Earnings Call Transcript - SILC Q1 2021

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Silicom First Quarter 2021 Results Conference Call. 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 & 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, please?

Ehud Helft, Investor Relations

Thank you, operator. I would like to welcome all of you to Silicom's first quarter 2021 results conference call. Before we start, I’d like to draw your attention to the following safe harbor statement. 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 markets 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, disruptions to our manufacturing and development, along with general disruptions to the entire world economy relating to the spread of the novel coronavirus, COVID-19, 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 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 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 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. Now, with us today on the call are Mr. Shaike Orbach, the CEO; and Mr. Eran Gilad, the CFO. Shaike will begin with an overview of the results followed by Eran, who will provide the analysis of the financials. We'll then turn over the call to the question-and-answer session. And with that, I would like to hand over the call to Shaike. Shaike, go ahead, please.

Shaike Orbach, CEO

Thank you, Ehud. I would like to welcome all of you to our conference call to discuss our first quarter 2021 results. We are very pleased with the solid and continued year-over-year improvement in our financial results this quarter with 31% year-over-year growth in revenues to $29 million, the second quarter in a row with over 30% growth. It demonstrates that 2021 is on track and the growth we have been planning for and expecting over recent quarters is here. Furthermore, we reported our 65th quarter of profitability with net income of $3 million, up 31% year-over-year. Our cash position remains strong, ending the quarter with over $78 million. We continue to use our strong cash generation to progress on our share buyback. And today, our Board announced a new $15 million share buyback plan bringing further value to shareholders. I will discuss this in more detail in a few minutes. Our strong results are on the back of tapping into today’s most important market trends, the shift to the cloud and the associated shift towards standardization, which is key for scalability. As you know, the move towards standardization has led to two important trends, which are disaggregation and decoupling. These disaggregation and decoupling trends, which started in the cloud, have created a process impacting all parts of the networking market. The process was started by the major cloud players, which are building the data centers under a generic infrastructure using standard servers. Standardization and the existence of standard service in the cloud increases the demand for smart cards as such servers need acceleration and offloading abilities to support the required performance. It is a huge opportunity for us. An important market segment, which also adopted these new trends was the SD-WAN market, followed by NFV, where telcos started to look for smart platforms, which are decoupled from the software, which was to be supplied from a software vendor. This allowed us to approach the market with our smart platforms, enabling us to gain strong traction and we were highly successful in this market. Due to this, the SD-WAN and NFV segments are a significant part of our current business as well as our future potential. As I’ve already spoken about previously, now telcos and mobile operators are increasingly adopting the open radio access network standards, which allows such disaggregation and decoupling in the 4G/5G infrastructure deployments. The concept behind O-RAN is to enable operators to decouple key network components, including radio units, distribution units and central units, enabling best-of-breed and standardized components from a diverse list of vendors, which can be combined into networks for superior performance. This approach is driving innovation and just, as importantly, reducing network costs significantly for operators. These trends play strongly in our favor by facilitating the need for our smart platforms and smart cards for cloud, telcos and OEMs. Furthermore, O-RAN creates opportunities for combinations of our products and expertise within the mobile infrastructure and enables us to leverage our unique and integrated capabilities in networking, acceleration, FPGAs and smart platforms. Correctly forecasting this trend, over the past few years, we directed our R&D investments as well as our sales and marketing efforts with increased focus and additional strategy fine-tuning in 2021. We are now seeing the fruits of those investments with successful customer penetrations throughout the relevant product line that address those strengths. To illustrate our success, following soon after our major top 5 global telco design win in January for our virtual O-RAN tech accelerator cards for the new network build-out, in February, we won a second 5G design win with another customer for these same cards. This new design win is a further confirmation of the power of the 5G build-out and the disaggregation trend, which is accelerating our growth. The customer and other leading U.S. service provider and 5G player is pioneering its stand-alone 5G network based on disaggregated Open RAN architecture and will use our cards in its network’s distributed units. In January, our first of 5 telco win kindled and excited industry-wide interest in our 5G-enabling technologies. Broad enthusiastic feedback with our solution has confirmed our approach and the superiority of our technology. And we are currently engaging many discussions with multiple players. This also includes expanding our two existing penetrations and scoring further design wins at our initial customers, the distributed unit suppliers and the hyperscalers they are cooperating with. We believe that our innovative and cost-effective products, our deep 5G system-level understanding, our years-long cooperation with Intel and the expanding relationships we have and our building with the all key telcos, hyperscaler, server manufacturers and 5G players position us for long-term success in these high potential markets. Beyond our existing achievements and the possibilities to date, today we see the potential to drive further accelerated growth with the explosive growth we see in the 5G, Edge and cloud infrastructure markets ahead and leveraging the close cooperation with corporation and joint go-to-market activities with Intel. We have decided to somewhat increase our investment in R&D