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Executives

Brian Dunn - President and Chief Operating Officer

Anson Chan - Chief Financial Officer, Principal Accounting Officer and Vice President of Finance

Bruce Weyer - Vice President of Worldwide Marketing

Ray Cisneros - Vice President of Worldwide Sales

Shaw Hong - Co-Founder, Chairman, Chief Executive Officer and President

Analysts

Rajvindra Gill - Needham & Company, LLC

Yair Reiner - Oppenheimer & Co. Inc.

Tristan Gerra - Robert W. Baird & Co. Incorporated

Betsy Van Hees - Wedbush Securities Inc.

Harsh Kumar - Morgan Keegan & Company, Inc.

Paul Coster - JP Morgan Chase & Co

OmniVision Technologies (OVTI) F4Q10 (Qtr End 04/30/2010) Earnings Call May 27, 2010 5:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the OmniVision Technologies Earnings Conference Call for the Fourth Quarter of Fiscal 2010. My name is Camina, and I will be your coordinator for today's call. [Operator Instructions] I would now like to turn our 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 fourth quarter earnings conference call. Just after the close of market today, OmniVision issued an earnings release reporting our financial results for our fourth fiscal quarter and fiscal year ended April 30, 2010. You can access this release from the Investor Relations section of our website 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 website.

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, May 27, 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 call today, we will present important factors related to our business, which may potentially affect these forward-looking statements. As a result, we caution you against placing undue reliance on these forward-looking statements.

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 goodwill impairment charge in fiscal 2009. A reconciliation between the two is available in our earnings release posted on our website.

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 will also like to welcome everyone who is participating on our call today. Joining me today are Anson Chan, our CFO; Ray Cisneros, our VP of Sales; and Bruce Weyer, our VP of Marketing.

I will begin the call with an overview of our results for the quarter followed by comments on the progress we made in meeting our strategic goals, which will include a highlight of our successes in the technological developments and our new and innovative product introductions. I will ask Ray to present an overview of our current sales activities and recent accomplishments, followed by Bruce with his comments on our leading strategic posture with our OmniBSI pixel technology and products and the same posture within the emerging video-centric world. Finally, Anson will discuss in detail our financial results for the fourth fiscal quarter. Anson will also provide our outlook for the first quarter of fiscal 2011. We will conclude as usual by answering as many of your questions as time permits.

We reported today our fiscal 2010 fourth quarter revenues of $157 million, which were equal to our third fiscal quarter results. Gross margins improved sequentially to 24.9% for the fourth quarter from 24.6% in the third quarter. This revenue results are consistent with our expectations and the fourth quarter revenue guidance that we provided in our last earnings conference call.

We recorded GAAP net income of approximately $3.5 million or $0.07 per diluted share, while our non-GAAP net income totaled $10 million or $0.18 per diluted share.

Our financial position remains strong, with cash and short-term investments at quarter end totaling $334 million. We are extremely pleased by the progress we made this quarter. This progress refers to our successes in fulfilling our goals of providing and delivering improved image-centric technologies and solutions to our customers and developing and making available a full range of innovative and cross-functional imaging products to all the markets.

This fulfillment is made possible because of our technological strength. And this strength laid a foundation across our entire product portfolio and has position us well to meet our customer needs across all of our target market segments.

In our later session, Bruce will discuss in greater details our leadership role in strengthening transition from a sensing to an imaging company.

As a part of the strategy towards offering you true imaging solutions and providing progress to an imaging video-centric consumer market, we recently completed the acquisition of Aurora Systems, a privately held company. Aurora is a supplier of liquid crystal on silicon devices for use in mobile projection applications and high-definition home theater projection systems. With our cost devices, we will expand our product portfolio with the growing popularity of imaging projection systems in consumer devices and to offer even more comprehensive and innovative imaging solutions to our customers.

In addition to offering comprehensive imaging solutions, we continue to perceive our primary long-term strategy in technology development. I will now highlight for you some of our recent exciting milestone achievements in technology development and supplies shipments.

As we noted last quarter, our first BSI pixel, the OmniBSI, continues to ramp in mass production with the increase accelerating rapidly as we enter our first quarter of fiscal 2011. In fact, the growth we anticipate in BSI shipments during the coming quarter is so profound that we have challenged our entire supply chain to respond. And they have. We have worked closely with each participate in each stage of production cycle to meet the quickly emerging demand for our BSI devices as we expand from simple volumes to multi-million unit shipments.

As we have demonstrated in the past with equally rapid ramp ups in production, our supply chain remains well-positioned to support any rapid increase in end customer demand for our imaging devices. Production in the volumes we anticipate in the first quarter will represent a paradigm shift in the production of BSI devices.

