奇景光電 (HIMX) 2015 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Himax Technologies second quarter 2015 earnings call.

As a reminder, today's call is being recorded.

I would now like to turn the conference over to Adam Holdsworth, US Investor Relations representative.

Sir, you may begin.

Thank you, operator. Welcome everyone, to Himax's second quarter 2015 earnings call. Joining us from the company are Mr. Jordan Wu, President and Chief Executive Officer and Ms. Jackie Chang, Chief Financial Officer.

After the company's prepared comments, we have allocated time for questions in a Q&A session. If you have not yet received a copy of today's results release, please call PCG Advisory Group at 1-646-862-4607 or access the press release on financial portals or download a copy from Himax's website at www.himax.com.tw.

Before we begin the formal remarks, I would like to remind everyone that some of the statements in this conference call, including statements regarding expected future financial results and industry growth, are forward-looking statements that involve a number of risks and uncertainties that could cause actual events or results to differ materially from those described in this conference call.

Factors that could cause actual results include, but are not limited to, general business and economic conditions, the state of the semiconductor industry, market acceptance and competitiveness of the driver and non-driver products developed by Himax, demand for end use application products, the uncertainty of continued success and technological innovations as well as other operational and market challenges and other risks described from time-to-time in the company's SEC filings, including those risks identified in the section entitled Risk Factors in its Form 20-F for the year ended December 31, 2014, filed with the SEC as amended.

Except for the company's full year of 2014 financials, which were provided in the company's 20-F, filed with the SEC on April 15, the financial information included in this conference call is unaudited and consolidated and prepared in accordance with US GAAP accounting.

Such financial information is generated internally and has not been subjected to the same review and scrutiny, including internal auditing procedures and external audits by an independent auditor to which we subject our annual consolidated financial statements and may vary materially from the audited consolidated financial information for the same period.

The company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Before I turn the call over to Mr. Jordan Wu, I would like to inform everyone that Taiwan has been at the center of a powerful typhoon and Himax's management and its facilities are safe and sound. Jordan and Jackie are weathering the storm at their headquarters in Taiwan and if for any reason there are connectivity issues on this call, Himax will issue a press release with details for an alternative time. Thank you for your understanding.

I will now turn the call over to Mr. Wu.

Jordan, the floor is yours.

Thank you, Adam and thank you, everybody, for being with us for today's call. In today's earnings call, in addition to reporting our performance in the second quarter, I will also provide our outlook for the third quarter of 2015 and update our product areas of focus for this year.

Our CFO, Jackie Chang will also provide additional details on our financial performance.

Our 2015 second quarter revenue, gross margin, GAAP and non-GAAP earnings per diluted ADS, all met at high-end or exceeded our guidance for the quarter.

For the second quarter, we reported net revenues of $169.2 million, at high-end of our guidance with a gross margin of 23.8%. Second quarter GAAP earnings per diluted ADS were $0.051 and non-GAAP earnings per diluted ADS were $0.054, both exceeded guidance.

During our first quarter 2015 earnings call, we mentioned the industry's low visibility, especially in China's smartphone market, yet we were able to arrive at the top end of our revenue guidance and beat EPS guidance because our driver IC business came in better than expected across all applications. We were pleased to see a snapback during the second quarter from our Chinese branded smartphone end customers. TV, as projected, was another bright spot amongst our IC products.

We will now review all of our business segments in greater detail. Our second quarter revenue of $169.2 million represented a 13.9% decrease from the second quarter of 2014 and a 5.5% sequential decrease from the first quarter. Revenue from large panel display drivers were was $54.3 million, an increase of 6.9% from the second quarter of 2014 and down 5.7% sequentially.

Large panel driver IC accounted for 32.1% of our total revenues for the second quarter, compared to 25.9% a year ago and 32.2% in the last quarter. The year-over-year increase in total revenue was a result of market share gain from our Chinese panel customers and accelerated 4K TV shipments during the quarter. Yet the sequential decrease was caused by continued weakness in the monitor market.

Revenue for small and medium-sized drivers came in at $82.8 million, down 22.6% for the same period last year and down 4.9% sequentially. Driver IC's for small and medium-sized applications accounted for 48.9% of total sales for second quarter as compared to 54.5% a year ago and 48.6% in the previous quarter.

While the overall demand in mobile devices are still trending down, the decline of our small and medium driver IC business was much smaller during the quarter compared to the last quarter. This was mainly because sales from our Chinese branded smartphone end customers who are trading behind the competition in the first quarter rebounded strongly in the second quarter.

The growth from Chinese branded smartphone customers was however largely offset by business from our key Korean end customer who was going through product transition during the quarter. Our Chinese end customers are using a multi-branding strategy in new sales channels such as e-commerce and direct sales points to gain market share back in China and exploring the long-awaited export opportunities.

Meanwhile our key Korean customer has decided to strategically increase the weight of AMOLED panels in their smartphone product portfolio. The transition in product development left a gap in the second quarter smartphone driver IC business as we have been its major TFT LCD driver IC outsourcing partner since 2012. We are foreseeing this issue and the work on the development of AMOLED driver products.

