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Executives

John Mattio - SVP, IR, MZ Group

Jordan Wu - President and CEO

Jackie Chang - CFO

Analysts

Jay Srivatsa - Chardan Capital Markets

Peter Liao - Nomura Group

Kyna Wong - Merrill Lynch

Scott Bishins - Caffeine Holdings

Himax Technologies, Inc. (HIMX) Q3 2012 Earnings Conference Call November 8, 2012 8:00 AM ET

Operator

Greetings and welcome to the Himax Technologies Incorporated Third Quarter 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, Mr. Mattio. You may begin.

John Mattio

Thank you very much, operator. Welcome everyone to Himax’s third quarter 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 remarks, we have allocated time for questions in the Q&A session following the company's presentation. If you have not yet received a copy of today's results, please call MZ Group at 212-301-7130, access to the press release on financial portals like Bloomberg, Yahoo or Google are also available and 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 the driver and non-driver products developed by the company; demand for end-use application products; reliance on a small group of principal customers; the uncertainty of continued success in technological innovations; and other operational and market challenges including the company's Taiwan depository listing TDR, the ability 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 is not yet 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 materially differ from the audited consolidated financial information for the same period.

Any evaluation of the 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, everybody for being with us for today's call. In this earnings call, I will start with discussing our third quarter performance including key growth drivers and milestones that we've achieved so far in 2012. Our CFO, Jackie Chang, will provide further details on our financials. I'll then elaborate on our fourth quarter outlook issued earlier this morning U.S. time.

Our 2012 third quarter revenues gross margin GAAP and non-GAAP earnings per ADS all met our previous guidance. For the third quarter, we reported net revenues of $190.4 million with gross margin of 23.3%. Third quarter GAAP earnings per ADS was $0.061 and non-GAAP earnings per ADS were $0.097 both coming in at the upper end of our earnings guidance.

Our third quarter revenues of $190.4 million represent a 17.5% increase from $162.1 million in the third quarter of 2011 and a 0.5% sequential increase from $189.5 million in the second 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 $76.5 million, up 23.4% from a year ago and down 4% sequentially. Large panel drivers accounted for 40.2% of our total revenues for the third quarter compared to 38.3% a year ago and 42.1% in the second quarter. The sequential decline came in after three consecutive quarters of growth and was attributed to slower demand from the TV models which our customers launched earlier this year. That said we have experienced 11.9% growth from large panel segments in the first three quarters mainly affect to the capacity increase in China.

We are happy to report that our driver sales of small and medium sized panels achieved another record high in the third quarter. They came in at $87.3 million up 9.5% from the same period last year and up 4.1%, sequentially. As a segment, driver ICs for small and medium size applications accounted for 45.8% of total revenues for the third quarter with tablet and automotive display being the fastest growing applications.

As we pointed out in the previous earnings call, sales from smartphone applications remained flat from those of the second quarter because our main clientele in China, many of them leaders in high end market experienced competitive pressure from lower end peers which undercut the price to penetrate the marketplace aggressively.

Notwithstanding the short-term momentum, smartphone remains our strongest growing product segment overall. We remain bullish on the growth prospects of the smartphone segment and we’ll elaborate more on this later. Revenues from our non-driver businesses were $26.6 million an increase of 30.2% from the same period last year and up to 2.3% sequentially. Non-driver product revenues accounted for 14% of total revenues as compared to 12.5% a year ago and 13.7% in the previous quarter.

Again, as we discussed in the last earnings call, sequential growth in non-driver business slowed down mainly because of a couple of reasons. First, the Win 8 launch delay affected our CMOS image sensor business. Second, our Q3 LCOS microdisplays revenue slowed down due to our decision to position the business to focus more on the head-mounted display products, although we remain committed to the new developments of pico projector products.

Notwithstanding the above mentioned negative factors, our non-driver businesses overall still grew 30.2% year-over-year as many products including touch panel controller, power management ICs, WLED driver, wafer level optics and operational amplifiers experienced double-digit growth.

Revenues from related parties remain flat from the previous quarter at 34% of total sales in Q3 compared to 39.3% a year ago and 33.4% in the previous quarter. Our GAAP gross margin for the third quarter 2012 was 23.3%; a 480 basis point improvement compared to 18.5% a year early and a 20 basis points improvement from 23.1% in the previous quarter.

This is the fourth consecutive quarter of gross margin improvements and the highest gross margin level since the fourth quarter of 2008. The trends in our margin expansion is a direct result of richer mix of higher margin products like those in our fast growing non-driver category. We also focus more on better value added higher end driver IC products which has higher entry barrier.

Gross margin improvement will continue to be one of our business goals going forward. As was the case in the past, regarding RSUs or restricted share units at the end of September pushed back to higher third quarter GAAP operating expenses compared to the other quarters of the year. The total value of our 2011 RSU is about $11 million of which $6.3 million was paid to employee in cash and thus expense in the third quarter. Jackie will add more details on this later.

