OmniVision's CEO Discusses F1Q 2014 Results - Earnings Call Transcript

OmniVision Technologies, Inc. (NASDAQ:OVTI)

F1Q 2014 Results Earnings Call

August 29, 2013 5:00 PM ET

Executives

Arnab Chanda - Director, Investor Relations

Shaw Hong - Chief Executive Officer

Ray Cisneros - Senior VP, Worldwide Sales and Sales Operations

Hasan Gadjali - VP, Worldwide Marketing and Business Development

Anson Chan - Chief Financial Officer

Analysts

Harsh Kumar - Stephens

Betsy Van Hees - Wedbush Securities

Joseph Zakaria - Needham & Co.

Anthony Stoss - Craig-Hallum

Tom Sepenzis - Northland Securities

Dan Scovel - Tokeneke Research

Operator

Ladies and gentlemen, thank you. And welcome to the OmniVision Technologies Conference Call for the First Quarter of Fiscal 2014. At the time all participants are in a listen-only mode. Later, we will open up the call for your questions. Instructions for queuing up will be provided at that time. As a remainder this conference is being recorded for replay purposes.

I would now like to turn the conference call over to Mr. Arnab Chanda, Director of Investor Relations at OmniVision Technologies. Please proceed.

Arnab Chanda

Thanks very much. Good afternoon, everyone. And welcome to our fiscal 2014 first quarter conference call. Joining us today are Shaw Hong, Chief Executive Officer; Ray Cisneros, Senior VP of Worldwide Sales and Sales Operations; Hasan Gadjali, VP of Worldwide Marketing and Business Development; and Anson Chan, Chief Financial Officer.

During the call, we may make forward-looking statements regarding our business, including statements relating to revenues, earnings targets and our product plans. This is based on information as of today, August 29, 2013.

Actual results may differ materially from those set forth in these statements. These and other forward-looking statements involve assumptions, risks and uncertainties that could cause actual results to differ materially.

For a discussion of these risk factors, you should review the forward-looking disclosures in the earnings release we issued today, as well as the risk factors and other disclosures in OmniVision's SEC filings and reports, including the most recent annual report on Form 10-K and recent quarterly reports on Form 10-Q.

During today's call, we will also discuss certain GAAP and non-GAAP financial measures, the latter of which excludes stock-based compensation expenses and the related tax effects. A reconciliation between the two is available on our earnings release posted on our website.

With that, I will turn the call over to Mr. Shaw Hong. Shaw?

Shaw Hong

Thank you, Arnab. Welcome to all of you joining the call and webcast. Earlier this afternoon, we issued a press release describing our fiscal Q1 2014 results. We reported Q1 revenues of $374 million, which was up 11% sequentially and 45% year-over-year.

During the quarter, we shipped 208 million sensors. On a non-GAAP basis, gross margin was 17.7% and net income was $31.7 million or $0.55 per diluted share. Our balance sheet remains strong and our cash balance was $241 million, a sequential increase of $28 million.

Before I turn the call over to our management team to provide details on our Q1 financial results and outlook, I'd like to make a few comments on our business.

Based on the financial results that we achieved in Q1, we continue to believe that we are among very few CMOS image sensor suppliers that have the scale to support the volumes needed today in consumer markets such as smartphones and tablets.

We are also proud to report that according to third parties researcher TSR incarnated 2012, we gain market share in unit shipment and remained the number one supplier of CMOS image sensors for the sixth consecutive year.

During the second half of the quarter, similar to the other market participants, we saw slowdown in our core smartphone market. Simultaneously, we have also seen competition in our core market intensified.

Despite this conditions, we remained confident that our long-term strategy which consist of three-prong approach. First, technology development, second, market growth and diversification, and third, cost structure improvement will allows us to navigate the market environment successfully as we have done in the past.

First, it is our firm belief that technology development and improvement is a cornerstone to the success of our company. We are pleased with our achievements in developing and improving our family of BSI technologies.

Starting from being the first company in 2009 to successfully deliver to the market CMOS image sensor product based on our first generation of BSI technology to today's high volume shipment of products based on our second-generation of BSI technology.

In fiscal 2014 and beyond, we will not only focus on enhancement to our family of BSI process technologies, but also continue our technology development efforts in order to design and deliver high performance products with right features that meet our customers need and consumers demand.

Second, and of equal importance to technology development and improvement is our approaching market growth and diversification. We are committed to designing and developing new applications for our core smartphone and tablet markets, as well as developing new markets for image sensors.

In our core market, we are shipping our image sensors into volume production for flagship phones and tablets across multiple platforms. While grow slow during the quarter in the smartphone segment, we continue to see incremental growth due to seasonality from various markets.

In addition to our development and growth in our core market, OmniVision continues to make significant progress in automotive market. New applications such as rearview, surround view, as well as mirrorless applications for drive assist and the infotainment functions are driving significant camera adoption in cars.

During the quarter, OmniVision won significant design wins at top machine vision, as well as automotive electronics OEMs. We believe we have gained market share at North America, European and Japanese automotive OEMs for both surround view, as well as rearview camera applications.

