Silicom Ltd (SILC) 2009 Q2 法說會逐字稿

Welcome to Silicom's Second Quarter 2009 Results Conference Call. All participants are at present in listen-only mode. Following management's formal presentation, instructions will be given for the question and answer session. As a reminder, this conference is being recorded, July 27, 2009. You should have all received by now, the Company's press release. If you have not received it, please call GK Investor Relations at 1-646-201-9246, or view it in the news section of the Company's website, www.Silicom.co.il. I would now like to hand over this call to Mr. Ehud Helft of GK Investor Relations. Mr. Helft, would you like to begin?

Yes, thank you. I would like to welcome all of you to Silicom's Second Quarter 2009 Results Conference Call. Before we start, I would like to draw your attention to the following Safe Harbor Statement. This conference call may contain projections or other forward-looking statements regarding future events or the future performance of the Company.

These statements are only predictions and may change as time passes. Silicom does not assume any obligations to update that information. Actual events or results may differ materially from those projected, including as a result of changing history or market trends, reduced demand for our products, the timing development of our new products and a reduction by the market, increased competition in the industry and parts deductions, as well as due to risk identifying the documents filed by the Company with the SEC.

With us on the line today are Mr. Shaike Orbach, the CEO and Mr. Eran Gilad, the CFO. As usual, Shaike will begin with an overview of the results, followed by Eran who will provide the analysis of the financials. We will then open the call to the question-and-answer session. And with that, I would like to hand over the call to Shaike. Shaike, please.

Thank you, Ehud. Good morning, everyone. Welcome to our conference call. We are pleased to report another profitable quarter in a tough market environment, plus especially strong cash generation, as well as solid progress from a strategic perspective. Additionally, based on the signs that we see in our market, we continue to believe that we will return to growth before the end of 2009.

As was the case in the first quarter, our revenues this quarter continue to be impacted by the global economic slowdown. Although we maintained our list of over 50 existing customers in tact, and even added a number of new customers during the recent quarters, it did not compensate for the reduction in ongoing purchase orders from a number of our larger customers, some of which were depleting existing inventory rather than reordering from us.

However, the good news is that the major customers that had been drawing down their inventories seemed to be nearing full depletion levels, which underlies our belief in our ability to resume our growth relatively soon. Another reason for my optimism is that the underlying trends that built our business over the past several years have not weakened. In fact, the industry has become even more reliant on servers and network appliances, implying an even greater need for our products.

The global demand for bandwidth continues to increase at a phenomenal rate, implying increasing numbers in complexities of servers and appliances to handle the growing data loads. It is important to note that our products are critical components inside many of these critical network infrastructure, server and appliance products.

While our appliance end customers can delay orders somewhat, there is not much leeway as the growing data demands remain ever present, and the infrastructure upgrade cycle cannot be further slowed by much. Our products, in particular, will support our clients migration up to 10 gigabit as the industry moves towards these increased data speeds utilizing mostly adapters to facilitate such a move. Thus, we continue to be very optimistic regarding Silicom's, and our industry's, long-term prospects.

We ended the quarter with a very strong cash position at just over $41 million, which was contributed by our strong positive operating cash flow in the quarter of $1.1 million. This ongoing achievement is a testament to the efficiency of our operations, and the stability of our business model, even in the current volatile macro environment.

I would like to again stress, as I did last quarter, the contribution, from a business development standpoint, that our very strong cash plays in the current macro environment. Many of our customers are large manufacturers with strict internal guidelines on the financial stability of their suppliers, since they need guaranteed support and minimal risk of supplier disruption over the long haul.

Our financial strength is now a significant asset. And we are leveraging this strength to acquire new customers, while retaining and further penetrating existing ones. In fact, it is pertinent that even in the current tough environment, not a single customer has left us. And we have been able to acquire new customers.

