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Executives

Brian Dunn – IR

Shaw Hong – President and CEO

Ray Cisneros – VP, Worldwide Sales

Bruce Weyer – VP, Worldwide Marketing

Anson Chan – VP, Finance and CFO

Analysts

Quinn Bolton – Needham & Company

Harsh Kumar – Morgan Keegan

Tristan Gerra – Robert Baird

Paul Coster – JP Morgan

Yair Reiner – Oppenheimer

Betsy Van Hees – Wedbush Securities

Doug Freedman – Broadpoint

OmniVision Technologies, Inc. (OVTI) F3Q10 (Qtr End 01/31/10) Earnings Call Transcript February 25, 2010 5:00 PM ET

Operator

Good day, ladies and gentlemen and welcome to the OmniVision Technologies earnings conference call for the third fiscal quarter of 2010. My name is Yvette and I will be your coordinator for today’s call. This conference call will include time for questions later in today’s sessions and all participants are in a listen-only mode at this time. (Operator instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host, Mr Brian Dunn. Please proceed sir.

Brian Dunn

Thank you very much. Good afternoon everyone and welcome to our fiscal 2010 third quarter earnings conference call.

Just after the close of market today, OmniVision issued an earnings release reporting our financial results for our third fiscal quarter. You can access this release from the Investor Relations section of our Web site at ovt.com. Please be advised that this call is being webcast live and is also being recorded for playback purposes. Both the live webcast and replay can also be accessed from the Investor Relations section of our Web site.

Before we begin, we wish to remind you that certain information discussed in this call, in particular, our revenues, earnings targets and our forward-looking product plans is based on information as of today February 25, 2010 and contains forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those set forth in such statements. During the presentation today, we will discuss important factors related to our business, which may potentially affect those forward-looking statements. As a result, we caution you against placing undue reliance on these forward-looking statements, which reflect our opinion only as of today’s date.

For a discussion of these risks and uncertainties, you should review the forward-looking statements disclosure in the earnings release we issued today as well as OmniVision’s SEC filings including our Annual Report on Form 10-K for fiscal 2009 and our quarterly reports on Form 10-Q and other reports filed with the SEC from time to time. And as a reminder, we disclaim any obligation to update information contained in any forward-looking statement.

During this call today we will discuss certain GAAP and non-GAAP financial measures, the latter of which excludes stock-based compensation expenses and other charges that are driven primarily by discrete events that management does not consider to be directly related to our core operating performance such as a goodwill impairment charge in fiscal 2009. A reconciliation between the two is available in our earnings release posted on our Web site.

With that, I will now turn the call over to OmniVision’s President and Chief Executive Officer, Mr Shaw Hong. Shaw?

Shaw Hong

Thank you, Brian. I would also like to welcome everyone who is participating in our call today. Joining me today are Anson Chan, our CFO; Ray Cisneros our VP of Sales; and Bruce Weyer our VP of Marketing.

Before I discuss the current quarter, I first want to mention that I am pleased that our Board of Directors has appointed Henry Yang, our VP of Engineering to the Board. Henry has been with OmniVision for over ten years. He has been an extremely important contributor to the success of OmniVision, leading the company’s research and engineering efforts for many years. As we move forward, Henry will continue to be a key contributor to the strategic development and business operations of OmniVision.

I will begin the call with an overview of our results for the quarter and then comment on our overall cause [ph] and strategy and (inaudible) of our strategy with our most recent technological advantage and new product introductions. I will ask Ray to begin an overview of our current sales efforts and the recent accomplishments followed by Bruce with his comments on our recent technological and product introductions, and a relationship to our strategic positioning within key markets. Finally, Anson will discuss in detail our financial results for the third fiscal quarter. Anson will also provide our outlook for the fourth quarter of fiscal 2010. We will conclude as usual by answering as many of your questions as time permits.

We reported today our fiscal 2010 third quarter revenues of $157 million as compared to $183 million last quarter. Gross margin improved sequentially to 24.6% for the current quarter from 24% in the second fiscal quarter. We recorded GAAP net income of approximately $5 million or $0.09 per diluted share while our non-GAAP net income totalled $10.8 million or $0.20 per diluted share.

Our financial position remained strong in the cash and short-term investments at quarter end totalling $243 million as consumer expectations and our sophisticated electronic products continues to increase and our customers continued to demand improve image centre technologies and solutions to enhance better performance and to produce innovative products. We are committed to the call of meeting those demands. I believe we have well positioned ourselves across all market segments with our long-term development strategy of expensive product portfolios based on our advanced technologies.

To extend our portfolio offering of unique solutions across market segments, our first and foremost long-term strategy is to focus on the continued development of imaging and inexpensive technology including extending our leadership in pixel technology. We are conscious [ph] of our debt in the past years, be focused on our cost trends of technology development in house, as well as working with manufacturing partners in process development.