We believe that shipments of AMOLED panel drivers to both Korean and Chinese customers starting in the second half of 2015 will help lift our smartphone driver sales going forward. I will elaborate more on Himax's competitive advantages in AMOLED driver IC a bit later.

For driver IC's used in tablets, seen sales stabilize after three consecutive quarters of decline and for driver IC's used in automotives, revenues remained robust during the quarter. Revenue from our non-driver businesses were $32.1 million, down 16.8% from the same period last year and down 6.6% sequentially.

Non-driver products accounted for 19% of total revenue, as compared to 19.6% a year ago and 19.2% in the previous quarter. Within our non-driver business segment, the main contributors included our timing controllers, programmable gaama OP, touch panel controllers, CMOS image sensors, power management IC's and LCOS microdisplays, WLO and ASIC services. As we reported in the last earnings call, quite a few of our non-driver business segments were affected by the weakness in the China market, particularly in the smartphone and tablet segments which resulted in the sequential decline of our non-driver businesses.

Our GAAP gross margin for the second quarter was 23.8%, a 40 basis points decrease from 24.2% in the same period last year and down 190 basis points from 25.7% in the previous quarter. As previously guided, the sequential decline was mainly due to unfavorable product mix.

Our GAAP net income for the second quarter was $8.8 million, or $0.051 per diluted ADS, compared to $24.1 million or $0.14 per diluted ADS for the same period last year and $0.6 million or $0.073 per diluted ADS in the previous quarter.

GAAP net income declined 63.4% year-over-year and declined 29.7% from the previous quarter.

The year-over-year decline was due to lower sales and gross margin, higher operating expenses and a one-time investment gain of $8.5 million or $0.05 in the second quarter last year. Excluding the one-time investment gain influence, our GAAP net income declined 51.3% year-over-year. The sequential decline was due to lower sales and gross margin in the quarter.

Jackie Chang, our CFO will now provide more details on our financial results. After Jackie's presentation, we will further discuss our second quarter results and third quarter guidance. Jackie?

Thank you, Jordan. I will now provide additional details for our second quarter financial results.

Our GAAP operating expenses were $31.4 million in the second quarter of 2015, up 8.3% from the same period a year ago and up 3.4% from the previous quarter. Operating expenses increased from the second quarter of 2014 due to higher expenses for additional headcount to support new projects, annual salary increases and an increase in R&D expenses.

The quarter-over-quarter operating expense increase reflected increase in R&D expenses. In response to the bearish market sentiment, we have started expense control since the beginning of the year. However in selective areas, mainly WLO and LCOS, we are still expanding right now. The combined total headcount of the two areas is expected to be up by around 230 during the year.

GAAP operating income for the second quarter of 2015 was $8.9 million or 5.2% of revenue, down 51.9% year-over-year and down 43.3% sequentially. The decline was mainly due to lower sales, decreased gross margin and higher expenses in the quarter.

Non-GAAP net income in the second quarter was $9.3 million or $0.054 per diluted ADS, representing a decline of 61.8% year-over-year and a decline of 28.5% sequentially. As previously mentioned, excluding the one-time investment gain, non-GAAP net income decreased 49.2% year-over-year.

Our cash, cash equivalent and marketable securities were $164.5 million at end of June 2015, down from $172.9 million during the same time last year and down from $178.8 million last quarter. In addition to our cash position, our restricted cash was $130 million at the end of the quarter. The restricted cash is mainly used to guarantee the company's short-term loan for the same amount. We continue to maintain a strong balance sheet and we remind investors that we remain a debt-free company.

Inventories, as of June 30, 2015, were $189.6 million, up from $166.3 million for the same period last year and up from $186.1 million last quarter. As mentioned in the last earnings call, we have been expecting customer restocking after Chinese New Year and yet market demand only picked up by later second quarter which has resulted in higher inventories. We believe we will be able to lower these inventory level starting the third quarter of the year.

Accounts receivable at the end of June 2015 were $182.3 million, as compared to $199 million for the same period last year and $192.7 million last quarter.

Day sales outstanding was 95 days at end of June 30, 2015 as compared to 92 days in the same period a year ago and 97 days at end of the last quarter.

Net cash outflow from operating activities for the second quarter of 2015 were $13.8 million, as compared to cash inflow of $22.9 million for the second quarter of 2014 and cash outflow of $3.7 million for the first quarter of 2015. The widening cash outflow quarter-over-quarter was mainly due to an income tax payment of $9.6 million. Both the year-over-year and sequential declines were mainly due to higher inventory and a decrease in accounts payable at end of the quarter, offset by lower accounts receivable in the quarter.

Capital expenditures were $2 million during the quarter of 2015 versus $3.8 million for the same period last year and $1.8 million last quarter. Among other things, we continue to expand our clean room facilities for WLO product line during the quarter.

During the second quarter, we declared our annual cash dividend of $0.30 per ADS, totaling $51.4 million, which was paid out in July. Our dividend is determined primarily by prior year's profitability. Our decision to payout 77.5% of last year's net profit demonstrates our continued support for our shareholder base and confidence in our long-term profitability.

As of June 30, 2015, Himax had 171.2 million ADSs outstanding, unchanged from the last quarter. On a fully diluted basis, the total number of ADSs outstanding is 172.2 million.

