Hello, ladies and gentlemen. Welcome to the Himax Technologies Incorporated Third Quarter 2020 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to your host, Mr. Mark Schwalenberg from MZ Group..

Welcome everyone to Himax’s third quarter 2020 earnings call. Joining us from the company today are Mr. Jordan Wu, President and Chief Executive Officer; Ms. Jessica Pan, Chief Financial Officer; and Mr. Eric Li, Chief IR/PR Officer. After the company’s prepared comments, we have allocated time for questions in a Q&A session.

If you have not yet received a copy of today’s press release, please e-mail himx@mzgroup.us. 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 in this conference call, including statements regarding expected future financial results and industry growth are forward-looking statements that involve a number of risks and uncertainties that could cause actual events or results to differ materially from those described in this conference call.

Factors that could cause actual events or results to differ materially from these 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 and technological innovations as well as other operational and market challenges and other risks described from time to time in the company’s SEC filings, including those risks identified in the section entitled Risk Factors and its Form 20-F for the year end December 31, 2019 filed with the SEC in March 2020.

Except for the company’s full year of 2019 financials, which were provided in the company’s 20-F and filed with the SEC on March 25, 2020, 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 are 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 would now like to turn the call over to Mr. Eric Li. Eric, the floor is yours..

Thank you, Mark and thank you everybody for joining us. My name is Eric Li and I am the Chief IR/PR Officer. Joining me today are Jordan Wu, our CEO and Jessica Pan, our CFO. On today’s call, we will first review the Himax consolidated financial performance for the third quarter followed by the fourth quarter 2020 outlook.

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. In addition to impact of COVID-19, which remained harsh in many parts of the world, the prolonged U.S.

China trade tension brought turbulence to the market and resulted in new market dynamic during the third quarter. The unceasing stay-at-home economic created new demand, but pushed foundry capacity constraint to a more severe level.

Despite these challenges, we continued to ask you efficiently and delivered strong business results in the changing environment. We pre-announced preliminary key financial results for the third quarter on October 6 for the revenue, gross margin and the EPS, all exceeding the guidance issued on August 6, 2020.

Today, our reported results for revenue, gross margin and the EPS are all in line with the pre-announced results. For the third quarter, we recorded net revenue of $239.9 million, an increase of 28.3% sequentially and an increase of 46.1% compared to the same period last year.

The 28.3% sequential increase of revenue exceeded our guidance of an increase of around 20% quarter-over-quarter. Display driver of TV, tablet, smartphone and automotive as well as CMOS image sensors, all contributed better than guided sales. Gross margin was 22.3%, exceeding the prior guidance of flat to slightly down from 21% of the second quarter.

IFRS profit per diluted ADS was $0.049, exceeding our guidance of around $0.02 to $0.028. Strong sales and improved gross margin contributed to the better than expected earnings results.

The EPS increase was, however, offset by the RSU expense, which was higher than what we were – was indicated on the last earnings call, but we raised the RSU amount to reward the team for the better than expected financial results. We will elaborate on this in few minutes.

Non-IFRS profit per diluted ADS was $0.073, exceeding our guidance of around $0.035 to $0.043. Revenue from large display drivers was $55.7 million, down 6.3% sequentially and up 11.3% year-over-year.

The sequential decline was driven by significantly lower shipments of monitor ICs due to customers’ inventory correction, following a demand hike in the first half. If combining the first three quarters of 2020, our sales into monitor segment still increased 22.1% from last year.

The demand for monitors remains robust and we expect a strong rebound in the fourth quarter. Offsetting monitor’s third quarter weakness was the surge in TV and notebook sales. TV segment revenue increased 17.6% sequentially, reflecting strong consumer spending and home entertainment demand.

Panel makers’ building of inventories in anticipation of higher TV panel prices also contributed to the sequential increase.

It was no surprise that notebook sales recorded the highest growth among large display products, increasing 31.5% quarter-over-quarter, thanks to the continuing demand for telework and e-learning with panel customers seemingly still sitting on low inventories.

Large panel driver ICs accounted for 23.2% of total revenues for the quarter compared to 31.8% in the second quarter of 2020 and 30.5% a year ago. Small and medium-sized display drivers recorded a very strong third quarter, with revenues of $151.6 million, up 53.5% sequentially and up 96.6% year-over-year.

TDDIs for both tablet and smartphone posted extraordinary sales growth in Q3. For the automotive segment, we delivered a decent low-teens sequential growth amid a declining automotive market worldwide. Small and medium-sized segment accounted for 63.2% of total sales for the quarter compared to 52.8% in the second quarter of 2020 and 46.9% a year ago.

Our smartphone sales, the best performing product category of all in Q3, reached a quarterly record high of $63.3 million, up 153.6% sequentially and 101.2% year-over-year. It represented more than 26% of our total sales in Q3. Our smartphone TDDI sales were up 155.7% sequentially and up 193.7% from the same period last year.

The significant sequential growth was a continuation from Q2 when the product category already grew 69% from the previous quarter. However, as mentioned in our last earnings call, the growth was capped by an industry-wide wafer foundry shortage.

