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Himax Technologies, Inc. (NASDAQ:HIMX)

Q4 2012 Earnings Call

February 7, 2013 8:00 a.m. ET

Executives

John Mattio - SVP, IR, MZ Group

Jordan Wu - President and CEO

Jackie Chang - CFO

Analysts

Jay Srivatsa - Chardan Capital

Peter Liao - Nomura Securities

Kyna Wong - Merrill Lynch

Operator

Greetings and welcome to the Himax Technologies Inc.’s Full Year 2012 Earnings Conference call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, John Mattio, Senior Vice President of MZ, North America. Thank you, sir. You may begin.

John Mattio

Thank you, operator. Welcome everyone to Himax’s fourth quarter and full year 2012 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 your questions in a Q&A session. If you have not yet received a copy of today's results release , please call MZ Group at 212-301-7130. Access the press release on financial portals like Bloomberg, Yahoo or Google or you could download a copy from Himax’s website at www.himax.com.tw.

Before we begin the formal remarks I would like to remind everyone that some of the statements in this conference call, including statements regarding expected future financial results and industry growth are forward-looking statements that involve a number of risks and uncertainties that could cause actual events or results to differ materially from those described in this conference call. Factors that could cause actual results include, but are not limited to, general business and economic conditions and the state of the semiconductor industry; market acceptance and competitiveness of driver and non-driver products developed by the company; demand for end-user application products; reliance on a small group of principal customers; the uncertainty of continued success in technological innovations and other operational and market challenges; the capacity to maintain the full two-way fungibles between the company's ordinary shares and ADSs, and other risks described from time to time in the company's SEC filings, including those risks identified in the sections entitled Risk Factors in its Form 20-F for the year ended December 31, 2011 filed with the SEC as amended.

Except for the company's full year 2011 financials, which were provided on the company's 20-F filed with the SEC, the financial information included in this conference call is unaudited and consolidated, and prepared in accordance with U.S. GAAP. Such financial information is generated internally and has not been subjected to the same review and scrutiny, including internal auditing procedures and audit by independent auditors to which the company subjects its annual consolidated financial statements, and may vary materially from the audited consolidated financial information for the same period.

Any evaluation of the financial information included in this conference call should also take into account the company’s published audited consolidated financial statements and the notes to those statements. In addition, the financial information included in this conference call is not necessarily indicative of the company’s results for any future 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.

At this time, I would now like to turn the call over to Mr. Jordan Wu. Jordan, the floor is yours.

Jordan Wu

Thank you, John, and thank you everyone for being with us for today's call. In today's conference call, in addition to reporting our performance in the fourth quarter, I will also summarize our results for 2012 and highlight key milestones we achieved this past year. I will then provide our outlook for the first quarter of 2013 and outlay our strategic focus areas for the full year 2013. Our CFO, Jackie Chang, will then provide further details on our financial performance.

Our 2012 fourth quarter revenues, gross margin, GAAP and non-GAAP revenues per ADS, all met our guidance. For the fourth quarter, we reported net revenues of $190.6 million with gross margin of 33.3%. Fourth quarter GAAP earnings per ADS were 8.4 cents and non-GAAP earnings per ADS were 8.9 cents. Both results falling in the top end of our earnings range. Our fourth quarter revenues $190.6 million represented a 12.7% increase from $169.2 million in the fourth quarter of 2011 and a 0.1% sequential increase from $190.4 million in the third quarter of this year.

Our revenues of this quarter are the highest since the fourth quarter of 2009. Revenues from large panel display drivers were $37.5 million, up 15.8% from a year ago, and up 1.3% sequentially. Large panel drivers accounted for 40.7% of our total revenues for the fourth quarter, compared to 39.6% a year ago and 40.2% in the third quarter. The sequential increase was attributed to strong TV demand arising from customers stock preparation for the Chinese New Year sales and China panel customers further new capacity ramp, offset by slower demand for notebooks.

Of our large size panel market regions, China showed the greatest growth year-over-year sequentially. Sales for both small and medium-sized drivers came in at $85.4 million, up 6% from the same period last year and down 2.2% sequentially. At the segment, drivers ICs for small and medium-sized applications accounted for 44.8% of the revenues for the fourth quarter, as compared to 47.6% a year ago, and 45.8% in the previous quarter. The sequential decline was mainly due to the weak feature phone demand as we push our focus to smartphone. China’s white-box market for both smartphones and tablets also experienced some correction towards the end of the fourth quarter. Excluding feature phones, sales for small and medium‐sized drivers, especially those for smartphone, tablet and automotive display applications, grew substantially for the fourth quarter 2012 from the same period last year. We will elaborate more on this later.

Revenues from our non‐driver businesses were $27.7 million, an increase of 27.6% from the same period last year and up 4.2% sequentially. Non-driver product revenues accounted for 14.5% of total revenues, this compares to 12.8% a year ago and 14% in the previous quarter. CMOS image sensors, power management IC and IP licensing were among the non‐driver products which delivered outstanding sequential growth. Also adding to this growth were our pilot shipments of LCOS microdisplays for the new and exciting head‐mounted display application.

