奇景光電 (HIMX) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Himax Technologies third quarter 2016 earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will follow at that time. (Operator Instructions). As a reminder, this conference call may be recorded.

I would now like to introduce your host for today's conference, Greg Falesnik, Managing Director with MZ North America. Sir, you may begin.

Thank you, operator. Welcome everyone to Himax's third quarter 2016 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 email greg.falesnik@mzgroup.us, 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'd like to remind everyone that some of the statements in this conference call, including statements regarding expected future financial results and the industry growth, are forward-looking statements that involve a number of risks and uncertainties that could cause actual results or events to differ materially from those described in the conference call.

Factors that could cause actual results to differ 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 at Himax, demand for end-use application products, the uncertainty of continued success in technological innovations, as well as other operational 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, 2015 filed with the SEC in April 2016.

Except for the Company's full year 2015 financials, which were provided in the Company's 20-F and filed with the SEC on April 13, 2016, 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 subject 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.

I will now turn the call over to Mr. Wu. Jordan, the floor is yours.

Thank you Greg. Thank you everybody for being with us for our earnings call on which we will detail results from the third quarter of 2016 and provide our fourth quarter 2016 guidance and outlook.

Our CFO, Jackie Chang, will give further specifics on our financial performance after my overview.

We are pleased to begin by saying that our revenues, gross margin and EPS for the quarter were in line with our reiteration of guidance on September 29.

For the third quarter, we reported net revenues of $218.1 million, at the high end of our guidance with a gross margin of 25.6%.

Third quarter GAAP earnings per diluted ADS came in at $0.079 and non-GAAP earnings per diluted ADS were $0.124, also meeting the higher end, or exceeding our guidance.

The third quarter revenues of $218.1 million represented an 8.5% sequential increase and a 31.7% increase year over year. Both the sequential and year-over-year growth was due to continual growth momentum across all our major product lines, driven by large panel driver IC sales, benefiting from our leading market share in China and in 4K TV, our better than expected smartphone driver IC sales and accelerating AR/VR related business from our leading US customer.

Revenue from large panel display drivers was $72 million, up 6.6% sequentially and up 42.6% from a year ago. Large panel display driver ICs accounted for 33% of our total revenues for the third quarter compared to 33.6% in the last quarter and 30.5% a year ago.

As opposed to original guidance of double-digit sequential growth, our large panel driver business grew just mid-single digit due to a certain customer's short notice shipment adjustment of its monitor products. Without the last minute change, we could have achieved double-digit sequential growth that we guided.

Despite the lower than expected sales mentioned above, our large panel products actually enjoyed more than 40% year-over-year growth thanks to strong demands from our Chinese and Taiwanese panel customers during the quarter.

In China, our drive IC business for large panel grew more than 70% year over year during the quarter. In comparison, worldwide large panel TFT-LCD panel shipments declined around 6% in the same period.

It is especially worth highlighting that our engineering collaboration and design activities with large panel customers across China, Taiwan and Korea all remain robust and we expect these trends to continue into the next year.

Revenue for small and medium-sized drivers came in at $99.3 million, up 9.6% sequentially and up 17.8% year over year. Driver ICs for small and medium-sized applications accounted for 45.5% of total sales for the third quarter as compared to 45% in the previous quarter and 50.9% a year ago.

Sales into smartphones came in better than guided to achieve low single digit growth sequentially and up more than 20% year over year as we fulfilled some of the surging rush orders of late from Chinese end customers through securing additional capacity from our supply partners.

The strong rebound of our smartphone driver IC business this year came from our longstanding leading market share in China where our end brand customers are performing strongly.

Automotive and tablet applications were also contributors to the segment and continued solid momentum, growing double digit during the third quarter, both sequentially and year over year.

Revenues from our non-driver businesses were $46.8 million, up 9% sequentially and up 52.1% from the same period last year. Non-driver products accounted for [21.5%] (corrected by company after the call) of the total sales, as compared to 21.4% in the previous quarter and 18.6% a year ago. The sequential growth was led by the LCOS and WLO shipments for AR applications. Other product lines, such as timing controller, touch panel controller, and ASIC, also enjoyed sequential growth.

The performance of LCOS and WLO increased several folds year over year thanks to shipments to our major AR customer.

The year-over-year growth was partially offset by the decline of programmable gamma OP, power management IC, and CMOS image sensors. We expect, however, the LCOS and WLO shipments to slowdown starting fourth quarter 2016.

We remain positive on the long-term prospects of these two product lines, judging by the numerous customers we have engaged, many of which are the world's biggest tech names and the busy engineering activities going on with such customers right now. I will elaborate further a bit later.

Our GAAP gross margin for the third quarter was 25.6%, down 50 basis points from 26.1% in the previous quarter and up 380 basis points from the same period last year. We have been able to maintain a relatively strong margin this year mainly thanks to a more favorable product mix in small and medium-sized driver ICs, increased LCOS and WLO shipments and certain engineering fees from AR/VR-related new project engagements. Gross margin improvement remains one of our business focuses.

In summary, we are pleased with the overall performance of the third quarter 2016.

Jackie Chang, our CFO will now provide more details on our financial results. After Jackie's presentation, we will discuss about the fourth quarter guidance and the insight on our business, markets and strategies going forward. Jackie.

Thank you, Jordan. I will now provide additional details of our third quarter financial results.

GAAP operating expenses were $40.4 million in the third quarter of 2016, up 32.2% from the preceding quarter and up 4.9% from a year ago. The significant sequential increase was caused by the $9.2 million 2016 RSU grant we have traditionally expensed in the third quarter, which was considered in our guidance.