Our smartphone and tablet TDDI ICs share the same pool of foundry capacity, and we were, and still are, unable to meet all the demands for these products.

The Q3 strength in smartphone TDDI reflected customers’ aggressive new product launch plans with our TDDI solutions as well as our ability to price our products higher to reflect the tight wafer foundry situation.

Amid the economic downturn and lackluster overall smartphone consumption, OEMs are pushing more for budget handsets using TFT-LCD screens, instead of more expensive AMOLED displays. Sales of traditional smartphone DDICs also surged by 147.8% sequentially and were up 5.3% from same period last year with demands from key brand customers.

We believe such strong sales of traditional smartphone DDICs were a short-term rebound as the product category is quickly being replaced by TDDI and AMOLED, as we have repeatedly indicated. Revenue for tablet posted a third consecutive record high, with Q3 sales growing 26% sequentially and 336.4% year-over-year.

The quarterly revenue reached $53.7 million, accounting for more than 25% of our driver IC revenue. We expect our tablet segment sales to continue to grow as overall market demand for tablet remains robust for more home working and online education needs, and TDDI’s penetration in tablet market continues to pick up.

Our tablet TDDI has a leading market position at a time when TDDI is quickly becoming mainstream for Android tablets. Third quarter tablet TDDI sales increased over 35% sequentially and were better than our guidance of a 20% increase.

This marked the second consecutive quarter of increase in tablet TDDI shipments since the initial mass production in the first quarter of 2020, and we are firmly in the leading position among peers. However, as mentioned above, the sequential growth was crippled by tight foundry capacity as we couldn’t ship enough to meet all customer demands.

Revenue of traditional discrete driver ICs for tablet also delivered 20.3% sequential growth and was up 164.5% year-over-year in the third quarter, thanks to strong orders from both leading brand and white box names.

Our third quarter driver IC revenue for automotive was up 13.2% sequentially and up 3.9% year-over-year despite a sluggish global automotive market. The sequential growth was owed, to a large extent, to the aggressive pursuit of market share gains by China panel maker customers, to which we are a major supplier.

These customers are comfortable with Himax leading technology and proven production record which supports them in their efforts to ramp up production swiftly. With global automotive demand showing signs of recovery, we expect to see robust and sustainable growth in Q4 and into 2021. Jordan will elaborate on this in few minutes.

Third quarter revenue from our non-driver businesses was $32.6 million, up 13.3% sequentially, but down 12.1% year-over-year.

The sequential increase was mainly a result of higher engineering fee income and increased shipments of the Tcon for higher frame rate and high resolution displays as well as CMOS image sensor products with demand coming from notebook and IP camera applications.

However, the increase in sales was offset by a decrease in WLO shipments to anchor customers. Non-driver products accounted for 13.6% of total revenue as compared to 15.4% in the second quarter of 2020 and 22.6% a year ago.

Gross margin for the third quarter was 22.3%, up 130 basis points sequentially and up 280 basis points from the same period last year.

The sequential increase was contributed by a favorable product mix of more shipments of better margin products such as tablet and automotive ICs, higher engineering fee income and resales of certain products whose values have been written-off previously in accordance with our inventory management protocol.

Weighing on gross margins were lower WLO shipments, which decreased factory utilization, and increased shipments for smartphone ICs, which registered a lower gross margin than corporate average.

Gross margin increased 2.8% from last year, thanks to a more favorable product mix with more shipments of tablet and Tcon, higher engineering fee income and resale of written-off products. Likewise, the gain was offset by lower WLO and higher smartphone shipments.

Our IFRS operating expenses were $44.2 million in the third quarter, up 17.4% from the preceding quarter and up 11.4% from a year ago.

The sequential expense increase was caused mainly by $4.8 million of RSU, the immediately vested portion of the total RSU grant, which was higher than the $3 million guided on the last earnings call to beneficially compensate employees from a better-off profit. The $1.8 million additional RSU expense represents $0.009 lower in after-tax EPS.

The increased salary also contributed to the higher operating expenses. The year-over-year increase was a result of increased RSU. 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 $5 million, out of which $4.8 million was vested immediately and expensed in the third quarter. Non-IFRS operating expenses for the third quarter were $38.9 million, up 4.8% from the previous quarter, but down 0.9% from the same quarter in 2019.

IFRS operating margin for the third quarter was 3.9%, up from 0.9% in prior quarter and up from minus 4.7% in the same period last year. The sequential increase was mainly due to higher sales and better gross margin, but offset by higher operating expenses.

The year-over-year improvement was primarily a result of higher sales and improved gross margin. Third quarter non-IFRS operating profit was $14.7 million or 6.1% of sales, higher from non-IFRS operating profit of $2.1 million or 1.1% of sales last quarter and up from minus 4.4% for the same period last year.

IFRS profit for the third quarter was $8.5 million or $0.049 per diluted ADS compared to profit of $1.4 million or $0.008 per diluted ADS in the previous quarter and loss of $7.2 million or $0.042 per diluted ADS a year ago.

Third quarter non-IFRS profit was $12.6 million or $0.073 per diluted ADS compared to non-IFRS profit of $1.7 million or $0.01 per diluted ADS last quarter and non-IFRS loss of $6.9 million or $0.04 per diluted ADS for the same period last year.

