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Silicom Ltd. (NASDAQ:SILC)

Q2 2014 Earnings Conference Call

July 22, 2014 9:00 AM ET

Executives

Ehud Helft – GK Investor Relations

Shaike Orbach – President and Chief Executive Officer

Eran Gilad – Chief Financial Officer

Analysts

Alex Henderson – Needham & Company, LLC

Amit Dayal – H.C. Wainwright & Co.

Lisa Thompson – Zacks Investment Research

Donald T. McKiernan – Landolt Securities, Inc.

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Silicom’s Second Quarter 2014 Results Conference Call. (Operator Instructions) 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 Relations or view it in the News section of the company’s website, www.silicom.co.il.

I would now like to hand over the call to Mr. Ehud Helft of GK Investor Relations. Mr. Helft, would you like to begin?

Ehud Helft

Thank you, operator. I would like to welcome all of you to the Silicom’s second quarter 2014 results conference call.

Before we start, I’d like to draw your attention to the following Safe Harbor statement. This conference call contains projections and other forward-looking statements regarding future events or future performance of the Company. These statements are only predictions and may change as time passes. Silicom does not assume any obligation to update their information.

Actual events or results may differ materially from those projected, including as a result of changing industry and market trends, reduced demand for Silicom’s products, the timing and development of new products and the adoption by the market, increased competition in the industry and price reductions, as well as due to risks identified in the documents filed by the Company with the SEC.

In addition, following the Company’s disclosure of certain non-GAAP financial measures in today’s earnings release, such non-GAAP financial measures will be discussed during this call. Such non-GAAP measures are used by the management to make strategic decision, focus future results and evaluate the Company’s current performance. Management believes that the representation of these non-GAAP financial measures 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 additional information to investors in order to provide them with an alternative method for assessing our financial conditions and operating results. These measures are not in accordance with or a substitute for GAAP. A full reconciliation of non-GAAP to GAAP financial measures is included in today’s earnings release, which you can find on Silicom’s website.

With us on the call today are Mr. Shaike Orbach, CEO and Mr. Eran Gilad, the CFO. Shaike would begin with an overview of the results, followed by Eran who will provide the analysis of the financials. We’ll then turn over the call for the question-and-answer session.

And with that, I would like now to hand over the call to Shaike. Shaike, please.

Shaike Orbach

Thank you, Ehud. Good morning, everyone, and welcome to our second quarter 2014 results conference call.

We reported solid year-over-year growth in revenues and profit for both the quarter and the first half of 2014. Achieving year-over-year growth in the second quarter was challenging and during the quarter we had started to feel a softer demand in our markets. This is although the reason behind this quarter’s 6% sequential revenue decline compared with the first quarter of 2014 and for us being increasingly cautious with regard to the second half of 2014.

Over the next few minutes, I will discuss the reasons behind these challenges, as well as the result and the outlook for the year. Yet, it’s important for me to emphasize that we see no signs and no reasons to change our strategy. We continue to believe in the long-term power of our growth engines, which we have been able to demonstrate again and again over the past few years.

During the second quarter, we began to feel a general softening and slowing down of the demand from our customer base. These software demand was prevalent across the board, including customers of different sizes and from different target markets.

Obviously, in every quarter, as well as in the past quarter, we experienced fluctuations in the demand between customers with some customers growing and other not or not as much. While for a long time, adding up the revenues of for our customers resulted in a continued trend of growth. We did not see this type of trend at the quarter. And as the quarter came to an end, we indeed could see that the combined trends, was no longer a clear growth trend.

That by itself would have made us increasingly cautious which we come to the second half of 2014. But aside of the general softening of demand, the results of one specific challenge that we will be facing, during the second half of the year and I would like to discuss that now.

Every few years, typically every three years each one of our customer systems tends to go through a refresh and upgrade cycle. Silicom undergoes many processes like this every year with customers. Each such refresh cycle may end up with the growth in business for Silicom, a decline in business or no change at all. Considering the number of customers and the number of platforms, you can understand that we actually experienced, several such changes every quarter.

