Silicom Ltd (SILC) 2011 Q3 法說會逐字稿

Welcome to Silicom's third-quarter 2011 results conference call. (Operator Instructions). As a reminder, this conference is being recorded October 24, 2011. 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?

Thank you, operator. I would like to welcome all of you to Silicom's third-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 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 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 believes that the presentation of these non-GAAP financial measures is useful to investors understanding a segment 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 operating results. These measures are not in accordance with or a substitute for GAAP. A full reconciliation of non-GAAP to GAAP financial measures are included in today's earnings release, which you can all find on Silicom's website.

With us on the line today are Shaike Orbach, CEO, and Mr. Eran Gilad, CFO. As usual, Shaike will begin with an overview of the financials followed by Eran who will provide the analysis of the financials. We will then turn over the call for the question-and-answer session.

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

Thank you. Good morning, everyone, and welcome to our third-quarter 2011 results conference call. We are very pleased with our achievements in the quarter. We broke new quarterly records across all parameters, including revenues in excess of $10 million for the first time in our history, as well as our highest ever operating and net income and excellent margins across the board. Our net income grew by 46% over last year, reaching $2.1 million, a demonstration of the exceptional traffic generation potential and success of our business model.

Over the past few quarters, we have continually met and surpassed every one of our goals, and achieving a revenue run rate in excess of $10 million during a quarter is one of those. It is a milestone that propels us into a new league and positions us well to achieve new and more aggressive targets in the future. Even given the new macroeconomic uncertainty that has developed since the late summer, the momentum in our business has remained strong. All-in-all we are proud of our achievements and happy with the continued strength of our business performance in the quarter.

We delivered a robust 36% year-over-year topline growth with the revenue made up from increasingly diversified sales across our entire product line both in long-established, as well as the newer product lines. In particular, the 10 Gb cards, intelligent cards, encryption cards, external BYPASS units and SETAC, the newer products that we are selling are all seeing strong market traction, and they continue to strongly grow their contribution to our revenue.

The growth was also driven by continued order momentum from a broad cross-section of all our customers in all our target markets. We believe that the fundamentals of our industry are strong, built on worldwide Internet and data traffic, which continues to grow quickly.

We also see the IT press of cloud computing and virtualization continuing to accelerate. The industry supplying the network appliances and other infrastructures to support these trends continues to grow quickly. Given that our products are core and critical building blocks for these next generation service and appliances, we expect to see continued strong demand with our sales exceeding the growth rate in our end markets, as well sell a broader range of products to a larger number of customers.

In terms of our balance sheet strength, our cash level continued to grow, and we ended the quarter with $47.4 million, our highest ever cash level. This remains an important asset for us, providing a substantial level of working capital and financial flexibility, which enables us to invest in our business and leadership while pursuing all our goals.

During the quarter, we announced two significant design wins, which I would like to discuss. The first was an important design win for multiport server adapters with a security division of a Tier 1 Fortune 100 server manufacturer. This win positions us as a critical supplier to one of the server industry's top players. This design win has already started generating [firm] orders. It also very much demonstrates the ongoing revenue generation potential of our established product lines.

This win is also strategic as this customer is already evaluating additional products of ours, including our 10 Gb cards, our intelligent product and our SETAC-based solutions. We are confident that developing relationship with this customer has the potential for a strong flow of additional design wins in the coming months and years.

In addition, during the quarter, we announced that a top tier networking giant decided to standardize on our SETAC as the front end connectivity solution for its network appliances. This is a major and exceptionally important achievement for two reasons.

Firstly, as an industry trendsetter, the fact that this customer has chosen to standardize on our technology and the SETAC concept demonstrates how the SETAC is becoming a fully accepted solution by the major players in the market and positions SETAC as a solution of choice for the building of next-generation appliances.

Secondly, this deal in and of itself has the potential to become a multimillion per year deal contributor to our topline. Just the sheer size and sales of this Company, combined with the fact that they will now be using SETAC, means that the relationship offers us an almost unlimited potential for additional sales growth over time. In fact, they are already considering the use of new SETAC modules in their next-generation appliances and in some existing products.

