Silicom Ltd (SILC) 2012 Q2 法說會逐字稿

(audio in progress) Following management's formal presentation, instructions will be given for the question-and-answer session. As a reminder this conference is being recorded July 23, 2012.

I would like to remind everyone that forward-looking statements for the respected Company's business, financial condition, and results of its operations are subject to risk 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.il.

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. Good day to everybody. I would like to welcome all of you to Silicom second-quarter 2012 results conference call. Before we start, I would like to draw your attention that following the Company's disclosure of certain non-GAAP financial measure 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, focus future results and evaluate the Company's current performance.

Management believes that the presentation of these non-GAAP financial measures is useful to investor understanding and assessments of the Company's ongoing cooperation and prospects for the future. And as already 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 conditions and operating results. These measures are not in accordance with or a substitute for GAAP. And for a reconciliation of non-GAAP to GAAP financial measures, it is included in today's earnings release which can be found on Silicom's website.

With us today on the call are Mr. Shaike Orbach, the CEO, and a 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.

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

Thank you, Ehud. Good morning everyone and welcome to our second-quarter 2012 results conference call.

The second quarter was another period of financial growth and strategic progress that is broadening our leadership in our target markets. We reported another quarter of growing revenues growing by 11% over last year and reaching $10.4 million this quarter. We also delivered a net income of $2.4 million growing 14% over last year. This very much shows the strength and financial stability of our business model and the results demonstrate that our growth trajectory continues into 2012.

I believe that we remain on course for another record year. Our balance sheet continued to strengthen and we ended the first quarter with net cash of about $53 million. As I have mentioned many times, this strong cash position is very much a significant asset for us far beyond the ongoing working capital and financial stability and flexibility that it provides us.

It demonstrates to both our existing customers as well as any new potential customers which we market to that we are a Company that can meet all their needs and provide them with support over the long-term.

Internally, we are leveraging that cash position for continued investment in our R&D and market leadership to build our future growth potential. Finally, it allows us to take advantage and move quickly should any opportunities arise.

While the global economic environment has been increasingly uncertain in the past few months, we have been able to diversify our addressable markets both with our standard product lines and with the new products that we are continuously developing and this underpins our continued optimism with regard to both our short- and long-term prospects.

We benefit from the continued rapid acceleration and demand for Internet bandwidth capacity being driven by the proliferation of on the go connectivity and bandwidth hungry apps from smart phones and tablets. This has enabled [advanced] Big Data or data hungry applications such as Facebook, Twitter and in the cloud applications from players such as Google and Amazon all of which are becoming ever more popular as they demonstrate their usefulness to our everyday lives. This in turn dramatically increases the rate at which data is generated creating a virtuous cycle of increasing capacity requirements.

Together with the increasing adoption of cloud and virtualization technologies in the Big Data era, these trends create an ever growing need for greater capacity and higher performance storage and networking solutions. The required infrastructure build out and investments remain significant and are accelerating and these trends are continuously expanding our end market as they are directly related to our traditional and new market segments.

A perfect example of where Silicom fits in this virtuous cycle was the design win we had achieved during the quarter with a new customer, one of the strongest emerging players in the Big Data storage industry. The design win was for our 10 gigabit multiport network conductors and we have received significant initial purchase orders. Looking ahead and based on the traction demonstrated by the Big Data market, we project that our sales to this quickly developing market will become significant in line with the market growth we are seeing.

Another important development in the quarter was the award of a patent for SETAC by the US Patent Office. The patent confirms the uniqueness of our SETAC server to a appliance converter concept and technology and we see this award strengthening our competitive positioning. This is just one more confirmation of our technological expertise and achievements in an area which is an underlying strength of ours.

With that as well as he already awarded design wins and significant pipeline, SETAC continues to be a very important element in our overall growth strategy.

Our constantly broadening product offering including both new product lines and that which is within the traditional product portfolio, provides us with increasingly diversified growth across our entire range of products all of which contribute to our consistently increasing design wins roster.

