Silicon Motion Technology's (SIMO) CEO Wallace Kou on Q1 2016 Results - Earnings Call Transcript

| About: Silicon Motion (SIMO)

Silicon Motion Technology Corporation (NASDAQ:SIMO)

Q1 2016 Earnings Conference Call

April 28, 2016, 8:00 am ET

Executives

Jason Tsai - Senior Director, IR & Strategy

Wallace Kou - President and CEO

Riyadh Lai - CFO

Analysts

Mike Crawford - B. Riley & Company

Mike Burton - Brean Capital

Anthony Stoss - Craig-Hallum

Mehdi Hosseini - SIG

Tom Sepenzis - Northland Capital

Suji De Silva - Topeka

Rajvindra Gill - Needham & Company

Daniel Amir - Ladenburg

Operator

Good day, ladies and gentlemen and welcome to the First Quarter 2016 Silicon Motion Technology Corp. Earnings Conference Call. My name is Sandler and I'll be your conference moderator for today. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session. [Operator Instructions].

Before we begin today's conference, I've 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 risk 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 any changes in our relationship with our major customers and changes in political, economic, legal, and social conditions in Taiwan.

For additional discussions 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 date of this conference call.

I would now like to hand our presentation over to our host, Mr. Jason Tsai, Senior Director of IR and Strategy. Please proceed.

Jason Tsai

Thank you, and good morning, everyone. Welcome to Silicon Motion's first 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 first quarter financial results and provide our outlook. We will then conclude with Q&A.

Before we get started, I'd like to remind you of our Safe Harbor policy, which is 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 is 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've 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.

Wallace Kou

Thank you, Jason. Hello, everyone and thank you for joining our earnings call. I am pleased to share with you the strong results of our first quarter. Revenue increased 15% sequentially to $130 million, the highest quarterly revenue in our company history and our third consecutive quarter of revenue growth.

Our embedded storage product, our eMMC and SSD controllers, and our enterprise and industrial SSD solutions grew 35% sequentially and account for 80% of total sales. Our strong sales result in EPS of $0.58 this quarter off to a record high for Silicon Motion. Riyadh will discuss our financial in greater detail later on the call.

Our first quarter revenue came in better than expected as a result of larger orders from our customers for client SSD controllers, eMMC controllers, and our enterprise and industrial SSD solutions. Our client SSD controller sales grew 35% sequentially, our eMMC controller sales grew 30% sequentially, and our enterprise and industrial SSD sales grew 50% sequentially.

Orders for client SSD controller this quarter was exceptionally strong, especially from our NAND flash partners. Sales from our NAND flash partners more than doubled this quarter driven by our DRAM solution and our solution for managing TLC flash, also client SSD that are primarily for PC OEMs. Our client SSD controllers are now used by all top five PC OEMs excluding Apple.

In addition to PC OEM, our customers are now using our controllers for client SSD that target non-mission critical data center storage and other channel makers including embedded applications. This quarter, we further extended our client SSD controller market share. We have grown our market share as we scale our sales to our third flash partners and as our three flash partners gain market share as expense of incumbent client SSD marker leaders, we have held our flash partners gain market competitiveness to our unique solutions. We’ll help our flash partners significantly reduce their new product development cycle with our highly customizable hardware plus software turnkey controller solutions, where our flash partners can commercially launch new SSD product our move at the same time of our introduction of new flash components.

This reduction in new product development cycle is important because flash makers are constantly introducing, new generation of NAND components every nine to 12 months and we help our flash partners capture the better economy available during the early part of the component lifecycles.

Silicon Motion is only emerging controller vendor supplying our NAND Flash partners customizable hardware plus software turnkey controller solution that can manage current MLC and TLC flash and upcoming 3D flash.

Our unique solution also include controller for TMS client SSD and for client SSD using low-cost TLC flash. One of our flash partners has being rapidly growing their sales of DRAM SSD. Silicon Motion is the only emerging controller supplier that can supply controller for SSD that do not require embedded DRAM and that can deliver performance compared to SSD with DRAM.

