OmniVision Technologies' (OVTI) CEO Shaw Hong on Q1 2015 Results - Earnings Call Transcript

OmniVision Technologies, Inc. (NASDAQ:OVTI)

Q1 2015 Earnings Conference Call

August 28, 2014 5:00 PM ET

Executives

Arnab Chanda – Director of Investor Relations

Shaw Hong – Chief Executive Officer

Ray Cisneros – Senior Vice President of Worldwide Sales and Sales Operations

Anson Chan – Chief Financial Officer

Analysts

Rajvindra Gill – Needham and Company

Harsh Kumar – Stephens Inc

Osten Bernardez – Cross Research

Betsy Van Hees – Wedbush Securities

Dan Scovel – Edison Investment Research

Operator

Ladies and gentlemen, thank you. And welcome to the OmniVision Technologies’ Conference Call for the First Quarter of Fiscal 2015. At this time, all participants are in a listen-only mode. Later, we will open up the call for your questions. Instructions for queuing up will be provided at that time. As a reminder, this conference call is being recorded for replay purposes.

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

Arnab Chanda

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

During the call, we may make forward-looking statements regarding our business, including statements relating to revenues, earnings targets and our product plans. This is based on information as of today 28th of August, 2014. Actual results may differ materially from those set forth in these statements. These and other forward-looking statements involve assumptions, risks and uncertainties that could cause actual results to differ materially.

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

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

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

Shaw Hong

Thank you, Arnab. Welcome to all of you joining the call and webcast. Earlier this afternoon, we issued a press release describing our fiscal Q1 2015 results. We reported fiscal Q1 revenues of $407 million, an increase of 23% sequentially and 9% year-over-year.

During the quarter, we shipped 249 million sensors. On a non-GAAP basis, gross margin was 22% and net income was $54 million or $0.91 per diluted share. Our balance sheet remains strong with cash and short-term investments of $524 million.

Before we discuss the highlights of the quarter, I would like to comments on some recent developments. We recently received a preliminary non-binding proposal letter from Hua Capital Management Limited or HCM, a Beijing based investment management company, pursuant to which a group of investors led by HCM proposes to acquire all of the outstanding shares of common stock of the company in cash, at $29.00 per share.

The investment group led by HCM includes Shanghai Pudong Science and Technology Investment Company Limited, a state-owned limited liability company, established directly under the Pudong New Area government of Shanghai.

The Company's Board of Directors is reviewing and evaluating HCM's proposal. No decision has been made with respect to the proposed transaction. And there are no assurance that this or any other transaction will be consummated. We are focused on our operating our [bench] (ph). We do not intend to provide update with respect to this or any other transaction except as required by applicable law. We think you in advance for your understanding.

With that said, I would like to start the call with a few comments on our business and strategy. Our fiscal Q1 results came in above the high and of our expectations. Our core mobile phone market experienced strong demand from Asia based OEMs, especially in the China region. This has more than offset the decline in our North American business.

Also we continue to see very impressive growth in our automotive business. Finally, our financial metrics continue to show sequential improvement including our gross margins and the cash position. OmniVision’s goal has always been to drive profitable revenue growth from diversified applications, products and markets.

In order to achieve our goal, we must continue to enhance our technology innovation, so that we can develop more new products and applications and expand our market opportunity and continue to work with our supply chain to optimize cost and increase capacity to support raising volumes.

First, focus on technology and new application development. Technology innovation is the foundation of our continued success. Our new flagship PureCel sensor are based on advanced semiconductor process note. And have industry leading image quality, light sensitivity, and the power efficiency. We’ve already launched our 30-megapixel, 8-megapixel, 5-megapixel as well as our 2-megapixel PureCel sensors and we expect a steady increasing shipping volumes throughout the current fiscal year.

While we are working on better and more advanced features for our future PureCel products. We are also developing a full complement of ASIC with advanced image procession functions by combining our sensors with image processing and other peripheral functions.

We can offer our customers with complete imaging system solution, such as in our machine vision products. In our core smartphones, tablet and PC market cameras are enabling new application such as capturing 3D depth information using computational photography to improve image quality and developing new human interface applications. We have partnered with industry leaders to enable 3D depth sensing for both smartphones and tablets.

Next, market expansion, in the near term, global adoption of smartphones and tablets in particular proliferation of smartphones in China and India market would drive our growth. In the long-term we believe that the proliferation of new applications in both core and the emerging markets, such as automotive and security led by machine vision will drive significant attention of the image sensor market.

For the global market adoption of smartphones, OmniVision has consistently invested resources over long period of time to enable geographic diversifications. Our long-term presence and deep relationship with OEMs, chipset vendors, ODMs, module manufactures and design houses in Asia and primarily in China have been extremely fruitful. We have been supporting all major changed OEMs in their efforts to transition to LTE based smartphones.

