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Executives

Jason Tsai - Director, IR & Strategy

Wallace Kou - President & CEO

Riyadh Lai - CFO

Analysts

Anthony Stoss - Craig-Hallum Capital

Monika Garg - Pacific Crest Securities

Daniel Amir - Lazard Capital Markets

Rajvindra Gill - Needham & Company

Tom Sepenzis - Northland Securities

Mike Crawford - B. Riley & Co.

Bob Gujavarty - Deutsche Bank

Silicon Motion Technology Corporation (SIMO) Q3 2012 Earnings Call October 25, 2012 8:00 AM ET

Operator

Good day ladies and gentlemen and welcome to the Third Quarter Silicon Motion Technology’s Corp. Q3 2012 Earnings Conference Call. My name is Leshan and I will be your conference operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions)

Before we begin today’s conference, I have been asked to read the following forward-looking statements. This press release 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 conditions and business prospects.

Although such statements are based on our own information and information from other sources we believe to be reliable; you should not place undue reliance on them. These statements involve risks and uncertainties and actual market trends and our results my different 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 pressures in the semiconductor industry and the effect of such pressures 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, 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 press release.

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

Jason Tsai

Thank you, operator and good morning everyone. Welcome to the Silicon Motion third quarter 2012 financial results conference call and webcast. With me here is Wallace Kou, our President and CEO and Riyadh Lai, our Chief Financial Officer.

The agenda for today is as follows: Wallace will start with a review of some of our recent business developments. Riyadh will then discuss our third quarter financial results and provide our outlook. We’ll then conclude with Q&A.

Before we get started, I would like 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 US 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. A 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 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 would now turn the call over to Wallace.

Wallace Kou

Thank you Jason and thanks to everyone for joining us on this third quarter earning call. I am happy to report another record setting quarter for Silicon Motion. Revenue in the third quarter of $77.1 million; net income of $18.7 million and diluted earning per ADS of $0.54 are all record quarterly high for Silicon Motion.

Our strong third quarter performance was a result of continuous strengths in our New Growth Products as well as recovery of our card controllers. Overall, I am very pleased with our performance and delighted that we're on track in term of meeting our full-year 2012 revenue growth objectives and building our business to deliver further growth next year. Riyadh will discuss financial result in greater detail later on the call.

The third quarter was another quarter where strong revenue growth was led by the continuous success of our New Growth Products. Revenue from New Growth Products, which are comprised of LTE transceivers embedded in SSD controllers grew 39% sequentially and account for 40% of our total corporate revenue.

Both our LTE and eMMC controllers grew sequentially. Our LTE products grew stronger than expected, as Samsung accelerated its procurement of our LTE transceivers. This accelerated procurement led to revenue originally planned for the fourth quarter being booked in the third quarter. Without Samsung accelerated orders, our New Growth Products revenue will still have increased by only 20% sequentially and our overall revenue would have grown in the rate within our guidance range.

We are extremely pleased with our LTE performance for 2012. We are on-track to increase our LTE revenue about 65% this year and grow rapidly again next year. This year we will have 15 design wins with Samsung LTE smartphones including the Galaxy S III. We are working on building our LTE projects pipeline we set out for next year and believe it is reasonable to expand that if we can grow our LTE revenue 50% to 75% next year.

Wireless carriers globally continue to aggressively rollout LTE services which will drive demand for LTE smartphones. Samsung has been the market share leader in LTE smartphones and the significant proportion of Samsung’s LTE smartphone use their own baseband and our transceivers. We believe Samsung will continue to be a LTE market share leader next year and a significant proportion of Samsung’s LTE smartphones will continue to use their own baseband and our transceivers.

Additionally, we believe Samsung remain very committed and focused on using their own LTE baseband paired with our LTE transceivers. We are about to release a newer LTE transceivers with better integration, better performance and is more (inaudible) to support our 2013 LTE projects.

In the third quarter, our LTE sales increased better than expected due to Samsung accelerating due to the Galaxy S III smartphone for the Korean domestic market. Two LTE plus transceiver main version and the one LTE plus CDMA EVDO version were very successfully launched in July by Korea three wireless carriers, KTE, LG U+ and SK Telecom. To me the revised further launch plan, Samsung accelerated build of Galaxy S III by procuring several mini-vendors of our LTE transceiver that were originally planned for the fourth quarter and the third quarter.

