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Edited Transcript of HIMX earnings conference call or presentation 8-Nov-18 1:00pm GMT

Q3 2018 Himax Technologies Inc Earnings Call

Taipei Nov 12, 2018 (Thomson StreetEvents) -- Edited Transcript of Himax Technologies Inc earnings conference call or presentation Thursday, November 8, 2018 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jacqueline Chang

Himax Technologies, Inc. - CFO

* John Mattio

* Jordan Wu

Himax Technologies, Inc. - Founder, CEO, President & Director

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Conference Call Participants

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* Charlie Chan

Morgan Stanley, Research Division - Technology Analyst

* Jaeson Allen Min Schmidt

Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst

* Jerry Su

Crédit Suisse AG, Research Division - Director

* Tristan Gerra

Robert W. Baird & Co. Incorporated, Research Division - MD and Senior Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Himax Technologies, Inc. Third Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this call is being recorded.

It is now my pleasure to introduce John Mattio, Investor Relations with

Lamnia International. You may begin.

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John Mattio, [2]

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Thank you, operator. Welcome, everyone, to Himax's Third Quarter 2018 Earnings Call. Joining us from the company are Mr. Jordan Wu, President and Chief Executive Officer; and Ms. Jackie Chang, Chief Financial Officer. After the company's prepared comments, we've allocated time for questions in a Q&A session. If you have not yet received a copy of today's results release, you can access the press release on financial portals or download a copy from Himax's website at www.himax.com.tw.

Before we begin the formal remarks, I'd like to remind everyone that some of the statements on this conference call, including statements regarding expected future financial results and industry growth, are forward-looking statements that involve a number of risks and uncertainties that could cause actual events or results to differ materially from those described in this conference call.

Factors that could cause actual events or results to differ materially from those described in this conference call include, but are not limited to, general business and economic conditions, the state of the semiconductor industry, market acceptance and competitiveness of the driver and non-driver products developed by Himax, demand for end-use application products, the uncertainty of continued success in technological innovations as well as other operational and market challenges, and other risks described from time to time in the company's SEC filings, including those risks described in the section entitled Risk Factors in its Form 20-F for the year ended December 31, 2017 filed with the SEC in March 2018.

Except for the company's full year of 2017 financials, which were provided in the company's 20-F and filed with the SEC on March 28, 2018, 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 the company subjects its 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.

Now, I would like to turn the call over to Ms. Jackie Chang. Jackie, The floor is yours.

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Jacqueline Chang, Himax Technologies, Inc. - CFO [3]

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Thank you, John, and thank you, everybody, for joining us. Our outline for today's call is first, to review the Himax consolidated financial performance for the quarter, and to provide you with our outlook for the fourth quarter of 2018. Jordan will then give an update on the status of our business, after which we will take questions. We will review our financials on both IFRS and non-IFRS basis. The non-IFRS financials exclude share-based compensation and acquisition-related charges.

Our third quarter 2018 revenues, gross margin, and EPS all exceeded our guidance issued on August 9, and were in line with our October 5th pre-announced key financial results.

For the third quarter, we record net revenues of $188.4 million, an increase of 3.9% sequentially, and a decrease of 4.4% year-over-year. Revenues were better than our guidance of flat quarter-over-quarter. The revenues increase in the quarter was attributed to greater than effective production outputs of the new foundries for both large display driver ICs and TDDI chips that allows us to fulfill more customer orders.

As anticipated, our WLO shipment volume to an anchor customer also increased significantly against that of Q2 2018.

Gross margin was 23.4%, up 40 basis points sequentially, outperforming the guidance by 90 basis points. A more favorable product mix, and stronger than expected engineering fee from project engagement enhanced the gross margin. IFRS earnings per diluted ADS were 0.5 cents, better than the guidance range of around a loss of 1 cent. Non-IFRS earnings per diluted ADS were 2.6 cents, outperforming the guidance of around 1.5 cents.

Revenue from large display drivers was $66.3 million, up 9.4% sequentially, and up 20.6% year-over-year, driven by increasing 4K TV penetration and Chinese panel customers' ramping of new LCD fabs. Large panel driver ICs accounted for 35.2% of our total revenues for the third quarter, compared to 33.4% in the second quarter of 2018 and 27.9% a year ago.

Revenue for small and medium sized display drivers came in at $85 million, down 4.8% sequentially and down 2.6% year-over-year. The driver ICs for the segment accounted for 45.1% of total sales for the third quarter, as compared to 49.2% in the second quarter of 2018 and 44.2% a year ago. Sales into smartphones were down 30.5% sequentially as opposed to 40% that we indicated in the last earnings call due to better than expected TDDI production output in the early ramp of our new foundry.

