Silicom Ltd (SILC) 2011 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Silicom's first quarter 2011 results conference call. All participants are at present in a listen-only mode. Following management's formal presentation, instructions will be given for the question and answer session. As a reminder, this conference call is being recorded, April 21, 2011.

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 new section of the Company's website at www.silicom.co.il.

I would now like to hand over the call 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 first quarter 2011 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 or any predictions 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 Silicom's products, the timing and development of 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.

In addition, following the Company's disclosure of certain non-GAAP financial measures in today's earnings release, such non-GAAP financial measures will be discussed during this call. Such non-GAAP measures are used by management to make strategic decisions, forecast future results and evaluate the Company's current performance. Management believe that the presentation of these non-GAAP financial measures is useful to investors' understanding and assessment of the Company's ongoing core operations and prospects for the future.

Unless otherwise stated, it should be assumed that financials discussed in this conference call will be on a non-GAAP basis. Non-GAAP financial measures disclosed by management are provided as additional information to investors in order to provide them with an alternative method for assessing our financial condition [and] the operating results. These measures are not in accordance with or a substitute for GAAP. A full reconciliation of non-GAAP to GAAP financial measures is included in today's earnings release, which you can find on Silicom's website.

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 Eran, who will provide the analysis of the financials. We will then turn over the call to the question and answer session.

And with that, I would like to hand over the call to Shaike. Shaike, go ahead, please.

Thank you, Kenny. Good morning, everyone, and welcome to our first quarter 2011 results conference call. Today, we demonstrated an excellent start to 2011 with another set of very good results. Our results represent growth in all parameters, and we have set the stage for what we believe will be another great year ahead for our Company, with continued strong year-on-year growth in revenue and profit.

We delivered robust top line growth, coming in at 43% over last year. We generated strong sales across all our product lines, at all our major customers, in all our target markets. It is very important to note that our growth is diversified across the board and not due to any one customer or a particular target market.

This was due to both, one, continued strong execution across our core business with market share gains; and, two, the increasing contribution from our new growth engines, such as 10 Gigabit per second cards, intelligent cards, encryption cards, external bypass units and, obviously, SETAC.

The demand for our products in all our served markets remained strong during the quarter, driven by the ever continuing and growing need for bandwidth capacity for many applications. This is especially true today, given the strongly expanding cloud computing and virtualized environment markets.

We are also just as pleased with our bottom line, reporting net income for the quarter, growing by 87% over last year, and reaching $1.9 million, or a diluted EPS of $0.27. This accomplishment confirms the exceptional profit generating potential and success of our business model.

We also continued to increase our cash levels, ending the quarter with $46.9 million, or $6.81 per outstanding share. This is an especially strong level of cash. As I've said before, these cash levels place us in a position of strength when selling to customers, many of which have a lot of cash themselves, and require this from their suppliers to guarantee a long-term relationship.

In addition, it provides us with a substantial level of working capital, enabling us to continually expand our business through R&D and marketing. It also places us in a continued position of strength to take advantage of any opportunities that may arise in the market.

I'd like to talk about some of the potential within our customer base. During the quarter, we announced a major design win at the security business unit of our top Fortune 100 networking customer. The customer's security business unit has selected our multi-port server adapters for its new firewall appliances. As we are already working with most of the industry leaders, the penetration of a new division as an existing customer is always a major goal for us, typically representing a significant opportunity.

This win represents phenomenal potential for us, with revenues expecting to initially ramp to $2 million in the first full production year. From a strategic standpoint, this win is especially important.

Firstly, it demonstrates the strength of the relationships we have with our existing customers, and the satisfaction they have with our service and products. Our customers, or another division at their organization, now initially turn to us as their natural and preferred supplier when seeking a new solution.

Secondly, this design win replaces an internally developed customized solution at this customer. This type of competing solution is very difficult for us or any external supplier to dislodge. The fact that we successfully replaced their internal solution indicates how much value our solution adds to their products.

Given that in the past we had already penetrated another one of the customer's business units, selling WAN optimization appliances, we had a powerful reference behind us. This new business unit gave us an opportunity to prove ourselves with a specific challenge in one of its appliances, and impressed by the speed of response and the technological excellence of our solution, immediately recognized the advantage in utilizing our product in conjunction with its own.

