Ladies and gentlemen, thank you for standing by and welcome to the Silicon Motion Technology Corporation Q3 2016 earnings conference call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session [Operator Instructions]. This conference call contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 as amended. Such forward-looking statements include, without limitations, statements regarding trends in the semiconductor industry and our future results of operations, financial conditions and business prospects. Although such statements are based on our own information and information from other sources we believe to be reliable, you should not place undue reliance on them. These statements involve risks and uncertainties and actual market trends and our results may differ materially from those expressed or implied in these forward-looking statements for a variety of reasons. Potential risks and uncertainties include, but are not limited to, continued competitive pressure in the semiconductor industry and the effect of such pressure on prices, unpredictable changes in the technology and consumer demand for multimedia consumer electronics, the state of and any changes in our relationship with our major customers, and changes in political, economic, legal and social conditions in Taiwan. For additional discussion of these risks and uncertainties and other factors, please see the documents we file from time to time with the Securities and Exchange Commission. We assume no obligation to update any forward-looking statements, which apply only as of the date of this conference call. I must advise that this conference call is being recorded today, Friday, 28 October 2016. I would like to hand over the conference to our first speaker today, Mr. Jason Tsai. Thank you. Please go ahead, sir.

Thank you and good morning, everyone. Welcome to Silicon Motion’s third quarter 2016 financial results conference call and webcast. My name is Jason Tsai. And with me here is Wallace Kou, our President and CEO, and Riyadh Lai, our Chief Financial Officer. The agenda for today is as follows: Wallace will start with a review of some of our recent business developments. Riyadh will then discuss our third quarter financial results and provide our outlook. And we will then conclude with Q&A. Before we get started, I’d like to remind you of our Safe Harbor policy, which was read at the start of this call. For a comprehensive overview of the risks involved in investing in our securities, please refer to our filings with the US SEC. For more details on our financial results, please refer to our press release which was filed on Form 6-K after the market closed is today. The webcast will be available for replay on our website, www.siliconmotion.com, for a limited time. To enhance investors understanding of our ongoing economic performance, we will discuss non-GAAP information during this call. We use non-GAAP financial measures internally to evaluate and manage our operations. We have, therefore, chosen to provide this information to enable you to perform comparisons of our operating results in a manner similar to how we analyze our own operating results. The reconciliation of the GAAP to non-GAAP financial data can be found in our earnings release issued yesterday. We ask that you review it in conjunction with this call. With that, I will turn the call over to Wallace.

Thank you, Jason. Hello, everyone, and thank you for joining our earnings call. This year has been an outstanding year for us and the third quarter is no exception. Revenue increased this quarter by 13% to a record $139 million, our seventh consecutive quarter of revenue growth. Our $135 million revenue is equivalent to 36% a year-over-year growth. Growth was led by our client SSD controllers, eMMC controllers, and SSD solutions. In addition to record sales this quarter, we also delivered record high quarterly EPS of $1.07, our first quarterly EPS over $1. Riyadh will discuss our financial performance in greater detail later on the call. Let me now update everyone on the progress of our key growth drivers, starting with our client SSD controllers, which has become our largest product, with sales now even bigger than our eMMC controllers. Sales of our client SSD controllers increased 25% in the third quarter, our eighth consecutive quarter of sequential client SSD controller growth. For full year 2016, we’re on track to grow our client SSD controller sales by approximately 175%. In the third quarter, our client SSD controller sales to our flash partners was especially strong. These sales increased over 50% sequentially, with our flash partners accounting for well over half of our overall client SSD controller revenue. Sales of SSD controllers to module maker customers, despite facing tight NAND flash supply conditions, also increased sequentially, though more modestly. We are confident our client SSD controller sales will very likely grow further in the fourth quarter, with continued growth led by sales of our flash partners. Our client SSD controller had been growing rapidly for many reasons. Demand for client SSD remains very strong, both with PC OEM and the channel markets. PC OEM are still increasing the adoption of the…

