UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 20-F
(Mark One)
 
o
 
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
 
x
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2007
OR
 
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the transition period from ________________ to ________________
 
 
Commission file number:  001-31335
 
HIMAX TECHNOLOGIES, INC.
(Exact name of Registrant as specified in its charter)
 
Not Applicable
(Translation of Registrant’s name into English)
 
CAYMAN ISLANDS
(Jurisdiction of incorporation or organization)
 
NO. 26, ZIH LIAN ROAD, FONGHUA VILLAGE
SINSHIH TOWNSHIP, TAINAN COUNTY 74445
TAIWAN, REPUBLIC OF CHINA
(Address of principal executive offices)
 
 
Securities registered or to be registered pursuant to Section 12(b) of the Act:
 
Title of each class
Name of each exchange on which registered
Ordinary Shares, par value $0.0001 per ordinary share
The Nasdaq Global Select Market Inc.*
   
*
Not for trading, but only in connection with the listing on the Nasdaq Global Select Market, Inc. of American Depositary Shares representing such Ordinary Shares
 
Securities registered or to be registered pursuant to Section 12(g) of the Act:  None
 
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:  None
 
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report. 191,979,691 Ordinary Shares.
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    o Yes      x  No
 
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.    o Yes       x No
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x Yes       o No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer  o                                              Accelerated filer  x                                             Non-accelerated filer  o
 
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
 
U.S. GAAP  x         International Financial Reporting Standards as issued by the International Accounting Standards Board  o    Other  o
 
If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.    o Item 17       o Item 18
 
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  o Yes       x No
 
 


 
 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This annual report on Form 20-F contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Although these forward-looking statements, which may include statements regarding our future results of operations, financial condition, or business prospects, are based on our own information and information from other sources we believe to be reliable, you should not place undue reliance on these forward-looking statements, which apply only as of the date of this annual report. The words “anticipate,” “believe,” “expect,” “intend,” “plan,” “estimate” and similar expressions, as they relate to us, are intended to identify a number of these forward-looking statements. Our actual results of operations, financial condition or business prospects may differ materially from those expressed or implied in these forward-looking statements for a variety of reasons, including, among other things and not limited to, our anticipated growth strategies, our future business developments, results of operations and financial condition, our ability to develop new products, the expected growth of the display driver markets, the expected growth of end-use applications that use flat panel displays, particularly TFT-LCD panels, development of alternative flat panel display technologies, and other factors. For a discussion of these risks and other factors, please see “Item 3.D. Key Information—Risk Factors.”
 
 
CERTAIN CONVENTIONS
 
Except as discussed in the next two sentences, all translations from U.S. dollars to NT dollars in this annual report were made at a rate of $1.00 to NT$32.43, the noon buying rate in The City of New York for cable transfers in NT dollars per U.S. dollar as certified for customs purposes by the Federal Reserve Bank of New York on December 31, 2007. NT dollar amounts relating to the estimated fair value per share of all share-based compensation issued to employees and consultants (as described in “Item 5A. Operating Results—Critical Accounting Policies and Estimates—Share-Based Compensation Expenses”) have been calculated based on historical exchange rates used for our accounting purposes. No representation is made that the NT dollar amounts referred to herein could have been or could be converted into U.S. dollars at any particular rate or at all. On June 19, 2008, the noon buying rate was $1.00 to NT$30.39. Any discrepancies in any table between totals and sums of the amounts listed are due to rounding.
 
Unless otherwise indicated, in this annual report,
 
 
the terms “we,” “us,” “our company,” “our,” and “Himax” refer to Himax Technologies, Inc., its predecessor entities and subsidiaries;
 
 
 
the term “Himax Taiwan” refers to Himax Technologies Limited, our wholly owned subsidiary in Taiwan and our predecessor;
 
 
 
“shares” or “ordinary shares” refers to our ordinary shares, par value $0.0001 per share;
 
 
 
“RSUs” refers to restricted share units;
 
 
 
“ADSs” refers to our American depositary shares, each of which represents one ordinary share;
 
 
 
“ADRs” refers to the American depositary receipts that evidence our ADSs;
 
 
 
“ROC” or “Taiwan” refers to the island of Taiwan and other areas under the effective control of the Republic of China;
 
 
 
“PRC” or “China” for purposes of this annual report refers to the People’s Republic of China, excluding Taiwan and the special administrative regions of Hong Kong and Macau;
 
 
 
“AMOLED” refers to active matrix organic light-emitting diode;
 
 
 
“IC” refers to integrated circuit;
 
 
“LCOS” refers to liquid crystal on silicon;

 
 
 
 
 
“LTPS” refers to low temperature poly silicon;
 
 
 
“OLED” refers to organic light-emitting diode;
 
 
 
“TFT-LCD” refers to amorphous silicon thin film transistor liquid crystal display, or “a-Si TFT-LCD;”
 
 
 
“processed tape” refers to polyimide tape plated with copper foil that has a circuit formed within it, which is used in tape-automated bonding packaging;
 
 
 
“semiconductor manufacturing service providers” refers to third-party wafer fabrication foundries, gold bumping houses and assembly and testing houses;

 
“large-sized panels” refers to panels that are typically ten inches and above in diagonal measurement;
 
 
 
“small- and medium-sized panels” refers to panels that are typically less than ten inches in diagonal measurement;
 
 
 
all references to “New Taiwan dollars,” “NT dollars” and “NT$” are to the legal currency of the ROC; and
 
 
 
all references to “dollars,” “U.S. dollars,” and “$” are to the legal currency of the United States.

 

 
PART I
 
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
 
Not applicable.
 
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
 
Not applicable.
 
ITEM 3. KEY INFORMATION
 
3.A. Selected Financial Data
 
The selected consolidated statement of income data and selected consolidated cash flow data for the years ended December 31, 2005, 2006 and 2007 and the selected consolidated balance sheet data as of December 31, 2006 and 2007 are derived from our audited consolidated financial statements included herein, which were prepared in accordance with U.S. GAAP. The selected consolidated balance sheet data as of December 31, 2003, 2004 and 2005 and the selected consolidated statement of operations data and consolidated cash flow data for the years ended December 31, 2003 and 2004 have been derived from our audited consolidated financial statements that have not been included herein and were prepared in accordance with U.S. GAAP. Our consolidated financial statements include the accounts of Himax Technologies, Inc. and its subsidiaries as if we had been in existence for all years presented. As a result of our reorganization, 100% of our outstanding ordinary shares immediately prior to our initial public offering were owned by former shareholders of Himax Taiwan. See “Item 4.A. History and Development of the Company.” In presenting our consolidated financial statements, the assets and liabilities, revenues and expenses of Himax Taiwan and its subsidiaries are included in our consolidated financial statements at their historical amounts for all periods presented. Our historical results do not necessarily indicate results expected for any future periods. The selected financial and operating data set forth below should be read in conjunction with “Item 5. Operating and Financial Review and Prospects” and the consolidated financial statements and the notes to those statements included herein.
 
   
Year Ended December 31,
 
   
2003
   
2004
   
2005
   
2006
   
2007
 
   
(in thousands, except per share data)
 
Consolidated Statements of Operations Data:
                             
Revenues from third parties, net
  $ 29,050     $ 109,514     $ 217,420     $ 329,886     $ 371,267  
Revenues from related parties, net
    102,793       190,759       322,784       414,632       546,944  
Costs and expenses(1):
                                       
Cost of revenues
    100,102       235,973       419,380       601,565       716,163  
Research and development
    21,077       24,021       41,278       60,655       73,906  
General and administrative
    4,614       4,654       6,784       9,762       14,903  
Sales and marketing
    2,669       2,742       4,762       6,970       9,334  
                                         
Operating income
  $ 3,381     $ 32,883     $ 68,000     $ 65,566     $ 103,905  
                                         
Net income (loss)(2)
  $ (581 )   $ 36,000     $ 61,558     $ 75,190     $ 112,596  
                                         
Earnings (loss) per ordinary share(2) and per ADS(3):
                                       
Basic
  $ (0.00 )   $ 0.21     $ 0.35     $ 0.39     $ 0.57  
Diluted
  $ (0.00 )   $ 0.21     $ 0.34     $ 0.39     $ 0.57  
Weighted-average number of shares used in earnings per share computation:
                                       
Basic
    116,617       169,320       176,105       192,475       196,862  
Diluted
    116,617       173,298       180,659       195,090       197,522  
                                         
Cash dividends declared per ordinary share(4)
  $ 0.00     $ 0.00     $ 0.08     $ 0.00     $ 0.20  

 
 
 
____________
Note:   (1)   The amount of share-based compensation included in applicable costs and expenses categories is summarized as follows:
 
   
Year Ended December 31,
 
   
2003
   
2004
   
2005
   
2006
   
2007
 
   
(in thousands)
 
Cost of revenues
  $ 827     $ 291     $ 188     $ 275     $ 422  
Research and development
    11,666       4,288       6,336       11,806       15,393  
General and administrative
    2,124       721       848       1,444       2,182  
Sales and marketing
    1,349       537       1,241       1,625       2,324  
Total
  $ 15,966     $ 5,837     $ 8,613     $ 15,150     $ 20,321  
 
In 2007, of the $20.3 million in share-based compensation, $14.4 million was settled in cash.
 
(2)   Under the ROC Statute for Upgrading Industries, we are exempt from income taxes for income attributable to expanded production capacity or newly developed technologies. If we had not been exempt from paying this income tax, net income and basic and diluted earnings per share would have been $52.4 million, $0.30 and $0.29, respectively, for the year ended December 31, 2005, $59.2 million, $0.31 and $0.30, respectively, for the year ended December 31, 2006, and $85.6 million, $0.43, and $0.43, respectively, for the year ended December 31, 2007. A portion of these tax exemptions expires on March 31, 2009, December 31, 2010 and December 31, 2012, respectively.
 
(3)   Each ADS represents one ordinary share.
 
(4)   In November 2005, we distributed a special cash dividend of approximately $0.075 per share in respect of our performance prior to our initial public offering. This special cash dividend should not be considered representative of the dividends that would be paid in any future periods or our dividend policy.
 
The following table presents our selected consolidated balance sheet data as of December 31, 2003, 2004, 2005, 2006 and 2007 and selected consolidated cash flow data for the years ended December 31, 2003, 2004, 2005, 2006 and 2007:
 
   
As of December 31,
 
   
2003
   
2004
   
2005
   
2006
   
2007
 
   
(in thousands)
 
Consolidated Balance Sheet Data:
                             
Cash and cash equivalents(1)
  $ 2,529     $ 5,577     $ 7,086     $ 109,753     $ 94,780  
Accounts receivable, net
    12,543       27,016       80,259       112,767       88,682  
Accounts receivable from related parties, net
    22,893       39,129       69,587       116,850       194,902  
Inventories
    21,088       54,092       105,004       101,341       116,550  
Total current assets
    88,245       144,414       300,056       466,715       538,272  
Total assets
    96,159       157,770       327,239       518,794       652,762  
Accounts payable
    22,901       38,649       105,801       120,407       147,221  
Total current liabilities
    43,613       52,157       160,784       153,279       185,599  
Total liabilities
    43,870       52,246       160,784       153,471       190,364  
Ordinary shares
    17       18       18       19       19  
Total stockholders’ equity (1)
    52,289       104,860       165,831       363,927       451,309  
                                         
Consolidated Cash Flow Data:
                                       
Net cash provided by (used in) operating activities
    (1,593 )     (8,688 )     12,464       29,696       77,162  
Net cash provided by (used in) investing activities
    (28,915 )     11,001       (25,363 )     (8,927 )     (25,019 )
Net cash provided by (used in) financing activities
    30,341       735       14,404       81,886       (67,241 )
 
 
 
____________
Note:   (1)   Cash and cash equivalents at December 31, 2006 increased significantly as compared to December 31, 2005. This increase was primarily due to net proceeds of $147.4 million received from our initial public offering in April 2006, which also caused the increase in our stockholders’ equity by the same amount.
 
 
Exchange Rate Information
 
The following table sets forth the average, high, low and period-end noon buying rates between NT dollars and U.S. dollars for the periods indicated:
 
   
Noon Buying Rate
 
   
Average(1)
   
High
   
Low
   
Period-end
 
   
(NT dollars per U.S. dollar)
 
Period
                       
2003
    34.40       34.98       33.72       33.99  
2004
    33.37       34.16       31.74       31.74  
2005
    32.13       33.77       30.65       32.80  
2006
    32.51       33.31       31.28       32.59  
2007
    32.85       33.41       32.26       32.43  
First quarter
    32.92       33.13       32.38       33.01  
Second quarter
    33.13       33.41       32.74       32.83  
Third quarter
    32.93       33.10       32.67       32.67  
Fourth quarter
    32.43       32.61       32.26       32.43  
2008
                               
January
    32.36       32.49       32.15       32.15  
February
    31.36       32.03       30.90       30.92  
March
    30.58       31.09       29.99       30.37  
April
    30.36       30.52       30.24       30.47  
May
    30.59       30.99       30.36       30.37  
June (through June 19)
 
30.36
   
30.44
   
30.15
   
30.39
 

____________
Source: Federal Reserve Bank of New York.
 
Note:  (1)    Determined by averaging the rates on each business day.
 

3.B. Capitalization and Indebtedness
 
Not applicable.
 
3.C. Reason for the Offer and Use of Proceeds
 
Not applicable.
 
3.D. Risk Factors
 
Risks Relating to Our Financial Condition, Business and Industry
 
We derive substantially all of our net revenues from sales to the TFT-LCD panel industry, which is highly cyclical and subject to price fluctuations. Such cyclicality and price fluctuations could negatively impact our business or results of operations.
 
In 2006 and 2007, approximately 97.6% and 97.4% of our revenues, respectively, were attributable to display drivers that were incorporated into TFT-LCD panels. We expect to be substantially dependent on sales to the TFT-LCD panel industry for the foreseeable future. The TFT-LCD panel industry is intensely competitive and is vulnerable to cyclical market conditions. The average selling prices of TFT-LCD panels could decline for numerous reasons, including the following:
 
·  
a surge in manufacturing capacity due to the ramping up of new fabrication facilities and/or improvements in production yields;
 
 
 
 
·  
manufacturers operating at high levels of capacity utilization in order to reduce fixed costs per panel; and
 
·  
lower-than-expected demand for end-use products that incorporate TFT-LCD panels.
 
An oversupply of large-sized TFT-LCD panels in 2006 resulted in downward pricing pressure on TFT-LCD panel manufacturers which, in turn, resulted in similar downward pricing pressure on us. We could not sufficiently reduce costs to completely offset the revenue losses from such downward pricing pressure. Moreover, we were required to extend the payment terms we offered to certain of our customers, which also negatively impacted our cash flows. There have been industry reports of a possible oversupply of TFT-LCD panels starting from the fourth quarter of 2008, which could result in downward pricing pressure on TFT-LCD panel manufacturers similar to the situation in 2006 and we cannot assure you that we will be able to reduce costs to offset such downward pricing pressure in the future. During periods of declining average selling prices for TFT-LCD panels, TFT-LCD panel manufacturers may also decrease capacity utilization and sell fewer panels, which could depress demand for our display drivers. As a result, the cyclicality of the TFT-LCD panel industry could adversely affect our revenues, cost of revenues and results of operations.
 
Our strategy of expanding our product offerings to non-driver products may not be successful.
 
We have devoted, and intend to continue to devote, financial and management resources to the development, manufacturing and marketing of non-driver products, including, among others, timing controllers, TFT-LCD television and monitor chipsets, LCOS microdisplays, and power management ICs. For example in January 2008 we announced a strategic alliance with 3M to commercialize LCOS mobile projectors, of which our LCOS microdisplays are a key component. We devoted, and intend to continue to devote, financial and management resources to the development, manufacturing and marketing of LCOS products as we believe end products utilizing LCOS technology could potentially be a large market. LCOS technology, however, is at a relatively early stage of commercialization and the producing LCOS products at acceptable yields has proven difficult. Therefore we cannot assure you that there will be market acceptance of these LCOS products, or that this strategic alliance with 3M will be successful.
 
Developing of each of our non-driver products requires a significant amount of management, engineering and monetary resources. Numerous uncertainties exist in developing new products and we cannot assure you that we will be able to develop our non-driver products successfully. The failure or delay in the development of any of these non-driver products or the low market acceptance of either our products or the end devices using our products may adversely affect our results of operations and growth prospects.
 
We face numerous challenges relating to our growth.
 
The scope and complexity of our business has grown significantly since our inception. Our growth has placed, and will continue to place, a strain on our management, personnel, systems and resources. If we are unable to manage our growth effectively, we may not be able to take advantage of market opportunities, execute our business plan or respond to competitive pressures. To successfully manage our growth, we believe we must effectively:
 
·  
hire, train, integrate and manage additional qualified engineers, senior managers, sales and marketing personnel and information technology personnel;
 
·  
implement additional, and improve existing, administrative and operations systems, procedures and controls;
 
·  
expand our accounting and internal audit team, including hiring additional personnel with U.S. GAAP and internal control expertise;
 
·  
continue to expand and upgrade our design and product development capabilities;
 
·  
manage multiple relationships with semiconductor manufacturing service providers, customers, suppliers and certain other third parties;
 
·  
continue to develop and commercialize non-driver products, including, among others, timing controllers, TFT-LCD television and monitor chipsets, LCOS microdisplays, and power management ICs; and
 
·  
manage our financial condition.
 
Moreover, if our allocation of resources does not correspond with future demand for particular products, we could miss market opportunities, and our business and financial results could be materially and adversely affected. Therefore, we cannot assure you that we will be able to manage our growth effectively in the future.
 
 
 
 
We do not expect to sustain our recent growth rates in revenues or net income, so you should not rely on the results of recent periods as an indication of future revenues or net income growth.
 
Our revenues and net income have grown significantly since our inception in 2001. Our annual revenues increased by 37.8% to $744.5 million in 2006 and further increased by 23.3% to $918.2 million in 2007. Our net income increased from $61.6 million in 2005 to a net income of $75.2 million in 2006 and then further increased to a net income of $112.6 million in 2007. We do not expect similar growth rates in our revenues and net income in future periods. Accordingly, you should not rely on the results of any prior quarterly or annual periods as indicative of our future revenues or net income growth or financial results.
 
Our quarterly revenues and operating results are difficult to predict, and if we do not meet quarterly financial expectations, our ADS price will likely decline.
 
Our quarterly revenues and operating results are difficult to predict. They have fluctuated in the past from quarter to quarter and may continue to do so in the future. Our operating results may in some quarters fall below market expectations, likely causing our ADS price to decline. Our quarterly revenues and operating results may fluctuate because of many factors, including:
 
·  
our ability to accurately forecast shipments, average selling prices, cost of revenues, operating expenses, non-operating income/loss, and tax rates;
 
·  
our ability to successfully design, develop and introduce in a timely manner new or enhanced products acceptable to our customers;
 
·  
changes in the relative mix in the unit shipments of our products, which have significantly different average selling prices and cost of revenues as a percentage of revenues;
 
·  
changes in share-based compensation;
 
·  
the loss of one or more of our key customers;
 
·  
decreases in the average selling prices of our products;
 
·  
our accumulation of inventory;
 
·  
the relative unpredictability in the volume and timing of customer orders;
 
·  
the risk of cancellation or deferral of customer orders in anticipation of our new products or product enhancements, or due to a reduction in demand of our customers’ end product;
 
·  
changes in our payment terms with our customers and our suppliers;
 
·  
our ability to negotiate favorable prices with customers and suppliers;
 
·  
changes in the available capacity of semiconductor manufacturing service providers;
 
·  
the rate at which new markets emerge for new products under development;
 
·  
the evolution of industry standards and technologies;
 
·  
product obsolescence and our ability to manage product transitions;
 
·  
increase in cost of revenues due to inflation;
 
·  
our involvement in litigation or other types of disputes;
 
·  
general economic conditions;
 
·  
income tax regulation changes; and
 
 
 
 
·  
natural disasters, particularly earthquakes and typhoons, or outbreaks of disease affecting countries where we conduct our business or where our products are manufactured, assembled or tested.
 
