Silicon Motion Technology Corporation (SIMO) Earnings Call Transcript & Summary

Our Shannon products, these are the SSD data center, SSDs that we've been building using our Shannon platform, those are all entirely for the Chinese market, primarily to Alibaba. We also have sales to Baidu and many other Internet companies [indiscernible] china for their data centers.

Is there a way to leverage what you're doing with this Shannon in business to U.S. data centers?

Yes, absolutely, though in a different -- slightly different direction. For us to go into the data center market with our Shannon platform, the aim isn't so much that we want to become a module maker. But the aim is twofold. The first is help jump-start our -- a move into the enterprise-grade SSD controller market. At heart, we're a controller supplier, right? We're a semiconductor, semiconductor company. We do very well designing controllers for SSDs. Historically, we've been been -- we've done well in the client market, and now we're now beginning to take steps into the enterprise data center classes of market. For these for the data center enterprise market, we're fairly new here. We're on our first-generation of products of controllers. And so by using -- by leveraging our relationship with Alibaba, where we're designing proprietary -- entire proprietary SSD drives, we're able to jump-start our move into this market. Again, street credibility, which is leading to traction from customers -- potential customers, hyperscalers in the U.S. who've been calling us up to see how we might be able to help them with their own initiatives for SSDs for their data centers. But today, we've got -- we have our controllers going into our Shannon SSDs going into Alibaba by doing and others. At the same time, these SSD controllers, we have also started shipping into the U.S. market, working with some of the enterprise SSD makers who have been providing these enterprise grades for some of the leading server OEMs in the U.S.

Moving on to the Ferri products. Can you talk about the outlook for the industrial Solutions? And if you're seeing any sort of pickup in that market?

Yes. So this year, we're still expecting fairly good growth from our Ferri products. Last year, in terms of bits, again, good growth. But last year, we were affected by dollar per gigabyte falling rapidly in the first half of the year. This year, we'll continue to benefit from fairly good bit growth and more stable dollar per gigabyte NAND pricing environment. So for our Ferri product, it's a very diversified set of end markets. We're supplying into the automotive. We're spying into ITC, industrial markets. We're supplying into office automation and the networking equipment market. So fairly diversified with customers in Japan and the U.S., in China and elsewhere. So the whole idea for us is using the existing controllers that we have, how do we add more value -- incremental value by going into markets underserviced by the NAND flash guys and underserviced by the module makers? So we're going into markets that are niche, high touch. So markets that the NAND flash got to shy away from because they're the wholesale by nature with their fabs running 24/7. They want high-volume businesses, not these niche high-touch situations. So on our margin customer, on their side, I mean, they like the niche type of opportunities. But they -- for the high touch, where there's a lot of customization, they lack the wherewithal, the technological wherewithal to address this. So this creates an opportunity for us between the NAND flash guys and the module maker for us to address. And so it's a pretty exciting area for us, and we've done quite well playing in this niche market.

And then do you expect any sort of automotive contribution next year in this market?

Yes. Yes, we've already started shipping to the automotive market for a couple of years now going into -- with our Ferri automotive-grade, SSDs going into many of the German and Japanese car brands. This has been going on for a couple of years. We're working with supplying our products to some of the car equipment suppliers to the brands.

Great. [Operator Instructions] Moving on to the mobile business. Can you talk about the growth outlook in mobile for the second half? What's causing the decline in the third Q, followed by a potential rebound in the fourth Q? And where are we sitting today in that?

