ability to obtain equipment from a limited number of suppliers in a timely and cost-effective manner. We have no binding supply agreements with any of our suppliers and we acquire our testing and assembly equipment on a purchase order basis, which exposes us to changing market conditions and other significant risks. Semiconductor testing and assembly also requires us to operate sizeable facilities. If we are unable to obtain equipment or facilities in a timely manner, we may be unable to fulfill our customers’ orders, which could negatively impact our financial condition and results of operations as well as our growth prospects. In addition, we have committed to purchase wafer sorting testers and probers as requested by Spansion under our assembly and testing services agreement, and any shortage of wafer sorting testers and probers may affect our ability to perform our obligations under the agreement.

If we are unable to manage the expansion of our operations and resources effectively, our growth prospects may be limited and our future profitability may be reduced.

We expect to continue to expand our operations and increase the number of our employees. Rapid expansion puts a strain on our managerial, technical, financial, operational and other resources. As a result of our expansion, we will need to implement additional operational and financial controls and hire and train additional personnel. We cannot assure you that we will be able to do so effectively in the future, and our failure to do so could jeopardize our expansion plans and seriously harm our operations.

Bermuda law may be less protective of shareholder rights than laws of the United States or other jurisdictions.

Our corporate affairs are governed by our memorandum of association, our bye-laws and laws governing corporations incorporated in Bermuda. Shareholder suits such as class actions (as these terms are understood with respect to corporations incorporated in the United States) are generally not available in Bermuda. Therefore, our shareholders may be less able under Bermuda law than they would be under the laws of the United States or other jurisdictions to protect their interests in connection with actions by our management, members of our board of directors or our controlling shareholder.

It may be difficult to bring and enforce suits against us in the United States.

We are incorporated in Bermuda and a majority of our directors and most of our officers are not residents of the United States. A substantial portion of our assets is located outside the United States. As a result, it may be difficult for our shareholders to serve notice of a lawsuit on us or our directors and officers within the United States. Because most of our assets are located outside the United States, it may be difficult for our shareholders to enforce in the United States judgments of United States courts. Appleby, our Bermuda counsel, has advised us that there is some uncertainty as to the enforcement in Bermuda, in original actions or in actions for enforcement of judgments of United States courts, of liabilities predicated upon United States federal securities laws.

Investor confidence and the market price of our common shares may be adversely impacted if we or our independent public registered accounting firm is unable to conclude our internal control over our financial reporting is effective as required by Section 404 of the Sarbanes-Oxley Act of 2002.

We are subject to the SEC’s reporting obligations, and beginning in this Annual Report on Form 20-F, we are required by the SEC, as directed by Section 404 of the Sarbanes-Oxley Act of 2002, to include a report of management on our internal control over financial reporting in our Annual Report on Form 20-F that contains an assessment by management of the effectiveness of our internal control over financial reporting. In addition, beginning in our Annual Report on Form 20-F for the year ending December 31, 2007, our independent public registered accounting firm must attest to and report on management’s assessment of the effectiveness of our

 

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internal control over financial reporting. In October 2004, we engaged Diwan, Ernst & Young, or Ernst & Young, to advise us on the internal control over financial reporting requirements under Section 404 of the Sarbanes-Oxley Act of 2002. Although our management concluded that our internal controls are effective in this Annual Report on Form 20-F, our management may not conclude that our internal controls are effective in the future. Moreover, even if our management concludes that our internal controls over our financial reporting are effective, our independent public registered accounting firm may disagree. If our independent public registered accounting firm is not satisfied with our internal controls over our financial reporting or the level at which our controls are documented, designed, operated or reviewed, or if the independent public registered accounting firm interprets the requirements, rules or regulations differently from us, then it may decline to attest to our management’s assessment or may issue an adverse opinion. Any of these possible outcomes could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our consolidated financial statements, which ultimately could negatively impact the market prices of our common shares.

Any environmental claims or failure to comply with any present or future environmental regulations, or any new environmental regulations, may require us to spend additional funds, may impose significant liability on us for present, past or future actions, and may dramatically increase the cost of providing our services to our customers.

We are subject to various laws and regulations relating to the use, storage, discharge and disposal of chemical by-products of, and water used in, our assembly and gold bumping processes. Although we have not suffered material environmental claims in the past, a failure or a claim that we have failed to comply with any present or future regulations could result in the assessment of damages or imposition of fines against us, suspension of production or a cessation of our operations or negative publicity. New regulations could require us to acquire costly equipment or to incur other significant expenses. Any failure on our part to control the use of, or adequately restrict the discharge of, hazardous substances could subject us to future liabilities that may materially reduce our earnings.

Fluctuations in exchange rates could result in foreign exchange losses.

Currently, most of our net revenue is denominated in NT dollars. Our cost of revenue and operating expenses, on the other hand, are incurred in several currencies, including NT dollars, Japanese yen, US dollars and Renminbi, or RMB. In addition, a substantial portion of our capital expenditures, primarily for the purchase of testing and assembly equipment, has been, and is expected to continue to be, denominated in Japanese yen with much of the remainder in US dollars. We also have debt denominated in NT dollars, Japanese yen, US dollars and RMB. Fluctuations in exchange rates, primarily among the US dollar, the NT dollar and the Japanese yen, will affect our costs and operating margins in NT dollar terms. In addition, these fluctuations could result in exchange losses and increased costs in NT dollar terms. Despite selective hedging and other techniques implemented by us, fluctuations in exchange rates have affected, and may continue to affect, our financial condition and results of operations.

We may not be successful in our acquisitions, investments and joint ventures, and may therefore be unable to implement fully our business strategy.

As part of our growth strategy, we may make acquisitions and investments in companies and businesses or establish joint ventures. For example, on November 21, 2005, we merged CHANTEK ELECTRONIC CO., LTD., or Chantek, into ChipMOS Taiwan, and on December 1, 2005, we merged ChipMOS Logic TECHNOLOGIES INC., or ChipMOS Logic, into ThaiLin Semiconductor Corp., or ThaiLin. In November 2004, we acquired certain testing and assembly equipment from First International Computer Testing and Assembly, or FICTA, as well as a 67.8% stake in First Semiconductor Technology Inc., which interest we transferred to First Semiconductor Technology Inc. in April 2005 for approximately US$2 million. The success of our acquisitions, investments and joint ventures depends on a number of factors, including:

 

   

our ability to identify suitable investment, acquisition or joint venture opportunities;

 

   

our ability to reach an agreement for an acquisition, investment or joint venture opportunity on terms that are satisfactory to us or at all;

 

   

the extent to which we are able to exercise control over the acquired or joint venture company;

 

   

our ability to align the economic, business or other strategic objectives and goals of the acquired company with those of our company; and

 

   

our ability to successfully integrate the acquired or joint venture company or business with our company.

 

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If we are unsuccessful in our acquisitions, investments and joint ventures, we may not be able to implement fully our business strategy to maintain or grow our business.

We depend on key personnel, and our revenue could decrease and our costs could increase if we lose their services.

We depend on the continued service of our executive officers and skilled engineering, technical and other personnel. We will also be required to hire a substantially greater number of skilled employees in connection with our expansion plans. In particular, we depend on a number of skilled employees in connection with our LCD and other flat-panel display driver semiconductor testing and assembly services, and the competition for such employees in Taiwan and Mainland China is intense. We may not be able to either retain our present personnel or attract additional qualified personnel as and when needed. Moreover, we do not carry key person insurance for any of our executive officers nor do we have employment contracts with any of our executive officers or employees, and, as a result, none of our executive officers or employees is bound by any non-competition agreement. If we lose any of our key personnel, it could be very difficult to find and integrate replacement personnel, which could affect our ability to provide our services, resulting in reduced net revenue and earnings. In addition, we may need to increase employee compensation levels in order to retain our existing officers and employees and to attract additional personnel. As of March 31, 2007, 13% of the workforce at our facilities in Taiwan are foreign workers employed by us under work permits that are subject to government regulations on renewal and other terms. Consequently, if the regulations in Taiwan relating to the employment of foreign workers were to become significantly more restrictive or if we are otherwise unable to attract or retain these workers at reasonable cost, we may be unable to maintain or increase our level of services and may suffer reduced net revenue and earnings.

Risks Relating to Our Relationship with Mosel

Mosel exercises significant control over our company and could cause us to take actions that may not be, or refrain from taking actions that may be, in our best interest or the best interest of our other shareholders.

Mosel indirectly owned approximately 23.2% of our common shares as of March 31, 2007. As our largest shareholder, Mosel exercises significant control over all matters submitted to our shareholders for approval and other corporate actions, such as:

 

   

election of directors;

 

   

timing and manner of dividend distributions;

 

   

approval of contracts between us and Mosel or its affiliates, which could involve conflicts of interest; and

 

   

open market purchase programs or other purchases of our common shares.

Mosel’s substantial interests in our company could also:

 

   

delay, defer or prevent a change in who controls us;

 

   

discourage bids for our shares at a premium over the market price; and

 

   

adversely affect the market price of our common shares.

Moreover, because Mosel has the power to direct or influence our corporate actions, we may be required to engage in transactions that may not be agreeable to our other shareholders or that may not be in the best interest of our other shareholders.

ChipMOS Taiwan entered into certain transactions that, if determined to have constituted impermissible financings or purchases of assets or equity of Mosel under ROC law, could result in the resignations of members of our management. As a result, our business operations could be disrupted and the market price of our common shares could decline.

ROC law limits the ability of a company incorporated in Taiwan to purchase any equity interest in companies, directly or indirectly, holding more than 50% of its issued and outstanding voting securities or registered capital or to provide loans or other financing to any company. ChipMOS Taiwan purchased NT$242 million worth of Mosel shares in 2002. ChipMOS Taiwan disposed of NT$84 million of Mosel shares in 2005. The market value of the remaining Mosel shares as of June 30, 2006 was approximately NT$28 million. In August 2006, ChipMOS Taiwan disposed of the remaining Mosel shares for approximately NT$30 million and

 

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we no longer own any Mosel shares. See Notes 4 and 19 to our consolidated financial statements contained in this Annual Report on Form 20-F for details. Lee and Li, our ROC special counsel, has advised us that these transactions do not violate relevant ROC law provisions prohibiting a subsidiary from buying or taking collateral in shares of companies holding, directly or indirectly, more than 50% of its issued and outstanding voting securities or registered capital because Mosel’s indirect interest (calculated as the product of (a) Mosel’s percentage interest in ChipMOS Bermuda and (b) ChipMOS Bermuda’s percentage interest in ChipMOS Taiwan) in ChipMOS Taiwan was less than 50% and ChipMOS Bermuda is incorporated outside of Taiwan. However, we understand that there is no applicable judicial precedent and there is some doubt as to how a court would rule if presented with the situation.

If it were to be determined that any of the transactions described above constituted an impermissible financing or purchase of assets of Mosel by ChipMOS Taiwan or an impermissible purchase of Mosel’s equity by ChipMOS Taiwan, then ChipMOS Taiwan’s then chairman and any responsible officers would be jointly and severally liable to ChipMOS Taiwan for any losses suffered by ChipMOS Taiwan and may also be severally liable criminally for any breach of fiduciary duties that resulted in losses and damages suffered by ChipMOS Taiwan. Moreover, certain of these transactions may not have been in full compliance with ChipMOS Taiwan’s then applicable internal procedures due to the failure to have received an appropriate valuation opinion prior to entering into such purchases. The failure to comply fully with ChipMOS Taiwan’s then applicable internal procedures could constitute evidence of a failure by the then chairman of ChipMOS Taiwan and responsible officers to comply fully with their fiduciary duties, which could result in them being held criminally liable for any breach of fiduciary duties that resulted in losses and damages to ChipMOS Taiwan. If members of our current management were held to have breached their fiduciary duties or become criminally liable for the transactions described above, they may become obliged, whether under law or otherwise, to resign from their respective positions at ChipMOS Bermuda and our affiliates. Any loss of the services of these persons could disrupt our business, damage our reputation, and cause the market price of our common shares to decline.

Potential conflicts of interest with our major shareholder and its affiliates may cause us to turn down orders from other customers.

As of March 31, 2007, Mosel indirectly held a 23.2% interest in us through its subsidiaries Giant Haven Investments Limited and Mou-Fu Investment Ltd. Its affiliate, ProMOS, in which Mosel held a 13.4% interest as of March 31, 2007, designs and manufactures DRAM. ProMOS is one of our largest customers.

Mosel, with its significant ownership interest in us, has the ability to influence our major business decisions, including the allocation of testing and assembly service capacities and the development of our testing and assembly technologies. Mosel’s involvement in the semiconductor business may lead to conflicts of interest in providing testing and assembly services to our other customers. Such a situation could damage our relationship with our other customers and could encourage them to divert their business with us to our competitors. In addition, one of our directors also acts as a director of Mosel. As a result, conflicts of interest between this director’s duty to Mosel and us may arise. For an example of such a conflict of interest, see “— Risks Relating to Countries in Which We Conduct Operations — The investment in Mainland China by our controlled consolidated subsidiary, Modern Mind, through ChipMOS Shanghai, and the related contractual arrangements may result in Mosel or Siliconware Precision violating ROC laws governing investments in Mainland China by ROC companies or persons. Any sanctions on Mosel or Siliconware Precision as a result of any violation of ROC laws may cause Mosel or Siliconware Precision to decrease its ownership in us significantly or cause Mosel or Siliconware Precision to take other actions that may not be in the best interest of our other shareholders.” We cannot give any assurances that when conflicts of interest arise, Mosel’s director on our board will act in our interests, or that conflicts of interest will be resolved in our favor. These conflicts may result in the loss of existing or potential customers.

Any decision by Mosel to pledge or sell its interests in us could result in a change of control in our company and could cause our stock price to decline.

In order to raise funds, Mosel may decide to pledge or sell our common shares to obtain additional capital. Any pledge or sale of our common shares by Mosel could result in a change of control in our company and could affect the market price of our common shares or any securities convertible for, or exchangeable into, our common shares. We have included 8,000,000 common shares held by Mosel in our shelf registration statement filed on December 9, 2005. In June 2006, Mosel sold 6,956,522 common shares through its wholly-owned subsidiary, Giant Haven Investments Limited, under our shelf registration statement, and as a result, the number of remaining common shares held by Mosel included in our shelf registration statement is 1,043,478. In addition, Mosel may be able to sell, in any three-month period, such number of common shares up to the greater of (i) one percent of our outstanding common shares or (ii) the average weekly trading volume of our common shares as reported on the Nasdaq Stock Market during the four calendar weeks prior to any such sales pursuant to Rule 144 under the U.S. Securities Act of 1933, as amended, or the Securities Act.

 

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Risks Relating to Countries in Which We Conduct Operations

The investment in Mainland China by our controlled consolidated subsidiary, Modern Mind, through ChipMOS Shanghai, and the related contractual arrangements may result in Mosel or Siliconware Precision violating ROC laws governing investments in Mainland China by ROC companies or persons. Any sanctions on Mosel or Siliconware Precision as a result of any violation of ROC laws may cause Mosel or Siliconware Precision to decrease its ownership in us significantly or cause Mosel or Siliconware Precision to take other actions that may not be in the best interest of our other shareholders.

ROC laws and regulations generally prohibit investment by ROC entities in Mainland China in most aspects of the semiconductor testing and assembly industry. “Investment” is defined for this purpose to mean:

 

   

establishing a new company or enterprise in Mainland China;

 

   

increasing one’s equity interest in an existing company or enterprise in Mainland China;

 

   

acquiring shares of an existing company or enterprise in Mainland China (other than shares of publicly traded companies, acquisition of which is prohibited under current policy of the Investment Commission of the ROC Ministry of Economic Affairs); or

 

   

establishing or expanding a branch office in Mainland China.

We provide our services in Mainland China through ChipMOS Shanghai, a company incorporated under the laws of the PRC and a wholly-owned subsidiary of Modern Mind. Modern Mind is a company incorporated under the laws of the British Virgin Islands and is wholly-owned by Jesper Limited, a company incorporated under the laws of the British Virgin Islands. While we do not own any equity interest in Modern Mind, we control Modern Mind through our ownership of a demand note issued by Modern Mind, convertible into common shares with a controlling equity interest in Modern Mind at a conversion rate of one common share of Modern Mind for every US$1.00 if repayment is not made when due. Under accounting principles that are applicable to us, Modern Mind is our controlled consolidated subsidiary. In addition, we have obtained from Jesper Limited an irrevocable option to acquire the common shares of Modern Mind then owned by Jesper Limited. Payment under the demand notes is fully and unconditionally guaranteed by Jesper Limited and secured by a pledge agreement in respect of the entire equity interest in Modern Mind and ChipMOS Shanghai. We have also entered into other contractual arrangements with regard to ChipMOS Shanghai. For more information, see “Item 4. Information on the Company — Our Structure and History — MODERN MIND TECHNOLOGY LIMITED and ChipMOS TECHNOLOGIES (Shanghai) LTD.”

As the regulations described above are applicable only to entities organized within the ROC with respect to specified investments in Mainland China made by these entities, in the opinion of Lee and Li, our ROC special counsel, ChipMOS Bermuda’s indirect control over ChipMOS Shanghai through the ownership of demand notes issued by Modern Mind and the above contemplated contractual arrangements are in compliance with all existing ROC laws and regulations. There are, however, substantial uncertainties regarding the interpretation and application of ROC laws and regulations, including the laws and regulations governing the enforcement and performance of our contractual arrangements. Accordingly, we cannot assure you that ROC regulatory authorities will not take a view contrary to the opinion of our ROC special counsel.

In addition, under current applicable ROC regulations, if a company incorporated in the ROC has directly or indirectly invested in a company incorporated outside of the ROC and has controlling power over the management and operations of that non-ROC company, an investment by the non-ROC company in the PRC will constitute an investment by the ROC shareholder that is subject to ROC laws and regulations. As a result, for the purposes of these regulations, any investment (within the meaning of the ROC laws regulating investments in Mainland China) by ChipMOS Bermuda in ChipMOS Shanghai may be deemed to be an investment in Mainland China by Mosel and/or Siliconware Precision, if Mosel and/or Siliconware Precision is determined to have controlling power over our management and operations. While the regulations do not define what constitutes “controlling power over management and operations,” we understand from our ROC special counsel, Lee and Li, that, due to Mosel’s and/or Siliconware Precision’s equity interest in us and representative on our board of directors, any conversion of the convertible notes or demand notes into shares of Modern Mind or other acquisition of shares of Modern Mind or ChipMOS Shanghai by ChipMOS Bermuda may be deemed an investment in Mainland China by Mosel and/or Siliconware Precision and require approval by the Investment Commission

 

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of the ROC Ministry of Economic Affairs, or the Investment Commission, and be subject to the prohibitions described in the first paragraph of this risk factor. As a result, so long as Mosel and/or Siliconware Precision is deemed to have controlling power over ChipMOS Bermuda’s management and operations, ChipMOS Bermuda may have to choose not to convert its convertible notes or demand notes into common shares of Modern Mind in order to avoid any violations by Mosel and/or Siliconware Precision under these regulations. As a result, any significant ownership of our common shares by Mosel and/or Siliconware Precision could materially and adversely restrict our ability and flexibility in structuring our investment in Mainland China and thereby affect our business prospects.

If Mosel or Siliconware Precision were determined to be in violation of the applicable ROC laws and regulations governing investments in Mainland China, Mosel or Siliconware Precision may be ordered by the Investment Commission to cease such investment activities in Mainland China within a specified period of time and may be subject to a fine of between NT$50 thousand and NT$25 million. Mosel or Siliconware Precision could comply with the order of the Investment Commission either by causing us to terminate our investment activities in Mainland China or by taking actions that will cause Mosel or Siliconware Precision to cease having controlling power over our management and operations. If Mosel or Siliconware Precision does not comply with the order of the Investment Commission, the ROC government can impose on the chairman of Mosel or Siliconware Precision up to two years’ imprisonment, a fine of up to NT$25 million, or both. We cannot provide any assurance that any actions taken by Mosel or Siliconware Precision to address any orders by the Investment Commission will be in the best interest of our other shareholders. See “— Risks Relating to Our Relationship with Mosel — Potential conflicts of interest with our major shareholder and its affiliates may cause us to turn down orders from other customers.” Any termination or disposal of ChipMOS Shanghai’s operations in Mainland China could have a material adverse effect on our financial condition, results of operations or prospects, as well as the market price of our common shares.

ROC laws and regulations prohibit certain technology cooperation between ROC persons or entities with PRC persons or entities, and our current technology transfer arrangements between ChipMOS Bermuda and ChipMOS Shanghai may be found to be in violation of such prohibition, which may result in the termination of such technology transfer arrangements and therefore have a material adverse effect on the operations of ChipMOS Shanghai and our financial condition and results of operations.

ROC laws and regulations prohibit any transfer of semiconductor testing and assembly technologies to any person or entity located in Mainland China, except for transfers involving certain low-end semiconductor testing and assembly technologies, such as conventional wire bond assembly technology, if certain requirements are met. The ROC Ministry of Economic Affairs has the ultimate administrative authority in interpreting such laws and regulations. Under a technology transfer agreement, dated August 1, 2002, ChipMOS Bermuda licensed to ChipMOS Shanghai testing and assembly-related technologies that ChipMOS Bermuda controlled at that time, which included technologies that ChipMOS Bermuda had licensed from ChipMOS Taiwan. ChipMOS Bermuda also provided technical support and consulting services under this agreement to ChipMOS Shanghai. On April 7, 2004, ChipMOS Bermuda entered into an assignment agreement with ChipMOS Taiwan, pursuant to which ChipMOS Taiwan transferred all of the technologies it owned as of that date to ChipMOS Bermuda, including those previously licensed to ChipMOS Bermuda. On April 12, 2007, ChipMOS Bermuda entered into an assignment agreement with ChipMOS Taiwan, pursuant to which ChipMOS Taiwan assigned and transferred fifty percent of the title to ownership of and interest in all of the technologies and intellectual property it owned as of that date to ChipMOS Bermuda. ChipMOS Bermuda will continue to license such technologies to ChipMOS Shanghai pursuant to the above mentioned technology transfer agreement dated August 1, 2002.

In the opinion of Lee and Li, our ROC special counsel, our technology transfer arrangements as described above are in compliance with all applicable ROC laws and regulations. However, substantial uncertainties regarding the interpretation and application of those laws and regulations exist. Accordingly, we cannot assure you that ROC regulatory authorities will not take a view contrary to the opinion of our ROC special counsel. If ChipMOS Taiwan were determined to be in violation of applicable ROC laws and regulations governing technology cooperation with PRC persons and entities, ChipMOS Taiwan may be ordered by the Investment Commission to terminate such activity within a specified period of time and may be subject to a fine of between NT$50 thousand and NT$25 million. In addition, if ChipMOS Taiwan does not comply with the order of the Investment Commission, the ROC government can impose on the chairman of ChipMOS Taiwan up to two years’ imprisonment, a fine of up to NT$25 million, or both. Any termination of our current technology transfer to ChipMOS Shanghai could materially adversely affect our Mainland China operations and our financial condition, results of operations or prospects, as well as the market price of our common shares.

 

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Our current ownership structure and contractual arrangements with Jesper Limited, Modern Mind and ChipMOS Shanghai may not be effective in providing operational control of our Mainland China operations.

We provide our services in Mainland China through ChipMOS Shanghai, a wholly-owned subsidiary of Modern Mind. While we do not own any equity interest in Modern Mind, we have a controlling interest in Modern Mind through our ownership of a demand note issued by Modern Mind. In 2004, we restructured our control of ChipMOS Shanghai and the way we provide our services in Mainland China through contractual arrangements with Jesper Limited, Modern Mind, and ChipMOS Shanghai. See “— The investment in Mainland China by our controlled consolidated subsidiary, Modern Mind, through ChipMOS Shanghai, and the related contractual arrangements may result in Mosel or Siliconware Precision violating ROC laws governing investments in Mainland China by ROC companies or persons. Any sanctions on Mosel or Siliconware Precision as a result of any violation of ROC laws may cause Mosel or Siliconware Precision to decrease its ownership in us significantly or cause Mosel or Siliconware Precision to take other actions that may not be in the best interest of our other shareholders” for further details on these contractual arrangements. These contractual arrangements, however, may not be as effective in providing control over our Mainland China operations as would direct ownership in ChipMOS Shanghai.

Our ability to direct the operations we conduct through our subsidiaries and affiliated companies that we do not fully own may be limited by legal duties owed to other shareholders of such companies.

We conduct almost all of our operations through companies that we do not fully own. For example, almost all of our current consolidated operations are conducted through ChipMOS Taiwan, our 99.1% subsidiary as of March 31, 2007, ThaiLin, ChipMOS Taiwan’s 35.6% subsidiary as of March 31, 2007, and ChipMOS Shanghai, in which we exercise control without holding any direct or indirect equity interest. We also conduct other activities through our affiliated entities. In accordance with the various laws of the relevant jurisdictions in which our subsidiaries and affiliates are organized, each of our subsidiaries and affiliates and their respective directors owe various duties to their respective shareholders. As a result, the actions we wish our subsidiaries or affiliates to take could be in conflict with their or their directors’ legal duties owed to their other shareholders. When those conflicts arise, our ability to cause our subsidiaries or affiliates to take the action that we desire may be limited.

Any future outbreak of avian influenza, severe acute respiratory syndrome or other new or unusual diseases may materially affect our operations and business.

An outbreak of a contagious disease such as avian influenza or severe acute respiratory syndrome, for which there is inadequate treatment or no known cure or vaccine, may potentially result in a quarantine of infected employees and related persons, and adversely affect our operations at one or more of our facilities or the operations of our customers or suppliers. We cannot predict at this time the impact any future outbreak could have on our business and results of operations.

We face substantial political risk associated with doing business in Taiwan, particularly due to recent domestic political events and the strained relations between the Republic of China and the People’s Republic of China, that could negatively affect our business and the market price of our common shares.

Our principal executive offices and most of our testing and assembly facilities are located in Taiwan. As a result, our business, financial condition and results of operations and the market price of our common shares and the notes may be affected by changes in ROC governmental policies, as well as social instability and diplomatic and social developments in or affecting Taiwan which are outside our control. For example, the ROC has a unique international political status. The PRC government regards Taiwan as a renegade province and does not recognize the legitimacy of the ROC. Although significant economic and cultural relations have been established during recent years between the ROC and the PRC, relations have often been strained. In March 2005, the PRC government enacted an “Anti-Secession Law” codifying its policy of retaining the right to use military force to gain control over Taiwan, particularly under what it considers as highly provocative circumstances, such as a declaration of independence by Taiwan or the refusal by the ROC to accept the PRC’s stated “one China” policy. Past developments in relations between the ROC and the PRC have on occasion depressed the market prices of the securities of Taiwanese or Taiwan-related companies, including our own. Relations between the ROC and the PRC and other factors affecting military, political or economic conditions in Taiwan could have a material adverse effect on our financial condition and results of operations, as well as the market price and the liquidity of our common shares.

 

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We are vulnerable to disasters and other events disruptive to our business and operations.

We currently provide most of our testing services through our facilities in the Hsinchu Industrial Park and the Hsinchu Science Park in Taiwan and all of our assembly services through our facility in the Southern Taiwan Science Park in Taiwan. Significant damage or other impediments to these facilities as a result of natural disasters, industrial strikes or industrial accidents could significantly increase our operating costs.

Taiwan is particularly susceptible to earthquakes and typhoons. For example, in late 1999, Taiwan suffered severe earthquakes that caused significant property damage and loss of life, particularly in the central part of Taiwan. These earthquakes damaged production facilities and adversely affected the operations of many companies involved in the semiconductor and other industries. We experienced NT$1 million in damages to our machinery and equipment, NT$6 million in damages to our facilities, NT$1 million in damages to our inventory and five days of delay in our production schedule as a result of these earthquakes.

In addition, the production facilities of many of our suppliers and customers and providers of complementary semiconductor manufacturing services, including foundries, are located in Taiwan. If our customers are affected, it could result in a decline in the demand for our testing and assembly services. If our suppliers and providers of complementary semiconductor manufacturing services are affected, our production schedule could be interrupted or delayed. As a result, a major earthquake, natural disaster or other disruptive event in Taiwan could severely disrupt the normal operation of business and have a material adverse effect on our financial condition and results of operations.

Risks Relating to Our Holding Company Structure

Our ability to receive dividends and other payments from our subsidiaries may be restricted by commercial, statutory and legal restrictions, and thereby materially adversely affect our ability to grow, fund investments, make acquisitions, pay dividends, repay or repurchase outstanding indebtedness and otherwise fund and conduct our business.

We are a holding company, and our most significant asset is our ownership interest in ChipMOS Taiwan. Although we control ChipMOS Shanghai through Modern Mind, we do not hold any equity interest in these entities due to ROC regulatory restrictions on investments in Mainland China. As long as we do not hold any equity interest in these entities, we are not entitled to any dividends distributed by these entities and our contractual arrangements may not effectively prevent these entities from declaring any dividends to their shareholders. Dividends we receive from our subsidiaries, if any, will be subject to taxation.

The ability of our subsidiaries to pay dividends, repay intercompany loans from us or make other distributions to us is restricted by, among other things, the availability of funds and the terms of various credit arrangements entered into by our subsidiaries, as well as statutory and other legal restrictions. In addition, although there are currently no foreign exchange control regulations which restrict the ability of our subsidiaries located in Taiwan to distribute dividends to us, we cannot assure you that the relevant regulations will not be changed and that the ability of our subsidiaries to distribute dividends to us will not be restricted in the future. A Taiwan company is generally not permitted to distribute dividends or to make any other distributions to shareholders for any year in which it did not have either earnings or retained earnings (excluding reserves). In addition, before distributing a dividend to shareholders following the end of a fiscal year, the company must recover any past losses, pay all outstanding taxes and set aside 10% of its annual net income (less prior years’ losses and outstanding taxes) as a legal reserve until the accumulated legal reserve equals its paid-in capital, and may set aside a special reserve.

