Jason Tsai - Senior Director, Investor Relations and Strategy Wallace Kou - President and Chief Executive Officer Riyadh Lai - Chief Financial Officer.

Mehdi Hosseini - SIG Anthony Stoss - Craig-Hallum Suji Desilva - ROTH Capital Mike Burton - Brean Capital Betsy Van Hees - Loop Capital Markets Jaeson Schmidt - Lake Street Capital Markets Mike Crawford - B. Riley & Company Rajvindra Gill - Needham & Company Tom Sepenzis - Northland.

Ladies and gentlemen thank you for standing by and welcome to the Silicon Motion Technology Corp. Fourth Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session.

[Operator Instructions] I must advise you that this conference is being recorded today, Tuesday, January 24, 2017. 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 limitations, statements regarding trends in the semiconductor industry and our future results of operations, financial conditions and business prospects.

Although such statements are based on our own information and information from other sources we believe to be reliable, you should not place undue reliance on them.

These statements involve risks and uncertainties and actual market trends and our results may differ materially from those expressed or implied in these forward-looking statements for a variety of reasons.

Potential risks and uncertainties include, but are not limited to, continued competitive pressure in the semiconductor industry and the effect of such pressure on prices, unpredictable changes in technology and consumer demand for multimedia consumer electronics, the state of and any changes in our relationship with our major customers, 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. Jason Tsai. Thank you. Please go ahead..

Thank you. Good morning, everyone. Welcome to Silicon Motion’s fourth quarter 2016 financial results conference call and webcast. My name is Jason Tsai. With me here is Wallace Kou, our President and CEO and Riyadh Lai, our Chief Financial Officer. The agenda for today is as follows.

Wallace will start with a review of some of our recent business developments. Riyadh will then discuss our fourth quarter financial results and provide our outlook. We will then conclude with Q&A. Before we get started, I’d like to remind you of the Safe Harbor policy, which was read at the start of this call.

For a comprehensive overview of the risks involved in investing in our securities, please refer to our filings with the 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 market yesterday.

This webcast will be available for replay on our website, www.siliconmotion.com for a limited time. To enhance investors’ understanding of our ongoing economic performance, we will discuss non-GAAP information during this call. We use non-GAAP financial measures internally to evaluate and manage our operations.

We have therefore chosen to provide this information to enable you 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 will turn the call over to Wallace..

Thank you, Jason. Hello, everyone and thank you for joining our earnings call. 2016 was an outstanding year and we ended the year with a strong fourth quarter. Our fourth quarter revenue of $144 million was the high end of our expectation and is a 47% increase from the same period a year ago.

For full year 2016, revenue increased by 54% to $556 million, a record high. Our fourth quarter operation margin expenditure is 30%, and earnings per share were $0.95. For the full year, EPS increased 73% to a record $3.64. Riyadh will discuss our financial results in greater detail later on the call.

The need for more advanced controller technology has been evident now for many years as NAND’s improving affordability had come to the cost of becoming increasingly weak and difficult to manage.

As the industry moved to 3D NAND and layer count increases from four 30 and 40 layers to 60 and 70 layers this year and nearly 100 years in the QLC 4 bits per cell NAND over the next 1 to 2 years. Unique new problem will continue to arise that will put a limit on controller technology.

As 3D NAND layer count increases, data corruption will get worse from time usage and temperature in these data retention issues. The effect of [indiscernible] circuitry noises and data read/write interference, increasing data corruption issues will require better controller technologies.

Our expertise in managing these and other NAND flash component issues in different applications, we use solutions optimized for performance, lower power, cost and ease-of-use. Our customers see our solution unique and unparalleled in the industry.

We are collaborator and partner of flash makers and we are able to see and understand the inner working of their new NAND technologies years before they are commercialized.

This unique role and position we play in the industry provide us with a long-term visibility of NAND technology trends and controller requirement, only by being a trusted partner to the flash makers are we able to help resolve their NAND technical issue, so their next-generation NAND can be commercialized sooner.

Let me now move on and talk about our key products. Our highly customizable hardware plus firmware turnkey client SSD controller sales grew 135% in 2016 and was one of our key growth drivers net last year. Sales of our SSD controller grew further in Q4, so nice quarter of rapid sequential growth.

And our SSD controller, have scaled to where they are, one of our two larger product lines. We are now the clear emerging market leader, with a market share of around 30%. Our primary customers are the NAND flash makers, specifically Intel, SanDisk and Micron and we also sell to significant majority of leading module makers.