Now, I would like to share with you some of our recent milestone achievements and we pursue today’s technology leadership strategy. Two weeks ago, we announced one of those exciting developments. At that time, we introduced our second-generation back side illumination technology, a new OmniBSI-2 pixel architecture. OmniBSI-2 delivers the world’s first 1.1-micron back side illumination pixel and is the first OmniVision pixel built on a 300-mm copper castings. With this introduction, we further extend our leadership in pixel technology development and building on the expertise we get through the development and the production of our first-generation BSI pixel technology.

I should note that we are at the forefront of the development of this technology well ahead of our competition. OmniBSI-2 technology is not limited to only smaller pixel designs, in fact, it can also be applied to larger pixel designs to achieve performance advantages and exceed both current BSI and FSI image sensors of similar size. OmniBSI-2 technology represents a significant improvement resulting in better image quality, and enhances the color in reproduction, and the improved camera performance.

I am proud not of only the work done by our dedicated team of engineers but also of the full support and the cooperation we enjoy with our strategic manufacturing partners including TSMC for the semiconductor process and the VisEra for the micro-lens and the color filter. This clearly demonstrates the scope and strength of our entire supply chain, which is the basic for our established model, a model that we help to advance

Meanwhile, our first BSI pixel, the OmniBSI is already in mass production and it is poised to ramp up to significantly higher levels in the coming quarters. This OmniBSI is employed primarily in high resolution devices. Our product mix should also improve the BSI shipment rent. Our strong design wins in the 5 and the 8-megapixel categories have become an increasingly important portion of our product portfolio. Indeed, our BSI pixel is setting the standard for high image quality in miniaturized cameras.

We must also recognize that the volume we intend to ship starting in the fourth fiscal quarter represents the first time that high volume manufacturing of this type of revolutionary technology has been achieved. In order to reach each level, we have worked closely with our supply chain partners to drive supply availability, quality control, and cost efficiency.

Another innovative technology, as we mentioned before, is the CameraCube technology. Currently, we see there is tremendous opportunity for our CameraCube devices based on this technology. Today, our customers use it predominantly for the secondary camera application [ph] in mobile handsets, however, going forward, we anticipate that CameraCube devices will be used as the primary camera in mobile handsets. To support our IT spacing of the rapid adoption of CameraCube products, we are increasing our resources in R&D investments. A major portion of this effort will be focused on the development of a waste wafer-level optics and packaging solutions for the next generation products and to reduce production costs.

Our introduction of new products based on our latest technology advances reflects our constant line to improve image-centered technology. This quarter we introduced a number of new products designed to meet our customers’ changing needs across a broad range of technologies and market applications. In January, we introduced three new products. First, we launched a remarkable 14-megapixel image centre built on our OmniBSI technology. This device delivers 4 HD video at 60 frames per second. We also introduced our first native 1-megapixel HD video sensor to run our 1.75 micron OmniBSI pixel technology. It is ideal for high performance HD cameras in a wide range of mobile devices. These products add to our growing portfolio of HD capability sensors. We have established clear leadership in streaming video-based market including the notebook, netbook, webcam, automotive and security markets. We are now well positioned for major transition to HD sensors in these markets.

As I mentioned before regarding our strategies that is based on our CameraCube technology, we have had a new VGA CameraCube solution to our portfolio of our CameraCube imaging devices. This device is a complete VGA camera solution and the features are proprietary of OmniPixel3-HS architecture. We remain focused on defending our positioning in key traditional markets at the same time, we are aggressively pursuing attractive opportunities in our emerging product segments that offer a potential above average returns.

Before I turn this discussion over to Ray, I will again emphasize that we never rest on our past successes. We continue to pursue the opportunity of our (inaudible). With that I will turn the podium to Ray, who will provide an update on the positive sales activity. Ray?

Ray Cisneros

Thank you Shaw. As we mentioned during our last earnings call, our regional sales coverage in North America has shifted, which has advanced some of our traditional third quarter business activity into our second fiscal quarter.

The third quarter results we released today support both those expectations and the outlook we provided. During the third quarter, we maintained a proportionally well-balanced sales portfolio in our largest markets in mobile handsets, notebooks, and security. We saw incremental sales improvement in the automotive and medical markets we serve, which is a positive sign for these emerging markets that take time to develop.

Our Asian regions experienced a steady quarter in fiscal Q3 and as we outlooked in November, both North America and Europe reflected a post-holiday seasonal decline. This seasonal cycle carries into our current fourth fiscal quarter. As we move beyond the fourth quarter, we believe that our recent socket design wins in the higher resolution categories are likely to contribute favorably to our future revenues. In the third quarter we shipped 130 million units at an average selling price of $1.18, this compares with approximately 145 million units shipped in the second quarter at an average selling price of $1.27. The sequential decline in revenues was driven primarily by the shift in seasonality we noted earlier. This shift in seasonality also impacted our shipment products with resolutions of 3-megapixel and above negatively affecting our ASP.

In the third quarter, unit sales of sensors 2-megapixel and higher increased slightly as compared to the second quarter to approximately 25% of total shipments. Most of this increase came from the (inaudible) 2-megapixel sensors, which carry an ASP lower than those of 3-megapixel and above. Unit sales of 1.3-megapixel sensors declined to approximately 5% of total shipments in the third quarter as compared to 10% in the prior quarter. Finally, unit sales of sensors that were VGA below were approximately 70% in the third quarter. We also experienced growth in wafer-level module shipments. The increasing wafer-level module shipments are an exciting trend that will allow us to start exercising our supply chain in this new production and business model.

