Silicom Q2 2023 Earnings Call Transcript

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July 31, 2023

There are 5 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Silicom Second Quarter 2023 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.

Operator

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 EK Global Investor Relations at 1212 378-8,040 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 EK Global Investor Relations. Mr.

Operator

Helft, Would you like to begin?

Speaker 1

Thank you, operator. I would like to welcome you to Silicom's Q2 2023 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 projected, including as a result of Silicom's increasing dependency for substantial revenues growth On the 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. Like you, the Tecom will rely increasingly on customers, which provide solutions in these evolving markets, resulting in increasing dependency on a smaller number of larger customers, difficulty in commercializing and marketing of silicon's products and services, Maintaining and protecting brand recognition, protection of intellectual property, competition, the disruption to our manufacturing, sales and marketing, Development and customer support activities, the impact of the war in Ukraine, rising inflation, rising interest rates, volatile exchange rates and commodities prices As well as any continuing or new effects resulting from the COVID-nineteen pandemic and the global economy uncertainty, which may impact customers' demand So they are exercising greater cautions and selectivity with their short term IT investment plan As well as those other factors discussed in our Annual Report on Form 20F and other documents filed by the company and that may be substantially filed by the companies from time to time with the Securities and Exchange Commission.

Speaker 1

In addition, following the company's disclosure of certain non GAAP financial 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, 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 A full reconciliation of non GAAP to GAAP financial measures is included in today's annual release, which you can find on Silicom's website. And now with us today on the call are Mr.

Speaker 1

Eilon Aizendran, President and CEO and Mr. Einar Gilat, the CFO. Yaron will begin with an overview of the results, followed by Eran, who will provide the analysis of the financials. We will then turn over the call to the question and answer session. And with that, I would like to hand

Speaker 2

over the call to Yaron. Yaron, please? Thank you, Kenny. I would like to welcome all of you to our financial results conference call Discussing our Q2 2023 results. We are happy to show a good set of Q2 2023 results.

Speaker 2

We grew our Q2 revenue to $38,100,000 in line with our expectations. It was a 12% increase over the Q2 of last year. We are indeed happy with those results, especially against the background of a more challenging economic environment and more limited visibility, which I will discuss in a few minutes. Our continued success has led us to more than 18 years or more precisely 74 quarters of uninterrupted profitability And we reported 2nd quarter earnings of $0.66 per diluted share. Our strong balance sheet has been the outcome of a very planned and As we discussed a few quarters ago, as supply chain issues improved, we continue to decrease our inventory.

Speaker 2

In this quarter, we further decreased our inventory by $10,000,000 moving towards a normalized level of inventory that matches current components lead times. Also, as discussed a few quarters ago, we continue to improve our cash position, which currently stands at $63,000,000 with no debt. It represents an increase of $10,000,000 during the Q2. Our strong cash position remains a key strategic asset and enables us to capitalize quickly on opportunities. As we have shown, we are very happy to share the rewards of our continued profitability and cash generation with our shareholders.

Speaker 2

Based on our improved cash position and our expectations to continue to be profitable during the coming years, we intend to accelerate the pace at which we repurchase our shares Under the $15,000,000 share repurchase plan that we announced 3 months ago. Our strategic decision to focus on the edge market as a primary growth continues to bring us further design wins. During the quarter, we announced that we were selected again by a leading U. S. Enterprise telecommunications service provider To develop an innovative edge networking product for them.

Speaker 2

The customer placed initial orders of around $5,000,000 and delivery will follow the successful completion of the development and testing processes. This customer expects orders to scale up over the next several years as the product enters mass deployment. The fact that this leading telco service provider turned to us is very gratifying and we are excited about the potential of the new use cases it brings to market. Apart from the long term sales to this customer, we believe this product will be attractive to a broader customer base, adding to Strong momentum, which has been building for our Edge product lines. This win confirms our value proposition and it's further evidence of the significant growth potential We see in our Edge product family.

Speaker 2

Our momentum in Edge networking has clearly broadened well beyond the SD WAN space with growing interest from customers seeking enhanced performance and flexibility for their next generation networks. It demonstrates the unique value proposition of our full service model And the broadest portfolio of edge networking offerings, namely our innovative best in class products at attractive price points, rapid development And customization capabilities, our partnership approach and uncompromising total support. In parallel, we continue to achieve design wins For the acceleration server adapter product, in April, a Tier 1 U. S.-based cybersecurity vendor awarded us with 2 NIC design wins, 1 for an advancing Cretien offload acceleration card and the other for an FPGA based SmartNIC. Both will be incorporated into 2 of the customers' next generation solutions, which are sold to some of the world's largest, most technologically advanced companies to secure and optimize their networks and applications in the cloud, on premise or at the edge.

