慧榮科技 (SIMO) 2019 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Silicon Motion Technology Corp.

Q4 2019 Earnings Conference Call.

(Operator Instructions) Please be advised that today's conference is being recorded.

I would now read the forward-looking statement.

This conference call contains forward-looking statements within the meaning of Section 27A of Securities Act of 1933 and the Section 21E of Securities Exchange Act 1934.

As amended, such forward-looking statements include, without limitations, 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 risks and uncertainties and actual market trends and our results may differ materially from those expressed or implied in forward-looking statements for a variety of reasons.

Potential risks and uncertainties include, but are not limited to, continued competitive pressure in the conductor industry and effective of such pressure on prices, unpredicted changes in technology and consumer demand for multimedia consumer electronics, the state of any changes in our relationship with our major consumers and 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 conference call.

I would now like to hand the conference over to your first speaker today, Mr. Chris Chaney.

Thank you.

Please go ahead, sir.

Thank you, AJ.

Good morning, everyone, and welcome to Silicon Motion's Fourth Quarter 2019 Financial Results Conference Call and Webcast.

As AJ mentioned, my name is Chris Chaney, I'm Director of Investor Relations, and with me today is Wallace Kou, our President and CEO; and Riyadh Lai, our Chief Financial Officer.

Following my comments, Wallace will make -- he will provide a review of our key business developments; and then Riyadh will discuss our fourth quarter results and our outlook.

Then we will conclude with a question-and-answer period.

Before we get started, I'd like to remind you of our safe harbor policy, which was read at the start of this call.

For a comprehensive overview of the risks and uncertainties 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 was filed on Form 6-K after the close of the market yesterday.

This webcast will be available for replay in the Investor Relations section of our website 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 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'd like to now turn the call over to Wallace.

Thank you, Chris.

Hello, everyone, and thank you for joining us today.

First, a few financial highlights before I discuss performance of our key products.

Our fourth quarter sales grew 35% sequentially to $153 million, accelerating from the 20% growth in the previous quarter.

We saw growth in all 3 of our key products, SSD controllers, eMMC+

UFS controllers and SSD solutions.

Earnings per ADS for the quarter were $0.96, up from $0.69 in the third quarter.

After my comments, Riyadh will discuss details of our financial performance and provide guidance.

Let me start with our SSD controllers.

I'm proud to report that sales of our SSD controller reached new corporate record highs for both the quarter and the year.

Sales were up 25% for the quarter and up 20% for the year.

50% to 60% of our total sales are now generated by SSD controllers, primarily for client devices, but also from initial sales for enterprise grade controllers.

As you may know, we have taken a deliberate strategy of diversifying our customer base.

We currently supply our SSD controller directly to 5 out of the 7 global NAND flash manufacturers.

And separately, we also supply to all of the leading module makers.

In terms of end markets, our controller can be found in PC marketed by all of the world-leading PC OEMs.

And separately, our controller are widely used in SSD sold in various channel markets by Amazon to certain integrators.

We are also now taking our first step into the large data center and enterprise markets.

So you may recall, we began 2019 with very limited sales visibility because NAND prices were falling rapidly.

NAND manufacturers had a high level of inventory and customers were also facing very limited visibility themselves.

Our sales visibility improved meaningfully by May 2019.

When NAND prices stabilized, we started seeing more confidence and higher quality sales forecast from customers.

And importantly, because of lower NAND prices, we started seeing stronger demand for our SSD controllers.

In today's NAND prices, SSD are attractively priced relative to hard disk drive and OEM PC.

Game console and other client devices are all interested in increasing their adoption of SSDs.

Our customers controller procurement forecast suggests that strong demand for SSD will continue in 2020.

In addition, to benefiting from better visibility from more stable NAND prices and better SSD price elasticity of demand, we are also benefiting from growing sale into OEM market versus the channel market.

More than half of our SSD controller are shipping through both our NAND flash and module maker customer to PC and other OEMs.

We expect our OEM proportion to grow further in 2020.

The OEM market tend to be more predictable because of the emphasis on supply continuity, longer qualification cycles and established supplier relationship, while the channel market is more price-driven and opportunistic.

In addition to growing with market, we are in good position to increase our market share.

We currently own at least 1/3 of the overall [client SSD] controller market and believe we should be able to increase this to 40% in the next few years by growing our share of the wallet and our current NAND flash and module maker customers.

Based on our current customer procurement forecast, we believe we should be able to grow our SSD controller sales 15% to 25% in 2020, exceeding the 15% market growth projected by industry analysts such as Gartner.

Our sales enterprise-grade SSD controller grew further in the fourth quarter by our sale to Alibaba and Baidu as well as to U.S. customers from the enterprise markets.

This is our second quarter of commercial sales, though sales are still quite small.