In terms of product market, our mobile phone sales represented approximately 60% of our revenues in the third quarter. Notebook and PC sales were approximately 25% of our revenues in the quarter. Sales of our other emerging market products accounted for approximately 15%. Within the mobile phone market, we experienced a post-holiday seasonal slowdown in our North American and European customers that we have previously outlooked. This appears to carry into our current fiscal fourth quarter, however we foresee improving sales trends for summer and fall seasons, which may benefit our operating results beginning in the first quarter of fiscal 2011. We also anticipate this upper trend will carry with it a more favorable sense of resolution mix.

The smartphone market category continues to increase worldwide and we are well positioned to serve this market with our higher quality OmniBSI and OmniPixel3-HS technologies. We anticipate a higher resolution mix for products shipping into this market anywhere from 2-megapixel up to 8-megapixel centres. New socket designs have been secured in all these resolutions. Another growing trend in this category is the use of a secondary camera. For this camera, we are well positioned with our VGA wafer-level camera solution. Although still relatively small compared to our overall quarterly shipments, in absolute terms, our VGA wafer-level modular shipments increased significantly in the third fiscal quarter.

In Asia we experienced consistent sales in our recent fiscal Q3. Notably, we recorded strong sales in our 2-megapixel resolution category for the Asia region, an indication of the trend towards a higher resolution mix. We also shipped 5 and 8-megapixel sensors into this region. The entry level mobile handset category served by this region remained strong and continued to be dominated by VGA sensors. DoD and business model in this region continued to develop. Through our sales channels we have learnt that a growth of sensor products manufactured in this region are exported as foreign OEM branded devices.

Our next largest market, the PC notebook and webcam segment, strong shipments were comparable to the previous quarter. We shipped sensor resolutions from 3-megapixel down to VGA into this market. A strong trend has developed for the 5 inch 2-megapixel and 6 inch 1.3-megapixel sensors for this market. VGA shipments to this market were also strong including upward trending of our new high performance SLT products. The drive for high-definition video streaming continues as we see more shipments of our HD format sensors on a quarterly basis as well as continual socket design wins. Our HD format sensors carry both our OmniPixel3-HS and OmniBSI pixel technologies.

In our emerging products categories, we recorded third quarter revenues from sales to the DVDSC [ph] and security markets that were consistent with our second quarter sales activity. In the DV market, we are especially proud of our next generation OmniBSI socket design wins in Japan. We are equally proud of our ODMD and C socket design that also feature our OmniBSI pixel. In the security market, our analysts products continued to retain a strong market position, while our HD devices for IT cam products continued to receive strong market support. The entertainment market was affected by the (inaudible) into the second quarter as we previously noted. However, we anticipate an upward trend in the summer season. A new emerging category referred to as a telepresence market is gaining traction and will drive innovative products for telecommunications later this calendar year.

In the absence of the holiday season impact of our revenues, the operating results we reported this afternoon continued to reflect increasing stability across our various sales regions. We expect this strength to continue through our fourth fiscal quarter. We are well positioned for the transition to a higher resolution mix and HD sensors in our high volume consumer markets. In addition, based on the trends that we noted earlier, we anticipate a resumption of growth in the summer season. We look forward to sharing with you in the coming quarters our continuing progress and the growing market acceptance of our advanced image sensor solutions.

Shaw Hong

Thank you Ray. I would now like to turn the call over to Bruce who will discuss our technology and marketing efforts in more detail. Bruce?

Bruce Weyer

Thank you Shaw. There are three main topics I will be discussing today. First, our recently announced OmniBSI-2 pixel architecture that further extends our leadership in pixel technology development; second, recent OmniBSI and CameraCube product announcements that provide unique imaging solutions for the mobile, PSC notebook and entertainment markets; and third, our strong focus on leadership and video centre of the imaging solutions.

At the Mobile World Congress show in Barcelona, OmniVision demonstrated our recently announced OmniBSI-2 architecture to strategic customers and partners. This second-generation BSI architecture represents a major milestone in digital imaging technology by enabling new imaging solutions with superior image quality and light sensitivity, especially critical and high performance video based applications. The architecture (inaudible) in the continuous miniaturization of digital imaging technology. OmniBSI-2 enabled higher resolution image sensor solutions with an aggressive form factor in lowering the height of the same product. Actual performance measurement of OmniBSI-2 product demonstrated improvement from the 20% to 75% across key quality metrics for similar size first-generation BSI pixels including quantum efficiency cross talk and alignment to the metrics.

By comparison, the new 1.1-micron OmniBSI-2 pixel not only outperforms the current 1.75-micron FSI architecture, but also equals the performance of the industry leading 1.4-micron BSI pixel that is currently in mass production. The OmniBSI-2 architecture leverages 300-mm copper processors at 65 nanometre pixel design rules developed in cooperation with our strategic manufacturing partner TSMC. We are excited to be introducing this second-generation BSI-2 architecture when many competitors have not successfully moved to BSI in critical technology for submicron image sensor development. Whereas OmniBSI-2 offers our customers a strong technology platform for the future, our first generation OmniBSI architecture represents the leading platform in the market today. We are very pleased to announce the immediate availability of new, highly differentiating OmniBSI products.