SSD manufacturers have traditionally used DRAM for buffering, within their products because DRAM data rate are faster than NAND. Our solutions enable competitors’ performance without a need for expensive DRAM components. This year NAND flash maker were aggressively introducing client SSD using TLC flash, the dollar per tigabyte cost of TLC flash is much lower than MLC flash.

And the use of TLC flash reduce the current generation of SSD using MLC flash and the upcoming generation of SSD using even lower cost 3D flash. PC OEM had in the past being well into use SSD with TLC flash after the completion of extensive evaluation and their vacation testing. PC OEMs are now well into access TLC flash.

The ability of cheaper SSD using TLC flash will further drive adoption of SSD in the PC and the displacement of mechanical HDDs. This year, most of our client SSD controllers will be used for managing TLC flash. Silicon Motion is only emerging controller company supplying turnkey SSD solutions managing TLC NAND to flash maker for PC OEMs.

We are on track both replacing our PCIe for our -- releasing our PCIe NVMe client SSD controller midyear. Our PCIe NVMe SSD controller which has previously secured design win has several NAND flash partners, which recently became late-stage testing at two of our flash partners, our PCIe NVMe controller similar to our SATA 3 controller are also highly customizable hardware plus software SSD controller solutions.

You should expect us to bring to the market an expanding portfolio of cloud competitors, high-performing PCIe NVMe controller solution to our customer initially probably high-end and gaming PC workstation and non-mission critical data center applications.

As we had highlighted in the past, most of our client SSD controller supply last year were managing MLC flash. This year, most of our client SSD controller supply will be for managing TLC flash. Most of our new product introduction this year however will be for managing 3D flash. We are seeing more and more commercial sampling of 3D Flash by non-sensor flash makers.

We expect all six NAND flash makers to be supplying 3D flash by the end of this year and their 3D output will scale next year, as they are manufacturing processes become more mature and yield improve. Based on our pipeline of design wins and our flash partners, 3D flash roadmap, it is likely that a majority of our client SSD controller next year will be for managing 3D flash.

We have been collaborating with all the flash vendors for nearly two years now developing custom-tailored proprietary controller technology to overcome the weakness of 3D NAND. 3D Flash is very hard to manage and will getting increasingly more difficult. While current 3D flash enduring better and has a faster data write speed than final flash. 3D data retention and aerial rate are much worse. 3D endurance is better than final flash because the transistor gate for storing data have been designed at order, more robust, 30-nanometer processes.

However in 3D flash the charge trapping layer are not isolated but are sharing a string of cells which introduced a path of current leakage with cost data retention loss. The bigger share with 3D flash is at the higher noise interference issue regarding more of the aerials, final flash regularly experience single cell beat, data flip because of chart disturbance and noise interference issue.

Because our secular 3D Flash in seven single cell d flip issues we have the bigger issue of having internal string of multiple string of cells that d flip, to manage the 3D aerial rate issue caused by multiple cell d flip, our controller round our very efficient proprietary hard decode and soft decode LDPC algorithm and also rate. Our controller rate block of data within flash drive and then can range multiple flash drive within an SSD. These are now issue that we need to manage for final flash. This 3D flash issue will get progressively worse as NAND flash maker increase their 3D layer count and a string to side of their transistor gates.

Today two of our advanced aerial correction algorithm and the proprietary controller technologies of flash partner are able to commercialize their 3D NAND sooner, used across broader range of product and bring to market more cost effective 3D SSD and embedded memory solutions faster.

Now let me turn to our eMMC controller business. Sales of our eMMC controller grew strongly in the first quarter and will likely remain steady and stable for the rest of the year. We expect that for the full-year our eMMC controller sales growth will exceed global smartphone sales growth of 5% to 10%.

Sale of our eMMC controllers grew rapidly as smartphone OEM build activity pickup and our NAND Flash partner aggressively pursue eMCP sales. This quarter, we benefit from Chinese smartphone OEMs building low cost 4G smartphone to supply local demand created by the government subsidizing consumer to trade up to 4G bounce. Also our Flash partner has been targeting smartphone OEM building ultralow cost smartphone both faster growing globally emerging markets like India.