Speaker 2

We expect that those design wins will start ramping up towards broad deployment in 2024. Those two design wins demonstrate the innovation underlying our technology, Our broad portfolio and the uniqueness of our full service package as well as our reputation for performance booster solution, it also underscores the ongoing power of our server adapter product lines to continue playing an important role. A few weeks ago, we announced the first in a new line of edge AI products Under a partnership with HALO, a leading artificial intelligence chipmaker. According to Polaris Market Research, in 2022, The global edge AI hardware market was valued at $1,200,000,000 and is expected to grow at 21% compound annual growth rate to $8,000,000,000 by 2,032. Our new Edge AI product line integrates HALO's AI accelerators into Silicom's existing edge platforms, Solving performance challenges for edge AI use cases.

Speaker 2

As a result, Silicom's product will be able to offer visual processing and AI inference at the edge At the uniquely attractive price performance ratio. By integrating AI into our product, we are making it cost effective to move behavior analytics, human intrusion detection, Facial recognition and vehicle analytics to the edge, opening up many new use cases, potential revenue streams for our customers. In fact, we are already engaged in proof of concept and in discussions with customers on various use cases. We are excited about the opportunity that's being created by the The architecture that we have built for this product can easily be extended for use with other AI chip vendors like NVIDIA and others. The requirements of the specific use cases determine the right shape for the product.

Speaker 2

I would now like to spend some time discussing the factors impacting Our guidance and outlook for the Q3. As I'm sure you remember, since the global COVID shutdown in early 2020, supply chains around the world became tight With very limited availability of electronic components. Silicom, like many other companies with strong balance sheets at the time, took the correct decision to Significantly increased and hold high levels of inventory of raw components. This was to ensure that we can build the product that our customer need in a timely way, Maintain strong business continuity and most importantly, keep our clients happy. Similarly, over the past 2 years, Many of Silicom's customers have in turn ordered a high level of our product, so they can manufacture products for their own customers.

Speaker 2

And this ordering in part for inventory drove above average demand and backlog for our products in both 2021 2022. As we enter the second half of twenty twenty three, supply chains are no longer tight and our customers are lowering their inventory levels, Reducing their backlog and drawing on their existing stock of our products were possible. As a result, revenues we had originally projected for the 3rd quarter have been pushed out to later this year or next. Furthermore, I want to add that because of the broad expectation of Slowing macro economy, some of the recent design wins, which we had earlier expected to ramp up quickly in 2023, Are proceeding more cautiously and ramping up slower than we had originally discussed and planned with the customer. I highlight that they have not paused And we are still seeing growing revenues from those design wins just at a slower pace than what we had originally expected.

Speaker 2

Taking all those factors into account, Q3 is expected to be slower quarter and our expectations are revenues between $30,000,000 $31,000,000 while the factors I mentioned earlier impact our revenue expectations in 2023 and may also have an effect on our first half of twenty twenty four results, we believe that we are currently under shipping end market And the overall longer term picture remains strong. With that, we remain positive that our fundamentals and long term growth story remains intact. Despite the current challenges we are facing, our mid to long term outlook remains positive. This is underpinned by a strong and continually growing list of Many of which are with some of the world's leading players in the telco and networking space. While given the macro environment, the ramp ups Our recent design wins tend to be slower than our original expectations.

Speaker 2

I stress that we have not experienced any significant cancellations of programs or displacement by a competitor. To highlight some of the recent design wins, during the last 18 months, 2 leading companies, a U. S. Communication service Provider and a large SD WAN vendor granted us 3 significant design wins. All three design wins are still at the early ramp up stage And thus our revenue from those wins in 2023 will be less than half of the full annual potential of those design wins.

