Jennifer Jarman - The Blueshirt Group LLC Richard A. Bergman - Synaptics, Inc. Wajid Ali - Synaptics, Inc..

Robert Stone - Cowen & Co. LLC Charlie Lowell Anderson - Dougherty & Co. LLC John N. Vinh - Pacific Crest Securities Rajvindra S. Gill - Needham & Co. LLC Paul Coster - JPMorgan Securities LLC Vijay R. Rakesh - Mizuho Securities USA, Inc. Dean Grumlose - Stifel, Nicolaus & Co., Inc.

Ambrish Srivastava - BMO Capital Markets (United States) Brett Simpson - Arete Research Services LLP Jagadish K. Iyer - Summit Redstone Partners LLC.

Good day and welcome to the Synaptics First Quarter 2017 Conference Call. At this time all participants are in a listen-only mode. Later you'll have the opportunity to ask questions during the question-and-answer session. As a reminder this call is being recorded. It is now my pleasure to turn the conference over to Ms. Jennifer Jarman. Please go ahead..

Thank you, Keith. Good afternoon and thank you for joining us today on Synaptics First Quarter Fiscal 2017 conference call. This call is also being broadcast live over the Web and can be accessed from the Investor Relations section of the company's website at synaptics.com.

With me on today's call are Rick Bergman, President and CEO; and Wajid Ali, CFO. In addition to the company's GAAP results, management will also provide supplementary results on a non-GAAP basis, which excludes share-based compensation, change in contingent consideration and certain non-cash or non-recurring items.

Please refer to the press release issued after market close today for a detailed reconciliation of GAAP and non-GAAP results. Additionally, we would like to remind you that during the course of this conference call, Synaptics will make forward-looking statements.

Forward-looking statements give our current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance, and business.

Although Synaptics believes our estimates and assumptions to be reasonable, they are subject to a number of risks and uncertainties beyond our control and may prove to be inaccurate. Synaptics cautions that actual results may differ materially from any future performance suggested in the company's forward-looking statements.

We refer you to the company's current and periodic reports filed with the SEC, including the Synaptics Form 10-K for the fiscal year ended June 25, 2016, for important risk factors that could cause actual results to differ materially from those contained in any forward-looking statements.

Synaptics expressly disclaims any obligation to update this forward-looking information. With that, I'll now turn the call over to Rick Bergman.

Rick?.

Thanks, Jennifer, and I'd like to welcome everyone to today's call. Synaptics delivered solid first quarter results as we experienced strong performance from our TDDI, fingerprint, and PC products. Our DDIC business came in roughly as anticipated. Fiscal first quarter revenue of $386 million was in the upper half of our guidance range.

Non-GAAP net income was $34 million or $0.96 per diluted share, and gross margins were approximately 35%.

It's important to note that our per share results reflect the negative impact net of tax of approximately $0.07 related to an unexpected customer specific inventory write-down realized at the end of the first fiscal quarter in our fingerprint business.

Consistent with our comments last quarter, TDDI reached an important inflection point during the period and has become a substantial revenue contributor, reaching 10% of total revenues in Q1.

While we originally targeted TDDI as a mainstream solution, we've chosen to address strategic tranches of high-volume business at the low end of the value chain. This decision to further capitalize on the significant growth opportunity provided by TDDI is evident in our Q2 guidance.

While it (03:29) contribute to lower gross margin profile than we have (03:32) historically, our investment in TDDI is paying off handsomely. It's proving to be an integral part of our growth strategy as expected, and Synaptics is benefiting as the first mover and clear technology leader within a rapidly expanding market.

We are seeing significant traction in customer adoption and design wins. We are proud to announce that Xiaomi, Huawei and Samsung have announced smartphones leveraging Synaptics TouchView TDDI technology. These designs follow the LG smartphone announced last quarter and precede many new phones expected to be announced over the coming months.

TDDI is enabling us to gain market share in both global display and touch as customers adopt our integrated solution. Our market-proven second generation TDDI portfolio covers resolutions from HD to WQHD while delivering a lower overall system cost in a simplified supply chain.

Smartphones adopting TDDI technology result in thinner devices with brighter displays and borderless designs. As TDDI continues to expand in the smartphone market, we continue to invest in this area to address the strong demand from our customers in Asia, including China and Korea.

As such, we recently announced a new product addition to our TDDI portfolio. Today we believe we have the most extensive breadth of TDDI solutions in the industry. Let's turn our discussion to OLED, as many of us have been monitoring its market adoption closely.

We believe the supply of OLED displays will start to expand meaningfully in late 2017 and continue to be featured primarily on flagship smartphones in 2018 due to its high cost versus LCD technology. Wider adoption of OLED technology in mainstream smartphones will likely take place in 2019.

We believe Synaptics is well-positioned to win in OLED when the market takes off. We are already a leading supplier of touchscreen controllers for OLED display panels, and as such, we have benefited from several years of experience in integrating our touch controller ICs into OLED panel designs.