The factors listed above are difficult to foresee, and along with other factors, could seriously harm our business. We anticipate the rate of new orders may vary significantly from quarter to quarter. Our operating expenses and inventory levels are based on our expectations of future revenues, and our operating expenses are relatively fixed in the short term. Consequently, if anticipated sales and shipments in any quarter do not occur when expected, operating expenses and inventory levels could be disproportionately high, and our operating results for that quarter and, potentially, future quarters may be negatively impacted. Any shortfall in our revenues would directly impact our business. Our operating results are volatile and difficult to predict; therefore, you should not rely on the operating results of any one quarter as indicative of our future performance. Our operating results in future quarters may fall below the expectations of securities analysts and investors. In this event, our ADS price may decline significantly.
 
We depend primarily on eight  foundries to manufacture our wafers, and any failure to obtain sufficient foundry capacity or loss of any of the foundries we use could significantly delay our ability to ship our products, causing us to lose revenues and damage our customer relationships.
 
Access to foundry capacity is crucial to our business because we do not manufacture our own wafers, instead relying primarily on eight third-party foundries. The ability of a foundry to manufacture our semiconductor products is limited by its available capacity. Access to capacity is especially important due to the limited availability of the high-voltage CMOS process technology required for the manufacture of wafers used in display drivers. Although we are in negotiations with our third-party foundries to enter into long-term supply arrangements that would guarantee us access to sufficient foundry capacity, we currently have such arrangements with only one of the foundries. As a result, if the primary third-party foundries that we rely upon were not able to meet our required capacity, or if our business relationships with these foundries were adversely affected, we would not be able to obtain the required capacity from these foundries and would have to seek alternative foundries, which may not be available on commercially reasonable terms, or at all, or which may expose us to risks associated with qualifying new foundries, as further discussed below. Our results of operations and business prospects could be adversely affected as a result of the foregoing.
 
We place our orders on the basis of our own customers’ purchase orders and sales forecasts; however, any of the foundries we use can allocate capacity to other foundry customers and reduce deliveries to us on short notice. It could be that other foundry customers are larger and better financed than we are, or have supply agreements or better relationships with the foundries we use, and could induce these foundries to reallocate our capacity to them. The loss of any of the foundries we use or any shortfall in available foundry capacity could impair our ability to secure our inputs, which could significantly delay our ability to ship our products, causing a loss of revenues and damages in our customer relationships.
 
The recent increase in the prices of certain metals, chemicals, and gasoline and the recent volatility of foreign exchange rates may have increased costs for the foundries and semiconductor service providers. This increase in costs could limit their ability to continue to make the research and development investments needed to keep up with technological advances. Any increase in costs for foundries and semiconductor service providers we use could lead to an increase in our cost and revenue and could limit our ability to lower our costs of revenues. We cannot assure you that we will be able to continue to reduce our costs and maintain our profit margins.
 
Taiwan Semiconductor Manufacturing Company, or TSMC, and Vanguard International Semiconductor Corporation, or Vanguard, have historically manufactured substantially all of our wafers. In order to diversify our foundry sources, we have begun to use Macronix International Co., Ltd., or Macronix, Lite-on Semiconductor Corp., or Lite-on, Chartered Semiconductor Manufacturing Ltd., or Chartered, United Microelectronics Corporation, or UMC, Maxchip Electronics Corp., or Maxchip (which was spun off from Powerchip Semiconductor Corp. on April 1, 2008),  and Silicon Manufacturing Partners Pte Ltd., or Silicon, to manufacture a portion of our products. As a result of outsourcing the manufacturing of our wafers, we face several significant risks, including:
 
·  
failure to secure necessary manufacturing capacity, or being able to obtain required capacity only at higher cost;
 
·  
risks of our proprietary information leaking to our competitors through the foundries we use;
 
·  
limited control over delivery schedules, quality assurance and control, manufacturing yields and production costs; and
 
 
 
 
·  
the unavailability of, or potential delays in obtaining access to, key process technologies.
 
In addition, in order to manufacture our display drivers used in TFT-LCD panels, we require foundries with high-voltage manufacturing process capacity. Of the limited number of foundries that offer this capability, some are owned by integrated device manufacturers which are also our competitors. As a result, our dependence on high-voltage foundries presents the following additional risks:
 
·  
potential capacity constraints faced by the limited number of high-voltage foundries and the lack of investment in new and existing high-voltage foundries;
 
·  
difficulty in attaining consistently high manufacturing yields from high-voltage foundries;
 
·  
delay and time required (approximately one year) to qualify and ramp up production at new high voltage foundries; and
 
·  
price increases.
 
As a result of these risks, we may be required to use foundries with which we have no established relationships, which could expose us to potentially unfavorable pricing, unsatisfactory quality or insufficient capacity allocation. Moreover, a scarcity in foundry capacity could necessitate us making investments in foundries in order to secure additional capacity, which would require us to substantially increase our capital outlays and possibly raise additional capital, which may not be available to us on satisfactory terms, if at all.
 
Shortages of processed tape used in the manufacturing of our products, increased costs of manufacturing such tape, or the loss of one of our suppliers of such tape may increase our costs or limit our revenues and impair our ability to ship our products on time.
 
There are a limited number of companies which supply the processed tape used to manufacture our semiconductor products, and therefore, from time to time, shortages of such processed tape may occur. If any of our suppliers experience difficulties in delivering processed tape, we may not be able to locate alternative sources in a timely manner. Therefore, if shortages of processed tape were to occur, or if the costs of manufacturing such tape increases, we would incur additional costs or be unable to ship our products to our customers in a timely fashion, all of which could harm our business and our customer relationships and negatively impact our earnings.
 
The loss of, or our inability to secure sufficient capacity from, any of our third-party assembly and testing houses at reasonable and competitive prices could disrupt our shipments, harm our customer relationships and reduce our sales.
 
Access to third-party assembly and testing capacity is critical to our business because we do not have in-house assembly and testing capabilities and instead rely on third-party service providers. Access to these services is especially important to our business because display drivers require specialized assembly and testing services. A limited number of third-party assembly and testing houses assemble and test substantially all of our current products. We do not have binding long-term supply arrangements with assembly and testing service providers that guarantee us access to our required capacity. If the primary assembly and testing service providers that we rely upon are not able to meet our requirements in price, quality, and service, or if our business relationships with these service providers were adversely affected, we would not be able to obtain the required capacity from such providers and would have to seek alternative providers, which may not be available on commercially reasonable terms, or at all. As a result, we do not directly control our product delivery schedules, assembly and testing costs and quality assurance and control. If any of these third-party assembly and testing houses experiences capacity constraints, financial difficulties, suffers any damage to its facilities or if there is any disruption of its assembly and testing capacity, we may not be able to obtain alternative assembly and testing services in a timely manner. We typically procure services from assembly and testing houses on a per-order basis. Because of the amount of time we usually take to qualify assembly and testing houses, we may experience significant delays in product shipments if we are required to find alternative sources. Any problems that we may encounter with the delivery, quality or cost of our products could damage our reputation and result in a loss of customers and orders.
 
 
 
 
Shortages of other key components for our customers’ products could decrease demand for our products.
 
Shortages of components and other materials that are critical to the design and manufacture of our customers’ products may limit our sales. These components include, but are not limited to, color filters, backlights and glass substrates. In the past, companies that use our products in their production have experienced delays in the availability of key components from other suppliers. For example, some TFT-LCD panel manufacturers experienced a shortage of glass substrates in 2001, 2003 and 2004, as well as color filters in 2003, 2004 and 2007. While shortages of components and other materials critical to the design and manufacture of our customers’ products have yet to significantly impact our business, such shortages could cause a slowdown in demand for our products and result in a decrease in sales for our products.
 
We depend on three customers for a substantial majority of our revenues and the loss of, or a significant reduction in orders from, any of them would significantly reduce our revenues and adversely impact our operating results.
 
Our top three customers, Chi Mei Optoelectronics Corp., or CMO, Chunghua Picture Tubes Ltd., or CPT, and Shanghai SVA-NEC Liquid Crystal Display Co. Ltd., or SVA-NEC, together with their respective affiliates, accounted for approximately 58.8%, 7.3% and 8.4%, respectively, of our revenues in 2007. The loss of CMO, CPT or SVA-NEC as our customer or a sharp reduction in sales to any of these customers would have a significant negative impact on our business. As discussed below, our sales to these customers are made pursuant to standard purchase orders rather than long-term contracts. Therefore, these customers may cancel or reduce orders more readily than if we had long-term purchase commitments from them. In the event of a cancellation, postponement, or reduction of an order, we would likely not be able to reduce operating expenses sufficiently so as to minimize the impact of the lost revenues. In the alternative, we may have excess inventory that we cannot sell, which would harm our operating results. We expect our reliance on sales to CMO, CPT and SVA-NEC and their respective affiliates to continue in the foreseeable future. Therefore, our operating results will likely continue to depend on sales to a relatively small number of customers, as well as on the ability of such customers to sell products that incorporate our products.
 
The concentration of our accounts receivable and the extension of payment terms for certain of our customers exposes us to increased credit risk and could harm our operating results and cash flows.
 
As of December 31, 2007, we had one customer that represented more than 10% of our accounts receivable balance. CMO, together with its affiliates, represented approximately 68.4% of our total accounts receivable as of December 31, 2007. Moreover, we have at times agreed to extend the payment terms for certain of our third-party and related party customers. We may also grant requests for the extension of payment terms in the future. As a result, a default by any such customer, a prolonged delay in the payment of accounts receivable or the extension of payment terms for our customers could adversely affect our cash flow, liquidity and our operating results.
 
Our close relationship with CMO could limit our potential to do business with CMO’s competitors, which may cause us to lose opportunities to grow our business and expand our customer base.
 
CMO is one of our largest shareholders and has been our largest customer since our inception. We expect to continue to maintain various contractual and other relationships with CMO. Our close relationship with CMO could limit our potential to do business with CMO’s competitors or other TFT-LCD panel manufacturers, who may perceive that granting business to us could benefit CMO. Our close relationship with CMO may result in lost business opportunities or may prevent us from taking advantage of opportunities to grow our business and expand our customer base.
 
An adverse change to our relationship with CMO could have a material adverse effect on our business.
 
CMO is one of our largest shareholders, beneficially owning approximately 13.0% of our outstanding shares as of June 1, 2008, and is also our largest customer, accounting (together with its affiliates) for approximately 58.8% of our revenues in 2007. Our engineers work closely with CMO’s engineers to design display drivers used in TFT-LCD panels manufactured by CMO. We have entered into various transactions with CMO in the past, and we expect to continue to do so in the future. See “Item 7. Major Shareholders and Related Party Transactions.” If our relationship with CMO deteriorates for any reason, our business could be materially and adversely affected.
 
 
 
 
Failure to attract new customers may limit our growth prospects.
 
We face challenges in attracting new customers for our existing products as well as our new products. Marketing our display drivers to other TFT-LCD panel manufacturers that have established relationships with our competitors may be difficult. Moreover, several TFT-LCD panel manufacturers have in-house design capabilities and therefore may not need to source semiconductor products from us. To sell new products, we will likely need to target new market segments and new customers with whom we do not have current relationships, which may require different strategies and may present difficulties that we have not encountered before. Therefore, failure to broaden our customer base and attract new customers may limit our growth prospects.
 
Technological innovation may reduce the number of display drivers typically required for each panel, thereby reducing the number of display drivers we are able to sell per panel. If such a reduction in demand is not offset by the general growth of the industry, growth in our market share or an increase in our average selling prices, our revenues may decline.
 
Except for certain small-sized panels, multiple display drivers are typically required for each panel to function. We are designing higher-channel display drivers to reduce the number of display drivers required for each panel while achieving the same resolution. By developing such innovative and cost-effective display driver solutions, we hope to grow our market share, attract additional customers, increase our average selling prices and capture new design wins. We cannot assure you that developing such display drivers with a higher number of channels will successfully achieve the aforementioned goals. If we fail to attain those goals, and the decrease in revenues resulting from a reduction in the number of display drivers that we sell per panel is not offset by an increase in average selling prices or unit sales, our revenues may decline. Furthermore, there have been industry reports on the development of panels which do not require external gate drivers or any external display drivers at all, as the driving functions are embedded in the panels. If such technology does become commercially available, the market for our display drivers will be reduced and we could experience a decline in revenue and profit.
 
We rely on the services of our key personnel, and if we are unable to retain our current key personnel and hire additional personnel, our ability to design, develop and successfully market our products could be harmed.
 
We rely upon the continued service and performance of a relatively small number of key personnel, including certain engineering, technical and senior management personnel. In particular, our engineers and other key technical personnel are critical to our future technological and product innovations. Competition for highly skilled engineers and other key technical personnel is intense in the semiconductor industry in general and in Taiwan’s flat panel semiconductor industry in particular. Moreover, our future success depends on the expansion of our senior management team and the retention of key employees such as Jordan Wu, our president and chief executive officer; Dr. Biing-Seng Wu, our chairman; Chih-Chung Tsai, our chief technology officer; and Max Chan, our chief financial officer. We rely on these individuals to manage our company, develop and execute our business strategies and manage our relationships with key suppliers and customers. Any of these employees could leave our company with little or no prior notice and would be free to work with a competitor. We do not have “key person” life insurance policies covering any of our employees. The loss of any of our key personnel or our inability to attract or retain qualified personnel, whether engineers and others, could delay the development and introduction of new products and would have an adverse effect on our ability to sell our products as well as on our overall business and growth prospects. We may also incur increased operating expenses and be required to divert the attention of other senior executives away from their original duties to recruiting replacements for key personnel.
 
If we fail to forecast customer demand accurately, we may have excess or insufficient inventory, which may increase our operating costs and harm our business.
 
The lead time required by the semiconductor manufacturing service providers that we use to manufacture our products is typically longer than the lead time that our customers provide for delivery of our products to them. Therefore, to ensure availability of our products for our customers, we will typically ask our semiconductor manufacturing service providers to start manufacturing our products based on forecasts provided by our customers in advance of receiving their purchase orders. However, these forecasts are not binding purchase commitments, and we do not recognize revenues from these products until they are shipped to customers. Moreover, for the convenience of our customers, we may agree to ship our inventory to warehouses located near our customers, so that our products can be delivered to these customers more quickly. We may from time to time agree that title and risk of loss do not pass to our customer until the customer requests delivery of our products from such warehouses. In such cases, we will not recognize revenues from these products until the title and risk of loss has passed to our customers based on the
 
 
 
 
shipping terms, which is generally when they are delivered to our customers from these warehouses. As a result, we incur inventory and manufacturing costs in advance of anticipated revenues. The anticipated demand for our products may not materialize; therefore, manufacturing based on customer forecasts exposes us to risks of high inventory carrying costs and increased product obsolescence and may increase our costs. If we overestimate demand for our display drivers or if purchase orders are cancelled or shipments delayed, we may incur excess inventory that we cannot sell, which would harm our financial results. Conversely, if we underestimate demand, we may not have sufficient inventory and may lose market share and damage customer relationships, which also could harm our business. Obtaining additional supply in the face of product shortages may be costly or impossible, particularly in the short term, which could prevent us from fulfilling orders. These inventory risks are exacerbated by the high level of customization of our products, which limits our ability to sell excess inventory to other customers.
 
If we do not achieve additional design wins in the future, our ability to grow will be limited.
 
Our future success depends on our current and prospective customers designing our products into their products. To achieve design wins, we must design and deliver cost-effective, innovative and integrated products that are customized for our customers’ needs. Once a supplier’s products have been designed into a system, the panel manufacturer may be reluctant to change its source of components due to the significant costs and time associated with qualifying a new supplier. Accordingly, our failure to obtain additional design wins with panel manufacturers and to successfully design, develop and introduce new products and product enhancements could harm our business, financial condition and results of operations.
 
A design win is not a binding commitment by a customer to purchase our products and may not result in large volume orders of our products. Rather, it is a decision by a customer to use our products in the design process of that customer’s products. Customers can choose at any time to stop using our products in their designs or product development efforts. Moreover, even if our products were chosen to be incorporated into a customer’s products, our ability to generate significant revenues from that customer would depend on the commercial success of those products. Thus, a design win may not necessarily generate significant revenues if our customers’ products are not commercially successful.
 
Some of our semiconductor products are manufactured at only one foundry. If any foundry is unable to provide the capacity we need,  does not deliver in a timely manner or the quality or pricing terms are not acceptable to us, we may experience delays in shipping our products or have to incur additional costs, which could damage our customer relationships and result in reduced revenues and higher expenses.
 
Although we use several foundries for different semiconductor products, certain of our products are manufactured at only one of these foundries. If any one of the foundries that we use for a specific product is unable to provide us with our required capacity, does not deliver in a timely manner or the quality or pricing terms are not acceptable to us, we could experience significant delays in receiving the product being manufactured for us by that foundry or incur additional costs to obtain substitutes. Also, if any of the foundries that we use experience financial difficulties, if their operations are damaged or if there is any other disruption of their foundry operations, we may not be able to qualify an alternative foundry in a timely manner. If we choose to use a new foundry or process technology for a particular semiconductor product, we believe that it will take us several quarters to qualify the new foundry or process before we can begin shipping such products. If we cannot qualify a new foundry in a timely manner, we may experience a significant interruption in our supply of the affected products, which could reduce our revenues, increase our expenses and damage our customer relationships.
 
Our products are complex and may require modifications to resolve undetected errors or failures in order for them to function with panels at the desired specifications, which could lead to higher costs, a loss of customers or a delay in market acceptance of our products.
 
Our products are highly complex and may contain undetected errors or failures when first introduced or as new versions are released. If our products are delivered with errors or defects, we could incur additional development, repair or replacement costs, and our credibility and the market acceptance of our products could be harmed. Defects could also lead to liability for defective products and lawsuits against us or our customers. We have agreed to indemnify some of our customers under some circumstances against liability from defects in our products. A successful product liability claim could require us to make significant damage payments.
 
Our display drivers comprise part of a complex panel manufactured by our customers. Our display drivers must operate according to specifications with the other components used by our customers in the panel manufacturing
 
 
 
 
process. For example, during the panel manufacturing process, our display drivers are attached to the panel glass and must interoperate with the glass efficiently. If other components fail to operate efficiently with our display drivers, we may be required to incur additional development time and costs to improve the interoperability of our display drivers with the other components.
 
Our highly integrated products are difficult to manufacture without defects. The existence of defects in our products could increase our costs, decrease our sales and damage our customer relationships and our reputation.
 
The manufacture of our products is a complex process, and it is often difficult for semiconductor foundries to manufacture our products completely without defects. Minor deviations in the manufacturing process can cause substantial decreases in yield and quality. In particular, some of our products are highly integrated and incorporate mixed analog and digital signal processing and embedded memory technology, and this complexity makes it even more difficult to manufacture without defects.
 
