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Silicon Motion Technology Corporation (NASDAQ:SIMO)

Deutsche Bank dbAccess Technology Conference Call

September 10, 2013 11:10 ET

Executives

Riyadh Lai - Chief Financial Officer

Analysts

Bob Gujavarty - Deutsche Bank

Bob Gujavarty - Deutsche Bank

Good morning everybody. Thanks for waking up so early for everybody in the room and on the webcast. We have Riyadh Lai, Chief Financial Officer of Silicon Motion this morning. He is going to go through a brief presentation, but I moderate some Q&A either through the live audience or on the web. So with that, I will let Riyadh take over.

Riyadh Lai - Chief Financial Officer

Bob, thank you very much for the introduction. It’s a pleasure to be here at Deutsche Bank Technology Conference today in Las Vegas. I am going to go through a presentation and will open up for Q&A. But before I begin, I will just refer everyone to our Safe Harbor statement, the risk and other filings available for your review. These are on our website as well as filed with the U.S. SEC.

Quick introduction to Silicon Motion, we are a fabulous semiconductor company with two primary product lines, our mobile storage and our mobile communications. Our mobile storage is our NAND flash controller business and our mobile communications is our specialty RFIC business.

Moving on our mobile storage, our key products there are our SSD controllers, eMMC controllers, card controllers and USB flash drive controllers. In our other major product line, our mobile communications product line, our specialty RF products are primarily LTE transceivers and mobile TV SoCs. We are an established company that has done tremendously well over the last three years. We grew our revenue over the last three years at a 48% CAGR to $212 million last year. We have done very well based on two important trends, a trend of smartphone growing rapidly over the last three years with high attach rates. Attach rates are cards with these smartphones that we are the leading supplier of controllers for these bundled cards.

We have also done tremendously well over the last two years with the growth and rollout of LTE networks around the world, primarily in the U.S. and in Korea. We are a supplier of LTE transceivers to Samsung for their LTE phones, including the Galaxy Nexus as well as Samsung S3 last year. We have done tremendously well as a company over the last three years, but we are also a company in transition. We are a company in transition with two of our primary products, transition with our NAND flash controllers, also transition with our LTE products. In NAND controller bit, our business has been transitioned as flash, which were primarily used for external storage are increasingly moving to internal storage.

For us, that meant facing a declining, a mature and declining market with cards and USB flash drives, while embedded especially our SSD and eMMC products are quickly growing as a market. And for us more directly, it meant declining revenues for our cards and USB flash product business being partially offset by growth from our very rapid growth from the eMMC side of our business. We are also facing transition on the LTE side of our business as our older transceivers are transitioning and awaiting the release of our LTE advanced transceivers. And I will go through these in a little more detail.

On the eMMC side of our business, we have done tremendously well. This is a very important element of our growth in our mobile controller part of our business, our NAND flash controller part of our business. We used to be almost entirely a card and USB flash driver controller. Over the last three years, we have been actively growing the SSD plus embedded segment of our controller business, where in 2010 these SSD and embedded controllers accounted for 5%, 10% of our segment revenue. And last year, this had grown to about 20%, 25% of our segment revenue as we released our eMMC controllers. This year in the second quarter, we have already reached a very important milestone, where our SSD plus embedded revenue is already larger than our card plus USB flash drive revenue. This is a very important milestone as it represents the transition from external storage to the embedded storage that are the longer term feature of storage in mobile devices and where we are heading as a business.

Specifically in the eMMC part of our business, we have done tremendously well. We started selling our eMMC controllers in the first quarter of last year to both Samsung and Hynix. And in the first year of our eMMC business, our revenue from these eMMC products were already 10% of our corporate revenue, so approximately $28 million. This part of business continues to grow very rapidly, where it’s going to be the primary driver for our company growth – for our company from a product perspective both from last year to this year. And well, it’s the primary driver for the 100% plus growth that we are expecting from our SSD plus embedded class of products.