As such, the customer has a high level of confidence in our technologies and solutions, an asset which we have successfully built up over time. We see significant further potential, as this particular customer may consider deployment of our solutions throughout its portfolio. In fact, this customer has already begun evaluating our external bypass solutions for an additional appliance.

We also announced at the beginning of the quarter that another one of our major customers, a worldwide leading provider of application acceleration, virtualization and cloud computing solutions, selected our solutions, including two types of encryption cards and one special networking card.

This customer was relatively new, going back only a year, and its annual revenue run rate with us has already reached approximately $3 million. This further deal is propelling the customer into one of the major contributors to our top line, potentially adding an additional $2 million to this run rate.

These two wins are classic examples of how one single design win has the potential to grow into something much more significant down the road as our relationship with the customers cements. Each win represents unlimited opportunity for further design wins with the same customer, with the associated significant ongoing flow of orders. As you can see, the scope of untapped business opportunities available to us just from our existing client base is immense.

Both of the two wins I just spoke about were with existing customers. These wins are in addition to the new customer wins that we continuously add to our portfolio. Given that the growth potential of any such new win is far beyond the scope of the specific win, our growth potential remains huge.

As we have announced in the past, even some of the small startup companies that we work with have become important players in the market niches, and our business with them grows as they grow.

I would like to now update you with regard to the continued success that the SETAC, our Server to Appliance Converter, which has far exceeded our initial expectations.

As you probably saw, during the quarter, we announced a major milestone achievement for our SETAC. A Tier-1 server manufacturer will offer appliances integrating our SETAC into one of its standard servers, allowing it to become a highly flexible customized network appliance.

What is most important though is that these appliances will be offered by the manufacturer's OEM group, a professional team which maintains contact with the majority of the relevant customers in the appliance market, offering our SETAC significant market exposure.

In addition, the appliances will also be sold and supported by one of the manufacturer's strategic partners and major global provider of purpose-built platforms and appliances, and this company will also carry out the actual conversion of the manufacturer's servers to SETAC-based appliances.

From an exposure point of view, the SETAC is moving into the spotlight, benefiting from the marketing efforts and recommendations of the manufacturer's OEM group and its customization partner.

We believe that this significantly grows the long-term potential of SETAC, which positioning us to continue accumulating important market wins. We are seeing the SETAC gradually transforming into the important revenue growth driver that we predicted it would become when we launched it. In fact, just in the first quarter of 2011, we generated the same level of revenues from SETAC as we did during the whole of 2010.

In summary, our business continues to power ahead, both our traditional business as well as our new growth engine, in particular the SETAC. This trend is driven by the addition of new and loyal customers which buy from us repeatedly, the penetration of new divisions of existing customers, and the sale of more products across our entire existing customer base.

Silicom remains very much on the right track with significant future potential. Our ongoing performance demonstrates the power of a winning combination, favorable markets, our strong base of customers, as well as our industry-leading products and our ability to innovate. In only the past two years, we've developed a continuous flow of new product families in areas such as 10 gigabit, redirection, encryption, external bypass and, obviously, SETAC.

We're expecting that 2011 to be another very strong year of growth and development for Silicom. In light of continuing market interest, increasing success with top tier customers and demand for our product, we strongly believe that we will show significant growth in 2011 over 2010. We believe that a significant potential inherent in our large and satisfied customer base will help us continue to deliver this growth going forward.

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?

Thank you, Shaike; and hello, everyone. Revenues for the first quarter of 2011 were $9.2 million, a growth of 43% compared with revenues of $6.4 million in the first quarter of 2008 (sic - see press release).

Our geographical revenue breakdown for the quarter was as follows; North America, 72%; Far East, 15%; Europe and Israel, 13%.

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

I will be presenting the rest of the financial results on a non-GAAP basis, which excludes the non-cash compensation expenses in respect of options granted to employees and directors. For the full reconciliation from GAAP to non-GAAP numbers, please refer to the press release we issued earlier today.

Gross profit for the first quarter of 2011 was $4.0 million, representing a gross margin of 43.4%. This is compared with $2.7 million, or 42.4% of revenues in the first quarter of last year. The gross margin does vary between quarters, mainly as a result of the specific mix of products sold during the quarter.

Operating expenses in the first quarter of 2011 were $2.1 million, or 22.9% of revenue, compared with $1.6 million, or 25.6% of revenues in the first quarter of last year. The continued weakening of the US dollar versus the Israeli shekel contributed significantly to the increase in our operating expenses.