The ability to manufacture products of acceptable quality depends on both product design and manufacturing process technology. Defective products can be caused by design, defective materials or component parts, or manufacturing difficulties. Thus, quality problems can be identified only by analyzing and testing our display drivers in a system after they have been manufactured. The difficulty in identifying defects is compounded by the uniqueness of the process technology used in each of the semiconductor foundries with which we have subcontracted to manufacture our products. Failure to achieve defect-free products due to the increasing complexity of display drivers and the panel system surrounding them may result in an increase in our costs and delays in the availability of our products. In addition, if the foundries that we use fail to deliver products of satisfactory quality in the volume and at the price required, we will be unable to meet our customers’ demand for our products or to sell those products at an acceptable profit margin, which could adversely affect our sales and margins and damage our customer relationships and our reputation.
 
We do not have long-term purchase commitments from our customers, which may result in significant uncertainty and volatility with respect to our revenues and could materially and adversely affect our results of operations and financial condition.
 
We do not have long-term purchase commitments from our customers; our sales are made on the basis of individual purchase orders. Our customers may also cancel or defer purchase orders. Our customers’ purchase orders may vary significantly from period to period, and it is difficult to forecast future order quantities. In addition, changes in our customers’ business may adversely affect the quantity of purchase orders that we receive. For example, one of our customers substantially reduced the utilization rate of its production facilities in late 2005 in connection with its renovation plans and, as a result, the quantity of purchase orders that we received from this customer decreased substantially. In 2006, one of our customers merged with another company. As a result of the merger, certain design-win projects were discontinued, which forced us to write off the corresponding inventory prepared based on forecasts provided by this customer. As shown by these examples, we cannot assure you that any of our customers will continue to place orders with us in the future at the same level as in prior periods. We also cannot assure you that the volume of our customers’ orders will be consistent with our expectations when we plan our expenditures. Our results of operations and financial condition may thus be materially and adversely affected.
 
We depend on sales of display drivers used in TFT-LCD panels, and the absence of continued market acceptance of our display drivers could harm our business.
 
In 2006 and 2007, we derived nearly all of our revenues from the sale of display drivers used in TFT-LCD panels, and we expect to continue to derive a substantial portion of our revenues from these or related products. In particular, display drivers used in large-sized panels represented approximately 86.7% and 81.9% of our revenues in 2006 and 2007, respectively. Continued market acceptance of our display drivers is therefore critical to our future success.
 
Potential conflicts of interest with CMO may affect our sales decisions and allocations. Our chairman also holds key management positions at CMO and may not be able to allocate sufficient time and resources to both companies.
 
We have a close relationship with CMO, which is one of our largest shareholders and has been our largest customer since our inception. In addition, certain of our directors hold key management positions at CMO. Jung-Chun Lin, our director, serves on our board and also holds the positions of director, vice president, chief financial officer and
 
 
 
 
chief accounting officer at CMO. Dr. Biing-Seng Wu, our chairman, is also a director, executive vice president and chief technology officer of CMO. We cannot assure you that our close relationship with CMO and the resulting potential conflicts of interest will not affect our sales decisions or allocations or that potential conflicts of interest with respect to representatives of CMO will be resolved in our favor. Moreover, Dr. Biing-Seng Wu, who holds key positions with both CMO and us, may not be able to allocate sufficient time and resources to both companies.
 
Our corporate actions are substantially controlled by officers, directors, principal shareholders and affiliated entities who may take actions that are not in, or may conflict with, our or our public shareholders’ interests.
 
As of June 1, 2008, Jordan Wu and Dr. Biing-Seng Wu (who are brothers) beneficially owned approximately 6.0% and 16.8% of our ordinary shares, respectively, and CMO beneficially owned approximately 13.0% of our ordinary shares. For information relating to the beneficial ownership of our ordinary shares, see “Item 7. Major Shareholders and Related Party Transactions.” These shareholders, acting together, could exert substantial influence over matters requiring approval by our shareholders, including electing directors and approving mergers or other business combination transactions. This concentration of ownership may also discourage, delay or prevent a change in control of our company, which could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our ADSs. Actions may be taken even if they were opposed by our other shareholders.
 
Assertions against us by third parties for infringement of their intellectual property rights could result in significant costs and cause our operating results to suffer.
 
The semiconductor industry is characterized by vigorous protection and pursuit of intellectual property rights and positions, which results in protracted and expensive litigation for many companies. We have received, and expect to continue to receive, notices of infringement of third-party intellectual property rights. We may receive claims from various industry participants alleging infringement of their patents, trade secrets or other intellectual property rights in the future. Any lawsuit resulting from such allegations could subject us to significant liability for damages and invalidate our proprietary rights. These lawsuits, regardless of their success, would likely be time-consuming and expensive to resolve and would divert management time and attention. Any potential intellectual property litigation also could force us to do one or more of the following:
 
·  
stop selling products or using technology or manufacturing processes that contain the allegedly infringing intellectual property;
 
·  
pay damages to the party claiming infringement;
 
·  
attempt to obtain a license for the relevant intellectual property, which may not be available on commercially reasonable terms or at all; and
 
·  
attempt to redesign those products that contain the allegedly infringing intellectual property with non-infringing intellectual property, which may not be possible.
 
The outcome of a dispute may result in our need to develop non-infringing technology or enter into royalty or licensing agreements. We have agreed to indemnify certain customers for certain claims of infringement arising out of the sale of our products. Any intellectual property litigation could have a material adverse effect on our business, operating results or financial condition.
 
Our ability to compete will be harmed if we are unable to protect our intellectual property rights adequately.
 
We believe that the protection of our intellectual property rights is, and will continue to be, important to the success of our business. We rely primarily on a combination of patent, trademark, trade secret and copyright laws and contractual restrictions to protect our intellectual property. These afford only limited protection. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to obtain, copy or use information that we regard as proprietary, such as product design and manufacturing process expertise. As of December 31, 2007, we and our subsidiaries had 364 U.S. patent applications pending, 353 Taiwan patent applications pending and 208 patent applications pending in other jurisdictions, including the PRC, Japan, Korea and Europe. Our pending patent applications and any future applications may not result in issued patents or may not be sufficiently broad to protect our proprietary technologies. Moreover, policing any unauthorized use of our products is difficult and costly, and we cannot be certain that the measures which we have implemented will prevent misappropriation or unauthorized use of
 
 
 
 
our technologies, particularly in foreign jurisdictions where the laws may not protect our proprietary rights as fully as the laws of the United States do. Others may independently develop substantially equivalent intellectual property or otherwise gain access to our trade secrets or intellectual property. Our failure to protect our intellectual property effectively could harm our business.
 
We are subject to a class action complaint alleging that we failed to disclose certain information in our initial public offering registration statement. If the class action is successful, it may have an adverse effect on our financial condition and operating results.
 
We are subject to a class action complaint, filed in the United States District Court for the Central District of California, for alleged violations of U.S. federal securities laws. The lawsuit asserts claims against us, our Chief Executive Officer Jordan Wu, our Chief Financial Officer Max Chan, certain of our directors, as well as CMO, for allegedly failing to disclose in our initial public offering registration statement and prospectus certain information concerning CMOs inventory level prior to our initial public offering. The complaint seeks unspecified damages on behalf of purchasers of our stock pursuant and/or traceable to our initial public offering in March 2006. We believe that the allegations in the class action are without merit, and we intend to vigorously defend ourselves against the claims. The outcome of this class action, like other litigation proceedings, is uncertain. Regardless of its merit, litigation and other preparations undertaken to defend the class action can be costly, and we may incur substantial costs and expenses in doing so. It may also divert the attention of our management. If the class action against us is successful, it may result in substantial monetary liabilities, which may have an adverse effect on our financial condition and operating results.
 
We may undertake acquisitions or investments to expand our business that may pose risks to our business and dilute the ownership of our existing shareholders, and we may not realize the anticipated benefits of these acquisitions or investments.
 
As part of our growth and product diversification strategy, we will continue to evaluate opportunities to acquire or invest in other businesses, intellectual property or technologies that would complement our current offerings, expand the breadth of markets we can address or enhance our technical capabilities. For example, on February 1, 2007, we acquired Wisepal Technologies, Inc., or Wisepal, a fabless design company located in Taiwan that specializes in TFT-LCD drivers for small and medium-sized panels. Under the terms of the acquisition, we issued one share in exchange for 5.26 shares of Wisepal, and we assumed all of the assets, liabilities and personnel of Wisepal. Acquisitions or investments that we potentially may make in the future, including our recent acquisition of Wisepal, entail a number of risks that could materially and adversely affect our business, operating and financial results, including:
 
·  
problems integrating the acquired operations, technologies or products into our existing business and products;
 
·  
diversion of management’s time and attention from our core business;
 
·  
adverse effects on existing business relationships with customers;
 
·  
the need for financial resources above our planned investment levels;
 
·  
failures in realizing anticipated synergies;
 
·  
difficulties in retaining business relationships with suppliers and customers of the acquired company;
 
·  
risks associated with entering markets in which we lack experience;
 
·  
potential loss of key employees of the acquired company;
 
·  
potential write-offs of acquired assets;
 
·  
potential expenses related to the depreciation of tangible assets and amortization of intangible assets; and
 
·  
potential impairment charges related to the goodwill acquired.
 
 
 
 
Our failure to address these risks successfully may have a material adverse effect on our financial condition and results of operations. Any such acquisition or investment may require a significant amount of capital investment, which would decrease the amount of cash available for working capital or capital expenditures. In addition, if we use our equity securities to pay for acquisitions, the value of our ADSs and the underlying ordinary shares may be diluted. If we borrow funds to finance acquisitions, such debt instruments may contain restrictive covenants that can, among other things, restrict us from distributing dividends.
 
Risks Related to Our Industry
 
The semiconductor industry, in particular semiconductors used in flat panel displays, is highly competitive, and we cannot assure you that we will be able to compete successfully against our competitors.
 
The semiconductor industry, in particular semiconductors used in flat panel displays, is highly competitive. Increased competition may result in price pressure, reduced profitability and loss of market share, any of which could seriously harm our revenues and results of operations. Competition principally occurs at the design stage, where a customer evaluates alternative design solutions that require display drivers. We continually face intense competition from fabless display driver companies as well as from integrated device manufacturers. Some of our competitors have substantially greater financial and other resources than we do with which to pursue engineering, manufacturing, marketing and distribution of their products. As a result, they may be able to respond more quickly to changing customer demands or devote greater resources to the development, promotion and sales of their products than we can. Some of our competitors have manufacturing capabilities as well as in-house design operations that may give them significant advantages such as higher research and development budgets and the ability to attract highly skilled engineers. Furthermore, some of our competitors are affiliated with, or are subsidiaries of, our panel manufacturer customers. These relationships may also give our competitors significant advantages such as early access to product roadmaps and design-in priorities, which would allow them to respond more quickly to changing customer demands and achieve more design-wins than we can. In addition, even competitors with no such strategic associations with panel manufacturers may resort to price competition to maintain their market share, which may impose pricing pressures on us, reduce our profitability or decrease our market share. We cannot assure you that we will be able to increase or maintain our revenues and market share, or compete successfully against our current or future competitors in the semiconductor industry.
 
We may be adversely affected by the cyclicality of the semiconductor industry.
 
The semiconductor industry is highly cyclical and is characterized by constant and rapid technological change, product obsolescence and price erosion, evolving standards, short product life cycles and wide fluctuations in product supply and demand. The semiconductor industry has, from time to time, experienced significant downturns, often connected with, or in anticipation of, maturing product cycles of both semiconductor companies’ and their customers’ products and declines in general economic conditions. These downturns have been characterized by diminished product demand, production overcapacity, high inventory levels and accelerated erosion of average selling prices. Any future downturn may reduce our revenues and result in our having excess inventory. Furthermore, any upturn in the semiconductor industry could result in increased competition for access to limited third-party foundry, assembly and test capacity. Failure to gain access to foundry, assembly and test capacity could impair our ability to secure the supply of products that we need, which could significantly delay our ability to ship our products, cause a loss of revenues and damage our customer relationships.
 
The average selling prices of our products could decrease rapidly, which may negatively impact our revenues and operating results.
 
The price of each semiconductor product typically declines over its product life cycle, reflecting product obsolescence, decreased demand as customers shift to more advanced products and increased competition as more semiconductor producers are able to produce similar products in larger quantities. We may experience substantial period-to-period fluctuations in future operating results if our average selling prices decline. We may reduce the average unit price of our products in response to competitive pricing pressures, new product introductions by us or our competitors and other factors. The TFT-LCD panel market is highly cost sensitive, which may result in declining average selling prices of the components comprising TFT-LCD panels. We expect that these factors will create downward pressure on our average selling prices and operating results. To maintain acceptable operating results, we will need to develop and introduce new products and product enhancements on a timely basis and continue to reduce our costs. If we are unable to offset any reductions in our average selling prices by increasing our sales volumes and
 
 
 
 
corresponding production cost reductions, or if we fail to develop and introduce new products and enhancements on a timely basis, our revenues and operating results will suffer.
 
We have a lengthy and expensive design-to-mass production cycle.
 
The cycle time from the design stage to mass production for display drivers is long and requires the investment of significant resources with each potential customer without any guarantee of sales. Our design-to-mass production cycle typically begins with a three- to twelve-month semiconductor development stage and test period followed by a three- to twelve-month end product development period by customers. This fairly lengthy cycle creates the risk that we may incur significant expenses but will be unable to realize meaningful sales. Moreover, prior to mass production, customers may decide to cancel the projects or change production specifications, resulting in sudden changes in our product specifications, further causing increased production time and costs. Failure to meet such specifications may delay the launch of our products.
 
Our business could be materially and adversely affected if we fail to anticipate changes in evolving industry standards, fail to achieve and maintain technological leadership in our industry or fail to develop and introduce new and enhanced products.
 
Our products are generally based on industry standards, which are continually evolving. The emergence of new industry standards could render our products or those of our customers unmarketable or obsolete and may require us to incur substantial unanticipated costs to comply with any such new standards. Likewise, the components used in the TFT-LCD panel industry are constantly changing with increased demand for improved features. Moreover, our past sales and profitability have resulted, to a significant extent, from our ability to anticipate changes in technology and industry standards and to develop and introduce new and enhanced products in a timely fashion. If we do not anticipate these changes in technologies and rapidly develop and introduce new and innovative technologies, we may not be able to provide advanced display semiconductors on competitive terms, and some of our customers may buy display drivers from our competitors instead of from us. Our continued ability to adapt to such changes and anticipate future standards will be a significant factor in maintaining or improving our competitive position and our growth prospects. We cannot assure you that we will be able to anticipate evolving industry standards, successfully complete the design of our new products, have these products manufactured at acceptable manufacturing yields, or obtain significant purchase orders for these products to meet new standards or technologies. If we fail to anticipate changes in technology and to introduce new products that achieve market acceptance, our business and results of operations could be materially and adversely affected.
 
Risks Relating to Our Holding Company Structure
 
Our ability to receive dividends and other payments from our subsidiaries may be restricted by commercial, statutory and legal restrictions, and thereby materially and adversely affect our ability to grow, fund investments, make acquisitions, pay dividends and otherwise fund and conduct our business.
 
We are a holding company and our assets consist mainly of our 100% ownership interest in Himax Taiwan. Dividends and interest on intercompany loans that we receive from our subsidiaries in Taiwan, if any, will be subject to withholding tax under ROC law. The ability of our subsidiaries to pay dividends, repay intercompany loans from us or make other distributions to us is restricted by, among other things, the availability of funds, the terms of various credit arrangements entered into by our subsidiaries, as well as statutory and other legal restrictions. In addition, although there are currently no foreign exchange control regulations that restrict the ability of our subsidiaries located in Taiwan to distribute dividends to us, we cannot assure you that the relevant regulations will not be changed and that the ability of our subsidiaries to distribute dividends to us will not be restricted in the future. A Taiwan company is generally not permitted to distribute dividends or to make any other distributions to shareholders for any year in which it did not have either earnings or retained earnings (excluding reserves). In addition, before distributing a dividend to shareholders following the end of a fiscal year, the company must recover any past losses, pay all outstanding taxes and set aside 10% of its annual net income (less prior years’ losses and outstanding taxes) as a legal reserve until the accumulated legal reserve equals its paid-in capital, and may set aside a special reserve.
 
Any limitation on dividend payments by our subsidiaries could materially and adversely affect our ability to grow, finance capital expenditures, make acquisitions, pay dividends, and otherwise fund and conduct our business.
 
 
 
 
Our ability to make further investments in Himax Taiwan may be dependent on regulatory approvals. If Himax Taiwan is unable to receive the equity financing that it requires, its ability to grow and fund its operations may be materially and adversely affected.
 
Since Himax Taiwan is not a listed company, it generally depends on us to meet its equity financing requirements. Any capital contribution by us to Himax Taiwan may require the approval of the relevant ROC authorities such as the Investment Commission of the Ministry of Economic Affairs of the ROC, or the ROC Investment Commission. We may not be able to obtain any such approval in the future in a timely manner, or at all. If Himax Taiwan is unable to receive the equity financing that it requires, its ability to grow and fund its operations may be materially and adversely affected.
 
Political, Geographical and Economic Risks
 
Due to the location of our operations in Taiwan, we and many of our semiconductor manufacturing service providers, suppliers and customers are vulnerable to natural disasters and other events outside of our control, which may seriously disrupt our operations.
 
Most of our operations, and the operations of many of our semiconductor manufacturing service providers, suppliers and customers are located in Taiwan, which is vulnerable to natural disasters, in particular, earthquakes and typhoons. Our principal foundries and assembly and testing houses upon which we have relied to manufacture substantially all of our display drivers are located in Taiwan. In 2007, approximately 85.5% of our revenues were derived from customers headquartered in Taiwan. As a result of this geographic concentration, disruption of operations at our facilities or the facilities of our semiconductor manufacturing service providers, suppliers and customers for any reason, including work stoppages, power outages, water supply shortages, fire, typhoons, earthquakes, contagious diseases or other natural disasters, could cause delays in production and shipments of our products. Any delays or disruptions could result in our customers seeking to source products from our competitors. Shortages or suspension of power supplies have occasionally occurred and have disrupted our operations. The occurrence of a power outage in the future could seriously hurt our business.
 
The manufacturing processes of TFT-LCD panels require a substantial amount of water and, as a result, the production operations of TFT-LCD panels may be seriously disrupted by water shortages. Our customers may encounter droughts in areas where most of their current or future manufacturing sites are located. If a drought were to occur and our customers or the authorities were unable to source water from alternative sources in sufficient quantities, our customers may be required to shut down temporarily or to substantially reduce the operations of their fabs, which would seriously affect demand for our products. The occurrence of any of these events in the future could adversely affect our business.
 
Disruptions in Taiwan’s political environment could negatively affect our business and the market price of our ADSs.
 
Our principal executive offices and a substantial amount of our assets are located in Taiwan, and a substantial portion of our revenues is derived from our operations in Taiwan. Accordingly, our business, financial condition and results of operations and the market price of our ADSs may be affected by changes in ROC governmental policies, taxation, inflation or interest rates, and by social instability and diplomatic and social developments in or affecting Taiwan that are outside of our control.
 
