Silicom's (SILC) CEO Shaike Orbach on Q4 2015 Results - Earnings Call Transcript

| About: Silicom Ltd (SILC)

Silicom Limited (NASDAQ:SILC)

Q4 2015 Earnings Conference Call

January 27, 2016 09:00 AM ET

Executives

Ehud Helft - IR

Shaike Orbach - CEO

Nir Dagan - CFO

Analysts

Alex Henderson - Needham & Company

Marcel Herbst - Herbst Capital Management

Edward Balinsky - Segmark International

Don McKiernan - Landolt Securities

Ronald Mullins - Segmark International

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Silicom’s Fourth Quarter and Full Year 2015 Results Conference Call.

All participants are at present in listen-only mode. Following management's formal presentation, instructions will be given for the question-and-answer session. As a reminder, this conference is being recorded. You 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-usa.com.

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

Ehud Helft

Thank you, operator. I would like to welcome all of you to Silicom's third quarter fourth quarter and full year 2015 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 or the 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 their adoption by the market, increased competition in the industry, and price reductions as well as due to risks identified in the document 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 management to make strategic decisions, focus future results and evaluate the company's current performance. Management believes that the presentation of these non-GAAP financial measures is useful to investors understanding and assessment of the company's ongoing corporation 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 discussed by the 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 today on the line are Mr. Shaike Orbach, the CEO and Mr. Nir Dagan, the CFO. Shaike will begin with an overview of the results, followed by Nir 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 now to hand over the call to Shaike. Shaike, please?

Shaike Orbach

Thank you, Ehud. Good morning, everyone and welcome to the fourth quarter and full-year results of 2015. We are very pleased with the results of the fourth quarter, our best ever quarter coming well ahead of our guidance that we announced at the end of last quarter and even ahead of the range of the increased guidance we shared with you earlier this month.

Revenues for the quarter were at $27.4 million, representing year over year growth of 20%

and 41% ahead of revenues of the prior sequential quarter. Our high level of revenues in the quarter led to record revenues for the year which came in at $82.7 million, up 9% from the previous year.

This strong rise reflects growth at most of our customers and product lines, which were in turn driven by an improvement in demand in our end markets. In particular, our growing sales demonstrate our continued success in our networking appliances market, as well as in our new target market, including those driven by the cloud computing, SDN, NFV, IoT, and virtualization and other trends.

This combination enables us to be optimistic with regard to our expected growth in 2016 and I will discuss our guidance in a few moments.

Our operating profit also reached an all-time record, both for the quarter and also for 2015 as a whole, demonstrating the power of our business model which provides strong profitability, combined with the growing revenues.

On the bottom-line, we reported net income of $6.3 million in the fourth quarter which translates to earnings per diluted share of $0.86, a very strong improvement over the prior quarter and the fourth quarter last year.

Our year-end net cash position amounting to $55.1 million remains strong, providing us with significant financial flexibility. As we have demonstrated, it also enables us with the ability to act decisively when the opportunity arises to acquire synergistic businesses to further fuel our growth. On October 28, we closed the acquisition of ADI Engineering.

ADI has strengthened our leadership and technological position in both our traditional markets of the network appliances industry, as well as our newer target markets.

These include the booming markets of SDN, NFV, and cloud-based CPEs on the one side, and the exploding IoT market on the other.

We are now offering Intel based compute products which are based on specific CPUs which Intel develops for networked computing nodes. This has grown our total addressable market TAM, as well as further diversifying our customer base.

In only the first few months since the acquisition, we are already beginning to realize the synergies by offering this expanded product line to our existing customers as well as potential sales to new customers which we had no relationship with before. The acquisition has also brought us new markets, those of cloud related providers of CPE branch office equipment,

NFV or network function virtualization, Edge product suppliers and more.

From a technological standpoint, ADI acquisition has also enabled us to increase our edge over our competitors. ADI frequently develops reference designs for upcoming Intel technologies and we believe we can leverage our new deep technical expertise in this area into a time to market edge over competitors.