As an annual practice, we reward employees with an annual bonus at the end of September each year, which always leads to a substantially increase in the third quarter GAAP operating expenses compared to the other quarters of the year. This year, the annual bonus compensation, including restricted share units, or RSUs, and cash payouts, totaled $12 million, out of which $9.2 million was vested immediately and expensed in the third quarter. The remainder will be vested equally at the first, second, and third anniversaries of the grant date.

Excluding the RSU charge, our third quarter operating expenses were $31.2 million, up 2% from the previous quarter and down 8.2% from the same quarter 2015.

GAAP operating margin for the third quarter of 2016 was 7%, up from negative 1.5% for the same period last year and down from 10.9% a quarter ago. The GAAP operating income decreased 30.2% sequentially, but increased 721.5% year over year. The sequential decline was mainly a result of the higher RSU expense to compensate the team for the much improved profitability of the year.

Third quarter non-GAAP operating income, which excludes share-based compensation and acquisition-related charges was $25.1 million, or 11.5% of sales, up from 1.6% from the same period last year and up from 11.1% a quarter ago. The non-GAAP operating income increased 12.1% sequentially and 835.7% from the same quarter in 2015.

Our GAAP net income for the third quarter was $13.6 million, or $0.079 per diluted ADS compared to $19.8 million, or $0.115 per diluted ADS in the previous quarter, and GAAP net loss of $2.3 million, or $0.014 per diluted ADS a year ago.

GAAP net income increased 683.1% year over year due to a higher revenue and much improved gross margin, but declined 31.3% from the previous quarter due to the $9.2 million 2016 RSU charge in the third quarter.

Non-GAAP net income actually increased 5.7% sequentially. Third quarter non-GAAP net income was $21.3 million, or $0.124 cents per diluted ADS compared to $20.2 million last quarter and $1.7 million the same period last year. Non-GAAP EPS exceeded our $0.10 to $0.12 guided range.

Turning to our balance sheet, we had $153.4 million of cash, cash equivalent and marketable securities as of end of September 2016 compared to $126 million at the same time last year and $179.3 million a quarter ago. We made a cash RSU payment of $9.2 million and a dividend of $22.3 million during the quarter.

On top of the above cash position, restricted cash was $138 million at the end of the quarter, same as the preceding quarter. The restricted cash is mainly used to guarantee the Company's short-term loan for the same amount. Himax continues to maintain a very strong balance sheet and remains a debt-free company.

Our inventories of September 30, 2016 were $169.4 million, down from $177.7 million a year ago and down from $186.7 million a quarter ago. The lower inventory was the result of increased shipments in the quarter.

Accounts receivable at end of September 2016 were $208.4 million as compared to $168 million a year ago and $187.9 million last quarter.

Days sales outstanding was 95 days at the end of September 2016 as compared to 89 days a year ago and 90 days at end of the last quarter.

Net cash inflow from operating activities for the third quarter was $2.9 million as compared to an inflow of $14.1 million for the same period last year and an inflow of $13.1 million last quarter. The year-over-year decrease was the result of higher receivables, although net profit actually increased.

The sequential decrease in cash flow was mainly due to increased receivables from higher sales and a decrease in accounts payable as more payments made at end of the quarter. We expect a significant operating cash inflow in the fourth quarter and for the full year.

Capital expenditures were $1.9 million in the third quarter of 2016 versus $2.6 million a year ago and $1.7 million last quarter. The capital expenditure in the third quarter consisted mainly of purchases of R&D related equipment. As of September 30, Himax had 172 million ADS outstanding, little changed from last quarter. On a fully diluted basis, the total ADS outstanding are 172.4 million.

I will now turn the floor back to Jordan.

Thank you, Jackie. We delivered solid results to achieve both top and bottom line growth during the first three quarters of the year as our driver and non-driver business segments both performed strongly.

We have increased market share in our core driver IC business this year and continue to solidify our leading position through technology advancement and customer engagement.

With the most comprehensive product portfolio in the industry, we will further capitalize on our strong position in display drivers to lead the market in major new technology trends, including higher display resolution, AMOLED and in-cell TDDI.

Equally important, Himax has many unique technologies and solutions for AR, VR and IoT applications with exciting long-term growth potential.

For LCOS micro display and WLO products, which are integral parts of the ecosystem of the booming AR sector, we continue to increase new project engagements with many heavyweight customers worldwide. We remain committed to our long-term strategy to diversify our products and customer base with innovative technologies.

With that, I will now provide our fourth quarter guidance followed by a more detailed outlook.

The fourth quarter is typically a low season for the semiconductor industry. For the fourth quarter 2016, we expect revenue to be down 4% to 9% sequentially.

Gross margin is expected to be slightly down sequentially, depending on our final product mix.

GAAP earnings attributable to shareholders are expected to be in the range of $0.085 to $0.11 per diluted ADS based on 172.4 million outstanding ADSs.

Non-GAAP earnings attributable to shareholders are expected to be in the range of $0.087 to $0.112 per diluted ADS based on the same number of ADSs.

In providing the above earnings guidance we have assumed a 14% income tax rate for 2016 calculated based on exchange rate of TWD31.5 against the USD, which is also the exchange rate as of the beginning of November.

Now let me provide you with some details behind our guidance and trends that we see developing in our businesses.

Our large panel driver IC business has grown from Chinese panel customers' rapid capacity ramping and rising 4K TV penetration this year. For this quarter, we anticipate our large panel driver IC revenue to increase high-single digit year over year but to decline mid-single digit sequentially due to one single customer's inventory adjustment.

