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Silicom Ltd (SILC) Q1 2019 Earnings Call Transcript

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Silicom Ltd  (NASDAQ: SILC)
Q1 2019 Earnings Call
April 29, 2019, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Silicom's First Quarter 2019 Results Conference Call. All participants are 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. You should have all received by now the Company's press release. If you have not received it, please contact Silicom's Investor Relations team at GK Investor and Public Relations at 1-646-688-3559 or view it in the news section of the Company's website, www.silicom-usa.com.

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

Ehud Helft -- Investor Relations

Yeah, thank you, operator. I would like to welcome all of you to Silicom's first quarter 2019 results conference call.

Before we start, I would like to draw your attention to the following Safe Harbor Statements. This conference call contains 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 our increasing dependency for substantial revenue growth on a limited number of customers in the evolving cloud-based SD-WAN, NFV and Edge markets; the speed and the extent to which solutions are adopted by these markets; the likelihood that we will rely increasingly on customers which provide solutions in these evolving market, resulting in an increasing dependency on a smaller number of larger customers; difficulty in commercializing and marketing Silicom's products and services; maintaining and protecting brand recognition; protection of intellectual property, competition and other factors 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 earning release, such non-GAAP financial measures would 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 investor understanding and assessment of the Company's ongoing cooperation 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 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 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.

Okay, with us today on the call are Mr. Shaike Orbach, the CEO and Mr. Eran Gilad, the CFO. Shaike would 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 now to hand over the call to Shaike. Shaike, go ahead please.

Shaike Orbach -- President and Chief Executive Officer

Thank you, Ehud. I would like to welcome all of you to our conference call to discuss the results of the first quarter of 2019. We are pleased with the results of the quarter. We demonstrated year-over-year revenue growth with revenues amounting to $30 million. We generated $4 million in net income and $7.5 million in operating cash flow, further strengthening our balance sheet. Our cash position now stands at over $81 million with no debt. Our balance sheet remains very strong, given our significant financial flexibility with shareholder's equity of over $162 million as a result of 14 years of ongoing and continued profitability.

As I've discussed in previous quarters, the primary drivers for our growth is from two directions, from our uCPE Edge products targeting the SD-WAN, NFV and other networking and telco-related sectors, as well as our advanced FPGA products. As you know, both of these markets are at the beginning of their growth curves which, as I will discuss in the next few minutes presents a huge long term opportunity for Silicom while, at the same time present significant timing and visibility issues in the short term.

In terms of our Edge product, as you know, we target some of the networking markets' most attractive segments, particularly that of SD-WAN and NFV. We're happy with the strategic progress our business is making in this space and as time moves forward, we are becoming increasingly excited with regard to the long term potential of our Edge products.

Our design wins in the Edge segment amount to more than 10 wins achieved in the past few years, some of which with revenue potential measured in the tens of millions of dollars per year at full deployment. Furthermore, our fat pipeline also includes additional such potential wins. Yes, in the short term, the picture is not clear due to growing uncertainty about the timing of the ramp up of our Edge wins. We are seeing delays to the launch dates of our direct major telco and service provider wins, due to a variety of factors, beginning with procedural reasons, funding issues and requirement for configuration changes. At the same time, we see lower forecasts coupled with excess inventory build by other SD-WAN, Edge, OEM customers, due to slower deployment than expected by their customers.

Customers continue to embrace and plan for integrating SD-WAN and NFV technologies as a part of their IT and networking strategy going forward. However, it is clear that SD-WAN deployment in general and as a managed service by telcos especially is being delayed and progressing at slower pace than the market and its players had originally anticipated only a few months ago. We are continuously monitoring the status of the launches, deployment plans and inventory build of our customers in the SD-WAN market and as new information comes to light, we will continue to share this with you in the upcoming conference calls.

However, we believe that our short term visibility will continue to be very limited and complex to focus for the rest of 2019. I want to emphasize, that we believe that it is only a short term timing issue. As I mentioned last quarter, across all our Edge design wins and especially those at top tier telcos and service provider leaders, the initial ramp process takes time, longer than what we typically experience with our more traditional design wins. And we are still early in the process for all our recent wins in this space.

Despite the extended timing, we will remain positive with regard to the long term prospects of our SD-WAN and NFV Edge-related business. Our success will be built on the ramp of our already existing design wins, which include wins with major telcos, service providers and leading SD-WAN players. Beyond that, our pipeline of deals that we're competing for is broad and deep and consequently, the long term revenue potential for Silicom is highly significant.

In fact, we continue to achieve additional design wins, which increase the long term revenue growth potential at Silicom. Today, we announced that an additional product group, as one of our customers, a Tier-1 service provider is replacing a competitor's Edge product currently using a non-SD-WAN/NFV service with one of our uCPE models, which is already being used by the customer. The customer is moving forward with the process expected to lead to general availability during the fourth quarter of 2019. Initial production will begin after the successful conclusion of this process with first production orders expected in early 2020.