In summary, our continued growth over a multiyear period is a demonstration of how we read the market's needs correctly and translated this into a differentiated positioning. This has been built on meeting our customers' demands by delivering the right technology and products to fast-growing industries while developing long-term relationships with all players, including the industry giants. Our ongoing recent success, particularly with those industry giants, testifies to the underlying growth potential remaining in our business model. Our largest and satisfied customer base of over 75 OEM customers, as well as the yet to be penetrated customers in our industry, remains a gold mine of significant growth potential for us. We continue to generate new design wins by selling to both new and loyal customers, which buy from us repeatedly, penetrating new divisions at existing customers and selling new products across our entire existing customer base.

Looking ahead, we continue to believe that we will show significant growth ahead of that of our industry and expect to continue growing into the future. With strong demand for all our product lines and exciting strategic wins with some of the industry's most important players, fruitful discussions in process and extensive pipeline of potential sales, we have never been better positioned or more optimistic regarding the future.

Our business platform is in the best situation it has ever been and is trying for future growth during the remainder of 2011 and 2012 and beyond.

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 third quarter of 2011 were $10 million, a growth of 36% compared with revenues of $7.4 million in the third quarter of 2010. Our geographical revenue breakdown for the first nine months of 2011 was as follows -- North America 75%, Europe and Israel 13%, Far East 12%. Our revenue split for the first nine months of 2011 between BYPASS and non-BYPASS was approximately BYPASS 53%, non-BYPASS 47%.

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 third quarter of 2011 was $4.4 million, representing a gross margin of 43.7%. This is compared with $3.2 million or 43.8% of revenues in the third 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 third quarter of 2011 were $2 million or 20.2% of revenues compared with $1.6 million or 22% of revenues in the third quarter of last year.

Operating income for the third quarter of 2011 was $2.4 million or 23.5% of revenues. This is a 46% increase over operating income of $1.6 million as reported in the third quarter of 2008 or 21.8% of revenues. Third-quarter 2011 net income was $2.2 million or 22.1% of revenues. This is a 48% increase compared with a net income of $1.5 million or 20.3% of revenues in the third quarter of last year.

Earnings per diluted share were $0.32 in the quarter compared with $0.21 in the third quarter of last year.

Now turning to the balance sheet, as of September 30, 2011, our cash, cash equivalents, bank deposits and marketable securities totaled $47.4 million, up $1.6 million for the $45.8 million recorded at the end of 2010. Our current strong cash position represents a level of $6.87 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 curious in terms of the networking client that chose to standardize, how long would that take to see meaningful revenues for that type of client?

Well, I mean revenues from that client has already started, but it would take some time before it gets to ramp up to the full volume because the design win is for several appliances. It started with one appliance for which they needed a solution to be quite urgent. So we are already having some orders from this customer. I believe that it will take a few months and maybe even up to a year, I would say, to ramp up to the full amount that this design win was for. Right now I am talking only about the specific design wins.

Obviously, in addition to the SETAC kit that we are selling within the design win, we are now talking to the customer about some additional wins for additional modules and several other parts to this solution, and they are not included in that. That may take a little bit more. But within this win itself, we are in the process of ramping up. We have started to see revenues. We will see more I would even say more or less linearity during the next six to nine months.

Jeff Meyers, Cobia Capital.

Congratulations. So talking just about the networking giant again, how big potentially a customer could they be if they really took SETAC across all their product lines and started using modules across their product lines as well?

Well, I don't know for sure, but in terms of potential, this could be a $3 million, $4 million, $5 million customer.

Got it. Okay. And what about on the -- I guess question on the Fortune 100 customer on the securities side. How big could that side of their business be if they really roll out your products group across the board?

