Silicom Q2 2024 Earnings Call Transcript

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Provided by Quartr
July 29, 2024

There are 5 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Silicom Second Quarter 20 24 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 EK Global Investor Relations at 1212-378-8040 or view it in the News section of the company's website, www.silicom usa.com.

Operator

I would now like to hand over the call to Mr. Kenny Green of EK Global Investor Relations. Mr. Green, would you like to begin, please?

Speaker 1

Thank you, operator. I would like to welcome all of you to Silicom's Q2 2024 results conference call. Before we start, I would like to draw your attention to the following Safe Harbor statement. Statements. This conference call contains forward looking statements.

Speaker 1

Such statements may include, but are not limited to, anticipated future financial and operating results and Silicom's outlook and prospects. Those statements are based on management's current beliefs, expectations and assumptions, which may be affected by subsequent business, political, environmental, regulatory, economic and other conditions and are subject to known and unknown risks and uncertainties and other factors, many of which are outside of telecom's control, which might cause actual results to differ materially from expectations expressed or implied in the forward looking statements and which include, but are not limited to, Silicom's increasing dependence for substantial revenue growth on a limited number of customers, the speed and extent to which Silicom solutions are adopted by relevant markets, difficulty in commercializing and marketing of Silicom's products and sales and marketing, developments and customer support activities. The impact of the war in Israel and in the Ukraine, rising inflation, rising interest rates, volatile exchange rates as well as any other any continuing or new effects resulting from the COVID-nineteen pandemic and the global economic uncertainty, which may impact customer demand through their existing their exercising greater caution and selectivity with their short term IT investment plan. The factors noted above are not exhaustive.

Speaker 1

Further information about the company's businesses, including information factors that could materially affect Silicom's results of operations and financial condition are discussed in the annual report on Form 20 F and in other documents filed by the company that may be subsequently filed by the company from time to time with the Securities and Exchange Commission, the SEC. Therefore, there can be no assurance that actual or future results will not differ significantly from anticipated results. Consequently, you are cautioned not to rely on these forward looking statements. Silicon does not undertake to update any looking statements as a result of new information or future events or developments except as may be required by law. 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.

Speaker 1

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 are useful investors' understanding and assessment of the company's ongoing core operations and prospects for the future. Unless otherwise stated, it should be assumed that the 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 processing the financial condition and operating results of the company. These measures are not in accordance with or a substitute for GAAP.

Speaker 1

A full reconciliation of non GAAP to GAAP financial measures are included in today's earnings release, which you can find on Silicom's website. With us on the line today are Mr. Leon Eisenman, President and CEO and Mr. Elan Gillard, CFO. Laurent will begin with an overview of the results, followed by Eran, who will provide the analysis of the financial.

Speaker 1

We will then open the call for the question and answer session. And with that, I would now like to hand the call over to Niran. Niran, please go ahead.

Speaker 2

Thank you, Kenny. Welcome, everyone, to our conference call to discuss the results of the Q2 of 2024. The Q2 was a period of focused execution of our strategic plan to generate significant long term value for our shareholders. Our sales and R and D activities are operating under a renewed focus as part of the plan with the goal of building a deeper pipeline, acquiring new customers and ultimately increasing revenue and long term upside. Those efforts have already brought us an exceptionally broad and deep pipeline of new and high potential sales opportunities.

Speaker 2

This is making us increasingly optimistic about the long term prospects for Silicom. In parallel, however, the sales cycle for all our product lines have become longer than any than they were in the past, negatively impacting the pace of progress in our strategic plan. Beyond that, we continue to believe strongly in the long term potential of our main product lines, including server adapters and edge systems, which continue to garner strong customer interest despite the current slowdown. A A further element of our strategic plan was the stabilization of operating expenses, which we completed early in 2024. We believe that our business is now appropriately sized, enabling us to support long term growth with expenses aligned to the plan's objectives.

Speaker 2

We will continue to tightly control expenses with only minimal increase expected in 2025 and beyond based on our plans needs. In terms of our financial performance for the 2nd quarter, we reported revenues of $14,500,000 with a net loss of $900,000 I stress that our strong balance sheet built up over many years enables us with the ability to continue and ensure that we can maintain adequate investment in our business and its growth engines without compromise at the revenue and expense levels predicted by the strategic plan. Regarding our balance sheet strength, our current working capital accounts receivable net of accounts payable of $8,000,000 as well as $78,000,000 in cash, cash equivalent and very highly rated marketable securities. All these represents about $21 per share. A further element in our strategic plan aims to enhance shareholder value by leveraging our strong cash position through a share buyback, which is planned to reduce our share count by 1,600,000 shares in total.

