Silicom Ltd.
Q2 2021 Earnings Call Transcript

Published: 1 Aug 2021

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Silicom Second 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 1646-688-3559 or view it in the News section of the company’s website, www.silicom-usa.com. I would now like to hand the call over to Mr. Ehud Helft of GK Investor Relations. Mr. Helft, would you like to begin, please?

[Ehud Helft:]

I would like to welcome all of you to Silicom’s second quarter 2021 results conference call.

[Shaike Orbach:]

Thank you, Ehud. I would like to welcome all of you to our conference call to discuss our second quarter 2021 results. We are very pleased with the solid and ongoing improvement in our financial results for this quarter. We reported 31% year-over-year increase in revenues to over $30 million, demonstrating that 2021 is on track and the expected growth we have been discussing in recent quarters continues. We reported our 66th quarter of continued profitability, with net income of $3 million, up 59% year-over-year. EPS was at $0.42 and an increase of 62% year-over-year. This significantly higher growth in net income and EPS demonstrates the inherent leverage of our business model. We completed our second $15 million buyback in the quarter and started a new third $15 million one. In total, we purchased 83,000 shares in the quarter, amounting to $3.6 million. Our strong cash position and ongoing cash generation allows us to contribute to increased shareholder value in this way. At the end of the quarter, we had over $74 million in net cash on the balance sheet. We continued to advance with our strategy that we have discussed in recent quarters and as our two recent design wins demonstrate, we continued to build our penetration in the 5G/O-RAN as well as the SD-WAN markets, leveraging further from the inherent growing market demand. In May, we were honored that one of the world’s largest mobile infrastructure equipment providers selected our acceleration cards for their next-generation 5G mobile networks. Not only has this customer selected our current solution, but even more importantly, understanding our capabilities, it has also decided to work with us in parallel on a different version of the solution, which by itself would be an important contribution to our portfolio on top of the requirements of this specific customer. This was our third major 5G win with a global leader in only 6 months, but was also the first time that a major 5G equipment vendor had selected our solution. This third major 5G win is a solid demonstration of our growing leadership in the 5G space and in particular, in the distributed unit performance booster market. It also helps us expand our momentum in this market segment. A few weeks later, we were very pleased that Telefonica Tech, which is Telefonica’s holding for digital businesses and is part of one of the world’s largest telcos, selected our flagship SD-WAN Smart platform for its global SD-WAN solution for the small to medium enterprise segment. Telefonica Tech strongly valued our Smart platform, differentiated feature set for the disaggregated network environment. We also demonstrated a superior performance to price ratio as well as flawless integration of our hardware with their software platform. We also enjoyed a highly effective collaboration effort and strong working relationship with Telefonica Tech and the other vendors involved in the project, which we believe will lead to additional wins down the road.

[Eran Gilad:]

Thank you, Shaike and hello everyone. Revenues for the second quarter of 2021 were $30.3 million. This is a year-over-year increase of 31%, compared with revenues of $23 million as reported in the second quarter of last year. Our geographical revenue breakdown over the last 12 months, were as follows

[Operator:]

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

[Alex Henderson:]

Thanks and just congratulations on all these great large wins that you’re delivering. I wanted to talk a little bit about the supply constraints relative to what you reported in the quarter that was just printed. Obviously, you’ve seen some pretty strong orders, but it’s hard to tell the timing of when those orders should kick in. And several of them I think you’ve talked about kicking in more in the ‘22 time frame. So was there enough demand that if you had had more parts and more availability, I know you got more than you had anticipated, but more than that, that you would have delivered further upside to the revenue? Or were you not supply-constrained because your good job of managing your inventory levels and the like? Can you talk about whether there was upside in demand?

[Shaike Orbach:]

Well, first of all, there was an upside in demand. And I mean, if I needed to give you just a bottom line answer as to whether or not if we had no constraints at all on components if we would have been able to deliver more, then the answer is, yes. Now that being said, I mean, we are investing a lot of time in, I would say, minimizing the impact of the shortages, and that includes both in terms of inventory planning as well as in time invested in talking to all our vendors and pushing them and explaining to them what we really believe in

[Alex Henderson:]

Similarly, when you look at the third quarter guide, I’m assuming that you’re also expecting continued constraints to limit upside to the numbers based on what you’re seeing. I mean, are we talking about $2 million, $3 million, $4 million, $5 million worth of potential upside that’s left off the guide because of that?