Thank you, Wallace, and hello everyone. First, I will outline our financial results and then provide our guidance. Before I begin, I would like to reiterate that my comments today will focus primarily on our non-GAAP results unless otherwise specifically noted. A reconciliation of our GAAP and non-GAAP data is included with the earnings release issued today. We continue to deliver on sales and earnings growth significantly above semiconductor industry average by focusing on unique market opportunities relating to NAND flash controller technologies. Our business continues to deliver results that can sustain a long-term gross margin of around 50% and gradually move our operating margin towards our 30% target. Wallace has just updated everyone on the progress and prospects of our three big market opportunities line. Client SSD controllers, eMMC and UFS controllers and our highly specialized SSD solutions. This quarter, revenue increased 13% sequentially to $159 million, 66% higher than the same period last year. Our revenue year-to-date is 56% higher than last year. Sales of our embedded storage products, which include our client SSD and eMMC controllers and our industrial and enterprise SSD solutions grew over 15% sequentially and continue to account for about 80% of total revenue. Within our embedded storage products, our client SSD controllers grew 25% sequentially. Our eMMC controllers grew over 15% sequentially. And our SSD solutions grew less than 10% sequentially. Our expandable storage products, our hard and USB flash drive controllers, declined about 10% sequentially due to tightness of Flash availability. This quarter, we had three 10% plus customers – Hynix, another NAND Flash partner, and a China BAT Internet company. Our gross margin increased to 48.9% in Q3 from 48.4% the previous quarter due to sales of a more favorable product mix. Our operating expenses increased 4% to $32 million from…

[Operator Instructions] Our first question comes from the line of Mehdi Hosseini from SIG. Please go ahead.

Yes. Thanks for taking my question. Just on your commentary on client SSD, it seems like you can grow revenues on a flattish – sequentially be flattish and you still hit the 20%. And I just want to make sure I understand the dynamics that are driving client SSD. I’m assuming that you will be shipping to multiple flash vendors, also continue to increase direct sale to year-end. These are assumptions. And to that extent, when – what would be the dynamics that will drive the market growth above 25%? So just to summarize, what are the key drivers that gives you confidence that, at the worst case, client SSD will be flattish on a sequential basis and the dynamics that would drive the client SSD growth about 25%? Then I have a follow-up.

I think our current SSD design pipeline from both SATA and the PCIe, we have the confidence to grow. Although we might see tight NAND supply in the first half of next year because the majority of design is from the NAND maker partners. So we have confidence through their forecasts and penetration with the PC OEM as well as the channel market. And we believe we should be able to grow 20% from this year.

So during your bookings and your relationship, you’re confident that 20% is the worst case scenario? How we should think about the 20% minimum growth driver?

That’s correct. From client SSD controller.

Okay. And then, you talked about that your operating margin target of 30%, is this going to be a multi-year target because you’re going to continue to invest in your enterprise SSD or is that target going to be hit sooner than later?

Mehdi, that is correct. This is – improving our operating margin is and will continue to be a multiple year project. Over the last few years, we've been improving our operating margin. Last year, our operating margin was roughly 24%. This year, we will probably finish this year around 27%. And, over time, as we continue to scale our revenue and keep our gross margins fairly stable and grow our operating expense at a lower rate compared to revenue, we should continue to be able to deliver on that improvement in operating margin towards our 30% target.

Thank you.

Our next question comes from the line of Anthony Stoss of Craig-Hallum. Please go ahead.

Hi, guys. Two-part question. First off, did I hear correctly, Wallace, that you expect Samsung to come on as a new customer in the SSD side in the middle of 2017? And then, Riyadh, if you won’t mind just talking about your OpEx thoughts kind of going forward throughout 2017?

First of all, we did not mention that Samsung will become our SSD customer. We said we are able to support all NAND flash makers, 3D NAND, for the SSD solutions. And we cannot comment – any NAND maker who is going to sell their 3D NAND to channel or module maker or OEM customer, we’re ready to support them.

Let me also add to what Wallace just said. What Wallace had mentioned in his prepared remarks is that by mid next year, our SSD controllers will be in volume production for managing Hynix, Intel, Micron, SanDisk, Toshiba and even Samsung 3D NAND.