Speaker 2

I noted the first half of the year, while we Our our current share count stands at 6,000,000 shares. In terms of our guidance for the Q3 of 2024, revenues are expected to remain similar to those of the 1st and second quarter at between $14,000,000 $15,000,000 This takes into account the longer than expected sales cycles that I mentioned earlier, the prolonged excess inventory digestion periods of several large customers and a continued global economic slowdown in our markets. All of those are having a negative impact on our revenues that is likely to persist for 7 more quarters through 2024 2025. With that, we expect that the second half of twenty twenty four revenues will be at a similar level to those reported in the first half and that 2025 will show only a slight increase over 2024 from the revenue standpoint. Long term, due to the market slowed sales cycles, which have significantly lengthened and time frames of our design win processes and sales ramp ups, we have extended our strategic plan by 1 year.

Speaker 2

We now expect strong annual growth rates of 20% to 30% to materialize in 2026 based on 2025 a baseline with the ultimate goal to exceed earnings per share of $3 as we return to revenues of $150,000,000 to 100 $160,000,000 I want to take a few minutes to discuss why I'm optimistic about Silicom's long term prospects and why I believe our strategic plan will bring us back to a strong level of growth in future years. And more and more of our broad and deep pipeline of high potential sales opportunities will be converted to design wins and revenues. To give you some more color, I would like to provide you with a number of examples of the upside we see given the thicker and longer pipeline we have built in recent months, with each example potentially representing annual revenue potential of $5,000,000 and above. First, some of our existing customers of Flow and Mid Range Networking Solutions are in discussion with us to potentially extend their engagement towards higher end networking systems. This expansion mirrors our previous experience with server adapter customers, where we began with 1 or 2 products and after a few years of successful relationship, we expanded the business to include additional products.

Speaker 2

It is exactly the same pattern by which we have grown much of our business over the years. To support this growth, we are broadening our system portfolio with more powerful CPUs, additional cores, increased memory and enhanced networking interfaces. We have several such potential customer engagements at various stages of discussion, each of which could contribute additional business of between $5,000,000 to $20,000,000 per year at full scale. 2nd, we are engaging with major new customers with whom we have been in a dialogue for a long time while considering a variety of our products, including FPGAs, smart NICs and systems. Some of those products will implement new and advanced feature specifically requested by those customers.

Speaker 2

Those customers have returned to Silicom due to our cutting edge technologies, advanced product capabilities and customizable features, which allows us to tailor our products to their specific needs. Those potential design wins involve products that we have either recently launched or are about to launch soon. Beyond the potential with those customers, the new products and features requested have significant potential with other customers as well. 3rd, we see existing SmartNIC customers evaluating the possibility of extending their business with us to include higher end SmartNICs, including FPGAs and potentially expanding to full systems. This broadening reflects the growing confidence in our ability to provide a comprehensive end to end solution that meets their demanding needs.

Speaker 2

Various stages of engagement. If we successfully close those opportunities, each could contribute a few $1,000,000 to tens of 1,000,000 of dollars per year at full run rate. 4th, we have current Sassy customers who are looking to gradually ramp their business with us as they gain increased confidence in Silicom as a critical supplier for their needs. We are in discussion with those customers to potentially add both higher end and lower end system to their current mid range purchases. Our existing business with those customers continue to grow steadily and with the addition of those new products, our total business with them has the potential to reach approximately $10,000,000 annually at full ramp up.

Speaker 2

5th, we are engaged in promising discussions for our new line of ruggedized systems, with demand coming from companies in verticals such as energy, retail, restaurant chains and connected vehicle operators. Those systems are designed to withstand harsh environments and demanding conditions, making them ideal for industries requiring durable and reliable solutions. We are already customizing our systems to meet the specific environmental conditions of various potential customers and each engagement has the potential to be very significant. Our early discussions have so far indicated strong potential for this new line. Taking a broader perspective, our long term growth trajectory will be supported by a diverse and expanding pipeline of both existing and potential design wins with new and existing customers.

Speaker 2

It will add a layer of stability to our business by diversifying our revenue streams and will provide us with multiple avenues to pursue additional growth in our business. Our pipeline includes engagements with some of the most prominent names in the networking, telco and security space, which demonstrate the strength and appeal of our technology offering to industry leaders. While the assumption in our strategic plan remains conservative, there is an upside potential and much to be excited about. The broadening and deepening of our pipeline in recent months is a testament to the initial success of our strategic plan. We are seeing early results for our strategy to target small to medium design wins, which are strongly expanding our pipeline of future potential design wins.