We have done very well focusing on Samsung and Hynix, through them we are – our controllers are found in eight out of top ten smartphone OEM devices for android, for RIM, for Windows devices towards smartphones, for tablets and other and mobile devices. We are also in flagship products. We are also in low cost smartphones. We are in global products, we are also in China-specific products. We are in some of the latest high profile products like the Google Nexus 7 tablet. We are also in a lot of the low-cost smartphones out of China. And in China alone we have close to 50% market share through Samsung and Hynix, so we have done very well. This is part of our business that we have strong hopes for and we have been investing aggressively in both technology as well as building out our product portfolio and building out our customer base. Currently we have Samsung and Hynix as our two flash partners for these eMMC controllers. We are in the process of brining on a third NAND flash partner as our customer. We are in product development and we are anticipating revenue, initial revenue from this third flash customer in the first quarter of next year.

The other part of our SSD plus embedded segment that we are focusing on is our SATAIII SSD controllers. These products recently became available for commercial sampling with customers based on third party benchmarks from Tom’s Hardware and iSuppli as well as others. We have – they have demonstrated that our SSD controller is among the top in class. We have a product that is – that can do a lot with less. We do more for less by having a SSD controller with unique architecture. We are able to best in class – deliver best in class performance with a lot less in terms of power requirements, in terms of die size. Our competitors’ products are using eight channels and we are able to deliver same top in class with has four channels, which means we have a product that draws a lot less power from mobile and it is important criteria for mobile devices, as well as with just four channels, it means that our dice are going to be very small. And similar to what the third-party benchmarks are showing, our OEM customers who are sampling our products have come back to us and our product is indeed quite good.

So if the anticipated design wins that we are targeting started coming through, we are anticipating our initial revenue, material revenue from our SSD controllers also be getting in the first quarter of next year. So, overall our SSD plus embedded which are led by our eMMC as well as our SATAIII controllers have been doing very nicely and we are expecting this to be a – our most important growth driver for the foreseeable future.

I mean I will turn over to our 4G LTE transceiver. This is a transceiver product that we have been developing with Samsung for a number of years. This is a transceiver that is designed specifically for Samsung preparing up with Samsung’s baseband, LTE baseband, we are the companionship to Samsung’s LTE baseband. We have been in a lot of their flagship products from their first LTE smartphone to many of their subsequent flagship products including their Galaxy Nexus for Verizon as well as the Galaxy S3 for the Korean market last year.

Our products hardware is in transition as Samsung has increasingly been emphasizing LTE advanced solutions for their smartphones and as Samsung’s latest LTE advanced baseband we only rollout later this year. That means that our product, our LTE advanced transceiver will almost also only rolled out later this year and begin testing with Samsung mobile.

With that said, since our product is in transitioning, our LTE transceivers are ramping down. We are waiting for the testing, the rollout and testing of our next generation LTE transceiver. If this works as anticipated, we should be very well positioned for next year with Samsung again on their LTE smartphones. So as I have said, we are a company that have done very well over the last three years, but we are also a company in transition with two of our important products with our controllers going from external to embedded, specifically led by our eMMC and SSD controllers. We are also a product – a company in transition on the LTE side of our business, where we are going from the older LTE transceiver that’s ramping down and we are positioning to rollout our LTE advanced transceiver shortly. So company in transition, we have done very well and we expect to continue to do well as these things continue panning up.

That concludes my presentation. I will open up for Q&A.

Question-and-Answer Session

Bob Gujavarty - Deutsche Bank

Riyadh, thanks for the presentation. I think one very pertinent topic is that we know Hynix is an important eMMC customer. They had a fire at one of their facilities, my understanding is it’s mostly a DRAM facility, but just curious if you can even address it from a SIMO’s perspective and if it’s anything that you are concerned about or if it has any impact on you?