For the third quarter GAAP net income was $10.4 million or $0.061 per diluted ADS compared to $0.6 million or $0.004 per diluted ADS in the same quarter a year ago and $15.1 million or $0.089 per diluted ADS in the previous quarter. GAAP net income grew 1421.7% year-over-year but increased 31.1% quarter-over-quarter mainly due to the $6.3 million 2012 RSU charge in the third quarter.

Excluding the share based compensation and acquisition related charges non-GAAP net income was $16.5 million or $0.097 per diluted ADS representing a growth of 244.1% year-over-year and 3.5% sequentially.

In summary, we’re pleased with the top and bottom line financial improvements during the third quarter of 2012. We will continue to execute our strategy and are excited about future growth opportunities going forward.

I'll now ask Jackie Chang our CFO to provide more clarity and details and our financial results. After Jackie’s presentation, I'll then come back to describe our outlook for the fourth quarter. Jackie?

Jackie Chang

Thank you, Jordan. I will now provide additional details for our third quarter financial results. Our GAAP operating expenses were $31.1 million in Q3, 2012, up 2.1% from $30.5 million a year ago and up 32.4% from $23.5 million in the previous quarter.

As Jordan mentioned the significant sequential increase arose primarily from the expense of $6.3 million for 2012 RSU grant, without the RSU charge, our operating expenses were $24.6 million in the third quarter of 2012, down 6% from the same quarter 2011 and up 6.7% from the previous quarter. The increase from the previous quarter came mainly from higher expenses related to salary and new product development. We raised the annual salary in the middle of the year.

The total value of our 2012 RSU is approximately $11 million out of which 58% was paid in cash immediately and therefore expense in the third quarter. The remainder will be vested equally at first, second and third anniversaries of the grant date and will be paid in shares. The maximum share dilution in the next three years resulting from 2012 RSU grant is about 2.3 million ADS in total or 1.4% of our total shares outstanding.

GAAP operating income for the third quarter of 2012 was $13.2 million representing 6.9% operating margin, it went down $7 million sequentially and up $13.7 million year-over-year. The main reason for the sequential decline in operating income is the expense from the $6.3 million RSU grant in the third quarter which accounted for 3.3% of sales.

Non-GAAP net income in the third quarter was $16.5 million or $0.097 per diluted ADS, up from $4.8 million or $0.027 per diluted ADS for the same period last year and up from $15.9 million or $0.093 per diluted ADS in the previous quarter.

Our cash, cash equivalents and marketable securities available for sale were $89 million at the end of September 2012, little change from $90.8 million for the same time last year and $103.2 million a quarter ago. We made a cash payment of RSU of $6.3 million and a cash dividend of $10.7 million during the quarter.

Inventories at the end of September were $128.3 million, up from $104.7 million a year ago and down from $139.2 million a quarter ago. Accounts receivables at the end of September were $218.3 million as compared to $174.7 million a year ago and $212.9 million last quarter. Day sales outstanding were 109 days at end of September compared to 103 days last year and 109 days at end of the last quarter.

Net cash outflow from operating activities for the third quarter was $7.1 million. This is mainly because we had a relatively high inventory level at end of the second quarter as delivery for much goods prepared for shipping before quarter end was postponed into third quarter out of short notice by the customers. As a result, while we had to pay for those goods in third quarter, we will not get paid until the fourth quarter. We expect to generate a substantial net cash inflow from operations during the fourth quarter.

Capital expenditures was $1.7 million in the third quarter versus $7.1 million a year ago and $1 million last quarter bringing the total capital expenditures to $4.4 million through the first three quarters of 2012.

With regards to our $25 million share buyback program, we have purchased a total of $12.7 million or approximately $9.1 million ADS through September 30, 2012 including $24 million or approximately 23 million ADS purchased in Q3 2012.

As of September 30, 2012 Himax had $159.9 million ADS equivalent outstanding. We will continue to add to the remaining share repurchase program in accordance with Rule 10b-18. Before I turn the floor back to Jordan, let me quickly summarize our financial results for the first nine months ended September 30, 2012.

Revenues were $546.7 million representing a growth of 17.9% over last year. Our gross profit growth were $126.1 million or 23.1% gross margins. Our gross profit increased $37.9 million from $88.2 million and our gross margins were up 410 basis points from last year.

GAAP operating expenses were $78.3 million for the first nine months of 2012 down $4.5 million or 5.4% from the same period 2011. The significant reduction was due to a better overall cost control and the reducing ramp up costs for production of WLO, WLM and LCOS products at our in-house fabs partially offset by increase of $29 million share based expenses.

Operating income was $47.8 million, or 8.8% of sales, as compared to $5.4 million, or 1.2% of sales, for the first nine months of 2011, representing $42.4 million or 780.9% increase year-over-year. The improvement in operating income was a reflection of our overall top and bottom line financial improvement from last year.