Speaker 2

At the same time, we continue to give much attention to opportunities within our pipeline that could generate substantial additional revenue, some with potential in the range of $20,000,000 annually. The realization and fast ramp ups of 1 or more of the potential upside deals mentioned earlier will bring to our strategic plan a goal a lot sooner than currently indicated in the plan. In summary, we have much to look forward to. Given our strong balance sheet and exceptionally high level of working capital for our needs, a design win roster full of Tier 1 customers, coupled with our superb products, a bursting pipeline of Eran, please go ahead.

Speaker 3

Thank you, Liron, and good day to everyone. Revenues for the Q2 of 2020 4 were $14,500,000 a decline from revenues of 38.1 $1,000,000 as reported in the Q2 of last year. The geographical revenue breakdown over the last 12 months was as follows: North America, 83% Europe and Israel, 14% Far East and Rest of the World, 3%. During the last 12 months, we had 2 10% plus customers. 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 2024 was $4,300,000 representing a gross margin of 29.7 percent and compared to a gross profit of $12,300,000 or gross margin of 32.2% in the Q2 of 2023. As discussed previously, in the near term, our gross margin is expected to be at the lower end of our 27% to 32% expected range. And as our revenues grow from current levels over the longer term, it will increase towards the upper end. Operating expenses in the Q2 of 2024 were 6 point compared to $7,500,000 reported in the Q2 of 2023.

Speaker 3

Operating loss for the Q2 of 2024 was $2,400,000 compared to operating income of $4,800,000 as reported in the Q2 of 2023. Net loss for the quarter was $900,000 compared to net income of $4,500,000 in the 2nd quarter of 20 23. Loss per share in the quarter was $0.14 This is compared with diluted earnings per share of 0 $0.66 as reported in the Q2 of last year. Now turning to the balance sheet. As of June 30, 2024, the company's cash, cash equivalents and marketable securities totaled CAD 78,300,000 with no debt.

Speaker 3

This represents an increase of over $13,000,000 compared to the end of 2023. We used about half of that at $6,600,000 for the repurchase of 410,000 shares during the first half of this year. That ends my summary. I would like to hand back over to the operator for the question and answer session. Operator?

Operator

Thank Needham. Please go ahead.

Speaker 4

Thanks. I wanted to spend a little bit of time talk about the balance sheet. If I look at the inventory levels of 44,500,000 dollars Any risk to that inventory? In other words, is there any portion of that inventory that is getting along a tooth or specialized for a particular customer that may not be achievable that might cause you to have to write down any of that inventory? Or conversely, are you feeling confident that, that inventory is all going to be utilized going forward?

Speaker 2

We don't see such a risk. It's a very high quality inventory.

Speaker 4

And similarly, any risk to the receivable side of the equation? No. So the essentially $22,000,000 and change in asset values per share is you're confident that those total current assets are all solid assets and are not going to be impaired. If I look at the liability side of the equation, I think it's $13.7 or $2.30 a share or so in liabilities that are current. Is there anything in there that we should be aware of?

Speaker 2

Nothing special or standard.

Speaker 4

Okay. So the balance sheet looks clean. Then the question then is how long do you think it takes to get back to breakeven on the earnings front? Do you think you can hit that in 20 25 or is that all the way out into 2026?

Speaker 2

Yes, I don't believe it will happen in 2025. As I said, I believe that the increase of revenue from 2024 to 2025 will not be that significant, which means we're still going to be in a situation that we're not breakeven. We expect that to happen in 2026. And let's say, during 20 26, probably in the second half of twenty twenty six.

Speaker 4

All right. And if I look at the quarter, the EPS came in a little bit than we'd expected, but it looks like a lot of that was below the line, particularly in the tax line. We were expecting a tax cost, not a tax benefit. Can you talk to what you think the tax line is going to do in the back half of the calendar 24?

Speaker 3

Yes. First of all, the tax income that we saw in quarter 2 is a result of a one time reason. This is due to almost $1,000,000 one time tax returns from previous years. Again, this is a one time occasion. Looking forward, assuming 2024, 2025 will not be profitable.

Speaker 3

We expect annual income tax in a very low amount of about $100,000 more or less.

Speaker 4

$100,000 per quarter, about $100,000 per quarter?

Speaker 3

Per year, a very low amount of tax expenses. So $0.1 for the full year.

