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OmniVision Technologies, Inc. (NASDAQ:OVTI)

F4Q2012 Earnings Call

May 31, 2012 5:00 p.m. EDT

Executives

Mary McGowan – IR, Summit IR Group

Shaw Hong CEO and President

Ray Cisneros – VP of Worldwide Sales

Hasan Gadjali – VP of Marketing and Business Development

Anson Chan – CFO and VP of Finance

Analysts

Philip Lee – Lazard Capital Markets

Paul Coster – JPMorgan

Raji Gill – Needham & Co.

Harsh Kumar – Stephens, Inc.

Brian Peterson – Raymond James

Betsy Van Hees – Wedbush Securities

Tom Sepenzis – Northland Securities

Operator

Ladies and gentlemen, thank you and welcome to the OmniVision Technologies conference call for the fourth quarter of fiscal 2012. 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 over to Mary McGowan. Please proceed.

Mary McGowan

Thank you very much. Good afternoon, everyone, and welcome to our fiscal 2012 fourth quarter earnings conference call.

On today’s call will be Shaw Hong, President and CEO; Ray Cisneros, VP of Worldwide Sales; Hasan Gadjali, VP of Worldwide Marketing and Business Development; and Anson Chan, Chief Financial Officer.

During this conference 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, May 31, 2012, and actual results may differ materially from those set forth in such 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 related tax effects. A reconciliation between the two is available in our earnings release posted on our website.

With that, I’ll now turn the call over to Mr. Shaw Hong. Shaw?

Shaw Hong

Thank you, Mary. And welcome to all of you joining us on the call and webcast.

Earlier this afternoon we issued a press release describing our results for the fourth fiscal quarter of 2012. For those who have not read the release, I will provide you with a recap of our financial results.

In Q4, we recorded revenues of $290 million and we shipped 147 million image sensors. On a non-GAAP basis, gross margin was 22.9% and net income was $11 million or $0.20 per diluted share. In addition, we increased our cash balance to $331 million.

Before I turn the call over to our management team to provide details on our Q4 financial results and outlook, I’d like to make a few comments on our business.

First, I'm pleased to report that for the second consecutive quarter we achieved the high end of our revenue guidance as demand for our image sensors continues to strengthen. We believe this is testimony to our resolve to maintain top line growth and to deliver value to our many customers.

On our initiative to rebuild the revenue momentum is yielding positive results, but there are challenges face OmniVision in the near term, specifically our corporate gross margin is under pressure. We have already launched multiple programs to improve our performance. These actions range from more aggressive development in integrated imaging solutions to more vigorously efforts to increase production yield. These measures may take time to produce favorable results, but we are committed to once again expanding our gross margins.

Second, as we work on the near-term challenges, our long-term strategy continues to be rooted in the technologies development. Our focus has always been we will remain on innovation that will place us at the forefront of imaging solution technologies. Technologies development is the basis on which we can produce better performance and our innovative products (inaudible) the demand on our key target markets. As such, OmniVision’s research and development efforts will continue to play a pivotal role in our growth strategy. We’ll expand our R&D focus to continue to drive our top-line growth and to position us well in this exciting industry.

Third, I’d like to comment on our target markets. As you know, our target markets today are largely concentrated in the consumer [base], which is highly competitive and volatile in demand. Although we are currently a leader in the mobile phone market, especially in the smartphone product category, and have had considerable success in the notebook and the entertainment market, our ongoing objective is to diversify our revenue stream into other promising markets. (inaudible) we see more opportunities in the automotive and medical markets. For both markets, OmniVision has already made initial inroads, and as we continue our technologies development, we believe we will offer some imaging solutions over the longer term. Hasan will speak more about this area later in the call.

With that, I will turn the call over to Ray, who will provide an update on the quarter sales activities.

Ray Cisneros

Thank you, Shaw. We are pleased to have exceeded the high end of our revenue guidance. There are stronger seasonality trends than previously anticipated from the markets we serve. Going forward, we are ramping a significant step-up in BSI-2 shipments that will serve some key customer applications.

In our fourth fiscal quarter, we shipped 147 million units as compared to 143 million in our prior quarter. The average selling price in our fiscal fourth quarter was $1.48 as compared to $1.29 in the prior quarter. The step-up is due to an increase in higher-resolution sensor product mix.

In the fourth fiscal quarter, unit sales of sensors 2 megapixels and above represented approximately 31% of total shipments as compared to 22% in the prior fiscal quarter. This positive shift was driven by almost a doubling of our 5-megapixel shipments in both our one-third inch and quarter inch form factors of this product line. We anticipate strong demand for this product category to continue through the upcoming seasonal cycles.

Another piece of good news is a steady growth trend for our 8 megapixel shipments which we anticipate will carry into our upcoming quarters. Our shipment of 3 megapixel sensors remained steady while 2 megapixel sensors continue to decline gradually as we have anticipated. Unit sales of 1.3 megapixel sensors represent approximately 14% of total shipments as compared to 19% in the prior quarter.

In this category, we incorporate our HD sensors which is a dominant form factor in this category. Going forward, we are still tracking this category and we anticipate that it will ramp up significantly as almost any product that carries a camera solution has an HD imaging camera to support the standard 16 x 9 displays.

Lastly, unit sales of sensors that were VGA and below represented approximately 55% of total shipments, as compared to 59% in the prior quarter. We continue to ship high-quality VGA products for self-view camera applications at a high rate. Additionally, we see a steadily increasing trend in our CameraCubeChip products, and we anticipate a significant step-up in shipments later in the fiscal year.