Our 720p HD and 1-megapixel sensors are shipping in volume production in multiple model for several luxury automotive OEMs. We continue to expect that longer term, automotive will drive higher margins and market diversification for OmniVision.

As we are committed to designing and developing new applications, we believe gesture recognition including eye tracking could hold premise as a new exciting applications for image sensors in our smartphone, tablet, PC as well as automotive markets. Most gesture recognition applications require the use of one or more cameras to implement the technology.

Gesture recognition has the potential to significantly expand the market opportunities for cameras in existing and new consumer devices. Another potential new market opportunity for image sensors is based on wearable technologies. These technologies highlighted very early stage of adoption. We are seeing interest from an increasing number of OEMs for wearable applications such as glasses, pens, smart watches.

OmniVision remains committed to driving long-term sustainable gross margin improvements through cost reduction efforts. For the near term, our team has been executing the cost reduction plan by among other actions, increasing product design efficiency, working with our supply chain vendors and better manage supply chain logistics.

However, as I discussed earlier, given the more competitive market environment, we did not see gross margin improve during fiscal Q1. If this market conditions persist, it may be difficult to improve our gross margin significantly in the near term. Nevertheless for the long-term, we believe continue our three pronged approaches regarding our margin expansion.

Before I turn the call over to Ray who will provide an update on the quarter’s sales activities, I would like to reiterate that we are pleased with the company's performance in fiscal Q1 2014, especially given the challenging environment in the second half of the quarter. We are committed to deliver high-quality sensors across our diverse markets and customers in a cost-effective manner.

With that, Ray?

Ray Cisneros

Thank you. Shaw. We are pleased to report that our revenues came in line with our guidance in spite of a slowdown in our core markets. Worldwide, we saw a very dynamic smartphone environment.

We continue to ramp our latest BSI-2 generation sensors for new platforms expected to launch in the fall. We continue to take market share in the automotive segment.

In our first quarter, we shipped 208 million units as compared to 188 million units in of our prior quarter. The average selling price in our first quarter was $1.79 equivalent to the prior quarter. This is the first time in the last six quarters that we did not see ASP rise. The first quarter ASP was due to the combined effects of higher HD shipments as well as better pricing in the China region.

Unit sales of sensors 2-megapixel and above represented approximately 47% of total shipments in the fiscal first quarter as compared to 50% in the prior quarter. On an absolute basis, we saw increases in 8-megapixel and 12-pixel shipments, steady 5 megapixel shipments and an initial shipments of our new 10-megapixel sensor.

Unit sales of 1.3-megapixel sensors represented approximately 39% of total shipments as compared to 33% in the prior quarter. HD sensors formed the bulk of the segment in the ramp up of our new 720p BSI-2 base sensor contributed to higher shipments in this category. Finally, unit sales of sensors that were VGA and below represented approximately 14% of shipments as compared to 17% in the prior quarter.

In terms of target markets, our mobile phone sales represented approximately 63% of revenues in the first quarter as compared to 65% in the prior quarter. Our entertainment segment represented 22% of sales as compared to 17% in our prior quarter.

Our sales of sensors entered notebook and webcam segment. We’re approximately 7% of sales as compared to 8% in our prior quarter. Other categories balanced out the remainder.

In the mobile phone market, we saw highly dynamic environment during fiscal first quarter. There were mixed results on some high-end smartphone products that a select number of our customers launched during the summer season. In the China market, there was some reduction in demand in the second half of the quarter which we expect to continue in our fiscal second quarter.

Nevertheless, we are pleased to see incremental growth in the mobile phone business driven by the China region in key North American customers, demonstrating the benefits of our diversified customer base. To support our diversified customer base, we launched a number of new products.

For lower resolutions, we launched our larger next-generation 720p BSI-2 based HD sensor, the OV9762. The OV9762 will ship in key platforms for the upcoming holiday season. For the mainstream high-volume category, we continue to ramp up our latest quarter-inch BSI-1 based 5-megapixel sensor the OV5648.

For the high-end, high-volume smartphone segment, we sampled our latest one-third inch BSI-2 based 8-megapixel sensor, the OV8865. Lastly, we launched our 10-megapixel sensor, the OV10820 along with the companionship of the OV660. A certain percentage of the sensor array in the OV10820 uses the panchromatic filter in order to maximize low-light sensitivity.

The China region continues to be a key driver for growth in the smartphone segment. Leading China-based OEMs are focused on gaining smart phone market share globally both for domestic Chinese sales as well as exports worldwide. Due to our long-term focus in solid sales channels in this region, we shipped all the major tier 1 and tier 2 OEM brand names in China.

We shipped a solid mix of products in this region including 12-megapixel, 8-megapixel and 5-megapixel products. In our entertainment market, the tablet segment continue to drive our revenue and saw strong growth. During fiscal Q1, we also continue to ship to top TV OEM customers for embedded camera applications.

In the tablet market, several key customer products were launched using OmniVision sensors during Q1. In addition, we also ramped up specific sensors for customer tablet products scheduled to launch in the fall.

Overall the concentration of sensors and tablet designs predominately revolves around 720p HD in the quarter-inch 5-megapixel resolutions and our products are shipping to all major operating systems. Another trend in calendar 2013 is the greater proliferation of the 7-inch tablet display form factor compared to the 10-inch display.