With the major addition of TDDI capacity available to us, we're very optimistic about the smartphone business growth in Q4 and next year. Jordan will elaborate on this a bit latter.

Our driver IC revenue for automotive applications recorded another historical quarter, up 18.3% sequentially and 55.4% year-over-year. The quarterly revenue reached $33.9 million, accounting for more than 22% of our driver IC revenue. We are happy with the strong momentum and our leading market position in this space.

Revenues from our non-driver businesses were $37.1 million, up 18% sequentially, but down 32.5% from last year. Non-driver products accounted for 19.7% of total revenues, as compared to 17.4% in the second quarter of 2018 and 27.9% a year ago. The sequential increase was mainly driven by the significantly higher WLO shipments to an anchor customer.

The year-over-year decrease was due mainly to certain one-off customer reimbursement, totaling $13.3 million, booked in Q3 2017 in relation to the AR goggle business. We expect WLO shipments to continue to increase strongly in the fourth quarter and into 2019. Jordan will also elaborate on this a bit later.

Our IFRS gross margin for the third quarter was 23.4%, up 40 basis points from 23% in the second quarter of 2018, but down 210 basis points from the same period last year. The sequential increase was due mainly to improved product mix. The year-over-year decrease was, again, due to the one-off customer reimbursement mentioned above. The reimbursement accounted for 120 basis points in Q3 2017.

Our IFRS operating expenses were $43.4 million in the third quarter, up 5% from the preceding quarter and down 7.7% from a year ago. The sequential expense increase was caused by $3.8 million of RSU expense, offset by R&D and salary expense reduction of $1.7 million. The year-over-year decrease was mainly a result of reduced RSU and R&D expenses.

As an annual practice, we reward employees with an annual bonus at the end of September, which always leads to a substantial increase in third quarter IFRS operating expenses compared to the other quarters of the year. This year, the RSU grant totaled $3.9 million, out of which $3.8 million was vested immediately and expensed in the third quarter. The remainder will be vested equally at the first, second, and third anniversaries of the grant date.

The non-IFRS operating expenses for the third quarter were $38.8 million, down 5.3% from previous quarter and down 3.6% from the same quarter 2017. IFRS operating margin for the third quarter was 0.4%, down from 1.7% in the same period last year, and little changed from 0.3% in the prior quarter.

Third quarter non-IFRS operating income was $5.4 million, or 2.9% of sales, down from 5.2% for the same period last year and up from 0.5% a quarter ago. IFRS profit for the third quarter was $0.9 million or 0. 5 cents per diluted ADS, compared to $2 million or 1.2 cents per diluted ADS in the previous quarter and $3.6 million or 2.1 cents per diluted ADS a year ago. The year-over-year decrease was, again, due to the one-off customer reimbursement mentioned above.

Third quarter non-IFRS profit was $4.5 million or 2.6 cents per diluted ADS compared to $2.3 million or 1.3 cents per diluted ADS last quarter and $8.9 million or 5.2 cents per diluted ADS the same period last year.

Turning to our balance sheet, we had $102.9 million of cash, cash equivalents, and other financial assets as of the end of September 2018, compared to $151.6 million at the same time last year and $126.7 million a quarter ago. The cash position dropped $23.8 million from last quarter due primarily to the dividend payout of $17.2 million and CapEx of $8.2 million.

On top of the above cash position, restricted deposit was $164.3 million at the end of the quarter as compared to $147 million in the preceding quarter and $147.2 million a year ago. The increase is due to additional restricted cash deposit made to guarantee the dividend payment withdrawn from the banking facility in the quarter. The restricted deposit is mainly used to guarantee the company's short-term borrowings for the same amount.

As of September 30, 2018, our inventories were $145.8 million, up from $142.1 million a quarter ago and $130.1 million at the same time last year. Accounts receivable at the end of September 2018 were $187.6 million as compared to $183.2 million a year ago and $176.3 million last quarter. Day sales outstanding was 96 days at the end of September 2018, as compared to 99 days a year ago and 93 days at the end of the last quarter.

Net cash inflow from operating activities for the third quarter was $2.2 million as compared to an inflow of $16.9 million for the same period last year and an outflow of $2.8 million last quarter. The year-over-year variance is mainly due to inventory prebuild in reaction to foundry capacity shortage. We expect this will repeat in the fourth quarter.

Capital expenditures were $8.2 million in the third quarter versus $10.1 million a year ago and $17.7 million last quarter. The third quarter CapEx consisted mainly of ongoing payments for the new building's construction, WLO capacity expansion, and installation of active alignment equipment for our 3D sensing business. As of September 30, 2018, Himax had $172.1 million ADS outstanding, unchanged from last quarter. On a fully diluted basis, the total ADS outstanding were $172.5 million.