Our largest customer is now going for this process with one of its platforms. And the system in question included two of our products. In the refresh, one of our upgraded products, replaced one of the two cause, which were included in the old system, providing potentially increased revenues in the coming quarters. While the second of our products was replaced with another non-Silicom next generation products, leading to an expected decrease in revenues.

The overall impact of this particular refresh is expected to result in a net decrease in revenues from this particular customer. Right now, we are at the stage, where the customer is selling both systems in parallel. While phasing out the old system and phasing in the new one, so this change has not yet been fully reflected in our results. It would have clear that the rate at which the new platform is picking up is increasing, and consequently will negatively impact our results in the following quarters.

To better explain the nature of the dynamics of this specific customer, you should note that during the second half of 2014 this customer was planning to bring out a new system which included one of our products. This product design win has significant revenue potential for us, which would have compensated for most of the loss from the lower sales from the recent refresh.

However, as we began the new quarter, we understand that the new system released has been put on hold. But that and new different – but that and new different platform which will include one of our products is now planned to be launched in early 2015. While it was very important for me to share with you the details of the short-term situation with this larger customer, I want to make it very clear that we have not lost this customer. Just as we have not lost any other customer.

On the contrary, we remain the customers’ preferred vendor and we consequently believe that the customer will during 2015 include our next generation product, which was not ready at the time of the refresh into its platforms. We are also aware of this customer plans for new appliances of which we will be a part and as this customer grows, we will grow with it.

All these factors in combination will have a negative impact on our results in the second half of 2014. We feel it is important to help you quantify the effect of these factors on our result in 2014 and we have therefore decided to provide guidance for the full year 2014. Our expectations are for revenues in the range of $68 million to $74 million. Based on this range, our full-year 2014 EPS is expected to be in the range of $1.82 to $2.09. Please bear in mind that our guidance is as of what we are seeing today.

Taking a longer-term view by the start of 2015, we believe most of the negative factors affecting us this year will have been mitigated or overridden by our natural growth and we will expect to resume growth early next year. We continue to gain more design wins, sell more products into more platforms of our current customers, grow into new customers two of which we have one during the quarter, continue to offer new products to both current and new customers and increase our total addressable market.

I would like to stress that our strategy remain sound and our growth engines are intact. We continue to believe that after our phenomenal growth of in excess of 50% in 2013, as well as the current more stable year in 2014, we will continue to show average growth rate ahead of that of our target market over the coming years.

I would like to stress that we have said countless times in the past. From time-to-time that there will always be some negative fluctuations in our results, but these fluctuations including what we may be seeing this year has no bearing when our long-term growth story and potential.

Accordingly, we believe that within the upcoming five-year timeframe, our revenues will reach to $200 million level representing an average growth rate of 22% per year.

In summary, we believe strongly in our strategy and our growth engines and we continue to invest resources in developing product and markets. In the past year, we have brought out two new and very important families of product, focused on a market segment showing significant growth. We intend to continue with this strategy, a strategy that has been so successful for us over the past few years.

In particular, we continue to believe in the significant growth potential inheriting our Time Stamp product, as well as that potential for our collaboration with Intel product including the Coleto Creek range and other products, we plan to launch in 2015.

In fact, we’re hoping to add new design wins with important customers with these new products, while we realize there are challenges ahead of us over the rest of the year. We’re confident and with these new products, our pipeline of new customers and products. And obviously, our current customer roaster, which remains a significant asset our future remains bright.

With that, I’ll now hand over the call to Eran Gilad, our CFO for a more detailed review of the quarter’s results. Eran?

Eran Gilad

Thank you, Shaike, and hello, everyone. Revenues for the second quarter of 2014 were $17.9 million, a growth of 14% compared with revenues of $16.7 million in the second quarter of 2013. Our geographical revenue breakdown for the first half of 2014 was as follows: North America 74%, Europe and Israel 14%, Far East 12%. I would 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 employees and directors as well as amortization of intangible assets. For the full reconciliation from GAAP to non-GAAP, please refer to the press release we issued earlier today.

Gross profit for the second quarter of 2014 was $7.2 million, representing a gross margin of 40.3%. This is compared with $6.3 million or 40.3% of revenues in the second quarter of last year. The gross margins that vary between quarters, mainly as a result of the specific mix of products sold during the quarter. Operating expenses in the second quarter of 2014 were $3 million or 16.6% of revenue, compared with $2.7 million or 17.1% of revenue in the second quarter of last year.

