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InvenSense, Inc. (NYSE:INVN)

F3Q13 Earnings Call

January 23, 2013 4:30 PM ET

Executives

Alan Krock – CFO

Behrooz Abdi – President and CEO

Analysts

Mark Delaney – Goldman Sachs

Krishna Shankar – ROTH Capital

Libby Dossie – Evercore Partners

Tristan Gerra – Robert W Baird & Company

Vernon Essi – Needham & Company

Richard Shannon – Craig-Hallum

Andrew Uerkwitz – Oppenheimer

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2013 InvenSense, Incorporated Earnings Conference Call. My name is Jeff and I’ll be your coordinator for today. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Alan Krock, Chief Financial Officer. And you have the floor, sir.

Alan Krock

Thank you, operator. Good afternoon and welcome to all. I need to begin our call with a forward-looking statement. Statement made by management in this conference call that are not historical are forward-looking statements as the term is defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements can constitute projection of revenue, gross margin, expense and other financial items discussed during this conference call and the potential for continued technology leadership of InvenSense devices, design wins and potential design wins for consumer electronic and other customer products.

Investors are cautioned that all forward-looking statements during this call involve risks and uncertainties that can cause actual results to differ materially from those currently anticipated, due to the number of factors including, without limitation, current global economic conditions, customer business environment, customer inventory, customer inventory level, vertical market mix, market acceptance of the company’s products, production, introduction schedules, the rate of growth of the company’s products, changes in the mix of our business as well as changes in economic conditions and other risk factors discussed in documents filed by the company with the Securities and Exchange Commission, SEC, from time to time.

Copies of InvenSense SEC filings are posted to the company’s website and are available from the company without charge. Forward-looking statements are made as of the date of this conference call and the company does not take any – undertake any obligation to update its forward-looking statements to reflect future events or circumstances.

With that introduction, I will turn the call over now to Behrooz Abdi, our Chief Executive Officer.

Behrooz Abdi

Thank you, Alan, and good afternoon, everyone. Welcome to our fiscal 2013 third quarter call. We had another record quarter where we were able to deliver at the high end of our stated revenue outlook for Q3, up $56 million to $59 million, with revenue for the quarter of $58.9 million.

Our revenue grew 7% sequentially and 43% year-over-year in the December quarter with smartphones and Tablets leading the growth, representing 67% of total revenue. Building upon our world-class mass technology and engineering achievements, we continued our design win momentum in fiscal third quarter, enhancing our growth opportunities across all of our focus market segments. We saw strong customer traction in mobile on consumer segments with continued adoption of our multi-access gyro, accelerometers and compass products. We increased our share at niche customers while winning new customers.

We saw unit volume growth across all of our end markets, with our multi-access integration strategy was validated once again with the robust double-digit growth of our 6-axis products as customers clamored to take advantage of smaller size and improved performance of the MPU-6050 product family. We also saw a significant ramp of our MPU-9150 MotionTracking solution which integrates 9 axes of gyro, accelerometer and compass with MotionFusion and calibration into an impressive 4x4x1 millimeter package. This product is especially valuable to Mobile on Consumer customers where board space is at a premium.

Another exciting product ramp was our market-leading 2-axis IDG and IXZ-2021 gyro tracking device for optical image stabilization or OIS customers. This high-performance, low-power solution is only 3x3x0.75 millimeters and enables camera modules with integrated OIS inside Mobile Phones and Tablets. We see additional opportunities for our Gyro products as OIS-enabled camera module run rates – attach rates continue to increase in smartphones.

Our MotionTracking solution is ideally suited to address the complex architectural requirements of new mobile trends such as custom gestures, enhanced navigation, contextual awareness and optical image stabilization. This solution integrates a very efficient motion processor with advanced algorithms and calibration to enable complex motion detection, saving tremendous system level power and cost. When combined with our motion app software, we’re able to hide the complexity of combining MotionTracking with other sensors and offer a seamless sensory experience to our customers.

Turning now to our ecosystem activities. We continue to gain traction with our motion interface solutions at customers who use the Google Android operating system. We saw tremendous enthusiasm from our customers, as well as hardware and software partners for our embedded MotionTracking features within the Android operating system, which demonstrate the value of our integration.

We also announced that our motion sensing solutions for Windows 8 and Windows RT are now in high volume production with multiple Tier I Ultrabook and Tablet manufacturers. Our field-proven motion app software is available for both Intel and ARM architectures within the new Windows 8 Operating System, providing OEMs with a one-stop sensor subsystem solution.

As we enable new customers, partners and markets, we continue to grow a vibrant developer community. At the end of fiscal third quarter, we had well over 5,500 registered developers across many application segments. We expect these developers to proliferate our solutions inside many new and exciting products.

The game-changing MEMS expertise and innovation of our engineering team is complemented with the execution of our fabless business model. In the fiscal third quarter, we increased our back end manufacturing capacity by over 40% while keeping within our efficient capital expense model. Also, while we continue to strengthen our close partnership with TSMC, we were pleased this past quarter to ship products in high volume from GLOBALFOUNDRIES. Bringing GLOBALFOUNDRIES to volume ramp significantly increases our wafer manufacturing capacity and offers a low-risk and cost-efficient multi-task strategy to our market and customers.