Also during our third quarter, we announced an exciting technological development, OmniBSI-2, our new second-generation backside illumination pixel architecture. OmniBSI-2 further extends our leadership in pixel-technology development by delivering the world's first 1.1-micron backside illumination pixel.

With the introduction of OmniBSI-2, we continue to advance the technological boundaries of BSI at a time when our competition remains focused on development of their first-generation BSI pixel designs.

The BSI shipment ramp provide an improvement in our product mix during the fourth quarter, with a concentration of OmniBSI primarily in our higher-resolution devices. In particular, we are pleased with the continue market share gain of our 5- and 8-megapixel devices in the mobile phone and DSC markets in which are now in full mass production with several major customers.

Consequently, we anticipate further significant increase in unit shipment during the first quarter of fiscal 2011, consistent with our comment last quarter regarding anticipated gain during the summer and fall seasons.

Another noteworthy technology continue to be our advanced CameraCube technology. Devices to employ this technology continue to ramp in volume. Although predominantly used as a secondary camera application in mobile handsets, we anticipate that CameraCube device will increasingly be used as a primary camera such devices.

We have supported the expected adoption of CameraCube product through increases in our investment in R&D. A major portion of this effort remain focused on the development of advanced wafer-level optics and the packaging solutions for next-generation products and to reduce product costs.

Enrollment [ph] of new product introduction employing our latest technology advances reflects our successful implementation of our strategy in meeting the constant drive in delivering improved image sensor technology.

This quarter, we advanced our leadership in HD video with the introduction of a new flagship image sensor for our secluded product portfolio. The new system-on-chip sensor capture HD-quality color video in any environment, including low-light sense or high-contrast lighting conditions. It does so by combining 720 [720p] HD video with advanced low-light sensitivity and the color high density range. It combines advanced pixel technology with proprietary new HDR image processing algorithm to enable a complete professional quality, so there is a camera on a single chip.

In addition, we announced our 10th OmniBSI device, a 5-megapixel image sensor that is also HD capable. Consumers have made HD video an increasingly required application across a broad range of markets, including not only the video-centric notebook, webcam, automotive and security markets, but also the entertainment and the mobile phone markets as well. I'm pleased that we offered the broadest portfolio of native HD video and the video-enabled high-resolution image sensors available today.

As I have noted during the prior quarter earnings call, each of our three product introductions during the third quarter represent advances in HD technology. We are well-positioned to meet our customers' changing needs across a broad range of technologies and market applications and for a major transition to HD sensors in this market.

Our fourth quarter announcement follows other recent product introduction and are highlight during our prior call, including our remarkable new 14-megapixel image sensor to run on our OmniBSI technology and our first native 1-megapixel HD video sensor to run on our 1.75-micron OmniBSI pixel technology.

We have established clear leadership in streaming video-based markets including the notebook, netbook, webcam, automotive and security markets while we remain intent on defending our key traditional markets. We are equally focused on the development of emerging market segments that offer the potential of above-average returns. Our recent successes in the automotive market are particularly encouraging as we have developed a large portion of the multi-camera display-based market.

Win in automotive space, we are seeing a continue and sustainable long-term increase. Our recent automotive design wins with Tier 1 customers supports our view there. As with the mobile phone NTSC market, CMOS has proven to provide disruptive technology which has substantially reduced the role of CCD devices in the imaging marketplace.

Before I turn this discussion over to Ray, I will again emphasize that we remain committed and continue to strive for excellence in technological innovation, provide our customers with the broadest portfolio and the best performance products and to be the imaging-solutions provider of choice. We will pursue the opportunities of our own dimension and not rest on our successes.

With that, I will turn the podium to Ray who will provide an update on the quarter's sales activity.

Ray Cisneros

Thank you, Shaw. Our reported fourth quarter operating results tracked well within our guided range, as we anticipated the seasonality factors that we've previously discussed that did impact on sales from our North American customer base.

However, we are confident in our expectations that sales activity in this important region will quickly ramp during the first and second quarters of fiscal 2011. Sales from our Far East customer base remained steady. At the same time, sales in the notebook and security markets were healthy, while sales into the automotive space continued on a steady upward track.

Throughout the quarter, our customers demonstrated a growing appreciation for the value-added benefits provided by our OmniBSI product portfolio as we continue to roll up new socket design wins worldwide and across several market segments.

We focused our efforts during the past several quarters in educating our customers on the range of benefits provided by our OmniBSI and OmniBSI-2 technologies. As we move forward into the first quarter of fiscal 2011, these efforts have borne increasingly strong results. Our expectations of an improving outlook during the summer and fall quarters is based on an exceptional mix of customers, products and regional sales.

We now anticipate that we will ramp OmniBSI during the first fiscal quarter and beyond in volumes exceeding even our own expectations. In the fiscal 2010 fourth quarter, we shipped approximately 125 million units at an average selling price of $1.26. This compares with approximately 130 million units shipped in the third quarter at an average selling price of $1.18. The sequential increase in ASP during the fourth quarter reflects a favorable shift to a higher-resolution product mix.

