Himax Technologies, Inc. (NASDAQ: HIMX) Q2 2022 earnings call dated Aug. 11, 2022
Corporate Participants:
Mark Schwalenberg — Director Investor Relations
Eric Li — Chief IR/PR Officer
Jordan Wu — Co-founder, President and Chief Executive Officer
Analysts:
Jerry Su — Credit Suisse — Analyst
Presentation:
Operator
Hello, ladies and gentlemen, and welcome to Himax Technologies, Inc. Second Quarter 2022 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded.
I would now like to turn the conference over to your host, Mr. Mark Schwalenberg from MZ Group. Please go ahead.
Mark Schwalenberg — Director Investor Relations
Thank you. Welcome, everyone, to the Himax second quarter 2022 earnings call. Joining us from the company are Mr. Jordan Wu, President and Chief Executive Officer; Ms. Jessica Pan, Chief Financial Officer; and Mr. Eric Li, Chief IR/PR Officer. After the company’s prepared comments, we have allocated time for questions in a Q&A session.
If you have not yet received a copy of today’s results release, please e-mail himx@mzgroup.us, access the press release on financial portals or download copy from Himax’s website at www.himax.com.tw. Unless otherwise specified, we will discuss our financials based on non-IFRS measures. You can find the related reconciliation to IFRS on our website.
Before we begin the formal remarks, I’d like to remind everyone that some of the statements in this conference call, including statements regarding expected future financial results and industry growth are forward-looking statements that involve a number of risks and uncertainties that could cause actual events or results to differ materially from those described in this conference call. A list of risk factors can be found in the company’s SEC filings, Form 20-F for the year ended December 31, 2021, in the section entitled Risk Factors as may be amended. Except for the company’s full year of 2021 financials, which were provided in the company’s 20-F and filed with the SEC on March 23, 2022.
The financial information included in this conference call is unaudited and consolidated and prepared in accordance with IFRS accounting. Such financial information is generated internally and has not been subjected to the same review and scrutiny, including internal auditing procedures and external audits by an independent auditor to which we subject our annual consolidated financial statements and may vary materially from the audited consolidated financial information for the same period. The company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
I will now turn the call over to Mr. Eric Li. Eric, the floor is yours.
Eric Li — Chief IR/PR Officer
Thank you, Mark. And thank you, everyone, for joining us. My name is Eric Li, Chief IR/PR Officer, at Himax. On today’s call, I will first review Himax’ consolidated financial performance for the second quarter 2022, followed by our third quarter 2022 outlook. Jordan will then give an update on the status of our business, after which we will take questions.
The second quarter presented a challenging business environment, yet we continue to diligently focus on navigating with opticals while positioning ourselves for long-term sustainable growth. Accelerating interest rate hikes to combat rising inflection, ongoing rolling breakdown — lockdowns in China and the Russia-Ukraine War continue to affect business activities and reduce consumer confidence. The gloomy visibility of our end customer led to reduced and shorter forecast, along with the more stringent inventory control across the board from brands to panel houses. We revised our guidance on June 20, 2022, to better reflect these soft conditions.
Our second quarter revenues, gross margin and EPS were all in line with the updated guidance range. Second quarter net revenues of $312.6 million decreased 24.3% sequentially, but were within our updated guidance of a decline of 22% to 27%. Our gross margin came in at 43.6%, a decrease from 47% last quarter, but within our initial guidance of around 43% to 45%. Non-IFRS profit per diluted ADS was $0.439, an upper range of the updated guidance of $0.40 to $0.45.
IFRS profit per diluted ADS was $0.404, at high end of the updated guidance of $0.365 to $0.415 Revenue from large display drivers was $68.6 million in Q2, a decrease of 38% sequentially. TV and notebook IC revenues were down double digits sequentially due to customers’ inventory control on the backdrop of slowing end market sell-through and reduce the business visibility. Monitor IC sales declined sequentially in Q2, but increased more than 100% year-over-year for the six months ended June 30, 2022. Thanks to substantial shipment growth for high-end areas such as [technical issues]
Hello. This is Eric. Hi, Mark. Can you hear us now?
Mark Schwalenberg — Director Investor Relations
Yes.
