Omnivision Technologies Q4FY06 (Qtr ending Apr 30, 2006) Earnings Conference Call Transcript (OVTI)

Omnivision Technologies (NASDAQ:OVTI)

F4Q06 Earnings Conference Call

June 15, 2006 5:00 p.m. EST

Executives

Jason Gold - Financial Dynamics, Investor Relations

Shaw Hong - President, CEO

Peter Leigh - VP Finance, CFO

Jess Lee - VP, Mainstream Products

Hasan Gadjali - VP, Advanced Products

Analysts

Jennifer West - Merriman

Quinn Bolton - Needham & Company

Harsh Kumar - Morgan Keegan

Sam Doctor – J P Morgan

Jason Pflaum – Thomas Weisel Partners

Heidi Poon - Piper Jaffray

Tristan Gerra – Robert W. Baird

Hugh Cunningham - CIBC World Markets

Kent Shaw – Buckhead

Dan Scovel – Tokeneke Research

Tayyib Shah - Longbow Securities

Mike Crawford - Barrington Partners

Operator

Good day, ladies and gentlemen. Welcome to the fiscal fourth quarter 2006 Omnivision Technologies earnings call. My name is Colby, and I will be your coordinator for today. (Operator Instructions) I would now like to turn the presentation over to your host for today's call, Mr. Jason Gold of Financial Dynamics.

Jason Gold

Thank you, Colby and good afternoon, everyone. Earlier this afternoon, Omnivision issued a release reporting its financial results for the fiscal fourth quarter and year ended April 30th, 2006. This release can be accessed from the investor relations section of our website at www.ovt.com or on the financial news wire.

Before we begin, here are a few items for everyone’s reference. This call is being webcast live and a web replay will be available for 12 months. We have also arranged for a recording and a taped replay of this call which may be accessed by phone. It will be available approximately one hour after the call's conclusion and will be accessible for 48 hours. The dial-in number for this replay is 617-801-6888 and the replay pass code is 93732224. Both the call and the webcast replay can be accessed in the investor relations section of Omnivision’s website at www.ovt.com.

This conference call contains forward-looking statements within the meaning of Section 27-A of the Securities Act of 1933, as amended; and Section 21-E of the Securities Exchange Act of 1934, as amended.

These forward-looking statements include statements about our financial projections for the first quarter of fiscal 2007 and our expectations for growth in the image sensor markets; our expectations regarding our ability to continue to lead the market; the anticipated introduction, acceptance and benefits of our new products; our expectations regarding our ability to take advantage of future opportunities; and anticipated product and market developments beginning in the first quarter of fiscal 2007.

All involved known and unknown risks, uncertainties and other important factors that may cause actual company or industry results, levels of activity, performance or achievements to differ from those expressed or implied by these forward-looking statements.

In evaluating these forward-looking statements, you should specifically consider various risk factors, including the risk factors detailed from time to time in Omnivision's Securities and Exchange Commission filings; and reports including, but not limited to, the Company's annual report on Form 10-K filed for the fiscal year ended April 30, 2005 and its most recent quarterly report filed on Form 10-Q. These factors may cause the Company's results to differ materially from the forward-looking statements made in the conference call.

Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, it cannot guarantee further results, levels of activity, performance or achievements. These forward-looking statements are made only as of today's date and Omnivision expressly disclaims any obligation to update or revise the information contained in the forward-looking statements. This concludes the Safe Harbor statement.

Please also note that on this conference call, we will provide listeners with an estimate of future earnings per share determined on a non-GAAP basis to include stock-based compensation expense and the related tax effects. Estimating stock-based compensation expense and the related tax effects for future periods is subject to inherent risks and uncertainties, including but not limited to, the Company's stock price and the number of options exercised, and sales during the quarter.

This information, together with the corresponding GAAP numbers and reconciliation to the comparable GAAP financial measures, are contained in today's financial results press release which we posted on our website at www.ovt.com under the investor relations page and were furnished to the SEC on Form 8-K. We encourage listeners to review these items.

I would now like to turn the call over to Omnivision's President and Chief Executive Officer, Mr. Shaw Hong.

Shaw Hong

Thank you, Jason. Good afternoon, ladies and gentlemen. Thank you for joining us on today's call. With me today are Peter Leigh, our CFO; Jess Lee, VP of Mainstream Products; and Hasan Gadjali, VP of Advanced Products.

On today's call, I will begin with an overview of our results and a discussion of highlights of the quarter. Peter will provide you with the financial details, and then I will address the broader strategic outlook. We will then take your questions and for that, Jess and Hasan are here to provide additional insights.

Revenue during the April quarter was $132 million and the earnings were $0.39 per share. Revenue for fiscal 2006 was about $492 million and the earnings were a record $1.56 per share. Our balance sheet at the end of the quarter remains strong. Our cash and short-term investments totaled about $355 million.