In January 2010, OmniVision extended our high-end imaging portfolio to 14-megapixels representing our largest resolution image sensors to date. With the new OV14810, the digital still camera and digital video camera market segments are converging allowing consumers to have one device for capturing the most important photo and HD video moments. The OV14810 develops full, 1080p HD video at industry leading 60 frames per second. In full HD video mode, the sensor also provides additional pixels for electronic image stabilization. The OV14825 sensor factored in the same features in a wider-angle micro wins technology optimized for the mobile phone market.

In January 2010, we introduced the OV9726, our first view of HD video centre built on a 1.75-micron OmniBSI pixel technology. The compact OV97.6 delivered 720p HD video of 30 frames per second making it ideal for high performance, high-definition cameras in notebooks, netbooks, webcams, mobile phones, portable video players, and other mobile media entertainment devices. The OV9726 achieved excellent low-light sensitivity in the industry’s smallest form factor. In January 2010, we also added the OVM7692 VGA CameraCube solution to our portfolio of CameraCube imaging devices. The OVM7692 is a complete VGA camera solution including automatic luminous detection integrated EMI solution. The OVM7692s compact size also ranks amongst the smallest VGA models in the industry.

As you can surmise from our product announcement, promising leadership and deals centered application is a strategic objective in our leadership. OmniVision has the broadest portfolio of native HD video and video enabling high resolution image sensors, providing high performance sensors is a founding basis for our market leadership in the video centered notebook webcam, automotive, and security markets where we hold over 60%, 50% and 50% respective market shares as measured by industry analysts technosystems research. HD video is rapidly becoming the must-have application for the entertainment and mobile phone markets as well. We believe OmniVision is ideally positioned and offers our customers the most widely differentiated and complete portfolio of products for the video applications.

In summary, OmniVision is well positioned for the major transition to HD sensors in the high lying consumer markets. We also maintained our strong technology leadership position with the announcement of the OmniBSI-2 pixel architecture. Finally, we continue to deliver highly differentiated solutions that meet and exceed the needs of our strategic customers and partners, who are industry leaders in their respective businesses.

Shaw Hong

Thank you Bruce. I will now turn the call over to Anson who will discuss the third fiscal quarter financial performance and provide guidance for the fourth quarter of fiscal 2010.

Anson Chan

Thank you Shaw and good afternoon everyone. As Shaw mentioned in the beginning of the call, revenues for the third quarter of fiscal 2010 were $156.9 million, as compared to $183.3 million in the second quarter, a decline of 40.4% sequentially. Please recall, as Ray mentioned earlier, this decline was in line with our expectations and the last good news is now the trend that we introduced in our last earnings conference call.

Direct sales to OEMs and VARs accounted for 55% of our revenues in the third quarter of fiscal 2010 and the remainder came from sales through our distributor channels. Our fiscal 2010 third quarter gross margin was 24.6%, which marked a further improvement from the 24% we reported in our second fiscal quarter. Excluding stock-based compensation expense of $0.8 million included in the cost of revenues, the gross margin was 25%, up from 24.3% in the second quarter.

The principal contributors to the increase in gross margin during the third quarter was a slightly improved product mix and a reduced inventory batteries and exposure due to the improving business outlook, with a quarter of approximately $3.4 million as an additional allowance for excess and obsolete inventories during the third quarter as compared to $6.4 million of additional allowance recorded during the second quarter. We expect to begin shipping products in our fiscal fourth quarter based on our most recent pixel designs, and we may experience some unfavorable yields. However, given a modest initial shipping volume, this may not have any immediate effect on our fourth fiscal quarter gross margin.

R&D expenses in the third quarter totalled $20.4 million, representing an 8% increase from the $18.9 million we recorded by our second fiscal quarter. The primary reason for the increase was our release of additional mass designs to TSMC, which increased our NRE costs, and NRE cost is a key component of our total R&D expenses. We currently expect R&D expense in the fourth quarter will decline slightly from third quarter levels. R&D expenses in the third quarter include an approximately $2.6 million of stock-based compensation expense and excluding stock-based compensation expense, first quarter R&D expense was $17.8 million as compared to $16.1 million in the second quarter.

SG&A expenses in the third quarter totaled $15.6 million or $0.6 million decrease from the $16.2 million that we reported in our second quarter. The change was driven by a decrease in commissions resulting from the 14.4% sequential decline in revenues during the third quarter. Our third quarter SG&A expenses included approximately $2.7 million of stock-based compensation expense. Excluding stock-based compensation expense, SG&A expenses in the third quarter was $12.9 million as compared to $13.4 million that we reported in the prior fiscal quarter.