Taiwan has a unique international political status. Since 1949, Taiwan and the PRC have been separately governed. The government of the PRC claims that it is the sole government in China and that Taiwan is part of China. Although significant economic and cultural relations have been established during recent years between Taiwan and the PRC, the PRC government has refused to renounce the possibility that it may at some point use force to gain control over Taiwan. Furthermore, the PRC government adopted an anti-secession law relating to Taiwan. Relations between the ROC and the PRC governments have been strained in recent years for a variety of reasons, including the PRC government’s position on the “One China” policy and tensions concerning arms sales to Taiwan by the United States government. Any tension between the ROC and the PRC, or between the United States and the PRC, could materially and adversely affect the market prices of our ADSs.
 
 
 
 
If the U.S. dollar fluctuates significantly against the NT dollar, our profitability may be affected.
 
We have foreign currency exposure, and are primarily affected by fluctuations in exchange rates between the U.S. dollar and the NT dollar. Although 99.7% our revenues and more than 97% of our cost of revenues were denominated in U.S. dollars in 2007, the majority of our operating expenses (including for research and development, general and administrative, and sales and marketing expenses) are denominated in NT dollars. For example, in December 2007, more than 50% of our operating expenses were denominated in NT dollars, with a small percentage denominated in Japanese Yen, Korean Won and Chinese Renminbi, and the majority of the remainder in U.S. dollars. From time to time, we enter into forward contracts to hedge our foreign currency exposure, but we cannot assure you that this will adequately protect us against the risk of exchange rate fluctuations and reduce the impact on our results of operations.
 
A decrease in the support of the ROC government may increase our tax expenditures and decrease our net income.
 
The ROC government has been very supportive of Taiwan-incorporated technology companies such as Himax Taiwan. In particular, Himax Taiwan, like many Taiwan technology companies, has benefited from substantial tax incentives provided by the ROC government. The ROC Statute for Upgrading Industries entitles companies to tax credits for expenses relating to qualifying research and development, personnel training and purchases of qualifying machinery. This tax credit may be applied within a five-year period. The amount from the tax credit that may be applied in any year is limited to 50% of the income tax payable for that year (with the exception of the final year when the remainder of the tax credit may be applied without limitation to the total amount of the income tax). Under the ROC Statute for Upgrading Industries, Himax Taiwan was granted tax credits by the ROC Ministry of Finance at rates set at a certain percentage of the amount utilized in qualifying research and development and personnel training expenses. The balance of unused investment tax credits totaled $9.4 million, $19.4 million and $32.7 million as of December 31, 2005, 2006 and 2007, respectively. In addition, the ROC Statute for Upgrading Industries provides to companies deemed to be operating in important or strategic industries a five-year tax exemption for income attributable to expanded production capacity or newly developed technologies. Such expanded production capacity or newly developed technologies must be funded in whole or in part from either an initial capital investment made by a company’s shareholders, a subsequent capital increase or a capitalizing of a company’s retained earnings. Beginning April 1, 2004, January 1, 2006 and January 1, 2008, Himax Taiwan has been entitled to three preferential tax treatments, each for a period of five years, which expires on March 31, 2009, December 31, 2010 and December 31, 2012, respectively. As a result of these preferential tax treatments, income attributable to certain of our expanded production capacity or newly developed technologies is tax exempt for the duration of these five-year periods. If the ROC government changed the laws to terminate, decrease or otherwise adversely change such tax incentives, our tax expenditures could increase, resulting in a decrease in our net income. For instance, if we did not have this tax exemption, net income and basic and diluted earnings per ordinary share would have been $85.6 million, $0.43 and $0.43 for the year ended December 31, 2007, respectively.
 
We face risks related to health epidemics and outbreaks of contagious diseases, including avian influenza and Severe Acute Respiratory Syndrome, or SARS.
 
There have been recent reports of outbreaks of a highly pathogenic avian influenza, or avian flu, caused by the H5N1 virus in certain regions of Asia, Europe, the Middle East and Africa. An outbreak of avian flu in the human population could result in a widespread health crisis that could adversely affect the economies and financial markets of many countries, particularly in Asia. Additionally, a recurrence of SARS, a highly contagious form of atypical pneumonia, similar to the occurrence in 2003 which affected the PRC, Hong Kong, Taiwan, Singapore, Vietnam and certain other countries, would also have similar adverse effects. Since all of our operations and substantially all of our customers and suppliers are based in Asia (mainly Taiwan), an outbreak of avian flu, SARS or other contagious diseases in Asia or elsewhere, or the perception that such an outbreak could occur, and the measures taken by the governments of countries affected, including the ROC and the PRC, could adversely affect our business, financial condition or results of operations.
 
Risks Related to Our ADSs and Our Trading Market
 
The market price for our ADSs may be volatile.
 
The market price for our ADSs is likely to be highly volatile and subject to wide fluctuations in response to various factors, including the following:
 
 
 
 
·  
actual or anticipated fluctuations in our quarterly operating results;
 
·  
changes in financial estimates by securities research analysts;
 
·  
conditions in the TFT-LCD panel market;
 
·  
changes in the economic performance or market valuations of other display semiconductor companies;
 
·  
announcements by us or our competitors of new products, acquisitions, strategic partnerships, joint ventures or capital commitments;
 
·  
the addition or departure of key personnel;
 
·  
fluctuations in exchange rates between the U.S. dollar and the NT dollar;
 
·  
litigation related to our intellectual property and shareholders’ lawsuit; and
 
·  
the release of lock-up or other transfer restrictions on our outstanding ADSs or sales of additional ADSs.
 
In addition, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our ADSs.
 
Future sales or perceived sales of securities by us, our executive officers, directors or major shareholders may hurt the price of our ADSs.
 
The market price of our ADSs could decline as a result of sales of ADSs or shares or the perception that these sales could occur. As of June 1, 2008, we had 190,905,649 outstanding shares, all of which are freely tradable. If we, our executive officers, directors or our shareholders sell ADSs or shares, the market price for our shares or ADSs could decline. Future sales, or the perception of future sales, of ADSs or shares by us, our executive officers, directors or existing shareholders could cause the market price of our ADSs to decline.
 
The level of investor interest and trading in our ADSs could be affected by the lack of coverage by U.S. securities research analysts and the lack of investor materials in the Chinese language.
 
Investor interest in us may not be as strong as in U.S. companies or Taiwan companies that are listed in Taiwan both because we may not be adequately covered by U.S. securities research analyst reports and because of the lack of investor materials in the Chinese language. The lack of coverage could negatively impact investor interest and the level of trading in our ADSs. The interest of both existing and prospective Taiwan-based investors to hold and trade in our ADSs may be impacted by the lack of investor materials in the Chinese language and the time difference between New York and Taiwan. As a result, the liquidity of our ADSs and the valuation multiples may be lower than if we were listed on a Taiwan stock exchange.
 
Although publicly traded, the trading market in our ADSs has been substantially less liquid than the average stock quoted on the Nasdaq Global Select Market, and this low trading volume may adversely affect the price our our ADSs.

Although our ADSs are traded on the Nasdaq Global Select Market, the trading volume of our ADSs has generally been very low. Reported average daily trading volume in our ADSs for the three month period ended March 31, 2008 was approximately 758,364 ADSs. In addition, between November 1, 2007 and March 31, 2008, we repurchased a total of approximately $33.0 million of our ADSs (equivalent to approximately 7.6 million ADSs) from the open market pursuant to an authorized share buyback program.  The repurchased ADSs and their underlying ordinary shares were cancelled, thereby reducing the number of outstanding ADSs by 4%, which could negatively impact the average trading volume of our ADSs.  Limited trading volume will subject our ADSs to greater price volatility and may make it difficult for you to sell your ADSs at a price that is attractive to you.
 
You may not have the same voting rights as the holders of our ordinary shares and may not receive voting materials sufficiently in advance  to be able to exercise your right to vote.
 
Except as described in the deposit agreement, holders of our ADSs will not be able to exercise voting rights attaching to the shares evidenced by our ADSs on an individual basis. Holders of our ADSs will appoint the depositary or its nominee as their representative to exercise the voting rights attaching to the shares represented by the ADSs. In certain circumstances, however, the depositary shall refrain from voting and any voting instructions received from ADS holders shall lapse. Furthermore, in certain other circumstances, the depositary will give us a discretionary proxy to vote shares evidenced by ADSs. You may not receive voting materials sufficiently in advance to instruct the depositary to vote, and it is possible that you, or persons who hold their ADSs through brokers, dealers or other third parties, will not have the opportunity to exercise a right to vote.
 
You may not be able to participate in rights offerings and may experience dilution of your holdings as a result.
 
We may from time to time distribute rights to our shareholders, including rights to acquire our securities. Under the deposit agreement for the ADSs, the depositary will not offer those rights to ADS holders unless both the rights and the underlying securities to be distributed to ADS holders are either registered under the Securities Act, or exempt
 
 
 
 
from registration under the Securities Act with respect to all holders of ADSs. We are under no obligation to file a registration statement with respect to any such rights or underlying securities or to endeavor to cause such a registration statement to be declared effective. In addition, we may not be able to take advantage of any exemptions from registration under the Securities Act. Accordingly, holders of our ADSs may be unable to participate in our rights offerings and may experience dilution in their holdings as a result.
 
You may be subject to limitations on transfer of your ADSs.
 
Your ADSs represented by the ADRs are transferable on the books of the depositary. However, the depositary may close its transfer books at any time or from time to time whenever it deems expedient in connection with the performance of its duties. In addition, the depositary may refuse to deliver, transfer or register transfers of ADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary deem it necessary or advisable to do so because of any requirement of law, any government, governmental body, commission, or any securities exchange on which our ADSs or our ordinary shares are listed, or under any provision of the deposit agreement or provisions of, or governing, the deposited securities or any meeting of our shareholders, or for any other reason.
 
Your ability to protect your rights through the United States federal courts may be limited, because we are incorporated under Cayman Islands law, conduct a substantial portion of our operations in Taiwan, and all of our directors and officers reside outside the United States.
 
We are incorporated in the Cayman Islands. A substantial portion of our operations is conducted in Taiwan through Himax Taiwan, our wholly owned subsidiary, and substantially all of our assets are located in Taiwan. All of our directors and officers reside outside the United States, and a substantial portion of the assets of those persons is located outside the United States. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in the United States in the event that you believe that your rights have been infringed under the securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Cayman Islands and of Taiwan may render you unable to enforce a United States judgment against our assets or the assets of our directors and officers. There is no statutory recognition in the Cayman Islands of judgments obtained in the United States, although a final and conclusive judgment in the federal or state courts of the United States under which a sum of money is payable, other than a sum payable in respect of multiple damages, taxes, or other charges of a like nature or in respect of a fine or other penalty, may be subject to enforcement proceedings as debt in the courts of the Cayman Islands under the common law doctrine of obligation, provided that (a) such federal or state courts of the United States had proper jurisdiction over the parties subject to such judgment; (b) such federal or state courts of the United States did not contravene the rules of natural justice of the Cayman Islands; (c) such judgment was not obtained by fraud; (d) the enforcement of the judgment would not be contrary to the public policy of the Cayman Islands; (e) no new admissible evidence relevant to the action is submitted prior to the rendering of the judgment by the courts of the Cayman Islands; and (f) there is due compliance with the correct procedures under the laws of the Cayman Islands.
 
As a result of all of the above, our public shareholders may have more difficulty in protecting their interests through actions against our management, directors or major shareholders than shareholders of a corporation incorporated in a jurisdiction in the United States would.
 
You may face difficulties in protecting your interests as a shareholder because judicial precedents regarding shareholders’ rights are more limited under Cayman Islands law than under U.S. law, and because Cayman Islands law generally provides less protection to shareholders than U.S. law.
 
Our corporate affairs are governed by our memorandum and articles of association, the Cayman Islands Companies Law and the common law of the Cayman Islands. The rights of shareholders to take action against directors, actions by minority shareholders and the fiduciary responsibilities of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from English common law, which has persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedent in some jurisdictions in the United States. In particular, the Cayman Islands have a less developed body of securities law than the United States. In addition, some U.S. states, such as Delaware, have more fully developed and judicially interpreted bodies of corporate law than the Cayman Islands.
 
 
 
 
For example, the Cayman Islands Companies Law differs from laws applicable to United States corporations and their shareholders in certain material respects which may affect shareholders’ rights and shareholders’ access to information. These differences under Cayman Islands Companies Law (as compared to Delaware law) include, though are not limited to, the following:
 
·  
directors who are interested in a transaction do not have a statutory duty to disclose such interest and there are no provisions under Cayman Islands Companies Law which render such director liable to the company for any profit realized pursuant to such transaction. Our articles of association, however, contain provisions that require our directors to disclose their interest in a transaction;
 
·  
dissenting shareholders do not have comparable appraisal rights if a scheme of arrangement is approved by the Grand Court of the Cayman Islands;
 
·  
shareholders may not be able to bring class action or derivative action suits before a Cayman Islands court except in certain exceptional circumstances; and
 
·  
unless otherwise provided under the memorandum and articles of association of the company, shareholders do not have the right to bring business before a meeting or call a meeting.
 
Moreover, certain of these differences in corporate law, including, for example, the fact that shareholders do not have the right to call a meeting or bring business to a meeting, may have anti-takeover effects, which could discourage, delay, or prevent the merger or acquisition of our company by means of a tender offer, a proxy contest or otherwise, which a shareholder may have considered in its best interest, and prevent the removal of incumbent officers and directors.
 
As a result of all of the above, public shareholders may have more difficulty in protecting their interests in the face of actions taken by management, members of the board of directors or controlling shareholders than they would have as public shareholders of a U.S. company.
 
Investor confidence and the market price of our ADSs may be adversely impacted if we or our independent registered public accountants conclude that our internal controls over financial reporting are not effective.
 
The SEC, as directed by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring public companies to include in their Annual Report on Form 10-K or Form 20-F, as the case may be, a report of management on the company’s internal controls over financial reporting that contains an assessment by management of the effectiveness of the company’s internal controls over financial reporting. In addition, the company’s independent registered public accounting firm must report on the company’s internal control over financial reporting. Our management may conclude that our internal controls over financial reporting are not effective. Moreover, even if our management does conclude that our internal controls over financial reporting are effective, if our independent registered public accounting firm is not satisfied with our internal controls, the level at which our controls are documented, designed, operated or reviewed, or if our independent registered public accounting firm interprets the requirements, rules or regulations differently from us, then it may conclude that our internal controls over financial reporting are not effective. Furthermore, during the course of the evaluation, documentation and attestation, we may identify deficiencies that we may not be able to remedy in a timely manner. If we fail to achieve and maintain the adequacy of our internal controls, we may not be able to conclude that we have effective internal controls, on an ongoing basis, over financial reporting in accordance with the Sarbanes-Oxley Act. Furthermore, effective internal controls over financial reporting is necessary for us to produce reliable financial reports and is important to help prevent fraud. As a result, our failure to achieve and maintain effective internal controls over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the trading price of our ADSs. In addition, we have incurred considerable costs and used significant management time and other resources in our effort to comply with Section 404 and other requirements of the Sarbanes-Oxley Act.
 
ITEM 4. INFORMATION ON THE COMPANY
 
4.A. History and Development of the Company
 
Himax Taiwan, our predecessor, was incorporated on June 12, 2001 as a limited liability company under the laws of the ROC. On April 26, 2005, we established Himax Technologies Limited, an exempted company with limited
 
 
 
 
liability under the Companies Law Cap. 22 of the Cayman Islands, or the Companies Law, as a holding company to hold the shares of Himax Taiwan in connection with our reorganization and share exchange. On October 14, 2005, Himax Taiwan became our wholly owned subsidiary through a share exchange consummated pursuant to the ROC Business Mergers and Acquisitions Law through which we acquired all of the issued and outstanding shares of Himax Taiwan, and we issued ordinary shares to the shareholders of Himax Taiwan. Shareholders of Himax Taiwan received one of our ordinary shares in exchange for one Himax Taiwan common share. The share exchange was unanimously approved by shareholders of Himax Taiwan on June 10, 2005 with no dissenting shareholders and by the ROC Investment Commission on August 30, 2005 for our inbound investment in Taiwan, and on September 7, 2005 for our outbound investment outside of Taiwan. We effected this reorganization and share exchange to comply with ROC laws, which prohibit a Taiwan incorporated company not otherwise publicly listed in Taiwan from listing its shares on an overseas stock exchange. Our reorganization enables us to maintain our operations through our Taiwan subsidiary, Himax Taiwan, while allowing us to list our shares overseas through our holding company structure.
 
The common shares of Himax Taiwan were traded on the Emerging Stock Board from December 26, 2003 to August 10, 2005, under the stock code “3222.” Himax Taiwan’s common shares were delisted from the Emerging Stock Board on August 11, 2005. As a result of our reorganization, Himax Taiwan is no longer a Taiwan public company, and its common shares are no longer listed or traded on any trading markets.
 
On September 26, 2005, we changed our name to “Himax Technologies, Inc.,” and on October 17, 2005, Himax Taiwan changed its name to “Himax Technologies Limited” upon the approval of shareholders of both companies and amendments to the respective constitutive documents. We effected the name exchange in order to maintain continuity of operations and marketing under the trade name “Himax Technologies, Inc.,” which had been previously used by Himax Taiwan.
 
In February 2007, we completed the acquisition of Wisepal, a driver IC company focusing on small and medium-sized applications. This transaction further strengthened our competitive position in the small and medium-sized product areas and broadened our supplier base, thereby securing additional foundry capacity, optimizing our foundry mix and further diversifying our technology and product mix.
 
On October 12, 2007, we formed Himax Media Solutions, Inc.,  which oversees our TFT-LCD television and monitor chipset business with a focus on expanding market share in the global TFT-LCD television and monitor chipset market.

Our principal executive offices are located at No. 26, Zih Lian Road, Fonghua Village, Sinshih Township, Tainan County 74445, Taiwan, Republic of China. Our telephone number at this address is +886 (6) 505-0880. Our registered office in the Cayman Islands is located at Century Yard, Cricket Square, Hutchins Drive, P.O. Box 2681 GT, Georgetown, Grand Cayman, Cayman Islands. Our telephone number at this address is +(1-345) 949-1040. In addition, we have regional offices in Hsinchu and Taipei, Taiwan; Suzhou, Foshan, Ningbo, Beijing, Shanghai and Shenzhen, China; Yokohama and Matsusaka, Japan; Anyangsi Kyungkido, South Korea; and Irvine, California, USA.
 
Investor inquiries should be directed to our Investor Relations department, at +886-2-2370-3999 ext. 22618 or by email to jessie_wang@himax.com.tw. Our website is www.himax.com.tw. The information contained on our website is not part of this annual report. Our agent for service of process in the United States is Puglisi & Associates located at 850 Library Avenue, Suite 204, Newark, Delaware 19711.
 
Our ADSs have been listed on the Nasdaq Select Global Market since March 31, 2006. Our ordinary shares are not listed or publicly traded on any trading markets.
 
4.B. Business Overview
 
We design, develop and market semiconductors that are critical components of flat panel displays. Our principal products are display drivers for large-sized TFT-LCD panels, which are used in desktop monitors, notebook computers and televisions, and display drivers for small and medium-sized TFT-LCD panels, which are used in mobile handsets and consumer electronics products such as digital cameras, mobile gaming devices and car navigation displays. We also offer display drivers for panels using OLED technology and LTPS technology. In addition, we are expanding our product offerings to include non-driver products such as timing controllers, TFT-LCD television and monitor chipsets, LCOS microdisplays, and power management ICs. Our customers are panel and television makers. We believe that our leading design and engineering expertise, combined with our focus on customer service and close relationships with semiconductor manufacturing service providers, has contributed to our success.
 