Operating income for the first quarter of 2011 was $1.9 million, or 20.6% of revenues. This is a 75% increase over operating income of $1.1 million as reported in the first quarter of 2010, or 16.8% of revenues.

First quarter 2011 net income was $1.9 million, or 20.5% of revenues. This is an 87% increase compared with a net income of $1 million, or 15.7% of revenues in the first quarter of last year.

Earnings per diluted share were $0.27 in the quarter compared with $0.14 in the first quarter of last year.

Now turning to the balance sheet, our net cash equivalents at the end of the quarter totaled $46.9 million. We generated $1.1 million in positive cash flow in the quarter. Our current strong cash position represents a level of $6.81 per outstanding share.

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

Thank you, gentlemen. Ladies and gentlemen, at this time, we will begin the question and answer session. (Operator Instructions). Marcel Herbst, Herbst Capital.

Congratulations to an excellent quarter and execution. You mentioned that the Tier-1 server manufacturer has started to offer SETAC with one of its standard servers. When did they release that product to the market? And are there any early indications on end user acceptance and feedback?

Well, you need to understand that, as I've said, this product is going to the market through the server manufacturer's OEM group. This means that it's not a standard offering. It goes through the OEM group, which is operating a little bit differently.

And when I say a little bit differently, it's that this group, just like anyone in the OEM market, it is not some sort of a general release, but it's rather knocking on the doors of the specific customers which are candidates for this kind of solution, and offering it to these customers specifically, which is what the server manufacturer is doing.

And from what we're hearing with them, there is definitely acceptance I would say of the concept. Having said that, just like we said with regard to our cards, and it's even more emphasized with the concept of SETAC, the sales cycle is relatively long, because the customer -- and this time not only it means evaluation and testing, and so on and so forth, but indeed, acceptance of a concept which is somewhat different.

So what we understand is that basically this acceptance is happening. The sales cycle is long, and this server manufacturer is, indeed, knocking on the doors of the relevant customers with this solution right now.

Okay. And now you also had a second large SETAC release where you collaborated with two other companies; a security company as well as another Tier-1 server manufacturer, and they were -- where the security company was releasing a specific product. Has that been released already? Or when do you expect that to be released?

Okay. Indeed, this other release that we have done, I think we made that in August last year, this is indeed different, because this involved a customer, I would say, which is using SETAC.

Now I am not sure exactly what are going to be the means of that customer to release his appliance, and how and who [he] would like to advise about that, but what I can tell you for sure is that this customer is buying SETAC units from us, which seems to be me as if he's selling these units.

And part of what I've said about selling SETAC units in Q1 at a value which is, I would say, more -- not more, more or less identical to everything that we did in 2010 is because we're selling SETAC units to this customer, which is a big customer.

So he's buying. We know for sure that he is not just buying for inventory. So he's selling these units, but he may be selling them without advertising that in a website, or whatever. He has his own consideration for that. But this product is in the market.

Excellent. And a quick housekeeping question; your inventory has been rising with higher revenues, and where do you plan for inventory to level out?

Can you repeat the question, please?

Yes, I said that your inventory levels, obviously, have been rising with higher revenues, and I was wondering where you plan for inventory to level out. What's your target there?

What do you mean exactly by to level out?

What do you see as a healthy level for your inventory given your revenue projections? Will we be seeing much higher inventory levels from here on out going forward? Or are you higher than you planned? Are you trying to reduce from here? What is the --?

I understand the question now. I apologize for not understanding that at first.

We believe that the current level of inventory is good for us looking forward towards the next quarter.

If things will happen in a way which is better than what we think, then the inventory level may even grow further. But based on the plans that we currently have, or think or believe, then the level of inventory right now is what we should have.

Okay. I also see a bit higher level of R&D expenses this quarter. Anything in the R&D product pipeline that you can talk about? And also, what level of operating expenses are you targeting going forward?

Okay. In terms of the R&D, so first of all, we are continuously, obviously, working on various projects of R&D. I do not see anything which is really specific in this quarter for R&D, even though it is true that in this quarter the expenses in R&D were a little bit higher than, let's say, in the previous quarter, or whatever.

But R&D, especially when a part of the R&D is working with subcontractors, etc., so it's not exactly flat, even the level of an effort is flat, but there are fluctuations, I would say, in the level of R&D and expenses, and that's what we are seeing right now. I don't think that we're seeing anything specific.