In the fourth quarter, unit sales of sensors 2-megapixel and higher increased as compared to the third quarter to approximately 27% of total shipments. As in the previous third quarter, the 1/5-inch 2-megapixel sensors were a strong portion of this mix with strong demand coming from the handset and notebook markets. Also contributing to this increase was our 3-megapixel product line predominantly for the handset market.

Finally, early shipments of our high-sensitivity 5-megapixel and 8-megapixel OmniBSI products have further contributed to this category. We expect that this latter two product lines will continue to ramp over the months ahead.

Unit sales of 1.3-megapixel sensors increased to approximately 12% of total shipments in the fourth quarter as compared to 5% in the prior quarter. This was primarily driven by a spike in notebook demand.

Finally, unit sales of sensors that were VGA below were approximately 60% in the fourth quarter. Our wafer-level module shipments were approximately equivalent compared to the prior quarter.

In terms of product markets, our mobile phone sales represented approximately 55% of our revenues in the fourth quarter. Notebook and PC sales were approximately 30% of revenues in the quarter. Sales of our other emerging market products accounted for approximately 15%.

In the mobile phone market, strong 3-megapixel and an upswing in 2-megapixel of product shipments contributed significantly to sales in this category in the fourth quarter. A rapid upswing of 2-megapixel product revenues is likely to continue through these summer months.

Additionally, we initiated our first high-volume shipments to multiple end customers using our high sensitivity 1/3-inch 5-megapixel product line, which employs our proprietary OmniBSI technology. Significantly higher 5-megapixel product sales is likely to continue into the first half of fiscal 2011 and will represent a watershed point in which we have realized our vision of expanding the novel BSI technology into the economies of scale required for major consumer markets.

Similarly, we ramped up early shipments of 8-megapixel also built on OmniBSI pixels. We expect that these 8-megapixel products will be featured in high-profile Android-based smartphone products. Underscoring the value-added benefits of superior image quality from these two OmniBSI products, we continue to record additional socket design wins with these two products that we anticipate would contribute significant to our revenue during this fiscal year.

In the Far East, the ODM business product trend continued, driving volume in new socket design opportunities. In the fourth quarter, we continue to ship several VGA products. The strong 2-megapixel surge we previously mentioned was primarily driven by sales within this region.

In addition, total solution reference design platforms are quickly shaping up to spur high-end resolution designs. We remain confident that our 1/4-inch 5-megapixel OmniBSI product category will capitalize on this emerging segment via our strong channels in this region.

In the PC, Notebook and Webcam segment, strong demand shaped up with our 2-megapixel, 1.3-megapixel and various VGA products. In this quarter, several major socket design wins with our dedicated HD OmniBSI sensor were recorded over several customers and regions. Early shipments were made, and we anticipate this category to quickly grow over the next several quarters. Specialized VGAs as well as mainstream VGAs also fed this market segment at a healthy clip. Specialized VGA products carry slightly higher ASPs, as these products typically have larger pixels for best-in-class image quality.

In our emerging products categories, several exciting trends continued to materialize. While we officially announced our revolutionary OmniBSI 14-megapixel in the fourth quarter, we also recorded multiple socket design wins utilizing this sensor with ODM brand names. We also continued to add more socket design wins to the already loaded 1/3-inch 5-megapixel OmniBSI sensor.

Another trend quickly emerging is the Telepresence segment. This involves point-to-point communication solutions, coupling digital imaging with voice. Several novel solutions provided by Tier 1 brand name infrastructure providers will materialize in this calendar year.

Additionally, solutions are being designed for the domestic market and not just the enterprise market. This will add scale and volume at a rapid pace.

Finally this summer, a fresh round of entertainment products, both mobile as well as console-type products, will carry embedded imaging solutions. Both OmniPixel3-HS and OmniBSI-based sensors will be featured in some of these novel consumer products. The entertainment category during the first half of fiscal 2011 will significantly contribute to our quarterly revenues.

In summary, our hard-working, highly focused effort in bringing to market the revolutionary OmniBSI technology has fulfilled our targets to increase the number of customer value-added solutions, grow our revenues and gain market share.

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. As OmniVision transitions to a new fiscal year, it's an ideal time to reflect on the tremendous strategic advancement we've accomplished in fiscal year '10 and the opportunity this represents for fiscal year '11 and beyond. Within this context, I will discuss our OmniBSI pixel technology's, leadership, leadership criteria for a video-centric world and OmniVision's strengthening transition from a sensing to an imaging company.

In the fourth quarter of fiscal year '10, OmniVision announced our 10th OmniBSI device, the OV5647, representing our fourth OmniBSI targeting the important 5-megapixel market. Our 5-megapixel OmniBSI family represents our most significant growth for fiscal year '11, reflecting the value and performance we're bringing to the worldwide smartphone and digital video camera markets.

