Silicom Ltd (SILC) 2010 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Silicom's fourth quarter and year-end 2010 results conference call. All participants are at present in a listen-only mode. Following managements' formal presentation, instructions be given for the question-and-answer session. (Operator Instructions).

If you have not yet received a copy of today's press release and would like to do so, please call CCG investor relations at 1-866-704-6710 or view it in the news section of the Company's website at www.silicom.co.il.

I would now like to turn the call over to Mr. Kenny Green, of CCG Investor Relations. Mr. Green, Please go ahead.

Thank you, operator. I would like to welcome all of you to Silicom's fourth quarter and full year 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 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 timing and development of our new products and their adoption by the market; increased competition in the industry and price reductions; 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 the call over to the question-and-answer session.

And 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 discussing our fourth quarter and full year 2010 results.

Today we are very proud to report our exceptionally strong results. Our results represent a quarterly record in every parameter and a cap off of a fantastic year during which we exceeded all our expectations from both a financial and strategic perspective.

We delivered exceptional topline growth, demonstrating solid execution in our core business and across all our engines of growth. Strong growth was driven by our success in increasing our penetration amongst all market players and we firmly outpaced the growth in our targeted markets. We did this by continuously winning and adding to our customer roster, selling new products across our full customer base both to existing customers as well as further penetrating into new markets, and expanding our business with our existing customers' infrastructure.

Our quarterly revenues reached an all-time record of $9.9 million. This is a 45% growth over the fourth quarter of last year and 34% sequentially. For the year, we also reached an all-time record revenue level of $30.4 million, 48% higher than in 2009.

Beyond this, I believe there is more good news to come and we will continue to build our business and grow revenues throughout the coming years.

We are also just as pleased with our bottom line, reporting record quarterly net income growing 45% over last year and reaching $2 million for diluted EPS of $0.28. This represents a very strong net margin of 20%. For the year, our net income of $5.7 million and diluted EPS of $0.82 more than doubled those of last year, a substantial achievement for any company.

We also continued to increase our cash levels, ending the year with our strongest cash position yet at $45.8 million. This is an especially strong level of cash for a Company of our scale and provides us with more than enough working capital to continually expand our core business through R&D and marketing. It also places us in a position of strength when selling to customers and it also opens up many potential opportunities for us.

We see demand for our products from a market which is being driven by the continuing need for low latency and increased bandwidth for many applications, especially within the cloud computing and virtualized environment. The areas that we are particularly focused on such as one optimization and other Internet-based applications have seen no let up in the thirst for bandwidth. And while our growth is not necessarily dependent on the growth of these end markets, we do expect them to continue the growth as well for the foreseeable future.

We recently announced that one of our major customers, a worldwide leading provider of application acceleration, virtualization, and cloud computing solutions selected our solutions, including two encryption cards and one special networking card for their product. We won this customer only a year ago and its annual revenues run rate with us already reached approximately $3 million. This further deal is propelling the customer into one of the major contributors to our top line by potentially adding an additional $2 million to our yearly revenues.

This is a prime example of how a single design win with a diversified industry-leading company has the potential to grow into something which is even more significant. This will demonstrate that the scope of the business opportunities open to us from our existing client base is phenomenal. In fact, every market in which we operate -- in every market in which we operate, we have leading industry customers with potential to grow and become far more significant.

Even some of the startup companies that we work with have been coming forth as players in the market niches and our business with them grows as they grow.

Time and again, we have proven our success at not only penetrating new customers but also building long-term and successful relationships with them. Our customer base is a tremendous asset and we hope to bring you further news in the coming quarters of our success in unleashing and uncapping the vast potential in our customer base.

I would like to update you with regard to the fantastic success that the SETAC server to appliance converter has seen in only a short time since its introduction to the market. As you may recall, the SETAC allows easy conversion of servers to highly flexible customized network appliances.

Only a few months ago, we announced a breakthrough deal for SETAC with a Fortune 100 pioneering developer and builder of high performance server platforms and a Tier 1 security company. The deal has helped us to propel our SETAC into the limelight, placing it on the radar of many other top-tier companies and consequently we are seeing that SETAC is now much more readily accepted by the market than before.

Furthermore, following the formal launch of the appliances which are built under this major deal, we believe that most if not all of the initial market adoption hurdles for this game-changing concept will be removed, leading us towards what we want SETAC to be, a major revenue stream for Silicom.

In fact, we are now in the process of making SETAC available through a major Tier 1 server manufacturer and we believe that we will be able to bring some good news to you with regard to this within a few weeks.