We expect sales of our enterprise-grade SSD controller to continue growing in 2020, as our sale to Alibaba, Baidu and U.S. customer grow further, and the business development activity continues to build.

Sales of our enterprise-grade SSD controller will remain quite small relative to our large client SSD controller sales.

Now turning to our eMMC+

UFS controllers for the mobile embedded storage market.

Quarterly sales of our eMMC+

UFS controllers accelerated further in the fourth quarter.

Sale in the fourth quarter grew about 70% sequentially after growing 40% in the third quarter and 20% in the second quarter.

Our full year 2019 sales were however down about 30% due to the sharp drop in the sales in the first quarter.

As you may recall, eMMC controller sales fell sharply at the start of 2019 because of our Korean customer risk.

Since then, our UFS program for our U.S. customer have scaled rapidly and sale to Chinese module customers have grown to where, exiting the year, our previous small module makers sales have become almost as big as those to our Korean customer.

We are confident our eMMC+

UFS controllers sales will revert to growth in 2020 as our UFS and module maker sales grow further, more than offsetting any residual Korean downside risk.

While the smartphone market is matured, we are benefiting from a major technology upgrade in embedded storage from legacy eMMC to newer, better performance UFS.

In 2019, we saw our strong rollout of UFS embedded storage in premium flagship phone for both 4G and 5G.

We are now beginning to see the initial rollout of UFS in mainstream phones.

The mainstream phone segment is much larger than the premium segment in unit terms.

So we are obviously very excited about this.

We have a multiple generation of UFS, including uMCP design win with our U.S. customer, for both current and upcoming technology specifications for current and upcoming generation of NAND technology.

Our customer had done an excellent job designing their UFS solution into a diversified portfolio of customers from China to Korea and the U.S. We are also delighted with the success of our eMMC controller sales to Chinese module makers.

As NAND manufacturers transition to UFS, they are creating an opportunity for module maker to grow in the legacy lower density and more fragmented eMMC segment.

Our module maker customers have been expanding their sales from smart set-top boxes to speakers and TV and to Tier 3 and Tier 4 smartphone OEMs.

Some of these smartphone OEMs have very strong market positions in Africa and other emerging markets and shipping large volumes.

Now I will provide a few comments on our SSD solutions.

SSD solutions sales grew about 50% (sic) [60%] sequentially in the fourth quarter, following a 45% increase in the third quarter.

Full year 2019 SSD solution are down about 50%, largely due to 1-year delay in the launch of our Shannon open-channel SSD and low NAND ASP offsetting strong bit growth of our Ferri industrial SSD.

In the third quarter, we started shipping our Shannon open-channel SSD to Alibaba and Baidu.

These SSD were commercially deployed during Alibaba's important November 11 Singles' Day by sales event.

And we are delighted they performed smoothly with no issues.

We expect sales of our open-channel SSD to scale sharply in 2020.

Alibaba had taken several strategic actions to reinforce their long-term commitment and to increase their deployment of open-channel SSD technology.

Our Ferri chip scale industrial SSD delivered strong bit growth in 2019, but revenues declined because of falling ASP per bit.

In 2020, we expect Ferri bit growth to continue.

But importantly, we've had revenue to return to growth as we benefit from stable to firm ASP per bit.

We supply our Ferri solution to a diversified customer base in many applications and geographic markets.

We are currently seeing strong design activity in the automotive and data networking markets for in-car telematics system and (inaudible) storage for high-end networking gear.

For 2020, we are delighted that all 3 of our engines of growth, SSD controllers, eMMC+

UFS controllers and SSD solution will all contribute to full year growth, the first time in many years.

With multiple growth drivers in place, we are positioned for more balanced growth going forward.

We continue to monitor the potential impact of the recent coronavirus outbreak to our supply chain.

Based on the situation today, our sales visibility remains significantly better than a year ago.

Lastly, our thoughts are with many employees in China, our customers and suppliers, their family as well as those who are impacted by viral outbreak.

May they all stay safe in good health.

Now I will turn the call over to Riyadh to discuss our financial results and our outlook.

Thank you, Wallace, and hello, everyone.

I will summarize our financial results and then provide our outlook for the first quarter and full year 2020.

Before I begin, I would like to reiterate that our comments today will focus primarily on our non-GAAP results, unless otherwise specifically noted.

Please note that all non-GAAP results exclude FCI in order to provide transparency to the performance of our continuing operations.

A reconciliation of our GAAP to non-GAAP data is included with the earnings release issued yesterday.

In Q4, revenue grew 35% sequentially.

For full year 2019, revenue declined 10%.

Results for our 3 key products are as follows.

In Q4, SSD controller sales grew about 25% sequentially.