[Shaike Orbach:]

Well, I don’t have a number. But once again, I mean, obviously, if we had no constraints, we would have been able to deliver somewhat more. I do not know exactly how much more. I would also like to say that this number that we’re giving you right now, on the other side, it is based on what we know right now on our planning that I discussed before. In these times, sometimes vendors de-commit to what they used to commit to and there are surprises. So on the other side, there is still risk in delivering that as well. But if you’re asking from a pure demand perspective, yes, we would have been able to deliver somewhat more.

[Alex Henderson:]

So going out into the fourth quarter, the guide that you’re implying is kind of low-single-digits growth rate. It’s a pretty big decel. Can you talk about why that decel is occurring there? Is it just simply because of the much easier comps in the first three quarters against a much tougher comp? Is it supply constraints further out look tighter and harder to forecast? What’s behind that?

[Shaike Orbach:]

So first of all, I would like to say that when you look at the full year, that even with the fourth quarter included in there, you would still see a year-over-year growth, which I believe is approximately 18% or something like that, or 19%, which I believe is significant. Now that being said, I would also agree on one of the things that you’ve said. Yes, I mean, the impact of the shortages in material is not being reduced for the fourth quarter; but rather, the other way around. So yes, we have even more difficulties, all of which are taken into consideration when we provided our guidance, but we do have more difficulties in terms of material shortages for the fourth quarter than before that. I would like to mention that we started to plan our inventory not only when this crisis started, but also before that, which is why at the beginning we were fully prepared with inventory against the upcoming orders. As we move into this scenario of prices and shortage of material, the scenario becomes even more challenging, which is why I would say that the results of the fourth quarter, the impact on the fourth quarter results is somewhat higher than the impact on the third quarter, than the impact on the second quarter, and so on and so forth.

[Alex Henderson:]

So when I look at the very significant wins that you’ve had over the course of the last 6 months and with the launch of the Evenstar product in March, it seems pretty clear, I mean, there are multiple large global Tier 1 type customers here, that there is a lot of future demand implied by that. Can you talk about the timeline for when you think those players will kick in, whether those projects are in the numbers in the back half of the year or are more of a ‘22 number, a ‘23 number? How do we think about that in terms of measuring the outlook?

[Shaike Orbach:]

Well, first of all, obviously, not all of these projects will kick in at the same time, and there are differences between these projects. But if I had to provide a generic answer to the question, I would say that the impact in 2021 is minimal of these projects, that we would feel a significant part of that in 2022 and possibly even more in 2023.

[Alex Henderson:]

I see. And is the pipeline as rich as the rear-view mirror?

[Shaike Orbach:]

Yes.

[Alex Henderson:]

One of the surprises in the quarter is against a backdrop of people expediting. Most companies are seeing compression in their gross margins. Yet you guys are seeing margins coming in at the higher end of the spectrum. Can you talk about why that’s the case? I would have thought larger deals and difficult challenges getting parts causing expediting would, in fact, cause the opposite to happen?

[Shaike Orbach:]

Well, I would say that from a day-to-day perspective, we do feel exactly the same pressure. However, we do have, well, I would call it, the privilege of having a very wide, I would say, portfolio of products which represents a mix in the gross margin that we could charge between them for a variety of reasons. So the main reason for the somewhat higher gross margin in this quarter is simply the mix of product. It’s not because we are different than anyone else and while everyone else’s prices or costs are increased we were able to reduce the price of components. I think we’re doing good, but we’re not doing that good. I mean, this kind of environment right now does not allow for cost reductions; it goes the other way around. And we are just like everyone else, somewhat maybe negotiating tougher, but that would not constitute the difference. The reason behind the increased gross margin is the mix of products sold in this quarter.

[Alex Henderson:]

So we’ve been tracking a lot of the appliance-related, more traditional customer base and been very positively surprised. It has a robust – the demand from enterprises are for data center and campus branch infrastructure, with order rates ranging from 15% to as much as 30% growth in what I would describe as traditional products that have been areas that have been declining. Is that part of what’s going on here, is that underneath the surface your traditional business of appliances into a variety of traditional customers is seeing a very strong uptake and that’s driving that mix?

