Silicom Ltd (SILC) 2011 Q2 法說會逐字稿

Welcome to Silicom's second-quarter 2011 result 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 25, 2011. I would like to remind everyone that forward-looking statements for the respective Company's business, financial condition, and results of its operations are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated. Such forward-looking statements include but are not limited to product demand, pricing, market acceptance, changing economic conditions, risks in product and technology development, and the effect of the Company's accounting policies, as well as certain other risk factors which are detailed from time to time in the Company's filings with the various securities authorities.

If you have not received a copy of today's press release and would like to do so, please call CCG Investor Relations at 1-646-201-2946 or view it in the news section of the Company's website, www.Silicom.co.io.

I would now like to hand over the call to Mr. Ehud Helft of CCG Investor Relations. Mr. Helft, would you like to begin, please?

Thank you, operator. I would like to welcome all of you to Silicom's second-quarter 2011 results conference call. With us on the line today are Mr. Shaike Orbach, the CEO; 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 turn over the call to the question-and-answer session.

Before we start, I'd like to draw your attention to the use 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 believes its presentation of these non-GAAP financial measures is useful to investor understanding and assessment of the Company's ongoing cooperation and prospects for the future. Unless otherwise stated, it should be assumed financials discussed in this conference call will be on a non-GAAP basis.

Non-GAAP financial measures disclosed by management are provided as an additional information to investors in order to provide them with an alternative method for assessing our financial conditions and operating results. These measures are not in accordance with or subject to 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.

And with that, I would like to now turn over the call to Shaike. Shaike, please.

Thank you, Ehud. Good morning, everyone, and welcome to our second-quarter 2011 results conference call. Today we demonstrated outstanding results, which exemplify our continued top-line growth momentum. We also achieved new records in operating and net income, with excellent margins across the board.

Over the past few quarters, we have continually met and surpassed milestone after milestone. It is a demonstration of how the momentum in our business remains strong and is accelerating. All in all we are extremely pleased with our performance in the second quarter.

We delivered robust 39% top-line growth over the second quarter of last year, with increased and diversified sales across all our product lines. The growth was driven by strong order momentum from most of our major customers across all our target markets. The demand for our products in all our served markets remains solid, including an increased contribution from our new growth engines such as the 10-gigabit-per-second cards, intelligent cards, encryption cards, external bypass units, and SETAC.

Growing global Internet traffic as well as the expanding IT trends of cloud computing and virtualization have driven the need for connectivity and increased bandwidth capacity for many applications. The infrastructure to support this has to be built out, creating a significant need for network appliances.

The markets supporting these trends are growing quickly, and we expect our sales to continue to exceed the growth rate in our end markets. Our products are very well positioned at the epicenter of these market trends and are the core critical building blocks for the next-generation servers and appliances.

We are also just as pleased with our bottom-line performance in the quarter, with net income growing by 45% over last year and reaching a record of $2.1 million, or diluted EPS of $0.30. This accomplishment confirms the exceptional profit-generating potential and success of our business model.

Our cash level remains strong, and we ended the quarter with $46.8 million. Maintaining a high cash level is important for us, as many of our customers require balance sheet strength from their suppliers to guarantee a long-term relationship with continued product supply and support.

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

Our current base of over 75 OEM customers provide us with stable and growing ongoing business, with additional unlimited potential for repeat orders and new design wins. During the quarter, we continued to see very positive momentum from our newer products selling to both current and new customers.

We announced two new design wins for networking modules, a product line launched as a part of our SETAC strategy, which is based on our clients' particular needs. We also announced a design win for an enhanced version of our 10-gigabit-per-second Intelligent external BYPASS Switch, or IBS for short.

One of the networking module design wins was with one of our major long-time customers, a dominant player in the global security market, which will use our modules in several appliances to enable the reconfiguration of ports without needing to open the appliance chassis. The other module design win was with a leading player in the network traffic management and policy enforcement industry.

This demonstrates how our SETAC strategy can evolve and provide additional revenue streams which are derivatives of the basic set of concepts. This also demonstrates why the SETAC is such an important part of our strategy.

The design win for our enhanced IBS is also an important achievement for us. It demonstrates that our Intelligent solution concept is being accepted by the market, as it answers a real need faced by the network appliance industry. With annual revenues from this one design win expected to exceed $1 million, and with several more significant IBS opportunities in our pipeline, we see significant potential for the IBS to become an important future growth driver for our business, while further expanding our total addressable market.