These ultralow low cost smartphone previously primarily use Raw NAND for embedded storage, more broadly our Flash partner has been there aggressively in the eMCP market is likely gaining market share, because of the market segment as our Flash partner is targeting we are seeing strong sale of the eMMC 5.0 and 5.1 controller for managing phone and the new trend of legacy eMMC 4.5 controller sale for ultralow cost phones.

We currently have multiple USS 2.0 program win as our flash partner, including USS 2.0 supporting 3D Flash and remain on track to begin that production in sometime in the second half of this year. We should be ready to scale our USS 2.0 sales in 2017.

While USS 2.0 is more likely adopted by smartphone OEM both for high-end phone and managing phones. Currently USS 2.0 only found in very high-end flashes smartphone and we expect this emphasis on flash devices to continue through 2016 into 2017.

Broader USS 2.0 adoption by smartphone OEM will be dependent on the ability of application processor supporting the standard and on USS 2.0 cost competitiveness. Currently USS 2.0 has now only more expensive than eMMC but is now widely supported by the big AP vendors.

CoreComm high-end chipsets support USS 2.0 but they are managing chipset are agnostic. Mediatek inspection do not support USS 2.0 and we’re not until sometime next year. Use of Mediatek new high-end 10 core Helio AP does not support USS 2.0. Our USS 2.0 controller is designed to be both high performance and also cost effective. The important criteria to help encourage chipset suppliers to transition support USS 2.0.

Let me now move on to our enterprise and industrial SSD solutions which are Shannon and Ferri products. This quarter sale of this product grew 50% sequentially as we started shipping in large volume of a customized enterprise grade PCI SSD solution to a leading Chinese ecommerce company. Our Shannon SSD is focused on providing customized solution demand primarily by Chinese internet companies and other enterprise for data center operating both private and public cloud.

Our Ferri SSD is focused on customized solution for many industrial applications with most of our business with big Japanese OEMs. Demand for our specialty tune enterprise and industrial SSD is very strong. And this year we expect the sales of this SSD solution to grow to be nearly as big as our expandable storage products, our legacy SSD card and USB flash drive controllers.

Overall we had outstanding start for 2016. You should expect our client SSD controller, our eMMC controller, and our enterprise and industrial SSD solution to drive our growth for the remainder of the year and into next year.

You should also expect the value of controller to continue to grow important with the 3D flash. With proliferation of devices using eMMC and SSD and rapid build out of the cloud-based storage using SSD, we are very excited about where our industry is had to and our increasing value added role.

I will now turn the call over to Riyadh to discuss our financial performance and outlook.

Riyadh Lai

Thank you, Wallace. First I will outline our financial results and then provide our guidance. Our strong 40% year-over-year growth in Q1 provided us with a head start to 2016. For the quarter, we delivered sales of $130 million, up 15% sequentially much higher than guidance because of stronger than expected orders for our client SSD and eMMC controllers and enterprise and industrial SSD solutions.

For the quarter, our mobile storage segment revenue grew 19% sequentially. This market segment sales growth was led by our embedded storage products which are composed of our eMMC and SSD controllers plus our Shannon and Ferri storage solutions.

Sales of our embedded storage products grew 35% sequentially to account for almost 80% of total revenue. Within our embedded storage products, our client SSD controllers grew 35% sequentially, our eMMC controllers grew 30% sequentially, and our SSD solutions comprising enterprise and industrial SSDs grew 50% sequentially.

On the negative side, our mobile communications segment sales declined 20% sequentially primarily due to timing of orders for mobile TV SoCs. Mobile communication sales now account for 6% of total sales.

Sales of our expandable storage products, our memory card and flash drive controllers fell 30% due to typical Q1 seasonal weakness but compounded by aggressive sales action of Taiwanese competitors. Expandable storage sales now account for 10% to 15% of total sales.

Our corporate gross margin increased to 50.6% in Q1 from 50.1% as the mix of our higher gross margin embedded storage products increased.

In Q1, our operating expenses increased to $26.8 million from $25.3 million in the previous quarter, primarily due to higher compensation expense related to higher headcount. Our Q1 operating expense however was understated by $1 million to $2 million due to IC tape-outs previously planned for Q1 that have now been postponed to Q2. As a result, our Q2 operating expense will be incrementally higher with addition of this $1 million to $2 million of delayed spending.