GAAP net income for the first nine months was $36.8 million, or $0.216 per diluted ADS, up from $7 million or $0.039 per ADS last year. GAAP net income for the first nine months of 2012 grew 427% year-over-year. GAAP EPS per diluted share ADS grew 453.8% over the same period last year. Non-GAAP net income for the first nine months was $44.6 million or $0.261 per diluted ADS up from $14 million or $0.079 per ADS for the same period last year. Non-GAAP net income for the first nine months of 2012 grew 219.5% year-over-year, non-GAAP EPS per diluted ADS grew 230.4% year-over-year. Net cash outflow from operating activities for the first nine months of 2012 was $0.3 million. As discussed earlier we expect to generate a substantial net cash inflow from operations during the fourth quarter. All of the above are strong indications that our overall business has bottomed out from the cloud of last year. The management is committed to continuing improvement of our overall financial performance going forward.

I will now turn the floor back to Jordan to discuss our growth strategies and fourth quarter guidance. Jordan?

Jordan Wu

Thank you, Jackie. I will now provide an outlook for each of our major product segments in greater detail and after that our guidance for Q4. I will start with now projects business segment small and medium size drivers. Thanks to all the technology and strong execution. We’ve enjoyed a phenomenal growth in this product segment for quite some time. We’ve not only lifted our overall sales but also contributed to the diversification of our revenues. As recent as Q4 2009 small and medium size driver’s company sales were only $37.7 million or 21.1% of our total sales at the time. In comparison, they were $87.3 million in Q3 this year or 45.8% of our total sales. Smartphone applications have delivered the strongest growth since the third quarter of last year mainly due to our successful penetration into the first tier brands in China.

On the back of the existing success in China and international brand markets with one further design wins from leading global brands will start shipment from Q4. We've also started to see positive results from our efforts in working with the fast growing tier 2 smartphone customers in China during the third quarter. We will continue to make progress and gain market share in that area. We expect the smartphone sector to experience double digit growth in Q4 and the growth momentum to continue into next year driven by strong demand from both international and China markets.

Amongst small and medium sized panel applications, we also see tablet and automotive displays growing strongly so far this year and we continue to work closely with numerous customers on this application. This product will continue to contribute noteworthy growth 2013. The overall fourth quarter outlook for the small and medium sized panel drivers appears lukewarm because of seasonal reasons. Large panel driver remains one of our main businesses accounting for 41.7% of our total sales in the first three quarters and were up 11.9% from last year during the period. We continue to thrive towards winning more market share in this segment. We are a leader in new technologies such as next generation high-speed interface, a simple high resolution panel including loans for the new 4K x 2K TV. It is for this reason that companies like Himax have retained the favorable market position and barrier to entry remain high.

Large panel driver IC has been the backbone of Himax since 2001 when we got started and will continue to be a major business for us within (inaudible) really affected by strong demands for monitor and laptop markets. The large panel cargo sales, however, looks at for some slight sequentially decline during the fourth quarter. The non-drivers category provides the most exciting long term prospects for growth and third quarter non-driver sales were up 30.2% over the same period last year. I will highlight some of the non-driver areas below by highlighting the capacitive touch panel controllers, delivered a phenomenal growth during the third quarter.

We started shipping to new handset customers in China in addition to being a system leading smartphone for end customers. We will continue to break into new smartphone brands; the fast growing tablet market and cash enabled Win 8 type laptops. We believe our large panel controller will contribute, will continue to be a long term growth engine for Himax.

In our CMOS image sensor product line, the delay of Win 8 launch from Q3 to Q4 did affect our shipments of 1 megapixel sensor during the third quarter. However, we expect such demand to start in Q4 same to design wins with a number of tier 1 laptop demands. New laptops, we have also won design wins is smartphone, tablet and surveillance applications from a wide range of customers. We also launched a 5 megapixel sensor in the third quarter of which have the smartphone market, we will begin some shipment in the fourth quarter.

Our wafer level optics experienced double digit growth during the third quarter. The production of WLO for VGA or 300,000-pixel brand in our fab has been met smoothly with higher stable yields, we are now moving up the scale to start assembling our WLO with HD or 1 megapixel resolution, which we believe has a good potential to pick up million phone model the front camera market for smartphones, we expect our HD WLO to commence production in early next year.

Timing controller or TCON remains the largest product line in terms of revenue among our non driver businesses. Again we are one of the leaders in the new technologies such as eDP TCON, the new eDP interphase will be applied in high end laptop and every product. They offer percentage of screen design, high resolution and better power efficiency as compared to the existing (inaudible) LVDS interface.

Our eDP 1.1 and 1.2 already with shipment track record. Our eDP 1.3 is expected to come on production in early 2013. At the (inaudible) eDP accelerate we are well positioned to benefit on this important new technology.

We also continue to make progress in our ASIC service and we get positive ideas, during the quarter we won new ASIC project award from top tier brand name customers. The development fees generated from the engagement of these new projects increased substantially in the third quarter and contributed to our gross margin improvement.

Last but not least, our LCOS business also has exciting opportunities on the horizon. We've been working with top tier customers to develop new head-mounted display products. We are shipping some early volumes for customers trying to launch this quarter. We remain confident our non-driver businesses will continue to account for an increasing percentage of our sales over time.