Riyadh Lai

To your question on Wuxi fire at Hynix, we don’t believe there is going to be much of an impact to us or to the NAND flash industry. We have had our conversations with Hynix. It seems that this factory is more dedicated to DRAM with very little NAND at all. So there should not be much impact according to what they tell us.

Bob Gujavarty - Deutsche Bank

Great, thanks for that update. Maybe I will get it started. And you mentioned a lot about the company is in transition on some key products, but that’s kind of maybe looking backwards, maybe looking forward, you introduced our SATAIII controller, tell us your strategy for that product, tell us how your go-to-market strategy with that product. Clearly, this SSD markets change in the last couple of years and just curious how you go to market with that product, how you be successful with that product?

Riyadh Lai

It’s a good question. In a nutshell, we have a strategy of doing more with less. This is our SATAIII strategy. This is going to be quite similar to our eMMC strategy. With eMMC, where we started rolling out our products in the first quarter last year, we took a do more with less. Before we came in, a lot of the – most of the eMMC controllers were two-channel products. When we rolled out our eMMC 4.41, we rolled out a one channel product, a one channel product with superior performance even compared to the two-channel product. Two-channel is essentially two data paths and we can do same performance or in fact we did we performed our iOS rates are even higher than with just one channel compared to what their suppliers of eMMC controllers are able to do with two-channels. So, this quickly give us important position in the marketplace, where we are able to vow our customers, and quickly we brought Samsung and Hynix in as customers and sue them, we rapidly ramped our revenue from zero at the start of the year to where it was already close to 10% or above 10% of our total revenue for last year. We are taking the same strategy with our SATAIII doing more with less. With our controller, our SATAIII controller, it’s a four-channel versus the other supplier of SATAIII controllers largely rolling out eight-channel products, eight data path versus four data path.

With our four-channel products through the third-party benchmarks, which are available for everyone to review, third-party benchmarks done by Tom’s Hardware, iSuppli and others show that we are top in class. And so the value proposition from us is we can deliver top in class performance was a lot less in terms of power requirement, which is an important factor for mobile devices as well as cost, four-channel cost is going to be less than a channel cost.

Bob Gujavarty - Deutsche Bank

Great maybe to follow-up a little bit that product is primarily a SATAIII product today, market is going to this MTU standard, if MTU can support both SATA and but also can support a new format in PCI Express, can you talk about your kind of where you see the market today, where you see your product and maybe talk a little bit that how you intersect the market kind of on a go forward basis?

Riyadh Lai

We are not the first in SATAIII obviously in this market but by coming in a bit later into the market, we have a clear picture of where the competitor stand, where the opportunities are and how we can take advantage of utilize our unique technologies to come up with unique solutions, where we are able to position our wells uniquely in this market. The market is beginning to transition certain laptop, PCs are already moving toward from SATAIII to PCIE. This is the longer term trend. Technology is never fixed, so is in transition, so as part of our roadmap we are also developing a PCIE solution. This is in our roadmap and we expect sometime next year that we will have this solution available for our customers.

So, it is also part of our solution, the solution as we are expecting to bring to our roadmap. But initially right now, where we are focused is bringing in a top of class SATAIII SSD controller that can do more for less to well position us, for us to develop our tracker with OEM customers as well as module maker customers, where when our PCIE express controller is available we can make more with that. And we have also quite a few other products between what we have now as well as between now and our PCIE controller which also includes our TLC controller. There is a lot of demand for ways to bring superior performance for cost and one of the way to do that is to use TLC controller, but TLC is very difficult component to manage, and we are one of the few companies that can do it very well. And we are targeting to also bring out our TLC controllers not too long after the rollout of our current MLC SATAIII controller.

Bob Gujavarty - Deutsche Bank

Great any questions from the audience? Maybe I will again kind of expand on this point. I think there is a lot of confusion about kind of the market and that some flash vendors pursue internal controller development, but that doesn’t seem to preclude them from using merchant controllers and you have a lot of experience with this from the first the card industry, then eMMC industry, so can you talk a little bit about the fact that maybe internal development doesn’t preclude the ability to work with Silicon Motion on some of these products?

