Himax Technologies, Inc. (HIMX) Q1 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. And welcome to the Himax Technologies First Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce John Mattio, U.S. based Investor Relations for Himax. Please go ahead.

Thank you, operator. Welcome everyone to Himax’s first quarter 2016 earnings call. Joining us from the Company are Mr. Jordan Wu, President and Chief Executive Officer; and Ms. Jackie Chang, Chief Financial Officer. After the Company’s prepared comments, we have allocated time for questions in a Q&A session. If you have not yet received a copy of today’s results, please call Lamnia International at 1-203-885-1058, access the press release on financial portals, including sec.gov or download a copy from Himax’s website at www.himax.com.tw. Before we begin the formal remarks, I would like to remind everyone that some of the statements in this conference call, including statements regarding expected future financial results and industry growth, are forward-looking statements that involve a number of risks and uncertainties that could cause actual events or results to differ materially from those described in this conference call. Factors that could cause actual results include, but are not limited to, general business and economic conditions, the state of the semiconductor industry, market acceptance and competitiveness of non-driver and driver products developed by Himax, demand for end-use application products, the uncertainty of continued success in technological innovations, as well as other operational and market challenges and other risks described from time-to-time in the Company’s SEC filings, including those risks identified in the section entitled Risk Factors in its Form 20-F for the year ended December 31, 2015, filed with the SEC as amended. Except for the Company’s full year of 2015 financials, which were provided in the Company’s 20-F, with the SEC on April 13, 2016, the financial information included in this conference call is unaudited and consolidated, and prepared in accordance with U.S. GAAP accounting. Such financial information is generated internally and has not yet been subjected to the same review and scrutiny, including internal auditing procedures and external audits by an independent auditor to which the Company subjects its annual consolidated financial statements, and these results may vary materially from the audited consolidated financial information for the same period. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Now, I would like to turn the call over to Mr. Jordan Wu. Jordan, the floor is yours.

Thank you John and thank you everybody for being with us today for our earnings call on which we will detail results from the first quarter 2016, and provide our second quarter 2016 guidance and outlook. Our CFO, Jackie Chang, will also detail more specifics on our financial performance after my overview. We are pleased to begin by saying that both our 2016 first quarter gross margin and EPS exceeded our guidance while revenues came in within our guided range. The first quarter revenue of $180.3 million represented a 1.3% sequential increase and a 0.7% increase from the same period last year. The sequential growth was due mainly to China’s panel capacity expansion, coupled with Himax’s large panel driver IC share gains. We also benefited from stronger than expected small and medium sized driver IC momentum, including the addition of a new major smartphone customer since the fourth quarter of 2015, and accelerating AR/VR related business. However, the earthquake that hit in Tainan on February 6th did cause some delayed shipments of large panel driver ICs to one of our major customers during the quarter. Without the earthquake, we could have been at the high end of, if not beat, our revenue guidance. We do not expect further negative impact from the earthquake as that customer’s facilities have recovered entering the second quarter. Revenue from our large panel display drivers was $65.7 million, up 5.8% sequentially, and up 14.1% from a year ago. Large panel driver ICs accounted for 36.4% of our total revenues for the first quarter, compared to 34.9% in the last quarter and 32.2% a year ago. Without the earthquake mentioned above, we could have achieved double digit sequential growth that we indicated earlier for this product line. Monitor demand continued to show strength for the past few quarters as UHD resolution models started to outgrow legacy models. TV remained the bright spot as in the last few quarters with 4K TV penetration doubled from the previous quarter. To sum up, if we look only at China, our driver IC business for TVs and large panel overall grew phenomenally, both sequentially and year-over-year. In comparison, worldwide TV panel shipments actually declined over 10% during the same period compared to the previous quarter, according to market research firm IHS. Our leading market share in China, coupled with rapid capacity ramping of Chinese panel customers and more in-sourcing from their local set maker customers, have led to this favorable result. It is especially worth highlighting that our engineering collaboration and design-in activities with Chinese panel customers remain robust despite the soft market sentiment. Revenue for small and medium-sized drivers came in slightly better than guided at $79.4 million, down 3% sequentially and down 8.7% from the same period last year. Driver ICs for small and medium-sized applications accounted for 44.1% of our total sales for the first quarter, as compared to 46% in the previous quarter and 48.6% a year ago. The main reason behind the year-over-year decline was the slowdown of business from our primary Korean end customer as they replaced much of the use of LCD displays, for which we were a major IC vendor, with AMOLED displays for their smartphone products. We only started the shipment of AMOLED driver IC in March 2016, thereby creating a gap in our small and medium-sized business compared to the same period last year. I will provide more update and illustrate our competitive strength in AMOLED driver ICs a bit later when giving outlook for the coming quarter. Without this however, our small and medium driver grew mid-teens versus the same period last year while smartphone driver ICs grew over 20%. Sequentially, first quarter sales for smartphones grew low single digit despite fewer working days around Chinese New Year. The positive momentum came from our Chinese smartphone customers, including a first top tier player that we added at the end of the fourth quarter of 2015, launching new models and replenishing inventories. But again, the strength was offset by double digit sequential decline in tablets. As in the last few years, the best-performing category among driver ICs used in small and medium-sized panels continued to be those used in automotive with Q1 revenue up 4% from the previous quarter. It grew double digit from the same period last year. Revenues from our non-driver businesses were $35.2 million, up 3.4% sequentially and up 2.2% from the same period last year. Non-driver products accounted for 19.5% of our total revenues, as compared to 19.1% in the previous quarter and 19.2% a year ago. The sequential growth in our non-driver segment was mainly driven by our AR/VR related businesses as LCOS and WLO revenues more than doubled during the quarter. We have been making shipments for multiple customers, including a major U.S. customer who has recently started shipping their new AR device. Additionally, timing controller, ASIC service and CMOS image sensor product lines also enjoyed sequential growth due to mass production of new design wins. The year-over-year growth was also led by AR/VR related businesses and timing controllers, partially offset by the deceleration in out-cell touch controllers. Our GAAP gross margin for the first quarter was 26.2%, a 330 basis points increase from 22.9% in the previous quarter and up 50 basis points from 25.7% in the same period last year, exceeding our original guidance of around 25%. The margin improvement came mainly from better product mix in small and medium-sized driver ICs and non-driver product segments. Major contributors included the accelerating higher end driver ICs for smartphones and strong development fees from AR/VR related businesses, as well as improving gross margins for the CMOS image sensor and touch controller product lines. Our gross margin expansion was also a testament to our cost reduction efforts. Gross margin improvement remains one of our major business focuses. Our GAAP net income for the first quarter was $13.1 million, or $0.076 per diluted ADS, compared to $6.1 million, or $0.036 per diluted ADS, in the previous quarter and $12.6 million, or $0.073 per diluted ADS, for the same period last year. GAAP net income increased 113.5% from the previous quarter and increased 4.2% year-over-year. GAAP EPS exceeded our $0.055 to $0.075 guided range. In our last earnings call, we have assumed a 20% income tax rate, calculated based on exchange rate of NTD 33.45 against $1, pushes the exchange rate at the beginning of February. And as it turned out, the NT dollar has actually appreciated against the U.S. dollar since February. We have therefore adjusted our income tax rate to 15%. The sequential and year-over-year profit increase was a combination of higher revenue, much improved gross margin together with lower income tax rate. Jackie Chang our CFO will now give more details on our financials. After Jackie’s presentation, we will provide our second quarter 2016 guidance and insight on our business, markets and strategies going forward. Jackie?

