Earnings Call Transcript - SIMO Q4 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Silicon Motion Technology Corp's Q4 2020 Earnings Conference Call. At this time, all participants are in listen-only mode. After the speakers' presentation, there will be a question-and-answer session. This conference call contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 as amended. Such forward-looking statements include without limitation, statements regarding trends in the semiconductor industry and our further results of operations, financial condition and business prospects.

Chris Chaney, Director of Investor Relations

Thank you, Ajay. Good morning, everyone, and welcome to Silicon Motion's fourth quarter 2020 financial results conference call and webcast. As Ajay just mentioned, my name is Chris Chaney, Director of Investor Relations. And joining me today on this call are Wallace Kou, our President and CEO, and Riyadh Lai, our Chief Financial Officer. Following my comments, Wallace will provide a review of our key business developments and then Riyadh will discuss our fourth-quarter results and our outlook. We will then 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 beginning of this call. For a comprehensive overview of the risks involved in investing in our securities, please refer to our filings with the U.S. Securities and Exchange Commission. For more details on our financial results, please refer to our press release, which was filed on our 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'll 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.

Wallace Kou, President and CEO

Thank you, Chris. Hello, everyone, and thank you for joining us today. In the fourth quarter, we delivered $124 million in sales, about 4% more than the high end of our guidance range. Compared to the third quarter, revenue was up 14% sequentially. Earnings per ADS for the fourth quarter were $0.86, up from $0.76 in the third quarter. For the full year, revenue was $540 million, up 20% when compared to last year. Earnings per ADS was $3.24, up 25% from a year ago. Our fourth-quarter results were strongly impacted as consumer procurement continued to be robust. Sales of our eMMC+UFS controllers for smartphones and IoT devices were especially strong, and our SSD controller continued to benefit from strong PC demand. Sales of our SSD solutions were however seasonally soft. Based on purchase orders we see from our customers, we are expecting the strength of our fourth quarter to strengthen further through the first quarter and stay robust through the rest of 2021. Purchase orders we see for the first quarter already exceed our first-quarter sales guidance, and purchase orders for the full year already meaningfully exceed our full-year guidance. Our ability to meet customer orders is however limited by our product supply. Our first-quarter sales are limited by variability of product in inventory, and our full-year sales growth is limited by the current foundry supply shortage, which is also affecting much of the overall semiconductor industry today. Demand for our SSD and eMMC+UFS controllers remained very strong. We continue to see robust sales of PCs driven especially by the need for working from home and online learning. Additionally, OEM adoption of SSD in PCs and other devices continue to grow as low-cost NAND for SSD replaces HDD. Furthermore, we are expanding our SSD controller market share gains based on our pipeline of design wins with NAND flash makers and module makers for the OEM market. We're expecting stronger SSD controller sales growth this year compared to last year. We continue to see OEM smartphone build activity improve. More meaningfully, the transition from the legacy eMMC mobile value storage to newer UFS technology continues to increase gradually as OEMs prefer UFS for new generation application processors and higher spec cameras.

Riyadh Lai, Chief Financial Officer

Thank you, Wallace, and hello everyone. I will discuss additional details of our fourth-quarter results and then provide our guidance. My comments today will focus primarily on our non-GAAP results less FCI unless otherwise specifically noted. A reconsideration of our GAAP to non-GAAP data is included with the earnings release issued yesterday. In the fourth quarter, revenue was $144 million, 14% higher sequentially and 6% lower year-over-year. For the full year, revenue of $540 million was 20% higher than a year ago. In the fourth quarter, earnings per ADS were $0.86, 12% higher sequentially, and 11% lower year-over-year. For the full year, earnings per ADS were $3.24 or 25% higher than a year ago.

Operator, Operator

Certainly. We have the first question from the line of Karl Ackerman from Cowen. Please go ahead.

Karl Ackerman, Analyst

Good evening, gentlemen, and good morning on the West Coast. First question from me, I appreciate the full year outlook you provided and in your prepared remarks, Wallace spoke about how competitors are facing challenges with supply, enabling you to bring some new customers on your platform. And he also spoke about how some NAND OEMs are easing on their willingness to move to internal solutions. So, my question is, are these volumes ad hoc and opportunistic, or what sort of volume commitments are you able to secure that would help support both your full year guide and due through 2023?

Wallace Kou, President and CEO

So, as we stated, our current committed wafer supply from our foundry makers can fulfill our full year guidance plan by 20% to 30%. There's no question. If we have additional incremental wafer allocation from our foundry makers, our guidance will be higher.