On an organic basis, we continue to be successful in bringing new design wins from both new customers, as well through our leveraging of the close relationships with existing customers to bring additional design wins.

Furthermore, across our range of over 100 customers, there is potential for our sales to expand as these customers in turn grow their sales in their respective end markets, particularly in growing sectors such as cyber security, storage and the cloud.

In December, we announced new design wins at two of our cyber security customers, both recognized industry leaders for Quick Assist Technology, QAT-optimized, Coleto Creek-based, encryption hardware accelerators and other networking solutions.

The combination of Intel’s advanced technology with our hardware and software solutions offer the industry’s best performance at the lowest cost, advantages that clearly differentiate us, enabling our increasing penetration of this market.

Cyber security is a quick, growing and highly important space and our working with these cyber security leaders provides us with important references to further penetrate this market.

We expect that our unique offering for this market will become an important revenue growth driver for Silicom.

Both these customers have already placed initial purchase orders and we expect sales from these two design wins to ramp up to around $2 million per year. These wins are once again a demonstration of the power of our strong customer base to fuel our long-term growth.

The ongoing stream of design wins that we present on a continual basis over many years demonstrate our strong and attractive product portfolio built upon our significant R&D capabilities, both internally developed and acquired.

With regard to our guidance, in general, we believe that 2016 as a whole will be another year of growth. For the first quarter of the year, we expect revenues in the range of $20 million and $21 million, or about 9% ahead of those of the first quarter last year at the midpoint.

In summary, we are very pleased with our progress this quarter and continue to be optimistic about our prospects to continue our long-term growth in the years ahead.

Our long-term strategy is on track and our growth engines are performing well. We are performing well in a broad cross section of market sectors with our sales driven by growing market trends and needs. Our highly successful quarter demonstrates our success in bringing our customers much needed products, whether through internal development or through acquisitions. And as we have demonstrated, we continue to invest our deep resources in developing our products and markets, as well as in synergistic acquisitions.

The recent acquisitions we have made are boosting our technology edge, helping us extend our penetration of the newly developing hot trends, while expanding our addressable markets.

Our strategy remains to realign the full inherent potential of our multiple growth engines, our expanding customer base, industry insight, superior core technologies and extensive existing product portfolio.

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

Nir Dagan

Thank you, Shaike and hello, everyone. Revenues for the fourth quarter of 2015 were at $27.4 million, a 20% increase over revenues of $22.8 million as reported in the fourth quarter of last year.

Revenues for the full year of 2015 were a record of $82.7 million, representing year over year

growth of 9%. Our geographical revenue breakdown for 2015 were as follows. North America 66%, Europe and Israel 20%, Far East and rest of the world 14%. 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 and acquisition-related adjustments.

For the full reconciliation from GAAP to non-GAAP numbers, please refer to the press release we issued earlier today. Gross profit for the fourth quarter of 2015 was $11.4 million, representing a gross margin of 41%. This is compared with $9.5 million or a gross margin of 42% in the fourth quarter of last year. I note that the gross margin does vary between quarters, mainly as a result of specific mix of products sold during the quarter.

Operating expenses in the fourth quarter of 2015 were $4.5 million or 16% of revenues, compared with $3.3 million or 14% of revenues in the fourth quarter of last year. The increase in the absolute level of operating expenses versus the fourth quarter of last year was mainly due to higher investment in R&D while expanding our product portfolio and developing more products and technologies for cloud computing, SDN, NFV, virtualization and such other trends.

Operating income for the fourth quarter of 2015 was $6.9 million or 25% of revenues, compared to $6.2 million or 27% of revenues as reported in the fourth quarter of 2014.

Fourth quarter 2015 net income was $6.3 million or 23% of revenues, compared to $5.4 million or 24% of revenues in the fourth quarter of last year. Earnings per diluted share in the quarter were $0.86, an increase of 16% compared with $0.74 in the fourth quarter of last year.