Our fourth quarter non‐driver businesses overall grew 27.6% year-over-year as many products experienced double‐digit growth. Such products include CMOS image sensor, touch panel controller, power management IC, WLED driver, wafer level optics, IP licensing and operational amplifiers. As a percentage of total revenue, revenues from related parties continued to decline relative to those from other parties. They were down 6.3% from the previous quarter and up 2.2% from the same period last year. In comparison, revenues from other parties went up 3.4% quarter‐over‐quarter and up 18.3% year‐over‐year. Related party sales accounted for 31.8% of total sales in the fourth quarter, compared to 35.1% a year ago and 34% in the previous quarter. As recent as Q4 2009, related party still accounted for 68.8% of total sales. That figure has come down to 31.8% in Q4, 2012, mainly because our related party customer that owns 15% of Himax equity undertook to diversify supply base.

The related party sales as a percentage of total revenue may continue to decline as our other businesses now look set to outgrow the related party business. However, the related party customer remains our single largest customer and we will continue to provide them with the best service in an effort to win the most popular business from them.

Our GAAP gross margins for the fourth quarter 2012 were 23.3%, 120 basis points improvement from 22.1% a year ago and a slight improvement from the previous quarter. This is the fifth consecutive quarter of gross margin improvement and the highest gross margin level since the fourth quarter of 2008. The trend in our margin expansion is a direct result of a richer mix of higher margin products like those in our non‐driver categories and the fast‐growing small and medium‐sized panel drivers. Gross margin improvement will continue to be one of our key business goals going forward.

For the fourth quarter, GAAP net income was $14.3 million or 8.4 cents per diluted ADS compared to $3.7 million or 2.1 cents per diluted ADS in the corresponding quarter a year ago, and $10.4 million, or 6.1 cents per diluted ADS, in the previous quarter. GAAP net income grew 285.8% year-over-year and 37.7% versus the previous quarter. The sequential net income growth was mainly a result of the difference in RSU charges. The third quarter RSU expense was $6.3 million while it was just $0.5 million in the fourth quarter. The net income surge of $285.8% year-over-year was partly attributable to difference in income taxes and tax credit provisions.

Excluding share‐based compensation, acquisition‐related charges, income tax and tax credit provisions, our non‐GAAP adjusted pre‐tax income for the fourth quarter was little changed from the previous quarter, but still grew 95.4% from the same period last year, reaching $20.2 million. The strong year‐over‐year growth resulted from a combination of 12.7% top line growth and a 120 basis points gross margin expansion on top of $1 million operating expenses reduction. GAAP EPS per diluted ADS grew 300% from the same period last year and 37.7% over the previous quarter.

In summary, we are pleased with the top and bottom line financial performance during the fourth quarter of 2012. We will continue to execute our strategy and are excited about further growth opportunities going forward. I'll now ask Jackie Chang, our CFO, to provide more clarity and details on our financial results. After Jackie’s presentation, we will further discuss our full year results and then 2013 outlook and first quarter 2013 guidance. Jackie?

Jackie Chang

Thank you, Jordan. I will now provide additional details for our fourth quarter financial results. Our GAAP operating expenses were $25.2 million in Q4 2012, down 3.8% from $26.2 million a year ago, and down 19.1% from $31.1 million in the previous quarter. The significant sequential decrease was primarily the result of the difference in RSU charges. The third quarter RSU expense was $6.3 million while it was $25 million in the fourth quarter. In accordance with our protocol, we grant annual RSUs to our staff at the end of September each year, which, given all other things equal, leads to higher third quarter GAAP operating expenses compared to the other quarters of the year. Ignoring the higher RSU expenses in the third quarter of 2012, our Q4 operating expenses actually stayed stable comparing to the previous quarter and down $1 million from the same quarter last year.

GAAP operating income for the fourth quarter of 2012 was $19.2 million, or 10.1% of sales, up $8.1 million, or 72%, compared to the same period last year and up $6.1 million or 46.1% from $13.2 million, or 6.9% of sales, in the previous quarter again. Excluding RSU expenses, operating income for the fourth quarter remained around flat compared to the previous quarter.

Non‐GAAP net income in the fourth quarter was $15.3 million or 8.9 cents per diluted ADS, up from $4.3 million, or 2.5 cents per diluted ADS for the same period last year, and down from $16.5 million, or 9.7 cents per diluted ADS in the previous quarter. Non‐GAAP net income represents a growth of 252.2% year-over-year but was down 7.3% from the previous quarter. I will go through the fourth quarter and full year balance sheet analysis and 2012 full year financial results a bit later, after Jordan gives the 2012 full year business review.

Jordan Wu

Now let me summarize full year performance. I will also take the opportunity to highlight our main business themes going forward. As we mentioned on our previous call and in numerous interactions with investors throughout the year, the first and all successive quarters of 2012 demonstrated a successful turnaround in our business from our trough of 2011.

Small and medium‐sized driver ICs replaced the large panel sector to become our largest source of sales, thanks to the exciting growth in global demand for smartphone and tablet and our leading position in most of the applications. Large panel driver IC sales also experienced a double‐digit growth last year, benefiting from the growth in China market where most of the new buildings of panel capacity took place. Last but not least, our non‐driver products delivered the strongest growth last year owing to many new product launches and project wins. We expect our non‐driver products to continue to outgrow driver ICs in the years ahead.

Our revenues totaled $737.3 million in 2012, representing a 16.5% increase year-over-year. The growth was a result of increasing sales in all product segments. Small and medium‐sized drivers is now our largest product segment. It grew 16.6% year-over-year , representing 44.6% of our total revenues. As I reported earlier our sales into the feature phone sector declined in 2012 as we switched our focus to smartphone. Excluding feature phones, our small‐and medium sized drivers grew over 50% year-over-year. We were able to achieve such an outstand performance in this area last year because we were able to expand our reach to our end customers across China, Korea, and the U.S. This strong growth momentum with continue into this year. Thanks many to the rapid growth in smartphone, tablet and automotive displays.