This gives us a great understanding of the design and production issues associated with the technology. Synaptics has a large team of design engineers actively developing OLED DDICs in collaboration with leading display manufacturers worldwide.

Since every display manufacturers' architecture and system requirements are different, the ability to work closely and effectively with their engineering teams is critical for the successful development of OLED panels.

Synaptics' status as a leading supplier of touchscreen controller in DDIC products means that display manufacturers are confident in our ability and technical expertise to support their OLED developments. As we announced last quarter, samples of our new OLED DDIC products are expected to be available by the end of this year.

Although the smartphone market is transitioning to OLED technology, the majority of smartphones continue to leverage proven LCD technology. In fact, we are forecasting that over the next several years over 1.2 billion LCD smartphone displays spanning flagship, mainstream and entry-level phones will be shipped each year.

As both OLED and LCD have their advantages and disadvantages, we believe they will continue to coexist in the market for the foreseeable future. Now let's jump to our Natural ID fingerprint sensor business. We are realizing increasing traction with customer design wins.

We're pleased to announce that Synaptics is a primary source of fingerprint solutions for the mainstream Huawei Honor 6X smartphone, and TCL is featuring our solution in its flagship TCL 950.

Additionally, Sharp along with NTT DOCOMO have just announced two new Aquos phones with our ultra-slim, one-touch fingerprint sensor placed on the side of the devices. We are also maintaining our leading market share with our largest fingerprint customer, Samsung, and we're now shipping with the new Galaxy C5 and C7 smartphones.

Our complete portfolio of fingerprint sensors with round, square and rectangle form factors in various sizes combined with unparalleled security features are competitive advantages for Synaptics.

We continue to invest in next-generation under glass fingerprint technologies and we recently announced a new chip that addresses glass or ceramic buttons and recessed cover glass.

The next two phases will include sensing through the entire cover glass thickness in the bezel of the phone and ultimately inside the display itself, enabling sleek, buttonless and borderless industrial designs. We expect our next under-glass solutions to come to market in the first half of calendar 2017.

Due to our unique patented sensor architecture that separates the sensing array from the control IC, Synaptics is well-positioned to address in-display fingerprint solutions for both OLED and LCD. China is a critical path for sustaining our business success, especially for our fingerprint business.

At Synaptics, we have a focused China strategy in place. We are aligning closely and strategically with top tier Chinese customers to develop unique solutions. We're building a strong, independent hardware vendor infrastructure to expand engagement with a broader customer base.

We are enabling these IHVs to be self-sufficient and to take ownership of module development. Furthermore, we have built a solid team in China to design products for the local market and support our growth. Today, we're excited to see the expanding design activity in the pipeline. Now on to our notebook PC business.

We see strong demand for our SecurePad and fingerprint solutions from our notebook PC customers. CLEVO, a leading notebook manufacturer, is now featuring our SecurePad technology on its new high-performance notebooks, available today and sold under several brands including AFTERSHOCK, AZOM SYSTEMS, CGScope, Monster, and Sager.

SecurePad integrates fingerprint sensors directly into the TouchPad and you will soon see wider adoption with additional OEMs announcing products. Lenovo also selected our fingerprint sensors for the new Yoga 910 convertible laptop, which also features our TouchPad and touchscreen controllers.

On this laptop, we collaborated with our ecosystem partners, including Lenovo, Intel, PayPal and FIDO to bring industry first secure authentication to enterprise and consumer PCs. This partnership helped shift the industry away from less secure and cumbersome passwords. Lastly, let's touch on our automotive business.

As we have discussed in past calls, we have a longer-term growth strategy to become the human interface leader in automotive, where strong IP assets are an ideal match. We are working closely with all global OEMs and Tier 1s and we continue to expand our auto-specific portfolio.

During the quarter we announced three new touchscreen controllers and a new DDIC solution.

New cars with Synaptics' latest automotive solutions will hit the roads in 2017 with new solutions – are designed specifically for the quality and reliability requirements and lifetime needs of the automotive market and address the rapidly advancing evolution of the modern vehicle cockpits that consumers crave.

As we enter the second fiscal quarter, we're pleased to have moved beyond the inventory effects in our display driver business, but note that shipments are still expected to be well below last year's levels.

Continued strong momentum in our TDDI business, along with growing attach rates for fingerprint solutions in smartphones and notebook PCs, remain key contributors in offsetting these declines as we move through the fiscal year.

TDDI is expected to continue to grow significantly to approximately 15% of our total revenues in Q2 with further expansion in subsequent quarters.

On the fingerprint sensor side, despite a major customer product disruption realized late in Q1, we expect the business to be flat quarter-over-quarter in Q2 with substantial growth expected in the second half of the fiscal year.

This is due to the major investments we've made in our new product roadmap, as well as stronger customer traction in China, reflecting the success of our focused China strategy.

We look forward to providing more details regarding our growth opportunities and strategic roadmap during our next Analyst and Investor Day, which will be held on Tuesday, December 13 at our headquarters here in San Jose.