In summary, our strong and stable custom base with over 85 OEMs, many of whom are global leaders in their industries as well as the yet to be penetrated customers in our ever-expanding total addressable market remains a source of vast potential for us. Our ongoing growth is due to our continual expansion of this roster of customers and design wins in terms of both quantity as well as quality in an industry with much growth potential to realize over both the short and long term.

In addition, many of our newer design wins have the potential to become significant growth contributors in the coming quarters. And as our customers grow their sales to their customers in turn and as they become increasingly important players in their respective markets, we grow with them.

Looking ahead, our optimistic message of continued growth remains the same as it has been over the past few quarters. We continue to expect that 2012 will be a year of growth ahead of our end markets.

With that, I will now hand over the call to our Eran Gilad, our CFO, for a more detailed review of the quarter's results after which we will open the floor to questions.

Thank you, Shaike, and hello, everyone. Revenues for the second quarter of 2011 were $10.4 million, a growth of 11% compared with revenues of $9.4 million in the second quarter of 2011. For the first half of 2011, we achieved a record $20.5 million, an 11% growth compared with $18.4 million in the first half of 2011.

Our geographical revenue breakdown for the first half of 2012 was as follows, North America 67%, Far East 18%, Europe and Israel 15%. Our revenue split for the first half of 2012 between BYPASS and non-BYPASS was BYPASS, 44%, non-BYPASS 56%.

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 2012 was $4.4 million representing a gross margin of 42.5%. This is compared with $4.1 million or 44.3% of revenues in the second quarter of last year. Please note that 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 second quarter of 2012 were $2.1 million or 19.9% of revenues compared with $2 million or 21.9% of revenues in the second quarter of last year.

Operating income for the second quarter of 2012 was $2.4 million or 22.6% of revenues. This is a 12% increase over operating income of $2.1 million as reported in the second quarter of 2011 or 22.4% of revenues.

Second quarter 2012 net income was $2.4 million or 22.9% of revenues. This is a 14% increase compared with a net income of $2.1 million or 22.3% of revenues in the second quarter of last year. Earnings per diluted share were $0.34 in the quarter compared with $0.30 in the second quarter of last year.

Now turning to the balance sheet as of June 30, 2012, the Company's cash, cash equivalents, bank deposits, and marketable securities totaled $52.9 million or $7.63 per outstanding share, up $1.6 million compared with the end of the first quarter and up $3.7 million compared with the end of 2011.

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

(Operator Instructions). Jeff Meyers, Cobia Capital.

Thanks, guys. Can you just break out the revenue from SETAC, 10 gig encryption and external in the quarter?

Smart adapters that we sold during the quarter was better than -- was higher than the previous quarter. Redirector was about 11%, Security was about 7%, and external BYPASS was about 7%. 10 Gigabit was also higher, quite significantly compared to the first quarter. It was 45% for the quarter which means 39% for the first six months of 2012.

Now regarding SETAC. SETAC was about $700,000 in this quarter.

Got it. Okay. And then if you could talk a little bit about the Big Data design win that you guys got. Did that produce any revenue this quarter and when do you expect that to really start ramping up?

It produced certain revenues in this quarter. It will continue to have revenues in the next quarter. It is a little bit difficult to say when it would be ramping up in full because our -- because that design win and the company win which is growing and the question would be how fast it would be growing. But the important part of that is that the overall area of Big Data is one of the fastest-growing segments of the market and now we start to become a part of that and I think that is important. What exactly the rate would be and the time that it would take I am not sure about but I think that overall, it is an important design win for us.

Okay. Then maybe you could talk a little bit about just generally the external and the intelligent cards what you are seeing there, how happy you are with your progress in those two areas?

As Eran has said, in the intelligent cards, we have increased our sales quite significantly this quarter. And what I see important is not only the fact that we have increased our revenues with intelligent adopters, but rather the fact that whatever we do with intelligent adopters and specifically the Redirector is very important because the amount of our own IP inside this card is such that you could say that we almost have a good (inaudible) marriage between us and our customers with regard to these solutions. So it is very important I think. I believe and I hope that this trend will continue.