Despite the temporary demand slowdown, our leading position in this segment remains intact. Our large panel customers are increasingly demanding a total solution from IC vendors in addition to their constant request for better IC solutions to support their high-end and high-resolution products.

On top of our unique offerings of technology solutions for advanced features required of high-end TVs, our capability to provide a total solution covering driver ICs, timing controllers and PMICs especially positions us very well in the 4K and 8K display markets.

For example, to handle the massive amount of video data, 8K TVs require higher speed interface, advanced driving and video processing technologies as well as highly integrated timing controllers with sophisticated functions.

We believe our technology strength and total solution capability are significant differentiators against our competitors and will further solidify our leading position as the industry migrates to 8K TVs.

We are one of the pioneers in product development of 8K TVs with our Chinese and Korean panel customers and are already shipping small volume to a leading Korean panel maker.

The other segment with our driver IC business is ICs used in small and medium-sized panels for applications, including smartphones, tablets and automotives. While the market demands remain strong, fourth-quarter sales for smartphones are likely to decline mid-single digit sequentially due to the foundry capacity constraints. However, the sales of smartphone DDICs will still grow close to 30% year over year driven by Chinese end brand customers' strong shipment growth this year.

Our AMOLED front, we are collaborating closely with leading panel makers across China for AMOLED product development. This positions us well for the coming growth of new AMOLED panel shipment expected from these customers, starting late 2017.

We have seen wider adoption of AMOLED panels, now almost exclusively supplied by Samsung, for smartphone brand customers' flagship models. This trend has prompted all leading Chinese panel makers to ramp up their investment in AMOLED manufacturing and accelerate their timetable for the mass production of AMOLED panels. We believe AMOLED driver ICs will be one of the critical growth engines for our small panel driver IC business, starting the end of 2017.

Among driver ICs used in small and medium-sized panels, the most noteworthy category in recent years is automotive applications. We expect continued solid momentum in Q4 with revenues expected to grow double digits sequentially and close to 50% year over year. With numerous tier 1 automobile brands as our indirect end customers, we have successfully engaged all key panel manufacturers and module houses worldwide for long-term partnerships and command a leading market share in this segment.

To address the growing demand of large automotive displays with higher resolution and built-in on-cell or in-cell touch screen feature, we continue to develop advanced solutions to enable new automotive display applications and provide our customers with the most comprehensive solutions in the industry. As such, we anticipate the strong growth will likely continue into the next few years.

Driver ICs used in tablets will continue to grow double digits in Q4, following Q3's strong momentum, thanks to shipment for several leading brand customers in the US and Korea and the holiday season impact.

Overall, we expect the small and medium-sized driver IC segment to increase sequentially by low single digits in the fourth quarter.

For the last few years, the non-driver business segment has been our most exciting growth area and a differentiator for Himax. New product developments continue to evolve and gain traction. While we are more positive than ever on the long-term growth prospect of our non-driver businesses, we anticipate near-term headwinds with about 20% sequential decline in our non-driver revenues for the fourth quarter.

Sales of timing controllers and CMOS image sensors will deliver strong growth in the quarter, but those of WLO and LCOS micro displays and, to a lesser extent, touch panel controllers and ASIC chips will decline sequentially.

I will now highlight some of the non-driver product lines. First, our touch panel controller product line. We have seen significant traction in customer adoption and design wins of our on-cell solutions. Notably, a leading Chinese smartphone maker is featuring our solution in its newly launched flagship tablet.

More importantly, we are one of the pioneers in offering TDDI solutions and are in partnerships with essentially all of the display makers of state-of-the-art pure in-cell touch panels for joint technological development. We are seeing the use of in-cell display with TDDI rapidly becoming the preferred choice for smartphone brand customers' next generation mid-to-high end models.

Also, the increased adoption of AMOLED panels has pushed TFT-LCD panel makers to turn to pure in-cell TDDI panel development for thinner display designs.

On top of the very busy design activities for TDDI solutions with Korean, Chinese and Taiwanese panel customers, we are also aggressively developing new products and strengthening our team to expand our product portfolio and get ourselves ready for the anticipated strong growth in this segment. TDDI will be a major growth engine for our small panel business starting early 2017, which will also boost our corporate gross margin over time.

I will now turn to the LCOS and WLO product lines. Our LCOS and WLO businesses have grown strongly through the first nine months of 2016 mainly due to shipments to one of our leading AR device customers. We were recently informed by the AR customer to reduce future shipments of the current generation device to a minimum and instead to focus on the joint development of future generation devices.

We therefore expect our LCOS and WLO sales to decline in the fourth quarter, as well as over the next few quarters in 2017. We are not particularly worried about the short-term headwind as the said major customer is more committed than ever in the long-term development of the AR product concept, which is viewed as a new computing platform and that Himax remains a critical partner to the customer in these AR efforts.

Equally important, while the revenue from LCOS and WLO may subside over the next few quarters, they will come from a much more diversified customer base. Quite a few of our other customers are expected to bring their AR products to the market starting next year, although we still don't expect large volumes from the early generation products of these customers.

Not only will we see more diversified revenue stream from multiple customers, our list of customers continues to expand and it now covers some of the world's biggest tech names. Such customers usually come to us for tailored solutions and pay for such developments. This is clear evidence for our undisputed leadership position in the industry.

Having invested in related technologies for over 15 years, we are uniquely positioned as the provider of choice for micro display and related optics, both of which are critical enablers to AR devices.

