奇景光電 (HIMX) 2016 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Himax Technologies fourth quarter 2016 earnings conference call.

(Operator instructions) As a reminder, today's conference is being recorded.

I would now like to introduce your host for today's conference, Mr. Greg Falesnik, Managing Director for MZ North America.

Sir, you may begin.

Thank you, operator.

Welcome, everyone, to Himax's fourth 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've 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 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 risk and uncertainties that could cause actual events or results to differ materially from those described in this conference call.

Factors that could affect actual results include, but are not limited to, general business and economic conditions, the state of the semiconductor industry, market acceptance and competitiveness of driver and non-driver products developed by Himax, demand for end-use application products, the uncertainty of continued success in 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, 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 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.

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

Jordan, the floor is yours.

Thank you, Greg, and thank you, everybody, for being with us today for our earnings call on which we will detail results from the fourth quarter and full year 2016, as well as provide our first quarter 2017 guidance and outlook.

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

Our 2016 fourth quarter revenue, gross margin, GAAP and non-GAAP earnings per diluted ADS were as preannounced on January 26.

For the fourth quarter, we reported net revenues of $203.4 million, representing a 6.7% sequential decrease and in line with our original guidance of a 4.0% to 9.0% sequential decline issued on November 10, 2016.

While gross margin EPS were below the guidance due to an additional inventory write-down, gross margin for the quarter was 19.1% versus guidance of slightly down from 25.6% reported in the third quarter.

The low gross margin is a result of an additional one-time non-cash inventory write-down totaling $12 million.

Excluding this additional inventory write-down, gross margin would have been 25.0% and met our guidance.

The $12.0 million inventory write-down is on top of the $2.7 million original inventory write-off estimate for the fourth quarter.

In comparison, the inventory write-off amounts were $2.5 million, $3.0 million and $2.5 million for the first, second and third quarter of 2016, respectively.

The vast majority of additional write-down was related to certain aged inventories of of traditional human vision CMOS image sensor or CIS, with smaller amounts also covering driver IC and other products.

Earlier in 2016, we decided to focus our CIS business on smart sensor, machine vision segments, as opposed to the traditional human vision segments.

As part of this new strategic direction, we made a decision recently to expedite the sales of some aged inventory of human vision sensors.

We believe it is appropriate that we write-down the inventory at this time, as we anticipate the need to offer discounted prices to accelerate the sales of some products and, for some other products, where the potential revenues do not justify the efforts, stop the sales altogether.

Our new CIS strategy is backed by new products, such as the Always-on-Sensor, or AoS, and the structured light 3D depth scanning total solution, which offer unique and market leading features.

The new strategy is also backed by close collaboration and intensive development activities with certain heavyweight partners and customers.

I will elaborate a bit later.

Following this one-time write-down, we believe our inventory will be healthy across CIS and driver IC and all other product areas.

The impact to earnings per diluted ADS of the aforementioned inventory write-down is $0.06.

Following the write-down, GAAP earnings per diluted ADS was $0.026, below the Company's guided range of $0.085 to $0.11.

Non-GAAP earnings per diluted ADS was $0.028, again below the guided range of $0.087 to $0.112.

Excluding the additional inventory write-down, GAAP and non-GAAP EPS would have been $0.086 and $0.088 respectively and both met our original guidance.

The fourth quarter revenues of $203.4 million represented a 6.7% sequential decrease and a 14.3% increase for year-over-year.

This sequential decline was a result of lower sales in our large panel driver IC business from a single customer's inventory adjustment, decreased smartphone sales due to the slowdown in China's smartphone market towards the end of the quarter and the decrease in non-driver revenues for lower WLO and LCOS demand from our major AR customer.

The combination of a few favorable factors across all our product lines led to the strong year-over-year growth: Robust large panel driver IC sales benefiting from our leading market share in China, strong driver IC shipments for smartphone, tablet and automotive applications and growth in the AR/VR related business from our leading US customer.

Revenues from large panel display drivers were $67.7 million, down 6.0% sequentially and up 9.0% from a year ago.

Large panel driver ICs accounted for 33.3% of our total revenues for the fourth quarter, compared to 33.0% in the third quarter and 34.9% a year ago.

The sequential decline was the outcome of one single customer's inventory adjustment.

Nevertheless, our large panel products actually enjoyed 9.0% year-over-year growth, thanks to strong demand from Chinese and Taiwanese panel customers during the quarter.

In China, our driver IC business for large panel grew more than 10.0% year-over-year during the quarter.

In comparison, worldwide large-size TFT-LCD panel shipments declined around 1.5% 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 this trend to continue into this year.

Revenue for small and medium-sized drivers came in at $99.7 million, up 0.4% sequentially and up 21.8% from the same period last year.

Driver ICs for small and medium-sized applications accounted for 49.0% of total sales for the fourth quarter, as compared to 45.5% in the third quarter and 46.0% a year ago.

As opposed to original guidance of low single-digit percent sequential growth, our small and medium-sized panel driver business grew just 0.4% because of lower than expected smartphone driver IC sales.

Sales into smartphones, while increased close to 25.0% year-over-year, declined high single digits percent sequentially due to the slowdown in China's smartphone starting around December.

The strong growth of our smartphone driver IC business compared to the same year ago period came from our long-standing leading market share in China, where our end brand customers were performing strongly.