For the fourth quarter of 2018, we expect revenue to be around flat to up 5% sequentially. Gross margin is expected to be around 24.2% to 25.2% depending on our final product mix. IFRS earnings attributable to shareholders are expected to be in the range of around 1.5 to 3.6 cents per diluted ADS based on $172.6 million outstanding ADSs. Non-IFRS earnings attributable to shareholders are expected to be in the range of 1.7 to 3.8 cents per diluted ADS based on 172.6 million outstanding ADSs.

I will now turn the call over to Jordan.

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Jordan Wu, Himax Technologies, Inc. - Founder, CEO, President & Director [4]

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Thank you, Jackie. Our Q3 results outperformed the original guidance. As indicated in the last earnings call, we are confident that we are moving out of the trough and will deliver better performance in the first quarter next year. We are seeing solid growth momentum in areas of TDDI, WLO, and large display driver IC in the fourth quarter, despite the prevailing weak sentiment in overall consumer electronics and in particular, the smartphone market.

Traditional discrete display driver for smartphone, however, will continue to decline in Q4 as it is being quickly replaced by TDDI and AMOLED as we mentioned repeatedly. The other area of decline in Q4 will be the display driver for tablet, a sector, which is still experiencing weak market demand.

Now, let me give you some insight behind our Q4 guidance and trends that we see developing in our businesses.

Our large display driver IC business recorded high-single-digit growth in the fourth ] quarter due mainly to a few factors, namely, improved supply from the newly added foundry capacity, our Chinese panel customers' ongoing capacity expansion, and shipment to a new panel customer who only started ramping up their first fab lately.

The ramping of our new foundry was in good progress as more of our panel customers completed qualification with their customers for the new capacity. Looking into Q4, we are seeing continued strength in customer demands and we are able to improve order fulfillment from last quarter, despite the new emergence of an industry-wide capacity constraint in relation to the packaging of the large panel display driver IC. With that, we expect large display driver business to increase by high single digit sequentially.

Looking into the future, many TV manufacturers are planning on introducing consumer-grade super high-end products with 8K resolution, which will benefit both our large panel display driver and timing controller businesses. One of our industry leading customers will be launching a new 8K TV with Himax technology inside early next year and we expect more to come from this and other customers in the future. Capitalizing on our 4K TV success, we are strongly positioned for this emerging high-end market opportunity.

Now, turning to our small and medium sized display driver IC business. I'm pleased to report that we were able to start the mass production of TDDI at the new foundry earlier than original schedule and achieved better-than-expected output yield at the early stage of mass production.

With the ramping of the new capacity, our constraint of TDDI shipment will be increasingly alleviated starting from the fourth quarter. We'll be able to fulfill more customer orders from the design-wins we already achieved, thereby doubling the revenue of Q4 from the last quarter.

With the new capacity's continued ramping, we target to completely resolve our foundry capacity issue in the third quarter of next year. For the time being when our capacity remains a constraint, our resources are prioritized for higher end FHD projects as they yield higher revenue and better margin with less competition.

TDDI penetration is expected to reach more than 30% in smartphone in 2019, representing a tremendous upside potential for Himax. Backed by the new foundry capacity and fast expanding design-win portfolio with tier 1 smartphone OEMs and leading panel makers, we are well positioned to win a major market share in this new space, repeating our historical success in the smartphone display driver IC business.

We believe TDDI will be the biggest growth driver for our business in 2019. With higher ASP and better margin, TDDI chips will help improve our corporate sales and profit in 2019.

As expected, our traditional discrete driver IC sales into smartphone is set to decline by close to 50% sequentially in the fourth quarter as the market is being quickly replaced by TDDI and AMOLED. This segment will account for less than 5% of our total sales in the fourth quarter.

Combining TDDI and discrete smartphone driver, our Q4 sales into the smartphone market is expected to grow more than 20% sequentially.

During the third quarter, our automotive business continued to perform well and recorded another historical high, delivering a 44.4% growth year-over-year through nine months 2018. The demands for more sophisticated and higher performing displays are still rising with automakers. Our technological prowess will continue to separate us from the rest as for the next generation display for automotive, we are the leader in key technologies such as TDDI, AMOLED, and local dimming timing controller.

Q4 revenue in this segment is set to grow around low single digit sequentially as we continue to benefit from our design-wins, which took place during the last few years.

Our tablet and consumer electronics businesses are expected to decline by over 30% sequentially driven by weak overall market momentum. They account for less than 10% of our total sales in the fourth quarter. For fourth-quarter small and medium-sized driver IC business, we expect revenue to decrease by low single digit sequentially. The non-driver IC business segment has been our most exciting growth area and a differentiator for Himax in the last few years.