With little competition in sight, we are currently working with over 30 customers on various current and future generation AR devices using LCOS micro display and/or WLO. Our increasing design engagements cover not only leading companies mentioned above, but also niche AR players which bring in innovative product ideas.

In addition to many AR devices under development, our WLO technology is also being adopted to enable new things such as 3D scanning, which can in turn be used in a wide variety of industries, such as consumer, industrial, IoT, AI, medical, automotive and military.

Some customers even come to us with novel bio-medical product ideas. Our customer base for this business is extremely diversified, again covering literally all of the most well-known tech names throughout the world, many of them leading end brand players or semiconductor platform solution providers.

Himax is one of the very few players in the market with WLO technology and the one possessing the most proven mass-production track record, with expertise ranging from design and high-yield production to cost and quality controls. We are very happy with our current development progress in this area.

With respect to the expansion plan for our next generation LCOS and WLO production lines, we are pleased to report that we have proceeded in line with our schedule. We plan to complete it around the end of 2017 or early 2018. The new production lines will enable higher-end product design and offer far better product quality for mass production of our next generation LCOS and WLO product lines that we expect will lead the industry in the future generation of related products. This investment will be financed through our internal resources and existing bank facilities, if needed.

We continue to make great progress with our new smart sensor areas by collaborating with certain heavyweight partners, including a major e-commerce customer, leading consumer electronics brands and a heavyweight international smartphone chipset maker.

By pairing a DOE integrated WLO laser diode collimator with a near infrared CIS, we are offering the most effective total solution for 3D sensing and detection in the smallest form factor, which enables easy integration into next generation smartphones, AR/VR devices and consumer electronics.

Similarly, our ultra-low-power QVGA CMOS image sensor can also be bundled with our WLO lens to support super low power computer vision to enable new applications across mobile devices, consumer electronics, surveillance, drones, IoT and artificial intelligence. We will report business progress in these new territories in due course.

Regarding other CIS products, we remain in a leading position in laptop applications and will increase shipments for multimedia applications, such as surveillance, drones, home appliances, consumer electronics, etc.

And that concludes our non-driver business discussion. Thank you for your interest in Himax. We are now ready to take questions.

(Operator Instructions). Our first question comes from the line of Tom Sepenzis with Northland. Your line is open.

Hi. Thank you for taking my (technical difficulty). The first question, I just would like to get a further clarity (technical difficulty) and when you think that's going to impact on the Company. One of your competitors is seeing growth already. So I know that you were one of the first to offer (technical difficulty), but it sounds maybe you haven't seen significant wins yet that have led to actual revenue and EPS (technical difficulty) scrip and that's something that comes next year.

Tom, you were a little on and off and I'm guessing you were referring to TDDI products, am I right?

Yes. Sorry, I was just asking, it seems like TDDI is going to start for you, whereas one of your biggest competitors here in the US is seeing an incredibly strong ramp right now in TDDI. So I'm just wondering if you feel like you've gotten behind their (technical difficulty) catch-up?

Yes, it's a good question and thank you for raising the question. We have mentioned in our prepared remarks that while we have made some shipments already, but they are not really that significant compared to the US competitor that you have mentioned right now.

And we mentioned, starting from Q1 next year, we expect to see volume shipments. And I believe our ramping for our TDDI products will be very fast quarter after quarter next year. And in a few quarters' time it will be a major contributor to our revenue and profit.

Now, as far as why we are so called behind compared to that US competitor of ours, I think that company comes with primarily a touch panel controller background. Historically, when touch panel is discrete from display, it is the end device maker such as smartphone makers, people like Huawei or Xiaomi, choosing the touch panel controller, while sourcing panels from panel makers, which in turn pick their driver IC providers, guys such as ourselves.

So, we have traditionally been serving panel makers while our US competitor because of our nature of being a touch panel controller provider, they are serving the end device makers.

Now, the touch panel and display panel are now being merged into one to form in-cell. In-cell will be provided by our traditional customer base, which is TFT-LCD makers. However, it is only very beginning stage right now. For example, one of our biggest Chinese customers, they are now using their Gen 6 to produce in-cell panels. They do have a plan to move into Gen 8.5, which is in design stage, but is not in mass production yet.

We are, meaning what I'm trying to say is that you are going to see next year more panel customers with even bigger capacity coming into the market with TDDI offerings. So what you are seeing right now, while the momentum, the growth momentum is really impressive and exciting, it is only the beginning of this very big long-term growth, we believe, for TDDI.

So our panel makers, who are already very used to driver IC technology because of their longstanding panel business, however, to adopt to a touch panel controller technology into as part of their products is totally new to them. So in their very early stage of IC vendor selection, they tend to select people with very longstanding touch panel controller background to minimize their technical risk for TDDI, or for their in-cell products.

People like us, driver IC makers with the capability of also providing touch panel controllers, i.e. TDDI, are then brought in as the alternative backup source in the very beginning stage of the ramp.

We, I guess, along with many of our panel maker customers, believe eventually and I believe in the not too distant future will surpass the volume of the early movers because of our longstanding relationship in technology development experience and business relationship with panel makers, which is really our turf.

And on top of that, those IC vendors come in with touch panel controller backgrounds, typically they only offer small panel TDDI. They don't have large panel driver IC business, while with our panel maker customers, our relationship with them is comprehensive and widespread. Coming from TV to cell phone, from driver to timing controllers to power management IC and so on and so forth. So I think the width and depth of relationship of such panel makers to people like us is nothing to compare with people who traditionally does touch panel controller.