Finally, as in the past, in the fiscal third quarter we observed significant pricing pressure in the mobile and gaming segments as our customers experienced maturity with some of their own platforms in their consumer markets and top mobile and Tablet customers transitioned their mainstream products from discrete accelerometers and gyros to integrated 6-axis devices. We believe our latest Generation 3-axis gyro and 6-axis device are well positioned to serve these highly competitive markets while preserving our manufacturing cost goals. We are working closely with our lead customers to transition them to these new products and expect to start volume ramp in the current quarter.

I will now turn the call over to Alan for more details on the fiscal Q3 FY 2013 financial results. I will then provide an update on our products and other developments and Alan will discuss fourth quarter fiscal 2013 financial outlook.

Alan Krock

Thank you, Behrooz. Please note that all financial results will be discussed on a Generally Accepted Accounting Principal, or GAAP basis; and additionally beginning in the current quarter, in our earnings press release the company provided certain non-GAAP financial measures that excludes stock based compensation expenses and other non-GAAP financial adjustments such as cumulative benefits associated with the change in our estimated effective tax rate and severance costs associated with our CEO transition. The company uses these non-GAAP measures in its own financial and operational decision-making process.

Further, the company believes that these non-GAAP measures offer an important analytical tool to help investors understand the company’s core operating results and trends, and to facilitate comparability with the operating results of other companies that provide similar non-GAAP measures. Realizing some analysts wish to track our financial information on a GAAP and non-GAAP basis, I will provide information that includes both financial measures.

As Behrooz mentioned, for the third quarter of 2013, net revenue was $58.9 million, up 7% for the second fiscal quarter – up 7% from the second fiscal quarter of 2013 and up 43% from the third fiscal quarter of 2012. Through nine months of fiscal year 2013, revenues were $153.4 million, up 28% from the comparable period in fiscal 2012.

Our market splits in the second quarter for fiscal 2013 were smartphones and Tablets, 67%; gaining 27%; all other segments, 6%. For Q3, our 10% customers were Samsung Electronics; Quanta, which is a contract manufacturer for a number of consumer electronics companies in the smartphone and Tablet markets; and Nintendo. Through nine months of fiscal year 2013, market splits were smartphones and Tablets, 67%; gaming 24%; all other segments, 9%.

Seasonally, the December quarter has historically been a stronger revenue opportunity for us, driven by the holiday shopping period. The fiscal quarter ending in September is also somewhat seasonally stronger for the same reason as our markets transition to their peak quarters. Consistent with seasonal patterns and significant and important new design wins, sales to all market segments that we serve experienced good sequential growth in fiscal Q3. Our year-over-year revenue growth of up 43% from the third quarter of fiscal year 2012, we believe is a very strong result.

Gross margin for the third fiscal quarter of 2013 on a GAAP basis was 53.0% and 53.3% on a non-GAAP basis, excluding stock compensation expense, consistent with our target operating model range. Gross margin for the first nine months of fiscal 2013 was also within our target operating range at 54.2% on a GAAP basis and 54.5% on a non-GAAP basis. The lower sequential gross margin in Q3 when compared to the immediately prior quarter reflects the relative maturity of some customer platforms in their markets and the competitive pricing environment that Behrooz previously commented upon during his remarks.

To offset these current customer and competitive dynamics, we believe that our new generation 3, 6, and 9-axis MotionTracking products, which are designed in the next generation of customer products, together with our own supply chain cost reduction initiatives, provides us with the opportunity to maintain our target financial model in our coming new fiscal year.

Turning to operating expenses, on a GAAP basis the total operating expenses were $15.1 million for the quarter versus $13.1 million in the immediately prior quarter. Subtracting the one-time current quarter costs related to the transition of our former CEO, operating expenses were $13.7 million for Q3. Excluding stock compensation and the CEO transition expenses, operating expenses were $11.7 million on a non-GAAP basis.

R&D expenses were $6.7 million or 11.4% of revenue for fiscal Q3 on a GAAP basis as compared to $5.9 million or 10.7% of revenue in the prior quarter. For the first nine months of fiscal 2013, R&D expenses were $18.3 million on a GAAP basis or 11.9% of revenue, generally consistent with our targeted operating range of 13% to 15% of revenue. Excluding stock compensation, R&D expenses were $6 million on a non-GAAP basis in fiscal Q3 and $16.2 million on a non-GAAP basis for the first nine months of this fiscal year.

SG&A expenses were $8.4 million or 14.3% of revenue in fiscal Q3 as it compared to $7.2 million or 13% of revenue in the prior quarter. Subtracting the one-time CEO transition costs, SG&A expenses were $7 million, essentially flat with the prior quarter. Excluding stock compensation and the CEO transition costs, SG&A expenses were $5.8 million on a non-GAAP basis. For the first nine months of fiscal 2013, SG&A expenses were $21.9 million or 14.3% of revenue, or $20.5 million and 13.3% of revenue, excluding the CEO transition costs. Excluding both stock compensation and CEO transition expenses, SG&A expenses for the first nine months were $17.2 million on a non-GAAP basis.