[Shaike Orbach:]

In terms of a mix, a part of that is coming from what you’re saying. I mean, that we did have some, I would say, traditional customers which, to a certain extent, increased their demand and, consequently, whatever they took from us during the quarters. But the mix difference is not only due to traditional customers and new customers. Even within the new customers and the new markets, the mix and the gross margins can vary between various products, sometimes various customers, sometimes simply due to the fact that in a certain opportunity we were able to significantly reduce the cost of certain components. So while I would say that what you said is definitely a part of that, it’s not the only part. I mean, and they are different in gross margins of various products and customers, even with the new market segments that we’re addressing.

[Alex Henderson:]

So just to take those comments out into the gross margins in the back half of the year, are we looking at more like last year’s gross margins or are we looking more like first half of this year’s gross margins in the back half?

[Shaike Orbach:]

Well, I – the only thing that I am saying is that fourth quarter, and then obviously there would be an average of that, fourth quarter was still within what we define for gross margin, which is 32% to 36%. And Q3 and Q4 may fall within the lower part of that or the higher part of that. And then, I mean, I am presuming that when you calculate the average, it may be somewhat higher. So, maybe 34% something or something like that.

[Alex Henderson:]

I see. And then just one more question, the interest income line went negative, after running at around $400,000, $500,000 in prior quarters. Is that going to snap back in the September quarter? Is there something unusual in that, that has caused this to go negative? I mean, obviously, you have got a huge cash balance.

[Eran Gilad:]

The main reason is that exchange rate may be a big factor in the financial income number. So, it depends – every quarter it depends on the actual exchange rates against the shekel and against the Danish currency. This quarter, the effect was negative.

[Alex Henderson:]

Okay. So, if we exclude the volatility in exchange, would that have been a $400,000 kind of number in that line, as it was in the first quarter? Is that the ongoing run rate we should be using, assuming flat currency, in the second half of the year?

[Eran Gilad:]

I would say that if we exclude the exchange rate effect, the real economic number is approximately $100,000 per quarter.

[Alex Henderson:]

Okay. So, we should be using $100,000.

[Eran Gilad:]

Correct.

[Alex Henderson:]

I appreciate that detail and I will see the floor. Thanks.

[Operator:]

The next question is from Sergi Mascaró. Please go ahead.

[Sergi Mascaró:]

The first question I wanted to ask today was about the potential of the deals that we have had this quarter. I think that we have had a deal with Telefonica Tech and another one with Ericsson. But you did not disclose the long-term sales potential of these deals. Can you speak a little bit about this, please? Are we in the same case as with the Facebook project that we spoke about at the last call? Thank you.

[Shaike Orbach:]

Well, first of all, indeed, we have identified Telefonica Tech, and we have not identified the second customer. So obviously, I am not referring to the name. I would say that the potential, in general, of the deal with Telefonica Tech is not yet very clear, even to them. Obviously, it’s going to be millions of dollars. And if it’s going to be a low number of millions of dollars, they would consider that to be a failure. But it’s a little bit difficult. It’s a new service that they are launching. So, what exactly the volume will be, we don’t know. As to the second win, I would say that we expect out of the specific product that we are selling to this customer, we are expecting a few million dollars per year, single digits. But we consider that penetration to this customer is extremely important, because we believe we would be able to sell more products to this customer as we move forward.

[Sergi Mascaró:]

Yes. Thank you. I said the second name because Ericsson has recently announced that it will be using Intel’s Acceleration eASIC cards for its mid-band Cloud RAN technology. And I think that only Silicom is using these cards. Also, Ericsson said in the press release that the Cloud RAN solution could work with 7 million of its radio. So, I don’t know if you can say anything about that.

[Shaike Orbach:]

No. I cannot comment on that.

[Sergi Mascaró:]

Okay. No worries. Great. Now about the Evenstar and Telecom Infra Project. This quarter, we also had lots of news here. Vodafone, MTN Africa, Telecom Egypt and others have disclosed that they were committed to the Telecom Infra Project and Open RAN. So, is Silicom involved in this project with the Evenstar program? I am not sure if Evenstar and Telecom Infra Project share connections.