Speaker 2

While the ramp up Is indeed slower than what we originally expected when signing with them, the full potential indicated by the customers represents strong long term potential Silicom and significant further room for growth. Furthermore, our work with 2 leading SARTI players is just beginning to ramp up, Having already shipped over $3,000,000 worth of products in the first half of twenty twenty three, as Sassy grows and given both our customers' dominant position within the Sassy We expect strong future growth in sales to those customers. In addition, we continue to see strongly growing opportunities like AJI In other markets within the broader trend of desegregation and decoupling. I want to spotlight one particular future opportunity that we are working on. We have been developing a line of white label switches, further expanding our total addressable market.

Speaker 2

White label switches are open network switches That separate the hardware and software layer running on off the shelf chips, which offers strong customization abilities. Key features include the ability to build on commodity hardware, Utilization of ASICs from established vendors and the operation of an open network operating system, they are prevalent For component in software defined networks, enabling network programmability, which has a distinct advantage over traditional switches. Based on our expertise, IT and know how in networking, hardware acceleration and edge platforms, coupled with superb customer relationships And market recognition, we are perfectly positioned to benefit from this market. Those switches are gaining broader popularity for the high end performance, simplicity, user choice freedom, fast innovation and cost With all those advantages, we are currently pursuing a significant design win with a potential Tier 1 cybersecurity customer Adding to our reasons for optimism about the future. All in all, we have every reason to be optimistic.

Speaker 2

Silicom is well positioned as a key player in our industry And given the growing potential within our design win roster, our long and deep pipeline and our continually growing total addressable markets, Including the recent addition of edge AI and white label switches, we continue to increasingly excited about the opportunities that play ahead of us. In summary, despite the tougher environment we are facing, we are happy with our Q2 2023 results. When smoothing out the over ordering in 2020 2021 and accounting for the digestion of inventory starting in the second half of twenty twenty three, We would still have shown solid growth over the past 3 years. The total addressable market for our Edge Networking products is much larger than we had initially estimated Only a few years ago and underlies our expectations for continued growth over the long term. Beyond that, we maintain an impressive roster Top tier customers and design wins, many of which are only in their initial ramp up stages and our robust pipeline of future design wins All significant further growth potential for us.

Speaker 2

We believe that our drivers for long term demand remain firmly intact. As we navigate the current situation, we remain highly focused on our first priority target of long term growth by achieving new design wins, Delivering on our new product and technology roadmaps and ensuring customer satisfaction. At the same time, we continue carefully manage the company to maintain profitability and cash generation. With that, I will now hand over the call to Eran for a detailed review of the quarter's results. Eran, please go ahead.

Speaker 3

Thank you, Leron, and hello, everyone. Revenues for the Q2 2023 were $38,100,000 up 12% compared with revenues of $34,200,000 as reported in the Q2 of last year. Our geographical revenue breakdown over the last 12 months were as follows: North America, 79%, Europe and Israel 17%, Far East and Rest of the World 4%. During the last 12 months, we had 1 10% plus customer and our top three customers together Accounted for about 30% 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.

Speaker 3

For the full reconciliation from GAAP to non GAAP numbers, please refer to the press release we issued earlier today. Gross profit for the Q2 of 2023 was $12,300,000 representing A gross margin of 32% and compared to a gross profit of 12,300,000 dollars or gross margin of 36% in the Q2 of 2022. The variance in the gross margin is a function of the specific product mix sold in the quarter And BOSSS remain in line with the expected range of our gross margin guidance of between 23% 36%. Not 23%, sorry, 32% 36%. Operating expenses in the Q2 of 2023 were $7,500,000 compared to $7,300,000 reported in the Q2 of 2022.

Speaker 3

Operating income for the Q2 Of 2023 was $4,800,000 compared to operating income of $5,000,000 as reported in the Q2 of 2022. Net income for the quarter was $4,500,000 compared to $4,700,000 in the Q2 of 2022. Earnings per diluted share in the quarter was $0.66 This is a year over year decrease $0.04 compared with EPS of $0.70 as reported in the Q2 of last year. For the first half year of twenty twenty three, our earnings per diluted share were $1.27 an increase of $0.13 compared with EPS of 1.14 dollars as reported in the first half last year. Now turning to the balance sheet.

Speaker 3

As of June 30, 2023, the company's cash, cash equivalents and marketable securities totaled $63,300,000 with no debt or $9.31 During the Q2, Silicom purchased approximately 25,000 shares at the cost of $900,000 under the new $15,000,000 share repurchase plan We announced during the quarter. In total, Silicom has purchased an aggregate of $44,000,000 in share buybacks in recent years. As mentioned by Liron, based On our strong balance sheet, improved cash position and our expectations to continue to remain profitable During the coming years, we intend to accelerate the pace at which we repurchase our shares. That ends my summary. I would like to hand back over to the operator for question and answer session.