Turning to the balance sheet, we had $142.9 million of cash, cash equivalents and other financial assets as of the end of September 2020 compared to $128 million at the same time last year and $107.1 million a quarter ago. The higher cash balance was mainly a result of an operating cash inflow of $33.5 million during the quarter.

Restricted cash was $104 million at the end of the quarter compared to $164 million of the preceding quarter and a year ago. The restricted cash is used to guarantee the short-term secured borrowings for the same amount.

We repaid a total of $60 million short-term secured borrowings during the quarter, and in the meantime, the restricted cash deposit was reduced by the same amount. Separately, during this quarter, we entered into a new 10-year unsecured loan agreement of $60 million and repaid all short-term unsecured borrowings totaling $58.4 million.

As a result, we had $60 million of long-term unsecured loans as of the end of Q3, of which $6 million was current portion. There was no more short-term unsecured loan as of the end of the quarter compared to $58.4 million a quarter ago and $90.6 million at the same time last year.

Not only have we strengthened our balance sheet by replacing all short-term unsecured borrowings with 10-year loans, we also managed to secure favorable terms of new long-term loan so that the additional interest payments are minimal.

Accounts receivable as of the end of September 2020 were $221.1 million, up from $206.1 million last quarter and $157.3 million a year ago. DSO was 99 days at the end of the quarter as compared to 86 days a year ago and 101 days at the end of the last quarter.

Inventories as of September 30, 2020 were $125.7 million, down from $161.5 million last quarter and $167.6 million a year ago. The much lower inventory level in Q3 was a result of strong customer demands amid tight foundry capacity.

While we will continue to pursue an aggressive inventory buildup strategy, our inventory position will likely remain at such a low level in the foreseeable future given the severe foundry capacity shortage prevailing in the marketplace.

Net cash inflow from operating activities for the third quarter was $33.5 million as compared to an inflow of $24 million for the same period last year and an outflow of $9.2 million last quarter. Third quarter capital expenditures amounted to $1.2 million versus $31.2 million a year ago and $0.7 million last quarter.

The third quarter CapEx was for R&D-related equipment for our IC design businesses. As of September 30, 2020, Himax had $172.4 million ADS outstanding, little changed from last quarter. On a fully diluted basis, the total amount of ADS outstanding was $173.4 million.

Now, turning to our fourth quarter guidance, for the quarter, we expect further revenue growth from the already high level of Q3 in most of our business sectors. Gross margins will see a major uptick and could reach a quarterly historical high for us. For the fourth quarter, we expect revenue to increase by around 10% sequentially.

Gross margin is expected to be around 29%, which will depend on final product mix. With the increase in revenue and the margin growth in fourth quarter, net income should increase sequentially. To further reward employees, there would be another $3 million of cash bonus in the first quarter, which will be expensed immediately.

This represents $0.014 lower EPS. IFRS profit attributable to shareholders is expected to be in the range of around $0.15 to $0.16 per fully diluted ADS. Non-IFRS profit attributable to shareholders is expected to be in the range of $0.151 to $0.161 per fully diluted ADS. I will now turn the call over to Jordan. Jordan, the floor is yours..

Thank you, Eric. Before we walk through each of our major product segments, I would like to briefly comment on the background for our upbeat Q4 gross margin guidance and our view on the sustainability of the higher margin.

First off, gross margin expansion has always been at the top of our agenda and we will surely work hard toward continuous profitability improvement. The upbeat Q4 gross margin guidance is mainly a reflection of the tight foundry capacity, which results in better pricing and more favorable product mix.

The foundry industry appears to be going through a structural change in the supply demand dynamics for the mature process nodes, both 8-inch and 12-inch. We believe the current tightness is likely to persist throughout the next few years.

Major volume applications such as display driver ICs for TDDI and AMOLED, PMIC for 5G smartphone, CIS that is ever upgrading in resolution, just to name a few, are significantly expanding in wafer consumption and competing for the same pool of mature nodes, while the industry has no major expansion plan in sight for such capacity.

As Eric mentioned, we are experiencing major foundry supply shortages in quite a few of our major business areas, including TDDI and DDIC for smartphone, tablet and automotive applications as well as CMOS image sensor.

For next year’s wafer demands, we have has secured with our foundry partners a capacity which is already larger than our total shipment for this year. On top of that, we are developing additional capacities for various product areas with an aim to further our available foundry pool for the next few years.

Some of these new capacities will start making contributions next year. We will report the progress in due course.

Another important factor for continuous gross margin improvement will come from a number of our non-driver products, which are either already in volume production and look on track to grow in size, such as timing controller and ultra-low power CIS or will be new additions to our revenue stream, such as the WiseEye total solution and the WE-I ASIC chip.

Again, gross margin expansion will continue to be one of our major business goals for next year and beyond. Now let us start with an update on the large panel driver IC business. For the fourth quarter, we expect large display driver IC revenue to increase by high-single-digit sequentially.

This is due to the extension of strong demand derived from persisting home working and distance education, resulting in growing monitor and notebook demands. We expect a decent sequential increase of around 20% in the monitor segment in the fourth quarter.