In closing, we're right where we want to be exiting the fiscal first quarter as our positive results and indicators moving into Q2 reflect solid execution across all our businesses as we position the company for a return to growth and greater diversification across our customer base.

In addition, our progress towards realizing the next important technology milestones in our business remains on track and position us to maintain a commanding position in the markets we serve, as well as deliver on expanding growth pillars, including OLED technology and automotive. With that, I'll now turn it over to Wajid..

Thanks, Rick. Revenue for the September quarter was $386.2 million, above the midpoint of our guidance range and up 19%, sequentially. Year-over-year September quarter revenue declined 18% primarily reflecting lower demand for our display driver solutions, partially offset by increased demand for TDDI products.

During the quarter we had three customers above the 10% revenue threshold at 11%, 23%, and 24%. Revenue mix from mobile and PC products was approximately 86% and 14%, respectively. Revenue from mobile products was up 16% sequentially and down 20% compared with the year-ago quarter.

Revenue from PC products was up 43% sequentially and down 5% year-over-year. I will now provide a high-level review of certain of our September quarter GAAP results and will follow with the corresponding non-GAAP results.

For the September quarter, our GAAP gross margin was 32%, which includes $12.2 million of intangible asset amortization and $500,000 of share-based compensation costs.

GAAP operating expenses in the September quarter were $117.8 million, which includes share-based compensation of $14.1 million, restructuring costs of $5.3 million consisting primarily of severance costs and acquisition-related costs of $4.5 million consisting of intangibles amortization. Our GAAP tax rate was 21.3% for the quarter.

In the September quarter, we had GAAP net income of $3.7 million or $0.10 per diluted share. Now turning to certain of our September quarter non-GAAP results.

Our September quarter non-GAAP gross margin of 35.2% was below the midpoint of our guidance range and primarily reflects overall product mix and a $2.8 million charge related to an unexpected customer specific inventory write-down in our fingerprint business.

September quarter non-GAAP operating expenses came in slightly below the low end of our guidance at $93.9 million, down $5.8 million from the preceding quarter. The decline primarily reflects cost-saving actions initiated in the prior quarter. Our non-GAAP tax rate was 17% for the quarter.

Non-GAAP net income for the September quarter was $34.2 million or $0.96 per diluted share, a 109% sequential increase but down 36% year-over-year. As noted earlier, these results include a $2.8 million charge, which equates to approximately $0.07 per diluted share. Excluding this charge, non-GAAP EPS would have been $1.03 per diluted share.

Turning to our balance sheet, we ended the quarter with $301 million of cash, a decrease of $51 million from the preceding quarter.

The decrease in cash during the quarter was primarily related to $25 million used for the purchase of approximately 508,000 shares of common stock under our stock repurchase program and a $14.3 million investment with a manufacturing partner to support TDDI product demand requirements.

Receivables at the end of September were $240 million and DSOs were 56 days, while inventories were $153 million and inventory turns were 6.6. Capital expenditures for the quarter were $5.7 million, and depreciation was $8.6 million. Now I will make a few comments regarding our quarterly outlook.

Based on our backlog of approximately $279 million entering the typically front-end loaded December quarter, subsequent bookings, customer forecasts, product sell-in and sell-through timing patterns, as well as expected product mix, we anticipate revenue for the December quarter to be in the range of $430 million to $470 million.

We expect the revenue mix from mobile and PC products in the December quarter to be approximately 87% and 13%, respectively. I will now provide GAAP outlook data for our December quarter and will follow with non-GAAP outlook data.

We anticipate the stock-based compensation charge in the second quarter to be in the range of $15 million to $15.5 million. GAAP expenses in the December quarter will include additional restructuring costs in the range of $3.5 million to $4.5 million consisting primarily of office space consolidation charges.

In addition, December quarter GAAP expenses will include non-cash charges of approximately $14 million for intangibles amortization, of which approximately $12 million will be reflected in cost of sales. I will now provide non-GAAP outlook data for our December quarter.

Taking into account our overall revenue mix, including Rick's prior comments related to the strategic expansion of our TDDI business, we expect non-GAAP gross margin in the December quarter to be between 32% to 35%.

We expect non-GAAP operating expenses in the December quarter to decline to approximately $90 million to $93 million, reflecting incremental quarter-over-quarter savings from our restructuring initiatives that we began in Q4 of the prior fiscal year.

We anticipate our non-GAAP long-term liability base tax rate for fiscal 2017 to be in the range of 16% to 18%. Non-GAAP net income per diluted share for the December quarter is anticipated to be in the range of $1.20 to $1.50 per share.

In closing, based on our solid first quarter results and current outlook for the second quarter, the first half of the fiscal year is shaping up to be better than we had expected.

Our core TDDI and fingerprint ID growth levers remain key drivers of our business in fiscal 2017 and are setting the stage for a return to growth, along with our development activities in new and exciting areas. With that we will now turn the call over to the operator to start the Q&A session.

Operator?.

We'll take our first question from Rob Stone with Cowen & Company. Please go ahead..

Hi, guys. Thanks for taking my question.