Now, I would summarize our Q4 guidance. Though the fourth quarter is traditionally low season, we expect revenues of this year’s Q4 to remain around flat or slightly down compared to the third quarter of 2012, gross margin to be around flat from the third quarter depending upon the final product mix, GAAP earnings attributable to shareholders to be in the range of $0.07 to $.0.085 per diluted ADS based on $470.5 million outstanding ADSs and non-GAAP earnings attributable to shareholder to be in the range of $0.076 to $0.091 per diluted ADS.

For the full year of 2012, we expect revenues to be around $737.1 million, up around 16.4% year-over-year, gross margin to be around 23.1% as compared to 19.8% last year, similarly GAAP net income per diluted ADS for full year this year to be in a range of $0.286 to $0.301 and cumulative non-GAAP income per diluted ADS for the full year to be in a range of $0.337 to $0.352.

Thank you for your interest in Himax. We appreciate you joining today call. Our operator will now open the floor for questions.

Question-and-Answer Session

Operator

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

Jay Srivatsa - Chardan Capital Markets

Jordan, in China it appears the smartphone market appears to still be ramping up pretty aggressively, China Mobile has given lot of subsidies and there is a sense that Q4 the ramp up in the smartphone segment could be pretty strong but yet I think your comment seems to indicate that the demand is kind of lukewarm for your small panel products. Can you kind of give us a sense of where you’ve seen the weakness?

Jordan Wu

Well, actually Jay, we did mention in remarks that although the overall small medium sized panel revenue on a sequential basis look to be lukewarm. We did mention for the smartphone in sales we are looking for double-digit growth sequentially. So, yes the market remains extremely dynamic and exciting and go ahead strongly and I think we’re one of the players to enjoy the growth from in Q4 but when we made a comment regarding overall small medium sized panels there are other facts such as digital CMOS still camera and others that are declining mainly because of seasonal reasons. So overall the small medium sized panels segment overall looks to be lukewarm.

Jay Srivatsa - Chardan Capital Markets

Fair enough in terms of the large panel side following the October holidays it looks like some of the manufacturers are now starting to ramp up towards linear and how do you see that demand slowing that seem to indicate that large panels could be sequentially down in Q4, how is that offsetting some of the ramp up towards the New Year holidays.

Jordan Wu

I think for the initial price Q4 December would be were to be shorter months because of Christmas, but China certainly December would be hot season because that would be months before preparing for the Chinese New Year and overall we do see, the market overall is strong and in fact with the hype and we’re hearing here and there customers even working their ASPs but they’re indeed segment that’s monitored and know that which is again we’re tracing off a very large factor they look to cover some decline sequentially but we do believe TV will help some growth from the previous quarter, so again, on volume basis large panel second as a whole we are looking to have to see some decline, small decline. But if you break it down I think TV is relatively strong.

Jay Srivatsa - Chardan Capital Markets

Okay. In the micro display segment you mentioned that the head-mounted displays you’re starting to ship in small volumes. When do you expect that to become meaningful for you in terms of revenue ramp as well as production volume?

Jordan Wu

You will appreciate it is a very, very new application and so the final outcome really depends on consumer reception to this new product concept and also the fact is that we are not the end device owner, so it really depends on customers promotion. So, sorry I cannot comment on my customer’s behalf. I think we did say that we are shipping some small volumes for our customer’s (inaudible) production and we think they have a candidate, certainly there is a product, is set to be launched somewhere hopefully early, not too late, in the year next year and we do stay focused of steady growth month after month next year. However, I do feel given the fact that again this is such a brand new product concept I feel reluctant to give more concrete indication of the volume next year. But certainly we would see a lot of growth from the low level of this year that is for certain. But it can vary a lot again I think it depends on lot of things among others most important (inaudible) to how our customers are going to price it, the applications associated with the (inaudible) so on and so forth that for us we are the key component maker and so we are very excited about this, we have seen real and real exciting progress makes on our customers and having said that I think it’s pretty much sure for me to comment too much beyond that.

Jay Srivatsa - Chardan Capital Markets

Fair enough. Looking at your fiscal ’12 guidance it’s been a pretty good year for you’ve made a lot of transition over the last year that has come to pay off pretty well for you especially in the small panel side. As we look at fiscal ’13 how do you see yourself position, what are some of the challenges and risk and what are some of the opportunities that you think you capitalize on to show some further revenue and earnings growth for the company.

Jordan Wu

I think next year we are looking for very, very exciting year sequentially on the back of a pretty deep circle who of this year so we are very, very satisfied with overall and if I give you again broad categories give you some highlights on the broad categories small panel, smartphone remain extremely excited. In China in particular and we also mentioned in our prepared remarks that we are operating major projects of certain international leading name which look set to approve to bring us good growth opportunities next year. And I think smartphones still has at least a couple of growth to come because although we've seen a lot of increase in penetration in smartphone. I think the penetration level can either increase probably start to saturate towards the end of next year or the year after. However, we are also seeing the resolution and the panel size increasing well substantially and customers are no longer satisfied with 3.5 inch and lower resolution. So that really provides a lot of opportunities for guys like Himax and the factory (inaudible) mentioned is extremely exciting, they are international names and they are Chinese market which tend to be overlooked but they are actually very, very dynamic with lots of exiting growth opportunities there.