We are extremely pleased with our success in China and we expect this market will continue to be a major driver of our future goals. India is the next large market to experience a major transition to smartphone with high resolution cameras. We have been investing resources in India, leveraging our key relationship with the supplying chain in China as well as with local India OEMs.

We expect India to rapidly grow to become a significant geography for OmniVision over the next few years. For the market diversification into automotive and security, OmniVision has also focused on developing new markets for cameras, the automotive markets is one of the new growth drivers for OmniVision, machine vision. In the form of Advanced Driver Assistance Systems or ADAS has been widely embraced by automotive OEMs.

Since ADAS requires multiple cameras for functions such as land departure monitors, pedestrian and obstacle detection and mirror replacement. The number of cameras for cars also increased dramatically. Imaging system solutions are also becoming more relevant to automotive OEMs as image processing continues to increase in complexity, consequently we have also seen strong interest from automotive OEMs in our image processing ASIC which complements our sensors.

Over the last few years, our automotive business has been our fastest growing market and we believe launch of our new technologies such as ADAS will drive further growth for years to come. After automotive, we believe the security market is next in line to potentially emerge as a strong end market for camera technology. The global focus on security and the proliferation of easy to install IP camera technology are likely to drive strong growth for security cameras overtime. OmniVision has been developing security products for a number of years and we expect security to become a significant contributor to our growth in the future.

Lastly, supply chain diversification. In conjunction with the development of PureCel OmniVision has also been focusing on optimizing our supply chain. In order to refine our cost structure, reduce risk and provide additional capacity to support our OEM demands. A key goal of supply chain diversification is to enable us to address different market segment with diverse cost and performance requirements.

Given the intense competitive environments we face, supply chain diversification is crucial to meet these objectives. As we continue to diversify our supply chain, we believe our new supply chain relationships will allow us to pursue profitable business across all our end markets.

I’ll now turn the call over to Ray, who will update you on our sales and marketing activities.

Ray Cisneros

Thank you, Shaw. We are pleased to report our fiscal first quarter revenues that exceeded the high end of our guidance. The mainstream and value smartphone segments in regional markets like China and India fueled our top line growth. Our automotive revenues continued to grow strongly, our PureCel sensors continued to ramp up into significant volumes, also our first global shutter sensor shipment volume to consumer device demonstrating a watershed point in which CMOS image sensors are used for a non-image capture application such as machine vision.

In our first fiscal quarter, we shipped 249 million units, as compared to 201 million units in our prior quarter. The increase in volume was predominately driven by increases in 5-megapixel and HD sensors. The average selling price in our first quarter was $1.63 as compared to $1.64 in our prior quarter.

Beginning in fiscal 2015 we will adjust the convention that we used to report the sensor resolution categories, as to reflect market dynamics. Our first category will be from 8-megapixel and above, which represents mainstream cameras in flagship smartphone segment.

Our next category will be between 3-megapixel to 5-megapixel, which represents main cameras in the mainstream smartphone segment. Finally, our last category will be 2-megapixel and below, which represents front cameras and smartphones, main cameras into values smartphone segment, notebooks as well as automotive cameras.

Unit sales of 8-megapixel and above represented approximately 10% of total shipments in the fiscal first quarter compared to approximately 9% of total shipments in the prior quarter, the significant increase in unit sales was primarily due to the increases in 8-megapixel and 13-megapixel shipments to the flagship smartphone segment, showcasing the success of our PureCel sensors.

Unit sales of 3-megapixel to 5-megapixel category represented approximately 40% of total shipments as compared to 34% in the prior quarter for the same category. The significant increase in unit shipments in this category was predominately driven by larger 5-megapixel sensor shipments to the mainstream smartphone segment in Asia.

Unit sales of 2-megapixel and below represented approximately 50% of total shipments as compared to 57% in the prior quarter. However, on an absolute unit sales perspective there was a modest increase primarily due to an increase in HD sensor sold to smartphones and tablets.

In terms of target markets, our mobile phone sales represented approximately 69% of revenues in the first quarter, equivalent to our prior quarter. Our entertainment segment represented 16% of sales as compared to 15% in our prior quarter. Our sales of sensors into the notebook and webcam segment were approximately 6% of sales as compared to 5% in our prior quarter.

Given the success that we have experienced in automotive, we will report on this market as a separate category beginning in fiscal 2015. The automotive market will include camera systems that are embedded in the automobile by the OEM as well as camera systems sold in the after market to consumers.