Well, once again, this customer also has a potential to be big. In that case, they are evaluating a variety of our products, and I would not be so I would say specific. I don't want to be as specific as I was with the other customer because there I know for sure what the potential is. With the security customer, I'm sure that their potential could be much higher than the deal itself that we announced, but I don't want to be that specific. It could be several million dollars as well.

Got it. Thanks, guys.

Marcel Herbst, Herbst Capital Management.

Congratulations on a strong quarter and solid execution there. Now in July there was no doubt that you collaborate with ntop regarding a solution called PF_RING. Can you talk a little bit about how and when this would add to revenues and what increment of revenue potential this has?

Well, first of all, once again, this is already contributing to revenues, and I believe that -- right now I think that the percentage of revenues that we can attribute to that is quite negligible. But it has the potential to become significant as well. It is very difficult to say how long that it would take and to what percentage it would come, but I think that it is another part in the puzzle allowing us to grow. Because it is also that sometimes the attribution could be a little bit difficult because there could be some customers who would buy our cards and our modules with this technology with the DNA drivers, etc., and you could either attribute it to this or they could have been buying that even without that. So the attribution here of whether or not something is due to that or not due to that is a little bit more difficult.

But we do have some revenues, which we know came to us specifically because of that. So I believe that it is very important for us to have this technology.

Okay. And can you talk in general about what is in your R&D pipeline that could benefit revenues in 2012?

Well, okay. I mean there are several areas which could be -- which could attribute revenues. In general, I would divide it into two parts because one part of what our R&D group is doing is very natural. It would add to revenues, but this is a part of our business model, and it comes to us very naturally. Because we follow on on the mainstream silicon which is going into the bucket. So if the next thing which is coming into the market, for example, is 10 Gb Base-T, then we would be building products with 10 Gb Base-T silicon, and obviously this would add to our revenues. And then if 40 Gb is coming into the market, then we would be doing that, and we would be doing cards with that, and that would add to our revenues. And that if another encryption silicon is coming into the market, we would be building cards with that, and that would add to our market. So that is one part that is very odd I would say natural. We don't have to invest too much thought or creativity in order to do that, and that is inherent to our business model. We just continue to follow the mainstream silicon that is coming to the market.

The other part of the market is built out of I would say new ideas just like SETAC, for example, was such a new idea that I don't think that this is the right time right now to elaborate on these new ideas at this point. I think that when they become more mature, we will announce them. Right now I think I don't want to be too dramatic on the one side or go to the other side, so I don't think I should elaborate. But I should say that there are several areas which are new ideas which we are developing as well, and hopefully we would be able to present them soon as we come to the market.

Okay. That is certainly understandable. Regarding last year's large SETAC deal, you estimated at $3 million. How much revenue have you realized from it in the first three quarters so far?

Close to $2 million (multiple speakers) for the first nine months.

Okay. And do you expect any significant increase or decrease from this design win in 2012?

We expect an increase. And, once again, this increase is divided into two parts. One part is just because the market increased that we hope that our customer will be selling more. The other part is, if we are successful, to add more product into this deal.

Okay. And speaking of SETAC, regarding the deal with one of the top server vendors that you announced in January, what progress is your partner making so far? Are there any milestones to talk about, for example?

Just a minute. Okay. What I can tell about this announcement that we announced in January that I believe that it was with a major server manufacturer. What I can say is that there is a lot of activity going on.

Now I would like -- maybe this is the time, the right time to emphasize again, and we have announced a major set of deals this quarter. We are I would say to a certain extent we are surprised by some of these deals. At certain points, they are coming earlier than what we expected. In this specific case, we got a deal because the customer had to have a solution immediately, and our solution was the only one that qualified for that. But I mean for whoever is taking this solution and going I would say in the regular way of presenting it to customers, moving through the evaluation, etc., this is a long sales cycle. So there is a lot of things going on with this customer as well. I can say that there are several places that we succeeded and were even selling, but they are not big at all at this moment. But a lot is still going on with that customer.