I will now return the floor back to Jordan.

Thank you, Jackie. We started this year with a sluggish first half as a result of weak overall market demands especially arose from China. The recent instability in the Euro Zone and turmoil in the Chinese stock markets have further worsened the already uncertain demands of consumer electronics overall in the second half.

More specifically, weaker demands have led to softening panel prices and lower capacity utilization of panel manufacturers. Pressured by the poor market sentiment, our gross margin will decline during the third quarter. However, we remain confident about our new growth opportunities lying ahead.

New customers, new design wins and new TDDI products of smartphone panel, market share gains for our large panel driver ICs and significant developments in our non-driver businesses should provide strong contribution in the quarters ahead. Furthermore we believe that our LCOS and WLO businesses will hit an inflection point during the second half of the year and now we have experienced such progress on that front shortly.

With that, I would now provide our third quarter guidance followed by some detailed outlook for the third quarter. For the third quarter of 2015 we expect revenues to decline 5% to 9% compared to the last quarter. Gross margin is expected to decline around 1.5% from the previous quarter depending on the final product mix. GAAP earnings attributable to shareholders are expected to be in the range of minus $0.015 to minus $0.009 per diluted ADS based on 171.9 million outstanding ADSs. Non-GAAP earnings attributable to shareholders are expected to be in the range of $0.01 to $0.016 cents per diluted ADS, based on the same amount of ADSs.

As we have done in the past, our third quarter GAAP earnings per diluted ADS guidance has taken into account our expected 2015 grant of restricted share units or RSUs to our team at the end of September. The grant of RSUs would lead to higher third quarter GAAP operating expenses compared to the other quarters of the year.

Now let me provide you with some details behind our guidance and trends that we see developing in our business segments. In our large panel driver IC business, after two strong quarters of shipments in TV application, we are starting to experience shipments slowdowns in TV along with continuous softness in notebooks and monitors. Hence, we will still see sequential decline by low teens in this segment in the third quarter. However we believe 3Q weakness is a temporary setback, as we have for repeatedly stated 2015 will be a year for our large panel driver IC business to post year-over-year growth amid poor market condition.

We are still gearing up our engineering collaboration and design-in activities with Chinese panel customers who, despite low market sentiment, are still adding new capacity after years of continuous expansion. The new capacity in China represents further growth opportunities for us with projected shipment growth and market share gains throughout the rest of 2015 and beyond.

On top of that, sales of 4K TVs are tracking better now than the beginning of the year, as Chinese panel customers are embracing the 4K TV market with mid-to-low end models that could stimulate purchase interests. Therefore, we remain positive on the outlook of our large panel driver IC business this year and also going forward.

The other segment in our driver business are ICs used in small and medium-sized panels for applications including smartphones, tablets and automotives. We highlighted in our previous earnings call that we were cautious in the second quarter outlook. However we experienced a snapback in Chinese customers' smartphone demand due to certain brand end customers' share gains through new model launches and change in their marketing strategy and sales channels as mentioned earlier.

We therefore exited the second quarter with smartphone sales tracking better than we expected. Despite the muted market demand, panel resolution will continue to get upgraded. We are positive that resolution above HD720, especially FullHD will accelerate from the third quarter and go on for the rest of the year. Our QHD driver IC shipment also started at the end of the second quarter, following the design win with a brand customer as reported in the previous earnings calls.

Meanwhile, for FullHD and beyond, the preferred technology would be low-temp poly silicon TFT LCD since it allows higher pixel density and more circuit integration with less power consumption. We are pleased to see more and more Chinese panel makers following Korean and Japanese players entered mass production for high resolution panels at their new LTPS facilities aggressively. Such progress means more business opportunities for the next few years for Himax as we have longstanding and solid business relationships with Chinese panel makers.

We believe FullHD and QHD will account for a growing percentage of our smartphone driver IC revenues starting this quarter. We discussed on our last call, two other areas which we believe will fuel the next growth drive in our small and medium drive IC business, namely AMOLED driver IC and TDDI technology which integrates driver IC and touch panel controllers into one.

On the AMOLED driver IC front, we continue to collaborate closely with multiple panel customers in Korea and China, some of which are likely to see meaningful volume late this year. There are few competitors in this marketplace and we are well positioned, having been previously engaged by numerous existing and new AMOLED panel makers in their new panel developments.

It is worth mentioning that major Chinese panel makers have announced the building of new AMOLED projects and we believe Himax is in a good position to be a major beneficiary. We look forward to working with our customers as the market for this technology expands. I will elaborate further on the TDDI opportunity a bit later.

For our driver ICs used in tablets, following three consecutive quarters of decline, the market stabilized in the second quarter and as previously indicated, may improve in the second half of the year. Our observations remain that the trend for the panels in the mainstream tablet market will be upgraded to 10 inch and above with higher resolutions, from the once popular sizes of seven to nine inches. This is a favorable trend to the driver IC demand. However, its contribution to our sales will not be significant until 2016.