Jordan Wu — Co-founder, President and Chief Executive Officer
Yes. So there is some interruption in our connectivity, but we are using the smartphones. So, we will carry on. Eric?
Eric Li — Chief IR/PR Officer
So I’ll probably start from the revenue for our large display drivers. So our revenue from the large display driver was $68.6 million in Q2, a decrease of 38% sequentially. TV and notebook IC revenues were down double digits sequentially due to customers inventory control on the backdrop of slowing end market sell-through and reduce the business visibility.
Monitor IC sales declined sequentially in Q2, but increased more than 100% year-over-year for the six months ended June 30, 2022, thanks to substantial shipment growth for high-end area, such as the high-frame rate gaming monitor. Large panel driver IC sales accounted for 22% of total revenues for this quarter compared to 26.8% last quarter and 23.4% a year ago.
Moving on to our small and medium-sized display driver segment. Revenue was $201.6 million, a decline of 22% sequentially. Our automotive business, as was the case in Q1, was once again the largest revenue contributor in the second quarter, representing over 30% of total sales. We expect this upward trend in automotive sales contribution to continue throughout 2022. Meanwhile, for AMOLED business, we successfully piloted the production of our total solution covering DDIC and TCON for the premium tablet for a global leading name as the sole source supplier.
Our AMOLED business in the second quarter accounted for more than 4% of total sales. Small and medium-sized driver IC segment accounted for 64.5% of total sales for the quarter compared to 62.6% in the previous quarter and 63.1% a year ago. The automotive IC sales in Q2 decreased low teens sequentially, but the market was adversely impacted by logistical hurdles brought on by China city lockdowns.
However, on a year-over-year basis, automotive IC sales for the quarter were up almost 100%, thanks to broad design win coverage and better product mix. Our automotive IC sales in the first half were up 130% year-over-year despite macroeconomic headwinds and the supply chain disruption. Second quarter smartphone and tablet revenues both declined double digits sequentially as channel inventory across panel houses, OEMs and end brands remained stubbornly high against the backdrop of continued sluggish demand. Both the smartphone and the tablet driver IC sales represented almost equal sales weighting in the second quarter.
Our e-paper business grew more than 100% sequentially in the second quarter, stemming from increasing demand by a leading customer, along with the catch-up shipments that were delayed last quarter due to logistical disruption from lockdowns in China. Second quarter nondriver revenue was $42.4 million, slightly down from a quarter ago.
Our TCON business was flat sequentially, supported by increasing TCON shipment for automotive, AMOLED for tablet and high-end displays. TCON business represented over 8% of our total sales in the second quarter. Nondriver products in Q2 accounted for 13.5% of total revenues as compared to 10.6% in the previous quarter and 13.5% a year ago. Non-IFRS gross margin for the second quarter was 43.6%, a decrease from 47% of last quarter and 47.5% of the same period last year.
As we previously reported, there were two primary factors that adversely impacted our margin profile. First, price adjustments in support of our nonautomotive customers amidst soft demand worldwide. Second, our cost of goods sold for Q2 reflected the higher foundry prices for the previous quarters. IFRS gross margin was also 43.6% for the quarter. Our non-IFRS operating expenses for the second quarter were $45 million, up 2.1% from the previous quarter and up 14.4% from a quarter ago — from a year ago.
The sequential increase was caused mainly by increased R&D expenses, while year-over-year expenses increased because of higher salary and R&D expenses. IFRS operating expenses were $52.6 million for the second quarter, up 2.1% from the preceding quarter and up 32.9% from a year ago. The higher IFRS figures were mainly due to the tranche of annual bonus compensation, which we award employees at the end of September each year. The 2021 annual bonus compensation, including RSU and cash awards totaled $74.7 million, out of which $24.8 million was immediately vested and recognized in the third quarter of 2021.
The remainder will be equally vested in three tranches the first, second and third anniversary of the grant date. The remaining compensation expenses will be recognized on a straight-line basis over the vesting period of each change. The second quarter non-IFRS operating income was $91.5 million or 29.3% of sales versus 36.3% of sales in the last quarter and 36.8% of sales from a year ago. Non-IFRS after-tax profit was $76.8 million or $0.439 per diluted ADS, decreased from $121.9 million or $0.697 per diluted ADS last quarter.