Now, let me share some of the progress we've made in the last quarter as well as our views on future growth opportunities. First, a 3D sensing update. As a leader in 3D sensing, we have participated in most of the smartphone OEMs' ongoing 3D sensing projects covering all 3 types of technologies, namely, structured light, active stereo camera or (ASC) and time-of-flight, where we provide 3D sensing total solution, or just the projector module or optics inside the module, depending on the customers' needs.

By offering either the projector module or critical optics, we have been collaborating with a small handful of smartphone names that have in-house capability to come up with their own customized 3D sensing solutions. We already have one such end customer using our technology for mass production with two more in the pipeline targeting 2019 product launch.

For most Android smartphone makers who don't have such in-house capability, however, we have to provide total solution to enable their 3D sensing. At present, the 3D sensing adoption for this market remains low. The adoption is hindered primarily by the prevailing high hardware cost of 3D sensing and the long development lead-time required to integrate it into the smartphone.

Instead of 3D sensing, most of the Android phone makers have chosen the lower cost fingerprint technology, which can achieve similar phone unlock and online payment functions with a somewhat compromised user experience. Reacting to their lukewarm response, we are working on the next generation 3D sensing, a total solution, with an aim to leapfrog the market by providing high performance, easy to adopt, and yet cost- friendly total solutions, targeting the majority of Android smartphone players.

In addition, we are providing 3D sensing developer kits, which is being used to develop applications over both smartphone and non-smartphone platforms. We believe that 3D sensing will be widely used by more Android smartphone makers when the ecosystem is able to substantially lower the cost of adoption while offering easy-to-use, fully-integrated total solutions, for which Himax is playing a key part.

I have mentioned previously that 3D sensing can have a wide range of applications beyond smartphone. While smartphone remains our top priority, we have started to explore business opportunities in various industries by leveraging our SLiM™ 3D sensing total solution. Such industries are typically less sensitive to cost and always require total solutions.

Our recently announced collaboration with Kneron, an industry leader in edge-based artificial intelligence, to develop an AI-enabled 3D sensing security and surveillance solution, is just an example of real-world applications using our 3D sensing technology.

As anticipated, the shipment volume to our WLO anchor customer for the third quarter was a lot higher than than of the previous quarter, thereby improving our WLO capacity addition substantially.

The fourth quarter will see another very significant sequential growth thanks to the customer's large-scale adoption of more models. The overall 2018 shipment will increase considerably year-over-year. Meanwhile, we are encouraged by the progress of the ongoing R&D projects with the same customer for their next generation products centering around our exceptional design know-how and mass production expertise in WLO technology.

Let me also talk about other WLO businesses. As we mentioned previously, we are already collaborating with a small handful of smartphone makers that have in-house capability to come up with their own customized 3D sensing solutions targeting 2019 product launch. For those customers, we provide full projectors or critical optics inside the 3D sensing module, of which WLO optics is a major component.

Now, some update on our capital expenditure. We announced the increase of the Phase I capital expenditure budget, which is on top of our regular CapEx for the IC design business, from $80 million to $105 million in early 2018. The majority of the Phase I investment goes to land and building, new equipment for the WLO anchor customer, and an initial capacity of 2 million units per month for 3D sensing. Of the Phase I CapEx of $105 million budget, $33 million has been paid out in 2017, followed by $38.6 million made in the first nine months of 2018.

As we mentioned in previous earnings calls, the CapEx budget will be funded through our internal resources and banking facilities. We have more than sufficient banking facilities with favorable cost for such CapEx budget.

On CMOS image sensor business update, we continue to make great progress with our 2-machine vision sensor product lines, namely, near infrared or NIR sensor, and Always-on-Sensor. NIR sensor is a critical path for both our structured light and ASC 3D sensing total solutions. Our Always-on-Sensor or AoS product line, the joint offering of Emza and Himax technologies uniquely positions us to provide ultra-low power, smart imaging sensing total solutions, leveraging Himax's industry leading super low power CIS and ASIC designs and Emza's unique AI-based computer vision algorithm.

We are pleased with the status of engagement with leading players in areas such as connected home, smart building and security, all of which are new frontiers for Himax.

For traditional human vision segments, we see strong demands in laptop and increasing shipments for multimedia applications such as car recorders, surveillance, drones, home appliances, and consumer electronics, among others.

I will now give an update on the LCOS business, where our main focus areas are AR goggle devices and head-up-displays for automotive. While AR goggles will take a few years to fully realize its market potential, LCOS remains the technology of choice in this space. Our technology leadership and proven manufacturing expertise have little competition, evidenced by the growing list of AR goggle device customers and ongoing engineering projects.

