Good day, ladies and gentlemen, and welcome to the Second Quarter Silicon Motion Technology 2017 Earnings Conference Call. My name is Annie and I will be your conference moderator for today. [Operator Instructions] Before we begin today's conference, I have been asked to read the following forward-looking statements. 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 limitation, statements regarding trends in the semiconductor industry and our future results of operations, financial condition 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 technology and consumer demand for multimedia consumer electronics; the state of and any change 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. Now I would like to hand the conference over to your first speaker today, Mr. Jason Tsai, Senior Director of Investor Relations and Strategy. Thank you. Please go ahead.

Thank you. Good morning, everyone. Welcome to Silicon Motion's second quarter 2017 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 our key recent business developments. Riyadh will then discuss our second quarter financial results and provide our outlook. We'll then conclude with Q&A. Before we get started, I'd like to remind you of the Safe Harbor policy that 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 U.S. SEC. For more details on our financial results, please refer to our press release which was filed on Form 6-K after the close of market yesterday. This 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 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. As you know, overall NAND availability continues to be very tight. While hindered supply has been improving gradually, continuing strong demand in cellphone, enterprise, and hyperscale data center application continue to limit availability. Hindered supply constraints have been affecting our module maker customers, hyperscale customers, and even NAND flash partners. As a result, despite our strong pipeline of SD design wins with customers and growing portfolio of unique solutions, our ability to grow sales has been limited. Our second quarter sales, therefore, came in slightly below our expectation and second half sales will also be impacted. We believe this is a temporary issue caused by NAND industry supply transitioning to new 3D technology. By the end of the year, we expect our growth to start to rebound. And in a few quarters' time, as the industry supply accelerates, this headwind should turn to a tailwind. Riyadh will discuss about our financial performance in greater detail later on this call. Let me talk more about NAND industry supply condition as this the biggest factor limiting our near-term growth. As you know, NAND flash makers are already in commercial production of 64-layer 3D NAND flash. For example, our controller already is shipping in the world first commercially available client SSD using 64-layer 3D NAND, Intel's 545 SSD. 64-layer 3D NAND components from Intel, Micron, Samsung, Toshiba and WD are now all commercially available. This flash maker has been reporting smoothly improvement in manufacturing yield and industry supply has been gradually increasing. However, initial 64-layer 3D supply remains inadequate. And for the time being, supply continues to be tightly rationed. Supply is limited not only by current manufacturing yield and current number of the fabrication tool sets, but also longer…

Thank you, Wallace, and hello, everyone. I will summarize our financial results and outlook. Before I begin, I would like to reiterate that our comments today will focus primarily on our non-GAAP results unless otherwise specifically noted. A reconciliation of our GAAP to non-GAAP data is included with the earnings release issued today. Our second quarter revenue increased 4%, sequentially, driven by the expected ramp of new SSD solutions projects and growth of our eMMC controllers. Our embedded storage product sales continued to be roughly 80% of our total revenue in the second quarter. Let me provide additional color on our key products. Our client SSD controller sales declined by almost 10% sequentially as temporary high-NAND flash prices and high-client SSD prices slowed adoption rates and flash vendors redirected their limited flash supply from client SSDs to enterprise SSDs. Based on our customers' rolling forecasts, we expect our client SSD controller sales to decline further in the third quarter before rebounding materially in the fourth quarter. Beyond this year, we remain confident about rapid growth for our client SSD controllers. The cost of these new and next-generation 3D NAND components from 64-layer to 96 layer, from TLC to QLC, are significantly cheaper than previous generations of NAND. Over the next 3 to 5 years, the majority of client HDDs will be displaced by increasingly less expensive and higher performing client SSDs. And as the industry's leading merchant client SSD controller supplier, we should continue to benefit from this multi-year trend. eMMC controller sales grew nearly 5% sequentially as SK Hynix prebuilt inventory as part of their internal flash capacity planning. Our eMMC controller sales will likely decline in the second half as our flag partner is planning on allocating flash from mobile towards SSDs. Longer term, we believe our eMMC…

[Operator Instructions] Your first question comes from the line of Mehdi Hosseini of Susquehanna International. Please ask.

Yes, thanks for taking my question. Two follow-up, wanted to better understand the impact of your largest customer, especially with their ramp of 3D NAND. Based on their quarterly earnings, it was very obvious that they're running late. Their 72 layer is also late. And I am - I want to better understand how that particular customer and unavailability of their 3D NAND is impacting. And to what extent are you trying to improve your exposure to the other NAND manufacturers? And I have a follow-up.