Our client SSD controllers are used in a variety range of applications from PC to data center and channel markets. SSD using our controller can be found in the PC of all top 5 Wintel PC OEMs.

Based on our discussion with all of the NAND flash makers, we believe that it’s more than likely that in a few years’ time, most of their client SSD controller requirement will be provided by a merchant controller supplier like Silicon Motion. The majority of our growth last year was driven by our SATA SSD controller for managing 2D TLC NAND.

For 2017, we expect our new product, primarily our new PCIe NVMe SSD controllers to drive our growth. In the second half of last year, we grew our first PCIe controller for Intel 3D NAND.

This year, we are expanding our PCIe NVMe product family with additional solutions offering better performance as well as lower cost products, such as DRAM-less and single-chip VGA SSD. Like our SATA controllers, most of these new products are targeted for PC OEMs, but some are targeted for non-mission critical data center applications.

While we have been shipping SSD controller for data center applications, bear in mind that these are computing-grade SSD controllers. Based on our business with the hyperscale data center and enterprise customers, in particular, cloud operators, our customers feel increasingly uncomfortable with replacing HDD with SSD.

The total cost of ownership continues to decrease and have reached breakeven on lower cost versus the HDDs.

Additionally, we are now gearing up to enter the enterprise grade SSD controller market because the addressable market for these controllers are expanding drastically, with growth coming from both expanding demand for high performance enterprise and hyper-scale applications and also from displacement of mission critical HDDs by SSDs.

We have already retooled some of our client SSD controllers to repurpose them for enterprise grade applications initially for our own channel SSD solution. Retooling includes special purpose firmware that have been specifically architecturally and optimized for data center application requirement.

We are now also developing our own enterprise grade controller based upon our deep understanding of both NAND flash and data center requirements and target introducing this controller to customers next year. I will be talking more about this activity in the near future.

We finished 2016 with a broad portfolio of high quality projects with our OEM partners. That will be our foundation for continuing strong growth in 2017. Currently, we have 20% to 30% more SSD controller budget with OEM than a year ago. Our client SSD controller will continue to be our fastest growing product line.

Let me now turn to our eMMC and UFS controllers. 2016 was a phenomenal year for our eMMC controllers growing by about 30% and continued to be as big as our client SSD controller business.

Our growth came from a number of different factors, including our primary NAND flash partner gaining share and the focusing on fast growing Chinese OEMs, such as OPPO and Vivo.

The TAM for EMC in margin of ultra low cost smartphones and tablets began using eMMC in several of their NAND and government subsidiary in China for 4G smartphone spreading upgrades. In 2017, we expand our eMMC controller sales to grow at least of SaaS overall smartphone market growth.

Currently, a significant majority of our Android smartphones from low cost mainstream to high end smartphone are using eMMC, most of the eMMC 5.1. Our new eMMC controller this year will be focused on bringing more cost effective, high capacity 3D NAND to mobile devices as well as with higher performance DDR4 and mobile DRAM in eMCP.

We are also seeing eMMC usage bordering to smart TV, set-top boxes and new classes of IoT devices. The market for embedding memory remained dominated by eMMC today and we expect the use of UFS to remain limited to the very high end until the end of 2017.

With the rollout of AP and support UMCP [ph] at the end of this year, it is very likely that UFS and UMCP will become a more material part of the mobile embedded memory market in 2018. Our UFS 2.1 controller was launched with a flash partner late last year and they are assembling today with leading smartphone OEMs.

Separately, we expand our UFS controller for SK Hynix the UMCP solution will launch in late second half of 2017. Coinciding with the timing of UMCP support for various AP provider, UFS is expected to be small, but still contributing – contribute meaningful revenue for us this year, growing more significantly in 2018.

Finally, I will speak about our SSD solutions. Our SSD solution also had a phenomenal 2016. SSD solutions sales grew over 3x from the previous year, driven by both our customized Ferri industrial SSD and Chinese [ph] hyperscale SSDs.

Our Ferri single-chip industrial SSD grew as we accumulate a growing portfolio of long-tail sales to OEM in Japan, but also expanding Europe and the U.S., with application ranging from multifunction printer systems to automotive and several applications. These Ferri SSD sales will expand further in 2017.

Our channel very high-performing hyper-scale SSD grew as our large Chinese hyper-scale customer placed very large orders for our data center in 2016 and have awarded us with new projects that will start scaling in Q2 2017.

