InvenSense's (INVN) CEO Behrooz Abdi on Q1 2017 Results - Earnings Call Transcript

| About: InvenSense (INVN)

InvenSense, Inc. (NYSE:INVN)

Q1 2017 Earnings Conference Call

July 28, 2016 04:30 pm ET


Leslie Green - IR, Green Communications Consulting LLC

Mark Dentinger - Chief Financial Officer & Vice President

Behrooz Abdi - President, Chief Executive Officer


Matt Ramsay - Canaccord Genuity

David Williams - Drexel Hamilton

Richard Shannon - Craig-Hallum

Justin Lee - Robert W. Baird

Joe Moore - Morgan Stanley

Jagadish Iyer - Redstone Capital

Gary Mobley - The Benchmark Company


Good day, ladies and gentlemen, and thank you for standing by. Welcome to the InvenSense's First Quarter and Fiscal Year 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode to prevent background noise [Operator Instructions]. We will have a question-and-answer session later and the instructions will be given at that time. Now, I would like to welcome your host for today's conference Ms. Leslie Green, Investor Relations for InvenSense. Please go ahead.

Leslie Green

Thank you, Carmen, and good afternoon, everyone. I'd like to begin our call with a Safe Harbor disclaimer related to forward-looking statements. Statements in this conference call that are not historical are forward-looking statements as the term is defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are generally in the future tense and/or preceded by the words such as will, expects, anticipates or other words that imply or predict a future state.

Forward-looking statements include any projection of revenue, gross margin, inventories, expense or other financial items discussed in this conference call, including the state of our customer design pipeline, our strategy and business focus and the potential for retention, loss or gains in our share of various product categories and segments.

Investors are cautioned that all forward-looking statements involve risks and uncertainties that can cause actual results to differ from those currently anticipated due to a number of factors. We encourage you to review the cautionary statements and risk factors contained in today's earnings release and in our Annual Report on Form 10-K for the year ended March 30, 2016, subsequent quarterly reports on Form 10-Q, recent current reports on Form 8-K, and other documents filed by us with the Securities and Exchange Commission from time-to-time. Copies of InvenSense's SEC filings are posted on the company's website and are therefore available from the company without charge.

Forward-looking statements are made as of the date of this conference call and the company does not undertake any obligation to update its forward-looking statements to reflect future events or circumstances.

With that, let me introduce Mark Dentinger, InvenSense's Chief Financial Officer. Mark?

Mark Dentinger

Thanks, Leslie. I'll start my comments on our Q1 performance, and then I'll turn it over to Behrooz for his review of the business. Then, I'll conclude with prepared remarks and guidance for Q2.

Most of my commentary on our income statement will refer to our non-GAAP presentation. The balance sheet and cash flow data are presented and discussed in GAAP format only. The reconciliation is attached to our release and available on our website. There was a $0.17 per share after-tax difference between our GAAP and non-GAAP results this quarter. The difference consisted of $0.12 for the after-tax effect of our normal recurring reconciling items, including removing stock-based compensation, accreting interest on our convertible notes, and amortization of intangibles from acquisitions from our GAAP results and a $0.05 impact from discrete tax item.

Total revenue for Q1 was $60.6 million, which represents a 43% decline from last year's Q1 and 24% sequential decline from the March quarter. Our Q1, 2017 versus Q4, 2016, revenue breakdown by market segment was as follows; mobile which includes smartphones and tablets was 63% of total revenue in Q1, up from 54% in Q4. Optical image stabilization was 12% in Q1, down from 14% in Q4. And other segments including IoT, was 25% in Q1 down from 32% in Q4.

We had one customer account for 46% of our total revenue this quarter and there were no other 10% plus customers in Q1. There were two 10% customers in Q4 individually they contributed 39% and 14% of our Q4 revenue. Geographically, based upon the headquarters of our end customers, Q1 versus Q4 revenue breakdown was as follows; the US was 50% of revenue in Q1, up from 43% in Q4. Korea was 9% in Q1, down from 11% in Q4. China was 20% in Q1, down from 32% in Q4. Japan was 9% in Q1, versus 5% in Q4. Taiwan was also 9% this quarter up from 6% last quarter. And the rest of the world was 3% in Q1, the same as Q4.

Our Q1 non-GAAP cost of revenue was $33 million, resulting in a non-GAAP gross profit of $27.6 million or a 46% non-GAAP gross margin. This compares to 45% gross margin in both Q4 and Q1 of fiscal 2016. Non-GAAP operating expenses for Q1 were $32.6 million down $1.7 million from what we spent last quarter, in part because we had an extra week of payroll in Q4. Research and development expenses were $22.4 million this quarter, and SG&A expenses were $10.2 million.

Our non-GAAP tax benefit in Q1 was about a $700,000 partially offsetting a $5.6 million pre-tax loss. The non-GAAP loss was $0.05 in Q1 and the average shares outstanding was $93.2 million. We ended the quarter with $270 million in cash and investments.