 
 
 
Industry Background
 
We operate in the flat panel display semiconductor industry. As our semiconductors are critical components of flat panel displays, our industry is closely linked to the trends and developments of the flat panel display industry.
 
Flat Panel Display Semiconductors
 
Flat panel displays require different semiconductors depending upon the display technologies and the application. Some of the most important ones include the following:
 
·  
Display Driver. The display driver receives image data from the timing controller and delivers precise analog voltages or currents to create images on the display. The two main types of display drivers for a TFT-LCD panel are gate drivers and source drivers. Gate drivers turn on the transistor within each pixel cell on the horizontal line on the panel for data input at each row. Source drivers receive image data from the timing controller and generate voltage that is applied to the liquid crystal within each pixel cell on the vertical line on the panel for data input at each column. The combination determines the colors generated by each pixel. Typically multiple gate drivers and source drivers are installed separately on the panel. However, for certain small and medium-sized applications, gate drivers and source drivers are integrated into a single chip due to space and cost considerations. Large-sized panels typically have higher resolution and require more display drivers than small and medium-sized panels.
 
·  
Timing Controller. The timing controller receives image data and converts the format for the source drivers’ input. The timing controller also generates controlling signals for gate and source drivers. Typically, the timing controller is a discrete semiconductor in large-sized TFT-LCD panels. For certain small and medium-sized applications, however, the timing controller may be integrated with display drivers.
 
·  
Scaler. For certain displays, a scaler is installed to magnify or shrink image data in order for the image to fill the panel.
 
·  
Operational Amplifier. An operational amplifier supplies the reference voltage to source drivers in order to make their output voltage uniform.
 
·  
Television Chipset. Television flat panel displays require chipsets that typically contain all or some of the following components: an audio processor, analog interfaces, digital interfaces, a video processor, a channel receiver and a digital television decoder. See “—Products—TFT-LCD Television and Monitor Semiconductor Solutions—TFT-LCD Television and Monitor Chipsets” for a description of these components.
 
·  
Others. Flat panel displays also require multiple general purpose semiconductors such as memory, power converters and inverters.
 
Characteristics of the Display Driver Market
 
Although we operate in several distinct segments of the flat panel display semiconductor industry, our principal products are display drivers. Display drivers are critical components of flat panel displays. As a result, we believe that the projected growth in the demand for flat panel displays will result in the growth in demand for display drivers. The display driver market has specific characteristics, including those discussed below.
 
Concentration of Panel Manufacturers
 
The global TFT-LCD panel industry consists of a small number of manufacturers, substantially all of which are based in Asia. In recent years, TFT-LCD panel manufacturers, in particular Taiwan- and Korea-based manufacturers, have invested heavily to establish, construct and ramp up additional fab capacity. The capital intensive nature of the industry often results in TFT-LCD panel manufacturers operating at a high level of capacity utilization in order to reduce unit costs. This tends to create a temporary oversupply of panels, which reduces the average selling price of panels and puts pricing pressure on display driver companies. Moreover, the concentration of panel manufacturers permits major panel manufacturers to exert pricing pressure on display driver companies such as ours. The small number of panel manufacturers intensifies this as display driver companies, in addition to seeking to expand their customer base, must also focus on winning a larger percentage of such customers’ display driver requirements.
 
 
 
 
Customization Requirements
 
Each panel display has a unique pixel design to meet its particular requirements. To optimize the panel’s performance, display drivers have to be customized for each panel design. The most common customization requirement is for the display driver company to optimize the gamma curve of each display driver for each panel design. Display driver companies must work closely with their customers to develop semiconductors that meet their customers’ specific needs in order to optimize the performance of their products.
 
Mixed-Signal Design and High-Voltage CMOS Process Technology
 
Display drivers have specific design and manufacturing requirements that are not standard in the semiconductor industry. Some display drivers require mixed-signal design since they combine both analog and digital devices on a single semiconductor to process both analog signals and digital data. Manufacturing display drivers requires high-voltage complementary metal oxide semiconductor, or CMOS, process technology operating at 10 to 18 volts for source drivers and 10 to 45 volts for gate drivers, levels of voltage which are not standard in the semiconductor industry. For display drivers, the driving voltage must be maintained under a very high degree of uniformity, which can be difficult to achieve using standard CMOS process technology. However, manufacturing display drivers does not require very small-geometry semiconductor processes. Typically, the manufacturing process for large panel display drivers requires geometries between 0.13 micron and 1 micron because the physical dimensions of a high-voltage device do not allow for the economical reduction in geometries below this range. We believe that there are a limited number of fabs with high-voltage CMOS process technology that are capable of high-volume manufacturing of display drivers.
 
Special Assembly and Testing Requirements
 
Manufacturing display drivers requires certain assembly and testing technologies and equipment that are not standard for other semiconductors and are offered by a limited number of providers. The assembly of display drivers typically uses either tape automated bonding, also known as TAB, or chip-on-glass, also known as COG, technologies. Display drivers also require gold bumping, which is a process in which gold bumps are plated onto each wafer to connect the die and the processed tape, in the case of TAB packages, and the glass, in the case of COG packages. TAB may utilize tape carrier package, also known as TCP, or chip on film, also known as COF. The type of assembly used depends on the panel manufacturer’s design, which is influenced by panel size and application and is typically determined by the panel manufacturers. Display drivers for large-sized applications typically require TAB package types and, to a lesser extent COG package types, whereas display drivers for mobile handsets and consumer electronics products typically require COG packages. The testing of display drivers also requires special testers that can support high-channel and high-voltage output semiconductors. Such testers are not standard in the semiconductor industry.
 
Supply Chain Management
 
The manufacturing of display drivers is a complex process and requires several manufacturing stages such as wafer fabrication, gold bumping and assembly and testing, and the availability of materials such as the processed tape used in TAB packaging. We refer to these manufacturing stages and material requirements collectively as the “supply chain.” Panel manufacturers typically operate at high levels of capacity utilization and require a reliable supply of display drivers. A shortage of display drivers, or a disruption to this supply, may disrupt panel manufacturers’ operations since replacement supplies may not be available on a timely basis or at all, given the customization of display drivers. As a result, a display driver company’s ability to deliver its products on a timely basis at the quality and quantity required is critical to satisfying its existing customers and winning new ones. Such supply chain management is particularly crucial to fabless display driver companies that do not have their own in-house manufacturing capacity. In the case of display drivers, supply chain management is further complicated by the high-voltage CMOS process technology and the special assembly and testing requirements that are not standard in the semiconductor industry. Access to this capacity also depends in part on display driver companies having received assurances of demand for their products since semiconductor manufacturing service providers require credible demand forecasts before allocating capacity among customers and investing to expand their capacity to support growth.
 
 
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Need for Higher Level of Integration
 
The small form factor of mobile handsets and certain consumer electronics products restricts the space for components. Small and medium-sized panel applications typically require one or more source drivers, one or more gate drivers and one timing controller, which can be installed as separate semiconductors or as an integrated single-chip driver. Customers are increasingly demanding higher levels of integration in order to manufacture more compact panels, simplify the module assembly process and reduce unit costs. Display driver companies must be able to offer highly integrated chips that combine the source driver, gate driver and timing controller, as well as semiconductors such as memory, power circuit and image processors, into a single chip. Due to the size restrictions and stringent power consumption constraints of such display drivers, single-chip drivers are complex to design. For large-sized panel applications, integration is both more difficult to achieve and less important since size and weight are less of a priority.
 
Products
 
We have four principal product lines:
 
·  
display drivers and timing controllers;
 
·  
TFT-LCD television and monitor semiconductor solutions;
 
·  
LCOS products; and
 
·  
power management ICs.
 
We commenced volume shipments of our first source and gate drivers for large-sized panels in July 2001 and have developed a broad product portfolio of display drivers and timing controllers for use in large-sized TFT-LCD panels. We commenced volume shipments of our first display drivers for use in consumer electronics applications in April 2002, volume shipments of two-chip display drivers for mobile handsets in August 2003 and volume shipments of single-chip display drivers for mobile handsets in August 2004. In September 2004, we commenced volume shipments of our first television semiconductor solutions. We commenced shipping engineering samples of LCOS products in December 2003 and started volume shipment in June 2006. We commenced shipping engineering samples of power management ICs in October 2006 and started volume shipments in January 2007.
 
Display Drivers and Timing Controllers
 
Display Driver Characteristics
 
Display drivers deliver precise analog voltages and currents that activate the pixels on panels. The following is a summary of certain display driver characteristics and their relationship to panel performance.
 
·  
Resolution and Number of Channels. Resolution refers to the number of pixels per line multiplied by the number of lines, which determines the level of fine detail within an image displayed on a panel. For example, a color display screen with 1,024 x 768 pixels has 1,024 red columns, 1,024 green columns and 1,024 blue columns for a total of 3,072 columns and 768 rows. The red, green and blue columns are commonly referred to as “RGB.” Therefore, the display drivers need to drive 3,072 column outputs and 768 row outputs. The number of display drivers required for each panel depends on the resolution. For example, an XGA (1,024 x 768 pixels) panel requires eight 384 channel source drivers (1,024 x 3 = 384 x 8) and three 256 channel gate drivers (768 = 256 x 3), while a SXGA (1,280 x 1,024 pixels) panel requires ten 384 channel source drivers and four 256 channel gate drivers. The number of display drivers required can be reduced by using drivers with a higher number of channels. For example, a SXGA panel can have eight 480 channel source drivers or four 960 channel source drivers instead of ten 384 channel source drivers. Thus, using display drivers with a higher number of channels can reduce the number of display drivers required for each panel, although display drivers with a higher number of channels typically have higher unit costs.
 
·  
Color Depth. Color depth is the number of colors that can be displayed on a screen, which is determined by the number of shades of a color, also known as grayscale, that can be shown by the panel. For example, a 6-bit source driver is capable of generating 26 x 26 x 26 = 218, or 262K colors, and similarly, an 8-bit source driver is capable of generating 16 million colors. Typically, for TFT-LCD panels currently in commercial production, 262K and 16 million colors are supported by 6-bit and 8-bit source drivers, respectively.
 
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·  
Operational Voltage. A display driver operates with two voltages: the input voltage (which enables it to receive signals from the timing controller) and the output voltage (which, in the case of source drivers, is applied to liquid crystals and, in the case of gate drivers, is used to switch on the TFT device). Source drivers typically operate at input voltages from 3.3 to 1.5 volts and output voltages between 10 to 18 volts. Gate drivers typically operate at input voltages from 3.3 to 1.5 volts and output voltages from 10 to 45 volts. Lower input voltage saves power and lowers electromagnetic interference, or EMI. Output voltage may be higher or lower depending on the characteristics of the liquid crystal (or diode), in the case of source drivers, or TFT device, in the case of gate drivers.
 
·  
Gamma Curve. The relationship between the light passing through a pixel and the voltage applied to it by the source driver is nonlinear and is referred to as the “gamma curve” of the source driver. Different panel designs and manufacturing processes require source drivers with different gamma curves. Display drivers need to adjust the gamma curve to fit the pixel design. Due to the materials and processes used in manufacturing, panels may contain certain imperfections which can be corrected by the gamma curve of the source driver, a process which is generally known as “gamma correction.” For certain types of liquid crystal, the gamma curves for RGB cells are significantly different and thus need to be independently corrected. Some advanced display drivers feature three independent gamma curves for RGB cells.
 
·  
Driver Interface. Driver interface refers to the connection between the timing controller and display drivers. Display drivers increasingly require higher bandwidth interface technology to address the larger data volume necessary for video images. Panels used for higher data transmission applications such as televisions require more advanced interface technology. The principal types of interface technologies are transistor-to-transistor logic, or TTL, reduced swing differential signaling, or RSDS, and mini-low voltage differential signaling, or mini-LVDS. Among these, RSDS and mini-LVDS were developed as low power, low noise and low amplitude methods for high-speed data transmission using fewer copper wires and resulting in lower EMI. In 2005, we introduced two new display driver interfaces: dual edge TTL, or DETTL, and turbo RSDS. DETTL enables the interface to function with lower power (below 1.8V), thus reducing power consumption. Turbo RSDS is an upgraded version of RSDS which increases the interface frequency from 85MHz to 135MHz, thus reducing the bus width and panel costs.
 
·  
Package Type. The assembly of display drivers typically uses TAB and COG package types. COF and TCP are two types of TAB packages. Customers typically determine the package type required according to their specific mechanical and electrical considerations. In general, display drivers for small-sized panels use COG package type whereas display drivers for large-sized panels primarily use TAB package types and, to a lesser extent, COG package types.
 
Large-Sized Applications
 
We provide source drivers, gate drivers and timing controllers for large-sized panels principally used in desktop monitors, notebook computers and televisions. Display drivers used in large-sized applications feature different key characteristics, depending on the end-use application. For display drivers for use in notebook computers, low power consumption is a key feature due to the portability of notebook computers and the need for long battery life. For display drivers used in desktop monitors, low cost is more desirable than low power consumption. For advanced televisions, display drivers must meet the requirements of larger panels, such as higher data transmission rates, wider viewing angles, faster response time, higher color depth and better image performance.
 
The table below sets forth the features of our products for large-sized applications:
 
Product
Features
TFT-LCD Source Drivers
·  384 to 1080 output channels
·  6-bit (262K colors), 8-bit (16 million colors) or 10-bit (1 billion colors)
·  one gamma-type driver
·  three gamma-type drivers (RGB independent gamma curve to enhance color image)
·  output driver voltage ranging from 4.5V to 24V
·  input logic voltage ranging from standard 3.3V to low power 1.5V
·  low power consumption and low EMI
·  supports TCP, COF and COG package types
 
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Product
Features
 
·  supports TTL, RSDS, mini-LVDS, DETTL, turbo RSDS and customized interface technologies
   
TFT-LCD Gate Drivers
·  192 to 400 output channels
·  output driving voltage ranging from 10 to 45V
·  input logic voltage ranging from standard 3.3V to low power 1.5V
·  low power consumption
·  supports TCP, COF and COG package types
   
Timing Controllers
·  product portfolio supports a wide range of resolutions, from VGA (640 x 480 pixels) to Full HD (1,920 x 1,080 pixels)
·  supports TTL, RSDS, mini-LVDS, DETTL, turbo RSDS and customized output interface technologies
·  input logic voltage ranging from standard 3.3V to low power 1.5V
·  embedded overdrive function for television applications to improve response time
·  supports TTL, LVDS and mini-LVDS input interface technologies

The industry trend for large-sized applications is towards low power consumption notebook computer display drivers, low cost desktop monitor display drivers and display drivers that can support higher speed interface technologies, have greater color depth and enhanced color through RGB independent gamma for use in advanced televisions.
 
In December 2007, we introduced Cascade Modulated Driver Interface, or CDMI, technology, a patented technology for LED notebook panels, benefits of which include a thin and light form factor, lower material costs and lower power consumption and supports a resolution of up to 1,920 x 1,200 pixels.
 
Mobile Handset Applications
 
We offer display drivers for mobile handset displays that combine source driver, gate driver and other functions into a single chip in various display technologies, such as TFT-LCD, LTPS LCD and AMOLED. As mobile handsets become smaller and more compact, customers are increasingly demanding smaller die sizes and higher levels of integration with source driver, gate driver, timing controller, as well as more functional semiconductors such as memory, power circuit and image processors, integrated into a single chip. Moreover, mobile handsets must operate for long durations without recharging the battery. Thus, display drivers with lower power consumption are desired and we integrated our proprietary low power driving circuits and Content Adaptive Brightness Control, or CABC, into display drivers in order to extend the battery life. Low cost is also an important feature as mobile handset manufacturers continue to reduce cost and customers increasingly seek out cost-effective display drivers.
 
The following table summarizes the features of our products for mobile handsets:
 
Product
Features
TFT-LCD Drivers
·  highly integrated single chip embedded with the source driver, gate driver, power circuit, timing controller and memory
·  product portfolio suitable for a wide range of resolutions, including QQVGA (128 x 160 pixels), QCIF (132 x 176 pixels), QCIF+ (176 x 220 pixels), QVGA (240 x 320 pixels), WQVGA (240 x 480 pixels), HVGA (320 x 480 pixels) and a range of panel sizes from 1.5 to 3.2 inches in diagonal measurement
·  supports 262K colors to 16 million colors
·  supports RGB separated gamma adjustment
·  supports CABC
·  supports MDDI (Mobile Display Digital Interface) or MIPI (Mobile Industry Processor Interface)
·  input logic voltage ranging from standard 3.3V to low power 1.65V
 
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Product
Features
 
·  low power consumption and low EMI
·  utilizes die shrink technology to reduce die size and cost
·  slimmer die for compact module to fit smaller mobile handset designs
·  application specific integrated circuits, or ASIC, can be designed to meet customized requirements (e.g., drivers without memory or drivers without gate driver embedded on the chip)
   
LTPS Drivers
·  highly integrated single chip embedded with the source driver, power circuit, timing controller and memory
·  suitable for a wide range of resolutions, including from QQVGA (128 x 160) to WVGA (864 x 480), and a range of panel sizes from 1.5 to 3.5 inches diagonally
·  supports 262K colors to 16 million colors
·  supports RGB separated gamma adjustment
·  supports CABC
·  supports CDP, MDDI, or MIPI
·  input logic voltage ranging from standard 3.3V to low power 1.65V
·  utilizes die shrink technology to reduce die size and cost
·  slimmer die for compact module
·  ASIC can be designed to meet customized requirements (e.g., gate-less or multi-bank output driver)

The industry trend for mobile handset display drivers is towards display drivers that can support high-speed interfaces, have greater color depth and enhanced image quality as mobile handsets increasingly incorporate multimedia functions.
 
Consumer Electronics Products
 
We offer source drivers, gate drivers, timing controllers and integrated drivers for consumer electronics products such as digital cameras, digital video recorders, personal digital assistants, mobile gaming devices, portable DVD players and car navigation displays. We offer an extensive line of display drivers covering different applications, interfaces and channel output and levels of integration. Similar to mobile handsets, consumer electronics products are typically compact, battery-operated devices. Customers are increasingly demanding display drivers with smaller and more compact die sizes and higher levels of integration with source driver, gate driver, timing controller, as well as more functional semiconductors such as memory, power circuit and image processors, integrated into a single chip. Moreover, display drivers with lower power consumption are desired in order to extend battery life.
 
The following table summarizes the features of our products used in consumer electronics products:
 
Product
Features
TFT-LCD Source Drivers
·  240 to 1200 output channels
·  products for analog and digital interfaces
·  supports 262K colors to 16 million colors
·  input logic voltage ranging from standard 3.3V to low power 2.5V
·  low power consumption and low EMI
   
TFT-LCD Gate Drivers
·  96 to 800 output channels
·  input logic voltage ranging from standard 3.3V to low power 2.5V
·  output driving voltage ranging from 10 to 40V
   
TFT-LCD Integrated Drivers
·  highly integrated single chip embedded with source driver, gate driver, timing controller and power circuit
·  resolutions include 480 x 240, 320RGB x 240, 480RGB x 272
 
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Product
Features
 
·  products for analog or digital interfaces
·  low power consumption
·  CABC function integrated for backlight power saving
   
Timing Controllers
·  products for analog or digital interfaces
·  supports various resolutions from 280 x 220 pixels to 1024 x 600 pixels

The industry trend for display drivers used in medium-sized consumer electronics products is towards higher channels and for the timing controller to be integrated into the video processor. The trend of display drivers used in small-sized consumer electronics products is towards single-chip solutions combining the source driver, gate driver, timing controller and power circuit into a single chip.
 