Operating income for the second quarter of 2014 was $4.3 million or 23.8% of revenue. This is a 16.6% increase over operating income of $3.6 million and reported in the second quarter of 2013 or 23.2% of revenue. Second quarter 2014 net income was $3.7 million or 20.5% of revenue. This is a 6.5% increase, compared with the net income of $3.5 million or 22% of revenues in the second quarter of last year.

Earnings per diluted share were $0.60 in the quarter, compared with $0.84 in the second quarter of last year.

Now turning to the balance sheet, as of June 30, 2014, the company’s cash, cash equivalent and marketable securities totaled $54.4 million or $7.57 per outstanding share. If you’re in the second quarter on April 17, 2014 we paid out $7.2 million as a dividend to our shareholders.

That ends my summary, and we will be happy to take any questions. Operator?

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen at this time we will begin the question-and-answer session. (Operator Instructions) The first question is from Alex Henderson from Needham. Please go ahead.

Alex Henderson – Needham & Company, LLC

Hey, guys. So can you give us a couple of data points? First, what was the headcount in the quarter? Second, was it 10% customer concentration in the quarter?

Shaike Orbach

Headcount…

Eran Gilad

Headcount right now is around 150 to 155 employees. Regarding concentration, this quarter we had one 10% plus customer, the same customer that we had in the previous quarter and in 2013.

Shaike Orbach

I would like to add to that because this customer is more than 10%, but it’s a significant customer. It’s a 30% customer. I believe we said that in the past. So this is the same customer we’ve talked about and in this quarter it was more or less the same kind of percentage that we had last quarter and previous year.

Alex Henderson – Needham & Company, LLC

And going back to this key customer’s product cycle, it sounds like you’ve lost a contract or a design wins with this customer on a product line that’s being launched. Sounds like from what you said on the call, and correct me if I’m reading this wrong that that loss of that contract was because your product was not ready at the time that they were ready to launch this generation of products. How confident are you that you will get, be able to displace that product when they launch the products with your product in it in 2015? So how much of the loss share as a result of the timing of that product launch will be recouped?

Shaike Orbach

Well, first of all your first part is accurate. Our next-generation product at the time of the refresh was not yet ready, which is like when the customer came with this new appliance, it did not use our product. Now, this product was probably used as the customer move forward in other refreshes.

So when we’re seeing that it would go into the customer platforms what we’re thinking is that it would not immediately replace again the product that they have selected right now, because this product is already in, but because it would be going to other platforms as well. Then our new generation product would, we believe that we would be successful to penetrate with this new product into these other platforms when the time of their refresh is coming and some of these platforms will be refreshed throughout 2015.

Alex Henderson – Needham & Company, LLC

Can you give us a sense of what type of margin we’re talking about here?

Shaike Orbach

Well, I don’t want to be very accurate in terms of what exactly we’re talking about, because I would say that this would be an important information for our competition, which I would not like to give. It is one of the areas that we are selling of course to these customers. We’re selling quite a wide range and I would not like to point our competitors into this specific area that we’re selling to this customer.

Alex Henderson – Needham & Company, LLC

Okay. And so, is this product going into the security space? Is that the category we should be thinking about?

Shaike Orbach

Well, the platforms – this customer is addressing many markets on the one side and many platforms and there is a cost section between the platforms and the markets that the customer is addressing. So it’s not possible to say that the customer using that only in security. It’s using it. The product that was replaced was used in a specific platform, which was used for several markets.

Alex Henderson – Needham & Company, LLC

I’ll leave the floor. Thanks.

Shaike Orbach

What is that?

Alex Henderson – Needham & Company, LLC

I said I’ll leave the floor. Thank you.

Shaike Orbach

Okay.

Operator

The next question is from Amit Dayal of H.C. Wainwright. Please go ahead.

Amit Dayal – H.C. Wainwright & Co.