Mehdi, our largest customer is a customer of - buys our eMMC controllers. Here, we had a fairly decent first half, but our eMMC sales will decline in the second half of the year as our customer allocates flash from mobile applications to SSD. So the full year, our eMMC sales will decline a little bit compared to last year.

Sure. But if they're running late with their 3D NAND project, doesn't that constrain their ability to supply inexpensive NAND into the client SSD market?

100% of our current eMMC project with [indiscernible] was 2D NAND. So although they're transitioning to the 3D NAND, the majority will be reserved for SSD, our high-end UFS product line. So our current eMMC product will not be affected even if they delay or slow down transition from 2D to 3D NAND.

Okay. And then you mentioned the 4-bit per cell and the QLC, and I'm under the impression that you will start sampling that in the second half. How will that impact your blended pricing? Is that going to have an impact? Or is this just another transition in 3D NAND that would require your customers to upgrade their controller?

We mentioned about 4-bit per cell TLC availability, we start to see samples at this moment. We believe it will be commercialized in the first half of 2018. We believe that will help the big growth of the whole NAND industry and it has nothing to do with our gross margin because we're selling controllers, manage [indiscernible] flash, shipping SSD products from our NAND OEM customers. And we believe that we're helping to improve the overall industry from the NAND supply and into the big growth.

Mehdi, let me also add that, generally, for all of our new controllers, when we launch new controllers, our ASPs are always initially always a little higher, but they gravitate towards our segment average over time.

Okay, got it. Thank you.

Thank you. Your next question comes from the line of Mike Burton of Longbow Research. Please ask.

Thanks for taking my question. I wanted to follow up on mobile. I missed your comment on UFS. Are your top customers still on track to ramp in the second half? And have you seen any movement at Hynix to doing an eMMC controller in addition to their UFS one?

I think our UFS program remains on track and we are waiting for broader AP support and smartphone design using UFS. Still only high-end AFC APs supporting UFS. Until broader, more mainstream APs supporting UFS and UMCP, the market for UFS will remain limited to Samsung, Qualcomm high-end platform. We understand some OEMs and some NAND makers will develop a new eMMC for high-end 3D NAND and - but that's their decision. We believe our current eMMC also already support certain 3D NAND for the customer.

Okay. And then also regarding the inventory correction at that customer; is your expectations for your full year guide that we should see sequential growth in mobile coming back in Q4?

No. You should expect our eMMC sales in the second half of the year to be down compared to the first half of the year. Q3, our large customer, they built inventory, prebuilt inventory and we believe this is relating to their fab equipment changeover. But for the second half of the year, specifically, we believe that they're going to be reallocating their flash more towards SSD. So this will impact their procurement of eMMC controllers for the second half of the year. So for the full year, you should expect our eMMCs to be down slightly

Okay, thanks and then just, you mentioned the mix effect, Riyadh. I was wondering if you could help quantify what kind of impact that's had on margins to you in the near term here as we look to that potentially becoming a tailwind as 64-layer starts to ramp? And then any other signs of increasing competition that's affecting pricing from either Marvell or internal solutions?

In the near term, our lower gross margins are a function of our SSD solutions increasing as a percentage of our business. And these products have lower margin due to higher NAND flash costs. By the fourth quarter, we should start seeing our SSD controllers rebound strongly and our SSD solutions decreasing as our Alibaba projects ramp down, which should lead to higher gross margins in the fourth quarter. As flash supply improves and our mix of business improves with more controller sales in the fourth quarter, we are confident that our gross margin will improve. When flash supply is readily available and prices come down with new generation 3D in mass production, we expect our SSD solution's gross margin to normalize again.

In addition, we do not see any meaningful changes to the competitive landscape for SSD. We have historically dominated the client software controller market and we continue to lead the market. Our same generation PCIe product lines are coming online later and we have a very strong design win pipeline and we're going to see the production from Q4 moving to 2018.

Okay, thanks.

Thank you. The next question comes from the line of Rajvindra Gill of Needham & Company. Please ask.

Yes, thank you for taking my questions. Riyadh, a question on the forecast for client SSD for the year, I believe you said it was going to be flat, if that's correct. Just wanted to get an understanding of the math there because, if I remember correctly, client SSDs in Q1 was down 20% sequentially and, in the second quarter, it was down 10% sequentially. In Q3, you're guiding it to be down slightly. So in Q4, it's going to require at least 50% sequential growth, if not higher, to get to the flat year-over-year. So just wondering if you could maybe provide a little more insight on that ramp in Q4 and if the math is right or not?

Rajiv, I'm not quite sure about your math, but for the full year, we're expecting our client SSDs to be flattish compared to last year. It will be down. It was down in the first few quarters, but we're expecting a very strong rebound in the fourth quarter leading to flattish client SSD sales for the full-year.