Now, if I compare our peers, meaning traditionally pure driver IC vendors, now try to get into TDDI, I think we are far ahead compared to our peers in terms of our touch panel IC expertise and track record.

So we are, if you'd like, compared to touch panel, we are certainly a newcomer compared to those traditionally touch panel players. But among driver IC vendors we are far ahead. We are very unique in our position in terms of being able to combine driver IC and touch panel solution to TDDI. Although for the reasons I mentioned, for risk mitigation, our customers indeed in the very early stage of production, they tend to select people with touch panel controller background. However, I think with a very comprehensive joint development engagement we have with panel makers, we are rather confident we can come from behind and surpass our competitors, hopefully starting next year.

Great. Thank you very much. I will get back in the queue.

Thank you, Tom.

Thank you. Our next question comes from the line of Tristan Gerra with Robert W Baird & Co. Your line is open.

Hi there. It looks like on the basis of your commentary that you expect continue shortages in small panel, that you see continued strong demand in the China smartphone supply chain. Any color that you could provide in terms of how that ramp is shaping up relative to real and demand and what type of seasonality and/or potentially inventory correction we could see some time in the first half of next year?

Thank you, Tristan. As you know, our end device customer base are primarily Chinese. Or let me put it the other way, non-Apple. Every non-Apple player is our customer. And I think Chinese players in particular are now really leading the pack when it comes to growth in smartphones. I think throughout the entirety of this year, and certainly the momentum is expected to continue through next year as well. So we really benefit from this.

We certainly enjoy very leading market share with end brands such as Vivo, OPPO, Huawei, Xiaomi and LeTV and so on and so forth, we really benefit from their very strong shipments. And as I mentioned, we are still in shortage, unfortunately. It's been that way for about two quarters now. That certainly the good side of it is evidence of our very comprehensive design-in base.

We are seeing the sales through to be healthy for our driver ICs and we are even hearing from customers that some of domestic customers are telling me at least first half of next year, no worries. More conservative ones, first quarter, no worries. That is not to say second half will have a problem, but certainly we don't have the visibility for that long.

But that is what literally all of my customers are telling me.

Certainly right now it's in shortage, so people are fighting to get new allocation. But I think overall, the industry supply/demand situation remains healthy. And certainly towards the end of next year, when Apple may have another major launch, then certainly it will be a major variable that we cannot predict. But as far as we can see, the leading Chinese brands in particular are enjoying very strong momentum and we benefit as a result.

Okay. That's very useful and then a quick second question. There's some industry forecast that predicts a fairly nice ramp in 3D scanning and smartphones starting next year, notably as the smartphone OEM tried to bring new features. Could you, as you've spoken about that technology on the call, could you elaborate a little bit on how you feel your position in that segment for the competition? And are your engagements limited to just one leading smartphone maker, or do you have additional engagement in smartphones for 3D scanning and what's the potential timing of one? Thank you.

Thank you. Interesting, I haven't seen the report myself, so it is very pleasing to hear that, so thank you for sharing.

We've actually got a whole bunch of customers waiting for 3D scanning solution to materialize. And our partner right now is the heavyweight smartphone chip set maker right now. So it's a joint development partnership under which the said heavyweight smartphone chip set maker together with us will co-promote a total solution, including AP and a total 3D scanning solution to the customer with the 3D scanning solution and the AP. The connection have already been taken care of by the two of us, the partnership.

So in short, we are not really targeting specific individual smartphone customer as such. We are working together with the platform maker. The beauty of this is that once the solution is ready, it can be adopted by many. And in fact, through our still rather limited joint promotion efforts, we are seeing overwhelming interest from smartphone makers. So we are not really so much worried about the end customer interest, so it is really us, the challenge is on us ourselves and our partner.

Now, the way we split the work, they provide the AP and we provide the entire what we call 3D scanning or structure light projector module. By which what I'm saying is if you imagine a projector with a laser, beaming a laser light, invisible light, through optics with a pattern, invisible pattern, which hits surroundings and bounce back and captured by a CMOS image sensor which is focus on IR bandwidth. So then you compare the outcoming pattern of the laser light and the incoming pattern being captured and you kind of compare the change of the pattern, or the distortion of the pattern. And with algorithm you can then figure out what the 3D surrounding is like on a real time basis, so this is what the solution is about.

So what we at Himax provide is the projector itself, including the laser which certainly we outsource from other people, and the entire optics are manufactured by our WLO design and manufactured by ourselves. And the related alignment, which is very, very tricky and difficult to handle. The lining is very, very ultra-precisely in between the optics and the laser. So that is the projector part.

In fact, as part of the projector solution we also provide a laser driver IC which as you know, has been our bread and butter, so why not.

And then we also provide the sensor part, the capture inside, with a state of the art sensor which is very good at the required bandwidth of IR. So we then outsource the thing to CMOS image sensor module houses to make a structure light projector module. So this is how you are going to see the 3D scanning.

Now, the 3D scanning technology is not new. It's not new at all. It's been around, but it's never been adopted by consumer electronics, primarily because number one, it's the form factor. So we are the only one in the world, I believe, as far as we can see, who can really squeeze everything I just mentioned into a size with the form factor for a smartphone, which is critically important.

And secondly, certainly it's the cost and then the power consumption. So again, based on our discussion with our chip set partner and also based on our limited promotion feedback, we feel rather positive about the product concept.

Now, we are likely to have, hopefully a major and official launch beginning of the year next year, and mass production hopefully by the second half of next year. And the beauty of our technology is that we are going to offer a roadmap for high resolution, better power consumption and better cost and also indoors and outdoors availability and so on and so forth, so there is going to be an ongoing roadmap to carry the industry forward.