We ended Q1 with 1,025 employees, 52 more than at the end of the previous quarter. Most of our new hires are R&D engineers.

Operating margin was 26.8% in Q1 significantly better than the 24.4% in the previous quarter as a result of strong revenue growth, higher gross margins, and smaller increase in operating expense.

In Q1, we achieved record quarterly net income of $24.3 million and earnings per ADS of $0.68.

Stock-based compensation in Q1 was $2 million lower than the $5.2 million in the previous quarter due to seasonal timing of RSU awards.

I will now move to our balance sheet and cash flow. Inventory days increased to 98 days in Q1 from 91 days in Q4. DSO increased slightly to 55 days in Q1 from 54 days in Q4. Payable days increased to 57 days in Q1 from 34 days in Q4. Our cash, cash equivalents, and short-term investments increased to $191 million in Q1 from $185.2 million in Q4.

Primary sources of cash in Q1 came from $24.3 million in net earnings, an increase in AP of $24.3 million. Primary use of cash in the first quarter included an increase of $25.7 million in inventory, an increase in $18.3 million in accounts receivable, $2 million for the routine purchase of software and design tools, and $5.3 million for quarterly dividend payments.

I will now turn to our guidance. For Q2, we are expecting sequential revenue growth of 5% to 10% equivalent to year-over-year growth of 36% to 42%. We expect client SSD controllers to grow strongly in Q2 as sales to our 3D flash partners scale further. Given our strong continued growth momentum, we are increasing our client SSD controller sales guidance from our pervious guidance of at least 50% growth for the full-year and we are now expecting our client SSD controller sales to double for the full-year.

We expect our EMMC controller sales to remain stable going into Q2 after the very large 30% sequential jump in Q1. For the full-year, we believe our EMMC controller sales will very likely grow much faster than overall smartphone market growth as our flash partner aggressively expand its market presence.

We expect sales of SSD solutions, our enterprise and industrial SSDs, to grow strongly in Q2. For the full-year, we expect sales of our SSD solutions to double to $50 million to $60 million as we scale our Shannon enterprise grade PCI SSDs with Chinese internet companies and our Ferri SSDs with Japanese OEMs.

We expect sales of our expandable storage controllers to remain stable going into Q2 and RFICs to rebound sequentially with new mobile TV SoC orders from OEMs. For the full-year, our expandable storage controller sales should decline at least 10% and our RFIC sales should be stable.

Based on business activities planned for the second half of this year, we believe sales should grow modestly in Q3, and decline seasonally in Q4. Our sales leader this year could potentially grow faster if we can resolve capacity constrains at our foundry partners. And as of today, we have no assurance capacity constraints can be resolved.

We expect Q2 gross margin to decline to 47% to 49%. Our gross margin target for full-year 2016 remains unchanged at 49% to 51%. In Q2, our gross margin will temporarily dip due to a large multimillion dollar one-time customized SSD solutions project where we are facing unfavorable accounting treatment. For this project, our customer will be supplying us with flash components. But due to how this transaction is structured, we will be recognizing these component costs as both part of revenue and cost of sales. We are not making a profit on the components. Excluding this one-time project, our second quarter gross margins would have been within our full-year gross margin range. With negligible impact from this project in Q3, we expect our gross margins to recover in Q3 and remain stable in Q4. And for the full-year, our gross margin should be in the 49% to 51% range.

Operating margin in Q2 is expected to decline to the 22% to 24% range from 26.8% in Q1, due to lower gross margin and higher operating expenses. As previously mentioned, our Q2 operating expense will be higher than planned because of $1 million to $2 million IC tape-outs previously planned for Q1 now taking place in Q2. For full-year 2016, we expect operating margin to be approximately 24% to 26%. As comparison, our full-year operating margin last year was 24%.

Stock-based compensation in Q2 is expected to be $0.5 million lower than the $2 million in Q1 and the lower amount in Q2 is related to seasonal timing of RSU awards. For full-year 2016, our stock-based compensation should be approximately $14 million to $16 million. Our model tax rate remains at 18%.