So we're, I think we're set to capture business opportunities in both and having said that though if you, I will comment on the risk or downside potential downside for the smartphone, I would say in China because of the fact that it is growing so phenomenally. In particular in middle to low end markets, the market does attract a lot of competition and some of our competitors are really undercutting their prices jumping others to get a piece of our action.

So I would say that that will be the risk for us for next year that’s why we mentioned although we're not going to keep away the mid or low end market, we want to shift towards higher end market want to move further upwards and that has been our tradition, we’ve done that successfully past few quarters. And I think in TV, we feel the large panel overall I think overall year-over-year in terms of unique growth I don’t think panel wise the market the whole market is going to grow phenomenally probably some single-digit growth. However, we do see our activities for our higher end panels. We predicted that (inaudible) certainly we believe you’re now going to see effect for penetration for such high end panel certainly by this year but it does happen. You provide the tremendous amount of provisional increasing value for driver IC, demand for driver IC. And also we’re seeing customers which over the past decade has been trying to have less pieces of IT for each panel by increasing the number of channels of IC and that itself has been out of demand sales of large panel for the industry, for the industry for the past decade. And we’re seeing the trend we’re working because customers are now looking to create (inaudible) payroll kind of decline and in order to achieve that they now do the reverse which is to lower the number of channels of IC and that be some like greater percentage for driver IC as well because you’re looking at over 10 panel size within resolution you’re looking at more pieces of demand for driver IC.

And certainly China within the opportunity and we’ll certainly try to building our strategy to not just Taiwan and China and very much so try to break into Korea as well the opportunity for us. But overall I think monitor will continue to remain sluggish not toward the substantially replaced by tablet, in our definition mobile is now in large panel and tablet in small panel so that will be the increase in small panel will represent a decrease in notebook in large panel. And I think, I think I have a lot of confidence to say, the most excitement will come from non driver next year.

This year, we’ve seen decent growth year-over-year 75% but we're now happy about it and actually we’re still in quite a few years in early ramp up stage only and we've seen a lot of exiting design win opportunities some involving (inaudible) and exiting new product concepts and just in about every single category we see very exciting growth potential for next year going forward. So I would say, non driver represent the best growth opportunity for us next year and going forward.

Jay Srivatsa - Chardan Capital Markets

All right, one last question in terms of future investments, where do you hope to put most of your R&D dollars as you look at fiscal ‘13 given that you appear to have a whole slew of opportunities that you could go after?

Jordan Wu

I think if you look at our R&D expenses this year against last year excluding RSU which is really a function of our profit excluding RSU. We're pretty similar even we have a small decline although our business, our revenue and profit grew so much, so what I am trying to say is that non driver IC there will be some increase of headcount because we are so busy, we are getting more projects in a way than we can handle so there will be some increase of headcount but I think the people opportunity should justify the increase and people for non-driver. Now what I am trying to say is I think we have pretty much set the groundwork for both driver and non driver so we are looking to really capitalize on our previous year’s R&D efforts.

So I would say most significant increase of our total investment will be on engineering service, customer service on in a field service that kind of engineering work, pure R&D because we have spend a lot in the past and we are looking to materialize that. So we don’t expect a lot of increase in R&D expenses next year, but there will be some increase because businesses looking exciting for us next year.

Operator

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

Peter Liao - Nomura Group

Hi Jordan, my first question is regarding (inaudible) war in China smartphone market. I just as you mentioned that price competition is very severe and but you also targeted gross margin growth, so the same for company, if we continue to see that severe price competition and negatively impact your margin, how will you do market share gain and also the margin improvement.

Jordan Wu

It is slightly related to and they can really I cannot promise too much on this segment alone, I think if we measure our gross margin a better approach is through for example non-drive products or technical products and so on but if I answer your question directly I think firstly we were to look up if we want to be the leader of the market trying to move up the resolution and the classification of the product.

For example this year in China that which year is (inaudible) considered to be high end and how year is the entry level for smartphone and through year each is the feature phone mainstream and next year we’re expecting how each year to become sort of, to kind of replace (inaudible) growing this year that (inaudible) could tickup the (inaudible) mainstream for smartphone and the high end would move up to say QSD or SD and in multimarket we were a leader and there is much higher over there and lot of people will definitely will start to they’re ready for HD content which certainly is likely to be the mainstream for next year but roughly the year after I think it is quite possible so I think we’re to be a leader in leading the trend to my, trend towards higher end for the whole market. But having said that so I mean what else can we can face challenge from our customers saying that you can’t just once we enjoy the high end you are to support us for the low end as well.

