慧榮科技 (SIMO) 2006 Q3 法說會逐字稿

Good day ladies and gentlemen, and welcome to the third quarter 2006 Silicon Motion Technology Corporation earnings conference call.

My name is [Shaquana] and I will be your coordinator for today.

At this time, all participants are in a listen only mode.

We will be facilitating a question and answer session towards the end of this conference. [OPERATOR INSTRUCTIONS].

I would now like to turn the presentation over to your host for today's call, Mr. Richard Wei, Chief Financial Officer.

Please proceed, sir.

Thank you.

Good morning everyone.

This is Richard Wei, Chief Financial Officer of Silicon Motion.

Thank you for joining us for review of our third quarter results, and for discussion regarding our strategy and outlook.

With me here is Mr. Wallace Kou, President and CEO of Silicon Motion.

During today's call we will discuss the following topics.

A summary of our financial results for the third quarter, an update on our business guidance and we'll have a short Q&A session.

Before we get started, I would like to remind you of our safe harbor policy.

Certain statements made during the course of our discussion today may constitute forward-looking statements that are based on management's current expectations and beliefs, and are subject to a number of risks and uncertainties that could cause actual results to differ materially, including factors that may be beyond the Company's control.

For these risks, please refer to our filings with the Securities and Exchange Commission.

With that behind us, as you know from our press release issued earlier this morning, we had a great quarter.

Revenue for the third quarter was approximately TWD1b, which was about $7.6m and that represents a 51% increase from the second quarter, and a 39% increase from the third quarter of last year.

Our gross margin was 53.5%, the same as in the second quarter of this year.

Operating margin was 28.0%, up from 24.6% in the second quarter.

Net income was TWD289m, equivalent to $8.8m in the third quarter.

And that was up 55% from the second quarter, and up 35% from the third quarter of last year.

The net margin was 27.9%, up from 27.2% in the second quarter, and down slightly from the -- from 28.8% in the third quarter of last year.

Diluted EPS per ADS under U.S.

GAAP were TWD9.23, which was equivalent to $0.28.

And that was up 35% from the third quarter of last year and up 55% from the second quarter.

Second quarter EPS was $0.19.

Based on our current business outlook, we believe that our guidance for Q4 is as follows.

The Company currently expects sales in the fourth quarter to be between $33 and $34m, which represents a sequential increase of about 4 to 7% from $31.6m in the third quarter.

The Company also estimates that its gross margin in Q4 will likely be between 20 -- 52 and 53%.

And its operating margin will be approximately flat from the third quarter.

I would now like to turn over the call to Wallace for his discussion.

Wallace?

Thanks Richard.

And welcome to everyone who has joined us on the call today.

I would like to touch on the highlights first, and then provide further detail on performance and key activity impacting our business.

Our Q3 result was a significant accomplishment for us.

And we think it certainly helped put more distance between us and our competition.

We saw a fairly strong demand for our controllers that are using flash memory card and in USB flash disk drives.

Beside micro-SD card bundle business for mobile phones, the primary driver for this market was the effective cost competitiveness of many of our customers.

Both Samsung and [HyNet] increased the output of their 63 nanometer and 90 nanometer MLC flash memory respectively in the third quarter.

Regarding the Q4 business outlook, I'm very excited about the momentum we are bringing into the fourth quarter of this year.

Earlier this year we began shipping controller to customers whose micro-SD card were bundle into mobile phones.

The majority of our controllers are designed low density cards, such as 64MB and 120MB.

During the last quarter we started to see strong demand for our controller micro-SD card with 512MB density.

They are ramping up for the retail market.

We [send] some volume production of 63-nanometer 4GB MLC memory in November.

Our customer can manufacture and ship 1GB and 2GB density of micro-SD card at a time. [That] will significantly increase our micro-SD controller market share in the retail market in Q4.

As highlighted previously, we also benefit from successful ramp up and market acceptance of controllers that we introduced two quarters ago, including our SM222 Compact Flash controller, SM324 USB flash disk controllers and high performance SM266 SD controllers.

Looking ahead for next years, in summary, I think there will be several drivers for our business.

One, we expect further penetration of our micro-SD cards into mobile phones as more phones are equipped with multimedia functions and need extra storage.

Two, we are introducing a new controller for use in solid state disks in the first half of '07, as Windows Vista expected to drive demand for USB flash disk drive and solid state disks.

