Silicom Ltd (SILC) 2010 Q1 法說會逐字稿

Welcome to Silicom's first-quarter 2010 results conference call. All participants 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 April 26, 2010.

If you have not received a copy of today's press release and would like to do so, please call CCG 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 the call to Mr. Kenny Green of CCG Investor Relations. Mr. Green, would you like to begin, please?

Thank you, operator. I would like to welcome all of you to Silicom's first-quarter 2010 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 obligation to update that information. Actual results -- actual events or results may differ materially from those projected, including as a result of changing industry and market trends, reduced demand for our products, the timely development of new products and their adoption by the market, increased competition in the industry and price reduction, as well as due to risks identified in the documents filed by the Company with the SEC.

With us on the line today are Mr. Shaike Orbach, CEO, and Mr. Eran Gilad, 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 turn over the call to the question-and-answer session. With that, I would like to hand the call over to Shaike. Shaike, go ahead, please.

Thank you, Kenny. Good morning, everyone. Welcome to our conference call. We are very pleased with the results we reported today for the first quarter of 2010. We delivered a strong quarter with both solid financial performance as well as significant strategic progress towards our long-term objectives.

We reported revenue growth of 28% over the first quarter of last year, as well as another quarter of strong profitability and cash generation. Our continued success confirmed the trends we reported last quarter -- the early signs of recovering markets, a strong underlying need for our traditional product line, and growing interest in sales of our latest product innovations.

Let me elaborate. We have seen the resumption and renewed purchasing by many of our customers. Ordering patterns that many customers are returning to similar levels to those prior to the financial crisis, which is indeed a sign that the market is recovering. We hope this trend will continue.

The increased demand for our traditional products has been manifested in several ways. First, we are seeing a ramp-up in order flow from recent design wins with large customers. Second, several of our customers have integrated our product into more of their product lines and, therefore, are increasing their business with us.

Third, we are seeing increased revenues from many of the 70 plus customers in our customer base. Many of these are market leaders in various networking and security market segments. Finally, we continue to increase our platform of customers, adding new customers which use our products.

I would like to spend a few minutes updating you on the performance of some of our recent product introductions. In the quarter we launched the Intelligent External Bypass Switch, which implements our Bypass solutions in an external independent unit. Very soon following the launch, we announced a series of orders from a leading application delivery company for the 10 gigabit external Intelligent Bypass Switch, with potential for a flow of repeat orders. This innovative new product extends our positioning as the industry's trusted one-stop shop for top-performing bypass solutions.

I would also like to discuss the Redirector and its intelligent solutions derivatives. The level of interest in the capabilities of the Redirector continues to grow. While the final customer decision does take time, we are enthusiastic by the fact that this Intelligent card is enhancing the offering of our important family of smart server adapters with additional capabilities, significant potential for more products, additional design wins, and future success in new market segments.

I would like to talk now about the progress we have made with our new product line, SETAC, the SErver To Appliance Converter line of products. We remain very excited with what the SETAC can do for our business. From a market standpoint, SETAC extends our offering for existing customers while even more importantly, opens the doors to many promising new customers and market segments.

Market traction for our SETAC is beginning to build as illustrated by the selection of SETAC by a leading Chinese national compliance manufacturer, which is the third SETAC marketing success since launching the product line in July of last year. The success so far confirms that we read the market well and its need for a new type of flexible, reasonably priced server grade appliances. We believe the SETAC is becoming an increasingly important new growth driver for Silicom.

These new products are just the latest fruit of our continuous investment in innovative R&D efforts. As you can see, our new products have all gained a strong positive reception and traction in the market, and they are all making inroads into our existing customer base. Just as importantly, they have also caught the attention of potential customers to which we do not currently sell, and we believe these new products will be instrumental in our ability to acquire new customers.

We believe our new products can provide us with significant upside for the coming years. The foundations of these growth factors are the investments we made as well as the stability we achieved in 2009. We navigated the downturn well. We maintained our profitability and ability to generate cash, while investing in R&D and expanding our customer base.

Everything that I have spoken about up until now ties in very well with the fact that our main market was and remains mostly the WAN optimization market. As WAN optimization becomes a key enabler underpinning storage and server virtualization, areas which in the near term are seeing substantial interest and growth, it implies an even greater need for our product. At the same time, if local demand for bandwidth continues to increase unabated and underlines my optimism with regard to our industry's long-term profit.

Finally, we ended Q1 with a net cash position of $43.8 million. This strong level of cash provides us with more than enough working capital to continually build on the strength of our business, take advantage of any opportunities that may arise, and advance our technological and product leadership, all which will enhance our competitive advantage.

To summarize, based on our good results and cash generation, our platform of globally diversified and satisfied customers, and a broad range of current products which we sell to a growing roster of customers, as well as exciting new products which we expect will significantly broaden our addressable market, we feel very well positioned as we move through 2010 and beyond. All of this increases our confidence in our ability to continue delivering long-term growth for the coming years.