Our fourth quarter LTE sales are going to be lower because of our third quarter accelerated sales. For the fourth quarter, we will have six new LTE design wins that will go into production. These are all lower volume projects for lower customers Samsung, LG smartphones for Korean and US carriers.

Now turning to our eMMC products; we are excited by the progress of our eMMC controller business and market penetration achieved so far. As you will recall, we started shipping our eMMC controller to our first NAND flash partner at the end of the first quarter of this year and started shipping to our second NAND flash partner in the second quarter. We are currently shipping to both Samsung and SK Hynix.

For full year 2012, we believe our eMMC controller market share should be around 5% to 10%. We believe the overall market for eMMC this year is over 600 million units and will grow above 20% in 2013. Based on our current pipeline of eMMC controller projects, we believe we should comfortably account for 15% to 20% of the market next year. We are providing eMMC controller to both Samsung and SK Hynix.

These two NAND flash makers have secured EMC design win using our controller with over half of the top 10 smartphones OEM, as well as the majority of the leading NJOY and Window 8 tablets OEM. HTC, Huawei, GTE, Lenovo and other OEM are already delivering smartphone to the global consumer using our eMMC controllers. A few tablet models using our eMMC controller are many NJOY and the Window 8 design wins are already shipping to consumers, and many more will reach consumers by the year end holiday season.

Beyond smartphone and tablets, our eMMC controllers have also entered the initially producing few smart TV. By partnering with leading flash vendors and providing them with eMMC controller that are both technologically and cost competitive, we are being able to help our flash partner quickly secure design wins from many OEMs, assist OEMs to enter production with our flash partner eMMC and eMCPs, and therefore help our flash partners boost growth to overall market as well as wining market share.

Our technologically and cost competitive eMMC controller include data management file system and power (inaudible) protection methods that enable us to significantly improve Rand and IR performance, reduce power consumption, reduce cost as well as protect and retain data. Another important competitive advantage that we bring to our flash partner and their OEM customer is our experience and broad engineering support infrastructure in Korea, China and Taiwan, the US and elsewhere that have OEM management issue and [true] performance to smoothly enable our flash partner eMMC to enter mass productions.

We continue to working aggressively with both Samsung and SK Hynix to bring newer generation of higher performance lower cost eMMC controller to market, as well as enlarge the overall eMMC market to improve newer classes of applications. We are tracking in terms of bringing eMMC [4.5] to the market and (inaudible) in the fourth quarter.

Moving to our core products, revenue from our core products declined 2% sequentially. Our card controller sales increased 21% sequentially. This very strong card controller growth was however not sufficient to offset weak USB flash drive controller, Mobile TVIC, China CDMA EVDO transceiver and embedded graphic processor sales. Our card controller rebounded strongly as our OEM customers due to more memory card for bundling with smartphone and for the tier one brand retail market.

NAND flash supply was relatively tight this quarter with a limited availability of flash to module makers. On the other hand, flash makers and other OEMs with close procurement related shifts with flash maker were not affected. This quarter one of our major flash maker customers (inaudible) amount of card to bundle with new smartphone, especially those with smaller embedded memory, that are being launched for the second half of 2012 seasonal sales specifically for low cost China smartphone market.

Looking to next year, we are confident that our card controller business should continue to grow, but at a modest rate. Our overall card bundle rate may continue to slide. We believe we can continue generating growth by working closely with the flash makers for bundled cards using low cost smartphone market of China and elsewhere.

By targeting high performance, (inaudible) cards for Tier 1 brands and application specific cards and by gaming control of the outsourcing market share. (inaudible) moderate growth strategy, we will continue working closely as a partner of choice to flash makers and other OEMs, as well as by extending our controller technology leadership.

Overall I am very pleased by our record setting third quarter and believe that our business remains on track to deliver strong long-term growth. With that, I'll now turn the call over to Riyadh to discuss our financial results.

Riyadh Lai

Thank you, Wallace. First I will outline our financial results for the third quarter, and then I'll provide our fourth quarter guidance. As Wallace had mentioned, we delivered a record $77.1 million in sales this quarter, an 11% increase compared to the prior quarter and a 22% increase compared to the third quarter of 2011.