Karl Ackerman, Analyst

Okay, I appreciate that. I guess then, relative to your SSD solution business, could you discuss how the shift in the consignment model will impact at least qualitatively your revenue and profitability in 2021 versus 2020? I guess is the widened operating loss expectation coming only from enterprise SSD? That's my question. Thank you.

Riyadh Lai, Chief Financial Officer

Yes. That's related to the operating loss and the consignment that relates specifically to our Shannon data center SSD product line. As we talked about during the call, our Shannon product line had under-delivered in terms of revenue growth, profitability, and cash flow generation. And so, as part of our regular testing of our acquisition, the valuation of our acquisition, we had determined that the assets were impaired and so took a full write-down over the remaining goodwill. In terms of the profitability of our business, our gross margins have been below our corporate average by a significant amount because of the products that we're building, requiring the purchase of NAND. So, as part of that, that was this issue. Last year we started for one specific customer for Alibaba, moving to a consignment business model where Alibaba procures NAND and we build the SSDs based on what other NAND they give us. So, our gross margins are significantly improved because of this. But we also have a lot of other customers. Most of our sales for our Shannon products are, in fact, standard NVMe SSDs to non-Ali customers. For these customers, we're buying NAND and so our gross margins are a lot lower.

Karl Ackerman, Analyst

Thank you.

Operator, Operator

Thank you. We have our next question coming from the line of Rajvindra Gill from Needham & Company. Please go ahead.

Rajvindra Gill, Analyst

Thank you, and congratulations on the momentum, very impressive. Wallace and Riyadh, you're putting up this $1 billion sales target, which is very ambitious. I just wanted to get a sense in terms of how to think about the cadence of that. If you look at your full year guidance, in 2021 the $675 million at the midpoint, I believe that's the highest in recent history for your company in terms of overall revenue. Correct me if I'm wrong there. But it's extremely high and that could be higher if you get more wafer allocation. So, once you get a sense from working on that base to get to $1 billion, that's about 50% growth. How do we think about the cadence on a kind of year-over-year basis? And is this really being driven by the combination of higher cash rates that you're seeing in other adjacent markets outside of PCs? Is it being driven by consistent, sustainable market share gains? I'm just curious in terms of some of the color there.

Wallace Kou, President and CEO

I think you have very good questions. We're definitely prepared to answer the questions. We have a very strong confidence to achieve our financial objectives of $1 billion within three years, through our major design pipeline from client SSD controllers as well as mobile eMMC+UFS controllers. I think we started to really build the design win pipeline two years ago. We're really gaining momentum in market share, focusing on technology for new product development, moving to 16, and 12 nanometer. Mobile, we're going to move to 7 nanometers three years from now. But I think a lot of R&D investment is why you see our increased R&D expense in the last two years year-over-year. From the current design pipeline, and from backlog in our hand, purchase orders in our hand, our sales, if there are no restrictions on wafer supply, will be much higher than our current full year guidance of 20% to 30%. That's why it gives us significant confidence that we can continue to carry the momentum found this year to next year. Yes, that's why we started to work with TSMC right now for 2022 wafer supply, for all the different technology nodes from 35, 40 nanometers to 28, 16, 12 nanometers, making sure we can get sufficient supply to meet our major OEM customer requirements for 2022. So of course, I think with TSMC, we have a long-term relationship and we've had significant good support from them in the past 10 years. We will probably be able to get more allocation in the second half of this year, there's no commitment right now. We can only base our guidance on what they provide midway for supply to make a full-year guidance to the investor. But for the three years, for the $1 billion target, we have a much better confidence to achieve the goal, maybe even earlier.

Rajvindra Gill, Analyst

Thank you for that. That's excellent news. And Riyadh, I know it might be hard to quantify, but if you could give us some sense, if you get more wafer allocation from TSMC, which you have a great relationship with to begin with. Any way to think about what the potential upside would be on that $675 target?

Riyadh Lai, Chief Financial Officer

Hi Rajvi, that's another excellent question. The way to think about this is our operating infrastructure has the ability to have considerable operating leverage. The operating expense infrastructure that we have built, our R&D teams, our sales and marketing teams, the rest of our operating infrastructure, it's an infrastructure that we can load a lot more revenue on. And so, for what we have today, if we're able to achieve much higher levels of revenue this year, in the event we secure additional wafer, there will be considerable upside beyond what we have guided. If we're able to secure additional wafer, that would just flow through our P&L and deliver the incremental profitability on our bottom line.

Rajvindra Gill, Analyst

Thank you.