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 questions. Eran?

North America 72%, Europe and Israel 16%, Asia Pacific 12%. The breakdown of revenue between bypass and non-bypass for the quarter was Bypass approximately 50% and non-Bypass approximately 50%.

Gross profit for the first quarter of 2010 was $2.7 million, representing a gross margin of 42.2%, and was higher than in prior quarters due to a favorable product mix. This is compared to $1.9 million or a gross margin of 38.7%, as reported in the first quarter of last year.

Operating expenses in the first quarter was $1.7 million compared with $1.3 million in the first quarter of last year. Operating income in the first quarter of 2008 (sic) was $1 million or 15.7% of revenues, a 55% growth compared with $649,000 or 12.9% of revenues as reported in the first quarter of last year. First-quarter 2010 net income was $938,000. This is compared with net income of 8000 -- sorry, of $867,000 in the first quarter of 2009. Earnings per diluted share were $0.15 in the quarter, at the same level as in the first quarter of last year.

Now, turning to the balance sheet. Our net cash, cash equivalents, bank deposits and marketable securities at the end of the first quarter totaled $43.8 million. This represents an increase of $0.6 million compared with the end of 2009, due to a positive operating cash flow. Our current strong cash position represents a level of $6.44 per basic share.

That ends my summary, and we would be happy to take any questions. Operator?

Thank you. (Operator Instructions) Jeff Meyers, Cobia Capital Management.

So first question is what percent of your revenue this quarter was from fiber products?

The percentage of fiber products was about 25%.

Which is, I guess, higher than it has been historically. Is that one of the reasons why gross margin was higher this quarter?

Not necessarily.

I see. I guess on a go-forward basis, do you think that the gross margin this quarter can be sustainable, or it is hard to say at this point?

It is hard to say, but we believe we will be able to keep this range.

Okay. Shaike, if you could talk a little bit more about the standalone Bypass solution that you sold this quarter maybe. Was it a security customer, WAN optimization customer? Was it one of their product lines or across the board, or how does that dynamic work?

Well, it is not exactly WAN optimization customer. As you know, these days customers are sometimes redefining or at least retitling, I would say, what they are doing. This specific customer is defining itself as working or as delivering product into application delivery type of market.

It has to do a little bit with WAN optimization, but it is not exactly WAN optimization. I think that they have some security features in their systems as well, but they are not exactly a security company, so the definitions are a little bit vague.

Now it is not across the board of all their products. Actually, it is a high end -- it is going to their high-end product line, which is using 10 gigabit. That is why we are saying that we have been able to sell the 10 gigabit Intelligent Bypass Switch, which is a good sign for us because we feel that 10 gigabit is picking up, which is good.

We believe this will continue. This is a 10 gigabit fiber bypass, and just like with many other customers in most cases fiber, fiber is per project. So sometimes you get a product which includes fiber; some other times you don't. Therefore, it is not as consistent as some of the copper cards that we are selling. But if you are looking at a long-term LAN and especially with 10 gigabit where fiber is much more popular than copper, then we believe this will continue.

Okay. Have you seen any -- I know some of the WAN optimization guys have now put 10 gigabit options on some of their higher-end boxes. Have you guys seen anything from that yet or is it still too early to say if there is an incremental demand there?

I think that overall, we can say that we see an increase in the demand for 10 gigabit solutions within the WAN optimization space. This is something we can say.

Okay, very good. Thanks, guys.

Thank you.

Abba Horowitz, Old School Partners.

Good afternoon. Congratulations on the quarter. You saw some very nice metrics, both on the sales growth line and on the operating line. Unfortunately, it didn't come to the bottom line, and I want to focus on that. As your tax rate was quite a bit higher, you got less interest income. And I am wondering how we could model, if you could maybe help out modeling these issues on a go-forward basis. Will this continue to impact? And also there were more shares outstanding [for me yet]. So how should we look at it for the rest of the year, these different numbers?

I would say that the percentage of the income taxes as we see in the first quarter would be more or less similar to what we believe to see in the next quarter.

Okay. So if I remember correctly, it was around 18%; is that correct?

I cannot say 18%, 17% or 16% or 19%, but I can say that the percentage that we saw this quarter will be more or less the percentage in the coming quarters.

Okay. Why did it go up so much, the tax rate?

It actually didn't go up. Actually, the percentage that we see this quarter, the effective percentage that we see this quarter is quite similar to the percentage in 2009. But in 2009, there were some other factors that impacted the final tax rate.

Okay. What were those factors; I assume they don't exist today?

The reasons that were relevant to 2009 are not relevant this year. So the important thing to know is that the percentage as we saw this quarter actually reflects the real tax rate of Silicom.