In addition, we continue to make great progress in developing high-end holographic head-up displays for high-end automotive. One of our customers will demo its state-of-the-art head-up-display product with Himax LCOS inside at the 2019 CES. LCOS for both goggle device and head-up-display represents much higher ASP and gross margin for us. In the meantime, we are working with various OEMs to bring LCOS microdisplays to mini projectors with revenue contribution to start from 2019.

For non-driver business, we expect revenue to increase by low single digit sequentially in the fourth quarter, driven mainly by WLO shipments.

That concludes our 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.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Tristan Gerra with Baird.

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Tristan Gerra, Robert W. Baird & Co. Incorporated, Research Division - MD and Senior Research Analyst [2]

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Given that your TDDI production is improving, what type of market share you think you can get in TDDI exiting next year in smartphones and also by next year, what type of price premium you think TDDI is going to generate relative to your traditional driver IC business?

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Jordan Wu, Himax Technologies, Inc. - Founder, CEO, President & Director [3]

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Bear in mind, this is our market share in TDDI rather than market share for the entire smartphone industry. Because as you know, for smartphones now, another very big trend for displays is AMOLED and certainly, there will be still discrete driver IC type of displays.

So on TDDI, our target towards the latter half of the year, next year -- I say that because I mentioned in my prepared remarks that we expect our capacity constraint will be removed starting from Q3 -- So our target by that time is about 30% global market share in TDDI.

The premium is harder to say because, it depends on resolution and also, it largely depends on whether the driver includes memory or not. And in addition to that, to make things even more complicated, there's a new trend, a newly emerging trend with display driver for TDDI for smartphone having COF as the packaging material as opposed to non-COF type, which is POIC, which we call our COG or chip-on-glass type.

So I don't have a good answer in terms of a weighted average number of price premium in front of me. I would say just a ballpark, I would say about 80% to double the premium,give and take a discrete driver IC with unit price of $0.70 to $0.80 as opposed to $1.15 for TDDI. And that is for non-COF and non-memory type.

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Tristan Gerra, Robert W. Baird & Co. Incorporated, Research Division - MD and Senior Research Analyst [4]

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Just a quick follow-up if you could talk about your positioning in OLED driver ICs. Another BOE is going to be ramping capacity next year.

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Jordan Wu, Himax Technologies, Inc. - Founder, CEO, President & Director [5]

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Without naming any specific customers. We are working with a few Chinese customers right now for their new capacity. Right now, our focus in TDDI for the time being, but AMOLED is certainly something very important to us longer-term. So it's in design stage. We don't expect significant volume for next year but we are very hopeful that the year after we will start to see significant ramping for AMOLED.

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Operator [6]

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(Operator Instructions) Our next question comes from the line of Jaeson Schmidt with Lake Street Capital.

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Jaeson Allen Min Schmidt, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [7]

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Just wondering if you could comment on given this new development of looking to develop lower cost 3D sensing solutions for the Android market, does that at all impact your current relationship with Qualcomm that was previously announced?

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Jordan Wu, Himax Technologies, Inc. - Founder, CEO, President & Director [8]

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No. On the contrary, we are working together with them. We are still shooting for a high end market but we definitely need to bring the cost down I would say substantially as well. But we do have a pretty solid roadmap and plan including architecture, new architecture, new algorithm, and so on and so forth. For the obvious reason, I cannot elaborate too much.

It's very confidential but I think we learned a lot of lessons through this round ofI would say first generation of 3D sensing total solution. And to realize that the cost needs to be much lower and also, through this learning though this experience, we also figured out a lot of ways to effectively bring down the cost. I'm not talking about marginal improvement because with marginal improvement, it doesn't really help. So, as I said earlier, right, we have to revamp (inaudible) (in audible) architecture, and algorithm, and so on.

So it's a work in progress but thank you for asking. Indeed, we are still working with key platform providers, to make it work.

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Jaeson Allen Min Schmidt, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [9]

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And the last one from me. Just to clarify your CapEx outlook, has that been changed as far as Phase 2 given that the Android OEM situation seems to be pushed?

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Jordan Wu, Himax Technologies, Inc. - Founder, CEO, President & Director [10]

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Now. Before I answer the question, let me just provide the important background. Our CapEx is only to cover the optics WLO and what we call active alignment "AA". Both are critical for the projector end. As far as the total, our so called total solution is concerned, Jaeson, that was your earlier question, right, the sensor, the ASIC, and all other things lens, all our outsourced.

So those have nothing to do with our CapEx, right. So our first one, the Phase 1 CapEx is primarily for our anchor customer, which is among obviously the very small handful of smartphone OEMs with in-house capability for their own design, right. So for the vast majority of our Phase 1 capacity, we are not targeting our so-called total solution market.

So it's primarily for the anchor customer and then we did prepare, as we said earlier repeatedly, about $2 million per month of capacity for other customers. They could be the first type in, being the ones with the in-house ability for total solution or a second type who requires our solution.