Operator, Operator

Thank you. Can we move to the next question, sir? The next question comes from the line of Craig from B. Riley Securities. Please go ahead.

Unidentified Analyst, Analyst

Hi, guys. This is for Craig. Congrats. And I just wanted to drill down on something that Wallace said in the last question. Wallace, when you said the 20% to 30%, is that the amount of supply constraint that you're currently seeing right now? So, in theory, if there were no supply constraints, the guidance would have been 20% to 30% higher? Did I understand that right?

Wallace Kou, President and CEO

No, I'm saying we've guided 20% to 30% growth for 2021 based on current comparable wafer committed, but we can grow much higher and guide much higher if we can get incremental wafer allocation from our foundry supplier.

Unidentified Analyst, Analyst

Got it. Okay. Sorry about the miscommunication. So, my second question is on the new you mentioned that a bunch of smaller suppliers, or a bunch of customers have kind of come your way due to the supply constraints. What are you guys doing, and how confident are you that you can hold on to these new customers as they come towards you, given that you're already supply constrained?

Wallace Kou, President and CEO

Most of these new demands are really from major customers. As you know, some of our customers maybe 80% use our controller, 20% use other controller makers in order to park in the pie within the past 10 years. But now because of wafer shortage globally, many small players - controller players, they probably cannot get wafer supply through the demand. That's why many of our customers who before might have used 80% of others now give us 90% or even 95% of their orders. But that is now our really main goal; I think our existing business estimate for our revenue is stronger than 30% growth year-over-year, but with additional demand, it just makes our allocation even worse than what we can offer to the customers.

Unidentified Analyst, Analyst

Got it. Okay. And then one last quick one for me. Obviously, I understand what's going on with gross margin, given the higher kind of inputs this year and not wanting to provide any insight about price increases at this point. But as I look out to fiscal '22, and you mentioned the 50% gross margin target. With Shannon now kind of a much smaller percentage of sales expected moving forward, would it be fair to say that gross margin in calendar '22 can get back to the 50% maybe quicker than expected, assuming that all of the things that are impacting gross margin this year come out of the model? It just seems to me that ultimately, why isn't that number - why couldn't that number be higher, we saw 50.1% in calendar '19? Just trying to get a sense of upside gross margin, from the 48% guided to in calendar '21.

Wallace Kou, President and CEO

I think you are correct. Theoretically, we definitely show improvement in our gross margin in 2022. I think this is all the goals we are looking for. However, I think we will have some major programs with this contract price that all depend on our foundry provider, whether they will continue some regular wafer discount annually. Because of the severe shortage, they're not going to reduce the wafer price. Instead, they increase the wafer price. So, we have to prepare all the different scenarios to play conservative models. That's our obligation to the shareholders to make sure we give you conservative guidance, and then we can have better results than expected.

Unidentified Analyst, Analyst

Got it. Okay. Thanks, guys.

Operator, Operator

Thank you. We have the next question from the line of Gokul Hariharan from JP Morgan. Please go ahead.

Gokul Hariharan, Analyst

Yeah. Hi, thanks for taking my question and congrats on the great results. So just wanted to understand, when we think about our $1 billion revenue target, do you think that the product mix is going to be reasonably similar to what we have right now? I think right now we have probably about 55% to 60% controllers, roughly about 25% mobile or 30% mobile, and about 10% to 15% SSD solutions. Is the mix going to be fairly similar when we get there? So, we'll talk a little bit about how we think about that and then I had a follow up question.

Wallace Kou, President and CEO

I think roughly the mix will be maintained the same. As I said in our statement, we don't count the new customer that we don't have today. We based on existing NAND maker and module maker customers we are able to achieve the $1 billion target within three years. So, we have enough design pipeline from PCIe Gen 3 to PCIe Gen 4 from eMMC to UFS 2.0-3.1. We don't even count enterprise controllers. We don't count on even UFS 4.0. We think we can achieve the $1 billion target within three years.

Riyadh Lai, Chief Financial Officer

Gokul, let me also add, well, when we achieve $1 billion in sales, the product mix should be quite similar to what it is today. But I would also add that our mobile controllers, eMMC+UFS, are expected to grow a little bit faster than our SSD controllers over the next few years.

Gokul Hariharan, Analyst

Got it. Just a related question, what gives you the visibility and pardon me for asking, but revenues have essentially been in the $500 million to $550 million range for probably three to four years. Right? So, just wanted to understand what gives us the visibility given the business needs are expected to be fairly volatile. So, what is the confidence interval on this, and what gives you that visibility suddenly to change that? Second, when we have foundry shortages like this in the past, in let's say 2017 or 2014, we clearly had a lot of concerns about inflated orders from customers, especially from PC module customers, eMMC customers, et cetera. How do you discount for that factor when you think about your forecasts and your appeals from customers?