In our fiscal first quarter the automotive market was 5% of sales, for fiscal 2014 automotive roughly represented about 4% of our overall revenues and grew over 50% year-over-year. On a sequential basis, automotive grew double-digit percentages in fiscal Q1. Hereafter our emerging market category will include security and medical DSC and other miscellaneous sub-categories. This category was 4% of sales in our first quarter compared to 5% of sales in our prior quarter.

In the mobile phones market growth continued in our China mainstream in valued smartphone segments. Chinese OEM served their own domestic market as well as export phones into Asia, Africa and Latin America. Growth was driven across all major resolution categories led in order by 5-megapixel, HD, 8-megapixel, 2-megapixel and 13-megapixel resolutions.

The domestic China market remain robust due to strength in 3G as well as 4G smartphones. One of the recent key developments in the mobile market has been the rise of Indian OEMs, which tend to use the existing design and manufacturing infrastructure in China. OmniVision is well positioned to capitalize on this trend given our core strengths of service and sales relationships in both China and India.

Indian OEMs are using a wide array of image sensor solutions ranging from VGA up to 13-megapixel. Fiscal Q1 was the first quarter where our India OEMs contributed a significant portion of revenues, although currently small relative to our overall revenue India has been on an exponential growth curve and we anticipate growth to be faster than any other mobile segment.

OmniVision has also secured reference design for a very high-volume low-cost smartphone operating system platform that is primarily targeted towards India. We also received numerous designs wins across all major Indian handset OEMs. OmniVision also recently gained major design wins in the Korea region with our new PureCel based 8-megapixel and 13-megapixel sensors to the Tier-1 OEM.

We have also seen success in machine vision applications for mobile devices. In North America a revolutionary human interface sensor technology for a smartphone product was launched based on our high speed global shutter sensor, OmniVision has also shipped into a machine vision based human interface system for Tier-1 notebook OEM.

We believe that there is a great potential for similar machine vision based systems and many other devices used in consumer as well as industrial markets. We believe that machine vision represents a major non-image capture market in its early phase of development and could develop into another significant opportunity for market expansion.

In the entertainment market, we saw seasonal growth in shipments into the tablet segment. However, there are clear indications of a market slowdown due to multiple reasons including cannibalization from tablet, phones and convertible notebooks, as well as market saturation. Going forward, we also have a customer transition that will be a factor in our decline of shipment levels to the tablet segment.

We saw steady shipments to the gaming segment for console and handheld products in fiscal Q1. Imaging solutions for console products are focused on machine vision for human interaction capabilities as well as gaming functions in addition to the traditional image capture sensor. Our global shutter sensors are also seeing success in gaming products.

In our notebook PC segment there was a good rebound back from the low levels in our prior quarter. Our next generation 720p, OV9728 sensors significantly increased in volume and accounted for most of the revenue in this market. Our legacy 720p, OV9726 sensor shipped in lower volumes. Our best-in-class BSI-2 based 720p sensor that sets the benchmark in notebook image quality, also shipped in steady volume to a Tier-1 OEM.

The automobile industry as a segment that will receive increasing attention going forward, because it is at the cusp of major revolutionary changes in imaging technologies. At OmniVision we have invested heavily in automotive imaging over many years. Beginning in fiscal 2015, we will report on the automotive market separately, as the automotive market size technologies used and revenues generated have become significant in warrant of separate discussion.

Automotive was 5% of our sales in the fiscal first quarter and reached about 4% of revenues in fiscal 2014. Most of the revenue is composed of sensor sold to embedded camera solutions installed in the automobile by the OEM. Sensor sold to the aftermarket camera solutions comprise a small portion of our revenue, but are expecting to grow rapidly in particular in emerging markets.

In the OEM embedded camera segment, our sensors are predominately use for Surround View Systems or SVS and Rear-View Cameras or RVC. Other applications that are ramping up for OmniVision include sensors for Lane-Departure Warning or LDW and Lane-Keep Assistance Systems or LKAS. In the future cars will have added even more cameras for exterior and interior functions with the fully autonomously driven car as a possible final stage.

The transition to autonomous driving will require image solutions and algorithms to be critical component of future advanced driving assistance systems. Surround View Systems or one of the most complex imaging systems used in an automobile, a typical system provides a full 360-degree display view and data acquisition around the entire automobile and requires up to four sensors. We believe we are well positioned in the SVS segment due to the best-in-class low-light sensitivity and high dynamic range sensors as well as our longstanding ecosystem partnerships.

Most of our mainstream OV10635 sensors are currently deployed in luxury European Tier-1 OEMs and are quickly being adopted in North America and Japan. The OV10635 also won two additional Tier-1 OEM designs during our first fiscal quarter. In fiscal Q1 we won one of the first major SVS systems that will be deployed from a North American automotive OEM based on our new OV10640. The new OV10640, our third generation of sensors use in SVS systems as already seen strong success in Tier-1 European OEMs.