The recent design wins confirm many aspects of our business model. One, the nearly unlimited potential of our existing customer base and the power of our relationships, which we can tap for future business. Two, the ability of our reputation for innovation and service to attract new customers. And three, the value of our differentiating abilities to create out-of-the-box solutions for customers' unmet needs.

In summary, our success over the past few quarters reflects the power of our differentiated products, our reputation for innovation and service, and our deep understanding of our served markets which enable us to win business. Our design-win momentum continues to build, driven by the addition of both new and loyal customers which buy from us repeatedly, the penetration of new divisions at our existing customers, and the sale of new products across our entire existing customer base.

We have a very powerful business platform, drive for future growth, and supported by very favorable global IT trends on which we are well positioned to capitalize. Looking ahead, we believe that we will show significant growth ahead of that of our industry in 2011 over 2010, and we expect to continue growing in 2012 and beyond.

We see continuing market interest, increasing success with top-tier customers, and demand for our products. We believe that the significant potential inherent in our large and satisfied customer base will help us continue to deliver this growth moving 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 second quarter of 2011 were $9.4 million, a growth of 39% compared with revenues of $6.7 million in the second quarter of 2010. For the first half of 2011, we achieved a record $18.5 million, 41% growth compared with $13.1 million in the first half of 2010.

Our geographical revenue breakdown for the first half of 2011 was as follows. North America 73%; Europe and Israel 15%; Far East 12%. Our revenue split for the first half of 2011 between bypass and non-bypass was -- bypass 50%; non-bypass 50%.

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 second quarter of 2011 was $4.1 million, representing a gross margin of 44.3%. This is compared with $3 million or 44.1% of revenues in the second quarter of last year. The gross margin does vary between quarters, mainly as a result of the specific of products sold during the quarter.

Operating expenses in the second quarter of 2011 were $2 million or 21.9% of revenues, compared with $1.5 million or 22.4% of revenues in the second 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 second quarter of 2011 was $2.1 million or 22.4% of revenues. This is a 44% increase over operating income of $1.5 million as reported in the second quarter of 2010, or 21.6% of revenues.

Second-quarter 2011 net income was $2.1 million or 22.3% of revenues. This is a 45% increase compared with a net income of $1.4 million or 21.4% of revenues in the second quarter of last year.

Earnings per diluted share were $0.30 in the quarter compared with $0.21 in the second quarter of last year.

Now turning to the balance sheet, our net cash and equivalents at the end of the quarter totaled $46.8 million and remained at around the same level as at the end of the first quarter. Our current strong cash position represents a level of $6.79 per outstanding share.

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

(Operator Instructions) Ken Nagy, Zacks Investment Research.

Congratulations on a strong quarter. I was just -- just had a couple of quick questions on SETAC. Just wondering if you are seeing strength in SETAC in any one specific area, or if it's across the board.

Then also, when you sign a typical SETAC client, how long does it take to be transformed into meaningful revenue?

Okay. First of all with respect to SETAC, we do see I would say specific strength in SETAC in the security market, security appliances market. We believe that this would be the area for which SETAC would be the most interesting one.

We do see interest in SETAC in other market segments as well. But I believe that in the security market it will be the most dominant. So that's one part of it.

The other part of it, actually there are two cycles which has to be combined together until we start to see revenues when you are talking about SETAC. So the first process is actually the sales cycle.

The sales cycle by itself is long. And when I am saying the sales cycle, it means until there is a final decision to go ahead with SETAC. Unlike our cards, this is a more complex decision I would say because a customer needs to decide about the whole configuration of his appliance rather than just only a card.

Right.

So the sales cycle takes longer. After a customer reaches a decision to use SETAC, then it still takes him some time to conclude all the qualification and testing and certifications for safety and security, etc., before he really launches that. And that takes another time.

So all in all I would say that it's quite a long process, which is why we were surprised by the fact that some customers ran so quickly and adopted that and we are actually having revenues with SETAC right now, which is actually quicker than what we thought.

Right. Great. Thank you.

Don McKiernan, Landolt Securities.

Thank you. I was looking at the inventory numbers. At the end of June you are up to $11.347 million, and that's up from $9.662 million at the end of March, and $8.162 million at the end of December. So in six short months it's up about $3 million plus or 40% or something.