Then on the OpEx question, Riyadh?

Can you refresh your OpEx question again? I’m sorry.

Maybe a little bit more detail regarding the – what you expect on OpEx next year. I know you expect revenues to grow faster, but any more help on OpEx would be appreciated.

Yeah. We will continue to build our operating infrastructure as we have a lot of projects related to all of our growth opportunity related to client SSD, relating to eMMC and UFS controllers, relating to our Shannon and Ferri SSD solutions and also [indiscernible] going into the enterprise SSD solutions. So, we will continue to be growing our operating expense. So, you should be expecting our operating [indiscernible] continue to invest in R&D and to grow our operating expense gradually in order to meet the demands of our customers. But we will be increasing at a slower rate compared to revenue.

Great. Thank you.

Our next question comes from the line of Charlie Chan of Morgan Stanley. Please go ahead.

Thanks for taking my question. And congratulations for great results. So, first of all, you have start to ship the PCIe [indiscernible]. So, what is that for? Is that for client SSD or mainly for enterprise SSD?

The product primarily for client SSD, both channel as well as PC OEM, but I think our customer may also for very low cost cloud, hyperscale SSD solutions.

Okay. And, Wallace, can you give us some sense of how the PCIe penetration in client SSD and enterprise SSD today and maybe next year?

I think that everybody know Intel and Samsung are really pushing PCIe and become from premium line – they would like to try to become mainstream. However, I think the momentum is growing for clients. I think next year, [indiscernible] penetration rate will be probably at least 10% or 20% bigger than this year. However, I think for enterprise side, primary solution is through SATA. The PCIe is the main factor to drive for the cloud, for cloud SSD. And we do see all the new design in the cloud side, the PCIe, NVME solution. So, that becomes standard. And that’s why all the NAND – all the flash maker shipping more NAND to enterprise and cloud side because it have a more profit in the area. But PCIe eventually, we think – and not just the [indiscernible] eventually we’re going to see BGA PCIe solution come to the market within one or two years.

Okay. So, for your company, what would be the PCIe product mix next year? And would that improve your blended ASP?

I think next year, our primary shipment, SATA still is bigger than PCIe. However, PCIe momentum is growing. And we see more demand for PCIe from PC OEM as well as all other applications. So, I think the PCIe eventually will become our major growth driver in the next few years.

Okay, thanks. So, my next question is regarding your module business outlook into 2017. I know this year you have some one-time, like, rolling of procurement. So, these could not be the normal revenue scale. So, for 2017, this should mean no more sort of one-time procurements what would be the revenue size for both enterprise SSD and Ferri industrial SSD.

Charlie, on this question you’re actually right. Our SSD solution this year is turbocharged, if you will, related to the inclusion of the NAND component into our cost of sales. And so, as a result, our SSD solutions revenue grew rapidly. We’re going to be growing our SSD solution this year in the tune of 3x compared to what we had last year. Last year, our SSD solution delivered revenue about $25 million. So, going into next year, we expect – because of the turbocharged nature of our SSD solution this year, we're expecting more moderate rate of growth for these sort of products. Moderate rate of around 15% to 20% for next year.

15% to 20% year-on-year.

That’s right. Year-on-year.

Okay. And yeah – okay. And lastly, on your 28 nanometer products, when would you start to recognize the [indiscernible] cost because the R&D [indiscernible] in the second half. Or that [indiscernible] costs would happen in 2017. And when will you start to ship the 28 nanometer product?

We believe our 28 nanometer product is the end – our UFS will be shipping by middle of next year or second half next year.

Okay. So, will the [indiscernible] cost reflect this year’s earning or next year?

The [indiscernible] will be reflected this year. It’s in Q3 and in Q4.

Okay, got it. And let’s see, if I may, for UFS, what would be the ASP difference versus the eMMC?

I apologize. We cannot comment on the price. But definitely UFS has a higher performance and a more sophisticated design and [indiscernible] much bigger than eMMC. So, ASP will be higher.

