Silicom Ltd.
Q4 2020 Earnings Call Transcript

Published: 28 Jan 2021

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Silicom Fourth Quarter and Full-Year 2020 Results Conference Call. All participants are at present in listen-only mode. Following management's formal presentation, instructions will be given for the question-and-answer session. As a reminder, this conference is being recorded. You 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 begin please?

[Ehud Helft:]

Thank you, Operator. I would like to welcome all of you to Silicom's fourth quarter and full-year 2020 results conference call.

[Shaike Orbach:]

Thank you, Ehud. I would like to welcome all of you to our conference call to discuss our fourth quarter 2020 results. We are very pleased with the solid improvement in our financial results in the fourth quarter. We reported revenue of $33.9 million ahead of our guidance expectations, a 33% improvement over the fourth quarter of the past year, and also a strong 19% improvement over the previous quarter. Despite what has been a very tough year 2020 still saw revenue growth versus 2019. Furthermore, we reported our 64th quarter of profitability with net income of $4 million. This represents a 29% increase over Q4 last year, and a 36% increase versus the prior quarter. We ended the quarter with over $76 million in net cash, and for the quarter used our strong cash position to further progress on our share buyback with the goal of bringing increased value for shareholders. Our results demonstrate that we have been able to move ahead with our strategy and more than maintain business continuity in a difficult environment. This shows the resilience of our business and our ability to plan and overcome the world challenges that the ongoing pandemic continues to bring all of us. During 2020, our strategy was made even more clear and more focused than ever before. Throughout 2020, we primarily ensured that we were ahead of and fully tapping into today's most important market trends, the shift to the cloud, as well as disaggregation and decoupling. This is where we directed our R&D investments as well as our sales and marketing efforts over the past few years with increased focus and additional strategy fine tuning in 2020. We already see the fruits of our investments with successful customer penetrations throughout the relevant product lines that addressed those trends. Today, I want to spend time talking about the trends that we cater to, that we see driving our business in the coming quarters. The first and obvious trend, which I would like to discuss is the shift to cloud provided services both public and private. The immediate outcome of the cloud shift is the move towards standardization, which is key for scalability. Standardization has led to two important trends, which are disaggregation and decoupling. Disaggregation means replacing the proprietary interfaces between the various parts of the network with standard interfaces. This has the benefit of allowing the various parts to be procured separately from independent vendors.

[Eran Gilad:]

Thank you, Shaike and hello everyone. Revenues for the fourth quarter of 2020 were $33.9 million. This is a year-over-year increase of 33% compared with revenues of $25.5 million as reported in the fourth quarter of last year, and a sequential increase of 19%, over the $28.4 million reported in the prior quarter. Our geographical revenue breakdown over the last 12 months were as follows

[Operator:]

The first question is from Alex Henderson of Needham & Company. Please go ahead.

[Alex Henderson:]

Thank you very much. First off, congratulations, outstanding quarter. And obviously, your strategies are really paying off, quite impressive. I did want to talk a little bit about the issues around the supply constraints, 12 months or longer lead times is really unusual. I get an unusual period relative to COVID in the light, but how do you think that that gets resolved? What are the suppliers telling you in terms of flexibility? How are you approaching it relative to giving up some margin to procure additional supplies if you needed to keep your customers satisfied, it seems like that's an unusually large constraint?

[Shaike Orbach:]