During the quarter, slightly more than 70% of our revenue came from the mobile handset market; just under 10% came from the digital still camera market; and about 20% of our revenue came from our Advanced Product Group, which includes security and surveillance, high end video game consoles, web cams and mobile PCs, and automotive products. We are delighted to conclude our fiscal year 2006 by posting another quarter of strong year-over-year growth and record annual revenues.

During the fiscal year, we were able to take advantage of an excellent demand environment with our customers enjoying the benefit made on our OmniPixel architecture. We also took the next step forward by introducing our OmniPixel2 architecture. These architectures enabled a number of sensors, including the world's first megapixel sensors on a quarter-inch form factor.

Going forward, we expect this architecture to be the basis for the majority of our new products. With multiple designs wins in both Mainstream and Advanced Product markets, we anticipate a return to sequential growth in the July quarter, throughout the second half of calendar 2006 and beyond.

Our goal as a Company has always been to be the image sensor of choice in the market that we serve. Over the years, we have accomplished this by introducing the right products at the right time.

As I mentioned, we were the first to introduce a 2 megapixel sensor on a quarter-inch form factor. When we introduced the 2 megapixel sensor in the fall of 2005, we were a couple of quarters ahead of the competition. Beginning in the July quarter, we will recognize our first revenue from this product as we drive it into the mainstream.

In fact, between now and Christmas, one of our tier 1 customers will be introducing more than a half dozen products using our 2 megapixel sensor. The handset makers are very excited about this resolution, because this is the first time in which the world is seeing digital still camera image quality in a camera phone.

We also introduced the OV3630-VL, which allows the handset customer to upgrade their camera phone from 2 megapixel to 3 megapixel with our mechanical design changes. This drop-in replacement for the 1/3 inch camera model significantly reduces our customers' time to market for these handsets.

Targeting the digital still camera and the hybrid video camera market, we introduced our second generation 5 megapixel camera chip, the OV5610. This sensor is a small form factor device that not only captures images in a stunning 5 megapixel resolution, it also allows the user to capture SGTV quality video at 4 to 70 frames per second. We believe that 5 megapixel has emerged at the sweet spot for high volume digital still cameras.

We have also expanded our offering for emerging mass market automotive applications. Our most recent introduction was the OV7949, which improves low light sensitivity by a factor of 3 and significantly reduced blooming. These are important product enhancements because both forward and rear view auto cameras must display an accurate and clean image, even when faced with bright headlights from nearby vehicles.

The volume of Omnivision image sensors shipped in the quarter increased by about 16% sequentially to just over $48 million. This was in part due to volume growth in VGA sensors sold to an increasing number of mobile handsets shipped to emerging markets in Asia.

For the full fiscal year, we sold about 155 million sensors, a record for Omnivision. This brings the total number of sensors sold in the Company's history to well over $300 million. We believe that these milestones are significant, because they demonstrate our ongoing ability to deliver innovative products to existing mainstream markets, as well as to an increasingly broad landscape of emerging markets.

Our Mainstream Products business, which addresses our large volume customer in mobile handset and digital still camera markets continued to grow in the fourth quarter. Omnivision is leading the industry's transition to 2 megapixel products with a quarter-inch solution, which will begin shipping during the second half of the July quarter. Additionally, the Company is currently ramping production of its [CIF and] VGA sensors and 1.3 megapixel sensors to meet the increasing demand in the handset market.

Later this summer, we expect to sample our first product which incorporates wafer encoding, a technology that we acquired when we joined forces with CDM Optics in April of last year. Wafer encoding is a truly revolutionary technology, that uses a specially designed lens and powerful algorithm embedded in the accompanying chip to eliminate the depths of field constraints of a conventional lens.

Using wafer encoding, an image is always in focus from a short distance in front of the lens to infinity. This in turn means that there is no waiting for the lens to focus before taking the picture. The first product will be a 3 megapixel product designed for the mobile handset market. We believe that this technology has applications across all of the markets we serve.

Several of Omnivision Advanced Products continue to achieve a success in the fourth quarter. In the toys and the interactive game sector, we are building on the success that we enjoyed with the Sony Play Station 2 iToy camera. Since the iToy’s launch two years ago, more than 25 games are now available that use a camera to enhance the player experience allowing the player to be truly in the game.

This market has been expanding. We have maintained a dominant position, and we now have design wins with two of the top three video game console makers, and in multiple platforms. We are currently ramping production of these sensors as the consul makers look to launch their products for the holiday season.

We have also had much success with our image sensors for notebook computers. Our sensors are installed and are now shipping at three of the top five notebook OEMs. In order to build on this success, we continue to increase our product offering for this new market and believe that we will win business with the other top OEMs. In calendar 2006, we believe that there will be about 8 million notebooks equipped with cameras and that this market will grow substantially over the next few years.