At full deployment, when an additional feature that the customer needs to add into the product is fully integrated, the order run rate is expected to reach more than $10 million per year. This decision to select our product was based on the strength of our underlying technology coupled with a deep relationship between us and the customer.

In large organizations like this, with hundreds of departments and product groups, the potential for new opportunities for us to penetrate is virtually unlimited. We will continue working to expand the breadth and depth of our relationship, building and leveraging on our successes to achieve more further wins in the future. As you see, the opportunities for Silicom remain huge and we are much greater -- and are much greater than what we have achieved to date.

This is why, we're so excited about our long term prospects emerging from the Edge products. Field programmable Gate Arrays or FPGA solutions are already becoming an important driver for our Company and the design wins we have recently won are expected to provide us with solid revenue in 2020 and beyond. Because of the significant potential in the FPGA space that we identified in recent years, we made high levels of R&D investments in this area. Our technology bridges the gap between their FPGA chips and cards, to fully functional FPGA-based integrated solutions allowing our customers to tailor solutions to their exact needs. One of the major selling points is that our SmartNIC uses a unique Packet Mover technology, a feature enabling both us and our customers to easily integrate their own specific or generic IP into our core FPGA framework.

In early 2019, we have already achieved some significant success and to-date, we have announced two FPGA design wins. First, with a leading ISP and global communications leader, which selected our FPGA-based SmartNICs for use in its data centers globally with orders expected to gradually ramp-up to around $4 million per year. And second, a limited early deployment of close to $1 million with a leading cloud player. This customer is piloting our FPGA-based SmartNICs for use as a part of their virtualized cloud. Should network wide deployment materialize, the order potential which this win could ramp-up to -- could ramp to is in excess of $10 million.

The fact that two important customers, both leaders in their respective industries have selected our FPGA solutions, confirms the attractive value proposition and demonstrates the feasibility of our FPGA technology for both cloud and service providers.

These initial FPGA win for us are an important step, opening doors for us to new possibilities with the broadened range of solutions that we can offer to further fast growing target markets. We have a strong pipeline and we expect to achieve additional FPGA design wins in 2019 with ramp-ups in 2020 and accelerated growth in the years following. However, as I've explained previously, the ramp process is a gradual one and it will take time for the revenues to reach their full potential which will only begin to happen in 2020. We continue to invest significantly in developing and advancing our FPGA technology and we consider it to be an important element in Silicom's long term growth strategy.

With regard to our guidance for the second quarter. As I mentioned, visibility in the Edge, NFV space is currently unclear and our customers have indicated a slower initial deployment pace, which for us means that revenue ramp is somewhat delayed. With that in mind, we are providing a moderate guidance for the second quarter and project revenues at between $25 million and $26 million.

In the case that we will continue to see delays in the development of our SD-WAN wins, the second half of 2019 may possibly not demonstrate growth over the first half. However, looking further out into 2020, we believe that the short term delays in SD-WAN deployment will be behind us and we will also begin to benefit from our FPGA-related wins, which altogether will likely be translated into a return to a double digit year-over-year growth in 2020 and even more accelerated growth in 2021.

In summary, we're happy with our first quarter 2019 performance and we continue to build our business for the long term. As we have successfully done over many years, we continue to identify and invest in those areas which show strong promise in the future taking advantage of the many opportunities.

Today, we see those opportunities in both the Edge and in FPGAs. And we also see some market segments which these two areas complement each other. Our business remains healthy. Many of the recent large design wins we have achieved will be moving into the early ramp stage through the end of this year and during early 2020, which will provide a long term runway for growth in years to come. Our growing design win momentum underlines my confidence that Silicom has the right products for today's as well as tomorrow's market with all the right existing relationships in place. We look forward to reaping those toward -- rewards in the coming years.

With that, I will now hand over the call to Eran for a detailed review of the quarter's result. Eran, please go ahead.

Eran Gilad -- Chief Financial Officer

Thank you, Shaike and hello, everyone. Revenues for the first quarter of 2019 were $30.2 million compared with revenues of $29.5 million as reported in the first quarter of last year. Our geographical revenue breakdown over the last 12 months were as follows; North America, 81%; Europe and Israel, 15%, Far East and rest of the world, 4%.

During the first quarter of 2019, our top three customers together accounted for about 45% of our revenues. I will be presenting the rest of the financial results on an non-GAAP basis, which excludes the non-cash compensation expenses in respect of options and RSUs granted to directors, officers and employees, acquisition-related adjustment, as well as discontinued project-related write-offs. 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 2019 was $10.3 million, representing a gross margin of 34.1% compared to a gross margin of $9.6 million in the first quarter of last year, representing a gross margin of 32.5%. Operating expenses in the first quarter of 2019 were $5.9 million or 19.6% of revenues compared with $5.2 million or 17.5% of revenues in the first quarter of last year.