So we are very excited about this and many people are hungry to see a smartphone having new features that consumers really want and like. And I think this is one of the few things that many cell phone makers are telling us that this can be one of the things. So some of them are already engaged in their internal resources and outside app developers to figure out applications for such 3D scanning technology.

I have actually tried with many of my friends and suppliers and customers a real time 3D scanning photo, just scanning my face myself, for example, but it's 3D. So the data actually is 3D and it appears on your 2D screen like very, very 3D. And because the data is 3D, you can actually export the data into your 3D printer and make a printout of my figurehead in 3D. So this is one of the applications that this can really enable, with pretty amazing resolution as well.

That's very useful. Thank you.

Thank you and our next question comes from the line of Mike Burton with Brean Capital. Your line is open.

Hey and thanks for letting me ask a question. Just a question on the gross margin guidance, guiding down sequentially year over year. Sorry if I missed this, but can you talk through some of that? The revenues are definitely up. Is it mostly just mix? Am I to assume then AR/VR is actually down sequentially? Or just kind of walk through some of the puts or takes on the gross margin line.

I think you have answered the question already yourself. It's the mix plus the AR/VR down. And the mix, I would say, excluding the AR/VR is similar. The level is similar. Our gross margin number will be similar

But we do see a gross margin for smartphone actually improving QoQ because of a high-end resolution requirement for the DDIC. That's where we are under the capacity constraint. But as we continue to ship more, we shall continue to improve gross margin.

But too bad, as I mentioned in my prepared remarks, we are limited by capacity and that happens to involve some of our high resolution products otherwise the margin would have been better. But that's just the capacity constraint.

Okay and then looking at the OpEx, that was down year over year in September. Are we expecting similar going forward into December and just how we should think about it going in the next year?

I think you should not expect dramatic up or down of OpEx next year versus this year. And this year's OpEx is slightly down so far, I mean excluding share-based compensation, right, excluding RSU. I mean including RSU, certainly this year is up compared to last year because RSU we pay out a lot more this year than last. So excluding that on a non-GAAP basis.

I think it's a combination. I mean it is not planned that way, let me just put it that way. It happened that way. Better efficiency and tape outs, depreciation in tools and stuff, so we actually continue to add a little bit of headcounts and we certainly continue to add salary this year.

So if you look at the salary expense per say and headcount, actually both increased year over year. However, I think our mask and tooling expense has been down compared to last year, not that we are trying to reduce our R&D. Rather it is just, I guess, a combination of better efficiency and it just happened that way. So you shouldn't expect next year's OpEx to be down from this year, nor should we expect next year's OpEx to be up meaningfully from this year either.

Okay. Thanks.

Thank you and our next question comes from the line of Jaeson Schmidt with Lake Street Capital. Your line is open.

Thanks for taking my questions. Just a really quick one. How much in NRE fees did you recognize in Q3 and how should we think about that revenue stream going forward?

Jaeson, we actually didn't really disclose it, but it's probably in the neighborhood of $15 million to $20 million this year in 2016. And as we continue to add customers in the joint development of AR project and also WLO project for consumer electronics and chip set platform for smartphone, etc., we would expect NRE to actually increase in 2017.

But I think I would elaborate on that, Jaeson. NRE for us is a lot more significant in terms of, for our long-term business, compared to what it shows in the P&L of that particular year. If you look at our traditional driver IC, or timing controller, or power management IC, or such businesses, we do charge from time to time, some NREs, but they are very rare, to be very honest, because this is a more commoditized market and we do offer our standard parts to many customers. So no customer would want to pay NRE for anything.

So when we say NRE, our NRE revenue started to increase probably starting from about last year and this year certainly rather significant. You can expect to see good NRE income in the next few years because of those very unique products, each unique technology area I mentioned; WLO, LCOS, AR/VR or going forward, 3D scanning and stuff like this.

NRE is not going to make you rich, but it is very important in the sense that firstly, it substantially reduces our burn rate when we are cultivating a new technology.

And secondly, it shows the customers' commitment. I don't like to see engineers in our team being engaged by a customer because their engineers are also fancy about that technology and then two groups of engineers are just working very happy and together and try to do something fancy.

No, I want to make sure my customers' engineering team are fully authorized by their management and they have to pay a rather meaningful amount to engage us for a product. That shows a lot of the customers' commitment.

So a typical NRE is in the range of a few million dollars at the minimum. Certainly there could be some small jobs and we charge a few hundred thousand dollars maybe. But a typical project can easily cost a few million dollars. And also, for these new technological areas we've mentioned, AR/VR, LCOS, WLO, 3D scanning and all these, they are so new, so they are not like a smartphone which is very, very standardized already in the industry.

So in such areas, different customers come to us with their different spec thinking. Their spec requirements are different. Even their application is very different, so quite often we don't even thought of their application before they come to us.

I just mentioned in my prepared remarks there is a very exciting biomedical application that really blew me out. I didn't imagine people could use our WLO technology to do stuff like that.

And for such things certainly we charge them an NRE because technology is unknown to us and we need to make sure the customer is committed and then quite likely we are making something really tailored for them and exclusively for them, so it's only fair.

But having NRE, typically it indicates that in mass production, the gross margin is good, because it means there is no competition and we are always the sole source and indeed very, very likely it involves a very unique product of our customers, meaning we are really adding value.