Thank you, Jordan. I will now provide additional details for our first quarter financial results. GAAP operating expenses were $32 million in the first quarter of 2016, down 0.4% from the previous quarter and up 5.3% from a year ago. First quarter operating expenses included a one-time donation of NT$10 million or US$300, 000 to the earthquake relief fund initiated by the Tainan Municipal Government. Operating expenses increased from first quarter of 2015 due to higher expenses for additional headcount to support our new AR/VR projects, annual salary increases and increasing R&D expenses. We continue to streamline core business R&D activities and implement other expense control measures. GAAP operating income for the first quarter of 2016 was $15.2 million or 8.4% of sales, up 76.3% sequentially and down 3% year-over-year. First quarter non-GAAP operating income, which excludes the share-based compensation and acquisition-related charges, was $15.7 million, or 8.7% of sales, up 72.1% from the previous quarter and down 4.1% from the same quarter of 2015. First quarter non-GAAP net income, which excludes the share-based compensation and acquisition-related charges was $13.5 million, or $0.078 per diluted ADS, compared to $6.5 million last quarter and $13.1 million the same period last year. This represents an increase of 107.2% sequentially and increase of 2.9% year-over-year. Our cash, cash equivalents and marketable securities were $168 million at the end of March 2016, compared to $178.8 million at the same time last year and $148.3 million a quarter ago. On top of the above cash position, restricted cash was $180.5 million at the end of the quarter. The restricted cash is mainly used to guarantee the Company’s short term loan for the same amount. We continue to maintain a very strong balance sheet, and we remind investors that we remain a debt-free company. Inventories as of March 31, 2016 were $182.8 million, down from $186.1 million a year ago and up from $171.4 million a quarter ago. We were able to lower the inventory year-over-year because of demand rebound. The sequentially higher inventory shows our confidence in strong quarters to come. Accounts receivable at the end of March 2016 were $173 million as compared to $192.7 million a year ago and $177.2 million last quarter. Day sales outstanding was 87 days at the end of March 2016, as compared to 97 days a year ago and 93 days at end of the last quarter. The decrease of DSO was due to more efficient cash collection from credit sales. Net cash inflow from operating activities for the first quarter was $21.5 million as compared to an outflow of $3.7 million for the first quarter of 2015 and an inflow of $25.9 million for the fourth quarter of 2015. The year-over-year increase is mainly due to lower working capital, lower receivables, and lower accounts payables. The sequential decrease in cash flow was a result of higher net profit offset by higher working capital. Capital expenditures were $2.2 million in the first quarter of 2016 versus $1.8 million a year ago and $3.6 million last quarter. The capital expenditure in the first quarter consisted mainly of facility updates and capacity expansion for LCOS and WLO product lines. As of March 31, 2016, Himax had 171.9 million ADS outstanding, unchanged from the last quarter. On a fully diluted basis, the total ADS outstanding are 172.4 million. I will now turn the floor back to Jordan.