Thank you. Just to get some clarity again on what these products’ necessity are. I guess you are not in a position to provide some of that information. But going back to the point of winning this product back in terms of the design win like what gives you confidence in terms of being able to replace this new product that has replaced you in such a short timeframe? Is this something that has been discussed with this client? Could you provide some clarity on what you believe will drive you winning back this product replacing your replacement?

Shaike Orbach

Okay. First of all, I would like to emphasize again what I’ve said before that we are not talking necessarily in 2015 and replacing the product that replaced us, but proud of getting the product into new refreshes, which is something which is happening continuously. And then, possibly when this system is being refreshed come back to this system.

And now to your question, there are several items that I would like to point out. First of all, we have very good relationship with this customer. The customer is selecting us and that’s what he is telling us that he is selecting us for each and every situation where we have a solution for it. So that’s what has been happening until now. This is still what is happening right now. So this is one thing that the customer is telling us. The other thing is that the customer tells us that he prefers the technology which is presented by our product to the technology of the products that replace our products.

However, I mean, I would like to be cheerful and say that once a customer qualifies some sort of a product and he has invested some efforts on it, so now replacing it which require additional effort, we believe that would happen, that’s what the customer is telling us, but there can be no guarantees, this will bridge the gap.

Amit Dayal – H.C. Wainwright & Co.

Right, so basically I mean this is an area that you have to redouble your efforts et cetera. But the other question I had along this line was your next generation product for this category I can’t qualify what it’s, because we haven’t been told. But has it impacted sales into other customers who are also refreshing for this product category?

Shaike Orbach

Well I would say that – I’m happy that you asked this question, because the response to that is actually that this is an opportunity to us and that’s because the current product that was replaced and it was significant in our sales only with that specific customer. So actually, I mean we don’t have any threat to other customers by our product being replaced by a product which is not ours, but we do have an opportunity on the other side, because right now we do have a next generation product, which would be able to get market share in areas or in situation where we did not exist before. So that’s why I believe that as long as we were talking about other customers other than this specific customer, it’s more of an opportunity than effort.

Amit Dayal – H.C. Wainwright & Co.

Could you qualify some of these? Are there new product lines or categories like can you give us some color. It’s very difficult to make the situation tangible without having a sense of (indiscernible)

Shaike Orbach

Do you mean like with this specific product?

Amit Dayal – H.C. Wainwright & Co.

Yes.

Shaike Orbach

Well I’m trying to find way as to how to get you somewhere

Amit Dayal – H.C. Wainwright & Co.

Is it security related? Is it virtualization related? I mean around those lines.

Shaike Orbach

It’s not virtualization related.

Amit Dayal – H.C. Wainwright & Co.

Okay.

Shaike Orbach

It’s being used but not necessarily virtualization related. This product could be used in virtualize environment as well, because it supports SR-IOV, but it’s not a product which is targeting specifically the visualized world. It’s a product which is – I would be able to tell you that it’s a product which is being used or it’s being applicable, not necessarily used in many areas not only in one area of networking appliances.

So this product you would be able to find this product in security, in WAN Optimization, in application delivery. I think that these are the major areas where you would be able to find this product.

Amit Dayal – H.C. Wainwright & Co.

Okay, okay. So, 2014 seems to be like a flattish quarter related to 2013, with your new guidance. So, 2015 could you give us some clarity in terms of what the drivers could be, is there any specific product category that could help you kind of comeback and start demonstrating growth again, or is there anything in the pipeline that we should be aware of from a slightly longer term outlook versus the next two quarters?

Shaike Orbach

Well, okay let me try and do that. So, first of all, we’ve really considered 2014 for our guidance some sort of a fluctuation, but because the basic mechanism will continue, then this is why we definitely believe that from that point on from where we are in 2015, we believe what we see right now is that we will continue to grow using the same mechanisms that we have used up until now. But there are really indeed, I would say, several specific, which lead us towards that understanding. And some of them are related to new products.

And I believe that I’ve mentioned that both the Time Stamping product and the Coleto Creek family of product both of which are new to us and with both of which we’re making significant advances with customers. And I believe they would be significant in 2015.

And on top of that, we are moving forward also with some potential significant design wins, of course, I cannot be sure begin of design win is something that you don’t know that it happens until it really happens. But we feel quite good about several, I would say of the traditional solutions that we’re having moving with them with some specific, quite significant customers.