Revenues from large panel display drivers grew 12.9% year‐over‐year, representing 41.4% of our total sales as compared to 42.7% in 2011. The growth was mainly driven by the sales to China customers. It also to our market share gain during 2012 in the large panel sector. Non‐driver products grew 28% year-over-year, representing 14% of our total sales as compared to 12.7% a year ago. Out timing controller IC, touch panel controller, power management ICs, WLED drivers, ASIC service, IP licensing and wafer level optics, all delivered strong growth in 2012. This illustrated our strong R&D capability and our commitment to a more diversified product portfolio.

Revenues from related parties were down $6.3 million or 2.4%, from the previous year. In comparison, revenues from other parties were $110.5 million, or 29.5% year‐over‐year. Related party sales accounted for 34.2% of total sales in 2012, compared to 40.8% a year ago. Gross margin in 2012 was 23.1%, a 330 basis‐point improvement from 19.8% in 2011. This significant margin improvement is a result of our product diversification.

Our GAAP net income was $51.2 million or 30 cents per diluted ADS, compared to $10.7 million, or 6.1 cents per diluted ADS last year. The strong year-over-year growth resulted from a combination of 16.5%, top line growth and 330 basis points gross margin expansion, on top of $5.5 million operating expense reduction. GAAP net income for the year of 2012 grew 377.9% year-over-year. GAAP EPS per diluted ADS grew 391.8% year‐over‐year.

In July 2012, we paid an annual dividend of 6.3 cents per ADS equal to 100% of 2011 net income. We remains committed to paying annual dividends, the amount of which is referenced primarily on prior year’s profitability. The high payout ratio in 2012 is an illustration of our confidence for our profitability to continue to improve. As I did with our report of the fourth quarter, I will now ask Jackie to explain the details for our full year financial results.

Jackie Chang

Thanks again, Jordan. In terms of 2012 full year performance, our GAAP operating expenses were $103.5 million, down $5.5 million or 5% from the same period of 2011. Excluding the bad debt collection from SVA‐NEC in 2011 and higher RSU expenses in 2012, our 2012 full year GAAP operating expenses were $97.2 million, down $13.3 million or 12% from the same period in 2011. The significant reduction was due to a better overall expense control and reduced ramp‐up costs for the production of wafer level optics at our in‐house manufacturing facility.

Operating income was $67.1 million or 9.1% of sales, as compared to $16.6 million, or 2.6% of sales, in 2011, representing 303.8% increase year-over-year. Non‐GAAP net income for 2012 was $59.9 million, or 35.1 cents per diluted ADS, up from $18.3 million, or 10.3 cents per diluted ADS for 2011. Non‐GAAP net income for 2012 grew 227.3% year-over-year. Non-GAAP EPS per diluted ADS grew 240.8% year-over-year. Our cash, cash equivalents and marketable securities were $138.9 million at end of December 2012, significantly improved from $106.3 million for the same time last year and $89 million of quarter results, due to the substantial net cash inflow from operating during the quarter.

On top of the above cash position, restricted cash was $73 million at the end of December, down from $84.2 million during the same period last year and same as the end of the last quarter. Inventories at the end of December were $116.7 million, up from $113 million a year ago and down from $128.3 million a quarter ago. Accounts receivable at the end of December were $209 million as compared to $181.1 million a year ago and $218.3 million last quarter. Days Sales Outstanding were 103 days at end of December 2012 as compared to 104 days last year and 109 days at end of the last quarter.

Net cash inflow from operating activities for the fourth quarter was $52.4 million as compared to $17.3 million during the same period last year. And the outflow of $7.1 million in the previous quarter. As indicated in our previous earnings call, we managed to generate a substantial net cash inflow from operations during the fourth quarter due to increased cash received from accounts receivable collection, and less vendor payments for improved inventory control. Cumulative cash inflows from operations in 2012 were $52.2 million versus $43.4 million the year before. Capital expenditures were $2.2 million in the fourth quarter versus $1.2 million a year ago and $1.7 million last quarter, bringing the total capital expenditure to $6.6 million through 2012, as compared to $18.9 million in 2011.

With regards to our $25 million dollars share buyback program, we have purchased a total of $13.4 million or approximately 9.5 million shares ADS, through December 31, 2012, including $0.7 million or approximately 0.3 million shares ADS, purchased in Q4 2012. As of December 31, 2012, Himax had 169.6 million shares ADS equivalents outstanding. We will continue to execute the remaining share repurchase program in accordance with Rule 10b‐18.

I will now turn the floor back to Jordan to discuss our 2013 outlook and first quarter guidance.

Jordan Wu

Thank you, Jackie. 2012 was a year of successful transition and we delivered a robust earnings growth. Looking to 2013, we are strong fundamentals across many of our product line that will continue to execute our strategy. We focus expanding related technology while diversifying our customer base and product portfolio. Large business driver business remains one of our long term focuses. We gained some of the share in 2012 and comparatively on the leading edge in key technology change across various high-speed interfaces at 4K TV.

However, large panel drivers short-term prospects looks sluggish. (Inaudible) to experience sub-sequential decline during the first quarter of 2013 because of slow monitor demand, high customer inventory, seasonal slowdowns and reduced large panel driver sales to our related-party customer. We believe that this has not really set back as we are committed that our competitiveness in this segment strong. With potential growth opportunities coming from customers in China and Korea. The prospect of our small and medium sized panel driver business remains robust and solid in 2013.