Based on the momentum that we have experienced in the notebook market, we have also begun recapturing share in the standalone PC camera market. We believe that we now have about 25% market share and we will look to continue to expand our presence in this market.

As we mentioned last quarter, we are excited about our prospects in the automotive market. This market requires the highest quality sensors that have the ability to withstand the harshest of environments. It also demands that we align ourselves with the tier 1 automotive component suppliers.

During this quarter, we announced that the German company Herra, one of the largest global suppliers of automotive components, selected Omnivision to supply them with image sensors for rear view camera systems. More recently, we announced a design win with another tier 1 component supplier to provide image sensors for their [early detection] warning systems.

We are excited about our early success in the automotive sector and are expanding our design activity for multiple potential applications such as smart air bags, rain sensors, dimming headlights, just to name a few.

In fact, the EU has mandated that beginning in 2007 all new trucks and buses have 360 degree visibility from the driver's seat. We have long believed that this is a major market opportunity and we are more confident than ever of the extraordinary magnitude of this market's potential.

Another market that has significant potential for Omnivision is the medical market. Recently, one of our partners demonstrated a device using our image sensor that significantly increased identification of polyps in the colon during a standard colonoscopy procedure. There are currently 17 million colonoscopy procedures performed in the United States every year and approximately twice that number worldwide. Since the camera will be [single use], you can see that this application alone makes this a very attractive market.

I will now turn the call over to Peter who will discuss our fourth quarter financial results in detail. Peter.

Peter Leigh

Thank you, Shaw and good afternoon, everyone. For the fourth quarter of fiscal 2006, which ended April 30th Omnivision had revenue of $131.8 million, down 4% sequentially, a little better than expected. The modest decline was primarily due to seasonal factors and product mix changes.

For the full year of fiscal 2006, revenue was $491.9 million, a 27% increase over fiscal 2005, primarily due to a strong demand environment particularly in the mobile handset market. Direct sales to original equipment manufacturers and valuated resellers accounted for about 67% of revenue in the fourth quarter of fiscal ’06, with the balance of 33% coming from sales through distributors.

We shipped approximately 48 million image sensors in the fourth fiscal quarter, up from the approximately 42 million units shipped in the January quarter. Our blended ASP was $2.72. The reduction from the third quarter was a combination of the secular decline in prices and the shift in product mix.

Gross margin for the fourth quarter was 36.8% compared to 40.3% last quarter. The decrease in gross margin in the April period was primarily the result of a product mix shift towards lower margin VGA products.

During the quarter, the Company booked additional provisions for excess and obsolete inventory of approximately $3.1 million. Revenue from the sale of previously reserved inventory was $1.2 million. Gross margin for fiscal 2006 was 36.9%, compared to 40.3% for fiscal 2005.

As we continue to see strong growth for the Company, we believe that investing in our business, primarily in the R&D and sales and marketing functions, is very important. R&D expense in the fourth quarter was $11.7 million, up from the $10.5 million we reported in the prior quarter. As a percentage of revenues, R&D expense was 8.9%, up from 7.6% in the third quarter. The increase was due primarily to increased employment expenses.

SG&A expenses in the quarter totaled $10.2 million, up from $9.2 million in the previous quarter. SG&A as a percentage of revenue was 7.8%, up from 6.7% in the third quarter. The increase was due primarily to increased employment expenses and to distributor sales commissions.

Operating income in the quarter was $26.6 million compared to $35.6 million last quarter. Our operating margin was 20.2% in the fourth quarter compared to 26% in the third quarter. Our net income for the quarter was $22.5 million, and our net margin was 17.1%. This compares to net income in the third quarter of fiscal ’06 of $29.6 million or 21.6% of revenue and $17.7 million, or 17.1% for the same period last year.

Diluted earnings were $0.39 per share compared to $0.53 last quarter and $0.30 for the fourth quarter of fiscal '05. Diluted EPS for the quarter were based on weighted average shares of $57.3 million.

Let me now turn to the balance sheet, which remains in excellent shape. We ended the quarter with cash and short-term investments totaling about $354.5 million. Accounts receivable at quarter end, net of reserves, were $64.9 million, down $11.6 million from last quarter. Our DSO were 45 days, down from 51 days at the end of January.

Inventory was $55 million on April 30, 2006 compared to $62.5 million at January 31, 2006. Inventory turns were 6.1X.

Now I'd like to turn to the outlook for the first quarter of fiscal 2007, which will end on July 31, 2006. Based on current trends, the Company expects fiscal first quarter 2007 revenue will be in the range of $135 million to $145 million.