We will now open the call for your questions.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions].

Our first question comes from the line of Mike Crawford from B. Riley & Company. Please go ahead.

Mike Crawford

Thank you. Are you working with Apple directly or through your flash partners?

Riyadh Lai

No, unfortunately we’re not working with Apple.

Mike Crawford

I thought you said that you were not top five?

Riyadh Lai

Non-Apple.

Mike Crawford

Excluding Apple, right. I see.

Riyadh Lai

Our client SSD controllers to the five PC OEMs non-Apple.

Mike Crawford

Non-Apple got it, misheard you. What about the -- what growth rate do you expect for client SSDs for the whole year?

Riyadh Lai

Client SSDs we are now expecting for the full-year to double. Previously we were guiding for 50% but based on the stronger momentum that we’re seeing well right now we are now expecting our client SSD sales to double this year.

Mike Crawford

Okay. And then your inventory jumped up almost $30 million in Q2 is that -- was that planned or what we should expect with inventory going forward?

Riyadh Lai

We have slightly higher inventory levels there and this is as a result of much faster sales that we’re planning and so it’s related to the higher sales we also need to maintain slightly higher inventory levels that correlate with that.

Mike Crawford

Okay, great. And then last question is when do you think we will see a drive hit the market with your SM226.0 controller?

Wallace Kou

We are probably going to see commercializing starting Q3.

Operator

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

Mike Burton

Hey guys and congrats on a very strong results. So first of all just you went in a little bit on the USS side but if you could help describe the competitive environment both within EMMC in USS going forward and then from other merchant suppliers in the client SSD markets right now?

Wallace Kou

As you know, we continue to now see any meaningful income traditionally in the EMMC controller market. We meant only meaningful supplier today. We do have a very low and selling base with Hynix and held them to become very successful in the EMMC market and probably number two supplier. And I see we’re on track to bring our USS 2.0 Solutions to market in the second half of the year and our solution expect to be better performed -- performing and won’t cost slightly than any other solutions captured or otherwise. We believe our USS 2.0 Solutions will move into our production in the second half this year.

Mike Burton

Great. And then just following up on the competition in client SSD. What are you seeing from some of the other merchant suppliers there and then also you walk through, thank you for walking through some of the dynamics for the 3D NAND controllers but what are you seeing from a pricing standpoint relative to what you were seeing in 2D? Thanks.

Wallace Kou

We’re seeing new generation of flash come into the market every nine to 12 months. Flash maker are increasing, reliance or high-performance cost effective solution that meets their time to market requirement. For mainstream high volume client SSD, we provide turnkey controller solution at lower cost with better performance and much faster time to market than what the flash maker can do with internal resources. So our nearest competitor has limited firmware expertise and has not being able to provide acceptable turnkey solutions to the flash makers.

Flash makers will use their hardware only controllers need to tie up their own expense engineers to develop somewhere and cannot match our short development cycle time. By providing a turnkey solution, we are working more closely with flash makers and their PC OEM customers. So we have better market intelligence, enabling us to develop solutions that are [indiscernible] industrial trends. And by understanding this trend and requirement while enabling customers to get a product to the market much faster and get qualified much more quickly at PC OEM.

So our flash partners focus on their internal resources on enterprise SSD solutions where the product cycle is much longer, they see much higher and we become their extending R&D arm to provide their client SSD turnkey solutions.

Riyadh Lai

Let me also get to you on your question, price difference between 2D and 3D SSD controllers. Generally for newer generations of controller solutions we get a price premium but for competitive reasons we’re not going to go into details of what that might be.

Operator

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

Anthony Stoss

Hi guys, my congrats on the grid execution. Can you talk a little bit about you mentioned you hired 52 employees since the last quarter, are any those hired onto potentially go after new verticals, I want to hear also your thoughts on going after new verticals this year. And then secondly if you won’t mind commenting about what you expect the growth be on Shannon Systems itself this year over last, I have a follow-up after that. Thanks.

