Omnivision Technologies Comment on Raising Gross Margins

On Omnivision Technologies' (OVTI) Fiscal 1Q conference call, executives discuss new technologies, such as wafer encoding, as an antidote to falling gross margins:

Peter Leigh, VP Finance, CFO

Gross margin for the first quarter was 36.3% compared to 36.8% last quarter. Our gross profit in the first quarter reflects approximately $0.9 million of stock-based compensation expense. Excluding stock-based compensation expense, gross margin in the quarter was 37%...

Jason Pflaum, Thomas Weisel Partners

... looking at the guidance and I guess what it implies for the gross margin, I was running some quick numbers and it seemed to suggest another step down in the 33% range or somewhere give or take. Can you talk about what the primary drivers are there, is it the ASP erosion or is there an ongoing mix consideration that’s weighing there?

Peter Leigh, VP Finance, CFO

The principle imprint is the one that you identified, Jason, which is ASP erosion. In the meantime, as we said in our prepared remarks, we’re working very diligently with all participants in our supply chain to continue to drive down cost, but that is of course a longer term proposition and we won’t necessarily see the results of all of those initiatives for a couple of quarters at least.

Jess Lee, VP, Mainstream Products

Jason, I’d like to add in more detail that there are three initiatives that we have. One is this constant review of our cost structure and working with our partners to improve our supply chain to get cost down. But there are two other initiatives and this is what we’ve been doing for a long and we will continue. The first is to aggressively adopt newer technologies and newer products. As we upgrade people to newer resolutions they will adopt higher quality product at a lower price with hopefully better margins for us. The second thing is we see this ongoing trend of people upgrading. So, people are upgrading from non-camera phones to camera phones, people are upgrading from 1.3 to 2 meg. So, there is a constant path wall to help our mix...

Harsh Kumar, Morgan Keegan

I’m thinking of your business long term. The way I’m computing a gross margin outside of all these kind of one-time things hat you had was bout 34%, is that how we should think about this business as a 34% margin business longer term, can you help me with that?

Peter Leigh, VP Finance, CFO

Our goal remains the mid-to-upper mid 30’s target that we talked about I think over at least a year, and that remains the goal. In the short run we will be competitive and I think that it’s prudent to anticipate that margins will be under pressure for the next one or two quarters, but longer term the goal remains this mid-to-upper mid 30 band that we talked about.

Harsh Kumar, Morgan Keegan

So, I guess what you’re saying is once you get the new capacity back in place, early part of next year calendar, you do expect margins to go up a little bit, is that what I’m hearing?

Peter Leigh, VP Finance, CFO

Subject always to the underlying overlying consideration of what happens to ASPs, and sadly we don’t have as much control over ASPs as we would like...

Tristan Gerra, Robert W. Baird

Good afternoon. Looking at he gross margin decline for the October quarter, you said that you expect to pick up in a couple of quarters, what will be really driving this particularly since you will be at seasonal peak from unit standpoint and what will be driving gross margin back to the 35% level?

Peter Leigh, VP Finance, CFO

Well, one of the things Jason you have to bear in mind is by then we expect wafer encoding well established in the revenue stream and that will have a positive impact. And our programs to reduce cost go on day and night regardless of how they impact a particular quarter.

Jess Lee, VP, Mainstream Products

Right, we just wanted to highlight again our three-part strategy here. As Peter talked about, first is really aggressively working with our partners to reduce cost in our supply chain, and second is to adopt newer technologies in terms of our sensors. What customers want is more features and more form factorance at lower cost. We’ve seen this successful execute with the OmniPixel 2 and I guess what we’re alluding to is you’ll see something from us fairly soon on newer technologies for newer products.

Tristan Gerra, Robert W. Baird

Now, assuming that the wafer encoding product launches successfully, my assumption is that it has to remain a very small percentage of total revenues for a long time given that even today VGA is still over 50% of your mix and that technology is really targeting 3 megapixels. So, can you tell us a little bit about the margin differential for that product and how much you think it can contribute to the topline a year from now?

Jess Lee, VP, Mainstream Products

Let me answer your question in a couple of different ways here. So between Peter and I we talked newer technologies being adopted in newer products. So wafer encoding is just one of those, that is as you said for the higher end, and as you can probably guess those have not been huge volumes compared to VGA 1.2 and 2. So, the other part of what I said was…maybe I should be more clear…is there will be newer technologies adopted into the lower end, mid range, and even 2 megapixel products. So, we’re looking forward some of these newer technologies coming out fairly soon.

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