To be comparable with previously reported periods, excluding the estimated expense and related tax effects associated with stock-based compensation in accordance with FAS 123-R, the Company expects earnings will be in the range of $0.38 to $0.43 per share. The Company will adopt FAS 123-R in the July quarter and expects GAAP earnings will be between $0.27 and $0.34 per share.

I'd now like to turn the proceedings back to Shaw for some strategic commentary.

Shaw Hong

Thank you, Peter. Before we take your questions, I would like to elaborate on what we see happening in the next fiscal year for Omnivision. Our entire team is committed to extending our technology leadership and increasing the number of design wins that we have with both Mainstream and Advanced Products.

We believe the things to watch for in the coming year include our 2 megapixel image sensor getting into the mainstream for handsets; our [inaudible] VGA increasing sales; the introduction of our product using wafer encoding technology. We will have a new 3 megapixel offering. We will expand our presence in the automotive sector. We will begin seeing revenue from medical applications; additional opportunities in commercial systems for the security market; a camera system for a new entertainment game console will enter the market. We will increase our presence in the notebook and PC markets, and much more.

Operator, we are now ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Jennifer West - Merriman.

Jennifer West – Merriman

Good afternoon, congratulations on a nice quarter. I was wondering if you could talk to your gross margin expectations in the July quarter and going into the second half of the year?

Peter Leigh

Well, Jennifer, as you know, what we have consistently said is that we expect margins to be in the mid to upper mid-30s and that continues to be our expectation.

Jennifer West – Merriman

Well can you maybe talk to the changes next quarter as far as product mix and how the ramp of 2 megapixel products should impact?

Peter Leigh

Well, 2 megapixel products in general should be a positive influence on margin, but that is always offset by other factors such as competition with VGA products.

Jennifer West – Merriman

Then in the April quarter, it looks like Advanced Products grew nicely. What was the main driver there?

Shaw Hong

We have penetration into new automotive markets and also into the security and surveillance market because of our new introduction of 3950 and 3940 chip sets; that was happening six months ago.

Jennifer West – Merriman

So you expect that ramp to continue? When does medical sales kick in?

Shaw Hong

The medical sales is under a lot of -- we have one product that we announced that has FDA approval and we expect this product to start seeing revenue maybe in the next year timeframe.

Jennifer West – Merriman

Okay. Thank you.

Operator

Our next question comes from Quinn Bolton - Needham & Co.

Quinn Bolton - Needham & Co.

Hi, thanks. I echo the congratulations on a good quarter. I just wanted to again follow-up on some of the changes as you look into the July quarter. This quarter you experienced a mix shift to VGA, but you've got the new 2 megapixel coming out. I think the 1.3 seemed to be on a pretty good ramp. Can you talk about how you see your mix shift changing into the July quarter? Then I have a couple of follow-ups.

Jess Lee

Hi, Quinn. I think in the coming quarter we see all three segments – VGA, 1.3 and 2 meg being all strong in terms of units. In terms of the mix, we do see a trend of VGA and 2 meg both increasing share within our mix. VGA is seeing a lot of strong sales from low-end handsets that are targeting the emerging markets.

I think we're pretty happy with the penetration that we're seeing in those markets. These are all efforts that we've put into our VGA products to gain the increase in share there. Our 2 meg, we're actually very delighted with the reception we've gotten from our customers and from our customers' customers who have seen the phones that are using our sensors. We have very positive expectations for our 2 meg as well in the coming quarter.

Quinn Bolton - Needham & Co.

So from a margin perspective, it sounds like you're getting a barbell effect where the lower margin VGA are strong, but the high margin 2 meg are strong, so maybe offsetting to keep you in that mid to high 30% range?

Jess Lee

I think it's pretty safe to say that they kind of offset each other, although we're looking forward to nice penetration from all three segments.

Quinn Bolton - Needham & Co.

Okay. Great. The second question, I was surprised to hear some of your commentary about the strength in low-end handsets in Asia. A number of the Taiwanese guys over the last month seemed to have reduced forecasts, especially those in Taiwan.

I was wondering if you could discuss what you're seeing in the market?

Jess Lee

I think the strength that we see in low-end handsets with cameras are across the board, not just from the second tier handset makers, but also from tier ones. I think it is not a hidden fact that many of the tier ones have actually gained market share in Asia over the last two quarters against the second tier. So what we're seeing is just pretty good, strong penetration with our VGA in overall low-end handsets.

Quinn Bolton - Needham & Co.

Okay. Great. I'll turn it over to the next question, thank you.

Operator

Your next question comes from the line of Harsh Kumar with Morgan Keegan. Please proceed.

Harsh Kumar – Morgan Keegan

Congratulations on a good quarter, good guidance. A couple of questions. First of all, SG&A and R&D were both up about 1% and change. Is this something we should expect? Is this the level we should expect going forward? Or, do you expect to go back to the previous level? Then I’ve got a couple more.