OmniVision now had optimized BSI products ranging from 720p high-definition sensors to 14-megapixel high-resolution sensors for the mobile phone, notebook, webcam, entertainment, digital still camera and digital video camera markets.

More importantly, we've extended this leadership position into our second-generation OmniBSI-2 pixel architecture, which we are broadly investing for design resources for next-generation solutions.

In the fourth quarter of fiscal year '10, OmniVision also announced our OV10630 high-dynamic range sensor for high-definition color applications. Throughout fiscal year '10, OmniVision has introduced market-leading solutions for the video-centric world. With the announcement of the OV10630, we advanced this leadership to the increasing need for high-dynamic range sensors.

Streaming video represents the highest growth application for the coming years including next-generation mobile phone, notebook, home entertainment, automotive, security and medical solutions.

OmniVision has the broadest family of native 720p and 1080p high-definition sensors and leading resolution sensors supporting streaming video applications. Our high-definition portfolio was broadly enhanced in the third quarter including announcements of three advanced-technology HD sensors.

The OV9726 is the first native 720p HD image sensor built on our OmniBSI technology. The OV2715 along with its sister product OV2710, is a highly tuned native 1080p high-definition image sensor. The OV14810 is our flagship 14-megapixel sensor for premier DSC while offering a full 1080p HD video output at 60 frames per second. Although light sensitivity leadership has been a curse on the market, it have been further enhanced by state-of-the-art binning, scaling and resampling filter technologies.

In the fourth quarter of fiscal year '10, OmniVision announced the acquisition of Aurora Systems, a provider of image-projection solutions. This acquisition accentuates OmniVision goal in providing comprehensive imaging solutions. OmniVision has been very diligent in the development of leading-edge technologies and fostering an industry-leading ecosystem to deliver the highest-quality video experience for the consumer and professional markets.

The opportunity of delivering a high-quality video experience requires market leaders to review all aspects of the video subsystem. OmniVision believes we can significantly enhance and enrich people lives by bringing affordable, high-quality video systems to the social, professional and health and safety environments.

Shaw Hong

Thank you, Bruce. I will now turn the call over to Anson, who will discuss our fourth quarter financial performance and provide guidance for our first quarter of fiscal 2011.

Anson Chan

Thank you, Shaw, and good afternoon, everyone. Revenues for the fourth quarter of fiscal 2010 remained comparable at $157.2 million, as compared to $156.9 million in the third quarter. Direct sales to OEMs and VARs accounted for 46.9% of our revenues in the fourth quarter of fiscal 2010, representing an 8% decline from the third quarter revenues percentage. The remainder of our revenues came from sales through our distributor channels.

Our fiscal 2010 fourth quarter gross margins was 24.9%, which marked a further improvement from the 24.6% when we reported our prior fiscal quarter. Excluding stock-based competition expense of $525,000 included in cost of revenues, our non-GAAP gross margins was 25.3%, up from 25% in the third fiscal quarter.

In the fourth quarter, we recorded approximately $5.9 million for the sale of previously written-down inventory and $5.7 million as an additional allowance for excess and obsolete inventories, for a net $200,000 of favorable impact on the gross margin. In comparison, during the third quarter, we recorded approximately $2.4 million for the sale of previously written-down inventory and $3.4 million as an additional allowance for excess and obsolete inventories with a net $1 million of unfavorable impact on gross margins.

As Ray mentioned earlier, we began shipping products in our fiscal fourth quarter that are based on our most advanced pixel designs. As with the introduction of any advanced technology, our initial yields were less than optimal. Given a month's initial shipping volume, this did not have any significant impact on our fourth fiscal quarter gross margin. However, as we ramp our volume in the first quarter, this may present itself a headwind to further margin expansion.

R&D expenses in the fourth quarter totaled $19.6 million, representing a 4% decrease from the $20.4 million we reported for our third fiscal quarter. The decrease was primarily due to a $0.8 million decline in NRE [non-recurring engineering] charges, a key component of our total R&D expenses. The decline is caused by the timing of our releases of mass designs to TSMC [Taiwan Semiconductor Manufacturing Company Limited].

We currently expect our R&D expense in the first quarter of 2011 will increase from fourth quarter 2010 levels as we continue to invest in our technological and product portfolio. R&D expenses in the fourth quarter included approximately $2.5 million of stock-based compensation expense. Excluding stock-based compensation expense, fourth quarter R&D expense was $17.1 million as compared to $17.8 million in the third quarter.