Our revenues from automotive applications also contributed to the segment and continued solid momentum, growing close to 10.0% during the fourth quarter, both sequentially and year-over-year.

Revenues from our non-driver business were $36.0 million, down 22.9% sequentially and up 6.0% from the same period last year.

Non-driver products accounted for 17.7% of total sales, as compared to 21.5% in the third quarter and 19.1% a year ago.

The sequential decline was primarily due to lower LCOS and WLO shipments for AR applications.

As we highlighted in the last earnings call, a major AR customer asked us that we reduce shipments for their current generation device to a minimum.

To a lesser extent, lower sales of touch panel controllers and ASIC chips also contributed to the sequential decline.

This decline was partially offset by the increased sales of timing controllers and CMOS image sensors.

It is worth noting that despite the near-term headwinds, we remain positive on the long-term prospect of our WLO and LCOS product lines, judging by the expanding customer list that covers some of the world's biggest tech names and the busy engineering activities going on with such customers right now.

I will elaborate on this a bit later.

Our GAAP gross margin for the fourth quarter was 19.1%, down 650 basis points from 25.6% in the third quarter and down 380 basis points from the same period last year.

The decline was due to the aforementioned additional inventory write-down.

Excluding the additional inventory write-down, our gross margin would have been 25.0% for the quarter.

Jackie, our CFO, will now provide more details on our financial results.

After Jackie's presentation, we will further discuss our full year results, 2017 outlook and first quarter guidance.

Jackie.

Thank you, Jordan.

I will provide additional details for our fourth quarter financial results.

GAAP operating expenses were $32.1 million in the fourth quarter of 2016, down 20.7% from the preceding quarter and down 0.2% from a year ago.

The sequential decrease was primarily the result of the difference in RSU charges.

In accordance to our protocol, we grant annual RSUs to our staff at the end of September each year, which, given all other items equal, leads to higher third quarter GAAP operating expenses compared to the other quarters of the year.

The fourth quarter RSU expense was only $0.2 million while it was $9.2 million in the third quarter.

Excluding the RSU expense, operating expenses increased 2.2% from the third quarter and decreased 0.1% year-over-year.

GAAP operating margin for the fourth quarter of 2016 was 3.4%, down from 4.8% for the same period last year and down from 7.0% in the third quarter.

The GAAP operating income decreased 55.1% sequentially and 20.3% year-over-year.

The sequential decrease was primarily a result of aforementioned additional inventory write-down and lower sales, offset by the lower RSU expense.

Fourth quarter non-GAAP operating income, which excludes share-based compensation and acquisition-related charges, was $7.4 million or 3.6% of sales, down from 5.1% for the same period last year and down from 11.5% a quarter ago.

The non-GAAP operating income decreased 70.7% sequentially and 19.3% from the same quarter in 2015.

Excluding the aforementioned inventory write-down, non-GAAP operating margin would have been 9.5% for the quarter, as compared to 11.5% in the previous quarter.

Our GAAP net income for the fourth quarter was $4.4 million, or $0.026 per diluted ADS, compared to $13.6 million or $0.079 per diluted ADS in the previous quarter and GAAP net income of $6.1 million or $0.036 per diluted ADS a year ago.

GAAP net income decreased 27.6% year-over-year and 67.4% from the previous quarter.

Fourth quarter non-GAAP net income was $4.8 million or $0.028 per diluted ADS compared to $21.3 million last quarter and $6.5 million the same period last year.

I will go through 2016 full year financial results and the balance sheet analysis a little later after Jordan's 2016 full year business review.

I will now turn the floor back to Jordan.

Thank you, Jackie.

We delivered a solid result to achieve both top and bottom line growth during 2016, as our driver and non-driver business segments both performed strongly.

We increased market share in our core driver IC business in 2016 and continued to solidify our leading position through technology advancement and customer engagement.

Our large panel driver IC business grew from the added capacities from China and higher 4K TV penetration last year.

In terms of small and medium sized driver ICs, our smartphone driver IC business rebounded well, reflecting our leading position in the Chinese smartphone market.

However, demand was stimulated by the rising adoption of 4G network and our end brand customers performed strongly in 2016.

Driver ICs for automotive applications, where we have a leading market share, continue its growth trajectory as more panels were going to vehicles.

We continued to lead the market in major new driver IC technology trends, including higher display resolution, AMOLED and in-cell TDDI.

We collaborated closely with leading panel makers across China for AMOLED product development.

On the TDDI front, we made volume shipments to a leading Chinese smartphone customer and were busy with design activities with Chinese, Korean and Taiwanese panel makers.

Our non-driver businesses experienced tremendous growth during 2016, primarily driven by the LCOS and WLO businesses due to shipments to one of our leading AR device customers.

We also made solid progress in new territories such as 3D depth scanning, IoT and machine vision with our latest CIS and WLO products, evidenced by more design-ins and engagements with certain heavyweight partners.

Now we will have a quick overview of the 2016 full year financial performance.

Our revenues totaled $802.9 million in 2016, representing a 16.1% increase over 2015.

Revenues from large panel display drivers increased 21.6% year-over-year, representing 34.0% of our total revenues, as compared to 32.4% in 2015.

Our large panel driver sales totaled $272.9 million for the year.

The strong year-over year growth originated from our focus in China starting in 2012 and our efforts to achieve a more diversified customer base by adding new customers in Taiwan, China and Korea.