Wearables like smart watches are being developed by top OEMs and we believe an imaging solution would be required in these devices. While it is too early to tell how much volume the wearable segment will drive, we believe OmniVision is well positioned to capture the growth opportunity.

In the notebook segment, despite PC market weakness OmniVision was able to maintain consistent shipments. The key reason is our strong position in the premium notebook product lines that maintain a high 720p HD image performance standard. In that segment, OmniVision has consistently delivered be our long-standing high performance image sensor, the OV9726.

To maintain our position in this space, we are transitioning our customer base to the next-generation product the OV9728. In addition, many PC OEMs are going through an intense period of innovation in order to rejuvenate the PC category.

Imaging is a key driver of differentiation for next-generation PC products. At OmniVision, we are closely collaborating directly with OEM customers or third-party partners to use our sensors and innovative applications such as gesture motion control and eye tracking.

In our emerging market category, we saw good growth in our security business due to the continued proliferation of IP digital camera products. This is a rapidly developing market as cost and ease-of-use are driving growth. High-performance 720p HD and VGA sensors are the primary products in this market.

In the automotive space, we shipped steady volumes. We saw the early ramp-up phase of our new one megapixel high dynamic range color sensor the OV10635. This product will roll out on several premier automotive models in calendar 2013. Additionally, we continue to gain market share with design wins with OEM customers and platform partners in the U.S., Europe, and Japan markets.

In summary, we are pleased with our performance at the beginning of a new fiscal year given the highly volatile market conditions.

Shaw Hong

Thank you, Ray. I will now turn the call over to Hasan who will provide an overview of the company’s marketing efforts and opportunities.

Hasan Gadjali

Thank you Shaw. During the first quarter of fiscal 2014, we continue to focus on expanding our position in the mobile devices segment, specifically the smartphones and tablets markets. Today’s mobile devices require compact high performance camera solutions with low power consumption to enable longer battery life without sacrificing quality.

Omnivision’s proprietary OmniBSI+ and OmniBSI-2 pixel technology continue to enable innovative camera solutions that drive demand in the high competitive smartphone and tablets market. We introduced the OV10820, a 10.5-megapixel Native 16:9 sensor.

OmniVision also launches a companion chips named OV660 which eliminates the need for manufacturer to modify existing standards image pipelines and algorithm. The combination of both chips offer customers a complete high performance camera solutions with exceptional low light performance for next generation smartphones and tablets.

During the quarter, we also introduced the OV8865 a low-power high performance 10 megapixel camera chip solutions based on an improved 1.4-micron OmniBSI-2 pixel. The new pixel technology delivers a number of performance improvements including better dynamic range and a significant reduction in dark color, improved image quality under standards as well as low light conditions.

At just under a third of an inch, the new sensor also supports full range high-speed photography, 10 adp full HD video as well as 720p HD video. In addition, OV8865 consumes considerable less power than its predecessors meeting the sub-200 milliwatt benchmark preferred by high-end mobile devices manufacturer.

A key development during the quarter was our joint announcement with e-con Systems. For the embedded market, we announced the ability of a new 5-megapixel full HD MIPI camera that support of free skill IMX 6 family of processors. The camera board is interfaced directly to free skill save the light board and include a 5-megapixel auto focus camera module using the OV5640. Application range from handheld devices and automotive infotainment to industrial, medical and home automation applications.

In summary, OmniVision continue to develop innovative products and technologies that support our core market in consumer devices as well as enable market diversification into emerging markets and obligations.

Shaw Hong

Thank you, Hasan. I will now turn the call over to Anson who will discuss our first quarter financial performance and provide guidance for our second quarter of fiscal 2014.

Anson Chan

Thank you, Shaw and good afternoon everyone. For the first quarter of fiscal 2014, we are reporting revenues of $373.7 million, up 11.1% sequentially and up 44.8% on a year-over-year basis. Direct sales OEMs and VARs accounted for 81.6% of our revenues in the first quarter of fiscal 2014, an increase from 78.4% in the prior quarter. The remainder of our revenues came from sales through our distributor channels.

Our fiscal 2014 first quarter gross margin was 17.4% compared with the 17.5% that we reported in our prior quarter, excluding stock based compensation expense of $1 million and included in the cost of revenues. Our non-GAAP gross margin was 17.7%, the same as our prior quarter.

The sequential reduction in our GAAP gross margin in fiscal 2014 first quarter was primarily the result of an increase in provision for excess and obsolete inventories, partially offset by some degree of manufacturing cost reductions. The increase in allowance for excess and obsolete inventories reflects a slowdown in the mobile handset market as well as a more competitive pricing environment. These issues have negatively affected the forecast for some of our products and prompted us to record allowances for quantities that were in excess of forecast.

In the first quarter of fiscal 2014, we recorded approximately $1 million for the sale previously written down inventory and $9.4 million as an additional allowance for excess and obsolete inventories with a net $8.4 million or 2.3 percentage points of unfavorable impact on our gross margins.