Okay. Okay, got it. Okay, thank you very much.

Our next question comes from the line of Rajvindra Gill of Needham & Company. Please go ahead.

Yeah, thanks for taking my questions and congrats on good results. Question on the UFS adoption next year. Can you maybe talk a little about the transition to UFS across the handset OEMs? How fast do you think that transition is happening? And what do you think the main growth drivers or catalyst for UFS adoption and how do you think you’re positioned competitively versus, say, internal solutions that are out there?

It’s a very good question. I think from our position, for 2016, this year, in the first half, the momentum for UFS adoption. However, go to the second half, it’s slowing down because primary – the smartphone adopter is Samsung. We do see there five or six other smartphone maker, but there only is one model, use small volume for UFS. But there are clients like Huawei, they really like to wait for [indiscernible] performance benefit from UFS. And many others and smartphone makers waiting for Mediatek, their new solution which can support UFS next year. And we believe, for UFS, if we become – want to become the mainstream product in mobile, it had to be UMCP [indiscernible] UFS controller and mobile DRAM and NAND to getting single BGA package. And this trend probably won’t be able to happen until late 2017 or 2018 timeframe.

Okay, thank you. That’s helpful. And, Wallace, you mentioned the client SSD penetration rates, some numbers. In terms of the notebook PC market, if I recall, you said one third of the market is SSDs. And then you’re also seeing growing traction in desktop PC SSDs as well. Can you maybe talk a little bit about how your market share or your competitive position is in the notebook PC and desktop PC? The attach rates are accelerating. Your market share is fairly good at a lot of the Flash OEMs outside of Samsung, which does internally. How do you look at the market share dynamics going into next year as the attach rates accelerate further? Can you talk a little bit about how you’re positioned to continue to grow that business relative to, say, Marvell or even other competitors?

Okay. I think it’s a very big question. [indiscernible] regarding our statement, yes, so we believe the notebook [indiscernible] is being adopted, SSD as of today. Of course, commercial notebook have a higher percentage than consumer product line for notebook. Regarding the desktop, [indiscernible] mini PC, also the gaming PC. The gaming PC user try to adopt SSD because they’re much faster playing the game. But normally they use a [indiscernible] HDD for data storage, for the SSD the gaming playing, so achieve high performance. We also observe the channel and CC shop and do-it-yourself PC [indiscernible] adopt SSD instead of HDD. Regarding the overall market, as you know, NAND supply today is tight. So NAND maker try to maximize the profit for every bit they can produce for the NAND. So from that angle, some major NAND maker has shift the NAND, more SSD solution into enterprise data center. So, I think Samsung, they aggressively transitioned from client SSD into enterprise SSD. So, we see that’s a tremendous opportunity for SIMO to grow and to work with other NAND maker and another module maker to fulfill this spot. And we believe our sort of turnkey solution can help out the NAND maker quickly enter into the market with the new generation 3D NAND. This is an advantage we have and we have a good track record compared with Marvell or other SSD controller competitor. And today, I think we are well known by all the PC makers and all the NAND makers and we have our products consistent and cost effective with a very decent performance. And we continue to put R&D investment in the new technologies, especially in the 3D NAND, either fresher algorithms, special rate designs, and to maintain high retention and better quality and can put more value to consumer end user. Thus, we believe we have very good and bright position in this client SSD market and we’ll work with all the major NAND maker and continue to grow the market.

And thank you for that. And just last question from me, on eMMC, you had mentioned that year-to-date it's up 50% year-over-year and you’re expecting the growth rate next year to grow in line with the market at 5%. That’s kind of the minimum case. Can you talk about some of the reasons why that growth rate might be higher next year and why was the growth rate so high this year? You mentioned market share gains with your customer, SK Hynix. Do you foresee more market share gains with your customer? Are you diversifying your eMMC customer base, which could potentially add more growth next year as well? Just wondering if you could talk about some of the potential upside catalyst to that 5% number next year, given the fact you grew 50%.