As for notebook, we anticipate even stronger momentum in Q4, increasing more than 75% quarter-over-quarter. We have active design activities in high end monitor and new generation low-power notebook where we provide not only our driver IC, but also timing controller.

Especially in gaming monitors and e-learning notebooks, we anticipate more market share gains from the design wins of our leading display driver ICs and Tcon with key customers. With respect to TV, we expect mid single-digit sequential decline in the fourth quarter owing to a correction to a surge in TV demand in the previous quarter.

Recently, we saw top-tier TV brands with aggressive promotion tactics in 8K TVs in anticipation of major sporting events resuming across many countries after a long lockdown. Our 8K TV display drivers and timing controller ICs have been widely adopted by multiple leading end customers.

It is worth highlighting that we have been developing and delivering timing controller products for many years, and this segment already represents more than 5% of our total revenues. It is applied in a wide range of products such as TV, monitor, notebook, and automotive.

Our technology not only provides higher resolution, higher frame rate and better image quality, it can also enable lower power in products where power consumption is critical. The margin and ASP of the timing controller products are much higher than those of display drivers, and we expect this segment to be an extensive long-term growth opportunity.

Our Tcon revenue in the fourth quarter, while limited by a capacity shortage in IC packaging due to competing demands from 5G chipsets, is on track to increase by more than 20% sequentially. This will represent more than 40% increase annually.

Now, let’s turn to the small and medium-sized display driver IC business, beginning with an update on the smartphone segment. Our TDDI product roadmap as well as new design wins and new production plans all position Himax well to gain market share throughout 2020 and into 2021.

As I mentioned on the last earnings call, the pandemic has weighed on the global smartphone shipment significantly due to supply chain disruption at the beginning of the year, followed by a lackluster consumer demand. However, the smartphone market has regained some momentum in Q3, and the momentum seems to have carried into Q4.

On the backdrop of a rebounding smartphone market, our smartphone TDDI revenue is projected to have nice high-teens sequential growth in the fourth quarter, although foundry capacity remains a major growth constraint. Traditional display driver ICs for smartphone, after a temporary spike in Q3, is set to decline double-digit in Q4.

As stated before, AMOLED technology has advanced to become the mainstream display for high end smartphones. Himax is highly committed in this field. Much progress has been made by collaborating with leading panel makers across China. Our development started from smartphone and extends to wearable, tablet and automotive with Chinese panel makers.

We believe AMOLED display driver IC will become one of the major growth engines for our small and medium panel driver IC business from 2021. Tablet has been one of our top sales contributors throughout 2020. In the fourth quarter, it is on track for another sequential growth of over 20%.

As mentioned on previous earnings calls, for consumers, tablet TDDI offers a lighter weight and slimmer and more stylish design as well as improved touch accuracy with added option for active stylus, specifically geared toward high quality writing and drawing.

Himax is a pioneer in the tablet TDDI technology and led the market for mass production in the first quarter of 2020. At present, we are the dominant supplier for literally all leading Android names.

Tablet TDDI represents a tremendous upside potential for Himax, thanks to its higher ASP and more units of TDDI chips in each tablet than those for smartphone. We expect a sequential increase of around 80% for our tablet TDDI in the fourth quarter as the penetration of in-cell touch into tablet continues to accelerate.

To expand and strengthen our position in the market for next generation models, we are working on new designs with resolution and touch accuracy upgrades, targeting larger size tablets from key customers.

For traditional DDIC for tablet, we expect low-teens sequential decline for Q4, but sales to be up more than 50% compared to the same period last year due to the booming tablet demand arising from home working and remote learning.

The demand for traditional DDIC for tablet is also being eroded by in-cell TDDI, but at a more moderate pace than that for smartphone. Turning to the automotive sector, as the panels inside a car continue to grow in both number and size, the demand for automotive driver ICs is well positioned for healthy growth in the coming years.

Although the global car demand has been badly hit by COVID-19, especially in the first half of the year, the market is showing signs of gradual recovery, starting Q3. Our automotive ICs, which enjoy higher gross margins, are experiencing a solid rebound lately with car makers rushing in for inventory replenishment after quite a few sluggish quarters.

The demand for automotive display ICs for more sophisticated and higher-performing displays has continued its rising trajectory.

Advanced new features such as in-cell touch, local dimming, cascade topology connection and point-to-point high speed interface bridging functions are being adopted with Himax being the primary partner for major automotive panel makers and Tier 1 players to enable these new technologies.

With these new technologies on track for more shipments starting 2021, we are confident that our automotive segment is hitting another inflection point with a strong and positive long-term outlook.

For the fourth quarter, revenues for small and medium-sized driver IC business, is expected to increase by around mid-teens sequentially with demand continuing to surpass supply. Capacity shortage remains a major factor that negatively impacts our capabilities to make more shipments to customers.

In consideration of capacity constraints, which may not be resolved shortly, we often have to strategically prioritize the production of products for those customer models where we are the key supplier and/or enjoy better profitability. Now, let me share some of the progress we have made on the non-driver IC businesses in the third quarter.