In comparison, in the fourth quarter of fiscal 2013, we recorded approximately $0.8 million for the sale previously written down inventory and $6.2 million as a special allowance for excess and obsolete inventories with a net $5.4 million or 1.7 percentage points of unfavorable impact on our gross margin.

Now, going forward at least in the near term, issues that affected our gross margin in our fiscal 2014 first quarter such as slowdown in our core mobile handset market, a more aggressive pricing environment and last but not least, our continued higher concentration of BSI-2 based sensors in our resolution mix may persist.

R&D expense in our fiscal 2014 first quarter totaled $27.7 million, a 4.1% increase from the $26.6 million in our fiscal 2013 fourth quarter. The increase is attributable to an increase in masks and other non-recurring engineering expenses coupled with our annual company wide salary increase that went into effect on July 1st.

We currently expect our GAAP R&D expense in the second quarter of fiscal 2014 will increase by close to 10% due to additional non-recurring engineering expenses and the salary increase taking effect for the full quarter. R&D expense in the first quarter of fiscal 2014 included approximately $3.8 million of stock based compensation expense.

Excluding the stock-based compensation expense, fiscal 2014 first quarter R&D expense was $23.9 million as compared to $22.9 million in the fourth quarter of fiscal 2013. SG&A expenses increased slightly from $17.9 million in the fourth quarter of fiscal 2013 to $18.2 million in the first quarter of fiscal 2014. We expect SG&A expenses in the second quarter of fiscal 2014 to increase slightly due to the salary increase I mentioned earlier.

Our fiscal 2014 first quarter SG&A expenses included approximately $3.7 million of stock-based compensation expense. Excluding the stock-based compensation expense, SG&A expenses in the first quarter of fiscal 2014 totaled $14.5 million compared to $14.6 million in our fourth quarter of fiscal 2013. The amount of amortization for our acquired patent portfolio remained at $2.3 million per quarter.

Our GAAP operating income in the first quarter of fiscal 2014 totaled approximately $16.9 million as compared to $11.9 million in the fourth quarter of fiscal 2013. Our GAAP pre-tax income in the first quarter of fiscal 2014 totaled $16.3 million as compared to $12 million in the prior quarter.

Our GAAP benefit from income taxes for the first quarter of fiscal 2014 was $6.7 million. This compares with a GAAP tax provision of $3.1 million in the prior quarter. Included in the GAAP benefit from income taxes for the first quarter of 2014 was the reversal of certain previously recorded tax reserves when the statute of limitations for the related tax matters expired. This reversal resulted in a one-time non-cash tax benefit of approximately $8.9 million.

Excluding the effect of stock-based compensation, our non-GAAP benefit from income taxes for the first quarter of fiscal 2014 was $6.9 million. This compares to our non-GAAP tax provision for the fourth quarter of fiscal 2013 of $2.3 million.

For the second quarter of fiscal 2014, we expect our GAAP income tax rate to be in the high-teen percentage range and our non-GAAP income tax rate to be around 10%. In the first quarter of fiscal 2014, our GAAP net income was $23.1 million or $0.42 on a per diluted share basis. This compares to $8.9 million or $0.17 per diluted share in the fourth quarter of fiscal 2013.

Excluding stock-based compensation expense and related tax effects, our non-GAAP net income for the first quarter of fiscal 2014 was $31.7 million or $0.55 per diluted share. This compares to a non-GAAP net income of $17.5 million or $0.31 per diluted share in the fourth quarter of fiscal 2013.

Let me now turn to the balance sheet. We ended the first quarter of fiscal 2014 with cash, cash equivalents and short-term investments totaling $240.5 million. This compares to $212.3 million at the end of fiscal 2013 fourth quarter. The increase in cash came primarily from cash generated by our business operations during the quarter.

Accounts receivable at the end of fiscal 2014 first quarter net of allowances were $174.5 million, an increase of 4.8% from the $166.5 million at the end of our fiscal 2013 fourth quarter. Our days sales outstanding in the first quarter was 43 days as compared to 44 days for our prior quarter.

As of July 31, 2013, our inventory totaled $426.6 million, a slight decrease of $3.7 million from the $430.3 million balance at the close of fiscal 2013 fourth quarter. Our fiscal 2014 first quarter inventory balance represented an annual inventory turn of 2.9 times or 127-day sales, an incremental improvement when compare to our inventory last quarter was an equivalent annual turn of 2.6 times or 138-day sales. We expected to continue to improve our inventory turns during the fiscal 2014.

Now, with that, I'll turn to our outlook for the second quarter of fiscal 2014, which ends on October 31, 2013. We currently expect our 2014 second fiscal quarter revenues will be in the range of $375 million to $410 million.

Our GAAP EPS are expected to range from $0.21 to $0.38 per diluted share. Excluding the estimated expenses and related tax effects associated with the stock-based compensation, we expect our non-GAAP earnings will be in the range of $0.36 to $0.53 per diluted share.

Shaw Hong

Thank you, Anson. In spite our near-term challenges, we believe that the long-term occurrence of higher-resolution cameras in our core markets, new applications such as the new human interfaces and wearables, as well as emerging markets in automotive and security will continue to drive strong growth in the image sensor markets.