In terms of product markets, our mobile phone sales represented approximately 52% of our revenues in the fourth quarter, no change compared to our prior quarter. Similarly, our entertainment segment represented 28% of sales, also no change compared to our prior quarter. Our sales of sensors into the notebook and webcam segment were approximately 11% of sales as compared to 8% in our prior quarter.

In the mobile market, we continue to ship a steady volume of 5 megapixel sensors in both the 1/3 inch and 1/4 inch form factor to the main camera for the smartphone segment. We also saw a pickup in 8 megapixel shipments for the main camera also due to the smartphone segment. And we foresee a steady increase in this trend. We believe the 8 megapixel resolution for smartphone main cameras will hold steady as the sweet spot through most of this year. But starting in calendar 2013 and beyond, higher resolutions or novo technologies will be adopted. We are actively engaged in several of our tier 1 customers in planning or designing new and unique solutions.

Similarly, the self-view camera category in smartphones is going through rapid changes in adopting a variety of solutions. In our fiscal Q4, we shipped a steady volume of our unique high-performance VGA products for smartphones. Additionally, our waist-level module product, the CameraCubeChip, also shipped an increasing volume to the smartphone segment for self-view cameras. In the future, however, a large percentage of self-view imaging solutions will transition readily to the HD format. We are well-positioned for this trend due to our long experience in HD solutions and broad portfolio offering.

In the notebook and webcam segment, we experienced a pickup in demand. In particular, we are going through a rapid transition from VGA solutions to HD solutions which is quickly becoming the standard. In our Q4, we went through a fast ramp-up of shipments of OV9726, our premier 720p BSI-1 product, to most of the tier 1 notebook OEMs. The trend appears to hold steady through most of the summer and our continuing investments in HD solutions is paying off. A second trend is the emergence of the Ultrabook notebook category. Here again, OmniVision is currently the leader in this category and the across-the-board growth of this category for all OEMs represents an opportunity. We will position our next-generation low-profile OV9724 for this trend.

In the entertainment segment, we include the tablet market, and we maintained our leadership position. We continue to serve a strong lineup of tablet OEM customers that use a variety of resolutions from HD up to 8 megapixel sensors. Recent release tablet products using some of our advanced high-resolution sensors have bolstered our sales in this category. The tablet device continues to broaden its usability and represents a permanent standalone product category.

Other novel products using OmniVision sensors will soon be launched into the marketplace. Some of these designs represent a watershed point in how image sensors are used. Capturing an image is not the only application for a CMOS image sensor, and future tier 1 OEMs will demonstrate that in upcoming quarters. Similarly, innovation is driving the automotive market growth. In conjunction with our third-party partners, our Surround View imaging solution, where multiple sensors are used in one system, is driving sales. Additionally, more novel imaging applications that are developed for the consumer products are now being designed into automotives.

Shaw Hong

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

Hasan Gadjali

Thank you, Shaw. This quarter I would like to focus on our product introductions, which include HD solution, higher resolution sensor, as well as our CameraCubeChips.

In the fourth quarter of 2012, OmniVision remained one of the leaders in the highly-competitive mobile phone market. That includes the smartphone product category as we continue to expand our Omni BSI-Plus and Omni BSI-2 products offering.

As you may recall in the third quarter, we introduced the Omni BSI-Plus technology which offers significant performance improvement in image quality over our original BSI technology, while at the same time maintaining a competitive cost structure. Based on this technology, our new 1080p high-definition OV2722 offers an attractive option for tablet and smartphone manufacturers seeking to upgrade their secondary front-facing camera designs. The OV2722’s 1/6 inch form factor allows it to fit into an extremely thin module design of only 3 millimeter height, making it also very attractive for the notebook and ultrabook market.

Our OV9724 is another strong addition to our HD product portfolio. This high-performance image sensor offer 720p high-definition video in a module size of only 2.5 millimeter high. Since its introduction in February, the OV9724 continues to find its way into many technology platforms developed by our partners. Both the OV2722 and OV9724 exemplify the continuous innovations that we bring into our industry-leading HD sensor product line. They expand our success beyond the notebook and entertainment market and strengthen our position in the secondary front-facing camera market for smartphones and tablets.

On a separate front, we continue to boost digital imaging technology to the next level in terms of resolution and performance. Our goal is to maintain a broad product offering that will maximize our growth and profitability as we focus on the high-end premium market. In our fourth quarter, as we enter our fiscal 2013, we have now several new products to meet the needs of our diverse customer base.

Our recent release of the 12 megapixel OV12830 brings to market a sensor capable of achieving 24 frames per second at full 12 megapixel resolution and full HD 1080p videos at 60 frames per second with enhanced image stabilization. Built on the OmniBSI-2 pixel architecture, this sensor can fit into an 8.5 by 8.5 millimeter autofocus module, making it very applicable for the main camera found in smartphones and tablets.

We would like to highlight our latest 16 megapixel product, the OV16820 and the OV16825 camera chip sensor. These state-of-the-art sensors are capable of recording 4K2K of full high-definition video at 60 frames per second. 4K2K resolution basically means it doubles the 1080p high-definition television standards in both the vertical and horizontal dimension, delivering an extremely high-quality video.