Wallace Kou, President and CEO

Okay, let me just give you an answer first for the first question. The reason we have high confidence to achieve the $1 billion target by 2023 is based on the current booking backlog and purchase orders in our hands for 2021. As we said already, we base our variable wafer supply, and we are 100% confident to reach 20% to 30% growth from 2020. However, our backlog and purchase orders in hand are much bigger than this number. So, this is going to continue through 2022 because that is a major design pipeline very hard to change customers' design. We also continue well with TSMC, hopefully that can produce more wafers. But as you know very well, it's very difficult at this moment. To answer your second question, yes, we suffered from one major NAND maker for eMMC business from the peak of 2016, and it started to use general controllers then we suffered the sales revenue decline down to very, very small last year, and that factor will be counted. For UFS 2.0, 3.0, I think it's going to stay for the next three years. UFS 4.0 will start to pick up from 2024. We have very high confidence our business model and growing our eMMC customers are very, very strong. We are dominating the eMMC provider among all sizes of NAND makers. So, we probably own 8% of the market share if you don't count on NAND maker customers. That's why we are confident to grow the mobile controller business as well as client SSD, which are very strong today. That gives us the confidence to show how we can reach to align for the $1 billion sales target.

Gokul Hariharan, Analyst

Got it. Could you also tell us like, I think are you taking some discount or something for the POs that it gets from your module maker customers or OEMs, even at times like this, when we hear about shortage across the board? Clearly there is some degree of inflated order books that is usual? Can you talk a little bit about how you think about the POs and the book order and how you think about the health of that order book?

Wallace Kou, President and CEO

I think some module maker POs, that's a very small portion of our revenue contribution. Major visibility comes from OEMs because they also worry they cannot get supply. That's why they are giving us better visibility, because normally they only give us three months POs and six months forecasts; now they give the full year POs. That's why we can see through the 2021 demand for our major OEM customers.

Gokul Hariharan, Analyst

Got it. Thank you.

Operator, Operator

Thank you. We have the next question from the line of Anthony J. Stoss. Please go ahead.

Anthony Stoss, Analyst

Hi guys. Going through 10 years of covering Silicon Motion, I have never seen this kind of visibility from you guys and excitement. Maybe you can talk about, if you scrub the pipeline for 2021, if you think there's a chance that there's double ordering in that pipeline or just mainly market share strength from you guys? And then also, you're not including the enterprise controller in the 2023 revenue goal. I am curious, maybe you can give us more detail, is that behind plan, or anymore color would be helpful? And then lastly maybe for Riyadh, if Shannon continues to underperform, why not just walk away from Shannon? Why are we still keeping it operational? Thanks.

Wallace Kou, President and CEO

So, let me comment on your first question. I think last year, we have so many major design focused OEMs, not just on NAND makers but also for module makers. They all start to ramp up in 2021. That's why we see we gain market share for global client SSD controllers. We expect to ship much more for this year. However, due to the wafer shortage from the foundry makers, we can only provide such a guidance, but we originally expect to have an even much stronger momentum if we can get a full supply from our TSMC major partner. This is also dependent on how we see the migration from technology nodes, from SATA to PCIe Gen 3, from PCIe Gen 3 to PCIe Gen 4. I think we will continue the momentum pipeline for client SSD. Regarding mobile controllers from eMMC and UFS, as I stated, we have more than 80% of global design outside the NAND makers. A lot of these module makers have been prepared for this over the past five to six years. Now finally, they have entered designs to smartphones in low-value line smartphones, Chromebooks, set-top boxes, and smart TVs. They are gaining market share. Please understand, this module maker mobile controller revenue together is close to the NAND maker sales revenue. So, it's not like a very big gap between module maker and NAND maker. We see the transition is very, very strong. Some module markers are eMMC customers also turning into UFS, giving us a much broader angle looking for the pipeline, not just 2021 also beyond this year to 2022 and 2023. We also have several major programs, which we cannot comment on right now. When these become materialized, we will talk to our investors.