Am I to read into that that you are building your inventory levels up and anticipating higher revenue streams in the very near term?

The increase in the inventory is due to a combination of factors. We are definitely buying components and building cost per the forecast of our customers. Therefore the increased level of stock reflects both our belief that we are in a growth pattern, based on such forecasts, but also the fact that customers are not necessarily buying exactly the same products that they included in their forecasts.

So when we are building our forecast, I would say that the more that we grow, to grow in inventory is more natural because we are preparing ourselves for growth but at the same time preparing ourselves for forecasts, which sometimes move between the various types of products that the customers are buying.

Okay. What was the actual impact in dollars with the dollar-versus-shekel conversion? I think you said it was significant in a negative way. Do you have a dollar number on that for the quarter?

Yes, first of all it was a negative effect. The negative effect in quarter two compared to quarter one was about $50,000; and the negative effect in quarter two compared to quarter two 2010 was about $250,000.

Okay. What percentage of the revenue in the quarter was SETAC-related?

SETAC in the quarter was about 9%, slightly above $800,000.

Okay, thank you.

Marcel Herbst, Herbst Capital Management.

Good morning. Congratulations on a strong quarter and solid execution. Regarding SETAC, how is the pipeline looking, and what customer feedback are you getting recently?

We think -- what we feel about SETAC is very, very good. As I said before, the sales cycle is quite long with SETAC. But the feedback that we are getting from everywhere -- and again especially in the security market -- is very, very good, and we are moving forward with a number of customers regarding SETAC as we speak, including some significant potential customers. But again, the cycle is long with SETAC.

Okay. In the past you mentioned that several customers are evaluating your redirector solution. How is the progress in that pipeline?

Customers are still evaluating redirector solution. We have more customers who would like to have the redirector, but I can tell you that because it's a long cycle -- and maybe this is a very minor point, but in the 10-gigabit arena unlike many other times it was -- it took Intel quite a short time to move from one chip to the other chip. So right now some of the customers would like us to present to them the redirector with the second generation of chip, which takes some more time.

Obviously this is something that we do and we can do, but it takes more time. It makes the cycle for the sales a little bit longer. So we're actually at the same position as the time that I updated last time. We are still being evaluated by several customers, and we still believe that we will be able to sell to these customers.

Okay, thank you.

Jeff Meyers, Cobia Capital.

Great, thanks. So first off, what was revenue from 10-gig cards in the quarter?

Revenue from 10 gig was about 25%.

Okay. Then in terms of the, I guess, two recent design wins that you announced, the Intelligent BYPASS and the (technical difficulty) modules, which of those are already ramping? How far along? (technical difficulty)

Can you please repeat your question? Your voice faded away towards the end, so I didn't hear the last part of the question.

Just in terms of the ramp of those design wins, how far along are you so far?

We are seeing revenues already of all these design wins. I would say that out of the modules some of these revenues -- I mean, one of these design wins the revenues are at the very beginning. The other one is more advanced a little bit, because it took us a little bit more time to be sure that it's really going to be stable. With the external bypass units, again we've started to see revenues and hopefully the revenues will grow.

Got it, okay. In terms of visibility right now into the next quarter, I guess, how is the visibility now versus let's say for this quarter? How it was for this quarter at the same point three months ago?

Well, I would say that -- first of all I would like to say that the visibility at the beginning of the quarter is in most times not very clear, I would say, because as you know a lot of our sales is happening towards the end of the quarter. I would say that there isn't any significant difference in visibility that we have right now compared to what we had last quarter.

Which doesn't mean too much, because on a quarterly basis, as I said, a lot is happening towards the end of the quarter. If you are not all -- asking only about the quarter, and again it's not exactly visibility, because obviously we do not have POs right now for the end of the year.

But because at least we are hoping that some additional design wins or some ramping of current design wins will happen throughout the period from now and until the end of the year, so that's why we are hoping that we would demonstrate significant growth in 2011.

Got it. Okay, great. Thanks, guys.

Liron Rochman, Oscar Gruss.

Just a couple of questions. First of all, trying to follow up for Jeff's question. I know you don't give any guidance, but just trying to understand the linearity during the year. Obviously first quarter is the weakest one, and we see -- if we look at 2010 we saw momentum build up quarter-over-quarter till the end of the year.

