Himax Technologies, Inc. (HIMX) Q2 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Himax Technologies, Inc. Second Quarter 2018 Earnings Conference Call. [Operator Instructions] As a reminder, this call is being recorded. I would now like to turn the call over to Greg Falesnik. You may begin.

Thank you, operator. Welcome everyone to Himax's Second 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, please e-mail greg.falesnik@mzgroup.us or 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 20, 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 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 Ms. Jackie Chang. The floor is yours.

Thank you, Greg and thank you, everybody for joining us. Our outline for today's call is first, review of the Himax's consolidated financial performance for the quarter, followed by the third quarter 2018 outlook. Jordan will then provide an update on the status of our business, after which we will take questions. We will review our financial on both IFRS and non-IFRS basis. The non-IFRS financials exclude share-based compensation and acquisition related charges. Our second quarter 2018 revenues and gross margin met our guidance, while IFRS earnings per diluted ADS exceeded our guidance. For the second quarter, we reported net revenues of 181.4 million, an increase of 11.4% sequentially and an increase of 19.5% year-over-year. Gross margin was 23%, up 0.5% sequentially. IFRS earnings per diluted ADS were 1.2 cents, better than the guidance range of 0 to 1 cent per diluted ADS. Revenue from large display drivers was 60.6 million, up 2.2% sequentially, and up 16.3% year-over-year, driven by increasing 4K TV penetration and Chinese panel customers’ ramping of new LCD fabs. Large panel driver ICs accounted for 33.4% of our total revenues for the second quarter, compared to 36.4% in the first quarter of 2018 and 34.4% a year ago. Revenue for small and medium-sized display drivers came in at 89.3 million, up 24.5% sequentially and up 27.5% year-over-year. The driver ICs for small and medium-sized applications accounted for 49.2% of total sales for the second quarter, as compared to 44% in the first quarter of 2018 and 46.1% a year ago. Sales into smartphones were up 54.3% sequentially and up 42.5% year-over-year. The growth was driven by accelerating TDDI shipments and the anticipated smartphone makers’ inventory replenishment for new product launches. Jordan will elaborate on this a bit later. Our driver IC revenue for automotive applications recorded another historical quarter, up 15% sequentially and more than 35% year-over-year. The quarterly revenue reached 28.7 million, accounting for more than 19% of our driver IC revenue. We are happy with the strong momentum in this space. Revenues from our non-driver businesses were 31.5 million, down 1.1% sequentially but up 6.4% versus last year. Non-driver products accounted for 17.4% of total revenues, as compared to 19.6% in the first quarter of 2018 and 19.5% a year ago. The sequential decline was mainly due to reduced NRE income. The year-over-year increase was driven mainly by WLO shipment. We expect WLO shipment to continue to rebound strongly in the second half. Our IFRS gross margin for the second quarter was 23%, up 50 basis points from 22.5% in the first quarter of 2018 but down 80 basis points from the same period last year. The sequential increase was due mainly to improved product mix. Our IFRS operating expenses were 41.3 million in the second quarter of 2018, up 3.6% from the preceding quarter and up 11.3% from a year ago. The year-over-year increase was primarily the result of rising R&D expenses in the areas of 3D sensing, WLO, TDDI, and high-end TV, as well as annual merit increase. IFRS operating margin for the second quarter of 2018 was 0.3%, up from minus 0.6% in the same period last year and up from minus 2% in the prior quarter. The sequential and year-over-year increase was both a result of revenue increase but offset by increased operating expenses. Second quarter non-IFRS operating income was 0.8 million, or 0.5% of sales, up from minus 0.3% for the same period last year and up from minus 1.8% a quarter ago. IFRS profit for the second quarter was 2 million, or 1.2 cents per diluted ADS, compared to IFRS loss of 2.8 million, or 1.6 cents per diluted ADS, in the previous quarter and IFRS loss of 0.7 million, or 0.4 cents per diluted ADS, a year ago. The sequential increase was a result of higher sales and better gross margin. Second quarter non-IFRS profit was 2.3 million, or 1.3 cents per diluted ADS, compared to a loss of 2.6 million, or 1.5 cents per diluted ADS last quarter and a loss of 0.3 million, or 0.2 cents per diluted ADS the same period last year. Turning to our balance sheet. We had 126.7 million of cash, cash equivalents and other financial assets as of the end of June 2018, compared to 185.9 million at the same time last year and 151.9 million a quarter ago. The cash position dropped 25.2 million due primarily to CapEx of 17.7 million, cash outflow of 2.8 million from operations, and Emza investment of 3.5 million. On top of the above cash position, restricted cash was 147 million at the end of the quarter, as compared to 147 million in the preceding quarter and 107.2 million a year ago. The restricted cash is mainly used to guarantee the company’s short-term borrowings for the same amount. As of June 30, 2018, our inventories were 142.1 million, down from 148 million a quarter ago and down from 147.7 million at the same time last year. Account receivables at the end of June 2018 were 176.3 million as compared to 164.5 million a year ago and 166.6 million last quarter. Days sales outstanding was 93 days at the end of June 2018, as compared to 97 days a year ago and 92 days at end of the last quarter. Net cash outflow from operating activities for the second quarter was 2.8 million as compared to the outflow of 1.2 million for the same period last year and an inflow of 2.3 million last quarter. Capital expenditures were 17.7 million in the second quarter of 2018 versus 11.7 million a year ago and 18.6 million last quarter. The second quarter CapEx consisted mainly of ongoing payments for the new building’s construction, WLO capacity expansion and installation of active alignment equipment to support our 3D sensing business. Other CapEx, primarily for design tools and R&D related equipment for our traditional IC design business, is around 2.5 million during the quarter. We declared annual cash dividend of 10 cents per ADS during the second quarter, totaling 17.2 million, which has been paid out on July 31. Our dividend is determined primarily by the prior year’s profitability. Our decision to pay out 61.7% of last year’s net profit demonstrated our continued support for our shareholder base and strong confidence in the near term outlook for our newly increased CapEx and the overall long-term growth prospects. The CapEx budget for 2018 and the dividend for the year of 2017 will be funded through our internal resources and banking facilities, if so needed. Jordan will elaborate a bit later. As of June 30, 2018, Himax had 172.1 million ADS outstanding, unchanged from last quarter. On a fully diluted basis, the total ADS outstanding are 172.5 million. For the third quarter of 2018, we expect revenues to be around flat sequentially. Gross margin is expected to be around 22.5%, depending on our final product mix. IFRS earnings attributable to shareholders are expected to be around minus 1 cent per diluted ADS, based on 172.5 million outstanding ADSs. Non-IFRS earnings attributable to shareholders are expected to be around 1.5 cents per diluted ADS based on 172.5 million outstanding ADSs. As we have done in the past, our third quarter IFRS earnings per diluted ADS guidance has taken into account our expected 2018 grant of restricted share units, or RSUs, to the team at the end of September. The 2018 RSUs, subject to our Board approval, is now assumed to be around 4.5 million, almost all of which, or 2.1 cents per diluted ADS, will be vested and expensed immediately on September 30th, the grant date. In comparison, the 2017 RSUs totaled 6.5 million, out of which 6.1 million was vested immediately. The grant of RSUs would lead to higher third quarter IFRS operating expenses compared to the other quarters of the year. I will now turn the call over to Jordan.