It is our expectation that solid state disk market will probably take off in the second half of '07 with 8GB to 16GB density, in '08 with 32GB to 64GB density.

Three, we think there will be significant demand of our controller in xD-Picture Card market.

And then we also plan to official ramp up our high performance USB 2.0 card reader controller to support new specification from various flash memory card associations.

Four, our flash memory card controllers are also designed in embedded [VJ] application for mobile phone and mobile digital media devices.

Currently [JDAK] has made this embedded [VJ] solution as [inaudible] specification.

We expect to see volume production in the second half of '07.

And five, our next generation MP3 controller will replace our first generation.

And we continue see no end to the explosion of [interest] and demand in this end market.

So, that is my comment.

Now, I would like to turn the call back to Richard.

Thank you, Wallace.

Operator?

[OPERATOR INSTRUCTIONS].

Your first question comes from the line of Jennifer West with Merriman.

Please proceed.

Congratulations on a very nice quarter and guidance going forward.

I was wondering if you could maybe give us some more detail about your shipments to the mobile market, maybe what those units were in the third quarter and what micro-SD was of that total?

So, in Q3 we're probably shipping around 31m units controller in the mobile phone market, around 20m controller for micro-SD card, around 9m units for mini-SD card, around 1.5m for MLC micro and MLC mobile cards.

Thank you.

And then can you maybe talk more, Richard, to the gross margin, maybe what's putting pressure on that in the fourth quarter and if you have any targets for '07?

If you are looking to maintain that above a certain percentage and how -- any factors that are helping that out, moving to smaller geometries or anything else?

Yes.

Q4 gross margin we decided to guide just a little bit lower, because the product mix we're not quite sure at the moment.

We have some higher margin products that may get pushed out a little bit into Q1, because some customers are not ready.

And so -- and it's on the basis, we wanted to be a bit more conservative.

I think for '07 we have a number of geometry migrations that we're planning to do.

And so, I think the low 50% range I think is certainly do-able for '07.

Okay.

And then my last question is if you can maybe give us some more detail about your new flash controllers that are qualified for Vista?

If you have any idea of implications for your business next year, is this like a replacement cycle that will go on?

I wouldn't say it's a replacement cycle.

We have two USB controllers that are -- that have passed the Microsoft test.

And so, we have qualified for the basic tier logo.

There is also a premium tier logo that we would like to get qualified for, but Microsoft has not spelled out how to get qualified for that yet.

So, we are waiting for that to get announced.

But we think that the added benefits from the ReadyBoost feature should make the -- what -- the added performance benefits really makes it quite attractive for consumers to have that platform.

And so, I think the [overall] demand for USB prices should be going up next year.

Great, thank you.

Congratulations again.

Your next question comes from the line Vijay Rakesh with Oppenheimer.

Please proceed.

Hello, Richard, just a couple more questions on that gross margin side.

Your conservative [inaudible] for Q4, but as you look into '07 what levels do you think you can sustain on the gross margin side during that year of new products coming in?

Should we model that in the 52% range, or how should we look at it?

Probably in the 50 -- I would say probably 53% range.

We do have a number of products and we plan to do shrinks.

And that will really help us lower our unit costs further.

And if you look at our ASD decline this year, we were down about, I think, 11% in Q1, flat in Q2, in Q3 the ASD was down by 6%.

Q4 we're looking for similar in the single digit range.

[Okay].

And so, if you have that type of ASD decline in '07, I think our cost reduction are in line with that and maybe a bit more.

So, I think 50 -- somewhere in the 52% range should be doable.

Great.

That's pretty good, actually.

And when -- how do you look at R&D, in the latest quarter's about 14% of revs?

How do you see that through '07?

Should that -- where should that be going for '07?

I think our R&D headcount [addition] has started to slow down a bit.

And so, I think -- right, so the really -- the [inaudible] is a payback.

Yes.

And we will certainly like to control that.

And so, our thinking is the R&D spending will increase in absolute dollars, but as the percent of total -- as a percentage of revenue I think that will gradually inch down.

So, should be in the 12 to 14% range for next year?

That sounds about the right range.

Okay.

And how do -- and you're operating margins had a nice bump up here, a gain of 28.

Where do you see that next year if your R&D is coming in lower?

Where do you see -- are your op margins going -- operating margins going to for next year?

It's hard to be very specific with the '07 numbers right now.

But if you look at our operating margin trend for this year, Q1 you see a decline, because your revenue base is a bit lower.

Okay.