The period-over-period increases in absolute ops dollar OpEx spend compared – when compared to comparable current and prior-year periods are: one, for R&D, primarily engineering head count and project-driven mask and wafer costs. And the – and that is the result of the company addressing leverage available within the InvenSense fabrication platform to drive further integration and innovation in MotionTracking and the consumer electronics mobile markets.

Additions to SG&A are primarily sales and head count-driven to address the company’s substantial global customer opportunity including sales channels in geographies like China where adoption of MotionTracking solutions by major customer – major consumer electronics customers represent a significant opportunity for the company and expansion of our marketing efforts targeting new market opportunities. Three, higher public company costs. Four, increased legal expenses related to patent-related litigation activities.

Stock based compensation included in the December quarter for fiscal Q3 in total was $2.8 million including $0.6 million related to our CEO transition versus $2 million in the prior quarter and $0.9 million for Q3 of fiscal year 2012. For the first nine months of fiscal year 2013, stock based compensation was $6.4 million and $2.5 million for the same period in fiscal 2012.

Operating margins were 27% this quarter on a GAAP basis, 30% excluding the CEO-related transition costs versus 31% in the prior quarter. On a non-GAAP basis, excluding CEO transition costs and stock based compensation, our operating margin was 33%. Our long-term operating margin target remains in the high 20’s percent to low 30’s percent but will vary primarily based on sales seasonality. Considering Q3 seasonality, we are in line with our target operating model for Q3.

On a GAAP basis, our income tax provision was a negative 4% of income before tax for fiscal Q3 and reflected the impact of primarily a lower effective tax rate applied to prior periods. On a non-GAAP basis, we expect our effective tax rate to be approximately 15% currently and in future quarters. On a GAAP basis, net income for the third quarter of fiscal 2013 was $16.8 million compared with net income of $13.7 million in the second quarter of 2013, an increase of 23%. On a GAAP basis for the first nine months of fiscal year 2013, net income was $38.1 million versus $31.1 million for the comparable period in fiscal year 2012.

On a non-GAAP basis for the first nine months of fiscal year 2013, net income was $41.1 million versus $32.8 for the comparable period in fiscal 2012, an increase of 25% year-over-year. Fully diluted GAAP EPS was $0.19 for Q3 fiscal year 2013, based on fully diluted shares of 87.4 million. Adjusted for one-time CEO transition costs and income tax gains, EPS was 17% – EPS was $0.17 per share, in line with our original outlook provided. On a non-GAAP basis, EPS was also $0.19.

Cash generated from operations in the third quarter of fiscal 2013 was $26 million, increasing our cash and investments to $193 million with essentially zero debt. Working capital increased, primarily resulting from the significant cash generation in the period, favorably impacted by lower receivables and inventories. As a result of the decrease in accounts receivable, our net days sales outstanding were 48 days, down from 65 days in the prior quarter on the higher sequential revenues. All customer accounts are substantially current to payment terms. As of the end of Q3 2013 our inventories stood at $19 million versus $21 million at the end of the prior quarter. With these remarks, I will turn the call back to Behrooz Abdi.

Behrooz Abdi

Turning our attention to the fiscal fourth quarter, we expect to see seasonal reduction in unit shipments to the gaming segment, offset mostly by growth in unit shipments in the mobile handset and computing as well as OIS segments. We also expect to see double-digit unit growth in our 6-axis products and expect this product line to cross over to comprise over 50% of our unit and revenue shipments.

While we expect to see continued pricing pressure this quarter, we also expect to start shipments of our second generation cost-reduced 6-axis MotionTracking solution MPU-6500 to lead customers. This device, which is offered in a 3x3 millimeter, will save 45% in board area and offer 60% lower power. We also plan to continue our capacity expansion in order to support our existing customers as well as new customer ramps.

This is a very exciting time for InvenSense. While our world-class mass engineers and product designers continue to produce innovative new products to continue to strengthen our ecosystem in existing and new market segments such as OIS camera modules and wearable sensors, we are best positioned to benefit from market trends such as the transition from feature phones to smartphones, increased attach rates of MotionTracking devices to smartphones, and a transition to higher integration.

At this point, I will turn the call back over to Alan to discuss guidance for the fourth fiscal quarter and then we’ll open up the call for your questions.

Alan Krock

Thank you, Behrooz. Now to conclude, I’ll provide our financial outlook for the fourth quarter of our fiscal 2013. As you have heard from us before, our end markets are seasonally slower during our fourth fiscal quarter which follows the calendar year in holidays, in particular in the consumer electronics gaming market. As such our fiscal Q2 ending September and fiscal Q3 ending December are generally our strongest revenue quarters. We expect Q4 revenue post the holiday period to be in a range of $52 million to $54 million. To support this Q4 fiscal year 2013 revenue outlook, we currently have backlog in place representing a significant portion of this total current quarter revenue target.

In fiscal Q4, we expect the impact of timing of customer product model transitions into mobile markets and the competitive pricing considerations noted in our markets in Q3 to also impact gross margin in our fiscal Q4. We also note that product mix this quarter favors our highest volume mobile customers who, based on volumes purchased, are traditionally entitled to our best pricing. As a result of these considerations, we believe that our gross margin will be in a range around approximately 52% this quarter; and that in future quarters, our new lower-cost products and additional production volumes will have a favorable impact on those quarters.