Thank you, Jackie. In our last call, we provided an overview of the trends developing in the industry and how we could stand out as a unique beneficiary from such trends and keep our business resilient to the current macro headwinds. I’m glad to say that we had a good start this year and that should be the beginning of a long term growth ahead of us. The impressive momentum of our large panel driver ICs for TV application will continue to come from accelerating 4K TV penetration. We are a unique beneficiary of our Chinese panel customers’ continued capacity expansion at a time when Chinese TV makers are sourcing more panels locally and starting to make more exports. Equally important, we finally saw smartphone driver IC order rebounds in China coming from end customers’ restocking and new model launches in the first quarter, backed by more 4G smartphone proliferation. Small revenue contribution from TDDI will start in the second quarter and we believe it will accelerate thereafter. Sales for automotive applications, where we have a leading market share, will continue to show strong growth as more and larger-sized panels are going into vehicles. For non-driver products, 2016 will be the year for us to see a bigger revenue percentage generated by LCOS and WLO product lines as shipments to our major customers started to take off. We are also on track regarding tapping into new territories such as IoT and machine vision with our latest CIS and WLO product offerings as stated in our recent technology press releases. Other non-driver products such as timing controllers and ASIC services will also continue the growth momentum as they are adopted by panel manufacturers for many new product areas. Overall, we are seeing strong momentum across all our major product lines and feel good about the growth prospect of 2016, despite the uncertain economic environment. With that, I will now provide our second quarter guidance, followed by a more detailed outlook. For the second quarter of 2016, we expect revenue to be up 7.5% to 12.5% sequentially. Gross margin is expected to be around 26%, depending on our final product mix. GAAP earnings attributable to shareholders are expected to be in the range of $0.085 to $0.105 per diluted ADS based on 172.4 million outstanding ADSs. In providing the above earnings guidance, we have assumed a 15% income tax rate, calculated based on exchange rate of NT$32.4 against the U.S. dollar, which is also the exchange rate as of beginning of May. Now, let me give you some more details behind our guidance and trends that we see developing in our businesses. Following a strong first quarter, though somewhat dented by the earthquake, large panel driver ICs should grow again by high single digit sequentially and more than 25% year-over-year, with China and 4K TV still the major growth engines. For reasons detailed earlier, we expect sales from our Chinese panel customers to almost double year-over-year. The other segment in our driver business is ICs used in small and medium-sized panels for applications including smartphones, tablets and automotive. Second quarter smartphones sales look set to continue its growth, to be up more than 20% sequentially as the outlook for end-market demand is turning positive and China’s local mobile operators have started to offer subsidies on smartphone purchases. Many of our end customers in China are aggressively launching new models, replenishing inventories in an effort to gaining market share. Now, switching gear to AMOLED market, since we are an early mover in the related driver IC technology, we have been collaborating with multiple panel customers across Korea, China and Japan for AMOLED product developments and are seeing more design-ins at these panel makers, reaffirming our technology leadership. We believe that AMOLED driver ICs will be one of the critical future growth engines of our small panel driver IC business, especially with quite a few new AMOLED fabs being built in China where we have the most comprehensive coverage. Among driver ICs used in small and medium-sized panels, the best-performing category has been automotive in recent years. We anticipate its Q2 revenue to grow more than 30% year-over-year. In this product segment, after two strong years, we still expect to see robust and sustainable growth throughout 2016 and beyond. Our confidence comes from the fact that higher resolution and larger panels are becoming mainstream for automotive applications. With numerous top automobile brands having been our indirect end customers, we are well-positioned to take advantage of this fast growing market. Tablet market, as previously indicated, remain weak in Q2, although the decline will likely slow down. Overall, we expect small and medium-sized driver IC segment in the second quarter to be up double digit sequentially. For the past few years, our non-driver business segment has been our most exciting growth segment and a differentiator for Himax. New product developments continue to evolve and gain traction, and we remain positive on the long-term growth prospect of our non-driver businesses. We expect around 20% growth in our non-driver products for the second quarter sequentially and more than 30% year-over-year. Looking ahead, many of our non-driver products, including CMOS image sensor, timing controller, touch panel controller, power management IC, ASIC service, WLO and LCOS microdisplay, are all set to grow sequentially in 2016 and the years ahead. I will now highlight some of the non-driver product lines. First onto our touch panel controller product line, we expect on-cell to emerge as the new mainstream touch technology in 2016. Our on-cell sales started to accelerate in late first quarter with shipments to Chinese and Japanese smartphone makers, and we expect the momentum to be carried into the second quarter. We have also launched force touch products, a new feature to the touch panel, and already secured design-wins from certain leading smartphone makers for their 2016 models. Furthermore, we are one of the pioneers in offering TDDI solutions for the state-of-the-art in-cell panels, and are in partnerships with essentially all of the panel manufacturers in pure in-cell touch for joint technological development. As announced on April 19th, we started mass production and volume shipment of TDDI for a leading Chinese smartphone customer. We are seeing the use of in-cell display with TDDI rapidly becoming the preferred choice for end product customers’ new high end smartphone designs. The volume shipment record validates our leading pioneer position and confirms the industry’s trend towards pure in-cell panels. We anticipate several TDDI design wins to enter mass production at additional Chinese and Korean smartphone customers and panel makers this year, and expect meaningful contribution from TDDI in late 2016 and beyond. Moving on to our most exciting AR/VR related businesses. The AR/VR era of technology is upon us. Over the last quarter, the level of excitement in the industry as well as capital markets reached a new high as numerous new AR/VR devices were launched with some of them even started making shipment. New applications and markets are being explored. Our design engagements with current and new customers now cover leading companies in gaming, search, mobile, social media, military, automotive and consumer electronics industries. Many of them have committed huge amounts of R&D and capital to capture the rapidly expanding future of this game changing product category. Having invested in related technologies for over 15 years, we are uniquely positioned as the provider of choice for microdisplay and related optics to enable AR, which is projected by many market research firms to be grabbing a lion’s share in the addressable market of AR/VR in the long term. As some of our major customers have already started shipment, we saw phenomenal growth from LCOS and WLO product lines in the first quarter. And in the second quarter, revenues from LCOS and WLO are expected to triple, again sequentially. Though we don’t expect big volume from the early generation products of our customers this year, we already see positive top line and bottom line contribution from these two product areas this year. We are confident that LCOS and WLO will account for a significant portion of our business, longer term. Over the past couple of months, we have been seeing constant additions of new or existing customers concurrently working on multiple future generation AR designs/devices using our LCOS and/or WLO for a variety of new applications. These applications range from various glass type AR devices to toys, industrial helmets and head-up displays for automotive. We currently have more than 30 customers using our LCOS and/or WLO for their AR devices and optical engine designs, with the vast majority of them in the U.S. When adopted, our LCOS and WLO typically represent two of the parts with the highest value in an AR product’s bill-of-materials. The models we are joint-developing with some of these largest, most recognized companies in the world for consumer market launches will advance the entire sector. We believe this is just the beginning of a long term growth story. As for VR applications, our customers’ continuous efforts in introducing new products aiming for consumer market are also encouraging. We have been developing customized driver chips with high refresh rate to perfect the performance of VR displays in the next generation AMOLED panels with two top-notch VR players. This reaffirms our leading position in AMOLED driver IC technology. We expect mass production to start in late 2016 to early 2017. Additionally, certain of our VR customers are also showing strong interests in our AR related product offerings as they work towards their AR product line. It is also worth highlighting that our CMOS image sensor product line bottomed out in the first quarter, rebounding from its trough in 2015. Looking into the second quarter, there will be mass production of several design wins for notebooks and increased shipments for multimedia applications. In recent press releases and the last earnings call, we briefly introduced our new smart sensor product lines targeting new applications across smartphones, tablets, AR/VR devices, IoT, AI and UMTV. These include the ultra-low-power QVGA CMOS image sensor and the Diffractive Optical Element or DOE integrated WLO laser diode collimator to be paired with a Near IR sensor. We believe the former is by far the lowest power CIS in the industry with similar resolution. It can be applied in a constant state of operation, enabling always on contextually aware computer vision capabilities. Regarding DOE integrated WLO laser diode collimator with NIR sensor, we believe this is the most effective total solution for 3D sensing and detection in the smallest form factor. This breakthrough allows 3D image sensing feature to be easily integrated into next-generation consumer electronics. Currently, we are making good progress and have seen encouraging and increasing customer responses. We will report the developments in this new territory in due course. And that will conclude our non-driver business segment. Thank you for your interest in Himax. We appreciate you joining today’s call and are now ready to take questions.