In summary, our traditional business of server adopters continues to grow. This trend is driven by the addition of new customers, the sale of more products to current customers, the penetration of new divisions at existing customers as well as through wins with our customers' new solutions, all of which are on top of the growth of our market segments. Concurrently, our new product strategy and specifically the SETAC has both seen tremendous traction and consequently can significantly complement our revenue stream in the coming quarters and years.

As you can see from our outstanding results in the quarter and year, Silicom remains very much on the right track. Our ongoing performance demonstrates the power of the winning combination, favorable markets, our strong base of customers, as well as our industry-leading product and our ability to innovate.

We are confident that the trends that drove our results in 2010 will continue to strengthen and that debt combined with the growing momentum of our new SETAC product line, we will demonstrate continued topline growth in 2011.

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.

Thank you, Shaike, and hello, everyone. Revenues for the fourth quarter 2010 were at a record $9.9 million, a growth of 45% compared with revenues of $6.8 million in the fourth quarter of 2009. Sequentially, our revenues grew by 34% from $7.4 million last quarter.

Revenues for the full year of 2010 were at a record $30.4 million, growing 48% compared with $20.5 million as reported from 2009.

In 2010, we continued to improve our customer concentration. We had 310% plus customers in the year, which amounted to 36% of our revenues in the year. Our geographical revenue breakdown for the quarter was as follows, North America 76%; Europe and Israel 14%; and Asia Pacific 10%.

Our revenues were evenly split between bypass and non-bypass at approximately 50% each for both the quarter and the past year. This split has remained more or less constant for the past few quarters.

Gross profit for the fourth quarter of 2010 was $4 million representing a gross margin of 40.7%. This is compared with $2.7 million or 39.6% of revenues in the fourth quarter of last year. The gross margin does vary between quarters mainly as a result of the specific mix of products, products sold during the quarter.

Gross profits for 2010 was $12.9 million, representing a gross margin of 42.5%. This is compared with the gross profit of $8.1 million or gross margin of 39.3% for 2009.

Operating expenses in the fourth quarter was $2.1 million or 21.1% of revenues compared with $1.6 million or 23.7% of revenues in the fourth quarter of last year.

For the year, our operating expenses were $7 million or 23.1% of revenues compared with $5.9 million in 2009 or 28.5% of revenues. The strong improvement is a solid indication of the inherent leverage we have been able to demonstrate over the past year.

Operating income for the fourth quarter of 2010 was a record $1.9 million or 19.6% of revenues. This is a 79% increase over operating income of $1.1 million as reported in the fourth quarter of 2009 or 15.8% of revenues. For the year, operating income was a record $5.9 million or 19.4% of revenues compared with $2.2 million in 2009 or 10.8% of revenues, a growth of 166%.

Fourth-quarter 2010 net income was a record $2 million or 19.8% of revenues. This is a 45% increase compared with a net income of $1.4 million or 19.8% of revenues in the fourth quarter of last year.

Earnings per diluted share were $0.28 in the quarter compared with $0.19 in the fourth quarter of last year. Full year 2010 net income was $5.7 million compared with $2.8 million in net income last year representing growth of 103%. Earnings per diluted share for 2010 were $0.82 compared with $0.41 for 2009.

Now turning to the balance sheet, our net cash and equivalents at the end of the quarter totaled $45.8 million. Compared with the end of 2009, we generated $2.6 million in cash flow in 2010. Our current strong cash position represents a level of $6.66 per outstanding share.

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

(Operator Instructions). Marcel Herbst, Herbst Capital Management.

Congratulations to your record quarter. This is truly outstanding results. Do you know what experience MaxStar had so far bringing SETAC to their customers?

I am not sure I understood the question.

MaxStar in China, you had an announcement about nine months ago.

Whether they did contribute to what?

No, what experience they had so far bringing SETAC to their customers, what feedback they got and how successful they are, anything you can share?

Well, I mean what we know is that MaxStar has presented the SETAC to several customers. There is out of these customers, there is at least one customer who is seriously considering buying SETAC because of that. So we believe they are working. I mean, MaxStar will not be the only partner that we are going to have in China because we feel that they cannot cover enough of what should be covered in China. But yes, we believe that they are doing what they were supposed to do. They are presenting SETAC and they generate interest of SETAC.

Okay, good. Your OpEx increased sequentially about 25% over Q3. What were some of the main reasons for that and what level of OpEx should we expect going forward?

The reasons are mainly the dollar effect and also some one-time reasons. The expectation for the next year is I would say a little bit less than the level of quarter four and more than the level of quarter three. In other words, more than $1.7 million, but somewhat less than the level of quarter for.

Okay, what was the currency impact this quarter in dollars?