And it start to -- should come up in Q2, and higher in Q3.

And this year at Q4 it should be about flat, and maybe up a little bit.

And I think the same trend should be true for next year.

So, for the year would you end up higher than the -- than 28%?

No, no.

That would be hard.

Okay.

I think for this year the average will not be 28%.

Right.

We started at about 20 -- I think 22% range.

It might be in the 25% range for this year, so?

Right, right.

So, you could -- so, the average for next year, probably it will be slightly higher than the average for this year, but it wouldn't be substantially higher.

Got it.

Okay, great.

Thanks a lot.

Good work guys.

Your next question comes from the line of Rob Adams with Montgomery & Company.

Please proceed.

Thanks guys.

Nice job.

Thank you.

Let me touch base.

Could you give us an update on the MP3 controller and PC camera product offerings?

Well, our MP3 controller in Q3 will be [slightly] going down, due to our second generation controller was not ready to ramp.

I think that in the next one or two months we'll have our second generation MP3 controller with fully integrated audio code and AC to DC converter.

We believe from late Q4 to Q1 we should be able to see the reasonable revenue grow for the MP3 product line.

And we do have -- as we mentioned, as we do add maybe additional more top tier customer, especially for low end, also for the toy side enter into production for Q1.

For PC camera I think [I] was disappointed here because we lost a major design cycle for two of the major mobile makers.

So, Q4 probably only shipping very, very small volume.

It's a really insignificant contribution for our total revenue.

But we believe probably late Q1 and Q2 that's another design cycle.

So, there we will try to catch up for the momentum.

Currently, we will try to focus on fine tune and focus on notebook application and stand alone PC camera application.

Okay, thanks.

And back to the MP3 controllers, so it sounds like you might get a little momentum in the Q4 to Q1 timeframe.

I know it's a pretty small piece of revenue, but to some extent do you think that could mitigate your normal large quarter seasonality?

Well, we think probably in Q2 next year we should be able to catch up, because the current design momentum and design activity we believe, probably late Q1 and Q2 we should start to see a reasonable contribution to our revenue.

Okay, great.

Thanks very much.

Your next question comes from the line of Daniel Amir with WR Hambrecht.

Please proceed.

Thanks a lot, and congratulations on a great quarter, a couple of questions here.

First of all, housekeeping, how many USB units did you ship this quarter?

We're shipping close to 8m units.

8m.

And do you expect that to -- what type of growth rates should we expect in the USB business here in the next couple of quarters?

It depends how we want [to address it] to penetrate, especially for the low end market.

As you know, the low end market may be is the majority [as -- in] China area.

So, just -- this really is about how we want to [increase] our margin in this bottom line.

But we -- we'll try to one is utilize the Vista trend.

Second is we try to leverage our know how in new MLC memory control, because we believe some of our competitors are not ready to support 63 nanometer MLC from Samsung, as well as the upcoming next year 55 to 50 nanometer MLC that require 8 bit error correction, as well as [inaudible] per page.

So, that will really push us -- push all the players into the very, very technology driven market.

So, we believe that when it happens, our controller probably can [inaudible] more with a reasonable gross margin.

So, if -- on top of that question, Samsung has commented on increasing MLC capacity to about 70% during the fourth quarter.

Do you expect that that's going to directly benefit you and market share gains, because it seems like by your comments that you guys feel that you're a step ahead of the competition here with -- regarding having controllers [inaudible]?

That is absolutely correct.

Not only are new product lines ready to support Samsung's 63 nanometer MLC, but also we all -- we put all the new [inaudible] to our old product.

It's in production today, because many of our customers they're probably not easy to changing to our -- not ready to transition to our new product line, due to maybe it's varied reasons, such as PC board, such as [inaudible] component in the factory.

So, I think now all our product lines from SD, MMC, Compact Flash, xD-Picture, USB, as well as upcoming MP3 controller will already support a new generation MLC with enhanced error correction.

So, that is a significant benefit for our controller compared with our competition.

Okay.

And then you commented on that with regard to Q4 margin, that some higher margin products may be pushed out to Q1 '07.

Can you comment which products are we talking about here?

Are these the card readers, PC camera stuff?

What are we exactly talking about here?

For example, such as xD-Picture controller, that is a pretty high margin product.

Due to customer [set] [inaudible] is not ready for complete qualification, so the [ramp up] push out probably to early Q1.

And is that the only product, or is there another?