At the same time, our cash is not only for show. It also places us in a particularly good position to preserve the strength of our business and our first rate customer support. It enables us to maintain and even build on the investment in our technological and product leadership, enhancing our competitive advantages. Finally, it provides us with an ability to swiftly take advantage of any potential opportunities that may arise, especially in the current environment.

We have recently introduced an exciting new product family that will take our portfolio to a whole new level, extending our offerings for existing customers, while even more importantly, opening the door to promising new customers and market segments. Our SETAC, Server To Appliance Converter, product line is based on a concept that eliminates the trade-off between using either a specialized hardware network appliance, or the more ubiquitous and standardized server platform.

This decision is currently faced by all network appliance providers, as each approach has its advantages and disadvantages. Our SETAC converters provide a solution where the advantages of both approaches are combined and the disadvantages are eliminated, enabling a standard server based solution, but with the specific modularity and flexibility advantages of the specialized hardware appliance.

It is important to note that the SETAC concept is nothing like anything that we have announced in the past. It is not just a card or a family of cards which we can sell to our customers. It is a whole new concept which provides us with possibilities we never had before. Through this concept, in addition to just selling SETAC converters, we are now able to approach new customers which could not use our product before, as well as provide a full system solution to both current and new customers. This significantly expands our addressable market.

It is also important note that while we are only in the early stages of introduction of this concept, we have already secured our first customer for the SETAC concept, a leading European provider of security solutions, which actually validates the strength of this concept. Additionally, we are receiving very encouraging responses from various other players in the market. Thus, we very much expect to see that become a new significant driver for our long-term revenue.

Overall, we are proud of our continued profitability and strong cash flow generation, especially against the backdrop of the global economic crisis. Looking ahead into the second half of the year, while we expect to continue to show profitability, we see promising signs for renewed growth.

In summary, the combination of our global and diverse customer base, our strong balance sheet, our continuous offering and development of new products, as well as our pipeline of new and potential customers, all provides us with confidence in our ability to emerge the current market downturn as a better and more diversified company.

Our company remains strong. Our structure is sound. And we believe our expansive footprint is at the right level for continued execution of our goals. With that, I will now hand over the call to Eran Gilad, our CFO, for a more detailed review of the quarter's results, after which, we will open the floor for quarters. Eran?

Thank you, Shaike, and hello, everyone. Revenue for the second quarter of 2008 (sic - see press release) was $4 million, compared with revenues of $5.2 million recorded in the second quarter of 2008 and $5 million as recorded in the prior quarter. Our geographical revenue breakdown for the quarter was as follows -- north America 72%, Asia Pacific 10%, Europe and Israel 18%. The breakdown of revenue between bypass and non-bypass for the quarter was approximately 50-50.

Gross profit for the second quarter of 2009 was $1.6 million, representing a growth margin of 39.8% at the higher end of our normal range. This is compared to $2 million or 38.2% in the second quarter of last year. Operating expenses in the second quarter was $1.5 million, compared with $1.8 million in the second quarter of last year and $1.3 million last quarter. The main reason for the variation in operating expenses is the US dollar Sheqel exchange rate. In local currency terms, our expense platform has remained more or less flat throughout the past year.

Operating income in the second quarter of 2009 was $152,000 or 3.8% of revenue. This is compared with $138,000 or 2.7% of revenues as reported in the second quarter of last year. Second quarter 2009 net income was $256,000 or 6.3% of revenue. This is compared with a net income of $323,000 or 6.2% of revenue in the second quarter of 2008. Earnings per diluted share were $0.04 in the quarter, compared with $0.05 in the second quarter of last year.

Now turning to the balance sheet, our net cash and equivalents at the end of the second quarter totaled $41.1 million. This represents an increase of $1.1 million attributed to positive operating cash flow compared with the end of the first quarter of 2009 and an increase of $1.9 million attributed to positive operating cash flow compared with the end of 2008. Our current strong cash position represents a level of $6.14 per basic share. That ends my summary. And we would be happy to take any questions. Operator? Operator, we are ready to take questions.