Riyadh Lai

That’s right Bob. The way we look at ourselves and the way our flash partners look at us is as extension of their internal R&D capabilities. Through the use of our capabilities, our flash partners are able to extend their overall capabilities to do more. All the flash makers or all our OEMs, all our other customers have limited resources. You can be a very, very big company like Samsung and you can still have limited R&D resources and this limits all the economic opportunities that you can target. Through the use of us outsourcing parts of their R&D to us, they are extending their capability to both target areas that they currently do not have the resources to do or free up current resources to target other opportunities that they see. So, some examples products that are increasingly mature like on the card side many years ago they decided Samsung and others decided that they no longer wanted to use their own internal R&D resources for that and wanted to do other stuff with it and so outsourced the controller development to us.

On the eMMC side, this is now we believe we are on the ground floor of this trend where over time we will see the same transition away from internal towards external use of merchant controllers. The ASCs for example for eMMC has come down a lot we are at $0.50 on average. It’s not too different from a card controller. Card controller now raises about $0.25. So, at these sort of economic levels, the question for the flash vendors is whether they want to do the development themselves or use external suppliers like ourselves. The other bit is we can help them free up the resources to do other stuff to focus on more on the premium ends of the market, to focus on the higher density ends of the market. They are in the business selling density not selling numbers of units or storage devices. We also help them free up their resources to go after the higher end SSD parts of the market, including the enterprise and datacenter parts of the business.

Bob Gujavarty - Deutsche Bank

Any questions from the audience? Actually going from kind of switching topics a little bit from the revenue side, I think you went through some of the temporary headwinds quite well, but one thing you have done a really job on is the gross margin even as revenues, even as you state some headwinds from the revenue side, how comfortable do you feel about the gross margins in the 47% to 49% range, what kind of gives you some comfort that you can maintain what by historical standard is pretty good gross margin for SIMO?

Riyadh Lai

We have a target gross margin of 50%. We have in past years been a little above that and in more recent years been a little below that, but we are still targeting 50% as a gross margin. One of the things that we have done well is through product mix both within product categories as well as within the different categories of products. For example, all of our new growth products, our LTE, our eMMC, or our SSD, these are all above average – corporate average gross margin products. So, the more of these new gross products that we can sell that we can blend into our overall revenue, where they account for a larger proportion of our total sales the better our gross margin profile will be. So, if you look at our gross margin last year, our gross margin took a bit of a drop off late last year as our LTE revenues start ramping down and this year as we continue to ramp our eMMC business that we are getting the benefit of that we are seeing the recovery of our gross margin through a larger proportion of our business coming from eMMC sales.

Bob Gujavarty - Deutsche Bank

Got it. So as long as product mix is healthy, you have a lot of confidence in the gross margin?

Riyadh Lai

That’s correct, that’s correct. And let me also add that even in mature products where markets and mature markets are declining where our sales are declining such as in the cards and USB flash drive, our ASPs have been increasing and continue to increase our ASPs for cards on an apples-to-apples basis have been increasing for the last 14 consecutive quarters. This is on a year-over-year basis. So, it’s a reflection we believe of our technology, the strength of our technology and the value-added that we deliver to our customers and where they are able and willing to pay for it.

Bob Gujavarty - Deutsche Bank

Okay, any questions from the audience? Maybe talking a little bit about your business, it changed a lot, but you alluded to it a little bit in your prepared remarks, but it’s still pretty much the end market is still consumer driven market. How do you think about kind of eMMC is a little different clearly than the removable market and that you have better visibility, but how do you think about seasonality of your business and how does maybe the changing product mix made some of these new customers you talked about the eMMC customers, how do you think about seasonality for SIMO now given your end markets, but also the change in the product mix?