And more and more we are moving from being a component supplier to a solution provider. The structure light projector that I just mentioned is a very good example. It involves multiple areas of technology, including an algorithm. Meaning if you take our stuff, it is no longer a hardware component. It is really a solution which can enable real applications already. So customers love that. In particular when it comes to IoT, you don't have bulky, huge, gigantic volumes of smartphones, but you need to provide solutions, you add value. You have small volume customers, but every customer you can make a pretty decent profit out of it.

Okay, that's great.

So NRE is very meaningful to us.

Okay, that's helpful. Thank you.

Thank you.

Thank you and our next question comes from the line of Suji Desilva with Roth Capital. Your line is open.

Hi Jordan. Hi Jackie. So on the large panel segment you had good year-over-year growth here. I'm wondering is that in the prepared remarks that you expect similar growth in the 2017 timeframe. I'm wondering is there sufficient customer share gain opportunity or share gain opportunity for you to continue to grow at these rates in the large panel market?

Certainly we continue to grow. Whether at the same rate, that I cannot comment one or the other. We can continue to grow at least over the next few years, because quite simply our customers are still building fabs, big time. And with such new customers, typically in China, we are their number one vendors and that is not changing.

So for example, you are talking about BOE, another Gen 8.5, by Q1 next year, HKC also in China, Q2 next year and BOE I believe later next year or early the year after, a Gen 10 will be coming on stream as well. There's another new fab Gen 8.5 from Innolux and the CSOT I can't recall the detailed timing, but somewhere next year. I think there will be another Gen 8.5 and Panda as well, another 8.5. Yes, there we go. Panda is what they call Gen 8.6 mass production commencement 3Q18. CSOT Gen 11 mid 2019, Innolux Gen 8.6 Q1 to Q2 next year. HKC I mentioned, Gen 8.6 Q3 next year, and finally BOE at Gen 8.5 Q2 next year and Gen 10 Q1 the year after, Q118.

So a whole bunch of new fabs and all these are our customers. With many of them we are either number one or number two IC vendor. So we continue to be quite confident.

Then because of these new fabs coming on-stream our design activities with such customers are very, very busy right now.

One last thing I want to mention, last but not least. I mentioned in my prepared remarks, one of our really major advantages is the fact that we can offer driver IC, timing controller, power management IC, gamma OP and a whole bunch of other things that we can answer all their IC, all panel makers' IC issues. So there are probably just one other player in the industry that can offer the same thing, so that is really a major advantage.

Okay. That's very helpful color. Thank you.

Thank you. Our next question comes from the line of Charlie Chan with Morgan Stanley. Your line is open.

Hi Jordan, and Hi Jackie. I feel sorry that your customer delayed the project, but I believe your position will pay out.

My first question is really on your AMOLED driver IC business because you mentioned that the contribution would start from 2017 and they should be from Chinese customers. So can I confirm that your opportunity with a Korean customer already gone? May I confirm that?

I think I cannot say it's gone because we do have a project engagement with them and we actually passed qualification. So, initially, out of our business issues that we didn't really take that project into real volume in production.

Later in the day I think I suspect, I think the top management strategy from that Korean customer is that they are seeing competition; aggressive competition from Chinese, their new lines. So I think the Korean wants to outsource as little as possible to the outsiders to keep the entry barrier as high as possible and for as long as possible. I think that's what they are thinking.

So we are seeing, not just with us, we are probably one of the better ones, but with all known group company, known group IC vendors, their attitude has turned very, very conservative of late. So don't count on that but I wouldn't say it's terminated, it's gone. I mean anything is possible in business. But I will be honest that is what we are seeing right now.

Okay, that's good. My follow-up question is that you mentioned that your LCOS and WLO revenue would be small in coming quarters. So did your big customer give you any commitments or will pay you some compensation? Because I remember that in a previous quarter you have spent some CapEx and hire some labors for the new capacity. So how would you compensate those, or can I assume margin would decline in coming quarters?

Thank you Charlie for asking the question. Number one, yes we'll be compensated for the loss of volume, although obviously I cannot comment on details. I will say I really appreciate the customer has been very responsible and very fair in this regard. Also, I think the customer has been generous and fair primarily because we are seen as a long-term strategic partner to their long-term effort of AR. So this is really just the very, very, very beginning. So I want people to know that they, and a whole bunch of my other customers, some of them biggest names in the tech world, they are more committed than ever. They are spending more R&D money into this and we are seeing more VCs putting more money into such AR efforts.

So don't be put down by this short term headwind, that's what I want to really highlight. As I mentioned in my prepared remarks that we are not worried and we are very honest about this, we are not worried.

Now, having said that though, I just want to again clarify, volume will start to decline in Q4, which we have mentioned and which has been built into our guidance. We have also said the next few quarters, the volume will be minimal.

Now, I just mentioned this is their first generation, very first generation product. The idea has always been to test the market. And I also mentioned the customer is not stopping at all. On the contrary, they are beefing up their investment and development efforts leveraging on the experience and lessons we have all learned from this first generation product.

Equally important is what you have not seen. Players who are not already out of the service, players who are developing it under the water. Obviously they are also working on their respective first generation products.

Literally, everybody is working with us and literally everybody is paying us development fees for such effort as I just mentioned in the previous question. So, some of them will take their products to mass production next year, but judging by the previous experience, I don't want to hold your expectation too high for next year first generation product volumes out of such customers unless somebody really hit a jackpot and launch something that consumers somehow really love.

I don't know, but we at Himax, we don't hold extremely high hopes for the volume of next year, although you are going to see a more diversified customer base with more customers trying to test their first generation products with the market.