In Q4 on a GAAP basis we expect operating expenses of approximately $13.7 million made up of $6.4 million for R&D and $7.3 million for SG&A. On a non-GAAP basis we expect operating expenses of $11.5 million made up of $5.7 million for R&D and $6 million for SG&A. We therefore expect a current quarter operating margin range around 25% on a GAAP basis and 29% on a non-GAAP basis. We expect fully diluted share count of approximately 88 million shares, a GAAP income tax rate in the range of 9% to 10% and therefore GAAP basis earnings per share of approximately $0.15. We expect a non-GAAP tax rate of approximately 15% and therefore earnings per share of approximately $0.14, including stock based compensation expense, or approximately $0.15 per share on a non-GAAP basis, excluding stock compensation expense.

Achieving our Q4 outlook expectations will result in achieving our fiscal year target of approximately 35% year-over-year revenue growth, an excellent result given all the current macroeconomic uncertainties our customers and our peers are currently experiencing. Further, we see continuing strength and adoption of our products, due to their higher performance and attractive features at a size – and size at a number of existing and new major customers in our Mobile Handset and Tablet markets that we believe could offer an important opportunity to continue our revenue growth in fiscal periods beyond the current year.

With respect to our annual business model, we plan for our margins and operating expenses to stay within our long-term model of gross margins of the mid-50s, R&D expense of 13% to 15% of sales, SG&A expense of 9% to 10% of sales. We expect operating margins in the high 20s percent to low 30% of sales. We expect a tax rate of 15%. As a result, we expect net income after tax percentage in a range around approximately 25%.

That completes our remarks with respect to earnings and the business aspects of this call. We’d like to turn our call over to the question-and-answer session. Operator, please proceed.

Question-and-Answer Session

Operator

All right. Thank you very much, Mr. Krock. (Operator Instructions) Our first question comes from the line of Jim Schneider with Goldman Sachs. Please proceed.

Mark Delaney – Goldman Sachs

Thanks very much for taking the question. This is Mark Delaney calling on behalf of Jim Schneider. I guess I was hoping you guys could talk a little bit more about the end market trends you’re seeing this quarter relative to your guidance. I know you talked about some seasonal trends in gaming relative to mobile but any other color you could provide maybe on trends driven by inventory or other factors, that would be helpful.

Alan Krock

Sure. Thank you. It’s Alan speaking. So generally, our outlook for the current quarter is in line with what we’d talked to previously on the prior call to complete the fiscal year opportunity. We mentioned in my remarks we expect the gaming segment to be seasonally slower, and Behrooz mentioned in his comments that we expect that to be partially offset by ongoing strength in the mobile market, being smartphones and Tablets, especially the smartphone segment there. So we do believe that certain of our key customers who are 10% customers in that space are experiencing positive overall market acceptance and market conditions for their products and therefore that element of our outlook is a bright spot and gaming is behaving sort of in line seasonally as we would expect it to. So hopefully that’s a little bit additional color for you.

Mark Delaney – Goldman Sachs

Yeah, that is. I appreciate that. Thanks. I appreciate all the color you guys gave on the margin trajectory and what the different factors are that are impacting that. I was hoping you could help us understand, as you go forward I understand some of the things you guys are doing you think can help get back to your historical gross margin levels. I was wondering is that going to be a linear type of a thing or is it going to come in chunks?

Alan Krock

No. The customers trend to go in production with our new products at certain times. We believe that there will be certain larger customers who are all, again also 10% customers, that will go into production with their new products and therefore we believe our new products in the second calendar quarter of this year. So currently in our fourth fiscal quarter, calendar Q1, we’re in advance of those new product announcements by our customers.

And the products that we have are running out the residual of their useful life as those programs wind down. And then as we believe these new products that we have are very cost competitive given the market conditions that are out there, we believe that as these new programs go into production during our second fiscal quarter, we should see the benefit associated with those new products and the customers’ new platform, primarily within that quarter.

Behrooz Abdi

This is Behrooz speaking. Cost reduction typically, part of it is entrenched, as Alan articulated, when customers do the transition. And when we do die size reduction, which is a big part of our strategy as we go to next generation products. We’re always optimizing the size of the chip itself. And that contributes quite a bit, along with material cost reduction which is test-time reduction, package cost reduction. And some of that is linear as well as the multi-tap strategy that we have with GLOBALFOUNDRIES coming on board. We’re very excited to have multi-tap strategy now that allows us to drive that cost quarter-on-quarter, a little bit better – and with a little bit more control than we had in the past.

Alan Krock

So a lot of the cost reductions initiatives can be somewhat linear. But the product transitions within certain key accounts can be very pronounced impact on any one period.

Mark Delaney – Goldman Sachs

Understood. Thanks for that. And if I could sneak one more in, obviously you guys have some visibility on the timing of different platform ramps. And you’re talking ramping in the June quarter and it helping on the margins then. As you look out with the design-ins that you already have for Mobile and Tablets, are there any significant new handset or Tablet customers that you are designed into?