In terms of operation expenses, then maybe, Eran, you would respond to that?

I would say first of all, as it happens every quarter, it depends on the dollar rate versus the shekel. Assuming a similar dollar rate in the next few quarters, I would say that operating expenses will be more or less as we saw this quarter; perhaps somewhat lower than that.

Okay, excellent; thank you very much. Again, congratulations to a great start in the New Year.

Thank you.

Ken Nagy, Zacks Investment Research.

Congratulations on a great quarter. I was just curious with the design win in SETAC, how long that design win takes to become meaningful revenue.

You're asking about the general SETAC design win?

Yes.

Well, if it's a general SETAC design win, then typically, it would be, I would say, between three months to six months that we see, I would say, revenues which start to become significant.

Typically, when we announce a design win about anything, not only about SETAC, in most cases, not in all of them but in most cases, we already have some sort of revenues, because unless it is a very special case, we announce a design win when the customer starts buying some evaluation units, etc.

So the process typically starts with a customer saying, okay, we've decided to work with you. Now I'm buying some evaluation systems, which there's already some sort of revenues. And then moving forward, he would go into qualification. Qualification testing would require more units, so the level of revenues will increase, but still it would not be production. And then it would go into pilot production, and then it would go into serial production.

So I would say that between the pilot and the serial would take us to the period between three months to six months after a design win has been reached.

Okay, that's great. Thank you. Congratulations on a strong quarter.

Thank you.

Don McKiernan, Landolt Securities.

You guys are doing a terrific job. The dollar/shekel conversion, I think you said there was a negative impact on the quarter. Do you have a dollar amount on that?

Yes, first of all, as we said earlier, there was a negative impact of the dollar on our operating expenses. I would say that the amount is about $100,000 to $200,000.

$100,000 to $200,000?

On our operating expenses.

Right. And then on Redirector, are you still getting revenues just from one customer, or have you expanded that to more?

We are receiving revenues from more than one customer, but there is still one customer which is by far bigger than the others. We don't have any major customers the size of the first one for the Redirect as of yet.

And I don't know if this is a question you can answer, but I'll throw it out there. Any idea what the addressable market is for SETAC?

For SETAC?

Yes. It's substantially bigger than what you had before you brought SETAC out, correct?

Yes. I'm sure about that. It's just like -- if you look at that overall, so look at the world of appliances and there are cards in the appliances.

So speaking in a general term, because right now when we're selling SETAC, we're just selling the kits for SETAC, but looking forward, not necessarily we will stop there.

So if you look at the best case scenario in terms of markets, so why when we were selling cards, we were selling cards which are a part of an appliance. So now with SETAC, the market is actually the cards and the appliance and everything in it.

Okay. And have you secured any patents yet for SETAC, or is that still in progress?

It's in progress.

It's in the process.

Okay. And then the last question; percentage of revenues coming from encryption, 10 gig and SETAC in the first quarter; percentage of the first quarter revenue?

Yes, regarding the 10 giga, the percentage in quarter 1 was 26%, which is obviously higher than the percentage in 2010. You asked about the security?

Encryption, yes.

Security, SETAC.

Okay, regarding security --

Encryption and SETAC.

The security's about 5%, and the SETAC is 7%.

7%?

Yes.

And as Shaike said earlier, the total sales -- the total revenues from SETAC in quarter 1 is more or less equal to the total amount in 2010.

Right. And then one last question I forgot. The number of bypass and non-bypass units sold in the quarter?

Okay, altogether, we sold about 23,000 units, of which about 10,200 are bypass cards; and the remaining is non-bypass cards.

Okay, great. Thanks for taking my questions.

Walter Ramsley, Walrus Partners.

Congratulations, a great quarter; most of my questions have been answered. I was curious about the tax rate though; was 9.5% in the first quarter. Do you expect that to be the rate for the entire year, or what is the outlook?

Yes, I expect that the current tax rate, as we saw in quarter 1, will be more or less similar to the remaining of 2011, which means an effective tax rate of around 10%.

Okay. And the operating margin was 20.6%, if you exclude stock option expenses there. Do you see that as being stable for the year, or is there a likelihood of it increasing or decreasing; or what do you think?

First of all, it obviously depends on the level of revenues; that's obvious. And I would say that the GP in quarter 1 is more or less at the level we saw in 2010, and we expect it to be more or less the same in the next quarter.