In addition, PRC law requires that our PRC-incorporated subsidiary only distributes dividends out of its net income, if any, as determined in accordance with PRC accounting standards and regulations. Under PRC law, it is also required to set aside at least 10% of its after-tax net income each year into its reserve fund until the accumulated legal reserve amounts to 50% of its registered capital. PRC-incorporated companies are further required to maintain a bonus and welfare fund at percentages determined at their sole discretion. The reserve fund and the bonus and welfare fund are not distributable as dividends. Moreover, a ROC-incorporated company is only able to declare dividends at its annual general meeting of shareholders, which cannot occur until after completion of its annual financial statements. Any limitation on dividend payments by our subsidiaries could materially adversely affect our ability to grow, fund investments, make acquisitions, pay dividends, repay or repurchase outstanding indebtedness, and otherwise fund and conduct our business.

 

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Our ability to make further investments in ChipMOS Taiwan may be dependent on regulatory approvals. If ChipMOS Taiwan is unable to receive the equity financing it requires, its ability to grow and fund its operations may be materially adversely affected.

As ChipMOS Taiwan is not a listed company, it generally depends on us to meet its equity financing requirements. Any capital contribution by us to ChipMOS Taiwan may require the approval of the relevant ROC authorities. For example, any capital contribution by us to ChipMOS Taiwan will require the approval of the authorities of the Science Park Administration. We may not be able to obtain any such approval in the future in a timely manner, or at all. If ChipMOS Taiwan is unable to receive the equity financing it requires, its ability to grow and fund its operations may be materially adversely affected.

Risks Relating to Our Common Shares

Volatility in the price of our common shares may result in shareholder litigation that could in turn result in substantial costs and a diversion of our management’s attention and resources.

The financial markets in the United States and other countries have experienced significant price and volume fluctuations, and market prices of technology companies have been and continue to be extremely volatile. Volatility in the price of our common shares may be caused by factors outside of our control and may be unrelated or disproportionate to our results of operations. In the past, following periods of volatility in the market price of a public company’s securities, shareholders have frequently instituted securities class action litigation against that company. Litigation of this kind could result in substantial costs and a diversion of our management’s attention and resources.

Certain provisions in our constitutive documents make the acquisition of us by another company more difficult and therefore may delay, defer or prevent a change of control.

Our bye-laws provide that our board of directors is divided into three classes of directors, each class to be re-elected only once every three years. As a result, shareholders would not generally be able to replace a majority of the directors until after two annual general meetings. In addition, any extraordinary corporate transaction such as a merger, amalgamation or consolidation, or a sale or transfer of all or substantially all of our assets, cannot be done without the approval of shareholders representing 70% of the total voting rights of all shareholders having the right to vote at such general meeting called to consider such extraordinary transaction. These provisions may increase the difficulty faced by a party which seeks to acquire control of our board or to approve an extraordinary transaction.

Future sales or issuance of common shares by us or our current shareholders could depress our share price and you may suffer dilution.

Sales of substantial amounts of shares in the public market, or the perception that future sales may occur, could depress the prevailing market price of our shares. As of March 31, 2007, we had approximately 83 million shares outstanding, approximately 48 million shares of which are freely tradeable within the United States without restriction or further registration under the Securities Act. As of March 31, 2007, we had US$71 million aggregate principal amount of the 2004 notes outstanding, and US$100 million aggregate principal amount of the 2006 notes outstanding. The 2004 notes and the 2006 notes are convertible into our common shares at the conversion price of US$6.28 per share and US$6.85 per share, respectively, in each case subject to certain adjustments.

On December 9, 2005, we filed a shelf registration statement on Form F-3, pursuant to which we may offer up to approximately US$194 million of additional common shares or debt securities which may be convertible into common shares. We have included 8,000,000 common shares held by Mosel in our shelf registration statement filed on December 9, 2005. In June 2006, Mosel sold 6,956,522 common shares through its wholly-owned subsidiary, Giant Haven Investments Limited, under our shelf registration statement and, as a result, the number of remaining common shares held by Mosel included in our shelf registration statement is 1,043,478. In addition, Mosel may be able to sell, in any three-month period, such number of common shares up to the greater of (i) one percent of our outstanding common shares or (ii) the average weekly trading volume of our common shares as reported on the Nasdaq Global Select Market during the four calendar weeks prior to any such sales pursuant to Rule 144 under the Securities Act.

On March 27, 2007, we issued 12,174,998 common shares pursuant to a share purchase and subscription agreement with ChipMOS Taiwan and Siliconware Precision, under which Siliconware Precision subscribed to our newly issued common shares through a private placement. In connection with the private placement, Siliconware Precision has agreed not to sell or otherwise

 

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transfer any of our common shares it acquired in the private placement for a period of nine months after the closing, and we granted to Siliconware Precision certain rights to require us to register its common shares for sale under the Securities Act. We plan to issue, from time to time, additional shares in connection with employee compensation and to finance possible future capital expenditures, investments or acquisitions. See “Item 6. Directors, Senior Management and Employees — Employees — Share Option Plan” for a discussion of the Share Option Plan that we have adopted for the benefit of all of our directors, officers, employees and consultants. The issuance of additional shares may have a dilutive effect on other shareholders and may cause the price of our common shares to decrease.

In addition, the indictment relating to Mr. Hung-Chiu Hu alleges that embezzled funds were used in investments by PacMOS, which, as of March 31, 2007, owned 4.1% of our outstanding common shares. As a result, PacMOS may be ordered by relevant authorities to dispose of its investments made with any embezzled funds, which may result in a sale of our shares by PacMOS. A sale of a significant number of our shares by PacMOS or our other current shareholders could depress our share price.

Conversion of our outstanding convertible notes will dilute the ownership interest of existing shareholders and future issuances of our securities could dilute your ownership.

In November 2004, we issued US$85 million of the 2004 notes, which bear interest at an annual rate of 1.75%. In December 2004, we repurchased and cancelled US$699,000 of the 2004 notes. As of March 31, 2007, the 2004 notes are convertible into our common shares at a conversion price of US$6.28, which was adjusted from the initial conversion price of US$7.85 pursuant to the terms of the convertible notes. In September 2006, we issued US$100 million of the 2006 notes, which bear interest at an annual rate of 3.375% and have an initial conversion price of US$6.85 per share, subject to certain adjustments. The conversion of some or all of these convertible notes will dilute the ownership interest of existing shareholders. Any sales in the public market of the common shares issuable upon such conversion could adversely affect prevailing market prices of our common shares. In addition, the existence of these convertible notes may encourage short selling by market participants because the conversion of the notes could depress the price of our common shares. In October 2006, we made an induced conversion offer to the holders of our 2004 notes pursuant to which we offered to each holder, as incentive for such holder to convert its 2004 notes, a cash payment equal to 7% of the principal amount of the 2004 notes converted by such holder. Pursuant to the induced conversion offer, noteholders converted US$7,000,000 in aggregate principal amount of the 2004 notes into 1,114,649 common shares and received from us aggregate cash consideration of approximately US$490,000. In addition, on November 3, 2006, we repurchased US$6,300,000 in aggregate principal amount of the 2004 notes pursuant to the noteholders’ put option under the indenture. Under the indenture, each noteholder of the 2004 notes had the right to require us to repurchase its notes on November 3, 2006 at a repurchase price equal to 100% of the principal amount plus accrued and unpaid interest. As of March 31, 2007, no other conversion of these convertible notes had taken place.

 

Item 4. Information on the Company

Overview

We believe that we are one of the leading independent providers of semiconductor testing and assembly services. Specifically, we believe that we are the largest independent provider of testing and assembly services for LCD and other flat-panel display driver semiconductors globally and a leading provider of testing and assembly services for advanced memory products in Taiwan. The depth of our engineering expertise and the breadth of our testing and assembly technologies enable us to provide our customers with advanced and comprehensive testing and assembly services. In addition, our geographic presence in Taiwan and Mainland China is attractive to customers wishing to take advantage of the logistical and cost efficiencies stemming from our close proximity to foundries and producers of consumer electronic products in Taiwan and Mainland China. Our production facilities are located in Hsinchu and Tainan, Taiwan and Shanghai, Mainland China.

Industry background

Semiconductor Industry Trends

Growth in the semiconductor industry is largely driven by end-user demand for consumer electronics, communications equipment and computers, for which semiconductors are critical components. Highly cyclical, the worldwide semiconductor industry has experienced peaks and troughs over the last decade, with a severe downturn at the end of 2000 that was followed by a modest

 

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recovery in late 2002. Since then, the industry has continued to expand and is expected to continue its growth over the next few years, driven by overall global GDP growth, increased information technology spending, and demand for new and improved electronic products and applications, along with further improvements in the cost, performance, speed and size of semiconductors.

Selected Key Semiconductor Markets

Various sectors of the semiconductor industry are expected to benefit from the anticipated growth in demand for new and improved electronic products and applications. These sectors include the memory semiconductor market, the LCD and other flat-panel display driver semiconductor market and the mixed-signal semiconductor market.

Memory Semiconductor Market

The memory market is expected to grow as memory content in consumer electronics and PC applications increases due to increasing operating system requirements, increasing use of graphics in gaming and other applications, continued growth of broadband content and a transition to 64-bit PC architecture. The memory market is dominated by two segments—DRAM and flash memory. Growth in the DRAM market is expected to be driven by the increases in average memory size per PC and PC unit shipment resulting from the launch of Microsoft’s Vista operating system and the introduction of new DRAM technology. The flash memory market is expected to continue to experience strong growth due to increasing memory requirements for cellular handsets, digital cameras and digital audio and video devices.

LCD and Other Flat-Panel Display Driver Semiconductor Market

Flat-panel displays are used in applications such as PC monitors, notebook computers, television sets, cellular handsets and digital cameras. Thin-film-transistor LCDs, or TFT-LCDs, account for about three-fourths of the flat-panel display market. We currently expect the market for LCD and other flat-panel display driver semiconductors to grow significantly due to increasing demand for flat-panel displays.

Mixed-Signal Semiconductor Market

The communications market is one of the main drivers of growth in the semiconductor industry. Mixed-signal semiconductors, which are chips with analog functionality covering more than half of the chip area, are largely used in the communications market. The increasing use of digital technology in communications equipment requires chips with both digital and analog functionality for applications such as modems, network routers, switches, cable set-top boxes and cellular handsets. As the size and cost of cellular handsets and other communications-related devices have decreased, components have increased in complexity. Mixed-signal semiconductors, such as LCD controllers and DVD controllers, are also used in consumer electronic products.

Overview of the Semiconductor Manufacturing Process

The manufacturing of semiconductors is a complex process that requires increasingly sophisticated engineering and manufacturing expertise. The manufacturing process may be broadly divided into the following stages:

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Process   

Description

Circuit Design    The design of a semiconductor is developed by laying out circuit patterns and interconnections.
Wafer Fabrication    Wafer fabrication begins with the generation of a photomask, a photographic negative onto which a circuit design pattern is etched or transferred by an electron beam or laser beam writer. Each completed wafer contains many fabricated chips, each known as a die.
Wafer Probe    Each individual die is then electrically tested, or probed, for defects. Dies that fail this test are discarded, or, in some cases, salvaged using laser repair.
Assembly    The assembly of semiconductors serves to protect the die, facilitates its integration into electronic systems and enables the dissipation of heat. The process begins with the dicing of the wafers into chips. Each die is affixed to a leadframe-based or organic substrate-based package. Then, electrical connections are formed, in many cases by connecting the terminals on the die to the inner leads of the package using fine metal wires. Finally, each chip is encapsulated for protection, usually in a molded epoxy enclosure.
Final Test    Assembled semiconductors are tested to ensure that the device meets performance specifications. Testing takes place on specialized equipment using software customized for each application. For memory semiconductors, this process also includes “burn-in” testing to screen out defective devices by applying very high temperatures and voltages.

Outsourcing Trends in Semiconductor Manufacturing

Historically, integrated device manufacturers, or IDMs, designed, manufactured, tested and assembled semiconductors primarily at their own facilities. In recent years, there has been a trend in the industry to outsource stages in the manufacturing process to reduce the high fixed costs resulting from the increasingly complex manufacturing process. Virtually every significant stage of the manufacturing process can be outsourced. The independent semiconductor manufacturing services market currently consists of wafer fabrication and probing services and semiconductor testing and assembly services. Most of the world’s major IDMs now use some independent semiconductor manufacturing services to maintain a strategic mix of internal and external manufacturing capacity. We believe that many of these IDMs are significantly reducing their investments in new semiconductor testing and assembly facilities. The availability of technologically advanced independent semiconductor manufacturing services has also enabled the growth of “fabless” semiconductor companies that focus exclusively on semiconductor design and marketing and outsource their fabrication, testing and assembly requirements to independent companies.

We believe the outsourcing of semiconductor manufacturing services, and in particular of testing and assembly services, will increase for many reasons, including the following:

Significant Capital Expenditure Requirements. Driven by increasingly sophisticated technological requirements, wafer fabrication, testing and assembly processes have become highly complex, requiring substantial investment in specialized equipment and facilities and sophisticated engineering and manufacturing expertise. In addition, product life cycles have been shortening, magnifying the need to continually upgrade or replace manufacturing, testing and assembly equipment to accommodate new products. As a result, new investments in in-house fabrication, testing and assembly facilities are becoming less desirable for IDMs because of the high investment costs, as well as difficulties in achieving sufficient economies of scale and utilization rates to be competitive with the independent service providers. Independent foundry, testing and assembly companies, on the other hand, are able to realize the benefits of specialization and achieve economies of scale by providing services to a large base of customers across a wide range of products. This enables them to reduce costs and shorten production cycles through high capacity utilization and process expertise.

Increasing Focus on Core Competencies. As the costs of semiconductor manufacturing facilities increase, semiconductor companies are expected to further outsource their wafer fabrication, testing and assembly requirements to focus their resources on core competencies, such as semiconductor design and marketing.

Time-to-Market Pressure. Increasingly short product life cycles have amplified time-to-market pressure for semiconductor companies, leading them to rely increasingly on independent companies as a key source for effective wafer fabrication, testing and assembly services.

 

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Semiconductor Testing and Assembly Services Industry

Growth in the semiconductor testing and assembly services industry is driven by increased outsourcing of the various stages of the semiconductor manufacturing process by IDMs and fabless semiconductor companies.

The Semiconductor Industry and Conditions of Outsourcing in Taiwan and Mainland China

Taiwan is one of the world’s leading locations for outsourced semiconductor manufacturing. The semiconductor industry in Taiwan has developed such that the various stages of the semiconductor manufacturing process have been disaggregated, thus allowing for specialization. The disaggregation of the semiconductor manufacturing process in Taiwan permits these semiconductor manufacturing service providers to focus on particular parts of the production process, develop economies of scale, maintain higher capacity utilization rates and remain flexible in responding to customer needs. There are several leading service providers in Taiwan, each of which offers substantial capacity, high-quality manufacturing, leading semiconductor wafer fabrication, test, assembly and process technologies, and a full range of services. These service providers have access to an educated labor pool and a large number of engineers suitable for sophisticated manufacturing industries. As a result, many of the world’s leading semiconductor companies outsource some or all of their semiconductor manufacturing needs to Taiwan’s semiconductor manufacturing service providers and take advantage of the close proximity among facilities. In addition, companies located in Taiwan are very active in the design and manufacture of electronic systems, which has created significant local demand for semiconductor devices.

Mainland China has emerged as a similarly attractive location for outsourced semiconductor manufacturing. Mainland China is an attractive manufacturing location for electronic products because companies can take advantage of a well-educated yet low-cost labor force, cost savings due to tax benefits and a large domestic market. These factors have driven a rapid relocation of much of the electronics industry manufacturing and supply chain to Mainland China. An increasing number of global electronic systems manufacturers and contract manufacturers are relocating production facilities to Mainland China. We believe that these electronic product manufacturers and contract manufacturers will source an increasing portion of their demand for semiconductors from semiconductor suppliers located in Mainland China in order to reduce production cycle times, decrease costs, simplify supply chain logistics and meet local content requirements. In line with this trend, we have in recent years expanded our operations in Mainland China.

Overview of the Company

We provide a broad range of back-end testing services, including engineering testing, wafer probing and final testing of memory and mixed-signal semiconductors. We also offer a broad selection of leadframe-based and organic substrate-based package assembly services for memory and mixed-signal semiconductors. Our advanced leadframe-based packages include thin small outline packages, or TSOPs, and our advanced organic substrate-based packages include fine-pitch ball grid array, or fine-pitch BGA, packages. In addition, we provide gold bumping, testing and assembly services for LCD and other flat-panel display driver semiconductors by employing tape carrier package, or TCP, chip-on-film, or COF, and chip-on-glass, or COG, technologies.

Semiconductors tested and assembled by us are used in personal computers, graphics applications, such as game consoles and personal digital assistants, or PDAs, communications equipment, such as cellular handsets, and consumer electronic products and display applications, such as flat-panel displays. In 2006, 46% of our net revenue was derived from testing services for memory and mixed-signal semiconductors, 32% from assembly services for memory and mixed-signal semiconductors, and 22% from LCD and other flat-panel display driver semiconductor testing and assembly services.

Our Structure and History

We are a holding company, incorporated in August 2000 under the Companies Act 1981 (as amended) of Bermuda. We provide most of our services in Taiwan through our majority-owned subsidiary, ChipMOS TECHNOLOGIES INC., or ChipMOS Taiwan, and its subsidiaries and investees. We also provide services in Mainland China through ChipMOS TECHNOLOGIES (Shanghai) LTD., or ChipMOS Shanghai, a wholly-owned subsidiary of MODERN MIND TECHNOLOGY LIMITED, or Modern Mind, which is one of our controlled consolidated subsidiaries. As of March 31, 2007, Mosel Vitelic Inc., or Mosel, indirectly owned approximately 23.2% of our common shares.

The following chart illustrates our corporate structure and our equity interest in each of our principal subsidiaries and affiliates as of March 31, 2007.(1)

 

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(1) Under ROC Financial Accounting Standards and the regulations of the Taiwan Securities and Futures Bureau, we are required to consolidate the financial results of any subsidiaries in which we hold a controlling interest or voting interest in excess of 50%. In 2003, we consolidated the financial results of ChipMOS Taiwan, ChipMOS Japan, ChipMOS USA, ChipMOS TECHNOLOGIES (H.K.) Limited, or ChipMOS Hong Kong, Modern Mind and its wholly-owned subsidiary, ChipMOS Shanghai, and ThaiLin. From January 12 and 28, 2004 onwards, we also consolidated the financial results of Advanced Micro Chip Technology Co., Ltd. (which was liquidated in October 2004) and ChipMOS Logic (which was merged into ThaiLin in December 2005), respectively, and from April 1, 2004 onwards, we also consolidated the financial results of Chantek (which was merged into ChipMOS Taiwan in November 2005). Starting from April 30, 2004, our financial results also included the financial results of WWT, which was subsequently merged into ChipMOS Logic. Starting from November 1, 2004, our financial statements also included the results of First Semiconductor Technology, Inc. in which ChipMOS Taiwan acquired a 67.8% equity interest on November 1, 2004 and transferred back this interest to First Semiconductor Technology, Inc. on April 29, 2005.
(2) As of March 31, 2007, 3,899,999 shares of ChipMOS Hong Kong were issued to us and one share was issued to Shih-Jye Cheng, our chairman and chief executive officer, representing 100% of the then issued share capital of ChipMOS Hong Kong. Shih-Jye Cheng holds the one share issued to him as trustee for and on behalf of our company.
(3) On March 27, 2007, we completed a share purchase and subscription transaction with ChipMOS Taiwan and Siliconware Precision, under which we and ChipMOS Taiwan purchased all of Siliconware Precision’s equity interest in ChipMOS Taiwan, and Siliconware Precision subscribed to 12,174,998 of our newly issued common shares through a private placement. As of March 31, 2007, we held 99.1% of the outstanding common shares of ChipMOS Taiwan.
(4) We control Modern Mind through our ownership of a convertible note issued by Modern Mind that may be converted into a controlling equity interest in Modern Mind. We do not currently own any equity interest in Modern Mind. ChipMOS Shanghai is a wholly-owned subsidiary of Modern Mind.

Below is a description of our principal consolidated subsidiaries:

ChipMOS TECHNOLOGIES INC. ChipMOS Taiwan was incorporated in Taiwan in July 1997 as a joint venture company of Mosel and Siliconware Precision and with the participation of other investors. Its operations consist of the testing and assembly of semiconductors as well as gold bumping and memory module manufacturing. We acquired our interest in ChipMOS Taiwan by issuing our common shares to ChipMOS Taiwan’s shareholders in exchange for their 70.3% shareholding in ChipMOS Taiwan in January 2001. In October 2001, ChipMOS Taiwan issued 6,911,732 common shares as employee bonuses. In December 2002, we issued 531,175 common shares in exchange for 5,633,442 ChipMOS Taiwan common shares held by these employees.

On June 16, 2005, ChipMOS Taiwan and Chantek, a 68.0% subsidiary of ChipMOS Taiwan, agreed to merge in a stock-for-stock transaction. Under the merger agreement, as amended on September 2, 2005, shareholders of Chantek (other than ChipMOS Taiwan) were entitled to elect to receive cash or ChipMOS Taiwan shares in exchange for their Chantek shares at the ratio of 3.6 to 1. As a result, ChipMOS Taiwan paid NT$81 million in cash and issued 6 million (which represented approximately 0.7% of ChipMOS Taiwan’s outstanding shares immediately after the completion of the transaction) shares to Chantek shareholders pursuant to the merger agreement. The transaction closed on November 21, 2005.

On March 27, 2007, we completed a share purchase and subscription transaction with ChipMOS Taiwan and Siliconware Precision, under which we and ChipMOS Taiwan purchased all of Siliconware Precision’s equity interest in ChipMOS Taiwan, and Siliconware Precision subscribed to 12,174,998 of our newly issued common shares through a private placement. As of March 31, 2007, we held 99.1% of the outstanding common shares of ChipMOS Taiwan.

 

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On April 12, 2007, we entered into a share exchange agreement with ChipMOS Taiwan pursuant to which we will exchange one common share for every 8.4 ChipMOS Taiwan shares outstanding. Following the completion of the share exchange transaction, which we expect to occur in the second half of 2007, ChipMOS Taiwan will then become our wholly-owned subsidiary.

ChipMOS TECHNOLOGIES (H.K.) Limited. ChipMOS Hong Kong (formerly ChipMOS Far East Limited) was incorporated in Hong Kong in November 2002. It is engaged in semiconductor testing and assembly services and trading of spare parts and tools. Effective May 31, 2005, the name of ChipMOS Far East Limited was changed to ChipMOS TECHNOLOGIES (H.K.) Limited. As of March 31, 2007, we held 100% of the outstanding common shares of ChipMOS Hong Kong.

MODERN MIND TECHNOLOGY LIMITED and ChipMOS TECHNOLOGIES (Shanghai) LTD. Modern Mind was incorporated in the British Virgin Islands in January 2002. Modern Mind conducts its operations through ChipMOS Shanghai, a wholly-owned subsidiary incorporated in Mainland China in June 2002. ChipMOS Shanghai is engaged in wafer testing and semiconductor assembly and testing. We acquired a 100% equity interest in Modern Mind on December 12, 2002, and then transferred it to Jesper Limited on December 31, 2002. In 2003, we acquired from Jesper Limited a convertible note in the amount of US$37.5 million issued by Modern Mind that may be converted into a controlling equity interest in Modern Mind at a conversion rate of one ordinary share of Modern Mind for every US$1.00 if the repayment is not made when due. In 2004, we restructured our control of ChipMOS Shanghai and our Mainland China operations. On July 29, 2004, we replaced the US$37.5 million convertible note previously issued by Modern Mind in its entirety with a US$62.8 million demand note issued by Modern Mind, with the difference representing a US$25 million loan that we extended to Modern Mind from the net proceeds of our July 2004 offering of common shares. In addition, we extended a loan in the aggregate amount of US$50 million to Modern Mind from the net proceeds of our November 2004 convertible debt offering in exchange for demand notes issued by Modern Mind in the same aggregate amount. As of March 31, 2007, the aggregate amount of total loans we extended to Modern Mind was US$122.8 million. The demand notes are convertible at any time into common shares representing, immediately after the conversion, almost 100% of the then outstanding common shares of Modern Mind at a conversion rate of US$1.00 for each common share of Modern Mind. Payment under the demand notes are fully and unconditionally guaranteed by Jesper Limited and secured by a pledge agreement in respect of the entire equity interest in Modern Mind and ChipMOS Shanghai. We have obtained from Jesper Limited an irrevocable option to acquire at any time the common shares of Modern Mind then owned by Jesper Limited.

In addition, on April 22, 2004, ChipMOS Hong Kong and ChipMOS Shanghai entered into an exclusive services agreement, pursuant to which ChipMOS Shanghai will provide its services exclusively to ChipMOS Hong Kong or customers designated by ChipMOS Hong Kong. Under the exclusive services agreement, ChipMOS Hong Kong will purchase and consign to ChipMOS Shanghai all of the equipment required to render those services. The exclusive services agreement has a term of ten years, which is automatically renewable for an additional ten-year period unless either party provides written notice of intention to terminate at least 30 days prior to the expiration of such ten-year term. In addition, ChipMOS Hong Kong may terminate the exclusive services agreement at any time by giving 30 days’ prior written notice.

For risks associated with our investment in Mainland China and these contractual arrangements, see ‘Item 3. Key Information — Risk Factors — Risks Relating to Countries in Which We Conduct Operations — The investments in Mainland China by our controlled consolidated subsidiary, Modern Mind, through ChipMOS Shanghai, and the related contractual arrangements may result in Mosel or Siliconware Precision violating ROC laws governing investments in Mainland China by ROC companies or persons. Any sanctions on Mosel or Siliconware Precision as a result of any violation of ROC laws may cause Mosel or Siliconware Precision to decrease its ownership in us significantly or cause Mosel or Siliconware Precision to take other actions that may not be in the best interest of our other shareholders” and “Item 3. Key Information – Risk Factors — Risks Relating to Countries in Which We Conduct Operations — Our current ownership structure and contractual arrangements with Jesper Limited, Modern Mind and ChipMOS Shanghai may not be effective in providing operational control of our Mainland China operations.”

ThaiLin Semiconductor Corp. ThaiLin was incorporated in Taiwan in May 1996, and is listed on the GreTai Securities Market in Taiwan. It is engaged in the provision of semiconductor testing services. ChipMOS Taiwan acquired a 41.8% interest in ThaiLin in December 2002. Under applicable accounting principles, ThaiLin was consolidated into our consolidated financial statements in 2003 because ChipMOS Taiwan was deemed to exert significant control over ThaiLin through common directors and management.

 

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In August 2004, ThaiLin completed a NT$1,000 million convertible bond offering, and ChipMOS Taiwan purchased bonds in an amount of NT$100 million in that offering to maintain its percentage ownership in ThaiLin. ChipMOS Taiwan converted these convertible bonds in March 2005.

On August 15, 2005, ThaiLin entered into a merger agreement with ChipMOS Logic, whereby ChipMOS Logic agreed to be merged into ThaiLin, with ThaiLin as surviving entity. Under the merger agreement, shareholders of ChipMOS Logic received one common share of ThaiLin in exchange for 2.8 common shares of ChipMOS Logic. As a result, ThaiLin issued approximately 43 million shares (which represented approximately 14.4% of ThaiLin’s outstanding shares immediately after the completion of the transaction) to ChipMOS Logic shareholders. The transaction closed on December 1, 2005.

As of March 31, 2007, ChipMOS Taiwan held a 35.6% interest in ThaiLin. Mr. S.J. Cheng, our chairman and chief executive officer and the director and chairman of ChipMOS Taiwan, is also a director and the chairman of ThaiLin. In addition, four of the seven directors of ThaiLin are appointed by ChipMOS Taiwan.

Advanced Micro Chip Technology Co., Ltd. AMCT was incorporated in Taiwan in March 2000. It provided gold bumping services, which are used in connection with the assembly of LCD and other flat-panel display driver semiconductors. In February 2003, ChipMOS Taiwan acquired a 23.1% interest in AMCT and increased its ownership during 2003 to 30.8% as of December 31, 2003. ChipMOS Taiwan purchased additional interests in AMCT in January, February and March 2004. As a result, ChipMOS Taiwan held a 99.7% equity interest in AMCT as of April 30, 2004. ChipMOS Taiwan completed the integration of all of AMCT’s business operations into ChipMOS Taiwan in April 2004 and completed the liquidation of AMCT in October 2004.

CHANTEK ELECTRONIC CO., LTD. Chantek was incorporated in Taiwan in May 1989 and was listed on the GreTai Securities Market in Taiwan until November 16, 2005. It provides semiconductor assembly services for low-density volatile and non-volatile memory semiconductors, consumer semiconductors and microcontroller semiconductors. ChipMOS Taiwan acquired its ownership interest in Chantek in September 2002.

PlusMOS was incorporated in Taiwan in March 2000 as a joint venture between ChipMOS Taiwan and Mosel for the manufacture, design and sale of DRAM modules. On April 1, 2004, PlusMOS was merged into Chantek in a stock-for-stock merger pursuant to which shareholders of PlusMOS received 1.1 common shares of Chantek in exchange for one common share of PlusMOS. The merger was approved by the shareholders of Chantek and PlusMOS in December 2003. Upon consummation of this merger, ChipMOS Taiwan directly held a 34.2% interest in Chantek, which is the surviving entity. As a result, ChipMOS Taiwan became the controlling shareholder of Chantek. Starting from April 1, 2004, we began consolidating Chantek into our consolidated financial results and increased our interest in Chantek to 68.0% on November 30, 2004.

On November 21, 2005, Chantek was merged into ChipMOS Taiwan, with ChipMOS Taiwan as the surviving entity. For additional information regarding the merger agreement, see “— ChipMOS TECHNOLOGIES INC.” above.

ChipMOS Logic TECHNOLOGIES INC. ChipMOS Logic was incorporated in Taiwan in January 2004, with ChipMOS Taiwan holding a 62.5% interest and ThaiLin holding a 37.5% interest. ChipMOS Logic is engaged in logic testing services. On April 30, 2004, WWT, a Taiwan-based company engaged in logic testing services, merged into ChipMOS Logic, with ChipMOS Logic as the surviving entity, in a stock-for-stock merger pursuant to which shareholders of WWT received one common share of ChipMOS Logic in exchange for 10 common shares of WWT. Upon consummation of the merger between WWT and ChipMOS Logic, ChipMOS Taiwan and ThaiLin owned approximately 52.9% and 24.6%, respectively, of ChipMOS Logic, with the original management team of WWT, two original shareholders of WWT, including one creditor bank, and the management team of ChipMOS Logic owning the remaining interest.