First, on the WLO business, the fourth quarter WLO revenue declined sequentially as a result of lower shipments to an anchor customer. Our WLO factory will continue to manufacture the anchor customer’s legacy products going forward.

With our exceptional technologies of WLO in nano-imprinting manufacturing and diffraction optics design, we have been engaged by multiple customers, partners to develop future generation products covering a wide range of applications such as ToF 3D sensing, waveguide for AR goggles, biomedical devices and others.

Next is an update on the 3D sensing business. Targeting next generation Android smartphones, we are collaborating with leading laser and ToF sensor vendors to develop a new world-facing 3D sensing camera, whereby we provide optical components and/or projectors which are critical for the performance of the whole ToF solution.

For non-smartphone 3D-sensing engagements where we provide a structured light-based 3D sensing total solution, our target markets range from smart door lock, facial recognition-based e-payment, business access control to biomedical inspection device. A number of recent design wins will enter into mass production soon.

Alternatively, we also offer a market-leading 3D decoder ASIC to those customers who wish to design their own structured light 3D sensing solution. Here we have had quite a few design wins from customers targeting China’s vast e-payment market with some shipments already starting in the fourth quarter.

We are also working with customers for industrial robotics, smart door lock and home security, all of which carry great potential for our 3D business in the future. Now switching gears to WiseEye smart sensing solution.

As I mentioned on the last couple of earnings call, in order for our WiseEye technology to reach its maximum potential, we have adopted a flexible business model, whereby in addition to a total solution where we provide processor, image sensor and AI algorithm.

We also offer those key parts individually in order to address the customer’s different needs and widen our market reach. For the total solution offering, our current focus applications include notebook, TV, doorbell, door lock and air conditioner as we continue to work out new solutions to cover further edge device AI markets.

In partnership with leading players in their respective industries, a number of these solutions are slated to enter mass production in 2021. For the other type of business model where we only offers key parts, our strategy is to actively participate in the ecosystems led by the world’s leading AI and cloud service providers.

In addition to the collaboration with Google on their TensorFlow Lite for micro-controllers that we announced previously, we are making another major breakthrough by partnering with another world-leading cloud service provider with a business focus more toward healthcare, financial services, government, retail and industrial manufacturing.

Separately, to further lower the technical barrier for using our WiseEye solution, we teamed up with a leading online store specialized in easy development tools for machine learning on edge devices.

We are extremely excited about the rapid business progress and believe our WiseEye offerings will become a major contributor to our P&L in the near future.

Now, turning to our CMOS image sensor business update, we continue to see extremely strong demands for our CMOS image sensors for IP camera and notebook, but our actual shipment has been badly capped by the foundry capacity available to us.

Separately, our industry-first two-in-one CMOS image sensor that supports RGB mode for video conferencing and ultra-low power AI mode for facial recognition has penetrated the laptop ecosystem for their most stylish super-slim bezel designs. We expect to have small volume shipment toward late 2020 with more to come in the next year.

Regarding ultra-low power always-on CMOS image sensor, which targets in battery powered or always-on applications, we are getting promising feedback and design adoptions from customers in various markets, such as car recorders, surveillance, smart electronic meters, drones, home appliances and consumer electronics.

In Q4, the CIS revenue is expected to be flat sequentially, although demand is much stronger than that. Again, our shipment is capped by foundry capacity constraint. For non-driver IC business, we expect revenue to decrease by low single-digit sequentially in the fourth quarter. That concludes my report for this quarter.

Thank you for your interest in Himax. We appreciate you joining today’s call. We are now ready to take questions..

[Operator Instructions] Our first question will come from the line of Tristan Gerra from Baird. You may begin..

Hi, guys and congratulations on the results.

Given the capacity that you secured for next year as well as your own capacity plans, what type of revenue do you think this is going to support for 2021?.

I said earlier in my prepared remarks, we have secured with our various foundry partners, that is one way of arrangements, many of which are legally binding a capacity, a total capacity covering all type of our products.

That has already been higher than our actual shipments made during this year, okay? So that is our starting point and something that is not enough for us. That is not going to satisfy our expected demand for next year.

So in the meantime, we are developing quite aggressively, again, with different foundry partners, covering different product areas to expand our capacity. But I have to say that such development is something we’re not starting to take, it started actually quite some time ago. But this is not something that you can turnaround overnight.

So I think additional capacity on top of the capacities we have already secured with our foundry partners. You will see – I mean, for example, in Q1, the addition will be rather limited. And there will be some contribution from Q2 and more Q3 and furthermore in Q4 and even more, probably much more going forward. So it’s a aggressive effort.

However, it has to be a gradual process. And again, the capacity is so tight nowadays, I mean, you guys all know. So we just have to accept the reality and manage our customers, manage our products, prioritize our production, and in the meantime, continue to develop new foundries and new capacities. And it’s fair to say, we are making good progress.

And right now, what we are seeing is – for our sales the most severe are basically three areas. The first area being smartphone and tablet TDDI, which share the same pool and our strategy, given our very high market share in the Android TDDI tablet market right now.

So we tend to give more favorable allocation to heavily over smartphone, to be honest because we carry a very heavy responsibility dealing with end customers, in particular when in many, many cases we actually the sole source. So if we stop, it will reduce.