So, let’s look at what happened this year, why we gained market share quickly and grow very fast with eMMC controller. This year, I think there are two major factor factors and because everybody knows smartphones only grow single digit, 3% to 5%. And why eMMC can grow, it’s almost 40 – 30% this year because China subsidized the 3G phone to 4G – low-cost 4G phone. So, that’s why – the 3G phone normally uses raw NAND, bare NAND and go to 4G phone they adopt eMMC or eMCP. That's why the demand, about 200 million units in transition this year from 3G to 4G. That’s created a strong demand for eMCP. And the reason, I think – I cannot see with the – our customers, but I think normally eMCP with a mobile DRAM that have a better profit than pure NAND solutions in other areas. That’s why our major customers prefer to grow eMCP, allocate more NAND into eMCP solutions to gain the market. This way, financially, we do gain market quickly in 2016. For 2017, next year, because of this transition from 3G to 4G, it’s done. So, the smartphone itself, we are going to continue grow in line with the market. However, eMMC solution is a JEDEC standard. They’re being expanded to other areas such as set-top box and smart TV and car navigation systems. So, I think we’re going to grow potentially upside [indiscernible] other non-smartphone area. And there is also UFS. We can also grow UFS the part of a smartphone. So, we believe we will be in line – [indiscernible] in line with the smartphone market growth and potential upside [indiscernible] other segments, other application areas.

Thank you, Wallace.

Our next question comes from the line of Mike Burton of Brean Capital. Please go ahead.

Thanks. And congrats on the strong results. A two-parter on mobile storage. What does typical Q4 look like for this segment. You’ve had a couple of years recently where I believe that business declined 20% plus. Is that typical in your expectation for this quarter? and then second year a lot of questions from investors concern about the tightness in the tiny handset OEMs as a precursor for an inventory correction, are you seeing any of that in Q4 or do you think we should be thinking about Q1 in 2017?

I think the – for this Q4 mobile solutions – mobile controller for eMMC still maintain strong. It could be similar range like a Q3. But we do not see the over inventory ni the channel and we do not see double booking at least from our customers and from what we can reach assets from the smartphone makers.

Okay. Okay. And then, regarding Hynix, you mentioned in your comments, making progress on eMMC pay packages with them. Just wondering if there's any change in the timing of when you had expected your ramps in UFS for next year. I believe you had talked about your first customer being in the first half and then your second – your largest customer in the second half. Is that still kind of the timing for next year?

And that's why we believe it’s a target we’re looking for.

You’re correct, Mike.

Thanks.

Our next question comes from the line of Suji Desilva of ROTH Capital. Please go ahead.

Hi, Wallace. Hi, Riyadh. Congrats on the strong results here. On the hyperscale side, trying to understand the customer base. Do you have really one or two large customers that are driving the bulk of the revenues there or have you diversified the exposure there to several customers to understand that segment?

Suji, we have a lot of customers, but our customer concentration – our customers are, in fact, quite concentrated with one particular customer, and this is one of the big BAT Internet companies out of China.

Is there prospect there, Riyadh, for more customers to join into that, along with the one you have now?

We’re working on that. But so far, our visibility going into next year stands with just this one customer.

Fair enough there. And then on UFS, I know a lot of questions have been asked, but just to understand how many partners/customers do you think you’ll be ramping with in 2017 just to understand the breadth of your penetration there.

As we’ve mentioned in our prepared remarks, we have one NAND flash vendor which we are going to be going into production now for the end of the year and we have another one that we’re working with that’s more going live sometime mid next year.

Okay, great. And then last question, what is going on with the ASPs in the SSD market. I know they were around $5. So, what are the trends you’re seeing as you see that segment and the mix between enterprise and clients?

We’re not going to comment specifically about the actually ASPs of our products – our controller products, given that we don’t have too many customers and for competitive reason we’re not going to be going into that level of detail. But as a benchmark, our ASPs for these products are very roughly $5.

Okay, great. Thanks, guys.

Our next question comes from the line of Jaeson Schmidt of Lake Street Capital. Please go ahead.