Wallace Kou

Majority of our hiring are focused on engineering R&D development, I think the 60% will be in SSD and above 30% in EMMC and USS. And I think we really need more R&D resources to support the strong demand on OEM customers worldwide and we are also planning increasing the headcount for Shannon Systems to meet the strong demand in China market because several major projects really need dedicated resources to support it. So I think we will continue increase the headcount in R&D side both Shannon and our own SSD product line.

Riyadh Lai

Tony for your question about our expected growth for our Shannon business, more broadly globally the size of the enterprise grade PCIe SSD market is approximately $1.5 billion to $2 billion. And in China the market focus -- that we focus on it’s roughly at least 10% of the global market and growing at least 50% a year. China, as you know, has some of the largest Internet companies in the world and these companies already established users of enterprise grade PCIe SSD on par with U.S. Internet companies. Chinese non-Internet corporate are several years behind now Western companies in the use of SSDs. More to your question we expect sales of our enterprise and industrial SSDs to double this year to $50 million to $60 million.

Anthony Stoss

Okay. And then I had a follow-up on you mentioned you had a one-time project that’s going to impact gross margins for Q2, can you share with us or give us a general sense of the size of that. And then secondly you’re launching what two flash partners familiar for your PCIe NVMe project also kind of expected range just from that are those two customers in the second half of 2016. Thanks.

Riyadh Lai

Yes, for that project, it’s for SSDs it is couple of million dollars of sales.

Anthony Stoss

Okay. And in the rev expected on the PCIe NVMe product for the second half of the year with the two flash makers?

Wallace Kou

We are on track with the two projects. This year PCIe [indiscernible] is really low; we don’t try with the high volume this year; probably in 2017, we will continue grow with PCIe.

Operator

Thank you. Our next question comes from the line of Mehdi Hosseini from SIG. Please go ahead.

Mehdi Hosseini

Thanks for taking my question. A couple of follow-ups. Can you help me understand how your customers would be required to redo their controller as they go from MLC to TLC? And I asked the question because as the new third generation 3D NAND capacities come online next year, there tends to be more of a TLC mix compares to MLC. So I want to understand how that would impact your business and I have a follow-up.

Wallace Kou

We mentioned in 2016 the NAND demand if it’s full engaged TLC base SSD because cost is more attractive compared with MLC base and so we see the entire year those channel as well as PC OEM will accept TLC base of value line client SSD. Although we also see that coming 3D NAND because at beginning of the 3D NAND was stay with 40A, so it’s just stack, a 40A stack TLC and is the cost structure is not comparable building a 50-nanometer or 40-nanometer TLC. So I think it takes about may be some time to fine-tune the process of the yield, improve the cost structure when 3D NAND move to a 3D 4 stack I think will be more cost competitive. And then I think there is product transition will move to 3D NAND become mainstream.

Riyadh Lai

May be I will add, TLC flash is a lot more difficult to manage than MLC flash. TLC endurance is well weaker number of times that you can write to the sales are a lot more limited to MLC flash, it’s also a bit slower in program time and air rates are also lot higher. These are all issues that we need to address to our controllers.

Mehdi Hosseini

Okay, great. And my second question has to do more of a longer-term look and beyond 2016, how should we think about scaling of Shannon and scaling in terms of the required investment and how it may do to scale revenue? Is there any way you can explain how much you have to invest and how should -- we should think about revenue growth opportunities beyond 2016?

Wallace Kou

I think on today Shannon is in a very unique position target for very high-end PCIe proprietary SSD product. So the mean redundancy is 3.2 terabytes and 6.4 terabytes or even higher. So it’s very premium wide. And in order to scale up Shannon the total revenue we not only need to expand broader customer base but also need to expand the product line. So I think we are also planning to move into the standard PCIe NVMe solution next year and to grow broader product offering to our customer in China.

Riyadh Lai

Let me also add, briefly we had mentioned that Shannon we should easily scale that to a $75 million revenue in 2018 and that is still on track for us. But we are for competitive reasons we are now bundling our Shannon business with our Ferri business and as such this year we should the two combined we should be able to do at least $50 million to $60 million of sales and this is a business that’s expected to grow at least 50%, I think growing 50% in the first quarter and should continue to grow solidly this year.