For the full year, SSD controller grew about 20% and accounted for 50% to 60% of total revenue, up from 40% last year.

In Q4 eMMC+

UFS controller sales grew about 70% sequentially.

For the full year, eMMC+

UFS controllers declined about 30% and accounted for 20% to 25% of total revenue, down from 25% to 30% last year.

In Q4, SSD solutions increased about 60% sequentially.

For the full year, SSD solutions declined about 50% and accounted for about 10% of total revenue, down from about 20% last year.

Gross margins in Q4 decreased to 49.3% from 49.8% in the prior quarter, as sales of lower-margin SSD solutions grew faster than the higher-margin controllers.

Gross margin for full year 2019 increased to 50.1% from 49.1% in the prior year, as sales of higher gross margin controllers grew while low gross margin SSD solutions declined.

Controller gross margins remained relatively stable, both quarter-over-quarter and year-over-year.

Operating expenses in Q4 were 21% higher sequentially because of higher R&D tape-out and bonus expenses.

Full year 2019 operating expenses were 15% higher than the prior year because of higher R&D tape-outs, salary and bonus expenses.

Operating margin in Q4 increased to 24.4% from 22.1% in the prior quarter.

Full year 2019 operating margin decreased to 21.3% from 26.7%.

Our effective tax rate in Q4 was 13% compared to 9% in the prior quarter.

Full year 2019 effective tax rate was 10% compared to 11% in the prior year.

Earnings per ADS in Q4 increased to $0.96 and from $0.69 in the prior quarter.

Earnings per ADS for the full year 2019 decreased to $2.60 from $3.43 in the prior year.

Stock-based compensation in our operating expenses, which we exclude from our non-GAAP results, was $7.2 million in Q4 compared to $2.6 million in the prior quarter due to seasonal timing of RSU awards.

For full year 2019, stock-based compensation was $14.1 million compared to $19.8 million in the prior year.

We had $350 million of cash, cash equivalents, restricted cash and short-term investments at the end of Q4 compared to $338 million at the end of the prior quarter and $311 million a year ago.

We paid $12 million in dividends to shareholders with the first quarterly installment of our $1.40 per ADS annual dividend that was announced in October of last year.

We did not repurchase any shares during the fourth quarter.

Now let me turn to our first quarter and full year 2020 guidance and forward-looking trends.

In this year's first quarter, we expect revenue to decline 10% to 15% sequentially to $130 million to $138 million, with strong SSD solutions growth more than offset by seasonal decline of SSD and eMMC+

UFS controllers.

For full year 2020, we expect revenue to increase 20% to 30%, led by growth from all of our 3 key products.

Now that our guidance -- note that our guidance incorporates the latest information about the recent coronavirus outbreak and its effect on demand and our supply chain, including extended Chinese New Year's holiday, weaker retail demand and strong online and data center activities due to stay-at-home restrictions.

Our Q1 revenue guidance is therefore softer than what we had envisaged prior to the coronavirus outbreak.

This situation continues to evolve rapidly, and we will update everyone if there are significant changes to our business.

Now I'll provide more color on each of our 3 key products.

In the first quarter, we expect a seasonal decline in sales of our SSD controllers.

For the full year, we expect SSD controllers to grow 15% to 25%.

In the first quarter, we expect our mobile eMMC+

UFS controllers sales to decline seasonally.

For the full year, we expect eMMC+

UFS controller sales to grow 35% to 40%.

In the first quarter, we expect our SSD solutions to continue growing rapidly as Shannon SSD sales to Alibaba and others expand further.

For the full year, we expect SSD solutions sales to grow 50% to 100%, with growth from both our Shannon and Ferri SSDs.

In the first quarter, our total gross margin is expected to be in a range of 44% to 46%, lower than the 49% in the prior quarter.

The decline in gross margin is due to an unfavorable product mix shift and falling SSD solutions' gross margin.

The unfavorable product mix shift is from a seasonal decline in high gross margin controller sales concurrent with a sharp increase in low margin -- lower margin SSD solution sales.

The lower SSD solutions gross margin are due to a steep sales ramp of low-margin standard NVMe SSDs to a large Chinese social media company and residual shipments of low-margin open-channel SSDs to Alibaba under pre-consignment arrangements.

While higher gross margin consignment sales to Alibaba will begin in the first quarter, they will not be significant enough to provide a benefit to gross margin until the second quarter.

Pre-consignment arrangements will end in the first quarter, and this will help improve SSD solutions gross margins in subsequent quarters.

For full year 2020, we expect gross margin to be in the 46% to 48% range, lower than the 50% in the prior year.

The decline in full year gross margin is expected to be primarily caused by our lower-margin SSD solutions sales growing faster than higher margin controller sales.

Our SSD solutions gross margin will benefit from sales to Alibaba under new higher gross margin consignment arrangements in the second and third quarters when our Alibaba projects ramp.