However, our China sale in 2017 will be affected by flash availability with our customer and our company are both unable to secure commitment of sufficient supply of high-grade NAND at reasonable terms for our products. Based on our discussion with the flash makers, we are increasingly optimistic about the quality and timing of new 3D NAND supply.

We believe the supply of 34 and 72 layers 3D flash will increase significantly in the second half of 2017 with the yield and manufacturer ability improve and new capacity come online.

However, flash availability will remain tight throughout this year, especially as increasing supply coincided with the strong seasonal demand for flash in the second half of the year.

With the high flash supply expected to remain throughout 2017, NAND flash vendors will continue to seek to capture more economy by prioritizing solution sales ahead of wafer sales. Our channel SSDs are being affected by this situation. This situation may improve in the second half of 2017 as more supply come online.

Overall, 2016 was a record breaking year for Silicon Motion and we finished the year strong, both financially and with a solid pipeline of projects that will grow in 2017. Our growth in 2017, however, will be constrained by limited flash availability with channel SSD.

Additionally, our NAND flash partner could potentially grow faster and they have more NAND today to meet the current strong demand. The NAND industry remain very dynamic. We expect to significant account for incremental 3D flash supply to come online in the second half of 2017.

When we and our customer have higher certainty about the rollout of the new supply, we may look to revise up our guidance. I would now turn the call over to Riyadh to discuss our financial performance and outlook..

Thank you, Wallace and hello everyone. I will summarize our financial results and provide our guidance. Before I begin, I would like to reiterate that my comments today will focus primarily on our non-GAAP results unless otherwise specifically noted. A reconciliation of our GAAP and non-GAAP data is included with the earnings release issued today.

Our Q4 revenue decreased 9% sequentially as client SSD sales growth was offset by seasonably weak eMMC sales and SSD solutions project transitions. Our Q4 revenue is 47% higher than the same period last year. Our revenue for the full year increased 54% because of very strong client SSD and eMMC controller sales and SSD solution sales during the year.

Our Q4 client SSD controller sales grew over 5% sequentially with growth coming from our NAND flash partners. Sales to our module makers, on the other hand, were flat sequentially as they continued to be affected by flash tightness.

For the first quarter, we expect our SSD controller sales to decline seasonally comparable with what you would expect of the PC component switching.

Based on our pipeline of SSD controller projects, especially our new PCIe/NVMe SSD controllers, we expect sales to start grow again in Q2, which should lead to full year 2017 growth of 20% to 25% from over $170 million in 2016. Our Q4 eMMC controller sales declined over 5% sequentially in line with past seasonal patterns.

In Q1, eMMC controller sales will likely be flat, again similar to past seasonal patterns. And for full year 2017, we expect sales to grow about 5% from over $170 million in 2016.

We are expecting 2017 eMMC controller sales to grow in line with smartphone growth, and as well as I talked about, our new relationship with Hynix continues to grow stronger. Our Q4 SSD solution sales declined more than 40% sequentially as our big 2016 hyper-scale SSD project ended and we do not expect our new 2017 projects to ship until Q2.

Our SSD solution sales will likely continue declining further in Q1 due to limited availability of high grade flash components at favorable prices.

In 2017, while we expect SSD solutions to rebound beginning in Q2 with our new hyper-scale projects for the full year, sales should decline 15% to 20% from over $80 million in 2016 due to lack of flash availability.

Currently we and our large hyper-scale customer are both unable to obtain sufficient supply commitment of NAND components at reasonable terms to grow our sales in 2017 and we do not believe this situation will change in the first half of 2017.

As a recap of our revenue trends, we expect our upcoming Q1 revenue to decline 11% to 16% sequentially, primarily because of seasonally soft client SSD Controller sales, flat eMMC controller sales and declining SSD solution sales.

This is in line with certain NAND flash industry leaders, such as Samsung, who we believe are planning on reducing their NAND big shipments in Q1.

For full year 2017, we expect revenue to be flat to up 10%, primarily because of strong client SSD controller sales growth plus modest eMMC controller sales growth, offset by the short-term decline in SSD solution sales. Let me reiterate that our full year revenue guidance is based on current tight NAND flash market conditions as we see it today.