TFT-LCD Television and Monitor Semiconductor Solutions
 
Himax Media Solutions, our subsidiary, provides TFT-LCD television and monitor semiconductor solutions. Set forth below are the various semiconductor components that may be utilized in advanced televisions:
 


TFT-LCD Television and Monitor Chipsets
 
Television chipsets contain numerous components that process video and audio signals and thus enhance the image and audio qualities of televisions. Advanced televisions typically require some or all of these components:
 
·  
Audio Processor/Amplifier. Demodulates, processes and amplifies sound from television signals.
 
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·  
Analog Interfaces. Convert analog video signals into digital video signals. Video decoder and analog-to-digital converter, or ADC, are included.
 
·  
Digital Interfaces. Receive digital signals via digital receivers. Digital visual interfaces, or DVI, and high-definition multimedia interfaces, or HDMI, are included.
 
·  
Channel Receiver. Demodulates input signals so that the output becomes compressed bit stream data.
 
·  
DTV Decoder. Converts video and audio signals from compressed bit stream data into regular video and audio signals.
 
·  
Video Processor. Performs the scaling function that magnifies or shrinks the image data in order to fit the panel’s resolution; provides real-time processing for improved color and image quality; converts output video from an interlaced format to a progressive format in order to eliminate jaggedness; and supports on-screen display and real-time video format transformation.
 
We are developing all of the above components and have shipped our analog TV single-chip solutions in volume. Our analog TV single-chip solutions are designed for use in advanced televisions as well as LCOS applications and our product portfolio includes high-performance chips that target high-end segments as well as cost-effective chips which target entry-level segments.
 
The following table summarizes the features of our video processors:
 
Product
Features
Analog TV single-chip solutions
·  ideal for LCD TV, MFM TV and LCOS applications
·  integrated with video decoder and 3D comb filter to support worldwide NTSC, PAL and SECAM standards
·  integrated with VBI Slicer for CC, V-Chip and Teletext functions
·  integrated with TCON and Over-Drive for additional cost-down
·  integrated with high performance scaler, de-interlancer, and ADC
·  built-in HDMI and DVI Receiver
·  built-in Himax 3rd generation video engine which supports variable dynamic video enhancement features
·  output resolutions range from 640 x 480 up to 1920 x 1080
 

LCOS Products
 
LCOS technology is beginning to migrate into the mass-production stage for some commercial applications and is expected to be utilized in near-to-eye applications and mini-projectors. We design our LCOS products at our subsidiary, Himax Display, which owns and operates a fab for the manufacture of such products. In January 2008, we announced a strategic alliance with 3M, one of the world’s leading companies in optics technology, to commercialize LCOS mobile projectors by combining their proprietary technologies to deliver a complete mobile projection solution to consumer electronics manufacturers. 3M developed, and is providing, a miniature LED projection engine that incorporates the single-panel color filter type LCOS module of Himax Display.
 
The following table sets forth the features of our LCOS products:
 
Product
Features
LCOS modules for near-to-eye, mini and mobile-projector applications
·  Color filter type: 0.38" 640 x 360 pixels (Q720P), 0.44" VGA and 0.59" SVGA resolutions
·  Color sequential type: 0.38" VGA and 0.59" SVGA
·  8-bit (16 million colors)
·  high reflectivity and greater than 100:1 contrast ratio
·  low power consumption
 
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Product
Features
LCOS modules for projection applications
·  WXGA and Full HD resolutions
·  8-bit (16 million colors)
·  high reflectivity and greater than 1,000:1 contrast ratio

Power Management ICs
 
Himax Analogic, our subsidiary, has three major products: class-D audio amplifiers, step-up DC-to-DC switching regulators, and white light LED drivers.
 
Class-D Audio Amplifier. The audio amplifier receives audio signals from the audio processor and delivers the amplified audio signals to speaker(s). The input audio signal is converted into a sequence of pulses with fixed voltage. By means of a modulated pulse width and an external low-pass filter, the output audio signal will be “reproduced,” but with larger amplitude. Since a class-D audio amplifier only switches between on and off instead of operating in linear mode, there is a very small amount of power consumed by the amplifier. Therefore, high power efficiency is a class-D audio amplifier’s major advantage. For those applications that are concerned about power dissipation, a class-D audio amplifier is an appropriate choice.
 
Product
Features
2.5W/2W Mono/Stereo Class-D Audio Amp for Portable Devices
·  3.3V to 5.5V input voltage range
·  Gain setting by external resistors or DC voltage
·  OCP/OTP/UVL
 
9W Stereo Class-D Audio Amp for TVs and Monitors
·  8.5V to 12.6V input voltage range
·  4 fixed gain selections
·  OCP/OT/UVL

Step-up DC-to-DC Switching Regulator. A step-up DC-to-DC converter, also called a switching regulator, integrates an error amplifier and a pulse width modulator (PWM) with a build-in n-channel power MOSFET (Metal-Oxide-Semiconductor Field-Effect Transistor) to perform with high efficiency and fast transient response in order to supply a higher voltage from a lower input voltage with an external inductor and diode. Electronic devices require various specific working voltages on different applications. However, there is normally one or two common power sources available. A step-up DC-to-DC converter plays an important role in supplying higher voltage from lower input voltage to make an electronic device work normally. In other words, most electronic devices need a step-up DC-to-DC converter as a stable working power supplier in various applications.
 

 
Product
Features
TFT-LCD Step-up DC-to-DC Converter
·  2.6V to 5.5V input voltage range
·  Max boost voltage: 24V
·  Programmable switching frequency
·  Programmable soft-start
 
TFT-LCD DC-to-DC Converter with Operational Amplifiers
·  2.6V to 6.5V input voltage range
·  1.2MHz current-mode boost regulator
·  Linear regulator controllers for gate driver power supply
·  Built-in 14V, 2.4A, 160 mΩ MOSFET
·  5 high-performance operational amplifiers

White Light LED Driver. The LED driver provides sufficient voltage and current to light up LED diodes. Moreover, in addition to turning LEDs on, the driver has to keep the brightness of LEDs uniform and stable. Therefore, voltage boosting and current sensing are the core functional blocks of a white light LED driver.
 
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Product
Features
WLED Driver for Small/Medium Size Panels
Ÿ  2.5V to 6V input voltage range
 
Ÿ  Built-in 1.3MHz step-up PWM converter
Ÿ  Capable of driving up  to 39 LEDs (13 strings of 3 LEDs)
Ÿ  Support 200~25KHz PMM dimming control
 
WLED Driver for Notebook Panels
Ÿ  4.5V to 24V input voltage range
Ÿ  Built-in 1.3MHz step-up PWM converter (max. boost voltage: 40V)
Ÿ  8 constant current source channels
Ÿ  Capable of driving up to 11 LEDs in serial for each channel
 
Other Products and Services
 
We established Himax Imaging Inc., or Himax Imaging, in March 2007 to design, develop and market semiconductors for CMOS image sensor applications. To date, Himax Imaging has not generated any revenues.
 
Core Technologies and Know-How
 
Driving System Technology. Through our collaboration with panel manufacturers, we have developed extensive knowledge of circuit design, TFT-LCD driving systems, high-voltage processes and display systems, all of which are important to the design of high-performance TFT-LCD display drivers. Our engineers have in-depth knowledge of the driving system technology, which is the architecture for the interaction between the source driver, gate driver, timing controller and power systems as well as other passive components. We believe that our understanding of the entire driving system has strengthened our design capabilities. Our engineers are highly skilled in designing power efficient and compact display drivers that enhance the performance of TFT-LCD. We are leveraging our know-how of display drivers and driving system technology to develop display drivers for panels utilizing other technologies such as OLED.
 
High-Voltage CMOS Circuit Design. Unlike most other semiconductors, TFT-LCD display drivers require a high output voltage of 10 to 45 volts. We have developed circuit design technologies using a high-voltage CMOS process that enables us to produce high-yield, reliable and compact drivers for high-volume applications. Moreover, our technologies enable us to keep the driving voltage at very high uniformity, which can be difficult to achieve when using standard CMOS process technology.
 
High-Bandwidth Interfaces. In addition to high-voltage circuit design, TFT-LCD display drivers require high bandwidth transmission for video signals. We have applied several high-speed interfaces, including TTL, RSDS, mini-LVDS, DETTL, turbo RSDS and customized interfaces, in our display drivers. Moreover, we are developing additional driver interfaces for special applications with optimized speed, lower EMI and higher system stability.
 
Die Shrink and Low Power Technologies. Our engineers are highly skilled in employing their knowledge of driving technology and high-voltage CMOS circuit design to shrink the die size of our display drivers while leveraging their understanding of driving technology and panel characteristics to design display drivers with low power consumption. Die size is an important consideration for applications with size constraints. Smaller die size also reduces the cost of the chip. Lower power consumption is important for many portable devices such as notebook computers, mobile handsets and consumer electronics products.
 
Customers
 
Our customers for display drivers are primarily panel manufacturers and mobile device module manufacturers, who in turn design and market their products to manufacturers of end-use products such as notebook computers, desktop monitors, televisions, mobile handsets and consumer electronics products. As of December 31, 2007, we sold our products to more than 70 customers. In 2005, 2006 and 2007, CMO and its affiliates accounted for  58.9%, 55.0% and 58.8% of our revenues, respectively; CPT and its affiliates accounted for 16.2%, 12.4% and 7.3% of our revenues, respectively; and SVA-NEC and its affiliates accounted for 5.6%, 7.3% and 8.4% of our revenues, respectively. We expect that sales to CMO, CPT and SVA-NEC and their affiliates will continue to account for a substantial majority of our revenues in the near term.
 
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Set forth below (in alphabetical order) are our ten largest customers (and their affiliates) based on revenues for the year ended December 31, 2007:
 
Chi Lin Technology Co., Ltd.
Chi Mei Optoelectronics Corp.
Chunghwa Picture Tubes, Ltd.
Excel Asian Taiwan Co., Ltd.
HannStar Display Corporation
InnoLux Display Corporation
Perfect Display Limited
Samsung Electronics Taiwan Co., Ltd.
Shanghai SVA-NEC Liquid Crystal Display
TPO Displays Corporation

Our customers typically provide us with a long-term (twelve-month) forecast plus three-month rolling non-binding forecasts and confirm orders with us one month ahead of scheduled delivery. In general, purchase orders are not cancellable by either party, although from time to time we and our customers have agreed to amend the terms of such orders.
 
Sales and Marketing
 
We focus our sales and marketing strategy on establishing business and technology relationships principally with TFT-LCD panel manufacturers and increasingly also with panel manufacturers using LTPS or OLED technologies and also with mobile display module and mobile handset manufacturers in order to work closely with them on future semiconductor solutions that align with their product road maps. Our engineers collaborate with our customers’ engineers to create products that comply with their specifications and provide a high level of performance at competitive prices. Our end market for large-sized panels is concentrated around a limited number of major panel manufacturers. We have also commenced marketing our products directly to mobile device manufacturers so that our products can be qualified for their specifications and designed into their products.
 
We primarily sell our products through our direct sales teams located in Taiwan, China, South Korea and Japan. We also have dedicated sales teams for certain of our most important current or prospective customers. We have sales and technical support offices in Tainan, Taiwan. We have regional offices in Hsinchu and Taipei, Taiwan; Suzhou, Shenzhen, Foshan and Ningbo China; Yokohama and Matsusaka, Japan; Anyangsi Kyungkido, South Korea; and Irvine, California, USA, all in close proximity to our customers. For certain products or regions we may from time to time sell our products through agents or distributors.
 
Our sales and marketing team possesses a high level of technical expertise and industry knowledge used to support a lengthy and complex sales process. This includes a highly trained team of field applications engineers that provides technical support and assistance to potential and existing customers in designing, testing and qualifying display modules that incorporate our products. We believe that the depth and quality of this design support are key to improving customers’ time-to-market and maintaining a high level of customer satisfaction.
 
Manufacturing
 
We are a fabless semiconductor company. We leverage our experience and engineering expertise to design high-performance semiconductors and rely on semiconductor manufacturing service providers for wafer fabrication, gold bumping, assembly and testing. We also rely on third-party suppliers of processed tape used in TAB packaging. We engage foundries with high-voltage CMOS process technology for our display drivers and engage assembly and testing houses that specialize in TAB and COG packages, thereby taking advantage of the economies of scale and the specialization of such semiconductor manufacturing service providers. Our fabless model enables us to capture certain financial and operational benefits, including reduced manufacturing personnel, capital expenditures, fixed assets and fixed costs. It also gives us the flexibility to use the technology and service provider most suitable for any given product.
 
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Manufacturing Stages
 
The diagram below sets forth the various stages in manufacturing display drivers according to the two different types of assembly utilized: TAB or COG. The assembly type depends on the application of the panel and is determined by our customers.
 

Wafer Fabrication:    Based on our design, the foundry provides us with fabricated wafers. Each fabricated wafer contains many chips, each known as a die.
 
Gold Bumping:    After the wafers are fabricated, they are delivered to gold bumping houses where gold bumps are plated on each wafer. The gold bumping process uses thin film metal deposition, photolithography and electrical plating technologies. The gold bumps are plated onto each wafer to connect the die to the processed tape, in the case of TAB package, or the glass, in the case of COG package.
 
Chip Probe Testing:    Each individual die is electrically tested, or probed, for defects. Dies that fail this test are discarded.
 
Assembly and Testing:    Our display drivers use two types of assembly technology: TAB or COG. Display drivers for large-sized applications typically require TAB package types and to a lesser extent COG package types, whereas display drivers for mobile handsets and consumer electronics products typically require COG package types.
 
TAB Assembly
 
We use two types of TAB technologies: TCP and COF. TCP and COF packages are both made of processed tape that is typically 35mm or 48mm wide, plated with copper foil and has a circuit formed within it. TCP and COF packages differ, however, in terms of their chip connections. With TCP packages, a hole is punched through the
 
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processed tape in the area of the chip, which is connected to a flying lead made of copper. In contrast, with COF packages, the lead is mounted directly on the processed tape and there is no flying lead.
 
·  
Inner-Lead Bonding:    The TCP and COF assembly process involves grinding the bumped wafers into their required thickness and cutting the wafers into individual dies, or chips. An inner lead bonder machine connects the chip to the printed circuit processed tape and the package is sealed with resin at high temperatures.
 
·  
Final Testing:    The assembled display drivers are tested to ensure that they meet performance specifications. Testing takes place on specialized equipment using software customized for each product.
 
COG Assembly
 
COG assembly connects display drivers directly to LCD panels without the need for processed tape. COG assembly involves grinding the tested wafers into their required thickness and cutting the wafers into individual dies, or chips. Each individual die is picked and placed into a chip tray and is then visually or auto-inspected for defects. The dies are packed within a tray in an aluminum bag after completion of the inspection process.
 
Quality Assurance
 
We maintain a comprehensive quality assurance system. Using a variety of methods from conducting rigorous simulations during the circuit design process to evaluating supplier performance at various stages of our products’ manufacturing process, we seek to bring about improvements and achieve customer satisfaction. In addition to monitoring customer satisfaction through regular reviews, we implement extensive supplier quality controls so that the products we outsource achieve our high standards. Prior to engaging a third party as our supplier, we perform a series of audits on their operations, and upon engagement, we hold frequent quality assurance meetings with our suppliers to evaluate such factors as product quality, production costs, technological sophistication and timely delivery.
 
In November 2002, we received ISO 9001:2000 certification which was renewed in February 2008 and will expire in February 2011. In February 2006, we received ISO 14001 certification which was renewed in March 2008 and will expire in 2009. In addition, in March 2007, we received IECQ QC 080000 and OHSAS 18001 certifications which will expire in 2010.
 
Semiconductor Manufacturing Service Providers and Suppliers
 
Through our relationships with leading foundries, assembly, gold bumping and testing houses and processed tape suppliers, we believe we have established a supply chain that enables us to deliver high-quality products to our customers in a timely manner.
 
Access to semiconductor manufacturing service providers is critical as display drivers require high-voltage CMOS process technology and specialized assembly and testing services, all of which are different from industry standards. We have historically obtained our foundry services from TSMC and Vanguard and have also recently established relationships with Macronix, Lite-on, Chartered, UMC, Maxchip and Silicon. These are among a select number of semiconductor manufacturers that provide high-voltage CMOS process technology required for manufacturing display drivers. We engage assembly and testing houses that specialize in TAB and COG packages such as Chipbond Technology Corporation, ChipMOS Technologies Inc., International Semiconductor Technology Ltd., and Siliconware Precision Industries Co., Ltd.
 
We plan to strengthen our relationships with our existing semiconductor manufacturing service providers and diversify our network of such service providers in order to ensure access to sufficient cost-competitive and high-quality manufacturing capacity. We are selective in our choice of semiconductor manufacturing service providers. It takes a substantial amount of time to qualify alternative foundries, gold bumping, assembly and testing houses for production. As a result, we expect that we will continue to rely on limited number of semiconductor manufacturing service providers for a substantial portion of our manufacturing requirements in the near future.
 
The table below sets forth (in alphabetical order) our principal semiconductor manufacturing service providers and suppliers:
 
36

 
 
Wafer Fabrication
 
Gold Bumping
Chartered Semiconductor Manufacturing Ltd.
Chipbond Technology Corporation
Lite-on Semiconductor Corp.
ChipMOS Technologies Inc.
Macronix International Co., Ltd.
International Semiconductor Technology Ltd.
Maxchip Electronics Corp. (which was spun off from Powerchip Semiconductor Corp. on April 1, 2008)
Siliconware Precision Industries Co., Ltd.
Silicon Manufacturing Partners Pte Ltd.
 
Taiwan Semiconductor Manufacturing Company Ltd.
 
United Microelectronics Corporation
 
Vanguard International Semiconductor Corporation
 
   


 
Processed Tape for TAB Packaging
 
Assembly and Testing
Hitachi Cable Asia, Ltd. Taipei Branch
Chipbond Technology Corporation
Mitsui Micro Circuits Taiwan Co., Ltd.
ChipMOS Technologies Inc.
Samsung Techwin Co., Ltd.
International Semiconductor Technology Ltd.
Simpal Electronics Co. Ltd.
Siliconware Precision Industries Co., Ltd.
Sumitomo Metal Mining Package Material Co., Ltd.
 


 
Chip Probe Testing
 
Ardentec Corporation
 
Chipbond Technology Corporation
 
ChipMOS Technologies Inc.
 
International Semiconductor Technology Ltd.
 
King Yuan Electronics Co., Ltd.
 
Siliconware Precision Industries Co., Ltd.
 

Intellectual Property
 
As of December 31, 2007, we held a total of 231 patents, including 134 in Taiwan, 66 in the United States, 16 in China, 11 in Korea and 4 in Japan. The expiration dates of our patents range from 2019 to 2027. We also have a total of 353 pending patent applications in Taiwan, 364 in the United States and 208 in other jurisdictions, including the PRC, Japan, Korea and Europe. In addition, we have registered “Himax” and our logo as a trademark and service mark in Taiwan, China and Japan and the United States.
 