in 2021. As you have seen in our financial results, R&D expenses were $4.8 million in the quarter, being slightly more aggressive than usual compared with our traditional approach. Given the opportunities, we believe this increased R&D investment is prudent and will pay off nicely in the future. For the remainder of 2021, we feel comfortable with this level of R&D expenses. I would like to briefly address our Evenstar collaboration, another example for the potential that O-RAN 5G presents for us and for our needs to invest more in R&D. A healthy ecosystem of Open RAN vendors plays an important role in accelerating the deployment of simplified, flexible and efficient RAN technologies. A few weeks ago, we announced our Evenstar distributed units collaboration with Facebook connectivity and other Evenstar partners, addressing the operator demand for best-in-breed, unbundled distributed units that meet 3GPP and O-RAN specifications to facilitate the rollout of Open RAN in 4G and 5G networks. The Evenstar program aims to accelerate the adoption of Open RAN solutions across the industry. The new collaboration with Facebook and other Evenstar partners allows us to provide operators with groundbreaking functionality, bringing the network flexibility and performance to a whole new level such as advanced offloads and time synchronization at highly competitive price points. This cooperation demonstrates that our ability to integrate the various functionalities required within the distributed unit is indeed considered as an important asset by the industry. As you can see, moving into 2021 and beyond, Silicom is very well positioned. The markets that we address are performing strongly and are expected to continue with the significant growth in CapEx investments. The trends within these markets support the areas that we have invested in over the last few years. They support our cloud penetration efforts for smart cards, our SD-WAN and NFV-related efforts through smart platforms and now they also support our smart platforms and smart cards together and separately for the huge 4G/5G O-RAN-based mobile infrastructure market. Many of our new potential telco design wins have much greater scaling potential than what we have traditionally experienced. And more than that, each design win we have already achieved and continue to achieve represents an opportunity for sustained long-term revenues once we establish a relationship with the customer. And this is also why our recent success and wins are indeed so important. Before moving on to our guidance, I’d like to address the global shortage of electronic components, which I’m sure you’re all aware of and which we already discussed last quarter. Practically, as of today, we feel this shortage with all our suppliers. I stress that this is an industry-wide issue affecting everyone in a very significant way. The extent of the component shortages is to a level we have never seen before and analysts expect it to persist at least for the rest of 2021. Component lead times are increasing and scarcity is increasing prices. In some cases, we see lead times of 12 months or even longer. Given careful planning and prudent inventory management, we’ve been able to resolve most second quarter component shortage issues. And the impact for the second quarter will be minimal. Looking further out to our deliveries during the second half of the year, our efforts today will also help us alleviate some of the issues. However, there remain component shortages, and we are working hard to resolve these as best as we can to meet the strong and growing demand for our products. I note that the longer lead times could have an impact if the mix of actually ordered products differs significantly from the forecasted mix and could delay the possible upside we would gain from faster-than-forecasted ramp-ups of existing design wins as well as the additional potential from design wins in our pipeline. There is also the concern that despite our meticulous and early planning, vendors that are currently scheduled to deliver on time will decommit as we move forward. We see this happening more and more. I would like to add that on our side is the caliber of our larger customers, which are thirsting for our products and our close working relation with them is pushing us up the components’ priority list. We are also leveraging our strong relationship with the vendors, especially Intel. We will, of course, keep you up-to-date on this. I would like to spend a few moments discussing our guidance. For the second quarter of 2021, we expect revenues of between $29 million and $30 million, which at the midpoint, represents strong year-over-year revenue growth of 28%, a third quarter in a row with about 30% growth. Given our very long and growing list of design wins, generating ongoing orders, our solid baseline of activities, and strong market fundamentals, with our focus on some of the fastest-growing markets in the networking space, we are well positioned for strong growth in 2021 and beyond. While the current component shortage adds some uncertainty into the second half of the year, we reiterate our guidance range for the year of $120 million to $130 million. Before summarizing and moving over to Eran, as I said earlier, we have a strong cash position, providing us with significant financial flexibility, giving us more than enough working capital. It enables us to continue to invest internally in our R&D efforts, ultimately fueling the long-term growth of our business. Furthermore, it also allows us to share the rewards of our continued profitability and cash generation with our shareholders. And today, the Board of Directors authorized a third 1-year share repurchase plan allowing Silicom to purchase up to $15 million of our ordinary shares in the market. Our current 1-year $15 million buyback plan will expire this month. To date, during the last two years, we have purchased approximately 870,000 shares of Silicom for a total sum of about $30 million. In summary, as I’ve shared with you, the disaggregation and decoupling trends continue to gain traction and are significantly increasing Silicom’s potential. Our long list of design wins, our partnerships with the market major players, our extensive collaboration with Intel and our current long and deep pipelines provide us with much optimism going forward with continued growth. Consequently, we expect that the coming few years for Silicom will see performance well ahead of what we have achieved over the past few years and that we will continue to achieve ongoing revenue growth at a double-digit compound annual growth rate for several years ahead. With that, I will now hand over the call to Eran for a detailed review of the quarter’s results.