In RVC systems, OmniVision has gain significant market share. We offer extremely low-light sensitivity analog output sensors and digital output sensors for the segment. The resubmits regulations requiring all cars in North America back of camera by 2018 is likely to drive rapid growth in the RVC market for the next several years. In other global regional automobile markets, RVC systems are also expected to see strong growth.

Additionally the RVC segment is where aftermarket camera solutions are develop and offered to the consumer. Aftermarket RVC sensors are a small portion of our automotive revenue, but we foresee growth in this segment in emerging markets. Machine vision will be a key enabler for automotive cameras going forward, a derivative of the OV10640 is the basis for another key automobile application the forward-looking machine vision system.

This type of system develop in conjunction with high profiled ecosystem partners will be used for next generation imaging systems that enable critical function such as lane-departure warning, pedestrian detection and collision avoidance. The automotive market represents a major opportunity in terms of revenue for OmniVision.

In addition, due to the broad range performance requirements needed customer support requirements and time to revenues the automotive market offers the highest barriers to entry among our target markets. As automotive becomes a larger part of our revenues we expect margins to be accretive.

The security market had some noteworthy developments in the quarter we continue to see volume growth with our workforce 720p HD OV9712 for IP cameras. This segment of the security market is growing rapidly to serve the consumer mass market for easy to use and installed security systems.

At the high end of the market we gain multiple design wins using a variety of different solution products including our 4-megapixel BSI-2 based OV4688 derivatives, our legacy 5-megapixel BSI-1 based OV5650 derivatives as well as our automobile based OV10635 base derivatives. Security has been a beneficiary of leverage gain from synergistic products initially develop for other markets such as automobile and mobile and we expect security to become an increasingly more important category over time.

Now, I would like to discuss some product highlights, in our first fiscal quarter we announced to release of the fourth member of our flagship PureCel family the OV2740. The OV2740 is a full 1080p, 1.4 µm pixel sensitive features at light sensing mode, ultra-low power mode and stereo ready frame synchronization for depth perception applications. A Coupled with PureCel loop operating power levels and superior image characteristics. The OV2740 is ideally suited for front facing camera sense smartphones and tablets as well as main camera in ultra low costs smartphones.

In our first fiscal quarter we continue to ramp up our first way of PureCel products the OV13850, the OV8858 and the OV5670, and we expect strong growth in our fiscal second quarter. The first four members of the PureCel family can now cover the complete range of high volume main and secondary cameras in the mobile market including entry level of mainstream and high-end smartphones.

Another major development discuss in our last earnings call was release of our latest automotive product OV10640, we believe the sensors the best-in-class high dynamic range 1-megapixel sensor pretty automotive market and surround view system applications.

In summary, we are pleased with our fiscal first quarter results, we believe we are in a good position to capitalize on a changing dynamics of our business environment.

Shaw Hong

Thank you, Ray. I’ll now turn the call over to Anson, who will discuss our first quarter financial performance and provide guidance for the second quarter of fiscal 2015.

Anson Chan

Thank you, Shaw, and good afternoon everyone. For the first quarter our fiscal 2015 we are reporting revenues of $406.5 million, up 22.8% sequentially and up 8.8% on year-over-year basis. To access OEMs and VARs accounted for 79.7% of the revenues. In the first quarter of fiscal 2015, a slight increase from 78% in the prior quarter. The remainder of our revenues came from sales through our distributor channels.

Our fiscal 2015 first quarter gross margin was 21.7% compared with 20.1% that we reported in our prior quarter, excluding stock-based compensation expense of $1 million included in cost of revenues.

Our non-GAAP gross margin was 22% compared with 20.4% in the prior quarter. Our gross margin improvement was primarily the result of a favorable mix shift towards our high resolution products, a portion of which was represented by our newer and high margin PureCel sensors. The net gross margin impact from sales of previously written off inventory and allowance for excess and obsolete inventories were comparable between our fiscal 2015 first quarter and our prior quarter.

In the first quarter of fiscal 2015, we recorded approximately $4.1 million for the sale of previously written down inventory, and $10.2 million as an additional allowance for excess and obsolete inventories, with a net $6.1 million or 1.7 percentage points of unfavorable impact on our gross margins.

In comparison, in the prior quarter, we recorded approximately $2.6 million for the sale of previously written down inventory and $7.2 million as an additional allowance for excess and obsolete inventories, with the net $4.6 million or 1.6 percentage points of unfavorable impact on our gross margin.

We’re pleased that our newer generation products were accretive to our corporate average margins. Let’s we’ve discussed in the past of the growth in our core smartphone and tablet markets is occurring in the value and mainstream segments, with competitions intense. We are maintaining our cautionary expense as we look into the second half of fiscal 2015, especially with regard to our gross margins.