Alan Krock

You know we don’t have – we’re not in a position at this immediate moment in time to talk about things that are not announced by the customers in their own markets. And so largely, our existing customer base has continued with the announcement of their ongoing normal product introductions. And we do supply those lists of names on our IR presentation. But for new opportunities that are out there in the marketplace, we just really aren’t in a position to comment on behalf of the customer. We have to wait until their products find their way into the market, and therefore, are publicly available.

Mark Delaney – Goldman Sachs

Understood. All right. Congratulations and thanks very much for taking the questions.

Alan Krock

Thank you for your time and effort. We appreciate it. Next question, please. Next caller, please.

Operator

Our next question comes from the line of Krishna Shankar with Roth Capital. Please proceed.

Krishna Shankar – ROTH Capital

Yes. Congratulations, Behrooz Abdi, on the nice quarter. It’s kind of positive that even in March, which is a seasonally weaker quarter for smartphones, it sounds like you will have growth in units and revenues from your smartphone and Tablet customers. Is that the way to read it?

Alan Krock

Yes. It partially offsets the decrease in revenue for the gaming-related customers. I mean we, overall we are down sequentially mid to high single digits in revenue. But yes, the gaming-related customers are down much more than that and they offset the dip in the mobile space, primarily in smartphones, correct.

Krishna Shankar – ROTH Capital

Okay. And then when will the transition to the cost-reduced platforms be complete, the 6550? Will that be in the June quarter or the March quarter where you transition to the cost-reduced lower power platforms?

Behrooz Abdi

I think it starts in the March quarter, slowly. I don’t believe it will be very material this quarter. Mostly it’ll be in the June quarter and after that it just phone-by-phone, platform-by-platform. Alan, do you have anything?

Alan Krock

No, that’s exactly right. Our business plans are based on the beginnings of product sales of the 6500 product this quarter. And as that curves toward the end of the quarter and – but we can begin to see the full quarter impact and benefit of new customer programs in the June quarter.

Krishna Shankar – ROTH Capital

And then a longer-term question, without taking into account any new customers or platforms that you might have design wins. Can you sort of give us your preliminary viewpoint on fiscal year 2014? And how much you think the market will grow in terms of units? And what the opportunity is for InvenSense growth in fiscal year 2014?

Alan Krock

I’m going to let you ask that one again in a quarter, Krishna. I apologize – well, I just haven’t had the chance to do a lot of work and we are waiting for certain decisions by customers, potential customers, et cetera relative to the rate of adoption of some of our new products. So just really not in a position to comment much beyond the current quarter, which is all we had planned to talk about. We’re going to – just actually needing to do the work myself on the trade-offs in the market, some of the new markets and the opportunities in China, which we believe are significant as well as the growth rate in the higher-end smartphones in which we participate already. So if you’ll give me a quarter to do my homework, I’ll do what I can to give you a better answer.

Krishna Shankar – ROTH Capital

Great. Thank you.

Operator

Our next question comes from the line of Mark McKechnie with Evercore Partners. Please proceed.

Libby Dossie – Evercore Partners

Hi. This is Libby Dossie on the call for Mark McKechnie. I was hoping we could get some more clarity on pricing, both overall and by segment. I know you mentioned that there was pressure on mobile gaming but can you give us any color on how pricing changed sequentially on smartphones, Tablets and gaming?

Alan Krock

Sure. Generally in our SEC filings we’ve talked to 20% to 25% year-over-year rates of decline in pricing in our markets. And so obviously again we’re at the end of our fiscal year and we’re at the beginning of a bunch of new product introductions starting the tail end of this quarter into June. We’re sort of down year-over-year pricing in line, I believe, or around what we’ve talked to in our filings. So that give us – that puts us in the position of looking forward to our new products and the impact our new products can have in the quarter after this coming but generally it’s hard to comment specifically customer by customer other than like-for-like products.

We usually plan and give outlook based on 20% to 25% year-over-year decline and we’re certainly well within that range from where we were a year ago. And then looking forward, we have a better margin opportunity in some of the new products that are going into – they’re going to start shipping later this quarter and into next to sort of tie together all our various remarks.

Behrooz Abdi

Yeah, on the pricing disparities again, really this is no different than any other consumer market that at least we’ve operated in and the semi space. There’s always year-on-year pricing that is in that range, 20% to 25%. So it’s not a surprise and it’s always been planned on and we continue to plan on it in terms of our cost reduction activities year-on-year with our products.

Libby Dossie – Evercore Partners

Were there any segments that were stronger or weaker than others?

Alan Krock

Is that relative to our fiscal Q3?

Libby Dossie – Evercore Partners

Yes, exactly. So just looking you know if on average it’s down 20% to 25% year-over-year, we know gaming was weak. Was that stronger with smartphones or...?

Alan Krock

Okay. So as far as – you know, the best way to look at that is volumes. We had very decent volume shipments into gaming in Q3. We had very decent volume shipments especially into mobile handsets and Tablets to a certain extent but the handsets is the majority of our mobile market. So we enjoyed very decent volume shipments into handsets.