Now, in our last earnings conference call, we mentioned that we had inventory stock option exchange program that would expire during the third quarter. At the end of this program, we canceled options to purchase 3.6 million of common stock and issued 1 million restricted stock units in exchange. The incremental cost of the restricted stock units was $1.5 million and this amount was amortized over eight quarters. Our stock-based compensation expense in the third quarter included the effects from this amortization.

Our GAAP operating income in the third quarter totaled $2.5 million, and our GAAP pre-tax income in the third quarter totaled $5.3 million. Included in our GAAP pre-tax income was a $2.2 million gain that we recorded when a listed company in Taiwan, Tong Hsing Electronic Industries Ltd. acquired one of our equity (inaudible) technology company limited. This was a stock-for-stock transaction and it had no implications on our cash flows.

Our GAAP tax rate for the third quarter was 8.9%, resulting in a GAAP income tax provision of $467,000. Our GAAP tax provision for the third quarter was compensated by the tax impact associated with our employee stock option exchange program. In addition to the incremental stock compensation charge mentioned before, we also recorded $2.1 million of additional before tax assets. Excluding the effects of stock-based compensation however, our non-GAAP tax provision remains very comparable between our third and second fiscal quarters. Our non-GAAP tax provision for the third quarter was $0.6 million and our non-GAAP tax provision for the second quarter was $0.8 million. For the fourth quarter, we expect our tax provision amount will again be dominated by our tax paying entities in foreign jurisdictions similar to our second fiscal quarter. Meanwhile we expect that a non-GAAP tax provision amount for our fourth quarter to be comparable to our third fiscal quarter.

In the third quarter, our GAAP net income attributable to OmniVision was $5 million or $0.09 per diluted share, as compared to GAAP net income attributable to OmniVision of $8.1 million or $0.16 per diluted share in the second quarter. Excluding non-cash stock-based compensation expense, our non-GAAP net income attributable to OmniVision for the third fiscal quarter was $10.8 million or $0.20 per diluted share. This compares to a non-GAAP net income attributable to OmniVision of $14.3 million or $0.27 per diluted share in the second quarter.

Let me now turn to the balance sheet, we ended the third quarter with cash, cash equivalents, and short-term investments totalling $342.8 million, this compares to $354 million at the end of the second quarter. The decrease in our cash balance was driven primarily by our investment in inventories. As of January 31, 2010, inventory was $109.8 million, an increase of 19% from $92.2 million balance at the close of our second quarter. Our January inventory represents 85 day sales or annual inventory turns of 4.3 times. We increased inventory to a level with which we are comfortable given our stated goals and the current business outlook. We are within our stated goal of 75 to 90 days sales and annual turns of 4 to 5 turns.

Now going back to accounts receivable, the balance at the end of our third quarter net of allowances was $67.7 million, the same amount as our second quarter balance, but with a lower revenues base for our third quarter, our days sales outstanding increased to 40 days from 34 days in our second quarter. The increase in days sales outstanding is related to the timing of our product shipments to our customers during the quarter and it does not represent a relaxation of our present tendency [ph].

Now, I would like to turn to our outlook for the fourth quarter of fiscal 2010, which ends on April 30, 2010. We are expecting improving sales trends and more favorable sense of resolution mix during the summer and fall seasons with our fourth fiscal quarter, we anticipate our business to be relatively consistent with our third quarter, consequently we now expect our fourth fiscal quarter revenues to be in the range of $145 million to $160 million. Our GAAP earnings are expected to range from breakeven to $0.10 per diluted share. Excluding the estimated expense and related tax effects associated with stock-based compensation, we expect our non-GAAP earnings will be in the range of $0.11 to $0.21 per diluted share.

Now, with that, I will turn the call back to Shaw.

Shaw Hong

Thank you Anson. In summary, we believe our fiscal third quarter results are indicative of a degree of relative stability in our revenues as we are seeing a comparable stability between the consumer products market and the overall global economy. We also view our results as a testament to the comparative depreciation and the customer demand we are seeing to our flagship OmniBSI and the CameraCube product and the introduction of our milestone technology OmniBSI-2.

We have outlooked a number of times. We expect to in effect have delivered our second-generation BSI technology by our (inaudible) experimenting effort. We believe we are uniquely positioned to capitalize on the growth and extension of the image sensitive market with the technology and financial strength and long history of delivering on our goals. We look forward to continuing to share our success with you in the quarters to come.

Operator, we are now ready to take questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Quinn Bolton with Needham & Company. Please proceed sir.

Quinn Bolton – Needham & Company

Hi guys, you mentioned a stronger seasonal summer period a couple of times on that prepared script, and I was just wondering if you can put any sort of numbers behind that. I do not know, last quarter you sort of talked about a new seasonal pattern, so it maybe hard for you what the July and October quarters would be seasonally up on a sequential basis, but what kind of ramp based on design wins and just the new seasonality could you expect in the July and October timeframe?

Ray Cisneros

Hi, this is Ray Cisneros, obviously we cannot talk specifically about numbers but suffice it to say that what we have described here is our design win activity that has been tracking with our new products coming out to the market, especially our BSI products, our higher resolution products that carry the BSI technology and then the growing trend of video streaming type applications from customers, you look at all that, you roll it all up, it backs into consumer markets that need to sell during the summer seasons as well as the fall seasons that start ramping up for Christmas. So again, no numbers but I am just trying to give you a little more background on what we are talking about.