As it turns out, I think it's more likely than not, looking into next year, our 2 million per month of capacity will be occupied by additional Type 1 customers, i.e. those with in-house capabilities. As I mentioned, we are still working with a couple of other names for projects, shooting for 2019 launch. As it turns out, actually, our 2 million per unit of capacity as expected demand is probably not sufficient and for that reason, we probably have to outsource some of our manufacturing to others as well.

So, in other words, to get back to your question, we will try to limit our CapEx for next year unless there are unexpected (inaudible)major project demands that we haven't seen so far. And in which case, we'll certainly report the progress and we'll probably embark on further CapEx addition.

Other than that, I think our CapEx there will be a marginal increase here and there, but there won't be a major increase from the existing capacity because I think, for CapEx typically you need a certain scale to make it work, unless there is a major addition of customer, big projects, I think our current capacity with the flexibility of putting some into outsourced vendors will be sufficient.

Now, if you talk about 2020 then there's a very, very high likelihood there will be a major CapEx embarkment, but that is something we will update much later on.

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Operator [11]

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(Operator Instructions) Our next question comes from the line of Jerry Su with Credit Suisse.

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Jerry Su, Crédit Suisse AG, Research Division - Director [12]

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Regarding TDDI, I would like to follow-up on this. Can you tell us about what is your expectation for the total addressable market this year and how will it grow into 2019? And then I think you also mentioned about some of the back end supply tightness. Can you give us a little bit of color on this and how Himax has done to secure more capacity to meet the demand for TDDI and also for the large-sized driver IC in 2019?

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Jordan Wu, Himax Technologies, Inc. - Founder, CEO, President & Director [13]

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The first question is about TDDI. In 2018, I mean it's no secret that the major smartphone OEM -- all major smartphones are using TDDI for their smartphones. The expected penetration for TDDI for '18 is somewhere around 25%. And next year, it's expected to be 35%. So from 25% to 35%. So it's a growth of about 35%-ish. So that's pretty significant.

And certainly, our situation in 2018, we repeated many times that we are rather limited in capacity this year. So, our share is rather limited this year. But again, get back to earlier question of Tristan,we expect to get major market share back in 2019.

Different people have different approaches of expanding into new fabs to alleviate their own demand problems. In the case of Himax, we are taking a hard but long-term solid approach, which is to go beyond the likes of TSMC and UMC where the capacity is always crowded, the utilization.

So we have worked with a foundry partner, which historically had a relatively little such experience, but through a lot of Himax support, and input, and actually a lot of our own recipe and fine tunig, we have managed to ramp up pretty quickly the new foundry partner's capacity, as I indicated in my prepared remarks.

So since moving better than on track right now. So again, we expect Q1 to see a major increase again. So actually, to recap, for this year, we indicated in August's Q&A, right, second quarter our target was 6 million for the whole quarter of shipments. Third quarter came down slightly from 6 million to 5 million because second quarter we have some old inventory for sale. We didn't have it in the third quarter.

So we say our third quarter target was 5 million and actually, we achieved about 10% higher than that as the actual result. And we said earlier in the fourth quarter, our target is 10 million for the whole quarter. I think we are on track to achieve -- to beat that number again, probably by another 10% also. We'll see.

But I think what's important is even within the fourth quarter, from October, November, December, the ramp in month after month is quite significant. So I would expect somewhere in the second quarter, our target on a single month basis will be 10 million and in the second half, our second single month basis, we will reach 20 million.

I'm not talking about 20 million every single month for the whole second half. I'm saying somewhere in second half, we hope to achieve 20 million per month. So if you put the numbers together, you do your own math, you can pretty much figure out our target market share, and revenue, and so on.

Your second question is around back end supply. I mentioned earlier there is a type of trial IC packaging called COF, i.e. chip-on-film, meaning you have a bare die and you bond the bare die onto a piece of film. So that's why it's called chip-on-film...and the film has a connector pin, is connected onto the display. That's how it works.

And traditionally, that kind of packaging is only applied in large display driver IC, because just by the nature of the technology. And historically, ever since we founded Himax, the industry has more or less been in a rather serious oversupply situation. And as a result, we have seen the industry consolidating, people getting out of the market, merging with each other to try to survive.

So it has historically been an oversupply situation, I would say until this year, when there's a major change in the industry, which is cell phones / smartphones and starting from AMOLED and thereafter, some TFT-LCD as well. Some high end smartphone in order to narrow its bottom end bezel a little bit, they are prepared to pay a lot more to buy the film and have their IC packaged by COF type.