The dollar effective on operating expenses and on the financial expenses or financial income, the effect on the operating expenses is around $100,000. And the effect on the financial income is about $50,000.

Okay, and the one-time items in the quarter in dollars, how much was that?

I would say $100,000.

Okay, and this year you had -- you just mentioned the 42.5% gross margin. In the coming years, your product mix and revenue is likely going to change quite a bit. Where do you see a gross margin range two years down the road?

I believe that overall, it's going to be more or less the same. We have indeed, there are many new products. We are selling these new products at the average which is very close to the current average, so we don't see very significant changes other than those which are resulting from the mix of the products themselves, but the introduction of new products would not necessarily change the overall gross margin.

We do have some products with higher gross margins, but we do have regular products as well. So overall, I cannot and I am not expecting right now that our gross margin is going to increase and neither do I think that it's going to be reduced.

Okay, your gross margin this quarter was a bit lower. Was this all because of product mix or were there other reasons?

This is the main reason. We think that it's important to see the yearly gross margin and to see that the gross margin in 2010 is better than the gross margin in 2009.

Okay, and what's the sales percentage of your 10 gigabyte product this quarter?

25%.

And how is the pipeline for the redirector product line looking?

It is looking very good. As a matter of fact, we have able to increase our sales of redirector products in this quarter as well. We are having now several customers which are seriously consider that in addition to the customers who are already using it. The customers who are using it and especially our major customer who is using it, bought a lot more of this card than they used to buy and to them that demonstrates a real success of that product, which we are now using when we're approaching other customers. So I think the pipeline is building well both with the current customers and with new customers.

That sounds great. Now, your revenue momentum has been truly excellent in Q4. Should we expect some seasonality in Q1 or do you see the strength extend into this quarter?

I think that you will see the strength, but that -- but by saying that, I don't mean to say that necessarily our revenues in Q1 will be higher than in Q4. But I hope that -- I hope and believe that you will be able to see that we are strong in terms of growth year-over-year. But it's even a little bit more than that because I'm not just saying we will be selling more than last year. I think that the results will demonstrate the strength on the one side, but on the other side as I said, not necessarily we are going to sell more than $9.9 million.

Thank you, that's all for me.

Don McKiernan, Landolt Securities.

Thank you and also congratulations on just a phenomenal quarter and end to the year. I want to know how many bypass units and non-bypass -- I know you gave the revenues, but in terms of units?

Okay, in quarter four, we sold 25,600 units, of which about 11,300 units were bypass and 14,300 units were non-bypass.

Okay, and then the major SETAC customer you announced several months ago, has that customer launched their products yet?

No, not yet.

When will that -- any color on that?

Well, it's supposed to happen soon. As you can imagine, there could be a lot of considerations, not all of which we were aware as to when exactly they will launch it, but we understand it's going to happen soon.

Okay, can you give us an idea of how much impact revenues were impacted by SETAC in the quarter and then in the year? Did we see much at all from SETAC last year?

Well, Eran will be able to provide you with the number, but I can tell you that we sold SETAC units more than what we thought that we would sell last year. I believe that Eran has the data.

Yes, SETAC sales in quarter four were 4% and for the full year, SETAC sales were slightly above 2%. It was about $700,000.

Which again is more than what we thought we would sell in 2010.

Right, right. Can you comment about your encryption product? Are they -- in terms of percentage of your revenues and maybe the momentum that's taken place with that product area?

First of all, I think that encryption products as well has become something which is no longer negligible. At the moment, there could still be ups and downs because we only have I think maybe two significant customers for these. But as you may remember, we have just announced -- I think it was just about a week or a week or something ago about another significant win which mostly included encryption products. So we believe that encryption product's role in 2011 is going to be even more significant than in 2010, which means another growth factor for us.

Right, well, thanks for taking my questions and again, congratulations, and good luck this year. Thank you.

Jeff Meyers, Cobia Capital.

Good. Thanks, guys. Congrats on this quarter. I guess really one question. Most of my questions was answered but in terms of tax rate going forward, how should we think about that?

Okay, first of all, the effective tax rate in 2010 was below 15%. It was about 12% to 13%. I would say that the percentage will be quite similar in 2011, which means 15% or slightly lower than that.

Got you. Okay, great. Thanks a lot, guys.

(Operator Instructions). [George Marymount].

Good morning. I had one question about your inventory. Since most of your products were made I understand by Flextronics, what is the nature of your inventory that you hold?

Well, first of all, I would like to say that it is not accurate to say that most of our products are made by Flextronics. Our inventory includes everything that is needed to build our cards. That includes from component to finished goods, everything. There isn't any part of what we need in order to build the cost which is held as inventory of others but still belongs to us.