Among driver ICs used in small and medium-sized panels, the best-performing category in 2015 is automotive applications. We have successfully engaged key panel manufacturers and module houses for long-term partnerships and secured leading market share in this segment. We anticipate second half sales to grow by high-teens compared to the first half, which will also lead to high-teens growth year-over-year.

Himax's ICs are well recognized by numerous Tier 1 automobile brands globally. Thus we are well positioned to take advantage of this growing market which honors its long-term product life cycle, stable pricing and higher gross margins when compared with the rest of the segments in small and medium panel driver ICs. So compared to the previous quarter, our small and medium-sized driver segment will decline low single digit in the quarter sequentially.

For the past few years, our non-driver business segment has been our most exciting growth engine. New product development continues to evolve and gain traction and we remain positive on our long-term growth prospect of our non-driver businesses. Our touch panel controller product line declined sequentially in the second quarter as we have foreseen in the previous earnings call.

As we enter the third quarter, several of our on-cell design wins will start mass production at multiple major end customers. On top of that, we are also excited about our technological advances and product development progress in the latest pure in-cell technology, where we are one of the pioneers in offering one-chip solutions integrating driver IC and touch panel controller or TDDI.

Driven by leading TFT LCD makers, the industry is moving towards pure in-cell panels, which remains set to start mass production in the second half of this year. We are in partnerships with essentially all of the leading panel manufacturers, module houses and OEMs in pure in-cell touch for joint development and feel there is a strong market for these products ahead with fewer competitors.

Our CMOS image sensors experienced a slow first half since 4G smartphone adoption in China remained weak. The lack of smartphone replacement demand hurt the shipments of our high end product offerings. Entering the third quarter, we are pleased to report that we have secured several new customers in the second half mass production pipeline with our 8-megapixel and 13-megapixel sensors.

Regarding our LCOS business, Himax continues to collaborate with industry heavyweights by providing tailor made designs for their head mounted devices and we remain enthusiastic about the projects in the pipeline. As stated, our LCOS and WLO businesses will hit an inflection point this year and we are gearing up for increasing pilot production shipments now with expected volume ramping thereafter.

We already secured a piece of land which is five hectares in size and is conveniently located nearby our headquarter building in Tainan, Taiwan. We have started planning for the construction of a new manufacturing, office facility with first phase investment of approximately $40 million in order to meet customers' desired output.

The first phase construction will occupy just around 20% of the newly secured land, leaving plenty of space for future expansion. The investment will be financed through our internal resources and existing bank facilities, if needed. While we remain debt free as mentioned earlier, we do enjoy great support from banks that have provided us with plenty of unutilized facilities.

Once started, the construction is expected to be completed in 12-18 months. This progress is sooner than we thought when we last reported and we will report further details in due course.

Furthermore, Himax continues to partner with numerous industry leading players using our industry dominant wafer level optics or WLO for the development of three technologies of the future, namely array camera, special purpose sensor and microdisplay wave-guides for head-mounted devices.

As our top-tier customers begin to mass produce products embedding these new technologies, Himax, being in the heart of that supply chain, should benefit significantly. However, we would like to remind investors that we believe, like HMD, while WLO can enable cutting edge products, such products are early stage in nature. Himax, along with our partners, are pioneers in these technologies and are committed to bringing them into commercialization. Overall, we expect our non-driver segment to decline mid single digit sequentially in the third quarter.

Thank you for your interest in Himax. We appreciate your joining today's call and are now ready to take questions.

(Operator Instructions)

Our first question comes from Daniel Heyler with Bank of America. You may begin.

Good evening, Jackie and Jordan. Hope that you guys are safe there in Taiwan. I wanted to ask just a few things. Maybe if just kicking off with the non-driver business. You just mentioned that the non-driver business would be down, I think you said, in single digit. And yet you sounded positive on the direction. So maybe highlight a little bit why the third quarter, is that in line with your expectation of the third quarter and what are the dynamics going on into the fourth quarter for non-driver business?

Thank you, Dan. In the third quarter, I think the WLO and LCOS are still in pilot production, although the volume is still increasing compared to the first half, but they are also still in pilot production and we certainly will continue with the ramp and while we cannot disclose this actually when the mass production is, we will continue to ramp the volume and hopefully not before too long we will start mass production. But LCOS and WLO, I want to emphasize again that it is going to hit inflection point this year.

And another major area for non-driver where we have a leading edge is on-cell and in-cell touch. Now the traditional out-cell touch is very slow and we suffer from a major decline of few key end customers' sales.

So out-cell touch this quarter is slow. However we are starting to see volumes for in-cell touch starting in Q3 and it will be more so in Q4, and in-cell touch hopefully will also start to ramp. We see some small volume in Q3, but that will ramp hopefully in Q4.

And on CMOS image sensors, our 8-megapixel and 13-megapixel, we are a latecomer to the demo of CMOS image sensors, you are aware and the very weak China demand this year certainly hasn't helped a player such as us.

In particular for high-end products, customers they are actually more reluctant to adopt a newcomer's product, in particular when the demand is weak and when they probably sit on the higher level of inventory. But we are now seeing very promising new design wins of several customers which are scheduled to start mass production in this quarter and a lot also in Q4.