Riyadh Lai, Chief Financial Officer

Tony, let me also address your third question about Shannon. Shannon clearly has been a disappointment to us. But it's also a strategically important piece of business to us. We're actively working to restore this product line's growth and profitability. What I mean by strategically important is that without Shannon, we will not be able to sell SSD controllers, enterprise-grade SSD controllers directly to Chinese hyperscalers, as they do not have the engineering capabilities to develop their own SSDs using merchant controllers. So, Shannon designs these SSDs using our controllers and therefore helps facilitate our sell into this market and also provides street credibility to our enterprise-grade controllers. We're new to the enterprise SSD controller market, and so it's important to develop street credibility in Shannon. Our experience exposure at Shannon was the Chinese hyperscalers and we're also gaining a lot of street credibility. It is strategically important for us to fix the financial profiles of Shannon. But eventually, if we cannot fix this, we may have to consider strategic options.

Wallace Kou, President and CEO

Let me add a comment to Riyadh. I think we underestimated the complexity for enterprise controllers and enterprise SSD business. Our competitors and NAND makers, they spent 20 years' experience in the front end, therefore they are leading in the technology and product. We have been focusing on enterprise controller just for two years. We have learned so much from Shannon customers, especially Alibaba, Baidu, and several leading hyperscalers. We understand the complexity is almost five times that of client SSD. We are improving pleasantly. We are filling the gap. We are gaining confidence and continue improving our firmware and our architecture. That's why we're excited about the enterprise PCIe Gen 5 controller, which we will take out in early next year and start shipping in the second half of 2022. We believe this will bring us significant momentum in the enterprise space. Client SSD in the next three to five years will be slowing down and potentially become saturated after five years from now. So, we are preparing for another momentum to grow for enterprise controllers. It's very important for the company to maintain the growth momentum continually and for the shareholders.

Anthony Stoss, Analyst

Thank you for that, Wallace. But if I'm not mistaken, did you say that you're not including any revenue from the enterprise controller in your $1 billion 2023 forecasts? Is that just to play conservative given what you just said?

Wallace Kou, President and CEO

Exactly. That's correct.

Operator, Operator

Thank you. We have our next question from the line of Mehdi Hosseini from SIG. Please go ahead.

Mehdi Hosseini, Analyst

Yes. This is Mehdi Hosseini from SIG. Just two follow up. Riyadh, did you say that any wafer price increase is already dialed into your gross margin guide for 2021?

Riyadh Lai, Chief Financial Officer

Mehdi, we're not expecting that wafer costs will increase this year. We are however expecting costs from substrates and packaging. That's reflected in the gross margin guidance that we have provided.

Mehdi Hosseini, Analyst

Okay, clear. Just curious if there is incremental capacity becoming available, but at a higher cost, would you be able to offset that?

Wallace Kou, President and CEO

Depends upon the line for very important mobile product line high-end without any need to because our customers desperately need more supply.

Mehdi Hosseini, Analyst

Okay. Got it. And then I joined the call a little bit late, so I apologize if the question has already been asked. But when you think about mobile opportunities, UFS and comparing it to SSD controller for 2021, which segment do you expect to offer higher growth?

Wallace Kou, President and CEO

I think, Riyadh has already mentioned, in total dollar amount, client SSD is still bigger; therefore, the growth rate for mobile controller will be a little higher and faster because the base is smaller. I think for mobile, there are only three NAND makers who have mobile DRAM. So, it's very easy to figure out why the momentum will grow stronger, and we have designs in the three major NAND makers with mobile DRAM.

Mehdi Hosseini, Analyst

Great, thank you. And then would you expect your mobile mix, especially from China, or contribution from China to increase as demand capacity comes online, and then capacity from domestic players?

Wallace Kou, President and CEO

When the China NAND makers increase their output, we definitely will benefit from this output. Because many of our module customers will also use the NAND from the China NAND makers. But I'm not sure how much they're going back to the mobile business because they're probably being valuable like eMMC, but now in the high-end eMMC.

Mehdi Hosseini, Analyst

Got it. Okay, thank you.

Operator, Operator

Thank you. As there are no further questions, I would like to hand the call back to our presenters for any closing remarks.

Wallace Kou, President and CEO

Thank you, everyone for joining us today and for your continuing interest in Silicon Motion. I would like to leave you with some final thoughts. Our business continues to be quite resilient. Despite the volatility caused by the pandemic, we continue to perform well. I have never been more confident in our business. We look forward to a safer world free of devastation caused by the Coronavirus. We also look forward to sharing with you the expected rapid growth of our business this year and our progress towards our 2023 $1 billion revenue target. We will be attending several virtual investor conferences in the next few months, the schedule of which will be posted on our Investor Relations website. Thank you for your continued interest and for listening to our call. Goodbye for now.

Operator, Operator

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect now. Thank you.