Now turning to the balance sheet, as of December 31, 2015, the company's cash equivalents and marketable securities total to $51 million or $6.99 per outstanding share.

That ends my summary and we would 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 of Needham & Company. Please go ahead.

Alex Henderson

Thanks. A couple of just block and tackle stuff. Can you give us some sense on the tax rate for CY 2016 [ph] what you’re expecting?

Nir Dagan

We are expecting 14%, approximately 14%.

Alex Henderson

14 percentage. Okay, great. Thanks. And the R&D obviously popped up from about a $2 million level in the prior three quarters to the $2.5 million, $2.4 million range here in 4Q, will we persist at that higher $2.4 million range, or will it revert back to the $2 million kind of level, are we looking at like $8 million, $8.5 million for 2016 or more like

Shaike Orbach

We will persist with the current rate. I mean we are investing more in R&D.

Alex Henderson

So hold it at the $2.5 million –

Shaike Orbach

Yes, something like that. Yes.

Alex Henderson

Yes, okay. That’s helpful, thanks. And then just on the gross margin stuff, you talked about the margin mix obviously a little over a point hit to gross margins versus the prior three quarters. I’m assuming it stays kind of at this current level going forward. Is there something specific in the mix that’s causing it to be down from the prior three quarters or is the mix going to – what are you thinking here in terms of what’s driving that back? I know you’ve historically typically been at the 40%, 41%, 42% range, so it’s not all that surprising, but -- some granularity would help.

Shaike Orbach

Yes, I mean, we don’t see anything here to either direction. I mean we still believe we’re going to be around 41% or something like that, could be a little more, could be a little less, but that’s where we are and it is indeed dependent on the mix of products. We don’t see any specific trend here.

Alex Henderson

Great. That gets me through the three key pieces. Okay. So, the last question I have for and I’ll cede the floor is, can you talk to what percentage of your sales are driven by demand

into the security sector or security-related products being sold to other segments? If you would sort of parse out security as a segment of your business, how should we think about that? And is that part of what’s causing this acceleration, I know you’ve been launching products targeting into that area?

Shaike Orbach

Well, first of all, I don’t have this data. So, I cannot tell you what is the percentage of our sales related directly to security. It is also a little bit difficult to provide this kind of data, because there are definitely some companies which are actually combining security into several other applications. So, I would say that still, I mean a very big percentage of our sales, maybe around 80% or something like that is still going to a variety of networking appliances and indeed, networking appliances, security is playing a very significant role. Now many of our customers are saying we are doing also security, and so on and so forth which is way it’s not exactly -- it’s not possible to specifically say this is security. We feel security is growing, I mean though, the companies we are doing only security are growing.

Alex Henderson

Right. But can you give us any sense at all of what portion or what’s just rough ballpark, what’s being driven by security? I mean obviously this is very distinctively different growth rates between say [indiscernible] market or C-market and the security markets?

Shaike Orbach

I can give you a gut feeling. It’s not something that – as I’ve said, so it’s going to be around 40% or something like that I would say is security driven, 40%, 50% mix.

Alex Henderson

So is that causing an acceleration in the rate of growth? I mean is that part of what happened here in the $27 million –

Shaike Orbach

It’s a part of that, definitely it is.

Alex Henderson

Okay.

Shaike Orbach

It’s definitely a part of that.

Alex Henderson

One last question before I cede the floor which I forgot, I wanted to ask, you had a problem back in the June quarter associated with one of your large customers doing an inventory reset which cost kind of the divide in the – over the summer. I assume that that kind of reversed a little bit here, is that reasonable to think and is it reasonable to think that the growth rates in the summer quarters would be higher than in the March and December quarter as a result of that kind of divide in your trailing numbers?