The OV16825 and the OV15820 are developed to support emerging standards in high-resolution video recording for the high-end smartphone market, as well as the DSC and camcorder market. These sensors are capable of high frame rates and will benefit from our next-generation OmniBSI-2 technology to deliver exceptional image quality. Once again, we are raising the image quality and performance bar of our sensors and narrowing the gap between cell phone camera and point-and-shoot digital still cameras.

Moving on to our CameraCubeChip, we are now in full production and are capable of supporting OEMs for all the smartphone secondary and front camera need. As mentioned in our last earnings call, we continue to expand our CameraCubeChip product (inaudible). With 2.5 millimeter in height, new OVM9724 CameraCubeChip is very popular among platform partners who design increasingly smaller consumer devices with HD video capturing capabilities.

Separately, we introduced the OVM7675, which at only 2.9 by 2.3 millimeter in size is our most compact CameraCubeChip today. Built on our OmniPixel3 technology, it delivers high-quality VGA video at 30 frames per second, making it [adept] for operating in challenging lighting conditions.

OmniVision also has products designed specifically for emerging markets. We continue to make progress, establishing a leadership position that we believe will offer substantial growth in the years ahead.

On the automotive front, our high dynamic range automotive sensor, the OV10630, continues to make headways with major tier 1 car manufacturers for 2014 vehicles production line. High-end cars are using the OV10630 for rear viewing as well as 360-degree surround view, while the lower-cost model uses the OV7960 for backup camera applications. The concept of dozens of sensor used in an automotive is quickly becoming a reality and OmniVision is working diligently to be a leading supplier in this market.

Turning to the medical market, last month we announced the deployment of our ultra-compact OV6922 camera chip image sensor in an incubation video [scope]. As designed into [this scope], our sensor delivered clear imaging for minimal invasive and (inaudible) medical applications, helping physician perform procedure with greater accuracy. We believe we are already gaining traction as well as stature in this industry as we work with medical device providers worldwide. We remain positive on the long-term potential within the emerging markets and in our expertise in security, automotive and medical imaging to realize that potential.

Shaw Hong

Thank you, Hasan. I will now turn the call over to Anson, who will discuss our fourth quarter financial performance and provide guidance for our first quarter of fiscal 2013.

Anson Chan

Thank you, Shaw, and good afternoon everyone.

For the fourth quarter of fiscal 2012, we are reporting revenues of $218.5 million, up 18% sequentially and down 15.4% on a year-over-year basis. Direct sales OEMs and VARs accounted for 77.4% of revenues in the fourth quarter fiscal 2012, a slight decrease from 79.2% in the prior quarter. The remainder revenues came from sales through our distributor channels.

Our fiscal 2012 fourth quarter gross margin was 22.5% compared with the 24.2% that we reported in our prior quarter. Excluding stock-based compensation expense of $930,000 including cost of revenues, our non-GAAP gross margin was 22.9% compared with 24.7% in the prior quarter.

The decrease in our gross margin was primarily attributable to a decrease in revenues in the quarter and the sale of previously written down inventory and the increase in allowance for excess and obsolete inventories. In the fourth quarter, we recorded approximately $1.2 million for the sale of previously written down inventory and $6 million as an additional allowance for excess and obsolete inventories, with a net $4.8 million of unfavorable impact on our gross margin.

In the third quarter of fiscal 2012, we recorded approximately $2.6 million for the sale of previously written down inventory and $3.4 million as an additional allowance for excess and obsolete inventories, with a net $0.8 million of unfavorable impact on our gross margin.

We expect margin to remain depressed for at least the first fiscal quarter 2013. This is largely due to our anticipated increase in shipment of BSI-2 device which has a high cost structure. And as a cautionary comment, I’d like to remind you all that we develop new technologies all the time, and in general, because of the complexity of our (inaudible) designs, we’re also dealing with various production risks as we ramp production. This production risk, if materialized, can result in unanticipated yield losses in the near term.

R&D expense in the fourth quarter fiscal 2012 totaled $27.2 million, a 3.7% increase from the $26.2 million in our fiscal 2012 third quarter. The increase in R&D expense was driven by an increase in R&D headcount. While we recorded a slight increase in stock-based compensation expense during the quarter, we currently expect the R&D expense in the first quarter of fiscal 2013 will increase further, mostly attributable to further increases in headcount and stock-based compensation expense.

R&D expense in the fourth quarter include approximately $3.9 million of stock-based compensation expense. Excluding stock-based compensation expense, fourth quarter R&D expense was $23.3 million as compared to $22.6 million in the third quarter of fiscal 2012.

SG&A expenses increased slightly from $15.8 million in the third quarter to $16.2 million in the fourth quarter. We expect SG&A expenses to increase further in the first quarter fiscal 2013 due to headcount and stock-based compensation increases, and forecast an increase in revenues.

Our fourth quarter SG&A expenses include approximately $3.2 million of stock-based compensation expense. Excluding stock-based compensation expense, SG&A expenses in the fourth quarter totaled $13 million, similar to our third fiscal quarter. The amount of amortization for our acquired patent portfolio remained the same at $2.3 million per quarter.

Our GAAP operating income in the fourth quarter totaled approximately $3.4 million as compared to $500,000 in the prior quarter. Our GAAP pretax income in the fourth quarter totaled $3.7 million as compared to $89,000 in the prior quarter.

Our GAAP tax rate for the fourth quarter was 27.2% and our GAAP provision for income taxes was $1 million. This compares with the tax rate of negative 24% that resulted in a GAAP benefit from income taxes of $22,000 in the prior quarter. Comparing tax rates is not meaningful since our pretax income is low.