Largely, our customers have pretty good visibility into global pricing of these products because they do use contract manufacturers or have their own manufacturing facilities within Asia and so the range of pricing that we offer the customers is largely volume-driven. And so the higher volume customers certainly get our best pricing, as I mentioned. But generally, whether it’s in gaming or whether it’s in mobile or whether it’s in other, I mean most of these customers do have pretty good visibility of the pricing of this technology in the adjacent markets that they serve and pricing is somewhat similar.

The nice thing about the other market that we serve is it’s a relatively fractured market. There’s 3,000 or better developers working on technologies that represent 10% of our sales so it’s nice for the future and the pricing and the margins in that segment is probably the best, otherwise we’re dealing with very sophisticated, savvy OEMs in the consumer electronics business and their related contract manufacturers and all of them have very good awareness of what generally pricing of this technology is. So hopefully that’s helpful.

Libby Dossie – Evercore Partners

No, that definitely is helpful. Thanks a lot.

Operator

Our next question comes from the line of Tristan Gerra with Robert W Baird & Company. Please proceed.

Tristan Gerra – Robert W Baird & Company

Hi. Good afternoon. So based on your commentary it looks like smartphone is going to increase sequentially which is better than seasonal trends. Is this primarily driven by your largest smartphone customer and potential share gains or is it broad based? If you could just give us additional color on the momentum you see in smartphones for the quarter.

Alan Krock

Certainly, Tristan. Will do. Thank you. Yeah, just doing the basic math on the seasonal trends on the different market segments that we serve, the customers in the gaming segment are off quite a bit sequentially from the calendar Q4 period into our fiscal Q4 in the March quarter. And the strength that partially offsets those declines is primarily in the smartphone segment and primarily with what will be, based on the outlook we just gave, our largest customer, which is Samsung.

Therefore, the offsets for the gaming are largely based on the strength of the 10% customer which I mentioned now and will mention next quarter, just part of the statutory process of disclosing who our largest customers are. So that customer will likely move into approximately 30-plus percent of our total sales for the brief period that is Q4 and then as the others adopt new technology, gaming moves from its seasonally slower period and so forth, a little better – a little broader balance across the customer base will occur.

Tristan Gerra – Robert W Baird & Company

Okay. That’s very useful. And then based on the commentary that you have, a cost reduced version of your gyro launching this quarter even though the momentum really begins in the June quarter, is it fair to say that gross margin likely troughs in the March quarter? And then how should we look at the cost reduction that are driven by new product introduction versus other steps that you’re taking on the manufacturing front?

Alan Krock

Yeah. The first part is Q – March – the March quarter or Q4 are the trough. Yes, that’s certainly the basis of our business plan. Looking forward, we believe that if the new products yield well and the adoption rate is as anticipated by us that, that will lead to sequential improvement in the gross margin opportunity.

Behrooz Abdi

Part of it is this device, as we talk about the new products, both gyro as well as the 6-axis, they are better powered, they’re better in size, so customers are motivated to move. At the same time, there are customers who have platforms today with the current MPU-6050 that quite frankly enjoy the traction that they have with the current platforms and those particular platforms may be slower to move. They’re not going to just change one component just for the sake of that particular component. So we have a mix.

We’re working with them. We’re putting in the appropriate incentives for them to transition and one part of that incentive is the smaller size and the power but it really depends on each platform. If they’re shipping in tens of millions and they’re really – there are other features in the phone that has got market traction they may not be as motivated to change platforms that quickly. So we’re working with them across their platform portfolio.

Alan Krock

And then I’ll just add another driver is again, Behrooz’s discussed the importance of GLOBALFOUNDRIES in a multi-source strategy for us for our silicon. Certain important new platforms such as OIS and so forth will be produced based on cost opportunities to leverage the multi-fab, multi-player strategy and therefore with respect to some of the new products that are in production and products for potential customers that could go into production, we’ll have the advantage of the results of this hard work on our own cost structure and the leverage that the multi-fab strategy provides, especially for higher-volume opportunities such as OIS which could play well in volume in the mobile market for handsets and Tablets. So that’s also another distinct benefit where we get improvements in mix based on a lot of work that’s been done to our internal cost structure.

Tristan Gerra – Robert W Baird & Company

Very useful. Thank you.

Operator

Our next question comes from the line of Vernon Essi with Needham & Company. Please proceed.

Vernon Essi – Needham & Company

Thank you very much for taking my question. Was wondering if you could elaborate a little bit more on the OIS front and give us an update on sort of your attach rates and how you are looking at that going out into fiscal year 2014.

Behrooz Abdi

The attach rates right now are very small. This is a new market for us; actually it’s a new market for the smartphones and the Tablets. And the catalyst for that is that the camera modules are now getting thin enough and small enough using OIS that they can actually go and fit into a smartphone or a Tablet that’s always continues to go get thinner every year. So right now it’s a very small market, although we are starting to shift and ramp aggressively. For next year we haven’t really given any guidance. What I’ve told people is that my hope is that within the next year or so we’ll get into double-digit attach rates but that’s going – something that we’re just starting to go and promote aggressively into the market. We don’t have really any forecasts for that right now.