We also believe that our breadth of products and markets sustain the market leadership and focus on innovation will continue to position us as a market leader in the years to come.

With that, Operator, we are now ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Harsh Kumar with Stephens. Please proceed.

Harsh Kumar - Stephens

Yeah. Hey. Thank you. Couple of questions, Anson and Shaw. How big is the Chinese end market exposure for you, so not talking about the phones that are made for U.S. OEMs or somebody else, but your China on China market, how big is that for you?

Anson Chan

Well, let Ray give you a better answer for that.

Ray Cisneros

Let’s look at couple ways, right. The China market in it of itself is extremely large. It’s driving a manufacturing and sales for domestic use, as well as for a growing amount of volume to export markets for factories that are in China that that market itself is a large number, I couldn’t tell you after cut what that number might be in terms of as it represents the market for us but it’s extremely large.

And then in regards to how much it represents of our business, we don’t break up our business by region, but suffice to say that we’re extremely happy in terms of the portion of revenue it provides for us, as well as the opportunities and then our ability to ship product to that region.

Harsh Kumar - Stephens

Okay.

Anson Chan

Harsh, I’ll just quick comment when we put out the revenue break out though in our SEC filings, the bulk of our shipments do go into China region simply because where camera modules are being manufactured, so.

Harsh Kumar - Stephens

No. I guess, since I was wondering China on China shipments which is consumption for China in China.

Shaw Hong

Good. Okay.

Harsh Kumar - Stephens

Okay. Let me ask another question, a lot of the handset customers are talking about better visibility going out into the second half of the year because of the larger North American customer OEM ramping. I'm curious why you're not seeing that. I understand that there's competition in the China market but suffice to say I would have expected our intuition, I mean comments sort of dictated you might have seen a pretty large ramp despite the China competition. I’m just curious if you could give us some color on that?

Ray Cisneros

This is Ray Cisneros again. I think if you look at your question in couple ways, one is looking in rears in previous quarters we saw a nice growth in the China region and that's driven by the market dynamics. There was a big swing in terms of the competitive landscape for China OEMs to compete for that smartphone market share and they did so and as you could see in any particular marketing report you might pick up. China OEM brand names have gained market share in the smartphone segment.

Now on the other hand as we marched going up until now, I think there's been some correction perhaps for due to a variety of reasons in the China market either for inventory corrections or may be also competitive issues or dynamics in that region as every China OEM brand name competes against each other. So there is a little bit of slowdown that we saw.

So that's offset by I would say the seasonal cycle that we are stepping into for North American customers. So you combine the two effects we got some a little slowdown in China and then we got some seasonal ramp ups in our North America customer base, so that’s how you come to what we’re guiding right now.

Harsh Kumar - Stephens

That’s fair. And my question and then I'll get back in line. I think in your prepared remarks you should that you are the number one supplier six years in a row. I would have expected given the scale that you would have a better cost of manufacturing sensors relative to the smaller Chinese competition or companies. So I'm a little surprised that that they are able to put pressure on your margins maybe you could just clarify for us how they are able to put pressure on your margins despite your scale?

Anson Chan

Sure. Let me try to clarify that. We are not exactly saying that in some of the lower cost competitors in the market are putting pressure on the margin per se. Most of the margin issues for this quarter in particular based on the prepared remarks, it’s coming from increase in our own recording of excess charge for inventories, as suppose to ASP type pressure. Albeit the pressure is there, right.

So I would have to say that that there is not so much pressure from in this low cost manufacturer, the cost a detriment to the gross margin. Now separately going back to a comment that we are making for the past couple of quarters, we’ve been incurred quite bit of cost in terms of putting out a fan sensors.

These devices are going into market very different from some of these low cost manufacturers. So we are not been talking about competing for the same kind of socket, maybe for similar company customers at the end of the day, but different tearing of product I’ll have to say.

Harsh Kumar - Stephens

Fair enough, guys. Thank you. And I’ll get back in the line.

Operator

(Operator Instructions) And your next question comes from the line of Harsh Kumar with Stephens.

Harsh Kumar - Stephens

Hey. I guess, I’m the only one on the line. That’s fair. I’ve got a couple of questions that I can ask still. So you guys generated a little bit of cash, in this quarter you have a very healthy balance sheet. I am curious if there is any plan to use some of that cash for buybacks or other means to perhaps help us stock out?

Anson Chan

Nothing that we have in the plan that we would like to announce yet, the cash build up. I won’t say that’s looking yet and we are still working hard to continue to improve our cash position. I think we’ll try to say something in our prepared remarks to extend that, we are still wanting to improve our inventory turns.

And in this year, frankly, based on the guidance we’ve provided for the second fiscal quarter. The quarter-to-quarter change in revenues wasn’t as pronounced as last fiscal year. So the overall demand for investment in working capital was lot less.

So if we continue to improve our inventory turns, speed up some collections, what not, our cash turn will improve, and so we can slowly continue to build our cash reserves. Hopefully, once we reach the point where we are more comfortable with what we have we can announce other plans.