We are currently in a strong position in the smartphone sector with leading technology, competitive product, and good customer line up. We carry a comprehensive range of products covering both mainstream and higher-end smartphone. We will further expand our smartphone customer base which has already covered both international and Chinese brands as well as the fast growing China white-box market. We believe that our leading position in this segment will be further solidified as the industry moved towards high resolution. Further technical complexity of driver IC is vastly complicated and the barrier of entry is higher than before.

We expect the sales for smartphone application to accelerate throughout 2013, boosted mainly by the China white-box market, typical (inaudible) embarking on the main stage approach. Similar to feature phones and smartphone before it, led by Chinese makers selling to both domestic and emerging markets. The demand of low cost white-box tablets surged in 2012 and is expected to further accelerate in 2013. Himax has long been a leading player in China’s medium sized panel market and is well positioned to benefit from the new found momentum of the white-box tablet market. Moreover, we have successful penetrated into several leading international tablet brands and have started to make shipments to some of them since Q4 2012.

With further design wins and shipments in the pipeline, we expect the tablet market will contribute to noteworthy growth for Himax in 2013 and beyond. Our non-driver business provides not only the most exciting growth prospects but also the synergy of product and know-how that we can bring to our customers through offering a total solution of image processing related technologies in addition to our driver IC products. This is one of our key differentiators against our competition. Our goal is to further lift the non-drivers percentage of total sales from the 14% of 2012. We will benefit not only from a more diversified sales base but also higher gross margin.

Many of our non-driver sectors including CMOS image sensor, wafer level optics, timing controller, touch-panel controller, power management IC, WLED driver, ASIC solution and LCOS microdisplay, are on track to enjoy decent growth during 2013.

I will now elaborate on a few long-driver products which we believe will see robust growth this year and going forward. The technology of timing controller is undergoing major changes recently. Integration for the industry trend towards higher panel resolution. We are among the leaders in this new technology development. Our eDP 1.1 and 1.2 solutions are already in mass production. In addition, we have successfully new eDP 1.3 timing controller IC, which were among the very few solutions to have thus (inaudible) by leading (inaudible) and chipset companies compliance tests. eDP 1.3 provides low power consumption and cross-interface for high end notebook and tablet applications.

We are working with numerous panel and end-user customers in the development of eDP 1.3 project and are excited about its long term prospect. Our CMOS image sensor delivered a phenomenal growth during the fourth quarter of 2012. Mainly due to numerous design wins in smartphone tablet, laptop and surveillance applications. We cover into the mainstream and entry level sets of products with pixel counts of up to 5 mega. And now are set to release a new 8 megapixel product very soon. However, the future prospect for CMOS image sensor looks gloomy as China market is going through correction and many of the customers adopting our new sensor product are still finishing up their product tuning.

Notwithstanding the short-term downtrend, we do expect the sale of this product line to surge in 2013 boosted by shipments of our new products, many of which were only launched in the second half of last year. We also expect to break into new and medium smartphone brands further penetrating the tablet, surveillance and automotive application markets. The sales of touchpanel controller more than tripled in 2012 as spend this share in our existing medium smartphone growing customer and began shipment to new handset customers in China from Q3 2012.

Beyond handsets, we are expanding our product offering to cover large panel for [TV] applications, targeting both international and China white-box markets. Recently we were awarded four new tablet projects from a leading brand customer. We are confident that touchpanel controller will continue to deliver growth in 2013 through many new customers in smartphone, tablet and Win 8 laptop applications. We are working with several top tier customers to develop new head-mounted display products using our LCOS panels. We shipped some early volumes for customers pilot runs in the fourth quarter of 2012. We expect early stage shipment in 2013, in addition we are still working with numerous partners to create new type of projector applications using our LCOS microdisplays.

We remain committed to long-term development of LCOS microdisplay and its exciting new applications. With all these new developments and design wins of non-driver products, we expect that our non-driver businesses will continue to account for increasing percentage of our sales and contribute to overall gross margin improvement in 2013. The non-driver products represent our best long-term growth engine. In the first quarter we expect the high single-digit to low-teens decline in our revenues compared to the last quarter. The first quarter is likely to be the bottom of the year in terms of sales because we have fewer working days due to Chinese New Year.

Our gross margin is expected to be slightly up from the fourth quarter of 2012. We expect small and medium sized panel driver sales will contribute to an increasing percentage of product mix and revenue in the first quarter. GAAP earnings attributable to shareholders per diluted ADS are expected to be in the range of 6.5 cents to 7.5 cents per diluted ADS, based on 171 million of outstanding ADSs. Non-GAAP earnings attributable to shareholders are expected to be in the range of 7 cents to 8 cents per diluted ADS, based on the same number of outstanding ADSs.

Thank you for your interest in Himax. We appreciate your joining today's call and we look forward to a productive and profitable year in 2013. Operator, we will now open the floor for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Jay Srivatsa with Chardan Capital. Please proceed with your question.

Jay Srivatsa - Chardan Capital

Couple of questions here, Jordan. In terms of the mix in Q4, it appears your large panel grew a little bit while the handset, while the small panel dropped off a little bit. I think you have talked about the shift from feather phone to the smartphone contributing to the shortfall or the decline in Q4 on the handset side or in the small panel side. Let me ask a question related to that. How comfortable are you and how well positioned are you on the smartphone business as that ramps up in China?

Jordan Wu

Specifically for China market you mean?