Amit Dayal – H.C. Wainwright & Co.

Okay, thank you. Just one last question on the operating expenses side, the numbers were little higher, relative to the previous quarters. Could you provide some clarity on whether this was R&D driven, or sales and marketing driven? And then just to take it one step further in terms of the forward guidance, should we be looking to model out expenses in line with what we are seeing in the second quarter, or should we move a little bit closer to historical averages from the operating expense point of view?

Eran Gilad

First of all, the level of operating expenses in the quarter two is actually quite similar to quarter one, it’s not less in quarter one, it’s similar. Secondly yes, operating expenses in quarter two and actually also in quarter two is a good base for calculating our operating expenses in the next two quarters.

Amit Dayal – H.C. Wainwright & Co.

Okay.

Shaike Orbach

We plan, I would add to that, just as we are planning to continue with our current plans and I have mentioned that in terms of developing the new products and investing in the areas that we have been investing until now, because the basic mechanism is still in place.

Amit Dayal – H.C. Wainwright & Co.

Okay thank you so much.

Operator

The next question is from (indiscernible). Please go ahead.

Unidentified Analyst

Good morning And thanks for taking my question. In the past you press released significant design wins and this year so far there hasn’t been any such of yours which kind of gives the impression rightly or not, that your design win momentum has slowed. May be you can comment on that before I ask other questions?

Shaike Orbach

Well, okay I do not think – let me say, I do not think that we have lost anything in terms of design wins momentum. I believe that I’ve said in the past, that as we grow, we do not announce each and every design win, because by definition what used to be significant when we were selling $30 million per year, is not so significant when we are selling $60 million or $65 million per year. So, it may seem as if the momentum of design wins has decreased, but this is not the case, I would say that in terms of design win momentum we are more or less the same as we used to be. And I would even say that due to the new product it’s even growing often to the positive side of our business.

And what we’re describing right now is more as to related to what happened with our current customer base and specifically this largest consumer that I have discussed, we do not see any, I would say slowdown in terms of the number of design wins that we’re achieving or receiving.

Unidentified Analyst

Okay, that’s good to hear. What’s the approximate revenue loss by that lost design win on that one platform?

Shaike Orbach

What on that, on that specific design, on that specific platform you are asking?

Unidentified Analyst

Yes, you mentioned you lost one, one refresh, and I was wondering in order to differentiate between what’s applicable to overall slowing situation in the market versus this one loss, what’s the approximate revenue that you have to replace there?

Shaike Orbach

Well, I do not want to give the differentiation, I mean between the various factors right now. I don’t think this is an information that we gave. Overall the impact of that of course is – the combination of impact is a guidance that we provide. How much of it is related to this existing product is not an information that we give. Not to mention the fact that it’s not 100% clear right now.

Unidentified Analyst

Yes. Okay. And you mentioned talks with major players regarding the family of encryption and compression cards based on the Intel 89 Chipset. How are those talks progressing? Has anything materialized? And do you still expect to see a [ministerial] (ph) ramp into the second half of this year or is that also more of a 2015 story?

Shaike Orbach

Well, we are making progress with that. We continue to make progress with that. I’ve said before that we hope to have some announcements regarding that, the Coleto Creek as well as the Time Stamp great as soon. So I believe that we will have design wins in 2014. The significance in terms of sales would happen in 2015.

Unidentified Analyst

When you kind of think of couple years now on those and when you compare the revenue potential of this product family that you just talked about with Time Stamp and you just mentioned, are they similar size opportunities or is one much bigger than the other?

Shaike Orbach

Well, I think that they maybe similar in size, but they may be different in nature. What I mean by that is that each of them could be very significant. The Time Stamp opportunity would be more concentrated around a few big customers while the smaller customers will buy quantities, which are not that significant. The Coleto Creek opportunities would be spread out between many more customers, maybe not as big as the biggest Time Stamp customers would buy, but combined it could even be bigger.

Unidentified Analyst

Okay. And speaking of Time Stamp, you mentioned good progress you’re making with several major players. Would do you expect a design than any time soon here or is this sort out?

Shaike Orbach

We would expect the design win during 2014.