During Q1 we consumed about $14 million in cash flow from operation. The Q1 cash flow also included investing about $2 million in capital purchases which was approximately offset by about $2 million in employee stock sales. DSOs were 57 days in Q1 versus 48 days in Q4. Net inventories of $52 million at the end of Q1 declined by $10 million since the end of Q4 and inventory turnover based on GAAP cost of revenue was 2.8 turns this quarter versus 3.0 turns in Q4.

Total head count increased by 27 during Q1, and we ended the quarter with 659 employees. We expect the head count to increase slightly during Q2.

Now let me turn the call over to Behrooz for his thoughts on the quarter. Behrooz?

Behrooz Abdi

Thank you, Mark. Our worldwide consumer and mobile markets were somewhat soft in the first fiscal quarter of 2017. The InvenSense team delivered on our financial guidance with revenue coming in at $60.6 million. Additionally, gross margins were incrementally higher as a result of improved manufacturing efficiency and product mix.

Over the past three years, we have built a differentiated sensor platform centered around a scalable high performance MEMS technology and enhanced through proprietary software algorithms and design tools. This unique multi-sensory platform is helping us build a high barrier to entry by enabling high value used cases such as activity recognition, image stabilization and inertial navigation for application spanning a number of vertical markets. We are very pleased to have these solutions ready in time to intercept several promising trends especially in our largest market.

While our near term challenges in the mobile market have been broadly discussed and are factored into our expectations for fiscal expectations for fiscal 2017. We continue to hold a majority position in our addressable market. Having successfully brought to market several generations of our 6-axis motion sensor we have maintained our sole position at our largest customer and have developed a collaborative relationship on high performance MEMS technology that allows to deliver to their rigorous specification and performance goals.

In the broader mobile market, we are very excited about new growth opportunities created by a number of trends that play well into our focus strength. New applications prioritizing raw sensor performance are gaining popularity and mobile OEMs are increasingly looking to integrate user interface capability with other used cases such as image stabilization, navigation and augmented reality.

A perfect example of this is, Pokémon Go, an augmented reality app for Apple and Android devices. This game has achieved unprecedented viral popularity worldwide, but there have been numerous reported cases of the user experience varying widely depending on the presence of their high performance gyroscope in the phone. Many consumers have complained about poor user experiences with Pokémon Go on handsets with no gyro or a sub-standard gyro performance.

Difficulties include slow response time as well as image and character grift [ph]. Given strong consumer demand, we expect to see the emergence of many more augmented reality applications and games beyond Pokémon Go and we believe that their proliferation in mobile devices will expand our cam [ph] to be mid-tier and low-tier smartphone markets for high performance gyro.

These market segments now addressable by us, are traditionally not adopted gyro's for purely cost reason. They are currently the fastest growing segments of the mobile market with 400 million to 500 million units collectively according to industry estimates. In addition for the past three years, we have been focusing on developing highly integrated solutions around our motion sensor hardware and software for electronic image stabilization or EIS, optical image stabilization or OIS, inertial navigation and augmented reality applications.

In order to enable compelling features that are visible to end consumers. These features includes cameras with sharper images, more stable video, better mapping and navigation experiences and responsive augmented reality applications. Our focus has culminated in a portfolio of industry leading system level solutions that are integrated with the user interface for greater efficiency performance and system design flexibility.

While competitive offerings maybe sufficient in supporting certain discrete used cases, no competitor has the mastery of delivering solutions with concurrent high performance in noise drift and low latency multi-interfaces. Our new all in one 6-axis motion tracking SoC announced earlier today was designed with such concurrency in mind. Our highest performing 6-axis MEMS is coupled with high speed dual interface. This enables the device to support the traditional user interface concurrently with electronic stabilization and OIS in a multitude of OEM architectural choices for single and multi-camera motion [ph] devices.

Furthermore, proprietary hardware features extend certain derivatives of this product to augmented and virtual reality applications. We have already won multiple designs and R&D early ramp case at a tier-1 Chinese OEM. OIS continues to be a key feature in flagship mobile devices and being adopted by many Chinese smartphone models for next year. We continue to hold a dominant share in the broader mobile market and are excited about our opportunities at the top Korean OEM.

At the same time, EIS for video stabilization is also gaining momentum as a differentiating feature in both flagship and mid-tier phones across Asia, adding to our content opportunities. We are pleased to report that, our EIS solutions are designed into a number of Asian smartphones ramping this fiscal year including across Asus's new Zenphone 3 family. And other example of incremental content in mobile is the proliferation of our inertial navigation solution, which enables a better mapping experience. This software technology that is optimized for performance with our 6-axis motion sensor has been widely adopted by Huawei across its flagship phones including the Mate P and Honor series.

We see a high level of interest for mapping companies globally and expect this solution to expand to other OEMs as they strive to enable improved location based services and mapping user experience. A significant opportunity for increasing our mobile content is UltraPrint, our ultrasonic fingerprint sensor. I'm very pleased to report that we are on track with the development of this game changing technology and have successfully passed several technology development milestones.