Thank you. [Operator Instructions] Our first question comes from Anthony Stoss with Craig-Hallum. Your line is open.

Nice execution, guys, especially on the gross margin front; two-part question. Jordan, maybe can chat a little bit more about your expected AMOLED wrap with your Korean customer in Q2, how you expect that to continue throughout the year? And then, related to your AR/VR customers, what kind of visibility do you have to the back half ramps? Maybe, more specifically, of the 30 different customers that you have designed wins with, do you have any sense on how many will launch product this year?

If I may I will start from your second question about AR/VR. We have -- I mean, obviously you’ll appreciate we’re restricted by many of our customers with their NDA requirements. But, we have way more than 30 customers and vast majority of them based in U.S. where actually -- it is where real innovation really comes from. And customers are actually exploring new applications. They are trying to encourage app developers to join again and industrial users to try industrial applications and so on so forth. So, we’re actually really seeing a lot of new efforts and new innovations, which actually varies sometimes quite widely, one from another. And certainly, we have a major customer already started mass production in this year. But, we keep emphasizing to our investors that in this early stage, don’t expect much volume because it really involves a lot of customers testing the water, trying the market. But, it’s also worth mentioning that -- I actually mentioned, commented on in my earlier prepared remarks that our share in the total bill-of-materials is very, very significant. We are not even talking about the same order compared to our driver IC or timing control. So, we are really quite uniquely positioned in this segment. So, even in this very, very, very early stage with as I said, rather limited volume, we’ve already seen very encouraging top line and bottom line contribution, given this year or this quarter. If you look at LCOS and WLO combined, it’s already over 5% of our total sales, if you mention with only this limited number for shipments. So this is very encouraging. Now as for the real launched dates and so on and expected volume, we really can’t comment much beyond what I just said, because it really involves many of our customers’ launching plan and marketing plan. But, I think it’s fair to say that we do expect much higher percentage in revenue in 2016. But, this is very, very beginning stage of our long-term story. So, I mean hopefully, barring any major, major surprises, next year, you should see a much more significant contribution for us and the same in the years after. Your first question is about our Korean customer’s AMOLED, again we don’t really comment on specific customer’s activities. And AMOLED, as we all know, really is a technology starting from Korea and as of today, dominated by Korea. And we see IC vendors coming exclusively from Korea. And I think it is probably fair to say that we are the first non-Korean IC vendor to get the -- qualify and to start shipments, although I really can’t comment on specific customer’s shipping volume and revenue. I think, probably more significant for us in a long-term is a fact that as I mentioned earlier, China is now building AMOLED fabs very aggressively. Some expected to start ramping later this year and some more in 2018 and so on. And it’s early ramp up, first of all, we certainly do see a more construction to come from China. And we are working with literally every single one of Chinese companies, while they are building their fabs and developing their technologies. And they do need the driver IC partners in early stage because driver IC or AMOLED do require a lot of tailor made customized designs. So, we are working with literally every one of them in China. So, I think the fact that we are early mover in Korea, for non-Korean vendors, I think it says a lot about our technology leadership. And certainly that helps enhance our position in China a great deal. China, we expect some ramping in later this year, although it certainly depends on how the customers react. But, I think more meaningful volume will probably not happen until next year.