Shaike Orbach

Well, I would say that overall indeed, what we’ve been able to get both from this customer and from other customers seems to have compensated what happened at that time and overall, I think we will grow as we are doing now, we will continue to grow next year, that’s what we believe in. So I’m not saying by that that the very specific issue that happened this year has been turned around and we’re back in that area that was the cause of what we announced in the summer, but I’m saying that it is no longer an issue overall.

Alex Henderson

All right. So the question was will the growth rates tend to be higher in the June and September quarters versus the book-end [ph] quarters, because of that divide [ph] into the summer?

Shaike Orbach

Well, I don’t about specific – I cannot say specifically if the growth rate during the summer will be higher than that. This is not something I can say. We’ve advised the growth that we expect for the first quarter, we expect the full year to continue with our growth, cannot speak about the summer. I can tell you that the specific issue that we have there, we no longer consider that as an issue which prevents us from growing.

Alex Henderson

Okay. I will cede the floor. Thanks

Operator

The next question is from Marcel Herbst from Herbst Capital Management. Please go ahead.

Marcel Herbst

Good morning and congratulations to a great comp, a great quarter. Looking out two to three years, do you foresee any changes in what the key trends and revenue drivers are going to be for you compared to today?

Shaike Orbach

Of course, whatever I say right now, I cannot know for sure and especially, I cannot know for sure the rate that things are happening. But obviously the – I mean there’s one thing which seems to be relatively clear and that’s the – actually there are two trends. So, one trend is related to the cloud, NFV, et cetera and so on and so forth, and we do believe that a more but a higher percentage of our revenues would be going to that segment compared to what have happened before. So, that’s definitely a trend that I’m seeing. I’m not sure how much that would be translated into dollars within two years or three years, three years definitely more, but it’s definitely a trend though, I mean, going to the cloud and NFV [indiscernible] and I’m including in that by the way the Edge products or the CPE products, which are required in order to make that happen. So, that’s one part which would be a change. The other part, but this is a little bit more complex to explain would be indeed the cyber security part. So, cyber security would be more, but just like I said before, I mean many people that we sold to something and they called it a certain name, the people are saying okay, we’re in cyber security. So, would that be considered the part of the growth in that segment or are they just naming it a little bit different way, I don’t know. But cyber security is growing, we see that the companies which are dealing with security only are growing, while the companies are doing security and several other things are not demonstrating that much of a growth. So I could say that that would be a significant trend as well.

Marcel Herbst

Okay, great. That’s very helpful. And he spoke a little bit about R&D already, but what level of non-GAAP operating expenses in general do you expect this year?

Shaike Orbach

Well, our investment in R&D, in ungrowing [ph] R&D are, just like I said, I mean there are – if you look at the fourth quarter, this is more or less representative as to what’s going to go on in terms of expenses in R&D and in the other OpEx components. So, that’s what we expect. There could be of course a little deviations here and there in the expense level, but in general that’s what we’re going to have moving forward as well.

Marcel Herbst

Okay, great. Thank you.

Operator

The next question is from Edward Balinsky of Segmark International. Please go ahead.

Edward Balinsky

Okay. With regard to contingent consideration, do you operate on a basis of an estimate for the entire period of the existence of the contingency, or do you provided, let’s say, as earned when the seller earns the consideration, then you record it? Are you operating off of an estimate which run through the period of contingency, or do you, as I say, post it as recorded as it is earned?

Nir Dagan

No, no. We calculate it in the date of the purchase and

Shaike Orbach

Based on estimation.

Nir Dagan

Based on estimations.

Edward Balinsky

I see. So, it could be like the last – like the – as Fireblaze, where there was – nothing was earned, is that correct?

Shaike Orbach

No. I think that this is not accurate. I think that indeed are estimations in order to be conservative, we didn’t want to find ourselves having to pay more than what we are estimating. So, our original estimation was at a certain level which at the end of the day turned out to be less than that which is why you could’ve seen in our non-GAAP additional profits coming out of that difference in estimation between what happened in reality, but it definitely was not zero.