Small and medium-sized driver sales increased 9.8% year-over-year, representing 46.0% of our total revenues, as compared to 48.6% in 2015.

Contributing to this growth was a strong momentum in driver ICs for smartphone and automotive applications.

We have the most comprehensive coverage of leading Chinese smartphone names and their fast-growing market share has led to our good results last year.

Automotive driver IC sales registered the strongest growth in this segment to increase about 26.0% year-over-year.

Non-driver products increased 22.6% year-over-year, representing 20.0% of our total sales as compared to 19.0% a year-ago.

This growth was primarily due to higher LCOS and WLO shipments to a major AR customer during the year.

Other product lines such as timing controller and ASIC also delivered strong growth, but offset by sales declines in CMOS image sensor and PMIC.

Gross margin in 2016 was 24.2%, a 60 basis point increase from 23.6% in 2015.

The increased gross margin was primarily due to a more favorable product mix in small and medium sized driver ICs, increased LCOS and WLO shipments for AR applications and certain engineering fees from AR/VR new project engagements.

The gross margin increase for the whole year was however offset substantially by the aforementioned inventory write-down.

Gross margin improvement remains one of our business focuses.

Our GAAP net income for the year was $50.9 million, or $0.295 per diluted ADS, up from $25.2 million or $0.146 per diluted ADS in 2015.

GAAP net income and GAAP earnings per diluted ADS grew 102.1% and 101.7% year-over-year respectively.

The increase in GAAP net income was a combination of higher revenue, improved gross margin and a lower income tax, partially offset by higher operating expenses.

In August 2016, we paid an annual dividend of $0.13 per ADS or 89.0% of 2015 GAAP earnings per diluted ADS.

We remain committed to paying annual dividends, the amount of which is based primarily on our prior year's profitability.

The high payout ratio in 2016 is an illustration of our confidence in our future profitability.

I will now ask Jackie to go through some details of our full year financial results.

Jackie.

Thanks again, Jordan.

For 2016, our GAAP operating expenses were $135.1 million, up $2.6 million or 2.0% compared to last year.

GAAP operating income of $59.2 million represented a 93.1% increase versus 2015.

Non-GAAP net income for 2016 was $59.7 million or $0.347 per diluted ADS, up from $30.6 million or $0.178 per diluted ADS for 2015.

Non-GAAP net income and non-GAAP earnings per diluted ADS grew 95.2% and 94.8% year-over-year respectively.

Turning to our balance sheet, we had $194.6 million of cash, cash equivalents and marketable securities as of end of December 2016 compared to $148.3 million at the same time last year and $153.4 million a quarter ago.

On top of the above cash position, restricted cash was $138.2 million at the end of the quarter, up from $138 million in the preceding quarter and down from $180.4 million a year ago.

The restricted cash is mainly used to guarantee the Company's short-term loan for the same amount.

We continue to maintain a very strong balance sheet and remain a debt-free company.

Our inventory as of December 31, 2016 was $149.7 million, down from $171.4 million a year ago and down from $169.4 million a quarter ago.

Accounts receivable at the end of December 2016 were $191 million as compared to $177.2 million a year ago and $208.4 million last quarter.

Day sales outstanding was 87 days at the end of December 2016, as compared to 93 days a year ago and 95 days at end of the last quarter.

Net cash inflow from operating activities for the fourth quarter was $47.2 million as compared to an inflow of $25.9 million for the same period last year and an inflow of $2.9 million last quarter.

Cumulative cash inflow from operations in 2016 was $84.7 million as compared to $22.5 million in 2015.

The increase in cash inflow was a result of improved profitability and lower working capital.

Capital expenditures were $2.2 million in the fourth quarter of 2016 versus $3.6 million a year ago and $1.9 million last quarter.

The capital expenditures in the fourth quarter consist mainly of purchases of R&D related equipment.

Total capital expenditures for the year were $7.9 million versus $10.0 million a year ago.

As of December 31, 2016, Himax had 172 million ADS outstanding, unchanged 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 are mindful that 2017 was actually a year of macro uncertainty, marked by currency fluctuations and the risk of China's slowdown.

However, looking into the new year, we believe our overall financial performance will be resilient to the potential macro headwinds.

Particularly following many years of R&D and investment, various areas of our non-driver IC businesses may start to contribute significantly to our overall financials.

Before we detail the prospect for our driver and non-driver businesses in 2017, we thought it's important that we update this year's CapEx plan, as its scale will be unprecedented in our history.

Being a fabless company for our IC business, we have typically had a low annual CapEx, as in the case of the last two years, $10 million in 2015 and $7.9 million in 2016.

The regular CapEx is primarily for the investment of design tools and testing equipment for our IC design business.

This year's CapEx plan will, however, include the construction of a new building, which we have announced before, and an increase of our WLO capacity on top of the regular CapEx.

The new building, located nearby our current headquarters, will house the next generation LCOS and WLO production lines and provide the extra office space that is desperately needed as we already have to take up sizable leases outside to cope with the current office space shortage.

The progress of the new building construction is in line with our plan as we have completed the design stage and are moving on to construction stage as we speak.

More specifically, we have budgeted $50.0 million to $55.0 million CapEx for the new office/fab construction in 2017, covering land, building, facilities and clean rooms.

The new building will be completed and ready for personnel and equipment move-in by early 2018.