Excluding the effect of stock-based compensation expense, our non-GAAP tax rate for the fourth quarter was 6.8% and our non-GAAP provision for income taxes was $0.8 million. This compares to our non-GAAP tax provision for fiscal 2012 third quarter of $7,000. For the first quarter of fiscal 2013, we expect our GAAP and non-GAAP tax provision will be between $1 million to $2 million.

In the fourth quarter, our GAAP net income attributable to OmniVision was $2.7 million or $0.05 on a per diluted share basis. This compares to a GAAP net income attributable to OmniVision of $111,000 or breakeven per diluted share in the third quarter fiscal 2012. Excluding stock-based compensation expense and related tax effects, our non-GAAP net income attributable to OmniVision for the fourth fiscal quarter was $10.9 million or $0.20 per diluted share. This compares to non-GAAP net income attributable to OmniVision of $7.1 million or $0.13 per diluted share in our third fiscal quarter of 2012.

Let me now turn to the balance sheet. We ended the fourth quarter with cash, cash equivalents and short-term investments totaling $331 million. This compares to $236.5 million at the end of the third quarter fiscal 2012. The increase in cash was primarily attributable to improvements in operating cash flows in the fourth quarter.

As of April 30, 2012, inventory totaled $291.3 million, an increase of $44 million from the $247.3 million balance at the close of fiscal 2012 third quarter. Our yearend inventory balance represented an annual inventory turn of 2.4 times or 155 days sales.

We’ve been working diligently to lower our on-hand inventory levels. For the old inventory that we built up during the early part of the year, we’ve made substantial progress in bringing down the quantity. However, due to a mismatch between our customers’ production ramp schedules and our capacity ramp-up timetable, we have to build inventory to stock, particularly with our BSI-2 devices. This way we can ensure that obligations to our various customers can be met. With that said, we’ll probably have to wait till our third fiscal quarter of 2013 before we can restore inventory level to our long-term goal of 45 turns a year.

Accounts receivable at the end of our fourth quarter net of allowances were $107.8 million, a decrease of 19% from the $132.7 million at the end of fiscal 2012 third quarter. Our days sales outstanding decreased to 44 days in the fourth quarter as compared to 66 days for our prior quarter.

With that, I will turn to our outlook for the first quarter of fiscal 2013, which ends on July 31, 2012.

We currently expect our 2013 first fiscal quarter revenues will be in the range of $235 million to $255 million. Our GAAP EPS are expected to range from breakeven to $0.11 per diluted share. Excluding the estimated expense and (inaudible) tax effects associated with stock-based compensation, we expect our non-GAAP earnings will be in the range of $0.16 to $0.27 per diluted share.

Shaw Hong

Thank you, Anson.

Fiscal 2012 presented OmniVision with a number of challenges. We believe we responded quickly to regain our revenue momentum. In doing so, we controlled our operating expenses while deploying the necessary R&D resources to support the long-term growth of the company. The last two quarters have demonstrated our resolve to regain our momentum and to capture key [focus] that should deliver future revenue growth.

As we enter fiscal 2013, more work remains, as it always will. However, we remain focused on developing leading image sensing technologies critical to our future success.

Operator, we are now ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions).

Our first question comes from Philip Lee with Lazard Capital Markets. Please proceed.

Philip Lee – Lazard Capital Markets

Hi. Thanks for taking my question. How much is the decline in the gross margin due to yields compared to the inventory write-down.

Anson Chan

For fiscal Q4, the so-called drop in margin is really attributable to the tier 1 off items that I mentioned on the call which is the allowance for additional E&O inventory and a sale from reserve inventory as well. So these two effects from Q3 to Q4 accounts for most of the drop in margin.

Philip Lee – Lazard Capital Markets

Okay. Then I guess you see for next quarter the yield being the main issue that margins remained depressed?

Anson Chan

I won't say it's just because of yield issue. As I tried to mention in my prepared remarks, we start to ship out a more -- higher volume of BSI-2 devices. And BSI-2 devices being such a complicated sensor on cost structure, it's actually very high at the moment. This is something that we have to battle, and obviously we are doing everything we can just that we won't be able to fix it immediately.

The other thing that I actually mentioned also on our prepared remarks is that there always be some production risks associated with new product introductions. So as we continue to ramp, these production risks, they do represent real risk. And to extent that there are any unexpected low-risk issues, then it will run its way through the P&L and reflect some unfavorably -- result in unfavorable results.

Philip Lee – Lazard Capital Markets

Okay, thanks for that. And as a follow-up, can we just step back and can you give us a view on the competitive landscape and where you believe your new product stand versus the competition?

Anson Chan

I'm sorry can you repeat that question? I couldn't quite hear it.

Philip Lee – Lazard Capital Markets

Yeah. Can you give us a view on the competitive landscape and where your new products stand versus the competition?

Ray Cisneros

Hello, this is Ray Cisneros. In regards to competition, we see it across the board. Definitely, as usual, markets are continuing to expand and competition continues to come in and out. So, from a general statement, we’re definitely seeing competition always there. It's no different today as it was yesterday or as we probably anticipate going forward in the future. I will say though, because the markets are expanding, I think typically they expand faster than most analysts predict. It represents obvious opportunities for OmniVision to always pick and choose what markets will be lucrative and give us the best return on our investment.