Peter Leigh

Well, Harsh, as we may have discussed before, I think it’s better to think of SG&A and R&D in absolute dollar terms and not as a percentage of revenue. As a first approximation, I think what I would do is go back and look at the average increase, the average quarterly increase over say the last four quarters, and use that as a basis for any projections going forward.

Harsh Kumar – Morgan Keegan

Okay. That’s fair enough. Then there’s a line item called other income that went from positive $1.2 million in January to negative $3.2 million. Can you remind us what that’s for?

Peter Leigh

This is our reported share of the equity that we own in our unconsolidated affiliates.

Harsh Kumar – Morgan Keegan

How should we think about modeling that going forward?

Peter Leigh

I think if you use an average, again, of the last couple of quarters, it’s not going to be a material number.

Harsh Kumar – Morgan Keegan

My last question -- I’ll turn it over and maybe come back later -- if we take the midpoint of guidance and we try to get to your midpoint EPS, we see a pretty substantial erosion in gross margins going down to the mid-30s. I mean, I’m trying to understand your commentary with respect to 2.0 having better margins, getting somewhat offset with VGA. If we do the math and just try to honestly model what you’re telling us, we come up with lower gross margins. How should we think about that?

Peter Leigh

I don’t think necessarily that the arithmetic works exactly as you’re describing it. We’re comfortable with those guidance numbers, and as you know, we guide revenues and EPS.

Harsh Kumar – Morgan Keegan

Fair enough. I’ll come back later. Thank you.

Operator

(Operator Instructions) Your next question comes from the line of Sam Doctor -JP Morgan. Please proceed.

Sam Doctor – J P Morgan

Thank you. This is Sam on behalf of Paul Coster. I have a couple of questions. First of all, could you comment on your market share trends, as well as the competitive landscape? Where are you winning share? How does your share in VGA compare with the overall product mix?

Jess Lee

Hi. I can hear most of that question. So, it was a question about overall share, share of VGA and competition, right?

Sam Doctor – J P Morgan

That’s correct.

Jess Lee

So overall share, I think in terms of raw units for the year, we shipped 155 million sensors. So, I think we’re pretty happy with what we’re seeing. We think we’re tracking the growth in the market for camera phones and we think we’re maintaining or even growing share a little bit in some areas.

With respect to VGA, we haven’t really broken it out. I don’t know if we’re ready to give that, but the gut feeling is that we have actually gained share in VGA.

Sam Doctor – JP Morgan

Okay, and in emerging areas such as notebooks, medical imaging, et cetera, how does the competitive landscape look there? Are you the only leader? Is there somebody else that’s coming up as well?

Hasan Gadjali

Actually, as Mr. Hong said, we actually announced that we have three of the top five notebook makers with our camera inside. So, in this market, for the notebook market, I think we are leading the market in the segment.

We are also recapturing the PC cameras market by getting back 25% of the market share in this market. So, we are very entrenched in this market. In automotive, we are having a lot of activity in the automotive market; however, lately we have announced two major design wins which is a major contribution to our current revenue. We have more designs that we will announce at a later time.

Sam Doctor – JP Morgan

Finally, can you give us a sense of the magnitude of this secular ASP decline?

Hasan Gadjali

For the automotive?

Sam Doctor – JP Morgan

No, this is across the board. Your ASP decline last quarter is a mix of a secular decline as well as a mix shift to VGA. Can you give us a sense of what that secular aspect is?

Peter Leigh

We reckon that the annual decline is in the order of magnitude of 20%, but it doesn’t necessarily equate to 5% a quarter.

Sam Doctor – JP Morgan

Right. What you saw this last quarter was consistent with that number?

Peter Leigh

It is consistent with the number, but with the caveat, the important caveat that as I said, the decline quarter over quarter is not necessarily going to be just one-fourth of the annual decline.

Sam Doctor – JP Morgan

All right. Thank you.

Operator

Your next question comes from the Line of Jason Pflaum - Thomas Weisel Partners.

Jason Pflaum – Thomas Weisel Partners

Thank you. Nice job, guys. Two quick questions here. First, you talked a lot about some of these new market opportunities contributing revenue here in the not so distant future. Maybe you could help; is there way you can rank these different opportunities by revenue contribution opportunity over the next 12-18 months? Just generally, to get a sense of where you see the bigger near-term opportunities.

Peter Leigh

Well, we don’t generally break out these subsets of Advanced Products by individual sector, if you will; we would prefer to look at it as an entity. Suffice it to say that all of these opportunities -- notebooks, surveillance, medical, automotive -- all of these have strong growth potential; but of course, in the case of the newer markets such as automotive and medical, we’re starting from a very low base.