Harsh Kumar - Stephens

Fair enough. And then, Anson, one more for you, I just want to clarify something I heard, I think you suggested that for the next quarter, the out quarter -- the October quarter, we should think of R&D going up about 10% and SG&A being flattish, is that accurate?

Anson Chan

What do you mean by flattish? I’m not sure that coming in for me, can you say that again?

Harsh Kumar - Stephens

Sure. Sure. I heard and maybe I miss heard, I just wanting to clarify here Anson that, for the October quarter we should think of R&D as up 10% and SG&A as flattish, is that accurate?

Anson Chan

SG&A will increase little bit, not so much flattish.

Harsh Kumar - Stephens

Okay.

Anson Chan

There will be something because of the pay increase that I mentioned.

Harsh Kumar - Stephens

Fair enough. And then R&D will up 10%, correct?

Anson Chan

Above in that range quarter-to-quarter.

Harsh Kumar - Stephens

Okay. So when I do the math and I dropped, try to zeroing on the gross margin line, it suggest -- your comment around the OpEx suggest a gross margin increase of greater than 100% -- 100 basis points, roughly 120, 130 bps what I get. And I’m trying to make sense of that relative to -- put that in perspective relative to your competition commentary, just to get to the numbers to work out at the midpoint of what you are guiding to. So could you help us understand what will be offsetting the margins or the competition with margins suggested to be up though you are guiding?

Anson Chan

I can’t quite confirm what you have in your modeling. But I will have to say that if you go back to the prepared remarks about what cause the 10 basis point decrease in gross margin, GAAP basis right for first fiscal quarter. A lot of that came from inventory charge.

In fact I’ll try to provide the quarter-to-quarter comparison. I think Q1 we said that detriment to gross margin, so it was about 2.3% effect and then detriment to the Q4 just on the inventory charge alone was 1.7%. So this 60 point -- basis point of difference just there base on these what we always call as the one-off adjustments to gross margin.

If you assume that going forward at least in second fiscal quarter some of these one-off charges will go back to call normalized run rate, you get some benefit from them.

Harsh Kumar - Stephens

I got you. Okay. Fair enough. I’ll jump back in line and see if there are any more questions. Thanks.

Operator

And your next question comes from the line of Betsy Van Hees with Wedbush Securities. Please proceed.

Betsy Van Hees - Wedbush Securities

Thanks for taking my questions. In terms of July quarter, it looks as if the entertainment business was up about 44% quarter-on-quarter and then handset business was up about 8%. I’m sorry if I missed this in the prepared remarks but could you talk about what was the driver for the entertainment business. And if that was unit driven or if it was mix related?

And then second part of my question is as we look at the October quarter, how should we be looking at these businesses from a revenue gross perspective, can you rank them for us in terms of what were the most and what were the least? The first question that has two parts. Thanks.

Ray Cisneros

Hi. Thank you. This is Ray Cisneros here. Yeah, we did see a very good growth quarter in for the entertainment segment and primarily driven by the tablet type of products. I think we’re combination of couple things. And the fiscal first quarter was obviously preparation for some fall, season rollout of products that our customers have as well as summer season rollouts of tablets that that occurred and you guys might have seen in the media some of those products.

And so that combined drove our tablet type business in the entertainment segment. Going forward, it’s again probably a very good growth quarter again for the tablet or the entertainment segment. And it’s -- there are similar drivers behind it. It's gearing up for the holiday season and so we expect to see a pretty healthy portion of our revenue from the entertainment segment.

As it ranks in priority, I don’t think priority will shifted too much. It’s going to be similar to every quarter we’ve had now for a while. Mobile will still be very large portion of our revenue followed by entertainment and then so forth.

Betsy Van Hees - Wedbush Securities

Thanks Ray. That was very helpful. And then I understand you guys only gave one quarter guidance but looking at seasonality and looking at the shift in your business, it seems that you have more towards the China handset business than you had in previous quarters. How does that impact seasonality as we look into the January quarter into the April quarter. Did that have any shift or how should we be looking at seasonality past the October quarter?

Ray Cisneros

This is Ray again. Yeah. It is extremely, extremely hard to answer that question. It just seems the way the market dynamics are going, the mix of where China type of business backs into what markets, what regions and what holiday seasons overlaid that into, I would say North American type customers that we have and even European customers. It’s a little bit I would say not clear.

On the other hand, the growth of these markets is still there on the aggregate. The smartphone markets are continuously growing. And there is a shift I would say from very high-end smartphone to I would say mainstream affordable type smartphones. That represents another growth opportunity and how that starts driving our revenues in individual regions and customers that remains to be seen. I suspect age will be driving quite a bit of that.

Then we have overlaid with that the continued growth of some of our other emerging segments like automotive and security. So we’re happy with that. So I mean, we're looking at hard question that you have given us but on the other hand, I’m trying to give you as much color as possible.

Betsy Van Hees - Wedbush Securities

Thanks Ray. And then my last question, I’ll jump out back into the queue is on the you did note that your ASPs have improved quarter-to-quarter for the last six, I think, it was consecutive quarters and then this quarter was flat 179 versus 179? What I am saying is that you guys have really been benefiting from the mix shift to higher resolution sensors? So we can enter into a situation now as move forward that we are not going to get that same positive impact from the mix shift because of the challenges we are seeing in the pricing environment? I was going back to something that we have seen thus far with OmniVision a couple of years ago and not just specifically you guys, but I should say just the overall industry itself?