Yes. Yes. So overall, the smartphone market this year will be down quite meaningfully because of the pandemic, right? And for us, we're actually growing our business related to this market quite rapidly. We've had 3 very strong sequential growth of our UFS eMMC parts, beginning in Q2 last year, Q3, Q4, and a lot more growth in the first half of the year. I mean, our second quarter growth was again very strong. So the growth for us is coming from the transition of technology of -- embedded memory technologies from legacy eMMC to the new UFS cards. So last year already, 1/4 of all smartphones were using UFS, primarily the flagship devices this year. The move is into the more mainstream phones adopting UFS technology. So going from a 1/4 to 1/2 of our phones this year, this is going to drive fairly strong growth, and we're participating in this growth with our UFS controller. We're working with was our U.S. NAND flash partner, and they've done a phenomenal job in securing design wins. But as you would expect, it was the rapid growth of UFS plus the very low lumpy end markets with smartphone sales down in Q1, in China, sharply, the rest of the world being impacted by COVID in Q2, down sharply. This has led to some overbuilding and inventory, temporary overbuilding inventory that we expect to clear in Q3. And Q3, we're seeing very strong builds of smartphones across the board by most of the OEMs. And so with the strong rebound -- sequential rebound in Q3, we believe the excess inventory in the supply chain should be quickly digested and will lead to growth in rebound in our UFS growth in Q4 and already we are seeing in our order books, reflecting the trend towards a rebounding growth in Q4.

On that UFS transition. You've also announced a second NAND maker using that product? Can you talk about how meaningful that partner could be in the second half relative to Micron in Korea, where you've successfully worked with them in the past?

Yes. Yes. So our Korean exposure used to be very significant, but it has been dialed down as they've reduced their exposure to the mobile space and also transition UFS from our eMMC part to their own UFS controller. So we were affected by this quite negatively for a couple of years. But that issue has now largely been derisked. Derisk in Q1, even our Chinese module maker sales of legacy eMMC were larger than the Korean customer. And then on top of that, we've been shipping our UFS controllers to our U.S. NAND partners since last year, and they've scaled very nicely, continue to scale and now the primary source of growth from our eMMC+UFS product lines. So we expect this to continue to grow nicely next year. And next year, on top of this one customer, we're going to be adding a second NAND partner as a customer for UFS cards. We've already secured design win with shipping -- shipments expected somewhere in mid of next year.

Can you talk about your opportunity in expanding with module houses and a controller, and what's going on there?

Sure. Related to our controllers for the module makers going into the mobile space. The module makers -- we're working with 5 or 6 module makers in China. They've been going after markets that are underserviced by the big NAND flash guys. So they've been focusing on the non-smartphone applications and more recently also been going into the Tier 2, Tier 3 OEMs in China for their eMMC requirements and now also moving into their needs for UFS. So for the Chinese module makers, we've been supplying eMMC to them for a number of years. They've been building smart speakers, eMMC for smart speakers, for a smart set-top box for smart TVs and a host of other IoT related applications. More recently, they've also been going into eMMC for the Tier 2, Tier 3 smartphone OEMs. There's quite a lot of those guys in China, and some of them are actually pretty big. For example, the leading -- the largest supplier of smartphones to Africa is one of these Tier 2, Tier 3 guys, and their volume is, frankly, quite big. But mostly more value line oriented smartphones. So they've been -- they're one of their customers for our module makers using our eMMC controllers. So as the overall smartphone market further transitions from eMMC to UFS, our module makers have also been seeking UFS controllers for -- to support their customers. And so this -- our UFS will also expand into the module makers. So longer-term growth for us is these Chinese module makers doing a phenomenal job with the non-smartphone part of the market. And frankly, the volume for non-smartphone is not small at all. If you look at the overall smartphone, you look at like roughly 1.4 billion units, right? With the non-smartphone volume, that's -- sorry, 300 million, 400 million units alone, so also fairly chunky. So growing with this, this part of the market, growing was these module makers going into Tier 3 product lines. And so we believe we should -- this will be incremental value to us and help further diversify our end customers beyond what we already have.

Can you talk about the decline rate and any potential stabilization in traditional external expandable card business?

Well, our micro SD card controller and USB flash drive has been in secular decline for almost a decade and continued decline annually declining in the teens. So we're expecting this to continue. I mean, this is now a very small part of our sales. We don't expect this to rebound. Many years ago, as these expandable products start declining, and when this was a very large part of our overall sales, our business was materially affected by this trend. But now this is no longer the case. This is now a very small part of the market. And we continue to address this for on the higher end for some of our module maker customers.

Switch over to some questions on the model. Looking at margins, do you see gross margins trending near sort of the 50% that were achieved in 2Q? 3Q was guided down a bit, but is there any room to kind of grow them back up again?