And as we know, the volume of smartphone is very significant and now, we are seeing the major adoption of the COF type being the top three phone makers. So there's a big turn of AMOLED adoption already in this type of prediction and there's an emerging but significant move of TFT-LCD into this space as well. So now, we are talking about the top three smartphone players being the major users of this technology.

So as a result, the COF industry has turned from a serious oversupply situation to a shortage situation and that directly impacted our large panel display driver IC business. So I would say the whole of next year for large panel display driver, we expect to see a continuous capacity issue, probably much less so for foundry, but rather it is primarily for COF industry. And related to this is bonding equipment, something we call ILB.

And certainly that has a lot to do with how much penetration of COF into smartphone we are going to see next year. And it's a variable because it is apples to apples basis. It's about 1-dollar more expensive. So to smartphone makers, necessarily want to narrow its bezel by paying so much. We have yet to see but as the design pipeline we see so far, I think next year, we expect to see continuous shortage.

But I think being a large display driver player for a long time, I think we enjoyed very solid relationship and strategic partnership with both Taiwanese and Korean COF makers. So I think hopefully our situation will be better than our peers but we're working very hard to try to resolve this issue as we speak actually.

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Jerry Su, Crédit Suisse AG, Research Division - Director [14]

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And then on this topic, I think your back end vendors is also talking about that TDDI testing is also under severe constraint. Could you also elaborate on this?

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Jordan Wu, Himax Technologies, Inc. - Founder, CEO, President & Director [15]

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Yes. The tester is supply primary. TDDI requires high end tester because it requires high bandwidth, high speed. And now, it's in shortage situation because there's only one major vendor of such equipment in the entire industry. There are minor ones but they are far away in terms of capability and capacity from the dominant vendor. And the industry is ramping so fast, so quickly. So it's no surprise that we are going to see some tightness over here.

But I think it's something that has been anticipated a long time ago. So and the vendor, the equipment vendor never set schedule of delivering X amount of sets per month. And as they go along, the supply and demand will kind of adjust itself and for Himax,, for example, will try to leave the very high end to such IC, while leaving the next notch of testers into other testers by rewriting our programs and so on and so forth.

So it's something that if it's a tight supply situation but I think it's something that the industry can somehow manage because it was expected a long time ago and it didn't come in so rushed and as such a big surprise.

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Operator [16]

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(Operator Instructions) Our next question comes from the line of Charlie Chan with Morgan Stanley.

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Charlie Chan, Morgan Stanley, Research Division - Technology Analyst [17]

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So my first question is regarding your next generation 3D sensing and you said that you plan to leapfrog. So can I get some more color on this leapfrog technology? Is that more for the front side 3D sensing, or for the rear side, or so-called world facing 3D sensing? And which type of technology you will see most advanced, meaning structured light TOF or active stereo from this technology improvement?

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Jordan Wu, Himax Technologies, Inc. - Founder, CEO, President & Director [18]

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The short answer is it's for front side, i.e. still for face recognition. It's going to be structured light. While are working ourselves with our partners on other things, but when we talk about this next generation 3D sensing, the so-called front-lit technology, we are talking about structured light and front side.

Front side because there's a solid demand and the customers do want it. They complain about integration being a real pain in the back and they complain about the cost. But they also said, actually, you know, our fingerprint is likely to be a temporary solution because guess what, fingerprint can only do one thing and one thing only, which is fingerprint, meaning to unlock. And you cannot do anything else.

Where, with 3D sensing, you do have the potential for other applications. So people are saying as long as you can deliver a much cost-friendly solution then we will jump into it. And why structured light? Because with ASC, there are two camera modules with a projector. With structured light, there is the one camera module with 1 projector. So you will remove the cost of one camera.

So if you want to, as long as you get your architecture right, I cannot get in too much detail, I'm sorry, for confidential reasons. But if you get your architecture right, removing that one piece of camera module away from your build material is very important to get your costs under control.

So we firmly believe that the structured light is the right solution for low cost, although today, structured light is actually is offered at higher cost compared to ASC. But I think that is because of the whole industry's old generation design. It's not something that cannot be improved. In fact, we are improving it big time.

As far as the world-facing camera is concerned, I know people are talking about it and indeed, are working with a few anchor customers on such projects. I think in general, yes, people seem to feel that in terms of world facing camera, TOF obviously is the strong contender as opposed to SC or structured light. However, TOF continues to suffer from the low resolution or big pixel size to other sensing, the major problem. And people complain about it because if you want to do some serious application, you do need the resolution.

So it's something that the industry is still working on. As far as

TOF is concerned, I want to make one thing clarified. Himax is going to play a major role in projector and optics but in the foreseeable future, we don't have sensor. We don't have algorithm in-house. So we are not offering total solution. We're only offering total solution right now for ASC type and structured light type and next generation.