Yes, thank you. Ladies and gentlemen, at this time we will begin the question and answer session.

(Operator Instructions).

The first question is from Jeff Meyers of Cobia Capital. Please go ahead.

Great, thanks, guys. Okay, just a few questions. The first one is on the pre-director product. Maybe you could talk about the progress you're having there.

I hope that we would start to show production saves, I would say, within this quarter. And that means that we're moving forward.

Okay. Second question is on the external TAPs bypass. How's that going? Are you able, so far, to penetrate that market?

I think that we're selling the units. And I cannot say that at the moment we see a clear trend as to significant growth with -- in sales of these products. However, they're currently being evaluated by several customers and in terms of the pipeline, so we do believe that this line of product will grow as well. I cannot -- it's going to be -- what it seems to us is that the sales cycle with these products is as long as we have the costs, so it's going to take some time before we will see the growth in the sales. But we do see that these products are being evaluated by more customers than before.

Now, do you think though that in that particular product line you can be a second supplier to, you know, one of the customers there? Or is that a business where they only have one supplier and you have to displace somebody entirely?

Well, I think that for the same product, we will probably replace someone entirely. But we can still find ourselves in a position where a certain customer is buying external units from us and from someone else. For example, someone may buy 10 gigabit from us and 1 gigabit from another vendor. Or let me give you another example, at the moment we do not have any copper product with the external units, we only have fiber product. So it could be that the customer would take fiber products from us and copper products from someone else.

I see, okay. And then in terms of the new customer you announced last quarter, you know, how is that relationship progressing so far?

Good. It's moving ahead good. I mean, we believe that's a part of the optimism which is why we maintained the level of optimism regarding the second half of the year or some point within the second half of the year. We believe that this customer will start to become significant at some point within the second half of the year.

Okay. And just to go back to the intelligent redirector for one second, I know so far you've had 10 Gigabit products there. Is that something where you're going to go back and come out with the 1 Gigabit as well and then maybe a copper product or, you know, how is that going to develop?

Yes, I mean, actually, we are now designing -- we are in the design phase of a 1 Gigabit product which will be a copper product.

I see. Okay. And then last question is on the new, you know, the SETAC product. You know, is there any economic benefit to a customer to, you know, doing a general purpose service instead a appliance? Like you know, in terms of maybe them not having to hold as much inventory or something like that or, you know, what are the main economic benefits, I guess, to this solution?

I mean, I think, if I'm trying to make the economic balance, I would say the following -- today, a customer who is making an appliance out of a standard server versus an appliance which is proprietary, so the standard server is less expensive, the SETAC modules will increase the price of the standard server with the SETAC modules, I would say.

But we believe that the end result would be that the servers -- the standard server solution, including the SETAC, would be more or less the same price of the proprietary appliance, but with the advantages which are both the advantages of the appliance and those of the server.

I see. Okay. All right, very good. Thanks, guys.

Thank you.

The next question is from Don McKiernan of Landau Securities. Please go ahead.

Yes, hello. Can you give the number of bypass and non-bypass units sold during the quarter?

Yes, first of all, it's about 50-50. Total quarter 11,000. So each one then is about 5,500.

Okay. And I believe early in your first quarter you had a revenue opportunity with a large US server company, can you give us any update as to additional new business from that particular customer or any others in that place?

You're talking about the big server company, I presume?

Yes, you had I think a $1.1 million --

Okay, so we continued to speak with these guys and we believe that there would be additional opportunities with them. There are some such opportunities that they are telling us about, but still, these opportunities are going to be on a project-by-project-basis. And as I explained last time, this is not something which is consistent every quarter on the one side, but on the other side, it's not a totally one time opportunity.

But it's one at a time, that's what I would say. So there are additional projects that these guys are trying to push forward and these projects that are talking to us about will include, if materialized, our product in them. As to exactly when such opportunities are going to happen, it's difficult to tell because, as I said, these are specific projects which are either awarded or not awarded.

Okay. How about in China? Any further progress there?