Quinn Bolton – Needham & Company

Ray, if you look at your design wins for the 5 and the 8-megapixel family of products and you sort of go back to say last year and compare your design wins today versus the design wins you had for the 3-megapixel, can you talk about – do you have a broader base of design wins with the 5 and the 8 now that you have got the OmniBSI architecture out to the market? Would it be comparable to sort of the design win penetration you had about a year ago, any sort of relative sense you can give us with the new BSI generation?

Ray Cisneros

Yes, it starts shifting as we are talking about these different resolution mixes, when you talk about 8 and 5, you not only talk about similar applications that we won a year ago, for example the handsets, but the 5 megs and 8 megs also lend themselves very well to the DSC DV markets that a 3 meg would not have. So we are extremely proud, as I mentioned, about some of our design wins in the Japan region. So that speaks highly for some of these product mixes.

Quinn Bolton – Needham & Company

And just the last one, you may not be able to answer, but with the summer ramp once the new 5 and 8 products go into production, any sense what percent of revenues the OmniBSI could be sort of exiting the fiscal third quarter of this year?

Ray Cisneros

Yes, we are not going to get into the specific numbers as well on this, quite simply suffices to see it is going to be a healthy mix the 5 backing into the DV and DSC type markets as well as some of the handset markets, and you know, I also have to remind people we have been shipping 5-megapixel already to certain regions around the world and those also continue to track upwards.

Quinn Bolton – Needham & Company

Great, thank you.

Operator

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

Harsh Kumar – Morgan Keegan

Hi guys, quick question, I was listening to the replay of the previous call and I remember a couple of times you guys have said that basically the June quarter would be the bottom. I want to first try to reconcile maybe what happened, was it again seasonality with some of the US customers and also if you can give us how much US was as a percentage of mix it would help us better analyze maybe what happened to the guidance.

Anson Chan

Hi Harsh, it is actually hard for me to just break out US the way you would like to hear because I think you are talking about end customers. But from our financial reporting perspective as I covered in the past, we go by the PO origin and so most of the orders actually come from Asia that being the hub where most of the process is being assembled.

And regarding your comment about we saying that third quarter is the bottom, I am not sure we exactly said that. I believe what we said was we do not believe there would be another step down for our fourth fiscal quarter, and I think that is reflected in the outlook that we have just provided.

Harsh Kumar – Morgan Keegan

Okay that is fair. Then kind of moving on, again coming back to what the previous caller was talking about, you seem extremely excited about summer, you were talking about record design wins and activity, is there any more color that you can provide that gives us some cause to believe that things will pick up dramatically in the summer timeframe?

Ray Cisneros

Yes, I think again, what we can say is, we have been at this for quite a while now, the BSI product portfolio is really a robust portfolio that we have. We are extremely happy with our progress with customers worldwide, Asia and Western hemisphere countries are adopting to BSI technology, and quite frankly, even the notebook market has now adopted to BSI technology in various areas, as well emerging markets like the entertainment sector or the telepresent sector. All combined, it is adding up to a very mix of BSI technology that OmniVision will be serving the market. It is a full list of good working activity from the sales and marketing for us here.

Harsh Kumar – Morgan Keegan

Okay, fair enough, and then maybe a question for Shaw, Shaw I mean cash is almost at this point in time roughly half of the market cap of the company. I know in the past you have kind of chosen to keep cash because of the economic uncertainty as you feel better about the business and as perhaps the economy is picking up a little bit of steam, can you talk about what may change for the usage of cash?

Anson Chan

Let me take this one Harsh, we come to it as it is the balance sheet, we are obviously wrapping up our fiscal 2010 in terms of what we are going to use the cash, we need some time to plan for our fiscal 2011. There are no immediate plans underway, if so I am sure you will hear about it and we will put out releases. So, for now, not much we can speak to.

Harsh Kumar – Morgan Keegan

Okay, fair enough, thanks.

Operator

Your next question comes from the line of Tristan Gerra with Robert Baird. Please proceed sir.

Tristan Gerra – Robert Baird

Hi, good afternoon. Just a quick question on mix, you mentioned that mix was a reason for the slight increase in gross margin but then your ASPs came down because of 3-megapixel and I am trying to reconcile the two, should I make the assumption then that we are not seeing this slightly higher margin on the higher megapixel products?

Anson Chan

I think that generally what you said is probably applicable because we tend to charge a premium for higher megapixel products, the reason for that is we tend to deploy our latest technology in the high resolution at first. But as to specific skews, I am not sure that it is the right forum for us to talk about.

Tristan Gerra – Robert Baird

Okay, great, thank you.

Operator

Your next question comes from the line of Paul Coster with JP Morgan. Please proceed sir.

Paul Coster – JP Morgan

Yes, thanks. Ray, you should not have acknowledged the world continues to generally impact us in the summer because that is all you are going to get questions about I think, as you go into fiscal first quarter 2010, obviously you are pretty optimistic, what do you expect to happen to ASPs as we go into the new fiscal year? Do you think it will go up on the back of this 5 to 8-megapixel design win activity?