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Charlie Chan, Morgan Stanley, Research Division - Technology Analyst [19]

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My follow-up is regarding your WLO business, right. I think this year, I think essentially one big customer contributes most of the revenue. And for next year, you are saying there are more projects going on but we are also seeing more competition. So for next year, do you think WLO business will grow year-on-year versus this year?

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Jordan Wu, Himax Technologies, Inc. - Founder, CEO, President & Director [20]

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I think the answer is yes because the customers do have more models into production or adopting this technology more compared to last year. And also, we, as I said earlier, right, we do have other customers who have the in-house capability of providing their own in-house solution. There will be some revenue coming from those other customers as well.

So yes, in all likelihood, I think we will see some growth, although we may not see very significant growth like this year. Actually, the ongoing R&D projects that we're working on with our anchor customer, I think the ramping is more likely to be year2020 story rather than next year. But for the (inaudible)(inaudible) program in our own space, we do enjoy the sole source status. So I think next year, we do anticipate some growth from this.

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Charlie Chan, Morgan Stanley, Research Division - Technology Analyst [21]

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Q So lastly, if I may, I think it would be very helpful if a the company can also share some of your observation on demand, right. Because we know that macro is a little bit tough now but company is growing. In first quarter, your smartphone business is growing 20% sequentially, right. And the large panel devices business seems to be okay.

So how should we reconcile the kind of weak in demand inventory issue to your good performance into fourth quarter? And do you see more downside risks into next quarter?

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Jordan Wu, Himax Technologies, Inc. - Founder, CEO, President & Director [22]

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Right. I think you are absolutely right, Charlie, in saying that the Q4 overall sentiment is weak. We managed to give guidance of flat to 5% growth. I think because of our special situation, in the large display driver space, yes, we also, like others, we're also suffering from a capacity shortage somewhat. But some of our customers are ramping their fabs and that is additional market for us. And particularly in China, where we have a major market share. So I think we enjoy the benefit of those ramping.

And also, in other markets such as Taiwan, there are customers-- where our design wins with those customers are more important projects, revenue generating, or profit generating projects. So in the tight supply situation, they are re-planning of their manufacturing plan and some of our projects enjoy the benefit of priority. I think that also partially explains.

In the smartphone, I think we have to admit, yes, we are enjoying a major growth but that was because we did come in from a relatively low base. So I think I can't say I'm very happy with the performance of this quarter because obviously, I'm not, because we are still suffering from capacity shortage. Although we enjoy a pretty decent growth.

I think you asked about Q1. Q1 is Chinese New Year. So we are not providing guidance for Q1 yet as we have shorter working days. So I don't expect another major growth for Q1. However, I think more importantly for the 2019 outlook, I'm sure somebody is going to ask this so I might as well comment on it right now. Again, we are not providing so called "guidance" for the whole year.

But I think next year, the overall trend looks optimistic for Himax, starting from large panel display again. We do expect another robust growth for next year. Actually for the same reason, as these 2 of our Chinese customers are ramping new fab Gen 8.6 and Gen 10.5 next year, in early next year actually. And with other customers, while not having new capacity, or new fabs into their family, they are still ramping, their --their newly ramped capacity from the second half this year.

So we're still seeing demand increase in terms of capacity. However, and also because of the CoF shortage, there is likely to be a continuous ASP hike and that in turn will also provide us good support for our margin as well for large panel display driver business.

The big uncertainty is the macro economy, which I don't know, you guys are the experts. And certainly, we are already seeing weakness in Chinese economy and that is going to have a major impact on the world economy I think. So we are cautious in watching the change of momentum in the overall economy. But that factor aside, I think large panel, we are looking good.

Small panel, again, I already talked about our ramping plan for TDDI next year, which is going to remain in for next year. So we're set to enjoy a strong growth for TDDI and small and medium sized display. And for non-driver, I already talked about WLO and another major factor in our non-driver is timing controller, which is going along with large display driver. So I think all our major sectors is set to enjoy good growth.

While if you look at our major problem areas in terms of growth for this year, which are traditional discrete drivers for smartphone, and we said earlier, in Q4 it's already less than 5% of our total sales. And certainly, the tablet market I think expected continuous weak momentum next year but that is also already quite small in our total revenue portfolio.

So that is kind of my outlook for next year.

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Operator [23]

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Thank you. And that concludes today's question-and-answer session. So with that, I would like to turn the conference back over to Himax for further remarks.

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Jordan Wu, Himax Technologies, Inc. - Founder, CEO, President & Director [24]

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As a final note, Jackie Chang, our CFO, will maintain investor and marketing activities and continue to attend investor conferences. We'll announce the details as they come about. Thank you and have a nice day.

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Operator [25]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a wonderful day.