We are expecting significant improvements in NAND flash supply in the second half of 2017. And if this were to happen sooner or we were to receive stronger confirmation of this improvement, we may look to raise our guidance. In Q4, we had two 10% plus customers, Hynix and another NAND flash vendor, down from three 10% plus customers in Q3.

In Q4, our two 10% plus customers accounted for 40% of total sales. Our Q4 gross margin increased to 50.2% from 48.9% in the previous quarter due to sales of a more favorable product mix of less SSD solutions and more SSD controllers.

In Q1, we expect our gross margin to be in the 48% to 50% range, which reflects less contribution from our client SSD controller sales because of seasonality factors. For full year 2017, we expect our gross margin to be in the 49% to 51% range, in line with our long-term 50% gross margin targets.

Our Q4 operating margin increased to 30.4% from 28.7% in the previous quarter due to lower operating expenses. We throttle back bonus and other compensation accruals so that they converge with actual payments.

In Q1, operating margins should decrease to 23% to 25% due to much higher R&D tape out expenses, including costs of several controllers at 28-nanometer. For full year 2017, we expect operating margins to be in the 27.5% to 29.5% range, similar to our 2016 operating margin of 28.2%.

2017 operating expenses should increase at a rate similar to our revenue growth. Note that our operating expenses this year will be front end loaded as we will be spending much more on expensive R&D tape out in the first half of the year and then in the second half, with most related to SSD and eMMC controllers.

We ended the fourth quarter with 1,122 employees, 28 more than at the end of the previous quarter. For full year 2016, we added 149 employees. We expect to hire fewer employees in 2017. Most of our new hires continue to be R&D engineers.

Our effective tax rate in Q4 was 23.8%, higher than the 16.8% in Q3 because of a one-time accrual adjustment at our Taiwan entity for conversion from NT dollars to U.S. dollar tax accounting.

For full year 2017, our model tax rate is 20%, higher than the 18% effective tax rate in 2016 and previous 18% model tax rate due to expiration of certain tax benefits in Taiwan. Our Q4 EPS was $0.95 lower than the Q3 $1.07. For full year 2016, our EPS was $3.64, 73% higher than 2015’s $2.11.

Total stock base compensation in Q4 was $8.4 million, higher than the $6.5 million in the previous quarter due to the seasonal timing of RSU awards, consistent with past years. For Q1, stock based compensation should decline to within $3.2 million and $3.7 million, again due to the seasonal timing of RSU awards.

For full year 2017, stock based compensation should be within $14.5 million and $16.5 million, consistent with 2016’s full year stock based compensation expense of $17.4 million. Let me now talk about a few key items from our balance sheet.

We had $277.8 million of cash, cash equivalent and short-term investments, $8.6 million more than in the previous quarter and $92.6 million more than a year ago. In November 2016, we paid $7.1 million of dividends to shareholders, the first quarterly installment of our annual dividend.

In Q3 last year, we borrowed $35 million from two banks as a replacement for intercompany lending because the cost of bank loans is comparable to the cost of using internal funds and without hassle, for example, without needing transfer pricing studies. We expect that with our strong operating cash flow, we can repay that loan within 12 months.

In Q4, we had $25 million of loans outstanding after repayments of $10 million. This concludes our prepared remarks. We will now open the call for your questions..

Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Our first question is coming from the line of Mehdi Hosseini from SIG. Please ask your question..

Yes. Thanks for taking my question. Two follow-ups, first can you please help me understand the kind of NAND that you use for high grade SSD, is it still for planar MLC or does it require more advanced 3D NAND.

And then the follow-up, what would be your revenue guide if there was no NAND shortage?.

So regarding the first question, our, the NAND we use for our enterprise grade SSD solution is the planar 2D MLC NAND with the enterprise grade..

And to your second question Mehdi, it’s a bit of hypothetical, but what would be very clear would be that if we had a much better availability of NAND for our China business, our revenue guidance for the full you would have been much higher..

Much higher than 10%?.

Okay. I mean this is a hypothetical question, but since there are certain – a lot of uncertainties, including how much more supply would be available from the NAND flash vendors versus what we currently see. And so it would have depended on the extent of the availability of NAND to feed into our products..

Okay. And just going back to my first question, I just want to make sure I understand.

If high-grade enterprise SSD requires planar MLC and will migrate into 3D NAND, does that imply that some of your NAND suppliers are actually going to add planar NAND capacity to alleviate the shortage?.

No, no NAND maker will increase planar NAND capacity. Actually, planar NAND capacity will be reduced, because some equipment are going to be used to produce 3D NAND..