In terms of the overall operating expense required to grow our Shannon business, we are managing this as part of our overall operating expense infrastructure. So this will fold into how we manage to maintain our operating margin and how we eventually over a longer period of time go towards our 30% operating margin target.

Operator

Thank you. Our next question comes from Tom Sepenzis from Northland Capital. Please ask your question.

Tom Sepenzis

Thank you and congratulations. I think you mentioned that you’re looking a couple of your suppliers are having capacity constraints is that across all your products or just the client SSDs or how should we be thinking about that and when do you expect that to no longer be an issue?

Wallace Kou

I think as you know there will be earthquakes from at least I’m seeing February time period and so they are in the recovering, but not across all the product line it’s specific in around the 40-nanometer geometry product. We believe the tight capacity supply you issue could be resolved in late Q3 timeframe.

Riyadh Lai

But let me just add these -- while we are expecting the capacity constraint to be resolved, we would like the capacity constraints to be resolved, currently we have no assurance that these capacity constraints can be resolved and so we still need to monitor the situation closely.

Tom Sepenzis

Great, thank you. And then in terms of the huge EMMC growth during the quarter, I know you mentioned part of that was your main customer seeing market share gains and the other was just a transition from RAM based memory. Can you give us some indication as to which was the greater source of that stream?

Wallace Kou

I think that a lot of people know this year China Government really pushing the carrier to subsidize the user consumer to upgrade from 3G smartphone to 4G smartphone. So that really increased tremendous demand for EMMC solutions. In the other hand for ultralow cost smartphone in the past with user roaming for Spectrum and MTK platform solutions. Now they are transitioning to EMMC or eMCP solutions that increase the demand. So the smartphone itself only grow about 5% to 10%. We believe our EMMC; our eMCP controller will grow beyond that.

Operator

Thank you. Our next question comes from the line of Suji De Silva from Topeka. Please go ahead.

Suji De Silva

Hi Wallace and Riyadh congratulations on the strong results here. I believe you mentioned Internet customers are largely engaged with them. I’m wondering how many large China Internet customers you are working with at this point?

A - Wallace Kou

We are working with couple of them, this one of the largest in China. So I think but we would need more resource and more product to serve all this demand from the large scale Internet telecom company.

Suji De Silva

Okay, great. And you talked about being able to target on top of the PC OEMs at the data center non-critical hard drive conversion to [indiscernible]. I’m wondering how big the chance of that is relative to the PC OEMs and where you share let’s say [indiscernible]?

Wallace Kou

For this year as we said it will be very small because the adoption rate for PCIe NVMe is still slow but we believe for 2017 the momentum will be stronger but you know Intel pushing very hard and to try introducing SATA PCIe in the high-end and we believe may be later 2017 or early 2018 PCIe main transitioning to the mainstream for client SSD.

Suji De Silva

Great and Wallace last question I would love to get your thoughts on 3D Flash points and the implications for your roadmap and the competitive landscape of 3D Flash points is that the meaningful effect of something that is not as relevant to your growth opportunities, thanks.

Wallace Kou

We cannot comment what should you call point, I think we could be part of it but we cannot comment.

Riyadh Lai

It’s still very early days Suji for us we can cross point at this stage.

Operator

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

Rajvindra Gill

Thank you and congratulations as well. Wallace a question on 3D NAND from a technological perspective how the controller is different versus a 2D NAND in terms of complexity in terms of air correction code any thoughts around that realm would be helpful.

Wallace Kou

So from programming point of view, 3D NAND is easier for controller. However I see 3D NAND better endurance more than 2D NAND but the data retention and noise interference is much worse than 2D NAND. So controller itself need to cover three dimensional noise interference and so we not only need to have soft decode, hard decode, LDPC engine and very smartly you see to handle that well you need to have a special rate technology to cover all the requirements because this is another single blog issue it could be multiple tie within the SSD.

This is quite different than traditional 2D NAND that you don’t need the really special ray for protection. So we have been working with NAND makers since 2014 with 2D NAND development and we are also looking for their second, third or fourth generation 3D NAND to define together that’s why we have a very strong technology covering for all of product line for the upcoming 3D NAND support.