Ray Cisneros

Well, we will see, obviously we could do our run on the back of the outlook analysis right, but I will let you, you folks with a better attitude, try that, again we are extremely happy going into Q1 and Q2 type seasons, and we will see.

Paul Coster – JP Morgan

What kind of products are you designed into and what kind of end customers do you think these products are going to be relating to?

Ray Cisneros

Yes, going by market, it is a good mix. If you look at our biggest markets, the handset markets, there is a big trend in the smartphone category that is driving the world handset market to another different level and that is driving, I think, a higher resolution product mix. And then, you look at the notebook segment, which I also mentioned a few facts, the 2-megapixel was actually a strong category in the notebook market and that again continues to drive very strong through the calendar 2010.

Then you keep going from there, there is emerging markets such as the multimedia and what we call the entertainment market, those categories again are picking up a variety of products. It is in the gray area, it does not fall neatly into one specific category, so therefore the sensor selected is not one specific category either. Then you got the DV and DSC categories that really I think is expanding and particularly with the DV market where consumers like to capture video and that is driving some of our higher resolution products to be sold in the marketplace as well. It is happening from all angles, all regions and all markets.

Paul Coster – JP Morgan

Okay, quick question to Shaw Hong, in your prepared remarks, you said that you will be committing some resource to the CameraCube activity, what is the nature of the investment you are making there and also what is it that gives you confidence that CameraCube adoption is about to accelerate? What market is this product going into?

Ray Cisneros

Let me handle –

Shaw Hong

First, is CameraCube is still focusing on the like I said secondary headset market, and then through this process we entered a different market. So to start with there is the handset market and I am very happy with the progress on those DSI and CameraCube technology.

Paul Coster – JP Morgan

Just to confirm that you have actually got design wins for CameraCube already, is that correct?

Shaw Hong

I am not quite sure, somebody help with this question.

Ray Cisneros

The CameraCube has already started shipping, as we mentioned, in mass production and what we are seeing right now is a nice steady growth front for our CameraCube in the VGA resolution category, and that is backing into the secondary camera for handsets, that market is extremely attractive. And then the market for the use of this CamercaCube into the primary camera, the upward bound camera that is now materializing as well. So we are looking at a pretty good sizeable opportunity and we have to move fast to try to gain as much market share as possible.

Paul Coster – JP Morgan

So the last question is what is the investment you are making there?

Ray Cisneros

The investment is basically I would say more about resources devoting themselves to product engineering, manufacturing engineering, and to make sure that the ramp up starts ramping up cleanly. That is the investment we are talking about and then of course you know about our partnerships with our supply chain partners that build these units in their factories.

Operator

Your next question comes from the line of Yair Reiner with Oppenheimer. Please proceed sir.

Yair Reiner – Oppenheimer

Thank you. So another question on the ramp up of BSI, as that takes place next year, what are you anticipating in terms of gross margin head wins kind of when you initially try to improve yields and once you are through those initial issues, do you expect BSI parts to carry a higher gross margin than you are having at your traditional products?

Anson Chan

I would not comment on specifically on whether or not a particular technology carries higher margin but I would say that introducing a new type of product, in this case happens to BSI, is no different than our any other new products. Upon initial production, you will have some unfavorable yields and it takes us typically about six months to resolve those issues before it starts to produce reasonable profit at (inaudible), I guess you can extrapolate some here regarding some of the call seasons I mentioned earlier.

Yair Reiner – Oppenheimer

Okay, so in other words extrapolate that gross margins are unlikely to expand until the ramps are fully behind us?

Anson Chan

We definitely not believe there would be any unusual effects on our gross margin for our fourth fiscal quarter 2010.

Yair Reiner – Oppenheimer

Okay, very good. Can you comment on whether a BSI chip relative to kind of a more traditional chip with the same resolution would carry a higher or an equivalent ASP?

Bruce Weyer

This is Bruce Weyer. The BSI technology has a lot of premiums for the market relative to the value it brings. It brings a lot better image quality and therefore actually gets us into a bit of a different class of designing products as well. So in that respect, yes, it typically would carry a higher average selling price. The technology also has more advanced process technology involved with it, so it also carries a little bit higher cost basis as well. So, that is where Anson was alluding towards the fact that in the long term you do not anticipate a broad differentiation relative to normal earnings curves.

Yair Reiner – Oppenheimer

Got it. And then one final question if I could on competition, it appears there are a lot of very cheap kind of lower quality sensors now kind of available in the Chinese market for the lower end kind of voice phones, how is that impacting the competitive landscape for you and to what extent are you kind of choosing to just leave some business on the table?

Ray Cisneros

Well, let us just say that the China market and for that matter the greater Asia market is extremely large. In fact it is not over yet in terms of that market because that market has established itself as the major manufacturing centre, it is actually exporting quite a big percentage of their builds to foreign markets. In other words, it just cannot be read as the low end of the handset market, say, pick a category, because the evolution of what is happening in Asia is transitioning quite fast from one model to a different model, in other words, from a domestic consumption to an ODM service type model. So, and top of that the resolution mix has been changing quite a bit where we are actually shipping record levels of 2-megapixel into the Asia market.