There is the -- also, some of the high end Compact Flash controller due to the certain resource issue, which is not ready to ramp up as the original plan.

So, final question is [there appears to be] -- as you look into Q1 here and some of these high margin products get pushed out into Q1, and in addition, you have your MP3 player second gen coming out here later this quarter.

And the third thing is you have the mobile handset growth, which you didn't have last year with the whole micro-SD business.

Could we see a Q1 from a seasonal perspective maybe not as soft as it tends to be in the industry for you guys?

This all depend whether we can really ramp up other product lines to balance the -- too avoid the seasonality impact to our product line.

In the past I think we almost fully concentrate on SD, MMC, as well as the USB flash disk controller.

By saying moving to next year [inaudible] diversify flash memory card controller to offer, as well as we also have, remember, MP3 controllers.

So, we believe probably the revenue drop from Q4 to Q1 should be better in'06, but how much better, we cannot say at the moment.

Okay, thanks a lot.

Your next question comes from the line of Quinn Bolton with Needham & Company.

Please proceed.

Good morning, guys.

I wanted just to talk about the market and how tight or loose it might be here in the fourth quarter.

You guys had a pretty strong growth in the unit shipments in Q3.

It looks like that's set to continue in Q4.

So, I'm just wondering how tight the market is and whether that's having any impact on pricing?

Well, we think the [inaudible] and we also see the competition, because competitors absolutely want to enter for the market we have.

But we probably see the ASD drop for the flash memory card controller probably will be around single digit, from maybe 6 to 8% range, but because of mix up with our -- some new product line in high end.

So, we believe the situation is definitely controllable.

But the flash supply due to the -- I think due to the -- I believe that currently the supply and the demand has reached balance around early Q4.

So, we think -- we're thinking probably the demand was just strong probably to the beginning of December.

Okay.

And then just looking in -- you mentioned the competitive environment, can you talk about what you're seeing in the micro-SD segment, whether other controller vendors are getting qualified and designed into the micro-SD cards?

Or how do you see that playing out as we head into 2007?

Today we see the only major player in micro-SD is SanDisk and Silicon Motion.

Although in Taiwan there's about 2 to 3 small players, but I think their monthly shipment is probably less than 2m a month at a time.

Probably total combined together less than 3m a month at a time.

The Panasonic, although they are also the founder of SD Association, I don't think they're going to play in micro-SD card business.

Although Toshiba announced they're going to enter micro-SD, but at this moment due to some internal issue, they're still not able to ship micro-SD card.

So we believe entering '07 we still represent the largest player in micro-SD card in both the bundle business, as well as the retail.

And any thoughts on what Intel is planning to do with the IM flash nand capacity as that ramps?

There are some articles in DigiTimes that they may be looking to enter the SD -- micro-SD market for cell phones.

Well, I can only tell you this we are also very close to Intel.

We cannot speak for Intel and we do have some solution in Intel for evaluation too.

But I'm not sure Intel really -- they plan to really focus on micro-SD card business.

So far, we believe IM flash memory, the lower density 2GB, two gigabit, which means that 256 [gigabyte].

So, they are not able to play low density micro-SD card.

And the high density micro-SD card today is dominated by SanDisk.

So, with 79 nanometer MLC for IM there'd be no [fitting] for micro-SD card phone [factor].

Okay, and then lastly, any update on the graphics business that -- the business looked a little slow in the third quarter.

Just sort of wondering what the outlook may be for Q4?

We think Q4 definitely is getting better in Q3.

We should benefit some starting in late Q4 to Q1 from Intel server business.

Okay, great.

Thank you.

Your next question comes from the line of Pranay Laharia with Deutsche Bank.

Please proceed please.

Yeah, hello guys.

To start out, why is the revenue guidance for 4Q only up 6% Q on Q when last year you were up 13% Q on Q?

What's changed this year?

The Q3 base is -- it's quite high.

So, but the retail business has a certain seasonality.

Has that changed, or is it the cell phone business that you think has a different seasonality to your retail business?

So, I think we see the retail business getting stronger when entering Q4.

However, the bundle business maybe the momentum will slow down a little bit, because we believe for some of the mobile phone makers, they may have some inventory in their side.

So, we think that we probably will not foresee the growth -- strong growth in Q4 for bundle business, but retail business will grow.

Okay, fantastic.

And then in your 31m cell phone controllers, how much of that do you think was through the retail channel and how much for bundling?

I think for micro-SD we believe about probably around 14m to 15m is bundle business, probably 5m to 6m the retail business.