The CapEx budget for 2018 for the new building is around $10.0 million.

Now let me move on to talk about the increase of our WLO capacity.

To meet the strong demand of new customers for our WLO technology, we are accelerating our WLO capacity expansion.

Rather than waiting for the new building to complete, we are now investing around $25.0 million in new WLO capacity during the first half of 2017, to be located in the existing headquarter building by retrofitting certain areas for the new equipment.

If everything goes as planned, we will see revenue and bottom line contributions from the new WLO investment starting the second half of 2017.

The CapEx budget for 2017 and the dividend for the year of 2016 will be funded through our internal resources and banking facilities.

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

The first quarter is traditionally the bottom of the year in terms of sales, because it has fewer working days due to the Chinese New Year.

The scale 5.6 earthquake that struck Tainan in early February also somehow impacted some of our customers' productions and therefore our driver IC shipments.

We expect the first quarter revenues to be down 18.0% to 25.0% sequentially.

Gross margin is expected to be around 23.0% to 24.0%, depending on our final product mix.

GAAP earnings attributable to shareholders are expected to be in the range of $0.005 to $0.02 per diluted ADS based on 172.4 million outstanding ADSs.

In providing the above earnings guidance, we have assumed a 16.5% income tax rate for 2017, calculated based on exchange rate of NTD 31.0 against the USD, which is also the exchange rate as of beginning of February this year.

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

During 2017, we expect our large panel driver IC business will continue to benefit from continued increase of 4K TV penetration and, starting the second half of 2017, Chinese panel customers' ramping of a brand new Gen 8.5 and another Gen 8.6 fab.

However, first quarter will see mid-teen percent sequential decline in our large panel driver IC revenue due to fewer working days in China and Taiwan and phase-out of certain customers' old models.

Despite the temporary slowdown, our leadership in this segment stays strong.

In our previous earnings call, we mentioned that 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.

We believe our technology strength and total solution capability are significant differentiators against most of our competitors and will further solidify our leading position as Chinese customers continue to expand their capacity and the industry further upgrades to 8K TVs.

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

The other segment within our driver IC business is ICs used in small and medium sized panels for applications including smartphones, tablets and automotives.

First quarter sales for smartphones are likely to decline by close to 45.0% sequentially on weak market, seasonality, customers' inventory adjustment for HD720 driver ICs and less addressable market for smartphones using pure TFT-LCD drivers due to higher TDDI adoption rate.

Compared to overall market, HD720 accounted for a relatively high percentage of our total smartphone driver IC shipment in 2016.

Due to the panel supply shortage, most notably in the HD720 segment in the second half of last year, some of our Chinese customers pulled in excess inventory of HD720 driver ICs and panels.

Many of them have therefore substantially slowed down their new panel purchases in the first quarter.

After customers' seasonal inventory adjustment, we expect the smartphone driver IC momentum to recover sequentially in the second quarter.

We are mindful of the trend that higher in-cell panel and TDDI adoption rate will reduce the addressable market for smartphones using traditional TFT-LCD driver ICs.

We are confident that our TDDI solutions and business will pick up soon.

We will elaborate on this in the non-driver IC business discussion a bit later.

On the AMOLED front, we've been collaborating closely with leading panel makers across China for AMOLED product development.

With fewer competitors and higher barrier of entry, we believe AMOLED driver ICs will be one of the long term growth engines for our small panel driver IC business.

Among driver ICs used in small and medium sized panels, the best performing category in recent years has been automotives.

We expect the category's Q1 revenue to be down high single digits percent sequentially and grow more than 15.0% year-over-year.

With leading market share and numerous Tier 1 automotive brands as our indirect end customers, we've successfully engaged all key panel manufacturers and module houses worldwide for long term partnerships and secured many of their key projects pipelined for the next few years.

To address the growing demand of larger automotive displays with higher resolution and built-in on-cell or in-cell touch screen features, we continue to develop advanced solutions to enable new automotive display applications and provide our customers with the most comprehensive and state-of-the-art solutions in the industry.

As such, we are well-positioned to take advantage of the growing automotive display market and anticipate the strong growth will likely continue into the next few years.

However, our driver ICs used in tablets will decline close to 40.0% sequentially for slow season.

Overall, we expect the small and medium sized driver IC segment to decrease sequentially by around 30.0% in the first quarter.

Now for the non-driver IC business segments.

We anticipate near-term headwinds as we mentioned in the previous earnings call and expect about high teens percent sequential decline in our non-driver revenues for the first quarter.

Sales of CMOS image sensors will deliver strong growth in the first quarter, but those of WLO, LCOS micro displays and touch panel controllers will decline sequentially.

I will now highlight some of the non-driver product areas.

First off, the touch panel controller product line.

On top of several projects entering volume shipments featuring our on-cell solution, we continue to secure new design-wins from Chinese smartphone brand customers for their 2017 models.

We have also seen significant traction in customer adoption and design wins of our discrete touch solutions to break into several leading Chinese and international end brand customers with new models to enter mass production from the first quarter of this year.

On TDDI, we are seeing rapid adoption of in-cell displays among smartphone brand customers for their new generation mid-to-high end models recently and expect TDDI to continue to expand in the smartphone and tablet market in the next few years.

We have comprehensive design-in activities with Korean, Chinese and Taiwanese panel and end product customers.