[Shaike Orbach:]

I am not sure I understood what the question is. Obviously, I mean, as we have said, we are a part of the Evenstar program. We have not delivered the units yet. It’s a long-term program. I am not expecting revenues of this program to be significant this year. It is obviously up to the participants within the program to decide what exactly they are going to take and from whom. And I am not sure that I answered your question, to be honest. I am ready. If you would like to direct me again what the question was, I would try to respond to that more accurately.

[Sergi Mascaró:]

Yes. So I mean, is there any kind of relationship between Evenstar and Telecom Infra Project? Because lots of companies like Vodafone or MTN Africa said that they were working with the Telecom Infra Project. So, maybe you could speak about that?

[Shaike Orbach:]

Is there a relationship between whom?

[Sergi Mascaró:]

Yes. Evenstar and Telecom Infra Project.

[Shaike Orbach:]

I am not familiar with this kind of a relationship.

[Sergi Mascaró:]

Okay. Okay. No worries. So, it is now eight months away since you announced the 5G field trials project in October last year. Is there any kind of update you can give us about these field trials?

[Shaike Orbach:]

Yes, I can give you an update about that. The customer has decided to use, I would say, next generation of solutions for these field trials, which is why we are still working with the customers in updating what we wanted to do at the beginning. That means actually the period or the timelines for these kind of field trials would be postponed into next year.

[Sergi Mascaró:]

Okay. And one more question about the tech side. During 2019, we had delays in the SD-WAN and FPGA deployments for a few quarters. Do you believe that these delays are already behind us?

[Shaike Orbach:]

Which delays?

[Sergi Mascaró:]

Yes. We had delays in the SD-WAN and the FPGA deployments in 2019 for a few quarters.

[Shaike Orbach:]

Delays from whom?

[Sergi Mascaró:]

Do you believe that these delays…

[Shaike Orbach:]

Which delays?

[Sergi Mascaró:]

Yes, for a few customers we spoke. SD-WAN and FPGA.

[Shaike Orbach:]

I am not sure what delays you are referring to right now, and we do not have any delays right now. And when I say delay, I mean that we commit something to our customers that we cannot deliver on the day committed. If the delays that you were talking about were due to COVID-19, I am not sure. But still, I mean, we do not have any delays right now. But obviously, with the increasing demand coming from our customers, we are not always able to deliver goods to them on the dates that they wish to get the goods, especially in the environment of shortages of materials. But I am not – right now, there are not any significant delays company-wide or something like that that I can talk about. There is nothing like that.

[Sergi Mascaró:]

Okay. So everyone is speaking about inflation right now. My questions here are, do you have pricing power to increase the prices of the design wins if we see sustained levels of inflation? And are you experiencing this inflation right now?

[Shaike Orbach:]

Inflation? No, no impact.

[Sergi Mascaró:]

Okay. But do you have pricing power to increase the prices of the design wins if we see sustained inflation?

[Shaike Orbach:]

It’s not an issue of pricing power; it is an issue of policy. I mean, we work with our customers. And even if we had the power, once our customers become dependent on us to increase the price for a certain demand, we are very reluctant to do that, because we work closely with our customers, making them partners. So, even if we do have the power, we do not do that.

[Sergi Mascaró:]

Okay. Thank you. And my last question. We have recently seen large semiconductor companies like Qualcomm and Nvidia presenting plans to develop ASICs for the use that support an Open RAN network model. Do you think that this increases the competition to your products?

[Shaike Orbach:]

Well, I would say, in general, that the competition to our products will increase, whether it’s by Qualcomm or Nvidia or maybe some other players as well. And yes, we are teamed with Intel. And let us just say that if we get the market share that Intel is planning to get for itself or even half of that, I would be very happy.

[Sergi Mascaró:]

Okay, well said. Thank you. Many thanks and best of luck.

[Operator:]

There is a follow-up question from Alex Henderson of Needham & Company. Please go ahead.

[Alex Henderson:]

Thanks. Clearly, there has been a lot of change over at Intel, Pat Gelsinger coming in and the like and realignment of their programs and policies and architectural decisions and things. Can you talk about whether there has been an improvement, a status quo or erosion relative to your positioning there?