Operating income for the first quarter of 2019 was $4.4 million or 14.4% of revenues compared to operating income of $4.4 million or 15% of revenues as reported in the first quarter of last year. Net income for the quarter was $4 million or 13.3% of revenue compared to $4.3 million or 14.7% of revenue in the first quarter of last year. Earnings per diluted share in the quarter were $0.52 compared with $0.56 as reported in the first quarter of last year.

Now turning to the balance sheet, as of March 31st, 2019, the Company's cash, cash equivalents, bank deposits and marketable securities totaled $81.5 million with no debt or $10.73 per outstanding share, up $7.5 million compared with $74 million at the end of 2018.

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

Questions and Answers:

Operator

Thank you. Ladies and gentlemen, at this time, we'll begin the question-and-answer session. (Operator Instructions) The first question is from Alex Henderson of Needham and Company. Please go ahead.

Alex Henderson -- Needham & Company, LLC -- Analyst

Thanks. Could you help us out with a couple of data points, what was the split between domestic and international and what do you think your tax rate is going to look like over the course of the year. Should we be using the level of the first quarter for the rest of the year?

Eran Gilad -- Chief Financial Officer

Can you repeat the first question?

Alex Henderson -- Needham & Company, LLC -- Analyst

What's the breakout on the international markets?

Eran Gilad -- Chief Financial Officer

As I said during the call, North America, 81% for the last 12 months, Europe and Israel 15%, Far East and rest of the world, 4%.

Alex Henderson -- Needham & Company, LLC -- Analyst

And -- the tax rate?

Eran Gilad -- Chief Financial Officer

As to the tax rate, the tax rate in the quarter was approximately 14%. On a yearly basis, we estimate that the effective tax rate will be in the range of 15%

Alex Henderson -- Needham & Company, LLC -- Analyst

Okay. So clearly the commentary sounds like your revenues are going to be quite soft in the back half of the year with this inventory correction, you are talking about with the SD-WAN is probably more than one quarter's worth of softness. But can you talk a little bit about whether your major Tier 1 customers have changed their intentions relative to deployment of SD-WAN white label boxes or -- a little bit more granularity on what's going on with the Tier-1s? Is it a function -- is that why you're suggesting business in the back half might quote, be comparable to the first half of the year.

Shaike Orbach -- President and Chief Executive Officer

Well, let me say that, I don't think that anyone of our Tier-1 customers is thinking differently about SD-WAN, NFV or whatever they're doing. I mean, in general, their forecasts are just like they were, they're just delayed. I mean, they're just delayed. We don't see any of them saying no, no, it's going to be so, it's not going to happen just like we thought before. Not at all. They're only saying, it's going to be delayed, sometimes it may be a little bit different because as I mentioned before there could be -- each of them is coming with different reasons as to why or what is the reason for this delay.

But from their perspective, it's going to happen, only it's going to be delayed. We're saying that delays obviously will impact us directly on the one side because when they are delayed, we are delayed, when they are having inventory then they don't buy more and so on and so forth or when they are changing configurations or whatever. So while they decide what they want to do, we're waiting. But if you look at that from a top level, in terms of what their plan is for SD-WAN, not changed. They speak about that as enthusiastically as they used to speak, but it's delayed.

Alex Henderson -- Needham & Company, LLC -- Analyst

All right. So, you've never had, as far as back as I can see on my model a flat 1H to 2H. So clearly something is quite significantly changed in your thinking. Could you give us a little bit more granularity on exactly how much it's -- why that would be so soft in the -- for back half of the year?

Shaike Orbach -- President and Chief Executive Officer

Well I can tell you, one thing in general, I cannot go into the depth -- into the details. But in the first quarter, I mean, some of these guys still bought equipment, but later on, toward the end of the quarter, they found out that they were actually stuck up with stock which is why, they're saying, OK, I mean, moving forward, now we will have to deplete the stock before we're moving forward. So that's an example as to -- and that actually, I mean, it happened with -- mostly with one of the Tier-1 customers, but not only with him.

So what we're seeing is that some of these customers actually did materialize their, I would say prospect in the first quarter or so, but they're saying, OK, now we're going to be slow because we have too much stock. So that's why we're saying that, if the delays continue then the second half may not be more than the first half. But the first quarter that -- the first quarter that we had right now still included revenues that may not be there if the delays continues moving forward.

Alex Henderson -- Needham & Company, LLC -- Analyst

So, you're telling me that there's more than 90 days worth of excess inventory because that would certainly impact 2Q. But it shouldn't -- wouldn't we'd expect that to continue to persist. There's an over -- inventory overhang for multiple quarters like that and certainly not into the fourth quarter by this -- by that measure.