With respect to TDDI, since you're just getting started with material of volumes, I wonder how you see the margin profile opportunity going forward as you gain volume, is it possible to see TDDI go up market? What kind of non-GAAP gross margin contribution are you expecting from TDDI and can you improve it from the starting levels over time?.

Yeah, Rob. I'll take this one and then Rick can follow up with some comments. So, our TDDI gross margins are tracking right now kind of closer to our display driver gross margins kind of very broadly speaking. And initially, obviously, we had a pretty steep ramp in the first quarter, and so there's kind of costs associated with that.

And we've been focused in on the low end of the market. Our plan initially was to have much broader growth in the mainstream portion of the market, which we expect to happen over the course of the coming quarters as you see a cadence of more design wins coming through with products ranging from full HD all the way up to WQHD.

So we do expect our gross margins to improve just because of the manufacturing margins improving on each of the products, as well as the mix favoring a product mix more towards the upper end of the TDDI range..

The only thing I'd add there, Rob, as Wajid alluded to, we're going through a very steep ramp and the first priority given all the display manufacturers that we had to support was to get the breadth of the products out the door. And in fact, about a month ago we announced a hybrid in-cell version of TDDI to add to our family of products.

It's kind of the next wave of products. There'll be a much higher focus around how we can reduce the cost and bring some additional innovation into the road map, which certainly could help further down the line in terms of gross margins..

Okay. My follow-up question is on the AMOLED DDIC opportunity.

I don't disagree with your high-level premise, probably out to 2020 about half the market at least is still going to be LCD, but do you see meaningful revenue opportunities for your first generation AMOLED DDICs in calendar 2017? Or are you really pushing that out as an opportunity for another year?.

Well, I guess, one thing I would like to point out about AMOLED, it's actually very meaningful to us already with, of course, our touch controllers. So we do have a nice chunk of business today with our touch controllers there.

And certainly, our ability to ramp as we've discussed in prior calls is roughly a six- to nine-month period post sampling as display manufacturers get ready and so on.

And to a certain degree, we're going to kind of dodge this question because it has broader implications in the industry, but we can certainly be ready to beef production in the second half of the year if the market demands it..

Thanks. I'll jump back in the queue..

And we'll take our next question from Charlie Anderson with Dougherty & Company..

Yeah. Thanks for taking my questions. I wondered embedded in the margin guidance was there anything different in fingerprint sensor margin and just maybe broadly how you're seeing pricing going there. That's my first question.

And then my follow-up would be given some of the revenue that we're seeing upside, do you have any sort of new comments on how the year plays out, Rick? Thanks..

Yeah. It's kind of two pieces there.

So first in terms of the gross margin, a couple of facts there, which we touched on in our fiscal Q2, continued strength in TDDI, which as Wajid just mentioned is closer to more the DDIC level margins and then actually strength in our DDIC product line, at least, relative to Q1 due to certain seasonality patterns with some major customers.

And then third, we haven't said this for several years, but it certainly feels good is continued strength in our PC area. In all of those if you remember from prior calls tended to be on the lower end of the corporate margin stack. In terms of fingerprints, no real material change there in terms of gross margin.

I should say as fingerprint plays a bigger role in our second half of our fiscal year, of course, that's also opportunity for gross margin improvement as well..

And then in terms of – you gave sort of a full year revenue outlook last call, given some of the revenue we're seeing now in the TDDI ramp, anything changing there as far as you're concerned?.

Well, if you remember what we said back in July was given the nature of our business, we're only going to go directionally and then we're not going to update during the year if we can avoid it. And I think we've now had two examples in the last six to nine months where call it things fairly unexpectedly came out that can be disruptive.

Sometimes those aren't great, sometimes things turn out well. So, Wajid in his prepared remarks said Q1 and Q2 were better than expected, but we're not going to really comment on the second half of the year at this point..

Great. Thanks so much..

And we'll take our next question from John Vinh from Pacific Crest. Please go ahead..

Hi. Thanks for taking my question. Just a clarification.

First, is there any sort of residual inventory write-down charges that are impacting your Q2 gross margin guidance? Or is that fully encapsulated in Q1?.

Yeah. Those are fully encapsulated in Q1..

Great. Thank you. And then just as a follow-up on gross margin. So, Rick, you talked about a meaningful ramp of fingerprint sensors in the second half of your fiscal year. Obviously, you've got some pretty sharp ramp-up costs in TDDI in the near term.

Is there a chance for margins to improve to potentially the lower end of your kind of long-term target range of 37% to 39% as we get back into the second half of your fiscal year? Or should we think about kind of another new target model for you going forward now that TDDI is inflected for you?.

Well, John, we're not going to kind of peg a number out there for the quarter plus one type of thing at this point. And certainly, as we always do when we have the Analyst Day, we'll talk about our longer term corporate model at that point and talk about the trends that we're seeing there.

I'll just kind of mention this as we already did, continued strength in TDDI, which is below corporate margins. That kind of, say, impacts the overall view but as our fingerprint business strengthens, that certainly helps things out.

But we're not going to go beyond kind of where we are today unless Wajid you want to add something?.