Regarding operating expenses, as I said earlier, first of all, it depends on the dollar level. Assuming more or less a similar dollar rate, I would say that we will see a similar level of operating expenses, or somewhat lower than that.

Okay. And as far as the pricing that the Company itself charges for the bypass and the non-bypass products, is that sloping lower, or is it steady; or what's the situation as far as your own pricing goes?

We are under constant pressure to reduce our prices to our customers. And we do that; we reduce our prices to our customers. Obviously, we're trying to keep this reduction to a minimum, but we reduce our prices.

At the same time, we're applying the same kind of pressure, if not even more than that, to our suppliers. Which is why -- and we are very successful with that.

And that's why I agree, and that's why Eran said what he said, that we believe that we will be able to maintain more or less the same level of gross profit in our products, and that's even though the prices by which we sell are being reduced every quarter, I would say, by a certain amount. Not too high, but they are being reduced. So are the prices by which we buy from our suppliers.

Okay. And just one last thing, I guess. In the SETAC arena, are there other competitors who have caught on to what you're doing and beginning to duplicate your approach, or what's going on on that front?

Well, I cannot say that we have seen competitors who are duplicating our approach. I think that it's also a known fact that we've applied for a patent for that. And also, the fact that we were able to build in a very short time a series of modules, makes it a little bit difficult for them to just propose the solution, because it would take them quite some time. We have been building that slowly throughout, I would say, the last two years to get to a critical mass of modules which are a part of the solution that others find more difficult to do.

But what we do see is actually two things, and they're good, I think. One is, we see that people are looking, including competitors, not necessarily direct competitors, but I would say competitors by concept, that they're trying to find out solutions which would give at a least a partial response to the need to which SETAC is actually providing a response.

For example, people are taking the motherboard, or a standard motherboard, because they know that a standard motherboard is better than a customized motherboard, and they're just turning it around and build a customized chassis. So doing that, they have a standard motherboard which is supposed to be mature, just like the approach that we promote in SETAC, but they have a customized chassis, and they don't have the modularity, because they still need to open the chassis in order to replace the cards inside.

But we do see that people are looking for solutions. These people, when we are coming to them with SETAC, they are, I would even say immediately say, well, okay, let's try it this way, because they like our solutions better from that perspective.

Another field that I'm optimistic is because I'm getting responses for -- from the manufacturers of customized appliances, the Taiwanese companies which are actually our competitors, and they're concerned by SETAC, and that's good.

[I like that]. Okay. I guess just one other thing. The Tier-1 server company that Silicom is working with, are you going to ever be able to identify that Company, or will it forever be a secret?

The Tier-1 server company that we announced in this quarter?

Yes.

Well, I do not think that we will be able to release the information, but I think that eventually, you will be able to know, and I don't think it's going to take much longer.

Okay. Anyway, congratulations. You guys are doing great. Thanks.

Thank you.

(Operator Instructions). Edward Balinsky, [Segmark] Capital.

Given the volatility in the Middle East, it's quite possible that Israel and New York capacity to deliver from Israel would be affected, even -- as I say, even if you're an innocent bystander in what is going on. What have you done, or been able to do with regard to assuring your customers that -- since I assume that at the present, the sole source of supply for the product is Israel. A, have you lost any customers because of the apprehension? And what kind of assurances have you been able to give your customers that you would be able to continue supply in the event of some kind of disruption?

Okay. As you have mentioned, we are working with very significant customers. These customers, indeed, just like you said, they require us to have what is called DRP. DRP's standing for Disaster Recovery Plan. And this is a plan by which we are required to indeed give them all the assurances, and give them, I would say, a plan as to how we would be able to operate if something happens which makes it impossible for us to deliver from our Israeli base.

We do have this kind of a DRP. We have developed a DRP. We have developed partnerships with companies in Asia who would be able to take over the manufacturing in a case something like that did happen. These DRPs have been approved by these customers who have been requesting them.

And just as an anecdote, I would add that one of our major customers just last month, this month, in April that was, has visited one of our Asian partners in order to make sure that indeed this DRP is in place; and to the best that we know, he didn't have any reservations, after making this visit.

All right, fine. Thank you very much then.

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 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. And thank you, everybody, for joining the call. We look forward to hosting you on our next call in three months time. Good day.

Thank you, sir. This concludes Silicom's first quarter 2011 results conference call. Thank you all for your participation. You may go ahead and disconnect.