Turning to the balance sheet. We had $461.6 million of cash, cash equivalents and other financial assets as of June 30, 2022, compared to $270.4 million at the same time last year and $447.1 million a quarter ago. The higher cash balance was mainly from $9.1 million of operating cash inflow during the quarter. And payments received from customers to secure their long-term chip supply. We had $49.5 million of long-term unsecured loans as of end of Q2, of which $6 million was the current portion. It was worth noting that our cash balance at the end of the third quarter will be substantially reduced following the annual cash dividend payout of $217.9 million in July.
The annual dividend of $1.25 per ADS is equivalent to 50% of last year’s net profit. The payout ratio was lower than our historical average, reflecting our decision to reserve cash in the light of macroeconomic uncertainty. Our quarter end inventory as of June 30, 2022, were $337.3 million, up from $253.1 million last quarter and up from $134.2 million a year ago. Our high inventory level reflected the abrupt drop in demand triggered by strict customer inventory control due to sluggish end market demand and reduced visibility, which led to growing customer inventory, particularly in consumer electronics. The halt in demand adversely affected our sales and in turn cost elevated inventory level as our production always begins months in advance.
Accounts receivable at the end of June 30, 2022, was $371 million, down from $442.2 million last quarter, but up from $329 million a year ago. DSO was 93 days at the quarter end as compared to 88 days a year ago and 96 days from last quarter. Second quarter capital expenditures were $2.5 million versus $3.6 million last quarter and $1.4 million a year ago. The second quarter capex was mainly for R&D-related equipment for our IC design business. As of June 30, 2022, Himax has $174.3 million ADS outstanding, unchanged from last quarter. On a fully diluted basis, total number of ADS outstanding for the second quarter was $174.8 million.
Now turning to our third quarter 2022 guidance. We expect third quarter revenue to decrease 35% to 39% sequentially. Non-IFRS gross margin is expected to be around 35.5% to 37.5% depending on final product mix. Non-IFRS profit attributable to shareholders is expected to be in the range of $0.116 to $0.156 per fully diluted ADS. The third quarter IFRS profit attributable to shareholders is estimated to be in the range of $0.2 to $0.42 per fully diluted ADS. Similar to our usual practice, we will grant employees’ annual bonus, including RSU and cash awards on or around September 30 this year.
The third quarter guidance for IFRS profit per diluted ADS has taken into account the expected 2022 annual bonus, which subject to board approval, is now assumed to be around $40 million, out of which $17.6 million or $0.08 per diluted ADS will be vested and expensed immediately on the grant date. As a reminder, the total annual bonus amount and the immediately vested portion are our current best estimates only and the actual amount could vary materially depending on, among other things, our Q4 profit and the final board decision for the total bonus amount and its vesting scheme. As is the case for previous years, we expect the annual bonus grant in 2022 to lead to higher third quarter IFRS operating expenses compared to other quarters of the year.
In comparison, the 2021 annual bonus totaled $74.7 million, out of which $24.8 million was vested immediately. As a side note, regarding the proposal resolution regarding the company’s LTIP, long-term incentive plan, at this year’s Annual General Meeting to be held on August 16, 2022, we’d like to clarify that we proposed is to extend the duration of the company’s existing LTIP for another three years, rather than to initiate a new plan.
As mentioned earlier, we grant an annual bonus, including cash and RSU to employees on or around September 30 every year to award them for their devotion to the company. The existing LTIP, which was initiated in 2011 for a duration of five years and thereafter extended a couple of time at Annual General Meeting in the past few years, will expire again on September 6, 2022. Therefore, unless the plan is extended again this year or a new claim is initiated.
For this year’s annual bonus, we will be able to grant only cash to employees at the end of September and lose RSU as the other means of compensation. We believe RSU is an important incentive for employees to focus on long-term success of the company. As of the end of June this year, among the total number of 20 million authorized ordinary shares of the existing LTIP, 49% have already been granted with the remaining 51% still valid to award our employees if the plan is extended.
I will now turn the call over to Jordan. Jordan, the floor is yours.