Thank you, Jackie. Before I discuss about our business outlook, I would like to highlight that our bottom line has been substantially affected by the major increase of R&D expenses since some two years ago when we decided to invest heavily into a number of new areas, something we brought to the market’s attention repeatedly before. We believe our operations will be out of the trough starting from the fourth quarter, initially driven by the anticipated ramping of the new foundry for the TDDI product line and, thereafter, shipment of 3D sensing products next year. 3D sensing, in particular, will represent a paradigm shift in our business when it starts to achieve a broader market adoption. With that, now, let me give you some insights behind our guidance and trends that we see developing in our businesses. Our large display driver IC business recorded low-single-digit growth in the second quarter due mainly to our Chinese panel customers’ ongoing capacity expansion, a more favorable product mix driven by the market’s 4K TV demands and shipment to a new panel customer who recently started ramping up their first fab. Looking into the third quarter, while the Chinese domestic market is relatively slow for reasons such as weak currency, the western markets, especially the US, remain robust. We see single digit growth for the third quarter as we continue to benefit from Chinese panel customers’ capacity expansion and ramping of new fabs. However, foundry capacity shortage remains an issue. While we are making good progress in adding new capacity into our pool, the ultimate ramping schedule will depend on how fast our panel customers can go through their customer qualification, something all our major customers are working very hard on. Looking into the future, with the 2020 Tokyo Olympics approaching and more Gen 10.5 fabs coming online to enable very large screen 8K TVs, many TV manufacturers are rushing to introduce consumer-grade super high end products with 8K resolution. Capitalizing on our 4K TV success, we are strongly positioned for this emerging market opportunity. Turning to the small and medium sized display driver IC business. The trend for full-screen, 18:9 display is already fully in place for smartphone with phone makers now aggressively adopting such screens for 2018 and 2019 models even for mid-end and entry-level products. Our comprehensive TDDI product portfolio positions us well to support this trend. We are pleased that both our full HD+ and HD+ TDDI ICs enjoyed significant growth during Q2, with revenue and shipment volume both more than tripled during the quarter, despite being able to fulfill just a fraction of orders amid severe foundry capacity shortage. Capped by the very limited capacity, our Q3 TDDI shipment will likely see some 10% decline from that of the second quarter. TDDI’s foundry capacity shortage is even more challenging than that of the large display driver IC. To capture the TDDI opportunity, we have been working very hard to source and qualify additional foundry capacity. We are on track to complete the porting of our existing products into another foundry vendor and start mass production toward early fourth quarter. The addition of the new foundry capacity will substantially grow TDDI revenue starting from Q4 with further growth expected throughout 2019. In parallel, to further widen our reach, we are working on new designs based on additional foundry partners’ processes which, however, will only be ready next year. We expect TDDI penetration will reach 40% in 2019, which represents an enormous growth opportunity for Himax. TDDI has more than double the ASP of the traditional driver IC with better margins. It will change our product mix for smartphone display driver IC and make a very significant contribution to our growth going forward. Looking into the third quarter, sales for smartphones are likely to decline around 40% sequentially as the TDDI shipment is constrained by capacity shortage and the traditional discrete driver IC is being quickly replaced by TDDI and AMOLED. In automotive segment, we continued to have new projects going into mass production which were design-wins of the prior years. During the second quarter, sales into automotive sector already accounted for more than 19% of our total driver IC sales and close to 16% of our total revenues. On top of the world’s first TDDI projects for automotives during the first quarter, our team further successfully added AMOLED design-wins during the second quarter. We have achieved a distant number one market share position thanks to our superior product quality, service and stable delivery. Q3 revenue in this segment is set to grow around 20% sequentially. For third quarter small and medium-sized driver IC business, we expect revenue to decline mid-single digit sequentially. The non-driver IC business segment has been our most exciting growth area and a differentiator for Himax in the past few years. Now, let me share some of the progress we made in the last quarter as well as our views on future growth opportunities. Since we announced 3D sensing as one of Himax’s long term growth initiatives in 2017, 3D sensing, led by Apple’s iPhone X, is gradually becoming a new industry trend as major Android smartphone makers beginning to integrate it into flagship models, although most of such projects are still in development stage. Leading Android smartphone makers are exploring various 3D sensing technologies, namely structured light, active stereo or ASC and, to a lesser extent, time-of-flight or ToF, trying to strike a good balance of cost, specifications and application. More software players are entering the ecosystem to develop 3D sensing applications beyond the existing applications, namely facial recognition, online payment and camera performance enhancement. Being a leading player in the 3D sensing space, Himax is in partnership with several leading smartphone names to enable their 3D sensing by providing optics, projector or total solution, depending on the customer’s needs and their in-house capabilities. The projects we are involved in cover all the three types of 3D sensing technologies mentioned above. These efforts will facilitate a broader adoption of 3D sensing on Android smartphones starting 2019. Our goal is to ensure that the smartphones backed by Himax 3D sensing technology will deliver the industry’s highest standard in all of 3D