However, until our Alibaba sales levels achieve sufficient economies of scale, we will be dependent on the sale of low-margin standard NVMe SSDs to Chinese Internet companies to cover operating expenses, which will dilute our higher gross margin Alibaba consignment sales.

And until Alibaba consignment sales scale up, SSD solutions gross margin will remain low, roughly half of our corporate average.

Our investment in our Shannon platform remains strategically important and financially attractive.

Our Shannon platform enables us to jump-start our strategically important enterprise SSD controller market rollout.

Financially, we believe open-channel SSD design services as a stand-alone is an attractive investment.

To give you a sense of magnitude of this opportunity, using very rough numbers, this year we could generate $5 million in gross profit for open-channel SSDs that represent only 1% of our customers' total SSD petabyte procurement.

Our gross profit will scale as our share grows and our customers' SSD demand increases.

As well as I talked about, we are confident open-channel SSD technology will scale at Alibaba because they have been taking certain concrete strategic actions to reinforce their long-term commitments and expand deployment of open-channel SSD technology.

First quarter operating margin is expected to be between 18% and 20%.

Full year 2020 operating margin is expected to be between 21.5% and 23.5%.

First quarter stock-based compensation expense is expected to be in the range of $2.5 million to $2.7 million.

Full year 2020 stock-based compensation is expected to be in the range of $14 million to $16 million.

Our effective tax rate in 2020 is expected to be approximately 14%, a touch below our 15% mobile tax rate.

Our effective tax rate in 2019 was lighter than expected due to certain onetime tax benefits.

This concludes our prepared remarks.

We will now open the call to your questions.

(Operator Instructions) We have the first question from the line of Karl Ackerman from Cowen.

Karl, are you on mute?

We can't hear your voice.

AJ, let's move on to the next question.

We'll circle back to Karl.

The next question comes from the line of Anthony Stoss from Craig-Hallum.

Riyadh, can you comment -- so I think I understand most of the moving parts on Alibaba and the gross margin impact to SSD solutions.

Can you maybe give us a glimpse what you think your gross margins might look like exiting 2020?

I assume we're going to see an increase in each quarter on gross margins going forward.

And then 2 other questions.

Can you give us a little bit more detail on the significant OpEx jump in Q1?

I know it's going to be fairly normalized for the full year.

And then maybe one for Wallace.

In the press release, you talked about you're going to expand your OEM exposure in 2020 on SSDs.

When will this new customer or customers come online?

I guess, I'm looking for one quarter.

Let me start with your question about our gross margin, Tony.

Our gross margins are going to continue to be lower than our overall gross margin because of the nature of the module maker type of product, the module products.

We're going to have the benefit of the Alibaba programs going into consignment, which means that gross margins are going to be significantly higher than everything else.

But that said, the Alibaba program is also quite lumpy, which means we're going to have gross margin improvements in the second and third quarter.

But once the programs taper off in the fourth quarter, the gross margin boost will temporarily die down until the following year.

Additionally, we will still have a lot of other programs that we will be carrying in order to continue to cover our Shannon operating expense.

Until our Alibaba consignment sales are able to scale significantly, we will need to be dependent on sales of standard NVMe SSDs to Chinese Internet company to help cover our operating -- our Shannon operating expenses.

So this -- the sales of these standard NVMe SSDs will cause our overall Shannon SSDs to remain lower than what they would be if we were just selling SSDs to Alibaba on a consignment basis.

Regarding your remaining question, we're always looking for opportunity to engage with OEM customers, particularly NAND customers.

As you all know, the NAND makers start to outsource their mainstream and the value line SSD controller to third-party like Silicon Motion.

So I think we are in the process to engage the opportunity.

I cannot really say when we are going to see that happen.

It could be later this year, it could be early next year.

We are -- have quite opportunities to engage with all NAND makers regarding their mainstream and value line client SSD controller.

Tony, I'll answer your third question about our operating expense.

So we now have about 1,300 employees, and we'll likely have to continue adding resources to support our growing client SSD and nascent enterprise SSD controller programs.

So we're going to have expenses relating to incremental headcounts.

We're also going to have expenses relating to tape-out expenses that have been increasing rapidly as we move more and more of our products to 28 nanometers and finer geometries.

So one of our goals is to grow earnings faster than sales, which means our operating margin needs to expand.

And so that's why we continue to maintain a 30% long-term operating margin target.

To get to the target of earnings growing faster than sales, we'll have to continue to tightly manage our operating expenses for this year despite having to continue to invest in engineering resources and expensive tape-outs.

Just as a follow-up, Riyadh, the 50% to 100% growth goal or part of the guide for SSD solutions, pretty wide in terms of the range.