So it's a broad question you asked, I'm giving you broad answers. Hopefully, that it still helps.

Philip Lee – Lazard Capital Markets

Great. Thank you.

Operator

Our next question comes from Paul Coster with JPMorgan. Please proceed.

Paul Coster – JPMorgan

Yes, thank you. Anson, I just want to make sure I understood, I'm sorry to keep going back to this question, but the margin, are you saying that they would have been the same as the fiscal third quarter but for the write-off of the one-time items that you detailed? And then, looking forward, okay, so I get it, the first quarter you got some risks associated with BSI-2 and the cost structure is greater. Can you talk us through what though the target gross margins are for that product, say, two or three quarters out from now?

Anson Chan

Okay. First of all, about Q4, the answer is yes. Actually, if you were to -- I'm not saying everyone should do that, but if you were to try to pro forma out the [82 effect I talked about], meaning the revenues from the sale of previously [written down] parts and additional inventory reserves, you get to something very, very comparable to our Q3. And the reason is we just don't really have a whole lot of shipment of brand new SKUs yet, so, any potential yield risks or whatnot simply will not run its way through our P&L yet.

So that dovetails into the second part of the question which is about Q1. I don’t normally quantify gross margins, I’ll stick with that. But needless to say though, we do not believe margins will all of a sudden recover to historical high levels, hence, in the prepared remarks I said that gross margins will remain depressed. And a lot of that I will attribute to BSI-2. I won't say it's all because of yield though, it's simply because the part is complicated and so there are a lot of effecting steps involved. And our whole supply chain also, they have new equipment and whatnot.

So, all in all the cost structure is high, and so we have to work with our supply chain, we have to improve the yield ourselves and so forth, before we can have a more favorable cost structure for this particular product. And which doesn’t really help because we are also in fiscal '13 going through a significant transition. More of our premium products will be in the form of BSI-2. So, just kind of push us to work even harder and try to get to a better result. But we will take time; will take at least a few quarters.

Paul Coster – JPMorgan

Okay. My last question is, you previously peaked at revenues in the 260 to sort of 280 range and now you are ramping on BSI-2. Do you think those kinds of revenues can be achieved again? I mean, in short, are we really at the very early stage of these next-generation products, or do you feel like you’re very quickly going to get back to sort of peak levels? In other words, are we already back at peak levels?

Ray Cisneros

Hi, this is Ray Cisneros. I think not getting into specifics of what we can say about going forward type of financials, what I could tell you is that we are having a good mix of products that are ramping up right now for a variety of applications and customers, and it's the kind of trend that we like to see. Hopefully, our guidance that we've given you is in the right direction for our fiscal Q1, and then when we come back in one quarter from now, we'll see what the numbers are. But what we can say is we’ve got a good mix of products coming forward and hopefully that spells good things for OmniVision.

Paul Coster – JPMorgan

Okay. Thanks.

Operator Our next question comes from Raji Gill wiht Needham & Co. Please proceed.

Raji Gill – Needham & Co.

Yes, thanks. So, just have a question going back on the gross margin. You mentioned that the gross margin is being depressed mainly because of the high cost structure associated with BSI-2. I'm just trying to get a better understanding of that. BSI-2 has been around for, I would say, almost two years. You have been shifting BSI-2 in other areas. So, just why is it so complex that that's creating such a high cost structure since it’s been around for a while?

Hasan Gadjali

Okay. Well, the pixel architecture, you can say that’s been around, but we are putting through in different kind of SKUs as well. As Ray has kind of mentioned earlier, we have a lot of new products lined up for this particular structure. So as we go to the production cycle, some of these costs are now coming through in terms of expanded capacity, new equipment that our vendors have to procure and so forth.

So, all in all it does result in a higher cost. Not to mention, any time we ramp a new product, be it FSI and BSI-1, in initial ramping stage, first two to three quarters, the yield will be less than optimal. And then all of these will result in a net inflation of the cost.

Raji Gill – Needham & Co.

So, for my follow-up question, Ray, you had mentioned that you’re seeing a good ramp up 8 megapixel product. Could you may be describe whether that’s through just demand being pulled in or share gains or maybe you could elaborate further on what you’re seeing on the 8 megapixel front?

Ray Cisneros

Yeah. What we have here, I think there’s a summer seasonality that we're in the middle of. I think some of our customers might be experiencing a very good summer, and so we're happy to beat back into their business, and there is a good assortment of customers we have like this. What it does is for the growth in terms of our revenues, it backs in nicely to the trend we'll have in our financials. A lot of this goes back into the smartphone category, I could say that. So we're extremely pleased with that.

Operator

Our next question comes from Harsh Kumar with Stephens. Please proceed.

Harsh Kumar – Stephens, Inc.

Hey, guys. Sorry to go back to BSI-2, and I apologize, I missed part of the call, apologize if you've already addressed this, but can you give us an idea of how much of your revenue comes from BSI-2? And also the big ramp, is it happening in one particular product or many products across the board? And how big is BSI-2 for you from the quarter you ended to the quarter you’re going to, to cause this kind of a disruption in margins?

Ray Cisneros

I'll take a swag at your question and maybe Anson might make some comments after me. We’re not -- we don't ever break down the portions of our revenue, how it backs into certain technologies. But it is another wave of BSI-2 products that we have to roll out to the marketplace that our customers are locked in and working with us to move into mass production. And it is a mix of a variety of products, and the spread will be sequential going in from Q1 and then beyond the next couple of quarters of peaking.

And so, from the trend standpoint, volume standpoint, and hopefully maintaining our momentum going forward as we have in our prepared commentary from a top line, that's how the BSI-2 looks for us. I don't know, Anson, if you have any --

Anson Chan

Yeah, just a quick comment on just related to Ray's comment on the margin as well. As we continue to have an increase in mix towards BSI-2, obviously the company, we have to work even harder to make sure that our margin will find us opportunity to expand. I just want to reiterate the fact that it's going to take us some time, so, maybe fiscal '13 is the year that we need to work hard to find a way to bring down the cost structure and work on the yield.

Harsh Kumar – Stephens, Inc.

Okay, that’s very helpful. Thanks, guys. And then, as a follow-up, can I ask you, as you look across the rest of the year, and there's three or four major markets you're participating from an end-market standpoint, which one do you think will be your fastest-growing end-market with all the products you have, new products that are hitting the marketplace?

Ray Cisneros

Hi, this is Ray Cisneros again. Obviously, we don't know everything that our products back into our customers because that remains confidential from our customers to us, and then obviously any information we hold, we can't break out in any more granularity. But we can say that the consumer markets are the biggest markets that we serve. We have served that kind of space historically and I don't see that changing anytime soon. Obviously, we could assume many of these products are in the wireless and handheld type of devices, and that, even that's a broad category because that could be anything from a handset to some kind of multimedia device. But those are the kind of broad general markets quite a number of our new products will be backing into, and hopefully they’re exciting products for our customers and backs into nice results for us.

Harsh Kumar – Stephens, Inc.

Got it, Ray. I was wondering if I could take another shot at maybe a similar question. Would you be willing to rank the growth of your end-markets by cell phones, entertainment, etc., etc.?

Ray Cisneros

Right. Yeah, that’s going to be hard to do from this perspective because, as I mentioned, it's not always clear to us how our customers will be utilizing our end-products. But it's our assumptions it's going to be in the consumer space and in wireless type devices.

Harsh Kumar – Stephens, Inc.

Fair enough, guys. Thank you.

Operator

Our next question comes from Hans Mosesmann with Raymond James.

Brian Peterson – Raymond James

Hi, this is Brian Peterson in for Hans. Just I was wondering how much the inventory build this quarter was related to the BSI-2 products and how much would you say is related to either more legacy products?

Hasan Gadjali

I'll try that. I think in my prepared remarks I did mention that for some of the old inventories we’ve been doing a really good job in bringing it down. So I would say we are -- if we have to pro forma out of the BSI-2 devices, we are pretty close to our long-term target of 4 to 5 turns type benchmarks. So we’ve been building up quite a -- the rest of it basically represents the new inventory that we are building to stock in preparation for customers’ order ramps.

Brian Peterson – Raymond James

So, should I interpret that to mean that we shouldn't see any material inventory write-downs over the next couple of quarters?

Hasan Gadjali

It's hard for me to predict inventory write-downs. As I’ve mentioned in previous calls, it's literally a quarter-end exercise. A lot of that are dependent on a SKU-by-SKU basis, what those 12-month outlooks will be for those SKUs. So, there will be another assessment by the time we get to the end of first fiscal quarter. But with that said, given what I just mentioned that we did a pretty good job in bringing down old inventories (inaudible) there's probably a less chance for us to have higher inventory [charge].

Brian Peterson – Raymond James

Okay, that’s helpful. And just one more for me, is there any architectural or competitive advantage for BSI-2 that you guys think is sustainable? Thanks.

Hasan Gadjali

Well, from a generic sense, BSI-2 represents another platform of technology for OmniVision, it's going from 8-inch wafers to 12-inch wafers, from aluminum metallization to copper mobilization, and more aggressive design rules for that technology. So there are significant architectural advantages utilizing BSI-2. And it also represents a multi-generation type platform that we could -- we can utilize going forward as compared to the 8-inch type technology wafers. But on the whole, OmniVision will be using a broad mix of both the FSI BSI-1 and BSI-2.

Operator

Your next question comes from Betsy Van Hees with Wedbush Securities. Please proceed.

Betsy Van Hees – Wedbush Securities

Thanks for taking my questions, and good afternoon everybody. I was wondering if we could go back to BSI-2. So, if I remember correctly last summer, and you guys were talking about BSI-2 and talking about your expertise in being able to resolve problems quickly, and here we are today and we’re talking about -- and Anson I thought I remember you having [the caveat] here about the concerns that you have in terms of yield losses as you’re producing these products. So I was wondering if you could talk about what’s different between last summer and this summer -- I mean, well, yeah, it’s actually last summer and this summer, in terms of your concerns on ramping BSI-2?

Anson Chan

I'll try that, maybe Ray can help me out little bit as well. Last summer it was literally the first mass production part that we’re trying to put out, so it’s a lot of things for us and our supply chain partners to learn in the production process. This time around, yes, going back to my cautionary comment that I made earlier, it has to do with more like in general type concept whereby when we start a production ramp, particularly in the high volume for any particular products, the yield projections that we're putting in and the margin estimates, cost estimates for the whole quarters, may not be reliable because we don't have a whole lot of statistical data for those parts yet.

So that's why I put a comment that, okay, there can be some unfavorable results coming off from the yield loss itself that we might not be taking into consideration appropriately as of this moment. So that's why I made that comment. So, it's little different in terms of the nature of the risks, I would say.

Betsy Van Hees – Wedbush Securities

Okay, thanks. That was very helpful. So I know you don't like to give forward guidance, but it just sounds like from a gross margin standpoint, that we’re looking at this range of gross margins throughout fiscal year '13. Is that sort of safe given all the caveats that you’re talking about?

Anson Chan

We generally do not go beyond the current quarter in terms of the guidance. So I'll just have to say that it will take us sometime to work through some of these cost issues that we have. The supply chain, they are going through a lot of new equipment and capacity expansion process. Everyone is learning putting something new in place, working through a lot of new additional steps to make these complicated parts.

So, a lot of complicated logistics we need to work through by our supply chain partners. Not to mention we need to continue to go through the production ramp to gain experience in producing these supplies in high volume so that we'll have the opportunity to bring down the -- increase the yield, so to speak.

Betsy Van Hees – Wedbush Securities

Thanks. And then last question, you had a nice bounce-back in the handset business. And was that related more to ASP or units or both -- did both come back?

Ray Cisneros

Let me just make sure the question you're asking, that you're asking how -- what was the effects or what effects contributed to the ASP pickup. If that's your question, as we mentioned in our prepared remarks, it was a favorable product mix resolution that improved our ASPs. As I mentioned in my prepared commentary, quite a bit of 5 megapixel improved for us in terms of volume shipments and then a slight steady increase in our prior quarter fiscal Q4 for the 8 megapixel. So those were the major contributors to the ASP step-up.

Betsy Van Hees – Wedbush Securities

So, is that across the board or -- the question I was asking was specifically for the mobile phones, Ray. Was ASP --

Ray Cisneros

I see.

Betsy Van Hees – Wedbush Securities

-- units, and if you could tell me which one contributed more to the balance, because it looks like it went up 18% quarter over quarter, had a nice move upward.

Ray Cisneros

Right. We had a good mix of 5 megapixel into the handset market as well as the entertainment market, and then most of the 8 megapixel backed into the handset market.

Betsy Van Hees – Wedbush Securities

Thanks. And I'm sorry, I do have one last question. Anson, if I missed this I apologize, but accounts payable seemed to go up quite a bit and I was wondering if you could tell us what happened there.

Anson Chan

It's basically related to what I said earlier about the building inventory to stock, specifically with BSI-2. As we build our inventory, a lot of the parts actually came through towards the end of the quarter. So in terms of paying our vendors, they’re not accepted due yet, and hence accounts payable increased.

Betsy Van Hees – Wedbush Securities

Okay. Thank you so much.

Operator

(Operator Instructions).

And our next question Raji Gill with Needham & Company.

Raji Gill – Needham & Co.

Yes. Just going back onto the gross margin issues, you -- I recall you mentioned similar things about yields that we didn’t -- that you didn’t have enough volume in order to have like -- to make a statistical analysis of the yields. So, I just don’t understand why you would -- why would you have faced the same issues on the yields if now volumes are starting to ramp pretty significantly? I mean you’ve gone through this process for nearly -- well over a year. You’ve been working with your foundry partner for well over a year on the second-generation sensor. So this seems very odd to me the level of concern going forward for BSI-2. I can understand the one-time items being resolved, the older inventory was not bought, that I understand, but your commentary about the BSI-2 issue doesn’t make really a lot of sense to me. So maybe if you could just elaborate further, that would be helpful.

Anson Chan

Okay. It's generally applicable for all the products, that we’re trying to say earlier -- I was trying to say earlier. It's not just pertaining to BSI-2. Any time we ramp the product, we will have this kind of yield risks.

Also for the BSI-2, specifically on this kind of architecture, I was trying to answer these questions earlier, that the BSI-2 device that we were dealing with last summer, it's not even the same device that we’re dealing with today. So, you are going to have design changes, you are going to have layout issues, production steps that are all a little different, and all these little differences that add up to a new process overall for our supply chain. And so, from that perspective, I just feel compelled to make that cautionary comment, to make sure that people understand why I made the comment earlier in the prepared remarks that the margin will remain depressed at least in the foreseeable quarter.

Raji Gill – Needham & Co.

Yeah, but if you remember, because of the yield issues or the production problems, there is share loss at a top customer. So, it seems like, you know, you’re attempting to kind of hedge yourself a bit, so I just want to get a better sense of how -- if you’re worried about that happening again?

Anson Chan

I'm not going to comment on anything about share loss or whatnot, but my cautionary comment has nothing to do with last year's event and whatnot. It's not something about worrying about the same thing again per se. It's just comment I want to make to make sure that the audience understand why when we said that the margin is remaining depressed, there is reason for it.

I also want to refocus everyone, it's not so much the yield issue that resulted in the lower margin. It's more the high cost structure for the current BSI-2 devices. And so we do have to work with our supply chain partners to bring down that cost. So, yield is more like a, in my mind, a secondary effect.

Raji Gill – Needham & Co.

Okay. Thank you for clarification.

Operator

Our next question comes from Tom Sepenzis with Northland Securities. Please proceed.

Tom Sepenzis – Northland Securities

Yeah, I just had a couple of housekeeping questions. One, what should we be using as a tax rate going forward?

Anson Chan

As we're going to the election year, we have to find out. But with that said though, based on the guidance, you know that the pretax income is not very high yet. And that's why I decided not to give you a rate; I just want to give you a dollar amount of $1 million to $2 million for first fiscal quarter. If the business turns out okay, all goes well, I think you can probably try to use a blended rate from fiscal '11 and fiscal '12 as a benchmark, if anything.

Tom Sepenzis – Northland Securities

Okay, great. Thank you. And in terms of the operating expenses, you had mentioned that you expect R&D and SG&A both to come up. Is that just kind of the normal run rate like we saw from Q3 to Q4 or are they going to come up higher than that?

Anson Chan

I think it's a fairly predictable ramp-up rate because we are still trying to come up with new products, new solutions to our customers. So we'll continue to have some headcount increases and whatnot. And we're also going to have some tape-outs and [RU] charges, what we used to call them. So these tend to be lumpy charges. So, anytime we put out a new design to our foundry, we'll have to pay for a tape-out, the [paper mask]. And so they do create lumpiness in R&D.

So if you’re talking about from a perspective about modeling, you can use Q3 to Q4 type ramp if you want to. But I’d just caution you that there may be some lumpiness when we report the actual results by Q1, particularly in R&D.

Tom Sepenzis – Northland Securities

Okay, but not like a $4 million jump or something, just something along the same lines since last quarter?

Anson Chan

Yeah. Probably not something that exceeds like 10% increase like the way you seem to imply.

Tom Sepenzis – Northland Securities

Great. Thank you. And can you just talk a little bit more about the CameraCube opportunity? You said that it's now in full production for phones. So I just was wondering if you could clarify maybe where you might see that going in and if that will compete at all with BSI-2, or how you see that market emerging?

Ray Cisneros

Hi, this is Ray Cisneros. Yeah, we’re extremely pleased with the traction our CameraCube product is taking on. Most of the business is backing into I would say mainstream high-volume smartphone type of devices, as well as feature phone, the remaining feature phone market that's out there in the Far East. Some of these Far East players do show up in Western countries, in Europe and particular. And so what's going on is the use of the CameraCube product is finally, I think, taking hold of its advantages in terms of manufacturability and form factors. So when you look at a CameraCube, it's primarily used for self-view -- the self-view camera and the ability to be able to mass-produce that quickly, cheaply, and then also fill in a form factor that is extremely small, that's where the opportunity is being found.

Tom Sepenzis – Northland Securities

Great. Thank you. Anc can you just talk a little bit about maybe what a couple of the top costs are in the cost structure for the BSI-2 that is contributing to the margin pressure?

Anson Chan

I think our cost structure will follow any other semiconductor company’s. Most of the costs going to wafers, and in the backend services, it's naturally a smaller portion of it. I have to leave it at that.

Tom Sepenzis – Northland Securities

Does it have to do with constraints from anywhere, or is it just -- what is the issue on the wafers?

Anson Chan

The constraint is in the form of we need time for our supply chain partners to ramp up capacity, and the capacity ramp-up schedule is a little different than when our customers need the products. So that's why I mentioned in the prepared remarks earlier that we just have to at this point build inventory to stock, so that we can meet those demand requirements from our customers.

Tom Sepenzis – Northland Securities

Okay. Thank you very much.

Operator

(Operator Instructions).

Our next question is from Harsh Kumar with Stephens. Please proceed.

Harsh Kumar – Stephens, Inc.

If you can just take us back to your experience with BSI-1 the broad-based transition that happened, give us a sense maybe of who many quarters or what it took from a timing angle to get the yields under control and what might be different this time, just trying to get a handle on this issue still?

Anson Chan

I think just to go back to the yield question, I would say at this point, I personally don't have a whole lot of visibility. But I'd say if you have to go back to the historical type experience, maybe two to three quarters. But again, I want to reiterate the fact that yield, it’s only the secondary effect. We have to pay our vendors through their whole cost structure and we have to work through that first.

Operator

And our last question comes from Paul Coster with JPMorgan. Please proceed.

Paul Coster – JPMorgan

Sorry, we’re all pretty confused here. It sounds to me like there’s something structurally different about these new products from BSI-2 in terms of the supply chain that cannot be fixed by you. It's very seldom I’ve heard a company talk about introducing a new product, where initially the cost structure is inevitably high, but through engineering and other efficiencies they eventually bring the cost structure down and also benefit from scale. And yet you seem to be denying that possibility, or at least denying it in the near-term. Is there something completely structurally different here? Does it require you to ultimately integrate your supply chain vertically in order to solve the problem? Do you have to build your own backend test and packaging in order to solve this problem?

Anson Chan

It is fundamentally different, because this is 12-inch versus 8-inch, so our entire supply chain, they have to -- particularly when this time when we have to increase capacity upon -- to bring in new equipment. So, everyone has to go through the whole depreciation process and so forth and recover all the investment. And that's what we have to work through with our supply chain partners within the next couple of quarters.

Product integration in the form of packaging and whatnot will not really solve per se the cost problem, but it will give us the opportunities to go into newer markets. So, a good example would be CameraCubeChip itself, right? By vertically integrating, meaning we put on the lines ourselves, gives us an opportunity to make small form factor ready-made cameras, so we can attack some market, as Ray mentioned earlier about the front-facing camera and so forth. So these are new opportunities. I won't see that these are the cost reduction strategies, we have more like product line expansion type strategy.

Operator

At this time there are no questions queued. I would like to hand it back Mary McGowan.

Mary McGowan

Thank you for joining us on this call and webcast. We anticipate holding our first quarter fiscal 2013 conference call on Thursday August 30, 2012. Thank you and good day.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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