On December 1, 2005, ChipMOS Logic was merged into ThaiLin, with ThaiLin as the surviving entity. For additional information regarding the merger agreement, see “— ThaiLin Semiconductor Corp.” above.

First Semiconductor Technology, Inc. First Semiconductor Technology, Inc. was incorporated in the United States of America in June 1998 and engages in IC logic testing services. ChipMOS Taiwan acquired a 67.8% ownership interest in First Semiconductor Technology, Inc. on November 1, 2004 in connection with the purchase of certain assets and equipment from First International Computer Testing and Assembly, and transferred this interest to First Semiconductor Technology, Inc. on April 29, 2005 pursuant to a share repurchase agreement.

 

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Our Strategy

Our goal is to reinforce our position as a leading independent provider of semiconductor testing and assembly services, concentrating principally on memory, mixed-signal and LCD and other flat-panel display driver semiconductors. The principal components of our business strategy are set forth below.

Focus on Providing Our Services to High-Growth Segments of the Semiconductor Industry.

We intend to continue our focus on developing and providing advanced testing and assembly services for high-growth segments of the semiconductor industry, such as memory, mixed-signal and LCD and other flat-panel display driver semiconductors. In 2006, our revenue from testing and assembly of semiconductors for these segments accounted for all of our net revenue. We believe that our investments in equipment and research and development in some of these areas allow us to offer a differentiated service from our competition. In order to continue to benefit from the expected growth in these segments, we intend to continue to invest in capacity to meet the testing and assembly requirements of these key semiconductor market segments.

Continue to Invest in the Research and Development of Advanced Testing and Assembly Technologies.

We believe that our ability to progressively provide more advanced testing and assembly services to customers is critical to our business. In addition, advanced semiconductor testing and assembly services typically generate higher margins due to the greater expertise required and the more sophisticated technologies used. We will continue to invest in the research and development of advanced testing and assembly technologies. For example, we are expanding our capabilities in fine-pitch BGA and the testing and assembly of COFs. We have also introduced fine-pitch COF based on our proprietary technology and COG testing and assembly services for LCD and other flat-panel display driver semiconductors.

In addition, we will continue to pursue the development of new testing and assembly technologies jointly with domestic and foreign research institutions and universities. We expect to focus our research and development efforts in the following areas:

 

   

developing new software conversion programs to increase the capabilities of our testers;

 

   

developing technologies for wafer-level burn-in and testing before assembly;

 

   

developing advanced assembly technologies for high-speed memory devices;

 

   

developing fine-pitch bumping, chip probing and bonding technologies for LCD drivers;

 

   

improving manufacturing yields for new assembly technologies;

 

   

developing environmentally friendly assembly services that focus on eliminating the lead and halogen elements from the materials employed in the package and reducing the toxicity of gaseous chemical wastes; and

 

   

implementing of radio frequency identification (RFID) logistics management system for the wafer probing process.

In 2006, we spent approximately 1.3% of our net revenue on research and development. We will continue to invest our resources to recruit and retain experienced research and development personnel. As of March 31, 2007, our research and development team comprised 273 persons.

Build on Our Strong Presence in Taiwan and Expand Our Operations Outside Taiwan.

We intend to build on our strong presence in key centers of semiconductor and electronics manufacturing to further grow our business. Currently, most of our operations are in Taiwan, one of the world’s leading locations for outsourced semiconductor manufacturing. This presence provides us with several advantages. First, our proximity to other semiconductor companies is attractive to customers who wish to outsource various stages of the semiconductor manufacturing process. Second, our proximity to many of our suppliers, customers and the end-users of our customers’ products enables us to be involved in the early stages of the semiconductor design process, enhances our ability to quickly respond to our customers’ changing requirements and shortens our customers’ time-to-market. Third, we have access to an educated labor pool and a large number of engineers who are able to work closely with our customers and other providers of semiconductor manufacturing services.

 

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As with our operations in Taiwan, we intend to similarly benefit from our operations in Mainland China. We intend to invest in and expand our operations in Mainland China, increasing our testing and assembly services for memory semiconductors. We also plan to expand our testing and assembly services to include LCD and other flat-panel display driver semiconductors and to establish our gold bumping capacity in our Shanghai facility.

Depending on customers demands, market conditions and other relevant considerations, we may from time to time look into other opportunities to expand our operations outside Taiwan.

Expand Our Offering of Vertically Integrated Services.

We believe that one of our competitive strengths is our ability to provide vertically integrated services to our customers. Vertically integrated services consist of the integrated testing, assembly and direct shipment of semiconductors to end-users designated by our customers. Providing vertically integrated services enables us to shorten lead times for our customers. As time-to-market and cost increasingly become sources of competitive advantage for our customers, they increasingly value our ability to provide them with comprehensive back-end services. Through ChipMOS Taiwan, ThaiLin and ChipMOS Shanghai, we are able to offer vertically integrated services for a broad range of products, including memory, mixed-signal and LCD and other flat-panel display driver semiconductors. We believe that these affiliations, which offer complementary technologies, products and services as well as additional capacity, will continue to enhance our own development and expansion efforts into new and high-growth markets. We intend to establish new alliances with leading companies and, if suitable opportunities arise, engage in merger and acquisition activities that will further expand the services we can provide.

Focus on Increasing Sales through Long-Term Agreements with New and Existing Customers.

From time to time, we strategically agree to commit a portion of our testing and assembly capacity to certain of our customers. We intend to enter into long-term capacity agreements with more of our existing customers, as well as diversify our customer base by entering into long-term agreements with new customers. The customers we currently have long-term agreements with include ProMOS, Himax Technologies, Inc., or Himax, Novatek Microelectronics Corp., Ltd., or Novatek, a leading NOR flash maker in the U.S., and a leading PC peripheral chip provider in the U.S. See “— Customers” below for a more detailed discussion of these long-term agreements. Under certain of those long-term agreements, we have agreed to reserve capacity for our customers and our customers have agreed to place orders in the amount of the reserved capacity (which is subject in certain cases to reduction by the customers). As of March 31, 2007, approximately 31.8% of our total capacity was reserved under this type of agreement. Under certain other long-term agreements, we have agreed to acquire equipment or reserve capacity for our customers and our customers have undertaken to compensate us to a certain extent if they fail to sufficiently utilize the acquired equipment or reserved capacity. As of March 31, 2007, approximately 10.1% of our total capacity was reserved under this type of agreement. We believe that these long-term agreements help to insulate us from volatility in our capacity utilization rates and help us develop close relationships with our customers.

Principal Products and Services

The following table presents, for the periods shown, revenue by service segment as a percentage of our net revenue.

 

     Year ended December 31,  
     2004(1)     2005(2)     2006  

Testing

      

Memory testing revenue

   36.5 %   39.4 %   43.0 %

Mixed-signal testing revenue

   3.5     3.1     2.9  

Total testing revenue

   40.0     42.5     45.9  

Assembly

      

Memory assembly revenue

   34.1     33.9     30.6  

Mixed-signal assembly revenue

   4.4     3.2     1.7  

Total assembly revenue

   38.5     37.1     32.3  

LCD and other flat-panel display driver semiconductor testing and assembly revenue

   18.3     20.4     21.8  

Semiconductor turnkey revenue

   3.2     —       —    
                  

Total net revenue

   100.0 %   100.0 %   100.0 %
                  

 

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(1) Beginning as of January 12 and 28, 2004, and April 1, 2004, we consolidated the financial results of AMCT (which was liquidated in October 2004), ChipMOS Logic and Chantek, respectively. Starting from April 30, 2004, our financial results also included the financial results of WWT, which was subsequently merged into ChipMOS Logic. Starting from November 1, 2004, our financial statements also included the results of First Semiconductor Technology, Inc. in which ChipMOS Taiwan acquired a 67.8% equity interest on November 1, 2004 and transferred back this interest to First Semiconductor Technology, Inc. on April 29, 2005.
(2) In 2005, we consolidated the financial results of ChipMOS Taiwan, ChipMOS Japan, ChipMOS USA, ChipMOS Hong Kong, ChipMOS Logic (which was merged into ThaiLin on December 1, 2005), Chantek (which was merged into ChipMOS Taiwan on November 21, 2005), Modern Mind, and its wholly-owned subsidiary, ChipMOS Shanghai, and ThaiLin.

Memory and Mixed-Signal Semiconductors

Testing

We provide testing services for memory and mixed-signal semiconductors:

Memory. We provide testing services for a variety of memory semiconductors, such as SRAM, DRAM and flash memory. To speed up the time-consuming process of memory product testing, we provide multi-site testing, which can test up to 256 devices simultaneously. The memory semiconductors we test are used primarily in desktop computers, notebook computers and handheld consumer electronic devices and wireless communication devices.

Mixed-Signal. We conduct tests on a wide variety of mixed-signal semiconductors, with lead counts ranging from the single digits to over 1024 and operating frequencies of up to 600 MHz. The semiconductors we test include those used for networking and wireless communications, data communications, graphics and disk controllers for home entertainment and personal computer applications. We also test a variety of application specific integrated circuits, or ASICs, for applications such as cellular handsets, digital still cameras and personal digital assistants.

The following is a description of our pre-assembly testing services:

Engineering Testing. We provide engineering testing services, including software program development, electrical design validation, reliability and failure analyses.

 

   

Software Program Development. Design and test engineers develop a customized software program and related hardware to test semiconductors on advanced testing equipment. A customized software program is required to test the conformity of each particular semiconductor to its particular function and specification.

 

   

Electrical Design Validation. A prototype of the designed semiconductor is submitted to electrical tests using advanced test equipment, customized software programs and related hardware. These tests assess whether the prototype semiconductor complies with a variety of different operating specifications, including functionality, frequency, voltage, current, timing and temperature range.

 

   

Reliability Analysis. Reliability analysis is designed to assess the long-term reliability of the semiconductor and its suitability of use for its intended applications. Reliability testing may include operating-life evaluation, during which the semiconductor is subjected to high temperature and voltage tests.

 

   

Failure Analysis. If the prototype semiconductor does not perform to specifications during either the electrical validation or reliability analysis process, failure analysis is performed to determine the reasons for the failure. As part of this analysis, the prototype semiconductor may be subjected to a variety of tests, including electron beam probing and electrical testing.

Wafer Probing. Wafer probing is the step immediately before the assembly of semiconductors and involves visual inspection and electrical testing of the processed wafer for defects to ensure that it meets our customers’ specifications. Wafer probing employs sophisticated design and manufacturing technologies to connect the terminals of each chip for testing. Defective chips are marked on the surface or memorized in an electronic file, known as a mapping file, to facilitate subsequent processing.

Laser Repairing. In laser repairing of memory products, specific poly or metal fuses are blown after wafer probing to enable a spare row or column of a memory cell to replace a defective memory cell.

After assembly, we perform the following testing services:

 

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Burn-In Testing. This process screens out unreliable products using high temperature, high voltage and prolonged stress to ensure that finished products will survive a long period of end-user service. This process is used only for memory products.

Top Marking. By using either a laser marker or an ink marker, we mark products according to our customers’ specifications, including the logo, product type, date code and lot number.

Final Testing. Assembled semiconductors are tested to ensure that the devices meet performance specifications. Tests are conducted using specialized equipment with software customized for each application in different temperature conditions ranging from minus 45 degrees celsius to 85 degrees celsius. One of the tests includes speed testing to classify the parts into different speed grades.

Final Inspection and Packing. Final inspection involves visual or auto-inspection of the devices to check for any bent leads, inaccurate markings or other construction defects. Packing involves dry packing, packing-in-tube and tape and reel. Dry pack involves heating semiconductors in a tray at 125 to 150 degrees celsius for about two hours to remove the moisture before the semiconductors are vacuum-sealed in an aluminum bag. Packing-in-tube involves packing the semiconductors in anti-static tubes for shipment. Tape and reel pack involves transferring semiconductors from a tray or tube onto an anti-static embossed tape and rolling the tape onto a reel for shipment to customers.

Assembly

Our assembly services generally involve the following steps:

 

Wafer Lapping

   The wafers are ground to their required thickness.

Die Saw

   Wafers are cut into individual dies, or chips, in preparation for the die-attach process.

Die Attach

   Each individual die is attached to the leadframe or substrate.

Wire Bonding

   Using gold wires, the I/O pads on the die are connected to the package inner leads.

Molding

   The die and wires are encapsulated to provide physical support and protection.

Marking

   Each individual package is marked to provide product identification.

Dejunking and

Trimming

  

Mold flash is removed from between the lead shoulders through dejunking, and

the dambar is cut during the trimming process.

Electrical Plating

  

A solderable coating is added to the package leads to prevent oxidization and to

keep solder wettability of the package leads.

Ball Mount and Reflow    Each electrode pad of the substrate is first printed with flux, after which solder balls are mounted, heated and attached to the electrode pad of the substrate through a reflow oven.

Forming/Singulation

   Forming involves the proper configuration of the device packages leads, and singulation separates the packages from each other.

We offer a broad range of package formats designed to provide our customers with a broad array of assembly services. The assembly services we offer customers are leadframe-based packages, which include thin small outline packages, and organic substrate-based packages, including fine-pitch BGA.

The differentiating characteristics of these packages include:

 

   

the size of the package;

 

   

the number of electrical connections which the package can support;

 

   

the electrical performance and requirements of the package; and

 

   

the heat dissipation requirements of the package.

 

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As new applications for semiconductor devices require smaller components, the size of packages has also decreased. In leading-edge packages, the size of the package is reduced to just slightly larger than the size of the individual chip itself in a process known as chip scale packaging.

As semiconductor devices increase in complexity, the number of electrical connections required also increases. Leadframe-based products have electrical connections from the semiconductor device to the electronic product through leads on the perimeter of the package. Organic substrate-based products have solder balls on the bottom of the package, which create the electrical connections with the product and can support large numbers of electrical connections.

Leadframe-Based Packages. These are generally considered the most widely used package category. Each package consists of a semiconductor chip encapsulated in a plastic molding compound with metal leads on the perimeter. This design has evolved from a design plugging the leads into holes on the circuit board to a design soldering the leads to the surface of the circuit board.

The following diagram presents the basic components of a standard leadframe-based package for memory semiconductors:

LOGO

To satisfy the demand for miniaturization of portable electronic products, we are currently developing and will continue to develop increasingly smaller versions of leadframe-based packages to keep pace with continually shrinking semiconductor device sizes. Our advanced leadframe-based packages generally are thinner and smaller, have more leads and have advanced thermal and electrical characteristics when compared to traditional packages. As a result of our continual product development, we offer leadframe-based packages with a wide range of lead counts and sizes to satisfy our customers’ requirements.

The following table presents our principal leadframe-based packages, including the number of leads in each package, commonly known as lead-count, a description of each package and the end-user applications of each package.

 

Package

   Lead-count   

Description

  

End-User Applications

Plastic Leaded Chip Carrier (PLCC)

   32-44    Package with leads on four sides used in consumer electronics products in which the size of the package is not vital    Copiers, printers, scanners, personal computers, electronic games, monitors

Plastic Dual-in-line Package (PDIP)

   16-56    Package with insertion leads on longer sides used in consumer electronics products    Electronic games, monitors, copiers, printers, audio and video products, personal computers

Thin Small Outline Package I (TSOP I)

   28-56    Designed for high volume production of low lead-count memory devices, including flash memory, SRAM and MROM    Notebook computers, personal computers, still and video cameras and standard connections for peripherals for computers

Thin Small Outline Package II (TSOP II)

   24-86    Designed for memory devices, including flash memory, SRAM, SDRAM and DDR DRAM    Disk drives, recordable optical disk drives, audio and video products, consumer electronics, communication products

Quad Flat Package (QFP)

   44-208    Flat structure with 4-sided peripheral leads designed for SRAM, graphic processors, personal computer chipsets and mixed-signal devices    Wireless communication products, notebook computers, personal computers, consumer electronics

 

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Quad Flat No Lead (QFN)    28-116    Thermal enhanced quad flat no lead package providing small footprint (chip scale), light weight with good thermal and electrical performance    Wireless communication products, notebook computers, PDAs, consumer electronics
Low-Profile Quad Flat Package (LQFP)    48-128    Low-profile and light weight package designed for ASICs, digital signal processors, microprocessors/controllers, graphics processors, gate arrays, SSRAM, SDRAM, personal computer chipsets and mixed-signal devices    Wireless communication products, notebook computers, digital cameras, cordless/radio frequency devices
Thin Quad Flat Package (TQFP)    44-128    Designed for lightweight portable electronics requiring broad performance characteristics and mixed-signal devices    Notebook computers, personal computers, disk drives, office equipment, audio and video products and wireless communication products
Small Outline Package (SOP)    8-44    Designed for low lead-count memory and logic semiconductors, including SRAM and micro-controller units    Personal computers, consumer electronics, audio and video products, communication products
Multi-Chip Package (TSOP with organic substrate)    24-86    Our patented design for memory devices, including SRAM, DRAM and SDRAM    Notebook computers, personal computers, disk drives, audio and video products, consumer products, communication products

Organic Substrate-based Packages. As the number of leads surrounding a traditional leadframe-based package increases, the leads must be placed closer together to reduce the size of the package. The close proximity of one lead to another can create electrical shorting problems and requires the development of increasingly sophisticated and expensive techniques to accommodate the high number of leads on the circuit boards.

The BGA format solves this problem by effectively creating external terminals on the bottom of the package in the form of small bumps or balls. These balls are evenly distributed across the entire bottom surface of the package, allowing greater pitch between the individual terminals. The ball grid array configuration enables high-pin count devices to be manufactured less expensively with less delicate handling at installation.

Our organic substrate-based packages employ a fine-pitch BGA design, which uses a plastic or tape laminate rather than a leadframe and places the electrical connections, or leads, on the bottom of the package rather than around the perimeter. The fine-pitch BGA format was developed to address the need for the smaller footprints required by advanced memory devices. Benefits of ball grid array assembly over leadframe-based assembly include:

 

   

smaller size;

 

   

smaller footprint on a printed circuit board;

 

   

better electrical signal integrity; and

 

   

easier attachment to a printed circuit board.

 

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The following diagram presents the basic component parts of a fine-pitch BGA package:

LOGO

The following table presents the ball-count, description and end-user applications of organic substrate-based packages we currently assemble:

 

Package

   Connections  

Description

  

End-User Applications

Mini BGA

   36-208   Low-cost and space-saving assembly designed for low input/output count, suitable for semiconductors that require a smaller package size than standard BGA    Memory, analog, flash memory, ASICs, radio frequency devices, personal digital assistants, cellular handsets, communication products, notebook computers, wireless systems

Fine-Pitch BGA

   54-119   Our patented design for DRAM products that require high performance and chip scale package (CSP)    Notebook computers, cellular handsets, global positioning systems, personal digital assistants, wireless systems

Very Fine-Pitch BGA

   48-90   Similar structure of Mini BGA package with thinner and finer ball pitch that is designed for use in a wide variety of applications requiring small size, high reliability and low unit cost    Handheld devices, notebook computers, disk drives, wireless and mobile communication products

Land Grid Array (LGA)

   44-53   Thinner and lighter assembly designed essential to standard BGA without solder balls, suitable for applications that require high electrical performance    Disk drives, memory controllers, wireless, mobile communication products

Multi-Chip BGA

   36-208   Designed for assembly of two or more memory chips (to increase memory density) or combinations of memory and logic chips in one BGA package    Notebook computers, digital cameras, personal digital assistants, global positioning systems, sub-notebooks, board processors, wireless systems

Stacked-Chip BGA

   66-119   Designed for assembly of two or more memory chips or logic and memory chips in one CSP, reducing the space required for memory chips    Cellular handsets, digital cameras, personal digital assistants, wireless systems, notebook computers, global positioning systems

LCD and Other Flat-Panel Display Driver Semiconductors

We also offer testing and assembly services for LCD and other flat-panel display driver semiconductors. We employ TCP, COF and COG technologies for testing and assembling LCD and other flat-panel display driver semiconductors. In addition, we offer gold bumping services to our customers.

Gold bumping technology, which can be used in TCP, COF and COG technologies, is a necessary interconnection technology for LCD and other flat-panel display driver semiconductors. Most gold bumping services are performed on six- or eight-inch wafers. Gold bumping technology provides the best solution for fine-pitch chips and is able to meet the high production requirement for LCD and other flat-panel display driver semiconductors or other chips that require thin packaging profiles.

 

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The gold bumping fabrication process uses thin film metal deposition, photolithography and electrical plating technologies. A series of barrier and seed metal layers are deposited over the surface of the wafer. A layer of thick photoresist material is spin-coated over these barrier and seed layers. A photomask is used to pattern the locations over each of the bond pads that will be bumped. UV exposure and developing processes open the photoresist material, which defines the bump shape. The gold bump is then electroplated over the pad and the deposited barrier metal layers. Once the plating is complete, a series of etching steps are used to remove the photoresist material and the metal layers that are covering the rest of the wafer. The gold bump protects the underlying materials from being etched. The gold bumped wafers will go through an annealing furnace to soften the gold bumps to fit the hardness requirement of TCP, COF and COG assembly processes.

Tape Carrier Package Technology

TCPs offer a high number of inputs and outputs, a thin package profile and a smaller footprint on the circuit board, without compromising performance. Key package features include surface mount technology design, fine-pitch tape format and slide carrier handling. Because of their flexibility and high number of inputs and outputs, TCPs are primarily employed either for STN-LCD or TFT-LCD driver semiconductors.

Testing of tape carrier packages. We conduct full function testing of LCD and other flat-panel display driver semiconductors with a specially designed probe handler to ensure reliable contact to the test pads on the TCP tape. We can test STN-LCD or TFT-LCD driver semiconductors with frequencies of up to 750 MHz and at voltages up to 40V. The test is performed in a temperature-controlled environment with the device in tape form. The assembled and tested LCD and other flat-panel display driver semiconductors in tape form are packed between spacer tapes together with a desiccant in an aluminum bag to avoid contact during shipment.

Assembly of tape carrier packages. TCPs use a tape-automated bonding process to connect die and tape. The printed circuit tape is shipped with a reel. The reel is then placed onto an inner lead bonder, where the LCD or other flat-panel display driver semiconductor is configured onto the printed circuit tape. The resulting TCP component consists of the device interconnected to a three-layer tape, which includes a polyamide-down carrier film, an epoxy-based adhesive layer and a metal layer. The tape metallization area of the interconnections is tin plated over a metal layer. The silicon chip and inner lead area is encapsulated with a high temperature thermoset polymer after inner lead bonding. The back face of the chip is left un-sealed for thermal connection to the printed circuit board.

The following diagram presents the basic components of a tape carrier package:

LOGO

Chip-on-Film Technology

In 2001, we commenced testing and assembly services using COF technology. We have developed this proprietary technology from our existing TCP technology, and it has been widely accepted by our customers. The primary use of the COF module is to replace the liquid crystal module, or LCM, in certain applications. LCM is mainly employed in handheld electronics, such as PDAs and cellular handsets.

COF technology provides several additional advantages. For example, COF is able to meet the size, weight and higher resolution requirements in electronic products, such as flat-panel displays. This is because of its structural design, including an adhesive-free two-layer tape that is highly flexible, bending strength and its capacity to receive finer patterning pitch.

The TCP and COF assembly process involves the following steps:

 

Wafer Lapping

   Wafers are ground to their required thickness.

Die Saw

   Wafers are cut into individual dies, or chips, in preparation for inner lead bonding.

 

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Inner Lead Bonding

   An inner lead bonder machine connects the chip to the printed circuit tape.

Potting

   The package is sealed with an epoxy.

Potting Cure

   The potting cure process matures the epoxy used during the potting stage with high temperatures.

Marking

   A laser marker is used to provide product identification.

Marking Cure

   The marking cure process matures the marking ink by subjecting the semiconductor to high temperatures.

Chip-on-Glass Technology

COG technology is an electronic assembly technology that is used increasingly in assembling LCD and other flat-panel display driver semiconductors for communications equipment. Compared to the traditional bonding process for TCP or COF, the new COG technology requires lower bonding temperature. In addition, the COG technology reduces assembly cost as it does not use tapes for interconnection between the LCD panel and the printed circuit board.

The COG assembly technology involves the following steps:

 

Wafer Lapping

   Wafers are ground to their required thickness.

Die Saw

   Wafers are cut into individual dies, or chips, in preparation for the pick and place process.

Pick and Place

   Each individual die is picked and placed into a chip tray.

Inspection and Packing

   Each individual die in a tray is visually or auto-inspected for defects. The dies are packed within a tray in an aluminum bag after completion of the inspection process.

Semiconductor Turnkey

Prior to 2005, we had from time to time engaged in semiconductor turnkey services when the market demand for our other testing and assembly services decreased. Our semiconductor turnkey services consisted of our purchase of fabricated wafers, primarily memory semiconductors, which we then tested and assembled the dies cut from the fabricated wafers and resold the completed semiconductors to our customers. In 2004, the level of our semiconductor turnkey services declined due to the increase in customer orders for our testing and assembly services, and after 2004, we did not have any semiconductor turnkey revenue.

Other Services

Drop Shipment

We offer drop shipment of semiconductors directly to end-users designated by our customers. We provide drop shipment services, including assembly in customer-approved and branded boxes, to a majority of our testing and assembly customers. Since drop shipment eliminates the additional step of inspection by the customer prior to shipment to end-users, quality of service is a key to successful drop shipment service. We believe that our ability to successfully execute our full range of services, including drop shipment services, is an important factor in maintaining existing customers as well as attracting new customers.

Software Development, Conversion and Optimization Program

We work closely with our customers to provide sophisticated software engineering services, including test program development, conversion and optimization, and related hardware design. Generally, testing requires customized testing software and related hardware to be developed for each particular product. Software is often initially provided by the customer and then converted by us at our facilities for use on one or more of our testing machines and contains varying functionality depending on the specified testing procedures. Once a conversion test program has been developed, we perform correlation and trial tests on the semiconductors. Customer feedback on the test results enables us to adjust the conversion test programs prior to actual testing. We also typically assist our customers in collecting and analyzing the test results and recommend engineering solutions to improve their design and production process.

 

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Customers

We believe that the following factors have been, and will continue to be, important factors in attracting and retaining customers:

 

   

our advanced testing and assembly technologies;

 

   

our strong capabilities in testing and assembling LCD and other flat-panel display driver semiconductors;

 

   

our focus on high-density memory products and mixed-signal communications products; and

 

   

our reputation for high quality and reliable customer-focused services.

The number of our customers has grown from 46 in 1999 to more than 130 as of March 31, 2007. Our top 15 customers in terms of revenue in 2006 include (in alphabetical order):

Cypress Semiconductor Corp.

Elite Semiconductor Memory Technology Inc.

Etron Technology, Inc.

Himax Technologies, Inc.

Hynix Semiconductor Inc.

Integrated Circuit Solution Inc.

Macronix International Co., Ltd.

Micron Semiconductor Asia Pte. Ltd.

MStar Semiconductor, Inc.

Novatek Microelectronics Corp., Ltd.

Oki Electronic Industry Co., Ltd.

Powerchip Semiconductor Corp.

ProMOS Technologies Inc.

Sandisk Global Ltd.

Spansion LLC

In 2004, our largest customer was ProMOS, our second-largest was Powerchip Semiconductor Corp., and our third-largest customer was Himax, accounting for 28%, 11% and 6% of our net revenue, respectively. In 2005, our largest customer was ProMOS, our second-largest customer was Powerchip Semiconductor Corp., and our third-largest customer was Himax, accounting for 28%, 15% and 9% of our net revenue, respectively. In 2006, our largest customer was ProMOS, our second-largest customer was Powerchip Semiconductor Corp., and our third-largest customer was Himax, accounting for approximately 27%, 14% and 11% of our net revenue, respectively.

We have been successful in attracting new customers, such as Hynix Semiconductor Inc. in 2004. In April 2005, we extended the duration of our agreement with ProMOS, under which we reserve assembly capacity and testing services for ProMOS and ProMOS is committed to place orders in the amount of the reserved capacity, until the end of 2009. In December 2006, we further revised our agreement with ProMOS to increase the reserved capacity for our assembly and final testing services for ProMOS. In May 2005, we extended the duration of our contract with Himax until the end of 2008. In May 2005, we also extended the duration of our contract with Novatek until the end of 2008.

The majority of our customers do not enter into long-term contracts with us, and instead purchase our services through purchase orders and provide us every month with three-month non-binding rolling forecasts. The price for our services is typically agreed upon at the time when a purchase order is placed.

In 2004, 2005 and 2006, we strategically entered into several long-term agreements with some of our key customers, including ProMOS, Himax, Novatek, a leading NOR flash maker in the U.S., and a leading PC peripheral chip provider in the U.S., under which we reserved capacity for the customers primarily through 2006 to 2009 and the customers committed to place orders in the amount of the reserved capacity (which is subject in certain cases to reduction by the customers). These agreements generally provide that the price of our services will be agreed upon at the time our customers place the orders under the agreement. If we are unable to test and assemble the agreed number of semiconductors in any given month, such customers may generally use a third party to cover the shortfall. However, under these agreements, we are generally entitled to cure any shortfall in the following month. If we fail to do so, we may generally be liable for damages up to the amount equal to the number of shortfall units in the given month multiplied by

 

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the average selling price per unit in that month. If a customer fails to place orders according to the reserved capacity, we are generally entitled to damages based on our costs for the equipment, tooling costs, costs for personnel dedicated to the provisions of capacity to such customer, and the costs for raw materials. As of March 31, 2007, approximately 31.8% of our total capacity was reserved under this type of agreement.

Under certain other long-term agreements, including our agreement with a leading NOR flash maker in the U.S., we have agreed to acquire equipment or reserve capacity for our customers and our customers have agreed to compensate us to a certain extent if they fail to sufficiently utilize the installed equipment or reserved capacity. As of March 31, 2007, approximately 10.1% of our total capacity was reserved under this type of agreement.

The following table sets forth, for the periods indicated, the percentage breakdown of our net revenue, categorized by geographic region based on the jurisdiction in which each customer is headquartered.