Okay. And what gives us kind of confidence in terms of the visibility? Because the tightness of the NAND flash, we saw signs of that at the beginning of the year. It hasn't loosened and there's expectations that it will start to expand, but that hasn't come to fruition in the past. So I'm just wondering, it's a pretty high bar - sequential bar in Q4 for the client SSDs to get to flat. So, I know you talked about based on customer rolling forecasts any other insights or elaboration would be helpful.

I think we have a very strong SSD design win pipeline through our second-generation PCIe with a major NAND maker, as well as PC OEM. And so even we believe NAND will gradually improve for the supply, but our client SSD is going to rebound strongly from Q4 this year, no matter if NAND supply improve or not improve because our NAND partner and OEM customer, they're going to secure the NAND, support the major launching new PCIe program and new SATA program with the new 3D NAND.

Okay. Got it. So we should see some new PCIe programs, 3D programs that, I would presume, would come with a higher ASP as well.

That's correct.

Starting to ramp in Q4.

Yes, that's correct ...

Is that fair to assume that we are going to get kind of a richer ASP mix with these new PCIe designs?

That's correct. As you know, for all of our new products, ASPs and margins are always better. But over time, they will converge towards our mean.

Okay, thank you. And last question for me and I'll step back. On the diversification in the eMMC business away from the top customer, can you maybe talk about the progress on that front? It seems like you've demonstrated excellent quality and dominance in the eMMC merchant market and it would make sense for other flash vendors to start to use your controller. Wondering if maybe you could give us thoughts on that? And how would you balance that with some of your top customer - with the top customer as well? If you're going to, perhaps, diversify, is there a conflict there? Or how you think about that? Thank you.

First of all, I want to say we stay very, very close [indiscernible] with SK Hynix and nothing changed with our business. For eMMC, we're seeing we're going to stay flat. How it grows is as the market grows in smartphone. We also diversify and with the new design with several key OEM customers and we can now name the other potential NAND maker because we believe when smartphones become mature, when the solution was stable and some NAND partners going to also to third-party with our eMMC controller because we are more stable, more cost-effective and fitting their needs. NAND makers tend to go to high-performance and higher - newer generation UFS development and competition, I think that's the strength with the 3D NAND. But a majority of eMMC is going to stay with the 2D NAND because the density has so many varieties and that will be more stable with our solution. And we do see our eMMC growing, expanding from smartphones, go to set-top box and moving to automotive and networking application and that becomes a more desirable and for a more balanced model for us to grow in long term.

Thank you.

Thank you. Next question comes from the line of Suji Desilva of Roth Capital. Please ask the question.

Good morning. Hi guys. On the 3D NAND, just to understand the supply demand dynamic here. You talked about availability improving, do we get to a point where there's a more normal supply/demand situation? If so, how far away production yields are kind of - or is it a situation where it remains in tight supply for several quarters to come?

I think flash makers are making good progress in ramping up new 3D NAND. And some are even accelerating CapEx investments to ramp new capacity sooner. So, we are optimistic about the long-term NAND supply growth. And flash makers, over the past week, have talked about how their yields and output for 3D NAND are ahead of expectations and some are even talking about next generation 96 layer and QLC NAND to try even faster bit growth next year. I think this year, because a majority of the industry bit growth will be back half-loaded, but that positions 2018 to be a meaningful year in terms of supply growth. So we are confident in maybe early 2018 or mid-2018, the supply and demand will become more balanced and made as a normal growth.

Okay. And then you talked about eMMC trying to diversify from phones. Can you tell us what percent of the eMMC business is not smartphones? I just don't understand where you're starting out here.

Yes. It's roughly about 10% based on our product sales. About 10% of our eMMC sales are going into non-smartphone applications.

Okay. And the last question. Can you give us a similar sort of split notion of the SSD solutions business, kind of how much is the Shannon business going into the hyperscale and how much is [indiscernible] just a baseline up to this point?

No, we don't break that down.

Okay. Alright thanks guys.

Thank you. The next question comes from the line of Mike Crawford of Riley. Please ask your question.

Thank you. On the SSD solution side, you're talking about new pricing arrangements that you're expecting to reset at year-end. Can you talk about the timing and duration of these type of agreements?

It varies quite a lot. We have a diversified - very diversified set of customers on our Ferri SSDs and on our Shannon side, while more concentrated, we have a lot of various different type of projects with various - lots of different types of programs. And so there's going to be a lot of variability. But what we've had is pricing arrangements that are set ahead of NAND procurement. And with NAND flash prices increasing rapidly, it's been affecting our margins, causing margin compression. But these should start changing as the year progresses, as we get closer to the end of year when a lot of the arrangements reset.