So, when we say that year over year we’ve seen a 10x growth in volume, that sounds very impressive, but you have to ask, well, what was the volume in the base year?

Jason Pflaum – Thomas Weisel Partners

Okay, maybe I’ll ask a different way. I think that group of the category was about 20% of your revenue this past quarter. If you look out 12 months from now, where do you see that percentage generally trending?

Peter Leigh

That’s a crystal ball that I don’t have.

Jason Pflaum – Thomas Weisel Partners

Okay. A last question here. Looking at your 2 megapixel design win activity. Can you just talk about the breadth that you’re seeing there? Do you have a good portion of the top tier? Maybe you could just provide a little color, Thank you.

Jess Lee

Yes, I think what we’re seeing here is pretty broad-based. We’re seeing a good portion of the top tier, good penetration within each of these handset makers. With a few of them, we’re seeing very significant numbers of handsets using our 2640. With some of the second tiers, we also have fairly good design-in activity. So, on that basis, I think we’re pretty positive about our 2 meg going forward in the next two quarters.

A lot of this is really based on the reaction to the product. It’s the right product, it’s the right size, it’s the right cost. It’s doing all the right things. It provides for the first time, as Shaw was mentioning, a true digital still camera quality in a camera phone.

So, as these roll out, I think we’ll be able to talk more about these products and we’ll be able to show you what kind of pictures these guys can take with our sensor.

Jason Pflaum – Thomas Weisel Partners

Great. thank you.

Operator

Your next question comes from the line of Tore Svanberg - Piper Jaffray.

Heidi Poon - Piper Jaffray

Hi. This is Heidi Poon calling for Tore. I just want to go back to Quinn’s question a little bit about the Taiwanese cutting estimates. We’re also hearing that for low-end handset inventory, it seems like there’s a little bit of build-up in the channel in the emerging markets. Do you see that, and what do you think it might do the pricing or your shipment outlook on the VGA segment?

Jess Lee

Yes, we also saw the same news this morning and in previous days about certain low-end handsets. What we found, and we did some cross-checking in our field, and what we’re finding is it’s maybe because of us that these events are happening. A lot of these handsets that you’re seeing a build up in inventory actually don’t have cameras. Meanwhile, we’re seeing ever increasing sales of our VGA for these particular types of handsets in these markets. So, we think we’re actually taking share or helping our customers take share in these markets with camera phones against non-camera phones.

Specifically to these Taiwanese makers, I think that’s maybe specific points in the market. We know these two guys that were mentioned in the morning very well, but I think overall our coverage with our VGA product goes far beyond these two guys.

Heidi Poon - Piper Jaffray

Okay, great, also just a little bit more on the mix with the ramp of the 2 megapixel -- obviously it is still ongoing -- but do you think that it might go to about maybe more than 15% of your handset revenue for the rest of the year?

Jess Lee

I think our 2 meg will contribute very nicely. I don’t know if we’ve ever given guidance on a split of how much revenue our 2 meg will do though. But, I don’t think you’re too far off.

Heidi Poon - Piper Jaffray

Okay, so it could be more than 15%?

Jess Lee

I don’t know if we’re ready to comment on that yet.

Heidi Poon - Piper Jaffray

Okay. I just want to get a sense of your ASP for the Advanced Products. For the automotive products, it seems like it’s more VGA-based, maybe more rugged. So, how does that compare in terms of ASP relative to your handset sensors?

Hasan Gadjali

Definitely, I don’t think we actually state specifically that number for ASP, but just to give you a ballpark figure. These products are basically in the high tens right now. So, we see pretty good ASP on this product because the volume is not really as high as cell phones, which is not close to cell phones, I want to say that. But there is strong demand for this product and the product has to be definitely – it’s very challenging to the requirements that they’re asking for.

So, we have to meet all the requirements: environmental, AZQ100 requirements, hot requirements, hot conditions. Since we’re able to do that, and we make sure that we have been through that, to meet the customers requirement, so it is in the high tens, the ASP right now.

Jess Lee

So, even though these are VGA products, they are much higher spec, much higher quality.

Shaw Hong

Much higher specs, much higher quality, higher reliability, package and everything.

Peter Leigh

And, therefore of course, higher costs as well.

Heidi Poon - Piper Jaffray

So, that leads me to my next question in terms of the margin and how do they compare relative to the overall corporate margin?

Peter Leigh

Well, we don’t break out the margin, but I think from what Hasan just said, I think you could reasonably draw the conclusion that the direction is favorable.

Heidi Poon - Piper Jaffray

Great thank you.

Operator

Your next question comes from the line of Tristan Gerra - Robert W. Baird.