Once again, this quarter it was very good. I am not saying that each and every quarter will grow but the trend of growth is evident in these intelligent adopters and I think that is good and I am happy with that.

As to the external boxes, so external boxes I think not only I think -- we do have a significant and important pipeline for external boxes as well and I think this will happen. I don't think that we had any significant differences -- Eran could correct me -- in this quarter compared to the previous quarter with external boxes.

One should note that the model with external boxes is a little bit different than with our regular cards because while our regular cards need to be integrated inside the box of our customers and then tested etc., so they need to get that prepared ahead of time for quite some time and therefore, they order from us based on our forecast and so on and so forth which is more steady. The external BYPASS because it is integrated with our customers' boxes externally, they can bite I would say at the very last moment and therefore they use -- most not all of them but most of them are doing that on a project basis. Which means that when they win a project, we get the order, more or less that is the case.

So it is more I would say jumpy, the revenues in there but once again, what we are focusing in just like always is getting the design wins. And as I have said, we do have design wins in the pipeline for the external boxes and I hope we will be able to see them soon.

Got it. Okay, great. Thanks, guys.

[Edward Bilinski], [Segmark].

I have three questions. First of all, what effect did the exchange rates have on revenues and particularly on profits?

The effect on revenues is zero. There is no effect on revenues. The only effect is on expenses. Due to the higher dollar this quarter, we got a positive impact of about $100,000.

Okay. The second, I noticed that you that in the past two years, there has been a sequential increase in sales. A, can you explain that and B, do you expect that that will be the case? Let's say in the 2010, 2011, each succeeding quarter was higher than the other quarter and then finally, on the first quarter you fall back and then you proceed on the way up. Is there any particular reason for that?

Let me say several things. I will provide several reasons -- so-called reasons to that but while I am going to provide these reasons, there is also revenues or sales which are associated -- could be associated with a specific order and that is why while I can't think about some reasons toward that, there are still -- it doesn't necessarily mean that this would always be the case.

So I mean indeed in the last years, the fourth quarter has been the strongest and in all of these years, the first quarter was the weakest I would say. I would think about several reasons why the fourth quarter would be the strongest. For example, we have a lot of customers who are selling to governments and government's budgets seem to be such that if you do not use the budget by the end of the year, then the budget sometimes disappears. So all these sales are then pushed into the fourth quarter and the fourth quarter represents more sales for them. So that is one reason.

There could be another reason. There are several companies sometimes private companies but not only private companies who are looking at themselves looking at the year level rather than a quarter level and in these cases, they try to make the fourth quarter as strong as possible for them. And if such a customer is a customer of ours, so that is moving to us.

That being said, this does not yet say that this always has to be the case because as I have mentioned before with the example about the external units, some of our customers buy based on projects that they either win or do not win. Sometimes they can win an order in a certain order or in another corner.

I mean for example, our Chinese customers, they buy only like that based on projects, on their projects. So sometimes they can buy in this quarter or in the next quarter and therefore I cannot say for sure that we will continue sequential growth on the one side and that the fourth quarter is going to be always the strongest and the first quarter the weakest.

What I can say and I think that should be the basic message. Where a business model is such that we are on a growth trajectory and I think it is very simple to explain. We have not lost any customer of our design wins. All of them continue to buy and on top of that, we get more design wins.

So as long as this continues, our trend continues to be growth. I can never say -- I never said anything about any particular order because this is really something that I cannot say. But if you look at us, if you will look at us for a longer term then all of our customers continue to buy with us and as long as the market grows, that by itself would mean growth.

And on top of that, we have our new design wins which could be to existing customers, new customers, current products, new products so all of that new design wins together with what is going on would make it I would say obvious for us to continue and grow.