Well, first of all, yes, I mean, this is an unusually large issue or constraint this year. This year is 2021 obviously is really going to be a challenging year from that perspective. And we are doing several things in order to mitigate that. First of all, I think we are - and this is not something that has started right now, we are preparing ourselves, we did have some indications that it's going to be a challenging year. We have approached our customers, and we asked them to provide as accurate with a certain potential for upside, a forecast as possible. We have had internal meetings, estimating the forecast and we have placed orders for components ahead of time. And that means that it's not as if these challenges are impacting everything that we have planned for just the other way around. In fact, the impact would be or I wouldn't say the impact, because we would try to mitigate the impact as well. But the challenges would be on everything, which is not planned. So everything which is a part of our plan, we took care of that, we placed orders even a certain while ago in order to be able to do that on time. So that's one part of that. Another part of that is, I would say applying pressure, I mean, it may not be that nice. But at the bottom line, we do see that pressure helps. So if you would say that, you would look at how I split my time for example, then due to these challenges, I am allocating more and more of my time to talk to the suppliers to their management to explain to them about our business potential, and so on and so forth. And I think that we're seeing some success in that area because we invest more in getting the components that we need, so we get more. So that's the second part of that. And third part of that is making our customers a part of that process. And when we have big customers, they're helping us with this process as well. Now on top of that, because some of these components, you could also buy in the free market rather than from the authorized - rather from the - I would say the manufacturers obviously only once confirming that from a quality perspective, this is okay. But in the free market, if you want to buy these components, you need to pay more. And we are talking to our customers to participate in that and to undertake for themselves, at least when they come up with an upside or an unfocused demand. So, they should take the expediting fees, which we call PPVs in order for us to be able to deliver to them their goods, and this is also working for us. Now, I would say that this is not always working. And sometimes we would need to pay somewhat more for components in order to need that to get them in time and some other parts, we would not be able to achieve what we want to achieve. But overall, I still feel that 2021 that we are going to be successful. There will be challenges. This is how we're trying to mitigate them. But the challenges are still there.

[Alex Henderson:]

Couple of questions, then it's for the guidance on '21 top line. Can you talk a bit about what you think the impact of the exchange rates are obviously, while shekel has been quite strong on operating margins, and what your plans are relative to investing in the R&D line given the magnitude of the opportunities in front of you? And then finally, can you talk about what you think is going to happen the gross margins as you continue to shift to larger and larger deals? These trends obviously have an impact?

[Shaike Orbach:]

I would respond, Eran would later elaborate on the shekel versus the dollar. I would say that, first of all, yes, we are investing in R&D. We are I would say increasing our R&D efforts, but it's not going to be anything dramatic overall. But what helps us a lot I think is that our strategy during 2020, we have been able to clarify our strategy to a level that we haven't been able to do before. And that's why I feel that our investments right now are much more focused. And that’s why - even though that's why I can tell you that I feel as if we are increasing our investment in those areas, which we believe in even more than the increase in R&D expenses, because we're able to take away from our table, take off the table, other things that we consider to invest in, which are not a part of the strategy right now. So overall, I would say yes, I mean, our R&D expenses in terms of men in labor hours, because indeed, the shekel versus the dollar can change the picture significantly just like it had this year. But in terms of how much we invest from the perspective of people that we engage in these efforts, sometimes subcontractors et cetera, that would increase not dramatically, but that would increase to a certain level. But it is much more focused, and I feel much better with this investment, because I really believe in our focus. Eran, you can add a little bit more color to the shekel versus the dollar.

[Eran Gilad:]

About the exchange rate, first of all, it's the effect of the dollar compared both the shekel and the Danish Krone, we have a subsidiary in Denmark. So the effect in the quarter was actually very significant. And the negative effect on our operating expenses was approximately $400,000. And the negative effect on our financial expenses was also approximately $400,000.

[Alex Henderson:]

Yes, I was really looking forward to obviously the move over the last couple of months to new highs on the shekel. I did not look at the krone but the obvious move - as we look forward, could you just remind us what your edging policy is and whether there is any hedging in there or whether we should be - negative impact in over the periods.

[Eran Gilad:]

Our hedging policy is very simple. We do not hedge.

[Alex Henderson:]

That’s right. Okay. I couldn't remember too many Israeli companies are coverage to remember. And then can you give tax guidance for the year?

[Eran Gilad:]

Yes, as you could see the tax expenses in the quarter was actually zero or close to zero. It is a result of a few one-time positive effect. And generally speaking, I will repeat the guideline that we say every quarter, we anticipate we forecast approximately 15% effective tax rate for 2021.

[Alex Henderson:]

And then one more question on the modeling. So obviously you've got tremendous cash generation capabilities. So what are you doing relative to share buybacks or other capital usage going forward?

[Eran Gilad:]

As I think we mentioned it on the call itself. We progress as planned with the buyback plan and actually intend to meet the targets, which was set by our Board buyback of $15 million within one year.

[Alex Henderson:]

And any - that exercised at this point?

[Eran Gilad:]

Any what?

[Alex Henderson:]

Have you ever exercised any of that at this point or is it just $15 million outstanding?