For mini-SD all 9m is retail business.

Okay, very good.

How was your pricing for USB flash drive versus flash card controllers?

I think the ASD was about, I believe 50 -- just a second -- $0.59 in Q3?

Is that for flash card controllers, or USB flash drive controllers, or both?

Both.

They came out to be the same number.

Okay, great, fantastic.

Thank you very much.

Your next question comes from the line of Adele Mao with Susquehanna International Group.

Please proceed.

Hello, I just have a quick question.

Now that Microsoft's acquisition of [inaudible] has been completed for more than a quarter, how has that impacted you guys specifically?

Have you seen any changes in terms of the order flow from the original [inaudible] business?

There has been no change.

Okay, great.

Thank you.

Your next question comes from the line of Dan [Ries] with [Monness].

Please proceed.

Hello, great quarter.

Your customers appear to have grown much faster than the micro-SD market.

Is there any -- can you elaborate a bit on what occurred to lead to such a big difference between the two?

And can you highlight for us any [10%] customers in the quarter or any color on [inaudible]?

I think the -- our business model are quite different with SanDisk, because SanDisk, because SanDisk is a [density] grow.

They grow with the flash memory.

And we grow if units grow.

So, we focus on the bundle business, especially for low density, which SanDisk probably is not interested at all.

So, I think in low density bundle business the unit growth become important, although SanDisk definitely take a majority of high density micro-SD card business in the past two quarters.

However, in November Samsung is going to ship 63 nanometer MLC 4GB that exactly fit in the micro-SD card [phone factor], which means a majority of our customer, which before cannot produce high density micro-SD card, they're going to ship.

So, in November we believe our customer were able to ship 1GB, as well as 2GB density for micro-SD card.

They are going to -- improving our market share in the retail market.

If Samsung ships that in November, how long does it take your customers to turn that around and actually get product?

It's actually all design are done today, it's just waiting for volume production.

Great, and 10% customers or maybe largest customers in the quarter?

I don't have that number with me.

I need to get back to you.

Okay.

Thank you.

[OPERATOR INSTRUCTIONS].

You have a follow up question from the line of Daniel Amir with WR Hambrecht.

Yes, one other question, Wallace.

Is there a possibility that you guys could get a license from Sony on the memory stick format?

That's an area that clearly Sony Ericsson phones are one of the leaders in the market for handsets with card slots, and that's a total segment that, unfortunately, you guys cannot play in right now.

So, can you just give maybe an update on the status there?

I think that in the past we really tried to discuss -- negotiate the license agreement with Sony.

But it look like Sony, they really are afraid of our entering into the market.

So, so far they really -- there's no decision.

But I believe next year we will try to leverage our relationship with Sony's major suppliers such as Samsung, and try to negotiate the supply, because we believe our controller is really 100% portable for all type of nand flash memory.

When the market moves into 55 nanometer, I believe in Q2 to Q3 next year, a lot of things are going to change, because all nand flash manufacture is going to have a similar cost structure in next year Q2 to Q3.

So, when the controller has more flexibility, able to provide 8 bit error correction feature, as well as a full [inaudible] byte per page and high performance, are going to be the winner.

So, that could be opportunity for us to negotiate with Sony again at that timeframe.

Okay.

And one other question on the xD, can you quantify what type of opportunity are we talking about in terms of units?

Is this a million unit type of per quarter type of product?

Is this only a few hundred thousand?

Can you help us quantify that?

xD-Picture, which is supported for all input Fuji Film, [they like] Kodak also have a [inaudible] camera support xD-Picture.

It's about -- totally about 30m a year, Samsung about two-third market, Toshiba about one-third market.

We -- our customer is Samsung.

We believe probably in Q2 timeframe, we represent probably 100% of Samsung business.

Did you say 100%?

Probably.

Okay, thank you.

At this time there are no further questions.

That's unbelievable.

I would now like --

Let me just follow up on an earlier question.

I think there was a question on over 10% customers.

I don't think we have an over 10% customer, but ST Micro and Samsung were close to 10% in Q3 for us, but not over 10%.

At this time there are no further questions.

I would now like to turn the call back over to Mr. Richard Wei for closing remarks.

Okay, well, we appreciate interest in our story.

And we look forward to talking to you again next quarter.

In the meantime, if you have more questions, please send us email or give us a call.

And thank you for your participation.

Good night.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect, and have a good day.