No, that's fine..

Great. And then just one more follow-up on fingerprint sensors. We've seen Qualcomm's ultrasonic sensor in the market now. You've seen InvenSense announce that they plan on entering the market in 2017.

Can you give us your thoughts in terms of how you're thinking ultrasonic compares to capacitive? Also, just given some of the limitations of capacitive, do you have the ability to support other fingerprint standards out there? Are you looking at ultrasonic, or even potentially optical sensors going forward?.

Hey, John, a couple questions. So certainly, there's acoustic sensors that are a possibility and we've seen a few different vendors come out with product. Now interesting from what we've seen, they actually have been limited to 400 micron, which is kind of right where capacitive limitations are as well.

I don't know all the specifics (27:58) the customer feedback and what we have to deal with, it's just not simply creating an image of a fingerprint. It goes a lot further than that.

You have to be able to do it across temperature range and different environments, old people that may have worn down fingerprints, all those different things come into play in this business, as well as you have to be low power, you have to be able to wake up, and so forth. That's not an easy recipe.

So we haven't seen like for example acoustic being in a major play, at least in all the decisions that are kind of happening now for six to nine months from now for those new phones. In terms of Synaptics own plans, clearly as you heard we have a breadth of solutions.

I don't know if you picked that up in our prepared remarks, but it really demonstrates what we can do that – the Sharp phone had a thin sensor on the side of the phone, the Huawei phone is more square, TCL phone is round and then, of course, the Samsung phones are rectangular on the front of the phone.

So it's kind of we had front, back, center and all different shapes in our prepared remarks. So we're well prepared on the capacitive side. And we've always said we're open. If there's other sensing technology, whether it's optical or acoustic, temperature, pressure, all those things could be possibilities in our roadmap.

We feel confident in our ability to fulfill our vision, which was to be a leader in under glass and be the leader in display technologies..

Great. Thank you..

We'll take our next question from Rajvindra Gill with Needham & Company. Please go ahead..

Yeah, thanks for taking my questions. A question again on the gross margin profile.

So, Wajid, you had mentioned that the TDDI gross margins are closer to the display driver gross margins, can you maybe quantify that for us? And can you explain kind of why the gross margin is that low for TDDI even though the ASPs might be higher than the display driver ASPs?.

Yeah. So I mean, we've got one major customer that makes up our display driver revenue. So we've historically said that our display driver margins are a standard deviation or so away from our corporate gross margin average. And with TDDI, we're basically getting at least 2x the ASP. And so we're earning more gross margin dollars off of that.

So the margins are lower, but like we've always said, we're now getting the margins also from the touch side as well as the display driver side.

Rick mentioned in his prepared remarks that we made a strategic decision to take on some high volume, low end strategic business so that we could really penetrate the market not only at the mainstream level, but also at the low end. And that's skewing our margins a bit, at least, at the beginning as we're ramping up.

And with the revenue mix being 10% in Q1 of our total revenues and then being 15% of even a larger number in Q2, that's skewing our overall corporate margins at a consolidated level. So those are really the reasons around the gross margins with TDDI..

Got it. And another question on the gross margins.

Based on previous calls you had mentioned that the fingerprint business was higher than corporate gross margin, as that business starts to ramp, do you see that having a positive impact to the overall corporate gross margins, the blended gross margins? Or do you anticipate the gross margins to remain stable or maybe even decline in fingerprint as the pricing market becomes more competitive next year than it is this year?.

Well, I mean, we've got the benefit of being a leader in fingerprint for the notebook side. And so we're able to have higher attach rates and, therefore, enjoy better gross margins on fingerprint.

You probably noticed in our prepared remarks that we said that we're seeing an increased business on the PC side of our business and that's going to allow us to have better gross margins as that attach rate increases.

As far as the mobile side is concerned, we would expect that to be beneficial to overall corporate gross margins as well as that becomes a larger part of the mix versus TDDI moving into the back half of the year..

Just the only thing I would add, again, if you go back now it's almost been three years since the Validity acquisition. All along we said we expected it to be competitive and pretty aggressive 15% to 20% price decline.

We've been planning for those days and we have a road map that reduces our cost to stay consistent with the ASP declines that we expect on one hand. And then on the other hand, as Wajid mentioned, a road map to maintain our leadership in the flagship area as well..

Thanks for that, Rick. And just last question on the OpEx for me and then I'll hop back in the queue. So the OpEx is guiding to about $91.5 million.

So as a percentage of sales that's 20% of sales, down from about 24% of sales in the September quarter and the operating margins are actually going up 300 basis points quarter-over-quarter for the December quarter, even though gross margins are coming down a couple hundred basis points.

So is that the level of OpEx that we're going to be looking at going forward, or is OpEx going to go back up again? I know you did the restructuring earlier in the year. Any color there in terms of kind of the actual operating margin of the business going forward? Thank you..

Raj, I'll take the broader question and then let Wajid fill in on the details. And again, Wajid just cited some of my comments in the prepared remarks, but to a certain degree we knew this day was coming. Strategically, you could even argue four, five years ago, we knew touch and we would lead the TDDI kind of revolution. We had a choice.