Okay.

So maybe I misunderstood, you said for the high-grade SSD you use 3D NAND MLC, correct?.

With a planar NAND, MLC, 2D NAND..

2D NAND, okay. So it seems to me that 2D NAND. So that implies that this shortage could sustain beyond 2017, because everyone is converting planar to 3D and the 3D NAND that is coming online is more TLC. And this is where I am a little bit confused. What gives you confidence that the shortage…..

So it all depends the combination of NAND chosen from different projects, because when the 3D NAND output improved significantly that will release certain 2D NAND obligations to certain customers. That’s why we believe we are going to see better visibility, better output from 2D NAND available to our customers in our channel business.

In addition, the new 3D – the new enterprise projects will adopt 3D NAND, the new project..

Right.

But these new projects are more like 2018 volume ramp?.

No, it’s 2017..

Okay, great. Okay, thank you..

Our next question is coming from the line of Anthony Stoss from Craig-Hallum. Please ask your question..

Hi, guys. A couple questions for you.

Stepping back, looking at the growth of the markets, maybe you can share with us a range of a multiyear kind of growth rates, what you expect from all the industries it serve, again if there is no NAND charges? And then secondly – also a two-part – by the end of 2017 what percentage of your client SSD business do you think will be PCIe versus SATA? And also if you can help us with the range on how much higher the ASPs are for PCIe? Thank you..

Let me start off with your questions about market growth. On the SSD side, with client storage devices we are looking about 500 million units of client storage devices, of which roughly about a quarter are already using client SSDs and the remainder are still using client HCD, right.

So given how fast NAND flash prices are falling and given how much NAND flash capacities are being built and will continue to be built, we are fairly confident that in say 3 to 5 years time the significant majority of the 500 million units are going to be going into – using client SSDs.

And so that should give you a framework in terms of how much how quickly the market is expected to continue to grow. On the eMMC side, eMMC plus UFS combined, most of these products are going into smartphones and so the expected growth rate for these type of products should be well in line with smartphone growth.

So if smartphones are expected to continue to grow 5%, then that’s what you should expect for this market..

And the PCIe versus SATA?.

Well, I assume we ship our PCIe NVMe controller solution to Intel and two model makers in 2016. And for 2017 we have numerous design wins and project for PCIe, with multiple flash vendors and many model makers. So, we are also introducing new PCIe NVMe controller in 2017 to firstly expand our product portfolio.

This is including high-end performance and including lower cost and including 4G vendors and for single-chip PGA solutions. So the ASP price range is very, very broad. It could be from $10 and down to $4, $5 range for dye business. So I think it’s a very wide range of PCIe portfolio.

We have a 3 to 4 generation new product coming in the second quarter of 2017..

Great. Thanks, Wallace..

Our next question is coming from the line of Suji Desilva from ROTH Capital. Please ask your question..

Thanks. Hi, guys.

So Shannon revenue, can you talk about what that – or the industrial SSD, what that will be? From the $80 million, how much is expected to decline in ‘17? And will it still be a single customer driving most of the revenues in ‘17?.

So, it’s – first of all, it’s not a single customer. We have multiple customers for our Shannon business. And on the Ferri side, we have very diversified set of customers.

And altogether, our Shannon plus Ferri products, we did about $80 million of sales last year 2016 and we are going to be growing that – declining, I am sorry, it will be declining 15% to 20% this year, 2017..

Great. Thanks for that.

And then in the smartphone upgrade cycle and the use of UFS, what do you think the cutover rate is to UFS for your mix versus eMMC exiting ‘17 or toward the back half?.

As we said, we expect the UFS will remain the very high-end smartphones. And until uMCP become popular, supported by the new AP end of 2017 and UFS or uMCP won’t be the mature mainstream product line. We believe 2018 will become more meaningful for UFS and uMCP..

Okay, good. Thanks for the color. Thank you..

Our next question is coming from Mike Burton from Brean Capital. Please ask your question..

Hi, guys. Thanks. Let me ask a question.

First on the mobile side, I was wondering if you could give us your view of downstream inventories, have you seen anything abnormal this year versus normal trends prior to the Lunar New Year? And then looking out further, any thoughts about the seasonality of the mobile piece this year?.

Regarding the channel inventory, we did not see that inventory in the channel is for our customer side. We did not see anything abnormal. And we see the smartphone growth will remain 5% annually and we will see a steady growth quarter-to-quarter..