Hey, guys. Thanks for taking my questions. Most have been asked already. But just curious, I know visibility is cloudy on the core business, that USB and card side. But is a 10% annual decline going forward kind of a good base case?

Yeah, it is. Given that we don't have much visibility into this segment of our business, with buildings quite murky. An annual decline of in the teens – of at least 10% is probably a good estimate.

Okay. And then the tax rate in 2017, is that Q4 rate a good number to use?

You should stick with our model tax rate. Our long-term model tax rate is 18%.

All right. Thanks, a lot, guys.

Our next question comes from the line of Mike Crawford of B. Riley & Co.

Thanks. B. Riley & Co. Regarding this new fast manufacturing Yangtze River Storage Technology, what, if any, support resources do you expect to apply to this entity?

We cannot comment too much. I think the government in China, with China play, they have – they’re really recruiting more people in the – looking for the strategic partner and the potential license of technology. But we keep us strong relation with them. They do have a NAND coming within three years, we will support them. And so, I think the – everybody understand the challenging, but overall I think the – more flash is better for us. And we have a broader market to play.

Okay. Thanks, Wallace. And then just to be clear on eMMC, UFS, if you look out a period of time, whether it’s two years, three years versus today, when I believe almost of your eMMC controllers revenue was coming just from Hynix. Do you expect – what kind of mix would you targeting for other flash partners to be part of that eMMC/UFS business for you?

I think that, today, for eMMC, primarily comes from one NAND maker. We also have two to three module maker start growing in China – China area. We believe they’re about 10% of our current revenue, but we’re seeing the continued growth in the next few years. In addition, for UFS, we engaged with the two NAND makers. One will be in production in Q1 and the other is our primary flash partner for mobile that probably will be in production in the second half next year. However, for the mobile space, it is done yet both for eMMC and UFS. And there’s high possibility that PCIe one day will move to mobile space. If you look at Apple today, they use PCIe based solution for iPhone. And if a PCIe will become really the mobile solution, we think we will have a broader opportunity to engage multiple NAND maker for mobile applications. That’s how we play.

Okay, thank you.

Our last question comes from the line of Tom Sepenzis of Northland. Please go ahead.

Yeah. I’m just curious. I know that the cost of the debt is really low, but is there any specific thing that you’ve earmarked that money for? Is that just to hire more people or are you looking at potential acquisitions? What will be the use of that cash?

We have a lot of operating entities in many different jurisdictions. Some of our operating entities are making a lot of – making some cash flows, while others are not. So, in certain places, we may need to bring cash into the entity that require investments. And, generally, in the past, we’ve been using internally generated cash flow for this. But this time around, given the very low cost financing environment, we determined that the use of external financing is comparable to the use of our own internal funds, especially when it's treated as a intercompany loan where you have to arrange it at arm’s length basis. You have to account for interest income and income is then taxable. So when you factor in all these expenses, plus the transfer pricing studies and the documentation, it works out that the use of very cheap bank loans – the cost of these bank loans are comparable to the arm’s length cost, plus all the other related costs that we need to build into it. The two costs are quite comparable.

Great, thank you. And then I was wondering if you could just provide us specifically on the Shannon business in terms of customer wins, just number or who and what type of picture are you seeing in the Chinese market for that.

We have quite a lot of customers, though, our customer base is concentrated at one large customer accounting for a big majority – a large majority of our total sales at Shannon. And this one customer is one of the BAT Internet companies out of China.

Great, thank you very much.

There are no further questions at this time. I’d like to hand the conference back to our presenters. Please continue.

I would like to thank all of you for joining us today and your continuing interest in Silicon Motion. We will be at the following conference in this quarter: Needham Next-Gen Storage/Networking Conference in New York; Bernstein Technology Innovation Summit in New York; Mizuho Investor Conference in New York; J.P. Morgan Investor Conference in Hong Kong; UBS Global Technology Conference in San Francisco; Morgan Stanley Investor Conference in Singapore; Bank of New York and Jefferies ADR conference in New York; Credit Suisse US Technology Conference in Phoenix. Detail of this event will be available on our website. Thank you and goodbye for now.

Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.