Thank you. Our next question comes from Suji De Silva with Topeka. Your line is open.

I’ll echo my congratulations on the margins and the cash generation in the quarter. So, the earthquake impact you had in the first quarter, does that -- is there some snapback benefit from that in the second quarter or does any of that business go to other vendors; how does that play out?

No, for us or for other vendors because what happened is our customer’s production line got really badly impacted. So, they had to clean room and facilities and work in progress, goods and so on. Really the earthquake caused quite a bit of damage. So, the customers just have to clean up their fab and throw away whatever work in progress that is not usable and restart. And as a result, their production line has to be suspended for some time. And certainly, they work like hell, trying to get it recovered, ASAP. So, in a time, we actually got the weekly or even daily or even more frequent updates than daily for customer’s new demands because as they work on their reconstruction or recovery, they have to move around their production line and their customers are jumping up and down, so they have to be really quite flexible in dealing with their in house problems and customers. And as a result, they have to move around their sourcing as well. So, we worked very, very closely with that customer in the aftermath of the earthquake. But once that is over, that is over. So, whatever is scraped, it is scraped, you never use that. But the good news is that everything has been fully recovered. So, we don’t expect further impact this quarter.

I appreciate that color. And then, on the AR/VR, do you anticipate having to hire additional engineers to support the many customers you seem to be taking on, at this point?

We are adding engineering resources into this area, as we speak. But, if you look at our total R&D, the size of our R&D team, you will appreciate the core of the R&D has long been developed. So, we are talking about marginal increase of our team to -- for example, to improve the year rate to cope with the customers’ increasing demand. And also -- this is a very new product category. So, as we are doing mass production, we are also in the mean time trying to fine-tune our production, increase our yield and sometimes even improve our product quality or some other things. So, you are really talking about increase of not the main share, not the core of our R&D team but certainly marginal increase of the team to enhance the production. That is needed. So, we are doing that. And certainly, I am talking about short-term production ramp. In the meantime, we are working with customer for their mix generation designs. Furthermore, equally important, we are actually providing our customers with even longer term technology road map. We are really -- we and our customers combine are taking a very long term view for this. So for example, major customers are very anxious on what the Himax microdisplay technology is going to be like, three years, five years down the road. So, we are talking about current R&D activities and one or two years for the next generation, and three to five years technology road map that pace on which the customer have to decide they are, they are long term product. So yes, some increase but only marginal increase.

Thank you. Our next question comes from Jaeson Schmidt with Lake Street Capital. Your line is open.

Just curious how much in NRE revenue you recognized in Q1, and what your expectations are for that going forward?

We usually don’t disclose the amount of the NRE.

Okay.

But we -- in our prepared remarks that is higher than last year. And we expect this -- the whole of this year NRE to be larger than last year. NRE, certainly, we enjoyed good margin, and NRE is margin enhancer for our overall business. However, we don’t really count on NRE to make profit for the business, only soft price. I think more important implication for NRE is the long term prospect. The fact that the customer, one single customer is willing to pay you millions to develop projects, it say a lot for their commitment. So, we appreciate that and we certainly -- and that is also kind of financial support from our customer at that time when the industry is still in early stage. And so the fact that we are getting more NREs from more customers across more applications is very, very encouraging sign for the long term. So in the short term, it helps in our gross margin, which is nice. But I think the long term implication is even more important.

And then, looking at your LCOS, WLO, do you think you have enough capacity to support the current design win pipeline?

Good question. We tell our customers where we are, right? We have limited capacity and we can’t build too capacity because it involves really too much risk. And we don’t want the capacity to be ready too early. So, we work very closely with major customers, with real products, ready for ramping or to be ready for ramping in any foreseeable future. And we discuss in detail with them, once their order comes in, how we are going to fulfill them. And they expect more meaningful or significant amount of orders than maybe if a situation where our current capacity is not sufficient, so what do we do, we tell them the lead time required with how much of a volume we are talking about and how much the lead time is require, i.e. and so at the moment and not just right now, we have been doing that for quite a while. We are very thorough in terms of getting ourselves fully prepared for quarter two if certain big volume of certain size is going to come in six months, nine months or year down the road. And the good news is we do have the land, which is the most important, which is very close to our current headquarters within walking distance which is convenient. So, customers love it. And the customers love the fact that we are very prepared, we have four different kinds of capacity requirements, we can give you within like days. We can give you detailed plan including even fab layout and equipment and investment and so on, and certainly most importantly the lead time. So, I think developing at this current stage, developing a brand new AR device is not an easy task. And development typically involves a pretty long time. So, we believe with any sensible customer, during the time of joint development, they will have to be able to come out with a ramping plan, and the ramping plan should give us sufficient time for expansion if so required. So typically, even for major expansion, we are talking about -- I am talking about really major expansion; we’re talking about one-year, slightly over one year of early long lead time and that will be sufficient for us because we’re very ready. And we are -- there is no shortage of capital. So, we’re just waiting for that to happen. And having said that though, we don’t want to be in a position where we’re sitting on a big chunk of idle capacity and then will be at our customers’ mercy. So, we rather be the other way around. The customer has to really work with us to expand the capacity when their ramping really takes place. And the good news is that for WLO and LCOS, for microdisplay and for AR devices, we are really, really the vendor of choice. So, it’s not like they have a lot of places to go around for. So, we are in a good position. So, we can afford to say come to us, we’ll work with you and give us, depending on your volume requirement, give us six months timeline or a year, and we’ll get stuff for you.