Our fully integrated CMOS MEMS fabrication method combined with [indiscernible] architecture is uniquely suited to enabling to unprecedented features and performance that are critical to mobile OEMs such as live finger and section under any surface including thick glass, metal and plastic. We are working closely with top-tier Asian mobile OEMs and module partners who are enthusiastic about the technology and we are on track to begin sampling with lead customers in early 2017.

Turning now to IoT and other applications. OEM design activity driving further creation across a wide variety of markets continues to be robust and has substantially increased from previous years. While design cycles are typically longer and unit volumes much lower than mobile. The large number of customers and applications with rapidly growing sensor content creates market diversification and margin improvement opportunities for us.

Furthermore, we are increasingly winning designs by cross-selling of our broader motion value of product portfolio as existing customers. This category is now consistently above 25% of our revenue mix. Our strategy for IoT is simply to leverage our technology investments in mobile used cases such as an image stabilization, navigation and activity recognition to bring industry leading solutions to the many customers who need fast time to market with minimal incremental cost.

For example, in the category of wearables, gaming and head mounted displays. The stringent technology requirements prioritize raw sensor precision and power efficiency as well as the integration of the high value used cases. Our portfolio of 6-axis and arm based FireFly hardware with automatic activity recognition software is now ramping into a number of Android wear based products from Chinese OEMs including smart watches, child trackers and fitness solutions.

We are also pleased to see design win traction of FireFly in wearable and action cameras and are who are looking to add activity and motion tracking features. In the gaming and virtual reality segments or VR, we have extended our market share with our latest 6-axis motion sensor and are currently ramping with a game controller at a tier-1 gaming OEM. We are especially excited about our traction in head mounted displays and VR. This market which according to IHS is forecasted to grow at more than 50% compounded annual growth rate over the next four years requires high performance motion sensing capabilities.

Extending our leadership, today we announced a motion tracking device specifically designed to meet their rigorous performance demands of head mounted displays. This high performance device has been in evaluation in virtual reality displays at a number of leading gaming and software companies and has achieved design wins at being majority of next generation tier-1 VR OEMs.

In addition to motion, head mounted displays and virtual reality applications provide an opportunity for increased sensor and software content inside the head mount as well as in the controller and accompanying accessories. For example, we currently have microphone design wins in many such devices.

In a category of consumer drones, there are now more than 30 million recreational drones sold each year across multiple tiers and InvenSense's design into all leading brands including DJI and Parrot. Further, sophistication and the need for performance and reliability in consumer drones continues to increase. In turn, the additional sensor content required for a new used cases such as EIS, OIS and navigation, presents an attractive opportunity with significant higher dollar content than in mobile.

For example, our FireFly based module device which significantly reduces cost on time to market by integrating temperature stabilization in drones is now sampling to a number of OEMs with positive early feedback. All these devices and solutions highlight our intimate knowledge of drones flight systems and used cases and leverage our mobile solutions.

Turning now to automotive markets. The trend towards adoption of consumer technology innovation is opening up new opportunities for our motion audio image stabilization and navigation solutions. Furthermore, we believe that trends towards advanced driver assistant systems and autonomous driving, creative sensor rich platform with amazing opportunities for high performance and high reliability sensors and solutions such as inertial navigation and audio.

Last year we launched a strategic alliance with a leading sensor and system integration partner for the development of sensor technology solutions for the evolving automotive safety applications. Which leverages our technology and expertise in MEMS based sensors. With our partner established automotive channels and in depth insight into automotive qualification. I'm pleased to report that expect to be sampling our first product to automotive OEMs this fiscal year.

On the audio front, we are very pleased to see the fast growing customer pipeline across a number of markets and applications such as wearable devices, next generation digital headsets and enterprise class feature phones. In different phases of design win and product ramp this fiscal year. As a result, our microphone revenue has been growing consistently by a double digit percentage every quarter, a trend we expect to continue into next fiscal year.

Our highly differentiated far field time multiplexed microphones are now gaining fast traction in smart home speaker products as well as industrial and robotics applications. In conclusion, while our business has no doubt been impacted by current transition in the broader consumer and mobile markets, we are evermore convinced that our strategy of market share gain, content increase and diversification is the right path to build scale for future sustainable growth.

Sensors are at the intersection of a number of new trends such as augmented reality and in door navigation. As these trends continue wider adoption are tightening and create sensor solutions enable enhanced user experience while solutions such as Coursa Retail will deliver unprecedented sensor data to enterprises looking to create new consumer experiences.

These trends transition gyroscope and other sensors from being the checkbox, to a necessity for consumer adoption, even in mid and low-tier smartphones. Our solutions inspire and excite our customers and are beginning to show positive impact on our financial performance.

With that, I'll turn the call back to Mark for guidance for the second fiscal quarter of 2017. Mark?