I think that, again, there is progress in China in terms of the pipeline. In terms of customers moving forward with the evaluation of our product, I cannot say that we have sold to China more this quarter than previous quarters, which means that we still did not see the -- I would say, the outcome of all these efforts that we're making in China in a consistent way. But we definitely see the progress in terms of the evaluation cycles, the questions, the number of customers who are now evaluating and trying to work to move forward with our products.

And what percent of your revenue this quarter was from the 10 Gigabit space?

10 Gigabit was about 16%.

16%?

16%.

Okay, so that's I think picked up a little bit from --?

That's correct, that's correct.

And once again, I'm not sure we will show such an increase every quarter, but overall, there definitely would be a trend for 10 Gigabit growth.

Can you be more specific about the inventory issues? You said by the end of the year, are we seeing some of that rectify itself in the current third quarter or anything more specific there?

Are you talking about the inventories of our customers?

Yes, right, right.

Well, I mean, it's difficult -- it's difficult to me to be much more specific because they're not giving us data, you know. The only thing that we are -- we understand from that is -- because there was a certain time when we saw that they were selling nothing at all, so we said, what's happening? Are you not selling anything?. And they said, no, no, we're just selling out of inventory.

And now that we -- that they do forecast -- they do have projections for sales, for renewed sales and these are starting to increase, so that's why we understand that they're probably coming close to depleting all their current inventory. But we don't have specific data as to the level of inventories that they have and how much of that and which costs have disappeared from -- have been depleted entirely and which are still in the process. So it's more based on the forecasts that were forecasted than we're receiving feedback.

And are most of the inventory issues related to the WAN optimization space or is it just overall from everywhere?

Well, I would say that most of our bypass customers are WAN optimization customers. It's a significant part of what we sell. So saying that, I would say that a significant part of that would be in the WAN optimization, but not only -- definitely not only in the WAN optimization.

Right. And just finally, the WAN optimization is still considered in your opinion one of the strong growth areas for you guys going forward?

It's a part of the market growth. I mean, in terms of customers, I believe that we are engaged with most if not all of the major players in the WAN optimization market.

As the only supplier?

I beg your pardon?

As maybe the primary or only supplier in most cases?

Yes.

Yes, okay. Thanks for taking my questions.

Thank you.

The next question is from [Edward Bilinski] of [Segma International]. Please go ahead.

Hi, no question, just a comment. Your investor relations man has a habit of not responding to either emails or phone calls. In my case, I sent an email on May 5th and I am still awaiting a reply. And an associate of mine called and was told that he -- and it was about a month ago or six weeks ago, and he was told that he would be called back, he too awaits the reply. That's all I have for this moment. Okay?

Obviously, I'll go ahead and ask the same question as a question rather than as a comment to our IR guys.

Good, thank you very much.

(Operator Instructions)

Please stand by while we pool for more questions. The next question is from [Elgad Goswick]. Please go ahead.

Hello. Hello, everyone, and really congratulations of very good success. Can you elaborate about your new product? What is the potential market of this and anything else that you can elaborate how you can get a patent on hardware? Most of the time, it's not something which is acceptable. That's my question.

I've seen many patents which were awarded for hardware only, not necessarily, but I believe it has to be including software. That's what I know at least.

I mean, most of the time, it's very easy to overcome this patent. What is (inaudible) that you made on this specific patent?

Well, I mean, it is unique. I'm not using the word unique many times, but it is a solution which provides something which has both the advantages of the hardware-based appliance and the server -- the standard server.

And I believe that this is unique and this would also explain to you -- this would also refer to the first part of your question, because that defines the market that we would be able, if we are successful, of course, to penetrate with this kind of a solution, because on the one side that would allow us to go to all these customers who started with, I would say, a hardware appliance because they wanted to have the modularity, the possibility to replace networking modules without having to open the server chassis, et cetera, and they wanted to have the look and feel of a router or a switch rather than server.