We are also aggressively developing new products and strengthening our team to expand our product portfolio and roadmap.

With very comprehensive joint development engagements covering many leading panel makers, we are confident that we can leverage our long-standing and widespread relationships with panel makers to increase our market share in TDDI.

TDDI is a major long term growth engine for our small panel business and will contribute to our business starting the second half of this year.

I will now turn to the LCOS product line.

As we warned in the last earnings call, we expect our LCOS sales to decline in the first quarter, as well as over the next few quarters of this year, because one of our leading AR device customers decided to reduce shipments of their current generation device to a minimum, and instead, to focus on the development of future generation devices which we are still a critical part of.

While the revenue of LCOS may subside over the next few quarters, they will come from a much more diversified customer base this year.

Quite a few of our other customers are expected to launch their AR products starting this year, although we are still uncertain of their volume potential given that they are still early generation products.

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 critical enablers to AR devices.

With little competition, we are currently working with over 30 customers on various current and future generation AR devices using LCOS micro display.

Our increasing design engagements cover not just leading tech companies, but also niche AR players, which are bringing in innovative product ideas.

Switching gear to WLO.

As in the case of LCOS that we just mentioned, we expect the near term business prospect to be affected by the reduced shipment of a major AR customer.

However, we continue to partner with numerous industry leading companies using our cutting edge and industry dominant WLO technology.

In addition to AR application, our WLO technology is adopted by our customers to enable new things such as 3D depth scanning and machine vision, which can in turn be used in a variety of industries such as consumer, industrial, IoT, AI, medical, automotive, military and surveillance.

Our customer base for this business is extremely diversified, covering numerous major tech names throughout the world, many of which are 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 best mass production proven track record with expertise ranging from design and high yield production to cost and quality controls.

We are very happy with our current development and business progress in this area.

As mentioned earlier, given the aforementioned exciting growth opportunities, we are accelerating our WLO capacity expansion to meet strong customer demand in the near term.

Earlier in 2016, we decided to switch our strategy of the CIS business to focus on smart sensor and machine vision segments, as opposed to the traditional human vision sensors.

We have launched two smart sensor product lines, i.e., near infrared or NIR sensor and Always-on-Sensor.

We continue to make great business progress with these two smart sensor products.

In addition to close collaboration and intensive development activities with certain heavyweight partners and customers, our smart sensors have garnered lots of customers' interests during the recent demonstrations at CES and the Japan Auto Expo.

By combining a NIR sensor and a structured light projector consisting of a laser diode and DOE with collimator fabricated using our WLO technology, we are offering the most effective 3D depth scanning total solution with the industry's smallest form factor to enable easy integration into next generation smartphones and other consumer electronics devices such as AR/VR.

We are targeting to work with our partners to have the structured light 3D depth scanning total solution embedded in next-generation partner smartphones in 2017.

We also attracted heavyweight potential customers' interest following the recent press release of our NIR sensor for its outstanding technical performance.

With regards to our AoS product, the sensor can be bundled with our WLO lens to support super low power computer vision to enable new applications across a very wide variety of industries.

After recent demonstrations at CES and the Japan Auto Expo, our AoS has gained significant customer interests, especially in smart home, industrial IoT and surveillance applications.

In a recent joint press release with CEVA Inc.

and Emza Visual Sense Limited, we announced the industry's first intelligent always-on visual sensor, specifically designed to overcome the power and cost constraints of vision processing for IoT applications.

The ultra-low power, always-on vision sensor is a powerful solution capable of detecting, tracking and recognizing its environment in an extremely efficient manner using a few milliwatts of power.

As our long-term goal is to provide complete solutions for always-on computer vision applications, we decided to form a strategic alliance with Emza, an Israeli company dedicated to developing extremely efficient machine vision algorithms that enable smart IoT visual sensors.

We will report business developments in these new territories in due course.

Lastly, for the traditional human vision segments, we maintain a leading position in laptop applications and expect mass production of several design wins for notebooks and increased shipments for multimedia applications such as surveillance, drones, home appliances and consumer electronics, among others, during the first quarter.

In summary, we are seeing weak seasonality and market demand in the driver IC business, which will lead to sequential revenue decline in the first quarter.

We also expect our gross margin to be under pressure in the short term due to continuous pricing pressure and less favorable product mix of driver IC products, lower revenues from high-margin AR/VR related businesses and lower NRE income.

Nevertheless, after many years of R&D and product development, we may see significant business progress in our non-driver business to contribute to both top and bottom lines out of WLO and CIS related areas as early as the second half of 2017.

Thank you for your interest in Himax.

We are now ready to take questions.

(Operator instructions).

Our first question comes from the line of Tristan Gerra with Robert W. Baird.

Your line is now open.

Hi there.

You're talking about the ramping in WLO production with still a high number of customer engagement.

Could you quantify the potential that you see from a unit standpoint?

I know that you don't have much visibility.

I thought that perhaps your large North American customer pushing away (inaudible) plans would have impacted your manufacturing plans, if you could elaborate on this.

Tristan, WLO, actually we explained in earlier conference calls.

We basically have a foundry business model where we fabricate or use our imprint process to make fine optical products for customers.

So the number of units of output actually depends heavily on customer design and application and we make the chips for eight-inch wafer we have made designs with less than 10 chips and as many as thousands of chips, even close to 10,000.