Eran Gilad, CFO

Thank you, Shaike, and hello, everyone. Revenue for the first quarter of 2021 was $29 million. This is a year-over-year increase of 31% compared with revenues of $22.1 million as reported in the first quarter of last year. Our geographical revenue breakdown over the last 12 months was as follows: North America, 59%; Europe and Israel, 33%; Far East and Rest of the World, 8%. During the last 12 months, our top three customers together accounted for about 35% of our revenues. 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 and RSUs granted to directors, officers and employees, acquisition-related adjustments as well as lease liabilities, financial income. 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 2021 was $10.1 million, representing a gross margin of 34.7%, within the range of our gross margin guidance of 32% to 36% and compared to a gross profit of $7.3 million or gross margin of 33% in the first quarter of 2020. The variance in gross margin is a function of the specific product mix sold in the quarter. Operating expenses in the first quarter of 2021 were $7.1 million compared with $5.7 million in the first quarter of 2020. Most of the increase is R&D related and, as Shaike mentioned, is planned and represents our continued significant investment in developing new products, IT, and technologies. Operating income for the first quarter of 2021 was $3 million, an increase of 90% compared to operating income of $1.6 million as reported in the first quarter of 2020. Net income for the quarter was $3 million, an increase of 31% compared to $2.3 million in the first quarter of 2020. Earnings per diluted share in the quarter were $0.42. This is a year-over-year increase of 36% compared with EPS of $0.31 as reported in the first quarter of last year. Now turning to the balance sheet. As of March 31, 2021, the company’s cash, cash equivalents, and marketable securities totaled $78.1 million, with no debt or $11.30 per outstanding share. During the quarter, we further executed our second $15 million share buyback plan, which we started on May 4, 2020. During the first quarter, we purchased approximately 86,000 shares at a total cost of $4 million. That ends my summary. And we would all be happy to take any questions.