[Shaike Orbach:]

Well, right now, it’s obviously status quo. We hope that there would be some improvement in some areas. I would say, in general, that we are really working closely with Intel. And when I say with Intel, it means that we are talking to, I would say, mostly three divisions within Intel. So with two of them, we are working really, really closely and really have partnership relationships. And this is where our growth is coming from. These are the areas where the growth is coming from. There are other divisions, the third one and possibly some others, where we did not experience exactly the same kind of a relationship. And due to these organizational changes, we are hoping that possibly we would be able to even increase, I would say, our partnership penetration within Intel for the better. But we are not sure that would happen.

[Alex Henderson:]

And again looking at what they are seeing in terms of projects, I know that they have historically handed a fair amount of business off to you where it was at the right scale for you, but not necessarily the right scale for them. Are you still seeing that relationship or do you see a good pipeline of projects coming over from them?

[Shaike Orbach:]

Well, first of all, we see a good line of projects coming from them. And we are seeing during the last year that even though, in general, what you have said before is still correct, but there are some projects that they are saying, no matter what, “We would give these to Silicom, even if they are scaling, if their required scale is high,” simply because we – I mean, they are maybe turning resources into the processors or whatever. So, in some situations that we work with them, they are allowing us to actually be the only ones acting in their names without them, themselves, having another product which would go to the high-scalers. But in general, it’s the same approach, yes.

[Alex Henderson:]

Okay. Great. I appreciate the answers. Thank you.

[Shaike Orbach:]

Thank you.

[Operator:]

The next question is from Robert Sussman of Bentley Capital. Please go ahead.

[Robert Sussman:]

Thank you. Could you update us on the status, I don’t think this has been asked, of the CPE business with the two large telcos? Last I heard, one had not started at all, and the other one was moving ahead, but very slowly.

[Shaike Orbach:]

So, the status is that the last one, which is moving ahead, and by the way, very slowly. It is slower than what we expected, but it’s not that slow. I mean, we are still selling quite a few millions of dollars to this telco. And with the other one, I would update that there – that we begin to see a certain change in there, at least in terms of requests coming up again and so on and so forth. I am not sure that they are really ramping up, because it’s happened in the past and then we got disappointed. But just recently, during this quarter, we have been able to say that even this second telco is – there is a possibility that it would be ramping up. Now, that being said, I would say that these two telcos are a relatively old story. Overall, our CPE business is booming. We are selling tens of millions of dollars of CPEs already. And this is the most, I would say, the area of our business which is growing in the fastest way.

[Robert Sussman:]

Okay, just a follow-up to that, what is the annual potential of these two telcos when they really ramp up?

[Shaike Orbach:]

Well, even – I mean, when the projects with them started, I may have been able to give a response, and I think we even included such a response in the PRs that we presented when we announced these wins. I would say that right now I really don’t know. I mean, it is very difficult to say. We have been disappointed, to a certain extent, with one of them; even in full to the other one. So the potential, yes, it’s tens of millions of dollars of each. Whether or not this would happen and what is the chance that that would happen with the experience of last year, it’s not very high. But once again, I mean, if you are asking not about these two telcos, the wins of which we received maybe 3 years or 4 years ago, but rather of the SD-WAN or CPE business as a whole, then the potential there, I would tell you, it is huge. We are selling right now tens of millions of dollars. And I wouldn’t flinch before saying that a potential there could come to $100 million or even more, just for CPEs.

[Robert Sussman:]

Are you saying $100 million on an annual basis?

[Shaike Orbach:]

Yes.

[Robert Sussman:]

Okay. If it’s not with the two telcos, can you tell us what products that you are selling into the CPE market and give us an idea of who the customers may be for it?

[Shaike Orbach:]

Well, we cannot give an idea about the customers. We have issued several PRs providing some examples of wins that we had. There are quite a few customers to which we are selling these units. And I see the potential both with these customers and with additional customers with which we have our pipeline with as a very strong one. As I said, speaking about potentially combining all of these together, yes, it could come to $100 million, not immediately, per year. Not immediately, not the next month. But speaking about potential, the potential is there.

[Robert Sussman:]

Okay. Thank you very much.

[Operator:]

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:]

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 second quarter 2021 results conference call. Thank you for your participation. You may go ahead and disconnect.