Vernon Essi – Needham & Company

Okay. And just as a sidebar on that, you don’t see any sort of mitigating factors in the supply chain on that front right now. It seems as though it’s really just up to the OEM to actually adopt a solution itself.

Behrooz Abdi

Yeah, it is mostly – obviously there’s additional cost with the OIS. Right now the camera modules don’t have the image stabilization that’s mechanical that – what we’re driving with the mechanical with the gyro enabled control, they’re doing it electronically but there’s nothing else in there to – it’s really the cost structure and it’s going down and the size that’s been going down. So there’s a couple of catalysts that we’re very hopeful for that market that’s starting to happen now.

Vernon Essi – Needham & Company

Okay. And then the next question, just on the working capital front, Alan’s great work pulling down a lot of the ratios there and generating cash, I’m just wondering – obviously this is sort of a lot of tailwind, I guess, on that front this time of year. As we head into the middle of calendar year 2013, will we see sort of a fan-out of all these part numbers and what not? Will inventory climb back up to where it was previously, or should we expect I guess the date to be perhaps a little bit less than where they came in a couple of months ago?

Alan Krock

Yeah, the previous days sales and inventory levels were primarily tied to the timing of new product introductions and the related customer adoption rates. In the June quarter we – it could be a somewhat similar phenomenon where it could be some of the new programs really get into volume production in the latter part of the quarter, although as we said, we expect some sales of the new products in the new customer platforms at the tail end of this quarter.

So if we use where it’s been in the past as one end of mark and the other end of the post is where we are today, likely with a bunch of new platforms and a bunch of new products and potentially new customers coming along, average, somewhere in the middle would be likely. So this time of year, yes, you would expect to see us work down the receivables when inventories are done and in this case generate $26 million in a single quarter of free cash. So hopefully that’s some helpful color on that thought.

Vernon Essi – Needham & Company

That is. All right. Thank you.

Operator

Our next question comes from the line of Richard Shannon with Craig-Hallum. Please proceed.

Richard Shannon – Craig-Hallum

Hi, Behrooz and Alan. Couple of questions for me, I guess first of all on – related to gross margins. Any incrementally more difficult environment from competitive pricing that may have impacted the gross margin results in December and obviously your outlook for March here? Has it gotten any worse than you’ve seen throughout the rest of 2012?

Alan Krock

Thank you. No. I believe generally this is a consistent environment. We do have a transition window here to get from some older products into some newer products. Some of our customers, the timing, we can’t control the timing of the introduction of customer platforms so if customers stay with an older platform a little longer than originally thought in that or some older products that are now price eroded at 25% year-over-year consistent with the experience, you can just get some timing and mix considerations.

But overall, the environment historically for the entire time I’ve been with the company and before that, competitors have, as we’ve said at conferences and on the road, largely competed against our model of offering features, function, availability and so forth with price. And the price competition, competitive nature of this market sort of based on the competitors that we have is what it is and it’s been relatively consistently so. So it’s more a question of mix, timing of new product introduction by customers that use the new products and considerations like that, that we really are not within our competitors’ control.

Richard Shannon – Craig-Hallum

Okay. I appreciate those thoughts. A couple other follow ups. Behrooz, I think you mentioned in your preliminary or your prepared comments regarding expectations of 6-axis growing. I think you said double digits sequentially and that you exceeded – or I can’t remember if you exceeded 50% in March or you already did in December. Can you give us a little better flavor for exactly what you expect from that product line in March?

Behrooz Abdi

Sure. And the – certainly in the Tablet and smartphones the higher integration is much more valued than any other segment, just especially in the smartphone because of the board space. And that transition is happening faster with some customers. They’re a lot more aggressive than others. But the transition to 6-axis and in general higher level integration is happening fairly aggressively. So the 50% that I mentioned is in the March quarter. And it’s the first time that we’re transitioning to 6-axis being a larger percentage.

Richard Shannon – Craig-Hallum

Okay. Great. And then just following up on the 7-axis products I think you first talked about last quarterly conference call. When should we start to see that introduced and coming to the market here? And what was your feedback from CS about that product? Especially as you talked about it in the context of indoor navigation and the contextual awareness.

Behrooz Abdi

In general, customers are very, very excited about any higher level of integration, more features that we’re adding, whether it’s the compass or any other axes that we’re adding. And they see the value of the platform that we have, the process technology platform that we can do this in a fabless environment. And we have the technology. With regard to the 7-axis in particular, I expect that we’ll be sampling lead customers in the second half of this year. And either really meaningful – and this is calendar, just to clarify. And I see that we’ll have meaningful revenues sometime in calendar year 2014, so by the end of fiscal 2014.

Richard Shannon – Craig-Hallum

Okay. Appreciate those thoughts. And just one last quick question from me regarding Windows 8 attach rate. What kind of attach rate are you expecting to see in Windows 8 in over – say calendar 2013? Or however timeframe you’d like to look at it.

Behrooz Abdi

Well, I don’t have exact numbers, but we’re very excited about that. There’s a lot more platforms that are migrating to us now. We see huge traction in terms of the share changes from other chips, from competing chips to our chips, to our platform, to our Motion 6-axis. And especially we’ve been working with both processors within that ecosystem.