And that is why I think overall in the second half, we are still optimistic on non-driver. I think if you look at the current forecast, while in the first half non-driver accounted for about 19.7% of our total sales, in Q4 alone towards the end of the year, non-driver will go above 25% of our total sales.

So hopefully you will see a lot of momentum in Q4.

Okay. Great. Thanks for that.

And then on the driver area, Jordan, we have had a couple of quarters of weakness and it was interesting that you had a snapback in the mobile market in the second quarter. Are we about due for a possible snapback within the large panel DDI? I know that there is demand concern, but you did talk about Chinese companies ramping the 4K and you have fall seasonality and the supply chain has been very conservative. So I am wondering to what extent do you think you may start to see a surprise within the large DDI in the way of orders? Or is just demand is still very, very weak?

I think it is fair to say that demand still remains quite weak, although customers are still hopeful. So they are, actually if you look at their front-end capacity utilization, in general they remain pretty high. But actually they are more conservative on the module level. So I think that we are seeing a bit of this industry inventory building up across the board for large panel applications. And Taiwan panel makers as well, certainly they are under pressure because China is expanding their capacity.

We are still positive about our growth potential for TV for large panel driver IC growth this year compared to last year because we are clearly gaining market share and that is particularly good news after several years of decline. So whether the market will enjoy a snapback, I really can't tell. But I think long-term Chinese are still building their capacity and we are working extremely closely with them. So we are still -- we remain long-term positive for large panel driver ICs going forward.

Yes. Just a quick follow-up on that. Thanks.

So on, there's two part obviously there, the weak macro as you said and very weak demand that's slowing the upgrade cycle of the 4K TV. So the mix is getting affected. The other side of the equation, I guess is of the Chinese panel makers, when they ramp 4K panels and improve yields, when do we hit an inflection point in terms of releasing cost down, especially with oversupply likely on panel? And as that happened in the past and that brought panel prices down quite a bit.

So when do we hit that inflection point whereby TVs, 4K TVs also would certainly be falling in pricing meaningfully as well? When do you think this happens?

It is really hard to tell. People are talking about panel makers controlling their inventory and also even cutting back their capacity utilization and hoping to stabilize the market.

Which panel makers? The Chinese?

Well, I think across the board, almost. Just everyone are contemplating about this and taking some actions towards it. However, first the certain key 4K TVs and also people are hopeful, for example we are talking to a few customers who are trying to strategically move the mainstream TV panel from 32 inch to 40 or even above. So they are fresh trends.

So I think there is overall atmosphere of uncertainty at the moment going around. And so people are not calling quit yet. So they are not really lowering their capacity utilization big time yet. On the other hand, people are obviously very cautious about the current macro environment.

Okay. Thank you. I will get back in the queue.

Yes. Sure.

Thank you. Our next question comes from Jaeson Schmidt with Lake Street Capital. You may begin.

Hi guys. Thanks for taking my questions. Jordan, I know there is a lot of moving parts and the overall macro is causing some headwinds, but are you confident that Q3 can be the trough from a revenue standpoint?

I think so, yes. The answer is yes.

Okay. And then looking at the small panel segment, has there been any change in the competitive landscape? Are you seeing any new companies gaining share? Do you think your share has remained fairly stable?

I think there aren't really major newcomers. There are a bunch of us competing against each other over the last few years. So I think no notable newcomer. However the dynamics of the industry does affect several IC players' performance short-term. For example, while iPhone was gaining market share globally, including their penetration into China we suffered, right, because they are getting market share and their supplier therefore were gaining market share and vice versa.

And I think it is fair to say that, if you look at the global landscape, we are relatively more exposed to Chinese end customers compared to some of our leading peers. And certainly China, in the first half and also later last year, I think performed relatively poor. If you look at IDC's forecast, they expect this year the global mobile shipments to grow about 11%, but Chinese smartphone growth is only forecasted to be 2.5%.

So China, after I don't know how many years of outperforming the rest, this year, is comparatively soft. So we suffer as a result and certainly we also suffer because we do enjoy a pretty long-term solid relationship with leading Korean end customer and I mentioned earlier in my script that they are strategically moving their product portfolio towards AMOLED and our supply to them has traditionally been TFT LCD driver IC. So we suffer again.

Having said that though, I think with AMOLED driver IC, we have been working on that for years and we will be in terms of working with both Korean and Chinese makers. So hopefully we should be able to get right back sooner rather than later.

And also talking about Chinese exposure, our exposure in China, compared with some of our peers, are all geared toward higher end brands which is gaining traction compared to the traditional so-called white box among these players.

So in that regard, we also benefit. So I don't think we are losing our competitive strength, but to be fair, if you look in the first half, I think we have grown some market share because of the dynamics of the end brands, the end customers. But I think as the industry continues to move forward, AMOLED, LTPS, higher end panels and also Chinese leading brands, I think these will play to our advantage. So we are pretty confident we should be able to rebound soon.

Okay. And the last one for me. Jackie, how should we look at the OpEx ramping going forward? It sounds like you are making some investments in WLO and LCOS?

Well, when I think that through the first half, our expenses went up 6.7%, by the $3.9 million and eventually, as a result of the weak overall market sentiment, we started disciplining our expenses already. Other than supporting new projects like LCOS and WLO, I think our second half, our overall expenses will go down by as much as 2.5%.