R&D expense in our fiscal 2015 first quarter totaled $34.7 million, a 10.3% increase from the $31.5 million in the prior quarter. The increase is mainly attributable to an increase with the mask and other non-recurring engineering expenses. We currently expect our R&D expenses in our second quarter fiscal 2015 to increase slightly due to our annual companywide salary increase that took place on July 1.

R&D expense in the first quarter of fiscal 2015 included approximately $4.3 million of stock-based compensation expense. Excluding stock-based composition expense, fiscal 2015 first quarter R&D expense was $30.5 million, as compared to $27 million in the prior quarter.

SG&A expenses increased to $19.2 million in the first quarter of fiscal 2015, from $18.6 million in the prior quarter. We expect our SG&A expenses in our second quarter of fiscal 2015 to remain comparable to our fiscal 2015 first quarter. Our fiscal 2015 first quarter SG&A expenses included approximately $3.2 million of stock-based compensation expense.

Excluding stock-based compensation expense, SG&A expenses in the first quarter of fiscal 2015 totaled $16 million, compared to $15 million in the prior quarter. The amount of amortization for our acquired patent portfolio remained at $2.3 million for quarter. Our GAAP operating income in the first quarter of fiscal 2015 totaled approximately $32.2 million, as compared to $14.1 million in the prior quarter.

On a non-GAAP basis, our operating profit margin for fiscal 2015 first quarter reached 10%, the highest in the last two years. We believe the reaching this key operational milestone is a validation of the strategic direction that we’ve taken to improve our financial performance, such as to that specification for end markets and I will continued focused on cost control.

Moving onto pre-tax income, on a GAAP basis, our pre-tax income in the first quarter of fiscal 2015 totaled $33.7 million, as compared to $18.3 million in the fourth quarter of fiscal 2014. As a remainder, including in our fiscal 2014 fourth quarter pre-tax income was a one-time benefit of approximately $3.1 million. This amount was a post-acquisition gain related to our 2012 acquisition of the CameraCubeChip production operations from VisEra, our joint venture with TSMC. The gain was a result of our agreement with VisEra to reduce the final installment of a cash consideration for the acquisition from $9 million to $4.5 million.

In excess tax, our GAAP benefit from income taxes for the first quarter of fiscal 2015 was $11.6 million. This compares for the GAAP tax expense of $3.2 million in the prior quarter. Included in the GAAP benefit from income taxes for the first quarter of fiscal 2015 was the result of a certain previously reported tax reserves. When the such a limitations for the really tax matters expired. This refers resulted in the one-time non-cash tax benefit of approximately $15.1 million.

Excluding the effective stock-based compensation our non-GAAP benefits income taxes for the first quarter of fiscal 2015 was $12.2 million. This compares to our non-GAAP tax expense for the prior quarter of $3.5 million. For the second quarter of fiscal 2015, we expect our GAAP income tax rate to be in the mid-teens percentage range and our non-GAAP income tax rate to be around 10%.

In the first quarter of fiscal 2015 our GAAP net income was $45.3 million or $0.78 on a per diluted share basis. This compares to $15.1 million or $0.26 per diluted share in the prior quarter.

Excluding stock-based composition expense and related tax effects, our non-GAAP net income for the first quarter of fiscal 2015 was $54.4 million, or $0.91 per diluted share. This compares to non-GAAP net income of $23.9 million, or $0.40 per diluted share in the prior quarter.

Let me now turn to balance sheet. We ended the first quarter of fiscal 2015 with cash, cash equivalents and short-term investments totaling $524.2 million. This compares to $450.9 million at the end of our prior quarter. The improvement in our cash position is primarily the result of cash provided by operating activities.

Our cash conversion cycle in the first quarter of fiscal 2015 was 70-days, as compared to 90-days in the prior quarter. Regarding our investment in WLCSP, at last Friday’s closing price, our WLCSP stake is worth approximately at $197 million, as compared to the recorded book value of $34.7 million as of July 31, 2014.

Accounts receivable at the end of fiscal 2015 first quarter, net of allowances were $176.8 million, a slight increase from the $172.5 million at the end of our prior quarter. Our day sales outstanding the first quarter was 40-days as compared to 46-days of our prior quarter as of July 31, 2014 now inventory increased slightly to $288.1 million from the $270.9 million balance at the end of our last quarter. Our fiscal 2015 first quarter inventory balance represents an annual inventory turn of 4.4 times or 83-day sales, from the 4 times or 91-day sales in the prior quarter.