For example, some of our Ferri products have been designed three-years ago with the major automotive makers. And through the designing, through the auditing, everything, we signed a supply agreement and secured pricing. And now, we're facing the NAND price up. So it's very hard for us to change the selling price. So there are many different examples like this. So we have to waiting for when the NAND supply becomes smooth, more balanced, I think that our SSD solutions gross margin will go to a normal situation.

Okay, thank you. And then the other question relates to the buyback. I guess part A, is it your intent to use the full $200 million authorization over the next 12 months. And then part B would be that even if you do that, plus the $30 million a year dividend you're paying, you're still - about this time next year would have about $150 million of cash left on the balance sheet. And I'm wondering if, with the tightness in the market that might be affecting other competitors, whether you see any distressed opportunities to buy capacity or capability from other players who might be stressed? Thank you.

Mike, could you rephrase your question, especially first about the share buyback?

Sure. So the first part, Riyadh, is if it is the company's intent to use, to execute on the full $200 million 12-month authorization.

So Mike, our board makes the decision is really trying to show that we have confidence our company will rebound and back to the growth mode. Of course, you also make very - we also consider every [indiscernible] availability and we might consider more things, but the $200 million [indiscernible] new cash coming, which should have sufficient cash for us to make other choice or directions.

Let me also add. From a finance perspective, Michael, is to buy as much of our shares as cheaply as possible so that we can maximize the accretion to our company purely from a perspective of finance relating to a share repurchase.

Okay, thank you. And the second part of that question just related to, even if you did execute on the entire buyback, you still would have, my estimate, some $150 million left of net cash on the balance sheet a year from now after paying the dividend, after the $200 million dollar buyback. And given, today, that others must be feeling some pain given the supply tightness in the market, whether there were M&A opportunities that might be opportunistic at this point that you're looking at.

Well, Mike, we actively look and evaluate M&A opportunities. But as you know, we don't have an extensive track record of actually pulling a trigger and buying companies. As Wallace mentioned earlier in our call, recently, we acquired a small company - a software company that will help us on software-defined storage solutions. So these are an example of how we deploy capital for M&A purposes.

Okay great, thank you very much.

Thank you. Next question comes from the line of Charlie Chan of Morgan Stanley. Please ask the question.

Hi gentlemen, thanks for taking my questions. So my first question is to reconcile your SSD shipment growth versus the industry growth. Because we all know that even the supply is tight, but client SSD penetration is still going up, right? From net - last year was 40% this year, maybe to 45%. So this is still like 10% industry growth, right? So how do we reconcile this disparity between [indiscernible] industry growth? Is that your customer is losing share in client SSD or you are losing share to other competitors?

Charlie, we don't believe we're losing market share. What we've seen is price of NAND have gone up a lot. The price of SSDs, client SSDs have also gone a lot. And so we're seeing adoption rate - adoption of SSDs by PC OEMs and other device OEMs decelerating. So the use of SSDs this year, the growth of SSDs this year is significantly slower than what we saw last year. So this, I think, is a very important factor for our industry. With upcoming NAND, especially with the 64 and the upcoming 96, the price of NAND, the cost of NAND will continue to come down. And so longer term, we're very confident that we'll get back on track and the adoption beginning to accelerate again when these cheaper components come around. But for the time being, with the high price of NAND, high price of SSDs, adoption has been impacted and it's affecting everybody across the board.

Okay, thanks Riyadh. And my next question is regarding your OpEx, right? So the new revenue guidance is down single-digit. How about OpEx in terms of absolute dollars, it's going to decreases as well?

OpEx for upcoming quarter should be quite stable compared to the previous quarter.

So for the full-year, should we assume it's still up slightly?

For the full-year, we'll be up slightly, yes. It's important to note that while we would like to dial back our OpEx, we have a lot of very important growth projects like enterprise SSD controllers and other projects that we continue to need to invest aggressively if we want to hit our longer term growth targets.

Okay. Understood. So, lastly also a follow-up from a previous question from other investors. So that the NAND supply will increase comments, right? So, I think at the beginning of the year, you provide guidance based on your assumption from your source, right? So this time around, what can give you better prediction about the NAND supply rebound timing?

For our rebound of our client SSD controller sales, the guidance - the color that we are providing is based primarily on the rolling forecasts of our customers, as well as backlog of orders. And these have increasingly been inching up for a rebound in the second half of the year, especially in Q4.