Okay. Now my last question which really -- why -- the large concentration of sales in North America -- I mean you have anywhere -- you have close to 70 and sometimes higher percentage of sales in North America. And I would think that Europe, along with Europe you would include Israel with that and the Far East would have a more significant presence with regard to the sales of these devices.

So can you explain why it seems to me that two-thirds or three-quarters of your sales get done in North America and so few in Europe and in Asia?

Yes, I believe that I can explain that. The reason for that is because we are selling to OEMs. If you would look as to where our cards are actually deployed in the end, you would probably find out that the breakdown is difference and that more of our cards are actually deployed in Asia Pacific or in Europe and Israel, etc. But as we are selling to OEMs, so you need to look at where the concentration of companies which are developing applications and selling them on appliances, where the concentration of these companies are. And by far, the concentration of such companies is in North America and that is why our sales to North America are higher than to the rest of the world.

I see, fine. Thank you very much and good luck in the quarter.

Don McKiernan, Landolt Securities.

Thank you and good morning or afternoon I guess over there. Earlier in the conference call, you said you expect growth for Silicom to be ahead of your end markets. Can you tell us what the end markets are growing at?

I think that no one can tell for sure what is going to be the growth of the markets especially right now where there is really some sort of uncertainty.

I think that you could look on the one side at what the analysts are saying about the various markets that we are active in and therefore, I would rather not provide a direct answer to you at this time not only this time because I think that it is very unclear as to what is the market growth in percentage of the various market segments that we are dealing with .

But just like I said before, we are having a lot of customers in the markets that we are addressing, we are not losing any one of them. We are not only selling to most of these big customers just a single product in a certain niche within what he is doing but rather several products which are spread across his offerings.

So I would say that if you take all that as an average, then whatever we will do would be more or less what the market is doing without counting on the additional wins with new products and new customers. So I cannot say what the figure is right now as to the certain markets that we address in percentage but I can say that -- to me, the mechanism under which we sell is such that I would say almost guarantee that we will be better than the market.

All right. How about on SETAC -- how many customers do you have right now and how many more are in the pipelines?

Right now I don't have the accurate number of customers that I have. I think it is between 10 to 15 something like that and I think that we have more than 15 companies in the pipeline right now.

Okay, and that number is growing, right?

That number is growing.

And of the 10 to 15 existing customers, how many products are actually out in the marketplace that one could buy that has SETAC as part of the design?

I am not sure that I understood the question.

As a technology purchaser out there, can someone go out there and buy SETAC today somewhere in the world -- buy the SETAC product that has been designed into an appliance?

I mean as you know once again, we are working with OEMs so typically we would work with these customers who are using SETAC. Eventually when we sell the SETAC, we would typically sell it to an integrator or a contract manufacturer but it is not as if SETAC is used being sold through the channel. I'm not sure that I understood -- that I responded to your question.

Right. I'm just trying to understand how many different appliances are out there in the world from different customers -- OEMs if you will -- where SETAC is designed in, where I can go out there today and buy it. How many different products?

I mean, there are of course there are thousands of the appliances there but I am not sure -- I mean if there is a company who is let's selling firewalls and they are selling firewalls using a platform which uses SETAC so they would sell thousands apiece, so there are between 10 to 15 such companies.

Okay, that is fine. And then the number -- you used to have just one customer for Redirector. How many do you have now?

No, I didn't say that we have just one customer for our Redirector. I said that we have only one very significant customer in the past and that is still the situation right now that we have one very significant. But it seems that this customer is now deploying the Redirector in I would say many scenarios which previously they were not deployed. And I would also add to that that we have a much thicker pipeline for Redirector than we used to have before.

Right. So you have other companies out there that may begin deploying Redirector, is that correct, other potential prospects?

I mean even right now there is more than one company but there is one of them which is significant. What I am saying is that we have a pipeline of additional hopefully significant companies who would buy Redirector.

Okay. Thanks for taking my questions.

Benjamin (inaudible), Jana Partners.