So for the year-over-year, we will only expect, with all the new project included, we will only expect 1% to 2% increase in operating expenses. And so if you exclude the salary increases, the overall expenses actually goes down this year. So we will continue that expense discipline until we see some business rebound. But for our new projects, we will continue to support the requirement.

All right. Thanks a lot.

Operator: Thank you. Our next question comes from Suji De Silva with Topeka Capital Markets. You may begin.

Hi Jordan. Hi Jackie. Can you talk about the gross margin outlook intermediate-term, the puts and takes there? And maybe what's happening with panel pricing in the small and large versus typical, what kind of declines you are seeing?

After many years of gross margin expansion, unfortunately we suffer now, if you look at our guidance, two consecutive quarters of decline. I think it is mainly a matter of the macro being so weak and panel makers are under such profitability pressure and particularly in two areas. One is smartphone, because naturally the volume is declining.

So that puts price pressure on everybody.

And also another area is touch panel, in particular for Chinese leading names, given the fact that they are aggressive for capacity expansion plans on the paper. So people are still there. Their future products and therefore that gives them better bargaining power in the short-term. I think, as a trend, if our non-driver percentage goes up, our gross margin will go up. So I just mentioned earlier, hopefully that is likely going to be the case in Q4.

However bear in mind, our driver IC remains the backbone of our business and indeed the industry is suffering from poor macro environment and we are suffering from pricing pressure.

So I think Q4 while non-driver certainly will help, but driver, it's hard to tell. Certainly we hope, it will start to stabilize, but I really cannot overpromise.

Understood. And then the share movement in the smartphone market, do you think the China customers that have gained share back from Apple, is that sustainable from where you sit? Or is that a dynamic that will go back and forth for you, as far as you can tell?

I think it is likely to go back and forth, Apple, who knows how their new launch is going to be like, right. So it really depends on the how fancy, how popular their new product launch is likely to be. But I think it's fair to say that the fact they are grabbing such a big piece of the market in such a short period of time, I think that is over. But whether they will lose market share from here and over in China is hard to tell. I think their new iPhone is, certainly we don't know much about it, right.

Okay. That's fair. And then lastly, can you quantify to some extent the capacity expansion you are in the wafer level optics area, just to understand the magnitude there? Thanks.

Unfortunately, we cannot disclose too much detail, because as you would appreciate our current projects are very much tied with a small number of key customers' production plan. So by disclosing too much, we are affecting their production plan and so on.

So unfortunately we are not allowed to do that. But we talk about $40 million planned expansion. That certainly includes land facility and equipments, right. And that covers both LCOS and WLO. And what I can tell is that if things go well and goes as planned, we will continue to expand from there.

So that is why the size of the land we acquired is significantly larger than the need for first phase. And another thing I want to point out is that both WLO and LCOS, because of the very nature of their tiny size, LCOS is called microdisplay for a reason because compared to a smartphone, which is about four point something, five point something inch in size, our LCOS is typically about point two something inch in size.

So they are tiny. Ditto for WLO. They are tiny in size. Their pixel is also much, much smaller in size. That makes it a lot more difficult to master. So what I want to highlight is that, this is not really a capital intensive business similar to semiconductor, DRAM or TFT LCD.

This is asset light and keeping a certain size of asset investment, the potential revenue and profit is significant compared to other industries. And another thing I want to highlight is that we mentioned that the $40 million, we will finance this internally. So there is not going to an equity raise or any such things in the pipeline.

Okay. Thanks for the color, Jordan.

Thank you.

Thank you. Our question is from Mike Burton with Brean Capital. You may begin.

Hi. Thanks for letting me ask the questions. First, two parts. It sounds like you have some confidence in large panels trending in the fourth quarter and I realize it's early to talk about the December quarter, but is that predicated upon a certain 4K penetration level? And then secondly, on the small midsized panel, can you give us your thoughts on the size of the inventory correction in the Chinese smartphone area? And how long you think it will take to digest the inventory out there? Thanks.

Actually I stopped only at second question. Small and medium-sized, actually the industry is now light overall. And that is why when there is a surge in sudden demand, on the customers' side, they chase us for immediate supply.

And that's exactly what you saw in our end of Q2 and that is why our Q2 result was slightly better than our guidance, right. So that is a reflection. That was mainly because of a short-term surge, with very short notice in smartphone. And that indicates that the industry supply chain overall is actually even [like the] inventory, I would be a lot more cautious on the inventory when it comes to large panel. I mentioned earlier large panel because panel makers, their equipment depreciates, right? In particular those advanced sets such as those Gen 8.5. So they are very reluctant to lower their iteration, unless the demand is really, really too weak. And I think they are not seeing that yet. So while we are seeing again they are still pretty high in the LCA, meaning front-end utilization, but they are more cautious on back-end utilization, meaning module like utilization.

Now if it turns out well, meaning if the demand rebounds, certainly they will be in a good position because of their front-end inventory. They will be in a good position to supply the short-term, to satisfy the short-term demand and that will benefit guys like us because our driver IC is part of their back-end. And certainly if the market remains weak or even becomes worse than the current situation, then the panel makers will really have to readjust their strategy.