depth accuracy, indoor/outdoor sensitivity, power consumption, size, data security and eye safety. Now, let me go through the progress we have made in structured light and ASC 3D sensing businesses and our approaches. SLiM, our structured light 3D sensing hardware total solution, which we jointly announced with Qualcomm in last August, targets premium smartphone market. The Qualcomm/Himax solution brings together Qualcomm’s industry leading 3D algorithm with Himax’s cutting-edge design and manufacturing capabilities in optics, NIR sensors, and ASIC, as well as our unique know-how in 3D sensing system integration. It is by far the highest quality 3D sensing total solution available for the Android market right now. At present, we are working with customers who are targeting to bring new 3D sensing applications to smartphone, on top of facial unlock and online payment. We are now targeting the end of the year or early 2019 for shipment to the customers for their product launch in first half 2019, although the actual shipment date will ultimately be dictated by end customers. Another noteworthy update is that our SLiM total solution can work on Qualcomm’s high end mobile platforms now, as opposed to being limited to only the premium Snapdragon platform when we first launched the technology, thereby lowering the total cost barrier of 3D sensing. Our ASC 3D sensing solution, targeting mass market smartphone models, achieved a significant milestone during the second quarter. While structured light 3D sensing offers outstanding depth precision for its complex projector design, ASC 3D sensing can also enable facial recognition with a simpler projector. While it is somehow constrained by its limited depth precision, it is a lower cost alternative for face authentication and enjoys better software readiness since it is building on the existing dual camera ecosystem. We are already working with top tier smartphone makers and leading platform partners concurrently on multiple projects. Early shipment is targeted to begin towards the end of the year with major ramp in 2019, although again the actual shipment date will ultimately be dictated by the end customers. We expect more design-wins in the coming months. It appears that ASC 3D sensing, with its cost advantage and the existing dual camera ecosystem, has a better chance of accelerating 3D sensing adoption for facial recognition on Android smartphone market during 2019. As anticipated, the shipment volume to our WLO customer for the second quarter was a lot higher versus that of the first quarter and our WLO capacity utilization improved subsequently. We expect the shipment for the second half to increase significantly versus that of the first half. The overall 2018 shipment will increase considerably year-over-year. Meanwhile, we are encouraged by the progress of our new R&D projects with the said customer for their next generation products centering around our exceptional design know-how and mass production expertise in WLO technology. We are very excited about the significant growth opportunities of these projects. While 3D sensing is the top priority of our WLO business at present, we also have engineering collaboration with select world-class technology leaders to develop wave-guide for AR glasses and micro displays using our advanced WLO technology. We expect to kick off new R&D projects during the third quarter. 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 is going 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 105 million budget, 33 million has been paid out in 2017, followed by 17.5 million made in the first quarter of 2018 and another 15.2 million in the second quarter. The payment for the remaining 39.3 million is to be made throughout the rest of 2018. With the anticipation of broader 3D sensing adoption in 2019, we expect to further expand production capacity towards the end of the second half. Kick-off timing and amount of the Phase II investment is still being evaluated, depending on the customers’ projected volume and timetable. As we mentioned in the 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 and will start to draw down some of them in Q3. In the last earnings call, I reported Himax has been working with the industry leading fingerprint solution provider to develop an under-display optical fingerprint product in the last two years, targeting smartphones using OLED displays. Himax provides a customized low-power image sensor in the solution. I am pleased to announce that the solution has entered into mass production with a major Android smartphone OEM for their new flagship model with shipment expected in the coming months. The CMOS image sensor used in the solution will have a notably higher ASP than the company’s traditional display driver IC products. On other CMOS image sensor business update, we continues to make great progress with our two machine vision sensor product lines, namely, near infrared sensor and Always-on-Sensor. NIR sensor is a critical part for both of our structured light and ASC 3D sensing solutions. We expect significant growth in our CMOS image sensor business as 3D sensing shipment gets started. On the AoS product line, the acquisition of Emza enables Himax to be uniquely positioned to provide ultra-low power imaging sensing solutions, leveraging Himax’s industry leading super low power CIS design 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 new frontiers for Himax. For traditional human vision segments, we see strong demands in laptop and increasing shipment 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 automotives. While AR will take a few years to fully realize its market potential, we have seen many companies, be the top name multinationals or new start-ups, invest heavily to develop the ecosystem -- applications, software, operating system, system electronics, and optics. We are slated to kick off another AR goggle project with tailor-made micro display for a tier-1 tech name during the third quarter. In addition, we continue to make great progress in developing high-end holographic head-up display for automotives. Timing for such revenue contribution would be 2019 the earliest. For non-driver IC business, we expect revenue to increase around 15% sequentially in the third quarter driven primarily by WLO shipment. That concludes by prepared remarks 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.