Tristan Gerra – Robert W. Baird

Good afternoon. You mentioned in the Q&A how you expect this trend going forward to come from both VGA and 2 megapixel. I was under the impression that your 1.3 megapixel was starting to gain traction, as you said on your comments on the previous quarters. Are you revising this comment? I mean, it seems that there’s not going to be a significant shift in product mix in the second half, or am I not understanding this right?

Jess Lee

Well, I think it’s a mixture of things. We’re not revising what we’re saying. I said before, and it was said in this call, all three categories are growing nicely in terms of absolute units.

Specifically to 1.3, we’re still seeing growth there, and we expect further growth as we go into this year; but VGA and 2 meg is seeing extremely strong acceptance in their respective markets. 1.3 is still a great product, still being wrapped up nicely in the next coming quarters.

Tristan Gerra – Robert Baird

Okay, and if we looked at your July quarter guidance, does that include the expectation for mobile phone revenues to increase again, or should we expect to see some decline similar to the April quarter, sequentially?

Jess Lee

I think our expectation is that sequentially it would increase. So, the contribution from mobile phones would increase quarter to quarter.

Peter Leigh

With mobile phones being 70% of total revenues, it’s almost impossible for the corporate direction to be different for mobile phones.

Jess Lee

First, if it is out of the Advanced Products it does really well.

Peter Leigh

Well, we don’t discourage them from doing really well.

Tristan Gerra – Robert W. Baird

Okay, and could you say what percentage of your revenues came from China this quarter?

Peter Leigh

Our revenues from China this quarter were approximately 28%.

Tristan Gerra – Robert W. Baird

Great, and do you have, by any chance, the number for last quarter?

Peter Leigh

It was, I think about 18% or 20%. I don’t have it in front of me, but there was no doubt that it was a significant increase this quarter over last.

Tristan Gerra – Robert W. Baird

Great, thank you.

Operator

Your next question comes from the line of Daniel Gelbtuch – CIBC. Please proceed.

Hugh Cunningham - CIBC World Markets

Congratulations, guy. This is Hugh Cunningham for Daniel Gelbtuch. Can you tell me if chip scale packaging is a positive factor for you guys competing against Asia-based competitors? If it is, how sustainable is the advantage?

Jess Lee

Well, chip scale packaging is a competitive advantage actually across the board against many of our competitors, not just our Asian competitors. It basically helps the module making process become much higher yield than in a traditional sense; traditional being chip on board.

Of course, if you had a really good chip on board module maker, that’s not going to be a huge plus, but what we’re seeing in the marketplace is we have a large number of module makers and most of them do benefit from our CSP packaging.

Hugh Cunningham - CIBC World Markets

Is that advantage sustainable or is it eroding or do you see people catching up?

Jess Lee

What we see is that it’s been pretty sustainable and we know that other folks are trying to introduce their form of CSP, and some have tried, and some have moved on.

CSP is actually pretty old news for us. We’ve used CSP for the last two-and-a-half, almost three years now. We see going forward that it’ll continue to be a competitive advantage. Going forward, we are looking in newer types of packaging that will continue to give us a nice advantage over our competitors.

Hugh Cunningham - CIBC World Markets

Great, thank you very much.

Operator

Your next question comes from the line of Kent Shaw - Buckhead. Please proceed.

Kent Shaw – Buckhead

Congratulations. Just have one quick question. I was wondering if you could outline the current medical products that either you have design wins -- I think in the press release you alluded to multiple medical products, but I don’t think I’m quite aware of everything that might include. Thank you

Shaw Hong

In the press release, we kind of mention a little bit about the incubations FDA approved products, and then we just announced our new partner’s collaboration on a colonoscopy camera. Those two applications are basically single use cameras.

The market has great potential, and we can see 80 million units for these two single use cameras that we mention. For example Incubation has about 50 million units, 50 million procedures a year done on that procedure and for colonoscopy about 34 million. So, if we have those two use in every application, we would be looking at 80 million very quickly.

Kent Shaw – Buckhead

What type of sensor actually goes into that product?

Shaw Hong

Right now, most of the quality for such disposable, we are looking at safe resolutions. And I think we are about make some comment and some release on new product to address this market.

Kent Shaw – Buckhead

Okay, thank you very much

Operator

Your next question comes from the line of Dan Scovel - Tokeneke Research.

Dan Scovel – Tokeneke Research

Thanks again. Nice quarter. Just a couple of housekeeping questions. Can you comment on CapEx, depreciation, and head count for the quarter please?

Peter Leigh

Well, CapEx, as you know, is relatively modest, and the expectation going forward is that outside of additional investments in affiliates in one form or another, we don’t expect CapEx to be a big number.

Head count continues to grow as you would expect in a growing company, but nothing extraordinary. Then, what was your third item? I’m sorry.