 

     Year ended December 31,  
     2004     2005     2006  

Taiwan

   81 %   79 %   78 %

Japan

   4     3     3  

United States

   11     11     15  

Korea

   1     4     3  

Hong Kong SAR

   1     1     1  

Others

   2     2     (1)
                  

Total

   100 %   100 %   100 %
                  

(1) Less than 1%.

Qualification and Correlation by Customers

Our customers generally require that our facilities undergo a stringent “qualification” process during which the customer evaluates our operations, production processes and product reliability, including engineering, delivery control and testing capabilities. The qualification process typically takes up to eight weeks, or longer, depending on the requirements of the customer. For test qualification, after we have been qualified by a customer and before the customer delivers semiconductors to us for testing in volume, a process known as “correlation” is undertaken. During the correlation process, the customer provides us with test criteria, information regarding process flow and sample semiconductors to be tested and either provides us with the test program or requests that we develop a new or conversion program. In some cases, the customer also provides us with a data log of results of any testing of the semiconductor that the customer may have conducted previously. The correlation process typically takes up to two weeks, but can take longer depending on the requirements of the customer.

Sales and Marketing

We maintain sales and marketing offices in Taiwan, Hong Kong, Japan, Mainland China and the United States. Our sales and marketing strategy is to focus on memory semiconductors in Taiwan, Japan, Korea and the United States, mixed-signal semiconductors in Taiwan, Japan and the United States, LCD and other flat-panel display driver semiconductors in Japan, Taiwan and Hong Kong, Mainland China, and module manufacturing in Taiwan and Mainland China. As of March 31, 2007, our sales and marketing efforts were primarily carried out by teams of sales professionals, application engineers and technicians, totaling 43 staff members. Each of these teams focuses on specific customers and/or geographic regions. As part of our emphasis on customer service, these teams:

 

   

actively participate in the design process at the customers’ facilities;

 

   

resolve customer testing and assembly issues; and

 

   

promote timely and individualized resolutions to customers’ issues.

We conduct marketing research through our in-house customer service personnel and through our relationships with our customers and suppliers to keep abreast of market trends and developments. Furthermore, we do product and system bench marking analyses to understand the application and assembly technology evolution, such as analysis on mobile handsets and CD-/DVD-ROM players. In addition, we regularly collect data from different segments of the semiconductor industry and, when possible, we work closely with our customers to design and develop testing and assembly services for their new products. These “co-development” or “sponsorship” projects can be critical when customers seek large-scale, early market entry with a significant new product.

 

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We have appointed a non-exclusive sales agent for promoting our services for memory semiconductors in the United States, Japan and Korea. Our sales agent helps us promote and market our services, maintain relations with our existing and potential customers and communicate with our customers on quality, specific requirements and delivery issues. We generally pay our sales agent a commission of 0.25% to 5% of our revenue from services for memory semiconductors in the United States, Japan and Korea. In 2004, 2005 and 2006, we paid NT$22 million, NT$42 million and NT$36 million (US$1 million), respectively, in commissions to our sales agent.

Research and Development

We believe that research and development is critical to our future success. In 2004, 2005 and 2006, we spent approximately NT$296 million, or 2%, NT$274 million, or 2%, NT$275 million (US$8 million), or 1%, respectively, of our net revenue on research and development. We intend to sustain these efforts.

Our research and development efforts have focused primarily on improving the efficiency, production yields and technology of our testing and assembly services. From time to time, we jointly develop new technology with universities and research institutions. For testing, our research and development efforts focus particularly on complex, high-speed, high-parallel, high-pin count and high-density semiconductors in fine-pitch and thin packages. Our projects include:

 

   

development of testing environments for simultaneous wafer probing and package testing;

 

   

development/conversion of test programs;

 

   

development of wafer-level burn-in;

 

   

development of wafer-level testing;

 

   

development of multi-chip testing;

 

   

implementation of a radio frequency identification (RFID) logistics management system to monitor the wafer probing process;

 

   

testing new products using existing machines; and

 

   

providing customers remote access to monitor test results.

We are also continuing development of interface designed to provide for high frequency testing by minimizing electrical noise.

For assembly, our research and development efforts focus on:

 

   

high performance;

 

   

fine pitch;

 

   

miniaturization;

 

   

multi-chip assembly;

 

   

multi-chip modules;

 

   

stacked-dice chip scale package;

 

   

thinner and more flexible assembly such as chip-on-film package;

 

   

three-dimensional assembly; and

 

   

developing environmentally friendly assembly services.

Our projects include developing multi-chip package, flip-chip technologies, environmentally friendly products, 12-inch wafer technologies, fine-pitch wire bonding technologies, 50-micron wafer thinning technology, advanced packages for DDR III, COF module, fine-pitch LCD driver bumping, testing and assembly technologies, and advanced probe card technology. We work closely with our customers to design and modify testing software and with equipment vendors to increase the efficiency and reliability of testing and assembly equipment. Our research and development operations also include a mechanical engineering group, which currently designs handler kits for semiconductor testing and wafer probing, as well as software to optimize capacity utilization.

 

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As of March 31, 2007, we employed 273 employees in our research and development activities. In addition, other management and operational personnel are also involved in research and development activities but are not separately identified as research and development professionals.

We maintain laboratory facilities to analyze the characteristics of semiconductor packages by computer simulation, and verify their performance by measurement devices. The implementation of computer simulation substantially reduces the time required to validate the suitability of a package design for a given application, as compared with physical testing methods.

Quality Control

We believe that our reputation for high quality and reliable services has been an important factor in attracting and retaining leading international semiconductor companies as customers for our testing and assembly services. We are committed to delivering semiconductors that meet or exceed our customers’ specifications on time and at a competitive cost. We maintain quality control staff at each of our facilities.

As of March 31, 2007, we employed 461 personnel for our quality control activities. Our quality control staff typically includes engineers, technicians and other employees who monitor testing and assembly processes in order to ensure high quality. We employ quality control procedures in the following critical areas:

 

   

sales quality assurance: following market trends to anticipate customers’ future needs;

 

   

design quality assurance: when developing new testing and assembly processes;

 

   

supplier quality assurance: consulting with our long-term suppliers;

 

   

manufacturing quality assurance: through a comprehensive monitoring program during mass production; and

 

   

service quality assurance: quickly and effectively responding to customers’ claims after completion of sale.

All of our facilities have been QS 9000 certified by the International Automotive Sector Group. In addition, our facilities in Hsinchu and Tainan have been ISO 9002 certified. With respect to our quality management system, on November 26, 2003, ChipMOS Taiwan obtained ISO/TS 16949:2002 quality system certification. ThaiLin and ChipMOS Shanghai also obtained ISO/TS 16949:2002 quality system certification on September 6, 2005 and January 28, 2006, respectively.

QS 9000 quality standards provide for continual improvement with an emphasis on the prevention of defects and reduction of variation and waste in the supply chain, and a QS 9000 certification is required by certain semiconductor manufacturers as a threshold indicator of a company’s quality control standards. An ISO 9002 certification is required by many countries for sales of industrial products. ISO/TS 16949:2002 certification system seeks to integrate quality management standards into the operation of a company, and emphasizes the supervision and measurement of process and performance.

In addition to the quality management system, we also earned the 1998 QC Group Award from The Chinese Society of Quality, which is equivalent to the similar award from the American Society of Quality. Our laboratories have also been awarded Chinese National Laboratory accreditation under the categories of reliability test, electricity and temperature calibration.

Our testing and assembly operations are carried out in clean rooms where air purity, temperature and humidity are controlled. To ensure the stability and integrity of our operations, we maintain clean rooms at our facilities that meet U.S. federal 209E class 100, 1,000, 10,000 and 100,000 standards. A class 1,000 clean room means a room containing less than 1,000 particles of contaminants per cubic foot.

We have established manufacturing quality control systems that are designed to ensure high-quality services to our customers and maintain reliability and high production yields at our facilities. We employ specialized equipment for manufacturing quality and reliability control, including:

 

   

Joint Electron Device Engineering Council (JEDEC) standardized temperature cycling, thermal shock and pressure cook reliability tests;

 

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high and low temperature storage life tests, temperature and humidity bias and highly accelerated temperature/humidity stress test (HAST); and

 

   

high resolution scanning acoustic tomography, scanning electronic microscope and X-Ray microscopy for physical failure analysis, curve tracer and semi-probe station for electrical failure analysis.

In addition, to enhance our performance and our research and development capabilities, we also installed a series of high-cost equipment, such as temperature humidity bias testers, low temperature storage-life testers and highly accelerated stress testers. We believe that many of our competitors do not own these equipment.

As a result of our ongoing focus on quality, we achieved monthly assembly yields of an average of 99.96% for our memory and mixed-signal assembly packages, 99.85% for our TCP packages, 99.82% for our COF packages and 99.76% for our COG packages in 2006. The assembly yield, which is the industry standard for measuring production yield, is equal to the number of integrated circuit packages that are shipped back to customers divided by the number of individual integrated circuits that are attached to leadframes or organic substrate.

Facilities

We provide testing services through our four facilities in Taiwan and one facility in Shanghai, with one facility at each of the following locations: Chupei, the Hsinchu Industrial Park, the Hsinchu Science Park, the Southern Taiwan Science Park and the Shanghai Qingpu Industrial Zone. We provide assembly services through our facility at the Southern Taiwan Science Park and our facility at the Shanghai Qingpu Industrial Zone. We own the land for our Hsinchu Industrial Park testing facility and Chupei facility and possess the land use right to the land on which our Shanghai Qingpu Industrial Zone facility is located until 2052, and we lease the land for our Hsinchu Science Park testing facility and Southern Taiwan Science Park facility from the Science Park Administration under three 20-year leases. Two leases for our Hsinchu Science Park facility will expire in 2008 and 2017, respectively, and the lease for our Southern Taiwan Science Park facility will expire in 2017.

In March 2002, Modern Mind entered into a cooperation agreement with the Shanghai Qingpu Industrial Zone Development Group Company under which Modern Mind has agreed to construct a permanent wholly-owned facility in the Shanghai Qingpu Industrial Zone to provide testing and assembly services. Modern Mind commenced construction of the facility in Shanghai in June 2002 and moved into the new facility in August 2005, with the grand opening of the new facility in November 2005. Modern Mind currently offers testing and assembly of memory semiconductors, TCP/COF, COG assembly and testing services, and intends to expand into gold bumping services. In connection with the Shanghai operations, Modern Mind has invested US$122.5 million in ChipMOS Shanghai for the new facility and related equipment and Modern Mind has committed to invest an additional US$127.5 million by December 6, 2007 in the facility and related equipment.

On August 24, 2004, we, through ThaiLin and ChipMOS Taiwan, entered into an agreement for the acquisition of certain testing and assembly assets of FICTA, including 52 testers, 133 wire bonders, machinery, equipment, raw materials, spare parts and related patents.

In December 2004, we sold our Kaohsiung testing facility to Radiant Opto-Electronics Corporation.

The following table shows the location, primary use and size of each of our facilities, and the principal equipment installed at each facility, as of March 31, 2007.

 

Location of Facility

  

Primary Use

  

Floor Area

  

Principal Equipment

Chupei, Hsinchu    Wafer Testing/Gold Bumping/Module    25,930 square meters   

3 steppers

9 sputters

170 testers

Hsinchu Industrial Park, Taiwan — ThaiLin    Testing    25,865 square meters   

142 testers

29 burn-in ovens

Hsinchu Science Park, Taiwan    Testing    28,632 square meters   

121 testers

72 burn-in ovens

Southern Taiwan Science Park, Taiwan    Assembly/Testing    109,676 square meters   

393 wire bonders

132 inner-lead bonders

180 testers

Shanghai Qingpu Industrial Zone, Mainland China    Assembly/Testing/ Modules and Subsystem Manufacturing    70,095 square meters    24 testers 118 wire bonders 7 inner-lead bonders 15 burn-in ovens

 

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Raw Materials

Semiconductor testing requires minimal raw materials. Fabricated wafers are the main raw materials for our semiconductor turnkey services. Substantially all of the raw materials used in our memory and mixed-signal semiconductor assembly processes are interconnect materials such as leadframes, organic substrates, gold wire and molding compound. Raw materials used in the LCD and other flat-panel display driver semiconductor testing and assembly process include carrier tape, resin, spacer tape, plastic reel, aluminum bags, and inner and outer boxes. Cost of raw materials represented 21%, 15% and 13% of our net revenue in 2004, 2005 and 2006, respectively.

We do not maintain large inventories of leadframes, organic substrates, gold wire or molding compound, but generally maintain sufficient stock of each principal raw material for approximately one to two months’ production based on blanket orders and rolling forecasts of near-term requirements received from customers. In addition, several of our principal suppliers dedicate portions of their inventories, typically in amounts equal to the average monthly amounts supplied to us, as reserves to meet our production requirements. However, shortages in the supply of materials experienced by the semiconductor industry have in the past resulted in occasional price adjustments and delivery delays. See “Item 3. Key Information — Risk Factors — Risks Relating to Our Business — If we are unable to obtain raw materials and other necessary inputs from our suppliers in a timely and cost-effective manner, our production schedules would be delayed and we may lose customers and growth opportunities and become less profitable” for a discussion of the risks associated with our raw materials purchasing methods. For example, with the exception of aluminum bags and inner and outer boxes, which we acquire from local sources, the raw materials used in our TCP/COF process and for modules are obtained from a limited number of Japanese suppliers.

Equipment

Testing of Memory and Mixed-Signal Semiconductors

Testing equipment is the most capital-intensive component of the memory and mixed-signal semiconductors testing business. Upon the acquisition of new testing equipment, we install, configure, calibrate and perform burn-in diagnostic tests on the equipment. We also establish parameters for the testing equipment based on anticipated requirements of existing and potential customers and considerations relating to market trends. As of March 31, 2007, we operated 443 testers for testing memory and mixed-signal semiconductors. We generally seek to purchase testers with similar functionality that are able to test a variety of different semiconductors. We purchase testers from major international manufacturers, including Advantest Corporation, Verigy Ltd. and Credence Systems Corporation.

In general, particular semiconductors can be tested using a limited number of specially designed testers. As part of the qualification process, customers will specify the machines on which their semiconductors may be tested. We often develop test program conversion tools that enable us to test semiconductors on multiple equipment platforms. This portability among testers enables us to allocate semiconductor testing across our available testing capacity and thereby improve capacity utilization rates. If a customer requires the testing of a semiconductor that is not yet fully developed, the customer consigns its testing software programs to us to test specific functions. If a customer specifies testing equipment that is not widely applicable to other semiconductors we test, we require the customer to furnish the equipment on a consignment basis. Currently, we have two testers consigned by ProMOS and one of our mixed-signal testing and assembly services customers.

We will continue to acquire additional testing equipment in the future to the extent market conditions, cash generated from operations, the availability of financing and other factors make it desirable to do so. Some of the equipment and related spare parts that we require have been in short supply in recent years. Moreover, the equipment is only available from a limited number of vendors or is manufactured in relatively limited quantities and may have lead time from order to delivery in excess of six months.

 

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Assembly of Memory and Mixed-Signal Semiconductors

The number of wire bonders at a given facility is commonly used as a measure of the assembly capacity of the facility. Typically, wire bonders may be used, with minor modifications, for the assembly of different products. We purchase wire bonders principally from Shinkawa Co., Ltd. and Kulicke & Soffa Industries Inc. As of March 31, 2007, we operated 511 wire bonders. In addition to wire bonders, we maintain a variety of other types of assembly equipment, such as wafer grinders, wafer mounters, wafer saws, die bonders, automated molding machines, laser markers, solder platers, pad printers, dejunkers, trimmers, formers, substrate saws and lead scanners.

Gold Bumping, Testing and Assembly of LCD and Other Flat-Panel Display Driver Semiconductors

We acquired TCP-related equipment from Sharp to begin our TCP-related services. We subsequently purchased additional TCP-related testers from Yokogawa Electric Corp. and Advantest Corporation and assembly equipment from Shibaura Mechatronics Corp., Athlete FA Corp. and Sharp Takaya Electronics Corp. As of March 31, 2007, we operated 3 steppers and 9 sputters for gold bumping and 139 inner-lead bonders for assembly and 194 testers for LCD and other flat-panel display driver semiconductors. We are currently in the process of purchasing additional testing equipment. The testing equipment can be used for the TCP, COF and COG processes, while the inner-lead bonders are only used in the TCP and COF processes. The same types of wafer grinding, auto wafer mount and die saw equipment is used for the TCP, COF and COG processes. In addition, auto inspection machines and manual work are used in the COG process, which is more labor-intensive than the TCP and COF processes.

Competition

The independent testing and assembly markets are very competitive. Our competitors include large IDMs with in-house testing and assembly capabilities and other independent semiconductor testing and assembly companies, especially those offering vertically integrated testing and assembly services, such as Advanced Semiconductor Engineering Inc., Amkor Technology, Inc., ASAT Limited, ASE Test Limited, International Semiconductor Technology Ltd., King Yuan Electronics Co., Ltd., Powertech Technology Inc., Siliconware Precision, STATS ChipPAC Ltd. and United Test and Assembly Center Ltd. We believe that the principal measures of competitiveness in the independent semiconductor testing industry are:

 

   

engineering capability of software development;

 

   

quality of service;

 

   

flexibility;

 

   

capacity;

 

   

production cycle time; and

 

   

price.

In assembly services, we compete primarily on the basis of:

 

   

production yield;

 

   

production cycle time;

 

   

process technology, including our COF technology for LCD and other flat-panel display driver semiconductor assembly services;

 

   

quality of service;

 

   

capacity;

 

   

location; and

 

   

price.

IDMs that use our services continually evaluate our performance against their own in-house testing and assembly capabilities. These IDMs may have access to more advanced technologies and greater financial and other resources than we do. We believe, however, that we can offer greater efficiency and lower costs while maintaining an equivalent or higher level of quality for three reasons:

 

   

first, we offer a broader and more complex range of services as compared to the IDMs, which tend to focus their resources on improving their front-end operations;

 

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second, we generally have lower unit costs because of our higher utilization rates; and

 

   

finally, we offer a wider range of services in terms of complexity and technology.

Intellectual Property

As of March 31, 2007, we held 423 patents in Taiwan, one patent in the United Kingdom, one patent in France, one patent in Germany, 23 patents in the United States and 11 patents in the People’s Republic of China relating to various semiconductor testing and assembly technologies. These patents will expire at various dates through March 23, 2026. As of March 31, 2007, we also had a total of 65 pending patent applications in the United States, 126 in Taiwan, one in Japan and 144 in the People’s Republic of China. In addition, we have registered “ChipMOS” and its logo and “InPack” as trademarks in Taiwan, and “ChipMOS” and its logo as trademarks in the United States, the People’s Republic of China, Singapore, Hong Kong, Korea, Japan and in the European Community.

We expect to continue to file patent applications where appropriate to protect our proprietary technologies. We may need to enforce our patents or other intellectual property rights or to defend ourselves against claimed infringement of the rights of others through litigation, which could result in substantial costs and a diversion of our resources. See “Item 3. Key Information — Risk Factors — Risks Relating to Our Business — Disputes over intellectual property rights could be costly, deprive us of technologies necessary for us to stay competitive, render us unable to provide some of our services and reduce our opportunities to generate revenue” and “Item 8. Financial Information — Legal Proceedings.”

On April 7, 2004, ChipMOS Bermuda entered into an assignment agreement with ChipMOS Taiwan, as amended on May 14 and October 11, 2004, pursuant to which ChipMOS Taiwan transferred all of the technologies it owned as of that date to ChipMOS Bermuda for a purchase price of US$19.7 million, which was paid in November 2004.

On April 7, 2004, ChipMOS Bermuda entered into a patent license agreement with ChipMOS Taiwan, which was amended on July 8, 2004, October 11, 2004 and December 30, 2004, pursuant to which ChipMOS Bermuda grants to ChipMOS Taiwan a non-exclusive royalty-bearing license with respect to certain patents and patent applications until the expiration of the term of the last of these patents. Under the patent license agreement, ChipMOS Taiwan will pay ChipMOS Bermuda a royalty in the aggregate of US$20 million, payable in 80 quarterly installments of US$250 thousand each. The first installment was paid in April 2005, the second installment was paid in June 2005, the third and fourth installments were paid in January 2006, the fifth installment was paid in April 2006, the sixth installment was paid in July 2006, the seventh installment was paid in October 2006, the eighth installment was paid in January 2007 and the ninth installment was paid in April 2007.

On June 3, 2006, ChipMOS Taiwan entered into a license agreement with Sharp Corporation, or Sharp, pursuant to which we acquired a perpetual license to use TCP testing and assembly technology for a lump sum royalty payment of 10 million Japanese yen (approximately US$87,000), which we paid in July 2006. This license agreement superseded the previous license agreement with Sharp entered into in February 2000 pursuant to which Sharp licensed to us TCP-related technology and intellectual property rights for five years starting from February 10, 2000 for a royalty fee based on the service fees paid to us by our customers. Our royalty obligations under the February 2000 license agreement were fully paid.

On April 12, 2007, ChipMOS Bermuda entered into an assignment agreement with ChipMOS Taiwan, pursuant to which ChipMOS Taiwan assigned and transferred fifty percent of the title to, ownership of and interest in all of the technologies and intellectual property it owned as of that date to ChipMOS Bermuda for a purchase price of US$6,400,000, which is expected to be paid on a date to be further determined.

Environmental Matters

Semiconductor testing does not generate significant pollutants. The semiconductor assembly process generates gaseous chemical wastes, principally at the molding stage. Liquid waste is produced when silicon wafers are ground thinner and diced into chips with the aid of diamond saws and cooled with running water and during the gold bumping process. In addition, excess material on leads

 

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and moldings are removed from assembled semiconductors in the trimming and dejunking processes, respectively. We have installed various types of liquid and gaseous chemical waste-treatment equipment at our semiconductor assembly and gold bumping facilities. We believe that we have adopted adequate and effective environmental protection measures that are consistent with semiconductor industry practices in Taiwan and Mainland China. In addition, we believe we are in compliance in all material respects with current environmental laws and regulations applicable to our operations and facilities.

All of our facilities in Taiwan and Mainland China have been certified as meeting the ISO 14001 environmental standards by the International Organization for Standardization. Our testing facility at the Hsinchu Science Park won both the “Plant Greenery and Beautification Award” in 1999, 2000 and 2002 and the “Safety & Health Excellent Personnel Award” in 2001 from the Science Park Administration, the “Green Office Award” from the Environment Protection Administration of the ROC in 2000 and the “Outstanding Voluntary Protection Program Award” by the Labor Affairs Commission of the ROC in 1999. Our assembly facility at the Southern Taiwan Science Park won the “Green Office Award” from the Environment Protection Administration of the ROC in 2001. In 2003, we won several environmental awards, including the “Environmental Protection Excellent Unit Award,” the “Plant Greenery and Beautification Award,” the “Environment Maintain Award” and the “Safety & Health Excellent Personnel Award,” each awarded by the Science Park Administration. We will continue to implement programs, measures and related training to reduce industrial waste, save energy and control pollution. In 2001, ChipMOS Taiwan completed a lead-free process control program, which offers a lead-free method in a semiconductor package, a lead-free plating, a lead-free solder ball and a lead-free reliability method and specification. In 2005, ChipMOS Shanghai completed a similar lead-free process control program.

Insurance

We maintain insurance policies on our buildings, equipment and inventories. These insurance policies cover property damages due to all risks, including but not limited to, fire, lightning and earthquakes. The maximum coverage of property insurance for ChipMOS Taiwan and ThaiLin is approximately NT$40,841 million and NT$5,205 million, respectively. ChipMOS Shanghai also maintains property insurance policies for a maximum coverage of approximately RMB798 million.

Insurance coverage on facilities under construction is maintained by us and our contractors, who are obligated to procure necessary insurance policies and bear the relevant expenses of which we are the beneficiary.

We also maintain insurance on the wafers delivered to us while these wafers are in our possession and during transportation from suppliers to us and from us to our customers.

Employees

See “Item 6. Directors, Senior Management and Employees—Employees” for certain information relating to our employees.

Taxation

See “Item 5. Operating and Financial Review and Prospects—Taxation” for certain information regarding the effect of PRC and ROC tax regulations on our operations.

 

Item 4A. Unresolved Staff Comments

Not applicable.

 

Item 5. Operating and Financial Review and Prospects

Overview

We provide a broad range of semiconductor testing and assembly services primarily for memory, mixed-signal, and LCD and other flat-panel display driver semiconductors. We also have in the past provided semiconductor turnkey services by purchasing fabricated wafers and selling tested and assembled semiconductors, although we have not provided semiconductor turnkey services after 2004. In 2006, our consolidated net revenue was NT$20,375 million (US$625 million) and our net income was NT$2,121 million (US$65 million).

 

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We are a holding company, incorporated in Bermuda on August 1, 2000. We provide most of our services through our 99.1%-owned subsidiary, ChipMOS Taiwan, and its subsidiaries and investees. ChipMOS Taiwan was founded in 1997 as a joint venture between Mosel and Siliconware Precision and with the participation of other investors. As of March 31, 2007, we held 99.1% of the outstanding common shares of ChipMOS Taiwan. In Taiwan, we conduct testing operations in our facilities at the Hsinchu Science Park and the Hsinchu Industrial Park, gold bumping, wafer testing and module manufacturing operations in our facility at Chupei, and testing and assembly operations in our facility at the Southern Taiwan Science Park. We also conduct operations in Mainland China through ChipMOS Shanghai, a wholly-owned subsidiary of Modern Mind, which is one of our controlled consolidated subsidiaries. ChipMOS Shanghai operates a testing and assembly facility at the Qingpu Industrial Zone in Shanghai. Through our subsidiaries, we also have equity interests in other companies that are engaged in the semiconductor industry. See “Item 4. Information on the Company—Overview of the Company” for more details.

The following key trends are important to understanding our business:

Capital Intensive Nature of Our Business. Our operations, in particular our testing operations, are characterized by relatively high fixed costs. We expect to continue to incur substantial depreciation and other expenses as a result of our previous acquisitions of testing and assembly equipment and facilities. Our profitability depends in part not only on absolute pricing levels for our services, but also on capacity utilization rates for our testing and assembly equipment. In particular, increases or decreases in our capacity utilization rates could significantly affect our gross margins since the unit cost of testing and assembly services generally decreases as fixed costs are allocated over a larger number of units.

The current generation of advanced testers typically cost between US$2 million and US$5 million each, while wire bonders used in assembly typically cost approximately US$65,000 each and inner-lead bonders for tape carrier package, or TCP, and chip-on-film, or COF, assembly cost approximately US$375,000 each and chip-on-glass, or COG, chip sorters cost approximately US$145,000 each. We begin depreciating our equipment when it is placed into commercial operation. There may be a time lag between the time when our equipment is placed into commercial operation and when it achieves high levels of utilization. In periods of depressed semiconductor industry conditions, we may experience lower than expected demand from our customers and a sharp decline in the average selling prices of our testing and assembly services, resulting in an increase in depreciation expenses relative to net revenue. In particular, the capacity utilization rates for our testing equipment may be severely affected during a semiconductor industry downturn as a result of the decrease in outsourcing demand from integrated device manufacturers, or IDMs, which typically maintain larger in-house testing capacity than in-house assembly capacity.

Highly Cyclical Nature of the Semiconductor Industry. Highly cyclical, the worldwide semiconductor industry has experienced peaks and troughs over the last decade, with a severe downturn beginning in the fourth quarter of 2000 that was followed by a recovery in early 2003. The significant decrease in market demand for semiconductors that began in 2000 adversely affected our results of operations for 2001 and 2002. During periods of decreased demand for assembled semiconductors, some of our customers may forego or simplify final testing of certain types of semiconductors, such as DRAM, further intensifying our difficulties.

Declining Average Selling Prices of Our Testing and Assembly Services. The semiconductor industry is characterized by a general decrease in prices for products and services over the course of their product and technology life cycles. The rate of decline is particularly steep during periods of intense competition and adverse market conditions. The average selling prices of our testing and assembly services experienced sharp declines during such periods as a result of intense price competition from other independent testing and assembly companies that attempt to maintain high capacity utilization levels in the face of reduced demand.

To offset the effects of decreasing average selling prices, we will continue to seek to:

 

   

improve production efficiency and maintain high capacity utilization rates;

 

   

concentrate on testing of high-demand, high-growth semiconductors;

 

   

develop new assembly technologies; and

 

   

implement new technologies and platforms to shift into higher margin services.

Market Conditions for the End-User Applications for Semiconductors. Market conditions in the semiconductor industry, to a large degree, track those for their end-user applications. Any deterioration in the market conditions for the end-user applications of

 

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semiconductors that we test and assemble may reduce demand for our services and, in turn, materially adversely affect our financial condition and results of operations. Our net revenue is largely attributable to fees from testing and assembling semiconductors for use in personal computers, consumer electronic products, display applications and communications equipment. The markets for these products are intensely competitive, and a significant decrease in demand could put pricing pressure on our testing and assembly services and negatively affect our earnings.

Change in Product Mix. Declines in average selling prices have been partially offset over the last three years by a change in our revenue mix. In particular, revenue from testing and assembly of LCD and other flat-panel display driver semiconductors and 12-inch wafer processing have increased as a percentage of our total net revenue. We intend to continue focusing on testing and assembling more semiconductors that provide higher margins and developing and offering new technologies in testing and assembly services, in order to mitigate the effects of declining average selling prices on our profitability.

Recent Acquisitions

On June 16, 2005, ChipMOS Taiwan and Chantek entered into a merger agreement, whereby Chantek agreed to be merged into ChipMOS Taiwan, with ChipMOS Taiwan as the surviving entity. Under the merger agreement, as amended on September 2, 2005, shareholders of Chantek (other than ChipMOS Taiwan) were entitled to elect to receive cash or ChipMOS Taiwan shares in exchange for their Chantek shares at the ratio of 3.6 to 1. As a result, ChipMOS Taiwan paid NT$81 million in cash and issued 6 million shares to Chantek shareholders pursuant to the merger agreement. The transaction closed on November 21, 2005.

On August 15, 2005, ThaiLin entered into a merger agreement with ChipMOS Logic, whereby ChipMOS Logic agreed to be merged into ThaiLin, with ThaiLin as surviving entity. Under the merger agreement, shareholders of ChipMOS Logic received one common share of ThaiLin in exchange for 2.8 common shares of ChipMOS Logic. The transaction closed on December 1, 2005, and as of March 31, 2007, ChipMOS Taiwan held a 35.6% interest in ThaiLin.