Speaker 3

Operator?

Operator

Thank Your questions will be pulled in the order they are received. Please standby while we poll for your questions. The first question is from Alex Henderson of Needham and Company. Please go ahead.

Speaker 4

Great, thanks. So a couple of baseline questions here. So clearly, the question on The revenues needs to be asked. Is the steep decline For the September quarter, cleaning up the inventory to a large degree or is there going to be a Process of cleaning up that will retain this type of level of revenues out through the March and The June quarter of next year, what do you think the slope of that cleanup looks like? And when do you Expect that you'll be able to get back to year over year growth.

Speaker 4

Is that all the way out into the September quarter of next year?

Speaker 2

So we still have the low visibility situation, I would say. I mean it's hard to say And it's also different from one customer to the other. Very hard for me to answer that question right now, but I think we have least several quarters here, some customers more, some customers less that will see the situation of over inventory still.

Speaker 4

So the December quarter historically has had a pretty significant seasonality to it. And I get it that there's an inventory correction going on, but do you expect a little bit of a Seasonal pop sequentially in the December quarter or do you expect that the inventory drawdown will fully offset the Seasonality in the December quarter.

Speaker 2

I think I would have to say similar to the previous question. It's hard for me to say. I mean, the It's not I don't know if the regular seasonality will be in effect or not. It really depends on our specific customers And the level of inventory, it's hard for me to say.

Speaker 4

Well, obvious question is from perspective of an exercise of us Forecasting it, would you prefer us to assume there's no seasonality?

Speaker 2

I think it's a question that I don't have the best answer for. I think we're tracking it very closely. At the moment, The visibility is still very, very limited. And I don't know if I can offer a very good answer here.

Speaker 4

Okay. Well, what about on the cost side of the equation? The downdraft here is pretty pronounced. It looks like it's going to be running for at least 3 or 4 quarters. Given that outlook, what should we be thinking about in terms of your ability to address the cost side of the equation so that the profitability doesn't get hit Too badly.

Speaker 2

From a GP perspective, we're not expecting any change. So that remains as Duran said before 32 to 36. On the OpEx side, we're definitely planning to continue investing. I mean from our perspective the long term growth is the key issue here that we want to continue in growing in the long term. We believe we have I mentioned before Some very good design wins that we're waiting to accelerate.

Speaker 2

We're working. We have a very good pipeline. And in order to support all of that, we need to keep investing. Okay.

Speaker 4

So we're talking about $30,000,000 plus in OpEx For the year, is that kind of the right range of expectations?

Speaker 2

I think it makes sense.

Speaker 4

All right. And just going back to the question of baseline, You make the comment that the last year or 2 have been Artificially enhanced by people building inventory and now you're saying that they're underspending. What do you think the real baseline is that you'll be growing off of as we get past this process? What should the 'twenty three full year revenue be if there was no correction or If you prefer the $150,000,000 was that really $10,000,000 $15,000,000 $20,000,000 worth Inventory build? How do we think about what the baseline is on a quarterly basis?

Speaker 4

Is it You're saying the $30,000,000 to $31,000,000 in the September quarter is well below. So I'm assuming it's somewhere up in the $35,000,000 range plus. Is that right?

Speaker 2

Maybe. I think it's reasonable to say this number. I think overall when we're looking with Trying to analyze the situation, obviously, it's not only inventories. I mentioned before also the economic, let's say, concerns, etcetera, that are Also in the mix, it's a little bit hard to distinguish between the two. But again, when we analyze the data, we looked at least $10,000,000 plus That were pushed out from this quarter per our expectations that customers would pull.

Speaker 2

So 35 maybe, a little more could be as well, But it's very hard to say an exact number given that it's a mix of reasons here.

Speaker 3

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

Operator

There are no further questions at this time. Before I ask Mr. Eisenman To go ahead with this 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. Eisenman, would you like to Make your concluding statement.

Speaker 2

Thank you, operator. Thank you everybody for joining the call and for your interest in Silicom. We look forward to hosting you on our next call in 3 months' time. Good day.

Operator

Thank you. This concludes Silicom's Q2 2023 results conference call. Thank you for your participation. You may go ahead and disconnect.

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