So I'm afraid at this point, I really cannot disclose too much as to when we say contributions starting from the second half of the year, how many units are we expecting from our customer.

It really depends on the customer design and it's too early for us to disclose too much about the details of customer design.

Okay, and then just a quick follow up.

In terms of the smart sensor technology, how much of that is in collaboration with some outside companies for the IT or is the IT outside of the WLO coming from Himax?

And if you could talk about the revenue and margin potential of smart sensor for later this year as well.

For smart sensor, in my prepared remarks.

I'm not going to repeat that.

One area is AOS, Always on Sensor, where we provide ultra-low power total solution.

We recently had a joint press release with CEVA and Emza and that is a good example of a partnership.

And we together basically offer the total solution covering not just the hardware but also software and the applications, offering people the capability of, for example people counting in extremely low power fashion.

Over there we have been working with or talking to customers across a very wide range of applications and industries from consumer electronics to industrial home applications to surveillance, etc.

And the other area is the structured light projector for 3D depth sensing applications.

Over there our main partner is the world-leading semiconductor SOC platform provider and we've been working with each other for a long time.

We have been promoting our joint solution to our customers.

And over there we are now talking to primarily a few leading cell phone customers and as well as a few industrial customers.

So there our key partner is this semiconductor major player while our customer base again is widespread with short-term focus now being smartphone application.

Great.

Thank you very much.

Thank you.

And our next question comes from the line of Tom Sepenzis with Northland.

Your line is now open.

Yes, thank you.

I'm just wondering, with the new facility that you're building, how long does it take to qualify the components that come out of that and when do you expect to ship the new WLO products?

Typically, it starts from design and samples and qualification and then industrial builds.

So eventually we have to go through all that standard procedure with our customer.

So a lot of things have been going on for some time.

Again, I cannot disclose the details but certainly this is not like something that just got started like yesterday.

It's been around for some time and again we have to go through the standard so-called design and qualification procedure.

We mentioned in our prepared remarks that if everything goes as planned we expect this accelerated investment to bring in contribution both for top line and bottom line starting from the second half of this year, so it is the second half.

So in terms of financial contribution this investment we believe is a good opportunity for us.

Great, thank you.

And then can you just talk a little bit about your progress in TDDI and also are you developing OLED TDDI and if so, when do you think you might have product available there?

No, our TDDI development is now primarily on low temp poly-silicon and amorphous silicon products, not OLED.

And our main focus right now is full HD and HD solutions with full HD covering both with or without the DRAM solution.

We have sent some small shipments to our customers.

We expect further shipments in Q2 but more meaningfully starting from Q3 of this year.

And we believe second half and the following years going forward this will bring in significant contribution to our top line and bottom line.

So this is a very important area of business for us.

We are working with literally everybody, every panel maker and many end customer makers, working on designing in the qualification.

At this stage we are quite busy, our team, on this product area right now.

Great.

Thank you very much.

Thank you, Tom.

Thank you.

And our next question comes from the line of Suji Desilva with Roth Capital.

Your line is now open.

Hi, Jordan.

Hi, Jackie.

Perhaps we can start off with the 3D scanning market, WLO.

Can you help us understand how to size that market and the revenue opportunity and the timing?

Is it really kind of a subset of the image sensor market or how should we think about it?

Let's try to differentiate WLO against 3D depth sensing.

WLO has many applications as we mentioned.

Obviously 3D sensing is one of them but other types of machine vision and obviously waveguide application for AR devices being also among the major applications.

So one should not necessarily connect WLO directly only with 3D depth sensing.

Now if I look from another angle, 3D depth sensing, I mentioned in my prepared remarks we do offer a total solution by working as I just mentioned in the previous Q&A, working with leading semiconductor SOC platform player where we basically provide a total solution covering on the projector side.

We use our WLO technology to make the optics, most specifically what we call our diffractive optical element, or DOE, with collimator.

That is the optics.

Then we purchase the laser from third parties and they require an extremely high level of precision to line up the optics and laser together.

So we also have development partners for that.

So that is also a unique technology for us.

So that together, the laser with alignment to the optics, that forms what we called projector.

So with the projector you basically project invisible images to the surroundings.

The image hits the object, and gets bounced back.

Then you have a Near IR sensor on the side to receive it.

We mentioned in our prepared remarks our outstanding performance of the NIR sensor where we believe we are the number one in the world as we speak with optical performance as good as twice our competitors.

So you have the projector and you have the receiver.

Then you need the algorithm to do calculations to figure out the depth map of your surroundings.

By working with our partner we also developed an ASIC chip for the algorithm.

So if you put the projector and the sensor, NIR sensor and the algorithm, you put them together, then you have a total solution of structured light 3D depth sensing.

Now our preferred approach is for the customer to take up the whole total solution.

As I just mentioned, we are talking extensively with a several customers trying to have that embedded in their new smartphone model.

Now I have to warn you guys, we do have the total solution pretty much ready but to have the thing embedded into cell phone, again takes a whole procedure of design, verification and test run and so on and so forth.

So our target is to have this design into cell phone happen during this year.

Now our preferred approach is to provide the total solution.

However, when requested by a good customer with a good business opportunity we are equally happy providing whether the projector side with the WLO technology or the sensor side with our NIR sensor.

Meaning we don't necessarily insist on providing the total solution.

We will be happy to provide a partial solution as well.

So I think the key point is that we've been talking about 3D depth sensing for over a year, even in this investor conference.