Unidentified Analyst

Okay. And in terms of the market adopting your newer technologies, where do you see the biggest risks and what are some of the milestones on the way to success that we would be looking out for?

Shaike Orbach

Okay. I mean in terms of risk, I would like to say that there are always of course local risks, which is something that we experience right now and you could see that. So I would generalize this statement by saying that fluctuations will continue to happen. And if you consider that to be a risk, then obviously it’s continuously here with us, this kind of a risk because fluctuations do happen. If we’re talking strategically, and while I would speak about one thing which could be very much an opportunity, but may also be a risk, but in general I would say that if we’re talking strategically long-term then I still think that our strategy is, I would say, very sound and very healthy because nothing has changed in terms of the strategy.

We still have all our customers. These customers continue to buy with us. They release new platforms. They go into new markets and each of them is actually using our products in any new platforms that they are releasing and when they grow, we grow with them, we add new customers, we add new products through that. All that continues to happen and I don’t see any sign or anything, which is not in that area, which is why I’m saying that for the long-term I feel very good about the company.

Still what I would like to mention one thing, which could be a very good big opportunity, but could be some threat in a certain way and that has to do with the cloud and the virtualization area, which is indeed a very big opportunity for us because the big market is opening, but no one knows exactly how this market is evolving and whether or not the kind of appliances as to which we’re selling to. Right now we’ll continue to be sold in exactly the same way that they are sold right now, so that may turn out to be a threat as well, even though I believe that with the products that we are developing towards the virtualization market and with all our customers also gearing ourselves into building products going into that market it’s not such a big threat, but it could turn out to be a threat.

Unidentified Analyst

Okay. Thank you very much.

Operator

The next question is from Lisa Thompson of Zacks Investment Research. Please go ahead.

Lisa Thompson – Zacks Investment Research

Hi, and good morning. I like to go back to your comment you made about the general softening of business, is that something that is specific to your company, or is it something is happening in the industry, or is it just the global economy? What do you feel is causing this?

Shaike Orbach

It’s hard to tell. We are not very high at the food chain, so we do not know exactly what are the reasons behind what we’re experiencing. What we are experiencing we know and we could feel this softness, as I’ve mentioned that. I cannot be 100% sure and it’s not clear to us exactly where it’s coming from.

We are looking at other players in our market and we’ve seen that some of them may experience similar effects as well, but still we’re not sure to say that it’s not typical to us, because we are not having information about the whole market, we’ve just seen some data point that we could identify. So I cannot provide more information on that. The only area where I can provide more information is what we feel.

Unidentified Analyst

Okay. And then just checking your current outlook on the competition; has competition changed at all? Are there different people that you’re more concerned of than you were a few months ago, or is it pretty much the same focus out there?

Shaike Orbach

No, I don’t think there has been any change which is significant. I mean, there could be minor areas, but in general, no changes in this area.

Unidentified Analyst

Okay, great. Thank you very much.

Operator

The next question is from [Dave Wilson of UCS Finance]. Please go ahead.

Unidentified Analyst

Good morning. I wanted to go back to the product that you said you didn’t win because you’ve always said that when you get contract award, it’s sort of a forward-looking type of indicator and so it’s not something that happens in the quarter. So my question is when exactly did you, for want of a better word, lose the design probably in the first quarter or may be late last year and presumably you would have known coming into this year or coming into the second quarter you’re going to get revenue from that product. Is that accurate?

Shaike Orbach

Well, let me say that once again. I mean, there are different in architectures and in designs which are happening continuously every quarter and every time these changes are happening. So it is not as if, this is the first time that something like that is happening. These things are happening all the time. That’s point number one. Number two is, I mean, a refresh is happening, you’re losing a product, you’re gaining a product, a new product is coming. It takes a lot of time – from the time that you that the refresh is coming then you know what the architecture is going to be, and then you know what the impact is going to be even though because in more cases – in most of the cases there is no impact as the part of the regular day-to-day business and nothing specific about that.

So yes, I mean as far as your refresh or the intention to do a refresh we know that more – I think a year ago something like that. But once again refreshers are having every time.

Unidentified Analyst

So, sort as a one more question and why do you think you will – did not – you must have known about an advance, and you’re able to provide a solution to your customer, it sounds like or they chose someone else. Why do you think that was?