Speaker 4

For the full year, so essentially near 0 per quarter? Exactly. All right. And when I look at the income statement based off of the commentary about the numbers on the top line. It sounds like you're still talking about around that $60,000,000 level in 25.

Speaker 4

Is that back half weighted or do you expect the income statement to be fairly low in the first half of the year and then start to recover in the back half of $25,000,000 to get to a higher level of, say, dollars 16,000,000 or something like that in the back half or $14,000,000 in the front half or do you expect it to be fairly flat around the current levels of 15.5 to 16

Speaker 2

range? I expect, let's say, the 1st two quarters of the year to be similar to what we're seeing right now, give or take. And then from there, it will increase a little bit as we go into the second half. So it will be more weighted on the second half, but not very dramatically.

Speaker 4

Okay. But something in the vicinity of €60,000,000 is kind of what you're thinking about in terms of the year? Roughly, yes. All right. And the gross margins on that, any mechanical change in the mix here that you're assuming or are we still kind of around that 30% level?

Speaker 2

I think it will be very similar to what we're seeing right now.

Speaker 4

All right. So continued. So that suggests you're kind of looking at about a $10,000,000 operating loss in $25,000,000 and another $5,000,000 or so in the back half. So we should be thinking then that roughly $15,000,000 in burn rate. Is that a reasonable assumption for the cash burn?

Speaker 2

I think we were talking something in the range of 10, maybe more than that, 15, I think. But it really depends on I mean, when we're looking at that, we're also thinking about future projects and when we will need to start getting more inventories ready for supporting the new product. So hard to give a very conclusive answer to that, but I

Speaker 4

Well, if you hold the OpEx flat fairly flat at current levels around $27,000,000 and have a 30% margin on just under $60,000,000 that's 10.10 percent or $10,000,000 operating loss. So I would assume that if you're going to build inventories, it's going to be more than that in 'twenty five plus you got the first half or the back half of 'twenty four to deal with, which is another, what, dollars 5,000,000 of operating loss. So I would think it's at least $15,000,000 plus

Speaker 2

any build in inventory that happens late in 'twenty five. If you're talking if you're including also the second half of twenty twenty four and the full year of 2025, then yes, but I would also add the fact that we are expecting to get some financial income as well that could improve the situation, again, depending on what will happen on that side. But give or take the number 15, I think it's a reasonable number.

Speaker 4

All right. I get it. Going back into the mechanics of the business, I know that you guys had been chasing a lot of large deals and that looked pretty attractive when those deals looked like they were profitable to metastasize into the revenues and drive the business. Obviously, those projects did not materialize as expected. And now I understand that you've shifted to a more of the traditional model of going after design ins that are what I would call singles business, it's a couple of $1,000,000 a year potential for each design in win.

Speaker 4

But design ins generally take longer to materialize. You got to design it in, the company has got to put it in their product and then they've got to launch the product and that just takes longer. Is that part of why this timeline to recovery is slower to than you thought? Or is it just revenues?

Speaker 2

So, I mean, a few points. So first of all, you're right that when we're designing in, when the our customers design us in, then it's a process, they need to get rid of their current inventories, they need to launch it and market the new product and design wins, big design wins. The macro right now and the overall situation of high inventories with customers are causing those processes to be longer even than what we used to see in the market. So that means that this is why we see delay even the timeline that we expected, which is causing the process to take longer.

Speaker 4

Yes. So but I want to what I'm trying to determine is, is the change in the strategy to do more singles business part of the reason why you're anticipating a slower recovery? No. Obviously, maybe an increased visibility to that recovery as those design in wins

Speaker 2

are very persistent business. No, this shift in strategy is not what's causing a slower recovery. What's causing the slower recovery is the fact that customers are sitting still on inventory is the fact that making decisions on new products and new technology for the customers take longer than it used to be, again, because of the macro and because of the situation that it takes longer, but it's not because of the shift to smaller and medium design wins. And I would also add that we didn't stop looking for the big design wins. It's just that we are also focusing very much on the small and the medium because our experience when we look back showed us that sometimes small and medium, they become large over time, whether it's with specific design win or whether it's with the new design win that we get from the same customer.

Speaker 2

So we're not focusing solely on the big ones, we're focusing on small and medium, while we still have our list of the very big design wins, which I talked about a little bit that could be even $20,000,000 a year, but we're not focusing only on those.

Operator

There are no further questions at this time. Before I ask Mr. Eisenman 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. 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. Good day.

Operator

Thank you. This concludes Silicom's Q2 2024

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