Competition
 
The markets for our products are, in general, intensely competitive, characterized by continuous technological change, evolving industry standards, and declining average selling prices. We believe key factors that differentiate among the competition in our industry include:
 
·  
customer relations;
 
·  
product performance;
 
·  
design customization;
 
·  
development time;
 
·  
product integration;
 
·  
technical services;
 
·  
manufacturing costs;
 
·  
supply chain management;
 
37

 
·  
economies of scale; and
 
·  
broad product portfolio.
 
We continually face intense competition from other fabless display driver companies, including Cheertek Incorporation, DenMOS Technology Inc., Fitipower Integrated Technology, Inc., Ili Technology Corp., Leadis Technology, Inc., Novatek Microelectronics Corp., Ltd., Orise Technology Co., Ltd., Raydium Semiconductor Corporation, Sitronix Technology Co., Ltd., SmartASIC Technology, Inc. and Solomon Systech Limited. We also face competition from integrated device manufacturers, such as MagnaChip Semiconductor Ltd., Matsushita Electric Works, Ltd., NEC Electronics Corporation, Oki Electric Industry Co. Ltd., Renesas Technology Corp., Seiko Epson Corporation and Toshiba Corporation, and panel manufacturers with in-house semiconductor design capabilities, such as Samsung Electronics Co., Ltd. and Sharp Corporation. The latter are both our competitors and customers.
 
Many of our competitors, some of which are affiliated or have established relationships with other panel manufacturers, have longer operating histories, greater brand recognition and significantly greater financial, manufacturing, technological, sales and marketing, human and other resources than we do. Additionally, we expect that as the flat panel semiconductor industry expands, more companies may enter and compete in our markets.
 
Our television semiconductor solutions compete against solutions offered by a significant number of semiconductor companies including Advanced Micro Devices, Inc., Broadcom Corporation, Huaya Microelecronics Inc., Mediatek Corp., Micronas Semiconductor Holding AG, MStar Semiconductor, Inc., Novatek Microelectronics Corp., NXP Semiconductor, Pixelworks Inc., Realtek Semiconductor Corp., STMicroelectronics, Sunplus Technology Co., Trident Microsystems, Inc. and Zoran Corporation, among others, some of which focus solely on video processors or digital TV solutions and others that offer a more diversified portfolio.
 
For LCOS products, we face competition primarily from Sony Corporation, Victor Company of Japan, Limited, also known as JVC, Displaytech Inc., Texas Instruments Incorporateds digital light processing technology-based products and Microvision, Inc.s laser-based products in mini-projectors and mobile-projectors.
 
Insurance
 
We maintain insurance policies on our buildings, equipment and inventories covering property damage and damage due to, among other events, fires, typhoons, earthquakes and floods. We maintain these insurance policies on our facilities and on inland transit of inventories. Additionally, we maintain director and officer liability insurance. We do not have insurance for business interruptions, nor do we have key person insurance.
 
Environmental Matters
 
The business of semiconductor design does not cause any significant pollution. Himax Display maintains a facility for our LCOS products where we have taken the necessary steps to obtain the appropriate permits and believe that we are in compliance with the existing environmental laws and regulations in the ROC. We have entered into various agreements with certain customers whereby we have agreed to indemnify them, and in certain cases, their customers, for any claims made against them for hazardous material violations that are found in our products.
 
4.C. Organizational Structure
 
The following chart sets forth our corporate structure and ownership interest in each of our principal operating subsidiaries and affiliates as of June 1, 2008.
 
38

 


39

 
The following table sets forth summary information for our subsidiaries as of June 1, 2008.
 
 
Subsidiary
 
 
Main Activities
 
 
Jurisdiction of
Incorporation
 
 
Total Paid-in
Capital
 
 
Percentage of
Our Ownership
Interest
           
$ (in millions)
   
 
Himax Technologies Limited
 
IC design and sales
 
ROC
 
81.9
 
100%
 
Himax Technologies Anyang Limited
 
Sales
 
South Korea
 
  0.5
 
100%
 
Wisepal Technologies, Inc.
 
IC design and sales
 
ROC
 
  9.9
 
100%
 
Himax Technologies (Samoa), Inc.
 
Investments
 
Samoa
 
  2.5
 
100%(1)
 
Himax Technologies (Suzhou) Co., Ltd.
 
Sales
 
PRC
 
  1.0
 
100%(1)
 
Himax Technologies (Shenzhen) Co., Ltd.
 
Sales
 
PRC
 
  1.5
 
100%(1)
 
Himax Display, Inc.
 
IC design, manufacturing and sales
 
ROC
 
23.2
 
  88.1%
 
Integrated Microdisplays Limited
 
IC design and sales
 
Hong Kong
 
  1.1
 
100%(2)
 
Himax Analogic, Inc.
 
IC design and sales
 
ROC
 
11.2
 
  73.7%
 
Himax Imaging, Inc.
 
Investments
 
Cayman Islands
 
  9.5
 
100%
 
Himax Imaging Ltd.
 
IC design and sales
 
ROC
 
  2.1
 
100%
 
Himax Imaging Corp.
 
IC design and sales
 
California, USA
 
  4.3
 
100%
 
Argo Limited
 
Investments
 
Cayman Islands
 
  9.0
 
100%
 
Tellus Limited
 
Investments
 
Cayman Islands
 
  9.0
 
100%
 
Himax Media Solutions, Inc.
 
 
TFT-LCD television and monitor chipset operations
 
ROC
 
34.2
 
  80.1%(3)

 

(1) Indirectly, through our 100% ownership of Himax Technologies Limited.
 
(2) Indirectly, through our 88.1% ownership of Himax Display, Inc.
 
(3) Directly and indirectly, through our 100% ownership of Himax Technologies Limited which holds 36.2%.

4.D. Property, Plants and Equipment
 
In October 2006, we completed construction on and relocated our corporate headquarters to a 22,172 square meter facility within the Tree Valley Industrial Park in Tainan, Taiwan. The facility houses our research and development, engineering, sales and marketing, operations and general administrative staff. Construction for our new headquarters commenced in the fourth quarter of 2005 and was completed in the fourth quarter of 2006. The total costs amounted to approximately $25.8 million, of which approximately $10.2 million was for the land and approximately $15.6 million was for the construction of the building and related facilities (which included architect fees, general contractor fees,
 
40

 
building materials, the purchase and installation of network, clean room, and office equipment and other fixtures). We also lease office space in Taipei and Hsinchu, Taiwan; Suzhou, Shenzhen, Foshan, Beijing, Shanghai and Ningbo, China; Yokohama and Matsusaka, Japan; Anyangsi Kyungkido, South Korea; and Irvine, California, USA. The lease contracts may be renewed upon expiration. Himax Display, our subsidiary, owns and operates a fab with 3,040 square meters of floor space in a building leased from CMO.
 
ITEM 4A.  UNRESOLVED STAFF COMMENTS
 
Not applicable.
 
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
 
5.A. Operating Results
 
Overview
 
We design, develop and market semiconductors that are critical components of flat panel displays. Our principal products are display drivers used in desktop monitors, notebook computers, televisions, mobile handsets and consumer electronics products such as digital cameras, mobile gaming devices and car navigation displays. We also offer display drivers for panels utilizing OLED technology and LTPS technology. We have also expanded our product offerings to include TFT-LCD television and monitor chipsets, as well as LCOS products and power management ICs. We primarily sell our display drivers to TFT-LCD panel manufacturers and mobile device module manufacturers, and we sell our television semiconductor solutions to television makers.
 
We commenced operations through our predecessor, Himax Taiwan, in June 2001. We must, among other things, continue to expand and diversify our customer base, broaden our product portfolio, achieve additional design wins and manage our costs to partially mitigate declining average selling prices in order to maintain our profitability. Moreover, we must continue to address the challenges of being a growing technology company, including hiring and retaining managerial, engineering, operational and financial personnel and implementing and improving our existing administrative, financial and operations systems.
 
We are a fabless semiconductor company. We leverage our experience and engineering expertise to design high-performance semiconductors and rely on third-party semiconductor manufacturing service providers for wafer fabrication, gold bumping, assembly and testing. We are able to take advantage of the economies of scale and the specialization of such semiconductor manufacturing service providers. Our fabless model enables us to capture certain financial and operational benefits, including reduced manufacturing personnel, capital expenditures, fixed assets and fixed costs. It also gives us the flexibility to use the technology and service providers that are the most suitable for any given product.
 
As our semiconductors are critical components of flat panel displays, our industry is closely linked to the trends and developments of the flat panel display industry, in particular, the TFT-LCD panel segment. Substantially all of our revenues in 2007 were derived from sales of display drivers that were eventually incorporated into TFT-LCD panels. We expect display drivers for TFT-LCD panels to continue to be our primary products. The TFT-LCD panel industry is intensely competitive and is vulnerable to cyclical market conditions. The average selling prices of TFT-LCD panels could decline for numerous reasons, including the following: a surge in manufacturing capacity due to the ramping up of new fabrication facilities; manufacturers operating at high levels of capacity utilization in order to reduce fixed costs per panel; and lower-than-expected demand for end-use products that incorporate TFT-LCD panels. An oversupply of large-sized TFT-LCD panels in 2006, resulted in downward pricing pressure on TFT-LCD panel manufacturers which, in turn, resulted in similar downward pricing pressure on us. We could not sufficiently reduce costs to completely offset such downward pricing pressure, and cannot assure you that we will be able to reduce costs to offset such downward pricing pressure in the future. Moreover, during periods of declining average selling prices for TFT-LCD panels, TFT-LCD panel manufacturers may decrease capacity utilization and sell fewer panels, which could depress demand for our display drivers. As a result, the cyclicality of the TFT-LCD panel industry could adversely affect our revenues, cost of revenues and results of operations.
 
Factors Affecting Our Performance
 
Our business, financial position and results of operations, as well as the period-to-period comparability of our financial results, are significantly affected by a number of factors, some of which are beyond our control, including:
 
 
·  
average selling prices;
 
·  
unit shipments;
 
·  
product mix;
 
·  
design wins;
 
·  
cost of revenues and cost reductions;
 
·  
supply chain management;
 
·  
share-based compensation expenses; and
 
·  
signing bonuses.
 
Average Selling Prices
 
Our performance is affected by the selling prices of each of our products. We price our products based on several factors, including manufacturing costs, life cycle stage of the product, competition, technical complexity of the product, size of the purchase order and our relationship with the customer. We typically are able to charge the highest price for a product when it is first introduced. Although from time to time we are able to raise our selling prices during times of supply constraints, our average selling prices typically decline over a products life cycle, which may be offset by changes in conditions in the semiconductor industry such as constraints in foundry capacity. The general trend in the semiconductor industry is for the average selling prices of semiconductors to decline over a products life cycle due to competition, production efficiencies, emergence of substitutes and technological obsolescence. Our cost reduction efforts also contribute to this decline in average selling prices. See “—Cost of Revenues and Cost Reductions.” Our average selling prices are also affected by the cyclicality of the TFT-LCD panel industry. There have been industry reports of a possible oversupply of TFT-LCD panels starting from the fourth quarter of 2008. Any downward pricing pressure on TFT-LCD panel manufacturers could result in similar downward pricing pressure on us. During periods of declining average selling prices for TFT-LCD panels, TFT-LCD panel manufacturers may also decrease capacity utilization and sell fewer panels, which could depress demand for our display drivers. Our average selling prices are also affected by the packaging type our customers choose as well as the level of product integration. However, the impact of declining average selling prices on our profitability can be offset or mitigated to a certain extent by increased volume, as lower prices may stimulate demand and thereby drive sales.
 
Unit Shipments
 
Our performance is also affected by the number of semiconductors we ship, or unit shipments. As our display drivers are critical components of flat panel displays, our unit shipments depend on our customers’ panel shipments. Our unit shipments have grown significantly since our inception primarily as a result of our increased market share with certain major customers and their increased shipments of large-sized panels. We have also continued to expand our customer base. Our growth in unit shipments also reflected the significant growth in the display driver market, as the demand for display drivers grew significantly in recent years reflecting the strong demand for TFT-LCD panels.
 
Product Mix
 
The proportion of our revenues that is generated from the sale of different product types, also referred to as product mix, also affects our average selling prices, revenues and profitability. Our products vary depending on, among other things, the number of output channels, the level of integration and the package type. Variations in each of these specifications could affect the average selling prices of such products. For example, the trend for display drivers for use in large-sized panels is towards products with a higher number of channels, which typically command higher average selling prices than traditional products with a lower number of channels. However, panels that use higher-channel display drivers typically require fewer display drivers per panel. As a result, our profitability will be affected adversely to the extent that the decrease in the number of display drivers required for each panel is not offset by increased total unit shipments and/or higher average selling prices for display drivers with a higher number of channels. The level of integration of our display drivers also affects average selling prices, as more highly integrated chips typically have higher selling prices. Additionally, average selling prices are affected by changes in the package types used by our customers. For example, the chip-on-glass package type typically has lower material costs because no processed tape is required.
 
 
 
Design Wins
 
Achieving design wins is important to our business, and it affects our unit shipments. Design wins occur when a customer incorporates our products into their product designs. There are numerous opportunities for design wins, including when panel manufacturers:
 
·  
introduce new models to improve the cost and/or performance of their existing products or to expand their product portfolio;
 
·  
establish new fabs and seek to qualify existing or new components suppliers; and
 
·  
replace existing display driver companies due to cost or performance reasons.
 
Design wins are not binding commitments by customers to purchase our products. However, we believe that achieving design wins is an important performance indicator. Our customers typically devote substantial time and resources to designing their products as well as qualifying their component suppliers and their products. Once our products have been designed into a system, the customer may be reluctant to change its component suppliers due to the significant costs and time associated with qualifying a new supplier or a replacement component. Therefore, we strive to work closely with current and prospective customers in order to anticipate their requirements and product road maps and achieve additional design wins.
 
Cost of Revenues and Cost Reductions
 
We strive to control our cost of revenues. Our cost of revenues as a percentage of total revenues for 2005, 2006 and 2007 were 77.6%, 80.8% and 78.0%, respectively. For the year ended December 31, 2007, as a percentage of Himax Taiwan’s total manufacturing costs, the cost of wafer fabrication was 49.9%, the cost of processed tape was 21.6%, and the cost of assembly and testing was 26.8%. As a result, our ability to manage our wafer fabrication costs, costs for processed tape and assembly and testing costs is critical to our performance. In addition, to mitigate declining average selling prices, we aim to reduce unit costs by, among other things:
 
·  
improving product design (e.g., having smaller die size allows for a larger number of dies on each wafer, thereby reducing the cost of each die);
 
·  
improving manufacturing yields through our close collaboration with our semiconductor manufacturing service providers; and
 
·  
achieving better pricing from semiconductor manufacturing service providers and suppliers, reflecting our ability to leverage our scale, volume requirements and close relationships as well as our strategy of sourcing from multiple service providers and suppliers.
 
Supply Chain Management
 
Due to the competitive nature of the flat panel display industry and our customers’ need to maintain high capacity utilization in order to reduce unit costs per panel, any delays in the delivery of our products could significantly disrupt our customers’ operations. To deliver our products on a timely basis and meet the quality standards and technical specifications our customers require, we must have assurances of high-quality capacity from our semiconductor manufacturing service providers. We therefore strive to manage our supply chain by maintaining close relationships with our key semiconductor manufacturing service providers and strive to provide credible forecasts of capacity demand. Any disruption to our supply chain could adversely affect our performance and could result in a loss of customers as well as potentially damage our reputation.
 
Share-Based Compensation Expenses
 
Our results of operations have been affected by, and we expect our results of operations to continue to be affected by, our share-based compensation expenses. Our share-based compensation expenses include charges taken relating to grants of (i) nonvested shares to employees, (ii) treasury shares to employees and (iii) shares to non-employees. We have since discontinued our practice of the above-mentioned share-based compensation.
 
 
We adopted a long-term incentive plan in October 2005 which permits the grant of options or RSUs to our employees and non-employees where each unit represents one ordinary share. The actual awards will be determined by our compensation committee. We recorded share-based compensation expenses under the long-term incentive plan totaling $2.8 million, $14.5 million and $20.1 million in 2005, 2006 and 2007, respectively. See “—Critical Accounting Policies and Estimates—Share-Based Compensation Expenses.” Of the total share-based compensation expenses recognized, $0, $0 and $14.4 million in 2005, 2006 and 2007, respectively, were settled in cash. We have applied SFAS No. 123 (revised 2004), Share-Based Payment, or SFAS No. 123R, to account for our share-based compensation plans. SFAS No. 123R requires companies to measure and recognize compensation expense for all share-based payments at fair value.
 
Set forth below is a summary of our historical share-based compensation plans as reflected in our consolidated financial statements.
 
Nonvested Shares Issued to Employees. In June 2001, November 2001 and January 2002, Himax Taiwan granted nonvested shares of common shares to certain employees for their future service. The shares vest five years after the grant date. Employees leaving Himax Taiwan before completing the five-year service period would be required to sell these shares back to Himax Taiwan at NT$1.00 ($0.03) per share. The forfeiture of such nonvested shares is limited to the original number of shares granted and does not apply to the shares received for stock splits and dividends. Since none of these shares has vested, we did not record a capital increase at the time the shares were issued. Share-based compensation expenses in relation to these nonvested shares are recognized on a straight-line basis over the five-year service period with a corresponding increase to stockholders’ equity. As of December 31, 2006, the total compensation cost related to the actual number of nonvested shares that vested had been fully recognized.
 
Treasury Shares Issued to Employees. In 2002 and 2003, treasury shares were issued to employees with a three-year vesting period. The forfeiture of treasury shares issued to employees is based on the original number of shares granted and does not include the shares received for stock splits and dividends. We recognized the difference between the fair value of these shares and the amount that an employee paid for treasury shares as share-based compensation expenses on a straight-line basis over the three-year service period with a corresponding increase to stockholders’ equity. As of December 31, 2006, the total compensation cost related to the actual number of treasury shares that vest has been fully recognized.
 
Restricted Share Units (RSUs). We adopted a long-term incentive plan in October 2005. We committed to pay a bonus to our employees to settle the accrued bonus payable in respect of their service provided in 2004 and the ten months ended October 31, 2005, which was satisfied through a grant of 990,220 RSUs on December 30, 2005. We accrued share-based compensation expenses of approximately $4.1 million and $3.6 million in 2004 and the ten months ended October 31, 2005, respectively, in connection with this commitment. All RSUs granted to employees as a bonus vested immediately on the grant date. The share-based compensation expenses accrued represents the portion of compensation to employees for their service in 2004 and the ten months ended October 31, 2005 and has been recorded as a liability and compensation expense reflected in our results of operations for 2004 and the ten months ended October 31, 2005, respectively.
 
We made an additional grant of 1,297,564 RSUs to our employees on December 30, 2005. The vesting schedule for this RSU grant is as follows: 25% of the RSU grant vested immediately on the grant date, and a subsequent 25% vested on each of September 30, 2006 and September 26, 2007, with the remainder vesting on September 30, 2008, subject to certain forfeiture events.
 
We also made a grant of 20,000 RSUs to our independent directors on December 30, 2005. The vesting schedule for this RSU grant is as follows: 25% of the RSU grant vested immediately on the grant date, and a subsequent 25% vested on each of June 30, 2006 and 2007, with the remainder vesting on June 30, 2008, subject to certain forfeiture events. No RSUs were granted to our independent directors in 2006 or 2007.
 