Shaike Orbach

As I’ve said at the time that they had to make a decision as to what product they would select, our next generation product was not ready. But once again, I mean the refresh was made of a lot of many components, not only of that. There were many parts to that going on so. That was not the only issue, for this specific product that was replaced, we did not have a replacement in place at that time.

Unidentified Analyst

Let me change the topics. You may not be able to comment, so what is your expectation on your dividend policy going forward, given that your revenues now are obviously not growing as fast and so forth. Do you have any comments what you might do next year?

Shaike Orbach

Well, at the moment we have not changed any products.

Unidentified Analyst

Okay, thank you.

Operator

The next question is from Don McKiernan of Landolt Securities. Please go ahead.

Donald T. McKiernan – Landolt Securities, Inc.

Thank you. My question concerns the Smart stock new line of solutions that you more or less announced in the last couple of quarters, which focuses on your proprietary off load engine and acceleration technologies. Can you give us an idea of the response from potential customers to the Smart (indiscernible) and maybe some color on some opportunity that you might be working on right now?

Shaike Orbach

I would provide a general response to that, because obviously there are differences between each customer responses to each different products. There are lot of products or several products in this product line, and there are many customers. So overall, I think that this has received very well in the industry and people are liking that and are interested to learn more and rate and with the Time Stamp and Coleto Creek that I mentioned before we are hoping to have design them pretty soon.

That being said I would like just as I have said, I mean the selling of smart solution, the selling cycle is longer than the selling cycle of, I would say, straightforward products. So telling you that with a Time Stamp and Coleto Creek we are coming close to design wins. So part of that is because with the Time Stamp who are in the market for quite a long time and I’m hoping that we’re getting closer to design wins, where like Coleto Creek it is somewhat simpler although because this was pushed very large by Intel and Intel is helping us by pushing that. So, receipt by customer is making even easier, because Intel is behind that.

Donald T. McKiernan – Landolt Securities, Inc.

Would you say that since you have your non-proprietary technology in there, especially with respect to the offload engine technology that the gross margins will probably be higher with some of these newer products versus your traditional gross margin levels?

Shaike Orbach

I do not want to commit to that at that point, because we are not the only ones. We still will have competition in these areas. I mean, so while indeed we believe that we will present solutions with unique ideas and unique benefits, but still we’re not the only ones in the market and there would be other companies proposing solutions which are addressing the same problem I believe. And therefore, while we are shooting for higher margins, I do not want to commit to that at that point.

Donald T. McKiernan – Landolt Securities, Inc.

Okay. Thank you.

Operator

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

Alex Henderson – Needham & Company, LLC

Yes, I wanted to go back to the feeling softer demand in our markets comment. I was hoping you could give us a little bit more granularity in terms of whether you’re seeing that in a particular segment? Is it a function of Wan Op, is it a function of ADC market, is it a function of security market, is it across all geographies and all product categories evenly? Can you give us just a little bit more color on sort of the mix of that comment, because it’s not something that’s intuitively obvious to people looking at the overall demand conditions that things are softening in fact just the opposite?

Shaike Orbach

Well, we have seen as, I would say, more or less across-the-board. I cannot say that we’ve seen it in a specific area. But once again when I say across-the-board and I mentioned that, it does mean that everybody decrease their demand from us. We do have customers, which increased their demand from us during the quarter. As I’ve said, this is happening each and every quarter. Each and every quarter we have customers which increased their demands and we have customers which decreased their demands compared to previous quarter or previous quarters.

However, it’s a combination of everything that we see. And in this quarter the combination of that gave us the feeling when we started to analyze all that it was a softening of some sort. Previously, we didn’t feel that, but it was definitely not related to a specific target market as we can identify.

Alex Henderson – Needham & Company, LLC

Second question, shekel hit a three year high at the end of the quarter, it’s come down as a result of the hostilities in the region subsequently, is that point of your factors has been look through the cost structure and did the back half, how should we think about your hedging of those type of swings.