Anson Chan

That is really good. There is couple of effects with the ASP in my mind. One was the competitor price pressures that came in fairly strong in the second half of the first quarter as we marched through it. The second is the higher shipment volume of HD sensors that carries slightly lower price points than the higher resolution sensors.

Going forward, though, it does become sort of a crystal ball type of response I got to give you, it is dependent upon our customer, our product mix and then a big fact will be the roll out of new products that will have here plan for ourselves that we have some, we have announced and some that we have not, and so that will represent a nice or hopefully a nice better mix again for in terms of ASP.

Betsy Van Hees - Wedbush Securities

All right. Thanks so much for taking my questions. I really appreciate it guys.

Operator

And your next question comes from the line of Joseph Zakaria with Needham & Co.

Please proceed.

Joseph Zakaria - Needham & Co.

Hey guys. Thanks for taking the call. I’m on behalf of Raj today. I had a quick question relating to some of the pressures that you saw in the low end of the market, I was wondering if you can give some commentary and whether or not you are seeing the same competitors in the higher-end of the segment?

Ray Cisneros

This is Ray. I think when it comes to price pressures it comes in waves and obviously, from our experience it -- the prices -- the highest price pressures typically come from the bottom up. What that means though is there is a migration of resolutions starting to -- usage of resolutions start to migrate up.

In other words, what might have been a high-end sensor a year ago is now mainstream this year and so forth, every year there is a cycle of that nature. So it was a broad, I would say, I would say a broad coverage in terms of price pressures across the board is in particularly in Asia, I would say mainstream down to low resolutions.

Joseph Zakaria - Needham & Co.

Okay. Thanks. And I guess maybe to rephrase it slightly, are you seeing the same competitive dynamics in the China market that you are seeing with, say, Korean or North American handset customers or is it a different set of guys you are growing up against in that segment?

Anson Chan

Right now it does appear to be a little bit of a segmented batch of competitors regionally. I would say there is some competitors that have a lower barriers to entry in the Asia market that, that cannot penetrate some of the North American markets or Japanese markets for example. So, yes, there is a mix of competitors that differ from region to region and also depends on resolutions.

Joseph Zakaria - Needham & Co.

Okay. Fair enough. And then I guess my another question, I am not really sure how this would effect you guys too much? But any commentary on visibility given what should turn into pretty low lead times in this industry these days?

Anson Chan

Sorry, given -- given I missed your, the last portion of your sense there?

Joseph Zakaria - Needham & Co.

I apologize. Looking for some commentary maybe on visibility given how low lead times seem to be these days or clearing out the channel? I was wondering if you have any commentary on visibility if it is getting better or same?

Anson Chan

Right. It’s anybody’s guess right now in terms of certain regions in the world and particularly in Asia, you are absolutely correct. The low lead time, I guess, customs out there in Asia do represent a challenge for visibility, but it is hard to say right now. I think globally everybody recognizes there is a little bit of a pause right now in Asia. And OmniVision just like everybody else is waiting to see how it materializes going forward.

Joseph Zakaria - Needham & Co.

It just seems like it is coming to new norm but, I guess, I certainly appreciate the added color guys.

Operator

(Operator Instructions) And your next question comes from the line of Anthony Stoss with Craig-Hallum. Please proceed.

Anthony Stoss - Craig-Hallum

Hi, guys. Probably meant for you, Ray. I am just curious if you have seen a change within your customer base where may be price is more important now than performance. Also, just love to hear your view on, for a kind of, near the tail end of that increase in megapixel curve war is becoming less important as a result price is becoming more important?

Ray Cisneros

Let’s see. In terms of change in resolution -- I would say change in the trend of marching up the resolution curve, I would say there is still very similar interest in our customer base across the board for that matter and it’s not bias to any region. I think all regions still see value in moving up the resolution curve.

So, from that standpoint, it would represent an opportunity because that means the differentiation of the haves and have nots with a higher resolution is technology based and that’s one of -- that's our core strength to be able to fulfill to the marketplace high resolution, small pixels and innovative technologies. So that’s my comment in terms of resolutions. Can you repeat your first question?

Anthony Stoss - Craig-Hallum

Whether the price was becoming a more important factor than performance?

Ray Cisneros

I think when I think about price, I think about the size of the markets. I guess you could -- I mean this is almost -- you could ask 10 different people, 10 different opinions you will get. My feeling is that the larger the markets, the more you start segmenting different, I would say, value propositions to the end customer.

As the markets get extremely, extremely large, like I would say the handset market, there is going to be a variety of segments in that market that would be driven by what the customer sees valuable whether its price or whether its technology. So, you are going to have a mix and that’s in fact exactly what we have with the handset market.

There is different segments and same thing is happening with other consumer devices. I would say tablets are starting to move in that category possibly. We’ve already been there for notebooks, PCs. So we -- I would say it is not negative because that allows us to pick and choose our strategies going forward.