Good afternoon. Just a question about the level of cash you guys hold. I know it has been a point of interest to many investors lately and I am wondering what -- you guys are building quite a large reserve. What are your plans for it, where you see that working in the future of the Company?

Well, I mean there are a few purposes I would say for the fact that we are holding this cash on top of course of the fact that we earn it, that we get it I mean out of our business. But we -- while I know that nothing happened until now and I know that I am repeating that between conferences call, but this is something that we are doing. This is a process and we are looking for opportunities in the market to use this cash in a way that would significantly or even dramatically increase our potential I would say in the market. And that is the main reason, not a main reason but the main purpose I would say that we keep this cash as it is.

This is something we are continuously looking at. It is not just something that I say even though obviously this is not something that I could elaborate or share details with you because it doesn't make sense to do that before it becomes really serious. But this is an ongoing activity of the Company. We feel that there is room for us to find such opportunities which would dramatically enhance our potential in the market segments that we are addressing right now and this is why -- this is the main purpose of the cash.

Interesting. Thank you very much. Appreciate your time.

Marcel Herbst, Herbst Capital Management.

Hello, good morning. Thank you. Can you please give us a general indication of this year's design win momentum as it compares to last year?

Let me put it this way, I mean it is a feeling because I did not make any statistics -- special statistics but I think -- I believe that we are doing better this year.

Excellent. Thank you. All my other questions have been answered.

Jay Steinhilber, Morgan Stanley Smith Barney.

In the previous quarters, you mentioned the possibility of new design wins with the giant server companies. You did mention one in the -- I believe was it the last quarter, the prior quarter. Where do we sit with these? Should we expect this quarter or the next quarter that a couple of these design wins are going to happen with these giant server companies?

Well, I mean especially with the giant companies, the process is long and I cannot say for sure as to when and if this would happen. These processes are very much dependent on -- there are resources that they can allocate for anything which we come forward with. Sometimes if they have the resources they can push it quickly but we are fighting for these resources continuously and therefore, I cannot say that this would happen next quarter or the following quarter. We are pushing but it is not easy and it is a long process whichever way you look at it.

Are they -- is it looking better I guess than a couple of months ago due to the new -- my understanding is the Romley chip that came out of Intel with these servers?

The Romley chipset -- I mean with these server guys, the fact that this chip came out was actually the reason to look for that. So even when we talked about that a year ago we knew that it was going if it would happen it would happen with this new chip. So the fact that it was finally released did not change the way that we will look at it. It only means that now it can really happen because this chip is out. But it is not as if this was not planned.

The basic plan with at least the major one within the server companies was understanding that this would be around this new chip.

Okay. In your corporate presentation that's on your website, you mention $100 million in revenue as the goal moving forward of which SETAC would be roughly half and your existing business half. Can you give us some idea time wise what we are talking as far as this $100 million? I know it is difficult probably to put out there but what is realistic? Are we talking three years, are we talking five years? Can you give us some time period? Are we talking a decade here?

If we were talking a decade, we wouldn't put a presentation. I think that both of your first figures, first numbers that you mentioned could be realistic.

So if that is the case, then it sounds like you are expecting growth to accelerate here over the next 12 to 24 months?

We are expecting growth. I don't know exactly 12 to 24 but obviously, we are hoping and expecting that our growth would not just be linear because if it is linear, we wouldn't meet this goal.

Okay.

And indeed, we are hoping to be more than linear.

And what are you doing -- what is the Company doing to market? It seems like we have a great Company, the growth could be a little bit better maybe to attract some attention. We have one analyst, I look at many of the other Israeli tech companies, they've got four, six, even eight or 10 analysts covering the company.

What are we doing from a marketing standpoint to get our name out there with the objective to get the price of the stock higher?

Now I understand that you are talking about marketing within the financial markets not marketing to our customers.

That is correct.