On February 13, 2007, we entered into a share purchase and subscription agreement with ChipMOS Taiwan and Siliconware Precision under which we and ChipMOS Taiwan agreed to purchase all of Siliconware Precision’s equity interest in ChipMOS Taiwan, and Siliconware Precision agreed to subscribe for 12,174,998 of our newly issued common shares through a private placement. The transaction closed on March 27, 2007, and as of March 31, 2007, we held 99.1% of the outstanding common shares of ChipMOS Taiwan.

On April 12, 2007, we entered into a share exchange agreement with ChipMOS Taiwan pursuant to which we will exchange one common share for every 8.4 ChipMOS Taiwan shares outstanding. Following the completion of the share exchange transaction, which we expect to occur in the second half of 2007, ChipMOS Taiwan will become our wholly-owned subsidiary. In connection with this transaction, we expect to issue up to 858,847 of our common shares to the current shareholders of ChipMOS Taiwan in exchange for their ChipMOS Taiwan shares. The exact number of our shares to be issued, however, may be fewer if any shareholder of ChipMOS Taiwan exercises its appraisal right.

Net Revenue

We conduct our business according to the following main business segments: (1) testing services for memory and mixed-signal semiconductors; (2) assembly services for memory and mixed-signal semiconductors; and (3) LCD and other flat-panel display driver semiconductor testing and assembly services. Prior to 2005, we also provided semiconductor turnkey services, whereby we purchase fabricated wafers and sell tested and assembled semiconductors, as well as certain trading activities. The following table sets forth, for the periods indicated, our consolidated net revenue for each segment.

 

     Year ended December 31,
     2004(1)    2005(2)    2006    2006
     NT$    NT$    NT$    US$

Testing

           

Memory

   $ 5,491.9    $ 5,996.4    $ 8,759.5    $ 268.8

Mixed-signal

     529.7      463.5      580.6      17.8

Total testing

     6,021.6      6,459.9      9,340.1      286.6

Assembly

           

Memory

     5,130.1      5,166.4      6,240.2      191.5

Mixed-signal

     660.7      489.5      349.4      10.7

Total assembly

     5,790.8      5,655.9      6,589.6      202.2

LCD and other flat-panel display driver semiconductor testing and assembly

     2,749.8      3,098.2      4,445.5      136.4

Semiconductor turnkey

     473.6      —        —     

Total

   $ 15,035.8    $ 15,214.0    $ 20,375.2    $ 625.2

 

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(1) Beginning as of January 12 and 28, 2004, and April 1, 2004, we consolidated the financial results of AMCT (which was liquidated in October 2004), ChipMOS Logic and Chantek, respectively. Starting from April 30, 2004, our financial results also included the financial results of WWT, which was subsequently merged into ChipMOS Logic. Starting from November 1, 2004, our financial statements also included the results of First Semiconductor Technology, Inc. in which ChipMOS Taiwan acquired a 67.8% equity interest on November 1, 2004 and transferred back this interest to First Semiconductor Technology, Inc. on April 29, 2005.
(2) In 2005, we consolidated the financial results of ChipMOS Taiwan, ChipMOS Japan, ChipMOS USA, ChipMOS Hong Kong, ChipMOS Logic (which was merged into ThaiLin on December 1, 2005), Chantek (which was merged into ChipMOS Taiwan on November 21, 2005), Modern Mind, and its wholly-owned subsidiary, ChipMOS Shanghai, and ThaiLin.

Our net revenue consists primarily of service fees for testing and assembling semiconductors, and to a lesser extent, fees from equipment rentals to semiconductor manufacturers for engineering testing, less allowances for product returns. We offer testing and assembly services for memory semiconductors, mixed-signal semiconductors and testing and assembly services for LCD and other flat-panel display driver semiconductors. In 2004, we also offered semiconductor turnkey services to utilize our excess capacity available from time to time. We have not provided semiconductor turnkey services after 2004.

Most of our customers do not place purchase orders far in advance and our contracts with customers generally do not require minimum purchases of our products or services. Our customers’ purchase orders have varied significantly from period to period because demand for their products is often volatile. We have strategically entered into long-term capacity agreements with some of our customers. Under certain of those long-term agreements, we have agreed to reserve capacity for our customers and our customers have agreed to place orders in the amount of the reserved capacity (which is subject in certain cases to reduction by the customers). As of March 31, 2007, approximately 31.8% of our total capacity was reserved under this type of agreement. Under certain other long-term agreements, we have agreed to install equipment or reserve capacity for our customers and our customers have undertaken to compensate us to a certain extent if they fail to sufficiently utilize the installed equipment or reserved capacity. As of March 31, 2007, approximately 10.1% of our total capacity was reserved under this type of agreement. As part of our strategy, we intend to enter into additional long-term capacity agreements in the future. Depending on customer demands, market conditions and other considerations, we may explore opportunities to expand our operations outside Taiwan and Mainland China in connection with future long-term capacity agreements.

Our financial condition and results of operations have also been, and are likely to continue to be, affected by price pressures on our service fees, which tend to decline in tandem with the declining average selling prices of the products we test and assemble over the course of their product and technology life cycles. In order to maintain our margins, it is necessary to offset the fee erosion by continually improving our production efficiency and maintaining high capacity utilization rates. We also plan to continue to develop and implement new technologies and expand our services into potentially higher-margin segments. These efforts require significant up front investment in advance of incremental revenue, which could impact our margins.

Pricing

We price our testing fees primarily based on the cost of testing the products to our customers’ specifications, including the costs of the required material and components, the depreciation expenses relating to the equipment involved and our overhead expenses, and with reference to prevailing market prices. Accordingly, the testing fee for a particular product would principally depend on the time taken to perform the tests, the complexity of the product and the testing process, and the cost of the equipment used to perform the test. For example, testing fees for memory semiconductors are significantly higher than those for other products because of the longer time required and the need for burn-in testing.

We price our assembly services on a per unit basis, taking into account the complexity of the package, our costs, including the costs of the required material and components, the depreciation expenses relating to the equipment involved and our overhead expenses, prevailing market conditions, the order size, the strength and history of our relationship with the customer and our capacity utilization.

 

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We price our testing and assembly services for LCD and other flat-panel display driver semiconductors on the basis of our costs, including the costs of the required material and components, the depreciation expenses relating to the equipment involved and our overhead expenses, and the price for comparable services.

We offer volume discounts to all customers who purchase large quantities of our services and special discounts to customers who use our turnkey services or all of our vertically integrated services.

Revenue Recognition

We generally recognize our revenue upon shipment of tested and assembled semiconductors to locations designated by our customers, including our internal warehouse for customers using our warehousing services. Revenue from product sales is recognized when risks of ownership are transferred to customers, generally upon shipment of the products. We submit invoices at the time of shipment or delivery and currently require customers to pay within 60 days after the last day of the month during which the invoice was sent, except that we currently require ProMOS to pay within 75 days. We have not experienced any significant collection problems for our services, except for NT$277 million (US$8 million) of receivables from Ultima Electronics Corp., or Ultima. We received from Ultima 4,250,000 and 4,190,000 shares of Ultima Technology Corp. (BVI) common stock on September 24 and December 18, 2004, respectively, as collateral for the outstanding receivables. We provided an allowance of NT$194 million and NT$83 million for these doubtful receivables in 2004 and 2005 respectively. These doubtful receivables were fully written off during 2006. In April 2007, we settled the civil proceedings related to these doubtful receivables with Ultima for NT$700 thousand (US$21 thousand) and recorded such amount as other income.

Related Party Revenues

In 2004, 2005 and 2006, 32%, 30% and 28%, respectively, of our net revenue were derived from related parties. While we believe that our transactions with related parties were entered into on an arm’s length basis, we extended them favorable payment terms, as discussed in the preceding paragraph. See “Item 7. Major Shareholders and Related Party Transactions” for more information concerning our related party transactions.

Geography and Currency

We generate most of our net revenue from customers headquartered in Taiwan, which represented 81%, 79% and 78% of our net revenue in 2004, 2005 and 2006, respectively. We also generate net revenue from customers in Korea, Japan, the United States, Hong Kong and other countries. Our service fees and revenue are generally denominated in the currency of the jurisdiction in which our facilities are located, for example NT dollars for our Taiwan operations and RMB for our Mainland China operations. As we generate most of our net revenue from Taiwanese customers using our Taiwanese operations, and since most of our labor and overhead costs are denominated in NT dollars, we consider the NT dollar to be our functional currency.

See Note 24 to our audited consolidated financial statements and “Item 11. Quantitative and Qualitative Disclosure about Market Risks—Market Risks—Foreign Currency Risks” for certain information on our exchange rate risks.

Cost of Revenue and Gross Profit (Loss)

Our cost of revenue consists primarily of the following: depreciation and amortization expenses, raw material costs, and labor and overhead expenses, which primarily include expensable equipments, sub-contracting fees and rental expenses. Our operations, in particular our testing operations, are characterized by relatively high fixed costs. We expect to continue to incur substantial depreciation and other expenses as a result of our previous and future acquisitions of testing and assembly equipment and facilities, including our investment in our Mainland China operations. Our profitability depends in part not only on absolute pricing levels for our services, but also on our capacity utilization rates. As of March 31, 2007, we had 637 testers, 116 burn-in ovens, 511 wire bonders, 139 inner-lead bonders, 3 steppers and 9 sputters. We use inner-lead bonders for the assembly of LCD and other flat-panel display driver semiconductors using TCP or COF technology, and wire bonders for TSOP, BGA, and some other package assembly technologies. Our average capacity utilization rate for testing of memory and mixed-signal semiconductors was 89% in 2004, 81% in 2005 and 86% in 2006. Our average capacity utilization rate for assembly of memory and mixed-signal semiconductors was 88% in 2004, 79% in 2005 and 75% in 2006. In addition, our average capacity utilization rate for LCD and other flat-panel display driver semiconductor testing and assembly was 76% in 2004, 83% in 2005 and 79% in 2006.

 

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Most of our labor and overhead costs are denominated in NT dollars. However, we also incur costs of revenues and operating expenses associated with testing and assembly services in several other currencies, including Japanese yen, US dollars and RMB. In addition, a substantial portion of our capital expenditures, primarily for the purchase of testing and assembly equipment, has been, and is expected to continue to be, denominated in Japanese yen with much of the remainder denominated in US dollars.

The following table sets forth, for the periods indicated, our gross profit (loss) and our gross profit (loss) margin as a percentage of net revenue.

 

     Year ended December 31,  
     2004(1)     2005(2)     2006     2006  
     NT$     NT$     NT$     US$  
     (in thousands)  

Gross profit (loss):

        

Testing

        

Memory

   $ 2,329.0     $ 2,186.6     $ 3,779.3     $ 116.0  

Mixed-signal

     (100.9 )     (148.9 )     (0.4 )     —    

Total testing

     2,228.1       2,037.7       3,778.9       116.0  

Assembly

        

Memory

     1,095.4       1,203.3       1,430.0       43.9  

Mixed-signal

     (122.3 )     (158.5 )     18.4       0.5  

Total assembly

     973.1       1,044.8       1,448.4       44.4  

LCD and other flat-panel display driver semiconductor testing and assembly

     970.2       868.9       894.5       27.4  

Semiconductor turnkey

     6.9       —         —         —    

Total

   $ 4,178.3     $ 3,951.4     $ 6,121.8     $ 187.8  

Gross profit (loss) margin:

        

Testing

        

Memory

     42.4 %     36.5 %     43.1 %     43.1 %

Mixed-signal

     (19.1 )     (32.1 )     (0.1 )     (0.1 )

Total testing

     37.0       31.6       40.5       40.5  

Assembly

        

Memory

     21.4       23.3       22.9       22.9  

Mixed-signal

     (18.5 )     (32.4 )     5.3       5.3  

Total assembly

     16.8       18.5       22.0       22.0  

LCD and other flat-panel display driver semiconductor testing and assembly

     35.3       28.0       20.1       20.1  

Semiconductor turnkey

     1.5       —         —         —    

Overall

     27.8 %     26.0 %     30.0 %     30.0 %

(1) Beginning as of January 12 and 28, 2004, and April 1, 2004, we consolidated the financial results of AMCT (which was liquidated in October 2004), ChipMOS Logic and Chantek, respectively. Starting from April 30, 2004, our financial results also included the financial results of WWT, which was subsequently merged into ChipMOS Logic. Starting from November 1, 2004, our financial statements also included the results of First Semiconductor Technology, Inc. in which ChipMOS Taiwan acquired a 67.8% equity interest on November 1, 2004 and transferred back this interest to First Semiconductor Technology, Inc. on April 29, 2005.
(2) In 2005, we consolidated the financial results of ChipMOS Taiwan, ChipMOS Japan, ChipMOS USA, ChipMOS Hong Kong, ChipMOS Logic (which was merged into ThaiLin on December 1, 2005), Chantek (which was merged into ChipMOS Taiwan on November 21, 2005), Modern Mind, and its wholly-owned subsidiary, ChipMOS Shanghai, and ThaiLin.

Operating Expenses

Research and Development

Research and development expenses consist primarily of personnel expenses, amortization expenses relating to technology, expenditures to qualify our services for specific customers and other consulting fees and certification fees paid to third parties. Research and development expenses are recognized as they are incurred. We currently expect that research and development expenses will increase in absolute terms in the future as we expand into new technologies and service offerings. We also expect to hire additional employees in our research and development department.

 

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Sales and Marketing

Sales and marketing expenses consist primarily of shipping and handling expenses incurred in delivering products to our customers’ designated locations, advertising, corporate communications and other marketing expenses, salary expenses for sales and marketing personnel, sales commission, professional service fees, bad debt provision and service support expenses. Although our sales and marketing expenses decreased in 2006 as a result of a decrease in bad debt provisions, we currently expect marketing expenses to increase in the future in connection with the planned growth of our business.

General and Administrative

General and administrative expenses consist of salaries and related expenses for executive, finance and accounting, and management information systems personnel, professional service fees, and other corporate expenses. They also include stock-based compensation that is expensed using the intrinsic value-based method. See “Item 6. Directors, Senior Management and Employees—Share Option Plan” for more information concerning our share option plan. We expect general and administrative expenses to increase in absolute terms as we add personnel and incur additional expenses related to the growth of our business and operations, particularly our Mainland China operations.

Other Income (Expenses), Net

Our other income principally consists of gains on sale of investments, warehouse space rental revenue, interest income, foreign exchange gains, gains on embedded derivative, fair value gains on financial assets and gains on disposal of property, plant and equipment. Our other expenses principally consist of interest expense, investment losses recognized by equity method, financing costs, impairment losses, fair value loss on financial assets, losses on disposal of property, plant and equipment and foreign exchange losses.

Minority Interests and Interest in Bonuses Paid by Subsidiaries

Minority interests represent the portion of our income that is attributable to the shareholding in our consolidated subsidiaries that we do not own. In 2004, 2005 and 2006, our minority interests were attributable to the minority interests owned by Siliconware Precision and other investors in ChipMOS Taiwan and the public shareholders’ interest in ThaiLin. In 2004 and 2005, minority interests also included the portion of our income attributable to the shareholdings in ChipMOS Logic and Chantek that we did not own before ChipMOS Logic was merged into ThaiLin on December 1, 2005 and Chantek was merged into ChipMOS Taiwan on November 21, 2005. Since we increased our shareholding in ChipMOS Taiwan from 70.4% to 99.1% in March 2007 as a result of our share purchase and subscription transaction with ChipMOS Taiwan and Siliconware Precision and we expect ChipMOS Taiwan to become our wholly-owned subsidiary in the second half of 2007 after completion of the share exchange transaction we entered into with ChipMOS Taiwan in April 2007, we expect minority interests to be substantially less in future periods.

Interest in bonuses paid by subsidiaries represents our portion of ChipMOS Taiwan’s and ThaiLin’s distributable earnings that are appropriated as bonuses to employees and remuneration to directors and supervisors of ChipMOS Taiwan and ThaiLin, as required by ROC regulations and ChipMOS Taiwan’s and ThaiLin’s articles of incorporation. None of our subsidiaries paid any such bonuses to directors, supervisors and employees in 2004. ChipMOS Taiwan and ThaiLin paid bonuses to directors, supervisors and employees of NT$166 million and NT$57 million, respectively, in 2005 and NT$242 million in (US$7 million) and NT$74 million (US$2 million), respectively, in 2006. As we increased our shareholding in ChipMOS Taiwan from 70.4% to 99.1% in March 2007 as a result of our share purchase and subscription transaction with ChipMOS Taiwan and Siliconware Precision and we expect ChipMOS Taiwan to become our wholly-owned subsidiary in the second half of 2007 as a result of the share exchange agreement between us and ChipMOS Taiwan, we expect our interest in bonuses paid by subsidiaries to increase in future periods. Please see “—US GAAP Reconciliation” for a discussion of the significant impact such bonuses had on our net income under US GAAP.

Net Income

Our net income was NT$1,676 million, NT$928 million and NT$2,121 million (US$65 million) in 2004, 2005 and 2006, respectively. We believe our future results will be dependent upon the overall economic conditions in the markets we serve, the competitive environment in which we operate, and our ability to successfully implement our strategy, among other things. For additional information on factors that will affect our future performance, see “Item 3. Key Information—Risk Factors.”

 

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Results of Operations

The following table presents selected operating data as a percentage of net revenue for the periods indicated:

 

     Year ended December 31,  
     2004(1)     2005(2)     2006  

ROC GAAP:

      

Net revenue

   100.0 %   100.0 %   100.0 %

Cost of revenue

   72.2     74.0     70.0  
                  

Gross profit margin

   27.8     26.0     30.0  

Operating expenses:

      

Research and development

   2.0     1.8     1.3  

Sales and marketing

   2.0     1.6     0.5  

General and administrative

   4.5     5.2     4.0  
                  

Total operating expenses

   8.5     8.6     5.8  

Income from operations

   19.3     17.4     24.2  

Other income (expenses), net

   (2.6 )   (3.3 )   (1.1 )
                  

Income before income tax, minority interests and interest in bonuses paid by subsidiaries(3)

   16.7     14.1     23.1  

Income tax benefit (expense)

   0.9     (0.7 )   (3.1 )
                  

Income before minority interests and interest in bonuses paid by subsidiaries

   17.6     13.4     20.0  

Minority interests

   (6.6 )   (6.4 )   (8.8 )

Interest in bonuses paid by subsidiaries(3)

   —       (0.9 )   (0.8 )

Pre-acquisition earnings (4)

   0.1     —       —    
                  

Net income

   11.1 %   6.1 %   10.4 %
                  

(1) Beginning as of January 12 and 28, 2004, and April 1, 2004, we consolidated the financial results of AMCT (which was liquidated in October 2004), ChipMOS Logic and Chantek, respectively. Starting from April 30, 2004, our financial results also included the financial results of WWT, which was subsequently merged into ChipMOS Logic. Starting from November 1, 2004, our financial statements also included the results of First Semiconductor Technology, Inc. in which ChipMOS Taiwan acquired a 67.8% equity interest on November 1, 2004 and transferred back this interest to First Semiconductor Technology, Inc. on April 29, 2005.
(2) In 2005, we consolidated the financial results of ChipMOS Taiwan, ChipMOS Japan, ChipMOS USA, ChipMOS Hong Kong, ChipMOS Logic (which was merged into ThaiLin on December 1, 2005), Chantek (which was merged into ChipMOS Taiwan on November 21, 2005), Modern Mind, and its wholly-owned subsidiary, ChipMOS Shanghai, and ThaiLin.
(3) Refers to bonuses to directors, supervisors and employees.
(4) For 2004, represents our share of pre-acquisition profits of Chantek prior to April 1, 2004, the date when we began to consolidate the accounts of Chantek, the surviving entity after the merger of Chantek and PlusMOS.

Year Ended December 31, 2006 Compared to Year Ended December 31, 2005

Net Revenue. Our net revenue increased by NT$5,161 million, or 34%, to NT$20,375 million (US$625 million) in 2006 from NT$15,214 million in 2005.

Net revenue from testing services for memory and mixed-signal semiconductors increased by NT$2,880 million, or 45%, to NT$9,340 million (US$287 million) in 2006 from NT$6,460 million in 2005, mainly due to an increase in net revenue from testing services for memory semiconductors. Net revenue from testing services for memory semiconductors increased by NT$2,764 million, or 46%, to NT$8,760 million (US$269 million) in 2006 from NT$5,996 million in 2005, principally due to capacity expansion and increased capacity utilization rates for our wafer testing and final testing services for DRAM and flash products.

Net revenue from assembly services for memory and mixed-signal semiconductors, which includes revenue from assembly services for memory and mixed-signal semiconductors and revenue from our memory module manufacturing business, increased by NT$934 million, or 17%, to NT$6,590 million (US$202 million) in 2006 from NT$5,656 million in 2005. This increase was primarily the result of an increase in net revenue from assembly services for memory semiconductors, partially offset by a decrease in net revenue from assembly services for mixed-signal semiconductors. Net revenue from assembly services for memory semiconductors

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increased by NT$1,074 million, or 21%, to NT$6,240 million (US$191 million) in 2006 from NT$5,166 million in 2005, primarily as a result of capacity expansion and increased sales of products with higher average selling prices, such as DDR II SDRAM products, which were partially offset by a decrease in net revenue from memory module manufacturing services. Net revenue from assembly services for mixed-signal semiconductors decreased by NT$141 million, or 29%, to NT$349 million (US$11 million) in 2006 from NT$490 million in 2005, principally because we reduced the volume of certain lower margin services in connection with the merger of Chantek into ChipMOS Taiwan.

Net revenue from LCD and other flat-panel display driver semiconductor testing and assembly services increased by NT$1,348 million, or 44%, to NT$4,446 million (US$136 million) in 2006 from NT$3,098 million in 2005. This increase was principally due to the increase in TCP, COF and COG products that resulted from our capacity expansion and slightly increased capacity utilization rates. The increase in net revenue from LCD and other flat-panel display driver semiconductor testing and assembly services was also a result of an increase in average selling prices for LCD and other flat-panel display driver semiconductor products.

We did not generate any net revenue from semiconductor turnkey services in 2005 and 2006.

Cost of Revenue and Gross Margin. Cost of revenue increased by NT$2,990 million, or 27%, to NT$14,253 million (US$437 million) in 2006 from NT$11,263 million in 2005, primarily due to an increase of NT$2,208 million in overhead expenses. Overhead expenses increased principally as a result of an increase in depreciation expenses and an increase in expenses related to tooling and equipment spare parts.

Our gross profit increased to NT$6,122 million (US$188 million) in 2006 from NT$3,951 million in 2005. Our gross margin was 30% in 2006, compared to 26% in 2005.

Our gross margin for testing services for memory and mixed-signal semiconductors increased to 41% in 2006 from 32% in 2005, primarily due to a higher capacity utilization rate, which increased to 86% in 2006 from 81% in 2005.

Our gross margin for assembly services for memory and mixed-signal semiconductors increased to 22% in 2006 from 19% in 2005. This increase was primarily due to increased sales of higher margin memory semiconductor assembly services, such as fine-pitch BGA package for DDR II SDRAM.

Our gross margin for LCD and other flat-panel display driver semiconductor testing and assembly services decreased to 20% in 2006 from 28% in 2005, primarily due to a lower capacity utilization rate. The lower capacity utilization rate principally resulted from lower customer demand for our LCD and other flat-panel display driver semiconductor testing and assembly services, particularly in the second quarter of 2006.

Research and Development Expenses. Research and development expenses increased by NT$1 million, or 0.4%, to NT$275 million (US$8 million) in 2006 from NT$274 million in 2005. This increase was primarily due to the net effect of an increase in professional services fees and a decrease in salary expenses. We currently expect our research and development expenses will increase in the future due to our focus on research and development projects relating to advanced packages for DDR III SDRAM, fine-pitch LCD driver testing and assembly technologies and radio frequency identification (RFID) logistics management system implementation.

Sales and Marketing Expenses. Sales and marketing expenses decreased by NT$126 million, or 54%, to NT$107 million (US$3 million) in 2006 from NT$233 million in 2005. This decrease was primarily due to a decrease of NT$117 million (US$4 million) in bad debt provisions.

General and Administrative Expenses. General and administrative expenses increased by NT$20 million, or 3%, to NT$813 million (US$25 million) in 2006 from NT$793 million in 2005, primarily due to bank fees associated with the NT$3 billion syndicated loan facility that we obtained in February 2006.

Other Expenses, Net. Other expenses, net decreased by NT$284 million, or 56%, to NT$223 million (US$7 million) in 2006 from NT$507 million in 2005. This decrease was primarily due to a decrease in impairment loss on property, plant and equipment and other assets, a decrease in impairment loss on long-term investment and a decrease in investment loss recognized by the equity method, which were partially offset by an increase in interest expense.

Income Before Income Tax, Minority Interests and Interest in Bonuses to Directors, Supervisors and Employees Paid by Subsidiaries. As a result of the foregoing, income before income tax, minority interests and interest in bonuses to directors, supervisors and employees paid by subsidiaries increased by 119% to NT$4,703 million (US$144 million) in 2006 from NT$2,144 million in 2005.

 

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Income Taxes. Income tax expense increased by NT$525 million, or 469%, to NT$637 million (US$20 million) in 2006 from NT$112 million in 2005, primarily due to a significant increase in income before income tax, minority interests and interest in bonuses to directors, supervisors and employees paid by subsidiaries and a significant decrease in losses carried forward.

Minority Interests. Minority interests increased by NT$822 million, or 84%, to NT$1,799 million (US$55 million) in 2006 from NT$977 million in 2005, primarily due to the increased income of ChipMOS Taiwan and ThaiLin.

Net Income. As a result of the foregoing, our net income increased by NT$1,193 million to NT$2,121 million (US$65 million) in 2006 from NT$928 million in 2005.

Year Ended December 31, 2005 Compared to Year Ended December 31, 2004

Net Revenue. Our net revenue increased by NT$178 million, or 1%, to NT$15,214 million in 2005 from NT$15,036 million in 2004.

Net revenue from testing services for memory and mixed-signal semiconductors increased by NT$438 million, or 7%, to NT$6,460 million in 2005, primarily due to the increase in our capacity utilization rates for wafer testing services and increased revenue from flash business.

Net revenue from assembly services for memory and mixed-signal semiconductors, which includes revenue from assembly services for memory and mixed-signal semiconductors and revenue from memory module manufacturing business, decreased by NT$135 million, or 2%, to NT$5,656 million in 2005, primarily due to the decrease in our memory module manufacturing business, partially offset by the increased demand for our assembly services for memory and mixed-signal semiconductors.

Net revenue from LCD and other flat-panel display driver semiconductor testing and assembly services increased by NT$348 million, or 13%, to NT$3,098 million in 2005, primarily due to the increase in our capacity utilization rates and the increase in our capacity for testing and assembly services for LCD and other flat-panel display driver semiconductors.

Our net revenue from semiconductor turnkey services was nil in 2005, compared to NT$474 million in 2004. The decrease was due to the increase in customer orders for our testing and assembly services and our decision to stop providing semiconductor turnkey services.

Cost of Revenue and Gross Margin. Cost of revenue increased by NT$405 million, or 4%, to NT$11,263 million in 2005 from NT$10,858 million in 2004. This increase was primarily due to an increase of NT$1,168 million in overhead expenses, partially offset by a decrease of NT$957 million in raw material costs. Overhead expenses increased primarily due to an increase of NT$815 million in equipment depreciation, an increase of NT$192 million in salaries for certain employees in our fabs, an increase of NT$134 million in expensable equipment and an increase of NT$116 million in utility expenses.

Our gross margin was 26% in 2005, compared to 28% in 2004, and our gross profit decreased to NT$3,951 million in 2005 from NT$4,178 million in 2004. This decrease was primarily due to the increase in equipment depreciation.

Our gross margin for testing services for memory and mixed-signal semiconductors decreased to 32% in 2005 from 37% in 2004, primarily due to lower capacity utilization rates.

Our gross margin for assembly services for memory and mixed-signal semiconductors increased to 19% in 2005 from 17% in 2004, primarily due to our effort to provide less services related to low-profit memory module manufacturing business.

Our gross profit margin for LCD and other flat-panel display driver semiconductor testing and assembly services decreased to 28% in 2005 from 35% in 2004, primarily due to the decline in the average selling price for these services.

 

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Research and Development Expenses. Research and development expenses decreased by NT$22 million, or 7%, to NT$274 million in 2005 from NT$296 million in 2004. This decrease was primarily due to a decrease of NT$10 million in depreciation of equipment and a decrease of NT$18 million in amortization expenses related to technology licensing. We currently expect our research and development expenses will increase in the future due to our focus on research and development projects relating to advanced packages for DDR III SDRAM, fine-pitch LCD driver testing and assembly technologies and radio frequency identification (RFID) implementation.

Sales and Marketing Expenses. Sales and marketing expenses decreased by NT$75 million, or 24%, to NT$233 million in 2005 from NT$308 million in 2004. This decrease was primarily due to a decrease of NT$75 million in bad debt provision.

General and Administrative Expenses. General and administrative expenses increased by NT$120 million, or 18%, to NT$793 million in 2005 from NT$673 million in 2004. This increase was primarily due to an increase of NT$81 million in salary expenses and an increase of NT$85 million in professional service fees, which were partially offset by a decrease of NT$26 million in entertainment expenses.

Other Expense, Net. Other expense, net increased by NT$111 million, or 28%, to NT$507 million in 2005 from NT$396 million in 2004. This increase was primarily due to an impairment loss on property, plant and equipment and other assets of ChipMOS Logic and Chantek of NT$109 million and investments loss recognized by the equity method of NT$127 million, which were partially offset by an increase of NT$48 million in interest income, a recovery of NT$86 million in allowance for loss on short-term investments and an increase of NT$21 million of claim payments received under our insurance policies.

Income Before Income Tax, Minority Interests and Interest in Bonuses to Directors, Supervisors and Employees Paid by Subsidiaries. Income before income tax, minority interests and interest in bonuses to directors, supervisors and employees paid by subsidiaries decreased to NT$2,144 million in 2005 from NT$2,504 million in 2004. This change was primarily due to the increase of our cost of revenues and the increase of operating expenses and net non-operating expenses.