If we can’t ship enough, then it’s a big problem for them, while customers for our smartphone TDDI tend to have better preparation from multiple sources. And so that is the first area of foundry tightness. And again, we are working rather aggressively with at least to make foundry partners developing new capacities.

And again, we are hoping to see real contribution sometime next year. But – I mean, before it actually happens, I really can’t comment much further than that, but we will certainly report in due course. The second major area of shortage is automotive display driver.

It’s an area where we enjoyed a very good market share, probably number one in the world, around 37% of market – global market share right now. And the shortage starting from early Q3 has been very, very severe. And looking into next year, it’s looking to probably get worse even.

And again, we have secured with a very solid arrangement with our foundry partners to meaningfully enlarge our capacity available to us next year compared to the shipments or excess shipments this year.

And on top of that, we are – hopefully we can announce fairly quickly, fairly soon, we are arranging additional major increase of capacities for automotive longer term. And it’s something that is so designated. We’ve got the pressure, inquiries from not just panel maker customers, but also Tier 1s in many of them.

And many of them wish to enter into some kind of arrangement to secure their supply, even though we are the major provider of the market right now. And the third area, which is relatively small in our business contribution, but the shortage is probably the most severe, which is CMOS image sensor.

This year, as we all know, because of the COVID situation, there is a huge – there is a sudden surge in demand for our PC camera because people tend to use their notebooks for teleconference and notebook which has relatively poor camera resolution, people like to get the PC camera connected.

So there is a sudden surge in demand and we simply cannot meet the demand. And we have certain customers who are major, major players in the PC camera market. So it is relatively small for us overall, but the shortage is quite severe. So we are prepared in all aspects to try to grow our capacity. But again, no miracle is going to happen.

And certainly, in Q1, we don’t expect any meaningful increase in capacity..

Okay, that’s very useful.

And then just as a quick follow-up, what are the implications for ASPs for the rest of – for this quarter and for next year?.

On an apple-to-apple basis to reflect the foundry capacity tightness, certainly, we are able to raise our ASP in a degree that it certainly varies in accordance with the different degrees of tightness in capacity.

So the sectors that I just named tend to – will tend to enjoy better ASP increase compared to those sectors that I didn’t mention just now, primarily large panel display drivers. Although they are still tight, but they are not in severe shortage, let me put it that way.

So I think we have very good visibility in Q1, unusually good visibility in Q1 with customers all lined up with the appeal and whatnot. And I can say with fairly good confidence across – toward the whole first half, I think the visibility is quite good. Longer term, it certainly hasn’t propelled.

It’s going to depend largely on the development of COVID situation. We all know that nobody has the answer. I think the quarter is something beyond our control.

What we can control ourselves is aggressive design-in and design win engagement at this moment, while taking advantage that we are one of the largest players in the marketplace and adding the capacity is very tight. So I think we have made tremendous progress across different product segments for new design-ins and design wins.

And our engagement has reached out much more compared to the past, not just panel makers, but also to system makers and product indirect customers. So I think that longer term is going to be a major plus for us. Historically, our engagement with such end customers typically are more toward technology discussions – technology engagements.

Now a lot of it is also about this – I think that is a very important benefit because of the tightness. I guess one last thing – and I appreciate your question. I think I will elaborate a little bit. One last thing is that I do believe we do have a very good solid visibility longer term in automotive sector, mainly for three reasons, really.

One, our major target customers are growing their market share in the big way. So we get to enjoy, because our market share with them individually is very, very high, much higher than our average in the world. So when they are growing their market share, we get the benefit. So we do support them aggressively in this effort.

And secondly is the pick-up of TDDI penetration in other market. We are the pioneer in the world in introducing TDDI to auto panels. Our first mass production actually took place maybe toward the end of last year, 2018. But more meaningful contributor – revenue contribution started from this year, but this year it’s still small.

We all know how automotive market works. It takes – the design cycle takes a long time. So next year, you are going to see many, many times the size of this year, many times. It could be as much as close to 10x and TDDI for automotive probably is starting from next year. We can see some meaningful contribution to our top-line and bottom line.

And we expect further penetration, non-stop. It’s a one-way street going forward for TDDI penetration into auto. And that is major, major good news for us, because one, our design-in coverage, our design win coverage is very, very good at the moment.

And secondly, TDDI for auto enjoys much better ASP and gross margin compared to the display driver for auto and certainly also compared with TDDI for tablet or smartphone, right? So that is the second reason TDDI penetration.

And the third reason, I mentioned earlier already, we are entering into major and aggressive long-term capacity expansion plan together with our partners, covering both traditional display driver IC for auto and also TDDI. So for these three major factors, I think we are really at an inflection point for auto business.

We have enjoyed – we enjoy many years of growth. I can’t recall how many, but many years of sequential growth for auto business before hitting a brake in kind of in 2018 – second half 2018 to first half 2019. And I think we will lead the market in seeing a recovery starting from Q3.

And in Q4 this year, I just mentioned in my prepared remarks, it’s looking very solid, the growth rate. And so, again, I think this is [indiscernible] to embark on a major long-term growth for auto sector. And the good news is auto has always been for many, many years the highest gross margin product segment for us. So this is very exciting new for us.