Thank you. Our next question comes from Tristan Gerra with Baird. Your line is open.

You’ve talked about notebook design wins ramping for your CMOS image sensor business this year. Could you talk a little bit about your mix, and notably the 12 megapixel and higher product offering and the type of traction you expect for those products later in the year? And also, if you see any potential in the automotive market, notably for ADAS type of applications?

We have -- in our CMOS image sensor business, there are a few major application areas, the first one certainly is smartphone where our major product offering includes 8 megapixel and 13 megapixel. And we are recently ready for a PDF, which is very important feature. I have to say however though, we are becoming more and more cautious in this market. The fact is that the market is becoming mature and CMOS image sensor business in smartphone while it’s very important and is super big as we all know, it’s also super-competitive. So, we’re -- in terms of our 13 and 8 megapixel sensor for smartphone, our current focus is primarily in China, and we’re working with a few existing customers, and we don’t really over commit. And in the meantime, we are really switching our focus to a few other areas, the first one is multimedia including surveillance drone, artificial intelligence and stuff. And in those markets, China is still being a major -- IoT certainly is one of them. China is still a very important market. And in that particular market, we are actually getting very good traction. And we realized actually the market is a lot less demanding and less competitive. And we actually get to enjoy the good position with better gross margin and so on. And the second thing is automotive which has to take a lot of patience, as we all know but we have been in committing to this area for a quite few years already. So, we’re already seeing some shipments. And we have penetrated into Korean and European market and U.S. markets in encouraging design win projects. As for exactly when we’ll start to see meaningful volume from automotive sector for CIS, I can’t really say. It could be as early as next year but it’s automotive. So, we get very good appraisals from our customers that’s all I can say. As for exactly when you will start to ramp is another story. Now, last but not least, very importantly, we are turning our attention to what we call niche market products, where we find it to be very exciting, with very little competition. So, two product examples, our early examples for this new effort, the first one is what we call, ultra-low-power always on sensor. It involves the QVGA sensor, with about 95% -- about 5% of power consumption compared to typical RGV sensors of similar resolution. And the idea is, you can keep it always on to provide wakeup and other features. So, whilst we launched that people are excited. Some top tier customers initially, when they saw the specs, they didn’t believe us because they couldn’t believe a sensor could be so power efficient. And now we have got the certain very big good names, design-in, certifications across TVs, drones and other things. So, I think this could be a very long life product. And also we’re working with certain IoT and other things, IC platform, SOC platform providers who can also help us reach into their customer markets. And the last thing I want to say, it’s also a good example is our so called structured light projector. Basically it’s -- we offer a total solution of optics, structured light with new IR sensor even with silicon for algorithm. So, we are going to offer a combined module total solution to our customers. Now, we are working with some of the biggest name in smartphone SOC market. So, there will be a joint effort promotion program, hopefully to be announced in a near future. So, what we’re trying to do is to create a new feature, firstly, probably starting from smartphone or your tablet. And the good thing about our solution is that we are the only one in the world who can provide a whole module of this feature with a total module height of around 5 millimeter or 6 millimeter, which is good enough for cell phone; it’s a very, very difficult criteria to meet. So, what we realized is that once we enter into such markets, there is actually very little competition. And that’s where we really provide value to our customers. So, I think in the longer term, hopefully you will see our CIS turning into such directions and moving gradually more away from smartphones because we believe, it’s really overly competitive. Now, we cannot just cut it off because we do have increasing customers, we need to continue to provide service, and we do have a pretty competitive product line of 30 megapixel and 8 megapixel. So, we can always take advantage of the existing products. But I think in the long-term, our focus is going to be IoT niche markets, multimedia and surveillance and certainly automotive.

And then, as a follow-up, the Chinese government initiating subsidies for smartphones that you’ve mentioned during the call. When did it start? And do you expect this to last for the rest of the year?

We really don’t know. Certainly, they started probably early this year and it’s still ongoing. Certainly, the scale of the subsidy is not as significant as what saw two years back. And certainly now with the economy not going very strongly and certainly, the government is still trying to encourage 4G penetration, so there’s a new round of subsidy. Certainly that is very good news for us. I think we are -- the subsidy aside. I think what’s important, more important for our current momentum in smartphone is the fact that we have very thorough design-in or design wins, starting from six months, nine months ago, with top Chinese brand names, covering the two mainstream product spaces being HD and full HD. So, the kind of name we talk about include people like Huawei, Xiaomi, Oppo, Vivo, Gionee, ZTE so on so forth. So, it’s a pretty comprehensive coverage. And so, once they get a momentum, we get our momentum, we take the right, along the way. Honestly, I tried to find out from my customer recently but nobody can really tell, exactly how long the subsidy is going to sustain.