Okay. So it was abnormally low last year, is what you're saying?

Correct.

In terms of the share count, are we going to see more dilution on the share count for the next couple quarters? We are now hovering close to 7 million shares. Where do you think we will be towards year-end in terms of the share count?

I believe that the number of shares, at least in the next two quarters, will be very, very similar to the number that we see now.

Okay. So can you comment at all on SETAC in terms of what you expect for the rest of the year?

If you are speaking about revenues with respect to SETAC, then I would say that while we believe that we would sell more from SETAC this year, but in any event it is going to be only the beginning for SETAC. We don't expect any significant sales for SETAC this year. SETAC is something which takes quite long to, I would say to get qualified and decided.

Well, there are several steps in there. First of all, the customer needs to decide that he wants to evaluate something like that. Then he evaluates together with some others, then he qualifies. So until we see revenues, it is going to take some time and I don't think it is going to be significant in 2010.

It is going to be more, because I believe that we will start. We will have many beginnings. But in terms of significance, it will start only next year.

Fair enough. What about Q2, can you give us any feel for your visibility going into the Q2 at this point?

Well, first of all, as you know, we have never provided guidance and we don't want to provide guidance. And the reason for that is mostly because within a quarter and because many of our customers are working project by project, there could be really things that we cannot know for sure when you are looking at a quarter.

We have been able to say that if you look at longer periods, say a period of 12 months or something like that, then we are pretty sure to say that we are growing. We definitely feel that we are growing and not growing by a single-digit something. So that is what our feeling. But we really cannot speak specifically about any specific quarter.

Okay. But given your commentary in your release today, you seemed quite optimistic compared to past quarters where both the business revenue and earnings are going. Can I safely assume that that commentary was not meant for the end of the year, but it was meant for over the next couple quarters?

We are optimistic. I think that last quarter we were optimistic as well. But I think that even last quarter when someone asked me to try and narrow it down for the next quarter, I was not able to do that. Not that I didn't want to do that; because there are still too many unknowns with respect to a specific quarter. I think that we are in a trend of growth in general.

Okay, that's fair. I am sure you recognize that the Company is selling not much above the current cash on your balance sheet. I was just wondering if you could maybe -- I know you guys went on a road show, I think it was in February or March. And I am just wondering what other activities you are doing in order to get the word out with regards to the valuation of the Company and the story?

Well, if you are talking about activities investment, then I think that indeed now we feel at least that we are within the trend of growing, then we will also consider the various steps that we can take towards investors.

Obviously, in addition to that, we also need to make sure that we really exercising this trend and really grow. So as I believe that the most important thing is really being able to grow the business, I hope this happens. That is what we feel and that is what we believe. And together with that, we will work towards the investors' community.

Okay. Thanks very much.

Don McKiernan, Landolt Securities.

Thank you. Do you have the number of Bypass and non-Bypass units that you sold this quarter?

Yes. The number of Bypass cards is about 10,000 which is 50%, and number of non-Bypass cards, actually more or less the same number, about 10,000.

Okay. What percent of the revenues were from the 10 gig market opportunity?

Percentage of the 10 gig was about 20%.

Okay, that picked up considerably, it looks like. So you have three customers right now for SETAC. Can you give us an idea of how many are in the pipeline, how many prospects that you were working with, additional prospects?

We are working right now with approximately 10 additional customers about SETAC.

Okay. The same question for the Redirector and the Intelligent External Bypass Switch.

With the Redirector, I would also say that there are approximately 10 companies that are looking at that. And with the external Bypass, there are even more, I would say. I don't know if that's important to mention, but many of the companies that we work with in China are interested in external Bypass.

How many are actually buying product in the Redirector and the Intelligent External Bypass Switch?

Well, okay, let's distinguish also between buying significantly or non-significantly. For the Redirector, there isn't that much of a difference. We have one company which is buying relatively significant quantities. We have I think one or two other companies which are already buying that are relatively small.

With the external Bypass, we have at the moment I think two companies already which are buying what I may say can be considered a significant, and several other companies who are buying smaller quantities.

Okay. In China are you seeing much in the server opportunity there? I know you had a design win or something a while back and then that didn't pan out too far. What is going on over there?

Well, again, specifically about servers, we continue to work with this very same server manufacturer. They continue to buy from us cards, even though the quantities that they buy are far from the quantities that they bought that quarter -- I believe it was the first quarter of last year or something like that -- where they bought or where we got a purchase order for several thousands of cards.

They keep telling us, you will have these kinds of orders again. We are pretty sure about that. We just can't tell you when. Meanwhile, they are still buying, and what they buy is rather then thousands they buy I would say hundreds, a few hundred.

So we continue with them, and the company that we were talking about last time is not even the only company that we sell to them, but the quantities are on one side, they are not very big. On the other side, they are continuously growing; not very rapidly but they are growing. That is the server side.