Jordan Wu — Co-founder, President and Chief Executive Officer
Thank you, Eric. Several macro level factors continue to present significant headwinds to our business, while also clouding visibility as we enter the second half of the year. Decades-high inflation, rapidly rising interest rates in addition to the ongoing war and potential for more China city lockdowns have caused widespread disruption to demand. Faced with frozen demand, piled-up inventory and eroding panel prices, end brands are downsizing their panel procurement plans. Consequently, panel makers all initiated downward and extended fab utilization adjustments along with rigorous IC inventory cuts.
The sudden halt in demand together with the length of our production lead time has led to elevated inventory level for Q3. While in the midst of this inventory offloading cycle, we are naturally cutting back on new orders with our suppliers. However, the contracts that we entered with foundries and back-end suppliers when the industry experienced unprecedented demand in 2021 may incur charges if the minimum purchase orders are not fulfilled. While the negotiation with suppliers are still ongoing as we seek ways to increase flexibility in executing agreements, such supplier charges have already been factored in for our Q3 guidance and is the predominant factor for the Q3 gross margin contraction. While we are uncertain about when the current business environment could turn it around, we believe our inventory will peak in Q3 as we curtail our new wafer starts and our customers continue to restock after inventory digestion.
On the revenue front, we believe the growth will be restored in Q4, boosted by healthy demand for automotive and tablet segments, where there is better visibility. Yet LDDIC sector is still set to remain sluggish for the remainder of the year. Against the backdrop of challenging market conditions, we expect our Q4 gross margin to be still under pressure because the cost of goods sold still reflects high pricing from previous quarters while inventory offloading could lead to selling price erosion.
However, the sequential decline in Q4 gross margin will likely be modest as there is still solid price support from a few product areas, notably automotive, Tcon, AMOLED and AI image sensing, which altogether now account for more than 40% of our total sales. Our automotive sales, especially, have a high likelihood of a strong fourth quarter rebound from the trough of Q3. From a longer-term perspective, we are very optimistic about our automotive business and continue to look to expand our leading market position.
With that, I will begin with an update on the large panel driver IC business. Our third quarter large display driver IC revenue is projected to decline by double digit sequentially and below what we typically see on a seasonal basis, as customers impose tight inventory control measures to reduce near-term inventory due to continuous deterioration of forecast visibility from their customers. The outlook for large size driver IC business remains soft with moderated TV sell-through and muted Chromebook sales, while monitor customers exercise strict inventory control. Q3 monitor, notebook and TV IC sales are expected to decline double digit, reflecting the overall market softness, reduced our business visibility and destocking pressure from our customers.
Now turning to the small and medium sized display driver IC business. In the third quarter, revenue is expected to decline double digits sequentially. Our Q3 automotive driver IC sales are anticipated to be down double digits sequentially as customers destock inventory accumulated during the second quarter when production was severely disrupted by the widespread city lockdowns in China. However, the extent of the sequential revenue decline for automotive is likely to be less than those suffered by other product areas, while business visibility into Q4 and next year are also much better for our automotive business.
As indicated earlier, despite the Q3 decline, we expect our automotive driver IC sales to see strong business momentum in Q4 with TDDI sales outgrowing those of DDIC. We expect our automotive TDDI business to continue to be a key driver of high-margin growth for Himax for many quarters to come. In the meantime, smartphone and tablet driver IC sales are set to decline double digit, a result of the ongoing deterioration of forecast visibility, as our customers prolong their efforts to reduce inventory amidst the backdrop of soft demand and the weaker macro environment.
Now for a quick update on each of the major sectors in small and medium-sized display driver IC business. First, on the automotive sector, as Eric mentioned earlier, automotive now is our largest revenue contributor, set to represent over 35% of total sales in Q3. We are poised to sustain our leading position and dominant global market share as we offer the most comprehensive automotive product portfolio ranging from traditional DDIC to technologies such as TDDI, local dimming TCON, LTDI and AMOLED.
Additionally, we are the pioneer of mass production for TDDI, a technology that is essential for large-sized interactive, stylish and curved automotive displays. While TDDI is still in early stage of mass deployment for automotive market, it is on track to be a fast-growing segment. We are glad to report that we expect our automotive TDDI to reach a milestone of over 10 million units cumulatively shipped by the end of Q3.