So all these customers, we actually didn't have access to them before and now we do with this solution. And on the other side, we still maintain the server grade reliability and robustness, stability of a server solution coming from the very well brand names, compared to the relatively -- or not relatively, to the much smaller companies who are doing hardware appliances.

So we would be able to approach both customers that we haven't been able to approach before that because they wanted to have the features of such hardware appliance, and on the other side, we would also be able to provide full solutions to these guys which would further -- or have the potential to further increase our revenue.

What is the potential for such a product if it is a success?

Well, it's a little bit difficult for me to quantify that, but I could say that if we are successful with that, that could be very significant to our revenue.

It can be a market of about $1 billion or I am exaggerating?

I think that the overall market could be over $1 billion.

For this specific product?

For -- yes, for everything which is included within this product family.

It means that it's a very, very big market for Silicom.

Yes, I'm not -- at the moment, I don't want to say that we are targeting to become the major supplier of platforms, because platforms is a part of that in that market. But as I said before, I mean, this could be very, very significant for us as it is, which means even if we were able to just sell to these guys who wanted to buy what we call hardware appliances rather than servers and then sell to a significant part of them and also -- and if we can approach, which is something that we would be able to do right now, those guys who previously wanted only to work with hardware appliances and now they -- and with that we couldn't work before we had this concept and now we can.

I understand. I would ask, if you really see that in the (inaudible) not as usual, I think that this is a real recovery if you'll give a public announcement for this then we will be happy.

I assume that you're asking about orders coming in.

It may be in orders for real, but because before it was stopped, now we need coming again hopefully, and I think it's important to give some announcement so that everybody will know that really something has changed. This is my wish, I don't know if you --

First of all, I would say just to make it clear, I didn't say that we have or are receiving orders which show the growth. I said that the promising signs that we were speaking about were more associated with forecasts coming from our customers. As to the question what we are going to do when and if such orders are going to flow in representing a change, I do not have an answer right now. We'll have to find out -- to look and find out whether this requires an announcement or not.

That's why I said -- I put it as a wish for me, from my side.

I understand, thank you.

Okay, thank you very much and good continued progress and success.

Thank you.

Thank you.

The next question is a follow-up question from Don McKiernan of Landau Securities. Please go ahead.

Yes, hi. I just wanted to clarify, we're talking about the new SETAC product here on a previous caller's question. What is the size of the addressable market?

I don't want to confuse anyone. The previous question has been associated with the overall market, whether it gets to $1 billion or not. And my question was that it does and I referred to that to all the appliances, the hardware appliances and servers which are being sold in the overall appliance market, which could be a market of $1 billion. I said also that we're not planning to become a major player in everything in there, but only to address these guys who are selling hardware appliances and now we can be a part of that as well.

So you would be a component supplier to that $1 billion marketplace?

No, we could -- at the level of these guys who are now within this market buying not servers but rather appliances, we may at a certain point sell to them the full solution in this case. But still, it would be addressing only these guys who were working with hardware appliances and not these guys who are working with servers, who would continue to buy the servers without us.

Okay. Would you characterize the opportunity with SETAC to be significantly larger than your WAN optimization opportunity with bypass cards?

I think that it could be at least of the same magnitude if we are successful.

Right, right, of course. Okay, great. Well, congratulations on that great news. Thank you very much.

Thank you.

Thank you. There are no further questions at this time. Before I ask Mr. Orbach to go ahead with his closing statement, I would like to remind participants that a replay of this call will be available within 24 hours on the Company website, www.silicom.co.il. Mr. Orbach, would you like to make your concluding statement?

Thank you, operator. Thank you, everybody, for joining the call. I'd like to conclude by saying that we will continue to work hard with our ultimate goal of increasing value for our shareholders over the long term. If you do have any questions or need information, please feel free to contact our Investor Relations team, GK Investor Relations. We look forward to hosting you on our next call in three months time. Good day.

Thank you. This concludes Silicom's Second Quarter 2009 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.