Operator, Operator

The first question is from Robert Sussman of Bentley Capital.

Robert Sussman, Analyst

Can you provide an update on the numerous design wins coming in? I'm curious about when we can expect to see a significant sequential increase in revenues, aside from the component shortage issue. Historically, the second quarter tends to be much stronger than the first, yet your guidance suggests that it will be relatively flat. Could you discuss the timeline for these design wins, specifically regarding the two CPE design wins? I understand one of them is in volume production, while the other has not yet begun.

Shaike Orbach, CEO

I’ll address both the older and new design wins, as well as provide some insights on the quarter. First, regarding the older design wins, there isn't any significant news. One of them is operational, and we hope to see more growth, but currently, I don’t have an update on that account. It remains an important account for us, and it is fairly stable at the moment. The other design win has not started ramping up yet due to some issues on their end. We are in discussions with them, and while it appears they want to increase production soon, we are facing challenges with component shortages. Therefore, I can't confirm if that will happen, especially since we haven't received any forecasts from them for the upcoming quarters. Now, concerning the new design wins, which we announced in January and February, we expect to see revenues from both of them this year that will contribute to our growth in the following quarters. Our guidance for the second quarter is slightly better than what we achieved in the first quarter and takes into account these new design wins as well as the impact of component shortages. If it weren't for these challenges, we would likely be able to demonstrate stronger results in the second quarter. Overall, I believe these new design wins will have a significant impact mostly in the second half of the year, with a slight contribution in the second quarter. I anticipate the second quarter will see around 30% year-over-year growth.

Robert Sussman, Analyst

Okay. One short follow-up on that. That’s very helpful. When do you think we’ll start to see meaningful revenues from the 5G wins?

Shaike Orbach, CEO

We expect to begin seeing revenues from our 5G wins primarily in the second half of the year. To clarify the situation regarding shortages and wins, our projections for the second quarter are based on our current focus and solutions available for component shortages. While there is never complete certainty, we are quite confident we will achieve our targets for the second quarter. For the third and fourth quarters, we have plans that take the shortages into account, and we remain hopeful that we can resolve some of these issues. In terms of revenue growth, we anticipate an increase thanks to these 5G wins. However, it's important to remember that telecommunications companies have been difficult to predict historically, so forecasting exact outcomes is challenging. We are averaging our expectations, but based on the latest information, we believe these 5G wins will have a substantial impact, contributing significantly in the second half of the year, although we cannot specify the exact amount.

Operator, Operator

The next question is from Alex Henderson of Needham & Company.

Alex Henderson, Analyst

I have a couple of questions. First, can you explain the growth trajectory? It seems like supply constraints are affecting the numbers, not just in the June quarter, but also in the second half of the year. As we consider the latter half, is the high end of projections limited by component availability? What conditions would lead you to achieve the low end of projections? Given the revenue of over $29 million in the first two quarters, the low end appears overly conservative for the second half. Would decommissioning or decommitment be necessary to reach that low end? Can you share your thoughts on both ends of the projections?

Shaike Orbach, CEO

Yes. I believe that reaching the lower end of the range would involve two main factors, primarily related to decommitment, as you mentioned. When I refer to decommitment, I'm talking about it in the context of our forecasts. We have forecasts that suggest we would be at the upper end. However, if our vendors were to decommit—something that happens frequently—our forecasts, which are based on numerous accounts, often do not align perfectly. Some accounts may underperform while others exceed expectations, balancing each other out. As long as we don't face component shortages, this is manageable since one account may be low and another high. However, if one account is underperforming and the other is overperforming, we face challenges: if we cannot deliver on the high due to component shortages, that could push us toward the lower end. I consider the upper end to be achievable if everything goes as planned, and while there could theoretically be a higher end, I hesitate to discuss that primarily due to the issues with components. If we encounter an unexpected opportunity for higher output now, it may be very challenging for us to fulfill it because of component shortages.