Is this something you expect to see this year as well, second half of the year as stronger?

Well, let me put it this way. Again on a quarterly basis I cannot say anything specific on a quarter-by-quarter because the differences between any specific quarter compared to the other does not necessarily mean too much. But overall I believe that the second half of the year would be stronger. Yes.

Okay. Then regarding the gross margin, what drove it to more than 44% this quarter, and what do you expect for the rest of the year?

Well, I can say two things. First of all, we have always said that the gross margin is a result of the mix of the products that we sell.

That being said, I think that over the last two years everyone could see that our gross margins are going up to a certain level. I believe that this is a result of the fact that we are selling products which are more unique, which are more complex to a certain extent, which can be demonstrated by the fact that our ASP is higher as well.

So I think that overall we are in a good trend here. But once again looking at a quarter and comparing one quarter to the other in terms of -- why is this quarter GP higher than Q1? I cannot say that this is necessarily a trend.

If you're looking long term, I think we are improving both in terms of products and in terms of our efficiency building the products. But this does not mean that necessarily the GP of the next quarter will be higher than the GP of this quarter.

Understood. Regarding the SETAC, you mentioned last quarter that one of the Tier 1 server manufacturers started to offer SETAC for the OEM group. I wonder if you can tell us how this is going on, and what reaction are you getting there.

Tier 1?

You said -- I think it was last quarter you mentioned that Tier 1, that several manufacturers that's selling through their OEM group.

You don't mean this quarter?

No, no, last quarter, on the last earnings call.

Well, so as I said, the sales process is long. There is an interest. Customers are looking at that. We are moving forward with that.

But the sales process is long. We are positive about that.

Okay. How many SETAC customers actively do you have right now?

I think we have announced -- well, it depends on the definitions. I think we have announced one, two, three end-customers using that. I think we have announced the OEM group of this guy who is proposing that; but that is not exactly customers.

We've announced two customers who are using actually SETAC derivative modules as well. So if you count them into that, there are five end-customers. So I think -- and please, I'm counting as we speak. So I think that we've announced five end-customers; and additional two I would say companies were selling SETAC which are not end-customers but rather, I would say, integrators or server makers or system makers.

Okay, okay. Great. Thank you very much. Good luck.

[Edward Belinsky], Segmark International.

Good morning. With regard to your cash, I know that you need it to continue financing your growth and to demonstrate staying power and credibility to your customers. But somewhere around here you are going to become a bank with a pretty good manufacturing business on the side.

Is there at some point that you envision either a modest buyback program or perhaps parting with it in a -- with a small dividend?

The only thing I can say about that is that, since you asked if we consider that, then this is coming up again and again each time. At the moment we are not doing a buyback; but this does not necessarily mean that we will never do that.

I see. Very indefinite, but thank you very much. The question will come up again, I'm sure.

Jeff Meyers, Cobia Capital.

Shaike, I know in the past you talked a little bit about the move to Intel's Sandy Bridge chip and some of the SETAC guys may be waiting for that. How is that going? Do you guys have samples yet that you could demonstrate to customers? Or do you have to wait until the chip comes out in full production?

We don't yet have samples. But we are supposed -- and when I am speaking about samples, I'm speaking about samples to show to customers. But I think that we are going to be one of the early ones who is coming out with a solution which is based on Sandy Bridge.

Got it; okay. Thanks.

(Operator Instructions) a follow-up question from Don McKiernan, Landolt Securities.

Thank you. I want to know the number of bypass and non-bypass units that were sold. I know the revenue split was 50-50, but do you have the unit number?

Yes. I will give you the numbers for the second quarter and also for the first half of the year. Regarding the second quarter, we sold about 12,700 bypass units and about 11,700 non-bypass units. Altogether 24,400 units.

Regarding the first six months, we sold 22,900 bypass units; 24,900 non-bypass units; which means a total of 47,800 units.

An update on the patent application process for SETAC. Any progress on that front?

It is in progress, but nothing specific happened during the last quarter.

But you still feel like you have the ability to patent the SETAC platform?

Yes.

Okay, 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 the Veidan's website, 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. We look forward to hosting you on our next call in three months' time. Good day.

Thank you. This concludes Silicom's second-quarter 2011 results conference call. Thank you for your participation. You make go ahead and disconnect.