Riyadh Lai

Seasonality used to be a very important factor in our business. And when we are doing mostly just cards, cards were used primarily for consumer electronics devices principally smartphones and DSCs. For these products there is significant seasonal patterns, the biggest selling quarter will be the fourth quarter the biggest Q-or-Q will be the third quarter and then the weakest quarter will be the first quarter the typical handset related – consumer electronics related seasonal patterns. As we have gone away from the cards and towards the eMMC, in theory, eMMC should follow the same smartphone type tablet – tablet type seasonal patterns, but we don’t quite see that yet because we are just coming from a lower base and we are – we continue to ramp our eMMC revenue quite sharply, we went from zero at the start of last year to 10% of total revenue and that eMMC revenue streams will grow in excess of 100% this year so because of the rapid growth that we are seeing the seasonal pattern that we would expect continue to be math by the rapid growth that we have and this seasonal – the expected seasonal pattern, will probably continue to be masked for at least through most of next year since we are in position to bring our third flash partner onscreen beginning of first quarter next year, so the seasonally the pattern actually would have expect I don’t believe we’ll see until our business reaches a more steady state profile.

Bob Gujavarty - Deutsche Bank

Great. And (indiscernible) is very early stages of share gains and that so you don’t think about your business in a seasonal framework at least over this period?

Riyadh Lai

That’s right now. We have business that’s going rapidly. We’ve been gaining market share. We’ve provided Samsung and Hynix with a very cost competitive high performance solution where they gained market share where the market itself is also growing rapidly. The MLC market probably grew 30% this year. We are capturing markets on the global basis as well as capturing market on the fast growth China segment, the low cost smartphones. And that part of business since its also coming from ground zero, it’s also not matured to level where they expect the seasonal pattern will be reflected into our business.

Bob Gujavarty - Deutsche Bank

Okay, any questions from audience? Maybe one, I think another key industry trend that I think you’ll be well placed to comment on is there is a lot of talk about 3D NAND in the industry today. General consensus says that it’s not a 2014 event, but that the industry may have to prepare for a 2015 event in 2014 kind of how SIMO kind of doing changing R&D necessarily, how you are intersecting what could be a big inflection for an industry from your perspective?

Riyadh Lai

3D NAND will be a very big architectural change to the NAND component and at some point in time it will be rolled out in a pretty significant way. But we are still in very early stages, it’s not in commercial production yet, but should begin soon. We are working very closely with the flash makers. The flash makers are working to bring us on board in terms of their technology in the controller requirements for their components. So, we are working very closely with them to develop the solutions that they need. And lot of the solutions they require are based on existing solutions that we already have on hand, as it relates to error collection we are leveling (indiscernible) shaping and so forth. These are technologies that we really have that we continue to develop, continue to advance and so when these 3D NAND components become ready for prime time our controllers – you should expect our controllers also to be ready for prime time when those components go live.

Bob Gujavarty - Deutsche Bank

Maybe a quick follow up on that. I think you alluded to it of how strong your ASPs have been on the controller side and I think that’s a testament to the complexity of what you’re doing. Do you foresee that 3D adds further complexity and it’s a further opportunity to SIMO to differentiate from maybe some of the other vendors out there in terms of the complexity that it may drive?

Riyadh Lai

3D NAND probably would offer more differentiation for us, it’s now I guess we think to going from MLC to TLC flash. TLC flash, a lot more difficult to manage the endurance as well as the bid integrity and other factors are a lot worse than the analysts see and lot more difficult to manage and even more difficult to manage, if you want to go into the higher performance application moving away from USB flash drive, moving into say eMMC and SSD controllers. The TLC requirement for moving into that higher performance storage devices are significantly higher. And so going from TLC, going from planer NAND to 3D NAND a lot of complexities will also continue.