Income Taxes. We recorded an income tax expense of NT$112 million in 2005 compared to an income tax benefit of NT$142 million in 2004. We incurred income tax expenses primarily as a result of a significant decrease in losses carried forward.

Minority Interests. Minority interests decreased by NT$21 million to NT$977 million in 2005 from NT$998 million in 2004. This decrease was primarily due to the decrease in income before income tax, minority interests and interest in bonuses to directors, supervisors and employees paid by subsidiaries.

Net Income. As a result of the foregoing, our net income was NT$928 million in 2005, compared to a net income of NT$1,676 million in 2004.

Critical Accounting Policies

We prepare our consolidated financial statements in conformity with ROC GAAP. Under ROC GAAP, we are required to make certain estimates, judgments and assumptions about matters that are highly uncertain at the time those estimates, judgments and assumptions are made, and our financial condition or results of operations may be materially impacted if we use different but nonetheless reasonable estimates, judgments or assumptions about those matters for that particular period or if we change our estimates, judgments or assumptions from period to period.

Under ROC GAAP, the significant accounting policies are set forth in Note 2 of the notes to the consolidated financial statements contained in this Annual Report on Form 20-F. The significant accounting policies that require us to make estimates and assumptions about the effect of matters that are inherently uncertain are discussed below. In connection with the reconciliation of our consolidated financial statements to US GAAP, there are no additional accounting policies that we believe are critical to us except as described below under “—Convertible Notes” and “—Share-Based Compensation.”

 

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Allowance for Doubtful Receivables and Sales Returns

Our accounts receivable balance on our balance sheet is affected by our allowances for doubtful accounts and sales returns, which reflect our estimate of the expected amount of the receivables that we will not be able to collect and our estimate of the expected amount of sales returns.

Our determination of the allowance for doubtful receivables is based on our determination of two different types of reserves. The first type of reserve involves an individual examination of available information regarding any customer that we have reason to believe may have an inability to meet its financial obligations. For these customers, we use our judgment, based on the available facts and circumstances, and record a specific reserve for that customer against amounts due to reduce the receivable to the amount that is expected to be collected. These specific reserves are reevaluated and adjusted as additional information is received. The second type of reserve is a general reserve established for all customers based on a range of percentages applied to aging categories. These percentages are based on historical collection and write-off experience. If circumstances change, our estimates of the recoverability of amounts due to us could be reduced by a material amount. As of December 31, 2006, we provided NT$27 million (US$828 thousand) for the first type of reserve and NT$44 million (US$1 million) for the second type of reserve.

Our determination of the allowances for sales returns as of the end of any quarter is based upon calculating an average historical return rate, usually based on the previous three quarters, and multiplying this by the revenue of that quarter. As of December 31, 2006, we provided NT$90 million (US$3 million) for the allowance of sales returns.

The allowance we set aside for doubtful receivables and sales returns was NT$292 million as of December 31, 2004, NT$401 million as of December 31, 2005 and NT$161 million (US$5 million) as of December 31, 2006. The allowances as of December 31, 2004, 2005 and 2006 represented 8%, 9% and 3%, respectively, of our accounts receivable and other receivables as of those dates. The allowance in 2004, 2005 and 2006 reflected a reduction of NT$194 million, NT$118 million and NT$884 thousand, respectively, in accounts receivable that was charged to marketing expenses. If we were to change our estimate of the allowance for doubtful receivables and sales returns either upward or downward 10%, our operating income would be affected by NT$4 million for 2006.

An increase in our allowance for doubtful receivables and sales returns would decrease our recorded revenue and our current assets.

Inventory Valuation

We state our inventories at the lower of cost or market value. Market value represents net realizable value for finished goods and work in process and replacement value for raw materials. We use the standard cost method to determine the cost of our inventories, adjusted to approximate weighted-average cost at the end of the period. We periodically evaluate the composition of our inventory and identify slow-moving inventories. Inventory items identified as slow-moving are evaluated to determine whether reserves are required.

In 2004, we reserved NT$64 million of inventory valuation allowance, primarily due to the consolidation of Chantek. In 2005, we did not record any inventory allowances because the market price for our inventory was higher than cost in 2005. In 2006, we reserved NT$20 million (US$614 thousand) of inventory allowance, primarily due to the market price of tested and assembled DRAM and SDRAM inventory was below historical cost. In addition, we reserved NT$47 million in 2004, NT$94 million in 2005 and NT$88 million (US$3 million) in 2006 for identified slow-moving inventories.

As of December 31, 2006, we recorded NT$108 million (US$3 million) of inventory valuation allowances. If the prevailing market price of our testing and assembly services had been 18% lower, we would have been required to recognize a valuation allowance of approximately NT$13 million (US$399 thousand) in 2006. A valuation allowance of NT$13 million in 2006 would have decreased our inventory value and net income by 1.4% and 0.6%, respectively.

Valuation Allowance for Deferred Tax Assets

When we have net operating loss carry forwards, investment tax credits or temporary differences in the amount of tax recorded for tax purposes and accounting purposes, we may be able to reduce the amount of tax that we would otherwise be required to pay in future periods. We recognize all existing future tax benefits arising from these tax attributes as deferred tax assets and then, based on our internal estimates of our future profits, establish a valuation allowance equal to the extent, if any, that it is not certain that deferred tax assets will be realized. We record a benefit or expense under the income tax expense/benefit line of our statement of operations

 

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when there is a net change in our total deferred tax assets and liabilities in a period. Because the calculation of income tax benefit is dependent on our internal estimation of our future profitability, it is inherently subjective. In 2004, we recorded a reversal of valuation allowance of NT$462 million, and in 2005, we recorded a reversal of a valuation allowance of NT$405 million. In 2006, we recognized valuation allowance of NT$280 million (US$9 million).

In calculating our valuation allowance for deferred taxes as of December 31, 2006, we have assumed that the semiconductor industry will continue its growth in the next few years. Furthermore, we have assumed that our revenue and profitability will be favorably impacted by this growth in the industry as a whole.

As of December 31, 2006, the ending balance for our valuation allowances was NT$1,079 million (US$33 million). If our current estimate of future profit had been 10% higher, we would have decreased our valuation allowances accordingly. That, in turn, would have increased our deferred tax assets. In contrast, if our current estimate of future profit had been 10% lower, we would have been required to recognize an additional valuation allowance. That, in turn, would have decreased our deferred tax assets and increased our tax expense in 2006. The steady growth in our sales and profitability in 2006 and our near-term outlook as of December 31, 2006 were key factors in determining the amount of our valuation allowance as of December 31, 2006.

In addition, because the recording of deferred tax assets and income tax benefit is based on our assumptions of levels of profitability, if we subsequently determine that it is unlikely that we will achieve those profit levels, or otherwise believe that we will not incur sufficient tax liabilities to fully utilize the deferred tax assets, we will reduce our deferred tax assets in an amount equal to that determination and incur a charge to income in that amount at that time. Because our expectation for future income is generally less during periods of reduced income, we will be more likely to take significant valuation allowances in respect of income tax assets during those periods of already reduced income.

Impairment Loss of Long-Lived Assets

ROC Statement of Financial Accounting Standard, or SFAS, No. 35 “Accounting for Asset Impairment” which addresses accounting for impairment of long-lived assets became effective from January 1, 2005. Prior to the adoption of this new accounting standard, we applied US GAAP to evaluate our long-lived assets for impairment purpose. We record impairment losses on long-lived assets used in operations if events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amount of those items. Assumptions about the carrying value of the long-lived assets require significant judgment on our expected cash flow. Our cash flow estimates are based on historical results adjusted to reflect our best estimate of future market and operating conditions. The net carrying value of assets not recoverable is reduced to fair value. Our management periodically reviews the carrying value of our long-lived assets and this review is based upon our projections of anticipated future cash flows. Based on the assessment of our management, in 2006, we recognized NT$58 million (US$2 million) of impairment loss for long-term investments. While we believe that our estimates of future cash flows are reasonable, different assumptions regarding such cash flows could materially affect our evaluations.

In determining whether any impairment charges were necessary as of December 31, 2006, we have assumed that the semiconductor industry will continue its growth in the next few years. Based upon our assumption of growth in the semiconductor industry and our other assumptions in our internal budget, for the purpose of determining whether any impairment charges are necessary as of December 31, 2006, we estimate that our future cash flows, on an undiscounted basis, are greater than our long-lived assets of NT$31,183 million (US$957 million) as of December 31, 2006. Any increases in estimated future cash flows would have no impact on the reported value of the long-lived assets. In contrast, if our current estimate of future cash flows had decreased, those cash flows would have been less than the reported amount of long-lived assets, and we would have been required to recognize an impairment loss that would have significantly decreased our net income before taxes in 2006.

Convertible Notes

Under US GAAP, we are required to account for the conversion option in the 2004 notes and the 2006 notes as derivative liabilities in accordance with SFAS No. 133 “Accounting For Derivative Instruments And Hedging Activities” and Emerging Interpretation Task Force (“EITF”) Issue No. 00-19 “Accounting For Derivative Financial Instruments Indexed To And Potentially Settled In A Company’s Own Stock.” The discount attributable to the issuance date aggregate fair value of the conversion option, totaling NT$1,199 million (US$37 million), is amortized using the effective interest method over the term of the 2004 notes and the 2006 notes.

 

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The change in fair value on revaluation of the embedded derivative liabilities represents the difference between the fair value of the embedded derivative liabilities at the beginning of the reporting period and their fair value at the end of the reporting period. We are required to record the change in fair value as a loss or gain on embedded derivative liabilities in determining our net income under US GAAP. As of December 31, 2006, the fair value of the embedded derivative liabilities amounted to NT$1,380 million (US$42 million) which resulted in a loss on embedded derivative liabilities of NT$339 million (US$10 million). These gains and losses were taken into account when determining our net income under US GAAP for the year ended December 31, 2006.

The fair value of the embedded derivative is determined using an option pricing model, which requires us to make various assumptions, including among others, the expected volatility of our stock over the life of the option and the expected life of the option. In determining these input assumptions, we consider historical trends and other relevant factors which may change from period to period. Because the option pricing model is sensitive to change in the input assumptions, different determinations of the required inputs may result in different fair value estimates of the options.

Under ROC GAAP, we are required to bifurcate and separately account for embedded put and call option features contained in our convertible notes issued after 2005 in accordance with SFAS No. 34 “Financial Instruments: Recognition and Measurement”. We issued the 2006 notes in September 2006 and carried the embedded put and call option features of the 2006 notes on the balance sheet at fair value with gains and losses reflected in our earnings. For more information, see Note 26p to our audited consolidated financial statements contained in this Annual Report on Form 20-F.

Share-Based Compensation

Under US GAAP, we are required to account for our employee share option plans under the fair-value-based method and to recognize share-based compensation arrangements as expenses in the consolidated statements of operations, in accordance with SFAS No. 123(R) “Share-Based Payments,” which became effective for the first interim period beginning after December 15, 2005. The determination of the fair value of our share options on the date of grant under the Black Scholes Option Pricing Model is affected by the price of our common shares and assumptions of a number of variables, including the risk-free interest rate, the expected life of the options, the estimated fair value of our common shares and the expected price volatility of our common shares over the term of the options. In 2006, the share-based compensation expense amounted to NT$109 million (US$3 million), which was taken into account when determining our net income and shareholders’ equity under US GAAP for the year ended December 31, 2006.

Prior to adopting SFAS No. 123(R), share-based compensation arrangements were accounted for under Accounting Principles Board Opinion No. 25, which utilized an intrinsic value approach to recognizing compensation expense. Under ROC GAAP, we continue to account for our share-based compensation arrangements under the intrinsic value method. For more information, see Notes 26 and 27i to our audited consolidated financial statements contained in this Annual Report on Form 20-F.

Senior Management’s Discussion with the Audit Committee

Our management has discussed the critical accounting policies described above with the audit committee of our board of directors and the audit committee has reviewed our disclosure relating to the critical accounting policies in this section.

Liquidity and Capital Resources

Since our inception, we have funded our operations and growth primarily through the issuance of equity, a mixture of short- and long-term loans and cash flow from operations. As of December 31, 2006, our primary sources of liquidity were cash and cash equivalents (excluding restricted cash and cash equivalents) of NT$5,896 million (US$181 million), short-term loans of NT$8,206 million (US$252 million) available to us in undrawn facilities, which have expired or will expire before December 2007, and long-term loans of NT$3,124 million (US$96 million) available to us in undrawn facilities, which have expired or will expire before December 2013.

 

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Liquidity

The following table sets forth our cash flows with respect to operating activities, investing activities, financing activities and the effect of exchange rate changes on cash for the periods indicated.

 

     Year ended December 31,  
     2004(1)(2)     2005(2)(3)     2006     2006  
     NT$     NT$     NT$     US$  

Net cash provided by (used in):

        

Operating activities

   $ 4,915.7     $ 8,822.6     $ 7,316.4     $ 224.5  

Investing activities

     (8,273.3 )     (7,622.5 )     (14,988.2 )     (459.9 )

Financing activities

     6,544.3       (1,519.9 )     8,947.9       274.5  

Effect of exchange rate changes on cash

     (68.5 )     77.7       12.8       0.4  
                                

Net increase (decrease) in cash

   $ 3,118.2     $ (242.1 )   $ 1,288.9     $ 39.5  
                                

(1) From January 12 and 28, 2004, and April 1, 2004, onwards, we consolidated the financial results of AMCT (which was liquidated in October 2004), ChipMOS Logic and Chantek, respectively. Starting from April 30, 2004, our financial results also included the financial results of WWT, which was subsequently merged into ChipMOS Logic. Starting from November 1, 2004, our financial statements also included the results of First Semiconductor Technology, Inc. in which ChipMOS Taiwan acquired a 67.8% equity interest on November 1, 2004 and transferred back this interest to First Semiconductor Technology, Inc. on April 29, 2005.
(2) As a result of the adoption of the ROC Statements of Financial Accounting Standards No. 34, “Financial Instruments: Recognition and Measurement” (ROC SFAS No. 34), and the ROC Statements of Financial Accounting Standards No. 36, “Financial Instruments: Disclosure and Presentation” (ROC SFAS No. 36), the balances in 2004 and 2005 were reclassified to be consistent with the classification used in our consolidated statements of cash flows for 2006 included herein. See Notes 2 and 4 to our audited consolidated financial statements contained in this Annual Report on Form 20-F.
(3) In 2005, we consolidated the financial results of ChipMOS Taiwan, ChipMOS Japan, ChipMOS USA, ChipMOS Hong Kong, ChipMOS Logic (which was merged into ThaiLin on December 1, 2005), Chantek (which was merged into ChipMOS Taiwan on November 21, 2005), Modern Mind, and its wholly-owned subsidiary, ChipMOS Shanghai, and ThaiLin.

Net Cash Provided by Operating Activities

Net cash provided by operating activities totaled NT$7,316 million (US$225 million) in 2006, compared to NT$8,823 million in 2005. The decrease in net cash provided by operating activities primarily reflected an increase in financial assets held at fair value through profit and loss, which was NT$1,743 million (US$53 million) in 2006, compared to a decrease in financial assets held at fair value through profit and loss of NT$2,646 million in 2005. The increase in financial assets held at fair value through profit and loss in 2006 primarily resulted from an increase in our holdings of investment funds, as well as an increase in the value of such holdings. The decrease in net cash provided by operating activities was also due to an increase in accounts receivable of NT$1,118 million (US$34 million) in 2006, compared to an increase in accounts receivables of NT$713 million in 2005. The increase in accounts receivable in 2006 was primarily the result of increased sales. The decrease in net cash provided by operating activities was partially offset by an increase in net income, which was NT$2,121 million (US$65 million) in 2006 compared to NT$928 million in 2005, as well as an increase in depreciation expenses, which was NT$5,489 million (US$168 million) in 2006 compared to NT$4,241 million in 2005. The increase in depreciation expenses was primarily the result of additional equipment acquired in connection with our capacity expansion program.

Net cash provided by operating activities totaled NT$8,823 in 2005, compared to NT$4,916 million in 2004. The increase in net cash provided by operating activities primarily reflected a decrease in financial assets held at fair value through profit and loss, which was NT$2,646 million in 2005 as compared to an increase of financial assets at fair value through profit and loss of NT$1,869 million in 2004. The increase in net cash provided by operating activities was also due to an increase in depreciation expenses, which was NT$4,241 million in 2005, compared to NT$3,439 million in 2004. The increase in depreciation expenses was primarily due to our acquisition of additional property, plant and equipment.

Net Cash Used in Investing Activities

Net cash used in investing activities totaled NT$14,988 million (US$460 million) in 2006, compared to NT$7,623 million in 2005. The increase in net cash used in investing activities was primarily the result of an increase in capital expenditures. Capital expenditures were NT$15,190 million (US$466 million) in 2006, compared to NT$7,651 million in 2005, primarily due to the acquisition of equipment required under our agreement with Spansion, as well as capacity expansion for our testing and assembly services for DDR II SDRAM and LCD and other flat-panel display driver semiconductors.

 

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Net cash used in investing activities totaled NT$7,623 million in 2005, compared to NT$8,273 million in 2004. The decrease in net cash used in investing activities primarily resulted from a decrease in capital expenditures in the acquisition of property, plant and equipment. Capital expenditures were NT$7,651 million in 2005, compared to NT$8,236 million in 2004.

Net Cash Provided by (Used in) Financing Activities

Net cash provided by financing activities totaled NT$8,948 million (US$275 million) in 2006, compared to net cash used in financing activities of NT$1,520 million in 2005. Net cash provided by financing activities primarily reflected the proceeds from long-term loans of NT$6,279 million (US$193 million) and the proceeds from the issuance of the 2006 notes of NT$3,191 million (US$98 million).

Net cash used in financing activities totaled NT$1,520 million in 2005, compared to net cash provided by financing activities of NT$6,544 million in 2004. Net cash used in financing activities primarily reflected NT$1,200 million repayments on long-term bonds and NT$333 million repayments on short-term bank loans, which were partially offset by proceeds from long-term loans of NT$318 million.

Tabular Disclosure of Contractual Obligations and Commercial Commitments

The following table summarizes our contractual obligations and commitments as of December 31, 2006 for the periods indicated:

 

     Payments Due by Period

Contractual Obligations

   Total    Less than
1 year
   2-3 years    4-5 years    More than
5 years
     NT$    NT$    NT$    NT$    NT$
     (in millions)

Long-term debt(1)

   $ 20,289.5    $ 2,906.5    $ 10,426.9    $ 6,755.9    $ 200.2

Short-term loans(1)

     1,077.4      1,077.4      —        —        —  

Working capital loans

     54.7      54.7      —        —        —  

Other short-term obligations

     1,022.7      1,022.7      —        —        —  

Operating leases

     387.3      68.2      125.5      41.0      152.6

Investment(2)

     4,383.4      4,383.4      —        —        —  

Total contractual cash obligations

   $ 26,137.6    $ 8,435.5    $ 10,552.4    $ 6,796.9    $ 352.8

(1) Includes interest payments. Assumes level of relevant interest rates remains at December 31, 2006 level throughout all relevant periods.
(2) Represents commitment to build a new facility in Shanghai Qingpu Industrial Zone and includes commitments under our agreement with Spansion.

In addition, the following table summarizes our other commercial commitments as of December 31, 2006 for the periods indicated:

 

Our Commercial Commitments

   Total
Amounts
Committed
   Amount of Commitment Expiration
Per Period
      Less than
1 year
   2-3
years
   4-5
years
   Over 5
years
     NT$    NT$    NT$    NT$    NT$
     (in millions)

Lines of credit

   $ 1,086.6    $ 1,086.6    $ —      $ —      $ —  

Total commercial commitments

   $ 1,086.6    $ 1,086.6    $ —      $ —      $ —  

Capital Resources

Capital expenditures in 2004 were funded by NT$4,916 million in cash flows from operating activities and NT$6,544 million in cash flows from financing activities. Capital expenditures in 2005 were funded by NT$8,823 million in cash flows from operations. Capital expenditures in 2006 were funded by NT$7,316 million (US$225 million) in cash flows from operating activities and NT$8,948 million (US$275 million) in cash flows from financing activities, including proceeds from long-term debt facilities and the issuance of the 2006 notes.

 

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We have budgeted capital expenditures of approximately US$260 million for 2007 and US$250 million for 2008. Our budgeted capital expenditures for 2007 include our currently anticipated capital expenditures to purchase equipment under our long-term customers agreements. See “Item 3. Key Information – Risk Factors — We are required to make significant capital expenditures in connection with our long-term customer agreements, and our business and results of operations would be adversely affected if we are unable to obtain sufficient funding or if our customers do not fulfill their purchase commitments.” In January and February, 2006, we obtained syndicated loan facilities of NT$6 billion (US$184 million) and NT$3 billion (US$92 million), respectively, from banks in Taiwan to fund part of the purchases required under our agreement with Spansion. We anticipate, subject to market conditions, issuing additional debt, convertible debt or equity securities and raising short- or long-term borrowings to fund our capital expenditures.

Our budgeted capital expenditures for 2007 also include capital expenditures by ChipMOS Shanghai for its planned expansion of its capacity, including equipment used to provide LCD and other flat-panel display driver semiconductor testing and assembly services. We currently expect to fund ChipMOS Shanghai’s remaining investment requirement through issuance of additional debt or equity securities and/or long-term borrowings.

As of December 31, 2006, we had long-term loans of NT$13,024 million (US$400 million) (including current portions of such long-term loans of NT$2,335 million (US$72 million)). As of December 31, 2006, NT$9,717 million (US$298 million) of our long-term loans were collateralized by equipment, NT$1,437 million (US$44 million) were collateralized by land and buildings (including land use rights) and NT$23 million (US$706 thousand) were collateralized by time deposits. Of our long-term loans, in the aggregate:

 

   

NT$11,760 million (US$361 million) were floating rate loans with a rate between 2.75% and 5.155% as of December 31, 2006 repayable quarterly, semi-annually or totally until December 2013;

 

   

NT$778 million (US$24 million) were fixed rate loans with a rate between 1% and 4.69% as of December 31, 2006 repayable quarterly, semi-annually or totally until April 2010; and

 

   

US$15 million (NT$486 million) were floating rate loans with a rate between 6.12375% and 6.35% as of December 31, 2006 repayable quarterly, semi-annually or totally until December 2009.

In July 2000, we obtained a NT$41 million interest-free research and development subsidy from the ROC Industrial Development Bureau for developing known-good-die solutions and COF assembly and testing technology, which was repayable quarterly from July 2003 to July 2006. As of December 31, 2006, the loan was fully repaid. ChipMOS Taiwan was obligated to pay to the ROC Industrial Development Bureau a maximum of NT$5 million or 2% of sales of products developed for three years after completing the project. ChipMOS Taiwan paid NT$5 million to the ROC Industrial Development Bureau in 2004.

Other than the NT$23 million 1% fixed rate industrial research and development advancement loan, all of our outstanding long-term loans as of December 31, 2006 were drawdowns under various bank loans and syndicated loan facilities. As of December 31, 2006, we had entered into the following syndicated loan facilities:

 

   

On July 24, 2002, we obtained a syndicated loan facility in the amount of NT$2,500 million from a group of financial institutions for a term of five years. This loan facility is secured by our facilities at the Southern Taiwan Science Park and our testing and assembly equipment located within our facilities at Chupei, the Hsinchu Science Park and the Southern Taiwan Science Park. This loan facility was fully drawn. Under this loan facility, ChipMOS Taiwan is required to ensure that we and Siliconware Precision collectively maintain a percentage of direct ownership in ChipMOS Taiwan of at least 50% of outstanding shares and have control over its operations. As of March 31, 2007, we have 99.1% of direct ownership in ChipMOS Taiwan and have control over its operations.

 

   

On March 21, 2003, we obtained a syndicated loan facility in the amount of NT$1,000 million. This loan facility is separated into two parts with its respective term of seven years and five years. This loan facility is secured by ThaiLin’s facilities and the testing equipment at Chupei. As of December 31, 2006, this loan facility was fully drawn.

 

   

On December 31, 2003, we obtained a syndicated loan facility in the amount of NT$2,000 million from a group of financial institutions for a term of four years. This loan facility is secured by our facilities at the Southern Taiwan Science Park and our testing and assembly equipment located within our facilities at Chupei, the Hsinchu Science Park and the Southern Taiwan Science Park. As of December 31, 2006, this loan facility was fully drawn.

 

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On July 27, 2004, we obtained a syndicated loan facility in the amount of NT$1,000 million for a term of five years. This loan facility is secured by our facilities at the Southern Taiwan Science Park and our testing and assembly equipment located within our facilities at Chupei, the Hsinchu Science Park and the Southern Taiwan Science Park. As of December 31, 2006, this loan facility was fully drawn.

 

   

On June 7, 2005, we obtained a syndicated loan facility in the amount of NT$1,000 million for a term of four years. This loan facility is secured by our facilities at the Hsinchu Science Park. As of December 31, 2006, this loan facility was fully drawn.

 

   

In January 2006, we obtained a syndicated loan facility from banks in Taiwan in the amount of NT$6 billion (US$184 million) for a term of five years. This loan facility is secured by our facilities at the Hsinchu Science Park and our testing and assembly equipment located within our facilities at Chupei, the Hsinchu Science Park and the Southern Taiwan Science Park. As of December 31, 2006, this loan facility was fully drawn.

 

   

In February 2006, we obtained a syndicated loan facility from banks in Taiwan in the amount of NT$3 billion (US$92 million) for a term of six years. This loan facility is secured by ThaiLin’s facilities at Chupei. As of December 31, 2006, NT$264 million (US$8 million) was drawn under this loan facility.

On November 3, 2004, ChipMOS Bermuda issued US$85 million in aggregate principal amount of the 2004 notes, which bear interest at 1.75% per annum, and on September 29, 2006, ChipMOS Bermuda issued US$100 million in aggregate principal amount of the 2006 notes, which bear interest at 3.375% per annum. The noteholders may convert the 2004 notes and the 2006 notes into our common shares at the conversion price of US$6.28 per share (adjusted down from the initial conversion price of US$7.85 per share) and US$6.85 per share, respectively, subject to certain adjustments. In December 2004, we repurchased and cancelled US$699,000 of the 2004 notes. In October 2006, we made an induced conversion offer to the holders of the 2004 notes pursuant to which we offered to each holder, as incentive for such holder to convert its 2004 notes, a cash payment equal to 7% of the principal amount of the 2004 notes. Pursuant to the offer, noteholders converted US$7,000,000 in aggregate principal amount of the 2004 notes into 1,114,649 common shares and received from us aggregate cash consideration of approximately US$490,000. In addition, on November 3, 2006, we repurchased US$6,300,000 in aggregate principal amount of the 2004 notes pursuant to the noteholders’ put option under the indenture. Under the indenture, each noteholder of the 2004 notes had the right to require us to repurchase its notes on November 3, 2006 at a repurchase price equal to 100% of the principal amount plus accrued and unpaid interest. As of March 31, 2007, we had US$71 million aggregate principal amount of the 2004 notes outstanding, and US$100 million aggregate principal amount of the 2006 notes outstanding. For a discussion of the accounting for the conversion feature of the convertible notes under US GAAP, see “—Critical Accounting Policies—Convertible Notes” and “—US GAAP Reconciliation.”

In addition, if certain fundamental changes occur, the noteholders have the right to require us to purchase the 2004 notes and the 2006 notes at a repurchase price equal to 100% of the principal amount plus any accrued and unpaid interest on those notes to, but excluding, the repurchase date. Generally, a “fundamental change” will be deemed to have occurred if:

 

   

any “person” other than us and our subsidiaries is or becomes the beneficial owner of more than 50% of our common shares;

 

   

during any period of two consecutive years, individuals who at the beginning of such period constituted our board of directors cease for any reason to constitute a majority of our board of directors then in office;

 

   

the termination of trading of our common shares; or

 

   

certain mergers or consolidation involving us or the sale of all or substantially all of our assets.

The noteholders’ right to require us to repurchase the 2004 notes and the 2006 notes upon the occurrence of a fundamental change is subject to a number of exceptions, including a trading price exception pursuant to which the repurchase right will not be exercisable if the trading price of our common shares exceeds a certain percentage of the conversion price.

The conversion prices of the 2004 notes and the 2006 notes are subject to customary anti-dilution adjustments upon the occurrence of certain events, including the declaration of stock dividends on our common shares and the repurchase of our common shares for consideration in excess of the market price.

 

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Certain of our loan agreements and indentures contain covenants that, if violated, could result in the obligations under these agreements becoming due prior to the originally scheduled maturity dates. These covenants include financial covenants that require us to:

 

   

maintain a current assets to current liabilities ratio above 1:1;

 

   

maintain total indebtedness to shareholders’ equity (excluding goodwill and other intangible assets) ratio below 1.2:1;

 

   

maintain total indebtedness to shareholders’ equity ratio below 1:1;

 

   

maintain the earnings before interest, taxes, depreciation and amortization to gross interest expense ratio above 2.5:1; and

 

   

maintain a guaranteed to issued capital ratio below 1:2.

As of December 31, 2006, we were in compliance with our financial covenants.

In addition, a substantial portion of our short-term and long-term borrowings may be subject to repayment upon a material deterioration of our financial condition, results of operations or our ability to perform under the loan agreements.

Set forth below are the maturities of our long-term bank loans outstanding as of December 31, 2006:

 

     (in millions)

During 2007

   NT$ 2,335    US$ 72

During 2008

     3,541      109

During 2009

     3,774      116

During 2010

     2,181      67

During 2011 and onwards

     1,193      36
             
   NT$ 13,024    US$ 400
             

As of December 31, 2006, certain of our land and buildings (including land use rights) and machinery with an aggregate net book value of NT$2,139 million (US$66 million) and NT$13,444 million (US$413 million), respectively, and time deposits in the aggregate amount of NT$30 million (US$921 thousand) were pledged as collateral in connection with our long-term and short-term borrowings. Approximately 51% of our net property, plant and equipment in terms of book value was pledged as collateral for our long-term and short-term loans.

Our unused credit lines for short-term loans, as of December 31, 2006, totaled NT$8,206 million (US$252 million), which will expire by December 2007. As of December 31, 2006, we had available undrawn long-term credit facilities totaling NT$3,124 million (US$96 million).