Is it fair to assume the 50% growth would assume just the 3 current customers you have?

And also, can you give us a sense of how many customers you think you'll have going live in 2020?

So we have 2 main products within our SSD solutions.

We have our Shannon data center SSDs.

We also have our Ferri industrial SSD.

So the 50% to 100% growth will be coming from both of these product lines.

Well, over on the Shannon side, we have one large customer, Alibaba.

We're also picking up a large Chinese social media, one of China's largest social media company, and we also supply a lot to a bunch of other Internet companies in China as well as Alibaba.

So the only customer where we're going to be going into consignment this year is Alibaba.

Everything else will be with the pass-through of NAND, similar to the pre-consignment with Alibaba.

On the Ferri side, we have a wide range of customers, a pretty diversified base of customers from automotive to data networking in other markets.

So we're counting on both sets of our products to drive towards the 50% to 100% growth for this year.

The next question comes from the line of Karl Ackerman from Cowen.

This is Sam on for Karl.

I apologize, I had technical difficulties earlier.

Just starting off, I'm curious if you guys -- I know you've been a little more reserved on this compared to competitors in the past, but I'm curious if you guys have a NAND ASP outlook for the near-term or the rest of the year, given last year's trough of pricing?

Yes, we do not forecast NAND prices.

Our NAND flash partner, however, regularly shared with us their expectation about NAND prices.

Current expectation is price could shift up, but demand continues to exceed supply.

While we prefer NAND price to fall, this encourage adoption of client SSD, the risk of higher NAND prices to us this year.

If this will happen, it's fairly limited as our SSD controller growth this year is coming from OEM demand.

OEM demand involved longer supply arrangement and is managed by the NAND manufacturer allocation and capacity.

I think we definitely see the NAND price in the first half as more stable.

And in the second half, as the demand is higher, supply is in shortage, the price will go up.

A.J. next question, please.

The next question comes from the line of Craig Ellis from B. Riley FBR.

Guys, can you hear me?

Yes.

So I just want to start with kind of the long-term dynamics in the SSD solutions business.

Obviously, it's good to see the growth, kind of tough to see some of the lower gross margins.

As we think about the long-term profitability of the business, is this the plan to kind of shift some of new customers over to a consignment model as well?

Or as that business grows as a percentage of revenues, can we continue to expect that, that will be kind of a drag on gross margins?

Yes.

I think it's a good question.

Ideally, we definitely prefer if the more customer, they can choose consignment of this model.

However, a majority of China customer, they really prefer is solution based, not consignment biz model because they don't have the scale, like Alibaba and choose multiple NAND sourcings.

And I think -- but for our situation, if we can have a more compelling end solution, our enterprise controller can be online, such as for our next Gen 4 and Gen 5 solution come in line in the market, we believe that will simply improve our gross margin.

And we also partner with certain NAND makers [such as Rising], YMTC and other NAND makers, who does not have a strong visibility in China enterprise SSD solution.

I think that will combine, it will help us to increase our gross margin gradually.

Got it.

So it would be fair to say that if you guys were to diversify into other larger customers that had scale similar to Alibaba, that might be on a consignment model rather than resolutions model?

That's correct.

And then just a quick follow-up here on the mix within SSD controllers.

I think last year, there had been some unfavorable mix towards the lower end.

Is there any -- can you just provide any color on what expectation is kind of going into calendar '20 for the SSD controller mix?

I know there's some expectation that PCIe 4.0 should be a boost around midyear, but kind of any color you guys have there would be great.

Craig, for the full year, our SSD -- our overall SSD controllers as well as broadly all of our controllers, the ASPs have been relatively stable, though we did have a temporary situation in the second quarter last year, where many of our NAND customers were stuck with elevated levels of inventory.

And so during that one quarter, they were buying a lot of DRAM-less solutions, which are lower gross margin, but that was a temporary issue.

Beyond that, our gross margins have been fairly stable for our controller products.

Yes.

Regarding the PCIe trend, we do see this year, clients are deemed moving toward PCIe much faster than last year.

And regarding the PCIe Gen 4, our product royalty may align with Intel.

I think that for this year, PCIe Gen 4 solution from PC OEM, the royalty is very small percentage compared to Gen 3. But in 2021, they're going to be increased dramatically.

Okay.

Let's move on to the next question, please.

The next question comes from the line of Gokul Hariharan from JPMorgan.

Congrats on the great performance.

So first of all, my question, first question is on eMMC and UFS.

Could you talk a little bit about the dynamics between UFS and eMMC currently in this business.

I think last year, either you or some of your competitors have mentioned that there were a lot of opportunistic demand in the eMMC market given NAND flash prices were coming down quite rapidly, especially in China.

If you expect NAND flash prices to strengthen this year, what would be the behavior of these typical module mega customers in the eMMC side?