Thank you. Our next question comes from Tom Sepenzis with Northland Capital. Your line is open.

I know you addressed this earlier, but I just wanted to see if I can understand it a bit better. The product that was impacted by the earthquake, that is not being made up for in the June quarter, or it is, are you seeing a one-time benefit there in June?

No, what we said was, it’s been over with our customer, which was impacted by the earthquake in the first quarter. So, in the second quarter, there’s no impact, it’s business as usual. Now, it did hit our customer and indirectly kind of impacted us. So, we did say in our prepared remarks that without earthquake, I believe in our first quarter, we could have beat our revenue guidance, and we didn’t because of the earthquake. But the good news is it’s been over with. So, it’s all business as usual. So, there will be no further impact from the earthquake.

But, are they ordering more in June to make up for what they weren’t able to produce in March?

No, because it’s a above their capacity. They will need so much capacity. So, part of the capacity during first quarter was impacted and was not productive. So, all they did was try to recover those capacities. So, what’s happened during the first quarter was they were able to ship less and therefore they bought less. But capacity -- capacity, it’s there. So, you cannot really use your lost capacity in the first quarter and use that for second quarter because they are running pretty full capacity right now. So, it’s not [Multiple Speakers]. And then actually with the earthquake, a lot of their so called work in progress, semi finished goods, including some glasses actually were shattered. So, they are shattered, they are gone. And so, it’s lost revenue for them; it’s lost revenue for us. And they cannot be kind of -- that cannot be additional demand for second quarter, because it’s just gone.

And then, just in terms of the inventories which went up, I believe you stated that that’s a signal of your confidence going forward. How much of that -- or I guess where are you building inventories? Is it across the board, through all your products or is there any color you can provide in terms of what type of inventory you’re building?

We typically build inventory in accordance with customers’ forecast. We have a long standing forecasting system with our customers, especially major customers, right. So, they give us a certain months of projection, and we build our inventory accordingly. So now, the slightly higher inventory level, I would say is across the board, because as we indicated earlier, the strength of our current business is pretty much across the board. I do want to add that in smartphone business, actually we are running some shortage because I think it’s indication that the supply chain across the board in the industry, the inventory level is quite lean, and the economy is weak. And the inventory is slow. But, end customers are still very cautious. So, once they see demand, they want their goods provided immediately. And in some cases, it just cannot happen. So, we are actually -- over the last few weeks, we are seeing increasing situation where we actually failed to meet some of our customers’, some of own customers’ demands because they are just very short noticed. So again, it’s good and bad. I mean if we had the inventory we could have much more shipments but certainly we don’t because without a projection we just didn’t want to build too much inventory because of the risk. So, across the board, I think we are increasing our inventory level in the quarter and with these customers’ forecast. And particularly in smartphone, we are actually running some shortage, right now in a short term.

Thank you our next question comes from Jerry Su with Credit Suisse. Your line is open.

Just two questions on the driver IC side. First is that I think in the past one month or so, there are some more discussion on the technology such as gate-on-array , GOA or double array, triple array are driving, which I think some people mentioned that this might impact the long-term growth or content per panel for the driver IC industry. I don’t know if you agree with this comment and what you are really seeing at your customer side of these technology deployment. The second question is, can you comment little bit about your market share in China, do you have any more room to grow, and then, are you seeing any competition from the local driver IC suppliers in the near-term and also in the longer term?

I would start by addressing your question about GOA or dual gate, triple gate technology. Actually GOA is nothing new; it has been around for more than 10 years, starting from Korean penal makers, and then Taiwanese and then right now also Chinese. If you keep all other sectors intact, certainly GOA -- for those people who are not familiar with the technology jargon, GOA is -- in a large penal, typically what we can provide is so source and gate [ph] driver. And GOA is so called gate on the array, which in essence is taking our [indiscernible] driver IC away and have driver IC circuit embedded in panel maker’s panels. And so, once that is successful, then in theory, the demand for driver IC gate driver decreases. So, certainly that impacts our business negatively, the whole driver IC industry. But again,. I would emphasize that it’s been around for more 10 years and it’s an ongoing thing and with a very high percentage of monitor and certain smaller size TVs having adopted GOA already. So, I would say if you look at very large sized panel, TV panel in particular, GOA is still difficult to get adopted because of cost issue. And so, the channel has been around and certainly it has a negative impact on industry, but there are also positive trends such as higher resolution and 4K TV and then smartphone becoming full HD and so on, which are the only positive sides. So, net-net, this is effectively what you see for our industry over the last 10 years. So, I think it is certainly correct to say that without this GOA technology, the driver IC industry would have been even bigger, but it’s not because GOA does exist. But it is -- what I want to emphasize that it’s nothing new and it’s been ongoing with a very high percentage of panel already adopted, GOA. So, I don’t think it has a major impact in a short-term or a long-term in our industry or us. And we have actually built our business model and business projection with the consideration of GOA having being adopted by our customers, certain percentage of that. I would say the same for dual-gate, triple-gate, although these are two more recent technologies. By saying recent, I really don’t remember exactly the time when it got started but I would say this four to five years already. So, it’s something that we have to deal with. And actually we have to be in the leading position to be providing such driver IC technology to our customers for their future GOA or dual-gate panels. So, we know about the trend inside and actually we’re part of trend, certainly we don’t like it, but it is where it is. It is the technology trend, it’s something we cannot resist. So, we just have to work with our customers. But, I want to emphasize that one should not overplay of sudden impact of this technology because it’s been ongoing for long time. And your second question is about China.