In the third quarter, sales from our new gross products increased 39% sequentially. New gross products accounted for 40% of total sales, up from 32% of total sales in the prior quarter.

Let me recap the performance of our two key product lines. First, Mobile Storage. Mobile Storage revenue increased 4% sequentially and 36% year-over-year. Mobile Storage controller shipment increased 13% sequentially and 21% year-over-year.

Mobile Storage controller ASPs decreased by 8% sequentially, but increased 12% year-over-year our 11th consecutive quarter of annual ASP increases. Our card control revenue increased by 21% sequentially and our USB controller revenue declined by 12% sequentially. Over 50% of our controller sales are for 19 to 21 nanometer NAND flash. As comparison, in the second quarter controllers for 19 to 21 nanometer NAND flash accounted for over 25% of our controller sales. OEM revenue increased by 25% sequentially and accounted for almost 65% of our controller sales in the third quarter as a result of increased eMMC and card controller sales this quarter.

Moving to mobile communications. Mobile communications revenue increased 40% sequentially and 8% year-over-year. Our LTE revenue increased significantly in the third quarter and was slowly offset by declining sales of mobile TV ICs and China EVDO transceivers. Our corporate gross margin decreased in the third quarter to 46.4% from 49.1% in the second quarter and is below our third quarter guidance range which had anticipated a slight reduction in our gross margin due to product mix shift and product cycle transitions.

Our third quarter actual gross margin came in lower than guidance because we strategically traded lower pricing for larger and longer program wins, with a few of our important OEM customers for several of our major existing parts primarily relating to our core products. This strategic pricing should help our business partners become more cost competitive and will be EPS accretive to us next year. This strategic pricing result in several quarters of lower gross margins.

In the fourth quarter, our gross margin should fall to 44% to 46% as revenue shifts more towards core products. In the first quarter of 2013, our gross margin should be similar to the fourth quarter if not slightly better. We are going to be rolling out near parts that are either higher value added, and lower cost or combination of value and cost over the next few quarter. So we anticipate our gross margin and reversing back to our 48% to 50% range by third quarter of 2013.

We reduced our prices for strategic reasons. Even after reducing our prices, as an example of apples-to-apples comparison, our blended card controller prices are still much higher than they were a year ago and even higher then they were two years ago. We have some pricing power because of our technology leadership.

Because of our controller technology leadership, we have been bringing to market over the last 2 to 3 years a continuous series of higher value added controller with higher ASPs. Now to ensure strategic alignment with our OEM customers whose storage device ASPs have been falling rapidly. We need to rebalance our pricing.

We believe closer strategic alignment with important OEM partners is an increasingly important criteria for success as classified big growth slows down a bit next year. We are confident that we will regain our margins when we rollout our next set of next generation controllers, currently most of our controllers are manufactured of using 110 nanometer processes.

Our new products, which we have recently launched over will be releasing soon are all significantly lower cost and most of these new products are or will be manufactured using 55 nanometer of finer process geometries. Despite lower gross margin in third quarter, our operating margin increased to 25.9% from 24.3% last quarter. In the third quarter, operating expenses decreased to $15.8 million from $17.2 million due primarily to the push out of several project product tapouts. We had 677 employees at the end of this quarter, seven more than at the end of the previous quarter. As a result of record [earnings] and higher operating margins, we generated a record diluted earnings per ADS of $0.54 in the third quarter, up from $0.42 per ADS in the second quarter and $0.40 per ADS a year ago.

Stock based compensation in the third quarter was $3.4 million similar to the second quarter. I will now move to our balance sheet and cash flow. Inventory days decreased to 77 days in the third quarter from 87 days in the second quarter. DSO decreased to 47 days in the third quarter compared to 54 days in the second quarter. Payable days increased to 47 days in the third quarter compared to 42 days in the second quarter.

In the third quarter, our cash balance increased by $33 million to $146.6 million at period’s end. In terms of primary sources of cash, we generated $18.7 million in net earnings, an increase in payable generated $12.1 million and a decrease in AR generated $4.2 million. In terms of primary uses of cash, an increase in inventory consumed $4 million. We also invested $1 million for testing equipment, software and design tools.