[Operator Instructions] Our first question comes from Jaeson Schmidt of Lake Street Capital.

Wondering if you could quantify the impact to Q3 from the capacity constraints you’re seeing?

Right. Actually the shortage, if you talk about TV and large panel display driver combined, it’s in the range of between 10 million to 20 million units. Having said that though, I think it is slightly tricky to so-called quantify the shortage because shortage is a general phenomenon right now in the marketplace for driver IC. So, when we have a severe shortage, customers tend to overbook their demand. So, but to high extent, certainly, we cannot know for sure. So, our 20 million, close to 20 million units of ICs of shortage can be slightly inflated, but the extent is very severe for sure.

Okay. That’s helpful. And then Jordan, just want to clarify your comments on the SLiM structured light 3D sensing solution. Are these wins you currently have or is this time table to ship towards the end of this year and ’19, just based on what you assume customer launches will be? I’m just trying to get a sense if these are actual wins occurred or if there is a risk that these OEMs might look to competing technologies?

I think I mean, certainly, they are – the customer is very secured and certainly this already a decision to use structured light as the technology of choice for such customers. And timetable is more pretty thin to predict, because in addition to engineering per se, always wants to be – this is primarily the hardware total solution, but there is a whole bunch of software stuff, the entire integration efforts and most importantly, the business aspects which depicts, it detects the customers’ launch timing as well. So, the timetable education, we mentioned in our prepared remarks, it’s something given by our customers. But I think, we have to understand in that – we just have to work with our customer for the actual on state, but certainly our shipment will be earlier than the consumers launch and shipment.