Are we going to stay in the touch market or are we going to lead with the integration of TDDI and have to deal with just the industrial lower margins that come with DDIC? And our answer was yes, and we wanted to stay the major player.

And we know a couple of our competitors have not made that decision and they've kind of faded out of the business and are now gone. So we believe it was the right decision. That's going to put pressure on our margins.

And as we ramp TDDI, actually a little faster than we expected, we wanted to put in an operating model underneath for at least that portion of our business where we could be successful. Not too different than what we've done with TouchPads for years, where it's just a lower gross margin business.

And we have lower R&D and lower SG&A than you typically will see with U.S. companies. And we can hit those mid-teen operating margins that we've enjoyed as a company for 12, 13 years now. And with that, operating expenses have to be at a certain level, which I'll let Wajid talk about..

Yeah. So, Raj, quick mention. We're expecting our target model to remain pretty consistent. You noted that our operating margins have improved, quarter-over-quarter, now obviously, we were starting from a low point last fiscal Q4, where we've had a couple of straight quarters of incremental improvement from an operating margin standpoint.

And our goal is really to manage our expenses, so that we can hit a mid-teens operating margin level. Now that will fluctuate quarter over quarter because our product development expenses don't just always happen perfectly in one quarter. Sometimes it'll be a little bit higher, and sometimes it'll be a little bit lower.

But over the mid-term, our goal is to hit a mid-teens operating margin number, and we'll be managing our operating expenses as well as our investments accordingly..

Thank you..

We'll take the next question from Paul Coster with JPMorgan. Please go ahead..

Yeah, thanks. I think we've run out of margin questions here. I've got a couple of others.

First of all, how long do you think it'll take for autos to become material to revenues, let's say, 5% of total revenues? And the other question is, are there any patents of technologies that you have from your, sort of, legacy DDIC business that port over into OLED, and which are really sort of strong differentiators?.

Sure, I guess I'll take both of those. In terms of, when is automotive going to be call it material, we mentioned in our prepared remarks that we'll start to see some rollouts of the business as soon as calendar 2017.

I think kind of over the last three or four months, we've really started to see, call it a breakthrough in our business, in terms of, we've been knocking on the doors of the automotive manufacturers for quite some time and doing some early design activity. But it's finally swung to design wins, and the pipeline's greatly increased.

And if you noticed a couple weeks ago, we announced three Touch products and a DDIC product specifically for that market. So we now feel we kind of have the broadest portfolio in the industry. That being said, we can't speed up the auto industry. So next year, we'll start to make a small dent.

But I think, as we've said, kind of fiscal 2019 timeframe is when we'll see a real dent in the business, where it gets measured in the many, many millions. Now I've forgotten the second question, somebody....

The question was to do with the technology impacts that you have from your legacy DDIC business, and how they port over that OLED if at all?.

No. They certainly do. And that was the strength of RSP when we acquired them is they had developed a lot of powerful IP from everything from display – or from compression to display technologies, how you manage sunlight, to power management, all those different things certainly come into play both for LCD as well as OLED technologies.

So what we have to change is the driver mechanisms of the display driver due to higher capacity, (38:58) and so on with an OLED system. But again, we kind of lived with some of those dynamics with our touch controllers. So in a lot of ways the short answer is there's a great deal of leverage between our current IP and OLED IP..

Thank you..

The next question comes from Vijay Rakesh with Mizuho. Please go ahead..

Hi, guys. Thanks for letting me ask a question here. On TDDI, I know you mentioned the low end – you took on some low-end handset business strategically, and there's some startup costs that impacted the margins there.

If you look out on a normalized basis as you start to get into some of the mid-end handsets, where do you see the TDDI margins? Do you see that improving a little bit more?.

Vijay, yes. Like we mentioned earlier, we do expect that as we move upstream a little bit, we will start to see some improvements in margins. A couple of reasons, we'll have some more experience behind our belts, some of the ramp-up costs that we saw or that we're seeing right now will hopefully fade away. Our manufacturing yields should also improve.

And then at that point in time as there's more capacity as well for our products, we should be able to have some cost reductions. And Rick mentioned in one of his comments earlier that our road map is focused in on low-cost TDDI products, which are actually significantly lower than our current cost structure.

Now obviously, we expect competition to catch up, but hopefully we'll be able to generate some more margins despite the increased competition as that happens.

So we do have a road map and we do have a plan to get our TDDI margins back up both from a mix perspective, a manufacturing yield perspective and a product perspective, but it's going to take a few quarters..

Got it.

And as you look at, let's say first half next year, as you go into volume ramps on the TDDI, with the current product, does it get you any closer to your corporate margins? Or you think it will still be a delta for the corporate margins?.

Well, I think you heard on the prepared remarks that we expect 15% of our revenues in Q2 to be TDDI, and then we expect it to actually increase from there. So we'll have increased mix of TDDI as we move forward in the year, so it's a little bit early to say how that all plays out. So, we'll just have to wait until then, and then we'll call it out.