Jay Srivatsa - Chardan Capital

No, just in general. It looks like the small panel business in Q4 declined versus Q3 and I think you alluded to the shift from feature phone to smartphone to be a part of the reason for that. The question is, how well positioned are you in the smartphone side, given that lot of the ramp this year could likely come from that side.

Jordan Wu

Well, I think the trend for smartphone is crucial for the up in panel resolution and we explained in our prepared remarks that we think the higher up it goes, the higher the barrier for second tier driver IC vendors. And so I think we will be better off in this trend. So I think the growth this year, both China and international brand, will come from higher resolution. So for last year, high VGA was the mainstream followed by WVGA. And this year WVGA I think is on track to replace high VGA to become the new mainstream. The high resolution of QSD even [IC720] will pick up the momentum. And I think we are on track to benefit from the new trend.

Jay Srivatsa - Chardan Capital

Okay. The next question I had was related to penetration newer panels and it’s now just looks like you are going to able to gain some traction at AUO through what I can tell. I wanted to get some sense of how is the business there ramping up and what portion of the revenues do you expect them to contribute as you look at the rest of the year.

Jordan Wu

You mean specifically on AUO?

Jay Srivatsa - Chardan Capital

Yes.

Jordan Wu

We still become (inaudible) customers specifically. But I think all I could say is that we have -- we probably share some lead in top-notch end customer in small panel segment. So certainly AUO is major customer in majority panel player in Taiwan and certainly we try to win a piece of their business. But I think other than that I really cannot comment any further.

Jay Srivatsa - Chardan Capital

Okay. In terms of your margin profile, it looks like you have had some pretty decent improvement through the last four to six quarters. As you look ahead to fiscal ’13, how do you expect that margin profile to be? Do you expect sequential improvement or is this kind of where you see the margins peaking out? Can you give us some sense on how do you expect product mix to impact your margins going forward?

Jordan Wu

I think if you look at our current portfolio, our non-driver overall enjoys better growth margin compared to driver IC as a total. So we repeated earlier that we do expect the non-driver percentage to further grow this year compared to last. And I will be honest, our performance in terms of non-driver as a percentage of total sales for last year, we are not totally satisfied with that performance. And I think there are quite a few segments which we believe are, as we move along to Q2 and second half, will pick up strongly. And they include, among others, CMOS image sensor, LCOS micro-display, touch-panel controller etcetera. So I think -- so that will be the point number one.

I think when we are able to raise our percentage share for our non-driver sales, we should be able to improve our gross margin overall. And secondly, I think a part of the reason why we have been able to raise our gross margin in the past few quarters was because feature phone has been declining in our sales. And feather phone, in general low-end products tend to suffer from very low, very poor margin and we intentionally switched our focus from feature phone to smartphone. And now low-end smartphone will start to suffer from some margin pressure and our strategy is to move further up. So I think barring a traumatic economic downturn here, I think we are pretty confident we should be able to further improve our gross margin overall in this year compared to last.

Jay Srivatsa - Chardan Capital

Okay. In terms of the guidance drop, in past years or in Q1 it’s typically not seen the high single-digit to low teens kind of decline. What is different for your this year versus in previous year in terms of the guidance itself?

Jordan Wu

Typically Q1 is always a difficult quarter to give guidance because there are just too many (inaudible) and it is very very hard to have a solid projection from the customer. And so typically we tend to give a conservative guidance in Q1. And actually the panel price in the last year and the year before, so we tend to, barring any sort of unexpected major event, we tend to -- I think our intention is to give a conservative guidance and to make sure we can always meet it. Because as I said, Q1 is always slow. So it’s a lot harder to predict. And if I breakdown into further details, I think we actually stated in our script that we do expect the large panel business to suffer from some decline, actually high double-digit decline. But we believe our small panel business to remain relatively robust.

So it’s a matter of the prospect for large panel for the whole year. And it’s a bit difficult to tell at this early stage of the year because on the negative side, the industry is not really growing capacity, unlike last year where China did grow a lot of capacity. I think China will start to see major capacity expansion only on the Q4 or even the end of Q4. So then customers will start to ramp their new gen [8.5] capacity, if everything goes according to plan. So we are not really expecting a large panel new capacity momentum.

However, we also mentioned in our script, we do hope to win new businesses from Korea. So we are very hopeful there, for instance in top line, we hope we will able to achieve for large panel. So now we will have (inaudible) second half of this year. So overall, I think we remained optimistic for the overall growth in 2013, the whole year. Although, I think even while we have right now and given the fact that we believe it is prudent to give a conservative guidance, our Q1 certainly looks excited.

Jay Srivatsa - Chardan Capital

All right. In terms of the panel business in China itself, it looks like more on more of the handset manufacturers in China looking to local suppliers as opposed to Taiwanese panel manufacturers. Can you give us some update on how are your positions with the Chinese panel manufactures and how you hope that will -- what that will mean for you in fiscal ’13?

Jordan Wu

I think Chinese panel makers certainly enjoy an advantage in their home market. But that doesn’t mean they don’t go export. But having said that, certainly China is now the strongest market overall. And the cellphone market ranging from high-end to low-end is a big market. It doesn’t just focus on low-end. I think our China panel customers are expanding aggressively both in terms of capacity build up and also in technology preparation. For example, if you look at -- if you talk about new [full] TV, they are all [LED]. So I think going forward for the next few years, China, still no doubt is still the fastest growing market.