Our next question comes from Suji Desilva of Roth Capital.

For the TDDI market, can you talk about what the unit growth is in the industry and what you think your share will be exiting ’18?

Our share will be very limited, because as I said, primarily of the [Technical Difficulty] trend, our product and technology have been well qualified by quite a number of top tier phone customers. But I actually – I mentioned, I answered the same question last quarter in our Q&A, I’m going to repeat it. We are in – actually a slightly unfortunate situation for us. Our qualification, I mean, it’s a capacity type situation that everybody knew and our qualification with the few top name end customer is behind our major competitor by probably, let’s say, in a month. But the result, the difference is enormous because he ended up, the function – the bulk of the capacity has been secured by our competitor. So our excess tool is in sync, capacity tool, which we share with our competitor is very, very limited and that limits our shipment for this year and that is why I think we work very hard and we believe we are ahead of peers in terms of qualifying and getting ready for new foundries. So, I can tell you our shipment in – our target for Q4 will be around 10 million units, which we actually said in our – in previous earnings calls. So we are not changing that target. Although, they are pretty much in the quarter, right. I am talking about last quarter. Total of 3 million, I will say, actually about 5 will be [Technical Difficulty] there will still be a ramp in process, even during the first quarter. So first quarter total will be 10 million units around. In comparison, third quarter will be about 5. And the previous quarter, second quarter will be about 6. The reason why we are, we suffered from some decline is because second quarter was our first threat and before the very first shipment, we get to an access to more earlier months of capacity and that is why we’ve got to have a little bit more capacity available to us for the first quarter of – the very first quarter, i.e., Q2 of shipments. But in Q3, there is no such luxury. So, our total shipment is expected to still decline. So Q4 is expected to above double from Q3 and I would say, in between end of Q1 to Q2, beginning of Q2 next year, our single month shipment I think is on track to reach, I would say, about 10 million, on a single month basis. And then the next breakthrough of additional capacity will take place probably in Q3 of next year. When I will say there will be no longer a capacity shortage issue for us. So there will be a ramp in schedule of 5 million in Q3, 10 million in Q4 and then going up to Q1, Q2, continue to increase. Within the first half of next year, we will reach about 10 million per month and then the second half will hopefully double that. That is our target, our goal and I think it is reasonable achievable. Customer demand is in qualification is not really an issue for us right now. We have suffered big time from capacity shortage. That’s unfortunate, but that’s something we are dealing with right now.

And then on the WLO, you can guide for a strong 3Q, do you have a sense of what the follow through demand would look like in the fourth quarter, does it hold at a high level, does it drop off from the initial build, any thoughts on WLO would be helpful.

The major shipments are to one end customer, as I mentioned. And we have said very much that second half, we’ll see a major, major increase from the first half. So, Q1 this year was a low point. Major increase in Q2, another major increase in Q3 and another major increase in Q4. So you will see sequential increase quarter by quarter within this year.

Our next question comes from Gus Richard of Northland.

Just a quick follow-up on the wafer level optics, I believe you mentioned in the press release you’re working with your major customer on a new program, can you talk about how that might change your content per handset?

I think it will likely be more likely than not to be mass production projects for 2020. It involves some pretty aggressive improvements in various -- from various aspects of engineering. The value add or the dollar content of such new optics will be many times that of our – the existing product that we are shipping to the same customer and obviously, I cannot get in to any further details, but that will just be the most important project that we are working always. Then there are other projects as well. So the new projects are very challenging, something that is taken very seriously by the set customer and we are, I think, we are just very excited that the long term relationship is going very well and the project according to us is really a big deal in both the dollar content and engineering challenge.

Got it. And then, can you talk a little bit about expanding your wafer level optics business to additional handset customers and how that business might grow over the next year?