But like we mentioned earlier on our earlier remarks, we're driving the business to a mid-teens operating margin level and so that's how we're managing it..

All right. One last question here on the fingerprint side, you mentioned you had some good experience on the fingerprint side, as you look at 2017.

How do you see that portion of your business doing? There's, obviously, a lot of chatter on competition from Goodix and Egis and Silead, but as you look at your business, how do you see that and outlook for that into next year? Thanks..

Well, as I noted on the fingerprint business, we kind of had to deal with one disruption here over the past couple of months.

And we had nice growth from our fiscal Q4 to Q1, and then it'll be flattish in Q2, and then we expect a real acceleration in the second half of our fiscal year based on the design activity that we're seeing out there for our current and new products..

Thanks..

And we'll take the next question from Kevin Cassidy with Stifel. Please go ahead..

Well, this is Dean Grumlose calling in for Kevin. Thank you for taking my question. It seems like there's dozens of new competitors in the fingerprint area appearing all the time, particularly in Asia.

I was wondering if you could characterize the relative technical difficulty of fingerprint solutions versus capacitive touch and TDDI and whether you believe that over time you'll be able to retain the same advantages that you have in the past..

Thanks, Dean. In some ways, again, this isn't an unexpected phenomena. A few years ago we entered this business, we saw the strong growth rates and we made a key acquisition to position us to take advantage of the growth rates in the marketplace, and then a bunch of guys are jumping in and copying the technology and so on.

Same exact thing we saw five or six years ago in Touch. And just like Touch, it's easy to do a demo, but it's much harder to have a very robust, complete, secure solution. And so the barriers end up being quite high to entering the market, and I'd expect dozens to sort itself out to a handful of competitors over the three- or four-year time period.

And Synaptics will certainly be one of those guys and it's our plan and expectation that we'll be the leading fingerprint sensor deliverable just as we are the leading touch controller vendor..

Thank you.

And as a follow-up, but it's basically the same question for OLED, is this a technology that presents yet higher barriers to competition? Or is it just something we could consider as different in difficulty in approach?.

Well, there's certainly call it some interesting dynamics with the OLED technology. I think one of those today is each manufacturer kind of has a little different approach and a different ramp time and so on. So one requirement is a worldwide structure to support the various OLED manufacturers.

And that's what I believe Synaptics is somewhat uniquely positioned. We have a sizable team in Japan, which is, of course, quite convenient for the manufacturers located in Japan and also for Korea for that matter. And then we have quite a sizable team in Taiwan for the Taiwan and Chinese manufacturers.

So that's kind of just the infrastructure to support the manufacturers is absolutely critical. In addition, OLED technology, it looks like with the drivers and some of the borderless designs and so on that we're seeing, we'll be pushing into smaller geometries than historically we've been in.

We're kind of used to that because we already do that for fingerprint solutions. I think some of our competitors have not gone to 55-nanometer or 40-nanometer or even below geometries. And so once again, I feel like we have a nice advantage there..

Very helpful. Thank you very much..

The next question comes from (sic) Ambrish Srivastava with Bank of Montreal. Please go ahead..

Hi. That must be me. I've heard many pronunciations, not that one. Hi, guys. This is Ambrish here from BMO..

Hi, Ambrish..

A, if something is structurally different, were you surprised? And then what's the timing we should be looking for, for the margins to recover?.

Okay. Ambrish, I'll take it, and Wajid can chime in if he has additional comments. So in terms of gross margins, maybe you've been covering us for a couple of years, but we're always what you call a product mix company, and that's by far the number one determinant on our gross margins.

And so when we get a surge of business from DDIC, which we saw maybe six quarters ago, it puts pressure on our gross margins. Conversely, when we ship more fingerprint solutions than we expected, that certainly helps out our gross margin percentage.

And we certainly see the trends for the second half of our fiscal year and how that is outlining, but it can change quite a bit. So I wouldn't say we were surprised by the gross margins that we have, but we were certainly surprised by how rapidly the TDDI ramp occurred in our business relative to some of the other areas that we're in.

And that, of course, is putting the downward pressure on our gross margin percentage. Now, that does help, as we discussed on our bottom line in some ways if – they call it the surprising growth that we're seeing in the first half of this year continues on in the second half of the year.

As you heard from Wajid, we're not increasing operating expenses, so we get leverage from admittedly lower gross margin business that's addressing the lower part of the phone market.

And I guess, you asked, when we give a little more color? Certainly, as we've done every year at our Analyst Day we talk about what our corporate gross margin model is and we kind of like to keep it that one time, so we're not always adjusting as we go through each subsequent quarter. Per our practice, we'll do that again on December 13..

Okay. Thank you, Rick..

Our next question is from Brett Simpson with Arete. Please go ahead..

Yeah, thanks very much. Wajid, maybe just on the production cost side, can you talk about any sort of meaningful cost reduction plans you see for some of the main product lines? So maybe on display drivers I think you've talked about 40-nanometer.