Okay. Thanks. And then on OLED, are you shipping any AMOLED drivers at this point? And when do you expect you will go into production for that? And then help us understand what that does to your ASPs and gross and operating margins?

We are only shipping a small volume AMOLEDs. But if you ask me if we are shipping them? Yes, we are shipping them, however a small volume. More significant, hopefully will start from Q4. And hopefully we will rapidly starting next year. We spoke to Korean and then they ask the Chinese panel makers. Quite a few Chinese panel makers are building a new AMOLED site and we are their partner of choice for driver IC, just to provide everyone of their projects. So we are actually seeing exciting progress that they are making in terms of taking their new production line to mass production.

And gross margin, you want to?

Yes. I think the gross margin will be higher for the AMOLED driver IC versus the normal TFT LCD driver IC.

They typically require the certain tailor made effort. And that is why I think competition is a little intense and gross margin is higher.

Okay. And then just a follow-up on that, you mentioned that you are shipping some small volumes. Is that across the customer base? Or really kind of more in the Chinese customers at this point? And then the other question and my last question will be just on the in-cell. You talked about shipping in Q3, Q4. Could you just assess the competitive landscape for us there? Thanks.

Okay. First question. Our AMOLED is only to small selective customers right now only for the small volume. And in-cell competitive landscape, certainly our customers are traditional TFT LCD panel makers and just about everyone in China and Taiwan are focusing very much on that. And certainly if this industry takes off, it very much plays to their advantage compared with traditional touch panel providers because effectively they are taking their touch panel providers market and become end product market to be part of the TFT LCD market.

And also, this is especially true when the demand is weak and heavy in-cell panel manufacturing not only adds to their value but also helps utilize their capacity because it means further progress in their TFT LCD manufacturing process. Okay. So that is why TFT LCD makers are very much incentivized to make this happen. And of course, just about everyone of them, we are their partner of choice, together with probably one or two others.

And one, I will be reluctant to comment directly on my direct competitors, but one thing I want to highlight is that those are two TDDI. As you know, you need to have both driver IC and touch panel controller products under one roof and we are arguably the only one, the leading player right now with both being grown organically from in-house.

So we didn't have to go around and merge or acquire another company to achieve this. And this certainly not only lower our financial burden, but also very importantly our internal communication integration is a lot more effective compared to some of my peers who I heard is still struggling with trying to make their acquisitions work. So the short-term, while it's holding back the industry right now, however we feel the yield challenge faced by our panel maker customers, right.

So though in theory, if you put the integrated TDDI IC and you compare that in cost with the traditional P2P solution, i.e. driver IC plus touch panel controller, on IC side, you are really selling cost, because TDDI requires small I/O pins and also it requires certain line buffer which adds to its cost. So it is not really a cost-saving solution on the IC side. However, in theory it is a cost-saving solution for the panel side overall because, as I said, you just need to add a few product sets to your existing TFT LCD production process and that's it.

However in those projects, it is early stage, it's still a challenge, in terms of year, right. So that is why on-cell is also our short-term focus before in-cell becomes truly successful. On-cell provides a very sensible short-term solution. It provides a light weight, the improved height of the module and it is easier to master and causes short-term competitive advantage. And that is why we are actually putting a lot of focus in the short-term on on-cell as well with good design win results.

Okay. Thanks.

Thank you.

Thank you. Our next question comes from Jay Srivatsa with Chardan Capital Market. You may begin.

Yes. Thanks for taking the questions. Jordan, on AMOLED business with the large Korean customer, have you done qualified yet? And if so, when do you expect the ramp up to start in terms of providing to that customer?

We have got qualified, yes. Fully qualified. In fact, compared to some of our peers, who are still struggling with things like ESP and other things. When would that mass production start? I think certainly it depends on how successful in their bidding for new projects with leading brand names. Obviously, I cannot discuss or comment too much, but we said in our prepared remarks that we expect our AMOLED solution to start mass production in Q4.

Okay. And then in terms of the LCOS, obviously you are starting your factory, you feel pretty good about the demand ramp. Just in terms of production capacity, where are you at now today and what do you expect that capacity to be by the end of the year and again going into next year?

We have said repeatedly in the past that for our standard commodity LCOS offering, our current capacity is 300,000 a month, okay. But that is a qualified statement because that is our standard offering, which compares to some of our tailor made products with branded customers are smaller in size and lower in resolution. And that is one thing. So if you talk about our current capacity for the existing major projects, it is small at 300,000.

I cannot disclose actually how much it is, but it is quite a bit smaller than 300,000 because of the reason I mentioned on the tunnel effect that LCOS, almost without exception, requires certain tailor made efforts when it comes to a customer's design, some of which actually requires new processes and new equipments. We very often have to develop the equipments in-house to make that happen. And our current major project does involve pretty complicated design and manufacturing, right.

And so that is why the qualified statement of 300,000 a month is a size that we cannot reach with our current design with major customers. But it is fair to say that the capacity for this project is between 100,000 to 200,000 a month. And for that we can fully satisfy for that capacity. And if we do need to expand and we told about the $40 million expansion plan and that involves some of this. If we do need to expand, our first stable expansion will be on the module process which is much less in capital requirement compared to the front-end process.