Mark Dentinger

Thank you, Behrooz. For Q2 fiscal 2017, we are estimating the total revenue will be within the range of $77 million to $83 million. Our expectations for non-GAAP gross margins in Q2 is range between 45.5% and 46.5%. Non-GAAP operating expenses are expected to increase to about $33 million. Our non-GAAP net other expense should be about flat with Q1 and we are estimating a 13% non-GAAP tax rate for Q2.

Our non-GAAP income should be within a range of $0.02 to $0.04 per share in Q2 assuming an average share count of about $94.5 million. If you're modeling us on a GAAP basis, we estimate that our Q2 loss per share will land between $0.09 and $0.13. This concludes our prepared remarks and now I'll turn the call back over to our operator Carmen for your questions.

Question-and-Answer Session


[Operator Instructions] and our first question comes from the line of from Matt Ramsay with Canaccord Genuity. Please go ahead, Matt.

Matt Ramsay

I guess a couple from my end. Obviously the mobile business is going to be doing what it's doing for right now and we can all make our assumptions about the largest customer going into the back half of the year, but what I really wanted to talk about was that Mark, maybe you can repeat again I don't know if it was the percentage of revenue from the gaming and the IoT segment 25% and if that's right, it's a pretty sharp jump down sequentially. Maybe you could walk us through that because the trends in the recent quarters have been quite positive in that business, which I expect it to be a higher margin going forward. Thanks.

Mark Dentinger

Yes, Matt. Let me answer that and I think you got to connect two data points in that in order to see the whole picture. The first thing is that you're right that is a better margin business for us from the basic mobile business that we have. Two things I think happened there and I'm again looking forward a little bit also to our outlook into our fiscal Q2, which I think we will see that bounce back in terms of absolute dollars. One, we ship very, very heavily in that segment in our Q4 and if you, I make this statement typically on the call, that you almost have to look over two quarters in order to get a pretty good sense about what's going on, but I mentioned in our Q4 earnings call that the inventory distributors actually spiked a little bit at the end of Q4 and part of that reason was, is that some of the stuff that we had shipped at the end of Q4 was in the distributor channel then and probably pushed out to customers during this quarter.

So I think if you average what happened in Q4, which was north of 25% and the 15% this quarter. You start to get around $20 million and that actually was where we were headed towards, if you look at the average at what happened at all of fiscal 2016. So I think $20 million is a pretty good number. I think this was a sequential dip but I think it's going to be a temporary dip. I think if you look forward into Q2, you're going to see that bounce back to the $20 million and probably $20 million plus range. So I hope that helps.

Matt Ramsay

No, it does. Thank you, that does help. One of the things, the other thing I picked up from the prepared remarks. Behrooz's discussion about sampling the first automotive product this year, as there I'm sure no doubt aware that's a quite topical market in the semiconductor space broadly and for sensors in particular. Maybe you could just talk about the product portfolio from an automotive perspective what the timelines are on potential revenue and what kind of an opportunity per car you envision for yourselves as a new entrance into that market. Thank you.

Behrooz Abdi

All right, thanks Matt. There's really two sets of opportunities one is inside the cabin and that's with inertial navigation and audio, there's other environmental sensors that we are working in the background in the R&D, I won't go into that. The ultrasonic, the UltraPrint authentication or the fingerprint sensor, we think that's an opportunity. So inside the cabin, we've already made inroads with the inertial navigation and our software what we call, IPL Positioning Library and that [indiscernible] get into really good traction in automotive and that's a little bit faster track to revenue.

And we think that, the activity that we have now should result design wins I would say next, I'm going to be conservative in next six months and then revenue within next year and half. So that's and that is really great content for us. Then we have the automotive safety and the dollar content inside the cabin depending what how you look at it, it could be anywhere from $3 or $4 up to about $5 to $10 inside the cabin depending if there are range of sensors and all that.

When you go into automotive safety, we think that there's tremendous opportunity for a lot of different sensors and that's the thing that we wanted to do last year was, we knew that it was going to be a typical four to five year timeline as a new entrance into market. So we chose to partner with somebody who is a sensor developer and as the traction at the automotive got OEMs, but what they didn't really have was a compelling growth map and the trend that we see there especially with ADAP [ph] and everything else coming in, there's all kinds of safety related sensors including the inertial sensors, what we're doing today.

I'm not going to go into a lot of details on what we're doing because I'm sure our competitors are going to be reading the script, but I can tell you that, we think that we're making really good progress there with the tier-1 OEMs and the dollar content in the safety is well above $10 to $20 range and we're making good solid progress there.

Matt Ramsay

Thank you very much, that was really helpful. I'll jump back in the queue.


And our next question comes from the line David Williams with Drexel Hamilton. Please go ahead. The line for Cody Acree, David Williams? Your line is open.

David Williams

I was wondering, see if you could talk a little bit about the pricing environment and whether that's really stabilizing or not and kind of what you expect over the next couple of quarters as far as pricing?