I mentioned in the prepared remarks that for 3D sensing, there are three types, right, structured light and ASC and ToF. And I also mentioned that we have been involved in all the three types of technology, especially the first two types. The adoption of ToF right now is fairly limited, as far as we can see in the marketplace. I also mentioned our involvement of our dispatching in customers’ projects in these three technologies, varied depending on the customers’ demand or they are multiple, they are in-house capabilities. So, the most limited exposure that we have is pure optics, meaning it is very old thing. Or we can be invited to do a bigger one, which is to integrate the optics with place, I put together with active alignment, put it together to form the projector. And that is the second type of involvement, which is heavier than the first type. And then there is a third type, which is a total hardware solution. This can be categorized into two different types as well, structured light, we talk about a fully totally integrated solution involving projector, and the sensor on the receiving end and ASC IC for algorithm. In the case of ASC, typically, it is projector and also two sensors. And there is no discrete ASC for the algorithm because two same costs, now the market tends to have the AP smartphone AP and the really algorithm. So there are different types of involvement, but regardless of which type, I think what we’re seeing right now is a few things. One, our optics is over developed, whether it is optics only or projector, because projector covers optics, it’s a total solution, certainly also covers optics. So I can say with all the projects we are involved in, optics is always a key item. Secondly, I also said in the prepared remarks that because of cost issue, ASC now appears to be a more popular solution compared to structured light, which is really limited to very high end premier model. So, in terms of volume ramping, targeting for next year, then you talk about our WLO capacity, I think, it will be driven primarily by ASC. I am certainly excited that the anchor customer, that I mentioned earlier, right, that is different story, I’m talking about they Android market 3D sensing. So ASC will drive our capacity expansion next year. I mentioned it is highly likely that we have to start to prepare more capacity. Our current capacity right now is about 2 million units of optics per month. It is more than likely that we have to add more capacity into that, starting perhaps later this year, because primarily the ASC, we have multiple customers in multiple projects as well as a lot of them enter into mass production. I think it is likely now as capacity will have to get increased. So I hope that answers your question.

Our next question comes from Rob Stone of Cowen and Company.

Good morning. A couple of questions. The first one, Jordan, you mentioned the design win for an AMOLED display driver in automotive. I’m just curious if you have a sense of the time to revenue or mass production, given lengthy design in cycles for auto?

The customers’ target is actually end of 2019, but I think more conservatively, I will say 2020.

And on your CMOS in display fingerprint sensor project, which I think you said is in mass production and it should be launching soon. Can you provide any color on how you see that positioned in terms of system costs relative to the options for facial recognition and how we should think about volume for that product?

It appears to be to enjoy pretty good momentum right now in the Android market. Okay, because of cost issue. The business can change overnight in how they are, firstly, the cost, I’m talking about the total solution, which includes most importantly the CMOS image sensor, and as I said optics and certainly algorithm chip combined at the module. Initially, when the technology was promoted, we’re talking about $10 in total, but now, we are seeing $10 plus in total. Now, we’re seeing the total cost is now coming down to $10 or even below. And because of certain cost saving measures adopted by module houses, in particular, in the optics side. So for that reason, again, customers want full screen design and they don’t want their capacity touch to be on the back, which is not convenient to use. So for full screen design, if you feel structured light too expensive, ToF is also quite expensive and even ASC is relatively expensive because ASC now, we’re still talking about $10 plus and this thing, fingerprint is already below $10. So for that reason, it seems to be picking up momentum. However, I will have to say that the limitation of fingerprint is that it can do nothing out of the fingerprint, whether it’s all three kinds of 3D sensing, you can have a lot of other applications beyond unlocking your smartphone and payment. Right. So I think that is the most important thing. And certainly, under glass fingerprint, one reason why it is getting traction by it, it is not really becoming overwhelming. One of the issues is it still suffers from its lesser satisfactory accuracy, meaning when you try to unlock your phone, the failure rate still is too high. And when it fails, you have to – the user will have to key in the password, which people hate, right. So in comparison, 3D sensing or face authentication, the accuracy level is a lot higher. And so they are certainly a big wildcard will be our first launch in expected September, right, in the new phones, whether they can introduce interesting attractive new features, application to 3D sensing. So all this combined that we are watching very closely and the thing is that we are participating in all the technologies mentioned above. So I’m not saying that we’re pretty necessarily very heavily on one thing and we are against other things not necessarily. We just have to play along with the market. But I think it is still slightly too early to tell who is going to dominate which segment of the market as of today.

Finally, just a more housekeeping question for Jackie, so your Q3 guidance revenue about flat, gross margins down some sequentially, but non-IFRS earnings per share up slightly, so should we interpret that as indicating operating expenses are going to be down quarter-on-quarter or is there something else going on within OIE and taxes that we should be aware of?

Yes. I think it is operating expenses. The operating expenses, taking out the RSU portion, the restricted stock unit in Q3, actually Q-on-Q, we are looking at a decline. The decrease in operating expenses in Q3 versus Q2. So contributed to a non-IFRS EPS higher than the ones in Q2. Yeah. Not necessarily higher, but that’s right. Yeah.

Our next question comes from Tristan Gerra of Baird.

Hi. Looking on the manufacturing standpoint, some companies have talked about increases in raw material costs. As you ramp capacity later this year, could there be any issue, could that be a mitigating factor to gross margin?