So Charlie, let me add. Regarding the NAND sourcing for our enterprise SSD solution and we're aggressively moving in a different direction. And some NAND makers, maybe they are - now within some main NAND makers, they are willing to sell the NAND to us because they want to enter enterprise industry. So, we are working with them. And through the price transition, we believe when NAND supply becomes better and pricing going down. We are working on the Q4 pricing with several NAND makers at the moment.

Yes. So for that big single customer, Alibaba, do they still consign the NAND or will it become the norm that you will buy better NANDs for Alibaba going forward?

So we have two different business models. They will purchase NAND consigned to us. We can provide a total solution. But even in the tight NAND supply condition, even Alibaba will have difficulty to procure their NAND in a full scale.

Charlie, for this year, we are procuring a lot more flash. The proportion of our business with Alibaba where we're procuring the flash, this year, that proportion is much higher than what it was last year. A big part of our business with Ali involves our company procuring flash for us to build SSDs for them.

Okay. Got it. So hopefully, your business can recover significantly in fourth quarter? Thanks.

We believe so. Yes.

Thank you. The next question comes from the line of Donnie Teng of Nomura Securities. Please ask the question.

Hi, thank you for taking my question My first question is to follow-up on Charlie's question. As we know, this year, client SSD is also slowing down due to the tightening supply. But the industry growth seems still like 10%, 15% year-over-year. So, you already gave a guidance that client [indiscernible] sales to be flat, but you also mentioned how you did not lose market share. So, can we say that could be mainly due to you have some new products not yet launched like PCIe or 3D NAND, which carries higher ASP, while your legacy products could face some ASP erosion in the maybe first half or in the first three quarters?

Donnie, think what you'll see is a lot of third-party analysts dial back - dial down their forecasts, their client SSD unit forecasts for this year. Some of the numbers from earlier this year are way too optimistic. And so what you'll see is some of the analysts beginning to take down the numbers as the year progresses.

Okay. Got it. So basically, we should not need to worry about any competition according to our current visibility, right?

That's correct.

Okay. My second question is regarding to your fourth quarter visibility. So in terms of the ranking of the visibility, which product line you will have higher confidence? And how should we think about any potential risk in the fourth quarter?

We're fairly confident pretty much across-the-board for all of our key products, whether it's client SSDs, eMMC or SSD solutions. They all have fairly good - for all our products, we have a good mix of high-quality businesses, as well as more risky prospects. But overall, feel fairly good about all our key products for Q3 and Q4.

Yes. We have very strong, very broad, Ferri SSD product PO. So unfortunately, we can only secure around 20%, 25% of the NAND. If we can secure more NAND, I think we can do better.

Okay. Got it. So I think, generally, the risk should be mainly from like whether NAND supply to be still tight, which - longer than your expectation? Or whether the end demand could see any weakness in fourth quarter or coming quarters, right? So it looks like...

We already considered all the factors. We believe we already use a conservative [ph] NAND supply situation to give our guidance for the whole year.

Okay, thank you so much.

Thank you. Our last question comes from the line of Tom Sepenzis of Northland Capital Markets. Please ask the question.

Hey, thank you for squeezing me in. So clearly, revenue is going to snap back Q4. Can you talk about gross margins and whether that's going to snap back simultaneously or if that will lag by a few quarters as the pricing of the NAND takes a while to come back down?

In Q4, our gross margins should snap back. It's going to be coming from two major factors. One is our higher gross margin client SSD products will rebound materially in Q4, while, at the same time, our lower gross margin SSD solutions ramp down as many of our projects, including the major ones with Alibaba, concludes for the year. Bear in mind, our SSD solutions this year is further impacted by the high cost of NAND that we didn't have in past years.

And in addition, in certain contract price for enterprise SSD solutions will be renegotiated in the beginning of 2018. So, we believe our gross margin will be rebound strongly reasonable from Q4 to next year.

Great, thank you. And then in terms of the revenue decline here in Q3, can you just qualify exactly what's driving that? I mean is this the shift to enterprise, mainly, from client on the SSD side? Or is it the mobile business? I just missed the explanation for why we're seeing an actual decline sequentially in units in Q3.

In Q3, NAND will continue to be very tight and this is leading to temporary rebalancing of NAND inventory by the major suppliers and leading to them dialing further down their client SSD procurements in order to have more NAND for enterprise data center applications.

Great, thank you. Appreciate it.

Thank you. That does conclude our Q&A session for today. I would now like to hand the conference back to Mr. Wallace Kou, President and CEO.

I would like to thank all of you for joining us today and your continuing interest in Silicon Motion. We will be attending several conferences in Asia, U.S., and London this quarter. Details of these events will be available on our website. Thank you and goodbye for now.

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