I don't know where you are with the ramp of 40-nanometer? And exactly where we are with TDDI in terms of nodes and whether there's a shrink that's pending? And maybe also talk about what you think is coming on – with cost downs on fingerprint? Anything you can point to would offer meaningful cost downs in those product lines would be very helpful.

Thanks..

Yeah. So, I mean, each one of our operations teams as well as our engineering and product marketing functions have got their mandates around what type of cost downs we need both in the midterm as well as in the longer term.

We mentioned in our prepared remarks that we've actually had to invest in some capacity so the capacity in the market is a little bit tight right now, so it's a little bit difficult to get wafer price reductions when you're in that type of market.

But as far as back-end costs are concerned and yields are concerned, definitely our product engineering teams are working closely with our supply chain to improve those.

As far as shrinks are concerned, we've got a road map that helps us by the midpoint or the end of this fiscal year from a TDDI standpoint as well as from a fingerprint standpoint so that we can address even lower cost points as the market demands and as we see competition ramping up.

So we're quite confident that the teams know what they're doing and they've got their mandates both for the short term, the midterm, as well as the longer term. I can't share any of those details more than we already have for obvious reasons, but you can rest assure that everybody knows what their goals are..

That's great. Thanks, Wajid. And maybe, Rick, just in OLED, I think you talked in your prepared remarks about wider adoption of OLED within smartphones outside of flagship starting 2019.

We've already got a number of OLED driver IC makers in the market already today, but can you talk about when you think we'll see meaningful revenues for Synaptics on OLED driver ICs, and do you think you need to make acquisitions to run value plans in this space? Thanks..

Okay. So, Rob, kind of gave a flavor to that question. So first, when do we see meaningful OLED? One thing and I don't want to push all questions off to December 13, but we'll be able to show you actually some very nice slides on how did we come to some of those conclusions in terms of the amount of capacity.

So we've tried to kind of go manufacturer by manufacturer, what they've announced and what manufacturing facilities are putting in place and when we expect to see those ramp and the size of them and in terms of the generation.

And so there's one guy out there that everybody knows who's supplying most of the OLED capacity today and a couple of others will participate next year. And then you really start to see a steep ramp in the second half of calendar 2018 and to 2019. So for us if we want to play with that much broader market, it's very important to be ready at that time.

That being said, we got multiple devices under development. We're ready to go. It won't be our development that holds us back. It'll be actually the OLED process developments and certainly there's possibilities for revenue in the second half of next calendar year in terms of OLED technology.

Do we need to do an acquisition? We always keep our eyes, our ears open for the right type of things, but we're engaged with multiple display manufacturers on OLED.

We feel like we have world-class IP as I articulated earlier that we can leverage from our LCD efforts and we're well under development and we'll be sampling parts at the end of this calendar year. So the prospects of an acquisition start to decline when we have the technology and then you'll get customer acquisition.

For the most part, we have strong relationships there as well..

Okay, great. Thanks..

And we'll take our last question from Jagadish Iyer with Summit Redstone. Please go ahead..

Yeah. Thanks for taking my question. Two questions. First, Rick, can you give us an idea on the competitive landscape for TDDI? And is there an opportunity for an ASP uplift as you engage with other customers in 2017? And then I have a follow-up..

Sure. So, competitive landscape there's certainly competitors out there, no one with the breadth, the technology. We are the clear leader. For the most part everybody is trying to map our functionality, our pinouts to go after the design win and the volume that we have.

So I think it would be a couple of folks you would expect, the Novateks and FocalTechs with solutions out there. In terms of ASP uplift, that would be a product mix phenomena for the most part. So we do expect to have a higher mix, for example, to WQHD then we do today, which is very low.

Full HD will certainly start to take off and that gives us more ASP opportunity. Right now a big chunk of our volume is in the TD4100, which is just a regular HD device, which will tend to be on the lower end of ASP and margin..

Okay. That's great. And just as follow up I want to understand, how should we think about your penetration of biometrics in China and what are some trends you are seeing there? We have some press releases about some socket wins and things like that. So just wanted to understand what kind of progress you are making in terms of the biometrics in China.

Thank you..

About six months ago we promised that you'd start to see a cadence of design win start to roll out, call it in non-Korea. Yeah. I think as you mentioned you're starting to see that now and that pipeline just continues to grow in terms of the opportunities that we have. I think we've now proven that we have the infrastructure.

We have the right products, and now with one Huawei, which of course everybody knows is the world's third largest smartphone manufacturer and kind of a standard bearer for China in terms of quality and the diligence they put into make sure their component suppliers have all the right features and quality. So in other words, we feel good.

Our position now in China is solid..

Thank you..

And this will conclude our Q&A session for today. I'd like to return the call to CEO, Rick Bergman for closing comments..

Well, thank you, everyone. Lots of good questions there. I look forward to seeing everyone on December 13 for our Analyst and Shareholder Meeting. And everyone have a great November. Thank you very much..

This will conclude today's program. Thanks for your participation. You may now disconnect and have a great day..