So partly in order to be a full solution provider we do have to also accept the fact that we also have to take up lower end market. We will continue to improve our design by launching new generations of solid products to lower the cost. But having said that all before doing that and enter there in these (inaudible) and so we expect price competition. So overall with smartphone we'll be able to keep up gross margin, increase our gross margin next year, yet this year it is hard to say I'll be honest, but our service is quite clear and I think high end market remains a lot less competitive compared to low end market that is for sure.

Peter Liao - Nomura Group

And my second question is regarding the breakthroughs to international brand and you just mentioned, may I have (inaudible) about this is a breakthrough for a company and what kind of advantage compared other peers. I think this question probably came up about to just as you mentioned in the China smartphone market?

Jordan Wu

Well, actually what I said I'll give you certainly I mean you appreciate and every detail and any other details but quite often there you attend it is the high end and technology leadership that makes the difference. In this case, we actually co develop with our customers to include certain IPs to basically enhance the image quality of the panel. So that driver IC becomes a pretty unique drive IC, so when that is successful our end customer meaning the handle maker start to confine such IP pool various panel customers and then we have a unique position for such opportunity. So I’ll tell you various illustrations how we try to break into higher market, break through brand names and also try to maintain our margins. So the uniqueness is a joint developed IP.

Peter Liao - Nomura Group

Also I have some question regarding larger size panels, driver IC, actually Himax had several of big role of its customers the occasion of driver IC in probably 2009 to 2011, but we have benefit from the growth in China customers and you just mentioned that there is a possibility to even enter like Korea base panel makers there and but as I know like a larger size panel, driver IC so they usually have like partnership with their driver IC company’s vendors. So this also because you have like (inaudible) over there and to gain the market share and even penetrate possibility next year to lose on Korea panel makers/

Jordan Wu

Yeah I think you are pushing through right zone, for TV you talked about now that the key things for among others is there has been the phase, and the plan over there the entry barrier is much higher than the ordinary large panel driver IC. So, it is mainly because of this reason among others that we feel that the real opportunity in Korea for us as well. Now, is that a promise but Korea obviously is such a big market, I mean we all know that it will end with biggest share, ultimately the biggest share worldwide. So I think we are trying and we believe given our technology leadership there’s a real opportunity for us over there.

Peter Liao - Nomura Group

My final question regarding the Taipei market. It’s very good to see you have realized strong sales growth from Taipei in the third quarter and Taipei is very, with a promising outlook device over the next two to three years. May you give us more colors on this segment like your target customers and before this year only like a few brands today are working on Taipei but there is a big market in China just like (inaudible) power and the market is quite huge. Is there also your target market and also how about the margin for Taipei, it seems like the margin for Taipei is higher than cap rate, right?

Jordan Wu

In terms of margin I think so far anyway, yes, the answer is yes, so far but I mean who knows about the future. But as far as whether we will target the international brands or China, I think we certainly do both and we are not in progress on both. I mean but I cannot really give too much detail beyond that. I will also want to like to highlight one very important point, which is for Himax, Taipei becomes, represents not just opportunity for driver IC, it also in timing controller. So, so unlike the sales timing controller is incorporated together with driver IC to make a single SLC solution but take a tablet you can do source driver, get driver and timing controller all discretely. So timing controller is a great opportunity for us and here you talk about either eDP interphase powered by Intel and maybe interphase favored by our ARM solution, ARM based solution. So we have, we are leader on both. And then beyond that we also, we are talking about camera solution and HD is likely to be the mainstream for digital camera next year. So we already are market leader in notebook. So I think tablet represent another opportunity for us.

And beyond that we also have touch panel controller, now our shipment all in smartphone segment but that doesn’t mean we are not entering to tablet in fact we believe we are going to provide unique technology for this particular market as well. So it growing but we believe that is well going opportunity. And apart from I think Himax is arguably the only company in the world which can provide the competitive technology on all these fronts, so that put us in a unique position wholly appraised and you the customers. So we are increasing our coverage in the U.S., we are increasing our coverage in China, overall engineering trying to really trying hard to capture this market to its full potential.

Peter Liao - Nomura Group

I see. May I have a follow-up on the tablet?

Jordan Wu

Yes please.

Peter Liao - Nomura Group

And you just mentioned where not like Taipei that use this driver IC, I mean get sourcing always on income but I hope under market there is also, there’s a possibility that Q2 consolidation and chip may be like for cost down efforts, is that possible and with on equity impaired your top line growth on the Taipei side?

Jordan Wu

The answer is no. Certainly integration always means less opportunity for us, but when you move upscale, move upper end, higher end, you tend to have these three pieces. Because the resolution, the higher resolution of a sensor, more data to transmit and so we tend have our timing control and driver IC. So, we do offer the software integrated solution as well that is now overwhelming and there are markets for both. And indeed what we are seeing is headwinds are moving. In terms of panel, I think headwind the challenge now is to give consumers better stuff rather than cheaper stuff I think is the overall trend. So you seeing end customers moving up according to the resolution for example for their panel. So, I think what you mentioned is correct, if everything moves into integrated solution then the market opportunity ultimately becomes less for us. But we almost see the other way around, there is another trend towards the opposite as well.