I will now move on to our guidance. For the fourth quarter we expect our overall revenue to fall slightly primarily due to third quarter’s accelerated sales of LTE transceivers to Samsung. Our eMMC controller sales should be flat sequentially due to strong pre-holiday sales build in the third quarter because of the sequential decline in LTE sales and flat eMMC sales, our fourth quarter New Growth Product sale should decline sequentially. We expect both our card and USB controllers to be up modestly while our other core products to be down sequentially in the fourth quarter.

For full year 2012, we expect our total revenue to grow 25% to 27% and our new growth products to account for 30% to 32% of total sales. We currently expect new growth products to scale further next year and account for 40% to 45% of our 2013 sales. While we are not prepared to provide official revenue growth guidance for next year, we can envision a scenario where we grow our revenue at least 15% next year based on moderate card controller growth, eMMC controller market share gains and continued solid LTE transceiver growth.

For our fourth quarter guidance, we expect fourth quarter revenue to be down 3% to 9% sequentially. We expect fourth quarter gross margin to be within the 44% to 46% range. We are targeting operating expenses to be in the range of $17 million to $18 million. Stock based compensation expense should be approximately $3 million to $3.5 million. Our target model tax rate remains at 15%.

Lastly before the Q&A part of our call, let me update you on our discussions with our board of directors regarding a share repurchase program. Management recently proposed to our board a new shared repurchase program. This proposal was not approved. Our board strongly believes that a repurchase at this time will reduce the liquidity of our shares and will not increase shareholder value. We will now open the call for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Okay and our first question comes from the line of Anthony Stoss [Craig-Hallum Capital].

Anthony Stoss - Craig-Hallum Capital

Riyadh, can you take us through with a little bit better detail on your product cost down, help us understand on a quarterly basis, maybe, you talked about gross margins bouncing back in Q3. I love to hear LTE, eMMC and your cards, how you think you can bump up each of those three different segments and can you give us a sense by quarter that would be definitely helpful and also if you have a view on 2013 tax rate. Thanks.

Riyadh Lai

Well let me first start with our product costing and work towards the tax. Overall, we took some important decisions this quarter about providing strategic pricing to some of our important OEM customers. Probably these strategic pricings affected mostly our core products specifically our card controllers. We expect our gross margin overall gross margin in Q4 to decline to 44% to 46%. This is a combination of both the strategic pricing as well as product mixtures.

In Q3, we sold a lot of LTE transceivers to Samsung and this also includes accelerated sales that were originally for the fourth quarter being sold in the third quarter with reduced amounts of New Growth Products taking place in the fourth quarter, our overall gross margin are also affected. So through a combination of these two factors our gross margins are going to be lower.

Now moving forward into the first quarter, we are also rapidly working on introducing newer parts that are of more high value added as well as lower costs, for example right now a lot of our products, most of our products still manufacture 110 nanometers. We are increasingly moving our newer products, products that are recently launched or will be launch to 55 nanometer and so overtime by third quarter we are going to be targeting to get our gross margin back up to the 48% to 50% range.

Wallace Kou

Let me add a specific color to your question. Regarding 50 micro SD card controllers majority of our controller today using 110 nanometer, we are in the transition moving to a 55 nanometer and more cost effective the high end performance controller. So all of these products are going to move production by late Q1, 2013. Regarding eMMC controller most of our production, high volume production controller using also 110 nanometer.

We are into transition of moving to 55 nanometer. We believe this also would move production at around the second quarter of next year. Regarding LTE, we are into delivering newer LTE technology and more integrated controller of LTE transceiver. This product will be much more cost effective than existing transceiver for Galaxy SIII, so we believe we will have cost advantage into 2013. And by Q3, 2013, we believe the overall gross margin will back to 48% to 50%.

Anthony Stoss - Craig-Hallum Capital

Okay then tax rate and also Riyadh while you are on, can you give us a directional sense on March quarter revenue? Thanks.

Riyadh Lai

First on taxes, our model tax rate still remained [15%], so there is no change on that. In terms of direction, we are expecting the typical seasonal patterns that we’ve seen to apply in the first quarter ending March. So we are going to be seeing our typical revenue decline in Q1 because of the typical seasonality patterns and then our revenue should begin to increase in the Q2 and Q3.

Specific for our key products, our card controller and other core products should be seasonally down in Q1. But we expect our eMMC and LTE products to be slightly up in Q1.

Operator

And our next question comes from the line of Monika Garg [Pacific Crest Securities].