So I think our intention is to cover them very very closely and try to maintain our market lead that we achieved last year. But other than that, certainly in China there is the government along with their capacity buildup and their ability to serve a higher percentage of their home markets demand. I think they will do a lot of things to protect their local players such as [TERE], as we all know. And such they are forming up alliance between their local panel makers and TV makers etcetera. So I think China panel maker customers will continue to remain pretty competitive in the global market.

Having said that though, we do see the first few international brands is an area where the China panel makers is not particularly competitive about for the time being. And I think it all makes sense to them because to cover their home turf has kept them very busy already.

Jay Srivatsa - Chardan Capital

All right. On the non-driver side, it looks like last year that business probably out grew your large panel and your small panel which is obviously very positive. I wanted to ask you, within the non-driver business, what segment do you see meaningful growth this year relative to some of the other areas that you are in in that side.

Jordan Wu

I would just only mention, momentum has been in like larger ticket items. And I think we mentioned in remarks that our CMOS image sensor will be sluggish in the first quarter. However, we are very excited about the rest of the year because this is mainly because we said earlier we launched quite a few new products. The 2-megapixel, the 5-megapixel, now our mainstream product for CMOS image sensor during the latter half of last year. So it did take some time for our customers to get through the engineering stage to enter the mass production. So I think we are very close to finalizing that.

So starting from Q2 and going forward, we are very excited about it. And we are also on track to launch our 8-megpixel sensor in the market where globally the supply is still very limited. So we are quite excited about the prospects of CMOS image sensor this year. Similar for wafer level optics. And in addition to that, touch panel controller, last year was really the first year of mass production -- meaningful mass production when we focused very much on serving our leading international brand customers in their phase one products. And we have managed to win the major share out of that. And after that we will move aggressively into China. We have started to pick up some momentum in China market in the second half of last year and we do expect the China sales to accelerate this year. And also the trend for laptop and tablet to adopt touch-panel. Our controller business over there is also quite promising.

And lastly, I would also want to mention (inaudible). I think starting second half, hopefully, we will see some exciting growth. But probably, certainly much less so in the first half when we will still be going through engineering ramp with our customers. But it’s on head-mounted display and there are now head-mounted display applications that we are working along with a few leading players in the world. So we are excited about that part. Again, in terms of (inaudible) you won't really see a meaningful volume until second half of the year.

Jay Srivatsa - Chardan Capital

All right. Last question on the balance sheet. Jackie, it looks like the cash position increased pretty significantly in Q4 over Q3. Can you give some highlight on what contributed to the increase in cash?

Jackie Chang

Yes. I think that we mentioned in the third quarter that we have increased sales in 2012 and in preparation for the business growth we have prepared rather inventory about the second quarter of 2012. Where on the receivable side it generated from the higher sales, the collection of the receivables tend to be longer days versus the payables that’s due from purchasing of the inventory. So in Q3 2012, we had a cash outflow in the quarter because of that dynamics of the receivable collection and the payable. So Q4, we were able to collect, own, all of our receivable that’s due current and we already paid the payables from the purchase of the inventory in Q3. So we generated the good financial result, the net income results from Q4. We were able to really generate a lot of cash inflow and significant improve our cash position at the end of the fourth quarter as we expected to do.

Jay Srivatsa - Chardan Capital

Okay. Thank you.

Jackie Chang

And also looking into Q1 I think our cash position will remain strong in the first quarter as we expect them to be.

Operator

Our next question comes from the line of Peter Liao with Nomura. Please proceed with your question.

Peter Liao - Nomura Securities

Most of my questions have asked by Jay already so only a few questions here. First is regarding China’s smartphone rising market. We notice that there is increasing competition and I think the key focus for you in this case would be, how could you maintain your margin or not to mention to improve it, given the severe competition in the China smartphone driver IC market.

Jordan Wu

I think the way to maintain is to move further up in terms of resolution and technology. And I will admit the price competition is very severe, coming from some of our competitors. And we have -- and typically in early stage let's say our HD 720 right now still enjoys pretty decent margins, ditto for QHD. Last year, while WVGA was quite good, now certainly is not as good as before. So, yes, margin pressure is there but the way to maintain the margin is to out-compete others in terms of higher end products.

Peter Liao - Nomura Securities

Okay.

Jordan Wu

And also I think our coverage on the brand name I think is comparatively is our strength. So last year when China’s brand name slowed down, we slowed down compared to our peers. So I think while we also cover [wide] market our strength, comparatively it’s on the brand name in China.

Peter Liao - Nomura Securities

Also regarding China smartphone market I notice that there is an increasing trend for RAM-less driver IC starting from second half. But since the penetration will remain very small in second half but I notice that there seems to be increasing demand for RAM-less driver IC, kind of it being low cost. Can you give some color on this and also will RAM-less driver IC give you better margin?

Jordan Wu

Not necessarily. Well actually we do both driver ICs, RAM and RAM-less, and they are equally important to us. And it is, as you say, it is actually choice of the customer. And typically RAM-less is certainly without a memory, so the IC is cheaper. But then power consumption for the whole panel module will be higher. So it is a very easy trade-off. And certainly when cost pressure becomes high, people tend to move to RAM-less, more than the other way around. And it’s hard to comment, the margin difference for RAM and RAM-less ICs, I think they are similar. And certainly our ICs with RAM just give us better ASP. But what we try to do is to provide a comprehensive coverage of product covering all resolutions and both RAM and RAM-less IC.

Actually, we go further than that. For example, we cover both (inaudible) panel and (inaudible) array and so on. And so for each to be specific resolution, we do have a range of products covering different technologies. So our strategy is to be a leader in high-end products and also to cover a comprehensive range of the products.