Eran Gilad

Okay. First of all, yes, impact of the dollar is negative for us, but the impact is not significant. I can say that let’s take a quarter two for example, the impact of the negative dollar, in such a (indiscernible) third quarter, so it’s not something significant. And therefore, we do not say hedge our expenses it’s not a dramatic factor.

Alex Henderson – Needham & Company, LLC

And so, if the dollar – the exchange rate was 5%, what would be the impact on a quarterly basis of that.

Eran Gilad

The impact of 5% per quarter will be around 150k on our expenses.

Alex Henderson – Needham & Company, LLC

That’s helpful. Thank you. Can we go back to the launch of the Time Stamp product and when do you expect that to generate revenues? I was little unclear on whether you’re expecting revenues from that in 2014 it all, whether that’s really all 2015 timeframe.

Shaike Orbach

Now we definitely expect revenues in 2014 and as you know, I mean we have revenues from that even right now. But…

Alex Henderson – Needham & Company, LLC

Revenues that should qualify, sorry.

Shaike Orbach

Okay. But we feel, what I wanted to say is that in 2014, we believe we would have meaningful design wins with that and the impact the meaningful revenues will be 2015, will start in 2015.

Alex Henderson – Needham & Company, LLC

And can you talk a bit about what’s been going on in terms of acceptance or design wins around the virtualization offload technology.

Shaike Orbach

Yes. I mean I can tell you that unlike the Time Stamp virtualization offload technology, we do not have any design wins. This is something which would take more time, we’re still working on that. We believe in that. There is a lot of interest, but it will take more time. It’s – this one is not a short-term design win cycle event. I believe that when we actually acquired the technology or the IP, we said that we need even to complete the productization of the product and even that is only in process right now, so it will take time before we have design wins with that.

Alex Henderson – Needham & Company, LLC

The time it takes to take that technology from – to product is one thing, but the time to get programmability into it and develop applications for it seems like much longer process. Can you talk about where you are on that part of the cycle?

Shaike Orbach

We are talking with customers right now. There are interested customers, but we still have many tasks both in developments, both in proof of ROI to many customers. We are working on that. The virtualization scenario is not 100% clear. We need to test that I think that we will not have any design win with the virtualization off load in 2014, not that it was ever our goal to have any design win with that technology in 2014. I hope that we will start to have design wins in 2015. But unlike the time stamping and the (indiscernible) about which I told you we have a pipeline which is something definite, we know customers that are telling us yes that’s the way that we’re going, et cetera. We’re not there yet with the virtualization offload.

Alex Henderson – Needham & Company, LLC

I will turn the floor, thank you.

Operator

Your next question is a follow-up from (indiscernible). Please go ahead.

Unidentified Analyst

Yeah. I was just going to follow-up, (indiscernible) if this is the case where the softer demand for Silicom versus the rest of the market, I mean, where do you think we need to make improvements? What is that overtime I guess that can be introduced to reverse this trend, if you will?

Shaike Orbach

Well as I said, I mean, I did say softer demand and it is for Silicom, but even if it’s for Silicom only, then I still consider that to be a fluctuation, because we did not lose customers and we’re continuing with these customers. So sometimes things are combined to take you upwards, look at Q4 in 2013 where everything combined to take us upwards into $25 million per quarter. Sometimes several repurchase or whatever or several other things like that are combined to take you downwards for a while which is what we believe is happening now or towards the second half of 2014, but we still consider that to be a fluctuation, rather than something that happened sort of with Silicom strategy. We don’t think that anything bad happened to our strategy.

Unidentified Analyst

All right. And just from a potential upside surprise to your guidance like what could be the catalyst that could make your – the guidance you gave today to get upside to that guidance? Is there anything in the pipeline just from a new customer win or design win that could come into play that could change the guidance towards the higher number?

Shaike Orbach

Well, let me put it like that. I mean, while there are obviously always some opportunities that could happen, I do not want to predict anything like that at this moment.

Unidentified Analyst

Okay, all right. Thank you. Thank you.

Operator

There are no further questions at this time. Before I ask Mr. Orbach to go ahead with his closing statement, I’d 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 look forward to hosting you on our next call in three months time. Good day.

Operator

Thank you. This concludes Silicom’s second quarter 2014 results conference call. Thank you for your participation. You may go ahead and disconnect.

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