Monika Garg - Pacific Crest Securities

If you look at NAND producers, they are guiding to lower bit growth next year, how do you see that first of all impacting your business? And secondly, we have seen very strong price increase recently in the market; do you think that impacts some of your core business next quarter?

Wallace Kou

I think the growth in 2013 could be a little bit lower than this year; (inaudible) has talked about 30% to 40% Hynix passing 50% to 60%, well other flash vendors speak for themselves. Overall availability could be tight depending on the strength of smartphone, tablet, and other devices sale. But we expect to be better protected from any of availability issue, because our OEM customer base continues to increase especially OEM program for eMMC and card. Some module maker might have some difficulty to access NAND memory, but we believe, more supply will come in line in the second quarter and next year with a supply in second half compared with the first half.

Monika Garg - Pacific Crest Securities

And do you expect any revenue from flash SSD products next year or any products you think you will get design wins over the next couple of quarters?

Wallace Kou

Yeah, we expect to sample our SATAIII controller by the end of this year. This will allow us to have a more competitive SSD solution targeting NAND flash, full size SSD product in 2013. We believe we will have some of the (inaudible) for this product coming to the market for competition.

Monika Garg - Pacific Crest Securities

Okay, I also have a question on the eMMC guidance for next quarter. Given that you have just started ramping the eMMC solution and that fourth quarter is a stronger handset sell through quarter; I just want to understand more like your guidance of flat quarter-over-quarter guidance for eMMC?

Wallace Kou

I think we are just having move from the end consumer and we ship our controller to flash makers and we then ship eMMC solution to OEM. So while holiday sales are stronger in the fourth quarter most of the component procurements will happen in the third quarter. This is why we expect to see only flat revenue in the fourth quarter of our eMMC controllers. But we believe the growth will resume in the first quarter of next year.

Monika Garg - Pacific Crest Securities

And just a last question on the cash; cash has increased on the balance sheet, you talked about kind of no buybacks, what are the other uses of cash you are looking at?

Riyadh Lai

Well, during these times our Board believes we should retain a larger cash balance. Also, we continue to evaluate strategic opportunities including M&As and also while the share buyback is not on the table right now, we will continue to explore ways to return cash to our shareholders.

Operator

And our next question comes from the line of Daniel Amir [Lazard Capital Markets]

Daniel Amir - Lazard Capital Markets

A few questions here, first of all, your comments on the eMMC; just to clarify, you quantified the market of 600 million, but then you said you have 15% to 20% share next year or is that 15% to 20% revenue growth next segment for next year and then I have follow up question as well?

Wallace Kou

We believe this year we have, the total market for 2012 is above 600 million units and we believe in 2013 to total eMMC unit growth will be around 20%. We estimate we’re about 5% to 10% share for this year and we found the current design pipeline will have come then, we will all around 15% to 20% in 2013.

Daniel Amir - Lazard Capital Markets

Now, with regards to the strategic pricing, this is the first time in a while that you have taken this approach. In the past, I mean you always had the opportunity with OEMs to offer them better pricing to capture more business and you’ve tend to not get that approach and enabled to maintain high gross margins, not high but average gross margins in the high 40s for a very long period of time and it seems like, you decided to break with that tradition here; I mean, is this because you just see the controller market changing here and the fact that you have a technology and you want to take advantage of that or is this a profound change in just the growth rates of cards out there slowing down that you really need to find new ways of growing that business?

Riyadh Lai

Well, we’ve historically not taken this approach, a strategic pricing initiative approach as you mentioned. We have taken it, decided to take our strategic initiative given the opportunity that lie and also as part of our plan that we should be more flexible with our strategic partners as well. While we do not plan on providing strategic pricing deals regularly, we also need to be cognizant that we need to be flexible with our strategic partners. Our business as you know is fairly dynamic and we will react quickly to lock in opportunities if the benefits outweigh the costs. If there are strategic deals that provide large revenue opportunities over multiple quarter and if they make sense then we may consider acting on the strategic these opportunities going forward.

Wallace Kou

And Daniel as you can see some of the markets are mature and some flash maker also announced the possibility in NAND also slowing down; I see that as a leading controller maker we’re also in certain program and we understand we need to share certain pattern. However, from the better product mix and from the custom reduction, we believe that we can manage gross margin very well and bring back to 48% to 50% by the second half of next year and may be even sooner. But I think as of today for the poor economic situation, we have complied with OEM customer for some strategic program and they are selling lower cost market.