Expansion, I mentioned already we are proceeding with expansion as planned and you are going to wonder if the customer volume is going to be down why you are still expanding. I think, already more than provided answer because I have much more customers coming on the stream and I'm taking their development fees. Many of them are giving us some indications of volume.

So if I give it some haircut and I assume not every single customer is going to be successful. Even if I make the most conservative assumption that only a limited number of customers will have limited success in their first generation products. Even if it's under this very rather conservative scenario, our current capacity is far from enough. I simply cannot wait until I'm in total shortage to start building because the building, it takes more than a year.

But the good news is once it starts mass production it's always high volume production, sole source, little competition. And equally important for our LCOS, we mentioned it's going to be 12 inch wafer, it's going to be really state of the art, and it will enable high end panel with super high resolution which is going to lift the industry to another level. Many of our customers are keeping very high hopes for our 12 inch. So we are already seeing very little competition in sight and with our 12 inch fab coming on stream, it will be even more so.

So I guess in conclusion I just want to mention because this is really so important for us. I don't want people to misunderstand that AR product is probably over and Himax is going to suffer because of this one customer's short-term headwind. So excuse me for a lengthy question.

So I think we are pioneer. We appreciate the fact that being pioneer doesn't necessarily guarantee you're going to be the ultimate winner. That is why we are now really try very hard to have the widest customer coverage, getting NRE charge from them so that to reduce our burn, really learn from the design in and mass production experience to solidify our leadership.

And finally, even though we are already ahead, we want to be even more ahead by launching our 12 inch. I really believe, judging by how the industry is taking place right now it is going to take off soon, and by the time it takes off we want to make sure we will be the winner.

[Multiple speakers].

I think you will be. So fair enough. I look forward to your future success. Thanks.

Thank you, and our next question comes from the line of Donnie Teng with Nomura. Your line is open.

Hi, CEO, CFO. Thank you for taking my question. This question is regarding to your large driver IC business. Recently the foundry companies such as UMC and Vanguard all see better sales momentum on large driver in the fourth quarter, while you and Novatek are all seeing weaker large driver sales. So I just wonder if you have seen that large driver demand will rebound in the first quarter next year, or you just preview the inventory when you have a relatively low inventory level by end of last quarter?

Donnie, I am not sure I agree with you on the volume of whether it is TSMC, or Vanguard on driver IC per say on Q4. I mean fair enough, they are very full and their Q4, they are doing okay in Q4. But I don't believe that comes from driver IC. TSMC driver IC exposure is already rather--

Sorry, I mean UMC.

Oh, UMC, but even UMC you just mentioned Novatek and us right. These two happen to be major customers of UMC, so I just don't see, I haven't see their detail earnings call or something, but as far as I know, we know UMC. UMC is a very important strategic partner of ours. I don't think they will be like increasing their driver shipment in Q4. Vanguard I think their booming business right now comes from things like power management IC, the fingerprint and so on, not necessarily driver.

We also have Powerchip, which is really the source of the capacity constraint. So Powerchip is totally full and we are overall large panel and small panel combined, I think we are their biggest customer and unfortunately that we are in shortage. So meaning I also am not sure I would agree. Q1, I think Q1 traditionally is always a low season, Q1 Chinese New Year and all that, so we expect Q1 to be a low season again. This year should not be exception although we are not providing Q1 guidance.

So can we say that this is due to a tight capacity, so maybe we need to book some capacity in advance, is that correct?

Well actually we have and that is in large panel drive IC in particular. It is an area of our very unique competitive advantage. We are not fighting over capacity with many others over such players as UMC or Vanguard. They are not for our larger panel drive IC. For us it is primarily Powerchip.

By the way, Powerchip where we say they have a shortage is refer to high-end smartphone. It's not the large panel. Large panel is okay. We are their only customer in large panel and their capacity and our demand we are all very well planned. We are in advance.

So large panel and also our customer's transparency, visibility is also better for large panel as well for us. So from our customer to us to people like Powerchip, I think large panel driver IC capacity normally is much better planned.

We have another large panel foundry vendor Macronix, or MXIC. We are now in their 8 inch. We are their sole customer for large panel driver IC. We actually co-develop that process for them so they really can't work with other people.

So these two if you'd like forms our core of the supply for large panel and with these two we are sole customer. We have a contractual relationship to assure as such and as a result, that is actually one of the reasons why our customers love us for being large panel driver IC vendor because they have seeing our supply to be very reliable and steady.

Thank you, and my last question regarding to a quick follow-up on TDDI. So may I ask what kind of a resolution of TDDI you can provide initially in 2017? Is that more like a WQHD or FHD or HD720?

It's more going to be primarily FHD and also a bit lower-end HD720. We can do higher end as well, but we don't believe when you move to high end right now, panel makers' yield rate is going to be a real challenge. So if panel maker is not going to make good profit, what's the point? So eventually this will move up to quadruple HD and so on, very high resolution. But right now our major competitor they are shipping primarily HD720. We believe next year it will be primarily FHD because HD720 will then be started to consider like mid to lower end with in-cell, which is still a bit more expensive. You want very thin design, very good form factor, so FHD is the right product category to be in.

Okay, got it. Thank you so much.

Thank you.

Thank you, and I'm showing no further questions at this time. I'd like to turn the call back to management for closing remarks.

Thank you, and as a final note, Jackie Chang, our CFO, will again maintain investor marketing activities and attend future investor conferences. We will announce the details as they come about, so please contact our IR department and/or Greg Falesnik if you are interested in speaking with the management. Thank you and have a nice day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a wonderful day.