Operator

Our next question comes from the line of Kyna Wong of Merrill Lynch. Please proceed with your question.

Kyna Wong - Merrill Lynch

I want to ask the revenue contributions on the smartphone driver ICs as well as the CapEx side, could you give some color on that?

Jordan Wu

I’m sorry I did quite get your question?

Kyna Wong - Merrill Lynch

Okay. How much revenue contributed by smartphone driver IC in the quarter and how about the CapEx?

Jordan Wu

We don’t really give such specific details.

Kyna Wong - Merrill Lynch

Roughly?

Jordan Wu

But for Q3 smartphone overall about 20%-ish.

Kyna Wong - Merrill Lynch

20%?

Jordan Wu

For smartphone, yeah.

Kyna Wong - Merrill Lynch

I see. And how about CapEx, last time you mentioned less than 5% in second quarter, how about third quarter?

Jordan Wu

In the range of 5% to 10%.

Kyna Wong - Merrill Lynch

I see.

Jordan Wu

At the moment somewhere around half of smartphone revenue.

Kyna Wong - Merrill Lynch

And may I ask about the non driver IC business, you mentioned the third quarter suffer from slower demand from the TV models mentioned in earlier this year. So, is that from the major customers like 39 inch and 50 inch?

Jordan Wu

I really don’t want to comment on specific customers so.

Kyna Wong - Merrill Lynch

I see, okay. And then how about is the China panel makers, any decline from their business in third quarter?

Jordan Wu

I mean look at the marketable China customers, right, so while there is certainly enough capacity operating, the other one is more mature because they do have the capacity in place for quite some time. So, the result is mixed.

Kyna Wong - Merrill Lynch

Mixed, okay.

Jordan Wu

Yeah.

Kyna Wong - Merrill Lynch

So, may I check the dependency on the largest customer in third quarter. Last quarter you mentioned some it will be around flat in third quarter over second quarter from the largest customer.

Jordan Wu

Yes.

Kyna Wong - Merrill Lynch

Yeah, is that still well?

Jordan Wu

You mean in Q4?

Kyna Wong - Merrill Lynch

Yes, yes.

Jordan Wu

In the Q3 for our major customer is spread sequentially and you’re asking about Q4 trend?

Kyna Wong - Merrill Lynch

Yes, yes.

Jordan Wu

So, trend is about flat.

Kyna Wong - Merrill Lynch

Okay.

Jordan Wu

Flat to slightly up maybe.

Kyna Wong - Merrill Lynch

I see.

Jordan Wu

Yeah, around that.

Kyna Wong - Merrill Lynch

And could you, may I try to conclude the growth driver in each segment which you mentioned earlier in the conference call. In large driver business it will be sequential decline in fourth quarter and in the small and medium it will be not some, but for long driver it seems you’re continuing to increase in fourth quarter. Is this, could you confirm this, is this correct?

Jordan Wu

I think so. I mean you certainly, I mean the product mix can always vary. So, none of these three segments would see a major increase or decrease sequentially but remember our overall guidance for top line is flat to slightly down, right so there’s got to be some segments which are declining and we’ve highlighted large panel based on the current (inaudible) to go down slightly and we also mentioned it is primarily we believe because there was slow demand for monitor and then notebook and small panel lukewarm by saying that we are not saying, we are saying it’s not very exciting but it’s not declining a lot either. So above flattish but amongst different application, smartphone remains strong with double-digit growth and I think for non driver Q4 and Q3 also somewhere around flat kind of level.

Operator

Our next question comes from the line of Scott Bishins of Caffeine Holdings. Please proceed with your question.

Scott Bishins - Caffeine Holdings

Yes, all right, thank you very much for taking my call. By the way great quarter and guidance looks excellent going forward. I just have one question, what is the status and timing on a potential listing on the Taiwan market?

Jordan Wu

We don’t have immediate time for that yet. We believe our stock performance while we're very happy about our current valuation but indeed we're happy that shipment share price has been, we’ve been rewarded this year than last because of our formal increase and I think we’re set for another very exciting year next year so we believe even a few quarters of proven evidence that we have indeed turn around and our prospects become will be more exciting in the future. I think I mean the U.S. basically is serving itself can actually bring us the fair value and fairly positive and so until that is tested we at the moment we don’t feel the need to come back directly to Taiwan yet and note that they’re recent and also and I think there is no urgency to come back because another reason we think that we’re still monitoring the PTS stated overall in Q1 and that is however it’s not that there will not be steady market in the world I would say so far anyway so we’re still under whether that the market we want to look at it so we’re not saying we’ve given on the trend but there is no immediate plan to come back to (inaudible) that’s for sure.

Scott Bishins - Caffeine Holdings

One other question, I know that I’ve been a long-term holder of chip based technology and they’ve been also just trading on the NASDAQ and I know they’re looking to move over to the Taiwan exchange because of the valuations over there seem to be so much greater so much truly to the potential earnings and cash flow and I was just wondering why do you think that over in the on the NASDAQ that we don’t get that kind of valuation.