Daniel Amir - Lazard Capital Markets

Okay, great. And then my final question on currently LTE business here, so can you reiterate kind of your revenue growth rate that you expect for that business next year and also do you think that the further integration that you are doing on the LTE transceiver, is that going to change in any way kind of your sales forecast that you see in that business for next year?

Wallace Kou

I think we are working on more specific solution and we are about to release our latest generation transceiver which offer much more integration functions, better power management, and we are positioned to win more flagship devices in 2013. So that's why we have a strong confidence with the current design pipeline in Samsung. We see the growth will be even higher than 2012.

Daniel Amir - Lazard Capital Markets

And what was your -- growth rate you were saying?

Wallace Kou

I am sorry, can you repeat?

Daniel Amir - Lazard Capital Markets

Yes, can you just reiterate the growth rate that you were talking about for 2013 on the LTE business?

Riyadh Lai

We are expecting to grow our LTE revenue 50% to 75% next year, as Wallace had mentioned, we are expecting the market to continue grow rapidly as wireless service provider continue to rollout LTE service globally. Samsung as you know has been the market share leader for LTE smartphones. We expect Samsung to maintain their market share leadership. We also expect Samsung will continue to use the same proportion of their own LTE baseband geared up with our transceiver going forward. So we are very confident that with the pipeline or projects as well as the rollout of our new LTE transceiver which has better cost, and better performance, more integration that we are fairly confident that we are going to be able to grow our business 50% to 75% next year.

Operator

(Operator Instructions) And our next question comes from the line of Rajvindra Gill.

Rajvindra Gill - Needham & Company

Just a follow-up on the LTE comment. You talked about growing LTE sales 50% to 75%; I just want to get a sense in terms of units and pricing that's pretty big growth. Are you expecting, you basically would imply that units would be growing somewhere in the range of 50% to 100%. If you could talk about how you see pricing in the LTE transceiver markets especially with the integration that's happening and where do you see the units coming from in 2013, that's pretty impressive growth on the LTE side.

Wallace Kou

I think in order to grow 50% to 75% we have to win flagship models, more flagship models and to win more global models. And I cannot comment regarding the price for ASP because its confidential, however what I can tell you is, our newer released LTE transceiver will be single chip, single dye and including all band. It’s a wideband single-chip solution. So that can cover our region and other carrier, other services.

Rajvindra Gill - Needham & Company

If I did my math right, it seems like the core products business has been declining three quarters in a row on a sequential basis, is its going to decline again in the fourth quarter. So talking about four sequential quarters of declining business now clearly you are also sitting there with the new products, but how much confidence do you have that the core products will be able to grow next year. Do you think that a lot of fall off up that you are seeing maybe in the other areas outside of the card controller such as Mobile TV and multimedia SoC that is pretty much behind you and that you think the card controller business could chuck along or maybe some clarity on the core products business in 2013 will be helpful.

Wallace Kou

Let me just comment first regarding the Mobile TV. As you can see Mobile TV market is almost saturated, but however we believe we still have opportunity to grow in Japan or other regions for ITBT and the TMM. But as revenue increase is not significant for core sale revenue. But regarding for USB flash drive, we believe our view of the market will increase slightly in 2013. But by introducing our new USB 3.0 and by providing more products in emerging markets and [gift] market and like a windows to go, we believe we can continue to grow USB product but with a modest growth in 2013. So overall for our core product we believe we can maintain and slightly grow in 2013.

Rajvindra Gill - Needham & Company

And last question on the pricing front, in 2012 you had talked about kind of gross margin in 48% to 50% range, do you expect to get back to that level kind of in the third quarter, how do you look at 2013 overall gross margins, do you expect to see that just carry on into the first half of ’13 and what makes you confident that you able to increase that 300, 400 basis points come third quarter when we could be in a situation which you’ve been you know more pressure on a [bundle] cards, more pressure on demand. Trying to get a better sense of why margins would go up or conversely why margins wouldn’t fall further?