And we have the soft reported with our partners. A lot of our customers have come to us very aggressively driven us to accelerate our transition in terms of the soft reporting which we did. And now we believe that we’re very well positioned to increase share there. Now depends on the product, of course. A lot of the laptops and, of course, desktops are going straight to – not much of an attach rate there. But certainly in the Tablets or convertibles, we feel that we’re very well positioned now versus let’s say six months ago.

Richard Shannon – Craig-Hallum

Okay. Sounds good. I appreciate the thoughts, guys. I’ll jump out of line.

Operator

Our next question comes from the line of Andrew Uerkwitz with Oppenheimer. Please proceed.

Andrew Uerkwitz – Oppenheimer

Hey. Thanks for taking my call. I think you’ve answered most of my questions. But I was just curious, in the past couple of quarters you’ve kind of given us an idea of what percentage you think the new products will be as far as a revenue perspective. Can you kind of give us a little clue there?

Alan Krock

Oh as far as coming in the March quarter? Or which particular period?

Andrew Uerkwitz – Oppenheimer

Yeah, you know like, historically you said like the 6-axis will be x percent by this quarter. I’m just trying to get a handle on the gross margin expansion from new products as they roll out. Is this summer activity? Is this going to be you know – from a percentage perspective, when will they be kind of the bulk of the revenue growth?

Alan Krock

So the – based on our comments earlier, we would expect some of the new products, some of those that are sourced from GLOBALFOUNDRIES and, and some of the new technology that we’ve got to be pretty active in the market place starting in the June quarter. We may not enjoy the full benefit of the entire quarter, although the customers, some of the customers actually start purchasing these new products with better margins attached in the March timeframe. So sort of a linear ramp through June is a way – the best way I would know to model it at this time and then as in the September and December quarters is where the volumes are the greatest you know, the products as with this year’s, percentage of the new products should be the greatest and then we’ll start the process over with the further features’ integration, additional features and DMP the following year.

So it seems to be based – following in the mobile space, you know you start –- the customers – the products are all announced and out there and being designed with actively by the customers late in the calendar Q4 period into calendar Q1, our fourth fiscal quarter. You start to see the benefit of that late in our fourth fiscal quarter, but really the timing of the introduction ramp continues for the six-month period from the June quarter through the December quarter.

Andrew Uerkwitz – Oppenheimer

And then just on the flip side, I’m kind of curious, some of your bigger customers I think, correct me if I’m wrong, get a bit of a discount which kind of compresses margin. If those seem to grow faster or that’s where some of these premium products are going, should the expand – I mean, can the expansion get back to – do you think – like how do you think you can get back to where you’re at now if some of these better – premium customers kind of pull down margins because they get better pricing?

Alan Krock

Well, so I mean there are a couple larger accounts out there that do the type of volumes to get the really advanced, best pricing in a model. But there’s – it’s a very – it’s somewhat of a fractured market. In other areas there are still probably more than 10, maybe more than 15, I’d have to check the smartphone manufacturers that do volume – still do volume platforms and so forth. But none nearly as large any longer as the big two. And we have this other segment of our business where we’re getting into some industrial opportunities based on customer demands and some – later on, potentially some in-cabin automotive opportunities based on customer pull. And all of those margin profiles are much greater than, say the margins that anybody in our industry earns off of the...

Andrew Uerkwitz – Oppenheimer

Sure.

Alan Krock

The two largest accounts in the marketplace. That being said, again our own cost reduction strategy where we have differences in foundry pricing between the two competitors in our supply chain, which are very significant and can offset essentially a full year’s worth of price erosion if we manage the supply chain carefully through just managing our own cost structure, those types of internal programs largely offset the – can largely offset the competitive dynamics we wind up with under the same sort of scenarios with our own customers. So we’re very aggressive in playing our suppliers off against each other as our customers are very aggressive in playing us off against our competitors.

So there are a number of opportunities in this new calendar year with to take advantage of pricing dynamics in our own supply chain together with continuing to work the margin opportunity in some of the more fractured markets that are either exist or are emerging in the MotionTracking.

Behrooz Abdi

The other thing is we try to differentiate more and more as we go with the next generation products. So it’s really not just offered just as a cost reduction to customers because then obviously they expect to take all the cost reduction that we gain from that. So the – and that’s where the size and lower power comes into play. So the more that we can innovate and out-innovate our competition and the more that we can integrate, there’s some of that cost reduction that we can hold; certainly with niche customers, once we deliver the new products to them that are more differentiated, we can hold the margins and hopefully expand for a while, as long as we have the lead.

Andrew Uerkwitz – Oppenheimer

I really appreciate that, guys. That’s excellent color. Thank you.

Operator

Ladies and gentlemen, that concludes the time we have for questions. I’d now like to turn the presentation back over to Mr. Alan Krock for closing remarks.

Alan Krock

Okay. Thank you, Jeff. We appreciate your support this afternoon. And just a quick word of thanks to all the participants in our call. And we do look forward to speaking with you again in our next public call relative to our Q4 and fiscal 2013 results and totals. Thank you again for time and effort for everybody and look forward to speaking with you soon.

Behrooz Abdi

Thank you.

Operator

Ladies and gentlemen, that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a wonderful day.

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