Okay. And then as a follow-up to Tony’s question on the ASPs for PCIe, and I understand there is a range there.

But can you help us understand as that becomes a larger portion of revenues, does that have an impact on gross margins or OpEx relative to your SATA controllers?.

Naturally, it won’t because our SATA controller is also in transition to be more cost competitive new-generation controller to support 3D NAND. And we have both offered DRAM and DRAM-less solution to our customer.

For PCIe, I think with the higher ASP and we have a variety of PCIe solution, some of the product mix, we believe, we can maintain better gross margin compared to 2016..

Let me add further to what Wallace said. Our ASPs for every category of products are generally very, very stable. And what we have is a natural cycle of products, products cycling in and products cycling out.

We constantly have newer and newer generation of products coming into our product mix, like the PCIe NVMe controllers and our mainstream products, they, over time, will become mature and will cycle out like our SATA SSDs.

And so the combination of the products that are coming in at higher gross margin, higher ASPs and higher gross margin as well as all the parts that are – where ASPs are falling and gross margins are coming down.

Through a blending of these products coming in and exiting our product portfolio, we are able to maintain our pricing and then gross margins at fairly stable levels..

Great. Thanks, guys..

Our next question is coming from the line of Betsy Van Hees from Loop Capital Markets. Please ask your question..

Hi. Thanks so much for taking my question. I just wanted to go back for a little bit of clarification.

So, when you guys gave your Q4 guidance, you went over some 2017 metrics and it sounds like the only thing that’s changing is the Shannon business, because you had guided it at the time that you expected it to be up 15% to 20% year-over-year and now you expect it to be down 15% to 20% year-over-year.

But the client SSD controller and the eMMC controller business, it sounds like you continuing to keep those guidances for 2017.

Am I understanding that correctly?.

That is correct, Betsy..

Okay, great. And then I was wondering if you could help us understand in terms of the Shannon business, you had expected NAND supply to be tight in the first half of 2017 when you gave your guidance in Q4 – for the Q4 quarter.

So, could you help us understand what’s really changed so much in the Shannon business that it’s going to be down so dramatically versus 15% to 20% year-over-year? What happened to NAND supply, to NAND dynamics in the last couple of months?.

Betsy, what NAND manufacturers are actually bringing new 60-layer 3D capacity online. It takes time to improve the yield. Because the yield related uncertainties of flash partner enable to provide firm procurement forecasts involving our controllers and their new capacity.

So we have the previous design-in product from last year using planar mode 2D NAND MLC. We have a new design project with the 3D NAND. So because it cannot reach confirmed pricing favorable trends, our customers and the channel were now able to secure or procure the sufficient NAND for the project..

Let me also add, markets are very dynamic. For example, Samsung today in their earnings call, they explained to everybody that expectations of bit growth for the full year are now going to be a lot less than what investors are expecting or what they have previously communicated.

I believe they were previously communicating 40% big growth and now they have taken it down to a 30% bit growth for the year. Similarly for the first quarter, most people were expecting Samsung’s bit shipments to grow in the first quarter and now they are communicating that their bit shipments are going to be declining in the first quarter.

So, this should give you a sense of the dynamic nature and how fast it changes in our industry..

Well, thanks so much for the clarification. That was very helpful. The understanding between the 2D NAND and the 3D NAND and where the shortfall is coming in the Shannon business, I greatly appreciate that. And then, Riyadh, I just wanted to ask a question.

I think you mentioned that the OpEx is going to be higher in the first half of the year and then it was going to come down in the second half of the year.

So, how should we be looking at OpEx for Q1 this quarter, your guidance?.

Our Q1 OpEx and our second quarter OpEx are going to be higher than in prior quarters, because of R&D tape-outs. Most of the tape-outs this year will take place in these two quarters. Most of our tape-outs, as I believe we previously explained are going to be 28 nanometers and these are very expensive.

These are necessary investments that we need to make as most of them are for SSD and eMMC controllers. After these tape-outs are done, however, our second quarter operating expenses will be much lower. This is going to result in our operating margin being lower in the first half than in the second half.

Also, we will have better operating leverage in the second half because of stronger revenue growth. For the full year, we believe we are going to be able to deliver our operating margin at levels similar to last year. And just to add a bit more, in Q1, our operating margin, as we have previously said, should decrease about 23% to 25%.