With that, I will turn to our outlook for the second quarter of fiscal 2015, which ends on October 31, 2014. We currently expect our 2015 second fiscal quarter revenues will be in the range of $360 million to $390 million. Our GAAP EPS are expected to range from $0.29 to $0.45 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 $0.43 to $0.59 per diluted share.

Shaw Hong

Thank you, Anson. In conclusion, I believe the OmniVision is well positioned was a long-term with the successful launch of PureCel in smartphones strong design wins in machine vision and automotive and supply chain diversification. We believe we are increasingly the partner of choice of global Tier 1 OEMs across all our markets. I remain confident of our long-term competitive position and our expanding market opportunity.

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Rajvindra Gill from Needham and Company. Please proceed.

Rajvindra Gill – Needham and Company

Yes, thanks for taking my question and saw results on the execution. Just if you could describe a little bit about what’s going on in the China handset market, there has been a lot of growth that you are seeing there, wondering kind of what your thoughts are as you go into the second half, there has been some possible inventory correction. I'm wondering kind of what your views are of the overall market. And with respect India you mentioned India several times, how are you positioned competitively in the India market in terms of the image sensor market, where do you see future competition of that market. Thank you.

Ray Cisneros

Hi, this is Ray Cisneros. In regards to the China market its pretty dynamic right now, there is a sense of everybody expecting 4G to launch that particular schedule ramp is I would say a little bit protracted, but nevertheless the combined 3G, 4G and Tier-2 and Tier-3 type handset business in and of itself of the China market is still very strong and very big.

In regards to India, I think our position is extremely strong simply because quite a bit of the India I would say type of business is almost a mirror type of – similar to the China market I would say and that means the type of products that we were serving to China market lend very nicely to the India market near-term. Long-term the India like many regions will develop their own style and their own I would say choices of what technologies and what products they prefer but for long-term its – I think we are well position.

Rajvindra Gill – Needham and Company

My as of follow-up Anson. On the gross margins it seems like the gross margin for the guidance is up 30 basis points to 50 basis points and we've kind of seen some steady improvement over the last several quarters, but very gradual and steady. I wanted to see if you could elaborate on what are some of the drivers of the gross margins, you said you are a little bit caution in the second half, but over the long-term what do you think kind of the main drivers of the margins would be and is there any idea what percentage of the inventory you are selling is on kind of the lower cost wafers versus higher cost now. Thank you.

Anson Chan

Okay, we will try to break that down, but I think at the end of the day we talk about gross margin, its all about competitive advantage, what kind of features we offer on our products, how current are they in terms of the functionalities, technologies, do they really satisfy the demand of the current consumer products, all that play a part in it. So in the short-term, in the near-term I would say with the reason launch of these PureCel products and we are operating from the latest features that people are looking for. So that’s definitely a positive as I mentioned in our prepared remarks, are accretive events to our gross margins.

Over the longer term however, in particular the fiscal 2015 we continue to increase the proportionate revenues coming from China that market being a very competitive market we will see some pricing pressures coming. So that will naturally cause some unfavorable impact on gross margins.

And also the other side also is because this market is very dynamic and if you have seen in the current quarter, we actually recorded more inventory reserve charge compared to the prior quarter, a lot of that has to do with how quickly our customer changes their preference into the devices and whatnot and can cause us to record additional charge, these also play a part in helping the gross margin, and hence trying to make it prepared and march up with that you know we need to remain cautionary regarding future gross margin projections be it going up or down.

Rajvindra Gill – Needham and Company

That’s helpful. Thank you.

Operator

Your next question comes form the line of Harsh Kumar from Stephens. Please proceed.

Harsh Kumar – Stephens Inc

Yes, hey guys. Quick question for you, in China are you seeing an expansion in unit, it sounds like that’s right, but are you also seeing an expansion upward in the mega – the CMOS sensors in terms of the quality, are moving from three to five to eight, like we've seen in the U.S?

Ray Cisneros

Hi, this is Ray. Yeah, we are seeing both obviously the China market continues to expand for domestic sales as well as export sales and in regards to the complexity and sophistication of the products that continues to develop as well essentially in other regions. I think the learning curve, the lines of handsets moving into China has occurred already for past couple of years that’s well established now so the engineering know now to develop a very sophisticated handset equipment to other material market OEMs there. So, likewise with imaging solutions that means we are also sort of seeing imaging solutions that are quite complex, be it high resolution, be it the leading edge technology and even I would say complex ISP processing.

Harsh Kumar – Stephens Inc

That’s fair. And then, what would be on the seg drop – versus going forward from margin expansion, gross margin expansion?

Ray Cisneros

What do you mean by drop? Sorry.

Harsh Kumar – Stephens Inc

Drivers, drivers for like what would be some of the big drivers that you guys can pull to keep your margins going up?