Behrooz Abdi

Let me answer that a little bit and maybe Mark can come in with more granular response. In general we see that, there is different tiers to the market, there are different segments to the market. In some segments we do see some stabilization to the pricing and depending on the season because we - depending on competition one of the competitors for example, they're not really investing in manufacturing so this is the time of the year that, they actually back off and it's not, they're not as competitive, they're not pushing pricing down as much, so there's some dynamics.

In general, we see a little bit more tapering off on the pricing and then, the other part of it, we are differentiating from the raw user interface sensor more towards used cases and with ourselves is very different nowadays, so when we talk to customers we're selling image stabilization, we're selling inertial navigation device and in some cases, we don't really even talk about the number of ACIS and the hardware features as much and that's actually helping us get the design wins with premium and on top of that, in some cases actually get the software premium above that and we're starting to see that, this is something I've been talking about for last two, three years and we're seeing actually it's starting to happen and the example is, we're getting really excellent traction right now, with EIS. With this 6-axis and the EIS solution software and with the inertial navigation software that we talked around Huawei.

So that's really starting to change a conversation and you're starting to see that reflected in some of the margin discussion that we've had. Mark?

Mark Dentinger

David, just a couple of things. Overall Behrooz is right very, very recently on the mobile side of the market the pricing has stabilized some and we're anticipating that's going to be the environment from here sort of moving forward at least in our visible horizon. On the IoT side and some of the growth areas and the very, very premium with the high end products and everything. We are still doing fairly well in terms of holding our ground, that IoT and another bucket also includes some areas that are fairly still reasonably competitive and there is some pricing pressure there. The combination of a growing market and competitive products always means that there is going to be some pricing, pricing pressure in the equation. Where we're out on our own and we're really in a dominant position, we can hold that ground for a while.

David Williams

Great. Thanks for the help. If we think about the newer non-handset applications, what is maybe that's aggregate longer term CAGR there and then maybe write those applications from what you're most excited about and then do you think that will be maybe be able to offset into [indiscernible] handset markets?

Behrooz Abdi

Well I think in short-term it will be tough, you know if you have a mobile market that is $500 million and it's reduced in terms of numbers, 5% to 10% even translates into hundreds of millions of units, but even in the mobile market actually we're excited about the mid-tier segment. Mid-tier segment, we've never really had much access in the very beginning when gyros were introduced and the market was growing, some of the mid-tier phones were adding gyros, but really was a check box.

As the smartphone market started to mature, some of them stopped adopting gyros and some of them actually started taking it out. Now we're seeing that with EIS and with augmented reality that segment is really opening up and becoming really essential in a lot of cases to add the gyro because the addition of the gyro is very incremental when you know in terms of not taking the risk, your phone not getting adopted by the consumer. So that's, so even in the mobile market we're pretty excited actually.

When you go out to the mobile market, there's number of different things that we see. We are excited about the drones. In terms of the drone CAGR there's varying different numbers on that, depending on who you believe. The thing we're more excited about on the drone is the content increase. Today in the high end drones we have multiple inertial sensors and we think that and that's actually opened up for us in terms of the integration of other features, EIS where we can get multiples of dollars instead of multiples of cents, that's pretty exciting for us.

So the content increase in drones is what's really nice for us and then we are actually getting design in with microphone in some of those cases too. Then you go to the wearable segment and again, wearable segment for us a platform. We sell a chip that, it's three to four times the ASP of the base sensor that we sell on mobile, in some cases more. And also it's, some of these guys are adopting the audio. Again on the CAGR on that, we went through the high cycle couple years ago and now we're at a point, where I think meaningful new used cases are coming up and everyone one of those required basic activity recognition which we have in our chips and very well integrated that nobody else has.

In the head mounted display that's an area that I'm actually excited about, that CAGR is a latest CAGR that we saw varies about 50% annual rate growth and that because of the just the devices have become to really the content is coming in and they're becoming more common place and with new contents and new devices coming, we're really well positioned there. Again that is, pretty sensor rich platform in terms of motion and audio and all the accessories that goes with it, like some of the controllers that we are getting design in with both motion and audio. So that's an interesting market that we think it will grow to about well over 40 million units in the next three to four years and with multiple dollars of content opportunity around it, with accessories.

So there are all these markets and we think that will help us grow while we, all these combinations are from mid-tier phone to IoT will help us grow until new contents such as fingerprint sensor comes in and automotive. So we're really layering all this in the next two to three years in terms of the content and diversification.

David Williams

Great, thanks so much.


And our next question is from the line of Richard Shannon with Craig-Hallum. Please go ahead.

Richard Shannon

Maybe a follow-on, in your last response, Behrooz - ask not in terms of revenues here but looking at it in terms of build [ph] materials and gross margins why don't you kind of type those into the diversification aspect when you subscribed happening over the next two years. Specifically, I'm curious when and where you see the ASP or build [ph] materials bottoming in the near future, is it next quarter or two, next year sometime and then coincidentally when do you see the gross margins started to bottom up?