Meaning we have been into this development for much longer than that.

And I just cannot over-emphasize how important this is because 2D photo taking is already a necessity for people's day-to-day life and I think there is this general demand for people to want to have 3D photo sensing and both for picture taking as well as for machine vision, data sensing applications.

I think the sky's the limit for this application and I'm just pleased to report that we are very much on the cutting edge right now by providing total solution as well as individual part solutions.

Okay, good.

Thank you.

And then the China smartphone market coming in 2017.

What are you seeing in terms of inventory levels around Chinese New Year and when do you think maybe if there is excess inventory that it gets worked down?

Yes, there is indeed excess inventory across the ecosystem as we see it, especially it's just too bad in the area where we have particular, percentage-wise, high concentration which is the HD720 segment.

HD720 segment starting from second half or even earlier, slightly earlier than that, panel capacity has been very tight and so actually 720 panel availability is extremely tricky.

So a lot of our customers I think pile up too much panels and therefore too many ICs.

And we said in our earlier remarks, starting December last year we started to see the impact and Q1 is going to hit the bottom.

We do believe the situation will get cleaned up and we'll see a nice rebound starting from Q2.

Okay, great.

Thank you for the color, Jordan.

Thank you.

Thank you.

And our next question comes from the line of Jerry Su with Credit Suisse.

Your line is now open.

Hi, Jordan and Jackie.

I just want to focus on the smartphone WLO.

So Jordan, can you help us to understand why smartphone makers need to have a WLO with the laser diode?

Why not just existing lenses from the other camera module makers?

What is that different for WLO to be used on 3D camera or 3D sensing?

It's different.

What WLO can provide is ultra-fine optical structure.

I'm sure you're talking about those camera lens makers, right?

The technology they have is something called injection molding.

With injection molding you can make very good lenses with very good curvature.

However, there are situations, for example, you want to make a very fine grating with pitches as fine as a nanometer kind of scale; grating or certain or regular or irregular cone structures or grating structures.

You mentioned very fine optical structures as opposed to a lens which is basically a single curvature.

So when you have engineering requirements for very fine and complex optical structures right now WLO is the best technology you can have.

And there are very, very few players around the marketplace to offer this.

And as we keep saying now, we are the one with the most proven production track record and that's why a lot of people come to us.

And that is why we decided to turn our business into one of a foundry business model where we basically take the very complex and fine and very different optical structure design for various kinds of customers from a wide variety of industries and basically tell them whether and how we are going to make it for them.

So really the short answer is this such fine optical structure cannot be made using the traditional injection molding technology.

It simply cannot.

Okay.

So just to clarify, so this will be used with the laser diode, right?

Not the current CMOS or CGD camera?

Well you see a laser diode is to provide a light source but 3D sensing you are really talking about machine vision, whether it's for gesture control, facial recognition, photo enhancement or even 3D photography or it could be a very wide range of applications I can't even think of right now.

People will develop, right?

So you basically try to capture such data out of invisible light.

So you need a light source projecting invisible light and laser diode provides that function.

So with laser diode through the complex optical structure I just mentioned, you then basically project an invisible image onto the surroundings and the image will get bounced and you'll receive the image with the NIR sensor.

And typically we will go through (inaudible), I don't want to get into too much technical details but this, but it is rather different from the traditional photo taking where you have invisible light and try to just shoot a picture from an object that you can see.

So in this case you still need a sensor.

You still need a CMOS image sensor.

Only that the CMOS image sensor may need to be tailored to perform well, especially well in those invisible bandwidths.

So my NIR sensor will not perform well in the tradition of human vision bandwidth but we have tailored NIR sensor which is super strong in the desired bandwidth which is non-visible for our application.

Okay, thank you.

And then a follow up question on the TDDI.

Since Himax has both a smartphone driver IC business and also a discrete touch business.

I know you mentioned that on second half this year TDDI is likely to see a bigger contribution.

But how should we think about the cannibalization of the existing business and how would that impact on revenue going forward?

I think we mentioned one of the negative factors affecting our Q1 smartphone driver IC business is the fact that the addressable market is getting smaller because of higher penetration of in-cell using TDDI or AMOLED.

I think those are the trends that we cannot fight against.

So yes, the traditional pure driver IC business will be affected but that doesn't really worry us.

It is actually a fantastic opportunity for us because as you correctly mentioned, growing from in-house, we have a driver IC and we have a touch panel control IC.

Now we need to integrate it together to make TDDI solution.

So with TDDI solution, the ASP will be much higher than a traditional driver IC and we didn't have touch panel control solution.

And that business, the so-called out-cell pure touch panel solution with pure touch panel controller IC must happen as well or get affected because the addressable market will be eaten up partially at least by the in-cell TDDI solutions.

We all suffer from the set.

However, I think this gives us the opportunity to more easily get into touch panel controller business by having the touch panel controller solution in our TDDI solution.

TDDI naturally for us anyway would represent the highest gross margin, much better ASP.

I would just elaborate one further point.

When TDDI becomes a big market, the players providing the panel solution will be the traditional panel customers with which we know very, very well.

We've been working together for a long time, good partnerships.

But those traditional panel makers, they are not used to touch panel and that is why in their earliest, relatively small volume, early ramp, they tend to choose IC vendors coming from touch panel solution, touch panel controller solution background because that is the one area they lack.