Would there be some potential downside to demand on the eMMC side, if flash price becomes stronger?

That's my first question.

And I had a second question as well.

Yes, as we mentioned, this year, we see the strong technology shift from eMMC to UFS for smartphone, not only premium line.

The mainstream model also start to adopt UFS uMCP solution for both Qualcomm and MediaTek.

So I think NAND makers, they favor to move their solution into the UFS or uMCP by minimum density at 34 gigabyte naturally, minimum density is at 128 gigabyte or above because of our manufacturing costs, uMCP, and they don't [imagine the] density of 16 gigabyte or 120 gigabyte, [is of] similar.

So NAND makers favor higher density for UFS or uMCP solution.

That'll leave a big opportunity for module maker to supply low-density legacy eMCP or eMMC solution to low-end smartphone or set-top boxes of TV for module maker.

So we believe the Shenzhen eMMC module maker, they have a really broader space to continue to grow because NAND allocation, NAND maker puts a higher density, higher margin, high-end product for UFS, uMCP.

The module maker from Shenzhen, they have a much better opportunity to penetrate legacy high-volume for smart, low-end smartphone and set-top box.

Gokul, let me also add, in the event our module maker customers, who typically have lower visibility because they don't own the source of flash compared to the NAND flash makers, who own this source suppliers and decide how they want to allocate their flash.

So there is always potentially more risk with module maker customers.

But as we said, the 35% to 40% eMMC+

UFS controller outlook that we have for this year, we believe is a very realistic target and incorporates the lower visibility that you typically see from module maker customers.

Okay.

So just a follow-up on that.

Would you say UFS is much bigger than eMMC when it comes to 2020 product mix, the way you see it at this point?

That is correct because the ASP is much higher.

Okay.

Got it.

Given the very strong performance in the last couple of quarters on the SSD controllers, could you talk a little bit about penetration -- market penetration dynamics in the core market, especially in the PC markets?

Also talk about what kind of strides we are making in other areas like it's in storage or game console or any of the other like set-top box, et cetera, as well?

Well, we believe we can continue growing our client and control their sales readily, the market continued to grow as we increase market share.

We believe the market for client SSD will continue to grow rapidly for a few more years, add new global shipment of client storage devices, whether SSD or HDD are about 500 million units.

Industry analysis such as Gartner believe, half the market last year had adopted SSD and its usage will continue to grow rapidly in the next few years.

Thus HDD are replaced.

We'll also grow SSD controller sales by increasing market share.

NAND flash makers are also interest in outsourcing controller for their mainstream and the value line SSD.

We already supply controller to 5 out of the 7 NAND flash makers.

We are working on increasing our share in many of them.

Additionally, over a year ago, we started shipping to the world's largest module makers that account for roughly 10% of all the clients that they ship annually.

Our current share, at this customer is still small, but we have a significant share of design win at this customer.

As these design wins continue growing into production, we expect our share at this customer to increase.

So we believe we can increase our market share from today's 1/3 to 40% in the next few years' time.

Regarding the game console, I think we engage with all NAND maker.

NAND makers, they are our primary supplier with game sensor, game console SSD.

It all depend on our customer, their decision, priority, NAND allocation.

So we believe in the, maybe, year-end or next year, we will gradually moving to game console when our NAND customer decide to enter.

And remember, game consoles also refresh every year.

So all the mainstream NAND controller customer have the opportunity to enter every year.

Understood.

One small question.

On the SSD solutions business, could you talk about what percentage of your business in 2020 is likely to be based on the new consignment model, roughly?

I know that the range of guidance is quite wide, 50% to 100% growth.

But is it like 10%, 20% is going to be under consignment model?

Or is it going to be a much bigger number than that?

Well, there's quite a lot of moving parts here because we have -- within our SSD solutions as you know, we have both our Shannon and our Ferri industrial SSD.

So it's a combination of both these products, and there are quite a lot of customers and different programs.

But on the tenant side, which is last year, our overall sales was about half-half in terms of SSD solutions, half Shannon, half Ferri.

In that part of the market of our product line, we also have a lot of variability between a more established, more predictable Alibaba program versus more opportunistic sales to -- of standard NVMe products to Chinese Internet companies.

So I hesitate to give you a proportional number because of the many moving parts that we have within our base.

But sufficient to say, the Alibaba programs are a lot more predictable, but we also have a lot of more opportunistic businesses coming from non-hyperscale customers in China.

The next question comes from the line of Suji Desilva from ROTH Capital.

So staying on SSD solutions, perhaps, can you talk about the lead customer?

You said it's going to have a lumpy 2Q, 3Q ordering and then 4Q pause, what kind of pattern do you expect longer term?

Is that kind of a couple of quarters of order and then pause?