So there will be still quite a bit before we need to expand the front-end, right. But we do need the space. That is why we are thinking, we are planning for the expansion projects. When it comes to LCOS, it is primarily to expand the module process, i.e. the back-end. Certainly that also involves the expansion in our WLO facility as well.

Okay. So if and when the factory materializes in the next 12 months, what level of capacity ramp would you be able to support at that point?

It really depends on the customer's demand which, on the one hand is confidential, on the other hand is still a subject for discussion at the moment. But what we can say is that our existing capacity for their product is between 100,000 to 200,000 a month. And we do have a plan for expansion.

Okay. Thank you very much.

Thank you, Jay.

Thank you. Our next question comes from Tom Sepenzis with Northland Capital. You may begin.

Hi. Just a follow-up on the last one. In terms of growing the capacity for the LCOS and WLO, do you have any guaranteed commitments in terms of volume next year for those products? Or are just doing this on speculation?

For such tailor made product, we are inevitably the sole supplier. And by nature it is highly difficult, if not impossible to change. So we don't really ask for guaranteed supply. We start assuming that our customers are trying to commercialize a new concept of device which is AMOLED device. So there is business review involved, right. So we don't really ask for a commitment as such. However we do ask for very transparent and close communication and collaboration. And surely they have a plan but even if I am shared with the plan, I cannot share with you guys. That's quite obvious. But what I can say is, we work very closely together and both sides are fully committed to making it happen. We understand that business is very, very new.

Great. Thanks. And then I think you mentioned that automotives is growing in the mid-teens for the remainder of the year? And I am just wondering if you could size that in terms of what percentage of revenue the automotive market represents for you now? If it's above 5% or still very small, like 1%?

Well, yes. Tom, I think second quarter, our overall market share is close to 25%, right, for the driver IC. Our share, right. Our market share.

No. I was just saying how big is automotive for you?

Currently we are generating over $55 million in revenue a year.

In automotive?

Yes.

Great. Thank you. And then lastly, I think you mentioned on an earlier comment, that the small to medium panel inventory is actually light in China right now. So I am just curious as to if that's the case, why would we be expecting September to be down sequentially?

Based on customer's forecast. Customers are very, very cautious about their focus and they are only willing to provide a conservative focus. Expecting we would be able to make the delivery when demand comes, even with uncertainty.

Yes. So if the demand picture were to improve here, then that could turn around pretty quickly?

Yes. Definitely. Certainly the recent China stock market crash, certainly that doesn't help, right. Consumers are not really in the mood to get a new phone. So we just have to wait and see. But certainly for sure, customers are gearing more towards higher end designs, such as HD720 and OLED, that plays to our advantage. Because their volume state is already low, so with their demand they want to hopefully increase their value by moving towards higher end.

Great. Thank you so much.

Thank you.

Thank you. Our next question is from Daniel Heyler with Bank of America. You may begin.

Just wanted to follow-up a little bit on the AMOLED. Thanks, Jordan. So that customer in Korea, has been known really in-source and do as much in-house stuff as is possible. Obviously they have capacity to use in things. So I am wondering and that's been a very volatile business, I am wondering how you think about that business? I heard that you want to diversify into the Chinese players as well, but just until that Korean doesn't seem so volatile? I just wonder whether this is going to be a problem going forward and whether there is a lot of risk to that AMOLED ramp or not?

I think to separate the Korean market, they have a big end product market which is smartphone and also they have a big panel market. And certainly the two leading brands have both, right. And their end product don't necessarily use 100% of their in-house supply and their panel capacity doesn't necessarily supply exclusively to their own demand.

And in this particular case with the customer, because AMOLED position I think in the past they couldn't satisfy even their internal demands and now with the internal demands becoming weak, they are looking into supplying to the outside especially China and for which they need a very strong partner. And that is certainly one of the reasons we have been now picked to be a partner because if they rely on their traditional Korean partner, their progress, in terms of penetrating into China will be most challenging, right.

And they claim that with the volume they have, with the maturity of manufacturing and technology and what not they enjoy so far, their AMOLED product can compete with TFT LCD panels. And obviously they are Koreans still enjoy the leadership in the business, right. So I think it is everybody's customer of choice. If you want to get started that you get a relationship with Korean players because Chinese after all are still latecomers in the camp. And lastly, as you rightfully pointed out, we do want to diversify and being able to work with Korean leading customer, certainly is a major, major plus for us.

Thank you. This concludes the Q&A session. I would like to turn the call back over to Jordan Wu for closing remarks.

Thank you, everybody, for taking the time to join today's call. As a final note, Jackie, our CFO, will maintain investor marketing activities and attend investor conferences in the US and Asia. We will announce the details as they come about. Please contact our IR department and/or Adam Holdsworth if you are interested in speaking with the management.

On a side note, we have recently redesigned our company website to reflect the new developments of Himax. So please do take some time to explore our product line that we take deep pride in. Thank you again and have a nice day

Thank you. Ladies and gentlemen, this concludes today's conference. Thanks for your participation. Have a wonderful day.