TDDI adoption rate for automotive has been advancing at a rapid pace and our design-win coverage continues to quickly expand with panel makers, Tier 1s and auto brands. Meanwhile, China’s government recently created incentives to stimulate more NEV sales, which may trigger accelerated adoption of higher automotive displays that incorporate in-cell TDDI. While our automotive sales growth for 2022 might be less than previously predicted, the growing reliance on automotive electrification and smart cabin dictates that semiconductor content values are increasing rapidly per vehicle. We’ll be a key beneficiary of these trends and expect to see sustainable growth in the automotive market on top of the already strong 2021 base.
Next, regarding smartphone and tablet businesses, we expect both product lines to decline double digits sequentially as earlier stated. With that said, our shipments for high-end AMOLED tablet where it provides both DDIC and TCON to certain leading brands, are on the rise with momentum expected to last in the foreseeable future. As for smartphone, despite being awarded a growing number of projects by brand customers, much of our shipments to key customers for their next generation new designs that support high-frame rate, ultra slim bezel and high-resolution features have been postponed in the midst of excess inventory for their older models on the backdrop of frozen end market demand.
Turning to the e-paper driver business, another product in our small and medium sized driver lineup. Our e-paper business is expected to decline double digits in quarter-over-quarter due to customers downsizing their annual business plans amidst soft consumer electronics market. As the world continues to transition towards green energy and carbon footprint reduction, we expect long-term demand for e-paper to endure.
Therefore, we continue to collaborate with world-class customers for certain ASIC projects with increased R&D efforts spent on their next generation products toward larger size, higher resolution and colored e-paper displays. We are glad to report that one of our e-paper ASICs in collaboration with E Ink for their latest e-book solution was awarded Best Choice Award of Computex 2022. The ASIC enables fast handwriting speed for e-paper display, while also greatly improving the average latency of the display with reduced power consumption, characteristics that are critical for next-generation e-paper devices.
Next, for an update on AMOLED. We continue to gear up for AMOLED driver IC development jointly with major Korean and Chinese panel makers in various applications. In the third quarter, AMOLED sales are expected to increase more than 50% sequentially with more AMOLED for tablet models commencing mass production this quarter.
Our AMOLED business, including TCON driver is expected to amount to more than 8% of total sales in Q3 and slated for strong growth in the next few years. As a reminder, we provide most AMOLED driver and TCON and are the sole source supplier for a global leading tablet customer. In addition, the number of awarded projects for our flexible AMOLED driver and TCON for automotive is also increasing with worldwide conventional carmakers and NEV vendors.
Finally, we are making good progress with leading panel houses for the development of AMOLED display drivers for smartphone, TV and notebook applications. In light of serious constraints on the capacity for smartphone AMOLED display driver in the next few years, we have secured and continue to vie for more such supply — more capacity for the future.
Now let me share some of the progress we’ve made on the non-driver IC businesses. Starting with an update on timing controller. We anticipate Q3 TCON sales to decline double digits sequentially, pressured by lower shipments for TV, monitor notebook markets. Yet TCON shipment for AMOLED tablet and automotive sectors is set to enjoy decent growth, and we expect these two areas to see accelerating design-in momentum in the coming quarters. Our cutting-edge automotive leading local dimming TCON has won numerous awards and penetrating into OEMs, Tier 1s and carmakers premium new car models with some of which already commencing mass production.
We anticipate more than 50% year-over-year sales growth for automotive TCON, which will represent about 2% of total sales in the third quarter with additional projects slated for bigger volume shipment starting in 2023. For AMOLED tablet TCON, as reported earlier, in the second quarter, we successfully commenced the mass production of our tablet AMOLED solution, including both TCON and driver, to support a leading tablet brand as the sole source supplier in their newly launched tablet model.
Additionally, we are undertaking new design developments, supporting even larger panel sizes with small named customers. We expect to gain traction with more shipments to key customers in upcoming quarters and are optimistic about the long-term potential for our TCON business with secured capacity from our foundry partners in pursuit of sustainable growth. Switching gears to the ultralow-power AI image sensing total solutions, which incorporates Himax’ ultralow-power CMOS image sensor, our proprietary AI processor and CNN-based AI algorithm. On the AI image sensing business for notebook, we continue to support Dell’s production ramp-up in the range of their new models.