And what kind of SSD solutions growth do you expect longer-term?

And do you expect additional customers like a U.S. hyperscaler for Shannon?

Or is it more China-centric?

So this is -- that customer is Alibaba.

And as you know, we've been doing projects for Alibaba for many years.

Alibaba has annual program refresh and generally programs for this year.

These are programs that we won last year.

So now we're gearing up to win programs for the following year.

So we have visibility from that perspective.

And as Wallace had talked about earlier, we already have about half a dozen projects with Alibaba that are going to go into production this year.

But as you know, in the past, Alibaba's projects have been seasonally lumpy, right?

They start scaling in Q1, scale sharply in Q3, scale further in Q4 -- in Q3, sorry -- in Q2 going to Q3 and then come down in Q4.

So these are the sort of patterns you probably should expect this year.

Let me add some comment.

Regarding our SSD solution, our Ferri product line, I think, the automotive sector, it will be long-term growth driver.

We have spent 5 years to develop the solution and design win.

We believe we have built a significant pipeline for the automotive industry, although the production run rate is slowly, but we believe this will -- could be the long-term driver of Ferri business.

Okay.

Great.

That helps.

And then for the eMMC and UFS, the growth here, 35%, 40%.

What kind of UFS share do you expect exiting in '20?

And what's the relative growth in that of UFS versus the module makers?

Is it mostly UFS driving the 20% growth?

Yes, our U.S. customer, they did a very good job, I think, beside the non-Android base Apple iPhone, I think they probably won almost every single major Android phone makers.

So we believe the major driver to growth for our eMMC UFS will be the UFS from the U.S. customer.

The next question comes from the line of Donnie Teng from Nomura Securities.

Congratulations, Wallace and Riyadh, for the good result and guidance.

So my first question is regarding to your client SSD growth momentum.

So could you elaborate more on why we are so confident on the growth momentum this year?

Because I remember during the 2016 and 2017, when there was NAND shortage, our guidance was revised down a few times during the period.

So what has changed compared with this year, 2020 versus last cycle?

And also could you also elaborate more on the coronavirus impact because of, I think, partly in China, there are lots of chaos there as they haven't resumed work -- working until next week at the earliest.

So I'm not sure what will be the impact from the retail customers like China module makers.

And my second question is regarding to eMMC and UFS.

So could you tell us more about what kind of UFS penetration rate in 2019 and 2020 or in the future?

And also, our relationship with Micron, whether it's sustainable or not because will Micron turn into the in-house in the future?

Or according to your visibility, what kind of relationship we can have?

How sustainable it would be?

And also, could you comment on -- again on the smartphone market, whether you will have some negative impact to our UFS progress?

Yes.

I think that you have quite a lot of questions.

Let me just try to do one by one.

First is the -- regarding the client SSD, why we are confident to grow because before the NAND in the shortage -- supply shortage, we really struggled regarding our sale revenue forecast and consistent growth.

Why we are confident for this year, because NAND supply seems -- will be tighter in 2020.

The main difference between 2020 and a year ago is because we have much more PC OEM customers in our site.

So we supply PC OEM model project, not only to NAND makers but to 4 different module makers.

That's why we have a very, very strong visibility and backlog in this year, even the NAND supply is tighter.

So that's why we have a great confidence regarding our client growth in 2020.

Regarding your second question regarding the Wuhan coronavirus, I think from the perspective of business continuity, we really face the next to no risk.

The coronavirus outbreak has so far been largely limited to the city of Wuhan and China Hubei province.

You are correct.

The many manufacturing around the Guangdong, Shenzhen, they are still closed.

But most of our customers are modular makers.

They either have their own factory or they use outside factory like in Taiwan, but there's definitely impact for some of our business.

However, we have put into consideration regarding the sales forecast for Q1.

And to remember, our major growth for this year is from all the region, not just China.

And our mobile phone makers, not only China mobile maker, but also Korea customer.

Korean mobile phone maker, they are growing very strong with the UFS solution, that's why from the offsetting potential, the slowdown from China smartphone.

So we have put into the judgment into the overall, the sales forecast for Q1.

Now back to your -- regarding the growth, regarding eMMC and UFS in 2020.

We believe because the UFS moving to mainstream, and that's why we're seeing UFS, the growth is much faster even than eMMC decline rate.

We're seeing this year, UFS will all pass the eMMC in total unit wise, not only just sale revenue because the UFS -- the dollar -- the ASP dollar probably is 3x than eMMC.

So we see that as a great potential for us and for our customer to grow for UFS.

And there was better consistency for our sale support or sale revenue growth, and we have opportunity to engage other customers for UFS too in 2020.

Regarding our relationship with Micron, I think it is better than ever.