Edward Balinsky

All right. My second – thank you on that. Second is, how – at what rate do you amortize your intangible assets?

Nir Dagan

It’s various rates. There are several components.

Edward Balinsky

I see. Ranging from what, from 1% per quarter to 10% a quarter, can you give me an estimate of what we might expect in this area?

Nir Dagan

It’s between 10 years and less than a year. There are many components and every asset is calculated – is amortized based on its estimated life.

Edward Balinsky

I see. All right. Fine, thank you. That ends my questions.

Nir Dagan

Okay.

Operator

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

Alex Henderson

Yes. Just a couple of housekeeping, can you give us your sense of what the headcount will look like going from – into the first quarter and what was the ending headcount for the December quarter? Second, is that any 10% customers in the quarter?

Shaike Orbach

Yes, I mean, so we are about 240 employees, we have one customer which is higher than 10%, actually about 20% and we have other three customers, I know that you have not asked for that, but still, three customers which are 7% to 8% each.

Alex Henderson

I see. And the sense of how many – what your headcount is going to do in the March quarter?

Shaike Orbach

More or less the same.

Alex Henderson

So holding it around 240 or so?

Shaike Orbach

Yes, something like that. Yes.

Alex Henderson

Okay. And then just going back to the sales and marketing line, it also popped up, is that a function of revenues, or is that a function of headcount, how do I think about that line item going into the March quarter? Will that revert back to the 11, 12 [ph] range or will it –

Shaike Orbach

We are – what you are seeing in the fourth quarter is actually what we are planning going ahead in terms of the OpEx, more or less, all of that, I mean, could be some changes, but insignificant changes.

Alex Henderson

So based off of the current guidance –

Shaike Orbach

I mean - by the way, I’m sorry about that, that is assuming that there are no changes in the dollar value compared with the shekel. Of course, that could change things, I’m not addressing that when I say that we’re going to be more or less the same.

Alex Henderson

All right. So based off of the midpoint of your revenue guidance, based off of 41% gross margins and a higher tax rate, it looks to me like you operating margin would in fact slip below 20% for the first time in a while and I’m a little concerned about that rate, is it reasonable to think that your operating margin can stay about 20% over the course of the year or should we be --

Shaike Orbach

Well, I’ve not made the accurate calculation, of course, I mean we are providing guidance and many times we were able to be better than that which would have an impact in there, okay, and I promise that of course, but that can happen. Now as you are talking about operating income, so I’m assuming that the tax issue is not a part of that. And one more thing to remember is that typically, not always, last year that was not the case, but typically the first quarter is our lowest.

Alex Henderson

All right. You’ve given guidance on the revenue line for the year, but it looks like your OpEx is quite a bit higher and your tax rate is higher, is it reasonable to think you could actually increase your EPS based on those too higher rates, both your OpEx line and your tax line when you R&D – when your gross margin are down a point as well? I mean, it feels like a challenge to have –

Shaike Orbach

Well, I mean, it could be

Alex Henderson

It feels like a challenge to have up earnings here in 2016 based on what you are –

Shaike Orbach

It’s a challenge, but it can be – I mean, we are hoping to grow revenues in a way which would facilitate that, of course, it is a challenge, just like you said. I mean, and that’s why we agree.

Alex Henderson

Okay. Well, I’ll cede the floor. Thanks.

Operator

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

Don McKiernan

Yes. Good morning. Thanks and congratulations on a great quarter and year. Just want to get more color on the Intel relationship, the two new design wins that you announced recently where it seemed like a long time in coming from when you announced a sort of relationship, your joint venture almost two years ago, is that finally ramping up? Should we expect more design wins with Intel and with the Coleto Creek?

Shaike Orbach

Okay. So – are we on?

Don McKiernan

Yes.

Operator

Yes. Please go ahead.