Shaike Orbach -- President and Chief Executive Officer

But it's not an inventory of just one product and some of that may go beyond 90 days, some others may not. So it's not a schematic picture like that, that how much it's delayed. Not all the delays are delays due to inventory. It's a combination of delays due to inventory. The fact that some of these guys made purchases for the first quarter is what's allowed us to be within our estimates in the first quarter. But moving forward, some of them would not be -- would not continue to buy from us in accordance with their earlier forecast, others that we estimated that we'd launch in a certain date would launch -- would or may not launch in this date due to some reasons that I mentioned before. So it's not as if all of that is just due to inventory.

Alex Henderson -- Needham & Company, LLC -- Analyst

All right. I'll cede the floor. Thanks.

Shaike Orbach -- President and Chief Executive Officer

What was that? Okay.

Operator

(Operator Instructions) The next question is from Martin Yokosawa of Torii Asset Management. Please go ahead.

Martin Yokosawa -- Torii Asset Management -- Analyst

Hi could -- you mentioned that there is a multiple of reasons why there are these delays from different vendors. Can you discuss in order of importance or impact, what these delays are?

Shaike Orbach -- President and Chief Executive Officer

Well -- OK. So, I'm not sure about the order of importance of these because these are different customers, each of which with different forecast. But the main reasons are just like I said before, one of them which is not a direct, I would say telco but rather one major customer of ours which used to buy quite significantly, told us that, he found himself -- he found out actually that his customers are not buying in accordance with his forecast. As a result of which he found himself with inventory and due to that he would not be buying from us for the short term.

By the way, even that is not fully accurate because that's just for one of the configurations. There is another configuration which is just initiating and for that configuration, he would begin buying from us but he is going to be much more careful because he found out that his original forecast did not actually materialize. So that's one reason. Another reason is that one of our Tier-1 customers said that he is not exactly sure as to when the funding within the organization will arrive to deploy some sort of a service which is replacing another service -- another service or another way of providing the service and that may take more time. Due to that, he is not putting the priority that he put before as to expediting the launch dates and he's taking that more on the easy side.

So the launch date that was supposed to be pretty soon would probably be moved toward the end of the year or something like that. Another of these guys says that, he looked at the market as it's developing and he would like to add or change some features into the current solution that we provided. That put a hold on everything that he wanted to do and due to that, he has come up with a different launch date which is more toward the second half of the year. And eventually that would mean that would -- there would -- there might not be as many as we thought units during the year depending on the accurate date that the actual launch would happen, because once again, it still may happen relatively early in the second half, in which case there would be significant revenues or it could happen a little bit later.

And in general, I would say that, once you're talking about new features, then there is a risk because you don't know where this is going to lead and how much time this is going to take. So I think that this is four or four -- or three main reasons due to the delays that we think or that may happen.

Martin Yokosawa -- Torii Asset Management -- Analyst

That's understandable. And I guess, in your opinion, the -- is the root of the problem, it goes of course the funding, but is the funding because the market for say 5G or whatever is not or cloud is not developing as fast. There's regulatory problems, there's technology problems and I'm not talking about on your side, I'm talking about the kind of the macro view of the environment that we're...

Shaike Orbach -- President and Chief Executive Officer

Of them -- of the customer side.

Martin Yokosawa -- Torii Asset Management -- Analyst

Yeah.

Shaike Orbach -- President and Chief Executive Officer

Yeah, I think, I'm not sure, first of all. I'm not an -- I'm not that much of an expert on what's going on with the customers, but I am -- I think that it may be a combination of some funding issues with some telcos around the world, which are experiencing some difficulties here and there and they're a little bit more hesitant. Before they emerged full force on new technologies. I think that may be a part of that as to why they're not moving forward that quickly. I think maybe although they are looking at the market and now saying, maybe we may need to change here something or do something a little bit differently.

So let's wait a little bit more to see someone else, how he is doing and then learn from his experience or something like that because overall, it is still a new market. But on the other side, I see more programs and more plans in different areas. And that's why, I don't feel any, I would say reduction in the level of enthusiasm overall. But the message is, it will take us more time.

Martin Yokosawa -- Torii Asset Management -- Analyst

Okay. Thanks.

Operator

(Operator Instructions) 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 by tomorrow on Silicom's website, www.silicom-usa.com. Mr. Orbach, would you like to make your concluding statement?

Shaike Orbach -- President and Chief Executive Officer

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

Operator

Thank you. This concludes Silicom's First Quarter 2019 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.

Duration: 31 minutes

Call participants:

Ehud Helft -- Investor Relations

Shaike Orbach -- President and Chief Executive Officer

Eran Gilad -- Chief Financial Officer

Alex Henderson -- Needham & Company, LLC -- Analyst

Martin Yokosawa -- Torii Asset Management -- Analyst

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