[Eran Gilad:]

Yes, yes actually during the fourth quarter, we purchased more than $4 million, which is even more than the…

[Alex Henderson:]

$11 million outstanding then?

[Eran Gilad:]

Sorry?

[Alex Henderson:]

Where there is a $11 million still outstanding in the buyback, it was $15 million you got $4 million in it's 11 million outstanding. Is that right?

[Eran Gilad:]

We still have in the pipeline, approximately $4 million, $5 million to invest.

[Alex Henderson:]

So there's $4 million, $5 million left of the $15 million?

[Eran Gilad:]

Correct.

[Alex Henderson:]

Okay, thank you. That's what I was looking for.

[Eran Gilad:]

Yes, $4 million, $5 million.

[Alex Henderson:]

All right, I'll see the floor and get back in queue.

[Operator:]

The next question is from . Please go ahead.

[Unidentified Analyst:]

So first of all congratulations for the great quarter, it seems that we're finally building some kinds of momentum. So that being said, my first question is about SD-WAN space. In the last quarter, there was a Tier 1 SD-WAN project that was not ramping up yet. Did you receive all those in Q4?

[Shaike Orbach:]

I think let me just - make sure that I understood the question perfectly. You're asking about one SD-WAN customer that we have that in the last call we said it was not ramping up yet. And you're asking if it's ramping up right now, was that the question?

[Unidentified Analyst:]

Yes, sure.

[Shaike Orbach:]

Okay. So I would say that this question was related to two telco wins that we had in the past out of which one, we said last time that one of them was ramping up. The other one did not ramp up yet, this situation has not changed right now, even though there is some dynamics. Well, I'm a little bit hesitant to say that it would ramp because each time that we saw that something is happening eventually we find out that something different is happening. So we did not. But on the other side, I mean during the quarter, we have announced even during the last quarter we have announced it's really design wins related to SD-WAN, which together would amount and are expected to ramp up to around $10 million per year. And we did have some revenues from these. And I do hope that these will have a certain level of ramp up during 2021.

[Unidentified Analyst:]

Does the press release of earlier this month have any kind of relationship with the previous one, which was about the O-RAN filterize win?

[Shaike Orbach:]

I did not understand the question. Can you run that again by me, please?

[Unidentified Analyst:]

Yes, sure. So does the press release of earlier this month as any kind of relationship with the previous press release, which was about the O-RAN filterize win?

[Shaike Orbach:]

No, the two press release are separate entirely separate with two different telcos.

[Unidentified Analyst:]

Thank you, great. And these networks is working with Intel for the 5G national deployments in the USA. I believe these deployments are going to start in the second half of this year. If I am not wrong, you are the only vendor that's partnering with Intel for one product that is selected from Intel. So could you maybe speak about this project since there is public information available?

[Shaike Orbach:]

Well, I cannot speak about specific customers right now. We are working with Intel, I would say across the board. And Intel is indeed helping us with a variety of customers. Intel is very significant in our engagements with all these customers. And what I can tell you, the one thing that I can tell you is that specifically with the FEC, FEC acceleration product we're doing. We're currently the only I would say product in the market at this time. At least that can support a non-FPGA and non-software, which means a hardware accelerator which is needed in the 5G deployment and this is based on Intel's silicon Intel's eASIC, which is obviously why Intel is helping us in such an intensive way. And that goes to actually all customers.

[Unidentified Analyst:]

Okay perfect. I believe that Asia is expected to grow really fast in the 5G segment. Are you targeting like China and India markets?

[Shaike Orbach:]

I would say yes, we are targeting the Asian market. Obviously, not only the Asian market, but we are targeting the Asian market as well.

[Unidentified Analyst:]

Yes, perfect. Thank you. Did you sell any kinds of software for your FPGA? And what does it mean in terms of gross margin?

[Shaike Orbach:]

You're saying if we sold FPGAs?

[Unidentified Analyst:]

No I mean, did you sell any kinds of software with your FPGA?