In addition, we are working in China with the companies which are more, I would say, even more traditional for us. These are the companies which are selling actually a variety of networking appliances product. And to them, we are selling mostly I would say Bypass products, a significant part of which is the external Bypass unit.

Now overall in China, it is very much similar to what I told you about a server company, which means we are growing in China. We can see that. I hope that the rate of growth will become higher as we move forward, but we consistently grow our business in China.

Thanks for taking my questions.

Marcel Herbst, Herbst Capital Management.

Good morning and congratulations to a very good quarter. Usually Q1 is your seasonally weakest quarter. But at like $6.4 million revenue, you seem to have a strong momentum growing. Has this momentum carried over into the second quarter so far, and is any of this related to inventory building or does the demand feel more like real end-user demand?

Okay. It is a little bit difficult to say about momentum because we have seen many quarters where we started the quarter, it didn't mean anything compared to where we were at the end of the quarter. Most of our sales are finalized toward the end of the quarter. So it is difficult to tell. We feel, I would say, a general momentum. But it is still difficult to say whether it would be implemented into the next quarter.

Now with respect to your second question whether it is generous an inventory issue or a real sales, again, we don't have a way to know for sure. But because this is going on now for the second quarter in a row, because last quarter was good as well, then it seems to us more -- and that is why we define it as early signs of market recovery. So it seems to us more as if this is for real, not only issues of inventory. Cannot be 100% sure about that yet.

Okay. Speaking of your operating expenses, can you give a little bit more detail on why they were up, and also would $1.7 million be a good level to model forward?

The number that we sold this quarter is supposed to reflect the operating expenses of Silicom, assuming no significant change of the dollar. If the dollar goes up, then the number is expected to be slightly lower. And if the dollar goes down, the operating expenses are expected to be slightly higher.

Okay, thank you very much.

[Ronald Mullins], [Segmark International].

Congratulations on the progress that you have made in the last couple of quarters. It is quite encouraging. My comment or question is about the board of directors. I noticed recently on the proxy vote that there are three directors that are continuing. These are all people working at the Company or intimately involved in the Company in the past.

And I wondered if it would benefit the Company if one or two independent or outside directors were added who would have knowledge and experience that could make a contribution? It would seem that it might be quite helpful.

I believe that this is something that -- the one individual to answer that would probably be the chairman of the board who is not here at the moment, but I am sure -- I mean that as we are now looking into, I would say, nominating directors or so, that the directors that he is looking for are such that would be able to contribute to the Company.

Yes, of course. But it seems like a little bit like when the three of you meet, it is almost like a management committee meeting rather than say a traditional board meeting.

Well, let me say that two of the three board members right now are indeed active within the Company, and that is the chairman of the board and myself. I think that Mr. Zisapel who is the founder of the Israeli RAD Group and is definitely not involved in whatever is happening in the Company on a day-to-day basis is a very significant contribution to the Company as an external director.

He is definitely not involved in what is happening in the Company day to day. And in his position as the founder of the RAD Group and many of the other companies within the RAD Group, I think he is indeed a wonderful and a very important contribution to the Company, far from being a part of the Company management committee.

The other two, these are independent directors. He is not considered independent because I am not familiar -- I don't remember exactly what, but he is definitely not a part of the Company management. The independent directors should be selected based on their contribution to the Company, fully agreed.

Thank you.

(Operator Instructions) Don McKiernan, Landolt Securities.

Thank you. There was an earlier comment about the WAN optimization market and with respect to storage and virtualization, and that as that part of the technology environment expands, it means more opportunity for WAN opt and, therefore, more opportunity for Silicom.

I recall an earlier press release maybe a year and a half ago about the virtualization space, and I don't know if much really materialized from that. Can you give us a little more input about this opportunity and where Silicom is positioned?

What I can tell you right now is that there are several things that we are doing individualization area. And none of them is actually finalized or fully finalized, I would say, which is why I don't want to go into details right now. But what I would like to say is two separate things.

One is that even if we don't change anything in our product, we believe that as long as virtualization would cause more WAN optimization solutions to go into the market, than we will be good with that even without changing anything in our product.

But in addition to that because we would like to contribute additional factors towards virtualization, we have done several activities in the virtualization business and we are planning, I would say, to have some unique solutions in that area. And I presume that when these solutions are ready, we will announce them.

Okay. Thanks.

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 three hours on Veidan's website, www.veidan.co.io. Mr. Orbach, would you like to make a completing statement?

Thank you, Operator. Thank you, everybody, for joining the call. I would 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, CCG Investor Relations. We look forward to hosting you on our next call in three months' time. Good day.

Thank you. This concludes Silicom's first-quarter 2010 results conference call. Thank you for your participation. You may go ahead and disconnect.