Peter Liao - Nomura Securities

Also I would like to know about, this year I notice no growth of first tier when the higher smartphone models start to adopt for full HD display resolution. I wonder whether you have this kind of solution or if not, when could we expect to have or launch to market in like what kind of period?

Jordan Wu

Full HD product is still very, very, very small in terms of volume. So we are very close to launch our solution and we didn’t want to be too early because we believe full HD, there is lot of technical considerations including cost, including power consumption and certain unique image processing features required by end-user customer. And that we need to be careful about. We need to clarify before we take out our solution. And that is why we have been in lot of discussions with certainly the branded customers on the specifications of full HD solution. And while we wanted to avoid to take out a pre-mature product and (inaudible) full HD into this, especially (inaudible). The take off cost is very very high, so we don’t take off pre-mature product.

But our full HD solution will be launched very, very soon. But we are certainly not in mass product stage yet. But we are not very worried about this because we do have the know-how and the market is still, as I said, still very very limited. And it is not likely to become anything close to a mainstream during this year, in our view.

Peter Liao - Nomura Securities

Just assuming they are still certain high-end which will likely adopt more advanced technology and may require higher R&D. So could we expect higher R&D spend this year compared to last year to make sure you have leading position in all products.

Jordan Wu

We will be into [higher] geometry is only one of the parameters for the R&D expense. So I don’t think our R&D expense will be higher because of this reason per say. But I would say, based on our current business plan, we do expect higher operating expenses this year compared to last, mainly because I think we have been running very stretched in terms of product development. I mean we have always suffered from the problem of having too many opportunities with too few people to cover. So we are embarking on a new wave of some degree of hiring.

And certainly we will always be careful about our expense control but it’s a difficult trade-off decision to make. And I want to highlight that by -- okay, our problem is we have to many opportunities to cover and we have too few people to cover them. So what we do, we try to hire a little bit more people to cover the opportunities. However, the downside is the short term. Right. When you start to hire and when those people start to do R&D and development, there is time lag before any revenue can be generated. So will be very careful managing this process during this year and we just have to look at that quarter-by-quarter.

So while we will bring people the whole year but we also have an internal decision to follow them very closely to see how fast or how slow we should go along with our plan to hire more people to cover more projects. But at the moment both, in particular for small panel businesses and our ASIC service, our CMOS image sensor and our touch panel controller, we have more projects than we can cover right now.

Peter Liao - Nomura Securities

My next question is regarding the combination of touch controller and smartphone driver IC. I know the market industry has talked about a change for (inaudible) right now answering in field solution for panel makers still is not mature yet. But what are you view on that? And it seems that earlier you also mentioned that kind of product, so maybe give us some color on [that] solution and when do you expect the market to bring up?

Jordan Wu

Peter, it’s a very good question. It actually involves a bit of a trade secret. I am just wondering how I should address this issue. I think in the long-term (inaudible), this should happen because it’s much [fast] to have integrated touch panel controller and driver IC. It’s a matter of when and how it will happen. And I think it is probably more a business decision than a technical decision because people like us are capable of doing that. It’s a matter of whether we are too mature. We are pretty mature. And indeed there are numerous end-user customers talking to us about this and I don’t think I can elaborate much more than that. But I think the key decision point is whether the industry is ready, right.

And I think we are in a unique position to implement this because I am in no doubt we are a leader in smartphone driver IC. And we also have pretty solid proven (inaudible) in certain leading handset brands for touch panel controller. So we have sufficient credibility for both to be in a position to indicate that. Because if you are only good at one of the two areas, than nobody is going to fully trust you, when you try to integrate the two technologies into one piece of IC. So I think that will be a major barrier. People need to have a lot of trust. Because once you embark on a certain project, it’s a lot of cost for all parties involved, particularly I think the end-user customer.

So indeed there are some [sure] customers talking to us seriously but I think that’s probably the most I can say right now. But I am not going to make a prediction as to effectively when that will happen.

Peter Liao - Nomura Securities

I think it’s good enough for you if you not show us this [colors]. And another growth driver in terms volume is tablet market and I think we are happy to see that you penetrated in some of global tier tablet brands this year. And considering you have no strength, position in China tablet market, is that possible to give us some color on that? Whether for tier one in your global tablet brands, their [margin falling] is bit hurting the China tablet customers, considering for China usually they consider cost some more.

Jordan Wu

At this stage there is no really significant difference in gross margin to be honest. I think China, the tablet market in China at this stage is a pretty fragmented market. So you are talking about many many, our main customers doing lot of different projects, large and small. So in such a fragmented market the key to cover them is to be able to offer service to cope with the wide range of demand and the fluctuation in their demands, accordingly. And as a result one can see those projects [ the margin] the international brands, it’s totally a different story where you are talking about one or two single customer who are extremely demanding in technology but they are extremely big. So they do have a lot of bargaining power.

Having said that, they do demand higher-end solution. So as a result I think they also are willing to pay a certain margin. So I think the nature of the two markets are extremely different. But they come down to, I would say, a similar margin level as of to date.

Peter Liao - Nomura Securities

And my final question is for Jackie. I notice though the number is small but I just wonder why did some [4 inch] turn to losses in fourth quarter. I think all your ASP is mainly based on [USP] as follows, I think more so your cost is to be in U.S. dollars and there would be a small ramp of foreign exchange losses in fourth quarter?