SG&A expenses in the fourth quarter totaled $15.6 million, unchanged from the level that we reported in the third quarter. Our fourth quarter SG&A expenses included approximately $2.2 million of stock-based compensation expense. We expect SG&A to increase slightly in the first quarter of fiscal 2011. Excluding stock-based compensation expense, SG&A expenses in the fourth quarter totaled $13.4 million as compared to $12.9 million that we reported in our prior fiscal quarter.

Our GAAP operating income in the fourth quarter totaled $4 million, as compared to $2.5 million in prior quarter. Our GAAP pretax income in the fourth quarter totaled $4.7 million as compared to $5.3 million in the prior quarter.

Our GAAP tax rate for the fourth quarter was 27% as compared to 8.9% in our prior quarter and resulted in a GAAP income tax provision of $1.3 million. The amount represents the final true up of our annual tax provision for our fiscal 2010. The comparison with our GAAP tax provision for the third quarter is not meaningful, and the third quarter tax rate was complicated by the tax impact associated with our employee stock option exchange program that we completed in December, 2009.

Excluding the effect of stock-based compensation, our non-GAAP tax provision for the fourth quarter was essentially zero, and our non-GAAP tax provision for the third quarter was $0.6 million.

For the first quarter of fiscal 2011, we expect our GAAP tax rate will be in the high teens, and our non-GAAP tax rate will be in the low teens.

In the fourth quarter, our GAAP net income attributable to OmniVision was $3.5 million or $0.07 per diluted share, as compared to GAAP net income attributable to OmniVision of $5 million or $0.09 per diluted share in the third quarter.

Let me remind you that our third quarter net income included a onetime gain of $2.2 million resulted from the acquisition of one of our equity investees by a public company in Taiwan.

Excluding non-cash stock-based compensation expense, our non-GAAP net income attributable to OmniVision for the fourth fiscal quarter was $10 million or $0.18 per diluted share. And this compares to non-GAAP net income of attributable to OmniVision of $10.8 million or $0.20 per diluted share in our third fiscal quarter.

And we now turn to the balance sheet. We ended the fourth quarter with cash, cash equivalents and short-term investments totaling $333.6 million. This compares to $342.8 million in the end of the third quarter. The decrease in our cash balance was driven primarily by our further investment in inventories in anticipation of increased sales activity during the first quarter of fiscal 2011.

As of April 30, 2010, inventory totaled $134 million, an increase of $24.2 million or 22% from the $109.8 million balance at the close of our third quarter. Our April year-end balance represented 104 days sales or annual inventory turns of 3.5x. Again, the inventory was prepared in anticipation of increased sales in the first quarter of fiscal 2011.

Turning to our accounts receivable, the balance at the end of the fourth quarter net for the last [indiscernible] was $74.3 million, an increase of 10% from the $67.7 million for the third quarter. Our day sales outstanding increased to 42 days from 40 days for our third quarter. The increase in day sales outstanding is related to the timing of our partnership shipments to our customers during the quarter.

Now I would like to turn to outlook for the first quarter of fiscal 2011, which ends on July 31, 2010. We expect significant strength in demand for our image sensors, which leads us to provide a very robust guidance for the first quarter. We now expect our 2011 first fiscal quarter revenues to be in a range of $190 million to $210 million, representing a 21% to 34% increase over our fourth fiscal quarter. Our GAAP earnings are expected to range from $0.17 to $0.30 per diluted share. Excluding the estimated expense and related tax effects associated with the stock-based compensation, we expect our non-GAAP earnings will be in the range of $0.27 to $0.40 per diluted share.

Shaw Hong

Thank you, Anson. In summary, we are pleased with our fiscal fourth quarter results, which reflect a growing stability in our operations and in the consumer product markets. We remain confident in the competitive differentiations and customer demand we have seen for our flagship OmniBSI and the CameraCube products, coupled with the introduction of our milestone technology, OmniBSI-2, our second-generation BSI technology, while our competition is still experimenting with their first. We believe we are uniquely positioned to capitalize on the growth and expansion of the image sensor markets with the technology. The financial strength and long history are 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] Our first question comes from the line of Paul Coster with JPMorgan.

Paul Coster - JP Morgan Chase & Co

So pretty impressive increase in average selling price per cents as you move up the megapixel curve, Ray, perhaps you're in a position to kind of give us some sense of whether this is sustainable and maybe marks a reverse in the trend that we've seen for really many years here. And perhaps adjacent to that, obviously the next quarters, the margins suffered from low yields, but moving beyond, do you think it's possible to sustain gross margins in the mid to high 25% range?

Ray Cisneros

Well, obviously, anything outside of the prepared commentary, we cannot comment on. But we can say that we're extremely happy with our product mix. That's what drove that Q4 number. And then of course, with our guidance in the Q1 quarter, we've already made our comment about our great position in 5-megapixel and 8-megapixel. So obviously, there is an anticipation of some kind of improvement. Beyond that, it's really hard to say. I can tell you this, that the type of socket designs that you typically win in our business remain with you anywhere between 12 to 18 months. So that gives you some kind of, I would say, headwind to continue going forward.