As of December 31, 2006, we had a short-term working capital loan of NT$52 million (US$2 million), with an interest rate of 6%, which will be due between July 2007 and December 2007. We also had credit loans for imports of machinery in the total amount of NT$1,003 million (US$31 million), which are due between January 2007 and June 2007.

We believe our current cash and cash equivalents, cash flow from operations and available credit facilities will be sufficient to meet our capital spending and other capital needs through the end of June 2008, other than our commitments to invest in ChipMOS Shanghai, a wholly owned subsidiary of our controlled consolidated subsidiary, Modern Mind. In order to meet ChipMOS Shanghai’s investment commitments, we may borrow additional amounts and issue additional debt or equity securities.

From time to time, we evaluate possible investments and acquisitions in Taiwan, Mainland China and elsewhere and may, if a suitable opportunity arises, acquire additional capacity by making an investment or acquisition at an attractive price. We may finance these expenditures from cash flow from operations, amounts available under existing credit facilities, additional borrowing and the issuance of securities.

Off-Balance Sheet Arrangements

As of December 31, 2006, we had no off-balance sheet arrangements.

 

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US GAAP Reconciliation

Our consolidated financial statements are prepared in accordance with ROC GAAP, which differs in certain material respects from US GAAP. The following table sets forth a comparison of our net income, total assets and shareholders’ equity in accordance with ROC GAAP and US GAAP for the periods indicated:

 

     Year ended as of December 31,
     2004    2005    2006    2006
     NT$    NT$    NT$    US$
     (in millions)

Net income in accordance with:

           

ROC GAAP

   $ 1,675.9    $ 928.2    $ 2,121.3    $ 65.1

US GAAP

     1,665.5      805.4      1,253.1      38.5

Total assets in accordance with:

           

ROC GAAP

     31,545.1      31,758.0      46,011.9      1,411.8

US GAAP

     31,521.7      31,653.6      45,976.1      1,410.7

Shareholders’ equity (including minority interests) in accordance with:

           

ROC GAAP

     17,253.1      19,091.9      22,884.9      702.2

US GAAP

     17,225.5      18,825.4      21,430.7      657.6

Note 26 to our audited financial statements describes the principal differences between ROC GAAP and US GAAP as they relate to us, and a reconciliation to US GAAP of certain items, including net income and shareholders’ equity. Differences between ROC GAAP and US GAAP which have an effect on our net income as reported under ROC GAAP relate to, among other things, accrual for bonuses to employees, directors and supervisors, share-based compensation and accounting for our convertible notes.

Under Statement of Financial Accounting Standard No. 123R “Share-Based Payment” adopted by the Financial Accounting Standards Board and Staff Accounting Bulletin 107 “Share-Based Payment” by the SEC, share-based compensation transactions are generally required to be accounted for using a fair-value-based method and recognized as expenses in the consolidated statements of operations. The standards became effective for the first interim period beginning after December 15, 2005. For more information, see “— Critical Accounting Policies — Share-Based Compensation” and Notes 26 and 27i to our audited consolidated financial statements.

Under Statement of Financial Accounting Standard No. 133 “Accounting For Derivative Instruments And Hedging Activities” and EITF Issue No. 00-19 “Accounting For Derivative Financial Instruments Indexed To And Potentially Settled In A Company’s Own Stock,” we are required to bifurcate and separately account for the conversion feature of our convertible notes as embedded derivatives contained in the convertible notes. Under US GAAP, we are required to carry these embedded derivatives on our balance sheet at fair value and changes in fair values of these embedded derivatives are reflected in the consolidated statement of operations. The change in fair value for embedded derivative liabilities for the conversion feature for the year ended December 31, 2006 under US GAAP was approximately NT$339 million (US$10 million) and the resulting net income for the year ended December 31, 2006 under US GAAP was approximately NT$1,253 million (US$38 million). For more information, see Notes 26 and 27j to our audited consolidated financial statements.

Taxation

ChipMOS Taiwan was granted a Republic of China income tax exemption for a period of four years on income attributable to the expansion of its production capacity as a result of purchases of new equipment funded by capital increases in 1998, 1999 and 2000. The tax exemption relating to the expansion of production capacity in 1998 and 1999 expired on December 31, 2002. The tax exemption relating to the expansion of production capacity in 2000 expired on December 31, 2005 and 2008, and has resulted in tax savings for ChipMOS Taiwan of approximately NT$198 million in 2004, approximately NT$158 million in 2005 and approximately NT$235 million (US$7 million) in 2006.

ChipMOS Taiwan is also entitled to other tax incentives generally available to Taiwan companies under the ROC Statute of Upgrading Industries, including tax credits of 30% for certain research and development and employee training expenses (and, if the amount of expenditure exceeds the average amount of expenditure for the preceding two years, 50% of the excess amount may be credited against tax payable) and from 5% to 7% for certain investments in automated equipment and technology. These tax credits

 

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must be utilized within five years from the date on which they were earned. In addition, except for the last year of the five-year period, the aggregate tax reduction from these tax credits for any year cannot exceed 50% of that year’s income tax liability. In 2004, 2005 and 2006, tax credits resulted in tax savings for ChipMOS Taiwan of approximately NT$455 million, NT$135 million and NT$295 million (US$9 million), respectively.

ThaiLin was granted a ROC income tax exemption for a period of five years on income attributable to the expansion of its production capacity as a result of purchases of new equipment funded by capital increase in 2002, which will expire on December 31, 2009. It has resulted in tax savings for ThaiLin of nil in 2004, approximately NT$39 million in 2005 and approximately NT$30 million (US$921 thousand) in 2006.

ThaiLin is also entitled to other tax incentives generally available to Taiwan companies under the ROC Statute of Upgrading Industries, including tax credits of 5% to 7% for certain investment in automated equipment and technology. These tax credits must be utilized within five years from the date on which they were earned. In addition, except for the last year of the five-year period, the aggregate tax reduction from these tax credits for any year cannot exceed 50% of such year’s income tax liability. In 2004, 2005 and 2006, tax credits resulted in tax savings for ThaiLin of approximately NT$20 million, approximately NT$84 million and approximately NT$101 million (US$3 million), respectively.

Net income generated by ChipMOS Taiwan and ThaiLin after January 1, 1998, which is not distributed in the year following the year the income was generated, is subject to income tax at the rate of 10%. If that net income is subsequently distributed, the income tax previously paid on that income is credited against the amount of withholding tax payable by shareholders, who are not individuals or entities of the Republic of China (for taxation purposes), in connection with the distribution.

The ROC government enacted the ROC Alternative Minimum Tax Act (“AMT Act”) which became effective on January 1, 2006. The alternative minimum tax (“AMT”) imposed under the AMT Act is a supplemental tax which is payable if the income tax payable pursuant to the ROC Income Tax Act is below the minimum amount prescribed under the AMT Act. The taxable income for calculating the AMT includes most income that is exempted from income tax under various legislations, such as tax holidays and investment tax credits. The AMT rate for business entities is 10%. However, the AMT Act grandfathered certain tax exemptions and tax credits granted prior to the enactment of the AMT. The effects of the AMT on the tax expenses of ChipMOS Taiwan and ThaiLin in 2006 were not significant.

In accordance with the relevant tax rules and regulations of the PRC, ChipMOS Shanghai is entitled to an income tax exemption starting from the first profit making year, with a full exemption available for the first two years and a 50% exemption available for three additional years thereafter. As the first profit-making year for ChipMOS Shanghai was 2004, the profits made in the years 2004 and 2005 were fully exempt, and the profits made in the years 2006 through 2008 were subject to a 50% tax exemption. Any tax losses can only be carried forward for five years.

 

Item 6. Directors, Senior Management and Employees

Directors and Senior Management

Our board of directors currently comprises nine directors, seven of whom were elected by our shareholders and two of whom were appointed by directors to fill vacancies on our board. The number of directors, which must not be less than three nor greater than nine according to our bye-laws, is set by our directors but so long as a quorum of directors remains in office, casual vacancies on the board may be filled by the board. The quorum for a meeting of the directors is set by the board and otherwise is two in number. The chairman of the board is appointed from among the members of the board.

There is no requirement under Bermuda law that a director be a shareholder.

The following table sets out the names of our directors and executive officers, their positions with our company and their ages as of December 31, 2006. The business address for our directors and executive officers is 11F, No. 3, Lane 91, Dongmei Road, Hsinchu, Taiwan, Republic of China.

 

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Name

   Age   

Position

   Term Expires  

Shih-Jye Cheng

   49    Chairman and Director/Chief Executive Officer    2008  

Antonio R. Alvarez

   51    Independent Director    2008  

Rong Hsu

   57    Independent Director    2008  

Hsing-Ti Tuan

   63    Director    2009  

Yeong-Her Wang

   51    Independent Director    2009  

Shou-Kang Chen

   46    Chief Financial Officer and Director    2009  

Pierre Laflamme

   61    Deputy Chairman and Independent Director    2007  

Chao-Jung Tsai

   53    Director    2007  

Takaki Yamada

   57    Independent Director    2007 (1)

Adam Hsien

   48    Acting President of ChipMOS Shanghai    —    

Lafair Cho

   45    President of ThaiLin    —    

Robert Shen

   57    President of ChipMOS USA    —    

Jessie Lin

   42    Vice President, Quality, Reliability & Assurance Center    —    

Joyce Chang

   46    Vice President, LCDD Production Group    —    

Ricky Liu

   45    Vice President, Wafer Bump and Wafer Fab Task Business Unit    —    

Michael Lee

   42    Vice President, Wafer Sort Business Unit    —    

Ivan Hsu

   41    Vice President, Memory Production Group    —    

Robert Tsai

   48    Vice President, Information Technology Management    —    

F.J. Tsai

   49    Vice President, Business Operation Management Center    —    

Jesse Huang

   41    Vice President, Assembly Production Group   

(1) Mr. Takaki Yamada was appointed on July 10, 2006 to fill the vacancy resulting from the death of Mr. Tadao Higashi on June 12, 2006.

Shih-Jye Cheng has served as one of our directors and chief executive officer since our inception. He was our deputy chairman from our inception to May 2004 and became our chairman in May 2004. He has also served as a director and president of ChipMOS Taiwan since 1997, the chairman of ChipMOS Taiwan since June 2003, the chairman of ThaiLin since 2002 and a director of Syntax-Brillian Corporation since November 2005. He was the chairman of ChipMOS Shanghai from 2002 to June 2005, the chairman of Chantek from 2002 to November 2005, the chairman of ChipMOS Logic from January 2004 to November 2005, the chairman of Advanced Micro Chip Technology Co., Ltd. from 2003 to April 2004 and a director of Ultima Electronics Corp. from 2000 to June 2003. He was a division head of the back-end operation of Mosel from 1992 to 1997. Mr. Cheng has a master’s degree in business administration from Saginaw Valley State University. Mr. Cheng is currently under indictment of the Taipei District Prosecutor’s Office for matters relating to the purchase by ChipMOS Taiwan and ThaiLin of certain repurchase notes in 2004. For more information, please see “Item 3 — Key Information Risk Factors — Risks Relating to Our Business — The ongoing criminal investigation involving Mr. Shih-Jye Cheng, our Chairman and Chief Executive Officer, and Mr. Hung-Chiu Hu, our former director, could have a material adverse effect on our business and cause our stock price to decline.”

Antonio R. Alvarez has served as one of our directors since July 2005. Mr. Alvarez has been the president and chief executive officer, and a director of Leadis Technology Inc. since November 2005. He was senior vice president and general manager of the memory products division of Cypress Semiconductor Corporation from 1998 to July 2005, and senior vice-president of research and development from 1991 to 2001. He holds master’s and bachelor’s degrees in electrical engineering from Georgia Institute of Technology, where he is a member of the advisory board of the Electrical Engineering Department. He is a member of the Institute for Electrical and Electronic Engineers.

Rong Hsu has served as one of our directors since July 2005. Mr. Hsu has been the vice president of Spatial Photonics Inc. since May 2006. He was a founder of eLCOS Microdisplay Technology Group where he was the president from April 2001 to December 2005, senior director of operations at Aurora Systems Co. from 1999 to March 2001, director of manufacturing for micro-display systems and testing at S-Vision Co. from 1996 to 1999, manager of manufacturing at nCHIP Co. from 1991 to 1996, research engineer at Lawrence Livermore National Laboratory from 1988 to 1991 and senior engineer at Intel Corporation from 1982 to 1988. He has a doctorate degree in material engineering from the University of Maryland, a master’s degree in material science from Brown University and a bachelor’s degree in mechanical engineering from National Taiwan University. He is a founding member and senior advisor of the Chinese American Semiconductor Professional Association.

Hsing-Ti Tuan has served as one of our directors since August 2000. Mr. Tuan currently is the executive vice president and the deputy chairman of ProMOS Technologies Inc. Mr. Tuan has served as a director of ProMOS since 1997. He has been the president of Mosel Vitelic Corp., USA since 1994. He was the acting president of Mosel from November 2004 to December 2005 and previously served as the executive vice president of their research and development division. He was also the vice president of Mosel from 1992 to 1996. Mr. Tuan also serves as a director of Mosel and SyncMOS Technology International. Mr. Tuan holds a master’s degree in electrical engineering from Utah State University and a bachelor’s degree in electrical engineering from National Cheng Kung University in Taiwan.

 

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Yeong-Her Wang has served as one of our directors since July 2004. He has been a professor in the Department of Electrical Engineering of National Cheng Kung University since 1992. He was also an associate dean of the College of Engineering between 1999 and 2003, chairman of the Department of Electrical Engineering between 1996 and 1999, associate director of the Department of Electrical Engineering between 1993 and 1996 and director of the Electrical Factory, College of Engineering of National Cheng Kung University between 1995 and 1996. Mr. Wang holds Ph.D., master’s and bachelor’s degrees from National Cheng Kung University in Taiwan.

Shou-Kang Chen has served as one of our directors since June 2005. He has served as our chief financial officer, investor relations officer and head of the finance division of ChipMOS Taiwan since 2002. He was the head of our strategy development department from 2000 to 2001. He was the department head of the quality lab of ChipMOS Taiwan from 1998 to 2000. Mr. Chen holds a bachelor’s degree in mining and petroleum engineering and a master of science degree and a Ph.D. degree from the graduate school of mining, metallurgy and material science of National Cheng Kung University in Taiwan.

Pierre Laflamme has served as one of our directors since February 2001, and as our deputy chairman since June 2005. Since July 2003, he has been engaged in international consultancy works and also participated in developing new residential housing concepts and projects. Since April 2007, he is a member of the board of Capital BLF Inc., a Capital Pool Company in Canada. He was the president and chief operating officer of SGF Tech Inc. from January 2000 to July 2003. Before that, he was the vice president of high technology investments of Société Génerale de Financement du Québec from 1997 to 2000. He was the senior vice president of Solidarity Fund from 1996 to 1997 and a deputy minister of the Quebec Prime Minister’s Department from 1994 to 1996. Mr. Laflamme holds a bachelor’s degree in Architecture from Université de Montréal.

Chao-Jung Tsai has served as one of our directors since November 2004. Mr. Tsai was a director of ChipMOS Taiwan from January 2001 to December 2005, as a representative of Siliconware Precision, where he has been a director since June 2005 and served as a supervisor from June 2002 to June 2005. He has also been a supervisor of Phoenix Precision Technology Co. Ltd. since June 2005. He was previously president of Grand Cathay Securities Co., Ltd. and assistant vice president of China Trust Commercial Bank Co., Ltd. Mr. Tsai received his bachelor’s degree in statistics from National Cheng Kung University and master’s degree in management of technology from National Chiao Tung University in Taiwan. He holds Taiwan CPA and CFA licenses.

Takaki Yamada was appointed by our board of directors on July 10, 2006 to fill the vacancy resulting from the death of Mr. Tadao Higashi. Mr. Yamada is currently the president of OKI Semiconductor Manufacturing Company and assistant operation officer of OKI Semiconductor Group. He joined OKI Semiconductor Group after graduating from Tokyo Keizai University in Japan, where he received a bachelor’s degree in business administration. He was also the vice president of OKI Semiconductor Manufacturing Company from April 2004 to March 2006.

Adam Hsien has served as the acting president of ChipMOS Shanghai since September 2006 and vice president since July 2006. He was executive vice president of Camtech Optronics Inc. from 2004 to 2006 and the director of the bumping operation division of He Jian Technology Inc. in Suzhou from 2003 to 2004. Mr. Hsien received a bachelor’s degree in electrical engineering from Feng Chia University in Taiwan.

Lafair Cho has served as ThaiLin’s president since December 1, 2003 and a director since December 30, 2002. He was vice president of ThaiLin from February 1, 2003 to November 30, 2003. He has also served as vice president of the memory production group of ChipMOS Taiwan from July 2003 to August 2004 and as a director of ChipMOS Taiwan since October 2003. He served as a deputy assistant vice president of the IC testing division of ChipMOS Taiwan from April 2000 to December 2001 and as an assistant vice president of the IC testing division of ChipMOS Taiwan from January 2002 to January 2003. He served as manager of production material control of Mosel from 1993 to 1997. He holds a master’s degree in industrial management from National Cheng Kung University in Taiwan.

Robert Shen has served as the president of ChipMOS U.S.A., Inc. since June 2005. He served as vice president of worldwide operations for Integrated Silicon Solution, Inc. from 1992 to 2005 and vice president for Atari (USA) Corp. from 1986 to 1992. He received a bachelor’s degree in industrial engineering from Tunghai University in Taiwan and an MBA from Northwestern Polytechnic University in the USA.

Jessie Lin has served as ChipMOS Taiwan’s vice president of quality, reliability and assurance center since June 2004. She was assistant vice president of ChipMOS Taiwan from 2002 to 2004 and deputy assistant vice president of ChipMOS Taiwan from 2000 to 2002. Ms. Lin received a master’s degree in industrial engineering from Chung Yuan Christian University in Taiwan.

 

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Joyce Chang has served as ChipMOS Taiwan’s vice president of LCD Driver production group since June 2004. She was assistant vice president of ChipMOS Taiwan from 2002 to 2004 and manager of ChipMOS Taiwan from 2000 to 2002. Ms. Chang received a bachelor’s degree from Chung Yuan Christian University in Taiwan.

Ricky Liu has served as ChipMOS Taiwan’s vice president of wafer bump and wafer fab task business unit since June 2004. He was executive vice president of Advanced Micro Chip Technology Co., Ltd. from 2003 to 2004 and director of the foundry division of Nanya Technology Corp. from 2001 to 2003. Mr. Liu received a bachelor’s degree from National Cheng Kung University in Taiwan.

Michael Lee has served as ChipMOS Taiwan’s vice president of wafer sort business unit since June 2004. He was assistant vice president of ChipMOS Taiwan from 2003 to 2004 and assistant vice president of King Yuan ELECTRONIC CO., LTD. from 2000 to 2003. Mr. Lee received a master’s degree from National Chiao Tung University in Taiwan.

Ivan Hsu has served as ChipMOS Taiwan’s vice president of memory production group since December 2004. He was ChipMOS Taiwan’s assistant vice president from 2003 to 2004 and deputy assistant vice president from 2002 to 2003. Mr. Hsu received a bachelor’s degree from Feng Chia University in Taiwan.

Robert Tsai has served as ChipMOS Taiwan’s vice president of information technology management center since October 2005. He was ChipMOS Taiwan’s assistant vice president from 2003 to September 2005 and deputy assistant vice president from 2002 to 2003. Mr. Tsai received a bachelor’s degree from Soochow University in Taiwan.

F.J. Tsai has served as ChipMOS Taiwan’s vice president of business operation management center since November 2005. He was the president of Chantek from 2003 to 2005. He also served as an assistant vice president of the strategy development center of ChipMOS Taiwan from 1998 to 2003. He received a master’s degree in business administration from National Sun Yat-Sen University in Taiwan.

Jesse Huang has served as ChipMOS Taiwan’s vice president of assembly production group since April 2007. He was the assistant vice president of assembly engineering division formerly. He received a bachelor’s degree in Physics from Soochow University in Taiwan.

Board Practice and Terms of Directorship

Our board of directors consists of three classes of directors. The first class of directors, consisting of Shih-Jye Cheng, Antonio R. Alvarez and Rong Hsu, is up for re-election at the annual general meeting in 2008 and then every third annual general meeting thereafter. The second class, consisting of Hsing-Ti Tuan, Yeong-Her Wang and Shou-Kang Chen, is up for re-election at the annual general meeting in 2009 and then every third annual general meeting thereafter. The third class, consisting of Pierre Laflamme, Chao-Jung Tsai and Takaki Yamada, is up for re-election at the annual general meeting in 2007 and then every third annual general meeting thereafter.

Any director vacates his or her office if he or she:

 

   

is prohibited by law from being a director or ceases to be a director by virtue of the Companies Act 1981 (as amended) of Bermuda;

 

   

resigns from his or her office;

 

   

becomes bankrupt under the laws of any country or compounds with his or her creditors;

 

   

becomes of unsound mind or a patient for the purpose of any statute or applicable law relating to mental health and the board resolves that his or her office is vacated; or

 

   

is removed by a resolution passed by our shareholders at a special general meeting called for that purpose.

Share Ownership

As of December 31, 2006, none of our directors or executive officers held, for his or her own account, 1% or more of our outstanding common shares.

 

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Compensation and Compensation Committee

The aggregate compensation paid in 2006 to our directors and our executive officers, including cash and share bonuses, was approximately NT$119 million (US$4 million). In 2006, we granted options to purchase 560,000 of our common shares to our directors and executive officers as set forth in the table below. These options will vest over a period of four to five years, with an equal proportion vesting on each of August 31, 2006, 2007, 2008, 2009 and 2010.

 

Number of shares issuable upon
exercise of options

 

Expiration date

 

Exercise price

 

Consideration paid
for options granted

560,000

  August 31, 2012   US$5.1425   None

We did not set aside any money for pension, retirement or similar benefits for our directors in 2006.

We do not provide our directors with any benefits upon termination of employment.

Our compensation committee currently consists of Antonio R. Alvarez, Pierre Laflamme and Yeong-Her Wang. This committee reviews and recommends to our board of directors the compensation of all our directors and officers on at least an annual basis.

Audit Committee

Under our audit committee charter adopted on February 28, 2001 and amended on May 14, 2004 and December 21, 2004, our audit committee:

 

   

is directly responsible for the appointment, compensation, retention and oversight of the work of our external auditors or any other public accounting firm engaged for the purpose of preparing or issuing an audit report or to perform audit, review or attestation services;

 

   

oversees our accounting principles and policies, financial reporting and internal control over financial reporting, internal audit controls and procedures, financial statements and independent audits;

 

   

meets with management, our external auditors and, if appropriate, the head of the auditing department to discuss audited financial statements, audit reports or other communications, including, without limitation, any audit problems or difficulties relating to our financial statements, any major issues regarding accounting principles and the adequacy of our internal control over financial reporting;

 

   

pre-approves, or adopts appropriate procedures to pre-approve all audit and non-audit services, if any, provided to us by our external auditors;

 

   

establishes our internal complaints procedure for the receipt, retention and treatment of complaints received by us regarding accounting, internal accounting controls or auditing matters, and for the confidential, anonymous submission thereof by our employees;

 

   

evaluates the independence of and discuss with management the timing and process for implementing the rotation of the audit partners of the outside auditors; and

 

   

reviews and approves all our related party transactions.

The audit committee currently consists of Pierre Laflamme, Rong Hsu and Yeong-Her Wang all of whom are independent directors according to Nasdaq Marketplace Rules requirements. We do not have an audit committee financial expert serving on our audit committee.

Nominations Committee

Under our nominations committee charter adopted on August 26, 2005, our nominations committee:

 

   

identifies individuals qualified to become members of the board of directors, selects or recommends nominees to the board of directors and, in the case of a vacancy of a director, recommends to the board of directors an individual to fill such vacancy;

 

   

develops and recommends to the board of directors standards to be applied in making determinations as to the absence of material relationships between us and a director;

 

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identifies members of the board of directors qualified to fill vacancies on any committee thereof and recommends the appointment of the identified member(s) to the respective committee;

 

   

assists our management in the preparation of the disclosure in our annual proxy statement regarding the operations of the nominations committee; and

 

   

performs any other duties or responsibilities expressly delegated to the nominations committee by the board of directors from time to time relating to the nomination of members of the board of directors and any committee thereof.

Yeong-Her Wang, Rong Hsu and Pierre Laflamme are currently the members of our nominations committee.

Special Investigation Committee

On December 21, 2004, in connection with alleged embezzlement at Pacific Electric by our former directors, Mr. Hung-Chiu Hu and Mr. Jwo-Yi Miao, and money laundering by our former director, Mr. Robert Ma Kam Fook, our board established a special investigation committee to identify and investigate any past and present dealings between ChipMOS Bermuda, including any of its subsidiaries and affiliates, and Messrs. Hu, Miao and Ma, and any companies or entities affiliated with them. For additional information on the allegations, see “Item 3. Key Information—Risk Factors—Risks Relating to Our Relationship with Mosel—The ongoing criminal investigations and trial involving Mr. Hung-Chiu Hu, Mr. Robert Ma Kam Fook and Mr. Jwo-Yi Miao, our former directors, could have a material adverse effect on our business and cause our stock price to decline.”

The special investigation committee was solely comprised of Messrs. Pierre Laflamme and Yeong-Her Wang, two of the Company’s independent directors. Concurrent with the establishment of the special investigation committee, our board requested the resignations of Mr. Hu and Mr. Miao, who subsequently resigned from our board on June 2, 2005 and June 8, 2005, respectively. On December 21, 2004, our board also accepted the resignation of Mr. Ma. The special investigation committee engaged Ernst & Young as its forensic accounting advisor and Baker & McKenzie as its legal advisor to review transactions that were similar in nature to the transactions that allegedly implicated Messrs. Hu, Miao and Ma at Pacific Electric as well as significant related party transactions between ChipMOS Bermuda, including its subsidiaries and affiliates, and Messrs. Hu, Miao and Ma and any companies or entities affiliated with any of them. The special investigation committee also engaged Hong Kong counsel.

On June 23, 2005, the special investigation committee presented its final report to our Board of Directors. The special investigation committee concluded that the review conducted by Ernst & Young and Baker & McKenzie did not reveal previously unknown information regarding losses suffered by ChipMOS Bermuda, other than a potential liability relating to a credit facility entered into with Trident (Asia) Investments Limited (“Trident”) and HSH Nordbank AG, Hong Kong Branch (“Nordbank”). The special investigation committee noted that total losses from transactions reviewed by it in the amount of NT$454 million (US$14 million), relating to impairment losses and realized losses of certain investments, were reflected in our 2002, 2003 and 2004 financial statements, and a potential decline in the value of our investment in respect of Ultima Technology Corp. (BVI). In 2005, we recognized an impairment loss of US$188 million (US$6 million) as a result of the decline in the value of our investment to Ultima Technology Corp. (BVI). See Note 7 to our audited consolidated financial statements contained in this Annual Report on Form 20-F and “Item 7. Major Shareholders and Related Party Transactions—Related Party Transactions—Other Related Party Transactions.” The special investigation committee did not make any factual findings as to the business purpose of the transactions reviewed or as to persons at the Company responsible for such transactions. On August 26, 2005, our board dissolved the special investigation committee.

The Special Investigation Committee provided the following recommendations to our board of directors:

 

   

reinforce the internal controls related to the Company’s investment decisions, including the design and adoption of comprehensive internal control procedures for investments in connection with the Company’s implementation of the internal control procedures required to comply with Section 404 of the Sarbanes Oxley Act of 2002 (“Section 404”);

 

   

strengthen the role of the board of directors in overseeing the Company’s investment activities;

 

   

develop an internal control mechanism applicable to the Company’s selection of banks that the Company will use for deposits so as to address both commercial risks and reputational risks; and

 

   

develop more prudent and conservative procedures regarding the entry by the Company into banking or other credit relationships.

 

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As of December 31, 2006, we have taken the following measures to implement the recommendations of the Special Investigation Committee:

 

   

engaged Ernst & Young to advise on the internal control over financial reporting requirements under Section 404, including testing and monitoring the effectiveness of our internal controls over financial reporting;

 

   

enhanced the board of directors’ ability to oversee our financial activities by adopting new internal control procedures, pursuant to which decisions relating to derivatives, loans to others, endorsement and guarantee for third parties, and equity investments, exceeding certain limits, are subject to the board of directors’ approval; and

 

   

reduced the risks inherent in banking or other credit activities by adopting new internal control procedures, under which the application for any credit line or the opening of any account at any overseas banks is required to be approved by the board of directors.

Special Committee

In connection with the indictment of Mr. Shih-Jye Cheng by the Taipei District Prosecutor’s Office, our board of directors formed a special committee to evaluate the circumstances surrounding the indictment. The special committee is comprised of three independent directors, Messrs. Yeong-Her Wang, Rong Hsu and Pierre Laflamme. It has engaged Preston Gates & Ellis LLP as its independent international legal counsel and Baker & McKenzie as its independent ROC legal counsel, and Diwan, Ernst & Young as its accounting advisor to assist in its evaluation and provide recommendations.

On June 28, 2006, the special committee issued its report, including its findings and recommendations. Based upon the results of its investigation, it found that (1) Mr. Shih-Jye Cheng has declared himself not guilty of the charges described in the indictment, (2) Baker & McKenzie, after reviewing the indictment and the prosecutor’s exhibits, have found that the evidence produced by the prosecutor seems to be inadequate and that there is a low probability of the charges in the indictment being founded, (3) the financial advisor to the special committee have found that we suffered no loss (not taking into account exchange rate factors) and that all monies (capital and interest) were remitted back to our subsidiaries involved, (4) we have suffered no identifiable harm to our reputation or our business and (5) Mr. Cheng has not been impaired by the indictment to perform as our chairman and chief executive officer. The special committee recommended that our board maintains Mr. Cheng as our chairman and chief executive officer with full responsibilities and our board unanimously (with Mr. Shih-Jye Cheng having recused himself) resolved to accept and adopt the special committee’s recommendation with regard to Mr. Shih-Jye Cheng.