Ray Cisneros

I think there are many, many driver [Technical Difficulty] impact would be when we introduce new devices, but for rest of the fiscal year, even the pricing pressure would started again in a very competitive market. Also as I mentioned earlier, the market is very dynamic, a product that has popped now may not be popular anymore by the end of the year right so that can also cause additional accounting charges that can pull down the gross margin. Separately we are also working with suppliers to try to provide better cost basis for our [Technical Difficulty] pricing pressures that we experience in the marketplace [Technical Difficulty] in terms of margin.

Harsh Kumar – Stephens Inc

All right guys. Thank you.

Operator

Your next question comes from the line of Osten Bernardez from Cross Research. Please proceed.

Osten Bernardez – Cross Research

Hi, good afternoon. Thanks for taking my questions. I guess just to – I was just wondering could you maybe provide some color in terms of what is the current state of your engineering resources with respect to your ASIC capabilities and do you think I guess from – given the increased focus you see there – obviously you have invested in that in past but do you see a need to further augment your capabilities in that realm?

Ray Cisneros

I would like to get clarification on that question; you said what are – what's the state of our engineering resource with respect to what?

Osten Bernardez – Cross Research

ASIC, in you ASIC design relative to your CMOS design, image sensor design excuse me.

Ray Cisneros

Yes. We actually historically OmniVision actually has been very strong in designing ASIC and many of our ASIC strategies are related to enabling the growth of our core products to CMOS image sensor itself. We have an ASIC capability for everything from enterprise to processing – in standalone processing ASIC. And now most recently ASIC that possibly could lend itself very well to the machine vision market as evolving.

In regard as research I think we are fairly well staff. It gives us a opportunity to look into that market its not our core strength or core focus, but again our major historical approach has been enable to CMOS image sensor business predominantly by going forward if it becomes an opportunity we like to focus on I think we are ready with probably to be right level researches to expand if we need to.

Anson Chan

And if I may add to it, it is also products are holistic strategy you start to offer our customers in a complete solution, particularly in some of these emerging target markets. They may not be familiar with deployment image sensors like say a mobile phone OEMs. And so if you have a supply like us you can walk in and give the engineering team a complete functional feasible solution to enable the application. It give us that much more advantage when it comes to get a design win.

Osten Bernardez – Cross Research

Understood, my second question, excuse me pertains to within your automotive revenues which we would provide between rear view cameras versus surround view systems?

Ray Cisneros

Yes. I think right now I am not prepared to really break it down to the detail, but surprise to say I think both are very strong. And I think we – in our prepared commentary we talk quite a bit about both the surround view systems as well as review the camera systems given our product line of this generating quite of bit of business right now and as well as future design socket wins that are generate additional revenue. My sense is there both contributing very well to the overall total automotive segment that we are breaking out.

Osten Bernardez – Cross Research

And could you remind you quickly what – how should we think about PureCel as a percentage of your total volume?

Ray Cisneros

I think PureCel is ramping up very fast. They are significant volumes right now. As we mentioned in our prepared commentary it’s a significant portion now. It’s not by any means small. I would say surprise to says in the low-teens percentage wise right now.

Osten Bernardez – Cross Research

Thank you very much.

Operator

Your next question comes from the line of Betsy Van Hees from Wedbush Securities. Please proceed.

Betsy Van Hees – Wedbush Securities

Good afternoon and thanks so much for taking my question. I was wondering if we could talk a little bit about the seasonality of the business. If I go back and I look at the history, the October quarter is normally a pretty strong quarter for you guys and if you look at the guidance that you given you’re guiding down in a range of 11% to 4%. So I was wondering if you could talk about the puts and takes in terms of how your seasonality has changed and how we should be thinking about seasonality moving forward.

Ray Cisneros

I think there is probably two major components for that. One is just the business mix transition that we’ve made I mentioned before in prior calls as well as in this call. And this is transitional mix of North America business reducing and the Asia business increasing. The other seasonality in fact is how do you gauge the Asian major component of our business now running through their cycles that is quite dynamic simply because there is a variety of other factors that are important to those regions.

One, they service a variety of other regions, for example China the large installed manufacturing base has to service other regions, so there is more of an aggregate mix of business that our China business is based on. Second, is their own seasonality, the Asia seasonality cycles themselves are going to be component of this, now larger component of our revenues.

So, unfortunately it maybe what you might have seen or experienced in the past with some of our revenues seasonal cycles is going to be shifting a little bit and we’ll just have to probably go through a couple cycles with this new mix and then several into perhaps something that we can predict.