Yair Reiner – Oppenheimer

Okay, thank you.

Operator

(Operator instructions) Your next question comes from the line of Betsy Van Hees with Wedbush Securities. Please proceed.

Betsy Van Hees – Wedbush Securities

Thanks so much. Good afternoon. Anson, I was wondering if you could go back to the gross margins, congratulations, 25% especially given the fact that your mix, actually you are continuing to ship quite a high level of VGA, how are you able to improve the gross margin with the mix especially when you are taking into account that ASPs went down quite a bit sequentially?

Anson Chan

First of all, thank you Betsy. To answer that question, I guess this quarter in particular demonstrates the fact that the ASP is not directly linked to our gross margin, in fact it is more associated with the life cycle of our products, where we are in the probable life cycle of any particular skew, to the extent that we are still early on in a particular skew there is still room for yield improvement and cost basis will improve, and that cost improvement can actually go faster than the ASP decline. In this case, you can kind of see the blended results here in the third fiscal quarter. I believe this is something that we should all keep in mind going forward as we go into another generation of products, more specifically OmniBSI, this is clearly in early stage in the life cycle of this kind of product technology and we do have room for expansion to the extent that we can resolve from these yield issues and what not as we start the volume ramp.

Betsy Van Hees – Wedbush Securities

Thank you Anson that was very helpful. Inventory, as you noted, did go up 85 days and you said that you were comfortable and that was well within your target especially as you look at the projection for your business in the summer and fall, given that you are entering into relationships with new customers, do any of these new customers require that you hold a certain amount of inventory, is that one of the reasons why you increased your inventory level?

Anson Chan

The increase in inventory is not really related to any particular customer requesting for buffer inventory. It is more like – it is just a level that given our lead time something that we feel comfortable with. What happened last quarter, I believe the turn was more than six times, it really had to do with the business then pulled [ph] into the second fiscal quarter as we talked about many, many times before, and that we felt it in our inventory balance being a little lower than we would have liked it to be. So this quarter what you see is more like an adjustment.

Betsy Van Hees – Wedbush Securities

Okay, great, thanks and I know it is only allowed one follow-up question but since everybody has been asking so many questions, I am going to ask just one more.

Anson Chan

For you, no worries.

Betsy Van Hees – Wedbush Securities

Thank you. So when I wrote to you the OpEx for this quarter, you did mention that R&D was going to come down a little bit and as we look forward into next year, I know you do not want to give guidance, but as you are developing new assets [ph] for these new products, for these designs that you have, can we expect to see another uptick in R&D, is that how we should be looking at it as we move forward?

Anson Chan:

It is very possible. Indeed our tape outs can be very lumpy, as happened before. What I mentioned earlier though is we are still working on our fiscal 2011 plan so some of these things do need to be laid down. We need to firm up on our products world maps and their tape outs schedules. So it is still too early to comment on those things yet.

Betsy Van Hees – Wedbush Securities

Okay, great, thanks so much for taking all my questions.

Operator

Your next question comes from the line of Doug Freedman with Broadpoint. Please proceed sir.

Doug Freedman – Broadpoint

Hi guys, thanks for taking my question. I am trying to get my arms around the ASPs and the mix shift that you have seen, would it be possible to offer what you are seeing in the particular markets from an ASP standpoint, maybe either quarter on quarter ASP declines for VGA or megapixel, and how the product stack looks in relative cost, any color you can offer would be helpful.

Ray Cisneros

I think that quarter on quarter there is always a constant pressure that anybody sees in a consumer type based market for ASPs and how you will have to fight that erosion back quarter on quarter. The stack up how it ended up falling out for us is it was not just 3-megapixel, we also as many of you have learnt a couple of quarters ago, our 8-megapixel was backing into some DV DSC type applications in the Japan region. So you mixed all that up those were the main drivers for certain of the ASP type factors we are in really right now.

Doug Freedman – Broadpoint

Okay. What are you expecting for year on year ASP declines on a like-for-like product basis?

Ray Cisneros

Like-for-like product basis, I think we historically made mention, year over year it could be anywhere between 10% or north of that. So that is typically the rule of thumb we see.

Doug Freedman – Broadpoint

Okay and my last one if I could, looking at sort of your demand planning Anson, what are you looking at doing with your inventories going forward? Are you at all concerned about wafer supplies coming out of the foundry, there is definitely some tightness in certain nodes, and I was wondering if that was having any impact on your year planning purposes.

Anson Chan

Well, if you look at our inventory, what we have on hand at the end of the quarter, we are talking about 4.5 turns, so it is not exactly posing any long-term issue, but when you talk about a down the road on any (inaudible) long-term partner PSMC, we are working day and night on planning. So we are doing everything that we need to do to make sure that our customers get what they need.

Doug Freedman – Broadpoint

Thank you, great thank you.

Operator

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

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Source: OmniVision Technologies, Inc. F3Q10 (Qtr End 01/31/10) Earnings Call Transcript
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