Shaike Orbach

Okay. Well, first of all, so the Coleto Creek is ramping up. I would say two things which are to a certain extent contradictory, but I hope that would give you the additional color that you are looking for. So on the one side, they are ramping up, not at the rate that I was hoping originally that it would ramp up. Now, that being said, now I’m coming to the other side, there are quite a few opportunities or within the pipeline that we are having which are thicker with Coleto Creek than we – than compared to anything that we ever had before. So, I am thinking that simply it takes more time, we have learnt this lesson for quite a few of our products, sometimes, it takes more time for people to adopt. So, to be accurate in responding to your question, it is ramping up. Right now, it’s still not at the rate that I was hoping it would be, but looking forward, I see several very important opportunities ahead of us with the Coleto Creek and with the – I was addressing only this component of the relationship with Intel which has to do with Coleto Creek, obviously, right now, the relationship with Intel is much more developed than just about Coleto Creek.

Don McKiernan

And doesn’t Intel have a new version or revamp of their chipset that replaces Coleto Creek coming out soon?

Shaike Orbach

Yes. I mean, there is going to be a new generation. When I say Coleto Creek, I don’t mean only Coleto Creek.

Don McKiernan

Right.

Shaike Orbach

I mean, Intel’s offering within the encryption compression area, and they are definitely going to come up, not only going to come up, I mean samples are available already with the next generation which is being called Lewisburg, so this is coming as well. And I think it’s good even the fact that it’s coming by itself is very important, because up until this next generation was coming, some people are a little bit concerned about Intel going into a certain type of business, and then getting away of that and the fact that they are now going into the third generation of this family of products is a very encouraging message that Intel is sending to the market, and that’s important to us as well.

Don McKiernan

Okay. Thank you.

Operator

Your next question is from [indiscernible] Please go ahead.

Unidentified Analyst

Hi, just two quick questions. One, can you speak to the motivation or strategy behind the delisting? And two, your shelf is expiring in a couple of months, just wondering if you could speak to any plans reserved for that? Thank you.

Shaike Orbach

Okay. So, the strategy behind the delisting is they are made out of four elements, I would say. First, we wanted to report and to behave and to run the company using one set of regulation. Second is, we wanted to be [ph] the full volume of trading to be concentrated in one place rather than being split into several places. Third, we felt that it would improve our management focus on the real business rather than splitting it over the regulations of two different places, and there is some cost saving which is associated with that as well.

Unidentified Analyst

Okay.

Shaike Orbach

Now – what was the second part of the question?

Unidentified Analyst

The shelf offering, I believe, is expiring in a couple of months, I was wondering if you can speak to plans reserved for that?

Shaike Orbach

Okay. So, at this moment, there is no decision regarding the shelf, and I believe that it’s valid till April 17. Is that right?

Nir Dagan

The 17th I think.

Shaike Orbach

Okay, yes. So decision at this point.

Unidentified Analyst

Okay, thank you.

Operator

[Operator Instructions] The next question is from Ronald Mullins of Segmark. Please go ahead.

Ronald Mullins

I was just wondering whether or not you are currently pursuing other acquisitions or you are going to stand, patent [ph] that area for a while?

Shaike Orbach

Well, we have not decided to stay quiet for a while with respect to acquisitions, I mean we are continuously looking for acquisitions as a part of the things that we are looking at. I mean, so just like we are looking at new opportunities in terms of getting more customers and building more products and so on and so forth, we are looking for additional potential acquisitions. So, there isn’t any decision to stay away for that. That being said, right now, there is nothing that we are pursuing at this very moment.

Ronald Mullins

Thank you.

Operator

There are no further questions at this time. Before I ask Mr. Orbach to go ahead with his concluding statement, I would like to remind participants that a replay of this call will be available by tomorrow on the 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 in our next call in three month’s time. Good day.

Operator

Thank you. This concludes Silicom’s fourth quarter 2015 results conference call. Thank you for your participation. You may go ahead and disconnect.

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