Earnings Transcript for SILC - Q2 Fiscal Year 2023

Operator: Ladies and gentlemen, thank you for standing by. Welcome to the Silicom Second Quarter 2023 Results Conference Call. All participants are at present in a listen-only mode. Following management presentations 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 EK Global Investor Relations at 1 (212) 378-8040 or view it in the News section of the Company's website, www.silicom-usa.com. I would now like to hand over the call to Mr. Ehud Helft of EK Global Investor Relations. Mr. Helft, would you like to begin?

Ehud Helft: Thank you, operator. I would like to welcome you to Silicom second quarter 2023 results conference call. Before we start, I'd like to draw your attention to the following Safe Harbor statements. 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 they change as time passes. Silicom does not assume any obligation to update that information. Actual events or results may differ materially from those projected, including as a result of Silicom's increasing dependency for substantial revenue growth on the limited number of customers in the evolving cloud-based SD-WAN, NFV and edge market; the speed and the extent to which solutions are adopted by these markets; the likelihood that Silicom will rely increasingly on customers which provide solutions in these evolving markets, resulting in an increasing dependency on a smaller number of larger customers; difficulty in commercializing and marketing of Silicom's products and services; maintaining and protecting brand acquisitions; protection of intellectual property, competition; the disruptions to our manufacturing; sales and marketing; development and customer support activities; the impact of the war in Ukraine; rising inflation; rising interest rates; volatile exchange rates and commodities prices as well as any continuing or new effects resulting from the COVID-19 pandemic and the global economy uncertainty, which may impact customer demand through their exercising greater caution and selectivity with their short-term IT investment plan; as well as those other factors discussed in our earnings report on Form 20F and other documents filed by the Company and that may be substantially filed by the Company from time to time with the Securities and Exchange Commission. 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, forecast 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 core operation 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 discussed 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. And now with us today on the call are Mr. Liron Eizenman, President and CEO; and Mr. Eran Gilad, the CFO. Liron will begin with an overview of the results followed by Eran, who will provide the analysis of the financials. We will then turn over the call to the question-and-answer session. And with that, I would like to hand over the call to Liron. Liron, please?

Liron Eizenman: Thank you, Kenny (sic) [Ehud]. I would like to welcome all of you to our financial results conference call discussing our second quarter '23 results. We are happy to show a good set of second quarter '23 results. We grew our second quarter revenue to $38.1 million, in line with our expectations. It was a 12% increase over the second quarter of last year. We are indeed happy with those results, especially against the background of a more challenging economic environment and more limited visibility, which I will discuss in a few minutes. Our continued success has added to more than 18 years or more precisely, 74 quarters, of uninterrupted profitability, and we reported second quarter earnings of $0.66 per diluted share. Our strong balance sheet has been the outcome of a very planned and executed strategy by the management. As we discussed a few quarters ago, as supply chain issues improved, we continued to decrease our inventory. In this quarter, we further decreased our inventory by $10 million, moving towards a normalized level of inventory that matches current components' lead times. Also, as discussed a few quarters ago, we continue to improve our cash, which currently stands at $63 million with no debt. It represents an increase of $10 million during the second quarter. Our strong cash position remains a key strategic asset and enables us to capitalize quickly on opportunities. As we have shown, we are very happy to share the rewards of our continued profitability and cash generation with our shareholders. Based on our improved cash position and our expectations to continue to be profitable during the coming years, we intend to accelerate the pace at which we repurchase our shares under the $15 million share repurchase plan that we announced three months ago. Our strategic decision to focus on the edge market as a primary growth driver continues to bring us further designs. During the quarter, we announced that we were selected again by a leading U.S. enterprise telecommunication service provider to develop an innovative edge networking product for them. The customer-based initial orders of around $5 million and delivery will follow the successful completion of the development and testing processes. This customer expects to orders to scale up over the next several years as the product enters mass deployment. The fact that this leading telco service provider turned to us is very gratifying, and we are excited about the potential of the new use cases it brings to market. Apart from the long-term sales to this customer, we believe this product will be attractive to a broader customer base, adding to the strong momentum which has been building for our edge product lines. This win confirms our value proposition and it's further evidence of the significant growth potential we see in our edge product family. Our momentum in edge networking has clearly broadened well beyond the SD-WAN space with growing interest from customers seeking enhanced performance and flexibility for their next-generation networks. It demonstrates the unique value proposition of our full-service model and the broadest portfolio of edge networking offerings, namely our innovative best-in-class products at attractive price points, rapid development and customization capabilities, our partnership approach and uncompromising total support. In parallel, we continue to achieve design wins for the acceleration of server adapter products. In April, a Tier 1 U.S.-based cybersecurity vendor awarded us with two NIC design wins

Eran Gilad: Thank you, Liron, and hello, everyone. Revenues for the second quarter of 2023 were $38.1 million, up 12% compared with revenues of $34.2 million as reported in the second quarter of last year. Our geographical revenue breakdown over the last 12 months were as follows

Operator: Thank you. 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.

Alex Henderson: So a couple of baseline questions here. So clearly, the question on the revenues needs to be asked. Is the steep decline in expectations for the September quarter cleaning up the inventory to a large degree? Or is there going to be a process of cleaning up that will retain this type of level of revenues out through the March and into the June quarter of next year? What do you think the slope of that cleanup looks like? And when do you expect that you'll be able to get back to year-over-year growth? Is that all the way out into the September quarter of next year?

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

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

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

Alex Henderson: Obvious question is from perspective of an exercise of us forecasting it, would you prefer us to assume there's no seasonality?

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

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

Liron Eizenman: From a GP perspective, we're not expecting any change. So that remains, as Eran said before, 32% to 36%. On the OpEx side, we're definitely planning to continue investing. I mean, from our perspective, the long-term growth is the key issue here that we want to continue growing in the long term. We believe we have, I mentioned before, some very good design wins that were waiting to accelerate. We're working -- we have a very good pipeline. And in order to support all of that, we need to keep investing.

Alex Henderson: Okay. So, we're talking about $30 million-plus in OpEx for the year? Is that kind of the right range of expectations?

Liron Eizenman: I think it makes sense.

Alex Henderson: All right. And just going back to the question of baseline, you made the comment that the last year or two have been artificially enhanced by people building inventory, and now you're saying that they're under-spending. What do you think the real baseline is that you'll be growing off of as we get past this process? What should the '23 full year revenue be if there was no correction or prefer -- if you prefer the $150 million, was that really $10 million, $15 million, $20 million worth of inventory build? Or how do we think about what the baseline is on a quarterly basis? Is it -- you're saying the $30 million to $31 million in the September quarter is well below. So, I'm assuming it's somewhere up in the $35 million range-plus. Is that right?

Liron Eizenman: Maybe, I think it's reasonable to say this number. I think overall, when we're looking -- trying to analyze the situation, obviously, it's not only inventories. I mentioned before also the economic, let's say, concerns, et cetera, that are also in the mix. It's a little bit hard to distinguish between the two. But again, when we analyzed the data, we looked at least $10 million-plus that were pushed out from this quarter per our expectations that customers would put. So, $35 million, maybe a little more could be as well, but it's very hard to say an exact number given that it's a mix of reasons here.

Operator: [Operator Instructions] There are no further questions at this time. Before I ask Mr. Eizenman 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. Eizenman, would you like to make your concluding statement?

Liron Eizenman: 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 three months' time. Good day.

Operator: Thank you. This concludes Silicom Second Quarter 2023 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.