Alex Henderson, Analyst

Before I move on to the next part of my question, I want to acknowledge you, Shaike, for nearly reaching 20 years with the company this year. Your long-term commitment to Silicom is commendable and significantly contributes to the stability of the company's leadership. Congratulations on that. Now, regarding the outlook, could you share insights about the SD-WAN segment? We've heard from other companies that enterprise spending is rebounding rapidly on a global scale. Additionally, as people start to return, there’s noticeable incremental spending in campus environments. While not everyone is returning, many are remaining remote, leading to sharp increases in traffic growth in what are referred to as hot networks. This has resulted in unexpectedly strong spending on campus edge and data centers. Does this translate into increased demand for your SD-WAN business? It seems like this trend will continue to accelerate over the next few quarters. What are your observations in that area?

Shaike Orbach, CEO

We are observing increased demand in the SD-WAN sector. This demand is coming from both our current customers and those in the pipeline. We hope to see positive developments in that area soon. The component shortages we are facing this year are a significant concern because the challenges arise even before we receive a purchase order. New customers are eager to implement solutions this year, but it is proving to be difficult. Nonetheless, we clearly see a growing demand and an expanding pipeline. With the support from Intel and our efforts, I believe we will increase our revenues in the SD-WAN sector this year, although much of that growth will likely be deferred to next year. Currently, SD-WAN is a vital component of our business, contributing to our overall growth rate of 30%.

Alex Henderson, Analyst

Within that context, there are larger companies with more capabilities for ordering and similar activities against a very tight backdrop. Are you at risk of losing business due to your smaller scale, possibly concerning potential customers about the outlook?

Shaike Orbach, CEO

I believe that we may not only be at no risk but possibly in a stronger position. This is due to our robust cash position, which enables us to plan effectively, make informed assumptions, and prepare our inventory. If we can interpret the market accurately, we could outperform other companies. A key factor in our success is making the right choices regarding which components to purchase and when to leverage our relationships with component suppliers to secure additional resources. We are successfully navigating this by utilizing our major customers to assist us, as well as our strong partnerships with vendors. For instance, we are currently engaged in discussions with Intel, which is advocating for us because of our solid partnership. Intel's influence is helping us to push our vendors, enabling us to be in a favorable position overall.

Alex Henderson, Analyst

I understand. That makes sense. Referring back to the broader topic, if we were to disregard any supply limitations, would you anticipate a growth range that aligns more with the first half of the year rather than the second half? Or do you believe there will still be some timing constraints related to these larger programs, resulting in growth being below 20% from the document house?

Shaike Orbach, CEO

What I can say is that if there were no constraints from the components’ perspective, our growth would be faster and at a higher percentage. I don’t know if that would be at 30%, but I’m sure it would be higher than what it will actually be moving forward because in the second half of the year, these constraints will limit our growth to some extent. I do not have an accurate number for where it would have ended without any constraints, but I’m confident it would be better than what we are predicting right now.

Alex Henderson, Analyst

Right. Okay. I get the gist of it. Just down below the line. Should we be assuming an increase in the taxes or a continuation of the 15% rate? And then second, can you give any guidance on the interest income line based off of the: a , the buyback; and, b, a little bit of a rebound in rates? Should we be assuming that to hold steady? Maybe improves a little bit? What are you thinking on those two lines?

Eran Gilad, CFO

Okay. I’ll start with your first question about tax rate. Still, it is expected to be in the range of 15%, no change. As to your second question about financial income, this is hard to predict because it depends on the dollar exchange rate, which nobody can know what the exchange rates will be in the future. Assuming no dramatic changes in the exchange rate of the U.S. dollar, I would say that approximately $215,000 to $300,000 is the right range for financial income.

Operator, Operator

The next question is from Serge Mascaro.