Betsy Van Hees – Wedbush Securities

Thanks, Ray. And then my whole question has you do with the automotive business and also the mobile handset businesses and competitive landscape. So, first thank you very much for breaking out, but I really appreciate that. We've seen some changes happening here in North America on recently acquired Aptina and you talked quite a bit about the focus will be on industrial and automotive and given at that that is a pretty big segment for you guys, I was wondering if you could talk about your views on the competitive landscape, specifically for the automotive business, who you see there, if there is any concerns with Aptina now being acquired by On and then the other part of that question is the competitive landscape in the mobile handset space and if there has been any changes there and you know what concerns you the most in the high-end smartphones on the mid range from a competitive landscape?

Ray Cisneros

Well in regards to the automotive segment its one of our favorite segment to talk about, I'm not going to comment too much about our competition, I can only tell you what we can do and what we have, I can tell you that our roadmap in regards to automotive is in many – in the eyes of many customers and were talking about very high-end Tier-1 OEM customers that use our parts today as well as plan to use our parts in the future with socket designs, we have one recently.

Our product roadmap is extremely advanced and highly regarded in the marketplace and we could point to a variety of very key strong OEM customers in Europe that have forged our business in the automotive segment and now we've seen extremely fast and big success in the discreet market. We’ve got in roads into the Japan market as well, so overall we are extremely pleased with our position and given our roadmap and roadmap we have today have publicly announce and in the future what we will be announcing.

We feel our position in the automotive market is very strong for both imaging as well as machine vision type of the applications. With regards to the mobile hand space, again that’s the big market that’s the 800 pound gorilla and everybody and anyone that – that’s a competitor is a competitor, the competition is on the high-end, mid and low, it’s across all resolutions and I think that hasn’t changed for us, I mean that hasn’t changed for our people that – our investors community that follows OmniVision. We are pretty consistent when it comes to the handset space, it’s large but it’s also full of competition.

Betsy Van Hees – Wedbush Securities

Okay, so I think I am just going to ask a follow-up to that. A follow-up questions so in the automotive space can you tell us who you see as a competitor, who do you run up against and you compete against? It is on semiconductor now formally Aptina, is it Sony, is it Samsung? I was just hoping you could tell us who is the competitive landscape that you see, when you know designs into trade [Technical difficulty].

Ray Cisneros

I’d like to answer the question that we see similar names that we see in other segments we kind of cross them in the automotive segment. But again, I am not going to focus under position of just bring the conversation back to our position are extremely happy and we are interested and continue to drive the automotive business, but there are similar names in the automotive business.

Betsy Van Hees – Wedbush Securities

Thanks [Multiple Speakers]

Operator

Thank you. Your final question comes from the line of Dan Scovel from Edison Research. Please Proceed.

Dan Scovel – Edison Investment Research

Yes. Thank you for the question and good quarter. The guidance that you are given on the weakness that predominantly the transition issue or we’ve also seen softness in China.

Ray Cisneros

I think it’s a little bit about there is a component that the transition mix of our business from North America moving over to Asia. But on the other hand, the China based business actually saw on natural basis is a growth quarter. What we are anticipating to the slightly bigger quarter out of China as mainly primarily due to the transition to the 4G installation of with the careers out there in Asia that as I mentioned has gone through protracted type of based that we expect that to start settling out and continue to drive growth as well as the export business out of the China based manufacturing infrastructure. So those are beliefs and that’s kind of what we are looking at, in addition, we have some steady business in the other regions that did not see. I was any kind of step down if you will in conversion to other regions.

Dan Scovel – Edison Investment Research

So you the China you are seeing is kind of flat to slightly down, is that the little locators in the investment of transition North America.

Ray Cisneros

No. Those are to be declared in regard for the China market, we actually saw a step up slightly step up in terms of actual dollar revenues for that.

Dan Scovel – Edison Investment Research

For guidance or for last year, last quarter.

Ray Cisneros

For Q2.

Dan Scovel – Edison Investment Research

Okay, okay. Thank you. And also, Anson, do you have a EPS number associated with the tax benefit to make sure.

Anson Chan

So you talk about the Q1 quarter that we just reported on.

Dan Scovel – Edison Investment Research

Yes, we talk about a little that calculate, little that result in terms of EPS.

Anson Chan

I do not want to give that pro forma type EPS number on these numbers. And you can just if I had $15 million of sell that by the share count in few months both in EPS adjustment.

Dan Scovel – Edison Investment Research

Okay. Thank you.

Operator

Thank you, ladies and gentlemen. That concludes our question-and-answer session. I will now turn the conference back to Arnab for closing remarks.

Arnab Chanda

Thank you all for joining us on this call and webcast. We anticipate holding our second quarter conference call on December 2, 2014. Thank you and good day.

Operator

Ladies and gentlemen that concludes today’s conference. You may now disconnect. And have a great day.

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