Sure. Our gross margin trend affected by 2 levers. The first is on the controller side. And most of our products are controllers. Our controller gross margins have been very stable, above corporate average. And we expect this to continue to be the case, stable gross margin, where we've got a very broad portfolio of controlled parts from mobile to SSDs and then the enterprise SSD controllers. So these -- and for each one of the product lines, we've got old products and new products. So we've done a pretty good job blending the products as well as the life cycles to keep our gross margins fairly stable. And so we'll continue to be stable. Where our -- where we've been getting variations in our gross margin from quarter-to-quarter, it has not been coming from the control, but coming from the mix of controllers versus solutions. Our gross margins for controllers is higher than corporate average and very stable. Our gross margins for our solutions, these are our Ferri and Shannon products are much lower. Much lower. And so in quarters where we have more sales of solutions. These solutions -- this will blend down our overall gross margin. And in quarters and in periods where we have lower proportional sales of solutions, our gross margins blend up.

And then same thing with operating margins, operating margins are coming down a little bit in the third quarter from 22% in the second quarter. Can you talk about leverage there and what you could do to sort of ramp operating margins any higher or you're comfortable sort of around this low 20% range?

Longer term, our business benefits from operating leverage. In the past, we were able to bring our -- run our business towards a 30% -- almost a 30% operating margin. So we do have that sort of leverage. If we can get our top line to grow more meaningfully, the 30% target still remains a longer-term operating margin target for us. But near term, there will be variations quarter after quarter. The key variation will be coming from projects, our tape out timing, timing of tape out. So in quarters where we have higher R&D expenditures, higher operating expenditures, it's generally the result of higher tape outs. And so tape out expenses continue to be higher and higher as we go into the finer and finer nanometers. If you sort of dial back to 10 years ago, when we were doing mostly, say, 130 nanometer, those would cost us less than $100,000 per tape out. With the recent 27-nanometer tape outs, we're talking about $2 million. So scale is now increasingly important in our business.

And can you talk about the priorities of uses of cash and how you look at that across organic growth, inorganic growth and then return to shareholders?

Yes. We have a business that, as many of you know, that is highly cash flow generative. So we aim to return a fair amount of capital to our shareholders, a primary means of returning that is to our dividend program. So in the last few years, we've been targeting the return of our free cash flow that is almost half of what we generate. So we continue to be able to demonstrate to our Board that we -- our free cash flow generation remains good. We'll continue to grow, have visibility for the growth. There is an opportunity where we might be able to increase our dividend rate going forward. So next time that will be revisited, it will be in October/November time frame for our next annual dividend decision-making. And so that would be the primary means. The additional means is a more opportunistic with buyback programs whenever we believe our share price is undervalued. We have visibility towards our business. We do buyback shares as we communicated, you should expect this quarter for us to be engaging in the buyback of our shares.

And are there any attractive areas that you'd be looking at for any sort of acquisitions?

We've looked. We've done some acquisitions, but we don't do that many. We'd like to stay within our area of expertise relating to the solid state storage industry relating to what we do well, controllers, right? So one of the acquisitions that we did a couple of years ago was the acquisition of Shannon, which gave us the breakthrough into the data center market allowed us to get a better understanding of this market that we previously had not participated in. And also gave us an opportunity to jump-start our move of -- jump-stating our -- the bringing out of enterprise-grade controllers for Chinese customers as well as for other customers. So we -- these are -- this is an example of what we could be looking for.

And do you have any sort of last thoughts that you'd like to leave investors with as we wrap up this session?

As I mentioned, this year is the first year in many years where all 3 of our products, our SSD controllers, our eMMC, UFS controllers as well as SSD solutions have been able to contribute towards overall corporate growth. Last few years, we were completely dependent on our SSD controllers. So SSD controllers providing stability for our overall business. This year, we have contribution from our other 2 products. So very excited about this. I mean we were -- we would have loved for our business to deliver even better growth if we didn't have this pandemic issue. But going into next year, with or without resolution to this year, we're expecting all 3 of our products continue to hum nicely and contribute to overall growth. So we're fairly well positioned for further growth and delighted with, with how we [Audio Gap]