We made a grant of 3,798,808 RSUs to our employees on September 29, 2006. The vesting schedule for this RSU grant is as follows: 47.29% of the RSU grant vested immediately on the grant date, and a subsequent 17.57% vested on September 26, 2007, with the remainder vesting equally on each of September 30, 2008 and 2009, subject to certain forfeiture events.
 
We made a grant of 6,694,411 RSUs to our employees on September 26, 2007. The vesting schedule for this RSU grant is as follows: 54.55% of the RSU grant vested immediately and was settled by cash in the amount of $14.4 million on the grant date, with the remainder vesting equally on each of September 30, 2008, 2009 and 2010, which will be settled by our ordinary shares, subject to certain forfeiture events.
 
 
The amount of share-based compensation expense with regard to the RSUs granted to our directors and employees on December 30, 2005 was determined based on an estimated fair value of $8.62 per ordinary share of the ordinary shares underlying the RSUs. The fair value of our ordinary shares was determined based on a third-party valuation conducted by an independent third-party appraiser. The amount of share-based compensation expense with regard to the RSUs granted to our employees on September 29, 2006 and September 26, 2007 was $5.71 and $3.95 per ordinary share, respectively, which was based on the trading price of our ADSs on that day.
 
RSUs issued in connection with the acquisition of Wisepal. We made a grant of 418,440 RSUs to former Wisepal employees in exchange for the unvested stock options held by such employees in Wisepal. Wisepal’s unvested stock option where each RSU represents one of our ordinary shares. The vesting schedule for this RSU grant is as follows: 30% of the RSUs granted vested immediately, and a subsequent 10% vested on September 30, 2007, with the remaining 33% and 27% of the RSU grant vesting on each of September 30, 2008 and 2009, respectively. The vested portion of the RSUs granted was included in the purchase cost of Wisepal while the unvested portion is treated as post-combination compensation expense, the value of which amounted to $0.9 million.
 
Determining the fair value of our ordinary shares prior to our initial public offering requires making complex and subjective judgments regarding projected financial and operating results, our business risks, the liquidity of our shares and our operating history and prospects. We used the discounted cash flow approach in conjunction with the market value approach by assigning a different weight to each of the approaches to estimate the value of the Company when the RSUs were granted. The discounted cash flow approach involves applying appropriate discount rates to estimated cash flows that are based on earnings forecasts. The market value approach incorporates certain assumptions including the market performance of comparable companies as well as our financial results and growth trends to derive our total equity value. The assumptions used in deriving the fair value are consistent with our business plan. These assumptions include: no material changes in the existing political, legal, fiscal and economic conditions in Taiwan; our ability to retain competent management, key personnel and technical staff to support our ongoing operation; and no material deviation in industry trends and market conditions from economic forecasts. These assumptions are inherently uncertain. The risks associated with achieving our forecasts were assessed in selecting the appropriate discount rate. If a different discount rate were used, the valuation and the amount of share-based compensation would have been different because the fair value of the underlying ordinary shares for the RSUs granted would be different.
 
Signing Bonuses
 
To complement our share-based compensation scheme, Himax Taiwan adopted a signing bonus system for newly recruited employees in the second half of 2006.
 
Employees are entitled to receive signing bonuses upon (i) the expiration of their probationary period and a satisfactory review by their supervisor, and (ii) execution of a formal “retention and signing bonus agreement.” If an employee leaves within 18 months (for any reason at all) of having commenced employment with Himax Taiwan, 100% of the signing bonus will be returned. If an employee leaves after 18 months but prior to 36 months after commencing employment with Himax Taiwan, 50% of the signing bonus will be returned.
 
We believe that under such a system, we will be better able to retain our employees. The system is applicable to all newly recruited employees irrespective of their function or position and is based on a prescribed formula.
 
For the years ended December 31, 2006 and 2007, Himax Taiwan paid $3.4 million and $2.6 million, respectively, in signing bonuses which was charged to earnings. Besides Himax Taiwan, signing bonuses were adopted by four subsidiaries in 2007 and a total of $0.6 million was paid to certain employees of our subsidiaries.
 
Description of Certain Statements of Income Line Items
 
Revenues
 
We generate revenues primarily from sales of our display drivers. We have achieved significant revenue growth since our inception, primarily due to a significant increase in unit shipments, partially offset by the general trend of declining average selling prices of our products. Historically, we have generated revenues from sales of display drivers for large-sized applications, display drivers for mobile handsets and display drivers for consumer electronics products. In addition, our product portfolio includes operational amplifiers, timing controllers, TFT-LCD, television and monitor chipsets, LCOS products for near-to-eye applications and mini-projectors, and power management ICs.
 
 
The following table sets forth, for the periods indicated, our revenues by amount and our revenues as a percentage of revenues by each product line:
 
   
Year Ended December 31,
 
   
2005
   
2006
   
2007
 
   
Amount
   
Percentage of
Revenues
   
Amount
   
Percentage of
Revenues
   
Amount
   
Percentage of
Revenues
 
   
(in thousands, except percentages)
 
Display drivers for large-sized applications
  $ 470,631       87.1 %   $ 645,513       86.7 %   $ 752,196       81.9 %
Display drivers for mobile handsets applications
    31,123       5.8       52,160       7.0       75,704       8.2  
Display drivers for consumer electronics applications
    18,571       3.4       28,616       3.8       66,634       7.3  
Others(1)
    19,879       3.7       18,229       2.5       23,677       2.6  
Total
  $ 540,204       100.0 %   $ 744,518       100.0 %   $ 918,211       100.0 %


Note:
(1)
Includes, among other things, operational amplifiers, timing controllers, TFT-LCD television and monitor chipsets, and LCOS products for near-to-eye applications and mini-projectors, and power management ICs.
 
A limited number of customers account for substantially all our revenues. We are seeking to diversify our customer base and to reduce our reliance on any one customer. We began recognizing revenues from the sale of display drivers to CPT and its affiliates in 2002 and began volume shipments to CPT and its affiliates in 2003. Accordingly, the percentage of our revenues generated by sales to CMO and its affiliates has decreased gradually since 2002, with the exception of 2007, when sales to CMO and its affiliates increased due to CMO’s capacity expansion, which was higher than the industry average. The table below sets forth, for the periods indicated, our revenues generated from our most significant customers (including their respective affiliates) and such revenues as a percentage of our total revenues:
 
   
Year Ended December 31,
 
   
2005
   
2006
   
2007
 
   
Amount
   
Percentage of
Revenues
   
Amount
   
Percentage of
Revenues
   
Amount
   
Percentage of
Revenues
 
CMO and its affiliates
  $ 318,008       58.9 %   $ 409,697       55.0 %   $ 539,737       58.8 %
CPT and its affiliates
    87,534       16.2 %     92,561       12.4 %     66,694       7.3 %
SVA-NEC
    30,360       5.6 %     54,272       7.3 %     76,774       8.4 %
Others
    104,302       19.3 %     187,988       25.3 %     235,006       25.5 %
Total
  $ 540,204       100.0 %   $ 744,518       100.0 %   $ 918,211       100.0 %

The global TFT-LCD panel market is highly concentrated, with only a limited number of TFT-LCD panel manufacturers producing large-sized TFT-LCD panels in high volumes. We sell large-sized panel display drivers to many of these TFT-LCD panel manufacturers. Our revenues, therefore, will depend on our ability to capture an increasingly larger percentage of each panel manufacturer’s display driver requirements.
 
We derive substantially all of our revenues from sales to Asia-based customers whose end products are sold worldwide. In 2005, 2006 and 2007, approximately 89.4%, 81.4% and 85.5% of our revenues, respectively, were from customers headquartered in Taiwan. We believe that substantially all of our revenues will continue to be from customers located in Asia, where almost all of the TFT-LCD panel manufacturers and mobile device module manufacturers are located. As a result of the regional customer concentration, we expect to continue to be particularly subject to economic and political events and other developments that affect our customers in Asia. A substantial majority of our sales invoices are denominated in U.S. dollars.
 

Costs and Expenses
 
Our costs and expenses consist of cost of revenues, research and development expenses, general and administrative expenses, sales and marketing expenses and share-based compensation expenses.
 
Cost of Revenues
 
The principal items of our cost of revenues are:
 
·  
cost of wafer fabrication;
 
·  
cost of processed tape used in TAB packaging;
 
·  
cost of gold bumping, assembly and testing; and
 
·  
other costs and expenses.
 
We outsource the manufacturing of our semiconductors and semiconductor solutions to semiconductor manufacturing service providers. The costs of wafer fabrication, gold bumping, assembly and testing depend on the availability of capacity and demand for such services. The wafer fabrication industry, in particular, is highly cyclical, resulting in fluctuations in the price of processed wafers depending on the available foundry capacity and the demand for foundry services.
 
Research and Development Expenses
 
Research and development expenses consist primarily of research and development employee salaries, including signing bonuses and related employee welfare costs, costs associated with prototype wafers, processed tape, mask and tooling sets, depreciation on research and development equipment and acquisition-related charges. We believe that we will need to continue to spend a significant amount on research and development in order to remain competitive. We expect to continue increasing our spending on research and development in absolute dollar amounts in the future as we continue to increase our research and development headcount and associated costs to pursue additional product development opportunities.
 
General and Administrative Expenses
 
General and administrative expenses consist primarily of salaries of general and administrative employees, including signing bonuses and related employee welfare costs, depreciation on buildings, office furniture and equipment, rent and professional fees. We anticipate that our general and administrative expenses will increase in absolute dollar amounts as we expand our operations, hire additional administrative personnel, incur depreciation expenses in connection with our headquarters at the Tree Valley Industrial Park, and incur additional compliance costs required of a publicly listed company in the United States.
 
Sales and Marketing Expenses
 
Our sales and marketing expenses consist primarily of salaries of sales and marketing employees, including signing bonuses and related employee welfare costs, travel expenses and product sample costs. We expect that our sales and marketing expenses will increase in absolute dollar amounts over the next several years. However, we believe that as we continue to achieve greater economies of scale and operating efficiencies, our sales and marketing expenses may decline over time as a percentage of our revenues.
 
Share-Based Compensation Expenses
 
Our share-based compensation expenses consist of various forms of share-based compensation that we have historically issued to our employees and consultants, as well as share-based compensation issued to employees, directors and service providers under our 2005 long-term incentive plan. We allocate such share-based compensation expenses to the applicable cost of revenues and expense categories as related services are performed. See note 15 to our consolidated financial statements. Historically our share-based compensation practice comprised grants of (i) bonus shares to employees, (ii) nonvested shares to employees, (iii) treasury shares to employees and (iv) shares to non-employees. We committed to pay a bonus to our employees in respect of their services provided in 2004 and the ten months ended October 31, 2005, which was satisfied through a grant of RSUs on December 30, 2005. We accrued
 
 
share-based compensation expenses of approximately $4.1 million and $3.6 million in 2004 and the ten months ended October 31, 2005, respectively, in connection with this commitment. We also adopted a long-term incentive plan in October 2005 which permits the grant of options or RSUs to our employees, directors and service providers. We granted additional RSUs on December 30, 2005 to our employees and directors and again on September 29, 2006 and September 26, 2007 to our employees. Share-based compensation expenses recorded under the long-term incentive plan totaled $2.8 million, $14.5 million and $20.1 million in 2005, 2006 and 2007, respectively. See “—Critical Accounting Policies and Estimates—Share-Based Compensation” for further discussion of the accounting of such expenses.
 
Income Taxes
 
Since we and our direct and indirect subsidiaries are incorporated in different jurisdictions, we file separate income tax returns. Under the current laws of the Cayman Islands, we are not subject to income or capital gains tax. Additionally, dividend payments made by us are not subject to withholding tax in the Cayman Islands. We recognize income taxes at the applicable statutory rates in accordance with the jurisdictions where our subsidiaries are located and as adjusted for certain items including accumulated losses carried forward, non-deductible expenses, research and development tax credits, certain tax holidays, as well as changes in our deferred tax assets and liabilities.
 
ROC tax regulations require our ROC subsidiaries to pay an additional 10% tax on unappropriated earnings. ROC law offers preferential tax treatments to industries that are encouraged by the ROC government. The ROC Statute for Upgrading Industries entitles companies to tax credits for expenses relating to qualifying research and development and personnel training expenses and purchases of qualifying machinery. This tax credit may be applied within a five-year period. The amount from the tax credit that may be applied in any year (with the exception of the final year when the remainder of the tax credit may be applied without limitation to the total amount of the income tax payable) is limited to 50% of the income tax payable for that year. Under the ROC Statute for Upgrading Industries, Himax Taiwan, Wisepal, Himax Display, Himax Analogic, Himax Media Solutions and Himax Imaging were granted tax credits by the ROC Ministry of Finance at rates set at a certain percentage of the amount utilized in qualifying research and development and personnel training expenses. The balance of unused investment tax credits totaled $9.4 million, $19.4 million and $32.7 million as of December 31, 2005, 2006 and 2007, respectively. In addition, the ROC Statute for Upgrading Industries provides to companies deemed to be operating in important or strategic industries a five-year tax exemption for income attributable to expanded production capacity or newly developed technologies. Such expanded production capacity or newly developed technologies must be funded in whole or in part from either the initial capital investment made by a company’s shareholders, a subsequent capital increase or a capitalization of a company’s retained earnings. As a result of this statute, income attributable to certain of Himax Taiwan’s expanded production capacity or newly developed technologies is tax exempt for a period of five years, effective on April 1, 2004, January 1, 2006 and January 1, 2008 and expiring on March 31, 2009, December 31, 2010 and December 31, 2012, respectively. If we did not have this tax exemption, net income and basic and diluted earnings per ordinary share would have been $85.6 million, $0.43 and $0.43 for the year ended December 31, 2007, respectively.
 
Critical Accounting Policies and Estimates
 
We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
 
Share-Based Compensation
 
Share-based compensation primarily consists of grants of nonvested or restricted shares of common stock, stock options and RSUs issued to employees. We have applied SFAS No. 123R for our share-based compensation plans for all periods since the incorporation of Himax Taiwan in 2001. The cost of employee services received in exchange for share-based compensation is measured based on the grant-date fair value of the share-based instruments issued. The cost of employee services is equal to the grant-date fair value of shares issued to employees and is recognized in earnings over the service period. Share-based compensation expense estimates also take into account the number of shares awarded that management believes will eventually vest. We adjust our estimate each period to reflect the current estimate of forfeitures. As of December 31, 2007, we based our share-based compensation cost on an assumed forfeiture rate of 11% per annum for awards granted under our long-term incentive plan. If actual forfeitures occur at a lower rate, share-based compensation costs will increase in future periods.
 
When estimating the fair value of our ordinary shares prior to our initial public offering, we reviewed both internal and external sources of information. The sources we used to determine the fair value of the underlying shares at the date of measurement have been subjective in nature and based on, among other factors:
 
·  
our financial condition as of the date of grant;
 
·  
our financial and operating prospects at that time;
 
·  
for certain issuances in 2001 and early 2002, the price of new shares issued to unrelated third parties;
 
·  
for certain issuances in 2002, 2003 and 2004, an independent third-party retrospective analysis of the historical value of our common shares, which utilized both a net asset-based methodology and market and peer group comparables (including average price/earnings, enterprise value/sales, enterprise value/earnings before interest and tax, and enterprise value/earnings before interest, tax, depreciation and amortization); and
 
·  
for our issuance of RSUs in 2005, an independent third-party analysis of the current and future value of our ordinary shares, which utilized both discounted cash flow and market value approaches, using multiples such as price/earnings, forward price/earnings, enterprise value/earnings before interest and tax, and forward enterprise value/earnings before interest and tax.
 
Changes in any of these factors or assumptions could have resulted in different estimates of the fair value of our common shares and the related amounts of share-based compensation.
 
Based on these factors, we estimated the fair value per share of nonvested shares issued to certain employees in June 2001, November 2001, and January 2002 at NT$4.02 ($0.116) per share and the fair value of 596,897 shares (adjusted for stock splits) granted to two consultants in 2002 at $68,000. Similarly, we estimated the fair value per share of employee bonus shares on the date of shareholder approval to be NT$39.44 ($1.15) per share and NT$67.13 ($1.96) per share in 2003 and 2004, respectively. These employee bonus shares were issued in relation to employee services provided in 2001, 2002 and 2003, respectively. We estimated the fair value of treasury shares issued to employees at prices ranging from NT$15.32 ($0.46) per share to NT$19.93 ($0.58) per share in 2002 and NT$20.17 ($0.58) per share to NT$52.10 ($1.54) per share in 2003. We estimated the fair value of the ordinary shares underlying the RSUs granted to our directors and employees at $8.62 per share in 2005. For our issuance of RSUs in 2006 and 2007, the fair value of the ordinary shares underlying the RSUs granted to our employees, was $5.71 and $3.95 per share, respectively, which was the closing price of our ADSs on September 29, 2006 and September 26, 2007, respectively.
 
Allowance for Doubtful Accounts, Sales Returns and Discounts
 
We record a reduction to revenues and accounts receivable by establishing a sales discount and return allowance for estimated sales discounts and product returns at the time revenues are recognized based primarily on historical discount and return rates. However, if sales discount and product returns for a particular fiscal period exceed historical rates, we may determine that additional sales discount and return allowances are required to properly reflect our estimated remaining exposure for sales discounts and product returns. We evaluate our outstanding accounts receivable on a monthly basis for collectibility purposes. In establishing the required allowance, we consider our historical collection experience, current receivable aging and the current trend in the credit quality of our customers. The movement in the allowance for doubtful accounts, sales returns and discounts for the years ended December 31, 2005, 2006 and 2007 is as follows:
 
 
Year
 
Balance at
Beginning
of Year
   
Additions
charged to expense
   
Amounts
Utilized
   
Balance at
End of Year
 
   
(in thousands)
 
December 31, 2005
  $ 240     $ 398     $ (457 )   $ 181  
December 31, 2006
  $ 181     $ 2,843     $ (2,156 )   $ 868  
December 31, 2007
  $ 868     $ 1,705     $ (2,080 )   $ 493  

Inventory
 
Inventories are stated at the lower of cost or market value. Cost is determined using the weighted-average method. For work-in-process and manufactured inventories, cost consists of the cost of raw materials (primarily fabricated wafers and processed tape), direct labor and an appropriate proportion of production overheads. We also write down excess and obsolete inventory to its estimated market value based upon estimations about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional future
 
 
inventory write-downs may be required which could adversely affect our operating results. Once written down, inventories are carried at this lower amount until sold or scrapped. If actual market conditions are more favorable, we may have higher operating income when such products are sold. Sales to date of such products have not had a significant impact on our operating income. The inventory write-downs for the years ended December 31, 2005, 2006 and 2007 was approximately $927,000, $5.2 million and $14.8 million, respectively, and are included in cost of revenues in our consolidated statements of income. The inventory write-down was particularly high in 2007 primarily due to excess inventory issues related to shorter-than-expected product life cycle for certain products and the revision of certain customer forecasts, which also partially contributed to decreased demand as customers shifted to more advanced products.
 
Impairment of Long-Lived Assets
 
We routinely review our long-lived assets that are held and used for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. The determination of recoverability is based on an estimate of undiscounted cash flows expected to result from the use of the asset and its eventual disposition. The estimate of cash flows is based upon, among other things, certain assumptions about expected future operating performance, average selling prices, utilization rates and other factors. If the sum of the undiscounted cash flows (excluding interest) is less than the carrying value, an impairment charge is recognized for the amount that the carrying value of the asset exceeds its fair value, based on the best information available, inc