Jordan Wu

I think I mean it may be in fact that in between 2009 and last year our performance was not great and I think we’re penalized for that and people are really waiting for us to really demonstrate that we’re much better than that. And so that is one reason and we have full confidence demonstrated by this year and we are very excited about next year as I said few times. So, we believe if you deliver, next step will give you the right reward. On the other hand, in Taiwan TDR market has not been very exciting to be honest with governments not beginning to be very committed to really develop this market and there are recently there are changing in touch regime and so also there’s been quite a bit of confusion. And the market whether in terms of volatility, reputation and size is not really very, very exciting for us at the moment and that’s really the trouble market so we intend to stay domestic. Certainly we all stay domestic but we intend to stay domestic solely for the foreseeable future and what we see, how the market reacts to our further performance and demonstration that we are much better than how we appeared in the last two or three years. And hopefully we will get probably a little bit and it’s got to see a better hope maybe with that to consider more seriously about Taiwan. But if you I mean if you compare these two markets, in aspect, from both aspect it’s better than current TDR market. The only thing is that we are telling as company but it’s true but then we do have some talk about the TDR market stages at the moment.

Scott Bishins - Caffeine Holdings

Okay, that’s fair enough. Thank you very much

Jordan Wu

Yeah, it’s not a decision you want to make right, right, you cannot say, okay, we’re getting that, we will take that also, we don’t like you, we will get out. If a company can do, you can do that like that, so it has to be very, very serious decision, So I can only say the board has not made its decision to come back to Taiwan yet.

Scott Bishins - Caffeine Holdings

Okay. Thank you very much and a great quarter like I said and prospects look going forward and hopefully that we will get the valuation going forward on the NASDAQ. Thank you.

Operator

Our next question is a follow-up question from the line of Jay Srivatsa of Chardan Capital Markets. Please proceed with your question.

Jay Srivatsa - Chardan Capital Markets

On the micro display side, given that you’re seeing some modest volumes and obviously you're optimistic about how that could shape up in 2013. Could you give us some sense on what's the competitive landscape there, how comfortable are you in terms of your position early in the product cycle and how do you see that playing out as other competitors could likely begin to look at that market as well? So, maybe a little bit of a description on the competitive landscape would be helpful.

Jordan Wu

Okay. Two fold, one is the first technology (inaudible) and our competition over there. And the other one is a competing technology and now probably the latter the only thing with competing technology really is PSDOP and PSDOP has been our competitor in pico projector and certainly remains potentially the competitor for head-mounted display as well. In short, I think quality OP is pretty competitive in terms of slight efficiency in pico projector market, when it comes to head-mount display, it is not as competitive because this one advantage of live cells, live efficiency there is much risk in role for head-mount display because the luminous we call for head-mount display for the panel is much, much, much lower because it’s near to eye, it’s near to eye. While LCOS has a lot of advantages over VOD. I’ll will give you some examples on our cost, our sales ability to move up the scale and bounce scale in terms of resolution, our ability to tailor-made panels for customers and so far we have discovered a lot upon this, we saw our customers and so far the only overwhelming response has been LCOS has advantages that VOD cannot meet for head-mount display. And that is why we are seeing almost (inaudible) without exception LCOS is winning against the other technology.

In terms of the LCOS trend, I mean it’s not really big market so there’s a very, very small handful of players there only. And Himax stand out because of two reasons, one, we are the most experienced in this field for over a decade, we have a ton of experience, and number two, we have volume outset compared to others throughout of the LSIP application to other people. And that is fairly the program because that if you know is not something we want to outsource but so far I think we are the only player in the market where we've a in-house fab and number three because of our driver IC and timing controller businesses, we're extremely experiencing all the interfaces, all the media processing know-how, all the power saving tricks and so on. And so I may be able to make a demonstration but our customers are worried about their capability for mass production, the reliability, the robustness on their solution and so on and Himax is extremely proven because you want parallel interface, you want interface whatever we're the leader because of our driver IC in the business.

And lastly, compared to our kind of peer (inaudible) players, we know how to handle supply chain, they tend to be more of some of them anyway tend to be more of a startup kind of niche player but we're a different kind of company, we know how to manage our supply chain. Now we have bargaining power with foundries and so on, so I think that is also a major factor to make us stand out. So far anyway, we're now really seeing a real competition on the horizon. So the question for us is what this is going to take us and how far and how big and how but it’s not really how we look at it, I think, and it’s in the foreseeable future.

Operator

Thank you. There are no further questions at this time. I would like to turn the floor back over to Mr. Wu for any closing remarks.

Jordan Wu

Well, thank you everyone for taking the time and for your questions and we looking forward to talking with you again in our next call in early February. I would like to make a final note, Jackie Chang, our CFO should be on the Roadshow in the U.S. in first week of December. So please do contact her and/or John Mattio at MZ Group if you are interested in meeting with us in person. So thank you again and have a nice day.

Operator

Thank you ladies and gentlemen. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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