Not necessarily. I think we – yes, capacity is limited and we have to accept some price increase from our vendors. But that’s something we can always pass on to our customers. So, that factor alone does not really impact, certainly not negatively to our gross margin.

Okay. And then could you talk about your expectation in terms of adoption for [indiscernible] TDDI and the market share that you expect to have next year in that particular segment relative to the entire TDDI market?

I think it really depends on the penetration of TDDI, and TDDI’s main competition right now obviously is OLED. So, let’s take a wild assumption, which is something I don’t know for sure. Right. Let’s say 40% to 50% smartphone penetration be in TDDI. Now, if you take a ballpark number of 120 million smartphones per month, you will be talking about 50 million to 60 million TDDI chips of demand. So per month, 50 million to 60 million per month. So that compares to our – my earlier Q&A where I said in somewhere in the first half, probably middle first half, our monthly output should reach 10 million and in Q3, hopefully, more than 20 million. So if you compare that, we started the some 15 million of demand that ballpark, I mentioned earlier. I think that will give you an idea.

Okay. And then finally, if you could elaborate a little bit on the outlook that you see for the emerging project in micro display for AR type of applications.

I’m sorry, what for AR type applications?

The micro display type of engagements that you have and elaborate a little bit on the trends that you see there?

We -- almost every quarter, we have new projects, engagement with various customers. I think we are still regarded as the industry leader in terms of providing micro display for AR goggles. We mentioned in my prepared remarks that we are set to kick off another AR goggle project with tailor-made micro display for a tier 1 tech name. This is something that I think could be quite important. It’s all of the biggest tech names in the world. They are still putting major resources into developing the AR devices and I think we together spend a very long time discussing the space and technology and we are ready to kick off a major new projects. So that I think is just a indication that the industry under water, let me put it that way, there are no major launches in terms of the eye catching project such as [indiscernible], but under the service, there are still a ton of activities, sponsored by such top tier end customers and we are still their partner of choice in terms of providing micro displays.

Our next question comes from Charlie Chan of Morgan Stanley.

So my question is also about 3D sensing, because now there is also some new design of under display fingerprint. So in your view, is that under display fingerprint and active stereo camera would be neutral at customers’ design. That is my first question.

I think so. Yes. I mean for now, because our fingerprint, I said earlier, right, the only function is to unlock your phone and if you already in 3D sensing, which can unlock your phone, why do you want to double the effort and cost. Unless you are not really very confident about your 3D sensing. So, I mean, when customers adopt high end solution, it is not happening. So when you have 3D sensing, I don’t see why you still don’t have fingerprint.

So where is the strength heading to, I mean, next year, do you expect AFC will outgrow under display fingerprint or put another way, finger print will strengthen at active stereo camera.

I think my view is it’s still too early to say. I mentioned earlier, right, lot of factors can change the picture. It is quite simple for fingerprint, which is unlocked and it added to us, so you can have it onto your display and do an unlock rather than to, like, if you want to have a full screen display, right, you still adapt the old capacity type fingerprint, the fingerprint has replaced on the back, which is not convenient, right. So that is the advantage. That is why it enjoys a major premium in terms of price compared to capacity type which is now already very, very long costs as you probably know. So, under glass has got advantage, fiber class [indiscernible]. So assuming 3D sensing, the market can develop some interesting applications, then I think that really will always be the cost saving provided by under glass fingerprint. That will be my view. However, there will always be more entry level phones, which primary objective being cost saving and they may thing otherwise. So, I think, they will coexist in the marketplace. How they will play out, get each other. I think the major difference is, in terms of their features and costs. I think I have covered it all. It’s mostly because payer is, for example, interesting features, it will really be a key application that customer really wants and if we can develop processing, then there is certainly 3D sensing, we will be very popular than fingerprint and very strong. So I think we will find out greatly next year.

And the next one would be, so within the ASC 3D sensing, what is the competition now? We’ve heard that Sony could have the kind of sensor and maybe OmniVision is also doing a similar solution. So if ASC 3D sensing were to take hold, what kind of market share would you expect?

No. There are two things, you must consider. One is optics fast projector, right. And your question was about the sensor type. Yes. We are competing with the names you mentioned who offer what we call global shutter sensor. And our sensor is really shutter, we have pros and cons in the two types. Shutter enjoys better cost while global shutter is faster in response. But, quite a number of customers on top of total solution, which covers both projector. That includes optics and sensor. They are also customers who adopt some of our competitor sensor while adopting our projector. Or other people’s sensors and even other people’s particularly the integration and only adopting our optics. So I mentioned, we are – one way or another, we are participating. We are participating in, I would say, as long as ASC for all the projects, I am aware of in the marketplace, we are involved one way or another. But you are right, in saying that we do have competitor in sensor. So, and they are indeed, I know of projects where our competitor sensor is adopted, projector is totally adopted.