Behrooz Abdi

In terms of ASPs, I'm looking to Mark in terms of where we think is things are bottoming, are you talking about the markets like mobile markets or and the gross margins in those markets or just general?

Richard Shannon

I was asking at a corporate level.

Mark Dentinger

Let me take a shot at it. So we've studied this for a long, long time and a couple phenomenon are pretty clear. When a market is growing rapidly and I'll define that as 10% to 20% more per year and there's any competition, there's usually going to be pretty strict ASP pressure introduced somehow through some means seasoned through competitive means or something that you know in that sense.

If the market tapers off a little bit, it does appear that we get a little bit relief on the ASP pressure side. So as we're looking at mobile right now because again the volumes are down a little bit, it does appear that you know that has stabilized. On the higher growth areas again, I then split those into two areas. One, where we've got a platform we got a product that right now is sort of running on host. We can hold our ground pretty well. You saw this back on our OIS product for better part of the last two years.

We really had a performance differentiated OIS, in fact still do and we were able to command and hold ASPs better there. They still went down a little bit on average overall, but they didn't' approach mobile overall. Where the product it tends to be towards more commodity end of the range, again if there's growth in the market, we do feel it there. So the IoT in other area is an amalgamation, right now it's probably on average across all of the products that's going down little bit but that's a combination of actually doing pretty darn well at the high end and actually conventional pressure at the low end.

On the cost side of the equation, again we invested a lot in this area, right around the time that I arrived and ramping up big North American customer and we have actually done very, very well in getting our yields consistently including what I call the transition yields when you're yielding off one product into another. Then very, very well in that area and that has been a big, big help to us on the margin front. So the combination to those two things does mean that we do see a generally improving gross margin scenario from here. I think it won't be a step function up, but I think it's going to be a gradual increase here and that's a combination of again, on product mix shift into this IoT and other area where we got some stickiness and the fact that at least on the manufacturing side we've enjoyed a sustained period of improved yields and cost opportunities.

Richard Shannon

Okay, appreciate that great detail, Mark. Maybe just two more questions from me. I'll jump on line. Behrooz, I think you talked about the increase catch-up rate driven by requirements on each for better raw sensor performance. Are you saying that you're seeing a fairly market increase here just fiscally as Pokémon has become such a creators of more general applications and when might we see that really hitting your shipments in your revenues.

Behrooz Abdi

Okay. Really good question, we need to start up to see this with EIS, with image stabilization because we've been working on this for a while and we've shown consistently to customers that, you need really good raw sensor performance and then we obviously added some hardware, software to make it work with synchronization to the video frames and things like that.

So we started to see this end customers and that actually helped us really get some of the competitors at least on defence and not able to show the same thing and actually it helped us start to getting some design wins in the last three months, that we normally would not have gotten just due to just user interface used cases.

When Pokémon Go came along we have been talking to customers about VR and AR for a while because we saw that trend on VR with head mounted displays about a year ago and we realized that their performance needs were much, much higher than just the regular user interface gyro and thermometer and we started working on that towards the phones because we felt that at some point, VR for head mounted display will translate into AR for the phone itself.

We didn't necessarily obviously forecasted or predict that something like the Pokémon Go was going to come along but we always felt that augmented reality was going to come along at some point and obviously the last few weeks have been, have frenzy of inbound interest from the customers in terms of the interest that they're seeing and now, it's a great opportunity for us to, so we'll capitalize on that.

So on with EIS, we started seeing it about three, six months ago and we started getting some design wins that helps us get the tax [ph] rate of the software and start getting some additional ASP, that for the premium performance and we're hoping that we're going to see that with AR. Now in terms of the timeline I don't know if we'll see it as much for Christmas, but I'm sure for MWC, for the Mobile World Congress in February.

If you have a phone that's even a mid-tier phone that's not AR compatible, I think you're going to get some questions from consumers that might be, wishful thinking on my end but I definitely see much more interest there which means in that quarter or little bit later, we should see a really good traction in terms of designs.

Richard Shannon

Okay, perfect Behrooz. Appreciate all that details. Well this is my last quick question for you Mark on the sales guidance for September. How do you view the mobile category growing relative to the overall growth rate you're implying in the mid quoting guidance, is it similar to that or higher or lower?

Mark Dentinger

I think it's probably going to be a similar contributor maybe down just a little bit because I think that the consumer in the IoT space will probably be a little bit bigger percentage contributor.

Richard Shannon

Okay, perfect that's great for me, that's all from me, guys. Thank you.


And our next question is from the line of Tristan Gerra with Baird. Please go ahead.

Justin Lee

This is Justin Lee calling for Tristan Gerra. So my first question would be about the China smartphone market. In the calendar second quarter, a lot of China smartphone vendors released their new models, then in the coming third quarter with potential match, a new model launch, are you seeing any volume decline or trampling [ph] from the China smartphone vendors?

Mark Dentinger

We don't see it here in a pronounced way, that's a competitive landscape for us right now. And our big opportunity as Behrooz indicated would be to get to the mid-tier phones with our new products, but I think that the competitive landscape on the existing high end structure right now is about what we've experienced in the recent past.