Paul Coster - JP Morgan Chase & Co

The design win activity that you cite at present presumably relates to product that will be coming to market in calendar year 2011. Is that a fair statement that you feel like you've got good momentum going into calendar 2011 here from this design win activity?

Ray Cisneros

Yes, that's too far out to comment. I mean, we're looking at design win activity that you're seeing results in our guidance for Q1. And obviously, as we also mentioned, our fall quarter, we also anticipate some very strong numbers. But beyond that, there's definitely a seasonal cyclicality to our business, and as well as our customers having controlled their product life cycles, it's hard to really predict beyond this quarter or even beyond the following quarter.

Operator

Our following question comes from the line of Harsh Kumar with Morgan Keegan.

Harsh Kumar - Morgan Keegan & Company, Inc.

Curious, could you tell us when you expect your yields and perhaps a gross margin to kick in from BSI? And I'm curious, maybe get a little technical on why you're not able to get the yield improvement when you're going into volume in this coming quarter?

Anson Chan

First of all, regarding the yield, as we've mentioned in the prepared commentary, this quarter, meaning Q4, the shipment volume, it's not exactly huge. And the ramp, we expect that to take place in the first fiscal quarter of 2011. So obviously, the learning experience we gain is valuable. But we need a little bit of time to monitor the yield before we can have reliable projections. And that will take us typically around six months. So hopefully that helps you understand where we are in terms of the ramp and the yield in terms of the progress getting to an optimal level.

Harsh Kumar - Morgan Keegan & Company, Inc.

And then maybe talk about some other cost applications, Aurora Systems' acquisition? Could you give us some color on what kind of end markets you're targeting with that?

Bruce Weyer

It's Bruce Weyer, Vice President of Marketing. One of our big interests in acquiring Aurora System was the fact that they have some leading-edge technology. Their Liquid Crystal on Silicon technology is based on solid-state color field sequential technology. And that is the trend for the future, to drive down into good resolutions, better cost structures and low-power consumption. That markets, you look at a few different classes of products, one is the standard projector market. But it quickly moves into a pico projector or pocket-type projector, which could be a add-on product. And then the biggest volume, long term, is getting an embedded projector into mobile phones. And that of course takes some development in driving down power consumption and driving down costs to effectively achieve that. So our investment in Aurora Systems is a long-term investment for what we think is a nice growth market over the next three to five years.

Harsh Kumar - Morgan Keegan & Company, Inc.

In terms of your end-market handsets versus cellphones, where are you seeing perhaps the most amount of strength in your orders, looking forward?

Ray Cisneros

This is Ray Cisneros. Obviously for this current first fiscal Q1 quarter, there's going to be a big drive out of the handset market in Featured as well as in the high-end smart-phone-category handsets. That's a big driver here, in particular, with the 5-megapixel and 8-megapixel that's across several regions and several customers. The other driver is the entertainment market, there's a pickup in very innovative consumer products out there with our tier-1 branded customers, and that's driving the pickup in new designs and new volume. And so these two major segments are driving most of our revenue in terms of the uptick.

Operator

Our following question comes from the line of Betsy Van Hees with OmniVision (sic) [Wedbush Securities Inc.].

Betsy Van Hees - Wedbush Securities Inc.

Guidance was great and just to follow on the last question, I know you don't want to guide for beyond the quarter that you're currently guiding for, but as we're looking at strength, is it going to be handsets where you're you going to see continued strength in? Or are you going to see more strength in the PC side? And then in terms of gross margins, are we going to be looking at gross margins kind of flattening out this area now for a little time?

Ray Cisneros

In regards to which markets are driving beyond Q1, as we mentioned, we're talking about the summer quarter feeding into that kind of consumer cycle of spending in the summer. And then the Q2 backs into the fall quarter that ends up being our customers' preparation for the Christmas season. And I could say confidently that across all segments, you're going to see drive in terms of revenue.

Anson Chan

I'll take the gross margin question. Like I said earlier, we do need a bit of time to improve the process and get the yield to an optimal level. So obviously in this coming quarter guidance, we've been a little cautious. But give it a little time, I think we'll have the opportunity to have margin expansion again.

Betsy Van Hees - Wedbush Securities Inc.

And then as we're looking at the 5-megapixel and the 8-megapixel, can you give us a sense of what percent of revenue will you break out VGA and 2-megapixel and above? What kind of sense can we expect that to be part of the mix, as we're looking for in the next couple of quarters to help us model ASPs and things like that?