So hope your existing will be materialized.

Our next question comes from Jerry Su of Credit Suisse.

The first question is on time-of-flight. I think you have elaborated a little bit about the three other different technologies on the 3D sensing side, but for time-of-flight, can you give us more color about the module cost for this versus the other two, and also a high max of value add or your role in the time of flight 3D sensing?

Time-of-flight is a more uncertain anymore as far as we can tell for now. We will probably have a better picture next year. We are aware of a project, which the customer adopt time-of-flight for main camera, 3D sensing. And the reason why time-of-flight is chosen is for – to take advantage of this longer range. So structured light or ASC for front camera, for, it’s only within one meter. Then you feel, if you use it for main camera, the operating range can be somewhere around 5 meter or maximum probably 5 to 10 meter. Beyond that, so far, there is, it’s not reachable. So that is where time-of-flight comes in and play a role. However, the total module cost of time-of-flight is still very expensive, arguably more expensive than structured light. And that is why, so for two reasons, one, for main camera application, quite effective, the apps. That consumers will be willing to pay so much to buy. And so that is still a big known question and secondly certainly the less than mature ecosystem and the relatively high costs, all these factors combined are like limited this adoption right now. And our participation, we’re invited to provide optics as usual, because, our WLO 3D is leading edge. So, that is the extent of our participation for now.

Okay. Thank you. And then the, just a follow-up question on the ASC, can you give us a little bit more color about what is the progress right now, you have mentioned about potential design wins in the next couple of months in the shipment, later this year or early next year. But what is the progress right now? Which steps are you or your partners, is it that final reliability test, where it’s software integration, payment authentication, just give us a little bit of color on this?

There are two types of partnerships. One is direct engagement with end customers and the other type is partnership with platform, AP platform providers. And we are very active on both. I would say no, it looks likely that the progress of the first type, i.e., directly with end customers is faster than the other type, for the obvious reason that customers directly take control and they can move the progress more quickly. So the, so because it’s direct customer, end customer’s project, I’m afraid, I cannot really disclose too much details about the progress of their projects. But I’m talking about multiple customers with certain customers, even multiple projects. But then again, so in terms of ASC, I repeat again, what I just mentioned in response to Charlie’s question, for the projects we know of, we have been able to play a role, whether it’s pure optics or projector or a total solution, including projector and sensor. So we are excited one way or another as long as some of the ASC projects take off, we will get to enjoy the benefit. And as far as timetable is concerned, I would just repeat what I just said in prepared remarks, end of the year, some – probably small volume at year end on preparation for customers’ launch first half next year. I think beyond that, I am afraid I cannot disclose too much, especially for direct customers’ project.

Maybe asking the other question the other way, so do you think that the payment qualification is going to be a issue for ASC, given that it has less accurate, less data on that sensing side.

What is happening right now is that although this is not final, final, final, right, the thinking for now is to limit the payment amount, meaning, it’s not limited limit the payment amount to X dollar or X renminbi for ASC, given that it is slightly compromised 3D, compared to structured light. But certainly, we together with our partners, are working very hard to even try to unlock that, but that is the direction we are moving towards right now.

[Operator Instructions] Our next question comes from Donnie Teng of Nomura.

My first question is regarding ToF. So I noticed that this is the first time you mentioned about ToF from past few quarters and could you elaborate more on your progress right now and what kind of component stack you can be reusing on ToF from your structured light and ASC solutions?

As I said, there is wide array of projects that we are involved in and that is arguably, probably the only project that we know of in the marketplace right now that involves main camera. Our participation is in optics, although, with some other things that have been discussed, we are being invited to have a broader participation. I cannot elaborate more on that. So, in terms of prior project, there is one that we know of, where we are optics provider, but there are other R&D projects that are being explored where we can have a bigger role or participation.

My second question is regarding to your project with the US customers. So I’m just wondering if the US customer has some design change next year, do you think we have more opportunities or risk after all, we have already participated in their project already. So what do you think about the opportunity and risk next year?

Good question. I think the opportunities that [indiscernible] and also the opportunities that we are being told, our products will be reused for next year’s projects. There will be no change and certainly longer term, as I said earlier, we are working with them for other more advanced projects, but the portion we play will get the carry into next year, next year’s production. And the volume is slightly to be bigger because there will be more firms.

There are no further questions. I’d like to turn the call back over to management for any closing remarks.

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

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