Justin Lee

Okay, thank you. Then my second question would be about biometric fingerprint sensing. So I know that you mentioned about sampling in early 2017. Could you talk a little bit more about how many customers you're engaged with and the potential volume and revenue opportunities?

Behrooz Abdi

Well that market is really a huge opportunity for us in terms of the adoption with the mobile payment, I think your number might be more accurate than mine in terms of how many phones are going to have fingerprint sensoring in the next two to three years. Obviously several hundred millions units, we are at this phase of the development and engagement. We are limiting engagement with very small number of customers just because the amount of work that needs to go into it in terms of the back and forth iteration of the design, we're getting a lot of great inputs from these limited number of customers amongst them definitely tier-1 customer. But we want to limit to make sure that we can deliver to them.

The other thing is that, it doesn't take large number for us because of the ASP uplift that we're getting versus motion, but it doesn't really take a whole lot of customers to really bring in the early revenue and allow us to then scale to other customers. So I won't go into much more detail in terms of how many customers and all that but definitely the interest, there's a lot of customers who obviously know and have heard and they approach us and we at this point, we are in a very nice way, we don't engage with them. We try and delay that engagement, if I can put it that way.

Justin Lee

All right, thank you.


And our next question is from the line of Joe Moore with Morgan Stanley. Please go ahead.

Joe Moore

I'm sorry, if I missed this. Can you talk about your cost on the traditional 6-axis going forward, is there are there any natural levers to bring that down over the next 12 months or we are kind of more at a steady state from the standpoint of your manufacturing cost?

Behrooz Abdi

Well there's been the traditional levers that we've pulled in the past, such as multi-fabs and that's definitely has helped us in the last year especially as Mark articulated as we did the multi, as we went through these transitional phases of new products. Really we've gotten that down very smoothly and we're now doing multi-fabs and that is really helping in terms of drive creating competition on the manufacturing side and driving the cost structure down.

As far as architecturally, we believe that there is still at least one or two nodes that we can architecturally reduce the MEMS and the ASIC size and that's something else that has helped in the last year for us to reuse our cost structure and we think that there's more room. So, then there is other things that, I won't speak publicly yet just not prefer to talk about them but we think that there is definitely more room especially being in fabless environment, where I don't have to worry as much about going and making an investment in capital and that's something that's really our competition is suffering from.

So we think actually we have much better opportunities. Keeping in mind, diode size reduction for IDMs [ph] is not a really good thing because what that does is, it reduces their loading and their fabs and that creates more cost structure problem for us, it's the opposite. It really bends the cost curve for us and diode size reduction is a great thing for us and but only we think twice about it and that's something that has helped us in terms of our gross margin. If you dig into the gross margin of the competition you will see more than a double digit difference because of that and we think that will improve.

Joe Moore

That's helpful. thank you and then looking at the video game console part of your business with a couple at least one of your customers having a product transition next year like, how should we think about that business on a multi-year basis. Is your business going to stay the same size, get bigger or get smaller, just give us a sense for that?

Behrooz Abdi

I'm actually really excited about the gaming because I think there is, you're going to see gaming and head mounted display and virtual reality coming together and it has this multiplication effect. One is on the sensor side, you're going to get more sensors in the head mount itself. In the game controller, so for example in the game controller we've been shipping, we started ramping with new tier-1 gaming company that we had they - some parts of the business but that really expanded quite a bit and we were shipping motion sensors and follow on to that, we wanted the microphone inside the controller and now we have won the head mounted display.

The next thing that we're going to see is the accessories and for gaming accessories multiple different accessories and these accessories go beyond the controller, especially if you have the head mounted display and each one of these accessories again have their own set of motion sensors and other type of sensors. So we really think that's multiplication it's like, so when we talk about VR and head mounted display becoming a 40 million unit market in the next few years, today gaming is about 40 million unit and when they come together you're going to see that multiplication and just recently at the E3 conference, we saw a number of these trends coming together and just multitude of content, coming in and gaming content coming in. So I think that's a market will be very, very beneficial for us.

Joe Moore

It's very helpful. thank you very much.


And our next question is from the line of Jagadish Iyer with Redstone Capital.

Jagadish Iyer

Two questions. First Mark, I'm just trying to reconcile the gross margin performance where you had a big chunk from your largest customer. You had solid gross margin performance despite a significant revenue downtick and if we assume that your largest customer continues to ramp through the remainder of second half of 2016, how should we view gross margin trajectory and then a follow-up?

Mark Dentinger

Yes, I think it's, believe it or not, Jagadish, actually it's a good question because it's not necessarily intuitive but we do expect the gross margins to continue to improve not the big leap functions but I think it's going to get steadily better as we move through this year and it's, not just the function you're right the largest customers, big customers get volume discounts in so on and so forth you can read into that, but on other areas of the business, we're doing fairly well on the cost side of the equation and as a result of that and a little bit of pricing stability on the mobile side, as well as a little bit of positive contribution from the IoT and other and you add it all together and we're actually, we got it going up into the right.