Ray Cisneros

As you well know, we don't break it out by revenues in terms of product categories. We break it out by unit shipments. But I could say this, that the 5-megapixel with our OmniBSI technology is now the gold standard in regards to image quality for video-centric-type applications in handsets as well as DSCs and as well as other emerging markets. And I could tell you that the 5-megapixel, we're very proud of its performance and contribution to revenues in our company. And then as well as the 8-megapixel has become a very significant contributor. So add that layered over our already strong position in 2-megapixel in the Far East. And then 1-megapixel and HD-type products for the Notebook business, it's turning out to be a good stack-up.

Betsy Van Hees - Wedbush Securities Inc.

Given that you guys have done such a fantastic job in terms of your technology, as you're looking at the competitive landscape, how far is your competitive lead now above your competitors? And can you kind of give us an idea of, in terms of ranking, when they're going to be catching up to you, if at all?

Bruce Weyer

Yes, so a big portion of our technology we discussed is our pixel technology underneath the sensors. And in February, we announced our second-generation BSI pixel technology and we have been in development at BSI for almost four years now with our key technology partner, TSMC. And so first-generation BSI is ramping very significantly for us. We see significant advancements coming in our second-generation BSI-2. And just now, you're starting to see our competitors discuss BSI products for the open market in mobile phones and those areas. So we think we have a pretty substantial lead in that development.

Betsy Van Hees - Wedbush Securities Inc.

So when you look into competition though, how far does that lead stay ahead? Is anyone catching you? Or are you just going to continue to dominate the field in this area?

Bruce Weyer

So we hear of competitors starting to potentially sample products, but sampling products and meeting the performance goals of our customers could very well be different things. It does take a while to perfect these types of technologies. So I'm not in a position to fully state where they're at in their development process, but based on our sampling window to strong leadership position, we think we're in a pretty good shape.

Ray Cisneros

And just another comment about that. It's going from sampling to mass production in tens of millions of units per quarter, that's the big learning curve that everybody's got to go through. And as Bruce mentioned, it's difficult to understand where our competition is in that curve. But suffice it to say from our side, it's a learning curve that's not easy and it's not overnight.

Operator

[Operator Instructions] Our following question comes from the line of Yair Reiner with Oppenheimer & Co.

Yair Reiner - Oppenheimer & Co. Inc.

I was wondering if you could help us with how you're thinking about seasonality for the remainder of the year, how you're pretty good last quarter but signaling that you saw a big upswing coming in the first fiscal quarter. Can you just give us a sense about how you think that, kind of seasonally, the rest of the year could play out, especially now that your geographic mix has changed quite a bit in recent years?

Ray Cisneros

As we have mentioned before, obviously, we're right spread-smack in the middle of the summer season. That's a big seasonality peak in the North American and European markets, as well as Asia for that matter. And then you step into our fiscal Q2, which is the fall calendar quarter and that's preparation for Christmas and that ends up being a very strong quarter, our anticipation anyway. And then you step into our fiscal Q3, although there might be a step down in, I would say, the western hemisphere, it's still extremely very strong in Asia due to preparations for the Chinese New Year. So you could regard Q1, Q2, Q3 as that kind of pace. And then Q4, it's sort of the low in most geographies, just in between seasonalities.

Yair Reiner - Oppenheimer & Co. Inc.

So would it be fair to understand that as kind of Q2, flattish to maybe slightly up?

Bruce Weyer

We're not going to comment on Q2. But again, I would just point your attention to our position in the marketplace with our products, with our customer mix and with our deliveries.

Yair Reiner - Oppenheimer & Co. Inc.

And in terms of the wafer-level camera, I know you've been trying to get that into design as a primary camera, kind of a lower-end feature phone. How is that coming, and when do you think there's a chance to start shipping that in volume?

Ray Cisneros

Well, we're shipping wafer-level module, a product today. And as Mr. Hong mentioned, as well as Bruce, it's right now, it's primary application is secondary video cameras for handsets. The nirvana or the end goal of many of these products is to be the primary camera for handsets as well as for other products. But it's going to be a learning curve for both sides, the supplier side, ourselves as well as the our customers' side, to understand where exactly that fits and when does it fit in. On top of that, there are some technological hurdles that most people are working on which are optical advancements. So it's in progress. I'd imagine it's going to take a few quarters before that is fully captured in primary applications.

Yair Reiner - Oppenheimer & Co. Inc.

Sequentially, your VGA shipments dropped off quite a bit, while 1-megapixel increased nicely and so did the 2-mega. Is that a reflection, largely, of maybe some of your customers in China starting to move up to better quality sensors. And if so, should we continue to think about VGA as being kind of the decreasing part of the mix?

Ray Cisneros

Well, I could tell you right now that the VGA in and of itself is extremely strong, still, in Asia. But what's happening is our strong position to capture the 2-megapixel market in that region, we capitalized on that. So that's a big driver for us on why it makes us shift a little bit. On top of that, the 1-megapixel, as we mentioned, was a spike in the Notebook business and that contributed to the shift as well outside of the VGA. So we're looking at a situation where VGAs are still strong but, on the other hand, the high resolutions are picking up.