Rajvindra Gill

Okay, great. And in terms of the 3D NAND flash customers or just in general, where are they in terms of migrating to a lower process node because my understanding is that some of these 3D NAND flash vendors will still that their initial developments will be on lagging edge process node. So I just want to get your thoughts on when are they transitioning what you say or what the pace is from 3D NAND on a lower process node and 3D NAND from MLC to TLC et cetera which would lay --

Wallace Kou

3D NAND may have a different strategy in their transition because some NAND makers their floating rate is most cost effective, so they’re transitioning slowly. Some NAND makers their floating rate is not that competitive, they will be transitioning faster. Although in my note the answer we cannot comment for the entry.

Operator

Thank you. Our next question comes from the line of Daniel Amir from Ladenburg. Please go ahead.

Daniel Amir

Thanks a lot and congratulations on great quarter. Couple of things here first of all I guess first of all in the EMMC just to clarify, you mentioned that the smartphone market growing 5% to 10% you will grow more than that. Previously I think you mentioned that you expect the EMMC growth to be 10% to 15% this year. I mean is that still your guidance or you’re kind of changing that here?

Riyadh Lai

Yes Daniel for the overall smartphone market, we’re expecting markets to grow about 5% to 10% this year. Markets are now a lot more matured than it was in past and so there is a lot more growth coming from replacement cycle versus first time buyers and so the blended growth rate is now a lot lower. But more broadly for the market, our guidance for the market growth is unchanged from before which is markets growing 5% to 10%.

Daniel Amir

Great, no matter what’s your outlook on your business on the EMMC business?

Riyadh Lai

Oh, for the EMMC growth we are expecting the growth significantly faster than the market growth with the market growing 5% to 10%.

Daniel Amir

Okay. Then the second on the client SSD side, you’ve been basically in one quarter you changed kind of your guidance for the year from 50% to double basically. So what’s happened here in this quarter that’s given you such a high change in terms of your outlook here in a very short period of time?

Wallace Kou

I see main reason is because we start to see PC OEM access TLC base at client SSD. In the past, more the PC OEMs they only assess MLC based client SSD. So that really increase our confidence and should see the sale forecast from our major NAND partners.

Daniel Amir

Okay. And then last question you mentioned it was one of your partners they’re working with an SSD without DRAM is that I mean is that a trend that you think will accelerate given that you have a unique solution here in this market and if so that I mean is that something that is very positive for your business compared that there is no other solution out there. I mean would be great to get a little more clarification on that?

Wallace Kou

I think Daniel if you know the client SSD product is very cost competitive and cost sensitive. So for some NAND makers, they don’t have DRAM. So DRAM is very expensive component to them. So I think the -- for some NAND makers DRAM solution, it’s ideal product for them to penetrate something in the value line and I won’t see it becomes a trend however in PCIe NVMe solution one of the trend feature will be BGA. As a PCIe BGA SSD become standard popular, [indiscernible] become very, very important because of the host memory buffer will become one of the key items for future trend to reduce total system cost. So we believe our current today with a DLS for SATA, we are also moving to PCIe NVMe in next year and that will broader product line offering to meet all given customer needs to meet the market segment.

Operator

Thank you. There are no further questions now. I would now like to hand the conference back to our CEO, Mr. Wallace Kou for closing remarks.

Wallace Kou

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 this quarter.

In May, we'll be presenting at the Citi Corporate Day 2016 in Hong Kong, Morgan Stanley TMC Conference in London, Jefferies TMT Conference in Miami, Goldman Sachs TechNet Conference in Hong Kong, B. Riley 17 Annual B. Riley Investor Conference in LA.

In June, we will be presenting at the Craig-Hallum 13th Annual Investor Conference in Minneapolis. Bank of America Merrill Lynch Global Tech Conference in San Francisco, Macquarie Global Emerging Leader Conference in New York, London, and Singapore. Credit Suisse Eighth Annual Semiconductor Supply Chain Conference in Boston and Toronto. Details of this event will be available in our website. Thank you and good bye for now.

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