Okay. That sounds exciting. Regarding a margin question, I recently read a report -- an analyst reported the soon rising revenues and declining margins. So I wanted to ask you what is your directional target on margins assuming a scenario of rising revenues over the mid- and long-term?

Can you repeat this question, please? I'm not sure I understood the question.

I wanted to ask you about, what is your directional target on margins assuming a scenario of rising revenues over the mid- and long-term?

Oh, okay. Okay, let me say that there are two trends which are kind of contradicting in here. On the one side, we believe that we do have a leverage and that our expenses are not growing at the same rate that our revenues are growing. And that would mean that our margins would grow.

On the other side, I mean we are experienced people, and we know that it is not only theory which can speak and hear, and therefore, it is not as if you can come to, I don't know, 40% net profit or anything of that sort if your revenues are growing dramatically. So I would like to be careful about here and say that we are hoping that our revenues would be -- not our revenues, our margins would be similar to what we are having right now and more than that and better than that. By how much exactly it is difficult to say, especially also because, as you can tell, if you look at our gross margin, so I believe that overall the trend of our gross margin is leading to some improvements as we sell more sophisticated products than we used to sell, but it is still a result of the mix of the products. So some quarters it could be a little bit higher and some other products it could be a little bit lower.

So overall I would say that I believe and hope that our margins would remain high, and I consider them to be high right now in terms of percentage and hopefully somewhat better than they are right now.

Liron Rochman, Oscar Gruss.

Congrats for the quarter. Can you give us some breakdown in terms of SETAC percent of the revenue in 10 Gb?

The percentage of SETAC in the first nine months is around 9%.

For the nine months?

Correct. The percentage of the 10 Gb for the first nine months is almost 25%.

Okay. I saw the DSO this quarter increased to about 75 days? Can you explain what has happened there?

First of all, that is correct. The DSO is higher than in the previous quarter. There is no specific reason for that. We expect it to go down in the next quarter.

Okay. Is that to normal mid-60s? That is kind of the number, right?

That is correct, yes.

Okay. Can you guys tell us a little bit about what you are seeing in terms of macro in terms of what your clients are telling you what they are saying, any shift in major clients in terms of the revenues or in major groups that you are selling it into?

Well, I mean everyone is reading the papers, I guess, and talking about the uncertainty. We don't feel it. At this moment we don't have anything which demonstrates that looking at what is happening with us and our customers. I would like to say that we are relatively down in the food chain. So not always we know and not always whatever we feel or do not feel is representative about the macro economy, but we don't feel it at this moment.

So no extra cautions from the clients, no pause in orders, nothing like that?

That is right. Nothing like that.

Okay. That is great to hear. Thank you very much and good luck.

Walter Ramsley, Walrus Partners.

Congratulations. Most of my questions have been answered. The one that is still on the list here is the tax rate. Could you fill us in as to what you expect for the fourth quarter and 2012?

Okay. First of all, the tax rate this quarter was 7%, while the percentage for the first nine months is about 8%. I expect that in the fourth quarter it will be more or less also around 8%.

Regarding your question about 2011, it will be somewhat higher than the current rate of 8%. It is very difficult to give a precise number because it is a mixture of a few elements. But, as a general guidance, I would say that it will be 10% to 12% next year.

Okay. Appreciate that. Thank you very much.

Don McKiernan, Landolt Securities.

Congratulations on a record quarter. You gave the SETAC percent of revenues for the nine months. Do you have it for the quarter along with 10 Gb?

Your question is regarding the SETAC for this quarter?

Yes, the percent of revenues for SETAC for the quarter.

Okay. It is also 9%, 9% in quarter three and 9% for the first nine months.

And 10 Gb, was that 25% for the quarter as well?

Yes, that is correct. Also, they are more or less the same number.

And the number of BYPASS and non-BYPASS units sold?

Yes, first of all, I give the dollar value of the BYPASS and then a number of units. Dollar value in the quarter was $5.6 million of BYPASS products, which means 56%, and the non-BYPASS $4.4 million, which is 44%. In terms of number of units, BYPASS units, about $11,500, which is 47%, and non-BYPASS units $12,900, which is around 53%. Total we sold 24,400.