Dan Scovel – Tokeneke Research

Depreciation.

Peter Leigh

Depreciation expense for the quarter is going to be fairly similar to what it’s been in prior quarters. So, I don’t think it’s a number that is particularly unusual. In the third quarter, depreciation and amortization was $3 million, and order of magnitudes, it will be the same.

Dan Scovel – Tokeneke Research

Two other questions. Any over 10% customers? Can you comment on any repurchases of shares during the quarter?

Peter Leigh

There were, if I recall, three over 10% customers during the quarter, and we did not repurchase any shares.

Dan Scovel – Tokeneke Research

Thank you.

Operator

Your next question comes from the line of Tayyib Shah - Longbow Securities. Please proceed.

Tayyib Shah - Longbow Securities

Hi guys. Congratulations on the quarter. Just wanting to get a sense of – [MyTone] has said that they’ll be increasing their wafer output for image sensors by their August quarter. I wondered if I could get a sense of how you are positioning yourself in the third quarter pricing wise to compete with that, and how that might affect your market?

Jess Lee

Well, we believe our pricing has been and will continue to be competitive regardless of any one particular competitor’s capacity. Any one competitor can only impact certain segments of many of the markets that we address. So, we believe we’ll maintain our competitiveness overall.

Tayyib Shah - Longbow Securities

And then, the wafer encoding product, can you give us a sense of how ASP for that product, how much higher that is compared to your normal 2 megapixel products?

Jess Lee

Yeah, the 2 meg products on its own already is fairly high ASP and with our wafer encoding product, that’ll be a two-chip solution tied to our 3 megapixel sensors. So, clearly that’ll be another jump in ASP if you consider that as a chipset.

Tayyib Shah - Longbow Securities

Okay, thank you.

Operator

Your next question is a follow-up from the line of Harsh Kumar. Please proceed.

Harsh Kumar - Morgan Keegan

Hey guys. Can you talk little bit about the notebook market? I think you said three out of five customers. Are they tier one customers? Can you mention their names at all, or how much market share you have in the sector?

Hasan Gadjali

Three out of five of those customers are tier one customers, and we can’t mention the name because we don’t have the permission to do that. However, we basically have 100% for those three of the top five.

Harsh Kumar - Morgan Keegan

Okay, can you give us a sense of, I mean, anything would be helpful – can you give us a sense of how many models are coming out?

Hasan Gadjali

I believe that they have almost 1,000 models out there right now that have cameras built in. As we said, this year we should have about 8 million notebooks with cameras built in, and the potential going up to 40 million by the year 2008.

Harsh Kumar - Morgan Keegan

That’s very helpful. Thank you.

Operator

Your next question is a follow-up from the line of Quinn Bolton - Needham and Co. Please proceed.

Quinn Bolton – Needham & Co.

I just wanted to clarify the blended ASP Did you say it was $2.72 this quarter?

Peter Leigh

Correct.

Quinn Bolton – Needham & Company

And, it was $3.27 last quarter?

Peter Leigh

I think it was actually $3.26, but I won’t lie to you.

Quinn Bolton – Needham & Company

Okay, obviously, that’s a pretty big shift in the ASP. Can you help us with just sort of the mix shift to the VGA? I know that you said you saw that shift, but if you could quantify what VGA versus megapixel was last quarter and where it may have shifted to this quarter, that would be very helpful. Thank you.

Peter Leigh

So, last quarter, VGA, the VGA number versus our 1.3 number, we shipped less VGA than 1.3, and this quarter was a pretty dramatic turnaround for our VGA. We actually shipped well in excess of 50% VGA and less than 50% 1.3. So, that shift contributed pretty significantly to the ASP decline.

Quinn Bolton – Needham & Co.

Okay, great. that’s helpful. Thank you.

Operator

Your final question comes from the line of Mike Crawford - Barrington Partners.

Mike Crawford - Barrington Partners

Yes, can you talk about what you think your increase in units will be, or is based on your guidance for next quarter? Thanks.

Peter Leigh

Well, Mike, we don’t generally give guidance in terms of units. All I would say in response to your question is that the guidance is based on a bottoms up forecast which is a combination of orders in the backlog and the forecast that we get from around the world from our sales teams. That is, I think, in many ways a more reliable way of doing it than trying to do it top down in terms of units.

Mike Crawford - Barrington Partners

Okay, thank you.

Operator

There are no further questions at this time. So, I will now turn the call over to Mr. Shaw Hong for closing remarks.

Shaw Hong

In closing, I want to reiterate our confidence in the ability of Omnivision to continue to advance image sensing technology. We are well positioned to introduce new and advanced products ahead of the competition. We appreciate all the work our team contributes to our success. We thank you for participating in our call. We look forward to speaking with you next quarter. Good bye.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect.

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