I think that we are doing all the standard activities that a company would do like that. I believe and hope that as soon as indeed the rate of growth of the revenues will indeed not only be linear but rather more than that, moving towards the goal that all of us -- I mean investors and company has in mind then that would be also the time to hammer even more powerfully or strongly I would say what we are and what we are doing and hopefully it will be better that time than it is now. That's about it, I think.

And just a comment -- I know you have that cash. I have been an investor for probably four or five years now. Two or three years ago we talked about a stock buyback. I believe strongly that for a couple million dollars you can keep the stock $20 or above if you use just a couple million dollars in cash and your growth prospects seem to be there moving forward with this SETAC product and so forth. I would strongly encourage you to take even just a couple million dollars and get the stock up. We are now on the same side of the table that the executives there got stock options two or three years ago and as a shareholder, we need to get the stock up.

There is no reason why the stock should be at $14 with the prospects that you have with $7.50 in cash. Just one person's opinion. But -- and it is not going to impact whether you have $53 million or whether you have $50 million in cash. It is not going to impact anything. So just a comment and I would hope that you might consider it strongly.

We will consider. This is something which is being discussed never off the table. It will continue to be on the table for discussion.

Okay. Thank you so much, guys.

(Operator Instructions). George (inaudible). .

Good morning, gentlemen. I had a question in particular about your new Big Data customer and also in general about your pipeline. Could you give a little more color on the pipeline of Big Data customers?

And also I am curious how that customer came to you. Did you solicit them? Did they discover Silicom through some other ways? And what kind of pipeline do you have in the Big Data area specifically and then in general?

I will try to respond to that. First of all in general, I would say that the customers that were having -- I would say between 50% and 50% either we knock on their doors even as cold calls sometimes or it could be in exhibitions. Or they find us typically -- but not only -- but typically through our website when they are looking for solutions.

So I don't remember exactly which one of these two was the case with this specific customer. I can only tell you that while obviously there is a difference in the starting point but the way that we handle that immediately later is almost similar. Because as we do have the OEM business model only, so what we do is immediately I would say -- I mean we have built a relationship with a customer whether it is a customer that we knocked on his door or whether it is a customer who approached us.

So we got there, we sit with them, we meet them, we go into a discussion with them as to about what do they need and what would be needed and so on and so forth and then we move forward to this solution.

So this has been the case with this customer as well and sometimes when we understand that the market is important, then later on it is not only the sales guy or whoever who goes to meet them, I go to meet them in order to understand more and so on and so forth.

Now in terms of the pipeline, it is beginning but I think that we see that we are developing in there because right now once we understood that this is something which is happening now, obviously it is supported very much by the fact that the amount of data which is generated is growing.

So we started to look for such customers. So just like let's say five years ago when we were looking for customers, we were looking for customers which using the word say security appliances -- so now we would use the words Big Data or Big Data appliances or Big Data solutions and we will identify these companies, start working to them. Because one thing is obvious, companies who are within this business, they would need connectivity because a lot of data is flowing so that would mean that more connectivity would be needed.

So while not everyone of them would be a potential customer but many of them would turn to be potential customers and there are companies emerging in these fields. They are older companies which are doing things in this area right now and we are knocking the doors of all of these companies so that the pipeline in this area is relatively new.

Up until recently, this was not a very well-known term at least not to us. But since it started, it becomes I would say a very promising pipeline because if you were talking to us I think six years go about (inaudible) optimization, that no one would hardly say too much about (inaudible) optimization.

But once it started to grow, we started to look for these companies and eventually we got all of them to become -- or almost all of them to become our customers. And we are hoping that something similar to that will happen in this case as well.

I see. 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 tomorrow on Silicom's website, www.Silicom.co.il.

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

Thank you, Operator. Thank you, everybody, for joining the call. I would like to conclude by saying that we will continue to work hard to bring you continued positive results with the ultimate value goal of increasing value for shareholders over the long-term. We look forward to hosting you in our next call in three months time. Good day.

Thank you. This concludes Silicom second-quarter 2012 results conference call. Thank you for your participation. You may go ahead and disconnect.