Jackie Chang

I think we have some inter-company loan between our Tainan company and our Himax in Taiwan. So that the loan is actually between U.S. dollar and NT. So we have some exchange rate loss. However, we did manage to change the loan agreement in last year. And hopefully that will take care of the problem going forward.

Jordan Wu

But, Peter, to address your question, we are pretty much falling (inaudible) as you said, we make all sales in U.S. dollar and total [sales] are in U.S. dollar. Right. So they may not be (inaudible). So there is no, on gross profit level there is no foreign exchange exposure. However, on operating level for (inaudible), we do pay our service in NT dollars. So at the time of the conversion there could some [essential] exchange proliferation. For example, there will be a [tech sale] which is U.S. dollar or paid liability, which is NT dollar based. Because we are a Taiwan company still, we pay Taiwan tax. So we are running on U.S. dollar books.

So over there we do have a small amount of NT dollar excess of liability. While I don’t know the details but we are not totally immune from foreign exchange fluctuation. However, we are very very neutral because it is a U.S. dollar book and our sales and cost of goods sold are denominated in U.S. dollars, which you have pointed out correctly.

Operator

(Operator Instructions) Our last question comes from the line of Kyna Wong with Merrill Lynch. Please proceed with your question.

Kyna Wong - Merrill Lynch

I just come up with two questions. So first is about the trends on what the contributions from related party. Last year, I think it’s on 34% from this related party and how is it in this year? Is it [coming] certain percentage or (inaudible)?

Jordan Wu

I think given last few years trend, we have to be prepared that it may continue to decline. Although it is really the customers decision and customers behavior. So it’s literally impossible for me to make any prediction here. And all we can do is try to compete over there and try to provide that service. But the fact of the matter is that we try to emphasize this particular point because we are talking about year-end result and we look at the whole year, last year result. And one thing very significant was the decline of related party sales. So we saw to it properly that we highlight this majority sector to our investors and analysts. But certainly we are not saying it would definitely be in decline further in the year but having said that, we did highlight that when we look at the first year forecast, U.S. on total declined quite a bit further.

Kyna Wong - Merrill Lynch

I think so. Are you confident that there was new (inaudible) or else on China customer to offset this decline?

Jordan Wu

That’s how we did in the past and there is no reason to believe why we cannot continue to do that. So both are important to us. We are not saying we will give up on our related party sales. But I mention there are opportunities in China, in Korea, even Japan and other Taiwan customers as well. So, yes, there are ‘new fall’ opportunities for us. Some of the major ones may only start to realize in the second half of the year. But, yes, we have all intention to gain back the share.

Kyna Wong - Merrill Lynch

And then one that’s about the ASP trends. Could you give you some idea about the ASP changes in full quarter, fourth quarter and this quarter in each segment. Like large display driver IC and also small, medium display driver IC.

Jordan Wu

Kyna, ASP is becoming a very confusing term because we are talking about for example, sales from higher and lower end. You talk about one unit of IC but there are very different ASP. Even large panel, you talk about different channel counts. And we do see interesting trend of the industry in large panel, where the channel count number has been reversed. Meaning, we were running that, for example, last year the mainstream is probably 9 to 60 channel. But there are good indications that 720 some channel is picking up the momentum again because customers are trying to get [many] frames in their TV. So all cost structures make the so called ASP very confusing. But I think to address your question, if you look at on apple-to-apple prices, quite price erosion in Q4 and have we spend in Q1.

I think they are somewhere around 1 percentage point on a [positive] basis, and probably even less than that. And the moment it is relatively stable compared to some other times in the past.

Kyna Wong - Merrill Lynch

In large display driver or ....?

Jordan Wu

In large display driver, yes.

Kyna Wong - Merrill Lynch

So any idea in small to medium or small segment. So can you comment on that?

Jordan Wu

About a cent.

Kyna Wong - Merrill Lynch

I see. So because I was thinking large area driver and the revenue grew in four quarter but which was out of expected because at the beginning of fourth quarter you may expect slower demand. After that, that should outperform, outgrow your expectation. So if there is not much change in the ASP, so definitely the upside would come from this shipment and the product mix. Is that right?

Jordan Wu

Yes. I would say smartphone, in China in particular, relative to other [tech buyers], we do see a higher price pressure. In comparison tablet is relatively better. Then I think probably because of smartphone as well know is, the whole industry is moving up in terms of volume and technology, and resolution and everything else so fast, so dramatically. So inevitably there is more competitive pressure.

Kyna Wong - Merrill Lynch

Are you looking for this similar situation in 1Q, like pricing pressure in smartphone, relatively okay in tablet and quite stable in large display driver IC?

Jordan Wu

Q1 is relatively stable. I was making the comments as a overall trend for the whole year. And that would be my prediction and that applied to the whole of last year as well.

Kyna Wong - Merrill Lynch

Okay. Relatively stable?

Jordan Wu

Yeah, relatively stable with smartphone being the most competitive segment in terms of price pressure.

Operator

Mr. Wu, we have no further questions at this time, I would now like to turn the floor back over to you for closing comments.

Jordan Wu

Thank you everyone for taking the time to join today's call and we certainly look forward to talking with you again next call in early May. And as a final note, Jackie Chang, our CFO, will be on a road show in the U.S. in the last week of February. So please contact or John Mattio if you are interested in meeting with us in person. So thank you again and Happy Chinese New Year.

Operator

Ladies and gentlemen, this does conclude today's teleconference, you may disconnect your lines at this time. Thank you for your participation and have a wonderful day.

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