Riyadh Lai

Regarding to our gross margin do the 44% to 46% in the fourth quarter and our gross margin to begin slight improvement in first quarter of next year and improve throughout 2013; we're targeting to return to 48% to 50% gross margin range by the third quarter. Our long-term targets still remains at 50%. We're ramping up more cost effective solutions and we are also introducing more higher value-added solutions and through the ramp of these products. We are fairly confident that we can improve our gross margins from the value additive as well as the cost reductive approaches. These are two different approaches. In addition, let me also comment that most of our products right now are still at a 110 nanometer. We have started rolling up new products at 55 nanometer. We will roll out most of our products at 59 nanometer, as we transition more and more products on a 110 to 55 nanometer, we're going to get significant cost savings. So, through these approaches, we are fairly confident that we can blend up our gross margin back up to the 48% to 50% range.

Rajvindra Gill - Needham & Company

Very good and congrats on a solid quarter.

Operator

And our next question comes from the line of Tom Sepenzis [Northland Securities]

Tom Sepenzis - Northland Securities

Just a follow up on the LTE ASP. I know you can’t give us the ASP, but can you talk may be a little about what kind of declines we should expect in 2013?

Riyadh Lai

We are not going to comment specifically about what the - because it’s a unique product that we have designed specifically for Samsung. It’s only for Samsung and there are confidentiality undertakings that we have in place. But you have seen last year we grew volume sharply and through that we are able to also generate fairly good revenue growth. Our expectation is units for smartphones are going to go very rapidly next year and through the continued growth of the market as well as Samsung being the market share leader and maintaining their market share leadership, Samsung maintaining the use of significant portion of their handsets using their own base band plus our transceivers. We are going to be getting a pretty good unit shipment as well as revenue growth next year.

Tom Sepenzis - Northland Securities

Do you still expect a 50-50 split on the new phone or the LTE phones coming out of Samsung or has that shifted?

Riyadh Lai

We can’t comment exactly how they are going to plan, but we are fairly confident, and as Wallace has mentioned about our a very cost competitive next generation transceiver that we are going to have a good share of Samsung’s use of our transceivers. They are going to be bringing out even more competitive base band solutions and you add that with our more competitive transceiver solution, it’s a win, win combination that we have and we believe it works well with the Samsung’s overall strategy of wanting to use more of their internal solutions.

Tom Sepenzis - Northland Securities

Just in terms of OpEx you obviously did a great job of getting expenses down in the current quarter. Is that kind of the new normal going forward, that we should be modeling from those levels?

Riyadh Lai

For the fourth quarter, we are expecting operating expense to be about $17 million to $18 million. Looking into next year, we think we are going to be willing to have some operating leverage. Our SG&A should come down a little bit in terms of our percent of total revenue, while our R&D projects spend should increase next year, while holding at the same proportion of revenue as this year. So we are expecting to increase our R&D projects spend further, but as I mentioned this R&D spend as a percentage revenue in 2013 should be similar to the 2012. Our R&D projects spend should increase more next year then this year as we increase the number of 55 nanometer tape outs, but let me also add and we are also will be adding few incremental R&D headcount next year versus this year.

Operator

(Operator Instructions) And we have the question from the line of Mike Crawford.

Mike Crawford - B. Riley & Co.

On the eMMC market how many different controllers are you offering now; and can you clear out the functionality by of your SM2712 part?

Wallace Kou

I think we offered more than two or three different controller to the market to-date. We based on their special need and tailored for special NAND type, for example SLC, MLP, given NAND manufacturing, given requirement we have a deepen specialty regarding certain technology like we try our data retention how to improve endurance. So each of the project for each of a given NAND identity we have (inaudible) software and to develop our NAND flash partner.

Mike Crawford - B. Riley & Co.

These are one and two channel solutions or?

Wallace Kou

I cannot comment one or two channels Rick because this is confidential. I think, but however, we are value provide low cost high performance controller and to deliver lower density for our major NAND partner. So the NAND density could be from 1 gigabyte all the way to 32 gigabyte but I think higher density and NAND maker may have their own controller to server for their special need.

Mike Crawford - B. Riley & Co.

Okay. And what's their geometry is moving to 55 nanometer next year, where do you think…

Wallace Kou

All our eMMC controllers are moving toward 35 nanometer in 2013.

Mike Crawford - B. Riley & Co.

Yeah, where to your knowledge is the competition producing today and what geometry that might give us a better sense of what their cost might be?