Operator

Our following question comes from the line of Tristan Gerra with Robert Baird.

Tristan Gerra - Robert W. Baird & Co. Incorporated

How would you characterize the supply of image sensors currently for the whole industry? And if you could give us an update in terms of the 300-millimeter transition?

Ray Cisneros

In terms of supply, obviously, as most of you may be well aware, there's a overall industry tightness. And that's a natural fact, just with the snapback in economies. As you look around, most industries, most markets, most products have seen an increase in demand. And so therefore, people are rushing to make sure the material readiness is there. So that's just a general effect that all of us are in. There's no getting out of that.

Yair Reiner - Oppenheimer & Co. Inc.

And then, if you could give us an update in terms of 300-millimeter transition in the future?

Bruce Weyer

300-millimeter is our base technology for our second-generation BSI-2 architectures. So we are in 300-millimeter, as we speak, and we're sampling products out of that. Typically, design cycles for our end customers take six to 12 months. So that technology will be more targeted for a 2011-type ramp in realistic volumes. And also, it's a 300-millimeter platter, so the available supply is broad upfront. So we don't see any challenges in whatsoever in ramping our 300-millimeter technology to our end customers.

Operator

Our following question comes from the line of Gill Rajvi [Rajvindra Gill] from Needham.

Rajvindra Gill - Needham & Company, LLC

Just a follow-up question on the seasonality. July, if you take the midpoint of your guidance, it's growing about 27% sequentially. That's well above the historical range that you typically experienced in the July quarter. So I just wanted to get a better sense, if you see July kind of peaking, is that the peak or do you continue to see continuation or experiencing normal seasonality in the October quarter? Or are we going to experience a kind of below seasonality in the October quarter, because October quarter is typically your highest in terms of growth?

Ray Cisneros

Again, we'll limit our sort of our predictive comments and that not to go to beyond Q1. But sufficing to say, as I've mentioned in previous questions, we have a strong position in our product mix, our customer mix, our geographical mix. And we're delivering products, so we'll leave it at that.

Rajvindra Gill - Needham & Company, LLC

And then in terms of the, either cost reductions versus kind of the ASP declines, how was that progressing in terms of your cost improvements getting the yields up relatively to your declining ASPs? Can you just elaborate in terms of how you're seeing both of those curves?

Anson Chan

Bobby, first of all, the ASP obviously is something different by the product mix. And as we mentioned in our prepared commentary, we do see a significant increase in 5-megapixel and 8-megapixel sensors. And they do carry the higher ASPs. But the counterpoint will be whether or not VGA will return a significant volume. And so we typically have to monitor that carefully, and at this point, we cannot give you any particular indicator as to what ASP would turn into. But separately though, I guess you also asked about yield and that plays into not as much as in ASP but more into a gross margin situation. And I'm trying to illustrate the point, just last two quarters, for example, ASP is not directly associated with gross margin. That's not really a one-to-one correspondence, meaning a high ASP doesn't necessarily come with a higher gross margins. So I want you to keep that in mind, first of all. Going back to the gross margin question though, I think when we ramp in BSI, that may carry a more significant effect on the gross margin in the coming quarters. And as I mentioned earlier, we will monitor the situation closely. I think after our first fiscal quarter, we'll have a much better idea as to what a steady state it would be for this kind of sensors. And we'll probably bake that into our Q2 guidance by then.

Rajvindra Gill - Needham & Company, LLC

Speaking of the ASPs, is there any way you can quantify the premium that you would get when you move kind of more of your production over to BSI-1 and then potentially, BSI-2?

Ray Cisneros

This is Ray Cisneros. It is obviously what we're trying to do in the marketplace is to sell value-added solutions. And with BSI, that's what the customers are getting. And on top of that, if you mix that in with higher resolutions, BSI has been leading with, obviously, there's going to be some commercial expectation from our side. But overall, I think it's a healthy balance on what we expect and what customers are willing to pay.

Rajvindra Gill - Needham & Company, LLC

Last question on the design cycle, I think you talked about 12 to 18 months. Are you working on designs that are already for 2011 phones? Are those designs going to be predominantly on the BSI-2 technology? And is that going to be predominantly on 8-megapixel?

Ray Cisneros

We're seeing a very high interest in BSI via the BSI-1, what we call OmniBSI, or our BSI-2 second generation. I would tell you that in both cases, customers are actively engaged with us.

Operator

We have no further questions at this time. Ladies and gentlemen, that concludes our conference today. Thank you for your participation. You may now disconnect and have a wonderful day.

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Source: OmniVision Technologies F4Q10 (Qtr End 04/30/2010) Earnings Call Transcript
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