We have a very strong relationship with Micron, and I cannot really predict when they're going to do the internal development, but we have probably more than 3 or 4 different generation UFS projects ongoing right now.

So we think we feel very confident to continue relationship and business with Micron for UFS business.

The next question comes from the line of Craig Ellis from B. Riley FBR.

Congratulations on getting the broad-based growth lined up for this year.

I wanted to follow up on some of the earlier gross margin questions.

So my question is this.

As we look at a year where we're going to start well below the target model for gross margins that rise through the year, is the company confident they can sustainably reenter the target gross margin range later this year?

And if not, are you thinking about reevaluating the target gross margin range, given the increased mix shift towards SSD solutions this year and what looks like good momentum heading into 2021?

Okay.

Let me answer this in 2 ways, near-term and longer term.

Near term, we -- in Q1, we have the pressure of the pre-consignment Ali sales that are still incurring.

And we also have a large 1 quarter sale of standard NVMe to a very large Chinese social media company.

The sale is largely taking place in Q1.

So we have gross margins for our SSD solutions that are going to be a lot lower than for the following few quarters.

As we move into Q2 and Q3, our consignment sales to Alibaba start picking up and gross margins will start improving.

So that will help blend up our overall gross margin.

But that said, near term, our gross margin for this business will still be diluted because of the need to continue to carry sales of lower gross margin standard NVMe for non-consignment customers.

This is important for us to do because until our Alibaba consignment sales are able to achieve sufficient economics of -- economies of scale, we still need to cover our Shannon operating expenses.

And so that's why we have to do these lower-margin sales.

But once our Alibaba programs are sufficiently big, then we can start reducing the sales of the lower gross margin products.

So this leads to the longer-term picture of our business, where once the consignment model becomes sufficiently large, our SSD solutions margins will improve significantly.

Additionally, we are also expecting, on the longer term, our enterprise -- higher margin enterprise SSD controllers to become a more meaningful part of our business.

Currently, it's very small, but we're investing a lot of resources.

We're doing a lot of business development activities, where in the longer term you should expect this to be a meaningful part of our overall sales.

So longer term, we believe our gross margins are going to be back to where they should be towards our target 50% gross margin levels.

Can we move to the next question, sir?

Yes, please.

Go ahead with the next question.

The next question comes from the line of Karl Ackerman from Cowen.

Quick one on inventory.

With the inventory days falling to the lowest they've been in the last 2 or 3 years, how should we model that for this coming year?

And then with the custom solutions business ramping, do you see any large shifts in the composition of your working capital going forward that we should be wary of?

Or is it pretty much going to be as it has been for the last couple of years?

Inventory levels for us do move around a bit, but they do quickly converge towards where historic patterns have been.

So if you were to let our historical working capital cycles, you can get a clear view of where they could be in a quarter or 2 quarters time, right?

And specifically for our SSD solutions, as we continue to grow this business, we have the 2 moving parts of the consignment and non-consignment pieces.

The consignment piece is the risk and also the use of capital is going to be fairly low because we don't have to carry NAND, but for our other products we still would have to carry NAND.

And so this is -- will be a big use of capital, relatively speaking, and we will continue to have exposure in terms of NAND from this business.

The next question comes from the line of Ariel Shusterman from Needham & Company.

I'm taking this question on behalf of Raji Gill.

And I wanted to ask about how the NAND price will grow throughout 2020?

How can we think about the impact on client SSD sales as well as margins on this product line, I guess, in the next few quarters?

And similarly, are there effects of this on your other product lines?

I just repeat it, because this year, the main growth for our client SSD come from OEM customers because we have a very strong project visibility and backlog from the NAND maker and the 4 major module makers, who support PC OEM project.

So we have a very, very high confidence regarding the growth of our client SSD business in 2020.

And the NAND prices on other product lines?

For NAND prices, we see the first half will be relatively stable.

And the second half, it might -- because if demand is stronger from data center, and NAND price might go up.

And because certainly current supply already very tight, but because we have our major growth for this year, it really comes from OEMs, doesn't matter UFS or client SSD or enterprise solution because we do have a very strong design pipeline.

So we are pretty confident regarding our guidance.

Got you.

And a quick follow up.

When it comes to the SSD solutions, like how can we think about the mix between a Ferri and a Shannon in 2020?

Normally, we don't talk specific regarding the ratio, but we do see a strong growth on both channel SSD solution and our Ferri SSD solution in this year.

As there are no further questions, I would like to hand the conference back to Mr. Wallace for any closing remarks.

Over to you, sir.

I would like to thank all of you for joining us today and you're continuing interest in Silicon Motion.

Thank you for joining us.

Thank you.

Ladies and gentlemen, that does conclude our conference for today.

Thank you for participating.

You may all disconnect now.

Thank you.