[Shaike Orbach:]

Oh, okay, I see. We definitely sell software with FPGA but not as a standalone mostly. I mean in most cases, we sell it as a part of the product that we sell, which is coupled with both software and IP, which is inside the FPGA, RTL or whichever way you want to call it. Now, this has an impact on the margins, which is why our margins on these sales are higher. However, that being said, now that we're approaching at the 5G and the major cloud players with FPGA proposals and the quantities there are going to be very, very significant. These huge player once they grow up in quantities, they may expect the margins to go down to a level which is - to a level which is closer to our I would say general type of margins rather than to the higher level which we are able to accomplish when the quantities are not yet that high.

[Unidentified Analyst:]

Could you maybe share with us which are your competitors in the O-RAN space, I can only find Eternity segment and it’s a really small company?

[Shaike Orbach:]

Well first of all, I should say that O-RAN is a big name. We are not covering the full space of O-RAN. For example, there are quite a few companies which are developing radios, which will support O-RAN and we are not there obviously. So, we are within O-RAN, we operate it well rather than giving you a number I would define where we are operating within O-RAN. So, first of all our major area of operation within O-RAN is what is called the distributed units. This is actually the unit there are different architectures. So please, I may not be 100% accurate here because my description may not be in accordance with all architectures. But anyhow, the distributed unit is a unit which is actually interfacing with the radios, sometimes with a switch but typically in our way of - in our architecture, it interfaces with the radios on the one side and with the central unit or compute unit on the other side. So within this distributed units, we are proposing to the market. First of all, what goes inside the distributed units which are two types of cards, one is an accelerator, the other one is time synchronization. And the accelerator could be either a card which is based on the Intel’s eASIC or an FPGA card and then the time synchronization card. We are also as I said, importing from our SD-WAN NFV, we're inputting the platform itself. And we are able to offer to customers not only the cards which go into the platform, but also the platform itself - somewhat customized to address the distributed units, requirements. And some customers, they do see value and we understand why because it's a relatively complex product, they do see value in buying the full unit the distributed unit, the platform the smart platform itself with the cards as a single unit, because this reduces - a quite a few elements of integration, which otherwise they would have would have had to take care by themselves. So this is one area within O-RAN that we support. The other area is with FPGA cards, which we are proposing to go into the central unit or the computing everything is still within Edge, but this one is closer to the core and to the telco cloud, I would say. So there we are proposing I would say higher end FPGA solutions, which is offered in order to support offloading of UPF, which is user plan functionality. So this is our offering within O-RAN, O-RAN includes not only that, it includes some other parts of that as I said, which we are not participating in.

[Unidentified Analyst:]

Yes, yes and maybe about your competitors in the O-RAN space?

[Shaike Orbach:]

Yes, so once again, I mean you mentioned Eternity and Eternity is really is a small property and Eternity the main area where Eternity is trying to compete with us is in the UPF area, not only but in the UPF, this is where they are operating. I believe that with Intel's assistance, we would be able to achieve most of our goals within this area. That being said, I would say that I think that we are really fast to the market with all these solutions both FEC acceleration, time synchronization let me say one thing about time synchronization, though, and UPF offloading. There is a competing architecture I would say the competing in terms of time synchronization. The competing architecture is using an external switch, where the time synchronization is achieved in the switch. This is a much more expensive architecture. And this is why many customers are interested in the architecture that we're promoting whereby the time synchronization sits inside the distributed unit, interfacing directly with the radios because this is saving a lot of money. So I think that this architecture will be the winning technology. But we indeed where - I believe the first, at least the first significant solution which is proposed to the market, but that doesn't mean that we would stay like these. I think that additional competition, both in terms of FEC acceleration and in terms of time synchronization will rise. What I'm hoping was is that because a lot of these business requires qualification of these cards within the platforms. We would be able to achieve sufficient one, I would say partners, which would qualify our solutions and that would make it more difficult for the competitors to plug themselves in once they're ready, but they will be for sure competition as well.

[Unidentified Analyst:]

Okay, thank you. So I believe that your current buyback program is going to be completed by April. Can you speak about your capital allocation plan?

[Shaike Orbach:]

For buyback program?

[Unidentified Analyst:]

Yes, yes, yes it's going to be completed by April I believe. So could you maybe speak about your future plans about your capital allocation?

[Shaike Orbach:]

We will think about that. Once we get closer to the end of this program and then we will decide and obviously modify our decision.

[Unidentified Analyst:]

Okay, we would wait for it. And my last question, can you speak about your expectations on the 5G and SD-WAN deployments for the year?