And again, this is all largely due to higher R&D tape-out expenses..

Okay, thanks for that. Appreciate it. And then my last question for you, Riyadh, is on the tax rate. You said it was going up to 20% from 18% and you mentioned several factors, and one of them being tax credits in Taiwan that are – you losing.

Do you expect those tax credits to come back anytime in 2017 or are those completely gone?.

Betsy, some of our tax benefits expired. These are tax benefits that we enjoy in Taiwan. They expired at the end of 2016. So, this is leading our effective tax rate to inch up to about 20%. We are actively managing this right now and we believe that next year, our tax rates could return to our long-term 18% mobile tax rate..

Okay, thanks so much. Appreciate it..

Our next question is coming from the line of Jaeson Schmidt from Lake Street Capital Markets. Please ask your question..

Hi, guys. Thanks for taking my questions.

Just curious if we should still think about the core, that card and USB business declining in that 10% this year or if you have had any changes to that outlook?.

The market for our memory cards in the factory are mature. We focus on high end, more differential UHS-I, UHS-II and USB 3.0 products to better differentiate from our competitors. The marketing for expandable storage long-term expected to decline around 10% annually.

But with the tightness this year, our expandable controller business will be even more impact and they will likely decline more than 10%..

Okay, that’s helpful.

And then just wondering if you have seen anything out of the ordinary from a pricing standpoint within the client SSD space?.

With the tight NAND supply, frankly speaking, we see the NAND price and client SSD price is moving up because of supply shortage. Unless the NAND supply situation improves, I think the current client SSD pricing will be stable. Our total pricing also will be stable..

Alright, thanks a lot..

Our next question is from the line of Mike Crawford from B. Riley & Company. Please ask your question..

Thank you, Wallace.

You talked about gearing up to enterprise grade controller market, is that beyond just the first 12.8 terabyte drive for Ali Baba?.

That is correct. I think our enterprise strategy today is in three parts. First, our channel enterprise would be targeted very high end meeting critical applications as a large internet and a cloud player in China. Second, our customers are using our computing grade SSD controlling datacenter applications already today.

And third, we are already developing enterprise-grade SSD controller and then will be launching these products in 2018..

In markets beyond just China?.

We will focus on Shannon initially in China. We could expand to outside China to U.S. and other countries..

Okay.

And what do you mean by retooled?.

Retooling is in – most of our controllers today of firmware is tailored for client SSD, our PC OEM. For enterprise grade data center, the priority and focus is different. For example, they now focus on high-performance sustain rate, right.

So your firmware and algorithm need to have a different copy collection, different feature to maintain sustainable performance in data center applications..

I see.

And when you are addressing the enterprise market, does that mean that there is much longer kind of design-in cycles or is that not materially different from what you have been experiencing so far in the client market?.

Regarding the controller, we retooled the firmware for the market. Naturally, the cycle is very quick. And I think Central India had already started shipping client grade SSD products into low-end enterprise cloud data center applications.

For real enterprise grade controller, I think design cycle is longer to be qualifying large-scale enterprise customers. That’s correct..

Okay, thank you. And then the final question in that regard is the – it’s my understanding enterprise controller ASPs can get up even into the $100 range, well above the $5 to $10 we are talking about for PCIe client controllers.

In 2018, when this business becomes more meaningful for you, what range of ASPs might you see for your enterprise controller efforts?.

We cannot comment on ASP right now. I am not sure when it will be $100, but that means ASP much higher than client SSD controller..

Alright. Thanks..

Our next question is coming from the line of Rajvindra Gill from Needham & Company. Please ask your question..

Yes. Thank you for taking my question.

I just wanted to see if you could elaborate on – Wallace, your comment on the allocation of capacity for the same SSDs, you had said the difference between wafer sales versus solution sales or system sales, I am wondering if you could elaborate that – elaborate further on that point?.

It seems it’s very clear. When NAND supplies are tight, every NAND maker has their own priority to allocate the NAND contribution. So some portion will deliver to commit their major OEM customers and some will based on their business model, for example, maybe focus on smartphones or enterprise SSD, not the client side.

Some NAND makers maybe prefer to sell NAND components, which will have better margin than sell solution in the client SSD, our expandable product. So every NAND maker have given priority allocating NAND. And especially for a module maker, nobody have lower priority to receive the NAND when NAND is in shortage condition..

So based on that logic then – go ahead, Riyadh..

Go ahead..