Jagadish Iyer

Yes, that's great job on that Mark and Behrooz, but I have follow-up on the EIS and OIS. I was just wondering, is it fair to say that now that your key customer in Korea is no longer a 10% customer, is it fair to say that your EIS, OIS segments have essentially dropped and we should now start to see some gradual uptick as these Chinese handset makers start to ramp. How should we think about its trajectory. Okay, let's look at it from one year from now or something like that, any color on that qualitative. It would be great.

Behrooz Abdi

Yes, certainly on the EIS we definitely see that and as I mentioned. We're going to drive EIS into the mid-tier and EIS is exciting because for one thing it drives gyro adoption into the mid-tier and I have jokingly say that now that we have 400 to 500 million units available we can actually help our competitors fill their fabs because now we bring that solution to the mid-tier market.

So really that we're excited about. On the OIS, that's still going to be more into the high-tier and flagship phones. What we're trying to do is really reduce the cost structure that's associated with the calibration and testing by bringing that solution into offering a solution that's also 6-axis main board that's concurred design. So that actually helps grow the flagship OIS in that direction, when they're adding multi-cameras and different type of front facing OIS, things like that.

So we think that there is different parts of that solution that is going to help us in China. Now in Korea I wouldn't say that we've given up on the opportunity. I will just leave it at that but I wouldn't say that's something we've given up but you're right that it's craft, at this point.

Mark Dentinger

Yes, Jagadish one other footnote is that you compare OIS today versus what it will be a year from now. I've no doubt that we will have be it in more platforms a year from now than we are today, but what will happen with the dual interface product that we just announced this, is that. We'll have to sort of kick it out of way to display because that will be basically as one solution that sells multiple issues, so how much of that is standard 6-axis functionality to a handset as opposed to how much of that do you allocate in value over to the EIS and OIS segment.

So we'll be doing a little bit of apples/oranges comparison, but I don't think that the discrete OIS. The stuff that we historically reported is going to fall off a cliff. It's actually, I think it's probably steady and Behrooz is right, it may have troughed [ph] in this quarter.

Jagadish Iyer

Okay, very good. Thanks so much.


And our next question is from the line of Gary Mobley with Benchmark. Please go ahead.

Gary Mobley

Thanks for allowing me to sneak my question in here. I think question about your largest customer presumably a large chunk of a sequential improvement you're expecting in the September quarter it comes from that largest customer in preparation for new product launch and with that in mind, do you think you can grow your revenue on your largest customers next gen, product cycle compared to the current product cycle?

Behrooz Abdi

It's probably going to be a function to unit volume, Gary. We certainly, we're fully penetrated so it really boils down to how much the unit volumes can change and you know we will ship everything they request.

Gary Mobley

No, obviously most MEMS companies count the same smartphone OEM as large customers I should say. In some of those MEMS companies describe remember supply chain is more even in this next generation product cycle maybe not so much a front end supply chain build. Is that sort of what you're seeing with this customers as well?

Behrooz Abdi

Gosh, I'm not sure. I think it's too early to tell. We just responded the order volumes in whatnot shipped [ph] good. It's little too early to tell is to whether not it's more even or it's shortened a result therefore taken some volatility out of it. It's hard to tell.

Gary Mobley

Okay, in a recent past you talked about how non-smartphone or perhaps otherwise characterises IoT can grow to become 30% of [indiscernible] 2017 revenue. Now we're starting from those, starting the year from smaller base following the inventory correction and the channel would not, do you still think that 30% goal is achievable?

Behrooz Abdi

It's based upon what we're looking at to-date, it's still a possibility. I would still say we got a lot of work to do and lot of will depend on the second half of the year and frankly we're looking for what the new Christmas got to have under the tree this year. It's going to be, because we're doing fairly well in the high growth areas already in terms of drones. So we'll have to see, if there's pull from in augmented reality, if there's a pull in some other areas. If we get the hover boards back on the streets. There's a number of things to variable there. We could get there but we would have to have a surge in the second half.

Gary Mobley

Okay, that's it from me. Thanks guys.


And ladies and gentlemen, this concludes our Q&A session for today. I will turn the call to the President and CEO, Behrooz Abdi for final remarks.

Behrooz Abdi

Well thank you all for participating in our conference call. This quarter we will be presenting at the Pacific Crest Global Technology Leadership Forum in Vail. The Oppenheimer Technology Internet and Communications Conference in Boston. The Canaccord Genuity Growth Conference in Boston and the Drexel Hamilton TMT Conference in New York. I encourage you to check the Investor Relations section of our website for details and always feel free to contact us if you would to schedule a call or meeting and we look forward to speaking with you in the near future.


Ladies and gentlemen, thank you for participating in today's conference. This concludes the program and you may all disconnect. Have a wonderful day everyone.

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