As you going to 3D NAND, you’re looking at three dimensional data storage so there are other – host of other factors that we will also have to deal with. But at the same time, the expectation is we will probably be going back if you know for that, so some of the issues maybe more relax, but at the same time dealing with 3D three dimensional data is a complicated matter and it’s also many time once 3D NAND goes live that you also start – the flash vendors start shrinking their nodes from the older nodes to the finer nodes. So we’ll start also seeing the issues that we’ve seen with planer NAND become issues on the 3D NAND when shrinks start taking place.

Bob Gujavarty - Deutsche Bank

Any questions from the audience? And maybe I will keep going and I think gave us a little bit of color what happened with the LTE transceiver business, how do you think about that business going forward. Clearly you still have a roadmap, you are still engaged with your primary customer there just kind of curious how is it a binary event, is it a long-term investment from SIMO’s perspective, is this a commitment that Samsung has made to a multi-year commitment to continue to work with you, just curious how you think about the business given it’s such a binary outcome one way or the other and how you kind of think about a binary outcome business?

Riyadh Lai

There is a – there are a lot of factors that we consider for our LTE transceiver business. You are absolutely right there are a lot of binary outcomes relating to that. The binary elements include Samsung’s own 4G baseband development. Our success is dependent on the success of their baseband, if they are not successful with their baseband we can have the best transceiver available and we will have zero sales. So, a lot of our – a big part of our business is dependent on the success of our star of Samsung. If they don’t well with their baseband and we will not do well with our transceiver, so there is a binary element to that. We also have factor that we have single customer our LTE transceiver is designed specifically for Samsung, we have no other customer for that part of – for our LTE transceiver, so it’s dependent on the success of Samsung as a whole. If their baseband works phenomenally well, our transceivers work phenomenally well. It also just depend on Samsung continue to be a leader – the leader in LTE smartphones in the marketplace and so there is also that element that we need to be focused on.

So, in sum, our LTE business while it has developed – delivered a lot of growth for our business, the important growth driver for our business over last two years, we grew our LTE transceiver 65% through – over two consecutive years to 2012. So it’s important factor. But at the same time this year it’s dropped off – will drop off significantly. We did about $40 million in this year. We are only down to about $11 million or so, so it’s also volatile business depending on how well Samsung’s baseband and how well Samsung does in the marketplace. And it’s also very difficult to predict and forecast and so difficult to manage. So to a certain degree we treated almost let’s say equity call option if you will. We continued to maintain the value option by investing R&D and we just have to manage it at that level where that investment is at a reasonable level where we are able to capture the upside when they are available.

Bob Gujavarty - Deutsche Bank

Great. And any questions from the audience? Maybe we have about two minutes left, but maybe you can talk a little bit about the – excuse me, yeah can you talk a little bit about Samsung – so there is also a positive and that the LTE transceiver business has declined the Samsung as a customer has become a smaller percentage customer, so as a percentage of revenue. So can you talk about what do you think I mean let’s leave LTE business outside obviously if that grew that would grow Samsung as a customer, but xLTE what do you see in terms of SIMO’s customer diversification going forward. And it sounds like that’s a good trend that potentially you’re going to become a more diversified company going forward, so can you talk a little bit about that?

Riyadh Lai

We have been actively trying to diversify our customer base diversifying the blue-chip elements of our customer base. We have gone from a business where we are primarily margin maker focused to one where Samsung captured a large part of our storage business. Samsung continued to be our largest customer. They are consistently our only top 10% plus customer for our business. But we are also trying to add other important OEMs into our customer mix. We have added Hynix. We have other smartphone – other flash makers who are also our customer like Micron. We have Sony and other OEM as our customer, so we are trying to expand that OEM that where it’s more diversified than what it is now, but that said we are fairly happy with the focus that we have on OEMs, where OEMs already account for roughly two-thirds of our total storage revenue.

Bob Gujavarty - Deutsche Bank

Well, with that I will just extend my thanks to Riyadh for participating and to next year. Thanks.

Riyadh Lai - Chief Financial Officer

Great, thank you very much Bob. It’s a pleasure to be here at the Deutsche Bank Conference.

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