Yes, Jerry, I’d like to make sure that you want us to comment on the market share position globally or in China?

Just in China.

Just in China? Well, I think for our large driver IC because of the Chinese capacity expansion and their in-sourcing initiative started earlier on and will continue through future years, we have gained new allocation from the Chinese capacity expansion. We were able to improve our overall market share in China from about 40% to probably close to 50% right now. And we have certainly over 50% market share with the largest panel marker in China and about 45% with the second largest panel maker in China. And for our small medium driver IC, we had over 50% before 2015. And because of landscape -- competition landscape change in 2015, we have lost -- our customers have lost the market share to two brand customers, brand OEMs, one in the U.S., the other one is Xiaomi. And we added a new customer in December 2015 and also we started shipping AMOLED driver IC to our Korean customer end of first quarter. So, we were able to improve our market share from about 35% in 2015 to now over 50% because we’re adding some major customer in China. So, we would expect our market share continuing to grow throughout 2016 because of the new product shipments.

Thank you. Our next question comes from Ricky Lee with Goldman Sachs. Your line is open.

My first question is regarding the technology roadmap for your AR device microdisplay system. So, I’m just curious about could you comment a bit about what is the key product differentiation and the spec upgrade for your new product shipping this year, compared to the earliest version of the microdisplay module you shipped two to three years ago for your main customer?

I think the current generation, which is in production is -- certainly, if you look at our current major products -- major customers’ product, the microdisplay is of much higher resolution compared to our previous -- some of our previous major customers. And certainly, it’s got two eyes rather than one eye, it’s binocular rather than monocular with high resolution, it’s certainly more power effective. I think the trend that is happening right now, there are few folds, one is to improve the FOV, the field of view. And for that reason, the customer would need much bigger microdisplay. So that is something that we’re working with certain of our major customers on for next generation products. We are certainly trying to substantially better the -- I’m talking about optics, WLO for microdisplay, we are trying to -- right now it’s really first generation. For next generation, we are trying to not just to improve year rate and so on, we are trying to substantially better the scale up capability and cost of our technology, which is now very welcome by our customers. So, we are making some rather exciting progress here. So, that is one thing. And another thing is that with the current technology, it is more classical LCOS design and our next generation LCOS design, our proprietary technology involves [indiscernible] which involves basically, having a layer of [indiscernible] on top of the microdisplay, so that you can actually eliminate or simplify the optical design substantially and make the whole design more compact and easier for mass production. And that technology is now being adopted by certain of our major customers for their next generation, so quite a few of our major customers for their next generation. In next generation, it will be of color filter type, but we’re also working longer term with our customers and certainly with -- our team is now looking for on color sequential types [indiscernible] LCOS and bear in mind [indiscernible] is technology and it does provide a lot of benefit to enable, easier to assemble and low cost and more compact design of the whole optical engine. So, all these are major trends. Certainly we’re also providing smaller pixels for our customers. However, I’ve mentioned earlier now the customers actually require larger FOV. So, in some of them, they actually have to enlarge their pixels. But that is another story. We actually can provide small pixel compared to before. Last but not least, I think for next generation our people are talking about high resolution as well. Right now, it’s more of HD or above, but in the future there will be full HD or even higher resolution, in a horizon. So, there are a few major direction where we’re working now with various of our customers. So, I think this we have very exciting technology roadmap to go, the industry is really exciting.

And just a follow-up, considering all the upgrades and the areas for improvement, how do you think your ASP [ph] and dollar content per box [ph] to increase in next one, two years compared to what you have in last few years?

We don’t really worry about worry about, so called ASP that much because driver IC for example, you’ve seen -- most of them is well within $1 piece. If you look at the LCOS or WLO or sometimes on a combined basis, they can range in the area of hundreds of dollars a set, so how to compare the two together. And then I mentioned for example, some of our niche market sensors, they are a few dollars of piece, automotive as well. And then I mentioned earlier, structuralized module, the whole module would start from -- I don’t know, at least $15 to $20 a piece. So that involves quite a few different components provided by us. So, our future business will be rather different compared to the past when we had primarily driver IC had primarily [indiscernible] and one can really compare ASP. And certainly, semi-conductor, most always -- the cost always goes up down. However, you have high resolution, driver ICs, so the price goes up. So, it is the two trends conflicting each other and determining the ASP. But in the future --driver IC certainly will carry on this such trend. So, if you look at driver IC, I would say ASP would probably remain pretty much unchanged with per channel cost being lower over time, but number of channels being higher each IC. So, net-net, ASP probably remains the same. However, our other new areas of business will involve very different kind of ASP concepts.

Thank you. I am showing no further questions. I would like to turn the call back to Mr. Jordan Wu for closing remarks.

As a final note, Jackie, our CFO, she will certainly maintain our investor marketing activities and she is going to attend investor conferences in the U.S. and Hong Kong. So, we will announce the details as they come about. So, thank you very much today for your time and your patients and have a nice day. Thank you.

Ladies and gentleman, thank you for participating in today’s conference. This does conclude the program. And now you may all disconnect. Everyone, have a great day.