Anthony Stoss - Craig-Hallum

Okay. And then lastly these new competitors that have showed up, are they showing up with BSI products or how would you classify their performance in quality?

Ray Cisneros

Well, I think similar to the markets the competitors start backing into a variety of levels of performance and technologies. We have seen other competitors coming with BSI on the other hand as we were well aware of and were getting this confirm just though our own crosschecks. Launching BSI is not -- not that easy and it remains to be seen those that promote or announce BSI technologies how well they do. And, so we do have -- we have a variety of competition for a variety of different technology segments.

Anthony Stoss - Craig-Hallum

Okay. Thanks.

Operator

Your next question comes from the line of Tom Sepenzis with Northland Securities. Please proceed.

Tom Sepenzis - Northland Securities

Hi guys. Thanks for taking my call. You mentioned comments earlier about potentially adding additional camera functionality. Is it facial or gesture recognition? So, I assume that means that there would be additional cameras then on the phones. So, I was wondering if you can give an idea of when that might happen and how many additional sensors you would expect to see in a phone that had, say gesture recognition?

Anson Chan

Hi. Yeah. This is a kind of exciting area for imaging technologies especially for OmniVision. When it comes to, I would say, almost a broad category called computational imaging, be it the imager to register the motion and gesture of a human or the information he needs to gather to understand depth information. It’s coming in all shapes and forms. The technology solutions or customers are considering using.

A lot of them are considering using multiple sensors. Some are considering using one sensor and it’s also combined with the type of software technology and architectural platforms that they are building off of. So -- but at the end of the day, it does represent extremely, extremely great opportunities for OmniVision.

And there will be differentiation not just with a, I would say, traditional photodiode that registers this kind of information for computational imaging. It could be a different type of sensor and we’re working across the board with a variety of proposals with customers.

Tom Sepenzis - Northland Securities

Any idea on the timing when someone might actually allow or something like that with a euro?

Anson Chan

I would say there is near-term projects as well as long-term projects. I really can’t pinpoint them exactly when these things might come up simply because they are part of our customers’ business and their plans. And we don’t have privy to that information nor do we typically give specifics. Thanks.

Tom Sepenzis - Northland Securities

Sure. And just in terms of the scale that you now have with all the extra capacity that you added last year. I guess, the idea would be now that you have that scale and you’ve got kind of a pretty good share of the North American customers and what not. What -- I mean, it seems like you should be able to at least bring your ASPs up a little bit or see some margin improvement.

So any kind of clarity on that? Why you can’t do that? I mean, just competition from small Chinese vendors, seems like they wouldn’t have the kind of power to keep you from improving your situation a little bit?

Anson Chan

Let me try. It looks that the ASP in particular, if it’s going to be dependent on the overall resolution mix. And as Ray has pointed out earlier, a lot of that will be really dependent on how our OEM customers intend to introduce a different theater products and kind of manufacturing volume that they plan fro this year anyway.

And separately regarding cost improvement and what not. We have made some incremental progress in terms of overall production costs, as you can see in this quarter. But I’m -- as I try to point out in my prepared remarks, if you take out some of these one-off adjustments to margin, you do see quarter-to-quarter improvements, albeit some incremental. And we are still working hard, as Shaw has pointed out, we are doing everything we can to fix our cost structure, so.

Tom Sepenzis - Northland Securities

Great. Thanks very much.

Operator

Your next question comes from the line of Dan Scovel with Tokeneke Research. Please proceed.

Dan Scovel - Tokeneke Research

Thank you for the question. The question on the sale of the previously written-off inventory, I believe you had a big slug of certain type of product from a couple of quarters ago. The written, excuse me, the writing-off of ops read inventory, not the sale of previously written-off but the writing-off of the inventory, you had a big slug of older inventory. Is that the product that’s being written-off or is there a broader reach or not necessarily disproportionate mix of that slugged profit?

Anson Chan

It’s very different types of products right now. I’m not sure exactly which period you are trying to refer to. But typically we assess all our one hand products on skew by skew basis. And should any products that we have on hand far exceeds generally 12 months of sales forecast, we have to put reserve against that, that way we went through this quarter.

And then simply because of the changing forecast, some of these little older products, I would say, there has been out in the market for little longer. They ended up with slower demand, part of it is attributable to simply new products coming out from our own portfolio and partly also because of some of the consumer products that have these devices built in designing way back then they coming to end of life.

So all of this contribute to a high inventory charge. It’s not exactly something that’s comparable I would say to whatever that we did year ago per se because they have every different skews and with -- looking at different forecast, different consumer products, its whole different ball game.

Dan Scovel - Tokeneke Research

Okay. So the inventory write-off was across a breath of different products, is that a fair statement?

Anson Chan

That’s correct. That’s a different skews in there too. It is not just one particular product or segment?

Dan Scovel - Tokeneke Research

Okay. Good. Thank you very much.

Operator

Ladies and gentlemen, with no further questions, I would like to turn the presentation back over to Mr. Arnab Chanda for closing remarks.

Arnab Chanda

Thank you all for joining us on this call and webcast. We anticipate holding our fiscal second quarter conference call on December 5, 2013. Thank you and good day.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. And have a great day.

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