And in order to make sure their early launch will be successful they tend to bring in such vendors to help them.

However, I think in the long term we do have at least a fair playing field against those competitors.

And I think we enjoy major benefits including our longstanding relationship with them and with cell phone customers as well as the fact that we are the only one in the leading group anyway with both driver IC and touch panel controller IC coming from organic in-house.

So we don't need to go through the hassle of having a merger or acquisition and integration of two or three teams together, we don't need that.

So give us a little bit of time as I said earlier, starting from second half we are confident the business will pick up strongly.

Okay, thank you.

Thank you, Jerry.

Thank you.

(Operator instructions).

And our next question comes from the line of Donny Teng with Nomura.

Your line is now open.

Donny Teng, your line is now open.

Please check your mute button.

Hi, CEO, CFO.

My first question is regarding to WLO and the CIS business.

So you are talking about you will see some sales contribution from WLO in second half this year.

May I ask what kind of application it could be?

Will it be a smartphone or like a waveguide or other applications?

We cannot comment too much on details.

Again, this technology can be applied for many applications across a very wide range of industries and we are working with heavy-weight players in those industries.

So in the long term I think we will hopefully and likely have a balance portfolio across customer's industry.

Now as far as the short term, you are talking about the second half.

If I comment I will be releasing too much of the customer specifics.

So as a Company policy we can't do that.

So I'm sorry, I can't elaborate the second part of question.

Can we say that it may not be total solution in the second half this year and maybe next year you will provide a total solution?

I mean combined WLO, laser diode, NIR and algorithm?

Some customers will use our discrete optical solution only, but some customers will use our total solution, so it'll be both.

And then I cannot comment on the specific, the proportion of each one of them.

Such questions I cannot comment.

: Yes, but I mean in the second half this year it's more like only WLO and the next year it will be total solution.

Can we say that this kind of schedule is more reasonable?

I cannot comment.

Sorry.

Okay and for the second questions, it's regarding to your CapEx plan.

You mentioned about there will be $50 million to $55 million CapEx for new facilities and if that includes the $25 million for expanding existing WLO capacity or not include that?

The answer is no.

The $50 million to $55 million is only for land, building our facilities and clean rooms.

So the $25 million WLO investment is on top of that $50 million to $55 million.

Got it.

So the total CapEx this year will be like $75 million to $80 million, right?

Correct.

Got it and --

Actually more than that because on an ongoing basis we have about $10 million of CapEx for IC design, tool and stuff, so that is going to be ongoing.

Got it.

So you add around $10 million to that.

So since you mentioned about this kind of huge CapEx, could you update the possible capacity for LCOS and WLO after your capacity expansion?

I think again $50 million to $55 million for the new building, including clean rooms, right?

So by early next year we will be ready for move in, personnel move in as well because the new building, one of the major reasons is for office because we are so jam-packed and some of our staff need to work outside.

Now once the new building is up and ready we will then, depending on the market situation and customer demand and design activity, etc.

at the time, to determine the pace of our new equipment move in, i.e.

CapEx, for both WLO and LCOS.

Now in terms of LCOS it looks like we are not in shortage of capacity for LCOS right now as you know so there will be certain CapEx for LCOS not to increase capacity but to enable our 12-inch capability, i.e.

our higher end displays, specifically higher resolution displays.

What we try to do is to take advantage of the more advanced geometry of silicon and they are only available for 12-inch and that is why we need the 12-inch LCOS fab.

For now it is to maintain our leading position in the LCOS technology.

So the early expansion plan, unless there are major surprises this year where I mentioned we do anticipate a few launches from a few of our customers.

Some of them are actually very, very well-known names although again I cannot disclose them.

We are expecting quite a few launches of new AR devices to the market this year.

Some of them may surprise me and if there are pleasant surprises then we may have to expand in the LCOS capacity as well next year.

However, for now we do have sufficient capacity, so the goal is to take us to 12-inch and be able to make higher end panels.

That's a short-term goal.

For WLO, as can you tell, we are in shortage of capacity already.

That is why we need to accelerate this $25 million of investment.

And next year there will be, I think -- I believe there will be more opportunities and more coming from WLO-only applications or customers and our total solution structured light application solutions.

I really cannot tell which one will outweigh the other but both are looking promising and exciting for now.

So I would not be surprised on top of this $25 million this year, when our new building is ready for move in we will invest further in WLO.

I would not be surprised if this is the case next year.

Previously you said that WLO capacity is less than 3000 8-inch mother glass and will increase to 6000.

So is this still the target?

No, we actually mentioned earlier that part of our existing capacity is consigned by customer.

I guess ballpark more specifically, if you talk about wafer input, our monthly wafer input capacity, we have existing consigned capacity of about 4000 wafers a month and non-consigned about 2000.

And we are adding about another 4000 out of this $25 million investment.

So ballpark that is the picture right now.

Okay, thank you so much.

(Multiple speakers) equipment is dedicated to a certain customer and we cannot do it for other customers' projects.

Okay, got it.

Very helpful.

Thank you so much.

Thank you, Donny.

Thank you.

And I'm not showing any further questions at this time.

I would now like to turn the call back to Mr. Jordan Wu for any closing remarks.

As a final note, Jackie Chang our CFO will maintain marketing activities and attend future investor conferences.

We'll announce the details as they come about.

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 great day.