Okay. And can you give us an update on SETAC's patent application?

SETAC's what?

It is patent pending, right?

Actually I have nothing to update compared to the previous quarter. It is still in process. It is a process that takes time. Usually three or more or less, so we are waiting for the next phase.

Okay. And was the revenue evenly split over the three months of the quarter?

Typically most of the revenues are generated in the last month of the quarter. That was the case in this quarter as well.

So that is how it is pretty much every quarter?

What was that?

That is how it is every quarter?

Typically. Not -- sorry -- each and every quarter, but that is the typical situation.

Okay. And then a quick update on China. Are you still seeing traction and progress in China?

We are seeing traction and progress in China. I would have been happier if progress was I would say quicker, but we are moving ahead there as well.

[George Maremma].

Excellent quarter, guys. Thank you. Most of my questions have been answered, but I wanted to see if you could give a little more color on your pipeline.

Okay. So let me try and give a little bit more color. Okay? So I would like to tell you a little bit about three aspects and use several examples within these three aspects of the pipeline. And I would divide that into what is happening with current customers, what is happening with new customers, and what is happening in SETAC.

So, with existing customers, it is almost every one of our existing big customers that is having discussions with us regarding more products which would contribute to our revenues, and each of these products could be significant by itself once it is decided. So each of these big customers that we cannot identify but I think that many of you are guessing, with each of them, we have currently ongoing discussions about more products, new products that would be added to the portfolio of products that we are selling to them. These products are coming from various areas. It could be BYPASS cards. It could be 10 Gb cards. It could even be SETAC in some of them. And even some of the new ideas that I mentioned before as ideas that I was not yet ready to disclose the contents of them are a part of these discussions with our customers. So that is the part of the existing customers.

New customers, while I think that we are selling to most of the industry leaders in the networking appliance space, but still there are some of them that we are not selling to them and we are making progress. So there are some deals that we are now discussing at various levels with still very significant customers, each of which could add quite a bit to our revenues if and once it is awarded to us. And, once again, across the board, I mean standard product, BYPASS products, external BYPASS units, SETAC or whatever.

Now specifically about SETAC I would say that there are customers who are evaluating SETAC, and hopefully we would get additional deals pretty soon. But, in addition to that, there is also the potential of I would say one of the major players in this area to make a SETAC-based server or appliance a standard product for itself. Now this could be different than the server Fortune 100 company that we announced in January because the January company is proposing SETAC through its OEM operations only, while this giant that we are talking about right now, once this is concluded, once and if this is concluded, will make it a standard product, which could have a very significant impact.

So I think that we are very well positioned in all aspects of our pipeline -- existing customers, new customers, both of which current and new products, as well as SETAC, which is a strategy for its own.

Excellent. Thank you, Shaike.

(Operator Instructions). Don McKiernan, Landolt Securities.

I wanted to clarify that in all of these SETAC opportunities, once the SETAC platform is built in or embedded in a server or appliance, that it will only accept Silicom modules. Is that still the case?

This is up to us. This would be up to us. I mean it is up to us to decide whether or not we would like to allow -- to allow other modules to go into it. I mean sometimes there could be some considerations or reasons where we would allow something which is not our module to fit in, but it would be up to us.

Okay. Hopefully not. Thank you.

Well, I mean, sometimes I could give you some scenarios where there could be customers who have, for example, built a certain type of a module that it does not work for them -- I mean the system does not work for them -- and they would like to have SETAC because that could be their only solution but they already have their own modules. So in such a situation for example, we would tell them go ahead, use SETAC. You can be sure that their next generation of modules is going to be ours.

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 Company's website at www.silicom.co.il or on Veidan's website, www.veidan.co.il.

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

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 third-quarter 2011 results conference call. Thank you for your participation. You may go ahead and disconnect.