Sorry for the very long answer. I thought I’d take this opportunity to elaborate a little bit..

That’s very useful. Thank you very much..

Thank you, Tristan..

And our next question will come from the line of Donnie Teng from Nomura. You may begin..

Thank you, Jordan, Eric and management team for taking my question and congratulations on the very strong guidance.

My first question is regarding to the guidance, so could you elaborate a little bit more or quantify how do you come up with like 10% sales growth in fourth quarter by breaking down into maybe roughly shipment and ASP growth if possible? Thank you..

I am afraid I can’t really give too much specifics on revenue and ASP growth. But again, I can give you a broad idea. ASP growth come primarily from TDDI, both for smartphone and tablet as well as automotive, right, those shortage sectors.

And for large panel, I think ASP has sustained in a solid level, but I can’t say they enjoy major growth like for those other sectors. And so for large panel, the market is – the foundry situation is tight, but it’s not in shortage as such. So I think that is kind of the background.

But why – I mean we guided for about 10% sales growth for Q4, I think that is – we are – I think that is quite solid.

And I think firstly TV is probably the only major sector that is set to decline a little bit, probably mid single-digit because TV makers after quite a couple of good seasons, they are entering into some kind of inventory correction period.

But other than that, I mentioned, for monitor, first three quarters combined very strong compared to last year, but the third quarter, there was a major dip. But we don’t see that as a weakness in demand, rather for monitor, it is really customers’ inventory adjustment. So Q4, we are seeing a major rebound.

And notebook also is kind of close to 100% kind of increase sequentially. And certainly, the biggest growth will come from tablet in kind of revenue contribution. Tablet TDDI continue to grow in penetration and we dominated the market.

So Q4, TDDI for tablet will be up something like 80%, right? And with good ASP contribution because a good percentage of TDDI goes into what we call IC tables, the active stylus, and that always will enjoy better ASP and better margin. Smartphone will be up high single-digit. Again, demand is much higher than our supply, the major capacity constraint.

But the good news is, we are – we continue to gain market share in smartphone, although under such difficult situations in terms of foundry. In automotive, I have mentioned, we’ll be up more than 20% sequentially. We are very, very happy with more of a rebound in the midst of a pretty bearish market for automotive worldwide.

And so that kind of gives you a flavor of the major revenue contributions, meaning monitor, notebook, smartphone, tablet and auto, with the major – with the only major declining sector being TV, which is only down – could be down like mid-single-digit only. So it’s across the board pretty even, the growth..

Thank you, Jordan.

And can I have a follow-up? Under this kind of situation, are you considering to raise price further in the first quarter, including in large display driver ICs or raise again on TDDI, as you just mentioned?.

I think we have to respond to the markets and our competitors’ move. But I think in all likelihood, the answer is yes. But we will just have to wait. We’ll have to continue to observe the market and manage the customer, and we’ll see. But I mean, certainly, the likelihood of our lowering – our ASP I think is very, very low..

I see. And my second question is regarding to the gross margin. Do you think this kind of 29% level will be a new norm or may I ask if your foundry partners have all raised the wafer price in fourth quarter yet or some of them will not raise the price until first quarter next year? Thank you..

They certainly have raised their prices for Q4 to a very large degree. And certainly – and also our second suppliers have worked, especially for testers and for timing control, the packaging as well. And your question whether this 29%-ish kind of growth module will be a new norm, we certainly hope so.

And certainly, we have all the intentions to keep it this way and to actually grow from here further next year and beyond for the reasons I mentioned. I think, one, our foundry tightness for material technology appears to be a long-term thing.

And two, our capabilities to grow potential capacity actually is going to enhance our – it is going to help defending our margin as well because customers were – will be happy to come to Himax more than less because we do have upside volume to grow. And thirdly, we have very good solid design wins across the board.

I just mentioned, covering not just direct customers, but also indirect customers, that is very helpful. I’m talking about from TV all the way to automotive. So I think this is very exciting development. And lastly, longer term, I just want to emphasize again the importance of our new product areas such as WiseEye. I think that will be very exciting.

It’s long-term, it’s something it will have less top-line contribution than bottom line because margin will be much, much higher for such products. And it’s something – timing controller, we have seen it is all within expectation. We have seen very healthy growth this year.

And I think the growth is in all likelihood is going to continue into next year and beyond. So yes, the short answer is, yes. We intend to defend such a level of margin and try to even improve it further for next year..

Thank you, Jordan. And kind of a follow-up is that, when you say that all the – most of your foundry partners have raised the price, is that in like wafer in base overall base cost. I’m just curious that I’m not sure whether it’s some foundry partners wafering, so the actual price – wafer price hike should be more....

Sorry, sorry. We were out. We were output. We – accounting wise, when we say they have raised the price, for us it is – the increase in our cost of goods sold. I mean in inventory already it’s we were out, and that is related to the shipments we make. So we are talking about the Q4 COGS.

That’s what we are referring to when we talk about foundry raising their prices..

So they....

They are raising prices much earlier on because the foundry production there is probably about a quarter of lead time..

Yes.