In addition, a number of other leading laptop vendors and CPU platform players have also shown interest in our AI total solution in an effort to further broaden use cases for next generation notebooks. In addition to presence, look-away and onlooker detections, we are developing a variety of new context-aware AI features for next-generation smart notebook market. Our AI image sensing solution, featuring ultra-low power tinyML vision AI in a tiny form factor, is a perfect fit for the resource-constrained and battery-powered endpoint applications. The new AI area, which is now ardently explored by AI communities.
Automatic meter reading or AMR is one of our successful showcases to the endpoint AI industry where our AI total solution has been adopted by several Chinese vendors and shipments is slated to begin in the second half of this year after some delay is caused by severe lockdowns in China. We have also kicked off projects jointly with water authorities, utility companies, meter OEM/ODMs and/or IoT network providers from China, Japan, Europe and India over the past few quarters.
Our power-efficient AMR solution can operate with a battery pack for over five years, and it’s easy to install over the existing conventional water meters for real-time water consumption readout and detection of abnormalities such as water leakage. We are also seeing expanding adoption of our tinyML based, endpoint AI solution in new areas such as shared bike parking, capsule endoscope and more broadly in areas of automotive, smart office, smart home, agriculture and environmental conservation. In smart office, we have several projects ongoing with office automation ODMs where our ultra-low power AI solution is used for meeting room human presence detection and people counting with an aim to save energy for lighting and temperature control.
For environmental conservation, we are collaborating with Seeed Studio, Edge impulse and hackster.io, jointly organizing event of IoT into the Wild Contest for Sustainable Planet 2022, aiming to cluster AI experts around the world to tackle different real-world environmental challenges. We are excited by the traction this relatively new AI product line has generated and expect to see increasing sales contribution throughout 2022 and beyond.
Lastly, I’d like to give an update on our optical related product lines covering WLO, LCoS and 3D sensing. Himax continues to work on strengthening our optical-related technologies, at the same time, better positioning ourselves to capture the vast opportunity presented by the future of the metaverse. Equipped with exceptional know-how and years of proven track record for mass production, Himax is playing a key role in enabling next-generation metaverse-related applications. Currently, we have multiple intensive collaborations ongoing with world-leading tech giants who are aggressively investing in this emerging field with a lot of potential.
Now to quickly go over a few recent updates. First, on our LCOS microdisplay. We continue to have steady joint collaboration with leading tech names and OEMs for their next-generation products in AR glasses, where we offer a leading edge front-lit LCOS microdisplay that features lightweight, small form factor and full color with unique characteristics of high illumination and low power consumption, which are critical for the success of future AR glasses. We have received promising feedback thus far and will report more progress in due course.
Moving on to the update for 3D gesture control for human interface sensing. Our WLO technology is deployed into 3D camera to empower 3D perception sensing for precise gesture control, a technology that can be applied to current AR/VR goggles for controller-free gesture recognition. Last for an update on 3D scanning and reconstruction project. Our 3D sensing technology is deployed for customer’s 3D scanning device for the purpose of generating real-time digital twins, avatar and 3D environment surroundings.
The collaboration is still underway, and we expect to begin engineering build from the end of 2022. While the opportunity in optical and metaverse related products is vast, it is still very much in the early innings. We are optimistic about its potential though and continue to work to position our strong optical product portfolio for future growth in the years to come. For non-driver IC business, we expect revenues to decline double digits sequentially in the third quarter.
That concludes my report for this quarter. Thank you for your interest in Himax. We appreciate you joining today’s call, and we are now ready to take questions.
Questions and Answers:
Operator
[Operator Instructions] And our first question comes from Jerry Su from Credit Suisse. Your line is now open.
Jerry Su — Credit Suisse — Analyst
Thank you. Thanks for taking my question. Jordan, I want to ask you about, I think, regarding the LTA and its capacity. I think this has — wafer has been turning less type for most of the [indecipherable]. I think except for the all that related. So what is your current structure of these contracts with new foundries? Are you able to renegotiate for new terms? Or you are pretty much forced to keep the obligation and then perhaps pay some penalties to the foundry suppliers? That’s the first question.
And then, the second question is more regarding the your comments about our fourth quarter for the revenue to rebound. I know you mentioned about automotive and tablet. But can you give us more color about what you think the tablet business by the fourth quarter could see some recovery? Thank you.