Wallace Kou

Today we are using 110 nanometer in TSMC. I think we are moving to 55 nanometer in TSMC for our all new eMMC controller next year.

Operator

And we have a question from the line of Bob Gujavarty [Deutsche Bank]

Bob Gujavarty - Deutsche Bank

Maybe just revisit the strategic decisions you made on the pricing side, it seems to me this time it’s a little different, in the old days some of that pricing might have been more transactional dealing with maybe some of the module makers, this seems a lot more strategic, can you kind of contrast the current decisions with maybe some of the pricing decisions that happens three years ago or something like that because it seems a lot different this time around?

Wallace Kou

I think we have a very, very broad days also very broad OEM customers in different products and different disengagement we will make different decision but I think really the strategic pricing initiatives we have taken and decision with really selective [view] strategic OEM to allow our partner to be more competitive because if certain program they need a certain price to bring their end customer and they will discuss, negotiate with us and because this is a (inaudible) ASP both will create more aggressive EPS for 2013. So that is, although it’s a critical difficult decision but we believe that we will be more positive for company growth.

Bob Gujavarty - Deutsche Bank

Thanks got it. And maybe on the eMMC side, is there an ASP uplift potentially from tablets? Are the eMMC controllers are going to tablets so they are ASP accretive to some of the other markets or is it pretty much the same as everything else?

Wallace Kou

So eMMC market have a very, very wide range of product and offering. eMMC is not just a Smartphone or tablet today; they are moving for Smart TV and moving for digital camera and also car navigation system and car entertainment [info] system. So we see eMMC is no way to have only one controller to provide all the different, to serve all the need to meet all the performance and cost requirement. So, there is a tremendous opportunity for us to become (inaudible) to the NAND maker to provide the solution for them.

Today, we have more business than we can take and we need to quickly grow our R&D and supporting team in order to catch this greater opportunity because we are above one generation ahead of our competitor in the companies and so we feel very (inaudible) our position. Just we need to quickly grow R&D resource and supporting resources in order to grow with the NAND makers. Currently only serve Samsung but we believe we will add one more in 2013.

Bob Gujavarty - Deutsche Bank

Got it and just a quick question for Riyadh. Riyadh you mentioned some tapout expense it’s pretty lumpy. You will see some of that in Q4. Is there going to be a big lump for that in Q1 or Q2 or is it pretty evenly spread out the next couple of quarters?

Riyadh Lai

Well, we're planning tapout expenses to be evenly spread out. It may not necessarily work that way. We were originally planning a few more tapouts in the third quarter these tapouts were ultimately postponed. So these tapouts can move around quite a lot, but overall we are expecting more tapout expenses next year, so the tapout expenses next year will be more than this year, but ultimately when you look at our total R&D expense for next year the idea is to grow on a percentage wise in line with our revenue. So the percentage that you see this year should be what you will see next year, but the increase will be coming more from the project tapout and less from the increase in headcount.

Operator

And there are no further questions at this time.

Riyadh Lai

Let me add a comment, one of our analysts I believe had asked question about the competitive landscape which I believe we did not adequately explained. We are about one generation ahead of other merchant suppliers of eMMC controllers of similar performance and cost solutions. The advantage of our eMMC controllers is that Wallace had pointed out we incorporate better data management solutions, card loss protection as well as random higher random high ops performance and lower power consumption at much lower costs and competing solutions.

So we balance out our flash vendors’ needs and allow them to focus more on high end solutions while outsourcing the high volume mass market solutions to us. So this is a very complementary approach while the flash vendors all have their own eMMC controller solutions, this is a complimentary approach that we add value to them. And so this is a continuation of the value added services that we provide to the flash vendors that we have previously demonstrated and continue demonstrate on the card controller side.

Wallace Kou

Well, I would like thank for all of you for joining us today and your continuing interest in Silicon Motion. We’ll be the following conferences in this quarter; in November, will be presenting at [Lazard S&D] Conference in New York, (inaudible) Conference in Boston, UBS Technology Conference in New York. Deutsche Bank Conference in Taiwan, and Canaccord Genuity [TMT] Conference in New York. Details on these events are available on our website. Thank you and good bye for now.

Operator

Thank you, ladies and gentlemen. That does conclude today's conference call. You may now disconnect.

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