Our board of directors also resolved to continue the role of the special committee, for the duration of the ongoing criminal proceeding involving Mr. Shih-Jye Cheng to actively monitor any developments of the criminal investigation and take or recommend any appropriate action in light of such developments.

During its engagement by the special committee, Diwan, Ernst & Young identified certain internal control weaknesses that existed during the relevant period of the special committee’s investigation within ChipMOS Taiwan, ThaiLin and ChipMOS Logic (which was merged into ThaiLin on December 1, 2005). These weaknesses were in areas related to segregation of duties and of corporate governance on investment authorizations, insufficiency of training for financial personnel in respect of derivative transactions, and non-compliance with the applicable ROC regulations. These identified internal control weakness have either been addressed previously or are in the process of being remedied by our company and our subsidiaries.

In light of the identification of these internal control weaknesses, the special committee recommended that the audit committee of the board of directors lead a special task force and report to the board of the directors as to the effectiveness of the implementation of internal control over financial reporting, with an aim to enhance our company’s financial personnel’s knowledge of derivative transactions. The board of directors unanimously resolved to accept and adopt the special committee’s recommendation in this regard.

In August 2006, we engaged Diwan, Ernst & Young to design certain employee training sessions regarding derivative transactions and the applicable accounting treatment for these transactions.

See “Item 3 — Key Information — Risk Factors — The ongoing criminal investigation involving Mr. Shih-Jye Cheng, our Chairman and Chief Executive Officer, and Mr. Hung-Chiu Hu, our former director, could have a material adverse effect on our business and cause our stock price to decline.”

 

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Employees

The following table sets forth, as of the dates indicated, the number of our full-time employees serving in the functions indicated:

 

     As of December 31,    As of
March 31

Function

   2004    2005    2006    2007

General operations

   2,569    2,632    3,312    3,291

Quality control

   405    387    460    461

Engineering

   1,130    1,125    1,447    1,466

Research and development

   188    224    253    273

Sales, administration and finance

   222    202    218    239

Others

   411    335    391    405
                   

Total

   4,925    4,905    6,081    6,135
                   

The following table sets forth, as of the dates indicated, a breakdown of the number of our full-time employees by geographic location:

 

     As of December 31,    As of
March 31

Location

   2004    2005    2006    2007

ChipMOS H.K. Taiwan Branch (Hsinchu)

   —      13    14    14

ThaiLin (Hsinchu Industrial Park)

   467    516    783    776

ThaiLin (Chupei City)

   279    236    —      —  

ChipMOS Taiwan Hsinchu Production Group

   1,806    1,484    1,870    1,916

ChipMOS Taiwan Southern Taiwan Production Group

   1,838    2,103    2,757    2,713

Shanghai

   527    545    649    708

Japan and the United States

   8    8    8    8
                   

Total

   4,925    4,905    6,081    6,135
                   

Our employees are not covered by any collective bargaining agreements. We have not experienced any strikes or work stoppages by our employees and believe that our relationship with our employees is good.

Share Option Plan and Share Appreciation Rights Plan

We adopted a broad-based share option plan in 2001, which was amended at a special general meeting on March 19, 2004 to increase the number of shares available for issuance under the share option plan from 5,800,000 to 9,000,000. In August 2006, we adopted a second broad-based share option plan, which has 7,000,000 shares available for issuance. Each share option plan provides that our directors, officers, employees and those of our affiliates may, at the discretion of our board of directors or a committee, be granted options to purchase our shares at an exercise price of no less than the par value of our common shares. The board or the committee has complete discretion to determine which eligible individuals are to receive option grants, the number of shares subject to each grant, the exercise price of all options granted, the vesting schedule to be in effect for each option grant and the maximum term for which each granted option is to remain outstanding, up to a maximum term of ten years.

In 2004, we granted a total of 2,809,800 share options to our employees, 309,983 share options were cancelled and 1,020,504 share options were exercised. In 2005, we did not grant any share options to our employees. In 2005, 312,750 share options were cancelled and 441,094 share options were exercised. In 2006, we granted 2,170,510 share options, with an exercise price of US$5.1425, US$5.2190, US$5.1, US$4.811 and US$5.7205 per share. In 2006, 319,200 share options were cancelled and 1,322,143 share options were exercised. The table below sets forth information about the share options outstanding as of December 31, 2006.

 

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Date of grant

   Exercise
Price
   Number
outstanding
as of
December 31,
2006
   Number
of
Options
   Exercisable on or after

April 3, 2002

   US$ 4.0375    870,450    131,225
358,621
380,604
   April 3, 2004
April 3, 2005

April 3, 2006

June 13, 2003

     0.7650    1,060,050    258,999
312,463
488,588
   December 13, 2004
December 13, 2005
December 13, 2006

October 1, 2003

     1.7425    502,001    71,001
92,000
160,750
178,250
   October 1, 2004
October 1, 2005
October 1, 2006
October 1, 2007

November 3, 2003

     1.7425    26,300    2,750
3,750
9,900
9,900
   November 3, 2004
November 3, 2005
November 3, 2006
November 3, 2007

April 30, 2004

     6.6300    1,035,925    249,800
256,925
264,600
264,600
   April 30, 2005
April 30, 2006
April 30, 2007
April 30, 2008

August 13, 2004

     3.6000    934,200    135,850
249,700
274,325
274,325
   August 13, 2005
August 13, 2006
August 13, 2007
August 13, 2008

August 31, 2006

     5.1425    315,000    63,000
63,000
63,000
63,000
63,000
   August 31, 2006
August 31, 2007
August 31, 2008
August 31, 2009
August 31, 2010

August 31, 2006

     5.1425    1,640,060    410,303
409,919
409,919
409,919
   August 31, 2007
August 31, 2008
August 31, 2009
August 31, 2010

September 20, 2006

     5.2190    36,000    9,000
9,000
9,000
9,000
   September 20, 2007
September 20, 2008
September 20, 2009
September 20, 2010

October 20, 2006

     5.1000    23,000    5,750
5,750
5,750
5,750
   October 20, 2007
October 20, 2008
October 20, 2009
October 20, 2010

November 20, 2006

     4.8110    69,000    17,250
17,250
17,250
17,250
   November 20, 2007
November 20, 2008
November 20, 2009
November 20, 2010

December 20, 2006

     5.7205    46,750    11,689
11,687
11,687
11,687
   December 20, 2007
December 20, 2008
December 20, 2009
December 20, 2010
             

Total

      6,558,736      
             

In September 2006, we adopted a share appreciation rights plan pursuant to which we may issue up to 2,000,000 cash-settled share appreciation rights to our directors, officers, employees and those of our affiliates. Under the share appreciation rights plan, each holder of share appreciation rights issued thereunder (“SARs”) will be entitled to receive, on the applicable exercise date, cash in an amount equal to the excess of the market value of our common shares on such date over the exercise price of such rights. Our board of directors or a relevant committee thereof has complete discretion over the administration of the share

 

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appreciation rights plan, including determining the recipients of the share appreciation right awards, the number of rights awarded, the exercise date, the exercise price and other relevant terms. Unless earlier terminated by our board of directors or the relevant board committee, the plan will remain effective until September 2016. The table below sets forth information about share appreciation rights outstanding as of December 31, 2006.

 

Date of grant

   Exercise
Price
   Number
outstanding
as of
December 31,
2006
  

Number
of

SARs

   Exercisable on or after

September 20, 2006

   US$ 5.1425    926,110    231,553
231,519
231,519
231,519
   August 31, 2007
August 31, 2008
August 31, 2009
August 31, 2010

September 20, 2006

   US$ 5.2190    75,000    18,750
18,750
18,750
18,750
   September 20, 2007
September 20, 2008
September 20, 2009
September 20, 2010

October 20, 2006

   US$ 5.1000    42,000    10,500
10,500
10,500
10,500
   October 20, 2007
October 20, 2008
October 20, 2009
October 20, 2010

November 20, 2006

   US$ 4.8110    93,000    23,250
23,250
23,250
23,250
   November 20, 2007
November 20, 2008
November 20, 2009
November 20, 2010

December 20, 2006

   US$ 5.7205    66,000    16,500
16,500
16,500
16,500
   December 20, 2007
December 20, 2008
December 20, 2009
December 20, 2010
             

Total

      1,202,110      
             

 

Item 7. Major Shareholders and Related Party Transactions

Major Shareholders

The following table sets out certain information as of March 31, 2007 regarding the ownership of our common shares by (1) each person known to us to be the owner of more than five percent of our common shares and (2) the total amount owned by our directors and executive officers as a group.

 

Identity of person or group

   Number of
shares owned
   Percent
Owned

Mosel Vitelic Inc.(1)(2)

   19,203,009    23.2

Siliconware Precision Industries Co., Ltd(3).

   12,174,998    14.7

Highbridge International LLC(4)

   11,253,196    13.6

Directors and executive officers, as a group(5)

   1,062,958    1.3

(1) Mosel owned 18,971,318 shares indirectly through Giant Haven Investments Limited, and 231,691 shares indirectly through Mou-Fu Investment Ltd. Mosel Vitelic Inc. is a public company listed on the Taiwan Stock Exchange whose largest known shareholder owned less than 4.3% of Mosel’s outstanding shares as of April 20, 2007.

 

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(2) Excludes shares owned by PacMOS Technologies Holdings Limited, or PacMOS, that may be beneficially owned by Mosel.
(3) Siliconware Precision Industries Co., Ltd. owned 12,174,998 common shares as of April 4, 2007, according to the Schedule 13D filed by Siliconware Precision Industries Co., Ltd. on April 4, 2007. See “Item 4. Information on the Company—Our Structure and History—ChipMOS TECHNOLOGIES INC.”
(4) Highbridge International LLC beneficially owned our 2004 notes and 2006 notes, which are convertible into an aggregate of 11,253,196 of our common shares at a conversion price of US$6.28 and US$6.85, respectively, as of February 13, 2007, according to the Schedule 13G/A filed by Highbridge International LLC, Highbridge Capital Corporation, Highbridge Capital L.P., Highbridge Master L.P., Highbridge GP, Ltd., Highbridge GP, LLC, Highbridge Capital Management, LLC, Glenn Dubin and Henry Swieca on February 13, 2007. As of April 30, 2007, none of the 2004 notes and 2006 notes beneficially owned by Highbridge International LLC had been converted into our common shares.
(5) Excludes Mosel’s beneficial ownership of our common shares which may be considered to be beneficially held by some of our directors or officers. Includes shares held by certain family members of certain directors.

As of December 31, 2006, approximately 68% of our common shares were held of record by shareholders located in the United States. All holders of our common shares have the same voting rights with respect to their shares.

Related Party Transactions

Mosel Vitelic Inc.

As of March 31, 2007, Mosel indirectly owned 23.2% of our outstanding common shares. Mosel designs and manufactures semiconductor products, including SRAM, flash memory, LCD and other flat-panel display driver semiconductors and power-related semiconductors. In the period from July to December 2003, Mosel transferred all of its DRAM business to its affiliate ProMOS. Mosel is also engaged in the semiconductor testing and assembly business through its shareholding in our company. Although Mosel was our second-largest customer in 2003, accounting for 19% of our net revenue in 2003, it ceased to be a key customer of ours following the transfer of its DRAM business to ProMOS, with sales to Mosel accounting for 0.1% of our net revenue in 2004. Mosel and its affiliates currently have, and are expected to continue to have from time to time in the future, contractual and other business relationships with us. Our relationships include the following:

 

   

Rental revenue from Mosel was NT$5 million, NT$5 million and NT$2 million (US$61 thousand) in 2004, 2005 and 2006, respectively. The rental fees paid by us to Mosel amounted to NT$2 million, NT$593 thousand and nil in 2004, 2005 and 2006, respectively.

 

   

In 2004, 2005 and 2006, we purchased integrated circuits for our module business and for resale to other customers from Mosel in an aggregate amount of NT$637 million, NT$12 million and nil, respectively.

 

   

In 2004, 2005 and 2006, we paid NT$2 million, nil and nil, respectively, annual administrative fees to Mosel for the provision of certain administrative services.

Siliconware Precision Industries Co., Ltd.

As of December 31, 2006, Siliconware Precision owned 28.8% of the outstanding shares of ChipMOS Taiwan. On March 27, 2007, we completed a share purchase and subscription transaction with ChipMOS Taiwan and Siliconware Precision, under which we and ChipMOS Taiwan purchased all of Siliconware Precision’s equity interest in ChipMOS Taiwan, and Siliconware Precision subscribed to 12,174,998 of our newly issued common shares through a private placement. As of March 31, 2007, we held 99.1% of the outstanding common shares of ChipMOS Taiwan and Siliconware Precision held 14.7% of our outstanding common shares. Siliconware Precision is an independent provider of semiconductor testing and packaging services. Siliconware Precision currently has, and is expected to continue to have from time to time in the future, contractual and other business relationships with us. From time to time, Siliconware Precision provides assembly services to us. Often, Siliconware Precision renders these assembly services directly to our customers through customer referrals from us. On January 1, 2001, ChipMOS Taiwan entered into a subcontracting agreement for a term of two years with Siliconware Precision, pursuant to which Siliconware Precision is obligated to provide assembly services to us. This agreement was extended for another two years from January 2004 to December 2005. Every month, ChipMOS Taiwan is required to provide Siliconware Precision with a rolling forecast of requested services for the following three months. The prices of these services are to be agreed upon from time to time taking into account the cost of the packaging raw materials. In 2006, we did not outsource to Siliconware Precision any sales.

Joint Venture Agreement between Mosel and Siliconware Precision

Under the terms of the joint venture agreement between Mosel and Siliconware Precision regarding the operation of ChipMOS Taiwan, Mosel has agreed, among other things, to cooperate with Siliconware Precision to ensure that ChipMOS Taiwan shares are listed on the Taiwan Stock Exchange or other stock exchange or the Republic of China Over-the-Counter Securities Exchange, and to

 

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maintain an equity interest in ChipMOS Taiwan of at least 29% for five years after such listing. We currently have no plans to seek such a listing by ChipMOS Taiwan, and Mosel currently has no direct equity interest in ChipMOS Taiwan. Under the joint venture agreement, remedies for breaches by Mosel of or non-compliance by Mosel with these terms may include damage payments by Mosel to Siliconware Precision and the right for Siliconware Precision to purchase Mosel’s shares of ChipMOS Taiwan or to force Mosel to purchase Siliconware Precision’s shares in ChipMOS Taiwan. Mosel has provided an undertaking to us to resolve any disputes with Siliconware Precision in connection with the joint venture agreement in a manner that does not adversely affect the business, operations or financial condition of ChipMOS Taiwan or our company.

Ultima Electronics Corp.

ChipMOS Taiwan is no longer a shareholder of Ultima, having disposed all of its interest in Ultima in December 2004. We provide mostly vertically integrated services and some independent testing and assembly services to Ultima. Sales to Ultima accounted for 3% of our net revenue in 2004, nil% in 2005 and nil% in 2006. In 2003, ChipMOS Taiwan acted as a guarantor and provided collateral for a loan in the amount of NT$600 million extended to Ultima by two Taiwan financial institutions, but as of December 31, 2006, ChipMOS Taiwan no longer acted as a guarantor for Ultima.

On December 22, 2003, ChipMOS Taiwan entered into a share purchase agreement with Caspian Worldwide Holdings Limited (BVI), or Caspian, a wholly-owned subsidiary of Ultima, for the acquisition of 30.0% of the shares of Ultima Technology Corp. (BVI), a wholly-owned subsidiary of Caspian, for a purchase price of approximately US$11 million. ChipMOS Taiwan provided Caspian with a performance bond in the amount of NT$290 million, which was returned to ChipMOS Taiwan on May 6, 2004. The investment was approved by the Investment Commission on April 19, 2004 and was made by ChipMOS Taiwan in May 2004. In 2005 and 2006, we recognized an impairment loss of NT$188 million and NT$58 million (US$2 million), respectively, as a result of the decline in the value of our investment in Ultima Technology Corp. (BVI).

For additional information on the transactions with Ultima, see “Item 5. Operating and Financial Review and Prospects—Pricing—Revenue Recognition” and “Item 6. Directors, Senior Management and Employees—Special Investigation Committee.”

DenMOS Technology Inc.

We do not own any equity interest in DenMOS. As of March 31, 2007, Mosel directly owned 44.2% of common shares of DenMOS. Sales to DenMOS were NT$567 million, NT$271 million and NT$125 million (US$4 million) in 2004, 2005 and 2006, respectively. We provided storage services to DenMOS in 2004 and 2005. Rental revenue from DenMOS for these storage services was NT$455 thousand, NT$30 thousand and nil in 2004, 2005 and 2006, respectively.

On October 15, 2003, we entered into a long-term agreement with DenMOS, under which we reserve a specified amount of capacity for LCD and other flat-panel display driver semiconductor testing and assembly services to DenMOS and under which DenMOS guarantees to place orders in the amount of the reserved capacity for a period of 48 months. This agreement supersedes a similar agreement that we entered into on May 25, 2002. The price for our services under this agreement will be agreed upon, based on our general price list, at the time DenMOS places orders under this agreement. If we are unable to test and assemble the agreed number of LCD and other flat-panel display driver semiconductors, DenMOS may use a third party to cover the shortfall. However, we are entitled to cure any shortfall in the following month. If we fail to do so, we may be liable for damages up to the amount equal to the number of shortfall units in the given month multiplied by the average sales price per unit in that month. If DenMOS fails to place orders according to the reserved capacity, we are entitled to damages based on our costs for the equipment, tooling costs, costs for personnel dedicated to the provisions of capacity to such customer, and the costs for raw materials.

SyncMOS Technologies Inc.

We do not own any equity interest in SyncMOS. As of March 31, 2007, Mosel indirectly owned 41.5% of SyncMOS Technologies Inc. We provided storage services to SyncMOS Technologies Inc. and rental revenue from SyncMOS Technologies Inc. was NT$1,126 thousand, NT$1,382 thousand and NT$1,864 thousand (US$57 thousand) in 2004, 2005 and 2006, respectively.

 

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Best Home Corp. Ltd.

As of March 31, 2007, ChipMOS Taiwan had a 19.9% ownership interest in Best Home. Best Home is engaged in the business of selling office supplies and providing cafeteria services. On October 11, 2002, ChipMOS Taiwan entered into a cafeteria construction and cooperation agreement with Best Home, under which Best Home is obligated to construct a cafeteria and provide cafeteria services for ChipMOS Taiwan and ChipMOS Taiwan is obligated to prepay Best Home an aggregate of NT$216 million. On December 17, 2003, ChipMOS Taiwan entered into a credit assignment agreement with Prudent Holdings Group Ltd., or Prudent, a 4% shareholder of ours, under which ChipMOS Taiwan assigned its right to the repayment of NT$216 million from Best Home under the cafeteria construction and cooperation agreement for Prudent and Prudent agreed to pay NT$216 million back to ChipMOS Taiwan by June 30, 2004. On June 25, 2004, a supplementary agreement was signed with Prudent whereby the payment date was extended to September 30, 2004 and on September 24, 2004, another supplementary agreement was signed with Prudent for the extension of the payment date to December 30, 2004. Prudent also entered into a pledge agreement on September 30, 2004 whereby the advance of NT$216 million was secured by Prudent’s shareholding in ChipMOS Bermuda to the extent of 2,360,000 common shares in favor of ChipMOS Taiwan. ChipMOS Taiwan received payment in full from Prudent on November 19, 2004.

ChipMOS TECHNOLOGIES (Shanghai) LTD.

ChipMOS Shanghai is a wholly-owned subsidiary of Modern Mind, which is one of our controlled consolidated subsidiaries. Under a technology transfer agreement dated August 1, 2002, we licensed certain technologies and systems, and agreed to provide certain technical support and consulting services to ChipMOS Shanghai relating to those technologies and systems, and ChipMOS Shanghai paid an aggregate of US$25 million to us in 2002 for the technology and services we provide under this agreement.

On April 20, 2004, ChipMOS Hong Kong and ChipMOS Shanghai entered into an exclusive services agreement, pursuant to which ChipMOS Shanghai will provide its services exclusively to ChipMOS Hong Kong or customers designated by ChipMOS Hong Kong. Under the exclusive services agreement, ChipMOS Hong Kong will purchase and consign to ChipMOS Shanghai all of the equipment required to render those services. The exclusive services agreement has a term of ten years and will automatically be renewed for periods of ten years, unless terminated by either party at least 30 days prior to the expiration of such ten-year term. In addition, ChipMOS Hong Kong may terminate the exclusive services agreement at any time by giving 30 days’ prior notice.

CHANTEK ELECTRONIC CO., LTD.

In 2003, ChipMOS Taiwan purchased equipment from Chantek at a cost of NT$10 million and sold equipment to Chantek for NT$17 million. In addition, ChipMOS Taiwan recognized gains on the disposal of certain properties to Chantek in the amount of NT$9 million. Chantek leased equipment and provided raw material and semiconductor processing services to ChipMOS Taiwan pursuant to certain agreements between Chantek and ChipMOS Taiwan. Under these agreements, we paid an aggregate of approximately NT$3 million and NT$0.2 million to Chantek in 2002 and 2003, respectively. In addition, we paid an aggregate of NT$8 million in rental fees to Chantek in 2003. We did not pay any fees under these arrangements or any rental fees to Chantek during the period from January to April 2004. From January to April 2004, we had revenues from Chantek of NT$15 million. ChipMOS Taiwan acquired 3,846,154 shares of common stock of AMCT from Chantek at an aggregate price of NT$38 million on March 19, 2004.

Chantek has been our consolidated subsidiary since April 2004. On November 21, 2005, Chantek merged into ChipMOS Taiwan, with ChipMOS Taiwan as the surviving entity. For additional information regarding the merger, see “Item 4. Information on the Company—Our Structure and History—ChipMOS TECHNOLOGIES INC.”

CHANTEK INTERNATIONAL INVESTMENT LTD.

In July 2004, ChipMOS Taiwan acquired from Chantek International Investment Ltd. 224,833 shares of common stock of ChipMOS Logic at an aggregate price of NT$2.5 million.

ThaiLin Semiconductor Corp.

ChipMOS Taiwan leased equipment and transferred certain technology to ThaiLin pursuant to certain agreements between ThaiLin and ChipMOS Taiwan. The rents paid by ThaiLin to ChipMOS Taiwan amounted to an aggregate of approximately NT$8 million in 2003. In 2003, ThaiLin purchased certain equipment from ChipMOS Taiwan for approximately NT$245 million, and sold certain equipment to ChipMOS Taiwan for approximately NT$105 million.

ThaiLin has been our consolidated subsidiary since December 2003. On December 1, 2005, ChipMOS Logic merged into ThaiLin, with ThaiLin as the surviving entity. See, “Item 4. Information on the Company— Our Structure and History—ThaiLin Semiconductor Corporation.”

 

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ProMOS Technologies Inc.

As of March 31, 2007, ChipMOS Taiwan owned 4,201,231 shares, or 0.06% of ProMOS, and ThaiLin owned 3,600,000 shares, or 0.05% of ProMOS. As of March 31, 2007, Mosel directly and indirectly owned 13.4% of ProMOS. Following the transfer of Mosel’s DRAM business to ProMOS in 2003, sales to ProMOS accounted for 28% of our net revenue in 2004, 28% of our net revenue in 2005 and 27% of our net revenue in 2006.

On July 1, 2003, ChipMOS Taiwan entered into a long-term agreement with ProMOS, under which ChipMOS Taiwan reserves a specified amount of capacity for DRAM testing and assembly services to ProMOS and under which ProMOS guarantees to place orders in the amount of the reserved capacity through the end of 2006. The price for the services of ChipMOS Taiwan under this agreement will be agreed upon quarterly, based on the then fair market price. If ChipMOS Taiwan is unable to test and assemble the agreed number of DRAM, ProMOS may use a third party to cover the shortfall and ChipMOS Taiwan may be liable for any operation loss of ProMOS caused by such delay or any additional costs in using a third party to cover the shortfall. If ProMOS fails to place orders in the amount of the reserved capacity, ChipMOS Taiwan is entitled to damages calculated based on the difference between the value of the reserved capacity and the value of the actual used capacity, provided that the value of the capacity by ChipMOS Taiwan that has been used for other customers shall be deducted.

In 2004, ChipMOS Taiwan purchased certain equipment from ProMOS for approximately NT$46 million. Rental revenue from ProMOS in 2004, 2005 and 2006 was NT$14 million, NT$9 million and NT$9 million (US$276 thousand), respectively.

Sun-Fund Securities Ltd.

As of March 31, 2007, ChipMOS Taiwan held a 16.7% equity interest in Sun-Fund. In 2003, we paid Sun-Fund NT$3 million for shareholders’ and related service fees. On August 30, 2004, the board of Sun-Fund resolved to liquidate Sun-Fund; however, this proposal was rejected by shareholders of Sun-Fund at shareholders meetings on September 30, 2004 and December 31, 2004.

Mou-Fu Investment Ltd.

As of March 31, 2007, Mosel held directly a 99.9% equity interest in Mou-Fu. In 2004, 2005 and 2006, we paid Mou-Fu NT$4 million, NT$3 million and NT$3 million (US$92 thousand), respectively, for the provision of shareholders’ services. In 2004, 2005 and 2006, we paid Mou-Fu NT$2 million, NT$4 million and NT$2 million (US$61 thousand) for management expenses, respectively.

 

Item 8. Financial Information

Consolidated Financial Statements and Other Financial Information

Please see “Item 18. Financial Statements” and pages F-1 through F-67.

Legal Proceedings

In 2003, we had a tax dispute with the ROC tax authority in the amount of NT$31 million relating to our income tax in 2000. We submitted our objections to this assessment to the relevant tax authority in March 2004 and we received a request from the ROC tax authority in April 2006 to make the payment of approximately NT$2 million (US$61 thousand), which we paid in May 2006.

In February 2006, ChipMOS Taiwan and ChipMOS USA received notice of a lawsuit filed by Tessera Technologies, Inc., or Tessera, in the United States Federal Court, Northern District of California (Civil Action No. C05-04063CW). Tessera added ChipMOS Taiwan and ChipMOS USA as co-defendants, along with several other semiconductor companies, to a lawsuit that it previously filed, alleging, among other things, that ChipMOS Taiwan, ChipMOS USA and the other defendants infringe certain patents owned by Tessera and that ChipMOS Taiwan is in breach of a license agreement with Tessera. Tessera also sought unspecified damages and injunctive relief. ChipMOS Taiwan and ChipMOS USA have responded to the lawsuit by denying and asserting affirmative defenses to Tessera’s claims of patent infringement and breach of contract, and have filed counterclaims against Tessera seeking a declaration by the Court that ChipMOS Taiwan and ChipMOS USA have not infringed any of Tessera’s patents and that Tessera’s patents are invalid and unenforceable. In addition, a co-defendant in the lawsuit, with concurrence of ChipMOS

 

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Taiwan and ChipMOS USA, requested the United States Patent and Trademark Office to reexamine each of Tessera’s patents that are at issue in the lawsuit. Such requests were granted and each of Tessera’s patents at issue in the lawsuit are currently being reexamined by the United States Patent and Trademark Office. A date for the trial has not yet been set.

In April 2006, ChipMOS Bermuda and ChipMOS Hong Kong received an Amended Writ of Summons and Statement of Claim from Pacific Electric, alleging that certain properties held in trust for Pacific Electric were improperly used to secure a HK$150 million credit facility that ChipMOS Bermuda, ChipMOS Hong Kong and Trident entered into with Nordbank in January 2003 without Pacific Electric’s consent, and that Nordbank’s security interests in such properties are therefore null and void or otherwise unenforceable. ChipMOS Hong Kong borrowed funds under the Nordbank facility in 2003 and repaid them in 2004, and ChipMOS Bermuda has never borrowed under the facility. According to information provided by Trident, the credit facility was fully paid in November 2006 and there is no outstanding loan balance.

Other than the matters described above, we were not involved in any material litigation in 2006 and are not currently involved in any material litigation.

For certain information regarding legal proceedings relating to certain of our current and former directors, see “Item 3 — Key Information — Risk Factors — Risks Relating to Our Relationship with Mosel — The ongoing criminal investigations and trial involving Mr. Hung-Chiu Hu, Mr. Robert Ma Kam Fook and Mr. Jwo-Yi Miao, our former directors, could have a material adverse effect on our business and cause our stock price to decline” and “Item 3 — Key Information — Risk Factors — The ongoing criminal investigation involving Mr. Shih-Jye Cheng, our Chairman and Chief Executive Officer, and Mr. Hung-Chiu Hu, our former director, could have a material adverse effect on our business and cause our stock price to decline.”

Dividend Policy

To date, we have not distributed any dividends. We currently intend to retain future earnings, if any, to finance the expansion of our business and thus do not expect to pay any cash dividends for the foreseeable future. In addition, we have no current plans to pay stock dividends. ChipMOS Taiwan, our 99.1% subsidiary, and its subsidiaries and affiliates may continue to issue stock or cash dividends in accordance with local practice in Taiwan.

 

Item 9. The Offer and Listing

Listing

Nasdaq Global Select Market is the principal trading market for our common shares, which are not listed or quoted on any other markets in or outside the United States. Our common shares have been quoted on the Nasdaq Global Market (formerly the Nasdaq National Market) under the symbol “IMOS” since June 19, 2001 and our common shares have been quoted on the Nasdaq Global Select Market since July 1, 2006. The CUSIP number for our common shares is “G2110R106.” As of March 31, 2007, there were 82,802,463 common shares issued and outstanding. The table below sets forth, for the periods indicated, the high, low and average closing prices on the Nasdaq Global Market or the Nasdaq Global Select Market for our common shares.

 

     Nasdaq(1) Price per share
(US$)
     Average    High    Low

2001 (from June 19 through December 31)

   2.31    5.06    1.40

2002

   3.23    5.25    1.48

2003

   3.19    9.39    0.85

2004

   8.24    15.00    3.60

2005

   6.21    7.55    4.80

First Quarter

   5.59    6.49    4.80

Second Quarter

   6.52    7.25    5.82

Third Quarter

   6.78    7.55    6.18

Fourth Quarter

   5.92    6.75    5.42

2006

   6.35    8.10    5.45

First Quarter

   6.47    8.10    5.45

Second Quarter

   6.86    7.37    5.87

Third Quarter

   5.80    6.20    5.45

Fourth Quarter

   6.03