And most of our production by the way, we are making it in-house and that does not mean that we have SMT machines or anything of that sort. But we are those who are buying the components. We are those who are preparing the kits. We then ship the kits to subcontractors who are doing the assembly and are doing only the assembly, they are not turnkey manufacturers. So the inventory is ours even when it's there because they are only subcontractors for the assembly and then the finished cards or the assembled cards are coming back to Silicom for final assembly and testing.

So that is the model that we are acting with with almost all our customers. And once again, everything which is needed to build the cards or including cards which are finished goods is included in this inventory.

I see, thanks for the clarification on that. Also during your prepared remarks, you'd mentioned that on SETAC, there perhaps may be more good news in the next several weeks. Is this an additional Tier 1 or are you talking about the Tier 1 you've previously announced?

Additional.

Additional Tier 1, possibly. Okay. And are you -- have -- when you see a Tier 1, we're talking about -- would this be in conjunction again with a security vendor or would a platform vendor perhaps be interested on their own?

No, in this case we're talking about a platform vendor.

I see. And about how many Tier 1 companies in the world -- let me rephrase that. Are all the Tier 1s in the world aware of this product, as far as you know?

Well, at least I think that at least there is someone within these Tier 1 companies who is aware of these products. The awareness level of all these Tier 1s is not the same. Some of them, as I mentioned before, some of them is considering that very seriously, which is why we said that we hope to bring some good news within a few weeks. Others are aware of that and we are at a different stage or different level of the process moving forward with them.

The one thing which I believe is important is that last time we have had a success with one of these companies, that were Fortune 100 companies that we mentioned before, and a Tier 1 security company. Now hopefully again this is supposed to be happening within a few weeks, we will have another one. The more Tier 1s we get, the easier it becomes for the other Tier 1s to adopt this concept as well. Because it becomes a trend and when it becomes a trend, it's easier to move forward. Because we need to remember that this is a relatively new concept. A new concept, they always have some hurdles when they go to the market.

But once it is selected by a Tier 1 and then another Tier 1, then most of the other players in the market including the other Tier 1s understand that these hurdles are disappearing or about to disappear.

Yes, okay, that's sort of -- was the essence of my question is if you're starting to see any move from a push model to a pull where they are actually demanding it from you? So hopefully that will happen during 2011 and 2012, then.

Well, I think that to a certain extent this is a combination. Because many times with these Tier 1 customers, it's a dance. They are calling on you and asking a question and then you are coming and explaining some more. So I wouldn't say that it's a pure push. It's a pull and push. It's not entirely pull and hopefully just like you said, it would move more towards a pull than a push but even right now, it's some sort of combination.

Excellent, thanks for the clarifications.

Walter Ramsley, Walrus Partners.

Thank you. Congratulations. Another great quarter. I've got a couple of questions. Could you update the number of customers the Company has now? And how many of those customers were involved in the revenues this quarter?

We have a customer base of 70 plus customers. I don't have the exact number but I can say that 30 or 40 of them contributed to the revenues in this quarter.

Okay, and of the revenues in the quarter, do you have a number for how many -- how much was generated by existing customers compared to new ones?

We do not have this data.

But I would also like to add to that that new customers, typically they start slow and then they grow and also you need to define a new customer. If you define a new customer by a customer who started to buy this quarter only, then if this is the definition of new, then it would always be a very low figure because when we start with a new customers, and we just started because it's the first quarter per the definition that I just used, then it's always going to be very low. Because this would be the first evaluation unit or pilot unit, etc.

I understand. Was there any change in the competitive climate this quarter?

I don't think so.

Okay, and as far as the cash reserves are concerned, any thought towards acquisitions?

Thoughts? Always. Nothing specific at this point. We are always looking -- we continuously investigate the market, the companies which are selling to the same customers with a similar or even not so similar technologies. We are always looking at that. There is nothing specific at this port.

Okay, great. Well, once again, congratulations. I appreciate it.

Don McKiernan.

Thank you, just curious about the patent situation with SETAC. Can you give us the latest on where you're at?

Patent pending. It has been submitted. I'm not sure -- we have not received any questions as of yet, is that right?

Correct.

We have not received any questions or anything. So we are waiting.

And you started the process a year and a half ago, maybe, is that right?

A little more than a year ago, I think.

We submitted the full patent less than a year ago.

Great. Thanks again.

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 at www.veidan.co.il.

Mr. Orbach, would you like to make your concluding statement?

Yes, 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 the aim of bringing you another record year and the ultimate goal of increasing value for shareholders over the long-term. We look forward to hosting you on our next call in three month's time. Good day.

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