[Shaike Orbach:]

For this year?

[Unidentified Analyst:]

Yes, yes, the 5G and the SD-WAN deployment yes?

[Shaike Orbach:]

The one thing that I can tell you and I cannot provide details at this time, is that we have a very thick and long pipeline. And we believe that we will be achieving additional design-wins in both areas, both in 5G and in the SD-WAN pretty soon.

[Operator:]

The next question is a follow-up question from Alex Henderson. Please go ahead.

[Alex Henderson:]

Thank you. So I was hoping we could talk a little bit about the lumpiness of some of these contracts versus the alternative dynamic which is the breadth of the number of contracts that you have. It seems pretty clear that when you have the IBM issue years ago, that - it was because you had a huge singular contract that eventually didn't work out, where we are now, it sounds like you have a lot of fairly solid size contracts, and the number of them is diversifying the demand picture enough that it should be a smoother and more predictable ride from here. Is that a fair characterization of the environment?

[Shaike Orbach:]

Yes, I believe it is. I mean, the contract that we had with IBM just like you said, had its risks. And while everyone knows by now that IBM I don't think it's important anymore, but even though we were not supposed to - at that time. And there were many unique parts of this contract. And definitely, what we're experiencing right now is more I would say smooth just like you said.

[Alex Henderson:]

So is there upside in terms of the pipeline that additional contracts are coming near in that will be constrained on supply side that therefore gives us visibility that this robustness of this demand will persist through '21 and into '22 as these supply constraints start to ease up, and if we actually see some improvement in COVID conditions does that meet in the supply constraints might ease significantly in which case there will be additional upside? Is that the right way to think about the dynamics here?

[Shaike Orbach:]

Well, once again in general, I would say yes. I would say that, first of all, and this is still mostly related to your previous question. And what we're seeing right now is that all these design wins and partners that we work with including our pipeline as a matter of fact, and this is why the sales cycle is so long, they are taking a very cautious approach before they are actually launching massive deployment. This was not the case with the IBM contract, where they took a huge risk and started to deploy before they have resolved all their internal problems or issues or challenges. In this case, what we're seeing from all our customers is a different approach. They are very carefully evaluating, testing, taking the time before they actually launch that. Now some of these - obviously with different customers, we are in different time or different phase within this process. So some of them are close and some of them we may be able to announce the design win pretty soon, and then hopefully experience their impact pretty soon and others it will take longer. Obviously, when the components challenges are eliminated and disappearing, then I think that we would be in a better situation. Because it does happen, and it did happen to us in the past that was something was delayed eventually, we lost this part of the business due to the delay, and customers decided to use their previous generation or whatever. So overall, once the challenges and components are disappearing, this would represent a higher ramp back, I would say capacity than what we're experiencing right now. So yes, I believe we would see continuous growth. And that's why we're talking about double-digit growth not only that's what we're planning for, not only this year, but in the years coming ahead.

[Alex Henderson:]

Let's talk a little bit about the OpEx numbers. Historically, your OpEx has been some 20% of revenues, but in the most recent couple of years, it spiked up to 20% to 23%, consequently 3% on average for the last two years. Should we be anticipating that stays at that higher level or will that gradually trend back towards the 20% level?

[Shaike Orbach:]

I think, well first of all, it's obviously a little bit difficult to speak about the OpEx, because they're so dramatically impacted by the dollar value. But I would say, to give you just some sort of flow that if the exchange rate is where it is right now, then we could expect an annual OpEx of approximately $28 million.

[Alex Henderson:]

Okay, that helps. Is it expected longer term to be able to bring that percentage down again or is that no longer predict?

[Shaike Orbach:]

Really grow the percentage will go down again, because I do believe that once our plan is working, we would be able to see again the famous leverage, and that's where the OpEx in percentage would be less.

[Operator:]

There are no further questions at this time. Before I ask Mr. Orbach to go ahead with his concluding 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:]

Yes, thank you, operator. Thank you everybody for joining the call. We wish you all health, and we look forward to hosting you on our next call in three months time. Good day.

[Operator:]

Thank you. This concludes Silicom’s fourth quarter and full-year 2020 results conference call. Thank you for your participation. You may go ahead and disconnect.