Is there any write-off, inventory write-off in fourth quarter as well as third quarter?.

Certainly. There are always inventory write-offs each quarter. But I think largely, thanks to our efforts over the last year or two to much tighten our inventory management. I think we are able to lower our overall inventory write-down each quarter.

And on top of that, it is just a lucky coincidence that the market is so tight that inventory now it is actually not only it is a problem in the sense that we feel our inventory level right now is too low rather than too high and the write-down requirement is much less than otherwise.

So, two factors, our much improved inventory write – inventory management internal procedure and secondly, the tightness of the market.

And I mentioned probably twice in my prepared remarks that in certain circumstances, there are certain goods that we have, according to volumes and inventory management protocol, which has been going on for many years. We have written down certain products, while the goods were still kept.

We are not going to sell them, although accounting wise there maybe much decrease in cost or the cost base can in some cases decrease to zero, but because of tightness of the market, we are able to sell those products. So, that certainly is very high margin, but the revenue contribution wise it’s really quite small, but there are such instances.

So, it’s just a reflection of how tight the market is right now..

Yes. Thank you so much, Jordan. Congratulations again..

Thank you, Donnie..

Thank you. Our next question will come from the line of – from Jerry Su from Credit Suisse. You may begin..

Hi, thank you for taking my question.

First question regarding on the TDDI, can you talk a little bit about what’s beyond tablet, automotive, etcetera, I think we have heard some of the industry, all your peers, a lot of carmakers are interested to adopt TDDI on notebook and also other applications, which area you are seeing more opportunities and what’s the entry barrier there?.

I think given the current tightness of capacity for smartphone and tablet already, I really don’t feel there is much room for notebook in the foreseeable future. First off, because we do have the technology and if TDDI for notebook is to happen, it’s going to have rather similar ICs compared to those for tablet as you only mentioned, right.

I think for us, TDDI, I mentioned already, so I will just repeat it very briefly. I think automotive is the major growth area. Automotive had different reasons. It’s not asking for – isn’t asking for the thin border or light display, it’s not. It is really for three reasons.

One, when the ambient light or sunlight is very, very bright, you feel better, the consumer can feel better with in-cell display, because you don’t feel kind of additional layer of course on top of your panel, right.

And right now it appears to be even more convincing reason for in-cell and TDDI is that our ultra-low displays are getting much larger in size and much higher in resolution and people are talking about its strength, such as what they call pillar-to-pillar displays.

We are talking about in some cases about 50-inch, 60-inch, even 70-inch panel displays for automotive. So, we want to make a display so big you do need to double in-cell technology, because with in-cell, you don’t have to have the trouble of bounding a third layer of glass, which is split on top of the already completed image display.

And if you – the third layer of glass, the bounding, if it goes wrong, it is going to damage the already finished display, which is very expensive as we mentioned.

And when you have display so large, it’s very difficult to bound, especially for automotive when you make – you were making such a large display, you need to enable what I call free form design, meaning the display is under a straight piece of glass. So that makes the bounding process even harder. So it is now proven to be a necessity.

Now, when the display size go to a certain level, you do have to have TDDI and now for larger display for automotive, is looking to be a major trend. So, I think again we are the leader in that space and we are very excited about this development.

So, I think TDDI for automotive application is going to be important for the industry and certainly for Himax..

Okay, thank you. And then the second question is about the AMOLED driver IC and you mentioned in the prepared remarks that you are expecting to see some more revenue contribution from 2021.

Can you elaborate a little bit more about which area will see a faster growth, I mean – or for Himax to faster penetrate into? Is it wearable or should we think about it as smartphone and also beyond the Chinese panel makers, any opportunities to get into the Korean panel makers, AMOLED? Thank you..

Thank you, Jerry. I don’t want to comment too much, especially I can’t cover too much specifics before it happens. So again, I want to repeat, we are very committed to this. So we are not going to be absent from this very important long-term market.

You have mentioned quite a few applications, meaning wearable, auto, smartphone and tablet we are in all of them. And we have good high-quality solid major engagements with direct panel makers and indirect end user customers in literally all of them.

Which one will enter mass production earlier than others, I think it’s probably a bit premature to tell. So if you would allow us to elaborate further when it happens, but I can say, certainly we are targeting mass production starting next year and the major contribution certainly, hopefully, will come from smartphone, correct.

That is quite obvious followed by tablet and then wearable, auto will be the lowest, right, but I think I can’t – I don’t want to start uncovering them before it actually happens, but I think we are very, very close to some major breakthrough. So we will see..

Okay.

And then about the panel customers are you seeing opportunities to penetrate into the Korean auto customers?.

I can’t comment on that. It’s too customer specific, because they are really just one for large panel and for small panel when it comes to Korea panel makers devices. I think that will be 12 years if I make any comments one or the other, sorry about that..

Okay, that’s fine. Okay. Thank you..

Thank you, Jerry..

Thank you. And I am not showing any further questions in the queue. I would like to turn the call back over to management for any closing remarks..

Okay. As a final note, Eric Li, our Chief IR/PR Officer will maintain investor marketing activities and continue to attend investor conferences. So, we will announce the details as they come about. Thank you and have a nice day..

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect..