OmniVision Technologies Inc. F4Q08 (Qtr End 04/30/08) Earnings Call Transcript

OmniVision Technologies Inc. (NASDAQ:OVTI)

F4Q08 Earnings Call

May 29, 2008 5:00 pm ET

Executives

Shaw Hong – President and Chief Executive Officer

Peter V. Leigh – Chief Financial Officer

Ray Cisneros – Vice President, Sales

Bruce J. Weyer – Vice President, Marketing

Steven Horwitz – Director, Investor Relations

Analysts

Tayyib Shah – Longbow Research

Richard Price – Jefferies & Co.

Paul Coster – J.P. Morgan

Yair Reiner – Oppenheimer

Hans Mosesmann – Raymond James

Quinn Bolton – Needham & Co.

Amit Kapur – Piper Jaffray

Doug Freedman – American Technology Research

Tristan Gerra - Robert W. Baird & Co., Inc.

Operator

Welcome to the 2008 Fourth Quarter OmniVision Technology earnings conference call. (Operator Instructions) I would now like to introduce your host for today’s call, Steven Horwitz, Director of Investor Relations.

Steven Horwitz

Good afternoon everyone and welcome to our Fiscal 2008 Fourth Quarter and Year End Earnings Conference Call. After the market closed today, OmniVision issued an earnings release reporting our financial results for our fourth quarter. You can access this release from the investor relations section of our website at www.ovt.com. You may be advised that this call is being webcast live and is also being recorded for playback purposes. An archive of the call will be made available for 12 months. Both the live webcast and replay can also be accessed from the OmniVision investor relations website.

Before we get started, I want to emphasize that some of the information discussed in this call, particularly our revenues and earnings targets and our forward-looking product plans is based on information as of today, May 29, 2008, and contains forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those set forth in such statements.

For discussion of these risks and uncertainties, you should review the forward-looking statements disclosure in the earnings press release we issued today as well as OmniVision’s SEC filings including our annual report on Form 10-K for fiscal year 2007 and our quarterly reports on Form 10-Q and other reports filed from time to time. During this call, we will discuss GAAP and non-GAAP financial measures. A reconciliation between the two is available in our earnings release posted on our website. I will now turn the call over to OmniVision’s President and Chief Executive Officer, Mr. Shaw Hong. Shaw?

Shaw Hong

Thank you Steven, and welcome everybody to our fiscal 2008 year-end conference call. Joining me today are Peter Leigh our CFO, Ray Cisneros our VP of Sales, and Bruce Weyer our VP of Marketing. We have revised a format of today’s call so that you can hear directly from other members of our management team. I will begin with an overview on results for the quarter and for the fiscal year, and how I see the company’s overall position. Ray will follow with a review from a sales perspective. Bruce will talk about our market, our opportunities, and how our technologies are evolving. Peter will then provide you with the financial details of our fiscal fourth quarter and our outlook for the first quarter of the new fiscal year. We will conclude as usual by answering as many of your questions as time permits.

Our fourth quarter revenues turned out to be somewhat weaker than we expected when we gave you our outlook on our last conference call. Revenues were $169 million, just slightly under the low end of our guidance. We will give you more details on the top-line later in our presentation. Our GAAP earnings were 17 cents per dollar this year. Our non-GAAP earnings were 27 cents per dollar this year, and we have returned about $75 million to our stockholders through the re-purchase of 4.4 million shares. Taken as a whole, fiscal 2008 was a very good year for OmniVision. In particular, our revenues in fiscal ’08 were a record $800 million, a 50% increase over fiscal 2007. Our GAAP earnings were $1.19 per dollar this year. Our non-GAAP earnings were a record $1.69 per dollar this year. Our cash and short-term investments at year-end remains strong totaling about $269 million.

We were honored as one of the 500 fastest growing companies in the United States, and more importantly, we are one of the only 10 companies in the entire United States to be on this list for seven consecutive years. As we begin our 14th year in business and our 9th year as a public company, I want to take a step back from the day-to-day issues and share with you my perspective of where we are now and where we are heading. Along with a small group of dedicated pioneers we founded this company in 1995 to make the CMOS image sensors the cost effective alternative to CCD. From the beginning, our principal goal was to be the largest supplier of CMOS image sensors to mass markets and make money doing so. In the process, we not only created an entirely new product. We also developed entirely new markets for the product itself. For example, when we first started shifting images sensors to mobile phone producers, most projections were that only 20% of mobile phones would have a camera on board. This year, projections are that 80% of mobile phones will have at least one camera on board and only 20% will not. And going forward, we expect that the 80% number will grow even larger and many phones will include secondary cameras. From the beginning, our goal has been to share our products in large volumes at competitive prices. Our success in achieving this goal depends on three key elements. First and foremost is our technology. We succeeded in continuously shrinking the size of the pixel while at the same time increasing its sensitivity and improving the signal to noise ratio. One of our latest architectures, OmniPixel3-HS or high sensitivity has increased our pixel sensitivity deep over our competitors and ensures what we can do to distinguish our products from a technology standpoint.

Two days ago, we introduced to you the next revolution in CMOS image sensors. OmniBSI technology is in my estimation the most important event since the invention of active pixel CMOS image sensors in the mid 1990s. This technology is based on an idea called backside illumination or BSI. Our current CMOS image sensors capture light on the front side of the chip, so the photosensitive portion has to share the surface of the sensor with the metal surface that converts photons into electrons. With our new OmniBSI architecture, the sensor received light through the backside of the chip. Not only does this enable us to produce a superior image, it also allows us more chip surface area for processing resulting in more functionality. Our new architecture represents a major advance over X-SIM technology and will further widen the gap between our products and those of the competition. Bruce will expand on this in a few minutes.

The second key element in achieving our goal is our ability to create and manage a comprehensive pricing. Our operations people have worked continuously to improve our processes and improve our yields. In this ongoing effort, we have been fortunate to develop an outstanding relationship with TSMC, and I want to take this opportunity to probably today acknowledge the contributions that TSMC had made and continues to make to our success. They are our outstanding partners in every sense of the word. The third element is our ability to anticipate new applications and new markets for our image sensors. For example, our high market share in notebooks is the direct result of the fact that we identified the opportunity and recognized that optimum product for notebooks needed to be a thin or even thinner than the product used in a mobile phone, but here’s the important point; this also needed to operate well in low light conditions. So, we developed a family of products for the market such that today it provides the image sensors to eight of the top 10 notebook makers. Bruce will have more to say about the ways in which we are developing our products to create and meet the needs of our unused markets – automotive and medical. My point is a broader one. An important part of our success comes from our ability not only to create products but also to create markets for those products to serve. When you create markets with high growth opportunities, you attract many competitors both large and small. Throughout the year, we have been very successful against very large competitors and we have been very successful against small competitors. Our identity to be a technology leader, to develop high-quality products, to deliver mass quantities, and to provide world-class service to our costumers has made us the largest provider of CMOS image sensors today. With that, let me turn the podium over to Ray who will tell you how we see things on the sales front. Ray?

Ray Cisneros

Thank you Shaw. Fiscal 2008 has been a very good year for OmniVision. We have worked diligently to reach our goal of being the largest supplier of CMOS image sensors through mass markets that we serve and to do so profitably. Going forward, we look to expand our position within these markets. We sold about 91 million units during the quarter and we sold a record of over 425 million units for the full year which represents 70% more units than we shipped in the fiscal 2007. And as Shaw mentioned, these units resulted in over 50% revenue growth for the full year. These numbers are the direct result of many designs wins we secured by our products throughout our portfolio. During the year, we increased our share with the Tier 1 mobile phone suppliers. We positioned ourselves well with the top-level notebook makers and we continued to expand our presence in the markets served by the rest of our emerging products. Our fiscal fourth quarter was a relatively challenging one. However, we shouldn’t lose sight of the fact that this April quarter’s revenue was more than 40% higher than the April quarter revenues from last year. The beginning of the calendar year is typically the weaker time for the mobile phone market, both for tier 1 players as well as the China mobile phone market and this year was no different. In addition, the demand environment was impacted by the beginning of the quarter with excess inventory downstream in the channel. We believe at that time that this excess inventory would be worked through during the course of our fiscal quarter, and at this point, our information indicates that inventory has returned to normal levels throughout the mobile phones supply chain.

Going forward, we are seeing encouraging signs from our customers that business should pick up for the second half of this calendar year. Current design wins for our 2- and 3-megapixel and the UVGA sensor are doing well. Shipments of our 3-megapixel sensors have already begun in small volumes and we expect these products will ramp higher through the October and January quarters. We have secured an impressive array of 3 megapixel design wins over the last several months that we believe will result in a relative product mix shifting more towards higher resolutions. In the fourth quarter, just over 60% of our revenues came from mobile phones and just under 40% from emerging products. As for the unit mix in the quarter, VGA and below was just over 65%, 1.3 megapixel was just below 15% and 2 megapixel and above was just below 20%. The mix shift towards higher resolutions during the quarter as two mega pixels and above sensors experiences a small uptick while weakness in China led to a meaningful downtick VGA shipments. As mobile phone makers focus on selling phones with higher resolution sensors, we believe that our 3 megapixel will begin to play a larger role in our business as it begins to ramp through the balance of the year.

During the quarter, the blended ASP for our products was $1.83. This 10-cent increase from the prior quarter was a direct result of the mix shift towards higher resolutions offset by an increased price competition in our VGA business in China. As Shaw mentioned, we have encountered this type of competition before and have always prevailed. In fact, we have already introduced a product that we believe effectively addresses this issue. The 1/13th of an inch VGA sensor that we introduced earlier this year at 3GSM should begin shipping later in the July quarter and ramp into the October quarter. Not only does this sensor allow us to provide our customers with a smaller product, but it incorporates our high sensitivity architecture thereby bringing cutting-edge product differentiation to the VGA market. We are always striving to bring value to the customers both in providing cost effective products and the highest quality sensors. We believe that we offered a highest performance to cost ratio in the industry.

Shaw Hong

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

Bruce Weyer

Thank you Shaw. I want to begin by expanding on the benefits of our revolutionary new OmniBSI architecture mentioned earlier by Shaw. There are two major trends in the camera market we serve – the desire for higher resolutions and the desire for improved image quality at all resolutions. Our OmniBSI architecture enables design shrinks from 1.75 micron down to 0.9-micron pixels thus allowing us to continuously provide higher resolution sensors. Additionally, BSI technology offers significant improvements in image quality. Not surprisingly as the pixel size shrinks, the area collecting light shrinks as well. In fact, 1.4-micron pixel has a photosensitive area that is less than two-thirds of that of the 1.75-micron pixel. This makes it very difficult for the pixel to operate well in low light environments. By capturing the light on the backside, the way for the light capturing constraints caused by multiple layers of metal is eliminated. In fact, you can more than double a photosensitive area because there is no metal to block the light thus considerably improving images especially in low light conditions. In addition to improving the amount of light the sensor can collect, our OmniBSI architecture significantly improves our quantum efficiency and reduces cross talk. Quantum efficiency measures the sensors’ effectiveness in color reproduction. Sensors with reduced cross talk or noise produce sharper images and better color. Basically, our customers’ cameras can deliver sharper images across broader lighting conditions with more vibrant true-to-life colors. Additionally, we have the advantage of capturing light from the backside in that we reduce the distance the light has to travel to the sensor and thus provide a wider angle of light acceptance which in turn makes this possible to reduce the height of the product. This obviously allows mobile phone makers to design even thinner phones. Over the past month, we have been demonstrating our initial products – an 8-megapixel sensor based on our 1.4-micron OmniBSI architecture to key customers and partners. We plan to begin sampling this product before the end of June, which should enable our customers to introduce products in the marketplace in 2009.

Going forward, we will also apply this groundbreaking technology to larger pixel sizes, 1.75 micron and above, bringing the improvements to our entire product line. In addition to technology leadership, superior product planning and development are key ingredients in our success as a company. Let me elaborate further on what is going on in the markets we serve. As you know, our largest single market is the mobile phone business. Over the last 90 days, you’ve heard from all the major mobile phone makers and in general that the results were a bit lower than somewhat expected. Obviously, we have felt the same impact as our customers have. What’s interesting is that none of the mobile phone makers reduced their unit volume estimates for the year as a whole, and as Ray mentioned, we have seen some encouraging signs indicating that the market should see fairly nice growth in the second half of the calendar year. Based on this information, we continue to expect that the mobile phone market will reach the approximate 1.25 billion units that the tier 1 suppliers have predicted at the beginning of the year. Keep in mind that we believe that about 80% of these phones will have at least one camera on them and dual-sensor phones will increase our addressable market size above that. Mobile phone makers are continuing to focus on providing higher resolution cameras on their phones. In addition to the 8-megapixel sensor that we will be sampling to customers beginning next month, we recently began shipping our first 5-megapixel sensor that is targeted towards mobile phones. We used a 1.75-micron high-sensitivity pixel for this 5-megapixel sensor which enabled best-in-class low light performance. Over the past 6 months, we have introduced VGA 3 megapixel, 5 megapixel, and higher definition products leveraging this pixel technology that doubles our sensitivity relative to prior product offerings.

The second biggest driver of revenue today is our notebook business. During the quarter, we secured another tier 1 design win which will be the sole supplier of images sensors demonstrating that customers appreciate the differentiation of a broad product portfolio targeted at this market. One of our key products for notebooks and webcams is our high-definition 1.3-megapixel sensor. It allows users to create high-definition video without requiring them to crop or scale the picture. Additionally, the functionality of this sensor has been tailored to user-created content applications, most common of which is posting video on media-based websites. We are pleased to report that the aggressive marketing of notebooks should approximately double this calendar year, incorporating sensors all the way up to 3 megapixel resolutions.

In the security market, customers are continuing to move away from CC images sensors and towards CMOS sensors because of the high quality, low cost, and easy to incorporate characteristics. IP network cameras are increasing in popularity both at home and in the office. These cameras allow you to view a desired area from anywhere in the world. IP network cameras represent a nice growth opportunity within security. We have many reference designs using a high quality VGA sensor, and we have been receiving good feedback from our customers regarding the same high-definition 1.3-megapixel sensor utilizing for the notebook market. One of the two newer markets that we are aggressively developing is automotives. Over the past few years, we’ve worked diligently to align ourselves with top-tier automotive component suppliers as well as the automobile makers. We believe that our hard work is paying off. We now have design wins and additional projects in evaluation for approximately a dozen applications, many of which require multiple sensors. We are well positioned for this potentially huge market because we are providing our customers with the best high dynamic range, low light sensitivity color sensors in the business. The other market we are aggressively developing is the medical market. For many applications, our medical image sensors are single use products, and as a result, the potential size of this market can also be fairly large. With a very small 1/18th of an inch sensor, we sparked the interest of medical device companies looking to further develop products for use in colonoscopy, intubation, cardiovascular surgery, urology, OB/GYN, ear, nose, and throat, and gastrointestinal procedures. During the fourth quarter, we secured more design wins with tier 1 endoscopic companies. We believe this market is really beginning to take shape.

Shaw Hong

Thank you Bruce. I would now like to turn the call over to Peter to discuss our financial performance. Peter?

Peter V. Leigh

Thank you Shaw and good afternoon everyone. For the fourth quarter of fiscal 2008 which ended April 30, 2008, OmniVision is reporting revenues of $169 million, down 25% sequentially, but up 42% on a year-over-year basis. Direct sales to original equipment manufacturers and value-added re-sellers accounted for approximately 65% of revenues in the fourth quarter of fiscal 2008 while about 35% came from sales through distributors. Gross margins of the fourth quarter were 27.2% compared to 27.1% last quarter. Excluding stock-based compensation expense of $697,000 included in cost of goods sold, gross margin was 27.7%, up slightly from the 27.5% we reported in the third quarter. I think it is worth noting that in a fabulous business model such as ours, gross margin is not volume dependent in the way it is typically for an IDM. R&D expense in the fourth quarter was $21.6 million, up from $20.1 million last quarter. R&D expense this quarter includes approximately $2.7 million of stock-based compensation expense. Excluding stock-based compensation expense, R&D in the quarter was $18.9 million compared to $16.5 million in the prior quarter. The main contributor to the increase in R&D expense was the $1.5 million increase in NRE expense principally relating to the release of additional mass designs to TSMC.

SG&A expenses in the quarter totaled $15.7 million, essentially flat from $15.6 million in the prior quarter. Our SG&A expense include approximately $2.7 million of stock-based compensation expense. Excluding stock-based compensation expense, SG&A in the quarter was $13 million, up about $0.5 million quarter over quarter. Our GAAP operating income in the quarter was $8.7 million. Excluding stock-based compensation, operating income was $14.8 million. Our GAAP pre-tax earnings in the fourth quarter were $11.2 million. Excluding stock-based compensation, pre-tax earnings were $17.3 million. Our GAAP tax rate in the quarter was 19%. When we exclude stock-based compensation expense, our non-GAAP tax rate was 17.9%. Our annual GAAP tax rate was 14.5% and our annual non-GAAP tax rate was 9.2%. Our tax expense in the quarter includes approximately $1.5 million of foreign exchange expense equivalent to 3 cents per share related to the reevaluation of reserves we have for tax liabilities in overseas jurisdictions. Going forward, we believe that our non-GAAP tax rate will be in the low double digits. Please note that our tax rate will be similarly impacted either positively or negatively by exchange rate fluctuations which are of course entirely independent of the performance of the business in any particular period.

Our GAAP net income in the fourth quarter was $9.1 million or 17 cents per diluted share compared to net income of $22.5 million or 40 cents per diluted share in the previous quarter. Net loss in the fourth quarter of last year was $1.5 million or 3 cents per share. Our results for the fourth quarter fiscal 2008 included $5.2 million of non-cash stock-based compensation expense and related tax effects under SFAS 123R. Excluding stock-based compensation expense, non-GAAP net income was $14.3 million or 27 cents per diluted share. This compares to non-GAAP net income in the fourth quarter fiscal 2007 excluding $4.6 million of stock-based compensation expense and related tax effects of $3.1 million or 6 cents per diluted share. As Shaw and Ray have already said, this quarter was more difficult than we expected, but for the longer term, we are exceptionally well positioned. The markets we serve are large and growing and we have the products to serve them.

Let me now turn to the balance sheet which remains in excellent shape. The company ended the fourth quarter with cash, cash equivalents, and short-term investments totaling $269.3 million. All these funds are invested in highly marketable, highly liquid securities, and we do not hold any auction rate or other reset securities which continue to be impacted by the current unsettled conditions in global credit markets. The decrease in cash from the previous quarter was principally due to the repurchase of $74.7 million of the company’s common stock. The average price of the repurchase was $16.9 per share allowing us to repurchase 4.4 million shares. Accounts receivable at quarter end net of allowances was $105.3 million, up $13.8 million from the last quarter. Our day sales outstanding were 56 days. You will recall that I said that maintaining day sales in the upper 30s was likely not sustainable, and the principal reason for the increase in DSOs is that our sales this quarter were even more concentrated in the final month of the quarter than normal. Aside from that and with the exception of one customer whose payments are currently slow, our receivables remain in good shape. At April 30, 2008, inventory was $115.1 million compared to $121.7 million on January 31. Quarter end inventory represented 84-day sales, which is equivalent to annual inventory turns of 4.3 times. Our goal remains for inventory to be in the range of 75 to 90 days equivalent to annual turns of four to five times and we are comfortable with the level of inventory we currently have.

I’d like to turn now to the outlook for the first quarter of fiscal 2009 which will end on July 31, 2008. We currently expect first quarter revenues will be in the range of $170 to $190 million. This should translate to GAAP earnings of between 14 and 27 cents per diluted share. Excluding the estimated expense and related tax effects associated with stock-based compensation in accordance with FSAS 123R, we expect non-GAAP earnings will be in the range of 27 cents to 40 cents per diluted share. Looking out beyond the first quarter to the balance of the calendar year, as Ray indicated, we are cautiously optimistic that based on the design wins and product portfolio we already have, sales will increase in the second half. Overall, we are optimistic about the outlook for the balance of the calendar year. With that, I’ll turn the proceedings back to Shaw for some concluding comments.

Shaw Hong

Thank you Peter. I am aware that for investors the most important question is how we intend to build on our success going forward. Let me just say that I believe that in terms of technology, in terms of products and delivery, in terms of market opportunities, and most importantly, in terms of management talents, this company is better positioned than at any time in its history. Operator, we are now ready to take questions.

Question-And-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Tayyib Shah of Longbow Research. Go ahead.

Tayyib Shah – Longbow Research

Hi guys. There has been a new competitor out of Korea that has been taking share in the Chinese markets – in the past whenever we’ve discussed new competitors in the market, you have argued that it would be pretty difficult for a relative newcomer who doesn’t have a history of producing CMOS sensors to take significant share – I just wanted to ask what changed in the market that allowed a newcomer to take share and maybe pressurize the pricing as well.

Ray Cisneros

I don’t think there’s much change in terms of competition. We’ve seen a lot of competition in the course of the 12 years that we’ve been in business. On the other hand, what we mentioned today is the release in mass production of our new VGA – this is our original plan – to combat always the competition with new products. I agree that there is a flurry of influx in terms of Korean competitors coming in for the China market – on the other hand is our weapon which is unlike what they have is to release the next generation product – I don’t think they’ll be able to hit the type of pixel technologies that we will come in with even at the VGA level.

Tayyib Shah – Longbow Research

Okay, and then, your revenue momentum seems very closely tied to VGA – what needs to happen to get your 2-megapixel market share to a significantly higher level?

Ray Cisneros

I think overall we’re giving you pretty good comments on our position for higher resolution products. I could say this in addition to the 3 megapixel we also have new 2-megapixel design sockets won in the course of this past quarter that should be ramping up – in fact are ramping up – very significantly in this quarter and then taking off pretty good into the quarter thereafter. The mix, as you heard today, is shifting towards the higher resolution mix; granted that some of it was driven by the competition in the VGA market, but we do see a shift overall going to higher resolutions.

Operator

Your next question comes from the line of Adam Benjamin of Jefferies & Co. Go ahead.

Richard Price – Jefferies & Co.

Hi. This is Richard Price covering for Adam – can you talk about your OmniPixel3-VGA Solution and how you see that ramp throughout the rest of the year?

Bruce Weyer

Yeah. As Ray mentioned, we’ve got a new product technology coming out of VGA and it actually is leveraging this pixel technology, and the benefit of that pixel technology is that it significantly improves low light sensitivity, which is always important, and especially important for VGA sensors that might be used as secondary cameras because they’re usually used in video format – and this pixel technology does not increase die size and it does not impact or increase costs – in fact, we’re implementing in the 1/13th inch camera which is actually the smallest in the industry, and we think it positions us well to deliver a very good value point for that really competitive pricing market of VGA.

Peter V. Leigh

And just to give you a little background on the ramp-up plan, we do intend to release already some volume in June, bigger volume in July, and increasing thereafter of course in the fiscal Q2.

Richard Price – Jefferies & Co.

Alright, and on your 3 megapixel, previously you had commented that it would ramp somewhere to – or is better positioned than your 2 megapixel when that was released, is that still on track?

Peter V. Leigh

The 3 megapixel projects are still on track in regards to design socket wins and they’re still on track to release in second half of this year; so, we’re still looking forward to that.

Richard Price – Jefferies & Co.

Okay, can you give any color on the confidence – is that largely because of design wins you have – I’m assuming.

Peter V. Leigh

Of course, yeah – I mean, obviously we’re speaking from the standpoint of design wins, and to even give you more background, there are plenty of other design engagements that we’re currently tracking right now; if those come our way, that adds to the current stack-up of design wins we currently have today.

Richard Price – Jefferies & Co.

Okay, and then your 5-megapixel solution, can you give us any color on that one?

Peter V. Leigh

The 5-megapixel solution is currently being evaluated by key customers – I would say that the way it’s really driven is by the 1.75 OmniPixel3-HS. The customer base is very familiar with it now, and when they have the 5 megapixel coming into their hands in sample form, they already have the expectation of the image quality. Obviously, it is going to take a little bit of time to develop the actual design sockets engagement that could generate some revenue, but suffice it to say the pixel is the thing that is well known and the fact that it is in the 5-megapixel resolution, all the better.

Richard Price – Jefferies & Co.

Okay. Great. And on the gross margin side, can you comment on your inventory reserves – do you reserve more inventory or less this quarter than what you normally do?

Ray Cisneros

The reserves for excess and obsolete inventory demonstrated we are roughly equivalent to what they were in Q3, so $5.7 million and we did have about $1.2 million of revenue from previously reserved products.

Richard Price – Jefferies & Co.

Okay, so net impact is about 200 basis points again.

Ray Cisneros

Yes.

Richard Price – Jefferies & Co.

Okay, alright I’ll sieve the floor here and might cycle back through. Thank you.

Operator

Your next question comes from the line of Paul Coster of J.P. Morgan. Go ahead.

Paul Coster – J.P. Morgan

Yeah, thank you. I just want to make sure I got the approximate size of your share of the market right here on the handset side – just over 60% of total units were in the handset market representing about 55 million in total. Now, given the size of the market, it feels like you’ve lost at least 500 basis points of share sequentially – if you concur, is that order of magnitude and is it all in the VGA segment?

Bruce J. Weyer

Well, there’s a combination of effects. It’s hard for us to say that there’s any market share loss. I would venture to say it probably is not much of any at all. I think what you’re seeing is a reflection of – as we mentioned the seasonality in Asia and particularly in China, the seasonal slow quarter – and so, we’re just lock-and-step tracking with that market size as it consumes material in quarter by quarter.

Paul Coster – J.P. Morgan

Yet you are looking for overall growth in this market year on year pretty significant. Aren’t you? You are looking for it to go from 70% to 80% approximate penetration of a slightly larger market of 1.25 billion. The numbers we’re seeing this quarter and the next sequential quarter don’t seem to reconcile or am I wrong?

Bruce J. Weyer

In regards to our fiscal Q4 we just closed out and then how the numbers look in our fiscal Q1, what we’re seeing is in this current quarter, fiscal Q1, there is a temperate type of condition in the marketplace. Again, I would venture to say that we’re lock-and-step tracking with the size of the market. So, as the market expands, we’ll be expanding with it hopefully in the balance of the year. Our number that you interpreted as being our market share loss this quarter, there is argument to say that it’s just tracking with the size of the market quarter by quarter.

Paul Coster – J.P. Morgan

Is there some reason why this year the ramp in the industry will be more pronounced later in the year. What was the fundamental driver for that?

Peter V. Leigh

That’s a good question Paul, and I think the point that I think Bruce was highlighting is that all of the mobile phone companies had – I think I imagine saying – they all had slightly lower revenues in their first reported quarters than was expected and yet I think they all reiterated their forecasts for the whole year, and of course by definition since ours is [their on-demand] product, our volume must necessarily in the long run track with theirs. So to some extent – if I understood your question – the question is are they right? And we don’t know that for sure, but the fact that they all say the same thing gives you some suggestion that they will be. There doesn’t seem to be any disagreement amongst them even though each one of them has reported lower revenues.

Paul Coster – J.P. Morgan

Okay. Do you have any greater than 10% customers this quarter outside of your distribution?

Peter V. Leigh

I suspect we did. We typically only name them on an annual basis.

Paul Coster – J.P. Morgan

Okay. And then are there any shares left to repurchase and any funds left in your repurchase – I believe there are – in your program.

Peter V. Leigh

There are some funds left. I think the total is approximately $16 million.

Paul Coster – J.P. Morgan

Okay. Great. Thanks very much.

Operator

You next question comes from the line of Yair Reiner of Oppenheimer. Go ahead.

Yair Reiner – Oppenheimer

Yes. Thank you. A quick question on the BSI technology you spoke about earlier. Can you give us a sense of the cost relative to FSI and whether this is going to be used exclusively with the high-end 8 megapixel or is it just technology that over time you want to also migrate down to five, three, two, and maybe even VGA?

Bruce Weyer

The BSI technology is first being deployed at 1.4 micron and that technology node is an area where due to the size of the wavelength of light being 550 nanometers, to get that technology into 1.4 pixel technology, even competitors using front light illumination are going to have to go to a more aggressive technique to allow their products to actually absorb that light. And even though they go to aggressive techniques we believe the performance of their silicon will be much worse than BSI. So, the comparative price points should be very similar. The real benefit of the BSI technology is that whatever node we put the technology on we’ll get better performance at that technology node. So, we believe, as the market is now looking at higher resolutions which will require the shrink to 1.4 micron and beyond or those customers that are getting off the resolution path and getting into the higher image quality pack that this technology barely squarely puts us in a leadership position to deliver image quality leadership at all those points and also to deliver higher resolutions.

Yair Reiner – Oppenheimer

When do you expect to get the first feedback from some of your customers on the samples?

Bruce Weyer

We mentioned the fact that we’ve been demonstrating with an 8-megapixel product for the past month. We’ve actually been engaged with our customers for the last 6 months with earlier development for the technology and all the customers we engage with are very excited about the technology. So we’ll need to sample them – the 8-megapixel products – next month and move forward from there. 8-megapixel is an important note for them for their planning for 2009. We see a lot of interest in the product.

Yair Reiner – Oppenheimer

Okay. Do you see a risk here that 3 megapixel could just be not that significant in the marketplace and we see that there is a lot of momentum for one and two and increasingly a lot of momentum for five mega pixel? What’s the risk that 3 megapixel could just get jumped over in a large part as being too good for the low end and not quite enough resolution for the high end.

Ray Cisneros

Here’s a good way to look at this. Absolutely not the 3 megapixel would be jumped over. It definitely will be a very large part of the business in the handset market and one of the key ingredients that really defines that is the form factor. There have been so many ¼-inch 2-megapixel cameras built into handsets in the past 2 years that that form factor is the mainstay. So, the ¼-inch 3-megapixel basically backs into that. Then you cannot go into the 5 megapixel or 8 megapixel because all of a sudden the system architectures or handsets are questionable on how many handsets can really handle that much data flow. So the 3 megapixel in addition with its JPEG compression in ability it will basically be able to feed that market.

Yair Reiner – Oppenheimer

Okay. Thank you. That’s helpful. One other quick financial question. On the R&D front, were there – I think you mentioned some one-time factors in this quarter – should we expect R&D to ease off the first quarter.

Peter V. Leigh

No. There are no one-time factors. The point about the NRE is that they naturally fluctuate from quarter to quarter simply because they are driven by the number of designs that we release, and I think quite honestly that you have to look at this as the good expenditure because this is the heart of the business. Releasing more designs to the foundry is a necessary step in developing new products. So the fact that it goes up slightly over the quarter is a good thing. And whether it goes up or down quarter to quarter depends entirely on the results of all the efforts of our engineering people who as we speak are toiling away on yet more designs.

Yair Reiner – Oppenheimer

Great. Thank you very much.

Operator

[Operator instructions]. Your next question comes from the line of Hans Mosesmann of Raymond James. Go ahead.

Hans Mosesmann – Raymond James

Thanks. Peter, just on that question regarding OpEx or R&Ds, how should we look as a percentage of sales for the July quarter – OpEx in general – and also any commentary on gross margin would also be helpful. Thanks.

Peter V. Leigh

On the OpEx front, I have tried consistently to discourage people from modeling gross OpEx as a function of revenues because fundamentally OpEx doesn’t fluctuate in relation to revenues – not in this business. I think what you need to do is to model it as increasing modestly at some level probably on an annualized basis. Bear in mind that we control this expense ourselves very carefully and the key to expenses is headcount – expense walks on the backs of people – and if you are careful about the numbers of heads you add, then naturally you are going to control expense.

Hans Mosesmann – Raymond James

Right. And comments on the gross margin.

Peter V. Leigh

Gross margin – I think you know it will fluctuate a little bit from quarter to quarter. We still have a target of increasing gross margin, but I don’t see it moving substantially in the first quarter.

Hans Mosesmann – Raymond James

Okay. And then my follow-up – just quickly for Bruce on BSI – what are the technical barriers for the competition to do this? What kind of IP is involved here or what kind of a timeline do you have versus the competition to come out with something like this – I am assuming that they are working on this as well.

Bruce Weyer

Our assumption as well will be that the competition is working on BSI. This technology has been around for about 20 years, but it has only been deployed on very large pixels for military and aerospace type applications in a few [cities base]. The real revolution here is the fact that we’ve dramatically shrunk the technology down to 1.4 micron and beyond and that we’re planning on making it in hundreds of millions of units, and to mass produce that takes a lot of wherewithal and architectural expertise around that pixel to do that with great color reproduction and very low noise. We’ve been working on this technology for over 2 years with TSMC very closely and there has been a joint effort by us, and we think that has put us in a good leadership position versus the competition. There are a couple of competitors that talked a little bit about development of BSI. One competitor talked about demonstrating it earlier this year and the only demonstration was in black and white, which is much more common technology than trying to put it into color. So, we think that we’ve got a good leadership position in that we can leverage that into product leadership over the next 1 to 2 years.

Hans Mosesmann – Raymond James

Great. Thank you.

Operator

Your next question comes from Quinn Bolton of Needham & Co. Go ahead.

Quinn Bolton – Needham & Co.

Peter just wanted to follow up on that last question about the gross margin. If I take the mid points of your guidance that you talked about, it seems to me that the gross margin probably has to be up close to about 100 basis points to hit the mid point of the EPS range if you take the mid point of revenue guidance and you have to hold OpEx flat on a dollar basis. Is that the right range we should be thinking about?

Peter V. Leigh

Quinn, you’ve got a faster computer there obviously than I have in front of me now, but the fact is that you got to bear in mind that there are other things that affect our gross margin. For example, excess and obsolete inventory. And did I mention we had about $5 million of excess and obsolete this current – actually it’s more $5.7 million this quarter – we don’t expect the number to be quite that high next quarter, but you never know. We have to look at this when the time comes because this is, if anything, an extremely dynamic marketplace. So, I am not sure that I want to particularly validate your analysis. I think there are a variety of ways in which you get from the top-line to the bottom-line and to some extent this is a little bit like a late night to the bar – you choose your own poison.

Quinn Bolton – Needham & Co.

Okay. But I guess maybe then your comment about the – you have had relatively high inventory charges or obviously product charges in the last couple of quarters – I think you said $5.7 million each in the last 3 quarters – you don’t expect that to be a level that continues – you think that that’s sort of higher than what you would call normal for a typical period. Is that fair to say?

Peter V. Leigh

Yes. I think that’s right. I mean after all the – in an ideal world you wouldn’t have any of those results, but we don’t live in an ideal world, but I would say that to some extent in those two numbers there are legacy situations which we had to deal with and at this point we don’t see any of those currently, but then again, of course if we did see them we have to deal with them now. So, my point simply is that the expectation is that we have inventories under better control now than we had and I would hope that those charges would go down going forward.

Quinn Bolton – Needham & Co.

Okay. And then just a question on technology especially that pertains to the VGA market. Can you talk about your expectations for wafer level packaging or wafer level cameras – is that something – that type of packaging – something you think that potentially becomes mainstream at some point in the future. Can you just talk about how relevant you think technology may become?

Bruce Weyer

It’s hard to say how relevant that is. Obviously there are a lot of strong companies, a lot of bright people looking at all kinds of technologies – not just that, but other technologies as well. Suffice it to say, OmniVision is a leader in technology, we’re not going to let our guard down. As you can see, BSI is a big step for us. What’s the next big step? Is it wafer-level modules? Who knows? But we are aware of it. We are smart in it. And so is everybody else, but I think time would tell how it all pans out. It’s one of those strategic questions that difficult to answer.

Quinn Bolton – Needham & Co.

Okay. Thank you.

Operator

Your next call comes from the line of Amit Kapur of Piper Jaffray

Amit Kapur – Piper Jaffray

Great. Thank you very much. Most of my questions have been answered, but maybe a quick one on your supply chain – are you seeing any signs of tightness particularly at the foundries, the TSMC, and if so how are you managing around that?

Bruce Weyer

No. The simple answer to that is no. No tightness seen anywhere.

Amit Kapur – Piper Jaffray

Sounds good. Kept it simple.

Operator

Your next question comes from the line of Doug Freedman of American Technology Research. Go ahead.

Doug Freedman – American Technology Research

Hi guys. Thanks for taking my question. I am not sure who to shoot this one at, but if we look at your lead times and if you could give us a little bit of insight onto your order visibility, what’s giving you the confidence that these inventories are going to be cleared and that things are going to be better. Is it really based on design wins or is it based on already ramping design wins?

Ray Cisneros

Well. As we sit in our current quarter we are talking about a lot of customers and we talk about customers that we have a lot of history with and we understand their business, we understand their forecasts, we understand their products – so it’s not a blindfolded type of process we have here. Obviously there are spot type businesses that we drive through our distribution channels and that’s normal – so all that is well modeled into our current quarter, even our future quarters going out. So, I am not sure how to – I am not sure where you are going to go with that.

Peter V. Leigh

Let me just clarify a little bit. Bear in mind that the guidance we give for this current quarter is bottoms-up. It’s based on specific orders in the system, and I think that’s impressive in what Ray was saying, but it’s done bottoms-up. It’s not done on a macro level based on market size and market opportunity.

Doug Freedman – American Technology Research

Okay. If I could move on a little bit – Peter, you mentioned your inventory reserves and aging of inventory – inventory came down a little bit here, but in days it actually has risen. I am having a hard time reconciling the fact that you are in the process of introducing a full new suite of OmniPixel3-based sensors. I’ve got to believe the market is going to want to move to those rather quickly. What is the risk of the inventory that we have on hand and how much of that is comprised of the new sensor technology?

Peter V. Leigh

Again, I think, the point I was making too is that when we assess inventory at the end of each quarter, we’re looking at inventory quarter by quarter, product by product, and we know exactly what we have good ideas about how the product transitions are going to play out. And you’re right that in anytime when you have a product transition that does of course present a possible risk, and when we plan our inventory purchases we’re taking that into account, and we’re releasing wafers to the foundry every 2 weeks and every 2 weeks we look specifically at the sales outlook and plan our procurement accordingly and in particular, when you are talking about a product that’s at the latter end of its life cycle you have to be very cautious about exactly how much you’re willing to put on the shelf.

Ray Cisneros

I can explain on that a little bit as well. When you go through a process change where you are introducing a new pixel, large customers go through a re-qualification process, and that re-qualification process is typically longer than the inventory we would be holding for the product. There is a heavy level of communication between the companies in that process. So, we feel that would be very manageable in that transition for the large customers that would introduce that concern you are talking about.

Doug Freedman – American Technology Research

Okay. Terrific. That’s very helpful. Thank you. Can you talk on a like-for-like product – what you think the environment is like as far as ASP trends in the past – it seems like this past year we’ve actually had a little bit of a hiatus from the really severe price pressure that we saw in fiscal 2007 where ASPs were really down 25% to almost 30%. In 2008, the numbers I am looking at now are looking more like down 10% to 15%. What is your outlook and expectation for 2009 on a like-for-like basis? What are the ASP trends looking like?

Ray Cisneros

Well. It’s obviously difficult to comment on what would be the outcome of a full year outlook for ASP trends, but the environment is still competitive. On the other hand it’s normal. I agree with you – there’s something that happened perhaps in 2007 that was almost on the extreme side and it could have been some of the bigger players establishing their corner of the marketplace and there could be some segmentation going on from tier 1 players in our market space and tier 2 type players, and the tier 2 type players end up suffering the most, and maybe the tier 1 players have enough critical math to withstand somebody’s extreme price pressure that we saw a year and a half or two years ago, but it is normal – there is competition – we’re not going to say it’s not going to be an uncompetitive market – it’s still there, but we’ll see.

Doug Freedman – American Technology Research

Is it more like a 2008 year or more like a 2007 year from the start of the year?

Peter V. Leigh

We obviously hope it’s more like 2008 – don’t you? I mean that’s obvious. I’d just make one other point just to make sure that I don’t lose you which is – the key here is to drive down your cost as fast or as fast as you’re price is eroding. So long as you can do that you can preserve or you can increase your margins. And I think one of the most notable accomplishments of this company in the last year is that we’ve raised our gross margin by over 500 basis points, and that is a tremendous accomplishment particularly by our operating people in terms of every step of the supply chain and it’s attributable also to our suppliers that they’ve been able to rise to the challenge. That’s the thing we have to focus on in addition obviously to being paid for the premium quality of our products.

Doug Freedman – American Technology Research

My next question was going to be what type of cost reductions do you think you can achieve year-on-year?

Peter V. Leigh

Well, it’s a good question. As I am sure you anticipate, we’re not going to give hostages to fortune by quantifying the expectation, but what I will say is that we’re working as hard on those issues today as we worked on them a year ago and every day in between. So, the answer is – there is no point at which you say, “Okay, I’m done.” I am sorry to say that that’s true, but it is true. There is simply no point in this business, and the good news is that I think our operation people understand that and they’re resigned to it.

Doug Freedman – American Technology Research

A couple of housekeeping ones for you – stock compensation – guidance last quarter to this quarter – very similar except for one change. The stock comp seems to be higher. What’s driving these stock comp calculation to be higher this quarter?

Peter V. Leigh

Specifically first of all in the fourth quarter we did have some true-up. So, that’s a factor, but going forward we do refresh grants effective July 1; so there is some bump in July, but that’s offset by the fact that we do have some options where they [pull you west] and so your amortization of the older grants is finished. So, it’s a very difficult number to predict even for us.

Doug Freedman – American Technology Research

Are payroll increases on a July 1 fiscal?

Peter V. Leigh

Yes.

Doug Freedman – American Technology Research

They are. Okay. And then, lastly, long-term investments – can you let us know what’s in that category. I noticed a couple of years ago it was sort of irrelevant, now it’s looking like a much larger percentage of the total assets.

Peter V. Leigh

Well, the biggest change from a couple of years ago is the fact that we deconsolidated VisEra. So, it now is part of long-term investments.

Doug Freedman – American Technology Research

So that is gains in VisEra that are there. Okay. You mentioned – I am concerned on the fact that you took interest in mentioning one slow customer in payments. Is there a risk there and how big a risk is that?

Peter V. Leigh

Well, I don’t think there is a risk. We know that the customer has money, and you know, the time when the economy is slowing it is not uncommon for certain customers to get confused and think their suppliers are in the banking business, but I think that every indication is that the customer is in fact going to pay, and so I am not concerned.

Doug Freedman – American Technology Research

And then my last question for you – last quarter you mentioned that bare dye cells were accrued up to gross margins – what is the present percentage sales going in bare dye and did that increase or decrease in the quarter?

Peter V. Leigh

We don’t break the revenues down by that matrix; so, I can’t give you a direct answer to that question. Suffice it to say that as we expand all this to customers, we are seeing an increase in the share of our business that is going out in bare dye form.

Doug Freedman – American Technology Research

Okay, thank you very much.

Operator

Our final question comes from the line of Tristan Gerra of Robert W. Baird & Co., Inc. Go ahead.

Tristan Gerra - Robert W. Baird & Co., Inc.

Hi guys. The Chinese government apparently made it easier last year for Chinese OEMs to get a license to build and sell mobile phones; does that impact you either way positively or negatively?

Ray Cisneros

I think it’s positive for OmniVision. One of our strengths is our sales channels in the Asian market and China included – when you have an increase of customer base and you have the strength of the sales channels we do – obviously that gives us more opportunity to garner more revenue, so it’s positive in the way I look at it.

Tristan Gerra - Robert W. Baird & Co., Inc.

Okay, and then the R&D on the backside illumination technology, is that all internal or is that the result of research cost agreements with the SMC in terms of spending?

Peter V. Leigh

There are no cross agreements. If what you mean – are there any contracts by which we fund any portion of that R&D – the answer is no. We cover our expenses and they cover their own.

Tristan Gerra - Robert W. Baird & Co., Inc.

Great. Thank you.

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