So based on that logic then and based on guidance for your client SSD still growing 20% to 25% that clearly – the flash vendors are prioritizing SSD or NAND supply to client SSDs because that’s where they are showing strong demand from that segment?.

For some NAND maker..

That’s correct..

And furthermore, for our Shannon business, as we mentioned for many of the flash makers, if they can capture better economics by using the flash within their products, they are going to be allocating less as sales of wafers to customers like us for – for us to build our own SSDs, right.

For us to build our own Shannon SSDs, we got to procure NAND wafers from the flash maker and it take the wafers to turn them into SSDs that we then sell to our hyper-scale customers..

So there hasn’t been any market share shift in the Shannon SSD business, is that correct, the reallocation of NAND or repriortization of the NAND flash, given the tightness in the market?.

That’s not the way to look at it, because our products are highly customized products, so we are not in the market of competing against the NAND flash makers who are making – who are providing standardized SSDs. SSDs that we are providing to our hyper-scale customers, these are custom designs.

These are based on the specifications that our customers provided to us and so we are not competing against flash makers for their products. Ours are customized, theirs are standard.

But that said, if our hyper-scale customer cannot secure sufficient NAND wafers for us to make SSDs, then our customers are going to be turning to standard products for the requirements..

And so that’s what they are doing then, right, all these hyper-scale customers in China are turning to standard products versus customized products, given the tightness in the supply?.

That’s correct. That’s the situation we are facing in the short-term. This situation will likely change when there is greater availability of flash, but currently, that’s how you are – that’s the situation our customers are facing.

I mean they would like to build more customized SSDs where these SSDs are designed specific for tailored to their data center requirements. But if they can’t secure sufficient flash or build them, then they will have to turn to other means to build the infrastructure..

And just last question on that and I will hop back in the queue, then what would be the actual business impact for those customers, those hyper-scale customers in China if they move to a standard product and I am just curious if the business impact is minor, will they just stick with the standard products versus going back to customized products? I guess, what is the differentiation between more of a customized versus standard?.

It depends on customer type. For Tier 1, very large scale customer, they temporarily might turn to standard for product, because either they cannot afford to wait and delay product launch. But for medium and small customer, they can wait and they are willing to pay more regarding to procure the NAND.

So I think so for Shannon, we will grow medium and the small customers in 2017..

To add further, when there is greater flash availability, we are – there is still a lot of demand for our type of product, these highly customized from our large hyperscale customer. So there is still that intention of they want to use the solutions that we are designing for them.

These are products that are – that fit very well within their infrastructure, that perform very well with their requirements and they like to do use more of these. And so when more flash availability comes around, we are pretty comfortable that they are going to want to use more of what we are selling.

But as things stand right now, that’s just not possible..

Thank you, Wallace and Riyadh. Appreciate the color..

Our last question is coming from the line of Tom Sepenzis from Northland. Please ask your question..

Yes, thank you.

Just a follow-up on the Shannon business, my question is, is there any danger that you have missed any programs? How quickly can you turn around and give product to customers if NAND flash availability loosens?.

We did not lose any customer or lose any program. I think just customer – our customer in China, major customer, because of tight NAND supply in certain NAND types, they tend to procure finished goods solution from NAND maker temporarily.

When NAND supply becomes better, I think our products, all products were going to continue to ramp up and our new project will continue ramping up with 3D NAND. So we mentioned our current product in production is 2D MLC. The new product is a 3D TLC..

To add further, we – as Wallace had mentioned, we did not lose any customers and we certainly did not lose any programs at these customers.

It just turned out that the volume expected for each one of these programs are now a lot smaller than what we had originally expected because our flash partner – our hyperscale customer is just not able to secure sufficient NAND components to build at the original planned levels..

Great. Thank you.

And then you mentioned that the removable storage will be down 10% quarter-over-quarter that you expect that year-over-year in ‘17 down 10%?.

That’s correct. Yes, at least 10% down..

Okay, thank you very much..

There are no further questions at this time. I would like to hand the conference back to today’s presenters. Please continue..

I would like to thank all of you for joining us today and your continued interest in Silicon Motion. We will bring the following conferences this quarter [indiscernible] Technology Summit in New York, ROTH Investor Conference in Laguna Beach; Merrill Lynch Investor Conference in Taipei; Morgan Stanley Investor Conference in Hong Kong.

Details of these events will be available on our website. Thank you and goodbye for now..

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