Jordan Wu — Co-founder, President and Chief Executive Officer
Thank you, Jerry. Firstly on LTA. That actually — our LTA’s actually cover mostly foundry, but also to some degree again as well. Some are expiring towards the end of the year, but that is a small portion compared to the total. I said in my prepared remarks that we are negotiating indeed I mean everybody — I mean if people are getting better and better picture about the short-term prospect of the market, right? And I mean, there’s no need for me to elaborate. So, I think us and our partners together, we are working to, as I said in our prepared remarks, to hopefully increase the flexibility for execution of those contracts. And so, we are not saying we are going to cancel the agreement or we are going to walk away from the agreement.
Firstly, I mean, certainly, as a company, we need to honor the agreement. And secondly, we feel if you look into a longer-term horizon, time horizon, this contract will still be very important for our long-term growth. So, I think on a mutually understanding world wide basis, we are working to hopefully increase the flexibility for our execution on these contracts. That is because I want to repeat because this is important.
In our Q3 guidance, we have factored in the potential penalties incurred by this agreement where we — our new wave starts would be less than the minimum required according to the agreement. So those have been factored in. And in fact, those charges represent the predominant portion of our Q3 margin construction. So, in short, I guess renegotiating, but we will continue to honor those contracts. And I think hopefully — and if everything goes as planned without any major surprises, I think hopefully, Q4 such charges incurred to us will be less than most of Q3.
For the simple reason that our application is based on wafer starts, right? So, if you look back in Q2, towards the end of Q2, there’s a sudden freeze in market demand. So, everybody was taken by surprise. That’s when we started to push our bricks, right? But that was already too late because all the Q2 new wafer starts will come out in Q3, and that explains why our Q3 inventory will reach the peak. And certainly, we have much reduced the new wafer starts starting from the end of Q2 and also in Q3. And that is one reason, and that is the main reason why the charges out of LTA will peak also in Q3 because our new wafer start will be the minimum.
But in Q4, hopefully — well, as I said, hopefully, there will be some negotiation and certain rules will be rewritten or compromised. And also, after our customers’ decision of inventory hopefully, in Q4, we will be able to selectively start some new wafers. And that certainly in itself will lower the LTA charges. And that’s certainly will very much depend on the outlook of Q1 and with visibility so limited, I really can’t comment too much on next year or even Q1, but that is the plan. And that looks to be the most likely scenario for now.
And your second question is about our Q4 revenue. We are staying there is a good chance of rebound from Q3, especially supported by automotive and tablet. The visibility now appears to be decent for both sectors, although I must say other than our AMOLED or AI and a few like new emerging areas where revenue relatively small, sectors, I must say, for TV, large panel, smartphone, etc., the visibility remains limited. Automotive, there’s the hiccup in Q3, as we said, right. In Q2, there’s a certain widespread severe lockdowns in China. And so, the inventories that our customers took during Q2 and which was supposed to be used in Q2 was unused.
And therefore, they are consuming those inventories during Q3, and that explains our automotive IC shipments in Q3. But again, visibility is creatively strong for automotive, and we believe our customers’ inventory level will be back to normal towards the end of Q3. And in starting Q4, it will be — I can’t say exactly business as normal, but I think it will recover a great deal from Q3 loss. And a very similar story for tablet. Having said that, tablet, we have suffered from two quarters of pretty significant sequential decline already, and our customers are really just running off of their inventory as we see it. So Q4 will be a process of restocking. Having said that, I must say in terms of longer-term visibility for tablet for us, the visibility certainly is lower than that of automotive.
Jerry Su — Credit Suisse — Analyst
Okay. Thank you, that’s very clear. Thank you.
Jordan Wu — Co-founder, President and Chief Executive Officer
Thank you, Jerry.
Operator
Thank you. [Operator Instructions] Now I’m showing no further questions. I would now like to turn the call back over to Jordan for closing remarks.
Jordan Wu — Co-founder, President and Chief Executive Officer
It’s a final note, Eric Li, our Chief IRP Officer, will maintain investor marketing activities and continue to attend investor conferences. We will announce the details as they come about. Thank you, and have a nice day.
Operator
[Operator Closing Remarks]